Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the accompanying interim Consolidated Financial Statements and notes, the Consolidated Financial Statements and accompanying notes in our 2022 Annual Report on Form 10-K and Management’s Discussion and Analysis in our 2022 Annual Report on Form 10-K.
Forward-Looking Statements
This report contains forward-looking information that involves risks and uncertainties. Our forward-looking statements express our current expectations or forecasts of possible future results or events, including projections of earnings and other financial performance measures, statements of management’s expectations regarding our strategic, operational and capital allocation plans and objectives, management's views on industry, economic, competitive, technological and regulatory conditions and other forecasts of trends and other matters. Forward-looking statements speak only as of the date of this filing, and we undertake no obligation to publicly update or revise such statements to reflect new circumstances or unanticipated events as they occur. You can identify these statements by the fact that they do not relate strictly to historic or current facts and often use words such as “anticipate,” “estimate,” “expect,” “intend,” “believe,” “will likely result,” “outlook,” “project,” “may,” “can,” “plan,” “target,” “potential,” “should” and other words and expressions of similar meaning.
No assurance can be given that the expected results in any forward-looking statement will be achieved, and actual results may differ materially due to one or more factors, including the sensitivity of our business to weather conditions; changes in economic conditions, consumer discretionary spending, the housing market, inflation or interest rates; our ability to maintain favorable relationships with suppliers and manufacturers; the extent to which home-centric trends associated with the pandemic will moderate or reverse; competition from other leisure product alternatives or mass merchants; our ability to continue to execute our growth strategies; changes in the regulatory environment; new or additional taxes, duties or tariffs; excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in our 2022 Annual Report on Form 10-K, as updated by our subsequent filings with the U.S. Securities and Exchange Commission. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
OVERVIEW
Financial Results
Net sales decreased 9% in the third quarter of 2023 to $1.5 billion compared to $1.6 billion in the third quarter of 2022 following 14% net sales growth in the third quarter of 2022 and 24% net sales growth in the third quarter of 2021. Our base business results approximated our consolidated results for the period. At the core of our business, maintenance activities remained stable, indicating steady demand for non-discretionary products, while pool construction-related activities remained weaker as challenging macroeconomic conditions continue weighing heavily on major project consumer spending. Our results were also negatively impacted 1% from one less selling day in the third quarter of 2023 versus the third quarter of 2022.
Gross profit decreased 15% to $428.7 million in the third quarter of 2023 from $503.7 million in the same period of 2022. Our gross profit increased at a 14% compound annual growth rate (CAGR) from the third quarter of 2019 to the third quarter of 2023. Gross margin decreased 210 basis points to 29.1% in the third quarter of 2023 compared to 31.2% in the third quarter of 2022 as we sold through our prior year lower cost inventory purchases.
Selling and administrative expenses (operating expenses) decreased 2% to $234.3 million in the third quarter of 2023 compared to $239.8 million in the third quarter of 2022 as volume-driven expenses were well managed during the quarter. As a percentage of net sales, operating expenses increased to 15.9% in the third quarter of 2023 compared to 14.8% in the same period of 2022.
While operating income in the third quarter of 2023 decreased 26% to $194.4 million from $263.9 million in the third quarter of 2022, operating income increased at a 17% CAGR from the third quarter of 2019 to the third quarter of 2023. Operating margin was 13.2% in the third quarter of 2023 compared to 16.3% in the third quarter of 2022.
Interest and other non-operating expenses, net for the third quarter of 2023 increased $1.9 million compared to the third quarter of 2022, primarily driven by higher average interest rates.
We recorded a $0.4 million tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended September 30, 2023, compared to a tax benefit of $0.6 million realized in the same period of 2022. This resulted in a $0.01 per diluted share tax benefit in the third quarter of 2023 compared to a $0.02 per diluted share tax benefit realized in the same period of 2022.
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Net income decreased 27% to $137.8 million in the third quarter of 2023 compared to $190.1 million in the third quarter of 2022. Earnings per diluted share decreased 27% to $3.51 in the third quarter of 2023 compared to $4.78 in the same period of 2022. Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 26% to $3.50 compared to $4.76 in the third quarter of 2022. Our earnings per diluted share increased at a 16% CAGR from the third quarter of 2019 to the third quarter of 2023 and a 17% CAGR without the impact of ASU 2016-19 over the same period. See RESULTS OF OPERATIONS below for definitions of our non-GAAP measures and reconciliations of our non-GAAP measures to GAAP measures.
References to product line and product category data throughout this report generally reflect data related to the North American swimming pool market, as this data is more readily available for analysis and represents the largest component of our operations.
Financial Position and Liquidity
As of September 30, 2023, total net receivables, including pledged receivables, decreased 16% compared to September 30, 2022, primarily due to our lower sales in 2023. Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 26.3 days at September 30, 2023 and 27.0 days at September 30, 2022. Our allowance for doubtful accounts balance was $10.6 million at September 30, 2023 and $8.9 million at September 30, 2022.
Net inventory levels of $1.3 billion as of September 30, 2023 decreased $280.3 million, or 18%, compared to September 30, 2022 and $331.8 million, or 21%, compared to December 31, 2022 as we sold the remainder of prior year strategic purchases we made to compensate for supply chain challenges. Our inventory reserve was $25.9 million at September 30, 2023 and $23.4 million at September 30, 2022. Our inventory turns, as calculated on a trailing four quarters basis, were 2.6 times at September 30, 2023 and 2.7 times at September 30, 2022.
Total debt outstanding at September 30, 2023 was $1.0 billion compared to $1.5 billion at September 30, 2022 down $478.6 million from September 30, 2022 and $352.9 million lower than $1.4 billion at December 31, 2022, as we have used operating cash flows to reduce our debt.
Current Trends and Outlook
For a detailed discussion of trends impacting us through 2022, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2022 Annual Report on Form 10-K.
We expect sales for the full year of 2023 to be down in the range of around 10% compared to 2022 as previously disclosed in our Second Quarter 2023 Report on Form 10-Q with sales in the fourth quarter of 2023 down in the mid- to high-single digits, primarily dependent on weather conditions and pool construction activities.
As previously disclosed in our 2022 Annual Report on Form 10-K, we project gross margin for the full year of 2023 to be in line with our long-term outlook of approximately 30.0%. We expect gross margin in the fourth quarter of 2023 of approximately 29.0%.
We plan to leverage our existing infrastructure and manage discretionary spending to limit operating expense growth to 1% compared to the full year of 2022, not considering any acquisitions that may arise in the last quarter of the year.
We project that our annual effective tax rate (without the benefit from ASU 2016-09) for 2023 will approximate 25.0% to 25.2%. We expect our effective tax rate will fluctuate from quarter to quarter due to ASU 2016-09, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. We recorded a $5.9 million, or $0.15 per diluted share, tax benefit from ASU 2016-09 for the nine months ended September 30, 2023. We may recognize additional tax benefits related to stock option exercises in 2023 from grants that expire in future years. We have not included any expected tax benefits in our guidance beyond what we have recognized for the nine months ended September 30, 2023.
We expect 2023 diluted EPS in the range of $13.15 to $13.65, including the impact of year-to-date tax benefits of $0.15. We expect to continue to use cash for the payment of cash dividends as and when declared by our Board of Directors (Board) and to fund opportunistic share repurchases under our Board-authorized share repurchase program.
The forward-looking statements in the foregoing section are based on current market conditions, speak only as of the filing date of this report, are based on several assumptions and are subject to significant risks and uncertainties. See “Cautionary
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Statement for Forward-Looking Statements.”
RESULTS OF OPERATIONS
As of September 30, 2023, we conducted operations through 434 sales centers in North America, Europe and Australia. For the nine months ended September 30, 2023, approximately 95% of our net sales were from our operations in North America.
The following table presents information derived from the Consolidated Statements of Income expressed as a percentage of net sales:
Three Months Ended Nine Months Ended
September 30, September 30,
2023 2022 2023 2022
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 70.9 68.8 69.9 68.2
Gross profit 29.1 31.2 30.1 31.8
Selling and administrative expenses 15.9 14.8 15.4 13.8
Operating income 13.2 16.3 14.7 18.1
Interest and other non-operating expenses, net 0.9 0.7 1.0 0.5
Income before income taxes and equity in earnings 12.3 % 15.6 % 13.7 % 17.6 %
Note: Due to rounding, percentages presented in the table above may not add to Operating income or Income before income taxes and equity in earnings.
We have included the results of operations from acquisitions in 2023 and 2022 in our consolidated results since the acquisition dates.
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Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022
Base Business
We calculate base business results by excluding, for a period of 15 months, sales centers that we acquire, open in new markets or close. We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that we consolidate with acquired sales centers.
We generally allocate corporate overhead expenses to excluded sales centers on the basis of their net sales as a percentage of total net sales. After 15 months, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.
We have not provided separate base business income statements within this Form 10-Q as base business results approximated consolidated results, and acquisitions and sales centers excluded from base business contributed less than 1% to the change in net sales.
The table below summarizes the changes in our sales center count during the first nine months of 2023:
December 31, 2022 420
Acquired locations 4
New locations 10
September 30, 2023 434
Net Sales
Three Months Ended
September 30,
(in millions) 2023 2022 Change
Net sales $ 1,474.4 $ 1,615.3 $ (140.9) (9)%
Following 14% net sales growth in the third quarter of 2022 and 24% net sales growth in the third quarter of 2021 (in both cases compared to the prior year quarter), net sales of $1.5 billion in the third quarter of 2023 decreased 9% compared to $1.6 billion in the third quarter of 2022. Our base business results approximated our consolidated results for the period. From 2019 to 2023, our third quarter net sales grew at a CAGR of 13%. At the core of our business, maintenance activities remained stable, indicating steady demand for non-discretionary products, while pool construction-related activities remained weaker as challenging macroeconomic conditions continue weighing heavily on major project consumer spending.
The following factors impacted our sales during the quarter and are listed in order of estimated magnitude.
• Our net sales were negatively impacted by lower sales volumes from reduced pool construction activity and discretionary replacement activity (see discussion below).
• Net sales benefited approximately 2% to 3% from inflationary product cost increases, which is net of price deflation for some products including chemical sanitizers, PVC pipe and rebar. This compares to a benefit of 9% to 10% in the third quarter of 2022.
• Sales were negatively impacted 1% from one less selling day in the third quarter of 2023 versus the third quarter of 2022.
Related to our product sales, following a period of significant growth over the past three years, we observed a period-over-period decline in volumes of discretionary products sold, largely due to lagging new pool construction activities. In the third quarter of 2023, sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, decreased 9% compared to the same period last year, and collectively represented approximately 28% of net sales for the period. Sales of building materials decreased 13% compared to the third quarter of 2022 and represented approximately 12% of net sales in the third quarter of 2023.
Sales to specialty retailers that sell swimming pool supplies and customers who service large commercial installations are included in the appropriate existing product categories, and sales trends in these areas are reflected in the discussion above. Sales to retail customers decreased 2% in the third quarter of 2023 compared to the third quarter of 2022 and represented
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approximately 14% of our total net sales. As consumers take advantage of travel opportunities, sales to commercial swimming pool customers increased 10% in the third quarter of 2023 compared to the third quarter of 2022 and represented approximately 4% of our net sales for the third quarter of 2023.
Gross Profit
Three Months Ended
September 30,
(in millions) 2023 2022 Change
Gross profit $ 428.7 $ 503.7 $ (75.0) (15)%
Gross margin 29.1 % 31.2 %
Gross margin decreased 210 basis points to 29.1% in the third quarter of 2023 compared to 31.2% in the third quarter of 2022. Our prior year gross margin benefited from our strategic inventory buys, when we purchased product ahead of vendor price increases. As our sales benefited from higher inflation, we were able to sell those products at a lower average cost to our sales price. Our gross margin in the third quarter of 2023 was also unfavorably impacted by a variety of factors, including product mix and customer mix and a more competitive pricing environment. Related to product mix, we realized lower sales of higher margin building materials due to a decline in construction and remodel activity, in addition to price deflation on trichlor. Changes in our customer mix resulted from a higher proportion of sales to larger, lower margin customers. Gross margin in the third quarter of 2023 also reflects a typical sequential decrease from the 30.6% gross margin realized in the second quarter of 2023.
Operating Expenses
Three Months Ended
September 30,
(in millions) 2023 2022 Change
Selling and administrative expenses $ 234.3 $ 239.8 $ (5.5) (2)%
Operating expenses as a % of net sales 15.9 % 14.8 %
Operating expenses decreased 2% in the third quarter of 2023 compared to the third quarter of 2022 as volume-driven expenses were well managed during the quarter. Our operating expenses reflect lower employee-related costs, lower variable and discretionary expenses and reduced delivery and vehicle operating costs. Employee-related expenses were down 5% from the third quarter of 2022, primarily reflecting lower performance-based compensation expense and controlled overtime and temporary employee pay that correlate with lower sales volumes. Freight-related costs declined due to lower fuel costs and lower sales. These expense decreases were partially offset by higher building and insurance costs between periods related to inflation and the expansion of our network. We recorded goodwill impairment of $0.6 million during the third quarter of 2023, primarily related to one of our Horizon reporting units in Texas that we previously identified as being most at risk of goodwill impairment.
Interest and Other Non-Operating Expenses, Net
Interest and other non-operating expenses, net for the third quarter of 2023 increased $1.9 million compared to the third quarter of 2022, as higher average interest rates more than offset a decrease in average debt between periods. Our weighted average effective interest rate increased to 5.2% in the third quarter of 2023 from 3.2% in the third quarter of 2022 on average outstanding debt of $1.0 billion and $1.5 billion for the respective periods.
Income Taxes
Our effective income tax rate was 23.8% for the three months ended September 30, 2023, compared to 24.7% for the three months ended September 30, 2022. We recorded a $ 0.4 million tax benefit from ASU 2016-09 in the quarter ended September 30, 2023, compared to a tax benefit of $ 0.6 million realized in the same period last year. Without the benefit from ASU 2016-09 in both periods, our effective tax rate was 24.1% for the third quarter of 2023 and 24.9% for the third quarter of 2022. Our third quarter effective income tax rate is typically lower compared to other quarters due to the annual expiration of statutes of limitations in the various jurisdictions where we have recorded uncertain tax positions.
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Net Income and Earnings Per Share
Net income decreased 27% to $137.8 million in the third quarter of 2023 compared to $190.1 million in the third quarter of 2022. Earnings per diluted share decreased 27% to $3.51 in the third quarter of 2023 compared to $4.78 in the same period of 2022. Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 26% to $3.50 in the third quarter of 2023 compared to $4.76 in the third quarter of 2022. See the reconciliation of GAAP to non-GAAP measures below.
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Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022
Net Sales
Nine Months Ended
September 30,
(in millions) 2023 2022 Change
Net sales $ 4,538.5 $ 5,083.8 $ (545.3) (11)%
Net sales for the first nine months of 2023 decreased 11% compared to the same period last year. Differing weather conditions in the first half of 2023 contributed to variability in our results across our geographic markets in the first and second quarters of the year. While our southern markets experienced more typical weather during the first quarter of 2023 and generated encouraging results, higher precipitation and cooler temperatures suppressed results in our western markets, including two of our largest markets, California and Arizona. In the second quarter of 2023, cautious consumer sentiment combined with a slow start to the swimming pool season after unfavorable weather early in the quarter led to slower maintenance activity than anticipated, reduced outdoor living construction activity and deferred discretionary replacement activity. In the third quarter of 2023, results reflected lower sales volumes from reduced pool construction activity and discretionary replacement activity. Net sales benefits from record hot temperatures across the southern United States in the third quarter were largely offset by rainy conditions in the Northeast.
The following factors also impacted our sales and are listed in order of estimated magnitude.
• Net sales benefited approximately 4% from inflationary product cost increases, which compares to a benefit of 9% to 10% in the first nine months of 2022.
• We estimate that unfavorable weather conditions in the first nine months of 2023 negatively impacted sales by approximately 2%.
• Sales were also negatively impacted 1% from lower customer early buy activity in the first nine months of 2023 versus the first nine months of 2022.
The impact of differing weather patterns contributed to variability in the results of our geographic markets in the first nine months of the year, particularly in the first half of the year. Net sales in our North American seasonal markets, representing 44% of our net sales in the first nine months of 2023, decreased 14% compared to the first nine months of 2022 as these markets are more sensitive to weather conditions, particularly in the shoulders of the season when unfavorable weather delays the openings of swimming pools. Comparatively, net sales in our North American year-round markets, representing 52% of our net sales in the first nine months of 2023, decreased 9% compared to the first nine months of 2022.
Related to our product sales, following a period of significant growth over the past three years, we observed a year-over-year decline in volumes of discretionary products sold, largely due to lagging new pool construction activities. In the first nine months of 2023, sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, decreased approximately 10% compared to the same period last year and collectively represented 29% of net sales in the first nine months of 2023. Sales of building materials decreased 9% compared to the first nine months of 2022 and represented approximately 13% of net sales in the first nine months of 2023.
Sales to specialty retailers that sell swimming pool supplies and customers who service large commercial installations are included in the appropriate existing product categories, and sales trends in these areas are reflected in the discussion above. Sales to retail customers decreased 9% in the first nine months of 2023 compared to the first nine months of 2022 and represented approximately 15% of our consolidated net sales. As consumers take advantage of travel opportunities, sales to commercial customers increased 10% in the first nine months of 2023 compared to the first nine months of 2022 and represented approximately 4% of our consolidated net sales in the first nine months of 2023.
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Gross Profit
Nine Months Ended
September 30,
(in millions) 2023 2022 Change
Gross profit $ 1,366.3 $ 1,617.7 $ (251.4) (16)%
Gross margin 30.1 % 31.8 %
Gross margin declined 170 basis points to 30.1% in the nine months ended September 30, 2023, compared to 31.8% in the first nine months of 2022. Our prior year gross margin benefited from higher levels of inflation and price increases, while gross margin in the first nine months of 2023 is in line with our longer-term annual gross margin outlook of 30.0%. Our gross margin in the first half of 2023 reflected benefits from sales of strategic lower cost inventory purchases we made ahead of vendor price increases, which was most impactful in the first quarter of 2023 when a higher portion of lower-priced inventory was sold. Gross margin in the third quarter of 2023 was also impacted by less advantageous product and customer mix and a competitive pricing environment.
Operating Expenses
Nine Months Ended
September 30,
(in millions) 2023 2022 Change
Selling and administrative expenses $ 699.0 $ 699.2 $ (0.2) —%
Operating expenses as a % of net sales 15.4 % 13.8 %
Operating expenses for the nine months ended September 30, 2023 were flat compared to the prior year period. Our largest expense growth drivers related to higher rent and facility costs, increased insurance and healthcare-related costs, the return of in-person customer-facing retail events and investments in customer-focused projects. These increases were offset by lower employee-related costs, lower variable and discretionary expenses and reduced delivery and vehicle operating costs. We also recorded goodwill impairment of $0.6 million in the first nine months of 2023, primarily related to one of our Horizon reporting units in Texas that we previously identified as being most at risk of goodwill impairment.
Interest and Other Non-Operating Expenses, Net
Interest and other non-operating expenses, net for the first nine months of 2023 increased $20.9 million compared to the same period last year, as higher average interest rates more than offset a decrease in average debt between periods. Our weighted average effective interest rate increased to 5.1% from 2.3% for the respective periods on average outstanding debt of $1.2 billion for the first nine months of 2023 versus $1.5 billion for the same period of 2022.
Income Taxes
Our effective income tax rate was 24.1% for the nine months ended September 30, 2023, compared to 24.3% for the nine months ended September 30, 2022. We recorded a $5.9 million, or $0.15 per diluted share, tax benefit from ASU 2016-09 in the nine months ended September 30, 2023, compared to a $ 9.5 million, or $0.24 per diluted share, tax benefit in the same period of 2022. Without the benefits from ASU 2016-09, our effective tax rate was 25.0% for the nine months ended September 30, 2023, and 25.3% for the nine months ended September 30, 2022.
Net Income and Earnings Per Share
Net income decreased 30% to $471.8 million for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. Earnings per diluted share decreased 29% to $ 12.00 for the nine months ended September 30, 2023, versus $ 16.82 per diluted share for the nine months ended September 30, 2022. Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 29% to $11.85 for the nine months ended September 30, 2023, compared to $16.58 for the nine months ended September 30, 2022. See the reconciliation of GAAP to non-GAAP measures below.
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Reconciliation of Non-GAAP Financial Measures
The non-GAAP measures described below should be considered in the context of all of our other disclosures in this Form 10-Q.
Adjusted Diluted EPS
We have included adjusted diluted EPS, a non-GAAP financial measure, as a supplemental disclosure, because we believe this measure is useful to management, investors and others in assessing our period-to-period operating performance.
Adjusted diluted EPS is a key measure used by management to demonstrate the impact of tax benefits from ASU 2016-09 on our diluted EPS and to provide investors and others with additional information about our potential future operating performance to supplement GAAP measures.
We believe this measure should be considered in addition to, not as a substitute for, diluted EPS presented in accordance with GAAP, and in the context of our other disclosures within this Form 10-Q. Other companies may calculate this non-GAAP financial measure differently than we do, which may limit its usefulness as a comparative measure.
The table below presents a reconciliation of diluted EPS to adjusted diluted EPS.
(Unaudited) Three Months Ended Nine Months Ended
September 30, September 30,
2023 2022 2023 2022
Diluted EPS $ 3.51 $ 4.78 $ 12.00 $ 16.82
ASU 2016-09 tax benefit (0.01) (0.02) (0.15) (0.24)
Adjusted diluted EPS $ 3.50 $ 4.76 $ 11.85 $ 16.58
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Seasonality and Quarterly Fluctuations
Our business is seasonal. In general, sales and operating income are highest during the second and third quarters, which represent the peak months of both swimming pool use and installation and irrigation and landscape installations and maintenance. Sales are lower during the first and fourth quarters. In 2022, we generated approximately 59% of our net sales and 67% of our operating income in the second and third quarters of the year.
We typically experience a build-up of product inventories and accounts payable during the winter months in anticipation of the peak selling season. Excluding borrowings to finance acquisitions and share repurchases, our peak borrowing usually occurs during the second quarter, primarily because extended payment terms offered by our suppliers typically are payable in April, May and June, while our peak accounts receivable collections typically occur in June, July and August.
The following table presents certain unaudited quarterly income statement and balance sheet data for the most recent eight quarters to allow for a meaningful comparison of the seasonal fluctuations in these amounts. We believe this information reflects all normal and recurring adjustments considered necessary for a fair presentation of this data. The results of any one or more quarters are not necessarily a good indication of results for an entire fiscal year or of continuing future trends for a variety of reasons, including the seasonal nature of our business and the impact of new and acquired sales centers.
(Unaudited) QUARTER
(in thousands) 2023 2022 2021
Third Second First Fourth Third Second First Fourth
Statement of Income Data
Net sales $ 1,474,407 $ 1,857,363 $ 1,206,774 $ 1,095,920 $ 1,615,339 $ 2,055,818 $ 1,412,650 $ 1,035,557
Gross profit 428,731 567,783 369,755 315,731 503,687 666,804 447,189 322,376
Operating income 194,443 327,009 145,771 107,295 263,877 418,888 235,723 127,891
Net income 137,843 232,250 101,699 71,863 190,055 307,283 179,261 107,609
Balance Sheet Data
Total receivables, net $ 461,582 $ 630,950 $ 564,171 $ 351,448 $ 549,796 $ 756,585 $ 679,927 $ 376,571
Product inventories, net 1,259,308 1,392,886 1,686,683 1,591,060 1,539,572 1,579,101 1,641,155 1,339,100
Accounts payable 429,436 485,100 739,749 406,667 442,226 604,225 685,946 398,697
Total debt 1,033,897 1,184,586 1,365,750 1,386,803 1,512,545 1,595,398 1,505,073 1,183,350
We expect that our quarterly results of operations will continue to fluctuate depending on the timing and amount of revenue contributed by new and acquired sales centers. Based on our peak summer selling season, we generally open new sales centers and close or consolidate sales centers, when warranted, either in the first quarter before the peak selling season begins or in the fourth quarter after the peak selling season ends.
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Weather is one of the principal external factors affecting our business. The table below presents some of the possible effects resulting from various weather conditions.
Weather Possible Effects
Hot and dry • Increased purchases of chemicals and supplies
for existing swimming pools
• Increased purchases of above-ground pools and
irrigation and lawn care products
Unseasonably cool weather or extraordinary amounts • Fewer pool and irrigation and landscape
of rain installations
• Decreased purchases of chemicals and supplies
• Decreased purchases of impulse items such as
above-ground pools and accessories
Unseasonably early warming trends in spring/late cooling • A longer pool and landscape season, thus positively
trends in fall impacting our sales
(primarily in the northern half of the U.S. and Canada)
Unseasonably late warming trends in spring/early cooling • A shorter pool and landscape season, thus negatively
trends in fall impacting our sales
(primarily in the northern half of the U.S. and Canada)
Weather Impacts on 2023 and 2022 Results
During the third quarter of 2023, sales benefited from record breaking temperatures and below average precipitation across the southern United States, especially Texas, Louisiana and Florida. These benefits were largely offset by rainy conditions in the Northeast. Comparatively, sales in the third quarter of 2022 were generally aided by above-average temperatures throughout much of the contiguous United States, although Florida saw a decline in sales due to closures resulting from Hurricane Ian towards the end of the quarter.
Overall, weather conditions unfavorably impacted sales in the second quarter of 2023, particularly at the beginning of the second quarter. The first week of April through Easter weekend was much cooler across the West versus both average temperatures and prior year. The last week of April was also significantly cooler than normal from Texas through the mid-Atlantic region, excluding the coastal Southeast. While the Northeast had warmer than average weather the first few weeks of April, temperatures cooled dramatically through the first week of May and smoke from wildfires in Canada unfavorably impacted sales in early June. Weather in Florida was more normal and consistent with prior year, while favorable weather conditions compared to the second quarter of 2022 were limited to the Pacific Northwest and Europe. Similarly, sales growth in the second quarter of 2022 was challenged by unfavorable weather conditions in our seasonal markets and Europe; however, our southern markets benefited from above-average temperatures, particularly in Texas.
Weather conditions varied across the contiguous United States throughout the first quarter of 2023. Conditions were generally favorable in our southern markets, where sales benefited from warmer weather and below-average precipitation. In contrast, results were unfavorably impacted by unusually wet and cold weather in the western U.S., particularly in California and Arizona, which are two of our largest markets. Comparatively, in the first quarter of 2022, overall weather conditions were generally favorable, and sales benefited from above-average temperatures along much of the west and the east coast, although Texas experienced cooler-than-normal temperatures.
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CRITICAL ACCOUNTING ESTIMATES
We prepare our Consolidated Financial Statements in accordance with U.S. generally accepted accounting principles (GAAP), which require management to make estimates and assumptions that affect reported amounts and related disclosures. Management identifies critical accounting estimates as:
• those that require the use of assumptions about matters that are inherently and highly uncertain at the time the estimates are made; and
• those for which changes in the estimates or assumptions, or the use of different estimates and assumptions, could have a material impact on our consolidated results of operations or financial condition.
Management has discussed the development, selection and disclosure of our critical accounting estimates with the Audit Committee of our Board. For a description of our critical accounting estimates that require us to make the most difficult, subjective or complex judgments, please see our 2022 Annual Report on Form 10-K. We have not changed any of these policies from those previously disclosed in that report.
Recent Accounting Pronouncements
See Note 1 of “Notes to Consolidated Financial Statements,” included in Part I, Item 1 of this Form 10-Q for discussion of recent accounting pronouncements.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is defined as the ability to generate adequate amounts of cash to meet short-term and long-term cash needs. We assess our liquidity in terms of our ability to generate cash to fund our operating activities, taking into consideration the seasonal nature of our business. Significant factors which could affect our liquidity include the following:
• cash flows generated from operating activities;
• the adequacy of available bank lines of credit;
• the quality of our receivables;
• acquisitions;
• dividend payments;
• capital expenditures;
• changes in income tax laws and regulations;
• the timing and extent of share repurchases; and
• the ability to attract long-term capital with satisfactory terms.
Our primary capital needs are seasonal working capital obligations, debt repayment obligations and other general corporate initiatives, including acquisitions, opening new sales centers, dividend payments and share repurchases. Our primary working capital obligations are for the purchase of inventory, payroll, rent, other facility costs and selling and administrative expenses. Our working capital obligations fluctuate during the year, driven primarily by seasonality and the timing of inventory purchases. Our primary sources of working capital are cash from operations supplemented by bank borrowings, which have historically been sufficient to support our growth and finance acquisitions. We have funded our capital expenditures and share repurchases in substantially the same manner.
We prioritize our use of cash based on investing in our business, maintaining a prudent capital structure, including a modest amount of debt, and returning cash to our shareholders through dividends and share repurchases. Our specific priorities for the use of cash are as follows:
• capital expenditures primarily for maintenance and growth of our sales center network, technology-related investments and fleet vehicles;
• inventory and other operating expenses;
• strategic acquisitions executed opportunistically;
• payment of cash dividends as and when declared by our Board;
• repayment of debt to maintain an average total target leverage ratio (as defined below) between 1.5 and 2.0; and
• discretionary repurchases of our common stock under our Board-authorized share repurchase program.
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We focus our capital expenditure plans principally on the needs of our sales centers, and in recent years have increased our spending on information technology. Historically, our capital expenditures have averaged roughly 1.0% of net sales. Capital expenditures were 0.7% of net sales in 2022 and 2021 and 0.6% of net sales in 2020. From 2020 to 2022, our capital expenditures as a percentage of net sales were lower than our historical average primarily due to our significant sales growth. Based on management’s current plans and our spending through September 30, 2023, we project capital expenditures in 2023 will approximate 1.0% of net sales.
Sources and Uses of Cash
The following table summarizes our cash flows (in thousands):
Nine Months Ended
September 30,
2023 2022
Operating activities $ 750,018 $ 307,470
Investing activities (54,506) (34,514)
Financing activities (656,835) (248,404)
Net cash provided by operations improved to $750.0 million for the first nine months of 2023 from $307.5 million for the first nine months of 2022, primarily driven by positive changes in working capital, particularly as we sold through our prior year strategic inventory purchases, partially offset by lower net income.
Net cash used in investing activities for the first nine months of 2023 increased $20.0 million compared to the first nine months of 2022, primarily due to a $15.0 million increase in capital expenditures and a $3.2 million increase in cash used for acquisitions.
Net cash used in financing activities was $656.8 million for the first nine months of 2023 compared to $248.4 million for the first nine months of 2022, primarily reflecting $353.4 million of net debt payments in the first nine months of 2023 versus $328.6 million of net debt proceeds in the first nine months of 2022 and an increase in dividends paid of $13.4 million, partially offset by a $284.1 million decrease in share repurchases between periods.
Future Sources and Uses of Cash
To supplement cash from operations as our primary source of working capital, we plan to continue to utilize our three major credit facilities, which are the Amended and Restated Revolving Credit Facility (the Credit Facility), the Term Facility (the Term Facility) and the Receivables Securitization Facility (the Receivables Facility). Effective June 30, 2023, we amended the index rate used to pay interest on our Credit Facility and Term Facility, from the one-month London Interbank Offer Rate (LIBOR) to the one-month Term Secured Overnight Financing Rate Index Rate (Term SOFR). For additional details regarding these facilities, including recent amendments, see the summary descriptions below and more complete descriptions in Note 5 of our “Notes to Consolidated Financial Statements,” included in Part II, Item 8 in our 2022 Annual Report on Form 10-K and Note 5 of “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Form 10-Q.
Credit Facility
Our Credit Facility provides for $1.25 billion in borrowing capacity consisting of a $750.0 million five-year unsecured revolving credit facility and a $500.0 million term loan facility. The Credit Facility also includes sublimits for the issuance of swingline loans and standby letters of credit. We pay interest on revolving and term loan borrowings under the Credit Facility at a variable rate based on one-month Term SOFR, plus an applicable margin. The term loan requires quarterly amortization payments during the third, fourth and fifth years of the loan, beginning in September 2023 aggregating to 20% of the original principal amount of the loan, with all remaining principal due on the Credit Facility maturity date of September 25, 2026. We intend to continue to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives.
At September 30, 2023, there was $176.8 million of revolving borrowings outstanding, a $493.8 million term loan, a $16.0 million standby letter of credit outstanding and $557.2 million available for borrowing under the Credit Facility. The weighted average effective interest rate for the Credit Facility as of September 30, 2023, was approximately 4.5%, excluding commitment fees.
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Term Facility
Our Term Facility provides for $185.0 million in borrowing capacity and matures on December 30, 2026. Proceeds from the Term Facility were used to pay down the Credit Facility in December 2019, adding borrowing capacity for future share repurchases, acquisitions and growth-oriented working capital expansion. We pay interest on borrowings under the Term Facility at a variable rate based on one month Term SOFR, plus an applicable margin. The Term Facility is repaid in quarterly installments of 1.250% of the Term Facility on the last business day of each quarter beginning in the first quarter of 2020 with the final principal repayment due on the maturity date. We may prepay amounts outstanding under the Term Facility without penalty other than interest breakage costs. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis.
At September 30, 2023, there was $109.9 million outstanding under the Term Facility with a weighted average effective interest rate of 6.5%.
Receivables Securitization Facility
Our two-year accounts receivable securitization facility (the Receivables Facility) offers us a lower-cost form of financing. Under this facility, we can borrow up to $350.0 million between April through August and from $210.0 million to $340.0 million during the remaining months of the year. The Receivables Facility matures on November 1, 2024. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis.
The Receivables Facility provides for the sale of certain of our receivables to a wholly-owned subsidiary (the Securitization Subsidiary). The Securitization Subsidiary transfers variable undivided percentage interests in the receivables and related rights to certain third-party financial institutions in exchange for cash proceeds, limited to the applicable funding capacities. Upon payment of the receivables by customers, rather than remitting to the financial institutions the amounts collected, we retain such collections as proceeds for the sale of new receivables until payments become due.
At September 30, 2023, there was $242.3 million outstanding under the Receivables Facility at a weighted average effective interest rate of 6.2%, excluding commitment fees.
Financial Covenants
Financial covenants of the Credit Facility, Term Facility and Receivables Facility include maintenance of a maximum average total leverage ratio and a minimum fixed charge coverage ratio, which are our most restrictive financial covenants. As of September 30, 2023, the calculations of these two covenants are detailed below:
• Maximum Average Total Leverage Ratio . On the last day of each fiscal quarter, our average total leverage ratio must be less than 3.25 to 1.00. Average Total Leverage Ratio is the ratio of the sum of (i) Total Non-Revolving Funded Indebtedness as of such date, (ii) the trailing twelve months (TTM) Average Total Revolving Funded Indebtedness and (iii) the TTM Average Accounts Securitization Proceeds divided by TTM EBITDA (as those terms are defined in the Credit Facility). As of September 30, 2023, our average total leverage ratio equaled 1.48 (compared to 1.48 as of June 30, 2023) and the TTM average total indebtedness amount used in this calculation was $1.2 billion.
• Minimum Fixed Charge Coverage Ratio . On the last day of each fiscal quarter, our fixed charge ratio must be greater than or equal to 2.25 to 1.00. Fixed Charge Ratio is the ratio of the TTM EBITDAR divided by TTM Interest Expense paid or payable in cash plus TTM Rental Expense (as those terms are defined in the Credit Facility). As of September 30, 2023, our fixed charge ratio equaled 6.07 (compared to 6.74 as of June 30, 2023) and TTM Rental Expense was $89.0 million.
The Credit Facility and Term Facility limit the declaration and payment of dividends on our common stock to a manner consistent with past practice, provided no default or event of default has occurred and is continuing, or would result from the payment of dividends. We may declare and pay quarterly dividends so long as (i) the amount per share of such dividends is not greater than the most recently publicly announced amount of dividends per share and (ii) our Average Total Leverage Ratio is less than 3.25 to 1.00 both immediately before and after giving pro forma effect to such dividends. Under the Credit Facility and Term Facility, we may repurchase shares of our common stock provided no default or event of default has occurred and is continuing, or would result from the repurchase of shares, and our maximum average total leverage ratio (determined on a pro forma basis) is less than 3.25 to 1.00.
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Other covenants in each of our credit facilities include restrictions on our ability to grant liens, incur indebtedness, make investments, merge or consolidate, and sell or transfer assets. Failure to comply with any of our financial covenants or any other terms of our credit facilities could result in, among other things, higher interest rates on our borrowings or the acceleration of the maturities of our outstanding debt.
Interest Rate Swaps
We utilize interest rate swap contracts and forward-starting interest rate swap contracts to reduce our exposure to fluctuations in variable interest rates for future interest payments on our variable rate borrowings. Interest expense related to the notional amounts under all swap contracts is based on the fixed rates plus the applicable margin on the respective borrowings.
As of September 30, 2023, we had two interest rate swap contracts in place and one forward-starting interest rate swap contract, each of which has the effect of converting our exposure to variable interest rates on a portion of our variable rate borrowings to fixed interest rates. For more information, see Note 4 of “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Form 10-Q.
Compliance and Future Availability
As of September 30, 2023, we were in compliance with all material covenants and financial ratio requirements under our Credit Facility, our Term Facility and our Receivables Facility. We believe we will remain in compliance with all material covenants and financial ratio requirements throughout the next twelve months. For additional information regarding our debt arrangements, see Note 5 of “Notes to Consolidated Financial Statements,” included in Part II, Item 8 of our 2022 Annual Report on Form 10-K, as updated by Note 5 of “Notes to Consolidated Financial Statements,” included in Part I, Item 1 of this Form 10-Q.
We believe we have adequate availability of capital to fund present operations and the current capacity to finance any working capital needs that may arise. We continually evaluate potential acquisitions and hold discussions with acquisition candidates. If suitable acquisition opportunities arise that would require financing, we believe that we would have the ability to finance any such transactions.
As of October 23, 2023, $463.3 million remained available to purchase shares of our common stock under our current Board-approved share repurchase program. We expect to repurchase shares on the open market from time to time subject to market conditions. We plan to fund these repurchases with cash provided by operations and borrowings under the above-described credit facilities.
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