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POOL > SEC Filings for POOL > Form 10-Q on 1-Nov-2012All Recent SEC Filings

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Form 10-Q for POOL CORP


1-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with Management's Discussion and Analysis included in our 2011 Annual Report on Form 10-K.

For a discussion of our base business calculations, see the RESULTS OF OPERATIONS section below.

In our discussion of results of operations below, adjusted operating income, adjusted net income and adjusted diluted EPS for all periods exclude the Goodwill impairment line item on the Consolidated Statements of Income. We have provided these adjusted amounts because we believe it helps investors assess our year-over-year operating performance.

Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995

Our disclosure and analysis in 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 future performance, statements of management's plans and objectives, future contracts, and forecasts of trends and other matters. Forward-looking statements speak only as of the date of this filing, and we undertake no obligation to 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," "believe," "will likely result," "outlook," "project" and other words and expressions of similar meaning.

No assurance can be given that the results in any forward-looking statements 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 the economy and the housing market, our ability to maintain favorable relationships with suppliers and manufacturers, competition from other leisure product alternatives and mass merchants and other risks detailed in our 2011 Annual Report on Form 10-K. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act.

OVERVIEW

Financial Results

We realized strong third quarter results despite the challenging external environment and one less selling day than the third quarter of 2011. Solid execution across the company drove market share gains and record year to date sales and earnings per share.

Net sales increased 5% quarter over quarter, with base business sales up 3% (over 4% on a same selling day basis). This growth is primarily attributable to market share gains, modest growth in consumer discretionary expenditures and some price inflation, offset by a 1% decline from the impact of unfavorable currency fluctuations.

Gross profit for the third quarter of 2012 improved 2% from the comparable 2011 period, while gross profit as a percentage of net sales (gross margin) declined 70 basis points to 28.7%. The decrease in gross margin reflects a difficult comparison given the 60 basis point improvement in the third quarter last year, which included the benefit of 2011 mid-year vendor price increases. Unfavorable product and customer mix changes and continued competitive pricing pressures also contributed to the gross margin decline in the quarter.

Selling and administrative expenses (operating expenses) decreased 3% in the third quarter of 2012 compared to the same period in 2011. Base business operating expenses were down 6% as lower employee incentive costs, the impact of currency fluctuations on expenses, the impact of one less selling day and lower bad debt expense more than offset higher professional fees and inflationary increases in other costs.

We performed an interim goodwill impairment analysis for our United Kingdom reporting unit during the third quarter of 2012 based on our identification of impairment indicators related to our results through the end of the 2012 pool season (sales and profits significantly lower than our forecast for 2012) and the current and expected continued depressed economic conditions in the United Kingdom. As a result of our impairment analysis, we recorded a $6.9 million non-cash goodwill impairment charge equal to the total September 30, 2012 goodwill carrying amount of our United Kingdom reporting unit of $6.9 million. This impairment charge had a $0.14 negative impact on diluted EPS for the three and nine months ended September 30, 2012. Since the goodwill impairment charge is not deductible for tax purposes, our effective tax rate for both the quarterly and year to date periods ended September 30, 2012 was much higher than normal.


Operating income for the quarter was essentially flat at $41.0 million compared to 2011, while operating income as a percentage of net sales (operating margin) decreased 30 basis points to 7.8% compared to the same period in 2011. Excluding goodwill impairment, adjusted operating income for the quarter increased 17% to $48.0 million and adjusted operating margin increased 100 basis points to 9.1% for the third quarter of 2012 compared to the same period in 2011.

Net income decreased 12% to $21.4 million in the third quarter of 2012, with earnings per share down 10% to $0.45 per diluted share versus $0.50 per diluted share for the third quarter of 2011. Adjusted net income for the third quarter increased 17% to $28.3 million, while adjusted EPS increased 18% to $0.59 per diluted share.

Financial Position and Liquidity

Total net receivables increased 9% due primarily to the increase in net sales and higher vendor receivables. Our allowance for doubtful accounts balance was $4.8 million at September 30, 2012, a $0.4 million decrease compared to September 30, 2011 that reflects continued improvements in our receivable aging trends. Days sales outstanding (DSO) improved between periods to 29.0 days at September 30, 2012 compared to 30.3 days at September 30, 2011.

Inventory levels were up 3% to $349.3 million at September 30, 2012, including a 2% increase from recent acquisitions. The inventory reserve increased to $9.6 million at September 30, 2012 compared to $7.4 million at September 30, 2011. Our inventory turns, as calculated on a trailing twelve month basis, increased to 3.3 times at September 30, 2012 compared to 3.2 times at September 30, 2011.

Total debt outstanding was $214.3 million at September 30, 2012, down $54.4 million compared to September 30, 2011.

Current Trends and Outlook

For a detailed discussion of trends, see the Current Trends and Outlook section of Management's Discussion and Analysis included in Item 7 of our 2011 Annual Report on Form 10-K. While there have not been any significant changes in those trends, we believe the economic environment remains uncertain given consumer confidence and employment levels in the United States and the lingering debt and economic issues in Europe.

Based on our results through September as well as expectations for the remainder of the year, we revised our 2012 earnings guidance from our previous range of $1.75 to $1.82 per diluted share to a projected range of $1.80 to $1.83 per diluted share excluding the $0.14 goodwill impairment charge or $1.66 to $1.69 per diluted share including the impact of the goodwill impairment charge.

For the fourth quarter of 2012, we expect mid-single digit base business sales growth including the benefit of one more selling day compared to the fourth quarter of 2011. We believe fourth quarter gross margin will continue to track lower than 2011. While the unfavorable comparative impact related to 2011 mid-season vendor price increases will diminish in the fourth quarter, we believe that unfavorable product and customer mix changes and competitive pricing pressures will continue.

We expect operating expenses will be up 3% to 4% in the fourth quarter compared to the same period in 2011, with the benefit of a projected $2.0 million decline in employee incentive costs more than offset by expected cost increases in other areas, expenses from our recent acquisitions and the impact of one more selling day. For the full year, we expect modest expense growth overall with employee incentive costs down approximately $6.0 million to a more normalized expense level after the extraordinary year we had in 2011.

For the full year, we expect our effective income tax rate will be approximately 40%. Excluding the impact of the non-deductible goodwill impairment charge, our full year effective income tax rate should be just over 38%. This is slightly below our more normalized rate of approximately 39% due to the benefit from the expiration of the statue of limitations for both our 2007 and 2008 income tax returns.

Consistent with our results for the first nine months of 2012, we anticipate base business results will generate operating profit growth as a percentage of base business sales growth (contribution margin) of 20% for the full year excluding the impact of goodwill impairment. While favorable timing differences related to inventory and tax payments will reverse in the fourth quarter, we still expect cash provided by operations will exceed net income for the full year as a result of operational improvements.


RESULTS OF OPERATIONS
As of September 30, 2012, we conducted operations through 312 sales centers in
North America and Europe.

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,
                                              2012           2011         2012           2011
Net sales                                     100.0 %        100.0 %      100.0 %        100.0 %
Cost of sales                                  71.3           70.6         71.0           70.4
Gross profit                                   28.7           29.4         29.0           29.6
Operating expenses                             19.6           21.2         19.2           20.4
Goodwill impairment                             1.3              -          0.4              -
Operating income                                7.8            8.1          9.4            9.2
Interest expense, net                           0.3            0.3          0.3            0.3
Income before income taxes and equity
earnings                                        7.4 %          7.8 %        9.1 %          8.8 %

Note: Due to rounding, percentages may not add up to operating income or income before income taxes and equity earnings.

Our discussion of consolidated operating results includes the operating results from acquisitions in 2012 and 2011. We have included the results of operations in our consolidated results since the respective acquisition dates.

Three Months Ended September 30, 2012 Compared to Three Months Ended
September 30, 2011
The following table breaks out our consolidated results into the base business
component and the excluded components (sales centers excluded from base
business):
(Unaudited)                   Base Business                   Excluded                       Total
(in thousands)             Three Months Ended            Three Months Ended           Three Months Ended
                              September 30,                September 30,                 September 30,
                           2012          2011           2012            2011          2012          2011
Net sales               $ 518,504     $ 502,301     $    9,523      $   1,283      $ 528,027     $ 503,584

Gross profit              148,738       147,541          2,763            365        151,501       147,906
Gross margin                 28.7 %        29.4 %         29.0  %        28.4  %        28.7 %        29.4 %

Operating expenses        100,315       106,619          3,229            374        103,544       106,993
Expenses as a % of
net sales                    19.3 %        21.2 %         33.9  %        29.2  %        19.6 %        21.2 %

Goodwill impairment         6,946             -              -              -          6,946             -

Operating income
(loss)                     41,477        40,922           (466 )           (9 )       41,011        40,913

Operating margin 8.0 % 8.1 % (4.9 )% (0.7 )% 7.8 % 8.1 %


In our calculation of base business results, we have excluded the following acquisitions for the periods identified:

                                                      Net
                                  Acquisition    Sales Centers           Periods
Acquired (1)                         Date          Acquired              Excluded
CCR Distribution                 March 2012            1         July-September 2012
Ideal Distributors Ltd.          February 2012         4         July-September 2012
G.L. Cornell Company             December 2011         1         July-September 2012
Poolway Schwimmbadtechnik GmbH   November 2011         1         July-September 2012
The Kilpatrick Company, Inc.     May 2011              4         July 2012 and July 2011

(1) We acquired certain distribution assets of each of these companies.

We exclude the following sales centers from base business results for a period of 15 months (parenthetical numbers for each category indicate the number of sales centers excluded as of September 30, 2012):

acquired sales centers (see table above);

existing sales centers consolidated with acquired sales centers (0);

closed sales centers (0);

consolidated sales centers in cases where we do not expect to maintain the majority of the existing business (0); and

sales centers opened in new markets (4).

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 of operations, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.

The table below summarizes the changes in our sales centers in the first nine months of 2012:

December 31, 2011  298
Acquired             5
New locations        9

September 30, 2012 312

Net Sales

Three Months Ended
September 30,
(in millions) 2012 2011 Change Net sales $ 528.0 $ 503.6 $ 24.4 5%

Net sales for the third quarter of 2012 increased 5%, including a 3% increase in base business sales despite a 1% impact from one less selling day and a 1% decrease attributed to the impact of unfavorable currency fluctuations. Our base business sales growth included a 3% increase on the swimming pool side of the business and an 8% increase on the irrigation side of the business. While comparative sales results in July reflected the early peak of the 2012 season, sales growth rates improved throughout the remainder of the third quarter when compared on a same selling day basis.

The overall base business sales increase reflects the impact of the following (listed in order of estimated magnitude):

market share gains evidenced by sales growth rates for expanded product offerings such as building materials (11% growth) and higher base business sales growth for the irrigation side of the business including the benefit realized from a regional competitor going out of business;

improvement in consumer discretionary expenditures, including some market recovery in remodeling activity;


the impact of inflationary product cost increases (estimated at approximately 1% to 2%); and

higher sales of non-discretionary products due to the increased installed base of pools, which we estimate grew 1% over the past year.

Gross Profit

                   Three Months Ended
                     September 30,
(in millions)       2012         2011        Change
Gross profit    $   151.5      $ 147.9     $ 3.6    2%
Gross margin         28.7 %       29.4 %

Gross margin declined approximately 70 basis points in the third quarter of 2012. This decrease reflects a difficult comparison to the third quarter of 2011 given the 60 basis point gross margin improvement in that period, which included the benefit from inventory purchases we made in advance of 2011 mid-year vendor price increases. The comparative decline in the third quarter of 2012 also reflected unfavorable changes in product and customer mix and continued competitive pricing pressures. Partially offsetting favorable impacts included lower debit card fees as a percentage of sales and continued improvements in purchasing and pricing discipline.

Operating Expenses

                                            Three Months Ended
                                              September 30,
(in millions)                                2012         2011          Change
Operating expenses                       $   103.5      $ 107.0     $ (3.5 )   (3)%
Operating expenses as a % of net sales        19.6 %       21.2 %

Operating expenses were down 3% compared to the third quarter of 2011, with a 6% drop in base business operating expenses partially offset by the impact of expenses related to recent acquisitions and new market sales center openings. Base business operating expenses declined mainly due to a $3.8 million decrease in employee incentive costs, a $0.9 million impact from currency fluctuations, the impact of one less selling day, a $0.8 million reduction in bad debt expense and small decreases in other expense categories. These expense decreases were partially offset by a $1.1 million increase in professional fees and inflationary increases in other costs.

Interest Expense, net

Interest expense, net was up 3% between periods due primarily to a year over year increase in interest expense related to borrowings. This increase was attributable to a higher weighted average effective interest rate, which increased to 2.6% for the third quarter of 2012 from 2.4% for the third quarter of 2011.

Income Taxes

Our effective income tax rate was 45.7% for the three months ended September 30, 2012 compared to 38.5% for the three months ended September 30, 2011. Excluding the impact of the $6.9 million non-deductible goodwill impairment charge, our effective income tax rate was 38.8% for the three months ended September 30, 2012. For a more detailed discussion of the changes to our effective tax rate, please refer to page 15 under the heading "Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011".

Net Income and Earnings Per Share

Net income decreased 12% to $21.4 million compared to the third quarter of 2011, while earnings per share decreased 10% quarter over quarter to $0.45 per diluted share. Excluding the goodwill impairment charge, adjusted net income for the third quarter increased 17% to $28.3 million and adjusted earnings per share increased 18% to $0.59 per diluted share.


Earnings per share for the third quarter of 2012 also included an accretive impact of approximately $0.01 per diluted share from the reduction in our weighted average shares outstanding due to our share repurchase activities during the year.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

The following table breaks out our consolidated results into the base business component and the excluded components (sales centers excluded from base business):

(Unaudited)                            Base Business                   Excluded                        Total
(in thousands)                       Nine Months Ended             Nine Months Ended             Nine Months Ended
                                       September 30,                 September 30,                 September 30,
                                   2012            2011           2012          2011           2012            2011
Net sales                      $ 1,608,947     $ 1,517,691     $ 38,209      $  5,205      $ 1,647,156     $ 1,522,896

Gross profit                       467,582         449,285       10,887         1,470          478,469         450,755
Gross margin                          29.1 %          29.6 %       28.5  %       28.2  %          29.0 %          29.6 %

Operating expenses                 305,354         309,438       11,003         1,907          316,357         311,345
Expenses as a % of net sales          19.0 %          20.4 %       28.8  %       36.6  %          19.2 %          20.4 %

Goodwill impairment                  6,946               -            -             -            6,946               -

Operating income (loss)            155,282         139,847         (116 )        (437 )        155,166         139,410

Operating margin 9.7 % 9.2 % (0.3 )% (8.4 )% 9.4 % 9.2 %

In our calculation of base business results, we have excluded the following acquisitions for the periods identified:

                                                      Net
                                  Acquisition    Sales Centers            Periods
Acquired (1)                         Date          Acquired              Excluded
CCR Distribution                 March 2012            1         March-September 2012
Ideal Distributors Ltd.          February 2012         4         February-September 2012
G.L. Cornell Company             December 2011         1         January-September 2012
Poolway Schwimmbadtechnik GmbH   November 2011         1         January-September 2012
The Kilpatrick Company, Inc.     May 2011              4         January-July 2012 and
                                                                  May-July 2011
Turf Equipment Supply Co.        December 2010         3         January-February 2012 and
                                                                  January-February 2011
Pool Boat and Leisure, S.A.      December 2010         1         January-February 2012 and
                                                                  January-February 2011

(1) We acquired certain distribution assets of each of these companies.

For a more detailed explanation of how we calculated base business results and a summary of the changes in our sales centers since December 31, 2011, please refer to page 11 under the heading "Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011".


Net Sales

Nine Months Ended
September 30,
(in millions) 2012 2011 Change Net sales $ 1,647.2 $ 1,522.9 $ 124.3 8%

Net sales for the first nine months of 2012 increased 8% on one less selling day, with an increase of 6% in base business sales and a 2% increase related to recent acquisitions and new market sales center openings. Our base business sales growth included a 6% increase on the swimming pool side of the business and more than a 7% increase on the irrigation side of the business, partially offset by a 1% decline from unfavorable currency fluctuations. In local currencies, net sales in Europe declined less than 1% compared to the first nine months of 2011 with sales growth in France, our largest European market, offsetting double digit sales declines in the United Kingdom.

The overall base business sales increase reflects the impact of the following (listed in order of estimated magnitude):

market share gains evidenced by above market sales growth rates for certain product offerings such as building materials and chemicals (see discussion below) and certain customer segments such as retail (5% growth);

the gradual improvement in consumer discretionary expenditures, including some market recovery in remodeling activity and increased sales of above ground pools (12% growth);

the impact of inflationary product cost increases (estimated at approximately 1% to 2%); and

higher sales of non-discretionary products due to the increased installed base of pools, which we estimate grew 1% over the past year.

Sales of building materials, tile and packaged pool products grew by 15% compared to the first nine months of 2011, although collectively these products only accounted for approximately 12% of our total sales in the first nine months of 2012. Chemical sales grew by over 4%, with a small benefit overall from price inflation despite some lingering price deflation for certain chemical products. Sales for parts products increased only 1% compared to the first nine months of 2011, reflecting a shift by some consumers from repairing to replacing swimming pool equipment.

Sales in 2012 also benefited from favorable weather conditions through May, with an unusually mild winter and record warm spring temperatures driving a higher first quarter base business sales growth rate and the early peak to the 2012 season. However, June sales were negatively impacted by unfavorable weather conditions compared to the same period in 2011. See discussion of significant weather impacts under the subheading Seasonality and Quarterly Fluctuations beginning on page 16.

Gross Profit

                   Nine Months Ended
                     September 30,
(in millions)      2012         2011         Change
Gross profit    $   478.5     $ 450.8     $ 27.7    6%
Gross margin         29.0 %      29.6 %

Gross margin declined 60 basis points between periods due primarily to difficult comparisons to 2011 (when our gross margin was up 60 basis points from the first nine months of 2010). Going into the 2011 season, we made greater early buy inventory purchases in advance of year-end vendor price increases and we made additional bulk inventory purchases in advance of mid?year 2011 vendor price increases. These strategic purchases benefited our gross margin throughout 2011. We made more modest early buy inventory purchases going into the 2012 season as vendor price increases were more modest.

Unfavorable impacts on comparative gross margin also included the following (listed in order of estimated magnitude):

unfavorable changes in customer and product mix, including a greater mix of higher priced and more energy efficient products that have higher gross profits per unit but lower gross margins;

continued competitive pricing pressures, which intensified in the latter part of the second quarter of 2012; and

a decline of approximately 10 basis points related to higher inventory obsolescence adjustments.


Favorable impacts on comparative gross margin also included the following (listed in order of estimated magnitude):

. . .

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