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POOL > SEC Filings for POOL > Form 10-Q on 30-Jul-2014All Recent SEC Filings

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Form 10-Q for POOL CORP


30-Jul-2014

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 2013 Annual Report on Form 10-K.

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

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 forward­looking 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," "should" 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 2013 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

Our second quarter results were generally as expected, with solid sales and gross profit growth and improvement in gross margin, albeit with sales below target in certain seasonal markets. The ongoing recovery of replacement and remodel activity along with market share gains continued to contribute to our growth. Likewise, we believe our second quarter results evidenced our ongoing efforts to provide exceptional value and our consistent investment in tools and resources to help our customers succeed.

Net sales for the quarter ended June 30, 2014 increased 7% compared to the second quarter of 2013, with base business sales also up 7% for the period. Replacement and remodel activity continued to drive sales growth with sustained double-digit sales increases in building materials. Prolonged cold and wet weather in our seasonal markets, particularly Canada and the northern United States, limited our second quarter sales growth in those markets.

Gross profit for the second quarter of 2014 increased 8% versus the same period in 2013. Gross profit as a percentage of net sales (gross margin) improved 25 basis points to 29.1% in the second quarter of 2014. This increase reflects our concerted effort on several fronts to improve margins.

Selling and administrative expenses (operating expenses) increased 7% in the second quarter of 2014 compared to the same period in 2013, with base business operating expenses up 6% for the period. This increase is primarily due to additional performance­based incentive compensation expense in 2014, which reflects comparatively better results versus performance targets this year compared to last. We also increased infrastructure investments, such as additional personnel and expenses related to equipment and technology to support greater sales growth, and we incurred higher freight costs in the second quarter of 2014 compared to the second quarter of 2013.

Operating income for the quarter increased 9% compared to the same period in 2013. Operating income as a percentage of net sales (operating margin) was 14.4% for the second quarter of 2014 compared to 14.2% for the same period in 2013.

Net income increased 11% to $73.9 million in the second quarter of 2014 compared to the same period last year. Earnings per share increased by $0.22, or 16%, to $1.61 per diluted share for the three months ended June 30, 2014.


Financial Position and Liquidity

Total net receivables, including pledged receivables, at June 30, 2014 increased 9% from June 30, 2013. Our allowance for doubtful accounts balance was $4.4 million at both June 30, 2014 and June 30, 2013. Days sales outstanding (DSO) improved between periods to 28.3 days at June 30, 2014 compared to 28.5 days at June 30, 2013.

Net inventory levels increased 6% to $451.5 million at June 30, 2014. The inventory reserve was $8.5 million at both June 30, 2014 and June 30, 2013. Our inventory turns, as calculated on a trailing twelve month basis, were 3.5 times at June 30, 2014 compared to 3.4 times at June 30, 2013.

Total debt outstanding of $431.0 million at June 30, 2014 increased 43% compared to June 30, 2013 primarily to fund greater share repurchases in the first half of 2014 versus 2013 and also due to timing differences in the inventory purchase and payment cycle.

Current Trends and Outlook

For a detailed discussion of trends through 2013, see the Current Trends and Outlook section of Management's Discussion and Analysis included in Item 7 of our 2013 Annual Report on Form 10-K.

For the remainder of 2014, we expect sales and gross profit growth rates to be similar to the first half of the year. We also anticipate sales growth from refurbishment and replacement related products will continue to exceed sales growth from maintenance and other non-discretionary product offerings. During the first half of the year, we completed two acquisitions consisting of four sales centers and opened two new locations. We plan to open four additional new sales centers before the close of the 2014 season. We expect gross margin to remain relatively flat compared to 2013.

Compared to the 6% base business operating expense growth in the first half of 2014, we expect that our base business operating expenses will grow more modestly in the second half of the year. This projection assumes approximately $3.0 million to $4.0 million more performance-based incentive compensation in 2014 than in 2013, most of which is generally recorded in the second and third quarters, consistent with the seasonality of our earnings.

For the full year 2014, we project our effective income tax rate will approximate 38.5%. Our effective tax rate is dependent upon the results of operations and may change if actual results are different from our current expectations, particularly any significant changes in our geographic mix. We expect the third quarter rate will be slightly below the estimated annual rate, while the fourth quarter effective income tax rate should be slightly above the full year rate.

We reaffirm our previously provided 2014 annual earnings guidance of $2.35 to $2.45 per diluted share. We expect cash provided by operations will be in line with net income for the full year 2014 and we anticipate that share repurchase activity will lessen in the third and fourth quarters compared to the first half of the year.


RESULTS OF OPERATIONS
As of June 30, 2014, we conducted operations through 326 sales centers in North
America, Europe and South America.

The following table presents information derived from the Consolidated
Statements of Income expressed as a percentage of net sales:

                                            Three Months Ended        Six Months Ended
                                                 June 30,                 June 30,
                                             2014         2013         2014        2013
Net sales                                   100.0 %       100.0 %     100.0 %     100.0 %
Cost of sales                                70.9          71.1        71.2        71.3
Gross profit                                 29.1          28.9        28.8        28.7
Operating expenses                           14.7          14.7        18.3        18.4
Operating income                             14.4          14.2        10.5        10.2
Interest expense, net                         0.2           0.3         0.3         0.3
Income before income taxes and equity
earnings                                     14.2 %        13.9 %      10.1 %       9.9 %

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

We have included the results of operations from acquisitions in 2014 and 2013 in our consolidated results since the respective dates of these acquisitions.


Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013 The following table breaks out our consolidated results into the base business component and the excluded component (sales centers excluded from base business):

(Unaudited)                          Base Business                 Excluded                      Total
(in thousands)                    Three Months Ended          Three Months Ended          Three Months Ended
                                       June 30,                    June 30,                    June 30,
                                  2014          2013          2014          2013          2014          2013
Net sales                      $ 841,210     $ 789,171     $   7,030     $  1,221      $ 848,240     $ 790,392

Gross profit                     244,614       227,833         2,362          333        246,976       228,166
Gross margin                        29.1 %        28.9 %        33.6 %       27.3  %        29.1 %        28.9 %

Operating expenses               122,832       115,797         1,645          376        124,477       116,173
Expenses as a % of net sales        14.6 %        14.7 %        23.4 %       30.8  %        14.7 %        14.7 %

Operating income (loss)          121,782       112,036           717          (43 )      122,499       111,993

Operating margin 14.5 % 14.2 % 10.2 % (3.5 )% 14.4 % 14.2 %

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
DFW Stone Supply, LLC               March 2014            2         April - June 2014
Atlantic Chemical & Aquatics Inc.   February 2014         2         April - June 2014
B. Shapiro Supply, LLC              May 2013              1         April - June 2014 and
                                                                    May - June 2013
Swimming Pool Supply Center, Inc.   March 2013            1         April - May 2014 and
                                                                    April - May 2013

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

We exclude sales centers that are acquired, closed or opened in new markets from base business results for a period of 15 months. We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that are consolidated with acquired sales centers. As of June 30, 2014, we excluded one sales center opened in a new market from base business.

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 identifies the changes in the number of sales centers during the first six months of 2014:

December 31, 2013      321
Acquired locations       4
New locations            2
Consolidated locations  (1 )
June 30, 2014          326


Net Sales
Three Months Ended
June 30,
(in millions) 2014 2013 Change Net sales $ 848.2 $ 790.4 $ 57.8 7%

Net sales for the second quarter of 2014 increased 7% compared to the second quarter of 2013, with base business net sales also up 7% for the period. Replacement and remodel activity continued to lead our base business sales growth. After last year's late start to the pool season, we anticipated a comparative benefit from more favorable weather conditions in the second quarter of 2014, but this expectation did not materialize due to prolonged cold and wet weather in many of our seasonal markets, particularly Canada and the northern United States. As a result, the timing of 2014 pool openings in many of those areas was similar to 2013.

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

• continued improvement in consumer discretionary expenditures, including some market recovery in remodeling and replacement activity, as evidenced by sales growth rates for product offerings such as building materials and equipment (see discussion below);

• market share gains attributed to continued improvements in customer service levels; and

• inflationary (estimated at approximately 1%) product cost increases.

Sales of building materials and tile grew by 22% compared to the second quarter of 2013. Collectively these products accounted for approximately 9% of our total sales for the quarter. Sales of equipment, which includes heaters, pumps, lighting and filters, increased by 9% compared to the second quarter of 2013. Chemical sales increased by 3% while chemical pricing remained relatively flat.

Gross Profit
                   Three Months Ended
                        June 30,
(in millions)       2014         2013         Change
Gross profit    $   247.0      $ 228.2     $ 18.8    8%
Gross margin         29.1 %       28.9 %

Gross margin for the second quarter of 2014 improved approximately 25 basis points compared to the second quarter of 2013. We attribute this improvement to our ongoing initiatives related to pricing, inventory management and sales execution combined with higher building materials sales growth rates and a reduction in equipment sales growth rates compared to the second quarter of last year. This sales growth dynamic and product mix provided a slightly favorable impact on our gross margin given comparatively lower margins on heaters, pumps, lighting and filters compared to building materials and other product offerings.

Operating Expenses
                                            Three Months Ended
                                                 June 30,
(in millions)                                2014         2013        Change
Operating expenses                       $   124.5      $ 116.2     $ 8.3    7%
Operating expenses as a % of net sales        14.7 %       14.7 %

Operating expenses increased 7% in the second quarter of 2014 compared to the second quarter of 2013, with base business operating expenses up 6% for the period. This increase is primarily due to additional performance-based incentive compensation expense recorded in 2014, which reflects comparatively better results versus performance targets this year compared to last, as well as increased infrastructure investments such as additional personnel and expenses related to equipment and technology to support greater sales growth. Freight costs were also higher, as driver shortages pushed up shipping rates.


Interest Expense, Net

Interest expense, net decreased 9% compared to the second quarter of 2013, including a 4% decrease in interest expense related to borrowings. Our weighted average effective interest rate decreased to 1.9% for the second quarter of 2014 from 2.4% for the second quarter of 2013 on higher average outstanding debt of $366.9 million versus $283.9 million for the respective periods. The decrease in our effective interest rate compared to last year reflects the utilization of available borrowing capacity on our Receivables Facility at lower interest rates than our Credit Facility.

Income Taxes

Our effective income tax rate was 38.8% for the three months ended June 30, 2014 compared to 39.5% for the three months ended June 30, 2013. The lower rate reflects our estimates for improved results in 2014 compared to 2013 for certain of our international entities for which we have recorded full valuation allowances on net operating losses.

Net Income and Earnings Per Share

Net income for the second quarter of 2014 increased 11% to $73.9 million compared to the second quarter of 2013. Earnings per diluted share was $1.61 for the second quarter of 2014, an increase of $0.22, or 16%, per diluted share over the same period of 2013. Earnings per share for the quarter also included an accretive impact of close to $0.02 per diluted share from the reduction in our weighted average shares outstanding due to our share repurchase activities.


Six Months Ended June 30, 2014 Compared to Six Months Ended June 30, 2013 The following table breaks out our consolidated results into the base business component and the excluded component (sales centers excluded from base business):

(Unaudited)                            Base Business                   Excluded                       Total
(in thousands)                       Six Months Ended              Six Months Ended             Six Months Ended
                                         June 30,                      June 30,                     June 30,
                                   2014            2013           2014         2013           2014            2013
Net sales                      $ 1,245,828     $ 1,159,416     $  8,756     $  1,338      $ 1,254,584     $ 1,160,754

Gross profit                       358,158         332,552        2,918          375          361,076         332,927
Gross margin                          28.7 %          28.7 %       33.3 %       28.0  %          28.8 %          28.7 %

Operating expenses                 227,373         213,526        2,558          476          229,931         214,002
Expenses as a % of net sales          18.3 %          18.4 %       29.2 %       35.6  %          18.3 %          18.4 %

Operating income (loss)            130,785         119,026          360         (101 )        131,145         118,925

Operating margin 10.5 % 10.3 % 4.1 % (7.5 )% 10.5 % 10.2 %

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
DFW Stone Supply, LLC               March 2014            2         March - June 2014
Atlantic Chemical & Aquatics Inc.   February 2014         2         February - June 2014
B. Shapiro Supply, LLC              May 2013              1         January - June 2014 and
                                                                    May - June 2013
Swimming Pool Supply Center, Inc.   March 2013            1         January - May 2014 and
                                                                    March - May 2013

(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, 2013, please refer to page 12 under the heading "Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013".

Net Sales
Six Months Ended
June 30,
(in millions) 2014 2013 Change Net sales $ 1,254.6 $ 1,160.8 $ 93.8 8%

Net sales for the first half of 2014 increased 8% compared to the same period last year, despite not having the expected benefit of a return to normal seasonal weather patterns. Base business sales growth of 7% in the first half of 2014 included an 8% increase from swimming pool product sales and a 6% increase from landscape and irrigation product sales.


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

• continued improvement in consumer discretionary expenditures, including some market recovery in remodeling and replacement activity, as evidenced by sales growth rates for product offerings such as building materials and equipment (see discussion below);

• market share gains attributed to continued improvements in customer service levels;

• an increase in customer early buy purchases; and

• inflationary (estimated at approximately 1%) product cost increases.

Sales of building materials and tile grew by 21% compared to the first half of 2013. Collectively these products accounted for approximately 9% of our total sales. Sales of equipment, which includes heaters, pumps, lighting and filters, increased by close to 11% compared to the first half of 2013. Chemical sales increased by 3% while chemical pricing remained relatively flat.

Gross Profit
                   Six Months Ended
                       June 30,
(in millions)      2014        2013         Change
Gross profit    $  361.1     $ 332.9     $ 28.2    8%
Gross margin        28.8 %      28.7 %

Gross margin for the first half of 2014 exhibited a 10 basis point improvement compared to the first half of last year. We believe our concerted efforts related to pricing, inventory management and sales execution offset the unfavorable gross margin impact of first quarter 2014 customer early buy activity. Purchases included in customer early buys are primarily comprised of lower margin discretionary products and include applicable discounts.

Operating Expenses
                                            Six Months Ended
                                                June 30,
(in millions)                               2014        2013         Change
Operating expenses                       $  229.9     $ 214.0     $ 15.9    7%
Operating expenses as a % of net sales       18.3 %      18.4 %

Operating expenses increased 7% in the first half of 2014 compared to the same period in 2013, with base business operating expenses up 6%. This increase primarily reflects the following (listed in order of magnitude):

• additional performance-based incentive compensation expense recorded in 2014, which reflects comparatively better results versus performance targets this year compared to last;

• increased infrastructure investments such as additional personnel and expenses related to equipment and technology to support greater sales growth;

• higher outside professional fees;

• higher freight costs; and

• increased costs due to the expansion in 2014 of our annual retail marketing event.

Interest Expense, Net

Interest expense, net for the first six months of 2014 was consistent with the first six months of 2013. Our weighted average effective interest rate decreased to 2.0% for the first six months of 2014 from 2.5% for the same period of 2013 on higher average outstanding debt of $322.6 million versus $264.5 million for the respective periods. The decrease in our effective interest rate compared to last year reflects the utilization of available borrowing capacity on our Receivables Facility at lower interest rates than under our Credit Facility.


Income Taxes

Our effective income tax rate was 38.8% for the six months ended June 30, 2014 compared to 39.3% for the six months ended June 30, 2013. The lower rate reflects our estimates for improved results in 2014 versus 2013 for certain of our international locations for which we have recorded full valuation allowances on net operating losses.

Net Income and Earnings Per Share

Earnings per share for the first six months of 2014 increased 15% to $1.69 per diluted share on net income of $78.1 million, compared to $1.47 per diluted share on net income of $70.0 million in the comparable 2013 period. Earnings per share for the first six months 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.

Seasonality and Quarterly Fluctuations

Our business is highly 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 landscape maintenance and installation. Sales are substantially lower during the first and fourth quarters, when we may incur net losses. In 2013, we generated approximately 66% of our net sales and essentially 100% 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 payments due under 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 data for the first and second quarter of 2014, the four quarters of 2013 and the third and fourth quarters of 2012. We have included 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. In our opinion, this information reflects all normal and recurring adjustments considered necessary for a fair presentation of this data. Due to the seasonal nature of our industry, the results of any one or more quarters are not necessarily a good indication of results for an entire fiscal year or of continuing trends.

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