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April 30, 2020, 3:00 p.m. EDT

10-Q: POOL CORP

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(EDGAR Online via COMTEX) -- 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 2019 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

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 plans and objectives and industry, general economic and other forecasts of trends, future dividend payments and share repurchases, 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," "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 impacts on our business from the COVID-19 pandemic, 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, excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in our 2019 Annual Report on Form 10-K and in Part II, Item 1A. of this Form 10-Q. 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 started the year with robust growth as we believe that underlying demand for our products has been strong. During the first quarter of 2020, we benefited from earlier pool openings, as mild weather combined with school closures drove greater early-season residential pool usage. Beginning in the middle of March, when stay-at-home orders related to the COVID-19 pandemic were being issued, sales growth began to level off.

Most of our North American operations are and have been continuously open for business as we are designated 'essential' in almost all of our markets. In Europe, our operations closed for a short period in France, Spain and Italy, in order to comply with local authorities' orders. Our products and services are used to maintain and protect outdoor commercial, residential and municipal environments, including chemically-balanced, virus and bacteria-free swimming pool water and in the prevention of runoff, flood, fire and other natural disasters, and are 'essential' to the health and safety of the general public. As a result, our supply chain remains relatively intact, and with some exceptions, our customers are continuing to meet end-user needs.

As of the end of April, stay-at-home orders of varying degrees are now in place in almost all jurisdictions in which we operate, resulting in year-over-year sales declines for the month of April of five to ten percent as these orders impact our business unevenly throughout our network. It is unclear how long these conditions will last and what the continuing social and economic impact will be on our business after these restrictions are lifted. We have taken steps to preserve capital and reduce costs where warranted, while retaining options for further business adjustments as conditions evolve and we gain more clarity. For example, we currently project that our capital expenditures for 2020 will be approximately half of the $33.4 million spent in 2019. Our lower planned capital expenditures include the deferral of previously planned sales center openings until future conditions are clearer. We are working closely with our suppliers to maintain the flow of essential products to provide customers with the materials they need to serve their communities. Given the seasonality of our business, our warehouses were already stocked with inventory in preparation for the upcoming peak season prior to the implementation of most stay-at-home orders. As a result, the limited vendor supply interruptions experienced to date have had a minimal impact on our business, although that could change depending on the duration and severity of social distancing conditions.

Net sales increased 13% to $677.3 million in the first quarter of 2020 compared to $597.5 million in the first quarter of 2019, while base business sales also grew 13% compared to the same period last year. During the quarter, sales benefited from strong demand for discretionary products as evidenced by higher sales growth in construction materials and products used in the remodel and replacement of in-ground pools. In addition, sales were favorably impacted by a pull forward of lower margin customer early-buy sales from the second quarter into the first and by an additional selling day in the first quarter of 2020 compared to the first quarter of 2019.

Gross profit increased 9% to $189.6 million in the first quarter of 2020 from $174.6 million in the same period of 2019. Base business gross profit improved 8% over the first quarter of 2019. Gross margin decreased 120 basis points to 28.0% in the first quarter of 2020 compared to 29.2% in the first quarter of 2019. Gross margin in the first quarter of 2019 reflected benefits from strategic inventory purchases we made ahead of vendor price increases resulting in a comparative decline in the first quarter of 2020 in addition to the impact of the customer early-buys mentioned above.

Selling and administrative expenses increased 13% to $154.0 million in the first quarter of 2020 compared to the first quarter of 2019. Base business operating expenses also increased 13% over the comparable 2019 period. In the first quarter of 2020, we recorded impairment charges of $6.9 million, which included $2.5 million from a long-term note, as collectability was impacted by the COVID-19 pandemic, and non-cash goodwill and intangibles impairment charges of $4.4 million, equal to the total goodwill and intangibles carrying amount of our Australian reporting units. Excluding non-cash impairments, both selling and administrative expenses and base business operating expenses increased 8%, reflecting increases in growth-driven variable labor and freight expenses as well as greater facility-related costs.

Operating income in the first quarter of 2020 decreased 7% to $35.6 million compared to the same period in 2019. Adjusted operating income, excluding non-cash impairments, was $42.5 million in the first quarter of 2020 compared to operating income of $38.4 million in the first quarter of 2019, an 11% increase. Operating margin was 5.3% in the first quarter of 2020, or 6.3% excluding impairment charges, compared to 6.4% in the first quarter of 2019.

We recorded an $8.0 million, or $0.19 per diluted share, tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, in the quarter ended March 31, 2020 compared to a tax benefit of $8.8 million, or $0.21 per diluted share, realized in the same period of 2019.

Net income decreased 5% to $30.9 million in the first quarter of 2020 compared to $32.6 million in the first quarter of 2019. Adjusted net income in the first quarter of 2020, excluding the tax-effected impact of non-cash impairments of $6.3 million, or $0.15 per diluted share, increased 14% to $37.2 million. Earnings per share decreased 6% to $0.75 per diluted share in the first quarter of 2020 compared to $0.80 in the same period of 2019. Excluding after-tax non-cash impairments in the first quarter of 2020 and tax benefits in both periods, adjusted earnings per diluted share increased 20% to $0.71 in the first quarter of 2020 compared to $0.59 in the first quarter of 2019. See the reconciliation of GAAP to non-GAAP measures included in RESULTS OF OPERATIONS below.

References to product line and product category data throughout this report generally reflect data related to the North American swimming pool market, as it is more readily available for analysis and represents the largest component of our operations.

Financial Position and Liquidity

As of March 31, 2020, total net receivables, including pledged receivables, increased 10% compared to March 31, 2019, driven by our March sales growth. Our DSO, as calculated on a trailing four quarters basis, was 29.2 days at March 31, 2020 and 29.8 days at March 31, 2019. Our allowance for doubtful accounts balance was $6.9 million at March 31, 2020 and $5.6 million at March 31, 2019.

Net inventory levels grew 5% compared to levels at March 31, 2019. The inventory reserve was $10.3 million at March 31, 2020 and $8.5 million at March 31, 2019. Our inventory turns, as calculated on a trailing four quarters basis, were 3.2 times at March 31, 2020 and 3.1 times at March 31, 2019.

Total debt outstanding at March 31, 2020 was $586.1 million, down 16% compared to total debt at March 31, 2019. We have used debt proceeds over the past 12 months primarily to fund business-driven working capital growth, acquisitions and share repurchases.

Current Trends and Outlook

For a detailed discussion of trends through 2019, see the Current Trends and Outlook section of Management's Discussion and Analysis included in Part II, Item 7 of our 2019 Annual Report on Form 10-K.

We expect 2020 diluted EPS of $5.30 to $5.90, including the impact of first quarter tax benefits of $0.19 and the $0.15 impact of non-cash impairments recorded in the first quarter of 2020. Excluding the impact of non-cash impairments, we expect 2020 adjusted diluted EPS of $5.45 to $6.05. Our updated guidance range includes a wide range of outcomes as the severity and duration of the COVID-19 pandemic remains unknown. Our previous 2020 earnings guidance range disclosed earlier in the year was $6.47 to $6.77 per diluted share, including an estimated $0.06 tax benefit. See the reconciliation of GAAP to non-GAAP measures included in RESULTS OF OPERATIONS below.

The top of our earnings guidance range assumes sales growth of 2% from 2019, while the bottom of our range assumes a sales decline of 2.5%. The majority of our business is driven by recurring revenue streams from the installed base of pools, and we believe that underlying demand for most discretionary products, including those serving the renovation and construction markets, remains strong. At the same time, the impact of extended stay-at-home and social distancing orders as well as unfavorable economic conditions resulting from the COVID-19 pandemic could have a more severe adverse impact on our business, including an easing of demand for products dependent on discretionary spending.

We expect gross margin to decline in the second quarter of 2020 compared to the second quarter of 2019 when margin growth was 30 basis points. Depending on competitor price concessions, we expect that gross margin for the full year of 2020 could decline slightly to moderately compared to gross margin for the full year of 2019.

We expect base business operating expenses for the remainder of the year to benefit from actions taken by management to reduce costs and to vary in line with changes in sales performance. For the year, we expect operating expenses to range from modest growth to modest declines compared to 2019.

We expect our annual effective tax rate (excluding the benefit from ASU 2016-09) for 2020 will approximate 25.5%, which is consistent with 2019. Our effective tax rate is dependent on our results of operations and may change if actual results differ materially from our current expectations, particularly any significant changes in our geographic mix. Due to ASU 2016-09, we expect our effective tax rate will fluctuate from quarter to quarter, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. We recorded an $8.0 million, or $0.19 per diluted share, tax benefit from ASU 2016-09 for the three months ended March 31, 2020. We may recognize additional tax benefits related to stock option exercises in 2020 from grants that expire in years after 2020. We have not included any expected benefits in our guidance beyond what we have recognized as of March 31, 2020.

We expect cash provided by operations will remain strong in comparison to net income for the 2020 fiscal year. We expect to continue to use cash to fund opportunistic share repurchases over the next year. We also expect to use cash for the payment of cash dividends as and when declared by our Board of Directors ("the Board"). Most recently, on April 23, 2020, the Board declared a quarterly cash dividend of $0.58 per share, a five percent increase over the previous dividend amount of $0.55 per share. The dividend will be payable on May 29, 2020 to holders of record on May 15, 2020.







        RESULTS OF OPERATIONS
        As of March 31, 2020, we conducted operations through 378 sales centers in North
        America, Europe and Australia. For the three months ended March 31, 2020,
        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
                                                                       March 31,
                                                                   2020              2019
        Net sales                                                      100.0  %     100.0  %
        Cost of sales                                                   72.0         70.8
        Gross profit                                                    28.0         29.2
        Selling and administrative expenses                             21.7         22.8
        Impairment of goodwill and other assets                          1.0            -
        Operating income                                                 5.3          6.4
        Interest and other non-operating expenses, net                   0.7          1.1
        Income before income taxes and equity earnings                   4.5  %       5.3  %
        


Note: Due to rounding, percentages presented in the table above may not add to Income before income taxes and equity earnings.

We have included the results of operations from acquisitions in 2020 and 2019 in our consolidated results since the acquisition dates.

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019 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
                                                         March 31,                                             March 31,                                          March 31,
                                                  2020               2019              2020             2019              2020               2019
        Net sales                             $ 667,804          $ 588,390          $ 9,484          $ 9,066          $ 677,288          $ 597,456
        Gross profit                            186,810            172,608            2,819            2,023            189,629            174,631
        Gross margin                               28.0  %            29.3  %          29.7  %          22.3  %            28.0  %            29.2  %
        Operating expenses (1)                  150,873            133,599            3,168            2,646            154,041            136,245
        Expenses as a % of net sales               22.6  %            22.7  %          33.4  %          29.2  %            22.7  %            22.8  %
        Operating income (loss) (1)              35,937             39,009             (349)            (623)            35,588             38,386
        


(1)Base business and total include $6.9 million of impairment from goodwill and other assets.

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







                                                                   Net
                                           Acquisition        Sales Centers               Periods
        Acquired                              Date              Acquired                  Excluded
        Master Tile Network LLC (1)      February 2020              4            February - March 2020
        W.W. Adcock, Inc. (1)            January 2019               4            January - March 2020 and
                                                                                 January - March 2019
        Turf & Garden, Inc. (1)          November 2018              4            January 2020 and
                                                                                 January 2019
        


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

When calculating our base business results, we exclude sales centers that are acquired, closed, or opened in new markets 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.

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 center count during the first three months of 2020:







        December 31, 2019         373
        Acquired locations          4
        New locations               2
        Consolidated locations     (1)
        March 31, 2020            378
        


Net Sales

Net sales and base business net sales increased 13% in the first quarter of 2020 compared to the first quarter of 2019. During the first quarter of 2020, sales benefited from earlier pool openings, as mild weather combined with school closures, drove greater early-season residential pool usage. In the first quarter of 2020, we observed above-average temperatures in most of the contiguous United States, particularly in the southern United States, whereas in the first quarter 2019, wetter and cooler-than-normal temperatures prevailed.

The following factors benefited our sales (listed in order of estimated magnitude):

strong demand for discretionary products, as evidenced by improvements in sales growth rates for product offerings such as building materials (see discussion below);

Additionally, sales were favorably impacted by a pull forward of lower margin customer early-buy sales from the second quarter into the first and by an additional selling day in the first quarter of 2020 compared to the first quarter of 2019.

We believe that higher sales growth rates for certain product offerings, such as equipment and building materials, evidence increased spending in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades. In the first quarter of 2020, sales for equipment, which includes swimming pool heaters, pumps, lights and filters, increased 18% compared to the same period last year. These products collectively represented approximately 31% of net sales for the period. Sales of building materials grew 14% compared to the first quarter of 2019 and represented approximately 14% of net sales in the first quarter of 2020.

Sales to customers who service large commercial installations such as hotels, universities and community recreational facilities are included in the appropriate existing product categories, and growth in this area is reflected in the numbers above. Sales to these customers represented approximately 5% of our consolidated net sales for the first quarter of 2020 and increased 5% compared to the first quarter of 2019.







        Gross Profit
                               Three Months Ended
                                   March 31,
        (in millions)          2020           2019            Change
        Gross profit       $   189.6       $ 174.6       $ 15.0        9%
        Gross margin            28.0  %       29.2  %
        


Gross margin was impacted in the first quarter of 2020 by a pull forward of lower margin customer early-buy sales from the second quarter into the first. In addition, gross margin in the first quarter of 2019 reflected benefits from strategic inventory purchases ahead of vendor price increases resulting in a comparative decline in the first quarter of 2020.







        Operating Expenses
                                                         Three Months Ended
                                                             March 31,
        (in millions)                                    2020           2019             Change
        Selling and administrative expenses          $   147.1       $ 136.2       $ 10.9         8%
        Impairment of goodwill and other assets            6.9             -          6.9        100%
        Operating expenses as a % of net sales            22.7  %       22.8  %
        


Operating expenses and base business operating expenses increased 13% in the first quarter of 2020 compared to the first quarter of 2019. In the first quarter of 2020, we recorded impairment charges of $6.9 million, which included $2.5 million from a long-term note, as collectability was impacted by the COVID-19 pandemic, and non-cash goodwill and intangibles impairment charges of $4.4 million, equal to the total goodwill and intangibles carrying amounts of our Australian reporting units. Excluding impairment charges, operating expenses and base business operating expenses were up 8%, reflecting increases in growth-driven variable labor and freight expenses as well as greater facility-related costs.

Interest and Other Non-Operating Expenses, Net

Interest and other non-operating expenses, net for the first quarter of 2020 decreased $1.8 million compared to the first quarter of 2019. The decrease reflects lower average debt levels and lower average interest rates between periods. Our weighted average effective interest rate decreased to 2.7% for the first quarter of 2020 from 3.7% for the first quarter of 2019 on lower average outstanding debt of $493.7 million versus $674.6 million for the respective periods.

Income Taxes

Our effective income tax rate was a 0.1% benefit for the three months ended March 31, 2020 compared to a 2.5% benefit for the three months ended March 31, 2019. We recorded an $8.0 million tax benefit from ASU 2016-09 in the quarter ended March 31, 2020 compared to a benefit of $8.8 million realized in the same period last year. Excluding the benefits from ASU 2016-09, our effective tax rate was 25.8% for the first quarter of 2020 and 25.1% for the first quarter of 2019. Since the goodwill and intangibles impairment charge of $4.4 million is non-deductible for tax purposes, it increased our effective tax rate 0.4% for the period ended March 31, 2020.

Net Income and Earnings Per Share

Net income decreased 5% to $30.9 million in the first quarter of 2020 compared to the first quarter of 2019. Adjusted net income in the first quarter of 2020, excluding the tax-effected impact of non-cash impairments of $6.3 million, or $0.15 per diluted share, increased 14% to $37.2 million. Earnings per diluted share decreased 6% to $0.75 in the first quarter of 2020 versus $0.80 per diluted share for the comparable 2019 period. The benefit from ASU 2016-09 increased diluted earnings per share by $0.19 in the first quarter of 2020 and $0.21 in the first quarter of 2019. Excluding non-cash impairments, net of tax, in the first quarter of 2020 and tax benefits in both periods, earnings per diluted share increased 20% to $0.71 in the first quarter of 2020 compared to $0.59 in the first quarter of 2019. See the reconciliation of GAAP to non-GAAP measures below.

Reconciliation of Non-GAAP Financial Measures

2020 Diluted EPS Guidance

We have included adjusted projected 2020 diluted EPS, a non-GAAP financial measure, as a supplemental disclosure in order to demonstrate the impact of our first quarter 2020 non-cash impairment charge on our projected 2020 diluted EPS and provide investors and others with additional information about our potential future operating performance. We believe adjusted projected 2020 diluted EPS should be considered in addition to, and not as a substitute for, our projected 2020 diluted EPS presented in accordance with GAAP, and in the context of our other forward-looking and cautionary statements included within this Form 10-Q.

The table below presents a reconciliation of projected 2020 diluted EPS to adjusted projected 2020 diluted EPS.







        (Unaudited)                                           2020 Guidance Range
                                                            Floor              Ceiling
        Diluted EPS (1)                                 $    5.30             $ 5.90
        After-tax non-cash impairment charges                0.15               0.15
        Adjusted Diluted EPS (1)                        $    5.45             $ 6.05
        


(1)Includes first quarter 2020 ASU 2016-09 tax benefit of $0.19 per diluted share and does not include potential additional tax benefits.

Adjusted Income Statement Information

Apr 30, 2020

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