UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2005
or
For the transition period from to
Commission File Number: 0-26640
SCP POOL CORPORATION
(Exact name of Registrant as specified in its charter)
985-892-5521
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES x NO ¨
At July 22, 2005, there were 52,743,486 outstanding shares of the registrant’s common stock, $.001 par value per share.
Form 10-Q
For the Quarter Ended June 30, 2005
INDEX
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets
Consolidated Statements of Income
Condensed Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits
Signature Page
Index to Exhibits
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
(In thousands, except share data)
June 30,
2005
2004
December 31,
2004(1)
Assets
Current assets:
Cash and cash equivalents
Receivables, net
Receivables pledged under receivables facility
Product inventories, net
Prepaid expenses
Deferred income taxes
Total current assets
Property and equipment, net
Goodwill
Other intangible assets, net
Equity interest investments
Other assets, net
Total assets
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable
Accrued and other current liabilities
Short-term financing
Current portion of other long-term liabilities
Total current liabilities
Long-term debt
Other long-term liabilities
Total liabilities
Stockholders’ equity:
Common stock, $.001 par value; 100,000,000 shares authorized; 52,604,237, 52,870,061 and 52,186,711 shares issued and outstanding at June 30, 2005, June 30, 2004 and December 31, 2004, respectively
Additional paid-in capital
Retained earnings
Treasury stock
Unearned compensation
Accumulated other comprehensive income
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying Notes are an integral part of the Consolidated Financial Statements.
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(Unaudited)
(In thousands, except per share data)
Three Months Ended
Six Months Ended
Net sales
Cost of sales
Gross profit
Selling and administrative expenses
Operating income
Interest expense
Income before income taxes and equity earnings
Provision for income taxes
Equity earnings in unconsolidated investments
Net income
Earnings per share:
Basic
Diluted
Weighted average shares outstanding:
Cash dividends declared per common share
The accompanying Notes are an integral part of the Consolidated Financial Statements
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(In thousands)
Operating activities
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation
Amortization
Other
Changes in operating assets and liabilities, net of effects of acquisitions:
Receivables
Product inventories
Other current assets and liabilities
Net cash used in operating activities
Investing activities
Acquisition of businesses, net of cash acquired
Purchase of property and equipment, net of sale proceeds
Net cash used in investing activities
Financing activities
Proceeds from revolving line of credit
Payments on revolving line of credit
Proceeds from asset-backed financing
Payments on asset-backed financing
Payments on other long-term debt
Issuance of common stock under stock option plans
Payment of cash dividends
Purchase of treasury stock
Net cash provided by financing activities
Effect of exchange rate changes on cash
Change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
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Note 1—Basis of Presentation
SCP Pool Corporation (the Company, which may be referred to as we, us orour) prepared the consolidated financial statements following accounting principles generally accepted in the United States (GAAP) and the requirements of the Securities and Exchange Commission (SEC) for interim financial information. As permitted under those rules, certain footnotes or other financial information required by GAAP for complete financial statements have been condensed or omitted. In management’s opinion, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The results for the three and six month periods ended June 30, 2005 are not necessarily indicative of the results to be expected for the twelve months ending December 31, 2005.
We reclassified certain deferred tax amounts in our Consolidated Balance Sheet for the six months ended June 30, 2004 to conform to the 2005 presentation. This reclassification had no effect on net income or earnings per share as previously reported.
You should also read the financial statements and notes included in our 2004 Annual Report on Form 10-K. The accounting policies used in preparing these financial statements are the same as those described in our Annual Report.
Note 2—Earnings Per Share
We calculate basic earnings per share (EPS) by dividing net income by the weighted average number of common shares outstanding. Diluted EPS includes the dilutive effects of stock and option awards.
All share and per share data and the related capital amounts for the period ended June 30, 2004 reflect the effects of a three-for-two stock split of our common stock, which was paid in the form of a stock dividend on September 10, 2004.
Note 3—Comprehensive Income
Comprehensive income consists of net income and other gains and losses affecting stockholders’ equity that, under GAAP, are excluded from net income. In our case, these consist of foreign currency translation gains and losses and unrealized gains and losses on cash flow hedges, net of related income tax effects.
Comprehensive income was $51.2 million and $43.3 million for the three months ended June 30, 2005 and June 30, 2004, respectively. For the six months ended June 30, 2005 and June 30, 2004, comprehensive income was $55.9 million and $47.7 million, respectively.
Note 4—Equity Investments
As discussed in Note 3 in our Annual Report on Form 10-K, in December 2004 we acquired certain assets of Latham International LP’s Canadian subsidiary, Pool Tech Distribution Inc. (Pool Tech or the Pool Tech Acquisition) and a 42% interest in Latham Acquisition Corporation (LAC) (collectively referred to as the 2004 Acquisitions). We funded the 2004 Acquisitions primarily through the exchange of manufacturing assets held by our subsidiaries in Ontario, Canada and Fort Wayne, Indiana and cash consideration. We have not yet finalized our allocation of the fair value received in connection with the 2004 Acquisitions, and we expect to complete certain working capital adjustments in the third quarter of 2005, pending receipt of additional information.
We account for our 42% interest in LAC using the equity method of accounting. Accordingly, we report our share of income or loss based on our ownership interest in LAC.
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Notes to Consolidated Financial Statements (Continued)
In May 2005, we acquired a 50% membership interest in Northpark Corporate Center, L.L.C. (NCC) through a $1.1 million cash contribution. NCC owns and operates an office building in Covington, Louisiana. We lease corporate and administrative offices from NCC, occupying approximately 41% of the office building. We account for our $1.1 million investment in NCC under the equity method of accounting. Accordingly, we report our share of income or loss based on our ownership interest in NCC.
Note 5—Stock-Based Compensation
We account for our employee stock options under the intrinsic value method described by Accounting Principles Bulletin 25, Accounting for Stock Issued to Employees. Accordingly, we do not record compensation expense for options issued with an exercise price equal to the stock’s market price on the grant date. If we had accounted for our stock-based compensation using the fair value method described in Statement of Financial Accounting Standards (SFAS) 123, Accounting for Stock-Based Compensation, our net income and earnings per share would have been reduced to the pro-forma amounts below (in thousands, except per share data):
Reported net income
Add: Stock-based employee compensation expense included in reported net income, net of the tax effect
Deduct: Stock-based employee compensation expense determined under the fair value method for all awards, net of the tax effect
Pro-forma net income
Basic earnings per share:
As reported
Pro-forma
Diluted earnings per share:
On April 15, 2005, the SEC adopted an amendment to Regulation S-X that delays the date by which we must adopt SFAS 123(R), Share-Based Payment. Under these new rules, we are required to adopt SFAS 123(R) on January 1, 2006, although earlier adoption is permitted.
We are in the process of reviewing the provisions of SFAS 123(R) and plan to adopt the statement on January 1, 2006, but we have made no definitive decisions regarding transition methods or option valuation methods. In 2006, we expect the annualized impact from SFAS 123(R) to our diluted earnings per share will approximate $0.05 to $0.06, which is consistent with the annualized impact of the pro-forma net income and earnings per share disclosed above.
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You should read the following discussion in conjunction with Management’s Discussion and Analysis included in our 2004 Annual Report on Form 10-K.
Overview
Net sales grew 12% to $564.0 million in the second quarter of 2005 compared to $504.2 million in the second quarter of 2004. Similar to our sales gains during the first quarter of 2005, this growth was a result of increases in both delivery volume and product pricing. Our volume gains reflect our success in meeting our customers’ needs by providing value-added products and programs, including the continued drive into newer product areas and growth in the installed base of pools. Supplier price increases, which we were generally able to pass through to customers, also contributed to the sales growth. These price increases have been more significant in 2005 than in prior years due to significant increases in underlying commodity costs, particularly oil and steel, as well as higher prices on certain imported chemicals used in the pool industry. The increase in chemical prices was a result of tariffs proposed by the U. S. International Trade Commission in December 2004 that were finalized in June 2005.
New product initiatives continue to be focused on our Complementary Products category, for which sales grew 33% over the same period last year. These products, which our customers historically purchased from other suppliers, carry gross margins comparable to our traditional product categories. We believe that Complementary Products will continue to grow at a faster rate than our overall sales growth, and should comprise approximately 10% of total revenues for the full year 2005.
Our operating income increased 14% to $82.8 million in the second quarter of 2005 from the same period last year due primarily to the growth in sales, as well as our ability to leverage our existing distribution and administrative infrastructure and our success with ongoing operational improvements. We remain focused on numerous supply chain management initiatives and improving our working capital management, and we expect to make continued operational improvements in the future.
Net income increased 18% from the second quarter of 2004 and included $1.9 million of net income from our equity investment in LAC. LAC’s business is highly seasonal and more heavily weighted to northern markets, with the first and fourth quarters being the slowest parts of the year and the second and third quarters being the busiest. In the second quarter, LAC’s sales were adversely impacted by extended cold and wet weather in northeastern markets. For both the third quarter and full year of 2005, we expect a positive contribution to our earnings from LAC.
Based on our financial results through the first half of 2005, we anticipate earnings per share growth of 20% for the full year compared to 2004.
Net cash used to fund operations was $51.6 million year to date in 2005 compared to $41.2 million in 2004. This change is primarily due to an increase in accounts receivable, driven by strong sales in the month of June. The Company expects to generate cash from operations in the second half of 2005, with the goal of exceeding net income in operating cash flow for the year. Given management’s long-term cash generation expectations, the Board increased the Company’s dividend payment in the second quarter of 2005 from $.07 per share to $.09 per share.
Our business is subject to significant risks, including weather, competition, general economic conditions and other risks detailed below in our “Cautionary Statement for Purpose of the ‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of 1995”.
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Results of Operations
We currently conduct operations through 204 service 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.
Note: Due to rounding, percentages may not add to operating income or income before income taxes and equity earnings.
Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004
Net Sales
(in millions)
Base business sales growth was 11% in the second quarter of 2005. Net sales increased primarily due to the following:
Gross Profit
Gross profit as a percent of net sales
Gross profit as a percent of net sales (gross margin) was unchanged between periods, with a decrease of approximately 60 basis points attributed to the disposition of our North American manufacturing assets in December 2004 offset by increases achieved through our focus on supply chain management.
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Operating Expenses
Operating expenses
Operating expenses as a percent of net sales
Operating expenses as a percent of net sales decreased 20 basis points from the second quarter of 2004 as increases in employee related insurance costs and incentive compensation were offset by our ability to leverage much of our existing distribution infrastructure and personnel base to support our sales growth.
Interest Expense
Interest expense increased $0.8 million between periods as the effective interest rate increased to 3.9% in 2005 from 2.2% in 2004 and average debt outstanding was 14% higher in the second quarter of 2005 compared to the second quarter of 2004.
Income Taxes
The increase in income taxes is due to the $9.4 million increase in income before income taxes and equity earnings, partially offset by a decrease in our effective income tax rate to 38.6% at June 30, 2005 from 39.0% at June 30, 2004. This decrease is due to the anticipated impact of certain tax advantaged business strategies.
Net Income and Earnings Per Share
In the second quarter of 2005, our equity interest in LAC contributed $1.9 million to net income. We expect similar results from our equity interest in LAC in the third quarter, followed by a seasonal slowdown in the fourth quarter. The second quarter results were adversely impacted by extended cold and wet weather in northern markets, where LAC has higher market concentration.
Earnings per share for the second quarter of 2005 increased 21% to $0.93 per diluted share compared to $0.77 in the second quarter of 2004.
Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004
Base business sales growth was 11% in the first six months of 2005. Net sales increased primarily due to the following:
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The decrease in gross margin is attributed primarily to the disposition of our North American manufacturing assets in December 2004 (an impact of approximately 50 basis points), as well as market and product mix changes and some margin erosion on the pass through of supplier price increases. These decreases were partially offset by increases achieved through our focus on supply chain management.
Operating expenses as a percent of net sales decreased 70 basis points from the first six months of 2004 as we were able to leverage much of our existing distribution infrastructure and personnel base to support our sales growth.
Interest expense increased $0.9 million between periods as the effective interest rate increased to 3.8% in 2005 from 2.3% in 2004 and average debt outstanding was 13% higher in the first six months of 2005 compared to the first six months of 2004. The increase in the interest rate and higher average debt outstanding was partially offset by a $0.3 million decrease in the amortization of financing fees.
The increase in income taxes is due to the $13.0 million increase in income before income taxes and equity earnings, partially offset by a decrease in our effective income tax rate to 38.6% at June 30, 2005 from 39.0% at June 30, 2004. This decrease is due to the anticipated impact of certain tax advantaged business strategies.
In the first six months of 2005, our equity interest in LAC contributed $0.4 million to net income. For the year, we expect a positive contribution to our earnings from LAC.
Earnings per share for the first six months of 2005 increased 19% to $1.01 per diluted share compared to $0.85 in the first six months of 2004. We expect earnings per share growth of 20% for the year ending December 31, 2005.
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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 swimming pool use and installation. Sales are substantially lower during the first and fourth quarters when we may incur net losses.
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 data for the first and second quarters of 2005, the four quarters of 2004 and the third and fourth quarter of 2003. 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 the swimming pool industry, the results of any one or more quarters are not necessarily an accurate indication of results for an entire fiscal year or of continuing trends.
(in thousands)
Statement of Income Data
Operating income (loss)
Net income (loss)
Balance Sheet Data
Total receivables, net
Total debt
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 service centers. We attempt to open new service centers at the end of the fourth quarter or the first quarter of the subsequent year to take advantage of preseason sales programs and the following peak selling season.
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Weather is the principal external factor 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
Unseasonably cool weather or
• Fewer pool installations
extraordinary amounts of rain
• Decreased purchases of chemicals and supplies
• Decreased purchases of impulse items such as above-ground pools and accessories
Unseasonably early warming trends
(primarily in the northern half of the US)
• A longer pool season, thus increasing our sales
Unseasonably late warming trends
• A shorter pool season, thus decreasing our sales
Liquidity and Capital Resources
Liquidity is defined as the ability to generate adequate amounts of cash to meet current 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:
Our primary capital needs are seasonal working capital obligations and other general corporate purposes, including acquisitions, share repurchases and dividend payments. Our primary sources of working capital are cash from operations supplemented by bank borrowings. Borrowings, together with cash from operations, historically have been sufficient to support our growth and finance acquisitions. Our priorities for the use of cash are as follows:
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Our unsecured syndicated senior credit facility (the Credit Facility), which matures on November 2, 2009, provides for a $120.0 million five-year revolving credit facility, which includes sublimits for the issuance of swingline loans and standby letters of credit. The aggregate maximum principal amount of the commitments under the Credit Facility may be increased from time to time by a total amount of up to $40.0 million.
During the six months ended June 30, 2005, we received net proceeds of $19.8 million from the Credit Facility. At June 30, 2005, there was $70.2 million outstanding and $47.8 million available for borrowing under the Credit Facility. The average effective interest rate of the Credit Facility was approximately 4.1% for the six months ended June 30, 2005.
Our obligations under the Credit Facility are guaranteed by all of our existing and future direct and indirect subsidiaries. Borrowings and standby letters of credit under the Credit Facility bear interest, at our option, at either of the following:
We are also required to pay (a) an annual facility fee of 0.150% to 0.250%, with such spread in each case depending on our leverage ratio, (b) an annual commercial letter of credit issuance fee of 0.125% multiplied by the face amount of each letter of credit and (c) a letter of credit commission of 0.150% to 0.250% multiplied by face amount of each letter of credit, with such spread in each case depending on our leverage ratio.
The Credit Facility contains customary terms and provisions (including representations, covenants and conditions) and events of default. If an event of default occurs and is continuing under the Credit Facility, the lenders may terminate their obligations thereunder and may require us to repay all amounts thereunder.
In the first quarter of 2005, we renewed our accounts receivable securitization facility (the Receivables Facility), which provides a seasonal borrowing capacity of up to $100.0 million, through June 2006. The Receivables Facility provides for the true sale of certain of our receivables as they are created to a wholly-owned, bankruptcy-remote subsidiary. This subsidiary grants an undivided security interest in the receivables to an unrelated commercial paper conduit. Because of the structure of the bankruptcy-remote subsidiary and our ability to control its activities, we include the transferred receivables and related debt in our consolidated balance sheet. We employed this arrangement because it provides us with a lower cost form of financing. At June 30, 2005, there was $100.0 million outstanding under the Receivables Facility at an average effective interest rate of 3.5%.
As of June 30, 2005, we were in compliance with all covenants and financial ratio requirements related to our Credit Facility and our Receivables Facility.
Cash used in operating activities increased $10.4 million to $51.6 million for the six months ended June 30, 2005, compared to $41.2 million for the same period last year. This change is due to increases in working capital in the second quarter of 2005, related to the increase in net sales.
We believe we have adequate availability of capital to fund present operations and anticipated growth, including expansion in existing and targeted market areas. We continually evaluate potential acquisitions and hold discussions with acquisition candidates. If suitable acquisition opportunities or working capital needs arise that would require additional financing, we believe that our financial position and earnings history provide a solid base for obtaining additional financing resources at competitive rates and terms. Additionally, we may issue common or preferred stock to raise funds.
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Accounts Receivable and the Allowance for Doubtful Accounts
Due to the seasonal nature of our business, accounts receivable increased $134.1 million to $231.7 million at June 30, 2005 from $97.6 million at December 31, 2004. Accounts receivable increased $34.0 million, or 17%, from $197.7 million at June 30, 2004. The increase from the second quarter of 2004 to the second quarter of 2005 is consistent with the 12% increase in net sales between periods.
The allowance for doubtful accounts decreased to $3.0 million at June 30, 2005 from $3.7 million at June 30, 2004. This decrease reflects a 14% reduction in our total past due accounts receivable balance between periods, as we have continued to enhance our collection management practices and improved average collection days from 34 days at June 30, 2004 to 33 days at June 30, 2005.
Product Inventories and the Reserve for Shrink and Obsolescence
Due to the seasonal nature of our business, product inventories increased $51.6 million to $247.4 million at June 30, 2005 from $195.8 million at December 31, 2004. Inventory increased $27.7 million, or 13%, compared to $219.7 million at June 30, 2004.
Consistent with the increase in inventory, our inventory reserve increased to $4.1 million at June 30, 2005 compared to $3.1 million at December 31, 2004 and $3.6 million at June 30, 2004.
Share Repurchase Program
In the second quarter of 2005, we repurchased approximately 1,400 shares of our common stock at an average price of $34.46 per share. These shares represent shares of common stock withheld upon the exercise of certain options outstanding under the Company’s 1995 and 1998 Stock Option Plans and having a value equal to the amount of tax required to be withheld with respect to such options and/or the exercise price of such options.
On July 22, 2005, $27.4 million of the amount authorized by our Board of Directors for future share repurchases remained available. We intend to continue to repurchase shares on the open market from time to time, depending on market conditions.
Critical Accounting Policies
Critical accounting policies are those that are both important to the accurate portrayal of a company’s financial condition and results, and require the most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
In order to prepare financial statements that conform to accounting principles generally accepted in the United States (GAAP), we make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Certain estimates are particularly sensitive due to their significance to the financial statements and the possibility that future events may be significantly different from our expectations.
For a description of our critical accounting policies, please see our Annual Report on Form 10-K for the year ended December 31, 2004. We have not changed these policies from those previously disclosed.
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
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projections of future performance, statements of management’s plans and objectives, future contracts, and forecasts of trends and other matters. 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 could be affected by one or more factors, which could cause them to differ materially. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act.
Certain factors that may affect our business and could cause actual results to differ materially from those expressed in any forward-looking statements include the following:
We are susceptible to adverse weather conditions.
Weather is the principal external factor affecting our business. For example, unseasonably late warming trends can decrease the length of the pool season and unseasonably cool weather or extraordinary rainfall during the peak season can decrease swimming pool use, installation and maintenance, which adversely affects sales of our products.
Our business is highly seasonal.
In 2004, approximately 66% of our net sales were generated in the second and third quarters of the year, which represent the peak months of swimming pool use, installation, remodeling and repair, and 96% of our operating income was generated in the same period. Our sales are substantially lower during the first and fourth quarters of the year, when we may incur net losses.
We face intense competition both from other leisure product alternatives and from within the pool industry.
We face competition from both outside our industry with sellers of other leisure product alternatives, such as boats and motor homes, and from within our industry with various regional and local distributors and, to a lesser extent, mass market retailers and large pool supply retailers. New competitors may emerge as there are low barriers to entry in our industry. Some geographic markets that we serve, particularly our largest, higher density markets in California, Florida, Texas and Arizona, representing approximately 51% of our net sales in 2004, also tend to be more competitive than others.
More aggressive competition by mass merchants could adversely affect our sales.
Mass market retailers today carry a limited range of, and devote a limited amount of shelf space to, merchandise and products targeted to the pool industry. Historically, mass market retailers have generally expanded by adding new stores and product breadth, but their product offering of pool related products has remained relatively constant. Should mass market retailers increase their focus on the pool industry or increase the breadth of their pool related product offerings and become a more significant competitor for direct and end-use customers, this could have an adverse impact on our business.
The demand for our swimming pool and leisure related products may be adversely affected by economic downturns.
In economic downturns, the demand for swimming pool or leisure related products may decline as discretionary consumer spending, the increase in pool eligible households and swimming pool construction decline. Although maintenance products and repair and replacement equipment that must be purchased by pool owners to maintain existing swimming pools account for more than 60% of our gross profits, the growth of our business depends on the expansion of the installed pool base, which may be viewed by most consumers as a discretionary expenditure that may be adversely affected by economic downturns.
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The nature of our business subjects us to compliance with Environmental, Health, Transportation and Safety Regulations.
We are subject to regulation under federal, state and local environmental, health, transportation and safety requirements, which govern such things as packaging, labeling, handling, transportation, storage and sale of pool chemicals and other products. For example, we sell algaecides that are regulated as pesticides under the Federal Insecticide, Fungicide and Rodenticide Act and state pesticide laws, which primarily relate to labeling and annual registration.
Failure to comply with these laws and regulations may result in the assessment of administrative, civil, and criminal penalties or the imposition of injunctive relief. Moreover, compliance with such laws and regulations in the future could prove to be costly, and there can be no assurance that we will not incur such costs in material amounts. These laws and regulations have changed substantially and rapidly over the last 20 years, and we anticipate that there will be continuing changes. The clear trend in environmental, health, transportation and safety regulation is to place more restrictions and limitations on activities that impact the environment, such as the use and handling of chemical substances. Increasingly, strict restrictions and limitations have resulted in increased operating costs for us, and it is possible that the costs of compliance with such laws and regulations will continue to increase. We will attempt to anticipate future regulatory requirements that might be imposed and to plan accordingly in order to remain in compliance with changing regulations and to minimize the costs of such compliance.
We store chemicals and other combustible materials that involve fire, safety and casualty risks.
We store chemicals, including certain combustible, oxidizing compounds, at our service centers. A fire, explosion or flood affecting one of our facilities could give rise to fire, safety and casualty losses and related liability claims. We maintain what we believe is prudent insurance protection. However, we cannot guarantee that we will be able to maintain adequate insurance in the future at rates we consider reasonable or that our insurance coverage will be adequate to cover future claims that may arise. Successful claims for which we are not fully insured may adversely affect our working capital and profitability. In addition, changes in the insurance industry have generally led to higher insurance costs and decreased availability of coverage.
We may not be able to sustain our pace of growth.
We have experienced substantial sales growth in recent years through acquisitions and the opening of new locations that have increased our size, scope and geographic distribution. Since 2000, we have opened 29 new service centers and have completed 12 acquisitions, consisting of 74 service centers (net of service center closings and consolidations). While we contemplate continued growth through acquisitions and internal expansion, no assurance can be made as to our ability to:
If we do not manage these potential difficulties successfully, our operating results could be adversely affected.
We depend on key personnel.
Our future success depends to an extent upon the continued service of Manuel Perez de la Mesa, our Chief Executive Officer, and to a lesser degree, our other executive officers and key management personnel, and on our ability to continue
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to attract, retain and motivate qualified personnel. The loss of Mr. Perez de la Mesa in particular could have a material adverse effect on our business. Mr. Perez de la Mesa is not nearing retirement age, and we have no indication that he intends to retire in the near future. We do not currently maintain key man insurance on Mr. Perez de la Mesa.
Our distribution business is highly dependent on our ability to maintain favorable relationships with suppliers and manufacturers.
As a distribution company, maintaining favorable relationships with our suppliers is critical to the success of our business. We believe that we add considerable value to the swimming pool supply chain by purchasing products from a large number of manufacturers and distributing the products to a highly fragmented customer base on conditions that are more favorable than these customers could obtain on their own. We believe that we currently enjoy good relationships with our suppliers, who generally offer us competitive pricing, return policies and promotional allowances. However, our inability to maintain favorable relationships with our suppliers could have an adverse effect on our business.
Our largest suppliers are Pentair Corporation, Hayward Pool Products, Inc. and Waterpik Technologies, Inc., which accounted for approximately 16%, 9% and 7%, respectively; of the costs of products we sold in 2004. While we do not believe that the loss of any single supplier would adversely affect our business, a decision by several suppliers, acting in concert, to sell their products directly to retail customers and other end-users of their products, bypassing distribution companies like ours, would have an adverse effect on our business. We dedicate significant resources promoting the benefits and affordability of pool ownership, which we believe greatly benefits our customers and suppliers.
The growth of our business depends on effective marketing programs.
The growth of our business depends on the expansion of the installed pool base. Thus, an important part of our strategy is to promote the growth of the pool industry through our extensive advertising and promotional programs that attempt to raise consumer awareness regarding the benefits and affordability of pool ownership, the ease of pool maintenance and the many ways in which a pool may be enjoyed beyond swimming. These programs include media advertising, website development such as www.swimmingpool.com ™ and public relations campaigns. We believe these programs benefit the entire supply chain from our suppliers to our customers.
We also promote the growth of our customers’ businesses through comprehensive support programs that offer promotional tools and marketing support to help generate increased sales for our customers. Our programs include such things as personalized websites, brochures, marketing campaigns and business development training. We also provide certain retail store customers with assistance in site selection, store layout and design and business management system implementation. Our inability to sufficiently develop effective advertising, marketing and promotional programs to succeed in an weakened economic environment and an increasingly competitive marketplace, in which we (and our entire supply chain) also compete with other luxury product alternatives, could have a material adverse effect on our business.
A terrorist attack or the threat of a terrorist attack could have a material adverse effect on our business.
The terrorist attacks that took place on September 11, 2001, in the U.S. were unprecedented events that have created many economic and political uncertainties, some of which may materially impact our business. Discretionary spending on leisure products such as ours is generally adversely affected during times of economic uncertainty. The potential for future terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility have created many economic and political uncertainties, which could adversely affect our business for the short or long-term in ways that cannot presently be predicted.
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Interest Rate Risk
There have been no material changes from what we reported in our Form 10-K for the year ended December 31, 2004.
Foreign Exchange Risk
The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the Act). The rules refer to the controls and other procedures designed to ensure that information required to be disclosed in reports that we file or submit under the Act is recorded, processed, summarized and reported within the time periods specified. As of June 30, 2005, management, including the CEO and CFO, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, management, including the CEO and CFO, concluded that as of June 30, 2005, our disclosure controls and procedures were effective at ensuring that material information related to us or our consolidated subsidiaries is made known to them and is disclosed on a timely basis in our reports filed under the Act.
We maintain a system of internal control over financial reporting that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Based on the most recent evaluation, we have concluded that no significant changes in our internal control over financial reporting occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
The table below summarizes the repurchases of our common stock in the second quarter of 2005.
Period
April 1-30, 2005
May 1-31, 2005
June 1-30, 2005
At the Annual Meeting of Stockholders held on May 10, 2005, the following proposals were adopted by the margins indicated:
Andrew W. Code
James J. Gaffney
George T. Haymaker
Manuel J. Perez de la Mesa
Harlan F. Seymour
Wilson B. Sexton
Robert C. Sledd
John E. Stokely
For
Against
Abstain
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Exhibits filed as part of this report are listed in the Index to Exhibits appearing on page 21.
Items 1, 3, and 5 are not applicable and have been omitted.
19
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on July 29, 2005.
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