================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1998 [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to Commission file number 0-26640 SCP POOL CORPORATION (Exact name of registrant as specified in its charter) <TABLE> <S> <C> Delaware 36-3943363 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 109 Northpark Boulevard, Covington, LA 70433-5001 (Address of principal executive offices) (Zip Code) </TABLE> Registrant's telephone number, including area code: 504/892-5521 Securities registered pursuant to Section 12(b) of the Act: None <TABLE> <S> <C> Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.001 per share </TABLE> 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of voting stock and non-voting common equity held by non-affiliates of the registrant as of March 19, 1999 was approximately $141,933,675. As of March 19, 1999 the Registrant had 11,489,031 shares of Common Stock outstanding. Documents Incorporated by Reference Portions of the Registrant's Proxy Statement to be mailed to stockholders on or about April 12, 1999 for the Annual Meeting to be held on May 12, 1999, are incorporated by reference in Part III. ================================================================================
PART I ------ Item 1. Business. - ------- --------- General SCP Pool Corporation (together with its wholly-owned subsidiaries, the "Company") distributes swimming pool supplies and related products to swimming pool remodelers and builders, independent retail stores and swimming pool repair and service companies. The Company distributes more than 34,000 national brand and private label products to approximately 26,000 customers. These products include both non-discretionary pool maintenance products, such as chemicals and replacement parts, packaged pools (kits to build swimming pools which include walls, liners, bracing and other materials), and pool equipment, such as cleaners, filters, heaters, pumps and lights. The Company is a successor to a business founded in 1980 by the Company's former President and Chief Executive Officer, Frank J. St. Romain. The Company and its wholly owned subsidiary, South Central Pool Supply, Inc. ("SCP Supply"), were organized by Code, Hennessy & Simmons Limited Partnership ("CHS") and members of the management of the Predecessor (as defined below) for the purpose of acquiring substantially all of the assets and business of Lake Villa Corporation (formerly known as South Central Pool Supply, Inc.), a Louisiana corporation (the "Predecessor"). CHS had no relationship with the Predecessor prior to such acquisition. On December 31, 1993, SCP Supply acquired substantially all of the assets and business of the Predecessor in a leveraged buyout. During 1998, the Company added 11 service centers in the northeastern United States through an acquisition, one service center in California following an inventory acquisition, and one service center in the United Kingdom through a third acquisition. In 1998 the Company also opened five new service centers and closed two service centers. As of December 31, 1998, the Company operated 89 service centers in 32 states and one service center in the United Kingdom. During January 1999, the Company added 20 service centers located primarily in the Midwestern United States through an acquisition (of which 13 are to be consolidated into existing service centers) and one service center in the United Kingdom through another acquisition. During the first fiscal quarter of 1999, the Company also opened four new service centers. The Company currently operates 100 service centers in 34 states and two service centers in the United Kingdom. The Company's net sales have grown from approximately $32.1 million in 1990 to $457.6 million in 1998. Operating income has increased from $2.1 million in 1990 to $25.4 million in 1998. The Company expects to continue its growth strategy by opening service centers in new locations, increasing sales at existing service centers and making strategic acquisitions. The Acquisitions In January 1994, the Company substantially increased its operations by acquiring certain assets of Aqua Fab Industries, Inc., including eight service centers (three of which the Company subsequently closed and consolidated into existing service centers) in the midwest and southeast regions of the United States. In February 1995, the Company acquired all of the outstanding capital stock of Orcal Pool Supplies, Inc., thereby adding nine service centers. In March 1995, the Company acquired certain assets of Aqua Chemical Sales and Delivery, Inc., primarily inventory and a service center in Illinois. In October 1995, the Company acquired certain assets, primarily inventory and one service center in each of Oregon and Washington, of Crest Distribution, a division of Aman Enterprises, Inc. In November 1995, the Company acquired the capital stock of Steven Portnoff Corporation, which operated a service center in Scottsdale, Arizona, and in December 1995, the Company acquired certain assets, primarily inventory and a service center in Las Vegas, Nevada, of Pool Mart of Nevada, Inc., an affiliate of Steven Portnoff Corporation.
In September 1996, the Company acquired certain assets (primarily inventory, property and equipment) of The B-L Network, Inc. ("BLN"), a wholesaler of swimming pool supplies with 39 service centers in 12 states (the "BLN Acquisition"), for an aggregate purchase price of approximately $34.5 million. The Company subsequently consolidated 15 of the BLN service centers into existing service centers. The purchase price for the BLN Acquisition was financed primarily through the issuance of promissory notes payable to BLN which have since been repaid. In connection with the BLN Acquisition, the Company sold the chemical manufacturing and repackaging assets of Alliance Packaging, Inc ("Alliance Packaging"), a subsidiary of SCP Supply, to Bio-Lab, Inc. ("Bio- Lab"), the parent of BLN and a subsidiary of Great Lakes Chemical Corporation, for approximately $5.4 million (the "Alliance Sale"). In addition, the Company and Bio-Lab entered into two five-year supply agreements pursuant to which Bio- Lab agreed to supply the Company with certain chemical products previously supplied to it by Alliance Packaging and with certain chemical products previously supplied to BLN by Bio-Lab (the "Bio-Lab Supply Agreements"). In January 1998, the Company acquired certain assets of Bicknell Huston Distributors, Inc. ("Bicknell"), a wholesaler of swimming pool supplies with 11 service center locations in six northeastern states (the "Bicknell Acquisition"), for an aggregate purchase price of approximately $21 million, subject to certain adjustments. The purchase price for the Bicknell Acquisition was financed through the offering to the public of 2,025,000 shares of the Company's Common Stock in December 1997 (the "1997 Public Offering"). In connection with the Bicknell Acquisition, the Company entered into a long-term supply agreement (the "Pacific Supply Agreement") with Pacific Industries, Inc., a subsidiary of Cookson Group plc and the sole stockholder of Bicknell ("Pacific"). Under the terms of the Pacific Supply Agreement, Pacific will supply the Company with polymer panels, braces, steps, liners and other products used in the construction of in-ground vinyl pools. The Pacific Supply Agreement has a term of eight years and is subject to renewal options. Mr. DeMichele, who, prior to his death in December 1998, was a director of the Company, was also a director of Pacific and held certain executive positions with affiliates of Pacific. See "Certain Relationships and Related Transactions." In February 1998, the Company aquired certain inventory of Valve Engineering Acquisition Co., a distributor of swimming pool supplies in Glendale, California. In August 1998, the Company acquired the capital stock of Nor-Cal Limited, which distributes swimming pool supplies through its service center in Crawley, England (the "Nor-Cal Acquisition") and in January 1999, the Company acquired the capital stock of Pratts Plastics Limited, which distributes swimming pool supplies through its service center in Essex, England under the trade name "The Swimming Pool Warehouse." In January 1999, the Company acquired certain assets of Benson Pump Company, a wholesaler of swimming pool supplies with 20 service center locations in 16 states (the "Benson Acquisition"). The Company is in the process of consolidating 13 of these service center locations into the Company's existing service center locations. The aggregate purchase price for the Benson Acquisition was approximately $21 million, subject to certain adjustments. Industry Overview The swimming pool supply industry can be divided into four categories by pool type: residential in-ground swimming pools, above-ground swimming pools, commercial swimming pools and spas or hot tubs. The Company's strategy has been to focus on distributing products to the residential in-ground and above-ground and small commercial pool markets. Management believes approximately 60% of total pool industry revenues are based upon numerous ongoing maintenance and repair requirements associated with pool ownership. The maintenance of proper chemical balance and the related maintenance and repair of swimming pool equipment, such as pumps, heaters, filters and cleaners, create a non-discretionary demand for pool chemicals and other swimming pool supplies and services. The balance of pool supply industry revenues is derived from sales of the parts and equipment required for pool remodeling, overhaul and repair and from the sales and installation of new swimming pools. Although the installation of new pools and, to a lesser extent, the remodeling and overhaul of existing pools are affected by general economic conditions, particularly new housing 2
construction, management believes that most continuing repair requirements are not as sensitive to these changes in economic conditions. The pool supply distribution industry is fragmented, with the majority of sales spread among over 170 companies. The five largest distributors operate on a national or regional basis, while the remaining distributors tend to be family-owned operations with one to three distribution sites, typically serving a highly localized customer base with a limited geographic focus. During the last ten years, the industry has experienced consolidation as certain larger distributors have acquired smaller local and regional distributors. Such consolidation has permitted the larger pool supply distributors to benefit from various economies of scale. Larger distributors also have been able to take advantage of more sophisticated management techniques and the development of management information systems specifically designed to enhance customer service and increase operating efficiency. Management anticipates further consolidation in the industry and increased competition as a result. Growth Strategy The Company intends to continue to make strategic acquisitions to further penetrate existing markets and to expand into new geographic markets. The Company continuously seeks out appropriate acquisition candidates and is frequently engaged in discussions regarding potential acquisitions. The Company completed one acquisition in 1994, five acquisitions in 1995, one acquisition in 1996, three acquisitions in 1998 and two acquisitions in January 1999. The Company intends to open service centers in geographic areas which are not currently served by, or are underserved by, the Company. The Company has opened nineteen new service centers during the last five years. Each new service center requires approximately $75,000 of capital expenditures for leasehold improvements and office and warehouse equipment and a minimum of $250,000 of inventory. The Company also intends to open satellite service centers that are smaller than the Company's typical service center, stock fewer inventory items and have fewer employees and a lower cost structure, yet have access to the Company's full inventory through its information systems. The Company intends to capitalize on opportunities to expand sales at its existing service centers. Comparable service center sales increased 15%, 16%, 19%, 11% and 14% in 1994, 1995, 1996, 1997 and 1998, respectively. The Company believes that it can increase its market share by expanding its private label marketing programs for chemicals and in-ground vinyl pools with swimming pool remodelers and builders and repair and service companies and by further developing its joint marketing programs with its customers. The Company also plans to increase the breadth of its replacement parts product offering and periodically to add to its outside sales force. Products The Company offers more than 34,000 national brand and private label products to approximately 26,000 customers. These products include both non- discretionary pool maintenance products, such as chemicals and replacement parts, packaged pools (kits to build swimming pools which include walls, liners, bracing and other materials), and pool equipment, such as cleaners, filters, heaters, pumps and lights. The Company supplies a substantial majority of the national brand products offered by swimming pool equipment manufacturers. Sales of national brands accounted for a majority of the Company's net sales in 1998. Management believes that national brands are attractive to many of the Company's customers who seek consistent product quality throughout their operations, particularly for heaters, pumps, filters and cleaners. The Company believes it has good relationships with all of its major suppliers of national brands, many of which provide important sales and marketing support to the Company. Approximately one-third of the Company's chemical products, which include chlorine, algicides, water clarifiers and Ph adjusters, are sold under the Company's private brands. These brands include Regal/R/, and EZ-Clor/R/, which are sold to retail and professional customers, pool remodelers and builders, and pool service and repair companies. Most of these chemical products are converted from bulk to retail form by Bio-Lab and sold to the Company under the Bio-Lab 3
Supply Agreements. See "--Purchasing and Suppliers." The Company sells packaged in-ground vinyl pools (which consist of prefabricated in-ground pool structures with a vinyl liner) under the Company's Weatherking(R), Heldor(R), Signature Pools/TM/, Regatta Pools/TM/ and Prestige/TM/ brands. The Company also sells a private label line of above-ground pool kits under the name Dream Line/TM/ and pool covers under the Cool Covers/TM/ brand name. Marketing The Company's principal marketing activities are conducted by a dedicated sales force of 84 employees and by its service center managers. The Company's dedicated sales force has responsibility for developing and maintaining customer relationships. These salespersons and service center managers make calls on customers, distribute the Company's product catalog and parts manual and provide promotional literature in the display areas of the service center. The Company's commission program is designed to reward account profitability and promote sales growth. Under the Company's incentive program, salespersons may earn bonuses of up to 50% of their annual salaries, based on attainment of certain sales and profitability targets. Customers The Company sells its products to approximately 26,000 customers, primarily swimming pool remodelers and builders, retail swimming pool stores and swimming pool repair and service companies. No customer accounted for more than 1% of the Company's sales during 1998. The Company estimates that in 1998, sales to swimming pool remodelers and builders accounted for approximately 40% of its sales, while sales to retail pool stores accounted for approximately 30% of sales, and sales to repair and service companies accounted for the remainder. Swimming pool remodelers and builders purchase products to refurbish, retrofit or overhaul existing pools and to build new pools. Customers that operate retail pool stores tend to have a single outlet and typically purchase a relatively broad range of products from the Company, including chemicals, maintenance supplies, repair parts and other related products. Repair and service companies tend to provide on-site repair and cleaning services for residential pools. These customers tend to be very small and typically purchase chemical products, maintenance supplies and repair parts. A substantial portion of the Company's sales are derived from "delivery" business, in which local deliveries of products are made directly to customer locations. The Company also offers "walk- in" service in all of the markets it serves. The Company maintains a credit policy for qualified customers. Credit policies and terms are established at the corporate level, and each service center manager is responsible for overseeing and collecting from local accounts. During each of the last three years, the Company's bad debt expense was less than 0.25% of net sales. Purchasing and Suppliers The Company has a good relationship with its suppliers which generally offer competitive pricing, rebates, return policies and promotional allowances. The Company works closely with many of its suppliers to develop joint marketing plans. In addition, it is common in the swimming pool supply industry for manufacturers to offer extended dating terms on their products to qualifying purchasers, such as the Company. Such terms are typically available to the Company for pre-season or early season purchases. Prior to October 31, 1996, a substantial portion of the Company's chemical products were supplied by its subsidiary, Alliance Packaging. On October 31, 1996, Alliance Packaging sold certain of its assets to Bio-Lab and Bio-Lab and the Company entered into the Bio-Lab Supply Agreements. Under the Bio-Lab Supply Agreements, Bio-Lab supplies the Company with certain chemical products previously supplied to it by Alliance Packaging and with certain chemical products previously supplied to BLN by Bio-Lab. In addition, in connection with the Bicknell Acquisition, the Company entered into the Pacific Supply Agreement with Pacific, the sole stockholder of Bicknell. Under the terms of the Pacific Supply Agreement, Pacific will supply the Company with polymer panels, braces, steps, liners and other products used in the construction of in-ground pools. The Pacific Supply Agreement has a term of eight years, subject to renewal options. The principal chemical raw materials used in the products sold by the Company are granular chlorine compounds, which are commodity materials. The prices of granular chlorine compounds are a function of, among other 4
things, manufacturing capacity and demand. Although price increases in granular chlorine compounds generally result in higher costs of supplies to the Company, the Company generally has passed through such increased costs to its customers. There can be no assurance that the price of granular chlorine compounds will not increase in the future or that the Company will be able to pass on any such increase to its customers. The Company believes that reliable alternate sources of supply are available for all of its products, including chlorine products. The Company regularly evaluates supplier relationships and considers alternate sourcing as appropriate to assure competitive costs and quality standards. The Company's largest non-affiliated suppliers are Pac-Fab, Inc. (a subsidiary of Essex Corporation), Hayward Pool Products, Inc. and Bio-Lab, and these suppliers provided approximately 15%, 13% and 8%, respectively, of the Company's material purchases in 1998. In 1998, Pacific supplied approximately 4% of the Company's purchases, and Pacific is expected to supply a similar percentage of the Company's purchases in 1999. See "Certain Relationships and Related Transactions." The Company currently has long-term contracts with Bio- Lab and Pacific, but does not have contracts with Pac-Fab, Inc. or Hayward Pool Products, Inc. The Company believes that it has good relationships with all of its suppliers. Decisions relating to pricing, suppliers and product selection are decentralized at the Company's service centers, with significant input from the Company's headquarters. Decisions relating to purchases and inventory management are made independently by each of the Company's service center managers using the data provided by the Company's information systems. Competition The Company faces intense competition from many regional and local distributors in its markets, from several companies that distribute swimming pool supplies on a national basis and, to a lesser extent, from mass market retailers and large pool supply retailers. The Company believes that there are five swimming pool supply distributors which compete with the Company on a national or regional basis: Hughes Supply, Inc., Pool Water Products, Superior Pool Products, Inc. (a subsidiary of Arch Chemicals, Inc.), Gorman Company (a division of Hajoica) and Fort Wayne Pools. Barriers to entry in the swimming pool supply industry are relatively low. The Company competes with other distributors for rights to distribute brand-name products, and the loss of, or inability to obtain such rights could have a material adverse effect on the Company. Management believes that the competition for such distribution rights results in a competitive advantage to larger distributors, such as the Company, and a disadvantage to small distributors. The Company believes that the principal competitive factors in pool supply distribution are the quality and level of customer service, product pricing, breadth and quality of products offered and consistency and stability of business relationships with customers. The Company believes it competes favorably with respect to each of these factors. Some geographic markets serviced by the Company, particularly California, Arizona, Texas and Florida, tend to be more competitive than others. Seasonality and Weather The Company's business is highly seasonal. In 1998, approximately 68% of the Company's 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 approximately 120% of the Company's operating income was generated in such period. Sales are substantially lower during the first and fourth quarters of the year, when the Company typically incurs net losses. The principal external factor affecting the Company's business is weather. 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, each of which adversely affects the Company's sales and operating profit. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations--Seasonality and Quarterly Fluctuations." 5
Environmental, Health and Safety Regulation The Company's business is subject to regulation under federal, state, and local environmental and health and safety requirements, including the Emergency Planning and Community Right-to-Know Act, the Hazardous Materials Transportation Act and the Occupational Safety and Health Act. Most of these requirements govern the packaging, labeling, handling, transportation, storage and sale of pool chemicals by the Company. In addition, the algicides sold by the Company are regulated as pesticides under the Federal Insecticide, Fungicide and Rodenticide Act and state pesticide laws, which primarily relate to labeling and annual registration. While the Company expends considerable resources to operate in substantial compliance with environmental, health and safety requirements, there can be no assurance that it will not be determined to be out of compliance with, or liable under, such requirements. Such an instance of noncompliance or liability could have a material adverse effect on the Company and its operating results. Fire, Safety and Casualty Issues The Company stores chemicals at each of its service centers. Certain chemicals the Company stores are combustible oxidizing compounds and the storage of such chemicals is strictly regulated by local fire codes. The Company maintains strict policies and procedures regarding chemical handling and fire and safety regulations, and has never incurred any material liability related to its handling of chemicals. A fire, explosion or flood affecting one of the Company's facilities could give rise to liability claims against the Company. Employees As of March 9, 1999, the Company employed approximately 1,100 persons on a full-time basis, of whom 270 engaged in management, administration and accounting, and credit and collections, 84 engaged in outside sales, 176 engaged in service center management and 570 engaged in warehouse, production and distribution operations. Of these employees, 82 are employed at the Company's corporate headquarters in Covington, Louisiana. In January, 1999, 91 of these employees were added to the Company in connection with the Benson Acquisition. No employees are covered by collective bargaining agreements. The Company believes it has good relations with its employees. In connection with the peak summer selling season, the Company typically employs additional warehouse, production and distribution personnel during the months from May through August. Trademarks The Company maintains registered trademarks in the United States, primarily for its private label products, and intends to maintain the trademark registrations which it deems important to its business operations. Item 2. Properties. As of March, 1999, the Company conducted operations through 102 service center locations located in 34 states and the United Kingdom. Service centers are located near customer concentrations, typically in industrial, commercial or mixed-use zones. The Company's executive offices are located in approximately 26,000 square feet of leased space in Covington, Louisiana. The Company's service centers range in size from approximately 6,000 square feet to 51,000 square feet and consist of warehouse, counter, display and office space. The Company owns the location of a former service center in Phoenix, Arizona, and the Company has entered a contract to sell such facility. In February, 1998, the Company sold 6
a facility in Fresno, California and leased it back from the purchaser for a three-year period beginning March 1, 1998. All of the Company's other properties are leased for terms which expire between 1999 and 2009, and many of such leases may be extended. In certain instances, the Company's service centers are leased from the former owners of businesses acquired by the Company. The Company believes that no single lease is material to its operations, and that alternate sites are presently available at market rates. See Item 13, "Certain Relationships and Related Transactions" and Note 7 to the Company's Consolidated Financial Statements. Item 3. Legal Proceedings. From time to time, the Company is involved in litigation and proceedings arising in the ordinary course of its business. There are no pending material legal proceedings to which the Company is a party or to which the property of the Company is subject. Item 4. Submission of Matters to a Vote of Security Holders. None. PART II ------- Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters. The Common Stock of the Company began trading on the Nasdaq National Market under the symbol "POOL" in October 1995. At March 19, 1999, there were 54 holders of record of Common Stock. The following table sets forth, for the period indicated, the range of high and low bid prices for the Common Stock as reported by the Nasdaq National Market, as adjusted to reflect a three-for-two stock split in July 1998. <TABLE> <CAPTION> Fiscal Year High Low ----------- ------- ------- <S> <C> <C> 1997 First Quarter................... $10.667 $ 8.781 Second Quarter.................. 11.115 8.667 Third Quarter................... 11.552 9.115 Fourth Quarter.................. 16.000 11.000 1998 First Quarter................... 15.672 12.250 Second Quarter.................. 16.922 14.672 Third Quarter................... 16.578 12.000 Fourth Quarter.................. 15.875 9.000 </TABLE> The bid information set forth above reflects inter-dealer prices, without retail mark-ups, markdowns or commissions and may not necessarily represent actual transactions. The Company currently intends to retain its earnings for use in its business and therefore does not anticipate paying any cash dividends in the foreseeable future. The Third Amended and Restated Credit Agreement dated as of December 31, 1997, by and among SCP Supply, the institutions from time to time party thereto as lenders, LaSalle National Bank as Agent and Co-Arranger and Hibernia National Bank as Co-Arranger (the "Senior Loan Facility") restricts the Company's ability to pay dividends. Any future determination to pay cash dividends will be made by the board of directors of the Company ("the Board") in light of the Company's earnings, financial position, capital requirements, credit agreements and such other factors as the Board deems relevant at such time. See Item 7, 7
"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and Note 3 of the Notes to the Company's Consolidated Financial Statements. Item 6. Selected Financial Data. The following table sets forth selected financial data of the Company and its Predecessor. This information should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Consolidated Financial Statements of the Company and the Predecessor and related Notes thereto included herein. <TABLE> <CAPTION> The Company -------------------------------------------------------------- Year Ended December 31, -------------------------------------------------------------- 1998 1997 1996 1995 1994 -------------------------------------------------------------- (Dollars in thousands, except per share data) <S> <C> <C> <C> <C> <C> Statement of Income Data: Net sales..................................... $457,598 $335,022 $235,844 $161,095 $101,977 Cost of sales................................. 355,059 261,645 183,814 123,974 77,488 -------- -------- -------- -------- -------- Gross profit........................... 102,539 73,377 52,030 37,121 24,489 Warehouse expense............................. 20,593 14,416 9,611 6,957 3,610 Selling and administrative expenses........... 55,459 42,355 31,139 19,907 13,518 Goodwill amortization......................... 1,102 885 793 735 683 -------- -------- -------- -------- -------- Operating income....................... 25,385 15,721 10,487 9,522 6,678 Other income (expense): Interest expense....................... (3,480) (4,482) (3,176) (5,113) (4,171) Amortization expense................... (848) (708) (698) (610) (498) Management fees paid to stockholder.... -- -- -- (208) (250) Miscellaneous income................... 724 852 823 228 118 -------- -------- -------- -------- -------- (3,604) (4,338) (3,051) (5,703) (4,801) -------- -------- -------- -------- -------- Income before income taxes and................ 21,781 11,383 7,436 3,819 1,877 extraordinary loss Provision for income taxes (1)................ 8,043 4,327 2,903 1,490 770 -------- -------- -------- -------- -------- Income before extraordinary loss (1).......... $ 13,738 $ 7,056 $ 4,533 $ 2,329 $ 1,107 ======== ======== ======== ======== ======== Income before extraordinary loss per share of common stock Basic (2).................................. 1.18 0.73 0.48 0.52 0.35 Diluted (2)................................ 1.15 0.71 0.46 0.50 0.33 Balance Sheet Data: Working capital............................... $ 61,672 $ 63,387 $ 34,602 $ 21,187 $ 8,493 Total assets.................................. 163,788 136,452 113,245 75,397 50,675 Total debt, including current portion......... 33,696 39,889 51,277 26,476 38,025 Stockholders' equity.......................... 80,564 66,635 36,810 32,277 3,037 </TABLE> (1) The Company recognized an extraordinary loss, net of tax, in 1995 of $750,000, or $0.17 per share on a diluted basis, in connection with the write-off of loan financing fees and a prepayment premium associated with the application of the proceeds of the Company's initial public offering to reduce indebtedness. (2) Earnings per share information has been restated to reflect the two three- for-two splits in September, 1997 and July, 1998 and the adoption of FASB 128, Earnings per Share. 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The Company was formed in December 1993 to acquire substantially all of the assets and assume certain liabilities of its Predecessor. From its inception in 1980 through the end of 1993, the Predecessor steadily increased its sales by opening new service center locations and by increasing sales to new and existing customers. Since the Company's acquisition of the Predecessor in December 1993, the Company has grown through strategic acquisitions, by opening new service centers and by increasing sales to new and existing customers. From January 1990 to March 1999, the Company expanded primarily through acquisitions from eight service centers in six states to a total of 102 service centers, 100 of which operate in 34 states in the United States and two of which operate in the United Kingdom. See "The Acquisitions." The Company derives its revenues primarily from the sale of swimming pool supplies and related products, including chemicals, cleaners, packaged pools and liners, filters, heaters, pumps, lights, repair parts and other equipment required to build, maintain, install and overhaul residential and small commercial swimming pools. The Company sells its products primarily to swimming pool remodelers and builders, independent swimming pool retailers and swimming pool repair and service companies. These customers tend to be small, family owned businesses with relatively limited capital resources. Losses from customer receivables have historically been less than 0.25% of net sales. The Company's business is highly seasonal. In general, sales and net 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 the Company may incur net losses. The swimming pool supply industry is affected by various factors, including general economic conditions, consumer saving and discretionary spending levels, the level of new housing construction, weather and consumer attitudes towards pool products for environmental or safety reasons. Although management believes that the Company's geographic diversity could mitigate the effect of a regional economic downturn and that the continuing maintenance and repair needs for existing swimming pools could mitigate the effect of a general economic downturn, there can be no assurance that the Company's results of operations and expansion plans would not be materially adversely affected by any of such downturns. The principal components of the Company's expenses include the cost of products purchased from manufacturers and sold during the year, and operating expenses, which are primarily related to labor, occupancy, commissions and marketing. Some geographic markets serviced by the Company, particularly California, Arizona, Texas, and Florida, tend to be more competitive than others. In response to competitive pressures from any of its current or future competitors, the Company may be required to lower selling prices in order to maintain or increase market share, and such measures could adversely affect the Company's gross margins and operating results. 9
Results of Operations The following table shows, for the periods indicated, information derived from the consolidated statements of income of the Company expressed as a percentage of net sales for such year. <TABLE> <CAPTION> Year Ended December 31 1998 1997 1996 ------------------------ <S> <C> <C> <C> Net sales 100.0% 100.0% 100.0% Cost of sales 77.6 78.1 77.9 ------------------------ Gross profit 22.4 21.9 22.1 Warehouse expense 4.5 4.3 4.1 Selling and administrative expenses 12.1 12.6 13.2 Goodwill amortization 0.2 0.3 0.3 ------------------------ Operating income 5.6 4.7 4.5 Interest expense (0.8) (1.3) (1.3) Amortization expense (0.2) (0.3) (0.3) Other income (expense): 0.2 0.3 0.3 ------------------------ Income before income taxes 4.8% 3.4% 3.2% ======================== </TABLE> The following discussions compare the results of operations for the year ended December 31, 1998 to the year ended December 31, 1997 and the results of operations for the year ended December 31, 1997 to the year ended December 31, 1996. Year Ended December 31, 1998 Compared to Year Ended December 31, 1997 Net sales increased by $122.6 million, or 36.6%, to $457.6 million in the year ended December 31, 1998 from $335.0 million in the comparable 1997 period. This increase was primarily due to sales at service centers acquired in 1998, sales at newly opened service centers, and increased sales at existing service centers. Service centers acquired in 1998 contributed $69.2 million to the increase, sales at newly opened centers accounted for $9.1 million of the total increase, and an increase of approximately 13.6% in sales at service centers open at least 15 months contributed $44.3 million to the increase. Gross profit increased by $29.1 million, or 39.6%, to $102.5 million in the year ended December 31, 1998 from $73.4 million in the comparable 1997 period. Gross profit as a percentage of net sales improved to 22.4% in the 1998 period from 21.9% in the 1997 period due primarily to higher margins at service centers acquired in the Bicknell Acquisition and also due to improved margins in California, Florida and the central United States compared to the same period in the previous year. Operating expenses increased by $19.4 million, or 33.6%, to $77.1 million in the year ended December 31, 1998 from $57.7 million in the comparable 1997 period. This increase is reflective of salaries, occupancy expense and other costs associated with new service centers, and, to a lesser extent, payroll and other operating costs required to support the increased sales volume at existing service centers. Operating expenses as a percentage of net sales decreased to 16.8% in the 1998 period compared to 17.2% in the 1997 period, primarily as a result of greater internal operating efficiences. Interest and other expenses decreased to $3.6 million in the year ended December 31, 1998 from $4.3 million in the comparable 1997 period. The decrease was primarily attributable to lower interest expense resulting from lower average outstanding debt levels between periods and a more favorable interest rate on the Senior Loan Facility. 10
The provision for income taxes increased $3.7 million, to $8.0 million for 1998 compared to $4.3 million for 1997 primarily due to the $10.4 million increase in income before income taxes. The Company's effective tax rate decreased to 37.0% for 1998 from 38.0% for 1997 to reflect decreases in the Company's blended state income tax rate. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Net sales increased by $99.2 million, or 42.1%, to $335.0 million in the year ended December 31, 1997 from $235.8 million in the comparable 1996 period. This increase was primarily due to sales at service centers acquired from BLN, sales at newly opened service centers and increased sales at existing service centers. Service centers acquired from BLN in September 1996 contributed $79.8 million to the increase, sales at newly opened centers accounted for $12.7 million of the total increase and an increase of approximately 11.4% in sales at service centers open at least 15 months contributed $12.4 million to the increase. These increases were partially offset by the loss of revenue from the assets of Alliance Packaging, Inc., which were sold in October 1996. Gross profit increased by $21.4 million, or 41.2%, to $73.4 million in the year ended December 31, 1997 from $52.0 million in the comparable 1996 period. Gross profit as a percentage of net sales remained relatively unchanged at 21.9% in the 1997 period compared to 22.1% in the 1996 period. Operating expenses increased by $16.2 million, or 38.8%, to $57.7 million in the year ended December 31, 1997 from $41.5 million in the comparable 1996 period. This increase is reflective of salaries, occupancy expense and other costs associated with new service centers, and, to a lesser extent, payroll and other operating costs required to support the increased sales volume at existing service centers. Operating expenses as a percentage of net sales decreased to 17.2% in the 1997 period compared to 17.6% in the 1996 period, primarily as the result of cost savings efforts instituted by management during 1997. Interest and other expenses increased to $4.3 million in the year ended December 31, 1997 from $3.1 million in the comparable 1996 period. The increase was primarily attributable to the increase in the Company's debt as a result of the acquisition of BLN in September 1996 and to the financing of seasonal inventory levels for a larger number of branches in the comparable 1996 period. The provision for income taxes increased $1.4 million, or 49.1%, to $4.3 million for 1997 compared to $2.9 million for 1996. The Company's effective tax rate decreased to 38.0% for 1997 from 39.0% for 1996 to reflect decreases in the Company's blended state income tax rate. Seasonality and Quarterly Fluctuations The Company's business is highly seasonal. In general, sales and net 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 the Company may incur net losses. The Company experiences a build-up of inventory and accounts payable during the first and second quarters of the year in anticipation of the peak swimming pool supply selling season. The Company's peak borrowing occurs during the second quarter, primarily because dated accounts payable offered by the Company's suppliers typically are payable in April, May and June, while the Company's peak accounts receivable collections typically occur in June, July and August. The principal external factor affecting the Company's business is weather. Hot weather can increase purchases of chemicals and supplies and pool installations. Unseasonably cool weather or extraordinary amounts of rainfall during the peak sales season can decrease purchases of chemicals and supplies and pool installations. In addition, unseasonably early or late warming trends can increase or decrease the length of the pool season and, therefore, the Company's sales. To encourage preseason orders, the Company, like many other swimming pool supply distributors, utilizes preseason sales programs which provide for extended dating terms and other incentives to its customers. Some of the 11
Company's suppliers also offer extended dating terms on certain products to the Company for preseason or early season purchases. In offering extended dating terms to its customers and accepting extended dating terms from its suppliers, the Company effectively finances a portion of its receivables with extended payables. The Company expects that its quarterly results of operations will fluctuate depending on the timing and amount of revenue contributed by new service centers and acquisitions. The Company attempts to open its new service centers at the end of the fourth quarter or the beginning of the first quarter to take advantage of preseason sales programs and the peak season. The following table sets forth certain unaudited quarterly data for 1998 and 1997 which, in the opinion of management, reflects all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of such data. Results of any one or more quarters are not necessarily indicative of results for an entire fiscal year or of continuing trends. <TABLE> <CAPTION> 1998 1997 ----------------------------------------- --------------------------------------- 1st 2nd 3rd 4th 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter -------- -------- -------- -------- ------- -------- ------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Net sales.......................... $73,988 $178,450 $133,883 $71,277 $63,565 $124,790 $98,492 48,175 Gross profit....................... 15,947 41,815 30,051 14,726 13,960 28,159 21,460 9,798 Operating income (loss)............ (1,156) 20,554 10,017 (4,030) 104 11,496 6,847 (2,726) Net sales as a percentage of annual net sales.................. 16% 39% 29% 16% 19% 37% 29% 15% Gross profit as a percentage of annual gross profit............... 16% 41% 29% 14% 19% 39% 29% 13% Operating income as a percentage of annual operating income........ (4%) 81% 39% (16%) 1% 73% 44% (18%) </TABLE> Liquidity and Capital Resources Currently, the Company's primary sources of working capital are cash flow from operations and borrowings under the Senior Loan Facility. As of March 1999, the Senior Loan Facility consisted of a term loan and a revolving line of credit with a total borrowing capacity of $86 million, subject to a borrowing base availability formula. Considering the Company's borrowing base and amounts outstanding as of March 1, 1999, the Company had approximately $25.1 million available for borrowing under the Senior Loan Facility, which amount represents the only additional credit source currently available to the Company. The Company's borrowings under its credit facility, together with cash flow from operations and seller financing historically have been sufficient to support the Company's growth and to finance acquisitions. Borrowings under the Senior Loan Facility may, at the Company's option, bear interest at either (i) the agent's corporate base rate or the federal funds rate plus 0.5%, whichever is higher, plus a margin ranging from 0.0% to 0.5% or (ii) LIBOR plus a margin ranging from 0.75% to 2.0%, in each case depending on the Company's leverage ratio. Substantially all of the assets of the Company, including the capital stock of SCP Supply, secure the Company's obligations under the Senior Loan Facility. The Senior Loan Facility has numerous restrictive covenants which require the Company to maintain minimum levels of interest coverage and fixed charge coverage and which also restrict the Company's and SCP Supply's abilities to pay dividends and make capital expenditures. As of December 31, 1998, the Company was in compliance with all such covenants and financial ratio requirements. The Senior Loan Facility expires on December 31, 2002. Between February 24, 1999, and March 19, 1999, the Company purchased 198,200 shares of its Common Stock pursuant to a share repurchase program announced in October 1998 (described below). Certain intercompany dividends paid prior to each of the purchases by the Company 12
of Common Stock created covenant defaults under the Senior Loan Facility. The lenders under the Senior Loan Facility have waived such defaults in accordance with the provisions of the Senior Loan Facility. In December 1997, the Company completed a public offering of 2,025,000 shares of Common Stock at a public offering price of $12.00 per share, resulting in net proceeds to the Company of approximately $22.6 million. Approximately $21 million of these proceeds were used to finance the Bicknell Acquisition in January 1998. In connection with the BLN Acquisition, the seller of BLN provided $31.8 million of financing to the Company. This financing, which accrued interest at 6%, was paid in full at December 31, 1998. During the year ended December 31, 1998, the Company borrowed $40.9 million to meet seasonal working capital requirements and made payments of $40.3 million under its revolving credit facility. Excluding acquisitions, the Company made capital expenditures of $1,971,000, $1,105,000 and $788,000 in the years ended December 31, 1998, 1997 and 1996, respectively. The Company believes that its cash flow from operations and the credit available under its line of credit will be sufficient to finance its operations for at least the next twelve months. To date, the Company's acquisitions have been financed primarily by borrowings under the Senior Loan Facility and seller notes. To finance future acquisitions, the Company expects to utilize its ability to borrow additional funds. Depending on market conditions, the Company may also incur additional indebtedness or issue common or preferred stock (which may be issued to third parties or to sellers of acquired businesses). Share Repurchase Program In October 1998, the Company announced that it may purchase in the open market or directly from stockholders up to $10,000,000 of Common Stock of the Company over a twelve-month period at prices that the Company deems appropriate. As of March 19, 1999, the Company had purchased a total of 198,200 shares of its Common Stock at an average price of $13.51 per share. Year 2000 Issue The Company utilizes and relies upon computer technology in many facets of its operations, including its inventory and ordering information systems, the internal and external reporting of financial and operating information and other systems and equipment, such as telephones and security systems. The Company is currently continuing the process it initiated in 1997 of identifying and remediating computer systems or other equipment which will not be Year 2000 compliant when handling date-related data beyond the twentieth century. State of Readiness - The Company's core accounting and information systems are based on consecutively numbered days, and not the "month-date-year" format which is more vulnerable to Year 2000 problems. The Company's hardware and software system vendors have assured the Company that its systems are able to correctly function beyond 1999 when handling date-related data. To verify the assurances of third-party hardware and software vendors regarding Year 2000 issues, the Company has been testing its hardware and software under a testing program. A portion of the testing program was conducted during the fourth quarter of 1998, and as a result of those tests the Company did not identify any areas of Year 2000 noncompliance. The Company will be working with consultants during the first quarter of 1999 to develop additional testing procedures, and the Company will perform such procedures during the first and second quarter of 1999. The Company will work to remediate any Year 2000 noncompliance as such noncompliance is identified as a result of the testing program. The Company is near completion of the process of collecting information from each of its service centers regarding all other devices, such as personal computers, telephones, security systems, and office and warehouse equipment which may have "embedded" microprocessors utilizing date information. The assessment, testing and any necessary remediation of such equipment is expected to be complete by June 1999. If the assessment, testing and remediation steps described above are not accomplished in a timely manner, the Year 2000 issue could have a material impact on the Company's operations. 13
The Company is communicating with its major suppliers and service providers and certain large customers regarding their compliance with Year 2000 requirements. The Company has sent out questionnaires to certain suppliers and service providers to identify potential problems and assess the compliance efforts undertaken by these parties. The Company has received responses from a majority of such parties. Since most of the responses indicated that efforts to comply with Year 2000 requirements are ongoing, further communications with the Company's major suppliers and service providers will be needed. There can be no guarantee that the systems of third parties will be made compliant in a timely manner and would not have an adverse effect on the Company. Costs to Address the Year 2000 Issue - In 1997, the Company upgraded the hardware and software of its core accounting and information systems for a total cost of $1.5 million. The Company believes this cost was, for the most part, not directly related to Year 2000 issues, but rather, the new systems were needed in the normal course due to the growth the Company has experienced. The Company recently incurred costs of $300,000 to upgrade certain data communications equipment. The Company believes that this data communications upgrade would have been required in the normal course, but the Company accelerated the timing of this upgrade in part to improve its Year 2000 readiness. Because it is still in the assessment phase in some areas, the Company does not yet have an estimate on its Year 2000 assessment, testing and remediation costs for all systems and equipment, but based on current information the Company believes that such costs are not likely to have a material adverse effect on the Company's business, financial condition or operating results. Management anticipates funding the costs to address the Year 2000 issue with cash generated from operations and from borrowing capacity under the Senior Loan Facility. Risks Presented by the Year 2000 Issue - There may be unanticipated delays in completing the Company's planned Year 2000 assessment and remediation and, as the process of inventorying the systems proceeds, the Company may identify additional systems that present a Year 2000 risk. In addition, if any third parties who provide goods or services essential to the Company's business activities fail to appropriately address their Year 2000 issues, such failure could have a material adverse effect on the Company's business, financial condition, or operating results. For example, a Year 2000 related disruption on the part of the financial institutions which process the Company's transactions could have a material adverse effect on the Company's business, financial condition or operating results. Contingency Plans - The Company's Year 2000 initiative includes the development of contingency plans to address failures of significant portions of the Company's systems or failures by third parties who provide goods or services essential to the Company's business to address their Year 2000 issues. The Company will be working with consultants to develop such plans and expect to conclude the development of these contingency plans by the end of the second quarter of 1999. Item 7a. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to market risks, including interest rate risk and foreign currency risk. The adverse effects of potential changes in these market risks are discussed below. The following discussion does not consider the effects of the reduced level of overall economic activity that could exist following such changes. Further, in the event of changes of such magnitude, management would likely take actions to mitigate its exposure to such changes. The Company has not used derivative instruments to engage in speculative transactions or hedging activities. Interest Rate Risk As a result of the variable interest rates on the Senior Revolving Note and Senior Term Note under the Senior Loan Facility, the Company's earnings are exposed to changes in short-term interest rates. If (i) the variable rates on the Company's Senior Loan Facility were to increase by 1% from the rate at December 31, 1998; (ii) the Company borrowed the maximum amount available under its revolving line of credit ($65.0 million) for all of 1999, and (iii) the Company made all required payments of principal ($5 million) in 1999, solely as a result of the increase in interest rates, then the Company's interest expense would increase, resulting in a $296,000 decrease in net income, assuming an effective tax rate of 37%. The fair value of the Company's Senior Revolving Note and Senior Term Note is not affected by changes in market interest rates. 14
Foreign Exchange Risk The Company has a subsidiary located in the United Kingdom for which the functional currency is the British Pound. The Company typically does not hedge its foreign currency exposure. Historically, fluctuations in British Pound/U.S. dollar exchange rates have not had a material effect on the Company. Future changes in the exchange rate of the U.S. dollar to the British pound may positively or negatively impact the Company's revenues, operating expenses and earnings; however, due to the size of its operations in the United Kingdom, the Company does not anticipate its exposure to foreign currency rate fluctuations to be material in 1999. Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 With the exception of historical matters, the matters discussed in this Annual Report on Form 10-K are forward-looking statements that involve risks and uncertainties, including but not limited to factors related to (i) the Company's ability to identify appropriate acquisition candidates, complete acquisitions on satisfactory terms, or successfully integrate acquired businesses; (ii) the sensitivity of the swimming pool supply business to cool or rainy weather; (iii) the intense competition and low barriers to entry in the swimming pool supply industry; (iv) the Company's ability to obtain financing on satisfactory terms and the degree to which the Company is leveraged; (v) the sensitivity of the swimming pool supply business to general economic conditions; (vi) the Company's ability to remain in compliance with the numerous environmental, health and safety requirements to which it is subject; (vii) the risk of fire, safety and casualty losses and related liabilities claims inherent in the storage and repackaging of chemicals sold by the Company; (viii) Year 2000 issues; and (ix) the other factors discussed in the Company's filings with the Securities and Exchange Commission. Such factors could affect the Company's actual results and could cause such results to differ materially from the Company's expectations described above. Item 8. Financial Statements. - ------- --------------------- See the attached Consolidated Financial Statements (pages F-1 through F-22). Item 9. Changes in and Disagreements with Accountants on Accounting and - ------- --------------------------------------------------------------- Financial Disclosure. --------------------- None. PART III -------- Item 10. Directors and Executive Officers of the Registrant. - -------- --------------------------------------------------- Incorporated by reference to the Company's 1999 Proxy Statement to be filed with the Commission. Item 11. Executive Compensation. - -------- ----------------------- Incorporated by reference to the Company's 1999 Proxy Statement to be filed with the Commission. Item 12. Security Ownership of Certain Beneficial Owners and Management. - -------- --------------------------------------------------------------- Incorporated by reference to the Company's 1999 Proxy Statement to be filed with the Commission. 15
Item 13. Certain Relationships and Related Transactions. - -------- ----------------------------------------------- Incorporated by reference to the Company's 1999 Proxy Statement to be filed with the Commission. PART IV ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. - -------- ---------------------------------------------------------------- The following documents are filed as a part of this report: (a) (1) The Consolidated Financial Statements included in Item 8 hereof and set forth on pages F-1 through F-22. (2) Financial Statement Schedules. All schedules are omitted, because they are not applicable or are not required, or because the required information is included in the consolidated financial statements or notes thereto. (3) The exhibits listed in the Index to the Exhibits. (b) Reports on Form 8-K. None. 16
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 March 25, 1999. SCP POOL CORPORATION By: /S/ WILSON B. SEXTON -------------------------- Wilson B. Sexton, Chairman, Chief Executive Officer and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on March 25, 1999. <TABLE> <CAPTION> Signature Title --------- ------- <S> <C> /S/ WILSON B. SEXTON Chairman, Chief Executive Officer and Director Wilson B. Sexton /S/ MANUEL J. PEREZ DE LA MESA President and Chief Operating Officer Manuel J. Perez de la Mesa /S/ CRAIG K. HUBBARD Chief Financial Officer, Treasurer and Secretary Craig K. Hubbard /S/ ANDREW W. CODE Director Andrew W. Code /S/ JAMES J. GAFFNEY Director James J. Gaffney /S/ PETER M. GOTSCH Director Peter M. Gotsch /S/ FRANK J. ST. ROMAIN Director Frank J. St. Romain /S/ ROBERT C. SLEDD Director Robert C. Sledd </TABLE>
INDEX TO FINANCIAL STATEMENTS Consolidated Financial Statements of SCP Pool Corporation <TABLE> <S> <C> Report of Independent Auditors.............................................. F-2 Consolidated Balance Sheets - December 31, 1998 and 1997.................... F-3 Consolidated Statements of Income - Years Ended December 31, 1998, 1997 and 1996................................................................... F-4 Consolidated Statements of Stockholders' Equity - Years Ended December 31, 1998, 1997 and 1996........................................................ F-5 Consolidated Statements of Cash Flows - Years Ended December 31, 1998, 1997 and 1996........................................................ F-6 Notes to Consolidated Financial Statements.................................. F-7 </TABLE> F-1
Report of Independent Auditors The Board of Directors SCP Pool Corporation We have audited the consolidated balance sheets of SCP Pool Corporation as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SCP Pool Corporation at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. New Orleans, Louisiana February 19, 1999, except for the fourth paragraph of Note 3, as to which the date is March 25, 1999 F-2
SCP Pool Corporation Consolidated Balance Sheets (In thousands, except share data) <TABLE> <CAPTION> December 31 1998 1997 --------------------- <S> <C> <C> Assets Current assets: Cash and cash equivalents $ 4,911 $ 22,296 Receivables 34,609 24,775 Inventory 69,377 48,261 Prepaid expenses 1,673 562 Deferred income taxes 1,600 580 --------------------- Total current assets 112,170 96,474 Property and equipment, net 5,435 4,792 Goodwill, net 43,940 32,614 Other assets, net 2,243 2,572 --------------------- Total assets $163,788 $136,452 ===================== Liabilities and stockholders' equity Current liabilities: Accounts payable $ 34,589 $ 20,266 Accrued expenses and other current liabilities 10,909 6,078 Current portion of long-term debt 5,000 6,743 --------------------- Total current liabilities 50,498 33,087 Deferred income taxes 4,030 3,584 Long-term debt, less current portion 28,696 33,146 Stockholders' equity: Preferred stock, $.01 par value; 100,000 shares authorized; no shares issued and outstanding - - Common stock, $.001 par value; 20,000,000 shares authorized; 11,639,434 and 11,610,071 shares issued and outstanding at December 31, 1998 and 12 12 1997, respectively Additional paid-in capital 52,516 52,348 Retained earnings 28,013 14,275 Accumulated other comprehensive income 23 - --------------------- Total stockholders' equity 80,564 66,635 --------------------- Total liabilities and stockholders' equity $163,788 $136,452 ===================== </TABLE> See accompanying notes. F-3
SCP Pool Corporation Consolidated Statements of Income (In thousands, except per share data) <TABLE> <CAPTION> Year ended December 31 1998 1997 1996 ------------------------------------- <S> <C> <C> <C> Net sales $457,598 $335,022 $235,844 Cost of sales 355,059 261,645 183,814 ------------------------------------- Gross profit 102,539 73,377 52,030 Warehouse expense 20,593 14,416 9,611 Selling and administrative expenses 55,459 42,355 31,139 Goodwill amortization 1,102 885 793 ------------------------------------- Operating income 25,385 15,721 10,487 Other income (expense): Interest expense (3,480) (4,482) (3,176) Amortization expense (848) (708) (698) Miscellaneous income, net 724 852 823 ------------------------------------- (3,604) (4,338) (3,051) ------------------------------------- Income before income taxes 21,781 11,383 7,436 Income taxes 8,043 4,327 2,903 ------------------------------------- Net income $ 13,738 $ 7,056 $ 4,533 ===================================== Income per share of common stock: Basic $ 1.18 $ .73 $ .48 ===================================== Diluted $ 1.15 $ .71 $ .46 ===================================== Weighted average shares outstanding: Basic 11,626 9,628 9,501 ===================================== Diluted 11,911 9,887 9,765 ===================================== </TABLE> See accompanying notes. F-4
SCP Pool Corporation Consolidated Statements of Stockholders' Equity (In thousands) <TABLE> <CAPTION> Accumulated Additional Other Common Stock Paid-In Retained Comprehensive Shares Amount Capital Earnings Income Total ----------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Balance at January 1, 1996 9,501 $ 9 $29,582 $ 2,686 $ - $32,277 Net income - - - 4,533 - 4,533 ----------------------------------------------------------------------- Balance at December 31, 1996 9,501 9 29,582 7,219 - 36,810 Common stock issued 2,025 3 22,555 - - 22,558 Exercise of stock option 41 - 182 - - 182 Conversion of convertible debt 43 - 29 - - 29 Net income - - - 7,056 - 7,056 ----------------------------------------------------------------------- Balance at December 31, 1997 11,610 12 52,348 14,275 - 66,635 Net income - - - 13,738 - 13,738 Foreign currency translation adjustment, net of income taxes of $14 - - - - 23 23 ------- Comprehensive income 13,761 ------- Exercise of stock options 29 - 168 - - 168 ----------------------------------------------------------------------- Balance at December 31, 1998 11,639 $12 $52,516 $28,013 $ 23 $80,564 ======================================================================= </TABLE> See accompanying notes. F-5
SCP Pool Corporation Consolidated Statements of Cash Flows (In thousands) <TABLE> <CAPTION> Year ended December 31 1998 1997 1996 --------------------------------------------- <S> <C> <C> <C> Operating activities Net income $ 13,738 $ 7,056 $ 4,533 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,285 2,553 2,503 Provision for doubtful accounts receivable, net of write-offs 247 544 388 Provision for inventory obsolescence, net of write-offs 730 447 (86) Provision for deferred income taxes (574) 1,277 1,029 Loss (gain) on sale of property and equipment 222 (28) 155 Changes in operating assets and liabilities, net of effects of acquisitions and disposals: Accounts receivable (1,321) (26) (12,571) Inventory (8,813) (7,086) 4,877 Prepaid expenses and other assets (1,420) (437) 31 Accounts payable 10,454 5,115 2,638 Accrued expenses and other current liabilities 2,852 (2,143) 4,129 --------------------------------------------- Net cash provided by operating activities 19,400 7,272 7,626 Investing activities Acquisition of businesses, net of cash acquired (29,676) - (1,664) Purchase of property and equipment (1,971) (1,105) (788) Proceeds from sale of property and equipment 864 127 73 --------------------------------------------- Net cash used in investing activities (30,783) (978) (2,379) Financing activities Net borrowings (repayments) of revolving loan 550 4,050 (1,000) Payments on long-term debt (6,743) (15,409) (1,669) Issuance of common stock 168 22,740 - --------------------------------------------- Net cash provided by (used in) financing activities (6,025) 11,381 (2,669) --------------------------------------------- Effect of exchange rate changes on cash 23 - - Change in cash and cash equivalents (17,385) 17,675 2,578 Cash and cash equivalents at beginning of year 22,296 4,621 2,043 --------------------------------------------- Cash and cash equivalents at end of year $ 4,911 $ 22,296 $ 4,621 ============================================= Supplemental cash flow information Cash paid (received) during the year for: Interest $ 3,416 $ 4,424 $ 3,279 ============================================= Income taxes, net of refunds $ 9,505 $ 4,508 $ (561) ============================================= Supplemental disclosure of noncash investing and financing activities Long-term debt issued to acquire businesses $ - $ - $ 31,846 ============================================= Long-term debt reduced through sale of business $ - $ - $ 4,376 ============================================= </TABLE> See accompanying notes. F-6
SCP Pool Corporation Notes to Consolidated Financial Statements December 31, 1998 1. Organization and Summary of Significant Accounting Policies Description of Business SCP Pool Corporation and its wholly owned subsidiaries (collectively referred to as the Company), after giving affect to the January 1999 acquisitions discussed below, maintain 100 service centers in 34 states and two in the United Kingdom, from which they sell swimming pool equipment and supplies to pool builders, retail stores, and service firms. In September 1996, the Company acquired certain assets, primarily inventory and property and equipment, of The B-L Network, Inc. (BLN), a wholesaler of swimming pool supplies with 39 service centers in 12 states. $31.8 million of the aggregate purchase price was financed by BLN, with the remaining $2.7 million representing liabilities assumed (see Note 6) and other costs incurred by the Company. This acquisition has been accounted for using the purchase method of accounting and the results of operations have been included in the accompanying consolidated financial statements since the date of acquisition. In connection with this acquisition, the Company recorded goodwill of $4.7 million. Unaudited pro forma results of operations of the Company for the year ended December 31, 1996, giving effect to the BLN acquisition as if it had occurred as of January 1, 1996, are as follows (in thousands, except per share data): <TABLE> <CAPTION> 1996 -------- <S> <C> Net sales $364,702 Gross profit $ 74,388 Operating income $ 10,095 Income before income taxes $ 3,098 Net income $ 3,098 Net income per share: Basic $ .33 Diluted $ .32 </TABLE> The unaudited pro forma consolidated results of operations for the year ended December 31, 1996 include pro forma adjustments for the incremental increase or decrease in amortization of goodwill and other intangible assets, interest expense, and income taxes associated with the acquisition. They do not reflect the anticipated savings in purchasing costs at BLN during the periods presented, nor do they reflect cost savings from the closure of certain BLN service centers. F-7
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 1. Organization and Summary of Significant Accounting Policies (continued) In January 1998, the Company acquired substantially all of the assets and assumed certain liabilities of Bicknell Huston Distributors, Inc. ("Bicknell"), which distributed swimming pool supplies and related products through its eleven service centers in six northeastern states, for a purchase price of approximately $22.7 million, which was paid in cash. This acquisition was accounted for using the purchase method of accounting, and the results of operations have been included in the accompanying consolidated financial statements since the date of the acquisition. In connection with this acquisition, the Company recorded goodwill of $6.1 million. In August 1998, the Company acquired the capital stock of Nor-Cal Ltd., which distributes swimming pool supplies and related products through its service center in Crawley, England, for a purchase price of $8.5 million, which was paid in cash. This acquisition was accounted for using the purchase method of accounting, and the results of operations have been included in the accompanying consolidated financial statements since the date of the acquisition. The purchase price was allocated to the net assets and liabilities based on fair value (assets of $5.1 million and liabilities of $2.9 million). In connection with this acquisition, the Company recorded goodwill of $6.3 million. Unaudited pro forma results of operations of the Company for the years ended December 31, 1998 and 1997, giving effect to the Bicknell and Nor-Cal acquisitions as if they had occurred as of January 1, 1997, are as follows (in thousands, except per share data): <TABLE> <CAPTION> 1998 1997 --------------------- <S> <C> <C> Net sales $463,432 $398,171 Gross profit $104,544 $ 88,682 Operating income $ 26,141 $ 20,014 Income before income taxes $ 22,308 $ 12,381 Net income $ 14,070 $ 7,675 Net income per share: Basic $ 1.21 $ 0.66 Diluted $ 1.18 $ 0.64 </TABLE> F-8
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 1. Organization and Summary of Significant Accounting Policies (continued) The unaudited pro forma consolidated results of operations for the years ended December 31, 1998 and 1997 include pro forma adjustments for the incremental increase or decrease in amortization of goodwill and other intangible assets, interest expense, and income taxes associated with the acquisitions. They do not reflect the anticipated savings in purchasing costs at Bicknell and Nor-Cal during the periods presented. In January 1999, the Company acquired substantially all of the assets and assumed certain liabilities of Benson Pump Co., which distributed swimming pool supplies and related products through its 20 service centers in 16 central and western states. Also in January 1999, the Company acquired the capital stock of Pratts Plastics Limited, which distributes swimming pool supplies through its service center in Essex, England under the trade name "The Swimming Pool Warehouse." The Benson Pump purchase price was approximately $21.6 million, which was paid in cash and The Swimming Pool Warehouse purchase price was $475,000, which was paid in cash. These acquisitions have been accounted for using the purchase method of accounting. Principles of Consolidation The consolidated financial statements include the accounts of SCP Pool Corporation and its wholly owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. Seasonality and Weather The Company's business is highly seasonal. Sales are substantially lower during the first and fourth quarters of the year, when the Company may incur net losses. The principal external factor affecting the Company's business is weather. Unseasonably early or late warming trends can increase or 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, each of which can adversely affect the Company's sales and operating profit. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. F-9
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 1. Organization and Summary of Significant Accounting Policies (continued) Financial Instruments The Company's carrying value of cash, trade receivables, accounts payable, and accrued liabilities approximates fair value due to the short maturity of those instruments. The carrying amount of long-term debt approximates fair value because it bears interest at variable rates. Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Credit Risk The Company performs periodic credit evaluations of its customers and generally does not require collateral. Receivables are generally due within 30 days, except for winter sales under early-buy programs for which extended terms are provided. Credit losses have been within management's expectations. Inventory Inventory consists primarily of goods purchased for resale and are carried at the lower of cost, using the average cost method, or market. At December 31, 1998 and 1997, the reserve for inventory obsolescence was approximately $3,008,000 and $2,161,000, respectively. The reserve for inventory obsolescence at each service center is based upon a number of factors, including the experience of the manager at the service center, the previous inventory management performance of the service center, geographical location, product offerings, and other factors. The Company believes that the reserve for inventory obsolescence may periodically require adjustment as the factors identified above change. Property and Equipment Property and equipment is stated at cost. The Company provides for depreciation principally by the straight-line method over estimated useful lives of three years for autos and trucks, five to ten years for leasehold improvements, and ten years for furniture and fixtures and machinery and equipment. Depreciation expense was approximately $1,335,000, $990,000, and $1,012,000 in 1998, 1997, and 1996, respectively. F-10
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 1. Organization and Summary of Significant Accounting Policies (continued) Goodwill Goodwill represents the excess of cost over the fair value of net assets acquired and is amortized over 40 years. At December 31, 1998 and 1997, accumulated amortization was approximately $4,196,000 and $3,096,000, respectively. The recoverability of goodwill is assessed periodically and takes into account whether the goodwill should be completely or partially written off or the amortization period accelerated. In evaluating the value and future benefits of goodwill, the recoverability from operating income is measured. Under this approach, the carrying value of goodwill would be reduced if it is probable that management's best estimate of future operating income before goodwill amortization will be less than the carrying amount of goodwill over the remaining amortization period. The Company assesses long-lived assets for impairment under FASB Statement No. 121, "Accounting for Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121). Under those rules, goodwill associated with assets acquired in a purchase business combination is included in impairment evaluations when events or circumstances exist that indicate the carrying amounts of those assets may not be recoverable. Other Assets Loan financing fees are being amortized over the term of the related debt. The noncompete agreement and organization costs are being amortized over five years. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities." The SOP is effective beginning on January 1, 1999, and requires that start-up costs capitalized prior to that date be written-off and any future start-up costs be expensed as incurred. The unamortized balance of start-up costs of $863,000, net of $319,000 tax benefit, will be written off as the cumulative effect of an accounting change as of January 1, 1999. Comprehensive Income As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (Statement 130). Statement 130 establishes new rules for the reporting and display of comprehensive income and its components. Under Statement 130, foreign currency translation adjustments, which prior to adoption were reported separately in shareholders' equity, are to be included in other comprehensive income. Since the Company had no such foreign currency translation F-11
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 1. Organization and Summary of Significant Accounting Policies (continued) adjustments in years prior to 1998, the adoption of Statement 130 had no affect on prior year financial statements. Income Taxes Deferred income taxes are determined by the liability method in accordance with Statement of Financial Accounting Standards (FAS) No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Stock Compensation Arrangements The Company accounts for its stock compensation arrangements under the provisions of APB 25, "Accounting for Stock Issued to Employees." Revenue Recognition The Company recognizes revenue when products are shipped. F-12
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 2. Details of Certain Balance Sheet Accounts Additional information regarding certain balance sheet accounts is presented below (in thousands): <TABLE> <CAPTION> December 31 1998 1997 ------------------------ <S> <C> <C> Receivables: Trade accounts, less allowance of $2,397 in 1998 and $1,938 in 1997 $28,068 $19,300 Vendor rebates 5,374 4,274 Income tax receivable 446 - Other 721 1,201 ------------------------ $34,609 $24,775 ======================== Property and equipment: Land $ 185 $ 429 Building 432 1,001 Autos and trucks 287 156 Machinery and equipment 2,465 1,485 Furniture and fixtures 4,082 3,434 Leasehold improvements 1,282 508 ------------------------ 8,733 7,013 Less accumulated depreciation 3,298 2,221 ------------------------ $ 5,435 $ 4,792 ======================== Other assets: Loan financing fees $ 2,539 $ 2,453 Noncompete agreement - 500 Organization costs 1,717 1,366 Other 356 282 ------------------------ 4,612 4,601 Less accumulated amortization 2,369 2,029 ------------------------ $ 2,243 $ 2,572 ======================== Accrued expenses and other current liabilities: Salaries, bonuses, and commissions $ 6,975 $ 2,880 Income taxes payable - 310 Other 3,934 2,888 ------------------------ $10,909 $ 6,078 ======================== </TABLE> F-13
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 3. Debt The components of the Company's debt were as follows (in thousands): <TABLE> <CAPTION> December 31 1998 1997 ------------------------ <S> <C> <C> Senior Revolving Note, variable rate (effective interest rate of 7.75% at December 31, 1998), due in 2002 $16,600 $16,050 Senior Term Note, variable rate (effective interest rate of 5.8% at December 31, 1998), payable in quarterly installments of variable amounts through 2002 17,000 21,000 Promissory Notes to BLN, interest rate of 6%, paid in 1998 - 1,859 8% Subordinated Notes, paid in 1998 - 884 10% Convertible Notes, due in 2002 96 96 ------------------------ 33,696 39,889 Less current portion 5,000 6,743 ------------------------ $28,696 $33,146 ======================== </TABLE> Maturities of long-term debt for the five succeeding years are $5,000,000 in 1999, $5,000,000 in 2000, $5,000,000 in 2001, and $18,696,000 in 2002. The Company's credit agreement includes, among other things, covenants which require the Company to maintain minimum levels of interest coverage and fixed charge coverage and restrict the ability of the Company and its subsidiaries to pay dividends and make capital expenditures. As of December 31, 1998, the Company was in compliance with all such covenants and financial ratio requirements. The Senior Loan Facility expires on December 31, 2002. Between February 24, 1999 and March 19, 1999, the Company purchased 198,200 shares of its Common Stock pursuant to a share repurchase program announced in October 1998. Certain intercompany dividends paid prior to each of the purchases by the Company created a covenant default under the Senior Loan Facility. On March 25, 1999, the lenders under the Senior Loan Facility waived such defaults. Substantially all of the assets of the Company are pledged as collateral for the Senior Revolving Note and the Senior Term Note. Available credit under the Senior Revolving Note, considering amounts currently outstanding, was approximately $48.4 million, subject to an accounts receivable and inventory borrowing base limit. At December 31, F-14
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 3. Debt (continued) 1998, the unused available credit under the Senior Revolving Note was approximately $30 million. The Company pays a quarterly commitment fee of .25% per annum of the unused portion of available credit under the Senior Revolving Note. The Convertible Notes may be converted at any time through December 31, 2002 into shares of the Company's common stock at a conversion price of $.98 per share. At December 31, 1998, the conversion of these notes would result in the issuance of 147,249 shares of the Company's common stock. Such shares have been reserved by the Company. 4. Income Taxes Significant components of the Company's deferred tax liabilities and assets were as follows (in thousands): <TABLE> <CAPTION> December 31 1998 1997 -------------------- <S> <C> <C> Deferred tax liabilities: Goodwill $3,853 $3,544 Trade discounts on purchases 106 157 Prepaid expenses 244 205 Other 919 906 -------------------- Total deferred tax liabilities 5,122 4,812 Deferred tax assets: Inventory 1,432 764 Allowance for doubtful accounts 1,023 736 Other 237 308 -------------------- Total deferred tax assets 2,692 1,808 -------------------- Net deferred tax liabilities $2,430 $3,004 ==================== </TABLE> F-15
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 4. Income Taxes (continued) Significant components of income taxes were as follows (in thousands): <TABLE> <CAPTION> December 31 1998 1997 1996 ------------------------------- <S> <C> <C> <C> Current: Federal $7,917 $2,644 $1,634 Other, primarily state 700 406 240 ------------------------------- 8,617 3,050 1,874 Deferred: Federal (513) 1,142 898 Other, primarily state (61) 135 131 ------------------------------- (574) 1,277 1,029 ------------------------------- Total $8,043 $4,327 $2,903 =============================== </TABLE> The reconciliation of income taxes computed at the federal statutory rates to income taxes was (in thousands): <TABLE> <CAPTION> December 31 1998 1997 1996 ------------------------------ <S> <C> <C> <C> Tax at statutory rates $7,623 $3,884 $2,528 Other, primarily state income taxes 420 443 375 ------------------------------ Total $8,043 $4,327 $2,903 ============================== </TABLE> 5. Common Stock and Earnings Per Share In July 1998, the board of directors declared a three-for-two stock split of the Company's common stock, which was paid in the form of a stock distribution on July 24, 1998 to the stockholders of record at the close of business on July 13, 1998. Accordingly, shares, per-share data and related capital amounts for all periods presented reflect the effects of this split. In accordance with FAS 128, the Company has presented basic earnings per share, computed on the basis of the weighted average number of shares outstanding during the period, and diluted earnings per share, computed on the basis of the weighted average number of shares and all dilutive potential shares outstanding during the year. A F-16
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 5. Common Stock and Earnings Per Share (continued) reconciliation between basic and diluted weighted average number of shares outstanding and the related earnings per share calculation is presented below for each of the years ended December 31: <TABLE> <CAPTION> 1998 1997 1996 ----------------------------- <S> <C> <C> <C> Numerator: Net income $13,738 $7,056 $4,533 Adjustment for interest expense, net of tax, on convertible notes 8 8 8 ----------------------------- Numerator for diluted earnings per share $13,746 $7,064 $4,541 ============================= Denominator: Denominator for basic earnings per share--weighted-average shares 11,626 9,627 9,501 Effect of dilutive securities: Stock options 138 93 72 Convertible notes 147 166 192 ----------------------------- Denominator for diluted earnings per share 11,911 9,886 9,765 ============================= Basic earnings per share $ 1.18 $ .73 $ .48 ============================= Diluted earnings per share $ 1.15 $ .71 $ .47 ============================= </TABLE> F-17
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 6. Commitments and Contingencies The Company leases facilities for its service centers, corporate office and vehicles under noncancelable operating leases that expire in various years through 2007 but which have options to extend for various terms. Rental expense under such operating leases was approximately $10,563,000 in 1998, $7,747,000 in 1997, and $4,815,000 in 1996. The future minimum lease payments as of December 31, 1998 related to noncancelable operating leases with initial terms of one year or more are set forth below (in thousands): <TABLE> <S> <C> 1999 $ 7,798 2000 6,080 2001 4,218 2002 3,084 2003 2,452 Thereafter 2,145 ------- $25,777 ======= </TABLE> In connection with the acquisition of BLN, the Company recorded liabilities at the date of acquisition of approximately $1,200,000 for lease buyouts, occupancy costs and employee termination costs related to the closing of 15 acquired facilities. During 1997, the Company recorded an additional increase of approximately $333,000 to goodwill for expected additional lease buyouts and occupancy costs related to these acquired facilities. As of December 31, 1998, the Company has closed all of the above-mentioned facilities, having paid $1,203,000 of such liabilities, and has a remaining accrual of approximately $330,000 to settle the remaining leases. In connection with the acquisitions of BLN and Bicknell, the Company entered into certain vendor supply agreements which require the Company to purchase a certain percentage of its annual requirements for certain products at prices defined by the supply agreements. These supply agreements have initial terms which expire in September 2001 and December 2005, respectively, with an indefinite number of three-year renewal periods until terminated by either party. In the normal course of business, the Company becomes involved as a defendant or plaintiff in various lawsuits. Although a successful claim for which the Company is not fully insured could have a material effect on the Company's financial condition, management is of the opinion that it maintains insurance coverage at levels generally consistent with industry standards to insure itself against the normal risks of operations. F-18
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 7. Employee Benefit Plans The Company's employees participate in a Company-sponsored savings and retirement plan which provides for discretionary Company contributions under a profit-sharing provision. Employees who are eligible to participate in the savings plan are able to contribute a percentage of their base compensation not to exceed 10%, subject to a dollar limit. The Company contributes an amount equal to 25% of employee contributions up to 6% of their base compensation. Employee contributions are invested in certain equity and fixed income securities based on employee elections. Matching contributions and profit- sharing contributions made by the Company were $272,000 and $1,100,000, respectively, in 1998, $197,000 and $934,000 respectively, in 1997, and $113,000 and $650,000 respectively, in 1996. 8. Stock Option Plans The 1995 Stock Option Plan authorizes the board of directors to grant, at its discretion, to employees, agents, consultants or independent contractors of the Company, options to purchase shares of common stock. The number of shares granted under this plan is limited to an aggregate amount of 900,000. Granted options have an exercise price of not less than the fair market value of the stock on the date of grant. Options generally are exercisable two years after the date of grant and expire December 31, 2003. In May 1998, the 1995 Stock Option Plan was suspended. This action had no effect on options granted prior to the suspension. In May 1998, the shareholders approved the 1998 Stock Option Plan, which authorizes the Board of Directors to grant, at its discretion, options to purchase shares of common stock, stock appreciation rights, restricted stock and performance awards to employees, agents, consultants or independent contractors of the Company. The number of shares authorized for issuance under this plan is limited to an aggregate amount of 1,125,000. Granted options have an exercise price of not less than the fair market value of the stock on the date of grant. Options generally are exercisable two or more years after the date of grant and expire ten years after the date of grant. No options were granted under the 1998 Stock Option Plan during 1998. The SCP Pool Corporation Non-Employee Directors Equity Incentive Plan permits the board of directors to grant to each non-employee director options to purchase shares of the Company's common stock. The number of shares granted under this plan is limited to an aggregate amount of 450,000. The options will have an exercise price of not less than the fair market value of the stock on the date of grant, and generally are exercisable one year after the date of grant and expire ten years after the date of grant. F-19
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 8. Stock Option Plans (continued) In March 1998, the Company's board of directors adopted the SCP Pool Corporation Employee Stock Purchase Plan. Under the plan, eligible employees may be granted rights to purchase up to an aggregate of 900,000 shares of common stock annually. Rights are exercisable at 85% of the applicable market value provided that this value is greater than book value per share. If 85% of the applicable market value is less than book value per share, rights are exercisable at book value per share. Rights are exercisable at the applicable market value if the applicable market value is less than book value per share. The applicable market value, as defined, is the lower of either the beginning of the plan year or the end of the plan year quoted market price of the Company's stock. Book value per share is determined as of the most recent audited consolidated balance sheet date. No shares were issued in 1998 under this plan. FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires the Company to disclose pro forma information regarding net income and earnings per share as if the Company had accounted for its employee stock options under the fair value method. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: <TABLE> <CAPTION> 1998 1997 1996 ------------------------------------- <S> <C> <C> <C> Risk-free interest rate 4.71% 6.2% 6.7% Expected dividend yield - - - Expected volatility .29 .38 .32 Weighted average expected life 4.1 years 4.1 years 3.4 years </TABLE> The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. F-20
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 8. Stock Option Plans (continued) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting period. As the Company accounts for stock compensation under APB 25, no compensation cost has been recognized for its stock options in the financial statements. Had the Company's stock based compensation plan been determined based on the fair value at the grant dates, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share data): <TABLE> <CAPTION> 1998 1997 1996 ------------------------------- <S> <C> <C> <C> Pro forma net income $13,193 $6,632 $4,392 Pro forma earnings per share: Basic $ 1.13 $ .69 $ .46 Diluted $ 1.11 $ .67 $ .45 </TABLE> A summary of the Company's stock option activity and related information for the plans described above is as follows: <TABLE> <CAPTION> 1998 1997 1996 ----------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ----------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Outstanding--Beginning of year 439,542 $ 7.38 253,202 $4.55 70,389 $2.29 Granted 178,500 13.50 226,125 9.25 182,813 5.42 Exercised 26,011 4.68 39,785 2.29 - - Forfeitures 11,280 9.85 - - - - -------- -------- -------- Outstanding--End of year 580,751 $ 9.92 439,542 $7.38 253,202 $4.55 ======== ======== ======== Exercisable at end of year 352,376 $ 7.38 210,605 $6.18 67,500 $5.00 ======== ======== ======== Weighted average fair value of options granted during the year $ 4.21 $ 3.63 $ 1.61 ======== ======== ======== </TABLE> Exercise prices for options outstanding as of December 31, 1998 ranged from $2.29 to $13.50, and had a weighted average remaining contractual life of 4.9 years. F-21
SCP Pool Corporation Notes to Consolidated Financial Statements (continued) 9. Quarterly Financial Data (Unaudited) The following is a tabulation of the Company's unaudited quarterly results of operations for the years ended December 31, 1998 and 1997 (in thousands, except per share data): <TABLE> <CAPTION> Quarter Ended 3/98 6/98 9/98 12/98 3/97 6/97 9/97 12/97 -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Net sales $73,988 $178,450 $133,883 $71,277 $63,565 $124,790 $98,492 $48,175 Gross profit 15,947 41,815 30,051 14,726 13,960 28,159 21,460 9,798 Net income (loss) (1,180) 12,233 5,820 (3,135) (603) 6,394 3,471 (2,206) Net income (loss) per share: Basic $ (.10) $ 1.05 $ .50 $ (.27) $ (.06) $ .67 $ .36 $ (.22) Diluted (.10) 1.03 .49 (.27) (.06) .65 .35 (.22) </TABLE> As a result of differences in the way in-the-money stock options are considered from quarter-to-quarter under the requirements of FAS 128, diluted EPS for annual periods may not equal the sum of the individual quarter's diluted EPS amount. F-22
<TABLE> <CAPTION> Sequential Exhibit Page Number Document Description Number - ------------------------------------------------------------------------------------------------ ---------- <S> <C> <C> <C> 3.1 Restated Certificate of Incorporation of the Company. (1) 3.2 Restated Bylaws of the Company. (2) 4.1 Form of certificate representing shares of Common Stock of the Company. (2) 4.2 Credit Agreement, dated as of December 31, 1993, by and among South Central Pool (2) Supply, Inc. (previously known as SCP Acquisition Corp.), The First National Bank of Chicago, as agent, and various lenders from time to time party thereto. 4.3 Amendment No. 1 to Credit Agreement, dated as of September 1, 1994, by and among (2) South Central Pool Supply, Inc. ("SCP Supply"), The First National Bank of Chicago, as agent, and various lenders from time to time party thereto. 4.4 Amendment No. 2 to Credit Agreement, dated as of January 20, 1995, by and among (2) SCP Supply, The First National Bank of Chicago, as agent, and various lenders from time to time party thereto. 4.5 Amendment No. 3 to Credit Agreement, dated as of February 28, 1995, by and among (2) South Central Pool Supply, Inc., The First National Bank of Chicago, as agent, and various lenders from time to time party thereto. 10.1 Asset Purchase Agreement, dated as of December 31, 1993, by and among the (2) Company, SCP Acquisition Corp., and South Central Pool Supply, Inc. 10.2 Registration Agreement, dated as of December 31, 1993, by and among the Company, (2) CHS, various management and outside investors, Berkeley Atlantic Income Limited, BG Services Limited, and PNC Equity Management Corp. 10.3 Asset Purchase Agreement, dated as of January 4, 1994, by and between Aqua Fab (2) Industries, Inc. and South Central Pool Supply, Inc. 10.4 Amendment No. 1 to Asset Purchase Agreement, dated as of January 7, 1994, by and (2) among Aqua Fab Industries, Inc. and South Central Pool Supply Industries, Inc. 10.5 Amendment No. 2 to Asset Purchase Agreement, dated as of January 18, 1994, by and (2) among Aqua Fab Industries, Inc. and South Central Pool Supply, Inc. 10.6 Amendment No. 3 to Asset Purchase Agreement, dated as of February 17, 1994, by and (2) among Aqua Fab Industries, Inc. and South Central Pool Supply, Inc. 10.7 Asset Purchase Agreement, dated as of January 20, 1995, by and among Alliance (2) Packaging, Inc., York Chemical Corporation and Wexco Incorporated. 10.8 Stock Purchase Agreement, dated as of February 15, 1995, by and among the Company, (2) Orcal Pool Supplies, Inc. and Ronald Hetzner. 10.9 Agreement, dated as of March 31, 1992, by and between Wexco and W.B. Sexton. (2) 10.10 Patent Assignment, dated as of January 20, 1995, between Wexco Incorporated and (2) Alliance Packaging, Inc. 10.11 Management Agreement, dated as of December 31, 1993, by and between CHS (2) Management Limited Partnership, an Illinois limited partnership, and SCP Acquisition Corp. 10.12 Management Agreement, dated as of February 28, 1995, by and between SCP Supply (2) and Ronald Hetzner. 10.13 SCP Pool Corporation 1995 Stock Option Plan.* (2) 10.14 Form of Individual Stock Option Agreement.* (2) 10.15 Form of Convertible Subordinated Note dated as of December 31, 1993 issued by SCP (2) Holding Corp. 10.16 Form of Junior Subordinated Note, dated as of December 31, 1993, issued by SCP (2) Holding Corp. </TABLE>
<TABLE> <CAPTION> Sequential Exhibit Page Number Document Description Number - -------- -------------------- ---------- <S><C> <C> <C> 10.17 Form of Executive Securities Agreement, dated as of December 31, 1993, among SCP (2) Holding Corp., Code Hennessy & Simmons Limited Partnership and certain executives. 10.18 Form of Lease, dated as of February 28, 1995, by and between Ronald Hetzner and (2) South Central Pool Supply, Inc. 10.19 Lease, dated as of November 8, 1993, by and between Northpark Alliance, LLC and (2) South Central Pool Supply, Inc. 10.20 Lease, dated as of November 7, 1991, by and between St. Romain Children's Trust and (2) South Central Pool Supply, Inc. +10.21 Sales Agreement, dated as of October 1, 1993, between PPG Industries, Inc. and SCP (2) Supply. 10.22 Asset Purchase Agreement, dated as of September 7, 1995, by and among SCP Supply, (3) Aman Enterprises, Inc., Stephen Aman and Walter Aman. 10.23 Stock Purchase Agreement, dated as of November 10, 1995, by and among SCP (3) Supply, Steven Portnoff Corporation and Steven Portnoff 10.24 Asset Purchase Agreement, dated as of December 12, 1995, by and among SCP Supply, (3) Pool Mart of Nevada, Inc., Robert Portnoff, Sarah Portnoff and Steven Portnoff 10.25 SCP Pool Corporation 1996 Non-Employee Director Equity Incentive Plan* (3) 10.26 Second Amended and Restated Credit Agreement, dated as of September 26, 1996, (4) among South Central Pool Supply, Inc., the First National Bank of Chicago and the Institutions party thereto as lenders 10.27 Asset Purchase Agreement, dated as of September 26, 1996, among South Central Pool (4) Supply, Inc., SCP Pool Corporation, The B-L Network, Inc. and Bio-Lab, Inc. 10.28 Asset Purchase Agreement, dated as of September 26, 1996, among Alliance (4) Packaging, Inc., SCP Pool Corporation, South Central Pool Supply, Inc. and Bio-Lab, Inc. + 10.29 Supply Agreement, among Bio-Lab, Inc., South Central Pool Supply, Inc., and SCP (4) Pool Corporation + 10.30 Supply Agreement, dated as of September 26, 1996, among Bio-Lab, Inc., South (4) Central Pool Supply, Inc., and SCP Pool Corporation ++10.31 Asset Purchase Agreement, dated as of November 13, 1997, among SCP Pool (5) Corporation, South Central Pool Supply, Inc., Bicknell Huston Distributors, Inc., Pacific Industries, Inc. and Cookson America, Inc. 10.32 Third Amended and Restated Credit Agreement, dated as of December 31, 1997, by and (6) among South Central Pool Supply, Inc., the institutions from time to time party thereto as lenders, LaSalle National Bank, as Agent and Co-Arranger and Hibernia National Bank as Co-Arranger. 10.33 Amendment, dated December 31, 1997, to the Asset Purchase Agreement, dated as of (6) November 13, 1997, among SCP Pool Corporation, South Central Pool Supply, Inc., Bicknell Huston Distributors, Inc., Pacific Industries, Inc. and Cookson America, Inc. 10.34 SCP Pool Corporation 1998 Stock Option Plan* (1) 10.35 Form of Stock Option Agreement under 1998 Stock Option Plan* 10.36 SCP Pool Corporation Employee Stock Purchase Plan* (1) 10.37 Amendment No. 1 to SCP Pool Corporation Employee Stock Purchase Plan* 10.38 Asset Purchase Agreement, dated as of January 8, 1999, among South Central Pool Supply, Inc., Benson Pump Co., Benson Pump-Georgia, Inc., and J.K.K.T. Corp. </TABLE>
<TABLE> <CAPTION> Sequential Exhibit Page Number Document Description Number - ------ -------------------- ---------- <S> <C> <C> 10.39 Employment Agreement, dated January 25, 1999, among SCP Pool Corporation, South Central Pool Supply, Inc. and Manuel J. Perez de la Mesa* 21.1 Subsidiaries of the registrant. (6) 23.1 Consent of Ernst & Young LLP 27.1 Financial Data Schedule </TABLE> ____________ + Confidential Treatment Granted. ++ Confidential Treatment Granted for portions of Exhibit C to this Agreement. * Management contract or compensatory plan or arrangement. (1) Incorporated by reference to the respective exhibit to the Company's Definitive Proxy Statement on Schedule 14A, filed April 8, 1998. (2) Incorporated by reference to the respective exhibit to the Company's Registration Statement No. 33-92738. (3) Incorporated by reference to the respective exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (4) Incorporated by reference to the respective exhibit to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1996. (5) Incorporated by reference to the respective exhibit to the Company's Registration Statement No. 333-40245. (6) Incorporated by reference to the respective exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997.