QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30‚ 2002 OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________.
COMMISSION FILE NO.: 0-26640
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 [_]
At November 12, 2002, there were 23,260,296 outstanding shares of the Registrant’s common stock, $.001 par value per share.
Note: The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date.
The accompanying Notes are an integral part of these Consolidated Financial Statements.
1
2
The accompanying Notes are integral part of these Consolidated Financial Statements.
3
SCP Pool Corporation (theCompany, which may be referred to as we, us or our) prepared the consolidated financial statements following accounting principles generally accepted in the United States (GAAP) and the requirements of the Securities and Exchange Commission (SEC). As permitted under those rules, certain footnotes or other financial information normally required by GAAP have been condensed or omitted. The financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The results for the interim periods are not necessarily indicative of the results to be expected for the full year.
We make estimates and assumptions that have an effect on the amounts that we report in our financial statements. Our most significant estimates are those relating to the allowance for doubtful accounts and the inventory reserve. We continually review our estimates and make adjustments as necessary, but actual results could turn out to be significantly different from what we expected when we made these estimates.
You should also read the financial statements and notes included in our latest Annual Report on Form 10-K. Except for the adoption of Statement of Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets, and SFAS 144, Accounting for the Impairment of Long-Lived Assets, as discussed in Note 3 below, the accounting policies used in preparing these financial statements are the same as those described in our Annual Report.
We reclassified certain amounts in our 2001 financial statements to conform to the 2002 presentation. These reclassifications had no effect on net income or earnings per share as previously reported.
We calculate basic earnings per share (EPS) by dividing net income by the weighted average number of common shares outstanding. Diluted EPS includes the dilutive effects of stock options and convertible notes.
On January 1, 2002, we adopted SFAS 142, Goodwill and Other Intangible Assets. Under these new rules, goodwill is no longer amortized but will be tested for impairment annually or at any other time when impairment indicators exist. Intangible assets with finite lives continue to be amortized over their useful lives. We completed the transitional goodwill impairment test in the first quarter of 2002 and determined that goodwill is not impaired.
4
The following table presents net income and earnings per share for the three month and nine month periods ended September 30, 2002 and September 30, 2001 in a comparative format assuming there was no goodwill amortization in 2001:
On January 1, 2002, we adopted SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses the financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and Accounting Principles Board Opinion 30, Reporting on the Results of Operations for a Disposal of a Segment of a Business. The adoption of this Statement did not have a material impact on our financial position or operating results.
Comprehensive income consists of net income and other gains and losses affecting stockholders’ equity that, under GAAP, are excluded from net income. In our case, these consist of foreign currency translation gains and losses and unrealized gains and losses on cash flow hedges, net of related income tax effects.
Comprehensive income for the three months ended September 30, 2002 and September 30, 2001 was $14.6 million and $12.0 million, respectively. Comprehensive income for the nine months ended September 30, 2002 and September 30, 2001 was $45.7 million and $38.4 million, respectively.
5
On August 16, 2002, we purchased 100% of the outstanding common shares of Fort Wayne Pools, Inc. (Fort Wayne or the Fort Wayne Acquisition). The results of Fort Wayne’s operations have been included in the Consolidated Financial Statements since that date. Fort Wayne was a distributor and manufacturer of swimming pool equipment, parts and supplies, and their distribution network consisted of 22 service centers in 16 states.
The acquisition of Fort Wayne is consistent with our strategy of complementing our internal growth with the purchase of additional service centers. The acquisition of these additional 22 service centers will expand the reach and market share of our Superior network allowing us to enhance our service capabilities and better serve the growing pool industry. In the fourth quarter of 2002, we plan to to close one of the acquired locations and consolidate 10 of the 22 acquired Fort Wayne service centers with Superior locations.
The approximate $44.2 million purchase price was paid in cash and included goodwill of approximately $28.8 million, none of which is expected to be deductible for tax purposes. Additionally, we signed non-compete agreements with certain former Fort Wayne shareholders providing for payments in the aggregate of $5.0 million over the next five years. We recorded the non-compete agreements at their present value of $4.4 million, which will be amortized over five years using the straight-line method.
The purchase price was determined based on negotiations with the former shareholders of Fort Wayne and our valuation considerations, which included historical and prospective earnings, net asset value and other valuation considerations consistent with our historical valuations of acquisitions. The purchase price, which is still preliminary, is being allocated primarily to inventory, accounts receivable, property and equipment, and goodwill.
This discussion should be read in conjunction with and is intended to update Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2001.
We currently conduct operations through 199 service centers in North America and Europe.
The following table presents information derived from the Consolidated Statements of Income expressed as a percentage of net sales.
Note: Percentages may not add to total due to rounding.
6
We calculate same store growth by excluding the following service centers from the calculation for 15 months:
We believe that this same store analysis best demonstrates the year-to-year performance of our service centers because it isolates the contributions from service centers that have continuously operated for at least 15 months in a stable environment unaffected by our acquisition and expansion activities. We often shift sales to or from an established location to a newly opened or acquired service center in order to provide a higher level of customer service as well as to decrease delivery costs.
The following discussion of consolidated operating results includes the operating results from service centers acquired in 2001 and 2002. We accounted for the acquisitions using the purchase method of accounting and the operating results have been included in our consolidated results since the respective acquisition dates.
Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001
Net sales increased $53.1 million, or 23%, to $288.8 million for the three months ended September 30, 2002 from $235.7 million in the comparable 2001 period. A 14% increase in same store sales contributed approximately $28.6 million to the increase and service centers acquired from Fort Wayne contributed $14.3 million. New locations opened within the last 15 months and service centers acquired in the second half of 2001 accounted for the remaining $10.2 million increase. The increase in same store sales is primarily due to the following:
Gross profit increased $13.4 million, or 22%, to $75.1 million for the three months ended September 30, 2002 from $61.7 million in the comparable 2001 period. Same store gross profit growth of 15% contributed $7.3 million to the increase and service centers acquired from Fort Wayne contributed $4.0 million. New service centers opened within the last 15 months and service centers acquired in the second half of 2001 accounted for the remaining $2.1 million increase. The increase in same store gross profit growth is primarily due to the 14% increase in same store sales.
Gross profit as a percentage of net sales (gross margin) decreased 20 basis points to 26.0% in the third quarter of 2002 compared to 26.2% in the third quarter of 2001, primarily due to higher freight-in costs compared to the prior period. Higher freight-in expense was a result of higher freight rates in 2002 and fewer freight-qualifying purchases made in the third quarter of 2002. The greater proportion and number of non-freight-qualifying orders were due primarily to the stronger than anticipated sales in the latter part of the pool season when service centers are motivated to reduce inventories, therefore buying in smaller non-freight-qualifying increments. When we place large orders or buy in bulk, the freight expense is either paid or discounted by the vendor. Despite the higher freight costs, same store gross margins increased by 20 basis points compared to the third quarter of 2001.
7
Operating expenses, which consist of selling and administrative expenses, increased $10.7 million, or 27%, to $50.6 million for the three months ended September 30, 2002 compared to $39.9 million in the third quarter of 2001. Excluding goodwill amortization in 2001, operating expenses increased $11.3 million, or 29%, from $39.3 million in the third quarter of 2001. Same store operating expenses increased 9%, or $2.6 million, while the acquired Fort Wayne service centers, new service centers opened within the last 15 months and service centers acquired in the second half of 2001 accounted for $5.1 million of the increase.
Operating expenses as a percentage of net sales increased 60 basis points to 17.5% in the third quarter of 2002 compared to 16.9% in the third quarter of 2001. Excluding goodwill amortization in 2001, operating expenses as a percentage of net sales increased 80 basis points to 17.5% in 2002 from 16.7% in 2001, primarily due to the dilutive effect of the Fort Wayne Acquisition, which was completed in the second half of the quarter when we typically experience lower sales, and new service centers. Other operating expenses with significant increases as a percentage of net sales in the third quarter of 2002 include insurance, advertising and payroll expenses. The increase in insurance expense is consistent with the overall rise in insurance costs, especially since the terrorist attacks of September 11, 2001. Our advertising and promotional expenses have also increased as a percentage of net sales as we continue to invest in our sales and marketing programs to promote the growth of the swimming pool industry and to help our customers grow their businesses. The increase in payroll is primarily attributable to an increase in our bonus accrual due to the strong sales and profit growth in the third quarter of 2002 versus the third quarter of 2001 when fewer service centers achieved their profitability and return on investment objectives. Same store operating expenses as a percentage of net sales decreased 60 basis points in the third quarter of 2002 compared to the third quarter of 2001 due to the strong sales growth and our overall control of expenses at the service center level.
In the third quarter of 2002, interest expense increased to $1.2 million from $1.0 million in the third quarter of 2001. Higher average debt outstanding in 2002 was partially offset by lower interest rates. The effective interest rate decreased to 3.7% in the third quarter of 2002 from 4.7% in the third quarter of 2001.
Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, 2001
Net sales increased $101.6 million, or 14%, to $824.2 million for the nine months ended September 30, 2002 from $722.6 million in the comparable 2001 period. A 10% increase in same store sales contributed approximately $55.6 million to the increase and service centers acquired from Fort Wayne contributed $14.3 million. New service centers opened within the last 15 months and service centers acquired in the second half of 2001 accounted for the remaining $31.7 million increase. The increase in same store sales is primarily due to the following:
Gross profit increased $27.7 million, or 15%, to $215.3 million for the nine months ended September 30, 2002 from $187.6 million in the comparable 2001 period. Same store gross profit growth of 10% contributed $14.9 million to the increase and service centers acquired from Fort Wayne contributed $4.0 million. New service centers opened within the last 15 months and service centers acquired in the second half of 2001 accounted for the remaining $8.8 million increase. The increase in same store gross profit growth is primarily due to the 10% increase in same store sales.
Gross margin increased 10 basis points to 26.1% in the first nine months of 2002 from 26.0% in the comparable 2001 period. The increase in freight costs in the third quarter of 2002 was largely offset by the increase in sales in the nine month period ended September 30, 2002. Same store gross margins increased 20 basis points in the first nine months of 2002 compared to the same period last year.
8
Operating expenses, which consist of selling and administrative expenses, increased $18.3 million, or 15%, to $138.1 million for the nine months ended September 30, 2002 compared to $119.8 million in the comparable 2001 period. Excluding goodwill amortization in 2001, operating expenses increased $19.9 million, or 17%, from $118.2 million in 2001. Same store operating expenses increased 6%, or $4.2 million, while the acquired Fort Wayne service centers, new service centers opened within the last 15 months and service centers acquired in the second half of 2001 accounted for $9.9 million of the increase.
Operating expenses as a percentage of net sales increased 20 basis points to 16.8% in the first nine months of 2002 compared to 16.6% in the first nine months of 2001. Excluding goodwill amortization in 2001, operating expenses as a percentage of net sales increased 40 basis points to 16.8% in 2002 from 16.4% in 2001, primarily due to the dilutive effect of the Fort Wayne Acquisition, which was completed in the second half of the quarter when we typically experience lower sales, and new service centers. Other operating expenses with significant increases as a percentage of net sales in the first nine months of 2002 include insurance and advertising expenses. The increase in insurance expense is consistent with the overall rise in insurance costs, especially since the terrorist attacks of September 11, 2001. Our advertising and promotional expenses have also increased as a percentage of net sales as we continue to invest in our sales and marketing programs to promote the growth of the swimming pool industry and to help our customers grow their businesses. Payroll expense as a percentage of net sales remained consistent between the nine month periods. Same store operating expenses as a percentage of net sales decreased 40 basis points in the first nine months of 2002 compared to the first nine months of 2001 due to the strong sales growth and our overall control of expenses at the service center level.
In the first nine months of 2002, interest expense decreased slightly to $3.9 million from $4.0 million in the same period of 2001. Although average debt outstanding was higher in the first nine months of 2002, the effective interest rate decreased to 4.0% from 5.6% in the comparable 2001 period, which is consistent with the overall decline in interest rates over the past year.
Seasonality and Quarterly Fluctuations
Our business is highly seasonal, and weather is the principal external factor affecting our business. The following table presents some of the possible effects resulting from various weather conditions.
In general, sales and operating income are highest during the second and third quarters, which represent the peak months of swimming pool use and installation. Sales are substantially lower during the first and fourth quarters when we may incur net losses.
9
We typically experience a build-up of product inventories and accounts payable during the winter months in anticipation of the following peak selling season. Excluding borrowings to finance acquisitions and share repurchases, our peak borrowing usually occurs during the second quarter, primarily because extended payment terms offered by our suppliers typically are payable in April, May and June, while our peak accounts receivable collections typically occur in June, July and August.
We expect that our quarterly operating results will continue to fluctuate depending on the timing and amount of revenue contributed by new service centers and acquisitions. We attempt to open new service centers at the end of the fourth quarter or the first quarter of the subsequent year to take advantage of preseason sales programs and the following peak selling season.
The following table presents certain unaudited quarterly data for the first, second and third quarters of 2002 and the four quarters of 2001. In our opinion, this information reflects all normal and recurring adjustments considered necessary for a fair presentation of this data. The results of any of these quarters are not necessarily a good indication of results for an entire fiscal year or of continuing trends.
10
Our primary sources of working capital are cash from operations supplemented by bank borrowings under a credit agreement (the Credit Agreement) with a group of banks. Our primary capital needs are seasonal working capital obligations and other general corporate purposes, including acquisitions and share repurchases. Borrowings, together with cash from operations and seller financing, historically have been sufficient to support our growth and to finance acquisitions.
Net cash provided by operating activities was $41.0 million for the nine months ended September 30, 2002 compared to $44.8 million in the same period in 2001. In 2002, third quarter estimated income taxes of approximately $20.0 million were paid in September while the third quarter of 2001 estimated income taxes of approximately $13.0 million were paid in the fourth quarter of 2001 due to the disruption caused by the terrorist attacks of September 11th.
The Credit Agreement, which matures on November 27, 2004, allows us to borrow funds under a revolving line of credit (the Revolving Credit Facility). In August, we expanded our borrowing capacity under the Revolving Credit Facility from $110.0 million to $150.0 million to facilitate the Fort Wayne Acquisition.
During the nine months ended September 30, 2002, we received net proceeds of $58.6 million from the Revolving Credit Facility. At September 30, 2002, there was $143.6 million outstanding and $6.5 million available for borrowing under the Revolving Credit Facility.
Interest on borrowings under the Revolving Credit Facility may be paid at either of the following rates, in each case depending on our leverage ratio:
Substantially all of our assets, including the capital stock of our wholly-owned subsidiaries, secure our obligations under the Revolving Credit Facility. The Revolving Credit Facility has numerous restrictive covenants, which require that we maintain a minimum net worth and fixed charge coverage and which also restrict our ability to pay dividends. As of September 30, 2002, we were in compliance with all covenants and financial ratio requirements. The average effective interest rate of the Revolving Credit Facility was 4.0% for the nine month period ended September 30, 2002.
We believe we have adequate availability of capital to fund our current operations and anticipated growth, including expansion in existing and targeted market areas. We continually evaluate potential acquisitions and we have held discussions with a number of acquisition candidates. However, we currently have no binding agreement with respect to any material acquisition candidate. If suitable acquisition opportunities or working capital needs arise that would require additional financing, we believe that our current financial position and earnings history provide a solid basis for obtaining additional financing resources at competitive rates and terms. Additionally, we may issue common or preferred stock in connection with any such acquisition.
11
Excluding the $12.2 million Fort Wayne accounts receivable at the end of the third quarter, accounts receivable increased to $101.4 million at September 30, 2002 compared to $87.3 million at September 30, 2001 and $60.2 million at December 31, 2001. The increase from the third quarter of 2001 to the 2002 period is consistent with the increase in net sales.
The allowance for doubtful accounts is our estimate of the risk of potential losses if our credit customers do not or are unable to pay on their accounts. The allowance is calculated based on total accounts receivable outstanding; however, a significant portion of the allowance for doubtful accounts is assigned to the greater than 60 days past due receivables, as write-offs of the current and less than 60 days past due receivables have averaged less than 0.2% of net sales over the past several years. Additionally, in circumstances where we are aware of a customer’s likely inability to pay, we record a specific reserve.
The allowance for doubtful accounts increased to $4.2 million at September 30, 2002 from $3.8 million at September 30, 2001 and $2.8 million at December 31, 2001. This increase is consistent with the increase in gross accounts receivable from 2001 to 2002. The allowance as a percentage of gross accounts receivable decreased to 3.5% at September 30, 2002 compared to 4.1% at September 30, 2001 and 4.4% at December 31, 2001. This decrease is a result of the improvement in the quality of our accounts receivable aging, which is evidenced by the decrease in the greater than 60 days past due receivables to $5.5 million at September 30, 2002 from $5.8 million at September 30, 2001 and $6.1 million at December 31, 2001.
We continue to maintain an adequate reserve of the greater than 60 days past due receivables. The allowance as a percentage of the greater than 60 days past due receivables increased to 76.0% at September 30, 2002 from 64.5% at September 30, 2001 and 45.6% at December 31, 2001. Changes in this ratio between periods occur as the reserve is affected by factors other than the greater than 60 days past due receivables balance. Such factors include current and less than 60 days past due receivables, of which a percentage is also reserved, and activity related to those accounts which have been specifically reserved.
Product inventories represent the largest asset on our balance sheet. Our goal is to manage our inventory such that we minimize stock-outs, thus providing the highest level of service to our customers. This requires maintaining at each service center an adequate inventory of SKUs with the highest sales volume. At the same time, we are continuously working to better manage our slower moving classes of inventory which are not as critical to our customers and thus inherently have lower velocity. We refer to our highest velocity goods as inventory classes 1 - 3. These products represent approximately 80% of our net sales. Inventory classes 4 - 12 consist of lower velocity goods that we stock to maintain a high level of customer service. Class 13 and available non-stock inventories consist of items with the least velocity that we strive to reduce due to their greater risk of obsolescence.
12
Product inventories increased $5.5 million, or 4%, to $138.5 million at September 30, 2002 from $133.0 million at September 30, 2001. Excluding the $15.6 million of Fort Wayne inventory at the end of the third quarter, inventory actually decreased $10.1 million, or 8% to $122.9 million at September 30, 2002.
Excluding Fort Wayne inventory, product inventories of $122.9 million at September 30, 2002 were $58.6 million, or 32%, lower than the $181.5 million inventory balance at December 31, 2001. As discussed in our 2001 annual report on Form 10-K, the inventory balance at the end of 2001 was approximately $35.0 million higher than typically required at the end of the year because we made early-buy purchases in the fourth quarter of 2001 to take advantage of off-season purchase discounts being offered by manufacturers motivated to reduce their own inventory levels.
As we have improved the quality of our inventory, the inventory reserve has decreased to $4.1 million at September 30, 2002 from $5.8 million at September 30, 2001. The balance of class 13 and available non-stock inventory has decreased to 5.4%, or approximately $6.8 million, of inventory (excluding Fort Wayne) at September 30, 2002 from 8.0%, or approximately $11.1 million, at September 30, 2001. Our reserve as a percentage of class 13 and available non-stock inventory has remained relatively consistent at 60% in 2002 compared to 52% in 2001. At September 30, 2002, approximately 65% of our inventory balance was comprised of high velocity inventory classes 1 - 3.
The inventory reserve balance of $4.1 million at September 30, 2002 is slightly higher than the $3.9 million reserve at December 31, 2001. Although the product inventory balance was higher at the end of 2001, the accelerated early buy purchases discussed above consisted mainly of high velocity inventory classes 1 – 3 which have little risk of obsolescence.
From June 1 through September 30, 2002, we repurchased 1.7 million shares of our common stock at an average price of $26.21 per share. In October 2002 we repurchased an additional 0.1 million shares at an average price of $25.85 per share.
Since the inception of our share repurchase program in October 1998, we have repurchased a total of 3.8 million shares of our common stock at an average price of $19.69 per share. As part of our continuing share repurchase program, in July 2002 our Board of Directors authorized an additional $50 million for share repurchases, of which $38.5 million was still available as of November 12, 2002.
There have been no material changes from what we reported in our Form 10-K for the year ended December 31, 2001.
The term “disclosure controls and procedures” is defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 (the “Act”). The rules refer to the controls and other procedures designed to ensure that information required to be disclosed in reports that we file or submit under the Act is recorded, processed, summarized and reported within the time periods specified. As of September 30, 2002, Management, including the CEO and CFO, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, Management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of September 30, 2002.
We maintain a system of internal accounting controls that are designed to provide reasonable assurance that our books and records accurately reflect our transactions and that our policies and procedures are followed. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to September 30, 2002.
13
Our disclosure and analysis in this report contains forward-looking information that involves risks and uncertainties. From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Forward-looking statements give our current expectations or forecasts of possible future results or events. You can identify these statements by the fact that they do not relate strictly to historic or current facts. We often use words such as “anticipate”, “estimate”, “expect”, “believe” and other words and terms of similar meaning in connection with any discussion of future operating or financial performance.
Among the factors that could cause actual results to differ materially are the following:
We cannot guarantee that any future event or result will be realized, although we believe we have been prudent in our plans and assumptions. Should additional risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could differ materially from those anticipated. Investors should bear this in mind as they consider forward-looking statements.
We undertake no obligation to publicly update forward-looking statements, whether as a result of subsequent events, new information or otherwise.
14
Items 1 — 5 are not applicable and have been omitted.
_________________
15
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on November 13, 2002.
16
I, Manuel J. Perez de la Mesa, certify that:
17
I, Craig K. Hubbard, certify that:
18
19