10-K 1 pool-12312018x10k.htm POOL 2018 FORM 10-K Document


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, 2018
or
o
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
poolcorplogoa10.jpg
POOL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
36-3943363
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
109 Northpark Boulevard, Covington, Louisiana
70433-5001
(Address of principal executive offices)
(Zip Code)
985-892-5521
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: 
Title of each class
Name of each exchange on which registered
Common Stock, par value $0.001 per share
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes  x    No  ¨ 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes  ¨    No  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.           
Yes  x    No  ¨




Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    
Yes x    No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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.                ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer ¨
 
 
Non-accelerated filer ¨ 
Smaller reporting company ¨
 
 
Emerging growth company ¨ 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x
The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant based on the closing sales price of the registrant’s common stock as of June 30, 2018 was $5,916,556,013.
As of February 21, 2019, there were 39,391,303 shares of common stock outstanding.
Documents Incorporated by Reference
Portions of the registrant’s Proxy Statement to be mailed to stockholders on or about March 28, 2019 for the
Annual Meeting to be held on May 1, 2019, are incorporated by reference in Part III of this Form 10-K.




POOL CORPORATION

TABLE OF CONTENTS
 
 
 
 
 
Page
PART I.
 
 
 
 
Item 1. 
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
PART II.
 
 
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
PART III.
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
PART IV.
 
 
 
 
Item 15.
Item 16.
 
 
 
 
 
 
 




PART I.
Item 1.  Business

General

Pool Corporation (the Company, which may be referred to as we, us or our) is the world’s largest wholesale distributor of swimming pool supplies, equipment and related leisure products and is one of the top three distributors of irrigation and landscape products in the United States. Our vision is to become the best worldwide distributor of outdoor living products that enhance the quality of outdoor home life. The Company was incorporated in the State of Delaware in 1993 and has grown from a regional distributor to a multi-national, multi-network distribution company. 

Our industry is highly fragmented, and as such, we add considerable value to the industry by purchasing products from a large number of manufacturers and then distributing the products to our customer base on conditions that are more favorable than our customers could obtain on their own.

As of December 31, 2018, we operated 364 sales centers in North America, Europe, South America and Australia through our four distribution networks:

SCP Distributors (SCP);
Superior Pool Products (Superior);
Horizon Distributors (Horizon); and
National Pool Tile (NPT).

Our Industry

We participate in a worldwide market for outdoor living products through our four distribution networks.

We believe that the swimming pool industry is relatively young, with room for continued growth from the increased penetration of new pools. Significant growth opportunities also reside with pool remodel and pool equipment replacement activities due to the aging of the installed base of swimming pools, technological advancements and the development of energy-efficient and more aesthetically attractive products. Additionally, the desire for consumers to enhance their outdoor living spaces with hardscapes, lighting and outdoor kitchens also promotes growth in this area.

Favorable demographic and socioeconomic trends have positively impacted our industry and we believe these trends will continue to do so in the long term.  These favorable trends include the following:

long-term growth in housing units in warmer markets due to the population migration toward the southern United States, which contributes to the growing installed base of pools that homeowners must maintain;
increased homeowner spending on outdoor living spaces for relaxation and entertainment;
consumers bundling the purchase of a swimming pool and other products, with new irrigation systems, landscaping and improvements to outdoor living spaces often being key components to both pool installations and remodels; and
consumers using more automation and control products, higher quality materials and other pool features that add to our sales opportunities over time.

Almost 60% of consumer spending in the pool industry is for maintenance and minor repair of existing swimming pools.  Maintaining proper chemical balance and the related upkeep and repair of swimming pool equipment, such as pumps, heaters, filters and safety equipment, creates a non-discretionary demand for pool chemicals, equipment and other related parts and supplies.  We also believe cosmetic considerations such as a pool’s appearance and the overall look of backyard environments create an ongoing demand for other maintenance-related goods and certain discretionary products.
 
We believe that the recurring nature of the maintenance and repair market has historically helped maintain a relatively consistent rate of industry growth.  This characteristic has helped cushion the negative impact on revenues in periods when unfavorable economic conditions and softness in the housing market adversely impacted pool construction and major replacement and refurbishment activities.


1


The following table reflects growth in the domestic installed base of in-ground swimming pools over the past 11 years (based on Company estimates and information from 2017 P.K. Data, Inc. reports):

installedbase2018.jpg

The replacement and refurbishment market currently accounts for close to 25% of consumer spending in the pool industry.  The activity in this market, which includes major swimming pool remodeling, is driven by the aging of the installed base of pools. The timing of these types of expenditures is more sensitive to economic factors that impact consumer spending compared to the maintenance and minor repair market.

New swimming pool construction comprises just over 15% of consumer spending in the pool industry.  The demand for new pools is driven by the perceived benefits of pool ownership including relaxation, entertainment, family activity, exercise and convenience.  The industry competes for new pool sales against other discretionary consumer purchases such as kitchen and bathroom remodeling, boats, motorcycles, recreational vehicles and vacations.  The industry is also affected by other factors including, but not limited to, consumer preferences or attitudes toward pool and related outdoor living products for aesthetic, environmental, safety or other reasons.

The irrigation and landscape industry shares many characteristics with the pool industry, and we believe that it will realize similar long‑term growth rates. Irrigation system installations often occur in tandem with new single‑family home construction making it more susceptible to economic variables. However, the landscape industry offers similar maintenance-related growth opportunities as the swimming pool industry. Product offerings such as chemicals and fertilizers, power equipment and related repair and maintenance services offer recurring revenue streams in an industry otherwise closely tied to the housing market. The irrigation and landscape distribution business serves both residential and commercial markets, with the majority of sales related to the residential market.  Irrigation accounts for approximately 50% of total spending in the industry, with the remaining 50% of spending related to landscape, power equipment, hardscapes and specialty outdoor products and accessories.

Our NPT network overlaps the swimming pool and irrigation and landscape industries as we offer our market-leading brand of pool tile, composite pool finish products and hardscapes. As more consumers create and enhance outdoor living areas and continue to invest in their outdoor environment, we believe we can focus our resources to address such demand, while leveraging our existing pool and irrigation and landscape customer base. We feel the development of our NPT network is a natural extension of our distribution model. In addition to our 17 standalone NPT sales centers, we currently have over 100 SCP and Superior sales centers that feature consumer showrooms where landscape and swimming pool contractors, as well as homeowners, can view and select pool components including pool tile, decking materials and interior pool finishes in various styles and grades, and serve as stocking locations for our NPT branded products. Given the more discretionary nature of these products, this business is more sensitive to external market factors compared to our business overall.


2


Economic Environment

Certain trends in the housing market, the availability of consumer credit and general economic conditions (as commonly measured by Gross Domestic Product or GDP) affect our industry, particularly new pool and irrigation system starts as well as the timing and extent of pool refurbishments, equipment replacement, landscaping projects and outdoor living space renovations.

We believe that over the long term, single-family housing turnover and home value appreciation may correlate with demand for new pool construction, with higher rates of home turnover and appreciation having a positive impact on new pool starts over time.  We also believe that homeowners’ access to consumer credit is a critical factor enabling the purchase of new swimming pools and irrigation systems.  Similar to other discretionary purchases, replacement and refurbishment activities are more heavily impacted by economic factors such as consumer confidence, GDP and employment.

While market conditions have been generally favorable the past year, a number of factors weigh on our industry, including lagging new home construction, tighter lending standards, and the slower progression of a younger generation burdened by student debt and underemployment. Labor availability and cost have also become issues in recent years, limiting our customers’ ability to fully meet consumer demand, particularly in construction and renovation markets.   

The post-recession market environment from 2010 to 2018 was characterized by the cautious recovery of consumer spending, modest housing recovery and low inflation. However, in terms of homeowners investing in their existing homes, discretionary expenditures, including backyard renovations, flourished over this time period. While we estimate that new pool construction increased to approximately 80,000 new units in 2018, construction levels are still down approximately 65% compared to peak historical levels and down approximately 50% from what we consider normal levels. An average of approximately 170,000 new units per year were built in the years leading up to the recession. We expect that new pool and irrigation construction levels will continue to grow incrementally, but we believe that consumer investments in outdoor living spaces beyond the swimming pool will generate greater growth over the next five years.

Times of strong economic conditions in the United States enable further replacement, remodeling and new construction activity. Although some constraints exist around residential construction activities, economic trends indicate that consumer spending has largely recovered, and we believe that we are well positioned to take advantage of both the market expansion and the inherent long-term growth opportunities in our industry. Additionally, recent regulation passed by the U.S. Department of Energy mandates all new and replacement motors and pumps for swimming pools must be variable speed by July 2021. This mandate, coupled with additional product developments and technological advancements, offers further growth opportunities over the next few years.

In an effort to mitigate inflation, the Federal Reserve raised borrowing rates several times in 2018. While it appears that the rising interest rates slowed down borrowing for home buying in the short term, interest rates remain low by historical standards. Perhaps more importantly, the scarcity of land and labor limited new home construction growth and drove up home values over the last several years. By mid-2018, this trend appeared to have reached its peak or at least paused in many markets due to home affordability coupled with rising interest rates.

Considering the factors discussed above, we believe we will realize an annual sales growth rate of approximately 6% to 9% over the next five years.

Business Strategy and Growth

Our mission is to provide exceptional value to our customers and suppliers, creating exceptional return to our shareholders, while providing exceptional opportunities to our employees.  Our core strategies are as follows:

to promote the growth of our industry;
to promote the growth of our customers’ businesses; and
to continuously strive to operate more effectively.

We promote the growth of our industry through various advertising and promotional programs intended to raise consumer awareness of the benefits and affordability of pool ownership, the ease of pool maintenance and the many ways in which a pool and the surrounding spaces may be enjoyed beyond swimming.  These programs include digital and media advertising, industry-oriented website development such as www.swimmingpool.com® and www.hottubs.com®, public relations campaigns and other online marketing initiatives.  We use these programs as tools to educate consumers and lead prospective pool owners to our customers.

We promote the growth of our customers’ businesses by offering comprehensive support programs that include promotional tools and marketing support to help our customers generate increased sales.  Our uniquely tailored programs include such features as

3


customer lead generation, personalized websites, brochures, direct mail, marketing campaigns and business development training.  As a customer service, we also provide certain retail store customers assistance with all aspects of their business including site selection, store layout and design, product merchandising, business management system implementation, comprehensive product offering selections and efficient ordering and inventory management processes. In addition to these programs, we feature consumer showrooms in over 100 of our sales centers and host our annual Retail Summit to educate our customers about product offerings and the overall industry. We also act as a day-to-day resource by offering product and market expertise to serve our customers’ unique needs.

In addition to our efforts aimed at industry and customer growth, we strive to operate more effectively by continuously focusing on improvements in our operations. We strive to create capacity with business to business development tools and execution to ensure best in class service and value creation for our customers and suppliers. In particular, we have developed the Pool360 and Horizon 24/7 platforms that help our customers be more productive by allowing them to get pricing, check availability, enter orders and make payments on line while leveraging our customer service staff resources, particularly during peak business periods. These tools not only offer real-time integration into our enterprise resource planning system, creating efficiencies in our business processes as well, but they also provide our customers graphical catalog presentation in the same platform. In addition to these initiatives, we strive to emphasize an Employer of Choice culture and to expand our Pool Corporation-branded products and exclusive brand offerings.

We have grown our distribution networks through new sales center openings, acquisitions and the expansion of existing sales centers.  In recent years, we have focused our efforts on new sales center openings, complemented by strategic acquisitions and consolidations, depending on our market presence. For additional information regarding our new sales center openings, acquisitions and closures/consolidations, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 2 of “Notes to Consolidated Financial Statements,” included in this Form 10-K.

We plan to continue to make strategic acquisitions and open new sales centers to further penetrate existing markets and expand into both new geographic markets and new product categories. We believe that our high customer service levels and expanded product offerings have enabled us to gain market share historically. Going forward, we expect to realize sales growth higher than the industry average due to further increases in market share and continued expansion of our product offerings.

We estimate that price inflation has averaged 1% to 2% annually in our industry over the past 10 years.  We generally pass industry price increases through the supply chain and may make strategic volume inventory purchases ahead of vendor price increases.  We estimate that annual price inflation between 2016 and 2018 was consistent with the ten-year average. In 2018, several manufacturers announced and implemented a mid-season price increase to offset raw material, transportation and labor inflation. Unlike previous years, we expect inflation in 2019 to fall outside of the historical range. Specifically, we expect inflation to be approximately 2% above historical norms in 2019, but we anticipate a return to the historical average over the long term.

Customers and Products

We serve roughly 120,000 customers. No single customer accounted for 10% of our sales in 2018. Further, in 2018, sales to our largest 100 customers collectively accounted for just over 10% of our total sales. Most of our customers are small, family-owned businesses with relatively limited capital resources. Most of these businesses provide labor and technical services to the end consumer and operate as independent contractors and specialty retailers employing no more than ten employees (in many cases, working alone or with a limited crew).  These customers also buy from other distributors, mass merchants, home stores, and certain specialty and internet retailers.

We provide extended payment terms to qualified customers for sales under early buy programs. The extended terms usually require payments in equal installments in April, May and June or May and June depending on geographic location. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates” for additional information.

We sell our products primarily to the following types of customers:

swimming pool remodelers and builders;
specialty retailers that sell swimming pool supplies;
swimming pool repair and service businesses;
irrigation construction and landscape maintenance contractors; and
commercial customers who service large commercial installations such as hotels, universities and community recreational facilities.


4


We conduct our operations through 364 sales centers in North America, Europe, South America and Australia. Our primary markets, with the highest concentration of swimming pools, are California, Texas, Florida and Arizona, collectively representing approximately 53% of our 2018 net sales.  In 2018, we generated approximately 94% of our sales in North America (including Canada and Mexico), 5% in Europe and 1% in South America and Australia combined. While we continue to expand both domestically and internationally, we expect this geographic mix to be similar over the next few years. References to product line and product category data throughout this Form 10-K generally reflect data related to the North American swimming pool market, as it is more readily available for analysis and represents the largest component of our operations.

We use a combination of local and international sales and marketing personnel to promote the growth of our business and develop and strengthen our customers’ businesses.  Our sales and marketing personnel focus on developing customer programs and promotional activities, creating and enhancing sales management tools and providing product and market expertise.  Our local sales personnel work from our sales centers and are charged with understanding and meeting our customers’ specific needs.

We offer our customers more than 180,000 manufacturer and Pool Corporation-branded products.  We believe that our selection of pool equipment, supplies, chemicals, replacement parts, irrigation and related products and other pool construction and recreational products is the most comprehensive in the industry. We sell the following types of products:
 
maintenance products, such as chemicals, supplies and pool accessories;
repair and replacement parts for pool equipment, such as cleaners, filters, heaters, pumps and lights;
packaged pool kits including walls, liners, braces and coping for in-ground and above-ground pools;
pool equipment and components for new pool construction and the remodeling of existing pools;
irrigation and related products, including irrigation system components and professional lawn care equipment and supplies;
building materials, such as concrete, plumbing and electrical components, both functional and decorative pool surfaces, decking materials, tile, hardscapes and natural stone, used for pool installations and remodeling;
commercial products, including ASME heaters, safety equipment, and commercial pumps and filters; and
other pool construction and recreational products, which consist of a number of product categories and include discretionary recreational and related outdoor living products, such as spas, grills and components for outdoor kitchens, that enhance consumers’ use and enjoyment of outdoor living spaces.

We currently have over 600 product lines and approximately 50 product categories. Based on our 2018 product classifications, sales for our pool and spa chemicals product category represented approximately 12% of total net sales for 2018 and 2017 and 13% of our total net sales in 2016. No other product categories account for 10% or more of total net sales in any of the last three fiscal years.

We continue to identify new related product categories, and we typically introduce new categories each year in select markets.  We then evaluate the performance in these markets and focus on those product categories that we believe exhibit the best long-term growth potential. We expect to realize continued sales growth for these types of product offerings by expanding the number of locations that offer these products, increasing the number of products offered at certain locations and continuing a modest broadening of these product offerings on a company-wide basis.

Recent regulation passed by the U.S. Department of Energy mandates all new and replacement motors and pumps for swimming pools must be variable speed by July 2021. Additionally, new product technology provides opportunities not only for improved energy efficiency but also new enticements for leisure activities. Smart controls provide growth opportunities as most existing swimming pools run on mechanical time clocks. Major equipment manufacturers have developed and will continue to develop more retrofit kits that allow homeowners to interact with their pools or hot tubs through their smartphones. Robotic cleaners offer consumers a more efficient option for maintaining their swimming pools. We see each of these developments as significant growth opportunities.

Over the last several years we have increased our product offerings and service abilities related to commercial swimming pools. We consider the commercial market to be a key growth opportunity as we focus more attention on providing products to customers who service large commercial installations such as hotels, universities and community recreational facilities. While we are leveraging our existing networks and relationships to grow this market, in 2017 we also acquired Lincoln Equipment, Inc., a national distributor of equipment and supplies to commercial and institutional swimming pool customers.


5


In 2018, the sale of maintenance and minor repair products (non-discretionary) accounted for almost 60% of our sales and gross profits while just over 40% of our sales and gross profits were derived from the refurbishment, replacement, construction and installation (equipment, materials, plumbing, electrical, etc.) of swimming pools (partially discretionary). During the economic downturn, which spanned from late 2006 to early 2010 and reached its low point in 2009, sales of maintenance and minor repair products had increased to approximately 70% of our sales and gross profits due to the significant declines in new pool construction and deferred remodeling and replacement activity. The current trend reflects a shift back toward a greater percentage of our sales coming from major refurbishment and replacement products due to the recovery of these activities since levels reached their historic low point in 2009.

Post-2009, we experienced product and customer mix changes, including a shift in consumer spending to higher value, lower margin products such as variable speed pumps, high efficiency heaters, and irrigation and related equipment. These products positively contribute to our sales and gross profit growth but negatively impact our gross margin. We expect continued demand for these products, but believe our efforts in various pricing and sourcing initiatives, including growth in our higher margin private label and exclusive products (PLEX) and our expansion of building materials product offerings, have helped offset these gross margin declines and will lead to somewhat flat gross margin trends over the next few years.

Operating Strategy

We distribute swimming pool supplies, equipment and related leisure products domestically through our SCP and Superior networks and internationally through our SCP network. We adopted the strategy of operating two distinct distribution networks within the U.S. swimming pool market primarily for two reasons:

to offer our customers a choice of distinctive product selections, locations and service personnel; and
to increase the level of customer service and operational efficiency provided by the sales centers in each network by promoting healthy competition between the two networks.

We distribute irrigation and related products through our Horizon network and tile, decking materials and interior pool finish products through our NPT network. We evaluate our sales centers based on their performance relative to predetermined standards that include both financial and operational measures.  Our corporate support groups provide our field operations with various services, such as developing and coordinating customer and vendor related programs, information systems support and expert resources to help them achieve their goals.  We believe our incentive programs and feedback tools, along with the competitive nature of our internal networks, stimulate and enhance employee performance.

Distribution

Our sales centers are located within population centers near customer concentrations, typically in industrial, commercial or mixed‑use zones.  Customers may pick up products at any sales center location, or we may deliver products to their premises or job sites via our trucks or third-party carriers.

Our sales centers maintain well-stocked inventories to meet our customers’ immediate needs.  We utilize warehouse management technology to optimize receiving, inventory control, picking, packing and shipping functions. For additional information regarding our inventory management, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Inventory Obsolescence,” of this Form 10-K.

We also operate four centralized shipping locations (CSLs) that redistribute products we purchase in bulk quantities to our sales centers or in some cases, directly to customers.  Our CSLs are regional locations that carry a wide range of traditional swimming pool, irrigation and landscape products and related construction products.  

Purchasing and Suppliers

We enjoy good relationships with our suppliers, who generally offer competitive pricing, return policies and promotional allowances.  It is customary in our industry for certain manufacturers to manage their shipments by offering seasonal terms to qualifying purchasers such as Pool Corporation, which are referred to as early buy purchases.  These early buy purchases typically allow us to place orders in the fall at a modest discount, take delivery of product during the off-season months and pay for these purchases in the spring or early summer.


6


Our preferred vendor program encourages our distribution networks to stock and sell products from a smaller number of vendors offering the best overall terms and service to optimize profitability and shareholder return.  We also work closely with our vendors to develop programs and services to better meet the needs of our customers and to concentrate our inventory investments.  These practices, together with a more comprehensive service offering, have positively impacted our selling margins and our returns on inventory investments.

We regularly evaluate supplier relationships and consider alternate sourcing to assure competitive cost, service and quality standards.  Our largest suppliers include Pentair Water Pool and Spa, Inc., Hayward Pool Products, Inc. and Zodiac Pool Systems, Inc., which accounted for approximately 20%, 9% and 8%, respectively, of the cost of products we sold in 2018.

Competition

We are the largest wholesale distributor of swimming pool and related backyard products (based on industry knowledge and available data) and the only truly national wholesale distributor focused on the swimming pool industry in the United States.  We are also one of the top three distributors of irrigation and landscape products in the United States.  We face intense competition from many regional and local distributors in our markets and from one national wholesale distributor of landscape supplies.  We also face competition, both directly and indirectly, from mass market retailers (both store-based and internet) and large pool supply retailers who primarily buy directly from manufacturers.

Some geographic markets we serve, particularly the four largest and higher pool density markets of California, Texas, Florida and Arizona, have a greater concentration of competition than others.  Barriers to entry in our industry are relatively low.  We believe that the principal competitive factors in swimming pool and irrigation and landscape supply distribution are:

the breadth and availability of products offered;
the quality and level of customer service, including ease of ordering and product delivery;
the breadth and depth of sales and marketing programs;
consistency and stability of business relationships with customers and suppliers;
competitive product pricing; and
geographic proximity to the customer.

We believe that we generally compete favorably with respect to each of these factors.

Seasonality and Weather

Our business is highly seasonal. In general, sales and operating income are highest during the second and third quarters, which represent the peak months of both swimming pool use and installation and irrigation and landscaping installations and maintenance. Sales are substantially lower during the first and fourth quarters, when we may incur net losses. In 2018, we generated approximately 62% of our net sales and 81% of our operating income in the second and third quarters of the year.

We typically experience a build-up of product inventories and accounts payable during the winter months in anticipation of the peak selling season.  Excluding borrowings to finance acquisitions and share repurchases, our peak borrowing usually occurs during the second quarter, primarily because 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 results of operations will continue to fluctuate depending on the timing and amount of revenue contributed by new and acquired sales centers.  Based on our peak summer selling season, we generally open new sales centers and close or consolidate sales centers, when warranted, either in the first quarter before the peak selling season begins or in the fourth quarter after the peak selling season ends.


7


Weather is one of the principal external factors affecting our business. The table below presents some of the possible effects resulting from various weather conditions.
Weather
 
Possible Effects
Hot and dry
Increased purchases of chemicals and supplies
 
 
for existing swimming pools
 
Increased purchases of above-ground pools and
 
 
irrigation and lawn care products
 
 
 
Unseasonably cool weather or
Fewer pool and irrigation and landscaping installations
extraordinary amounts of rain
Decreased purchases of chemicals and supplies
 
Decreased purchases of impulse items such as
 
 
above-ground pools and accessories
 
 
 
Unseasonably early warming trends in spring/late cooling trends in fall
A longer pool and landscape season, thus positively impacting our sales
(primarily in the northern half of the U.S. and Canada)
 
 
 
 
 
Unseasonably late warming trends in spring/early cooling trends in fall
A shorter pool and landscape season, thus negatively impacting our sales
(primarily in the northern half of the U.S. and Canada)
 
 

For discussion regarding the effects seasonality and weather had on our results of operations in 2018 and 2017, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Seasonality and Quarterly Fluctuations,” of this Form 10-K.

Environmental, Health and Safety Regulations

Our business is subject to regulation under local fire codes and international, federal, state and local environmental and health and safety requirements, including regulation by the Environmental Protection Agency, the Consumer Product Safety Commission, the Department of Transportation, the Occupational Safety and Health Administration, the National Fire Protection Agency and the International Maritime Organization. Most of these requirements govern the packaging, labeling, handling, transportation, storage and sale of chemicals and fertilizers. We store certain types of chemicals and/or fertilizers at each of our sales centers and the storage of these items is strictly regulated by local fire codes. In addition, we sell algaecides and pest control products that are regulated as pesticides under the Federal Insecticide, Fungicide and Rodenticide Act and various state pesticide laws. These laws primarily relate to labeling, annual registration and licensing.

Employees

We employed approximately 4,000 people at December 31, 2018. Given the seasonal nature of our business, our peak employment period is the summer and, depending on expected sales levels, we add 200 to 500 employees to our work force to meet seasonal demand.

Intellectual Property

We maintain both domestic and foreign registered trademarks and patents, primarily for our Pool Corporation and Pool Systems Pty. Ltd. (PSL) branded products that are important to our current and future business operations. We also own rights to numerous internet domain names.


8


Geographic Areas

The table below presents net sales by geographic region, with international sales translated into U.S. dollars at prevailing exchange rates, for the past three fiscal years (in thousands):

 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
United States
 
$
2,720,077

 
$
2,545,270

 
$
2,354,726

International
 
278,020

 
242,918

 
216,077

 
 
$
2,998,097

 
$
2,788,188

 
$
2,570,803


The table below presents net property and equipment by geographic region, with international property and equipment balances translated into U.S. dollars at prevailing exchange rates, for the past three fiscal years (in thousands):

 
 
December 31,
 
 
2018
 
2017
 
2016
United States
 
$
100,905

 
$
95,659

 
$
79,064

International
 
6,059

 
5,280

 
4,226

 
 
$
106,964

 
$
100,939

 
$
83,290


Website Access and Available Information

Our website is www.poolcorp.com. The information on our website is not a part of this document.

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our website at www.poolcorp.com as soon as reasonably practicable after we electronically file such reports with, or furnish them to, the Securities and Exchange Commission (SEC).

Additionally, we have adopted a Code of Business Conduct and Ethics (the Code) that applies to all of our employees, officers and directors, and is available on our website at www.poolcorp.com. Any substantive amendments to the Code, or any waivers granted to any directors or executive officers, including our principal executive officer, principal financial officer, or principal accounting officer and controller, will be disclosed on our website and remain there for at least 12 months.


Item 1A.  Risk Factors

Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995

This report contains forward-looking information that involves risks and uncertainties. Our forward‑looking statements express our current expectations or forecasts of possible future results or events, including projections of earnings and other financial performance measures, statements of management’s expectations regarding our plans and objectives, and industry, general economic and other forecasts of trends, future dividend payments and other matters. Forward‑looking statements speak only as of the date of this filing, and we undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. You can identify these statements by the fact that they do not relate strictly to historic or current facts and often use words such as “anticipate,” “estimate,” “expect,” “intend,” “believe,” “will likely result,” “outlook,” “project,” “may,” “can,” “plan,” “target,” “potential,” “should” and other words and expressions of similar meaning.

No assurance can be given that the expected results in any forward-looking statement will be achieved, and actual results may differ materially due to one or more factors. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act.



9


Risk Factors

Certain factors that may affect our business and could cause actual results to differ materially from those expressed in any forward‑looking statement include the following:

The demand for our swimming pool, irrigation, landscape and related outdoor living products may be adversely affected by unfavorable economic conditions.

Consumer discretionary spending affects our sales and is impacted by factors outside of our control, including general economic conditions, disposable income levels, consumer confidence and access to credit. In economic downturns, the demand for swimming pool, irrigation, landscape and related outdoor living products may decline, often corresponding with declines in discretionary consumer spending, the growth rate of pool eligible households and swimming pool construction. Maintenance and repair products and certain replacement and refurbishment products are required to maintain existing swimming pools, and each currently account for approximately 60% and 25% of net sales related to our swimming pool business; however, the growth in this portion of our business depends on the expansion of the installed pool base and could also be adversely affected by decreases in construction activities, similar to the trends between late 2006 and early 2010. A weak economy may also cause consumers to defer discretionary replacement and refurbishment activity. Even in generally favorable economic conditions, severe and/or prolonged downturns in the housing market could have a material adverse impact on our financial performance. Such downturns expose us to certain additional risks, including but not limited to the risk of customer closures or bankruptcies, which could shrink our potential customer base and inhibit our ability to collect on those customers’ receivables.

We believe that homeowners’ access to consumer credit is a critical factor enabling the purchase of new pools, irrigation systems, and outdoor living products. Between late 2006 and early 2010, the unfavorable economic conditions and downturn in the housing market resulted in significant tightening of credit markets, which limited the ability of consumers to access financing for new swimming pools and irrigation systems. Although we have seen improvement since 2010, tightening consumer credit could prevent consumers from obtaining financing for pool, irrigation and related outdoor projects, which could negatively impact our sales of construction-related products.

We are susceptible to adverse weather conditions.

Weather is one of the principal external factors affecting our business. For example, unseasonably late warming trends in the spring or early cooling trends in the fall can shorten the length of the pool season. Also, unseasonably cool weather or extraordinary rainfall during the peak season can decrease swimming pool use, installation and maintenance, as well as irrigation installations and landscape maintenance. These weather conditions adversely affect sales of our products. While warmer weather conditions favorably impact our sales, global warming trends and other significant climate changes can create more variability in the short term or lead to other unfavorable weather conditions that could adversely impact our sales or operations. Drought conditions or water management initiatives may lead to municipal ordinances related to water use restrictions. Such restrictions could result in decreased pool and irrigation system installations which could negatively impact our sales. For a discussion regarding seasonality and weather, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Seasonality and Quarterly Fluctuations,” of this Form 10-K.

Our distribution business is highly dependent on our ability to maintain favorable relationships with suppliers.

As a distribution company, maintaining favorable relationships with our suppliers is critical to our success. We believe that we add considerable value to the swimming pool and irrigation supply chains by purchasing products from a large number of manufacturers and distributing the products to a highly fragmented customer base on conditions that are more favorable than these customers could obtain on their own. We believe that we currently enjoy good relationships with our suppliers, who generally offer us competitive pricing, return policies and promotional allowances. However, any failure to maintain favorable relationships with our suppliers could have an adverse effect on our business.

Our largest suppliers are Pentair Water Pool and Spa, Inc., Hayward Pool Products, Inc. and Zodiac Pool Systems, Inc., which accounted for approximately 20%, 9% and 8%, respectively, of the costs of products we sold in 2018. A decision by our largest suppliers, acting individually or in concert, to sell their products directly to retailers or other end users of their products, bypassing distribution companies like ours, would have an adverse effect on our business. Additionally, if our suppliers experience difficulties or disruptions in their operations or if we lose a single significant supplier due to financial failure or a decision to sell exclusively to retailers or end-use consumers, we may experience increased supply costs or may experience delays in establishing replacement supply sources that meet our quality and control standards.


10


We face intense competition both from within our industry and from other leisure product alternatives.

Within our industry, we directly compete against various regional and local distributors as they compete against our customers for the business of pool owners and other end-use customers. We indirectly compete against mass market retailers and large pool or irrigation supply retailers as they purchase the great majority of their needs directly from manufacturers, and to a lesser extent with internet retailers, as they purchase the majority of their needs from distributors. Outside of our industry, we compete indirectly with alternative suppliers of big ticket consumer discretionary products, such as boat and motor home distributors, and with other companies who rely on discretionary homeowner expenditures, such as home remodelers. New competitors may emerge as there are low barriers to entry in our industry, which has led to highly competitive markets consisting of various-sized entities, ranging from small or local operators to large regional businesses. Given the density and demand for pool products, some geographic markets that we serve also tend to have a higher concentration of competitors than others, particularly California, Texas, Florida and Arizona. These states encompass our four largest markets and represented approximately 53% of our net sales in 2018.

More aggressive competition by store- and internet-based mass merchants and large pool or irrigation supply retailers could adversely affect our sales.
 
Mass market retailers today carry a limited range of, and devote a limited amount of shelf space to, merchandise and products targeted to our industry. Historically, mass market retailers have generally expanded by adding new stores and product breadth, but their product offering of pool and irrigation related products has remained relatively constant. Should store‑ and internet-based mass market retailers increase their focus on the pool or irrigation industries, or increase the breadth of their pool and irrigation and related product offerings, they may become a more significant competitor for our direct customers and end-use consumers, which could have an adverse impact on our business. We may face additional competitive pressures if large pool or irrigation supply retailers look to expand their customer base to compete more directly within the distribution channel.

We depend on our ability to attract, develop and retain highly qualified personnel.

We consider our employees to be the foundation for our growth and success. As such, our future success depends in large part on our ability to attract, retain and motivate qualified personnel. This includes succession planning related to our executive officers and key management personnel. If we are unable to attract and retain key personnel, our operating results could be adversely affected.

Past growth may not be indicative of future growth.

Historically, we have experienced substantial sales growth through organic market share gains, new sales center openings and acquisitions that have increased our size, scope and geographic distribution. Our various business strategies and initiatives, including our growth initiatives, are subject to business, economic and competitive uncertainties and contingencies, many of which are beyond our control. While we contemplate continued growth through internal expansion and acquisitions, no assurance can be made as to our ability to:

penetrate new markets;
generate sufficient cash flows to support expansion plans and general operating activities;
obtain financing;
identify appropriate acquisition candidates;
maintain favorable supplier arrangements and relationships; and
identify and divest assets which do not continue to create value consistent with our objectives.

If we do not manage these potential difficulties successfully, our operating results could be adversely affected.

Our business is highly seasonal.

The demand for our services and our results of operations are affected by the seasonal nature of our business. In 2018, we generated approximately 62% of our net sales and 81% of our operating income in the second and third quarters of the year. These quarters represent the peak months of both swimming pool use, installation, remodeling and repair, and irrigation installations and maintenance. Our sales are substantially lower during the first and fourth quarters of the year, when we may incur net losses.


11


We may not timely identify or effectively respond to consumer needs, expectations or trends, which could adversely affect our relationship with customers, our reputation, the demand for our products and services, and our market share.

The success or our business depends in part on our ability to identify and respond promptly to evolving trends in demographics and consumer preferences, expectations and needs while also managing appropriate inventory levels and maintaining an excellent customer experience. It is difficult to successfully predict the products and services our customers will demand.

Customer expectations about the methods by which they purchase and receive products or services are also becoming more demanding. Customers routinely use technology to rapidly compare products and prices, determine real-time product availability, and purchase products. Once products are purchased, customers are seeking alternate options for lower-cost delivery of those products. We must continually anticipate and adapt to these changes in the purchasing process.

The nature of our business subjects us to compliance with employment, environmental, health, transportation, safety, and other governmental regulations.

We are subject to regulation under federal, state, local and international employment, environmental, health, transportation and safety requirements, which govern such things as packaging, labeling, handling, transportation, storage and sale of chemicals and fertilizers. For example, we sell algaecides and pest control products that are regulated as pesticides under the Federal Insecticide, Fungicide and Rodenticide Act and various state pesticide laws. These laws primarily relate to labeling, annual registration and licensing.

Management has processes in place to facilitate and support our compliance with these requirements. However, failure to comply with these laws and regulations may result in investigations, the assessment of administrative, civil and criminal fines, damages, seizures, disgorgements, penalties or the imposition of injunctive relief. Moreover, compliance with such laws and regulations in the future could prove to be costly. Although we presently do not expect to incur any capital or other expenditures relating to regulatory matters in amounts that may be material to us, we may be required to make such expenditures in the future. These laws and regulations have changed substantially and rapidly over the last 25 years and we anticipate that there will be continuing changes.

The clear trend in environmental, health, transportation and safety regulations is to place more restrictions and limitations on activities that impact the environment, such as the use and handling of chemicals. Increasingly, strict restrictions and limitations have resulted in higher operating costs for us and it is possible that the costs of compliance with such laws and regulations will continue to increase. We will attempt to anticipate future regulatory requirements that might be imposed and we will plan accordingly to remain in compliance with changing regulations and to minimize the costs of such compliance.

We store chemicals, fertilizers and other combustible materials that involve fire, safety and casualty risks.

We store chemicals and fertilizers, including certain combustibles and oxidizing compounds, at our sales centers. A fire, explosion or flood affecting one of our facilities could give rise to fire, safety and casualty losses and related liability claims. We maintain what we believe is prudent insurance protection. However, we cannot guarantee that our insurance coverage will be adequate to cover future claims that may arise or that we will be able to maintain adequate insurance in the future at rates we consider reasonable. Successful claims for which we are not fully insured may adversely affect our working capital and profitability. In addition, changes in the insurance industry have generally led to higher insurance costs and decreased availability of coverage.

We conduct business internationally, which exposes us to additional risks.

Our ability to successfully conduct operations in, and source products and materials from, international markets is affected by many of the same risks we face in our U.S. operations, as well as unique costs and difficulties of managing international operations. Our international operations, which accounted for 9% of our total net sales in 2018, expose us to certain additional risks, including:

difficulty in staffing international subsidiary operations;
different political economic and regulatory conditions;
local laws and customs;
currency fluctuations;
adverse tax consequences; and
dependence on other economies.


12


For foreign-sourced products, we may be subject to certain trade restrictions that would prevent us from obtaining products and there is also a greater risk that we may not be able to access products in a timely and efficient manner. Fluctuations in other factors relating to international trade, such as tariffs, transportation costs and inflation are additional risks for our international operations. 

Changes in tax laws and accounting standards related to tax matters have caused, and may in the future cause, fluctuations in our effective tax rate.

Taxation and tax policy changes, tax rate changes, new tax laws, revised tax law interpretations, and changes in accounting standards and guidance related to tax matters, may cause fluctuations in our effective tax rate. The Tax Cuts and Jobs Act (TJCA or the Act), enacted in December 2017, significantly changed U.S. tax law. Our income tax provision is based on our current interpretation of this legislation and on reasonable estimates and may change as a result of new guidance issued by regulators. Our effective tax rate may also be impacted by changes in the geographic mix of our earnings.

In the first quarter of 2017, we adopted Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, on a prospective basis. Our projections of financial statement impacts related to ASU 2016-09 are subject to several assumptions which can vary significantly, including our estimated share price and the period that our employees will exercise vested stock options. Excess tax benefits or deficiencies recognized under ASU 2016-09 vary from quarter to quarter and past results may not be indicative of future results.

We depend on a global network of suppliers to source our products. Product quality or safety concerns could negatively impact our sales and expose us to legal claims.

We rely on manufacturers and other suppliers to provide us with the products we sell and distribute. As we increase the number of Pool Corporation and Pool Systems Pty. Ltd. branded products we distribute, our exposure to potential liability claims may increase. Product and service quality issues could negatively impact customer confidence in our brands and our business. If our product and service offerings do not meet applicable safety standards or our customers’ expectations regarding safety or quality, we could experience lost sales and increased costs and be exposed to legal, financial and reputational risks, as well as governmental enforcement actions. The risk of claims may also be greater with respect to products manufactured by third-party suppliers outside the United States, particularly in China. Uncertainties with respect to foreign legal systems may adversely affect us in resolving claims arising from our foreign sourced products. Even if we are successful in defending any claim relating to the products we distribute, claims of this nature could negatively impact customer confidence in our products and our company. 

We rely on information technology systems to support our business operations. Any disturbance or breach of our technological infrastructure could adversely affect our financial condition and results of operations. Additionally, failure to maintain the security of confidential information could damage our reputation and expose us to litigation.

Information technology supports several aspects of our business, including among others, product sourcing, pricing, customer service, transaction processing, financial reporting, collections and cost management.  Our ability to operate effectively on a day‑to‑day basis and accurately report our results depends on a solid technological infrastructure, which is inherently susceptible to internal and external threats.  We are vulnerable to interruption by fire, natural disaster, power loss, telecommunication failures, internet failures, security breaches and other catastrophic events. Exposure to various types of cyber-attacks such as malware, computer viruses, worms, or other malicious acts, as well as human error, could also potentially disrupt our operations or result in a significant interruption in the delivery of our goods and services.

Advances in computer and software capabilities, encryption technology and other discoveries increase the complexity of our technological environment, including how each interact with our various software platforms. Such advances could delay or hinder our ability to process transactions or could compromise the integrity of our data, resulting in a material adverse impact on our financial condition and results of operations. We also may experience occasional system interruptions and delays that make our information systems unavailable or slow to respond, including the interaction of our information systems with those of third parties. A lack of sophistication or reliability of our information systems could adversely impact our operations and customer service and could require major repairs or replacements, resulting in significant costs and foregone revenue.
 
We have designed numerous procedures and protocols to mitigate cybersecurity risks. We continually invest in information technology security and update our business continuity plan. In the event a cybersecurity threat occurs, we have processes in place to timely notify the appropriate personnel for assessment and resolution. We also continue to expand our company-wide training programs as part of our efforts to prevent such attacks. However, the failure to maintain security over and prevent unauthorized access to our data, our customers’ personal information, including credit card information, or data belonging to our suppliers, could put us at a competitive disadvantage. Such a breach could result in damage to our reputation and subject us to

13


potential litigation, liability, fines and penalties, resulting in a possible material adverse impact on our financial condition and results of operations.

A terrorist attack or the threat of a terrorist attack could have a material adverse effect on our business.

Discretionary spending on leisure product offerings such as ours is generally adversely affected during times of economic or political uncertainty. The potential for terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility could create these types of uncertainties and negatively impact our business for the short or long term in ways that cannot presently be predicted.

Item 1B.  Unresolved Staff Comments

None.


14



Item 2.  Properties

We lease the Pool Corporation corporate offices, which consist of approximately 60,293 square feet of office space in Covington, Louisiana, from an entity in which we have a 50% ownership interest. We own two sales center facilities in Florida, two in Texas, one in California, one in Georgia and one in Tennessee. We lease all of our other properties and the majority of our leases have three to seven year terms. As of December 31, 2018, we had 11 leases with remaining terms longer than seven years that expire between 2026 and 2032.

Most of our leases contain renewal options, some of which involve rent increases. In addition to minimum rental payments, which are set at competitive rates, certain leases require reimbursement for taxes, maintenance and insurance.

Our sales centers range in size from approximately 2,000 square feet to 60,000 square feet and generally consist of warehouse, counter, display and office space.  Our centralized shipping locations (CSLs) range in size from approximately 103,000 square feet to 185,000 square feet.

We believe that our facilities are well maintained, suitable for our business and occupy sufficient space to meet our operating needs. As part of our normal business, we regularly evaluate sales center performance and site suitability and may relocate a sales center or consolidate two locations if a sales center is redundant in a market, underperforming or otherwise deemed unsuitable. We do not believe that any single lease is material to our operations.

The table below summarizes the changes in our sales centers during the year ended December 31, 2018:

Network
 
12/31/17 (1)
 
New
Locations
 
Consolidated
Location (2)
 
Acquired
Locations
 
12/31/18
SCP
 
168

 
2

 

 

 
170

Superior
 
67

 
3

 

 

 
70

Horizon
 
64

 

 
(1
)
 
4

 
67

NPT (3)
 
16

 
1

 

 

 
17

Total Domestic
 
315

 
6

 
(1
)
 
4

 
324

SCP International
 
36

 
3

 

 
1

 
40

Total
 
351

 
9

 
(1
)
 
5

 
364


(1) 
At the beginning of 2018, we converted one Superior sales center to SCP and one Horizon sales center to Superior.
(2) 
Consolidated sales centers are those locations where we expect to transfer the majority of the existing business to our nearby sales center locations.
(3) 
In addition to the stand-alone NPT sales centers, there are over 100 SCP and Superior locations that have consumer showrooms and serve as stocking locations that feature NPT brand tile and composite finish products.



15



The table below identifies the number of sales centers in each state, territory or country by distribution network as of December 31, 2018:
Location
 
SCP
 
Superior
 
Horizon
 
NPT
 
Total
United States
 
 
 
 
 
 
 
 
 
 
California
 
29

 
25

 
17

 
6

 
77

Texas
 
21

 
5

 
16

 
6

 
48

Florida
 
35

 
5

 
4

 
1

 
45

Arizona
 
6

 
7

 
9

 
2

 
24

Georgia
 
6

 
2

 

 
1

 
9

Nevada
 
2

 
3

 
3

 

 
8

Tennessee
 
5

 
3

 

 

 
8

Washington
 
1

 

 
6

 

 
7

Alabama
 
4

 
2

 

 

 
6

New York
 
6

 

 

 

 
6

Virginia
 
2

 
1

 
3

 

 
6

Colorado
 
1

 
2

 
2

 

 
5

Louisiana
 
5

 

 

 

 
5

New Jersey
 
3

 
2

 

 

 
5

North Carolina
 
3

 
1

 
1

 

 
5

Pennsylvania
 
3

 
1

 

 
1

 
5

Illinois
 
3

 
1

 

 

 
4

Indiana
 
2

 
2

 

 

 
4

Missouri
 
3

 
1

 

 

 
4

Ohio
 
2

 
2

 

 

 
4

Oregon
 
1

 

 
3

 

 
4

South Carolina
 
3

 
1

 

 

 
4

Arkansas
 
3

 

 

 

 
3

Idaho
 
1

 

 
2

 

 
3

Oklahoma
 
2

 
1

 

 

 
3

Connecticut
 
2

 

 

 

 
2

Kansas
 
2

 

 

 

 
2

Maryland
 
1

 

 
1

 

 
2

Massachusetts
 
2

 

 

 

 
2

Michigan
 
2

 

 

 

 
2

Minnesota
 
1

 
1

 

 

 
2

Mississippi
 
2

 

 

 

 
2

Hawaii
 
1

 

 

 

 
1

Iowa
 
1

 

 

 

 
1

Kentucky
 

 
1

 

 

 
1

Nebraska
 
1

 

 

 

 
1

New Mexico
 
1

 

 

 

 
1

Puerto Rico
 
1

 

 

 

 
1

Utah
 
1

 

 

 

 
1

Wisconsin
 

 
1

 

 

 
1

Total United States
 
170

 
70

 
67

 
17

 
324

International
 
 
 
 
 
 
 
 
 
 
Canada
 
14

 

 

 

 
14

Australia
 
6

 

 

 

 
6

France
 
6

 

 

 

 
6

Mexico
 
4

 

 

 

 
4

Portugal
 
2

 

 

 

 
2

Spain
 
2

 

 

 

 
2

Belgium
 
1

 

 

 

 
1

Colombia
 
1

 

 

 

 
1

Croatia
 
1

 

 

 

 
1

Germany
 
1

 

 

 

 
1

Italy
 
1

 

 

 

 
1

United Kingdom
 
1

 

 

 

 
1

Total International
 
40

 

 

 

 
40

Total
 
210

 
70

 
67

 
17

 
364


16



Item 3.  Legal Proceedings

From time to time, we are subject to various claims and litigation arising in the ordinary course of business, including product liability, personal injury, commercial, contract and employment matters. While the outcome of any litigation is inherently unpredictable, based on currently available facts we do not believe that the ultimate resolution of any of these matters will have a material adverse impact on our financial condition, results of operations or cash flows.

Item 4.  Mine Safety Disclosures

Not applicable.


17



PART II.

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is traded on the NASDAQ Global Select Market under the trading symbol “POOL.”  On February 21, 2019, there were approximately 87,073 holders of record of our common stock.  

We initiated quarterly dividend payments to our shareholders in the second quarter of 2004 and we have continued payments in each subsequent quarter. Our Board of Directors (our Board) has increased the dividend amount thirteen times including in the fourth quarter of 2004, annually in the second quarters of 2005 through 2008 and in the second quarters of 2011 through 2018.  Our Board may declare future dividends at their discretion, after considering various factors, including our earnings, capital requirements, financial position, contractual restrictions and other relevant business considerations. For a description of restrictions on dividends in our Credit Facility and Receivables Facility, see Note 5 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K. We cannot assure shareholders or potential investors that dividends will be declared or paid any time in the future if our Board determines that there is a better use of our funds.

Stock Performance Graph

The information included under the caption “Stock Performance Graph” in this Item 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 (the 1934 Act) or to the liabilities of Section 18 of the 1934 Act, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the 1934 Act, except to the extent we specifically incorporate it by reference into such a filing.

The following graph compares the total shareholder return on our common stock for the last five fiscal years with the total return on the S&P MidCap 400 Index and the NASDAQ Index for the same period, in each case assuming the investment of $100 on December 31, 2013 and the reinvestment of all dividends. We believe the S&P MidCap 400 Index includes companies with market capitalizations comparable to ours. Additionally, we chose the S&P MidCap 400 Index for comparison, as opposed to an industry index, because we do not believe that we can reasonably identify a peer group or a published industry or line-of-business index that contains companies in a similar line of business.
stckprfmgraph2018.jpg

 
 
Base
Period
 
Indexed Returns
Years Ending
Company / Index
 
12/31/13
 
12/31/14
 
12/31/15
 
12/31/16
 
12/31/17
 
12/31/18
Pool Corporation
 
$
100.00

 
$
110.71

 
$
142.95

 
$
186.96

 
$
235.19

 
$
272.69

S&P MidCap 400 Index
 
100.00

 
109.77

 
107.38

 
129.65

 
150.71

 
134.01

NASDAQ Index
 
100.00

 
114.75

 
122.74

 
133.62

 
173.22

 
168.30


18




Purchases of Equity Securities

The table below summarizes the repurchases of our common stock in the fourth quarter of 2018:

Period
 
Total Number
of Shares Purchased (1)
 
Average
Price
Paid per
Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plan (2)
 
Maximum Approximate
Dollar Value of Shares
That May Yet be Purchased
Under the Plan (3)
October 1 – October 31, 2018
 
353,071

 
$
145.63

 
353,071

 
$
166,922,688

November 1 – November 30, 2018
 
339,645

 
$
148.36

 
339,645

 
$
116,531,471

December 1 – December 31, 2018
 
321,409

 
$
145.46

 
321,409

 
$
69,779,132

Total
 
1,014,125

 
$
146.49

 
1,014,125

 
 


(1) 
These shares may include shares of our common stock surrendered to us by employees in order to satisfy minimum tax withholding obligations in connection with certain exercises of employee stock options or lapses upon vesting of restrictions on previously restricted share awards, and/or to cover the exercise price of such options granted under our share-based compensation plans. There were no shares surrendered for this purpose in the fourth quarter of 2018.
(2) 
In May 2018, our Board authorized an additional $200.0 million under our share repurchase program for the repurchase of shares of our common stock in the open market at prevailing market prices or in privately negotiated transactions.
(3) 
As of February 21, 2019, our total authorization remaining was $49.2 million.


19



Item 6.  Selected Financial Data

The table below sets forth selected financial data from the Consolidated Financial Statements. You should read this information in conjunction with the discussions in Item 7 of this Form 10-K and with the Consolidated Financial Statements and accompanying Notes in Item 8 of this Form 10-K.
 
(in thousands, except per share data)
 
Year Ended December 31,
 
 
2018 (1)
 
2017 (1)
 
2016
 
2015
 
2014
Statement of Income Data
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
2,998,097

 
$
2,788,188

 
$
2,570,803

 
$
2,363,139

 
$
2,246,562

Operating income
 
313,889

 
284,371

 
255,859

 
216,222

 
188,870

Net income
 
234,461

 
191,339

 
148,603

 
128,224

 
111,030

Net income attributable to Pool Corporation
 
234,461

 
191,633

 
148,955

 
128,275

 
110,692

Earnings per share:
 
 
 
 
 
 

 
 

 
 

Basic
 
$
5.82

 
$
4.69

 
$
3.56

 
$
2.98

 
$
2.50

Diluted
 
$
5.62

 
$
4.51

 
$
3.47

 
$
2.90

 
$
2.44

Cash dividends declared per common share
 
$
1.72

 
$
1.42

 
$
1.19

 
$
1.00

 
$
0.85

 
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data
 
 
 
 

 
 

 
 

 
 

Working capital
 
$
609,634

 
$
460,682

 
$
399,337

 
$
356,899

 
$
345,305

Total assets (2)
 
1,240,871

 
1,101,062

 
994,095

 
934,361

 
890,971

Total debt (2)
 
666,761

 
519,650

 
438,042

 
328,045

 
318,872

Stockholders’ equity
 
223,590

 
223,146

 
205,210

 
255,743

 
244,352

 
 
 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 

 
 

 
 

Base business sales growth (3)
 
7
%
 
7
%
 
7
%
 
5
%
 
7
%
Number of sales centers
 
364

 
351

 
344

 
336
 
328

 
(1) 
Our Net income and Net income attributable to Pool Corporation in 2018 and 2017 were impacted by both U.S. tax reform and Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting. In the first quarter of 2017, we adopted ASU 2016-09, which requires us to recognize all excess tax benefits or deficiencies related to share-based compensation as a component of our income tax provision on our Consolidated Statements of Income, rather than a component of stockholders’ equity on our Consolidated Balance Sheets. This adoption benefited our Net income and Net income attributable to Pool Corporation by $15.3 million in 2018 and $12.6 million in 2017. As a result of U.S. tax reform, we recorded a provisional tax benefit of $12.0 million in the fourth quarter of 2017, which primarily reflects re‑measurement of our net deferred tax liability. No such tax benefits were applicable in prior years.
(2) 
Upon adoption of Accounting Standards Update 2015-03, Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs, we now include financing costs, net of accumulated amortization as a component of long-term debt. For comparability across all periods presented on our Consolidated Balance Sheets, we reclassified certain amounts from Other assets, net in prior periods to Long-term debt, net to conform to our 2018 through 2016 presentation.
(3) 
For a discussion regarding our calculation of base business sales, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - RESULTS OF OPERATIONS,” of this Form 10-K.

20



Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

2018 FINANCIAL OVERVIEW

Financial Results

We delivered solid results in 2018. Despite a later than normal start to the year, and an earlier end, we produced sales growth of 8% in 2018 on top of sales growth of 8% in 2017. Our focus on organic growth, process discipline and value creation allowed us to convert this top line growth into operating income growth of 10% over 2017.

Base business sales grew 7% over last year fueled by continued demand for discretionary products such as building materials, lighting and swimming pool equipment. Gross profit increased 8% for the year ended December 31, 2018 compared to 2017. Gross margin grew 10 basis points to 29.0% for 2018 compared to 28.9% in 2017. We attribute much of the gross margin improvement to our execution of supply chain management initiatives in a higher than normal inflationary environment in our industry.

Selling and administrative expenses (operating expenses) increased 7% compared to 2017, with base business operating expenses up 5% over last year. The increase in base business operating expenses was primarily due to higher growth-driven labor and freight expenses, as well as greater facility-related costs. As a percentage of net sales, operating expenses declined 10 basis points.

Operating income for the year increased 10% to $313.9 million, up from $284.4 million in 2017. Operating income as a percentage of net sales (operating margin) increased to 10.5% in 2018 compared to 10.2% in 2017.

Both Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, which we adopted on January 1, 2017, and U.S. tax reform enacted in December 2017 impacted our income tax provision in 2018 and 2017. Our effective tax rate was 20.1% in 2018 and 29.0% in 2017. We recorded a $15.3 million, or $0.36 per diluted share, benefit from ASU 2016-09 for the year ended December 31, 2018 compared to a benefit of $12.6 million, or $0.24 per diluted share, realized in the same period in 2017. Excluding the benefits from ASU 2016-09, our effective tax rate was 25.3% in 2018 and 33.7% in 2017. We expect our annual effective tax rate (excluding the benefit from ASU 2016-09) for 2019 will approximate 25.5%, which is consistent with 2018 and a reduction compared to our historical rate of approximately 38.5% due to the impact of U.S. tax reform.

Net income attributable to Pool Corporation increased 22% compared to 2017, while earnings per share was up 25% to $5.62 per diluted share. Excluding the impacts of ASU 2016-09 discussed above, diluted earnings per share increased 23% over last year.

Financial Position and Liquidity

Cash provided by operations was $118.7 million in 2018. Combined with $146.5 million in net proceeds from borrowings, cash from operating activities helped fund the following initiatives:

share repurchases in the open market of $183.6 million;
growth in net working capital of $165.8 million;
quarterly cash dividend payments to shareholders, totaling $69.4 million for the year;
net capital expenditures of $31.6 million; and
payments of $2.6 million for acquisitions.

Total net receivables, including pledged receivables, increased 6% compared to December 31, 2017, reflective of fourth quarter sales growth and recent acquisitions. Our allowance for doubtful accounts was $6.2 million at December 31, 2018 and $3.9 million at December 31, 2017, primarily reflecting additional specific reserves for certain customers. Our days sales outstanding ratio, as calculated on a trailing four quarters basis, was 30.1 days at December 31, 2018 and 29.8 days at December 31, 2017.

Inventory levels grew 25% to $672.6 million at December 31, 2018 compared to $536.5 million at December 31, 2017, primarily related to increased inventory purchases ahead of greater-than-normal vendor price increases. Our reserve for inventory obsolescence was $7.7 million at December 31, 2018 compared to $6.3 million at December 31, 2017. Our inventory turns, as calculated on a trailing four quarters basis, were 3.2 times at December 31, 2018 and 3.5 times at December 31, 2017.


21



Total debt outstanding of $666.8 million at December 31, 2018 increased $147.1 million, or 28%, compared to December 31, 2017 primarily to fund the additional inventory purchases discussed above and share repurchases.

Current Trends and Outlook

While market conditions have been generally favorable the past year, a number of factors weigh on our industry, including lagging new home construction, tighter lending standards, and the slower progression of a younger generation burdened by student debt and underemployment. Labor availability and cost have also become issues in recent years, limiting our customers’ ability to fully meet consumer demand, particularly in construction and renovation markets.   

The post-recession market environment from 2010 to 2018 was characterized by the cautious recovery of consumer spending, modest housing recovery and low inflation. However, in terms of homeowners investing in their existing homes, discretionary expenditures, including backyard renovations, flourished over this time period. We expect that new pool and irrigation construction levels will continue to grow incrementally, but we believe that consumer investments in outdoor living spaces beyond the swimming pool will generate greater growth over the next five years.

Although some constraints exist around residential construction activities, economic trends indicate that consumer spending has largely recovered, and we believe that we are well positioned to take advantage of both the market expansion and the inherent long term growth opportunities in our industry. Additionally, recent regulation passed by the U.S. Department of Energy mandates all new and replacement motors and pumps for swimming pools must be variable speed by July 2021. This mandate, coupled with additional product developments and technological advancements, offers further growth opportunities over the next few years.

While we estimate that new pool construction increased to approximately 80,000 new units in 2018, construction levels are still down approximately 65% compared to peak historical levels and down approximately 50% from what we consider normal levels. Favorable weather plays a role in industry growth by accelerating growth in any given year, while unfavorable weather impedes growth. For 2018, we started the year off strong, but a delayed spring resulted in a later than normal start to the swimming pool season, and we finished the year with an earlier end based on weather trends. In contrast, in 2017 specifically, our industry experienced modestly favorable weather overall, despite the severe storms that impacted our industry in Texas and Florida in September and October. In 2016, an earlier start to the swimming pool season due to warmer than usual temperatures and overall favorable weather throughout the rest of the year benefited the industry as a whole. In establishing our outlook each year, we base our growth assumptions on normal weather conditions and do not incorporate alternative weather predictions into our guidance. 

We established our initial outlook for 2019 based on reasonable expectations of organic market share growth, ongoing leverage of infrastructure and continuous process improvements. For 2019, we expect the macroeconomic environment in the United States will be quite similar to 2018. We expect to continue to gain market share through our comprehensive service and product offerings, which we continually diversify through internal sourcing initiatives and expansion into new markets. We also plan to broaden our geographic presence by opening 4 to 6 new sales centers in 2019 and by making selective acquisitions when appropriate opportunities arise.

The following section summarizes our outlook for 2019:

We expect sales growth of 7% to 9%, impacted by the following factors and assumptions:
normal weather patterns for 2019;
continued growth from replacement, remodeling and construction activity and market expansion through newer product offerings like hardscapes and commercial pools;
inflationary product cost increases of approximately 3% to 4% (or approximately 2% above the historical average);
estimated 1% growth from acquisitions completed throughout 2018; and
same selling days in 2019 compared to 2018, with one less day in the first quarter and one additional day in the third quarter in 2019.

By quarter, we expect shifts in our 2019 sales activity, which will affect sales growth comparisons to 2018. For the first quarter of 2019, we expect the loss of a selling day, a delayed Easter and lower customer early buy sales to defer an estimated $20 million to $30 million of sales to the second and third quarters in 2019.




22



We expect relatively neutral gross margin trends for the full year with higher gross margin growth in the first quarter of 2019 compared to 2018 due to projected benefits from our strategic inventory purchases in 2018 and expected lower customer early buy sales in the first quarter of 2019. We expect gross margin growth to moderate substantially in the second and third quarters and become a difficult comparison in the fourth quarter of 2019 based on our 2018 results.

We expect operating expenses will grow at approximately 60% of the rate of our gross profit growth, reflecting inflationary increases and incremental costs to support our sales growth expectations. The main challenges in achieving this metric include managing people and facility costs in tight labor and real estate markets. However, we continue to see significant opportunity to leverage our existing infrastructure to achieve this goal.

In 2019, we expect our effective tax rate will approximate 25.5%, excluding the impact of ASU 2016-09. This projected rate is a reduction from our historical rate of approximately 38.5%. Our effective tax rate is dependent upon our results of operations and may change if actual results are different from our current expectations, particularly any significant changes in our geographic mix. Due to ASU 2016-09 requirements, we expect our effective tax rate will fluctuate from quarter to quarter, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. Based on our December 31, 2018 stock price, we estimate that we have approximately $7.2 million in unrealized excess tax benefits related to stock options that will expire in the second quarter of 2019 and restricted awards that will vest in 2019. We may recognize additional tax benefits related to stock option exercises in 2019 from grants that expire in years after 2019, for which we have not included any expected benefits in our guidance. The estimated impact related to ASU 2016-09 is subject to several assumptions which can vary significantly, including our estimated share price and the period that our employees will exercise vested stock options. We recorded a $15.3 million benefit in our provision for income taxes for the year ended December 31, 2018 related to ASU 2016-09.

We project that 2019 earnings will be in the range of $6.05 to $6.35 per diluted share, including an estimated $0.18 favorable impact from ASU 2016-09. Excluding the impact of timing differences from our strategic inventory purchases in the second half of 2018, we expect cash provided by operations will approximate net income for fiscal 2019, and subject to additional authorization by our Board of Directors, we anticipate that we will use $150.0 million to $200.0 million in cash for share repurchases.

On January 1, 2019, we adopted ASU 2016-02, Leases. We do not expect the new accounting pronouncement to have a material impact on our results of operations and cash flows. For additional details, see Note 1 of our “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K.

The forward-looking statements in this Current Trends and Outlook section are subject to significant risks and uncertainties, including the sensitivity of our business to weather conditions, changes in the economy and the housing market, our ability to maintain favorable relationships with suppliers and manufacturers, competition from other leisure product alternatives and mass merchants, and other risks detailed in Item 1A of this Form 10-K. Also see “Cautionary Statement for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995” prior to Item 1A.

CRITICAL ACCOUNTING ESTIMATES

We prepare our Consolidated Financial Statements in accordance with U.S. generally accepted accounting principles (GAAP), which requires management to make estimates and assumptions that affect reported amounts and related disclosures. Management identifies critical accounting estimates as:

those that require the use of assumptions about matters that are inherently and highly uncertain at the time the estimates are made; and
those for which changes in the estimates or assumptions, or the use of different estimates and assumptions, could have a material impact on our consolidated results of operations or financial condition.

Management has discussed the development, selection and disclosure of our critical accounting estimates with the Audit Committee of our Board. We believe the following critical accounting estimates require us to make the most difficult, subjective or complex judgments.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts based on an estimate of the losses we will incur if our customers do not make required payments. We perform periodic credit evaluations of our customers and typically do not require collateral. Consistent with industry practices, we generally require payment from our North American customers within 30 days, except for sales under early buy programs for which we provide extended payment terms to qualified customers. The extended terms usually require

23



payments in equal installments in April, May and June or May and June, depending on geographic location. Credit losses have generally been within or better than our expectations.

Similar to our business, our customers’ businesses are seasonal. Sales are lowest in the winter months and our past due accounts receivable balance as a percentage of total receivables generally increases during this time. We provide reserves for uncollectible accounts based on our accounts receivable aging. These reserves range from 0.05% for amounts currently due to up to 100% for specific accounts more than 60 days past due.

At the end of each quarter, we perform a reserve analysis of all accounts with balances greater than $20,000 and more than 60 days past due. Additionally, we perform a separate reserve analysis on the balance of our accounts receivables with emphasis on past due accounts. As we review these past due accounts, we evaluate collectability based on a combination of factors including:

aging statistics and trends;
customer payment history;
independent credit reports; and
discussions with customers.

During the year, we write off account balances when we have exhausted reasonable collection efforts and determined that the likelihood of collection is remote. These write-offs are charged against our allowance for doubtful accounts. In the past five years, write-offs have averaged approximately 0.06% of net sales annually.  Write-offs as a percentage of net sales approximated 0.07% in 2018, 0.05% in 2017 and 0.07% in 2016. We expect that write-offs will range from 0.05% to 0.10% of net sales in 2019.

At the end of each fiscal year, we prepare a hindsight analysis by comparing the prior year end allowance for doubtful accounts balance to (i) current year write-offs and (ii) any significantly aged outstanding receivable balances. Based on our hindsight analysis, we concluded that the prior year allowance was within a range of acceptable estimates and that our estimation methodology is appropriate.

If the balance of the accounts receivable reserve increased or decreased by 20% at December 31, 2018, pretax income would change by approximately $1.2 million and earnings per share would change by approximately $0.02 per diluted share (based on the number of weighted average diluted shares outstanding for the year ended December 31, 2018).

Inventory Obsolescence

Product inventories represent the largest asset on our balance sheet. Our goal is to manage our inventory such that we minimize stock-outs to provide the highest level of service to our customers. To do this, we maintain at each sales center an adequate inventory of stock keeping units (SKUs) with the highest sales volumes. At the same time, we continuously strive to better manage our slower moving classes of inventory, which are not as critical to our customers and thus, inherently turn at slower rates.

We classify products into 13 classes at the sales center level based on sales at each location over the expected sellable period, which is the previous 12 months for most products. All inventory is included in these classes, except for special order non-stock items that lack a SKU in our system and products with less than 12 months of usage. The table below presents a description of these inventory classes:

Class 0
new products with less than 12 months usage
 
 
Classes 1-4
highest sales value items, which represent approximately 80% of net sales at the sales center
 
 
Classes 5-12
lower sales value items, which we keep in stock to provide a high level of customer service
 
 
Class 13
products with no sales for the past 12 months at the local sales center level, excluding special order products not yet delivered to the customer
 
 
Null class
non-stock special order items


24



There is little risk of obsolescence for products in classes 1-4 because products in these classes generally turn quickly. We establish our reserve for inventory obsolescence based on inventory classes 5-13, which we believe represent some exposure to inventory obsolescence, with particular emphasis on SKUs with the least sales over the previous 12 months. The reserve is intended to reflect the value of inventory at net realizable value. We provide a reserve of 5% for inventory in classes 5-13 and non-stock inventory as determined at the sales center level. We also provide an additional 5% reserve for excess inventory in classes 5-12 and an additional 45% reserve for excess inventory in class 13. We determine excess inventory, which is defined as the amount of inventory on hand in excess of the previous 12 months’ usage, on a company-wide basis.  We also evaluate whether the calculated reserve provides sufficient coverage of the total class 13 inventory.

In evaluating the adequacy of our reserve for inventory obsolescence, we consider a combination of factors including:

the level of inventory in relation to historical sales by product, including inventory usage by class based on product sales at both the sales center and on a company-wide basis;
changes in customer preferences or regulatory requirements;
seasonal fluctuations in inventory levels;
geographic location; and
superseded products and new product offerings.

We periodically adjust our reserve for inventory obsolescence as changes occur in the above-identified factors. At the end of each fiscal year, we prepare a hindsight analysis by comparing the prior year end obsolescence reserve balance to (i) current year inventory write-offs and (ii) the value of products with no sales for the past 12 months that remain in inventory. Based on our hindsight analysis, we concluded that our prior year reserve was within a range of acceptable estimates and that our estimation methodology is appropriate.

If the balance of our inventory reserve increased or decreased by 20% at December 31, 2018, pretax income would change by approximately $1.5 million and earnings per share would change by approximately $0.03 per diluted share (based on the number of weighted average diluted shares outstanding for the year ended December 31, 2018).

Vendor Programs

Many of our vendor arrangements provide for us to receive specified amounts of consideration when we achieve any of a number of measures.  These measures generally relate to the volume level of purchases from our vendors, or our net cost of products sold, and may include negotiated pricing arrangements.  We account for vendor programs as a reduction of the prices of the vendor’s products and therefore a reduction of inventory until we sell the product, at which time we recognize such consideration as a reduction of cost of sales in our income statement.

Throughout the year, we estimate the amount earned based on our expectation of total purchases for the fiscal year relative to the purchase levels that mark our progress toward the attainment of various levels within certain vendor programs. We accrue vendor program benefits on a monthly basis using these estimates provided that we determine they are probable and reasonably estimable. Our estimates for annual purchases, future inventory levels and sales of qualifying products are driven by our sales projections, which can be significantly impacted by a number of external factors including changes in economic conditions and weather.  Changes in our purchasing mix also impact our estimates, as certain program rates can vary depending on our volume of purchases from specific vendors.

We continually revise these estimates throughout the year to reflect actual purchase levels and identifiable trends. As a result, our estimated quarterly vendor program benefits accrual may include cumulative catch-up adjustments to reflect any changes in our estimates between reporting periods. These adjustments tend to have a greater impact on gross margin in the fourth quarter since it is our seasonally slowest quarter and because the majority of our vendor arrangements are based on calendar year periods. We update our estimates for these arrangements at year end to reflect actual annual purchase levels. In the first quarter of the subsequent year, we prepare a hindsight analysis by comparing actual vendor credits received to the prior year vendor receivable balances. Based on our hindsight analysis, we concluded that our vendor program estimates were within a range of acceptable estimates and that our estimation methodology is appropriate.

If market conditions were to change, vendors may change the terms of some or all of these programs. Although such changes would not affect the amounts we have recorded related to products already purchased, they may lower or raise our cost for products purchased and sold in future periods.


25



Income Taxes

We record deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities using currently enacted rates and laws that will be in effect when we expect the differences to reverse.  Due to changing tax laws and state income tax rates, significant judgment is required to estimate the effective tax rate expected to apply to tax differences that are expected to reverse in the future.
In December 2017, the Tax Cuts and Jobs Act (the TJCA or the Act) was enacted, which significantly changed U.S. tax law. In accordance with Accounting Standards Codification Topic (ASC) 740, Income Taxes, we are required to account for the new requirements in the period that includes the date of enactment. The Act reduced the overall corporate income tax rate to 21%, created a territorial tax system (with a one-time mandatory transition tax on previously deferred foreign earnings), broadened the tax base and allowed for the immediate capital expensing of certain qualified property. Due to the complexities presented by the Act, particularly for companies with multi-national operations, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 118 (SAB 118) to provide guidance to companies who were not able to complete their accounting in the period of enactment prior to the reporting deadlines. Under the guidance in SAB 118, provisional amounts based on reasonable estimates were allowable for companies that had not yet completed their accounting for certain elements under the Act. As a result of this guidance, we recorded a provisional net benefit to our income tax provision in the fourth quarter of 2017. As of December 31, 2018, we completed our accounting for the tax effects of the Act, which did not result in a material adjustment to our provisional amount. For the Global Intangible Low Tax Income (GILTI) provisions of the Act, we have elected an accounting policy to record GILTI as period costs if and when incurred.
As of December 31, 2018, United States income taxes were not provided on the earnings or cash balances of our foreign subsidiaries, outside of the provisions of the transition tax from U.S. tax reform. As we have historically invested or expect to invest the undistributed earnings indefinitely to fund current cash flow needs in the countries where held, additional income tax provisions may be required. Determining the amount of unrecognized deferred tax liability on these undistributed earnings and cash balances is not practicable due to the complexity of tax laws and regulations and the varying circumstances, tax treatments and timing of any future repatriation. We determined not to change our indefinite reinvestment assertion in light of U.S. tax reform.

We operate in 39 states, 1 United States territory and 12 foreign countries. We are subject to regular audits by federal, state and foreign tax authorities, and the amount of income taxes we pay is subject to adjustment by the applicable tax authorities.  We recognize a benefit from an uncertain tax position only after determining it is more likely than not that the tax position will withstand examination by the applicable taxing authority. Our estimate for the potential outcome of any uncertain tax issue is highly judgmental. We regularly evaluate our tax positions and incorporate these expectations into our reserve estimates. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters.  However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, or when statutes of limitation on potential assessments expire.  These adjustments may include changes in valuation allowances that we have established.  As a result of these uncertainties, our total income tax provision may fluctuate on a quarterly basis.

Each year, we prepare a return to provision analysis upon filing our income tax returns. Based on this hindsight analysis, we concluded that our prior year income tax provision was within a range of acceptable estimates and that our provision calculation methodology is appropriate. Differences between our effective income tax rate and federal and state statutory tax rates are primarily due to valuation allowances recorded for certain of our international subsidiaries with tax losses.

Performance-Based Compensation Accrual

The Compensation Committee of our Board (Compensation Committee) annually reviews our compensation structure to oversee management’s implementation of maintaining a program that attracts, retains, develops and motivates employees without leading to unnecessary risk taking. Our compensation packages include bonus plans that are specific to each group of eligible participants and their levels and areas of responsibility. The majority of our bonus plans have annual cash payments that are based primarily on objective performance criteria. We calculate bonuses based on the achievement of certain key measurable financial and operational results, including operating income and diluted earnings per share (EPS).


26



We use an annual cash performance award (annual bonus) to focus corporate behavior on short-term goals for growth, financial performance and other specific financial and business improvement metrics. Management sets the Company’s annual bonus objectives at the beginning of the bonus plan year using both historical information and forecasted results of operations for the current plan year. Management also establishes specific business improvement objectives for both our operating units and corporate employees. The Compensation Committee approves objectives for annual bonus plans involving executive management.

We also utilize our medium-term (three-year) Strategic Plan Incentive Program (SPIP) to provide senior management with an additional cash-based, pay-for-performance award based on the achievement of specified earnings growth objectives. Payouts through the SPIP are based on three-year compound annual growth rates (CAGRs) of our diluted EPS.

We record annual performance-based compensation accruals based on operating income achieved in a quarter as a percentage of total expected operating income for the year. We estimate total expected operating income for the current plan year using management’s estimate of the total overall incentives earned per the stated bonus plan objectives. Starting in June, and continuing each quarter through our fiscal year end, we adjust our estimated performance-based compensation accrual based on our detailed analysis of each bonus plan, the participants’ progress toward achievement of their specific objectives and management’s estimates related to the discretionary components of the bonus plans, if any.

We record SPIP accruals based on our total expected EPS for the current fiscal year and earnings growth estimates for the succeeding two years. We base our current fiscal year estimates on the same assumptions used for our annual bonus calculation and we base our forward-looking estimates on historical growth trends and our projections for the remainder of the three-year performance periods.

Our quarterly performance-based compensation expense and accrual balances may vary relative to actual annual bonus expense and payouts due to the following:

differences between estimated and actual performance;
our projections related to achievement of multiple-year performance objectives for our SPIP; and
the discretionary components of the bonus plans.

We generally make bonus payments at the end of February following the most recently completed fiscal year. Each year, we compare the actual bonus payouts to amounts accrued at the previous year end to determine the accuracy of our performance‑based compensation estimates. Based on our hindsight analysis, we concluded that our performance-based compensation accrual balances were within a reasonable range of acceptable estimates and that our estimation methodologies are appropriate.

Impairment of Goodwill and Other Indefinite-Lived Intangible Assets

Goodwill is our largest intangible asset. At December 31, 2018, our goodwill balance was $188.5 million, representing approximately 15% of total assets. Goodwill represents the excess of the amount we paid to acquire a company over the estimated fair value of tangible assets and identifiable intangible assets acquired, less liabilities assumed.

We perform a goodwill impairment test in the fourth quarter of each year or on a more frequent basis if events or changes in circumstances occur that indicate potential impairment.  If the estimated fair value of any of our reporting units falls below its carrying value, we compare the estimated fair value of the reporting unit’s goodwill to its carrying value. If the carrying value of a reporting unit’s goodwill exceeds its estimated fair value, we perform a calculation to measure impairment, which includes valuing the tangible and intangible assets. We recognize any impairment loss in operating income.

Since we define an operating segment as an individual sales center and we do not have operations below the sales center level, we define a reporting unit as an individual sales center.  As of October 1, 2018, we had 223 reporting units with allocated goodwill balances. The most significant goodwill balance for a reporting unit was $5.7 million and the average goodwill balance was $0.8 million.

In October of 2018, 2017 and 2016, we performed our annual goodwill impairment test and did not identify any goodwill impairment at the reporting unit level. In the third quarter of 2016, we recorded a $0.6 million goodwill impairment charge related to an at-risk reporting unit in Quebec, Canada. This location’s results came in above expectations at the end of both the 2018 and 2017 swimming pool seasons, and as of December 31, 2018, the remaining goodwill balance for this reporting unit was $1.7 million.
 

27



We estimate the fair value of our reporting units based on an income approach that incorporates our assumptions for determining the present value of future cash flows.  We project future cash flows using management’s assumptions for sales growth rates, operating margins, discount rates and multiples. These estimates can significantly affect the outcome of our impairment test.  We also review for potential impairment indicators at the reporting unit level based on an evaluation of recent historical operating trends, current and projected local market conditions and other relevant factors as appropriate.

To test the reasonableness of our fair value estimates, we compared our aggregate estimated fair values to our market capitalization as of the date of our annual impairment test. We expect that a reasonable fair value estimate would reflect a moderate acquisition premium. Our aggregate estimated fair values fell in line with our market capitalization, which we consider to be reasonable for the purpose of our goodwill impairment test. To facilitate a sensitivity analysis, we reduced our consolidated fair value estimate to reflect more conservative discounted cash flow assumptions, the sensitivity of a 50 basis point increase in our estimated weighted average cost of capital or a 50 basis point decrease in the estimated perpetuity growth rate. Our sensitivity analysis generated a fair value estimate significantly below our market capitalization and resulted in the identification of no goodwill impairments and no additional at-risk locations.
  
Based on our 2018 goodwill impairment analysis, we consider our reporting units in Australia as most at risk for goodwill impairment. We entered Australia in July 2014 with the acquisition of a controlling interest in Pool Systems Pty. Ltd (PSL). The previous owner of PSL provided executive oversight until our purchase of the non-controlling interest in June 2017. Since 2014, we have continued to expand our operations in Australia via one sales center opening and the acquisitions of Newline Pool Products in July 2017 and Pool Power in January 2018. The most sensitive assumptions related to our fair values for these locations relate to future projected operating results and management’s ability to effectively leverage our operating structure and manage costs as we expand our presence. As of December 31, 2018, our aggregate goodwill balance for our five reporting units in Australia was $4.0 million.

If our assumptions or estimates in our fair value calculations change or if operating results are less than forecasted, we could incur additional impairment charges in future periods, especially related to the reporting units discussed above.  Impairment charges would decrease operating income, negatively impact diluted EPS and result in lower asset values on our balance sheet.  

Recent Accounting Pronouncements

See Note 1 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K for details.



28



RESULTS OF OPERATIONS

The table below summarizes information derived from our Consolidated Statements of Income expressed as a percentage of net sales for the past three fiscal years:

 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
Net sales
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
 
71.0

 
71.1

 
71.2

Gross profit
 
29.0

 
28.9

 
28.8

Operating expenses
 
18.6

 
18.7

 
18.9

Operating income
 
10.5

 
10.2

 
10.0

Interest and other non-operating expenses, net
 
0.7

 
0.5

 
0.6

Income before income taxes and equity earnings
 
9.8
%
 
9.7
%
 
9.4
%

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

Our discussion of consolidated operating results includes the operating results from acquisitions in 2018, 2017 and 2016.  We have included the results of operations in our consolidated results since the respective acquisition dates.

Fiscal Year 2018 compared to Fiscal Year 2017

The following table breaks out our consolidated results into the base business component and the excluded components (sales centers excluded from base business):

(Unaudited)
 
Base Business
 
Excluded
 
Total
(in thousands)
 
Year Ended
 
Year Ended
 
Year Ended
 
 
December 31,
 
December 31,
 
December 31,
 
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Net sales
 
$
2,957,006

 
$
2,776,103

 
$
41,091

 
$
12,085

 
$
2,998,097

 
$
2,788,188

 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
857,590

 
801,716

 
12,583

 
3,573

 
870,173

 
805,289

Gross margin
 
29.0
%
 
28.9
%
 
30.6
 %
 
29.6
 %
 
29.0
%
 
28.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
541,462

 
516,183

 
14,822

 
4,735

 
556,284

 
520,918

Expenses as a % of net sales
 
18.3
%
 
18.6
%
 
36.1
 %
 
39.2
 %
 
18.6
%
 
18.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss)
 
316,128

 
285,533

 
(2,239
)
 
(1,162
)
 
313,889

 
284,371

Operating margin
 
10.7
%
 
10.3
%
 
(5.4
)%
 
(9.6
)%
 
10.5
%
 
10.2
%


29



We have excluded the following acquisitions from base business for the periods identified:



Acquired
 

Acquisition
Date
 
Net
Sales Centers
Acquired
 

Periods
Excluded
Turf & Garden, Inc. (1)
 
November 2018
 
4
 
November - December 2018
Tore Pty. Ltd. (Pool Power) (1)
 
January 2018
 
1
 
January - December 2018
Chem Quip, Inc. (1)
 
December 2017
 
5
 
December 2017 and
January - December 2018
Intermark
 
December 2017
 
1
 
December 2017 and
January - December 2018
E-Grupa
 
October 2017
 
1
 
October - December 2017 and January - December 2018
New Star Holdings Pty. Ltd. (Newline)
 
July 2017
 
1
 
January - September 2018 and July - September 2017
Lincoln Aquatics (1)
 
April 2017
 
1
 
January - July 2018 and
May - July 2017

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

When calculating our base business results, we exclude sales centers that are acquired, closed or opened in new markets for a period of 15 months. We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that are consolidated with acquired sales centers.

We generally allocate corporate overhead expenses to excluded sales centers on the basis of their net sales as a percentage of total net sales.  After 15 months of operations, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.

The table below summarizes the changes in our sales centers during 2018:

December 31, 2017
351

Acquired locations
5

New locations
9

Consolidated location
(1
)
December 31, 2018
364


For information about our recent acquisitions, see Note 2 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K.


30



Net Sales

(in millions)
 
Year Ended December 31,
 
  
 
 
2018
 
2017
 
Change
Net sales
 
$
2,998.1

 
$
2,788.2

 
$
209.9

 
8%

Net sales increased 8% compared to 2017, with 7% of this increase coming from base business sales growth. We started the year off strong, but multiple storms in March hindered our customers’ ability to complete projects, and cold temperatures and snow in our seasonal markets delayed pool openings through April. Our seasonal markets finally warmed up in May 2018, allowing us to serve the pent-up demand and generate solid sales growth through the remainder of the second and third quarters, despite several occurrences of severe weather during the third quarter. In the fourth quarter of 2018, much cooler and wetter weather patterns made pool construction and remodeling activities from Texas to the East Coast difficult for our customers to pursue. Further, the comparison to the fourth quarter of 2017 was especially tough given the favorable weather last year in our year-round markets, which drive most of our sales in our seasonally slower fourth quarter, and the revenue generated from the Hurricane Irma recovery in Florida in the fourth quarter of 2017. Despite a later than normal start to the season, and an earlier end, we produced 8% sales growth in 2018 on top of sales growth of 8% in 2017.

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

continued improvement in consumer discretionary expenditures, including continued growth in remodeling and replacement activity (see discussion below);
market share growth, particularly in building materials and commercial product categories;
chemicals, our largest product category at 12% of total net sales for 2018, had increased sales of 7% compared to 2017; and
inflation driven (estimated at approximately 1%) product selling price increases, with higher increases on certain swimming pool equipment and parts in the fourth quarter of 2018.

We believe that sales growth rates for certain product offerings, such as building materials and equipment, evidence increased spending in traditionally discretionary areas including pool construction and pool remodeling, as well as equipment upgrades. In 2018, sales for equipment, such as swimming pool heaters, pumps, lights and filters, increased 7%, and collectively represented approximately 27% of net sales. This increase reflects both the growth of replacement activity and continued demand for higher‑priced, more energy-efficient products. Sales of building materials, which includes tile, grew 11% compared to 2017 and represented approximately 12% of net sales in 2018.

Sales to customers who service large commercial installations such as hotels, universities and community recreational facilities are included in the appropriate existing product categories, and growth in this area is reflected in the numbers above. Sales to these customers increased 11% compared to 2017 and represented 5% of our consolidated net sales for 2018.

In terms of quarterly performance, base business sales increased 5% in the first quarter of 2018. Base business sales then increased 6% in the second quarter of 2018 despite a slow start to the quarter as discussed above. In in the third quarter of 2018, base business sales increased 8% despite severe weather events and elevated rainfall in Texas and wildfires in California. For our seasonally slowest fourth quarter, base business sales increased 5% in 2018 on top of 13% base business sales growth achieved in the fourth quarter of 2017. In addition to the sales discussion above, see further details of significant weather impacts under the subheading Seasonality and Quarterly Fluctuations below.

Gross Profit

(in millions)
 
Year Ended December 31,
 
  
 
 
2018
 
2017
 
Change
Gross profit
 
$
870.2

 
$
805.3

 
$
64.9

 
8%
Gross margin
 
29.0
%
 
28.9
%
 
 
 
 

Gross margin for 2018 increased 10 basis points compared to 2017. We attribute much of the gross margin improvement to our execution of supply chain management initiatives in a higher than normal inflationary environment in our industry. In the second half of 2018, we made strategic inventory purchases in advance of greater-than-normal vendor price increases.

31



Operating Expenses

(in millions)
 
Year Ended December 31,
 
 
 
 
2018
 
2017
 
Change
Operating expenses
 
$
556.3

 
$
520.9

 
$
35.4

 
7%
Operating expenses as a percentage of net sales
 
18.6
%
 
18.7
%
 
 
 
 

Operating expenses increased 7% compared to 2017, with base business operating expenses up 5%. The increase in base business operating expenses was primarily due to higher growth-driven labor and freight expenses, as well as greater facility-related expenditures, offset by lower performance-based compensation.

Interest and Other Non-operating Expenses, net

Interest and other non-operating expenses, net increased $5.7 million compared to 2017. This increase mostly reflects higher interest expense on our debt. Average outstanding debt was $579.1 million in 2018 versus $504.0 million in 2017. Our 2018 average outstanding debt balance reflects greater borrowings, primarily to fund working capital growth. Our weighted average effective interest rate increased to 3.3% in 2018 compared to 2.7% in 2017.

Income Taxes

Our effective income tax rate was 20.1% at December 31, 2018 and 29.0% at December 31, 2017. Our provision for income taxes in 2017 was positively impacted by both U.S. tax reform and ASU 2016-09. We recorded a $15.3 million benefit from ASU 2016-09 for the year ended December 31, 2018 compared to a benefit of $12.6 million realized in the same period in 2017. Excluding the benefits from ASU 2016-09, our effective tax rate was 25.3% and 33.7% for the years ended 2018 and 2017, respectively.
 
Net Income and Earnings Per Share

Net income attributable to Pool Corporation increased 22% to $234.5 million in 2018 compared to $191.6 million in 2017. Earnings per share increased 25% to $5.62 per diluted share compared to $4.51 per diluted share in 2017. Excluding the $0.36 per diluted share impact of ASU 2016-09 in 2018 and $0.24 in 2017, diluted earnings per share increased 23% over last year.





32



Fiscal Year 2017 compared to Fiscal Year 2016

The following table breaks out our consolidated results into the base business component and the excluded components (sales centers excluded from base business):

(Unaudited)
 
Base Business
 
Excluded
 
Total
(in thousands)
 
Year Ended
 
Year Ended
 
Year Ended
 
 
December 31,
 
December 31,
 
December 31,
 
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Net sales
 
$
2,749,672

 
$
2,558,368

 
$
38,516

 
$
12,435

 
$
2,788,188

 
$
2,570,803

 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
793,866

 
737,335

 
11,423

 
3,752

 
805,289

 
741,087

Gross margin
 
28.9
%
 
28.8
%
 
29.7
 %
 
30.2
%
 
28.9
%
 
28.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
508,273

 
481,924

 
12,645

 
3,304

 
520,918

 
485,228

Expenses as a % of net sales
 
18.5
%
 
18.8
%
 
32.8
 %
 
26.6
%
 
18.7
%
 
18.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss)
 
285,593

 
255,411

 
(1,222
)
 
448

 
284,371

 
255,859

Operating margin
 
10.4
%
 
10.0
%
 
(3.2
)%
 
3.6
%
 
10.2
%
 
10.0
%

For an explanation of how we calculate base business, please refer to the discussion of base business under the heading “Fiscal Year 2018 compared to Fiscal Year 2017.”

For purposes of comparing operating results for the year ended December 31, 2017 to the year ended December 31, 2016, we excluded acquired sales centers from base business for the periods identified in the table below.



Acquired
 

Acquisition
Date
 
Net
Sales Centers
Acquired
 

Periods
Excluded
Chem Quip, Inc. (1) (2)
 
December 2017
 
5
 
December 2017
Intermark
 
December 2017
 
1
 
December 2017
E-Grupa
 
October 2017
 
1
 
October - December 2017
New Star Holdings Pty. Ltd.
 
July 2017
 
1
 
July - December 2017
Lincoln Aquatics (1)
 
April 2017
 
1
 
May - December 2017
Metro Irrigation Supply Company Ltd. (1)
 
April 2016
 
8
 
January - June 2017 and
April - June 2016
The Melton Corporation (1)
 
November 2015
 
2
 
January 2017 and
January 2016
Seaboard Industries, Inc. (1)
 
October 2015
 
3
 
January 2017 and
January 2016

(1) 
We acquired certain distribution assets of each of these companies.
(2) 
We completed this acquisition on December 29, 2017. Thus we reported no results of operations in fiscal 2017 for this acquisition due to the acquisition date; however, the acquired sales centers are included in the sales center count below.





33



The table below summarizes the changes in our sales centers during 2017:

December 31, 2016
344

Acquired locations
9

New locations
1

Consolidated locations
(3
)
December 31, 2017
351


For information about our recent acquisitions, see Note 2 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K.

Net Sales

(in millions)
 
Year Ended December 31,
 
  
 
 
2017
 
2016
 
Change
Net sales
 
$
2,788.2

 
$
2,570.8

 
$
217.4

 
8%

Net sales increased 8% compared to 2016, despite one less selling day. Our 7% increase in base business sales generated much of this growth. We experienced modestly favorable weather during the swimming pool season, which ended with severe storms in September and October in both Texas and Florida. By the end of the fourth quarter, we mostly recovered sales lost over these time periods.

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

continued improvement in consumer discretionary expenditures, including continued growth in remodeling and replacement activity (see discussion below);
market share growth, particularly in building materials and commercial product categories;
increased pool and spa chemical sales, our largest product category at 12% of total net sales for 2017, up 4% compared to 2016, excluding the recent Lincoln Aquatics acquisition;
inflation driven (estimated at close to 1%) product selling price increases; and,
acquisitions, particularly in the commercial market (Lincoln Aquatics) and Australia (Newline Pool Products).

We believe that sales growth rates for certain product offerings, such as building materials and equipment, evidence increased spending in traditionally discretionary areas including pool construction, pool remodeling, as well as equipment upgrades. In 2017, sales for equipment such as swimming pool heaters, pumps, and lights increased 10%, and collectively represented approximately 23% of net sales. This increase reflects both the growth of replacement activity and continued demand for higher‑priced, more energy-efficient products. Sales of building materials, which includes tile, grew 13% compared to 2016 and represented approximately 10% of net sales in 2017.

Sales to customers who service large commercial installations such as hotels, universities and community recreational facilities are included in the appropriate existing product categories, and growth in this area is reflected in the numbers above. These sales increased 10% compared to 2016 and represented 5% of our consolidated net sales for 2017, excluding the recent acquisition of Lincoln Aquatics.

In terms of quarterly performance, base business sales increased 5% in the first quarter of 2017, despite a 2% decline in sales related to customer early buy purchases. Base business sales then increased 7% in the second quarter of 2017 under overall neutral weather conditions for most of the quarter. Despite the severe weather events in the third quarter of 2017, and one less selling day compared to the same period in 2016, base business sales increased 6% in the third quarter. For our seasonally slowest fourth quarter, base business sales increased 13% in 2017 reflecting strong consumer demand, excellent execution by our team, the recovery following Hurricane Irma and overall favorable weather conditions. See discussion of significant weather impacts under the subheading Seasonality and Quarterly Fluctuations below.


34



Gross Profit

(in millions)
 
Year Ended December 31,
 
  
 
 
2017
 
2016
 
Change
Gross profit
 
$
805.3

 
$
741.1

 
$
64.2

 
9%
Gross margin
 
28.9
%
 
28.8
%
 
 
 
 

Gross margin for 2017 increased 10 basis points compared to 2016 mostly reflecting product mix coupled with benefits from sourcing initiatives.


Operating Expenses

(in millions)
 
Year Ended December 31,
 
 
 
 
2017
 
2016
 
Change
Operating expenses
 
$
520.9

 
$
485.2

 
$
35.7

 
7%
Operating expenses as a percentage of net sales
 
18.7
%
 
18.9
%
 
 
 
 

Operating expenses increased 7% compared to 2016, with base business operating expenses up 5%. The increase in base business operating expenses was primarily due to higher growth-driven labor and freight expenses, as well as greater facility-related expenditures, equity-based compensation, and technology spending as we continue to invest in our business. Base business operating expenses as a percentage of net sales improved 30 basis points over 2016, as we continued to leverage our existing infrastructure.

Interest and Other Non-operating Expenses, net

Interest and other non-operating expenses, net increased $0.7 million compared to 2016. Average outstanding debt was $504.0 million for 2017 versus $424.6 million for 2016. Our 2017 average outstanding debt balance reflects greater borrowings, primarily to fund working capital growth. Our weighted average effective interest rate increased to 2.7% for 2017 compared to 2.2% for 2016.

Income Taxes

Our effective income tax rate was 29.0% at December 31, 2017 and 38.5% at December 31, 2016. Our provision for income taxes for 2017 was positively impacted by both U.S. tax reform and ASU 2016-09. As a result of the recently enacted tax legislation, we recorded a provisional tax benefit of $12.0 million in the fourth quarter of 2017, which primarily reflects the re-measurement of our net deferred tax liability. In addition to the impact from tax reform, we recorded a $12.6 million benefit in our provision for income taxes for the year ended December 31, 2017 related to our adoption of ASU 2016-09.

Net Income and Earnings Per Share

Net income attributable to Pool Corporation increased 29% to $191.6 million in 2017 compared to $149.0 million in 2016. Earnings per share increased 30% to $4.51 per diluted share compared to $3.47 per diluted share in 2016. Excluding the $0.28 per diluted share impact of tax reform and the $0.24 per diluted share impact of ASU 2016-09, diluted earnings per share increased 15% over last year.








35



Seasonality and Quarterly Fluctuations

For discussion regarding the effects seasonality and weather have on our business, see Item 1, “Business,” of this Form 10-K.

The following table presents certain unaudited quarterly data for 2018 and 2017. We have included income statement and balance sheet data for the most recent eight quarters to allow for a meaningful comparison of the seasonal fluctuations in these amounts. In our opinion, this information reflects all normal and recurring adjustments considered necessary for a fair presentation of this data. Due to the seasonal nature of our industry, the results of any one or more quarters are not necessarily a good indication of results for an entire fiscal year or of continuing trends.

(Unaudited)
 
QUARTER
(in thousands)
 
2018
 
2017
 
 
First
 
Second
 
Third
 
Fourth
 
First
 
Second
 
Third
 
Fourth
Statement of Income Data
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
585,900

 
$
1,057,804

 
$
811,311

 
$
543,082

 
$
546,441

 
$
988,163

 
$
743,401

 
$
510,183

Gross profit
 
166,073

 
308,655

 
235,003

 
160,442

 
153,621

 
289,664

 
216,606

 
145,398

Operating income
 
33,541

 
162,042

 
92,337

 
25,970

 
30,998

 
154,186

 
81,928

 
17,259

Net income
 
31,339

 
117,049

 
69,261

 
16,811

 
22,270

 
94,620

 
48,783

 
25,665

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net sales as a % of annual net sales
 
20
%
 
35
%
 
27
%
 
18
%
 
20
%
 
35
%
 
27
%
 
18
%
Gross profit as a % of annual gross profit
 
19
%
 
35
%
 
27
%
 
18
%
 
19
%
 
36
%
 
27
%
 
18
%
Operating income as a % of annual operating income
 
11
%
 
52
%
 
29
%
 
8
%
 
11
%
 
54
%
 
29
%
 
6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total receivables, net
 
$
314,596

 
$
404,415

 
$
287,773

 
$
207,801

 
$
290,019

 
$
370,285

 
$
262,796

 
$
196,265

Product inventories, net
 
703,793

 
606,583

 
609,983

 
672,579

 
647,884

 
542,805

 
484,287

 
536,474

Accounts payable
 
467,795

 
300,232

 
204,706

 
237,835

 
465,928

 
273,309

 
209,092

 
245,249

Total debt
 
568,110

 
657,120

 
580,703

 
666,761

 
490,217

 
553,480

 
564,573

 
519,650

 
Note:  Due to rounding, the sum of quarterly percentage amounts may not equal 100%.
 
Weather Impacts on Fiscal Year 2018 to Fiscal Year 2017 Comparisons

Storm activity, as well as cooler-than-normal temperatures late in the first quarter of 2018, inhibited our first quarter sales growth. Much of the Atlantic Coast experienced below-average temperatures in March of 2018, which caused pools to open later than in 2017, and greater storm activity in Texas and the central United States and above-average precipitation in California delayed construction activity during the first quarter of 2018. In contrast, unseasonably mild weather benefited sales in the first quarter of 2017 as Texas and surrounding markets experienced record warm temperatures.

While warming trends started out slow in the second quarter of 2018, the unfavorable weather comparisons turned around by the end of the quarter. April 2018 sales struggled as much of the country experienced cold to record cold temperatures this year in contrast to warm to record warm temperatures in 2017. With the exception of Florida, where it rained most of May and into June, and California, which generally experienced a cooler-than-usual spring, 2018 results in the last two months of the second quarter benefited from the warm weather throughout the country and helped relieve the effects of the slow start from earlier in the year.


36



California wildfires, large amounts of rain throughout Texas, and Hurricane Florence in the Carolinas all impacted our sales in the third quarter of 2018. Likewise, severe storms in the third quarter of 2017, particularly Hurricanes Irma and Harvey, hindered our sales growth in Florida and Texas last year, although Texas largely recovered by the end of September 2017. In the third quarter of 2018, the West experienced record heat and below-average rainfall, while temperatures were also above-average in the central United States and the Midwest, but each experienced above-average rainfall. These weather patterns were consistent with the third quarter of 2017, resulting in overall similar weather comparisons. Much of the United States experienced cooler-than-normal temperatures and higher than average precipitation in the fourth quarter of 2018, particularly in Texas, making it difficult for customers to initiate and complete projects over this time period.

Weather Impacts on Fiscal Year 2017 to Fiscal Year 2016 Comparisons

Unseasonably mild weather benefited sales in the first quarter of 2017. However, while favorable weather trends early in the year normally have a seasonally larger impact, the comparison to the first quarter of 2016 was especially tough given the benefit of the warmer-than-normal weather across nearly all markets in the United States in the first quarter of 2016. For the first quarter of 2017, Texas and surrounding markets experienced record warm temperatures, which when coupled with below-average precipitation for that area, spurred higher sales growth. In two of the more seasonal regions where we operate, below-average temperatures in the North and above-average precipitation in the West negatively impacted our first quarter 2017 sales growth.

Cold and wet weather throughout the Mid-South and North impacted those seasonal markets in the middle of the second quarter of 2017, while the weather impact overall for the quarter was fairly neutral. Temperatures and precipitation throughout most areas, other than those described above, were normal, with only Texas benefiting from drier weather in the second quarter of 2017 compared to the above-average rainfall experienced in the same period of 2016.

Severe storms in the third quarter of 2017, particularly Hurricanes Irma and Harvey, hindered our sales growth in Florida and Texas, although Texas largely recovered by the end of September. In the Central and Midwest, temperatures were normal for the third quarter, contrasting with the above-average temperatures in the third quarter of 2016. The West experienced record heat and normal rainfall in the third quarter of 2017, similar to the above-average heat in the same period of 2016. Overall, the United States experienced favorable weather in most of the fourth quarter of 2017, particularly in Florida, which allowed for sales recovery following Hurricane Irma.

Geographic Areas

Since all of our sales centers have similar operations and share similar economic characteristics, we aggregate our sales centers into a single reportable segment. For additional details, see Note 1 of our “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K.

For a breakdown of net sales and property, plant and equipment between our United States and international operations, see Item 1, “Business,” of this Form 10-K.


LIQUIDITY AND CAPITAL RESOURCES

Liquidity is defined as the ability to generate adequate amounts of cash to meet short-term and long-term cash needs. We assess our liquidity in terms of our ability to generate cash to fund our operating activities, taking into consideration the seasonal nature of our business. Significant factors which could affect our liquidity include the following:

cash flows generated from operating activities;
the adequacy of available bank lines of credit;
the quality of our receivables;
acquisitions;
dividend payments;
capital expenditures;
changes in income tax laws and regulations;
the timing and extent of share repurchases; and
the ability to attract long-term capital with satisfactory terms.


37



Our primary capital needs are seasonal working capital obligations and other general corporate initiatives, including acquisitions, dividend payments and share repurchases. Our primary sources of working capital are cash from operations supplemented by bank borrowings, which have historically been sufficient to support our growth and finance acquisitions. The same principle applies to funds used for capital expenditures and share repurchases.

We prioritize our use of cash based on investing in our business, maintaining a prudent capital structure, including a modest amount of debt, and returning cash to our shareholders through dividends and share repurchases. Our specific priorities for the use of cash are as follows:

capital expenditures primarily for maintenance and growth of our sales center structure, technology-related investments and fleet vehicles;
strategic acquisitions executed opportunistically;
payment of cash dividends as and when declared by our Board of Directors (Board);
repayment of debt to maintain an average total leverage ratio (as defined below) between 1.5 and 2.0; and
repurchases of our common stock under our Board authorized share repurchase program.

Capital expenditures were 1.1% of net sales in 2018 and 1.4% of net sales in both 2017 and 2016. Our higher capital spending in 2017 and 2016 related to expanding our facilities and purchasing delivery vehicles to address growth. Over the last 5 years, capital expenditures have averaged roughly 1.0% of net sales.

Our capital spending primarily relates to leasehold improvements, delivery and service vehicles and information te