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Management’s Discussion and Analysis of Financial
Condition and Results of Operations
2006 FINANCIAL OVERVIEW
Financial Results
Our 2006 financial results reflect another
year of strong growth. Net sales increased 23% in 2006 to $1.9 billion
due to $204.7 million of sales growth related to acquired sales
centers and $152.4 million of sales growth from our base business.
The 10% base business sales growth reflects the continued growth
in the installed base of swimming pools, market share gains through
our execution of sales, marketing and service programs that we offer
to our customers, inflationary price increases passed through the
supply chain, 26% growth in complementary product sales and sales
from new locations.
We believe the impact of weather on sales
in 2006 was mixed, with a favorable sales impact from near record
high temperatures throughout much of the year across North America
and negative sales impacts due to record precipitation in the northeast
and much colder than average August and September temperatures which
shortened the pool season in certain markets.
Gross profit increased 25% in 2006 compared
to 2005 due primarily to the increase in net sales. Our gross profit
as a percentage of net sales (gross margin) increased 40 basis points
to 28.3% in 2006. The majority of this increase was attributable
to the benefits achieved through our supply chain management initiatives,
including our pre-price increase inventory purchases in the fourth
quarter of 2005 and second quarter of 2006. Gross margin also benefited
from higher margin contributions from our acquired businesses and
a slight shift in product mix to higher margin products. These margin
improvements were partially offset by a reduction in our earned
vendor incentives as a percentage of total net sales.
Operating expenses in 2006 increased 25% compared
to 2005. This increase was higher than our 2006 sales growth rate
due to higher expense ratios for our recently acquired businesses,
start-up costs and higher expense ratios for the 17 new sales centers
we opened in 2006 and expenses for other investments that expanded
our sales center locations and value-added programs. Examples of
new programs that we launched in 2006 include a new branded retail
customer program called The Backyard Place and a new pool financing
brokerage business that enhances our swimming pool builder programs.
Our operating income increased 24% in 2006
while our operating margin increased slightly to 8.8% of net sales
from 8.7% in 2005. Interest expense increased 136% in 2006 due to
higher debt levels for borrowings to fund share repurchases and
acquisitions and a higher average effective interest rate compared
to 2005. Net income increased 18% to $95.0 million compared to the
same period in 2005 and included $1.6 million of net equity earnings
from our investment in Latham Acquisition Corporation (LAC).
Financial Position and Liquidity
Cash provided by operations increased $29.6
million to $69.0 million in 2006 due primarily to the increase in
net income compared to 2005 and the impact related to our fourth
quarter 2005 early buy purchases. In 2005, our cash provided by
operations was negatively impacted by early buy inventory purchases
that we received and paid for in the fourth quarter of 2005. This
impact is reflected in the net change in our inventory and accounts
payable balances between periods, but the benefit to our 2006 cash
provided by operations was largely offset by the decrease in accrued
expenses which included a $27.0 million payment for estimated federal
tax payments that were deferred from the second half of 2005 as
allowed by the Katrina Emergency Tax Relief Act of 2005
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