General

We sell everything necessary to build, maintain, install and overhaul residential and small commercial swimming pools, including:

• swimming pool equipment;
• parts and supplies;
• chemicals;
• cleaners;
• packaged pools;
• liners;
• filters;
• heaters;
• pumps;
• lights;
• repair parts; and
• other equipment.

Since 1999, we have significantly increased our offering of complementary products including:

• building materials;
• electrical supplies;
• toys and games;
• water features such as fountains; and
• spas and spa accessories.

We primarily sell to:

• swimming pool remodelers and builders;
• retail swimming pool stores; and
• swimming pool repair and service companies.

These customers are mostly small, family owned businesses with relatively limited capital resources. We maintain a strict credit policy. In the past, losses from customer receivables have been within our expectations.

Our expenses consist primarily of (i) the cost of products purchased for resale and (ii) operating expenses which are primarily related to labor, occupancy, freight, marketing, and selling and administrative expenses. We compete for business and may respond to competitive pressures by lowering prices in order to maintain our market share. Such measures adversely affect our gross margins and operating results.

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Part II.

General (continued)

We calculate same store growth by excluding the following service centers from the calculation for 15 months:

• New service centers opened within the past 15 months;
• Service centers acquired within the past 15 months;
• Service centers consolidated with acquired service centers; and
• Service centers that experience market disruption due to their location in the immediate market areas of those mentioned above.

Beginning in the fourth quarter of 2002, we began calculating our “base business” growth, which is consistent with measures used by other distributors. We calculate base business growth by excluding the following service centers from the calculation for 15 months:

• Service centers acquired within the past 15 months;
• Service centers consolidated with acquired service centers; and
• New service centers opened in new markets in the past 15 months.

The base business calculation differs slightly from the same store calculation because base business includes (i) new service centers opened in existing markets and (ii) service centers affected due to their location in the immediate market areas of newly opened or acquired locations. Additionally, we allocate overhead expenses to the base business by considering base business net sales as a percentage of total net sales.

The Swimming Pool Industry

We believe that the swimming pool industry is relatively young, with room for tremendous growth. Of the approximately 68 million households in the United States that have the economic capacity and the yard space to have a swimming pool, barely 10% own a pool. The industry has grown at a 4-5% annual rate for the past 20 years.

We believe the swimming pool industry will continue to grow 4-5% annually over the next five years, primarily by the need to maintain the growing installed base of pools and secondarily by new pool installations.

The greater part of revenues in our industry is derived from the maintenance of existing swimming pools and the repair and replacement of the equipment that maintains those pools. Thus, the industry generally has not been negatively affected by economic downturns, although there is no assurance that this will continue.

The demand for new pools is driven by the perceived benefits of pool ownership including relaxation, entertainment, family activity, exercise, convenience and landscaping. 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 business in the swimming pool industry is seasonal, and weather is the biggest challenge. The industry is also affected by other factors including consumer saving and discretionary spending levels, the rate of new housing construction and consumer attitudes toward pool products for environmental or safety reasons.

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SCP POOL CORPORATION

Part II.

Critical Accounting Policies

Critical accounting policies are those that are both important to the accurate portrayal of a company’s financial condition and results, and require the most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe that the nature of our business is such that there are few, if any, complex challenges in accounting for operations.

In order to prepare financial statements that conform to accounting principles generally accepted in the United States (GAAP), we make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Certain estimates are particularly sensitive due to their significance to the financial statements and the possibility that future events may be significantly different from our expectations.

We have identified the following five accounting policies that require us to make estimates in order to present fairly our consolidated financial position and results of operations.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses if our customers do not make required payments. We perform periodic credit evaluations of our customers and we typically do not require collateral. Consistent with industry practices, we require payment from our customers within 30 days except for sales under early-buy programs for which we provide extended payment terms to qualified customers. The extended terms require payments in equal installments in April, May and June or May and June, depending on geographical location. In the past, credit losses have been within our expectations.

As our business is seasonal, our customers’ businesses are also seasonal. Sales are lowest in the winter months, and our past due accounts receivable balance generally increases during this time. We provide reserves for uncollectible accounts based on the accounts receivable aging ranging from 0.2% for amounts currently due up to 100% for specific accounts more than 60 days past due.

At the end of each year, we perform a specific reserve analysis of all accounts with past due balances greater than $25,000. Additionally, we perform a general reserve analysis on the balance of our accounts receivables with emphasis on the remainder of the past due portion of the aging. As we review these past due accounts, we evaluate collectibility 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. Such write-offs are charged against our allowance for doubtful accounts. In the past five years, write-offs have averaged approximately 0.2% of net sales.

If the balance of the accounts receivable reserve increased or decreased by 50% at December 31, 2002, pretax income would change by approximately $1.7 million or $0.04 per diluted share based on the number of diluted shares outstanding at December 31, 2002.

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SCP POOL CORPORATION

Part II.

Critical Accounting Policies (continued)

Inventory Obsolescence and Shrink Reserve

Product inventories represent the largest asset on our balance sheet. Our goal is to manage our inventory such that we minimize stock-outs and provide the highest level of service to our customers. To do this, we maintain at each service center an adequate inventory of SKUs with the highest sales volume. 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 have lower velocity. Service centers classify products into 13 classes based on sales at that location over the past 12 months. The table below presents a description of these inventory classes:

Products in classes 1-3 turn quickly, thus there is little risk of obsolescence. We establish our reserve for inventory obsolescence based on inventory classes 4-13, with particular emphasis on SKUs with the weakest sales over the previous 12 months. The reserve is intended to reflect the value of inventory that we may not be able to sell at a profit. We believe our greatest exposure to inventory obsolescence is inventory classes 4-13. We provide a general reserve of 5% for such inventory. We also provide an additional 5% reserve for excess inventory in classes 4-12 and an additional 45% for excess class 13 inventory. We define excess inventory as the amount of inventory on hand in excess of the previous 12 months usage on a company-wide basis.

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

• the level of inventory in relationship to historical sales level by product, including inventory usage by class based on product sales at both the service center and company levels;
• changes in customer preferences;
• the experience of the service center manager;
• the previous inventory management performance of the service center;
• geographical location; and
• new product offerings.

The reserve for inventory obsolescence may periodically require adjustment as changes occur in the above-identified factors.

If the balance of the inventory reserve increased or decreased by 50% at December 31, 2002, pretax income would change by approximately $1.6 million or $0.04 per diluted share based on the number of diluted shares outstanding at December 31, 2002.

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SCP POOL CORPORATION

Part II.

Critical Accounting Policies (continued)

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin (SAB) 101, Revenue Recognition in Financial Statements, and the appropriate amendments. SAB 101 requires that four basic criteria must be met before we can recognize revenue:

1. Persuasive evidence of an arrangement exists;
2. Delivery has occurred or services have been rendered;
3. The amounts recognized are fixed and determinable; and
4. Collectibility is reasonably assured.

We record revenue when customers take delivery of products. Customers may pick up products at any service center location, or products may be delivered via our trucks or third party carriers. Products shipped via third party carriers are considered delivered based on the shipping terms, which are generally FOB shipping point.

We may offer volume rebates, which we accrue monthly as an adjustment to net sales. Additionally, in certain markets, we may offer discount terms of 5% for invoices paid within 10 days. We record customer returns, including those associated with early-buy programs, as an adjustment to net sales. In the past, customer returns have not been material.

Vendor Rebates

We account for vendor rebates in accordance with the Emerging Issues Task Force Issue 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor . Many of our arrangements with our vendors provide for us to receive a rebate of a specified amount of consideration, payable to us when we achieve any of a number of measures, generally related to a specified cumulative level of purchases from our vendors. We account for such rebates as a reduction of the prices of the vendor’s products and therefore as a reduction of inventory until we sell the product, at which time such rebates reduce cost of sales in our income statement. Throughout the year, we estimate the amount of the rebate earned based on our estimate of purchases to date relative to the purchase levels that mark our progress toward earning the rebates. We continually revise these estimates to reflect actual rebates earned based on actual purchase levels.

If market conditions were to change, vendors may change the terms of some or all of these programs. Such changes could lower or raise our gross margins on products we sell or revenues earned.

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SCP POOL CORPORATION

Part II.

Goodwill

Goodwill represents the excess of acquisition costs over the estimated fair value of net assets acquired. At December 31, 2002, our net goodwill balance was $107.7 million, representing 27% of total assets and 76% of stockholders’ equity.

In January 2002, we adopted SFAS 142, Goodwill and Other Intangible Assets . Under these new rules, we no longer amortize goodwill. Instead, we test goodwill for impairment annually or at any other time when impairment indicators exist.

We completed the transitional goodwill impairment test as required under SFAS 142 and determined that goodwill was not impaired. This transitional test required comparison of our Company’s estimated fair value at January 1, 2002 to the book value, including goodwill. Additionally, we performed the first annual impairment test in October 2002 noting that goodwill is not impaired.

If circumstances change or events occur to indicate that our Company’s fair market value has fallen below the book value, we will compare the estimated fair value of the goodwill to its book value. If the book value of goodwill exceeds the estimated fair value of goodwill, we will recognize the difference as an impairment loss in operating income.