Pool Corporation (POOL) — Q2 2015 Earnings Call Transcript

Thank you, Kate. Good morning, everyone, and welcome to our second quarter earnings call. I’d like to remind our listeners that our discussions, comments and responses to questions today may include forward-looking statements, including management’s outlook for 2015 and future periods. Actual results may differ materially from those discussed today. Information regarding the factors and variables that could cause actual results to differ materially from projected results is discussed in our 10-K. Now, I’ll turn the call over to President and CEO Manuel Perez De La Mesa. Manuel?

Thank you, Mark, and good morning to everyone on the call. We successfully managed through the challenge of adverse weather conditions in many large markets to realize 17% EPS growth year-to-date and 11% EPS growth in the quarter on a constant currency basis, factoring in a $0.03 EPS difference for the stronger U.S. dollar. Looking at sales, our domestic blue business sales were up 5.6% year-to-date, including an increase of just 2.5% in the quarter. Part of the lower second quarter sales growth was related to the acceleration of early shipments into the first quarter, but a bigger impact was from record rainfall caused by delayed remodeling replacements and new construction activity in the South Central part of the country including Texas and adjacent states, as well as delayed pool openings in the Midwest and Northeast markets. For those that ask about the drought in California, our blue business sales were up 6.3% year-to-date in California as we work to educate the market on the net water efficiency of pools, especially as related to their economic contribution relative to most other alternatives. On the other hand, our blue business sales in Texas were down 0.6% as record rainfall and saturated ground reduced our customer’s effective work days. Building materials again led the way with 11.9% sales growth year-to-date and 9.4% in the quarter despite Texas and adjacent markets being down. We continue to gain share with building materials as well as expand the market working in conjunction with our customers and suppliers. Equipment sales increased 8.1% year-to-date and 4.9% in the quarter reflecting both the gradual recovery of replacement activity and an improved mix with higher priced, more energy efficient products. Commercial product sales were up 8.8% year-to-date and 5.6% in the quarter as we continue to capture share in this product category. Retail product sales increased 3.1% year-to-date and were down 0.1% in the quarter reflecting our acceleration of early shipments in the first quarter, the adverse impact of delayed pool openings in Midwest and Northeast markets, and recent years’ negligible growth of the pool install base. Especially noteworthy within retail is that in chemicals, by far the largest product category sold in the retail channels, our sales were up 5% year-to-date, which is in sharp contrast to the industry decline as we, together with our customers, continue to gain market share. Our chemical sales were up 3% in the quarter despite the delayed pool openings in northern markets. Staying within the blue business, our international sales in local currencies were up 8.2% year-to-date and 6.3% in the quarter, although in U.S. dollars they were down 9.4% year-to-date and down 10.8% in the quarter. While exchange also helped to mitigate the adverse exchange impact, the net impact was $0.03 in EPS in both the quarter and year-to-date. Turning to our green business, our sales were down 3% year-to-date and 7.4% in the quarter. Here the results are due to our elimination of certain unprofitable equipment lines and the retro green fall in Texas pushing out new installations. Our gross margins were essentially flat versus the prior year as expected. Expenses were lower than last year in both the quarter and year-to-date primarily due to the stronger U.S. dollar and lower performance-based compensation. Otherwise, expenses are being responsibly managed in the normal course. Our base business operating margins increased by 80 basis points to 11.3% year-to-date and by 84 basis points to 15.3% in the quarter. Given the limited sales leverage this year, this improvement demonstrates how we are managing the business. In the second half, we expect to see sales growth more like the year-to-date results on a constant currency basis. Together with comparable gross margins and disciplined expense controls, we should have another year of solid operating profit and EPS growth. Factoring everything in, we decided to tighten our annual EPS guidance to $2.72 to $2.82 per diluted share. Our results and our success are founded on the commitment of our people; it is their dedication, their engagement, and their use of the tools and resources uniquely available to them that enable us to provide exceptional value. In a year where the industry is not growing year-to-date, we are; in a year where our sales growth is below expectations, our earnings meet expectations on a constant currency basis. Our people are the ones making it happen. Now I’ll turn the call over to Mark for his financial commentary.

Thank you, Manny. I am going to start my commentary today with a bit of color on the weather in Q2, adding to the commentary in our press release and what you just heard from Manny, and focusing on the major weather events and how we think it impacted our results in the U.S. markets in the second quarter. I did this with the understanding that, as we said frequently over time and as highlighted in our SEC filings, weather is the most important external factor impacting our business in a given year. While we don't use weather as an excuse, it was more impactful than usual this quarter as a number of large U.S. market areas were impacted by weather and/or cooler conditions in contrast to the normal ups and downs that we more often see. The biggest impact to us in the quarter was the record rainfall that took place in Texas and adjacent markets, and then moved up north into the Ohio Valley and in the northeast, with much of this area receiving either record or well above average rainfall. On top of that, in the north central and northeast regions, temperatures were cooler than normal in our peak June selling month. So how did this weather impact our business? Excessive rain directly impacted the renovation and construction businesses in these markets, on both the blue and, as it relates to Texas, the green side of the business, as adverse weather kept crews indoors while saturated ground further delayed work even when it wasn’t raining. The good news is that we expect much of this work to be deferred rather than canceled, which should benefit us in future periods. While that’s significant but still impactful, the north central and northeastern markets experienced cooler June temperatures in addition to the higher precipitation. This impacted the retail and service sectors in these markets, driving lower retail store traffic and less maintenance and impulse purchases. Given the seasonality in these markets, we do not expect to recoup this lost opportunity. We expect the total impact in our sales due to the rain and cooler conditions in these markets to constitute approximately $16 million or 2% of prior year Q2 sales. Outside these markets, we experienced more than normal weather ups and downs with both positive and negative conditions impacting regional areas. I’ll take a few minutes now to discuss the impact of currency changes on our results, which is largely in line with our expectations as we’ve discussed on our last conference call. After the run-up in the value of the U.S. dollar relative to most other currencies that began in the second half of last year and continued into early 2015, the U.S. dollar has been relatively stable with about a 20% appreciation in dollar this year compared to this time last year. The impact to our results this year has been lower sales, lower operating cost, and lower operating income. The impacts on our sales results from the devaluation of local currencies was $21.1 million year-to-date, including $15.6 million for the second quarter. The impact to our operating costs was lower by $4 million year-to-date and $2.2 million for the quarter, while operating income was negatively impacted $1.9 million year-to-date and $2.2 million for the quarter. Looking ahead to the rest of the year, and assuming the U.S. dollar continues to trade in the same range relative to other currencies for the rest of the year, we’d expect the impact on our results to be similar in the third quarter to that in the second quarter. While our seasonally slower fourth quarter, we’d expect less of an impact to sales and potentially a positive impact on earnings. Turning now to operating expenses. We have a positive story to tell here at this point of the year with total year-to-date operating expenses down 1% year-over-year and down 4% for the quarter. Obviously we benefited here from currency translation, as I’ve already discussed, as well as from lower performance-based incentive given our year-to-date results and expectations for the year as reflected in our guidance range. This has resulted in a $2.3 million lower performance compensation expense year-to-date, including $3 million lower expense in the second quarter. We expect further expense benefit here for the remainder of the year of about $2 million compared to last year, $1 million lower in each of the third and fourth quarters. Exchange and incentive compensation were the big differences in our year-over-year operating costs. We had some other less significant ups and downs, but of particular note, our personnel and headcount were relatively flat year-over-year, including the impact of acquisitions and new locations, as these costs account for almost 60% of operating expenses. This is a good indicator of discipline our field management has been using to control costs, which should continue to benefit us as the year progresses. Moving on to the balance sheet and cash flow, and starting with our total receivables of $319 million, these are up $12 million or almost 4% compared to last year. Even though our sales were relatively flat for the quarter, we had an extra billing day in June this year compared to last, offset by one less day in May, but the June day resulted in an increase in receivables at the end of the quarter. Looking at the quality of our receivables at the end of June compared to last year, our total accounts receivable greater than 30 days past due this year improved to 1.4% of sales, compared to 1.8% of sales as of June 2014, which was a nice improvement on already very good results. Our total inventory investment at quarter end was $473 million, up $22 million or 5% over last year with similar improvements in the quality of inventory on hand. As reflected in the changes in our inventory by classification, our domestic blue business accounted for 87% of our inventory on hand at quarter end and 100% of the inventory increase. Almost all of this increase, 97%, was in classes zero to four of our 13 inventory classes, which are either new products or products with a higher sales velocity. I point this out to emphasize here that we believe our inventory is well managed with minimal risk of obsolescence, and it will be appropriately adjusted to reflect expected demand over time. Looking at our cash flow and cash used for operations year-to-date is relatively in line with last year with the usual minor timing differences as we remain on track to reach our annual target of cash from operations exceeding net income for the year. Finally, I’d like to update you on our share repurchase activity. For the quarter, we purchased 809,000 shares of company stock in the open market at an average purchase price of $67.16, which used $54.3 million in cash. Year-to-date, we’ve purchased 847,000 shares for a total of $56.9 million in cash. This gives us $108 million remaining on our current board authorization. At this point, I’ll turn the call back to our operator to begin our question-and-answer session.

Thanks for the color and all the weather that really was beneficial, so I just wanted to start there and ask if those states affected have bounced back to more normalized levels or possibly higher in July as your customers try to catch up on those lost work days, what have you seen there?

They have returned to normal activity rates, but there hasn't been a recovery as they remained quite busy during the third quarter.

Then in those markets with more normal weather that either met or exceeded your expectations like you mentioned. Can you talk about which markets those were and how much more they’ve driven that 3% overall blue business growth that you saw?

When you look at the markets, let’s take Florida up through the southeast they were largely unaffected, the West Coast was fine, California I mentioned that in my comments was solid on to the Pacific Northwest. So, basically the adverse weather, the real adverse weather was obviously Texas; we saw a lot on the news back in May and June and tremendous levels of precipitation. And then going up through the central part of the country into Missouri, Kansas and then further East affecting markets like Indiana and then on to the northeast. So really but if you take the slot, let’s say from Maryland, South was fine and West, Texas was basically fine as well.

And then just about how would you characterize on average how much more those grew than that overall 3% growth rate you saw in the blue...

Those states overall we're looking at year-to-date numbers average would be close to 7%.

Given some of the issues that you’re seeing in these weather-affected markets, are you seeing signs of increased commercial activity or irrational price competition from any of your competitors?

Great question David, we have not seen that yet. That would be something we would probably be more likely to happen as we exit the season. Although these are year-around markets, so the risk there is less than if it were a more seasonal market.

So the expectations for gross margin that you’ve laid out previously still relatively intact?

Yes.

Okay, and then in terms of the base business growth expectations, should we pencil in for the second half sort of the run rate that you’re seeing in those markets that weren’t affected by weather sort of that 6% to 7%?

You’re going to adjust, first of all, adjust 2% for currency.

Correct, yes.

And so I would be more inclined to look at it based on what our year-to-date trends are.

So, Manny you mentioned the California year-to-date number 6.3% increase. I missed what the increase was for the quarter, can you repeat that please?

Sure, let me check my notes for a moment. For the quarter, they experienced a modest increase; they had a strong start in the first quarter but saw a slight decline due to cooler weather in April and May. California had a modest rise during the quarter.

Modestly up, okay.

Modestly up in the quarter, and that was, they got off to a strong start and then we hit with a little cool weather, but year-to-date still solid and, in fact, typically we get a lot of questions from investors about the drought, and certainly that's taking up some of our management time in the west as well as here in Covington working to educate the local water boards. And so far we’ve been pretty effective in just educating them on the fact that pools are relatively efficient and when you factor in the economic activity provided by the pool industry, it dwarfs most industries including technology or agriculture. So, from an economic development standpoint, the last thing you want to do is tamper with water-efficient industries.

Okay, that’s helpful color. And with that in mind, can you give us an update on what your outlook is for overall pool construction for 2015?

Pool construction right now is profits are up modestly year-on-year. I mean if I look at markets like California, it's up, Florida is up, and Texas is also up in terms of permits. Now in terms of the actual pools getting finished, California and Florida are fine, but Texas obviously is really backed up. So when I look at the three big states overall, I would say that they should be flat to modestly up year-on-year. In terms of the rest of the country, I would say flat to modestly up year-on-year. So whereas last year we finished the year with just about 60,000 pools built, and for point of reference, that’s down over 70% from where it was 10 years ago. This year probably will be modestly up overall but not much more, maybe a couple thousand up year-on-year.

And also within your green segment, you mentioned that you eliminated certain equipment lines. Can you just give us a little bit more color on that, and were these lower-margin products in line with the rest of the company average for that segment?

From a gross margins standpoint, they were not too different from our normal business. But the resources required, both in terms of personnel as well as facilities, really, and when you look at the inventory investment, there was, we were really realizing negligible to no return on investment. So, these are sectors that are not what I’ll call core irrigation; these were in adjacent markets primarily related to golf courses and higher bigger turf equipment. So therefore, the thought process was let’s just prune back and focus on our core where we can get a higher return on invested capital.

And last question, so far year-to-date you have added three sales centers; just wondering what your expectation is for the balance of the year and any early read on 2016 would be helpful?

We were planning to open a few sales centers earlier this year, but we faced several permit delays from local authorities, which has delayed their opening by about three to six months from our original schedule. We hope to open them later this year, although they won't contribute to our performance this year; they will be ready for the 2016 season. In the next two months, we will outline our plans for openings in 2016. In addition to the three delayed locations, I expect we will plan for a few more, but specific details are still to be determined.

Regarding SG&A, outside of normal volume-driven expenses, are there any other reasons why SG&A would step up substantially in the second half?

No. You would expect the SG&A to be basically flattish on a dollar basis; it would be up a little bit in constant currency. But on a U.S. dollar basis, it would be about flat.

This is Mark on for Derek today. You mentioned delayed pool openings in the Midwest and Northeast in the quarter. What’s the impact on margins there and how should we think about that in the second half of the year?

The impact on gross margins is negligible from a percentage standpoint because there is nothing unique to stand out. What does happen though is because of delayed openings, some of the typical maintenance type expenses, whether it be chemicals or accessories, whatever, those are impacted, so those are lost. And in fact, I am still getting information about in certain markets; people are still opening pools as recently as this week, which is about, in some cases, two months later than normal. So that just gives you an indication of some of the delays that have transpired; now that’s at the outside end of the spectrum, but still it’s a lost sale because the pools are open less time and therefore there is less consumables.

Did you guys say what the headwind was from the 1Q inventory stocking and how does that unfold in the second half of the year?

There was no headwind on…

Are you talking about the early buy pull forward…

Yes, early buy.

The fact that we shipped early buys earlier that impacted about 1% of our sales from the second quarter; it was a bigger impact because the sales are bigger in the second quarter versus first quarter, but basically it was about a 1% impact on our second quarter reported sales.

And no impact for the rest of the year obviously.

Thank you all for listening. Our next earnings call is scheduled for Thursday, October 22nd when we’ll discuss our third quarter results. Have a great day.