Pool Corporation (POOL) — Q2 2017 Earnings Call Transcript

Thank you. Good morning everyone and welcome to our second quarter 2017 earnings call. I would like to remind our listeners that our discussion, comments, and responses to questions today may include forward-looking statements, including management's outlook for 2017 and future periods. Actual results may differ materially from those discussed today. Information regarding the factors that could cause actual results to differ materially from projected results is discussed in our 10-K. In addition, we may make references to non-GAAP financial measures in our comments. A description and reconciliation of our non-GAAP financial measures is posted to our corporate website in our Investor Relations section. Now I'll turn the call over to our President and CEO, Manny Perez de la Mesa. Manny?

Thank you, Mark, and good morning to everyone on the call. As reported, we had a solid second quarter, with 7% base business sales growth, which was on top of last year's 6% base business growth in the quarter. Year-to-date, our base business sales increased 6% on top of last year's 9% base business sales increase, which benefited from favorable weather. This level of growth reflects the resilience and favorable characteristics inherent to our business, together with our team's ability to provide exceptional value, and we are being rewarded with an ever-increasing share of our customers' business. Our gross margins were solid, especially when you factor in the 30 basis points increase realized in last year's second quarter. Year-to-date, our gross margins were flat compared to last year's 30 basis points increase, which again benefited from favorable weather. Expenses were seasonally a bit higher, but largely as planned, as we continue our ongoing investments in our business. Altogether, a solid second quarter, as we further solidify our foundation as a value-added distributor. Our base business sales growth in our largest four markets, California, Florida, Texas, and Arizona, and in the rest of the markets, was 7% in both cases. Within the quarter, the cold and wet weeks before and after Memorial Day adversely impacted seasonal markets, as did the heavier than normal rain in June in the east. The first part of the quarter had more favorable weather, which largely offset the adverse weather effect later in the quarter. Also, our base business sales results include our green business, which had a 5% base business sales increase in the quarter, despite the exit of a product line that adversely impacted sales by 5% in the quarter. On the product side of sales, building materials and related outdoor living products continued their strong performance, with 12% growth, while commercial also had 12% growth, excluding the Lincoln acquisition that we closed in the quarter. Pool equipment growth was 9%. The growth in these product categories reflects both the ongoing recovery in the remodel and replacement sectors of our business, as well as our consistent market share gains. The resale product side of our business grew by 4% in the quarter, as the install base of pools grew by 1%, with virtually no inflation, and our performance again reflects the market share gains. Our base business gross margins were down just 15 basis points, after being up 30 basis points in last year's second quarter and 30 basis points also in the first quarter of this year. All of this was due to the minor product and customer mix differences, with a modest shift of early buy shipments in the second quarter of this year in comparison to last year. Our base business contribution margin was 18% in the quarter and 14% year-to-date, despite our continued investment in our business. We expect to get to a 15% plus contribution margin on base business for the year, as we have an easier comparison in the second half. Our diluted earnings per share increased 12% in the quarter and 16% year-to-date, which is consistent with our expectations, as is our ROIC increasing by 160 basis points to 24.2% on a trailing four-quarter basis, which reflects the ongoing effectiveness and discipline in our execution and allocation of capital. One subject that has gathered increasing interest in the investment community is the potential impact of the online channel on the wholesale distribution industry. To spare those on the call, what has transpired over the past 20 years in the swimming pool industry, allow me to summarize by saying that A, the online channel represents approximately 5% of industry activity, as only a limited portion of the industry's products are conducive to online trade. B, the online share of the swimming pool industry has been relatively stable for the past few years. C, Amazon has participated in the industry for over 10 years. D, online retailers represent 3% to 4% of our business, as we are more selective with this channel than what we do with the trade and storefront retail channels. And E, our sales to the online retail channel are essentially flat year-to-date. The principal impact of the online channel in the swimming pool industry has been increased price transparency, which has increased margin pressure on storefront retailers, especially in seasonal and smaller markets. We saw this impact years ago, with progressive storefront retailers migrating their offering since then to professional grade and other differentiated products. For additional perspective, the greater popularity of so-called spas has been a more significant factor on storefront retail than the internet. Fortunately, favorable industry characteristics provide progressive storefront retailers the opportunity to succeed, as evidenced by our 4% growth in retail product sales in the quarter and year-to-date, and the over 8% growth realized by storefront retailers that attended our retail summit in January. Of course, our results are only possible because of the commitment of our people throughout the company to our customers, our suppliers, and each other. We are extremely fortunate to be involved in a business where every day we help people realize their dreams of a better home life, while simultaneously assisting over 100,000 customers realize success. We look forward to making 2017 another successful year, as we continue to create exceptional value for our customers and suppliers. Now I will turn the call over to Mark for his financial commentary.

Thank you, Manny. I will start my commentary with operating expenses, where I believe we have gained some traction compared to Q1, although we have a bit more work to do here to reach our objectives for the year. For the quarter, our base business operating expenses grew 4.7% over last year compared to our 6.5% growth in gross profit. This resulted in 20 basis points of operating leverage, as base business operating income was 15.7% of net sales for the quarter, compared to 15.5% last year. Year-to-date, our base business operating leverage is 10 basis points. As mentioned in our press release, we had some growth-driven expense increases in areas like labor and delivery costs. In addition, investments in information technology systems and hardware, as well as the timing of recognition of employee health costs, added to our expense growth in the quarter. I expect the cost increases to moderate as we move into the back half of the year. Our goal here on expenses is, as always, to grow less than gross profit growth in order to gain 20 to 40 basis points of operating leverage in the year. This means we have a bit more work to do here to get there this year, which I think is achievable. Our income tax rate in the quarter was 37%, which compares favorably to our 38.4% rate last year. A majority of this rate improvement was driven by our adoption of ASU 2016-09, which also increased our share count by 550 basis points in the quarter. The net result of this was that our Q2 EPS was $0.02 better than it would have been without the tax accounting change. At this point, I leave unchanged the impact from this accounting change for the rest of the year that I had provided on our previous call. Since many of you will be building out your 2018 models and 2019 models over the next few months, it might be useful to mention that we believe the annual reduction in tax expense from the adoption of this new tax GAAP will be approximately $13 million in both years, which is about $2 million less than our expected impact in 2017. Putting this into perspective from a tax rate standpoint, we expect our annual effective tax rate in 2017 to be 32.7%; 34.1% in 2018, and 34.6% in 2019. Given the variability in the assumptions that impact this calculation, including our expected share price and the timing of employee option exercises, I'd expect these estimates to be directionally correct, but certainly subject to adjustment as we move forward. Moving on to the balance sheet and cash flow, you can see that our total net receivables grew 5% year-over-year, which was in line with our sales growth in the quarter. Our inventories grew 10% year-over-year, reflecting the impact of growth and then seasoned opportunity buy, new products, and inventory from an acquisition we completed in April in the commercial retail space. This inventory increase, net of the associated accounts payable increase, as well as the impact of last year's federal income tax payment deferral of $15 million, accounts for the increase in our cash use in operations of $28 million from last year. This GAAP and operating cash flow from last year should close in Q3 and Q4 as we work down inventory in last year's tax deferral. I expect to be on track to reach our annual goal of cash flow from operations that meets or exceeds net income for the year. One more comment on our statement of cash flow relates to our capital spending, which was $34 million year-to-date and $9 million more than we spent this time last year. As I stated on our Q1 call, our capital spending this year is largely front-end loaded, as we expect our total capital spending for the year to be in the low $40 million range. This stems from early year investments we made in delivery trucks and facility upgrades that help us achieve the capacity expansions needed for future growth. I will update you now on our share repurchases, which we have dipped our toe into in Q2 after staying out of the water in Q1. During the quarter, we repurchased 50,000 shares on the open market at $119 a share for a use of cash of $5.9 million. In addition, we have repurchased another 39,000 shares after the quarter end, at an average price of $118. With the remaining $186 million board authorization and a quarter-ending leverage of 1.54, you can expect to see greater share repurchase activity moving forward. Finally, one modeling item which I need to make you aware of is that we will have one less billing day in the third quarter this year compared to last, which we do not get back this year. So one less day for the year overall. In a quarter which had 64 billing days last year, one less day is 1.6% of the total days, and this roughly translates into the same amount of sales, which is notable for the quarter and should be dialed into your modeling of 3Q sales estimates. At this point, I will turn the call back to the operator to begin our question-and-answer session.

Hey, thank you. Good morning everyone.

Good morning.

So first question is on gross margin; and I understand that mix in a tough comp was the reason that gross margin was down year-over-year this quarter. In the second half of the year, Manny, should we expect that to continue? And then secondly, I think your goal was flat gross margin for the year, so just update us if that's still the goal?

Right. First of all yes, the expectation is essentially flat for the year and flat for the back half of the year, as it is flat for the first half of the year. So that's all consistent. Last year, we had favorable weather as you recall in the seasonal markets, and that helped us a bit, all the way around, more impulse items being sold with a longer pool season, and that helped our margins obviously as well as our sales, and resulted in the strong first half and second quarter gross margins that we had last year. The fact that they are flat year-on-year, I think is again a very favorable statement, given that being a very tough comp.

Yeah, I agree. Okay. And then secondly, Manny, you have a pretty good idea at this point in the year about where EPS will end up. So I am wondering, would you put us more to the midpoint of the EPS guidance at this point, or is there a real shot at the high end, if weather cooperates?

Well, typically when we provide the guidance, the midpoint is the fair number to use. You have to factor in Mark's comments towards the end there about the fact that we have one less sales day in the third quarter. But I think everything is on track, as we expected, about three months ago.

Okay. And then just lastly if I could, many of the distributors I cover are investing in technology in a big way, trying to stay ahead of the competition, and you have always been a leader in this regard. But any update on what you are working on now, and how customer expectations for service have changed?

Great question. We have been ahead of most; not ahead of all, but ahead of most in terms of using technology to enhance the customer experience, our own operations, as well as how we manage the business, and that continues. Mark, in fact, highlighted part of the expense increase year-on-year is our ongoing investments in technology. That's something that we are not going to compromise at quarter or year, because we may spend a little more than anyone else would have thought on that because we are looking at the long-term plan. And now mind you, given all that we do and how we carry it out, it doesn't rise to be a significant number in the big picture, but we continue to invest. And in terms of translating that to the customer experience, there have been a number of initiatives that we continue to roll out, both operationally, navigation technology, as well as using it from a data and marketing standpoint. So yes, we continue to invest. Items are constantly being rolled out to further enhance the customer experience, and it's part and parcel with business today. Every company today is really a technologically enabled business, it has to be. If you don't use technology, you are behind the curve.

Okay. Thank you very much. Appreciate it.

Thank you. Good morning.

Good morning.

Good morning.

I am interested in the growth algorithm from this point in the cycle forward. You said that your guidance for 2017 implies a 15% contribution margin. I am just wondering if there is anything materially different in 2018, and then just generally Manny, I know in the past you had outlined how you build up to your growth expectations. Can you give us an idea or remind us how you hope to achieve double-digit earnings growth from this point forward?

The key factor here is the number of pools already in use, as that drives the industry. The increase in the net number of installed pools has been relatively modest, with some minor inflation on top of that. Additionally, there is a rebound in remodeling and replacing existing pools, which contributes to the ongoing recovery in the construction of new pools. All of this together suggests a growth rate around four percent for the industry. Furthermore, despite facing a tough comparison from last year due to weather conditions, we expect to see six to seven percent growth in our top line for the year. For the base business, we anticipate a contribution margin of 15 to 18 percent. Contribution margin refers to the operating profit from the base business divided by base business sales. With this margin, we project double-digit growth in operating profit, which correlates with an increase in base business operating margin by 20 to 40 basis points. Additionally, stock buybacks usually add another two to three percent, leading us to expect growth in earnings per share of 15 to 20 percent. This formula has been consistent since we first communicated it back in the fall of 2009, and we have been at the high end of that range for earnings per share growth since then, and this year will be no exception. While tax benefits should be considered separately in our calculations, the essential expectation remains at 15 to 20 percent earnings per share growth moving forward, with no substantial changes anticipated in the next three to five years.

All right, okay. Thank you for that. And then Mark, you mentioned healthcare insurance expenses. Could you talk to us a little bit about the magnitude of that in the second quarter, and then how does that peel off in the third quarter?

Yes, you bet David. Really, what happens there, is we accrue healthcare expenses while we have actual, then we accrue at the end of the quarter, which is usually a percentage based on some actuarial estimates we get, and that estimate increased in the fourth quarter of last year from 12% to 14% over the last 12 months, all that is to say that, as we move through the year, the accrual rate will lapse when we get to the fourth quarter, and so that's one component of it. The other is the fact that we have had some high individual claims this year, which hopefully will not continue. Although, we certainly don't have any insights there. And so those are why I think the increase will moderate as we move through the year. The magnitude in the second quarter was about $1 million cost increase year-over-year.

Okay, Thank you very much.

Sure.

Hi, thank you. Good morning. Manny, in our last call you mentioned noticing a shift or an increase in underlying demand. Can you elaborate on whether you're still observing that in the channel and how it might trend into the second half of the year and into next year?

Sure. From a contractor standpoint, demand is not an issue at all. And in fact, since you live in Atlanta, you were a witness to the heavier rains that happened throughout the southeast, especially, vis-à-vis most years in terms of June. And that really just pushed back some of the work. So yeah, demand is a non-issue, contractors in the space, whether they are building pools, remodeling pools, replacing equipment on pools, their backlog is whatever they want it to be because the demand is there, and we don't see that changing. Now I will also go to the other side, because I talked to a couple of times I think in previous calls, which is that the capacity to serve that demand is constrained, and is not unique to the swimming pool space I think it applies to all trade sectors and other sectors as well. There is frankly a labor talent/labor shortage in the contractor space. And we are not exempted from that. So the point here is, if the demand was there and could very well be there for the industry to grow faster than it's growing, the constraint is just capacity. But again, it provides us with the confidence that we are going to be on track, and not just a 2017 phenomenon, but for the next X number of years, given the fact that certainly the demographics, the demand characteristics, all those factors are there.

Thank you. Can you discuss the Lincoln Aquatics acquisition in relation to the commercial business? From our research, it appears that while the company is not very large, it is well-regarded in its segment.

Very much so. It's interesting. I met the principal that owned and ran Lincoln back in the fall of 1999, as I was exploring that commercial space and trying to prioritize growth opportunities for the company. And as you I think witnessed, I believe about eight years ago, that moved up enough on the radar screen to become a priority opportunity for us, and over the course of the past seven-eight years, we've quintupled our commercial business to last year, just shy of $100 million and certainly just over $100 million this year, excluding Lincoln acquisition. The focus of Lincoln is very complementary to what we are doing. Our strength within the commercial space was in the HVAC sector. We played in the larger pools as well as water parks. But our strength was more in the HVAC sector. Lincoln's strength is more on the larger pools, whether they be municipal pools, YMCA pools, competitive pools, as well as water parks. And that just is a nice complement to us. It will further our business in the commercial space by the fact that we can leverage each other's strengths. Our ability to serve our network, our relationships throughout North America, coupled with their technical expertise of the team there, as well as their existing customer base.

That sounds great. On the green business, last couple of quarters, you have struggled a little bit. It sound like you tried to address some execution issues. Would you say that has all been fixed now with the performance this quarter, or do you still feel like you have some room to go there?

We are certainly moving in the right direction in the green business. I mean, the fact that we exited a product line and if we take that out of the equation, our base business sales were up 10% in the quarter, I think is a reflection of the fact that we are certainly moving in the right direction in the green business. Are we where we want to be? And the answer is no. It's also no in the blue business domestically, it's also no internationally. We are never going to be where we want to be because we are always going to look to be a lot better than we are. And that opportunity exists throughout the organization, and it's part of our culture that we have to get better every year in everything we do. And that applies, but the fact that again, taking out the business we exited, the fact that we are up 10% year-on-year in sales in the quarter, is certainly a reflection of us moving forward in a very positive way.

Great. I have a housekeeping question for Mark regarding the ASU benefit. It appears that your expected impact for the full year hasn't changed from the previous quarter, likely due to the price at the start of the day, which is currently about $11 lower. Could you provide some insight on what the ASU impact would be if the price remained at this level for the rest of the year, and how that would affect your pro forma guidance?

Dave, that's a good question. That's a difficult question to answer though. There are a couple of factors there. One is the ASU, the other is our stock expense. The stock expense, I would say, would have a favorable impact. On the ASU side, what this lower stock price might do is encourage fewer people to exercise options or push the exercise out. So I really can't tell you at this point. We will have to take a look at it, where the stock price is now or what it ends up with has certainly changed. So I don't have a good answer for you. We will have to kind of play that by ear, and hopefully all understand the complications and estimating what that ASU impact is. And I guess the bottom line for me is, it's an accounting change; it has nothing to do with our business. That's why we call it out and try to make transparent what the impact is. Whether it's positive or negative from our projections, I don't view as being material to our business.

Very good. Thank you for all the insights. Good luck for the rest of the year.

Thank you.

Thank you.

Hey, good morning Manny and Mark.

Good morning.

Manny, I appreciate your insights regarding the online model and its impact on the industry, as it is a significant concern for many right now. Another question that frequently arises is about pricing and its trends across various distribution channels. Can you discuss any changes in competitive pricing? Is it still business as usual? Also, could you walk us through your main product categories and share your pricing experiences over the past few years? That would be very helpful.

Sure. Well, just to provide a little bit of insight. When I joined the company 18.5 years ago, one of the top two or three items that was then an issue was the internet and how it was going to affect business. If you go back to 2000-2001, there were close to 1,000 storefront retailers largely that were selling products online, and it was primarily an arbitrage play between the larger year-round markets and the smaller and seasonal markets in terms of what the retail prices were, and the guys in Florida and California selling to consumers in New York and Ohio. I will say the greatest pressure there happened in the 2005, 2006, 2007 timeframe. That was the greatest stress period because there were so many guys playing, and then at the same time, there were a few guys that were calling a special focus on the online channel, as opposed to being storefront retailers that were arbitraging prices between markets. And then Amazon came into it about 10 years ago, which drove the cost to get traction on page 1 for these guys that were specialists in this space. Made it a little bit harder for them, so there was a little bit of a shakeout that happened, and the last few years has been pretty stable. Manufacturers have the cognizance of the sectors, and customers have come up with professional grade or trade series products. They have been more improved in their communication on their packaging to make sure that their products are installed by professionals. Most of them have differentiated their warranties to require a professional installation, because God forbid you'd have a regular pool owner trying to put in a pool heater and blowing up his home in the process. It's kind of naive or foolish to think that pool owners are going to install these products themselves. The great majority, as I mentioned, are not conducive. I mean, whether it's freight, whether it's the bulkiness of the products, whether the fact that they require professionals to install them, it's only a very small set of the product offerings that has any that is conducive to online trade. So those are all things that have been there, and again, we see this as something that was historically more of a factor. I am not saying it's not a factor today; 5% of the industry sales, about 3-4% of our business is selling to online retailers. A few of them are still the same guys that started almost 20 years ago that are playing a price arbitrage, a little bit of price arbitrage, given their volumes and their storefronts. And also, there are guys that are specialists in the space, like Amazon. So again, I don't see that as being a factor for us much in the last few years, and the share has stabilized—the growth of the channel, vis-à-vis other channels has been pretty stable. If anything, maybe declined in the last year or two.

But Manny, to clarify, your stock appears to be confused about the current situation regarding pricing and gross margins for your company. The approach to gross margins seems to be reactive at this point. Price did not affect your gross margin this quarter, correct? It's simply just...

Oh no. The online channel had no impact. It was all product mix. As I mentioned, I think last quarter, about $10 million of business that we did and shipped on early buy in the first quarter of 2016, got shipped in the second quarter of 2017, and early buy shipments are a little lower margin than regular day-to-day shipments. And so therefore, that's not the factor. Frankly, the factor is, the fact that equipment sales, which are generally speaking a little lower margin than the rest of our products, grew a little faster than the overall sales growth. I mean 7% base business sales growth, equipment was 9%. So the fact that equipment was a little higher, that's in essence, it.

Okay. Yeah, I just wanted to make that clear for anybody that didn't quite catch that yet. So last thing real quickly, on 3Q revenue growth and then the impact from Lincoln. It's a market that sounds like the one last day, the 1.6% drag, you were at 7.5% revenue growth this quarter, so should we extrapolate that I mean, something closer to 6% is more likely in the 3Q, and then what are Lincoln's annual revenues?

Well to answer your first part of your question, I think that's a reasonable adjustment to make. In terms of Lincoln, Manny, do you want to address that?

Lincoln generated approximately $20 million for the year, which is slightly less than that amount. If you break it down quarterly, this business isn't very seasonal, so we can anticipate around five million in the third quarter.

Okay. Very helpful. Thank you.

Thank you.

Thank you. Just wanted a little bit more color on how to think about the improved operating leverage expectations in the second half of the year. Also just given the context of the one fewer shipping days in Q3. Should we assume that Q3 is still a, call it a transition quarter, as you get up to speed with the freight and with the labor, or should the operating leverage improvement to EBIT balances spread across the second half?

The main reason, Garik, is that in the first quarter, we faced a very challenging comparison. Last year's first quarter was exceptional. Therefore, achieving positive year-on-year sales growth compared to last year's first quarter, and maintaining flat operating margins compared to that extraordinary period, was a notable achievement in itself. If we set that aside, we are starting to return to more typical levels. Our contribution margin in the second quarter was 18%, and I expect it to be comfortably above 15% in the second half of the year, where we will have more reasonable year-on-year comparisons. The second half of last year was solid in every aspect but wasn’t extraordinary, and we didn't experience the favorable weather that boosted performance in the first quarter of last year.

I might have missed it, but could you discuss two areas that have shown double-digit growth for you: the underlying growth in the commercial sector, excluding the Lincoln acquisition, and the performance of building products during the quarter? I don't expect any change in trend, but I would appreciate any insights on how these performed.

Building materials increased by 12% in the quarter. This category allows us to gain market share, supported by the recovery in remodeling and a favorable economic environment. Additionally, our marketing efforts and customer education while introducing new products, such as tiles and pool finishes, are expanding the market. These factors have significantly contributed to our strong growth in this sector over the past eight to nine years, and we anticipate continued growth at double-digit rates moving forward. Regarding the commercial sector, we have been focusing on it for about eight years. During this time, we invested in stocking locations and talent in the field to better assist our customers. These investments have yielded returns in increased share, although our share in commercial is still lower than in residential. This suggests ongoing growth potential in the coming years.

Great. Thanks a lot.

Thank you.

Hi gentlemen.

Yes sir.

So clearly, Manny, you explained how the percentage of the channel related to online sales is all centered around Amazon today. I apologize for the focus, but appliances are also moving online, as evidenced by another announcement from Amazon today. Personally, I believe this is important to address because I've had this conversation more in the last quarter than at any other time while covering you. You mentioned that only 5% of the market is online due to factors like freight costs, bulkiness, and the requirement for professional installation. My pool service provider, who manages over 1,000 pools, agrees with you. However, this discussion is more about the future rather than just the present. For instance, if I belong to the 70% of pool owners who maintain their own pools and my pump or filter breaks, I might find a pump for $420 online at Amazon. If I reach out to a pool technician I don’t usually use, they might quote me $480 for labor and the pump. What would prevent me from purchasing that pump online and having it delivered to my house, especially since it’s $70 cheaper? Moreover, why would I let the technician's warning about potential warranty issues deter me, considering I’m already focused on the price due to being a self-servicer? This represents a dynamic that people are trying to understand regarding the transparency in these decisions.

The core issue here is that this isn't something new. There are two main points to consider. First, the typical pool owner belongs to a higher-end demographic that generally does not want to spend time figuring out what they need. If their pump is eight to ten years old, it might not be the same model as they currently have, which means they are likely to need a new and different pump. Second, the waiting period for delivery is significant; during that time, the pool won't be circulating water, which can cause it to turn green.

Well you’d think I'd ask to install it too.

I also have to install it. The reality is there are people willing to drive 10 miles to save a small amount on gas. These individuals do not consider the cost of making that trip or the value of their time. There will always be a small group of people who do this, and it has been the case for many years. This pattern isn't going to change. Additionally, Amazon has been involved in this market for over a decade. Looking back at their website from 10 years ago, they featured countless products from the swimming pool industry, as did various online retailers. The situation you mentioned has existed for 18 years and persists today, with a handful of pool owners willing to go out of their way to save a little on gas, while those same individuals will also shop online to save money. It's just a tiny fraction of the market and doesn't make much sense.

Yeah. Mark, I hear you Manny. I might have mentioned $50 because I saw it as a retainer for my service person. Mark, could you discuss the other aspect in this context, specifically your EBIT leverage? The first quarter was exceptional given the comparison. However, your EBIT contribution seems a bit lighter in the first half, indicating some strength, yet you mentioned easy comparisons. Manny, you pointed out that equipment sales could account for some of that. Overall, you've indicated how stable your business is. Typically, the first half represents about 68% of your earnings, which would suggest that if applied to the first half earnings, it would exceed the $412 million range. Could you clarify why the operating leverage will be stronger and why your second half earnings are expected to perform well? In the past, you've mentioned the significant earnings once the pool is open. Why is this year's acceleration and leverage in the second half particularly notable? Thank you.

Well, can I look at the factors that have impacted us in terms of expense growth, and the things that we pointed out there, first of all are volume-driven labor and freight. And on the labor side, a lot of the cost increase there is in variable labor, particularly over time and temporary health. I think Manny mentioned the deceleration that we saw in the quarter because of weather in the northern, central and northern markets. So that is a controllable expense, that our field is going to begin to clamp down on as we move through the third quarter and into the fourth quarter. That's one. Two, as I mentioned, the healthcare costs; the increase there was driven by a couple of factors. One, the change in the accrual rate, which was lapped in the fourth quarter, and the other by, unusually higher expenses. I will say, it was a $1 million impact on the quarter, but a 20% increase year-over-year, which is very unusual for us. I go back three or four years in time, and our healthcare cost increases have been growing, but very modestly in the 3% to 5% range. The 20% range is just very unusual, doesn't mean it won't continue, but I'd be surprised if it did. And then I mentioned technology spending being another factor. Less than the employee benefits, but also a factor in the quarter, and some of that was driven by some software implementation costs we had in the first half of the year, that we won't have in the second half of the year. So I just look at all those things. Those again are the higher growth categories in terms of expenses year-to-date, and we don't anticipate that we will have that same level of spending in the second half of the year and therefore have greater operating leverage.

Okay. Fair. And then these are micro housekeeping questions. Your expected share count for the year, repeat it if I missed it, I apologize. And then explicit 2Q, 3Q and 4Q tax rates. I know you gave that full year, when I just didn't know if it was going to swing around between 3Q and 4Q. Thank you, gentlemen.

Yes. Ken, I need you to do a bit of work because I don’t have the share count forecast with me. I presented that during the year-end call, and since the share repurchases have been modest in the first half of the year, I intended to use that previous share count forecast for the remainder of the year, broken down by quarter. Regarding the rates, the 2017 rates I shared were the annual rate, which typically sees a slight improvement in the third quarter during normal years. However, this year, due to the significant effects of the tax accounting change, we are anticipating a much larger benefit in the fourth quarter. I provided details on that benefit in an earlier call, but I don’t have the specific number right now.

$2.5 million.

Yes. So that has a big impact and I don't know the rates specifically, but the fourth quarter would be much lower than the third quarter because of that tax accounting change.

Understood. Thank you.

By the way Ken, just a point; the share count is approximately 43 million, and from a big picture standpoint, other than repurchasing shares, which we don't assume at this point, you would expect that to remain relatively flat in the second half of the year.

Thank you.

Well, thank you. I will turn it over to Manny for his closing remarks.

Thank you, Phil, and thank you all for listening. Our next conference call is scheduled for October 19 at 11:00 AM Eastern, 10:00 Central, and 8:00 Pacific, when we will discuss our third quarter 2017 results. Have a great day.