Pool Corporation (POOL) — Q1 2018 Earnings Call Transcript

Thank you, Rocko. Good morning, everyone, and welcome to our first quarter 2018 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 2018 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. In addition, we may make references to non-GAAP financial measures in our comments. A description and reconciliation of our non-GAAP financial measure 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. In the first two months of 2018, we were off to a very strong start, only to be hit by multiple storms in March, which reduced our customers' ability to get work done, as well as delayed pool openings in seasonal markets. This weather headwind has carried over into April, although fortunately we should be able to recover most of the sales over the balance of the year. Despite this headwind, we still realized 5.4% base business sales growth, 6.2% base business profit growth, and an 11.2% increase in base business operating income, all of which are solid. Our base business sales growth in our four largest markets; California, Florida, Texas, and Arizona was 6.4%, while the growth in the rest of the markets that we serve was 3.7%, as these markets were the most affected by the weather. These base business sales results include our green business, which had a 10% base business sales increase in the quarter, as our network is largely in the sunbelt and less impacted by the weather. On the product side of sales, building materials continued its strong performance with 9% growth while commercial had 15% growth. In addition, pool equipment growth was 7%. The growth in these product categories reflects both the ongoing recovery in the remodel and replacement sectors of our business, as well as consistent market share gains, and are especially noteworthy, given the inclement weather. The retail product side of our business decreased by 3% in the quarter, which is where the impact of delayed pool openings is most apparent. There should be some catch-up here in the second quarter when pools are opened. Our gross margins were up modestly due to minor product and customer mix differences. These differences in mix should largely work themselves out during the course of the year. Our expenses in the quarter were largely as expected, reflecting our ongoing investments in different technology and fleet assets together with volume-related cost increases. Our base business operating margin increase of 40 basis points is a testament to our operating disciplines and continuous process improvements. We increased our annual guidance by $0.09 to a new range of $5.45 to $5.70 to recognize the benefit from ASU 2016-09. We're cognizant that we are just now entering the seasonally busiest time of the year, which is when our service level and value proposition are most extensive as we work to help our customers succeed. All results are only possible because of the commitment of our people throughout the company to our customers, our suppliers, and to each other. We are extremely fortunate to be involved in a business where our 4,000 employees work every day to help people realize their dreams of a better home life, while simultaneously assisting over 120,000 customers realize success. We look forward to making 2018 another successful year as we continue to create exceptional value. Now I'll turn the call over to Mark for his financial commentary.

Thank you, Manny. As you can see from our results, our base business gross profit increased 6% in the quarter, while base business operating expenses increased 5%, resulting in 40 basis points of base business operating margin expansion. We think this is a good result, particularly given the weather-driven fall off in sales that we experienced late in the quarter. Acquisitions had a bigger than normal impact on our results in the quarter, given that we completed six of them in the last year, bringing in 10 new locations, which resulted in a combined operating loss of $1.3 million for the quarter. Moving down to the P&L, you can see that interest and other non-operating expenses were relatively flat year over year. This line is composed of interest expense, which was up nearly $1.5 million year over year due to higher interest rates and higher debt. Other gains and losses included elements like interest rate swaps that offset the higher interest costs in the quarter. For modeling purposes, I would not expect that offset to continue and would use a 75 basis point year-over-year higher interest rate on debt for the balance of the year. Moving on to taxes, I think we covered this pretty well in our press release, but we'll reiterate a few points here. As we discussed on our year-end call and mentioned in the release, tax reform lowered our historical annual tax rate of about 38.5% to a projected 25.5%, excluding the impact of ASU 2016-09. Although this may vary some by quarter, that is where we expect our tax rate to be at the end of the year. On our year-end call, we had also discussed our approach to providing guidance on ASU 2016-09, which was to include in our projections only the known impact from vested options that would expire if not exercised, as well as the impact of any restricted stock grants. We had estimated this known impact from ASU 2016-09 to reduce our 2018 income tax expenses by $5.4 million and add $0.13 to EPS, all in the first quarter. Given both the increase in our share price following that estimate, as well as the pull forward of future option exercises into Q1 that would have expired in 2019 and later years, we recorded a $9 million reduction in tax expense in the quarter, which added $0.22 to our earnings per share. This $0.09 EPS improvement was added to our guidance range for the year, as noted. Moving on now to the balance sheet and cash flow, our total receivables grew 8% year over year, while inventory grew 9%, both slightly ahead of our 7% revenue growth in the quarter, but reasonable when adjusted for acquisitions. The quality of these assets remains strong as they have historically. Turning to cash flow, you can see that our $44 million seasonal use of cash to fund operating activities was more than 2017, including an approximate $4 million benefit from our lower tax rates this year compared to last. One factor accounting for the additional cash usage, which we referenced in our press release, was an inventory payment made in Q1 that was supposed to be made in Q2 because of favorable terms. Factoring this in, our cash flow from operations would have improved in the first quarter from last year, which should be evidenced in our Q2 cash flow results. Note as well that our capital expenditures are down $4.5 million this year from last, reflecting the early year timing of vehicle purchases last year, but also an expectation that our capital expenditures should be more modest this year than last. One final comment on modeling our results for the balance of the year; we have confidence in our earnings guidance range for the year and expect that much of the business loss in Q1 due to weather conditions, including delayed pool openings and lower construction and remodeling activity, will be recaptured later in the year. Although the impact from delayed pool openings will be pushed to Q2 due to April weather conditions and the capacity constraints of our customers. Overall, we expect Q2 results to be more modest with some pickup in the back half of the year.

Good morning. Thank you for taking the questions. So Mark, just to follow up on your last comment, as far as Q2 and the capacity constraints, are you seeing, as far as capacity constraints in all your markets, or is it more so in some of your year-round markets? Maybe you could touch on that first?

Sure. Anthony, we have higher demand in really all our markets during the peak part of the season, which is May, June, and July, a little bit in April, although that's certainly more pronounced in the seasonal markets. So there will be constraints throughout the network, but more predominant in the seasonal markets. As I mentioned, the pool openings are going to happen, and that's pushed into Q2, but where the construction and renovation activities are generally strong, demand is good. We will see some impact from that capacity constraint throughout.

As far as your operating expenses, obviously you called out the components of that. I was just wondering if there were any timing issues or if this was more or less in line with what you expected?

Well, the timing issues are more about us ramping up for a little bit higher sales activity in the quarter. Otherwise, the expenses are pretty much as expected. So no issues there from our standpoint.

I'll just add that we have the acquisitions that came into play during the course of the year. Mark mentioned the six acquisitions; the first one of note happened in the second quarter of last year and the last ones came into play late in the fourth quarter. So what you've got is that playing into it as well as the opening of several new locations. Overall, our expenses are pretty much in line with what we expected.

So as the season progresses, I imagine that you'll start to see benefits from those acquisitions?

Well, definitely, yes. In fact, if you look at the negatives in the quarter, part of that is due to the nature of where the locations are, as the seasonal markets drive that. But then you have the pickups in the second and third quarters.

Okay. And lastly, share repurchases were rather modest in the first quarter and they were rather modest last year as well. Should we expect a similar pattern of share buybacks this year versus last year?

Our objective here is that we finished the quarter well on the lower end of our target debt to EBITDA in terms of capital structure. Given the strong cash flow expectations that we have for the year, it's reasonable to expect that we will buy a million or so shares back during the course of the year. That will happen during the course of the year; it's hard to project when it will happen exactly, but that's our objective.

Okay, thanks very much.

Thank you.

Thank you. I'm just wanting to discuss your outlook for base business growth. I think coming out of Q4, you were looking at about 6% to 7% for the year. Given the slow start to the season, how are you viewing the base business guidance that you provided previously?

The same 6% to 7%, probably closer to 6%, but largely unchanged. The expectation is that pool openings are just delayed a little bit, a few weeks. Once those happen, there's an injection of products that pool owners consume when they open their pools and balance the chemistry and water. Additionally, in terms of the inclement weather and delays for our customers working outside, the expectation is that over the course of the year, that will largely balance out with less rainfall. To that end, they will be able to catch up, but they won't be able to catch up in the second quarter unnecessarily because they are pretty well booked. That's typically a capacity hoarder. The demand is strong, and they will be able to catch up at some point during the course of the year.

As it relates to OpEx leverage, moving into the next three quarters of the year, is it fair to assume, just given your commentary around how Q2 is looking, that you'll see a bounce-back in leverage in the second half of the year in conjunction with the expectation of accelerated sales growth?

Sure. So there's two parts here. One part is base business, and we had operating leverage of 20 basis points in the first quarter, plus 20 basis points from gross margins. Thus, we have an overall operating margin leverage of 40 basis points year over year in base business. That's consistent with our expectations for the year of 20 to 40 basis points altogether. For the acquired revenues, our flyer businesses that flow into, they are not included in the base business. Obviously, the leverage point there will be in the second and third quarters, then there will be a little bit of a hit in the fourth. But again, it's relatively small numbers, although on the margin it does affect it by a couple of pennies here and there.

And just lastly, on inflation, you had called out in the release lease labor and freight as some items that had been headwinds and these have been headwinds for some time, but you also indicated in your prepared remarks that these were tracking in line. Is there anything else to call out on inflation that you view as potentially problematic for the rest of the year? Is it truly, something that you feel is within your control, and you don't need any additional pricing to offset?

Sure. I'm going to take the question but also shift gears afterward. In the case of expenses, they are pretty much as expected. We've known for a while that there has been a very tight market on the freight side, particularly regarding third-party freight carriers and the cost for those services. That's rolled into our expense expectations. In a year-over-year comparison, it is higher, but again within our expectations. My pivot here is with respect to our costs of products, and there have been some raw material cost pressures on our suppliers. I mentioned last quarter about some of the components that are used for the manufacturing of the basic sanitizer for pools. Recently, I saw that one manufacturer announced a 5% price increase effective in June. I expect that others will follow as their cost pressures are driving them to do that. I also expect later in the year additional price increases on products affected by raw material fluctuations. While looking at the 2018 year and our general perspective of inflation being 1% to 2%, I think with some increases that will take place, mainly back-weighted to the year, we'll still be within 1% to 2%. Although, we might shift more toward the 2% given that activity again will be back-end weighted. Looking into next year, however, it's possible it could be higher than that. It's too early to make that call for ‘19, but it could very well be a year where we see inflation north of 2%.

Thanks for all the color. Best of luck.

Thank you.

Good morning, guys. This is Will on the call from Matt.

Good morning, Will.

I'm wondering if any pre-buy activity had an impact on growth in the quarter and how you would compare relatively to the past few years from an early purchasing perspective?

Sure. In terms of the orders we have on early buys, that is heavily weighted to retail customers in terms of stocking their stores for the upcoming season. Those orders and that activity were a little ahead on the order side compared to prior years. However, we didn't ship as much this year, so we generated less sales in the first quarter of this year than last year because of the weather, as a lot of this is in seasonal markets. Many retail stores at the end of March did not have a desire to take their full orders by that time. Additionally, the weather affected our ability to prioritize shipments to them. Those orders have largely been fulfilled now, and that was just a timing issue from the latter part of March to the early part of April.

Okay. Then on the growth rate between the businesses, you mentioned that 10% growth in the green business, but when calibrating for the blue and international business, how did growth in the first quarter change by the different segments? And what are your expectations for the year on each?

Sure. If you look at our four big markets, as I mentioned, we were up 6.4%. Texas got a little bit of a weather hit in the quarter, but we would have certainly been 7% in those four markets. Our expectation is that this will balance out during the course of the year. The seasonal markets, which were most affected, were up by 3.7%. We expect their catch-up to happen in the balance of the year, and those should reach around 6% for the whole year with the catch-up in the second, third, and fourth quarters.

Great. And then on operating EPS this year, do you still expect gross margins to be relatively flat, or should we be thinking about coming back to the operating expense leverage in the back half of the year? Maybe that growth on the OpEx dollar amount is closer to 75% of GP dollar growth relative to your 50% target. Is that how we should approach this year?

On the base business, that's still between 50% and 60% of our GP dollar growth for the year. For the acquired businesses, that's a different situation altogether. Most acquisitions that we make, like the majority of our competitors, have very modest, if any, operating margins. These businesses typically come with little to no contribution. Therefore, it's a matter of instilling the right practices and making the right adjustments to get to double-digit operating margins eventually. This will take time, and we'll play out, but the acquired businesses don't come with any profit, so to speak.

Stated in another way, you said earlier the 20 to 40 basis point expansion in base business operating margins is expected, with a little more in the back half of the year than the first half, given the constraints of capacity and challenges from our customers.

Okay, that’s helpful. The last thing for me on the January acquisition, can you discuss the size and location of that deal and what it brings?

The January acquisition was one that we did in Australia and it’s a small location there. More significantly, we also made an acquisition in Northern California that closed at the end of December, which involved five locations that are now being incorporated into our Northern California operations.

Great. Thank you, guys.

Thank you.

Well, today appears to be a short day and we have plenty to do. Thank you all for listening. Our next conference call is scheduled for July 19 when we will discuss our second quarter 2018 results. Thank you.