Pool Corporation (POOL) — Q3 2022 Earnings Call Transcript

Welcome to our third quarter 2022 earnings conference call. Our discussion, comments and responses to questions today may include forward-looking statements, including management's outlook for 2022 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 from projected results are 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 included in our press release and posted to our corporate website in our Investor Relations section. I will now turn the call over to our President and CEO, Peter Arvan.

Thank you, Melanie, and good morning to everyone on the call. This morning, we were pleased to report another solid quarter for the business. Net sales including acquisitions came in at $1.6 billion, a 14% improvement, with base business posting a 10% improvement over the same period in 2021. Our results were fueled by solid demand for non-discretionary maintenance and repair products, continued new pool construction activity, strong renovation and remodel activity, and inflation in the 9% to 10% range. Now that we have closed the third quarter, we are fairly certain that new pool construction activity in 2022 will be down when compared to 2021. We would estimate that new pool construction units this year will be 10% to 15% less than the previous season. As expected, remodel activity has tapped into the free capacity of our builders to keep them busy. From a macro perspective, inflation, adoption of smart pool products, consistent demand for non-discretionary maintenance on the installed base of pools, and the leveraging of our operating network, are all enabling continued share gain and growth. Looking at end markets, I'm pleased to report that commercial pool product demand remains strong with sales up 28% for the quarter. This is in line with the total year-to-date growth rate of 27%. Retail sales excluding Pinch A Penny were up slightly at plus 4%, which reflects some inventory correction into channel and less favorable weather in the seasonal markets. Looking at Pinch A Penny as a standalone, we continue to be very pleased with the results. Retail sales through the franchise stores are up 16% over the prior year third quarter. From a product perspective, equipment sales growth is solid, posting gains of 9% for the period. This category includes pumps, heaters, lights, filters, and automation. Chemical sales were up 32% for the quarter as the trichlor shortage and inventory issues have abated. At this point, the only chemicals that remain in short supply are liquid bleach and Cal Hypo, which are used to shock the swimming pool. Lastly, building material grew 14% in the quarter reflecting solid demand in a still labor-constrained market. Let me now add some commentary on our European operations that, as a reminder, make up about 4% of our total revenue. After a tremendous year last year, the teams in Europe have been impacted by less than favorable weather, a very tough economy, spiraling energy costs, and the war in Ukraine. This has combined to create a significant headwind for our team as we saw sales decline to 24% in the quarter, 11% on a constant currency basis. This follows two solid years of growth in the quarter where combined sales grew approximately 44% in the same quarter. Turning to gross margins for the quarter, our overall gross margin was 31.2%, which is a decline of 10 basis points when compared to last year. Generally, we are pleased with the stability of our gross margins, with the year-to-date results being a very solid 31.8%, which is a 140 basis point improvement over the prior year. From an expense perspective, the team again delivered incredible results. Our operating expenses for the quarter were up 17% which slightly exceeds our revenue growth, but is in line with expectations given the acquisitions, new location and investments in growth. You can see clearly that our capacity creation activities continue to deliver value for our customers' team and supplier partners alike. POOL360 and our other digital platforms continue to grow. In the third quarter, POOL360 sales increased 14%. As previously mentioned, we released a new version of POOL360 this year and are entering the rollout phases. As a percentage of our revenue, sales through POOL360 are at 12%. This is an area that we expect to expand as more and more customers experience the benefits of using this improved app and other B2B tools. Wrapping up the income statement, you will note that our operating income came in at a solid $264 million, which is an 11% increase over the previous year same period. Operating margins came in at 16.3% for the quarter with our year-to-date operating margin at a strong 18.1%. Finally, with three full quarters behind us, and a favorable outlook for the balance of the year, we are updating our earnings guidance for the full-year 2022 to $18.50 per share to $19.05 per share. Excluding the ASU adjustments, the range is $18.26 to $18.81 per share. This represents an incredible 22% improvement at the midpoint on top of a tremendous year in 2021. As you can see, the POOLCORP team continues to raise the bar within the industry and deliver very strong results in a dynamic economic environment. The last two-and-a-half years have been both challenging and, at the same time, transformative for the industry. No single company was or is better positioned to capitalize on these challenges and opportunities than POOLCORP. The depth of our team, our expansive footprint, our strong balance sheet, and sheer grit and determination have allowed us to not only gain share but gain efficiencies at the same time. Thank you. And I'll now turn the call over to Melanie Hart, our Vice President and Chief Financial Officer for her commentary.

Thank you, Pete, and good morning, everyone. The third quarter finished with a record $1.6 billion in sales, representing 14% growth over the 24% growth realized in 2021 for a two-year cumulative increase of 42%. In comparing the quarterly growth of 14% to the full-year expectations of 17% to 19%, we saw third quarter growth of approximately 10% on pricing, 4% on acquisitions, and net overall domestic volume growth. This was offset by unfavorable impacts of 1% each for Europe operations and foreign currency, and one last selling day in the quarter. We also had some sales center closures during Hurricane Ian during the last few days of the quarter. Gross margins at 31.2% came in slightly below prior year margin of 31.3%. Base business margin decreased 80 basis points over prior year, where we saw a 250 basis point increase in the third quarter 2021 over 2020 levels. Focused pricing efforts, supply chain initiatives, and product mix all contributed to sustaining higher margin levels during the quarter, as the prior year benefited from our strong ability to pass-through price increases from our vendors. Base business operating expenses as a percentage of net sales decreased from 14.5% in the prior year to 14.2%, as our capacity creation efforts continue delivering operating margin leverage. Interest expense for the quarter increased $9.4 million as we have higher debt levels compared to the same time last year, reflecting our investment in acquisitions, share buybacks, and working capital. Our average interest rate increased from 2.8% to 3.2%, reflecting higher borrowing costs. We anticipate finishing the year with solid adjusted cash flows around 80% of net income excluding the IDA tax payment, while positioned to benefit from inventory investments going into 2023. Our inventory balance at year-end could range from plus 10% to plus 25%, depending on the timing of vendor early buy shipment. This is slightly ahead of the plus 5% we were expecting earlier in the year. We have paid $112 million to date in dividends to shareholders, a 27.5% increase over last year, in the third quarter. Additionally, we have purchased $192 million worth of shares on the open market during the quarter for a total of $461 million year to date and have $230 million available under our current authorization. Leverage at the end of the third quarter was 1.25x and is well managed within our dated capital allocation model.

First off, Melanie, I think you just said that the fourth quarter gross margin would be somewhere in the 29%, and that you did say that you're focused on the annual amount. I just wanted to gauge your current confidence in that prior view about holding the line on the 30% annual gross margin in 2023 and beyond.

Yes, we maintain our long-term guidance and will reaffirm it when we provide our 2023 guidance in February. Historically, the fourth quarter tends to show lower margins compared to other quarters in the season, so the decrease in margin from the third quarter to the fourth quarter aligns with our historical expectations.

Right. Okay. And then as a follow-up, how should we think about earnings leverage in the model? I mean, you've had years of successful capacity creation and this recent inflation taking things to a higher price level. And now your operating margins at least this year are probably shake out in the 17% range. Will contribution margins in the future be higher than the mid to upper teens level you've typically seen in the past? Just trying to understand earnings leverage from this point given contribution margins versus reported margins.

Yes. So as we take a look at just kind of our operating model and our expense leverage, as we've seen over the last two years, we've certainly seen higher levels of sales growth. And with that we've seen lower than the sales growth on expenses, but certainly, growth. And so as we continue to look forward from a long-term standpoint, we would always expect that we would grow expenses less than the overall sales growth, and so do believe that within our model, we have many types of expenses that are available and flexible based on volumes. And so we do still believe that we have some ability to maintain our current operating margins and to continue to grow those long-term with sales growth.

First off, can you just talk about volume growth through the quarter and into October? And really what I'm driving at is, are you seeing any signs of weakness anywhere in your business?

Yes. Good question, Ryan. As we said, we're forecasting at this point that new pool construction is going to be down, as I said in the 10% to 15% range. A little bit the shoulders of the year, as you know, are the time that are most affected by weather. That it may be at the higher end of the decline if weather closes up sooner and maybe a little bit better if the seasonal weather stays buildable. So on balance, to say that new pool construction is going to be off likely at least double digits. The fact that volumes are still flattish is actually a pretty good position we think.

Yes. I agree. Can I follow-up on that new pool comment? Is that down 10% to 15%? Is that in units or dollars? And another question is, I thought there were backlogs out there, so I'm a little surprised, right, that we're seeing this kind of dip here.

What I would say is that it is in units, and dollars will be higher, of course, because of the structural inflation. I think the backlogs really need to be analyzed carefully. First of all, we had a slow start to the season, especially in the northern climates, where builders got a late start. So they got less pools in the ground. And as you know, when you loop those days early on, you typically don't get those back. I'm happy with the fact that volumes are holding up. And remember they're holding off of an elevated level compared to where we have historically grown. And that's partially because the installed base is growing and partially because we believe that there was some pent-up demand in renovation. And it's offsetting the decline in new pool construction.

Okay. That's helpful. And then just lastly, I wanted to ask a high-level question that is on everyone's mind. So we've got a situation. We've got rising rates. We've got a slowing housing market. Really, Pete, I just want your high-level views on how to think about each segment of your business over the next couple of quarters. So maintenance, upgrade, rental, and new pools. How do you see that trending in this environment?

If you examine the maintenance and repair of the installed pool base, this segment has typically expanded alongside the growth of the installed base and inflation. Once someone has a pool, they must manage the water by moving, filtering, and treating it, regardless of whether the pool is used frequently or occasionally. We are confident that this aspect of the business will keep growing as the number of installed pools increases. Although new pool construction has decreased this year, renovations and remodels account for about 20% of the business, while maintenance and repair continue to experience growth.

My first question is, I want to follow-up a little bit about the inflation point. You made the comment that you see the 4% to 5% for next year. Can you talk about the sources of those inflationary items, how we should think about them going forward and how we should think about that relative to perhaps some commodities or some other areas that may deflate on a relative basis next year?

Sure. Good question. So the 4% to 5%, that's really a composite number that we are seeing assembling from the major equipment folks. Pure commodity things like rebar and PVC pipe to some degree, do I think that there could be more deflation on those items? There could be. But when I look at those items in total, our exposure in terms of dollars to those items is relatively small. In the future expected rate increases during the balance of the year and our higher borrowing levels, interest expense for the fourth quarter is expected to be significantly higher than last year, resulting in interest expense for the year of $43 million to $44 million, up from our previously estimated $40 million.

So I appreciate the commentary, Pete, you walked us through on the different business lines and almost putting out a worst-case scenario down one. In that kind of scenario, what would be your flex at the SG&A level? I mean, would the gross margin be higher than your 30%? Could you help us understand how you think about the takes across the P&L that would help you mitigate some of that kind of sales decline?

Yes. The gross margins will be better positioned to be able to provide a little bit more color on that when we talk again in February. But as we look at the expense line item, we've already talked about specifically we've called out incentive compensation and there are several areas when you look at the overall contributions to our expense line. The biggest expense is really in the people area. So where we are from a staffing standpoint, we have the ability to flex there as well. Then really, there are just many of the natural items as it relates to delivery expenses and even discretionary expenses when you start getting into travel and entertainment.

Yes. Good morning, everyone and thanks for taking the question. I guess just again, thinking about 2023, how much of a drag could Horizon or SCP Europe be?

I think if you look at Europe, we said that it is 4% of the business overall. And its sales decline this year is something we keep in perspective when considering our global outlook.

Thanks. This is actually Noah Merkousko on for Trey. So my first question, I wanted to touch on commercial demand. I know that's a small part of your business, but it sounds like that's still an area for growth. As you look out over the next few quarters, do you think that's an end market that can continue to show growth? And can you just remind us how much of the business that is?

Yes, I believe it's in the 4% to 5% range overall. That segment experienced significant challenges during COVID, resulting in substantial spending in those areas, which is reflected in our sales growth. We have seen a 28% increase for the year, and I can assure you that the pipeline in that area is quite robust.

Well, hi, thanks. Well, thanks for squeezing me in. Just on the comment that you made, the contractors are switching more to renovation work as some of the new construction has slowed. Should we read into this that backlog on the renovation side is still strong and the outlook there is still quite good into next year?

Yes. I mean the information that we're getting from dealers right now is that they still have plenty of work. Our conclusion is that where pools are being built, they're still strong in those areas. Although permits are down, pools are still being built in those areas and renovations in those markets have strong demand.

Yes. Thank you all for your support and for joining us today. We hope you all have a safe and happy holiday season. We look forward to reviewing our fourth quarter and full-year results for 2022 on February 16, at which time; we will also provide preliminary guidance for the 2023 year. Thank you very much.