Good morning, and welcome to the POOL Corporation Third Quarter 2017 Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mark Joslin, Senior VP and Chief Financial Officer. Please go ahead.

Thank you Phil. Good morning everyone and welcome to our third quarter 2017 earnings call. I'd 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 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 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.

Thank you, Mark, and good morning to everyone on the call. As reported, we had a solid third quarter with 6% base business sales growth or 7% after considering one less sales-day in the quarter. Year-to-date, our base business sales also increased 6% on top of last year's 7% base business sales increase that benefited from the favorable weather. This level of growth is a reflection of the resiliency and favorable characteristics inherent to our business together with our team's ability to provide exceptional value and our being rewarded with an ever-increasing share of our customers' business. Our base business gross margins were also solid, especially when you factor in the 30 bps increase realized in last year's third quarter. Year-to-date, our base business gross margins were up 11 bps on top of last year's 20 bps increase. Expenses were largely as planned as we continue our ongoing investments in our business. Altogether, a solid quarter as we further solidify our foundation as a value-added distributor. Our base business sales growth in our 4 largest markets, California, Florida, Texas and Arizona; and in the rest of the markets was 6% in both cases. Within the quarter, the storms were the most disruptive with the impact from Harvey essentially recovered in the quarter, and the impact from Irma expected to be recovered this month. Also our base business sales result include our green business which had a 4% base business sales increase in the quarter despite the exit of a product line which adversely impacted its sales. On the product side of sales, building materials and related outdoor living products continued its strong performance with 9% growth in the quarter despite the disruptions of the storms. The lost sales-days in these product categories will likely not be recovered as builders and…

Thank you Manny. I'll start with our view of where we're at on operating expenses, which is that we've continued to make progress in bringing down the rate of expense growth as the year has progressed, although this may not be readily apparent. First, as you can see when you look at the base business addendum to our press release, approximately 3% of the 7% increase in our operating expenses in the quarter came from acquisitions. Looking at just our base business operating expenses, you can see that we had a 20 basis point improvement in base business operating expenses as a percent of sales over last year, compared to the 10 basis point improvement we reported for the first half of the year. What is an even better gauge of our progress here is the rate of our base business expense growth by quarter excluding performance-based incentive compensation. For our business, incentive compensation is a significant cost at over 1% of sales, and although paid on an annual basis, the expense recorded each quarter varies based on our progress towards our annual performance targets rather than on business activity in the quarter. This can create some bumpiness in our reported expenses, so stripping this out gives a better view of the rate of our underlying expense growth. For examples, our incentive comp expenses are $1.5 million higher this year than last in the quarter, but $1 million lower than last year on a year-to-date basis. So excluding our quarterly incentive compensation expense, our year-over-year base business expense growth by quarter in 2017 was 7.5% in Q1, 7% in Q2, and just 3.5% in Q3 which demonstrates the progress we've made heading into the home stretch this year. This should keep us on track towards our targeted 20 basis point…

[Operator Instructions]. The first question comes from Ryan Merkel with William Blair.

So my first question is on incremental margins. You mentioned that this quarter was 20%, but what if we adjust for the one less day and for the hurricane impact, would incremental margins be more like 23%, 24%?

Let me just think about that a second. It would be a little bit higher, Ryan, but I haven't done that modeling and calculation to see how much higher that would be, but certainly it would be a little bit higher, yes.

Okay, that's what I thought. And then at the end, Mark, you mentioned gross margins being down sequentially and actually in line with what I was thinking, but could you put some parameters on that just so we've got to calibrate correctly, how much were you thinking was going to be down sequentially?

Yes, well, and I wasn't talking sequentially, I was talking year-over-year. So what I said was that margins for the year would be relatively flat. We're up year-to-date, so the difference essentially consist relatively flat margins plus or minus. And again the difference there is first of all the fourth quarter, most of the business is coming from the year-round markets, Texas and Florida being significant components of that, and some of the storm recovery business is equipment sales which is generally lower margins. And then we also had a tough comp last year, which we had a 20 basis point improvement in margins in the quarter.

Okay, got it. And then just lastly, retail up 2% year-to-date, you mentioned storms caused a little bit of delays here in the quarter, but do you think you should be doing a little bit better than that? And my recollection is you've been growing about 4% in retail the last couple of years?

That's correct. Two things; first, we have been running up through August right around 2% to 3% year-on-year and obviously this year we didn't have the same weather benefit that we did last year in the seasonal markets where it was a longer season with an earlier start. So therefore we had a tough comp on that retail side, again because of seasonal markets having a longer season last year. But then the storm hit and between August, September we gave -- essentially gave the year-on-year increase back. So that's the essence of that. The chemical side of retail is pretty much on track with were expectations are, but the other sides of retail are down a little bit again with lost sales days in both Florida and Texas primarily.

The next question comes from Luke Junk with Baird.

First question, just wondering if you'd -- any color you can provide on the New Star Holdings acquisition from July?

I'm sorry, what acquisition?

The New -- yes, the New Star Holdings acquisition?

Yes. That is an acquisition in Australia that we did earlier this year. It is at this juncture early, as you can well imagine, the seasons are -- they run a different program than here, so the first 3 months' worth of activity was right on plan and it's all moving in the right direction and we're realizing also some synergies with our existing business there before. So it's progressing nicely, but it's still just 3 months in.

That's helpful. Then second question, Manny, just wondering what your outlook for new pool construction is heading into 2018? Just wondering if there's any clues in [indiscernible] growth could be nearing an inflection point here? And as far as factors to watch, would you say that borrowing availability is the most important factor that we should be watching at the margin or is there something else that you guys are watching closely?

I think the -- great question, Luke. I think the natural demands frankly is really poised for an inflection point, if not in 2018, certainly within the next 2 or 3 years. But the caution here, and I think I talked about this during the comments last quarter and maybe a quarter before that as well, is new pool construction is the most labor-intensive aspect of our customer-base activity. In other words, if you tie a new pool, the cost, the materials for that pool represents typically 15%-20% of the cost of the pool, whereas there are higher percentage for example of a remodel job because the labor content is modestly lower. So the whole impediment to realizing what's there is labor and I think you may have witnessed this in the new home construction site where the demand is very strong and basically labor constraints in general are inhibiting the natural growth that could take place. So I am looking for solid growth again next year, but if the demand were to be for 30% growth that will be realized because of the labor constraints, but 10% growth in new pool construction is very reasonable for next year.

And then if I could just get another one in quick, Mark, you had mentioned a 34.1% effective tax rate. I didn't catch the year that you were referring to when you gave that, just if you could clear that up for me?

Yes, that was just reiterating tax rates guidance I gave on the second quarter call for 2018, which was at 34.1% and given the push of ASU benefits of the first quarter that would be heavily weighted to the first quarter. I also gave a rate of 2019 on the second quarter call of 34.6%. So we will take a look at that and have some kind of update on that on our year-end call in February.

The next question comes from that Matt Duncan with Stephens.

So Mark, I'll piggyback on that last one just real quick. If it was 34.1% before you saw the shift to the first quarter of '18 from the back-half of this year for options exercised, how do you think we should adjust that rate for '18? It seems as though it's got to be a decent amount lower now, but what are we now thinking?

Well, I guess my guidance would be keep it at 34.1%, as you could assume that will be a little bit conservative. I'm a little gun shy, Matt. These option exercises are extremely hard to predict and they're relatively meaningful, and so we predicted too high when we entered this year and had to bring it down when we got into the back-half of the year. So the 34.1% is certainly very doable and it includes almost $10 million of benefits we expect in the first quarter on the tax expense line with little marginal benefit in the rest of the year, and so I would start with that, and we'll update it when we have a better view.

Okay. That helps. And then on -- just on -- in terms of revenue growth, you guys obviously had a really healthy growth rate this quarter and if I'm doing my math right, if I take out hurricanes and the one less selling day, daily sales look like they were up about 9% which is a pretty nice acceleration from the second quarter, that's at the higher end of the range of growth that you guys target of kind of 6% to 9%. Manny, anything you would call out there that's helping push growth a little bit higher right now? Are you perhaps seeing any strength in seasonal versus year-round markets, other product categories that are standing out to you right now?

I would say there are two factors. First of all, the external environment is positive. Existing pool owners are continuing to invest in their homes and then there are obviously more prospective demand for new pool owners, but that's -- the biggest factor is existing pool owners continuing to invest in their outdoor living space, and within that the second factor is our continuing efforts to roll out new products and work with our customers to help them grow their businesses enabling us to grow at a rate faster than market. So those are the two factors that I think are positive and basically it's very good. I mean, we call it the little hurdles that we have with a storm, and I can't say little hurdle because certainly that was very disruptive and a number of our people as well as customers were affected by it, but long term from a business standpoint we get over that pretty quickly and then continue on. So the biggest impediment and it's to the question earlier, and it's not so much '17 limitation, but I see it as in the next 3 or 5 years is the capacity of our customers to grow their business and a lot of that is given by the availability of labor for them. And while I certainly am very comfortable with our long-term projections of 6% to 9%, Matt, that you mentioned, as well as our 15% to 20% EPS growth, the national demand and our continuing share increases, they are that -- and that's very positive and I'm just -- whether it's -- the difference whether it's going to be 6% or 9% for example on top line is going to be more affected by availability of labor than anything else.

Okay. Are you seeing -- in the mix of your business, are you seeing homeowners do more intensive backyard remodels right now when they're doing pool refurbishments? Are you seeing a mix up in terms of the type of products that they're buying? Are they making their pools I guess better, I don't know what the right word for it would be, but is there maybe a little bit of a tailwind from that going on right now too?

Definitely. Definitely, and I don't see that changing anytime soon.

The next question comes from Anthony Lebiedzinski, Sidoti & Company.

So just to go back to the previous caller's question, Manny, you had mentioned that you are looking to roll out some new products. Can you give us some examples perhaps for what you're looking to do in 2018 and beyond?

Sure. I got to go back in time a little bit, Anthony, if you bear with me. At one point in time, distributors in the industry and us specifically were selling products that were unique to the pool industry. Gradually over time we looked at what our customers were buying from other sources and we began selling products, right, that may have been available through other types through other distribution verticals, but were being bought by our customers and started selling them those products. Then as we looked at the pool structure, I'll call it from the pool in, the pool structure itself, we started then looking at what's the adjacent space around it, and for example I'll mention hardscapes, we're not focusing on hardscapes to sell hardscapes across the board to the world, we do some of that, but the strength that we provide is selling hardscapes around a pool, and more and more pool owners are upgrading their outdoor living spaces with higher-end decking products, outdoor kitchens and that is just basically becoming another room in the house. And that's positive across the board for us. To that end we have -- we work with manufacturers throughout the world as you well know and we continue to roll out products and work with them on the rolling out of new products and establishing and creating demand for those new products that help provide that outdoor living experience for that homeowner.

Thanks for that color, Manny. And also certainly you guys stepped up your share buyback activity pretty heavily in Q3. How should we think about [Technical Difficulty] 4Q and heading into 2018?

Sure. I think you're going to step back and look at it again from a macro perspective, our target trading 12 months EBITDA, debt to EBITDA is 1.5x to 2x. We were almost at the bottom of that in the last 12 months or so and when opportunities become available, like they did earlier this -- earlier -- or in the third quarter, we pounced on those opportunities. And as that happens, as opportunities are created in an imperfect market, we take advantage of those opportunities over time, but within the constraints of 1.5x to 2x. And Mark mentioned we finished just a shade higher than last year in terms of debt to EBITDA, but we still have a lot of capacity and obviously our EBITDA continues to increase. So with all that said, opportunistically we will be buying -- continue to buy. This year I think we're about 140 or so year-to-date. That's well within our expected range. Next year I would look to do ideally a similar number and each year prospectively something along those lines as well. So it's part of our formula, has been for many, many years. It ties back to our discipline and deployment of capital and the fact that we're not looking to get into every business, it has to make sense, it has to have the right return on capital with the right levels of organic growth. And when you have that filter upfront and that discipline upfront, given the nature of business with our strong cash generation, you're going to have available cash and we certainly don't want to reduce debt beyond where it is now because it's very low cost of capital and therefore we're going to deploy it to the benefit of the shareholders and that means share repurchase.

And I guess we should assume as far as the other usage of cash would be your cash dividend that we should assume a continued increase in there?

Yes, the policy that the board has established is 35% of net income as the payout ratio and that's reviewed when we have the capital structure discussion in our May board meeting and that's been consistent now for a number of years, maintaining that 35% payout ratio, so with earnings going up, you would expect that the dividends would go up in kind.

Yes, that 35% is a non-ASU basis which is a non-cash tax adjustment, so.

Yes. Yes. That's just one.

Thanks for that clarification, Mark. And then couple of other small questions and I'll let you go. So as far as the product line extension that you mentioned as far as the packing and green business, can you just remind us as to when this exactly occurred so we should know when the anniversary is?

It would anniversary in December.

And lastly I assume that the number of billing days in Q4 this year versus last year is the same?

Yes.

The next question comes from Garik Shmois with Longbow Research.

Just wondering on the -- for your guidance, the concerned range, is it fair to assume that in the fourth quarter given you provided your gross margin outlook that the main variance is just dependent on weather and how long the pool season lasts here in the winter or is there something else going on within the guidance that's made the range [indiscernible]?

That's it. That's essentially it because everything else is pretty much normal and it's in seasonal markets and when it shuts down.

Got it. And then if you could speak to the gross margin improvement in Q3, just wondering if there's any mix benefits that you saw, and then also was there any benefit from the gross margin from some of the deferrals in Irma that you expect to be a head-winner, reversal in Q4?

First, yes and yes, there is certainly a mix benefit, but before you get to the mix benefit we had an ongoing program in execution, every facet of execution on the -- both the sales and the sourcing side which is a positive factor that we've been -- that's been incorporated into our numbers for many, many years. The offset of that is the mix on the growth of certain product categories, the lower margin products that we sell are equipment which has a lower cost to serve. So therefore the equipment growth rate, while still very healthy in the quarter and year-to-date, was a little lower than we've had most recently and therefore because of that there is a little bit of a mix benefit, right, embedded into the numbers. And that -- and we basically -- the logic in Mark's comments earlier is that we give some of that benefit back as that kind of restored itself in terms of our mix of our total business in the fourth quarter.

And I wanted to ask about commercial, how did that perform in the quarter and what's the M&A opportunity?

Sure. The performance in the quarter was solid. We are -- I mentioned 10% earlier. That's from our base operations on the commercial side. The Lincoln acquisition that we closed on in the second quarter is certainly a contributor, but the growth there is not as strong as it is on our I'll call it legacy commercial, but we are certainly working together and leveraging the two organizations to further our presence, thinking more about '18 and '19 than necessarily '17 in that regard, but that's coming along well. In terms of future M&A, yes, I mean that's a market space that our share is lower than we like it to be. So we will -- we are looking -- continue to look at opportunities there, but again with the right discipline that we've had historically in terms of everything we do.

Got it. And then just last housekeeping question, just given the buybacks that occurred in Q3, what's the right share count that you exited the quarter with?

It would be -- it should be the basic -- I'm sorry, no, it wouldn't be. The actual share count would be approximately -- again the benefit was about half during the quarter, so if you look at the year-to-date versus the 3 months the difference of about 0.5 million, right, you can figure that the end of the quarter was about a 0.5 million shares less.

[Operator Instructions]. The next question comes from Ken Zener with KeyBanc.

There was an article today about how -- I don't know if it's accurate or not, but talking about how backyard space in homes is going up specifically in new homes. So your building material, your outdoor stuff, I wonder can you talk to what your -- how often are those projects done in association with the pool? I think I've always assumed it's yearly one-for-one, if you could comment on that, as well as put it in the context of your outlook for financing which you're hearing for people's -- what they're doing for financing now and what you think '18 might look like in terms of being tighter or looser credit?

First, in terms of existing pool owners, in many cases, but not all cases, in many cases when they remodel their pool, they tend to also look at the perimeter of the pool and the associated decking and refresh or replace that deck. Okay? That doesn't always happen because in many cases that decking is perfectly fine and no need. There are also cases one-off what people redo the decking and not have to do the pool. So there is some connection when they're redoing their backyard, but not necessarily. I'd make the association when people redo the cabinets in their kitchen, in many cases they also redo their appliances, but sometimes they redo appliance, but sometimes they're very much independent events, okay? In terms of new pools, there is more of a tendency on new pools to not just do the pool, but do the perimeter as well, and that certainly is positive for us, and -- but even more telling for us is across the borders we talked about in a couple of other questions earlier people are doing it and stepping up, so they're not just doing a I'll call it a plain white plaster shelf, they are doing whether it's stonescapes or JewelScapes or whatever, one of our higher end were more aesthetically appealing pool finishes. So that's an example of what's happening there. In the same way when they're doing decks instead of doing a what I'll call a simple cement deck with perhaps a dye from a color and a stamp process which is very common 15, 20 years ago, now they're using natural stone or papers and both of which have very positive attributes that help sell them through the channel. So those are the things that are happening. And I think it's positive. Again, I don't see the external market being an impediment any time soon, I think more the impediment, if any impediment is there, is going to be labor.

Right. And I guess as it relates to the very good increases in equipment, building material et cetera, how much in collectively has inflation kind of flowed through in 3Q or throughout 3Q and year-to-date numbers, is it 1%, 2% or is it some more in specific categories?

In the overall business it's probably very close to 1%. There are certain product categories like for example chemicals, accessories, where there's been no inflation at all and in other product categories like for example you mentioned equipment, it's been probably running at about 2%, 2.5%. So -- but the overall weighted number is closer to 1% overall.

Great. When you say that 2%, is that like-for-like or is that kind of mix creeping in there, just to understand that?

That's a great derivative, that's like-for-like. Many factors have invested in more innovative products, and there has been some top grading that's also been taking place, whether that's in lighting, whether that's in pumps and a number of product categories there's been some gradual top grading from a mix -- product mix standpoint which is independent of the like-for-like inflation that I answered about -- I answered earlier.

This concludes our question-and-answer session. I would like to turn the conference back over to Manny Perez for any closing remarks.

Well, thank you very much, and thank you all for listening. Our next call is scheduled for February 15, mark it on your calendars, February 15 when we will discuss our full-year 2017 results. Thank you and have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.