Pool Corporation (POOL) Q1 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the Pool Corporation First Quarter 2019 Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mark Joslin, Senior Vice President and Chief Financial Officer. Please go ahead.

Thank you, Nancy. Good morning, everyone, and welcome to our first quarter 2019 earnings call. As usual 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 2019 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 included in our press release and posted to our corporate website in our Investor Relations section. Now I'll turn the call over to our President and CEO, Peter Arvan.

Thanks, Mark, and good morning to everyone on the call. We delivered a solid first quarter despite the cooler and weather impacted many of our year-round markets. Our sales were up 2% overall, while our base business grew 1%. Keep in mind that the first quarter of 2018 had one additional billing day, which is a 2% drag on the quarter, and currency exchange negatively impacted our 2019 sales by 1%. Our year-round markets, primarily Florida, California, Arizona and Texas, were up 2% for the quarter. Florida, which experienced favorable weather in the period, saw sales increased 7%, Texas was up 4%, with January and February sales climbing over 7% only to be impacted by a very wet March. California and Arizona, where we saw a nice growth in the first quarter of 2018, saw sales on a combined basis declined 2% as they were impacted by record-breaking cold and rain this year making construction and remodel challenging. We believe the unfavorable weather pattern in the west impacted our sales by $10 million to $15 million based on normal growth rates. Our builders are reporting plenty of pent-up demand, and we believe the shortfall can be made up – or much of the shortfall can be made up assuming normal weather, as these are predominantly year-round markets. Labor remains tight, but especially in the peak months, but we believe that much of this can be made up in the balance of the year. Turning to our green business, which was also challenged with unfavorable weather, our base revenue growth was 5%, reflecting our continued efforts to improve this business and solid demand in the end markets. International sales were up 9% with Europe up 36% in local currency and 20% in U.S. dollars. But remember, this is a seasonally less significant quarter for our European operations so the impact was somewhat muted. It is noteworthy though that Europe had a great weather in 2018, and this pattern is continuing. Our European teams are also executing very well and have been able to take share and leverage our operations. As we look at the North American end markets, retail sales were essentially flat, largely driven by the Easter holiday falling later this year as it tends to delay pool openings and the associated buying and restocking at our independent retailers. Commercial product sales were up 2%. And building materials were strong, with 8% growth in the quarter. Moving on to gross margins. We anticipated – as we anticipated, our overall gross margin percent increased in the quarter by 90 basis points to 29.2%. The increase is largely driven by the strategic inventory buys and the deferral of customer early buys. As the second quarter progresses and we sell-through the remaining pre-increase inventory, we should see a slight uptick in margins, but again this will diminish through the quarter. Overall, gross profit dollars were up a total of 5%, 4% was driven by our base business and 1% from acquisitions. Looking at operating expenses, the team did a very nice job managing expenses. Our base business SG&A costs were up 1%, reflecting efficiency gains and continued investment in technology and growth. Our POOL360 sales were up 32% for the quarter, which is encouraging as it creates capacity for our customers and for our sales centers. As we look at operating income, despite challenging weather, our team remained focused on execution and managed to deliver a 14.5% increase in operating profit for the quarter by leveraging expenses and by leveraging the investments we made in inventory last year. Our base business operating margin percent improved 90 basis points, again, reflecting the efforts of a strong team and a solid plan. From a cash perspective, we delivered a very strong quarter, with cash flow from operating activities improving by almost flow from operating activities improving by almost $73 million from the first quarter of 2018. Much of this improvement is a result of the burn down in incremental inventories that we highlighted during our year-end call. Lastly, as a result of the ASU benefit we saw in the quarter, we are increasing our annual guidance by $0.04. Our new range is $6.09 to $6.39. All in all, our results were very solid given the challenges we faced with weather. We are very fortunate to have the best team in the industry that strives every day to make a difference and be the best channel to market for our suppliers and provide the best value proposition to our over 100,000 valued customers. I will now turn the call over to Mark for some financial commentary.

Thank you, Pete. Overall, other than the impact from weather and taxes, our Q1 results came in largely as expected. On our year-end call, we had estimated a $20 million to $30 million impact on revenue for the quarter due to the later Easter holiday, which impacts pool openings and customer early buys and the loss of a billing day. In addition to this, the unusually cold and wet weather in the western U.S. impacted revenues by another $10 million to $15 million most of which we expect to be pushed back to later in the year rather than lost, as Pete mentioned in his comments. Going down to P&L. Gross margin and expenses, other than taxes, were more or less in line with our expectations, with the expense line benefiting from currency translation as well as the loss of a billing day. The growth in interest expense in the quarter was also discussed on our February call, and as mentioned then, should moderate after the second quarter. On our tax line, the positive impact of ASU 2016-09 was greater than expected as the increase on our share price following our year-end call resulted in more employee stock option exercises than we had anticipated. On our February call, we have stated that we expected a 2019 benefit from the ASU to be $7.2 million or $0.18 in EPS by the second quarter. Instead, we recognized a benefit of $8.8 million or $0.21 in earnings per share just in the first quarter. This resulted in $7.1 million or $0.17 in added EPS from options that expire this year and $1.7 million or $0.04 in EPS from options that would expire in years after 2019 and which was not included in our estimate for this year. As a result, we increased our guidance range for 2019 to include the unexpected $0.04 benefit. For Q2, we are now expecting just a $500,000 or $0.01 EPS benefit from unexercised 2019 expiring options. For those of you modeling these things out, this is a big shift in tax benefit from Q2 to Q1, and I want to make sure you pick this up. Moving on to our balance sheet, you'll note that receivables were relatively flat year-over-year, in line with our sales growth, while inventories were up $112 million or 16%. As noted in our release, there were a number of reasons for the larger-than-normal inventory increase, including last year's prebuy, acquired inventories, business expansion and the slowdown in Q1 sales. As we move into the second quarter, we'd expect to see the rate of inventory growth over last year to narrow. From a cash perspective, and as we discussed on our year-end call, we expect to benefit this year from the inventory adjustments we made last year and build on the $73 million improvement in operating cash flow we reported in the first quarter. On share repurchases in the quarter – excuse me, our share repurchases in the quarter took place earlier in the year and were discussed on our last call. But to recap, we've repurchased approximately 140,000 shares at an average price of $148 a share for a use of cash of $20 million. This leaves us with a $49 million current board authorization. To comment briefly on exchange, the stronger dollar had offsetting impacts on sales and expenses in Q1. Assuming a similar exchange rate for the remainder of the year, I'd expect this to have about a 50-basis-point negative impact on sales each quarter and roughly a $1.05 negative impact on Q2 earnings, a modestly negative impact on Q3 earnings and no impact on Q4 earnings. Finally, as discussed previously, we adopted the new lease accounting guidance in the first quarter, with results as previously communicated. New assets and liabilities added to our balance sheet for about $180 million each, with no impact on our P&L or cash flow. Now I'll turn the call back over to our operator to begin our question-and-answer session. Nancy?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Ryan Merkel from William Blair. Please go ahead.

Hello, can you hear me?

Yes Ryan, how are you?

Hey good morning Ryan.

Oh, good. Okay so first of all, last quarter, you talked about $20 million to $30 million of sales shift in the 2Q from the Easter shift. Is this still your estimate?

Yes, but it was the combination of Easter, which impact pool openings, also the early buys from customers and the loss of the billing day. So that, in total, we think was about $20 million to $30 million. So estimate, we think is really what happened in the quarter.

Okay. So nothing is changing on that estimate. And then could you comment on sales trend, maybe the last two weeks of March and the start to April? I'm wondering if it's consistent with the high single-digit organic growth you're expecting for the year.

Yes, sure, Ryan. Yes, sales for March when the weather turned, sales picked up. And the high single-digit that you mentioned is what we were experiencing, and that has continued into April.

Perfect. And then maybe just lastly, commercial, up 2% is little softer, I think, than trend.

Yes.

Was this weather-driven? Or is there anything else going on?

Yes. I think a lot of that is weather-driven. Because remember for commercial, it's not just indoor pools. Many of the commercial pools are, frankly, the outdoor pools and the HVAC category as well. So the guys specifically out west in California and Arizona, where the weather was just dreadful, they got behind on the commercial work. So I don't think it's anything other than weather.

Right. Okay, very good. I’ll pass it on.

Thank you.

The next question comes from David Manthey from Baird. Please go ahead.

Hey good morning guys.

Good morning.

Good morning David.

You probably don't want to comment on a supplier's financial results, but is it correct to assume that you didn't see anything in your first quarter that changes your outlook for the demand backdrop generally?

No. Obviously, we're not going to comment on somebody else's. But as I mentioned in my comments, underlying demand is strong. Builders have plenty of work. And as usual in this industry, when the sun comes out, people get back to work. And as I mentioned with Ryan's question, sales had picked up.

Yes. The other thing to keep in mind, David, is just looking at the housing market overall. Although construction isn't particularly strong, home values have been stable and strong, and that drives a lot of the growth that we've had in renovation replacement. So no change in expectations there.

Okay, sounds good. And then with Easter seen as a turning point for seasonal pool openings, shouldn't the lateness of Easter this year cost you a little bit in the second quarter as well? Or are you assuming that it'll catch up by the time you report the full quarter?

I think it'll catch up. There's – as you know, there's big rush to get pools open. And now that the sun is out in most places, with the exception of Texas today, the – I think it'll catch up.

Okay. And then my final question, could you give us a generic overview of how you're thinking about your acquisition strategy today?

Yes. I think it's really no different than it's been in the past. We're opportunistic and strategic, right? So everything that – we look at a lot of deals both – we look at green and blue. So as you know, we did a small one on the green side in the end of last year. We did Adcock in the beginning of this year. So there's nothing out there that is transformational for us, so we are opportunistic. When we see an acquisition that fits our strategic plan and we think it's a good cultural fit with us, then we're able to jump on those. But nothing out of the ordinary from what you have seen in the past.

Sounds great. Thank you.

Yes, thank you.

And our next question comes from Blake Hirschman with Stephens Incorporated. Please go ahead.

[Indiscernible] about pricing, just kind of what that looked like in the quarter, how that stacked up blue versus green and if you're still expecting the 200 basis points above average that you kind of talked about last call.

You cut out in the beginning of your question. I just want to make sure I got the whole thing. Could you repeat the question?

Yes. I was just asking about price, what it looked like in the quarter, and if you're still expecting 200 basis points above normal this year.

Yes, I think that’s a fairly good range. There's been no real – one of the suppliers has announced a small increase kind of preseason this year, but I think the numbers that we have talked about in the past are still intact.

Well, yes, let me just clarify, though. You mentioned 200 basis points of improvement for the year.

Inflation.

Inflation, yes. Let's be clear about that. That's inflation. So the margin impact, as we discussed, we've gotten the vast majority of that benefit in the first quarter but maybe a little bit bleeding into the second quarter.

Got it. Got it, okay. And then I know you've kind of talked about base business, sales growth expectation and kind of around price versus volume. But to kind of slice it up a different way, can you give any color as to how that splits out from an end market sales growth perspective. Like what level you're expecting in nondiscretionary R&R versus larger discretionary R&R versus new construction?

Yes. We say our new construction – so last year, new pool construction was in 80,000 units, and that was up from 75,000 units the year prior. So I would expect a similar increase this year, although we're a little bit behind because of the weather in the beginning of the year, but there's still plenty of time to make that up. The rest of the market, so you have the organic growth with just the new pools in the market. You have building material sales, which for us have been strong. So the renovation market continues to be strong, so I don't expect anything from a different trend in that area. As we talked about before, a lot of what drives the – or limits the demand – or limits the improvement is labor. And there hasn't been a big change in the labor pool, so the demand is there. So the same growth rates that you have seen in the past by category are probably going to maintain for the year. Again, when it comes to new pool construction, there's not going to be a big shift there. And those same contractors that are doing new pool construction are also doing renovation.

Got it. All right, thanks a lot. I will turn it over.

The next question comes from Steve Volkmann from Jefferies. Please go ahead.

Hi. Good morning. Thanks for taking my question. Anything interesting to call out relative to some of your other cost like wages and transportation and so forth? And any changes on those trends?

Interesting to call out. Well, I mentioned that the quarter was impacted by a couple of things, one, being favorable exchange, and that should continue. Although as we get into the second quarter, the impact is less significant there but will still benefit us, assuming rates stay about where they are, with the U.S./euro being a primary rate that impacts the expenses. And the other thing that benefited us in the quarter was just a loss of a billing day, so it impact sales, but it also impacts the number of expense days. So fixed costs, in particular, get pushed out. As I said, I think on the last call, we lose the day in the first quarter but gain it back in the third quarter, and so a little bit heavier expenses there. Other than that, the trends are pretty much as expected. We benefited a little bit on the bonus line, just in terms of how we booked that based on expectations compared to last year. Not big enough to really call out, but a little bit of benefit there, and everything else was as expected. We did, given the lower sales growth, push out – I think our folks did an excellent job of managing labor costs, and so some of some of the hires and things that generally we'd have gotten started on got pushed back a little bit, and that helped us for the quarter.

Okay, great. That’s good color. Thanks. And then just on the gross margin benefit from some of the advanced buys that you did, it sounds like you're saying those sort of fade through the second quarter and then will be kind of back to normal in the second half. Is that the way to read it?

Yes. So for perspective, remember in the second quarter, we'll do almost twice the sales volume that we did in the first quarter. So by the end of the second quarter, it kind of fades away. Third quarter will be about even. And then on a year-over-year comp basis, fourth quarter will be slightly negative because of the benefit we had last year in the fourth quarter.

Okay. And then just from a cash flow perspective. Did you – I can't remember if you disclosed sort of order of magnitude of how many millions this might be.

Millions of inventory?

Yes.

End of the

I think at the end of – yes, at the end of the year, we said it was approximately 100 million?

Right.

Okay. So we'd expect that to come back out of inventory and into cash flow during this year?

Right.

Right. Right.

Superb. Thanks so much.

Yes.

Yes.

Our next question comes from Anthony Lebiedzinski from Sidoti & Company. Please go ahead.

Yes, good morning and thank you for taking the questions. So just wondering, as far as your outlook for new sales center build-out so you opened two new locations in the first quarter, kind of how are you thinking about the balance of the year? Obviously, you talked about – earlier about acquisitions, but just kind of organically, I just wanted to check in how you guys are thinking about that.

Sure. So far this year, we've added six. So there was four from the acquisition with Adcock – I'm sorry, so it's five net. Because four from the acquisition in Adcock, two new facilities have come online, and we consolidated one. For the year, we're planning on – at this point, we have nine new approved. So there's two new online already, so expect another seven to come online before year-end. And they're in various stages of construction.

Right. And are these primarily in existing markets? Or are you going into any new markets?

No. They're primarily in existing markets. I mean, if you look at our coverage, Anthony, there's not many markets that we're not in. Basically, when we add facility, it's usually because we're running out of capacity in the existing facilities. And we're following the market, so to speak, and growing parts of the geographies that we basically break up a portion that – out of an existing branch. And that becomes the scene for the new branch, and then both of them continue to grow.

Yes. And just remember, from a timing standpoint, as Pete said, the seven will come later in the year after the season. So from a revenue standpoint, they really don't benefit us too much, and there's a little bit of expense that comes with those as they get opened.

Right. And remember, all of our new branches go on our focus list as do acquisitions to make sure they get the attention, so that they come online and produce in line with the rest of the company.

Got it. That makes sense. I was a little bit also surprised – switching gears now to Europe about the sales shrink there. I know it's a seasonally small quarter for them but just wondering as to how – when you look at the European market, does it present perhaps opportunities to do some additional sales center expansion there? Or would that be more of a place where you would look to grow through acquisitions?

So I think the answer is yes and yes. So Europe is a good market for us. They – and remember, as I said, they – Europe had a very, very, very good weather pattern. I was over there a couple weeks ago, and they've had a very nice spring. So they're benefiting from that. Our team is very good and is executing. We have a new facility planned in Europe and I would tell you that our M&A strategy for Europe is no different than it is in the U.S. We're strategic and opportunistic. When we find something that makes sense, great. If not, then we basically follow the same expansion strategy that we do here in the U.S.

Okay, all right. Thank you very much and best of luck.

Thank you.

Thanks Anthony.

Our next question comes from Garik Shmois from Longbow Research. Please go ahead.

Hi, thanks. Just wondering if you could touch on how we should think about SG&A and operating leverage for the rest of the year, just given that sales growth is expected to accelerate, you deferred some personnel expenses into the second quarter due to some of the timing and some of the seasonality. So any help on the drop-through would be helpful.

Sure, Garik. Just going back to our guidance is probably the best way to answer that, which – what we look for generally on SG&A is growth at about 60of gross profit growth. And in doing that, the net provides us the leverage. In terms of how we get that leverage is that really goes to capacity creation initiatives that we have going on throughout the company, which is ways to make better utilization of our investments in people, facilities, vehicles. POOL360 one of the ways that we do that on the labor side, and we've had very good results there due to a strong kind of focused effort from our team, and really explaining to our customers the benefits to them and giving them new adoptions on POOL360. So in any case, that all – the POOL360 and then a number of other initiatives around capacity creation are what helps drive that operating leverage. And using that 60% for the year and then kind of backing that in by quarter based on where we finished Q1 and factoring in what I mentioned on exchange rates and the billing day in the third quarter should help – get that model out for you.

Okay. That helps. And then just one last question, just on the $10 million to $15 million in weather-related deferments. Just wondering, I know it's not a big number in the grand scheme of things, but just your level of confidence in being able to recover the lost sales, just in the context of the labor constraints that you've been highlighting for quite some time.

Yes, I think given that it's in the western half of the U.S., so there are large markets. And in the whole grand scheme of things, what we'll do in the west between now and year-end, it's really not that big a deal. So we look at $10 million to $15 million, I'm very comfortable saying the $10 million. Could we have risk on $5 million if we have weather – bad weather in the balance of the year at some point? We could. But in the whole grand scheme of what those markets will do, I don't think it's really significant.

Okay, makes sense. Thanks.

Yes.

[Operator Instructions] Our next question comes from Ken Zener from KeyBanc. Please go ahead.

Good morning, gentlemen.

Good morning.

Good morning, Ken.

Pete, you got to like interest stock, it's in all-time high. You got to like this as weather volatility for shareholder industry, I imagine. I just would ask some vanilla questions because you guys are obviously executing well, and the story hasn’t changed that much. So on these delayed products, I get it. I mean is it – what type of product, and I know you got the gross margin benefit from your pre-buys, but I mean is it across the board? Or is it really more pumped and pool maintenance coming out of winter? Or what’s the kind of just 30 second – what gets delayed? Is it everything or is it particular categories?

Yes, you’re talking about the $20 million to $30 million plus?

Yes, just in general, like when you get weather issue like this, not heavy rains like Texas, but just kind of layer, is it just more like a more northern climate, where stuff jut gets delayed, period?

Well, if you think about the fact that we’re in this time of year when pools are starting to get open, so you have a little bit of everything going on. So the weather impacts construction days, and construction days as both renovation and new build. And then the delay in pool openings affects chemical usage and the start-up expenses that you incur when you open a pool. So you’ve got some maintenance products. The things that didn’t – pools that weren’t properly maintained where things may have frozen in the winter or deferred maintenance from the end of the year. Somebody said I’ll wait until the next season to change the light that had burned out. So really it – it really is across the board, Ken.

Okay. And then, looking at spend, just to kind of think about this again. I’m just kind of refreshing. But for the blue side, like if a new pool that tends to be about $5,000 a unit and R&R on the blue tends to be about $1,500, is that still the numbers that that you’re kind of using in terms of expenditures per that category?

No. I believe that’s about right.

And then on the renovation, which could include green or hardscape, do you guys have a kind of number that when people are redoing a pool, which could include not only the widening of the pool, pool piping, et cetera, but it could also include the concrete around it or finishing, do you have a general number for when the pool gets renovated and what that is, and if that’s half financed or is that all cash? I’m just trying to understand that R&R side a little better.

And it’s a big range, Ken. As you know, there is a lot of variation, and the variation is driven by what the customer wants as well as how well the customer homeowner is feeling economically. And so when you are sitting on equity in your home and you have a pool that is, let’s call it, long as a tooth, it needs a number of things. And you’re more likely to buy today because of all the features and benefits that have been having over time. There is just such a wide variety of things that you can do with your pool in terms of the pool finishes and tile and fountains and fire. And really, the other thing too is, Ken, is starting to appear, and it’s sorely needed in the industry is technology, things that make a pool easier to own whether it’s the next generation of robotic cleaners or whether it’s the next generation of robotic cleaners or whether it’s being able to control your pool even on a retrofit basis from your phone. Those products are just starting to really come out and gain exposure in the market, and that’s also going to just – it’ll simply expand – it will expand the market. I mean there’s a – of the 5.5 million in-ground pools for instance, 3.5 million of those, we believed, operate on a mechanical time clock. And every one of those is a candidate for an automation update, which for relatively nominal amount allows you to control that pool from your phone. So the long answer, the wide variety, and we’ve expanded our share of products as well as our presence by opening these entity centers, where homeowners can come in. So we don’t want have a specific number. It’s just a…

Yes, yes. So what I was trying to understand there in the mechanical clock, and I have God knows how [indiscernible] mechanical clock. In many industries, you talk about a life cycle, so pools – appliances might be 10 years. It’s a very fungible number. But I’m wondering is as these in-ground pools get older, if in fact you are you experiencing arising needs for R&R because they’re just literally breaking down? You know what I mean? You have to show, but everything else is really just hitting points where it has to be greater upgrades than you’ve had in the past, right, which is your combined not only with your expansion in the hardscape, et cetera, but the pool infrastructure itself is requiring. Do you see any of that? I don’t know how to think about a pool’s life cycle. I know comp score out and stuff like that. But it seems like the pools, because they’ve been on the ground longer, are actually facing greater upkeep themselves.

Yes, I mean it’s – we think about the interior of a pool, I mean there’s so many variables that come into play, and then you have – water chemistry being the biggest one. You can have a pool that has great water chemistry, and the water is always balanced, and that pool finish will last a lot longer than one where the water chemistry is out of balanced and people don’t take care of it. But we think about equipment pad, life cycle, similar to which you would expect for the appliances in your home. And the interior of a pool is probably kind of like a 10-year cycle. So – but there are – a lot of that has to do – it’s not just that it wore out. It is design, changes and features. So some of it is not – it’s not that there’s anything wrong with the finish. It’s just that it’s not aesthetically pleasing and when somebody sees a picture of a new pool and says, wow, that’s great. And it’s a pool that its basic form is a concrete shell. What you put on, it determines – and what you put around it determines what it looks like.

Thank you very much. Sorry for that extended questions.

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

Great. Thank you very much for listening today. Our next conference call is scheduled for July 18th when we will discuss second quarter results for 2019. Have a great day.

This concludes our presentation. Thank you for attending. You may now disconnect.