POOL
#All right.
Thank you.
Good morning, everyone.
And welcome to our first 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 of reconciliation of our non-GAAP financial measures is posted to our corporate website in our Investor Re<UNK>tions section.
Now I'll turn the call over to our President and CEO, <UNK>y <UNK> de <UNK> <UNK>.
Thank you, <UNK>, and good morning to everyone on the call.
Our challenge this first quarter was to surpass the extraordinary first quarter that we had <UNK>st year, and we accomplished that.
In fact, we realized 5% base business sales growth on top of <UNK>st year's 13% growth without the same weather benefit.
In addition, we continued to make investments in our business as we continued to build for the future.
And yet, we were still able to realize growth in our base business operating profit.
Altogether, a strong first quarter as we solidify our foundation as a value-added distributor.
Our base business sales growth in our <UNK>rge ---+ <UNK>rgest 4 markets: California, Florida, Texas, Arizona was 6%, while the growth in the rest of the markets was 3% as these markets were the primary beneficiaries of the mild winter <UNK>st year.
These base business sales results include our green business, which had a modest base business sales decrease in the quarter.
Although, their sales were up when including the acquisition that we closed in April 2016.
On the product side of sales, building materials and re<UNK>ted outdoor living products continued its strong performance with 14% growth, while commercial had 12% growth.
Pool equipment growth was 8%, despite the challenging comparable from <UNK>st year.
The growth in these product categories reflect both the ongoing recovery in the remodel and rep<UNK>cement sectors of our business as well as our consistent market share gains.
The retail product side of our business increased by 4% in the quarter, as the installed base of pools grew by 1%, with virtually no inf<UNK>tion and our performance reflecting market share gains.
Our gross margins were modestly up due to minor product and customer mix differences.
These differences in mix should <UNK>rgely work themselves out as we proceed throughout the year.
While our base business operating margins reflect a modest decline, that's <UNK>rgely due to both the extraordinary first quarter of 2016 and certain expense timing differences, for the year, we expect operating margins as well as our ROIC to increase.
We increased our annual guidance by $0.12 to $4.12 to $4.32 per share, reflecting both an increase in our estimated benefit from the new ASU from $0.20 to $0.30 per share and an increase of $0.02 in our diluted EPS using 2016 GAAP based on our first quarter results.
We are 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 distinctive as we work to help our customers succeed.
Of course, these results are only possible because of the commitment of our people throughout the company to our customers, our suppliers and each other.
We are extremely fortunate to be involved in a business where every day we help people realize their dreams of a better home life, while simultaneously assisting over 100,000 customers realize success.
We look forward to making 2017 another successful year as we continue to create exceptional value.
Now I'll turn the call over to <UNK> for his financial commentary.
Thank you, <UNK>y.
I'll start off by commenting on our base business operating expenses in the quarter, which were 7% higher than Q1 2016 and didn't provide the kind of operating leverage that you might be used to seeing.
There's a couple of reasons for that.
First, while we had a tough comp overall for the quarter, this was particu<UNK>rly true for our operating expenses given that base business expenses were up just 3% on 13% sales growth in the first quarter of 2016.
Looking at the 2-year growth rate on sales and expenses provides a better view of how expenses have been managed as well as the leverage we have.
Without going into details here, there were also some timing issues on expense recognition, which contributed to the high growth rate this year.
One factor of note is our employee-re<UNK>ted costs, which accounted for 58% of our total operating expenses in the quarter and are primarily driven by headcount.
Our total base business headcount was up less than 2% at March 31, 2017, compared to the prior year period, so no issues here.
The bottom line on expenses is that our Q1 expense growth rate does not cause us concern in meeting our projections for the year.
Next up for discussion is our tax expenses, which excluding the ASU adoption were in line with our previously stated guidance of 38.5% for the year.
The higher-than-expected positive impact from adoption of the new accounting standard was due to the higher than forecasted stock price in the quarter on invested equity and restricted stock as well as the acceleration of pull-forward of option exercises in the quarter from what we had forecasted.
This pull-forward of exercises <UNK>rgely came from exercises that we would have expected to take p<UNK>ce over the remainder of the year.
As we look out at the rest of the year and knowing that the higher stock price has a positive impact on our ASU-adjusted tax expense, while the pull-forward will reduce the benefit and <UNK>rgely offset the impact of the higher stock price, we are leaving intact our forecasted ASU tax benefit of $0.18 per diluted share per quarters 2 through 4 that I communicated on the February call.
As previously stated, we will continue to be very transparent about the impact from this accounting change as we report our quarterly results, and we'll be excluding this when evaluating management performance for compensation purposes.
Turning to our ba<UNK>nce sheet and the 2 major components of our working capital, receivables and inventory, you can see that net receivables increased 2% year-over-year, which was in line with our sales growth.
Our net inventories grew $52 million or 9% year-over-year, $51 million of which was for our domestic blue business.
90% of that increase was for new products and our highest velocity items or what we internally categorize as c<UNK>sses 0 through 4 items, which is out of 14 c<UNK>sses of inventory we carry.
So we have no concerns about carrying too much inventory into our peak selling season.
Looking at our statement of cash flow.
Let me first point out how the tax accounting changes impact the statement, which essentially moves the benefit of excess tax deductions we historically reported as a financing activity clubbed into the operating activity section of the cash flow statement.
As the benefit is recorded in our reported tax expense and net income and is, therefore, now included in operating activities, this increased our operating cash flow by $5.5 million over what would have been reported under the old accounting guidance.
One more item to point out in our statement of cash flow is our $19 million purchase of property, p<UNK>nt and equipment in the quarter, which is up nearly $6 million from Q1 <UNK>st year.
The increase is primarily re<UNK>ted to timing of delivery vehicle purchases, which were put in service before the season this year and also resulted in additional depreciation expense in the quarter.
Overall for the year, we expect our capital expenditures to be plus or minus $40 million or about 1.5% of revenue.
Finally, you will note we did not repurchase any shares on the open market in the quarter, although we do expect to repurchase 100 million to 150 million of shares for the year.
We ended the quarter with a very comfortable leverage level of 1.59, which is calcu<UNK>ted on a basis of debt to trailing 12 months EBITDA.
At this point, I'll turn the call back over to our operator to begin our question-and-answer session.
Well, we don't have it cut quite that way, but the blue business, basically it's a rounding error from a number standpoint.
So the blue business was just over 5% overall base business and the green business was modestly down.
And given the weighting, the green business is about 9% of the total, it just ---+ it still hovers around the same.
And the green business was affected primarily by the much higher levels of rainfall that took p<UNK>ce in the western part of the country, which is where our green business is concentrated.
Yes, the year-round markets were a shade stronger than the overall as indicated in my comments, up 6%, whereas the seasonal markets were up 3%.
And the reason that they were up a smaller amount was logically is that it was in the seasonal markets where we had the toughest comps.
Yes, what basically happened just to give you a little color.
Last year was an exceptionally mild winter.
So we basically got just about all our early buys out and shipped by the end of the quarter.
This year, for those of you in the northern states, you realized a little bit of cold snap in the middle to <UNK>tter part of the month.
So that de<UNK>yed some of the shipments and that basically have already taken p<UNK>ce in April, but there was about ---+ it impacted us about 2%, about $10 million have shifted from <UNK>st year, where we shipped it in March, this year we shipped it in April.
Okay.
Well, 2 parts.
The <UNK>tter part I really can't answer, we don't have that quantified quite like you ask for.
But in terms of when you look at our categories, our building materials and re<UNK>ted outdoor living products were up 14% overall for the quarter.
And that level of strong growth rate includes just like you described a fair amount of just market share gains on the same items that we were selling a year ago, but also include our continual rollout of adjacent complementary product categories.
And that's something that has very long legs to it for the future.
In terms of order of magnitude, those typical categories don't amount too much from an overall company standpoint in the first 2 or 3 years.
But certainly, over time, they continue to build progressively more and more traction.
And as you know, the whole category of building materials and outdoor living products is north of 12% of our business overall.
And perhaps to answer your question, if you look back, let's say, to 2011 time frame, it was less than half of that in terms of share recovery.
So it's adding certainly collectively at least 1% a year to our growth rate ---+ sales growth rate.
As long as people have houses and want to spend money on outdoor living space, and that's obviously a big deal in the Sun Belt, that is long legs for the next 20, 30 years.
Last year, we had 6%.
That was a very solid number.
For the year, our expectations are 5% to 7%.
So put it this way.
Is 7% possible.
Certainly, but I would say 6% is much more realistic.
When you look at the year, for us to have, on a base business level contribution margins of 15%, that's a reasonable expectation for the year.
Obviously, that didn't materialize in the first quarter, but some timing things that will get back over the course of the year.
So I think, 15% contribution margins for the year are reasonable.
And obviously, that means that given the weighting of our business in the second and third quarter, it's going to be 15%, 17% in the second and third quarters.
Well, not necessarily, I think if you read their recent S1, they noted that they were also down in the first quarter in base business sales.
So they didn't report a number, but I suspect it's simi<UNK>r to ours.
So the bottom line is that weather was not as favorable in the first quarter, that business is ---+ in our case, the weather sensitivity is weighted towards the West Coast given our presence being in the West Coast, heavily weighted towards West Coast.
And so everything is fine, moving right along.
We expect, obviously, as we proceed through the year for the comps to be positive and that business to continue growing both top line and certainly bottom line.
Yes, well, I'd say it is a little more challenging for the first half given that we're half way through the first half.
But for the year that is certainly still the target.
Whether we're on that or outside of that a little bit, I think that our expectation is we'll be close to that in the year.
No, no.
Yes, I had gone through that in the year-end call in terms of how I thought that broke out by quarter.
Obviously, first quarter, the difference was significant, but my comment on the $0.18 re<UNK>tes not only to the total, but also to how it breaks out by quarter.
And I'd have to go back and look, but it's generally smaller benefit in the second quarter and third quarter and the bigger benefit in the fourth quarter.
Yes, <UNK>.
If you look at rep<UNK>cement and remodeling activity, that's been strong since ---+ and recovering since 2011.
And obviously, when you look at our building materials growth rate over the course of time and our equipment growth rate over the course of time, those <UNK>st 6 years has been certainly very strong.
New construction is, in fact, recovering.
There is more ---+ appears to be more consumer band at present than perhaps we've seen in the <UNK>st 2 or 3 years.
So that's strong.
I will caution though that how much that can grow is limited, because of a <UNK>bor capacity issue.
Not to say that it's not going to grow, but it's not going to grow from 65,000 in-ground pools to 100, even though that may be the demands.
And I'm not saying that it is that the hundred is a demand this year, but certainly, the demand is stronger and, certainly, it's going to grow, but how much it grows is going to be in part limited by <UNK>bor avai<UNK>bility.
Sure.
I am ---+ I think confident in what we're going to be doing in the second quarter.
And as I mentioned just a touch ago, one of the issues we are having and this is not unique to our space, but at certain times of the year and given that our business is seasonal and the second quarter is the biggest quarter of the year, there is essentially a capacity limit on the part of our customers.
As you and all on the call know, what we sell to our customers is for them <UNK>rgely to utilize as they do what they do.
So they are selling their time and their talent.
They are using the materials and supplies that we provide to them to provide at the end of the day a customer experience.
So therefore, our growth from an industry standpoint is limited by our customer's ability to grow and add capacity and <UNK>bor is a constraint in and some of the more <UNK>bor-intensive services that they provide.
So therefore, my reference to 6% earlier in response to <UNK>'s question is more along the lines of how much share can we grow and how much is the industry overall capacity growth.
If it were more like the retail side of our business, that is not as <UNK>bor constricted, then perhaps it would be higher than 6%, but since the lines of our business is, in fact, <UNK>bor constricted, I think 6% is a very reasonable number.
Yes.
Sure.
Pete's been on board now 3.5 months.
And during that time, he has, I think, visited around 50 of our sales centers throughout the company, primarily ---+ entirely in the U.S. He is actively participating in every decision of any consequence in the company.
And he is actively involved, meeting not only our people and looking at operations and providing input into how we can get better, but also meeting with our more strategic vendors as well as a number of customers.
So he is out and about and contributing to our business to help us get better, faster.
Well, <UNK>, I would say, yes.
We would certainly have leveraged, but maybe not to the historic degree, because timing had to do with both how expenses were recorded <UNK>st year as well as this year.
And then, we had some acceleration of expenses leading into the second quarter.
So as we're preparing for the peak season, we got a head start in some areas to make sure that all the infrastructure was in p<UNK>ce and ready to go.
So I think that contributed to a little bit higher expense load just from a first quarter standpoint.
So if that helps you there.
Sure.
There is no one silver bullet.
And our process there is we're constantly evaluating different product categories that enhance the entire outdoor living space.
And we bring those in typically in 1 or 2 regions of the country, gauge customer and ultimately, consumer reaction.
And then based on what we see, then we begin to roll out in adjacent markets gradually over the course of time.
So ---+ but there is no one silver bullet.
There is no $100 million product category or anything like that, that we see as one.
We ---+ but there are a number of other product categories that gradually over time will gain more and more traction and continue to add to our overall business growth.
One of the other references there is appreciating the fact that our focus is our customer base and the highest point of leverage is to sell more to our customer base and while we ---+ as we gain traction in doing that, certainly our product avai<UNK>bility may enable us to sell those same products to other adjacent customers.
That's a tougher sale process and doesn't have the same overall leverage.
So again, it's both an opportunity, but also a limitation is our focus being selling more through the same channel.
Sure.
If you look at it in perspective, there are approximately 335,000 commercial in-ground pools in the United States.
The great majority of those pools are in the HMAC sector; hotel, apartment, condominium sector, so ---+ and then you have competition pools and then you have water parks.
When you look at that space <UNK>st year, our sales in that space were close to $100 million, which would round up to 4% of our total business.
And those are ---+ specifically the way we captured is products that are primarily sold to the commercial space.
So our actual sales in the commercial space is greater than that, because there are some products that are, for example, a lot of our chemicals are many of the same chemicals that are also sold to the residential sector.
So we don't capture that as commercial since most of the volume goes residential, so the bottom line is that when you look at that and our share of that business, we should be growing that at a double-digit rate for a number of years going forward as we continue to further our presence from an inventory standpoint and regionally throughout the country, as we continue to add talent on the sales side to be more of a resource to the customers in that space.
And frankly, also as we build our portfolio of products that we sell here to the commercial customer base.
<UNK>, I just wanted to c<UNK>rify to get out some more color to this expense question.
The ramp and support cost for the peak selling season, is that what are your referencing there.
Well, I made 1 reference already, which was trucks.
So we had ---+ just seeing our CapEx, we had a high CapEx for the first quarter and about half of what we'd expect to spend for the year.
So there is depreciation expense on that and that is really in anticipation of having the right equipments in our locations as they gear up for the season.
So that's really the type of thing I'm talking about, just a timing issue as well as preparing for the season ahead.
Right.
So it's the D&A piece that I wasn't picking up, that's in that channel line category.
Okay, the other question I have is, and then maybe this is a little bit broader question and maybe it's a trend, but nothing to worry about.
But it seems like the freight expense, maybe some growth-driven <UNK>bor, I don't know if that's the phrase you use, but is the mix of business causing a little bit more demand from customers for you to be shipping product, therefore higher freight cost or what's ---+ is there anything to decipher out of that ---+ those comments.
Two parts.
Certainly, on the freight side, we have been p<UNK>ying catch-up in the <UNK>st few years as we entered the season getting our fleet squared away.
And this year or <UNK>st year, we made the decision to order those delivery vehicles earlier, which is what <UNK> referenced a minute ago.
Part 2 is fuel costs are marginally higher than <UNK>st year, but when you get to the essence of your question, which is mix, there isn't anything significant from a mix standpoint in terms of delivery versus pickup that we've seen so far this year and don't anticipate anything significant from a delivery standpoint ---+ delivery versus pickup mix to take p<UNK>ce for the year.
Okay.
And then a follow-up to a question earlier on the green business.
In my observations, it appears you are proceeding strategically, but also cautiously.
Is that fair or is it a function of just not seeing the right business opportunities out there to further expand that business, whether that be geographically to the East Coast or less reliance on the West Coast.
Sure.
First of all, given our overall business, we have a high filter from a return standpoint, much higher filter than most companies and as evidenced by our own ROIC after-tax being over 20% and not that we are adverse, because we do every day, make investments where on a short-term basis dilute ROI<UNK>
We got to look at ultimately that they're going to have the right level of ROIC to make sense on overall company enterprise evaluation standpoint.
So switching over to our irrigation business, in our irrigation business, we're very focused on certain product categories and certain customer segments as well as some certain geographies that we believe have the opportunity to realize the same or very simi<UNK>r ROICs and organic growth rates over time, as the swimming pool business does.
And to that end, yes, we are not geographically going after every nook and cranny in the country nor we interested in ---+ so much in certain product categories, for example, the perishable side, which have different distribution dynamics.
Those are good businesses, but not good compared to ---+ not as good as the ---+ or don't meet our filter test.
So circling back, we're also cognizant of how we do things, and while our focus is very much Sun Belt oriented in the irrigation space, we continue to have dialogue, but again, we're not going to just do deals to do deals, we're going to do deals that make sense, not just for the short-term to drive EPS, because that's a very, very low hurdle.
We're looking at driving long and concerned about long-term organic growth.
We're concerned about long-term return on invested capital.
And that's the filters that we have in p<UNK>ce.
We did do a good size regional ---+ we did make an acquisition of a good-sized regional distributor in the irrigation space in the April of <UNK>st year and they, in fact, met their profit objectives for the rest of 2016 and continuing to positively contribute in the first quarter of '17.
So that business is good, and we continue to look for opportunities like that throughout the Sun Belt.
Right.
And just a c<UNK>rification, <UNK>y, it's very helpful.
Given the broader governmental policy and potential lower tax rates, does that open up more opportunities for sellers, because of their ability to have maybe a higher reinvestment rate.
Or is the nature of the candidates that come through the filter or get to the filter line, are those maybe because of broader events like death, divorce, et cetera.
Yes.
No, there is a number of factors that motivate a business owner to exit.
The more common one over time is age, but other factors also p<UNK>y in.
And certainly, when there is a tax change, and I remember when taxes were going to be going up years ago, that certainly was a motivation for people to act.
So yes, taxes, age, other events and business owner's lives, those are all factors.
And we as a practice, do not buy businesses unless the owners want to sell.
And that's an important distinction in the whole process.
It adds up to a good number.
Okay.
2 parts.
First, on the basic maintenance and repair, right.
The pools are there, they're going to consume, that's it.
On the discretionary part and discretionary part comes rep<UNK>cement, remodeling and the most discretionary being new construction.
I put them in that order, because from a <UNK>bor standpoint, that's how it is, in other words, tying into the product that we sell.
So to rep<UNK>ce a heater or a pump, it takes a fair amount of time and you tie that time to the products that we sell, and the products that we sell may represent depending on the product, 30% to 60% of the cost of that activity.
When you get to remodeling, more <UNK>bor-intensive proportionately and the cost of materials that we provide there represent a smaller percentage of the total bill to that consumer.
And then when you get to new construction, that's obviously the much ---+ the most comprehensive and the most <UNK>bor-intensive overall since you're building the foundation ---+ foundational structure of the pool and not just dealing with the surface.
So in that case, the percentage of materials that we sell is even less.
So when you look at all those pieces, I see ---+ we see the dynamics that you are identifying being very positive for the industry.
We have not yet seen the financing elements come into p<UNK>y as it was back in the 1980s and 1990s where people could borrow 80% against the value of their home.
That has not been really in p<UNK>y just yet.
But certainly, the native demands is there, the desire is there.
But there is only so much capacity from a <UNK>bor standpoint.
And therefore, I don't see any constraints whatsoever in basic maintenance and repair.
I see very little constraint on the equipment rep<UNK>cement side.
I see some constraint on the remodeling side.
And the greatest constraint is on the new pool side, which is the one that is the most <UNK>bor-intensive.
And again, the constraint is not a negative, it's a constraint on how much it can grow.
It didn't really impact the blue business for the quarter.
It impacted it in January and February, but March was a big recovery month.
And part of the answer there is that, as you mentioned, California is a very <UNK>rge market and is a significant installed base of pools.
So therefore, while it may have constrained the construction side, which is what is most impeded by rain, it didn't ---+ the basic maintenance, the basic repairs and a <UNK>rge part of the remodeling ---+ rep<UNK>cement took p<UNK>ce in the normal course.
So we didn't ---+ our customers did not lose as many days there as they did on the construction side, which is where the green is weighted.
That is correct.
Thank you, Anita, and thank you all for listening to our call.
Our next conference call is scheduled for July 28, mark it on your calendars, when we will discuss our second quarter 2017 results.
Thank you very much, and have a great day.
