Pool Corporation (NASDAQ:POOL) Q2 2023 Earnings Call Transcript

Pool Corporation (NASDAQ:POOL) Q2 2023 Earnings Call Transcript July 20, 2023

Pool Corporation misses on earnings expectations. Reported EPS is $5.89 EPS, expectations were $6.32.

Operator: Good morning, and welcome to the Pool Corporation Second Quarter 2023 Conference Call. All participants will be in a 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 like now to turn the conference over to Melanie Hart, Vice President and CFO. Please go ahead.

Melanie Hart: And welcome to our second quarter 2023 earnings conference call. Our discussion, comments and responses to questions today may include forward-looking statements, including management’s outlook for 2023 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 the Investor Relations section. Peter Arvan, our President and CEO, will begin today’s call. Pete?

Peter Arvan: Thank you, Melanie, and good morning. Three months ago, you will recall that we said the year was off to a challenging start driven primarily by weather, but we cautiously believe at the time that as the year progressed, things would improve. Although, things did improve sequentially, allowing us to post the second best quarter in our company’s history, they did not improve as much as we would have liked as weather continued to provide headwinds and new construction remains under pressure. One notable exception to this is for high-end new construction where demand remains solid. The weather change that we count on to initiate the start of the pool season came later than what we have seen for the last couple of years.

This effectively shortened our season as homeowners delayed openings into cooler weather kept water temperatures lower, which negatively impacts our maintenance business, particularly chemical usage. Higher interest rates and uncertain macroeconomic conditions continue to weigh heavily on new pool construction, particularly at the lower end of the market. Additionally, we have seen some indication that more discretionary purchases like heaters and high-end cleaners have been deferred, but we are seeing resiliency in the remodel market. Dealers are reporting that demand for renovation is outpacing demand for new construction in many markets. Despite the challenging market conditions, POOLCORP recorded a strong quarter, demonstrating the power of the brand and tremendous execution by the team.

We continue to invest in our growth and focus on the customer experience, which is helping us retain and grow our market share. We have opened eight new sales centers since the beginning of the year, far more than the rest of the industry combined. In Japan, we added nine new stores since the beginning of the year, adding to our already impressive network of over 275 franchise stores. Our ability to manage operating expenses in a declining demand environment is noticeable as our operating expenses declined 3% on a year-over-year basis in a quarter even though we continue to invest in our new locations, new technology and our people. POOL360 adoption is growing as dealers are recognizing the added benefit and time savings that they receive by using the latest release of the tool.

Additionally, we are launching our POOL360 water test application at our independent retailers, which is a best-in-class online water testing solution that helps dealers provide water chemistry excellence and drive sales of our private label chemical brands. Our strong balance sheet has gotten even stronger as we have generated over $377 million of cash from operations, paid down debt, reduced inventory while providing best-in-class service. As in past recessionary periods, we get stronger and we’ll exit this cycle stronger than ever. When I step back and look at the revised earnings outlook that we reported this morning and put it in context to historical results, not just 2022, I’m proud of how the team is performing and all that we have accomplished.

Our market share is improving. The team is more focused than ever on providing best-in-class service. Of course, we are disappointed to report a year-over-year decrease in sales. But when you put things in perspective in this environment, we have achieved a 93% growth in sales and EPS growth of almost 200% from 2019 to 2022. Our North American market has been expanded by over 311,000 new pools built in the last three years. Over 30% product inflation has passed through the channel, market growth from new products, strategic acquisitions, continued market share gains and consistent renovation and remodel activity of the aging installed base all gives us confidence in the future. Our size, scale and unmatched experience in the industry allows us to excel in each of these areas and outperform the competition because we have the broadest footprint, the best talent in the industry and the swiftest access to capital, allowing us to prudently and responsibly invest during all business cycles.

Even with these negative impacts, our second quarter 2023 sales of $1.9 billion exceeded 2021 second quarter sales by $70 million or 4% as adverse weather carried over into April, then varied in impact by geography for the rest of the quarter, the negative trend on top line moderated in the second quarter to minus 10% compared to the first quarter where sales declined 15%. When we look at our year-round base business markets, the impact of varying weather patterns are apparent. For the second quarter, we saw California sales declined 8%, which is a sequential improvement when compared to the weather-driven down 24% that we saw in the first quarter. For reference, California sales increased 9% in the second quarter of 2022 and 33% in the second quarter of 2021.

Moving to Arizona. Sales declined 7%, which again is a significant improvement over the 14% decline that we saw in the first quarter. For historical context, sales in the second quarter of 2022 and 2021 were up 20% and 24%, respectively, in Arizona. Texas experienced cooler temperatures throughout the second quarter and significant precipitation in May, resulting in a 13% decrease over last year and trending down from the 6% first quarter decrease. For perspective, sales in Texas increased 17% in the second quarter of 2022 and 30% in the second quarter of 2021. Florida sales decreased 7% over last year, where for the quarter, we observed typical weather for this time of year other than a wetter June. You will remember that Florida sales was up 7% in the first quarter, bringing the year-to-date number to essentially flat.

We have seen a slowdown in Florida new construction, but we must keep in mind that Florida experienced a 23% and 35% growth for the second quarter of 2022 and 2021, respectively, so it remains significantly higher than pre-pandemic levels. Turning to our seasonal markets. Our sales declined 11% in the second quarter, in contrast to the 23% decrease we experienced in the first quarter. Although we observed some improvement as the ground began to thaw, key areas such as Canada, the Northeast and Midwest still experienced temperatures below swimming standards through June. Sales in our seasonal markets grew 5% and 32% in the second quarter of 2022 and 2021, respectively. Pricing on equipment continues to hold with overall sales down 8% for the quarter and less unfavorable than the declines in new construction.

Chemical sales in the quarter were down 3%, driven by the weather patterns I discussed earlier and trichlor pricing came down more than we saw in the first quarter, resulting in a 1% drag on consolidated sales for the quarter. Building material sales for the quarter were down 8%, continuing to indicate renovation and remodel numbers are faring somewhat better than anticipated despite the lower new pool construction. As consumers take advantage of leisure travel, our commercial swimming pool sales continue to see an uptick with net sales for the quarter increasing 8%, following a 12% increase in the first quarter over last year. Pinch A Penny franchisees collectively reported relatively flat sales for the quarter compared to last year. The franchisees have seen overall impact from less sales of discretionary items such as equipment and recreational items, but non-discretionary sales are steady.

Sales to our independent retail customers were off 11% and improvement over the 16% decrease that we saw in the first quarter. Europe’s second quarter sales remained challenged and were down 6% compared to the prior year, but also saw a seasonal increase in trend improvement from the 25% decrease they reported in the first quarter. In the Horizon business, base business sales were flat for the quarter, an improvement over the 7% decrease we reported in the first quarter. Our Irrigation and product category as strength for us performed well, particularly boosted by commercial projects, but growth was offset by some pricing pressures on commodities, which have seen higher levels of inflation over the last couple of years. POOL360, our B2B tool saw sales increase 3% over prior years, which continues to be better than total sales activity.

Line volume growth for the same period was 4%, which indicates an accelerating adoption rate as our customers find value in the tool. We are encouraged by the resiliency of our gross margins, which came in at 30.6% in the quarter where competition has increased due to softer new pool construction and current market conditions. Melanie will provide more detail on this topic in her comments. During the quarter, our operating expenses were 13% of net sales, an improvement over the 18.6% of net sales we reported in the first quarter. We still have good leverage on our fixed expenses and continue to add new sales centers opening three during the quarter to expand our market presence. We also continued to invest in and expand our employer of choice initiatives and customer facing programs to ensure we can expand our service offering to our customers.

Operating income for the second quarter of 2023 was $327 million, down $92 million compared to last year, and almost 90% increase over 2019. With our reported operating margins of 17.6%, you can see that we’ve held onto the majority of the benefits we realized as the business rapidly grew over the last three years due to our disciplined execution. During the second quarter, we added five new locations, two acquired and three greenfield. This puts us at eight new greenfield distribution locations to date, keeping us on track to open around 10 for the full year. We also expanded our Pinch A Penny franchise network by adding four new franchise customers in the quarter. We continue to invest in the future of the business as we expect the return to steady historical growth after lapping the swift ramp that we have seen over the last several years.

Last quarter, we began to experience the impact of weather, heightened interest rates, lower consumer spending in the end of COVID tailwinds. As part of our full year expectations, we believe we could see new pool construction down 30% with around 70,000 new pools being added to the install base in 2023. We expect some increases in the average spend on new pools built this year as lower price pools are experiencing stiffer headwinds than higher priced units that typically are less dependent on financing. Our product offering continues to expand and we are adding additional capabilities to our sales centers. Similarly, on remodel and renovation activities in a typical year, we would see around 10% or 550,000 pools upgrading their pad equipment and taking advantage of new automation, more efficient pumps, alternative sanitizers, all of which increase the ease of pool ownership.

Renovation and remodel activities often involve changing the look of the pool in the backyard using our proprietary tile pool finish and deck material selections. The owners of the 5.4 million in-ground pools are continuing to spend approximately $1000 or more on pool maintenance annually, although, some may choose to defer installation of more discretionary items in times of economic stress. Chemical and minor repairs will continue on these bodies of waters, along with the above ground pools and spas that also saw accelerated growth over the last few years. While we are expecting a decline in sales in the current year mostly due to tough comps, we are comparing again on a year-over-year basis, the long-term outlook of the industry as a whole remains strong.

The install base is bigger than 2019 and continues to grow. Equipment and most all other product inflation is holding and continues to buoy the top line. As I mentioned earlier, some trichlor pricing is under pressure as supply conditions have returned to historical normal levels following a period of significant supply disruptions, but this is largely being offset by inflation of other chemicals. Looking ahead, we expect these dynamics to stabilize and reflect consistent pricing and supply characteristics. Everything that we love about this industry and our numerous competitive advantages are every bit as true today as they were in the past and give us great confidence in the future. Lastly, with almost seven months of the year behind us providing an even clearer picture, we have adjusted our full year guidance for 2023 to $13.14 to $14.14 delivering solid teens EPS in the face of unfavorable weather early on macroeconomic headwinds, higher interest rates and market normalization show the cumulative benefit from exceptional execution by a very dedicated and talented team.

Melanie will now provide additional comments in her financial commentary.

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Melanie Hart: Thank you, Pete and good morning everyone. This morning we reported $1.9 billion in net sales for the second quarter of 2023. This was the second best top line in history after the exceptionally strong results we generated in 2022. Inflation in the quarter was approximately 3% to 4%, slightly higher for equipment products and a marginal overall pricing benefit from chemicals. We saw some pressure on trichlor prices in the quarter offset by inflation and other chemical products. The pricing impact of trichlor was around a 1% drag on net sales for the quarter. As we had anticipated, gross margin of 30.6% saw a 180 basis point decline compared to second quarter 2022. The benefit from lower cost inventory on hands have largely been sold through and contributed nominally to the second quarter gross margin.

Current gross margin primarily reflects replacement cost and the seasonal benefit we would typically expect to see in the second quarter. Gross margin was somewhat negatively impacted by sales concession activity in our response to competitors reacting to the slower start to the season. Operating expenses declined by 3% year-over-year in the quarter. SG&A cost as a percentage of net sales was 13% for the quarter, significantly better than the 18.6% we recorded in first quarter, as we realized improved expense leverage on our fixed costs in the higher sales quarter. Our field teams did an excellent job in managing through the seasonal expense growth between the first quarter and the second quarter. Last year, we increased expenses by $36 million from first quarter to second quarter, and we were able to moderate that to only $17 million in the current quarter compared to Q1.

We remain focused on compensation and freight-related bearable expenses, while continuing our investments in new locations and tools and technology to support our long-term growth. The 13 new locations opened since June 2022 added incremental expenses and were a moderate drag on operating income. We completed three acquisitions year-to-date, each providing unique strategic benefits and once pulled into the network will contribute profitable growth going forward. Together, these added less than 1% to net sales for the quarter. So for us, it was not significant to break out separately in the press release. Our second quarter operating margin was 17.6% versus 20.4% last year, but continues to be above the 15.4% in 2019. Looking back to 2019, we ended the year with a 10.7% full year operating margin.

That expanded almost 600 basis points to 16.6% for the full year 2022 as we realize benefits of around 150 basis points from inflation-driven price increases and inventory gains that have now largely normalized. We are experiencing some pullback in our operating margin from last year, but we believe the margins we will achieve in 2023 well above the pre-pandemic levels are setting a good baseline and will be sustainable as we hold on to the 30% to 35% industry growth from inflation, combined with our strategically beneficial acquisitions, increased scale, product expansion and improved operating efficiencies. We reported diluted EPS, excluding ASU of $5.89 compared to $7.59 in second quarter 2022. While 22% below last year, this is comparable to 2021 second quarter EPS and is 94% higher than the $3.03 excluding ASU, we reported in second quarter 2019.

Many changes have affected our historically stable and growing industry since then, which bring positive opportunities for our future growth and profitability. Receivables continue to be well managed. Day’s sales outstanding was 26.2 days compared to prior year of 27.2. We have made excellent progress on rightsizing our inventory by vendor and by location now that supply chains have normalized. I guess [ph] one of the metrics we monitor to ensure a great customer experience and analyzed for lost sales opportunities continue to trend well. We have reduced inventory year-over-year by $186 million against the $260 million inventory reduction we estimated at year-end. We are continuing to aim toward the end of the season or end of third quarter to achieve these inventory levels.

As we accomplish this, we will be uniquely positioned to work with our channel partners on early buys to best position us for the 2024 season. With acquisitions, new locations and expanded product line offerings at many of our sales centers, our capabilities in managing work at capital is another indicator of our focus on capacity creation and the value we continue to provide to our customers while generating strong returns for our shareholders. We reduced debt outstanding by $411 million from June of 2022. And although we had lower average debt outstanding during the quarter, an increase in our average interest rate resulted in a rise of $8 million in our quarterly interest expense. Cash flow from operating activities was $377 million, an increase of $348 million compared to last year as strong earnings and working capital reductions contributed to increased cash flow.

We have completed $44 million of share buybacks in the open market during the first half. Our Board increased our authorization under our share repurchase program to $600 million during the quarter. Our full year cash flows are expected to be about $800 million, benefiting from cash generated due to reductions in inventory. From a timing standpoint, our cash flow is strongest in the second half of the year after building preseason inventory in first quarter and paying for early buy inventory purchases in the second quarter. Moving to our outlook. For the full year, we expect sales compared to 2022 to be down in the range of negative 10%. We’re down 12% through the first half with a 15% year-over-year decrease in Q1 and a 10% decline in Q2. Last year for base business, we realized a 10% increase in Q3, which was the same as Q2 and a 1% growth in fourth quarter.

We will have one less selling day in the third quarter and for the full year, which we typically add or subtract around 1% to 2% for the quarter. Gross margin is expected to return to seasonally normalized level in the second half of the year as inventory gain benefits have now fully passed through. As we have stated previously, we expect full year 2023 gross margins to be around 30%. Operating expense growth moderated in the second quarter for year-to-date growth over prior year of 1% and will continue to be well managed for the full year. With continued investments in the business, we will maintain certain core expenses and limit full year base business expense growth to 1%. This will have us well positioned for in top line growth returns.

When we look at potential uses for the increased cash flows, we expect to generate this year, we anticipate spending around $25 million to $50 million on acquisitions, $50 million to $60 million on capital expenditures, $170 million on cash dividends and the remaining approximately $550 million on a combination of debt reductions and share buybacks. We continue to maintain our leverage ratio at the low end of our target rate of 1.5 times to two times with the mix of floating and fixed rate debt, reflecting a strong and flexible financial position to take advantage of future growth opportunities. Interest expense for the full year is expected to be between $55 million and $62 million, including slightly higher interest rates in the second half.

Our annual tax rate should be in line with last year’s tax rate of 25.2%, excluding ASU. We expect the third quarter rate to be slightly lower than the annual rate. Our Board increased the quarterly dividend payout by 10% this quarter, increasing the quarterly dividend to $1.10. We expect to pay full year 2023 dividends of around $170 million, more than double the $84 million paid to shareholders in 2019. As Pete commented earlier, we have updated the range for our EPS guidance for the full year 2023 to $13.14 to $14.14, which includes the $0.14 ASU tax benefit realized to date. This assumes a share count of 39.4 million shares consistent with June 30. We based our guidance on the assumption of normal historical weather conditions as the midpoint.

We issued our second annual corporate responsibility report during the quarter. We are proud to have expanded our disclosures in the areas that we are focused on as part of our capacity creation efforts. These initiatives and activities are paying off through more efficient water usage and the benchmarking of our electricity usage in our continued efforts to lower our overall emissions. Our results for the second quarter, while somewhat less favorable than we had hoped, through the resilience of our industry and the sustainability of much of the pricing and market growth components we realized over the 2019 to 2022 period prior to this period of market stabilization. Our financial position is strong, and we are well situated to support the return of industry growth.

I will now turn the call over to begin our Q&A session.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Ryan Merkel of William Blair. Go ahead.

Ryan Merkel: Good morning. Thanks for taking the questions. I wanted to start off with a question I’m getting from clients this morning, which is how can we be comfortable that this is the last cut to guidance. So Pete, maybe just walk us through how you approach guidance, what’s changed and why you’re comfortable that the new guidance range is achievable?

Peter Arvan: Sure. That’s a good question, Ryan. And we spent considerable time on it. I guess the difference between now and when we guidance out at the end of the last quarter is that we have passed the most seasonally significant part of the year, and we’re three weeks through the month of almost three weeks through the month of July, which gives us much better visibility into how the year is going to trend. So nothing new to report on new pool construction. We had said last time we thought new pool construction was going to be up 30%. We still think it’s going to be often in neighborhood of 30% skewed more heavily towards the lower-priced pools with higher priced pools doing better. Our ability to gain share as evidenced by our analysis of our new pool sales is consistent with what we thought before.

So we’re down slightly less than the industry as we believe in new terms of new pool construction, so nothing new to report. The weather provided significant headwinds in the second quarter. The season started late. And as you know, we basically contemplate normal weather in our guidance. We didn’t get the normal weather that we were counting on and the seasonal markets opened late. And then, frankly, the poor weather moved around some of the year-round markets too and presented significant headwind. The other thing that we saw and we have better visibility to now is the consumer buying patterns and what we see there. We are – the non-discretionary spend is good. I mean we talked a little about the spend on chemicals with the pricing on chemicals that trichlor is down, everything else is up a little, it’s about the same.

Chemical sales are going to be higher when the weather is hotter. So the hotter water and hotter weather came later than anticipated. We are now getting good weather in terms of heat and that is that’s having an impact on the chemical spend. So the non-discretionary portion of our business is doing well. What we’ve seen is that a continuation really of the, we’ll call semi-discretionary purchases by consumers. So the consumer that has a heater that may need to be repaired. Well, this time of the year, nobody is thinking about heating their pools because most of them are too hot as it is. But those that would consider buying a new cleaner given the current economic environment, we’re – what we’re seeing is some people deferring some of those expenses to next year and not doing – not making the purchase this year.

So we’ve got 6.5 months, almost seven months of visibility into the year. So we have a better view of what the consumer buying pattern is and the idea that we think it would significantly improve over what we have seen based on the macroeconomic conditions and the weather pattern, we baked into our guidance. The only thing I didn’t touch upon in my commentary just now with the renovation and remodel market. And as I said, the renovation and remodel market is doing better than what we see in new construction. If you look at I mentioned our building materials being off a two products to consider when we look at new pool construction and renovation and remodel would be tile and pool finish. Pool finish is down 2% for the year and tile is down 9% for the year.

We think that the backlog on renovation was higher in the beginning of the year, and we expect that to moderate. So we think it was more favorable than the full year – our full year outlook at the beginning of the year, but we think that’s going to moderate as dealers work through the backlog. We consider normal weather for the balance of the year. So we’re not counting on an extended season. And I think we’ve captured most of our possibilities in terms of market demand, pricing considerations, supply chain interruptions within our guidance. So I just think we have more clarity now with a large portion of the year behind us and a good look at what July is going to bring.

Ryan Merkel: Got it. That’s very helpful. Thank you for that. And for my follow-up, I was hoping you could comment on what you’re seeing in June and what you’re seeing in July? Have you seen trends improve a bit as the weather has got a bit hotter in some of the key pool markets?