Pool Corporation (NASDAQ:POOL) Q3 2023 Earnings Call Transcript

Pool Corporation (NASDAQ:POOL) Q3 2023 Earnings Call Transcript October 19, 2023

Pool Corporation beats earnings expectations. Reported EPS is $3.51, expectations were $3.41.

Operator: Good day. And welcome to the Pool Corporation Third Quarter 2023 Conference Call. 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 Melanie Hart, Vice President and Chief Financial Officer. Please go ahead.

Melanie Hart: Thank you. And welcome everyone to our third 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 at — in the Investor Relations section. We will begin today’s call with comments from Peter Arvan, our President and CEO. Pete?

Peter Arvan: Thank you, Melanie, and good morning to everyone on the call. Our third quarter results came in largely as expected. As the 2023 swimming pool season winds down, we consider our results to be solid on a standalone basis, particularly when considering the dynamic conditions we have been operating in. The third quarter carried down with typical summer weather conditions overall, allowing us to evaluate our performance in the industry environment on a mostly weather-neutral basis. Our third quarter 2023 sales of $1.5 billion is a 9% decline compared to 2022, with one less selling day, but exceeded 2021 third quarter sales by 63 million or 4%. As expected, sales declines continue to moderate in the third quarter, showing sequential improvement versus the 10% and 15% declines we saw in the second quarter and first quarter of 2023.

In view of the neutral weather conditions during the third quarter, our sales trends across our major markets were relatively consistent. Starting with year-round markets, sales declined 5% for the quarter in Florida compared to the third quarter last year, with Arizona finishing down 8%, California down 10% and Texas down 11%. For context, last year in the same quarter, Florida sales were up 20%, Arizona was up 18%, California was up 16% and Texas was up 10%, respectively, versus the third quarter of 2021. This simply highlights the difficult comps that we were up against this year. Year-round base business declined 8%, while seasonal base business markets declined 10%, a slight sequential improvement from the 9% and 11% decline in the second quarter of 2023.

Again, for comparison, last year in the same period, we saw growth in our year-round base business markets of 15% and 5% in our seasonal base business markets. Moving on to product category results. Chemical sales increased 5% in the third quarter, mostly driven by increased volume as chemical pricing came in relatively flat for our collective offering. Our strong footprint, leading proprietary products and enhanced technology tools gives us an unmatched value proposition and contributed to our share growth. Building material sales for the quarter were down 13%. This category includes products necessary for both new pool construction and renovation and remodel projects. The building material trend continues to suggest that renovation and remodel demand is stable and outperforming new pool construction and our NPT footprint and product offering enables us to outperform the industry in this category.

Equipment sales declined 9% in the quarter. As you can see, this implies solid demand for maintenance and repair despite the softer demand for new pool construction and renovation and remodel. Looking at end markets, commercial pool product demand remained strong in the third quarter, with sales up 10%. Sales to our independent retail customers were down 8% for the third quarter, an improvement from the 11% decline and 16% decline we saw in the second and first quarters of this year. Pinch A Penny franchisees collectively reported sales growth of 1% for the quarter. The franchisees generated solid sales for their maintenance products, but weaker sales of discretionary items in line with what we are seeing across our distribution business. Europe’s third quarter sales showed a 2% decline in local currency, a notable improvement from the 7% and 22% decline in the second and first quarters of 2023.

Europe has been challenging for the past 15 months to 18 months and we are encouraged by this more favorable trend. For Horizon, sales declined 7% during the quarter. Consistent with prior quarters, sales activities for commercial projects remained stronger than residential. Moving on to gross margins, where we ended the third quarter at 29.1%, consistent with our past thinking, we believe gross margins for the full year will be an approximate — will be approximately our long-term guidance of the 30% range. As is typical, Melanie will provide more details on what to expect in the fourth quarter gross margins in her comments. Even while continuing to invest in new locations, acquisitions and technology during the quarter, we reduced operating expenses by 2% compared to last year.

The team did a good job managing expenses that typically ramp up during the season in light of the softer demand environment. Thankfully, the team has been focused on capacity creation for many years and that helps us offset inflationary headwinds and leverages our fixed expenses, leading to a 15.9% operating expense percentage. POOL360, our B2B tool, saw sales increase 5% over the prior year, a higher growth rate than our overall sales activity. The line volume growth for the same period was 3% and demonstrates the tool’s contribution to our capacity creation effort, while also improving the customer experience and productivity and adding value to our business and our customers. We view this tool as best-in-class, providing multiple benefits for both our customers and the local operating teams.

Operating income for the third quarter of 2023 was $194 million, down $69 million compared to last year. This however represents an 85% improvement over 2019. Our reported third quarter operating margin of 13.2% is 10-basis-point expansion from 2019 and a 20-basis-point expansion from 2020, showing the sustainability of our fixed cost leverage initiatives. During the third quarter, we added two new greenfield locations. This puts us at 10 new greenfield locations for the 2023 season, a further testament to our strong bent and refined expansion process. In addition to our organic openings, we added four new locations through acquisitions this year. Additionally, we expanded our Pinch A Penny franchise network by adding two new franchise customers in the quarter, bringing the new franchise store count to 11 for this year.

We continue to prioritize organic growth investment as the future of the business, which not only expands our customer reach, but also creates capacity for additional products and service offerings at our existing locations. Melanie will be commenting on most of the balance sheet items, but I would like to highlight one significant accomplishment that is the work that the team did on rightsizing our inventory. Because of the tremendous effort of our team, in conjunction with our vendor partners, the team surpassed our inventory reduction goal and delivered a reduction of over $216 million year-to-date. This was done while expanding our footprint, integrating acquisitions and maintaining best-in-class inventory availability. This achievement helped us generate $750 million in operating cash flow through September 30th, a company record and nearly 2.5 times that of this time last year.

As we move into the final quarter of the year, we have proven that even in the most difficult operating conditions, our experienced team delivers an unmatched value proposition, which enables us to outperform the industry and expand our share. We have built the largest fully integrated network of sales centers in the industry and we are adding new locations faster than anyone with a proven process that delivers a solid ROI. We have a vertically integrated chemical packaging operation and the broadest selection of proprietary building material products from pool tile to finish, over 135 NPT showrooms and design centers, four centralized shipping locations for importing consolidation, industry-leading technology solutions for our customers and our own use and best-in-class retail franchise development and support operations, perhaps most importantly, we have over 6,000 employees that operate in a performance based culture that know how to compete and win.

While new pool construction is likely to finish down with — with units down 30% in 2023, we still expect about 70,000 additional pools will be [Technical Difficulty] expanding ever growing installed base of pools where we derive over 80% of our revenue. No doubt, the current macroeconomic environment is tough, but the desirability of swimming pools and outdoor living has never been stronger and we do not see that changing. We firmly believe that even with fewer pools being built, our share and the value of our products on a per pool basis has grown. We know that renovation activity will continue as homeowner’s upgrade both services and pool technology to enhance their backyard oasis. We believe that our relentless focus on delivering a second-to-none customer experience positions us better than anyone in the industry to serve the pool professional and support the specialty retailers that cater to the DIY owner.

In short, we believe in the long-term growth characteristics of the industry, the strength of our company and we believe in our team. As I look back on the pool season, I am very proud of our team that has remained focused on innovation, execution and collaborative partnerships to deliver a customer experience that, as I said, is second to none. Lastly, with over three quarters of the year behind us, we have narrowed our annual earnings guidance and now expect diluted earnings per share in the range of $13.15 to $13.65, including the impact of year-to-date tax benefits of $0.15. Melanie will now provide additional details in our financial commentary. Melanie?

Melanie Hart: Thank you, Pete. Net sales for the quarter finished at $1.5 billion, a 9% decrease from prior year record sales in the third quarter. We estimate a year-over-year quarterly sales decline in the range of 5% related to new pool construction, which is trending as expected, with units likely to show a 30% decline for the year. Remodel activity with a roughly 3% year-over-year comparative decrease effect on our topline is outperforming new pool construction, but still at lower levels from prior year and in the range of our previously estimated down 10% to 15%. We also saw several other areas, which each represented an approximately 1% decline in net sales. First, we had one less selling day in the quarter compared to last year.

Secondly, selling prices on commodities, including trichlor. Pricing on trichlor is showing recent signs of stabilizing. But during the quarter, selling prices were approximately 20% lower than third quarter of last year. Third, volumes on certain discretionary products, such as above-ground pools, heaters and cleaners reflected weakness, suggesting consumer hesitation on these more discretionary items. Outside of these products, maintenance spend remains relatively stable. Inflation continued to provide an overall advantage, resulting in a benefit of approximately 2% to 3% for the quarter. Net sales from acquisitions or new market openings contributed less than 1% in the quarter, and therefore, we have not broken out these activities from base business separately in the press release, as they had an insignificant impact on the financial information for the quarter.

Gross margin was 29.1% in the third quarter, reflecting a typical sequential decrease from second quarter. Gross margin was 210 basis points less than prior year, resulting from the expected decrease in inventory gains realized in 2022 that benefit from investments in inventory ahead of the multiple inflationary price increases. Other items impacting margins in the quarter, our product mix, including the lower selling prices on trichlor and new construction and remodel activity, which resulted in building materials seeing a higher year-over-year decrease than other products. Customer mix, such as a higher proportion of sales to larger customers, also had a negative impact on margins when comparing to 2022. Weaker industry demand and wrapping up of channel inventory rationalization contributed to a more competitive pricing environment, causing some modest additional pressure on gross margins during the quarter.

We also saw lower purchasing incentives than a normal year in conjunction with our inventory reduction plan. SG&A expenses continue to be very well managed, reflecting a 2% decrease year-over-year after seeing a 3% decrease in the second quarter as these two seasonally larger quarters have the most ability to benefit from reductions of volume related expenses. Operating expenses compared to prior year also includes the impact of four locations added from acquisitions and 14 new sales center openings since third quarter of last year. Additionally, expenses for the third quarter include a $550,000 goodwill impairments. Operating margin of 13.2% was 300 basis points less than prior year, reflecting the 210 basis points impact from gross margin and effects of lower topline revenue.

We reported 11.6% operating margin in third quarter 2019. So we have been able to maintain benefits in our operating margin. Interest expense on a comparative basis for the third quarter resulted in a $1.9 million increase in expense as a result of higher rates, offsetting a significant reduction in debt outstanding. As is consistent with prior years, our third quarter tax rate is generally the lowest quarterly rate, with all other quarters being slightly higher and averaging to our full year rate. Third quarter EPS, excluding ASU of $3.50, compares to $4.78 in third quarter 2022. Despite the decline from our record 2022 results, these earnings highlight our ability to retain the majority of the significant growth seen throughout the 2020 to 2022 period as Q3 2023 results are higher — 90% higher than the third quarter of 2019.

Our credit and collections process and management of trade receivables remains a business advantage, with DSO of 26.3 days at the end of the quarter, comparable to prior year. I was confident in our ability to execute when I stated our inventory reduction goal at the beginning of the year to bring down inventory by $260 million. In fact, we were able to reduced inventory $332 million from December 2022, even with acquisitions, new locations and current year inflation exceeding our goal. In the fourth quarter, we plan to selectively participate in vendor early buys that we determine to make strategic sense for us. As we look ahead to the 2024 season, we are expecting to see a range of price increases for next season of around 3% to 4% based on some equipment vendor pricing announcements to-date.

This will result in dollar growth in inventory from third quarter to fourth quarter as we would normally build inventory to be ready for next season. There will be no cash flow impact in 2023 from early buy shipments we received before year-end as these purchases will be done on deferred payment terms. We generated $750 million in cash flow from operating activities year-to-date. We have also completed $137 million of open market share repurchases during the quarter, leaving $463 million available under our authorization. We have also reduced debt by $479 million from the same time last year and $353 million from year-end 2022. Our debt leverage ratio remains conservative at 1.48 times and at the low end of our stated target expectations of 1.5 times to 2 times.

As we finish out the year, we are confirming that our sales expectations for 2023 is to be down in the range of negative 10%. For the fourth quarter, we would expect to see sales down mid-to-high single digits, mostly dependent on the weather and how the level of new pool construction finishes out the year. The one less selling day that we reported in the third quarter will not be made up in the fourth quarter and so we will have one less selling day for the full year. Gross margin for the full year will approximate our long-term guidance of 30%. Fourth quarter is seasonally expected to be less than the full year rate. Our range for margin for fourth quarter is expected to be around 29%, but could vary in either direction. Margins in the fourth quarter will be reduced by the year-over-year increase in average cost we have seen to-date as we compare against last year’s fourth quarter that benefited from lower cost inventory.

From a comparative view, this will primarily offset the 120 basis points negative impact recorded in fourth quarter 2022 for the additional import tax expense. Additionally, we would expect to see some continued pressures on margins from product mix, similar to what we saw in the third quarter. The other structural benefits we have discussed on gross margin all remain. Our target for full year operating expense growth is still to limit base business expense growth to 1%. Fourth quarter will not see the year-over-year decrease in operating expenses we saw in second quarter and third quarter due to the lower volume related expenses in the smaller quarter, but the year-over-year increase will not be as high as we saw in first quarter. Full year interest expense is expected to be approximately $61 million.

Our fourth quarter tax rate will be consistent with our rate in first quarter and second quarter to result in our full year expected rate of between 25% to 25.2%. The expected annual rate is similar to our prior year rate excluding ASU. Our guidance on uses for capital allocation are the same as those discussed at the end of the second quarter, with a use of cash of approximately $25 million on acquisitions, $60 million on capital expenditures and $170 million on cash dividends, reflecting the 10% quarterly increase approved in the second quarter. We will continue to retire debt and repurchase stock opportunistically throughout the balance of the year, with the remaining excess cash flow. We have completed $180 million of share buybacks to-date, leaving our expected share count for fourth quarter to be 39.3 million shares and weighted average diluted shares outstanding for the full year will also be 39.3 million, down 700,000 from last year.

We have narrowed our range for our EPS guidance for the full year 2023 to $13.15 to $13.65, including the $0.15 ASU tax benefit realized to-date. Providing a narrower range in the third quarter after completion of the full season is consistent with our historical process. Third quarter came in very much in alignment with our latest expectations. Our focus on operational improvements and customer experience will allow us to continue to support our customers and provide them the broadest product selection with continued opportunities to grow their business. We will now begin our Q&A session.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Ryan Merkel with William Blair. Please go ahead.

Ryan Merkel: Thanks. Good morning. Thanks for taking the questions.

Peter Arvan: Good morning.

Ryan Merkel: I wanted to start off with a big picture question. Pete, it seems that perhaps the worst might be over for the pool declines, can you just walk us through the puts and takes as you think about 2024, I am not looking for specific guidance, just the positives and negatives that you see heading into next year?

Peter Arvan: Yeah. Sure. So, 2023 was no doubt a kind of a crazy year, which followed a couple of years crazy, but for different reasons. So it was — we had bad weather in the beginning of the year, we had interest rates that continue to rise and that we think put a crimp on new pool construction, which was actually — is turning out to be lower than what we thought it was when I was talking to you a year ago, and frankly, when we initiated guidance at the beginning of the year. I think new pool construction this year, as I mentioned, is going to be down 30%. I think it depends on the — that’s an average, right? So I think if you look at entry level pools in some markets, it’s actually down more, and in some cases, significantly more.

The flip side is that the higher end pools remain solid. The builders that build the higher end pools for the more affluent people that have less financing connected or no financing connected to, that business is good. So when I look at the steps back and look at the macro economic environment, based on what we see today, I would tell you that, I don’t think new pool construction is going to drop much more. Could it drop a thousand — a couple of thousand, it could, way too soon to tell because the builders are frankly just putting together their plans and pricing and starting their selling season for next year. But I have talked to many builders in the last couple of months and everybody is fairly optimistic that this year the new pool count is down.

They don’t really expect it to fall much more than where it is today. The other comment I would make on the market is on renovation. Renovation is again that plays a little bit of that same pattern, right? The renovations that would require financing are going to be under the most pressure because of interest rates. Now I read the same things that you guys do on interest rates. If there is moderation in interest rates next year, then that will bode well for both new pool construction and for large renovations. Smaller renovations, most of those are paid for in cash and it really doesn’t have a big impact on whether the jobs get done or not. From a maintenance perspective, maintenance is maintenance. It has to happen. The overall desirability of the pool, outdoor living is still very high, people still want pools.

There would be more pools being built if they were frankly more affordable. So those that have a pool, like them, use them when the weather is good, then they are in them. If I look back at the beginning of the year, a couple of the headwinds we had was very tough weather in the beginning of the year and we also had some of the inventory hangover from the previous year that was in the channel. So as I look forward, and again, too early to give you a guidance, but I am more optimistic about next year than this year, but I also want to be clear with the setting expectations. I am not looking for a material, it’s — new pool construction, it’s not going to take off, it’s not going to grow, but I look at the headwinds that we faced, the stability of the market and I remain confident that I think next year will not be another year of down, down, down.