Good morning, and welcome to the Pool Corporation Fourth Quarter 2018 Conference Call. All participants will be in listen-only mode. [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. Good morning, everyone and welcome to our Q4 and year-end 2018 earnings call. 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. Pete?

Thanks, Mark, and good morning to everyone on the call. 2018 was a favorable year for POOLCORP. Our team’s focus and the resiliency of our industry proved formidable in the face of the less-than-ideal weather that we experienced in 2018. For the year, our total sales grew by 8% while our base business sales grew by 7%, demonstrating our team’s focus on organic growth. For the quarter, our total sales grew by 6%, while our base business sales grew by 5%. In our year-round blue markets, we achieved 6% sales growth for the year and 6% sales growth for the quarter. It is noteworthy that the fourth quarter numbers are comped with an extremely strong fourth quarter from last year, where our base business sales grew by 13%. For context, remember, last year’s fourth quarter was positively affected by the favorable weather in the year-round markets, which drive most of our sales that time of the year and the recovery from Hurricane Irma in Florida and Harvey in Texas. In the final quarter of this year, a much cooler and wet weather pattern made pool construction and remodeling activities from Texas to the East Coast difficult for our customers. In 2018, our footprint continued to expand, as we completed two small acquisitions, one late in the year for the green business and one early in the year for the blue business in Australia. We opened nine locations in the year, six domestic blue business and three internationally, which reflects our confidence in the industry and the strength of our team’s value proposition. Overall, our markets and underlying demand for our products remained strong, and our team continued to drive organic growth and increased share. Our green business showed solid performance with organic growth of 7% for the year. During the…

Thank you, Pete. I’m going to review some of the highlights of our fourth quarter and full year results, and then I’ll provide a bit of color on our expectations for 2019. As I do this, keep in mind that each year, the fourth quarter marks the low point of sales activity for our business, given the significant impact weather has on the seasonal markets we participate in. In 2018, our fourth quarter accounted for 18% of our total annual sales and just 8% of our operating profit. I’ll start with some comments on margins, both gross margin and operating margin. In our call of last year, and as referenced in our press release and by Pete, the higher-than-normal blue business vendor price increases that began midyear and continued throughout the second half, played a part in our results. Specifically, this was the main contributor to the 100 basis points improvement in our Q4 gross margin. As we also mentioned in our call, we expected the base business gross margin to be flat to up for the year, and in fact, we ended the year with 10 basis points improvement. So very much in line with our expectations. Also, on our Q3 call, I reiterated our expectation for improved expense and operating leverage in the back of the year from what we experienced earlier as well as the expectation that we’d improve our base business operating leverage to higher end of our 20 basis to 40 basis point target for the year. Despite our softer sales results, we hit the mark on expenses with a 60 basis point improvement in Q4 base business operating expenses of 24.5% of sales compared to 25.1% of sales last year. This, with the help of the gross margin improvement, got us to our targeted…

We will now begin the question-and-answer session. [Operator Instructions] The first question is from Ryan Merkel of William Blair. Please go ahead.

Hey, good morning, everyone.

Good morning, Ryan.

So I want to start off with SG&A in the quarter. I had in my notes that you were thinking SG&A could be flat year-over-year in the fourth quarter if that SG&A was up about 5%. So my question is, were there any surprises there? Or maybe I just heard it wrong and I was just too aggressive.

Ryan, I must have missed my calling in sales. I think I’ve oversold the reduction in SG&A expenses. I’m not sure – if you take The Street’s numbers and baked them into our results, we would have actually had to have a decline, which was certainly not the expectation. But the main focus was a shift in our bonus expense throughout the year, where we added expense earlier in the year and lowered it later in the year. And that resulted in a reduction in the fourth quarter of around $2.5 million. But otherwise, expenses came in right in line with our expectations. And so with the softer sales still, I think the contribution that we got from expenses was very good, 3% growth in base business operating expenses. So that, for us, is a very good result, and there’s really nothing of significance. Yes, there’s a few things up here and there, but nothing pretty significant that was missed.

Okay, got it. And then I want to ask about first quarter gross margin. You’ve given us a little help, but just want to make sure I have it right. So are you going to have about 100 basis points of gross margin help in the first quarter of 2019 with pricing ahead of COGS? And then I think you also mentioned the pushout of some early buy that happen to be lower margins. So should we be expecting sort of a year-over-year 100 basis point-plus increase in first quarter 2019 gross margin?

Yes. I think the 100 basis points is a reasonable expectation. Similar to the fourth quarter, it might be a little bit better than that with the shift in early buy. We’re going to have to wait and see how that plays out. But in that range, we won’t be far off.

Okay. And then lastly and I’ll turn it over. So 2019 guidance was essentially what I thought, but I’m just wondering, did you bake in any conservatism for weaker housing, remodeling, anything, maybe weather? Anything to talk about there?

Really, nothing on the guidance in terms of baked-in conservatism. We’re really pretty much in line with our long-term guidance. The range that we have is kind of lower teens on the bottom and mid – upper teens on the top, with the midpoint right around mid-teens, which is right in line with our long-term guidance range in our investor presentation, so no – nothing, in particular, different in 2019. Pete, I don’t know if you have additional.

The only thing we baked in differently was the inflation for the first part of the year – or for the year. But if you look at the rest of the drivers of our growth, they’re basically the same; new pool construction, recovery of the remodel, share gains. It’s basically the same set of numbers stepped up for the incremental inflation for the year.

Got it.

And remember, those all contemplate a normal weather pattern.

Sure. Okay. Helpful. Thanks.

Thank you.

Thank you, Ryan.

The next question is from David Manthey of Baird. Please go ahead.

Hi, good morning, guys. First off, I don’t know if you mentioned it. If you did or didn’t, could you tell me what the base business growth was in the blue and in the green businesses – base businesses? And then, if you could talk about price realization in each of those.

Sure. So your first question was base business, blue, year-round?

Just in the fourth quarter, base business growth for blue and green.

So for green, it was 6% and 5% for blue, right.

And was price realization pretty consistent across those? Or was it better in one than the other?

Green really had very little price.

Okay. All right. And then, Mark, I wanted to explore this, the days this year. Because, if I remember correctly, you also had one extra day in the fourth quarter you just reported. Is it right to assume that, in a seasonally off period like the fourth quarter, it’s probably more of a drag than a benefit because you have incremental costs and you don’t really get a lot of sales versus what you talked about this coming year in the third quarter where you pick up a day, even though you have incremental costs doing business, your sale levels are higher so it should actually be a benefit? Am I thinking about that correctly? Or any other issues we should be thinking about?

Yes. No, Dave, thanks for bringing that up. That’s very true. As you say, the expenses don’t go away. Many of our costs are fixed. Obviously, we have some variables, but there’s a – the majority of them are fixed. So when you lose a billing day, the – you’re paying – still paying salaries, you’re paying warehouse leases and vehicle depreciation, all those things, but the sales do go away. So one day out of a quarter – and it depends on when that day is. Early in the fourth quarter – October is our biggest month of the quarter. And so when you lose a day there, that’s roughly 1.5% of the sales for the quarter. And that’s similar to this first quarter, which we lose March, the biggest month of the first quarter. And then that comes back in September, which is the lowest month of the third quarter. So thank you for mentioning that. That’s a very good comment.

Okay. All right, thanks very much guys.

Thank you.

Thank you, Dave.

The next question is from Steve Volkmann of Jefferies. Please go ahead.

Hi, good morning, guys.

Good morning.

Sorry, I’m still kind of new at this. So, Mark, I’m curious if you have any thoughts about sort of the consensus on the top line, just relative to sales growth sort of being consistent in 2019 with 2018. Is that the right way to think about it? Or are there any puts and takes sort of for the full year, not for the quarters?

Yes. So you mentioned consensus, talking about The Street numbers. But I would say our expectation for 2019 – first of all, 2018 came in a little bit below our expectation from the sales results due to a shortened season. So the expectation for 2019 starts with normal weather year. So we gain a little bit from that, and then we also have inflation, which, as Pete said, 2% incremental over normal inflation. So that gets us to sales expectations a couple of percent higher than what we had for 2018.

Okay, great. That’s helpful. And then maybe switching gears. It seems like you’re going to generate more cash than normal, I guess, in 2019. Can you just talk about capital deployment? And I guess, if you wouldn’t mind, maybe it’s still too early, but if we do pass a tax on share repurchases, does that change the way you think about capital deployment?

I’m trying not to choke on the last part of that. We haven’t gotten there in terms of our thinking, the tax on capital deployment. But yes, to your first point about 2019 being a higher share – I’m sorry, a higher cash-generation year because of the purchases we did last year, that’s certainly the case. But it doesn’t change our capital deployment in any way, which is long term in nature and starts with investing everything we can in the business, including acquisitions; and then dividends. We will continue to grow our dividends over time with earnings growth. And then we’re keeping leverage in a comfortable – very comfortable range of that 1.5x to 2x, which gives us investment grade. Then we’re buying back shares. So that’s the basic capital deployment model. No changes there. CapEx is a part of that as well. And no big changes in our CapEx from 2018 to 2019, so roughly 1% – 1.25%, 1.5% of sales, something in that range, $40 million, $50 million. So no big changes expected next year.

Great, thank you.

Yes.

The next question is from Anthony Lebiedzinski of Sidoti & Company. Please go ahead.

Yes, good morning, and thank you for taking the question. So first, looking at Q4, I was wondering if perhaps you could kind of try to isolate the weather impact on Q4 or maybe discuss sales performance in markets that were not impacted by the adverse weather.

So in Q4, we mentioned it was particularly wet, particularly cold. So Texas, a very important market for us. And if you remember, the weather in Texas got very cold and very wet, and that rain pretty much extended all the way through to the East Coast, which are very good markets for us. Arizona was fine. Arizona was a normal weather pattern. I would tell you that California was more normal. But remember, last year was actually really good. It was very hot, very dry in most of California. So from a comp perspective, it made for a tough comp. And in Florida, that’s the – which also, by the way, impacted Texas as well. It’s – their comps were tough because of the recovery from the hurricanes, so there was a lot of activity last year. So all in all, not bad, considering. And when I look at permit activity in the fourth quarter, permit activity was actually pretty good in the space where we have visibility.

Yes. Just in terms of dollar estimate, I think we – the impact was in the $8 million to $10 million range, our estimate of weather impact on Q4 results.

Okay. That’s very helpful. Okay. So overall, when we look at the base business sales growth for 2019 with the added benefit of inflation, coming off of roughly 7% growth in 2018, so we should expect 7% to 9%, is that kind of what you’re thinking?

Yes. I think that’s fair. That’s a fair estimate.

And again, this is all – in our estimate, it’s all based on a normal weather pattern.

Absolutely. And obviously, that’s outside of your control. And just kind of taking a step back, a couple of years at your Investor Day, you guys talked about private label and exclusive products, seeing continued increase in penetration. Where did you finish up 2018 with that? And what’s your outlook for the next year or two?

Yes. Well, 2018, we’re still kind of going through the specifics on that, but we continue to make progress on private label. As you may recall, we have private label products in a number of different segments of the business, so chemicals, there are some cleaners. There are various white goods or parts that we sell private label. There’s a pool – packaged pool brands, above-ground pool. So there’s a whole host of different things that we do private label products in, and those generally have higher margins when you look at the margin contribution of those products. And just private label and exclusive products, we also have a number of exclusive areas where we have relationships with vendors that believe that we do a great job of getting their products to market. And so those things have progressed in different levels of progression for different product categories. So I’m not prepared to give specifics on that here, but it continues to do well. And we expect that to be a contributor going forward.

Got it. That’s very helpful. And Pete, you talked about briefly about POOL360, seeing continued growth there. So where are you as far as percentage of sales coming through POOL360 now?

So our total electronic platform is about 11%, and POOL360 is about 70% of that. And the POOL360 number is the one we’re most pleased with. From a growth perspective, that’s in the 24% to 25% range.

Got it, okay. And one last housekeeping item. Where was the year-end share count with all the buybacks that you did?

Anthony, I had that in my call comments, and I took it out. I said, well, too much detail. I have so many other things to cover. If you’re desperate for the number, we can give that to you – get back to you afterwards.

No worries. Okay, thank you. Best of luck.

All right. Thanks, Anthony.

The next question is from Garik Shmois of Longbow Research. Please go ahead.

This is Jeff Stevenson on for Garik. And just had a question on the strong customer backlogs you called out in your press release. I was just wondering if you could provide any more color both on the new construction and refurbishment side and how those compare with last year at this time.

Yes. So the preliminary numbers for new pool construction for the year is – we think it’s going to come in at about 80,000 pools, up from roughly 75,000 from a year earlier. And again, with the constraints on weather, the backlog continued to build as the remodel work got pushed back. So most of the builders that I’ve spoken to, and I’ve spoken to many in the last several months, say that the same factors still are at play. Labor for them, trying to get the subs is extremely difficult with unemployment levels being what it is. Every day that they can’t work simply pushes back the backlog. So with the wet weather that we had in Texas in the fourth quarter, there is a fairly large backlog. And the permit count in those areas is actually very good. So from that perspective, everybody is optimistic with what the year is going to look like, again, assuming that the weather doesn’t crash things. But for the most part, everybody is very optimistic.

Great. And then you saw another year with market share gains in commercial. Just wondering kind of where you’re at now as far as your share in the market and where you think that can go in the next couple of years.

I think we’re about – we look at it as about a 10% share business today, and there won’t be a big step function. It will be like everything else, every other product category that we bring on. We bring it on, we spread it through the network. That business for us grew at about 11% last year. We would continue to – we expect to see that continue to grow at rates faster than the overall business. So our share – we’ll continue to gain share every year in that category for the, at least, near term.

Great. Thank you.

[Operator Instructions] The next question is from Ken Zener of KeyBanc. Please go ahead.

Good morning, gentlemen.

Good morning.

Good morning, Ken.

Mark, very solid forecast, obviously. You – as well as your performance. Now the 2% additional price, could you kind of talk about what’s driving that, the chemicals, the equipment, just a little bit, please?

I’ll start, and Pete, if you want – have anything you want to add, feel free. So 2% price is basically our expectation based on all of the vendor price changes that would have been communicated to us over the last 6 months and which really, by now, have all been rolled into our pricing in the marketplace. And kind of bigger part of our business, as you know, is really on equipment side. The equipment accounts for roughly 30% or so of our total sales. And those equipment carriers saw some of the bigger price increases, but we also saw increases in other different pool components. And in some areas, there weren’t a lot of increase, some of the commodities that we sell. So when you average that altogether and look at what normal inflation is over the last several years, it’s been very modest, in the 1% to 20% range. And so looking at 2% greater than that historic 1% to 2% equation, which is kind of baked into our expectations for 2019.

Yes. Adding a little more to what Mark said. On the equipment side, which is 30% to 33% of our business, somewhere in that range, those numbers were the larger ones. We saw 5% to 6% increases on some of those products. But chemicals were more stable in the 1% to 2% range. So when you roll all that through with many of the items we saw no increases on, that’s where the – that’s how we get to the incremental 2%.

Okay. Yes, that’s quite a bit. Given your, properly so, clear comments around the first quarter, Mark, I just want to kind of lay it out here. But I mean, if you’re doing that 7, 8, 9, that Easter, $20 million, $30 million, that’s about a 3% headwind in that one day lost. I mean, that’s clearly going to be the lowest quarter, I mean, on the revenue side. You talked about up gross margins. So what does that kind of mean about the EBIT leverage? I mean, how should we think about the SG&A? I’m just thinking optically. Because you had such a good tax rate last year, it almost looks like your EPS, which – again, it’s not EBIT, EBITDA. I just want to make sure I’m thinking about the quarter right as we – given the details that you gave us. Because you had a negative tax rate last year, your gross margin is up, but is your SG&A going to be – I mean, are you doing basically 15% EBIT – incremental EBIT in the quarter? Or is there something different that we should think about?

Yes. I don’t want to get too specific on kind of bottom line results, if you will, or expectations for the quarter. But certainly, the $20 million, $30 million – and by the way, that’s not just Easter. That’s also a billing day, as I said, one billing day in the quarter, and this is March. That’s around 1.5% of sales expectation, somewhere in the $600 million range. So that itself gives you $9 million, $10 million. So if you take the sales out – and we’ve already commented on margins likely being 100 plus basis points. SG&A, there’s a lot of fixed cost, fixed in the short term. And so certainly, profitability year-over-year is not going to be – profitability growth is certainly not going to be high in the first quarter

Yes. I just want to kind – you’re being obviously very clear about the full year. Now given weather backlog, I would imagine California people can’t get their pools built obviously. What is it about – I mean, have you seen anything on this R&R side? And obviously, you’re focusing on weather, given that many building product companies faced a lot of concerns around housing. Did you see any signs of that type of tepidness? I mean, it’s in the fourth quarter, your seasonally low quarter, but I mean, is there, in your mind, any connection between how concerns over housing, remodeling expenditure were expressed by many building product companies and anything you saw in terms of demand?

Yes. I mean just – again, I’ll answer your questions from my perspective. Yes, the concerns about housing are primarily around new homes and what’s happening in that market, which really has little impact on our business. Home selling prices are still high, and that – average sales prices for existing homes are high. And so people sitting on home equity feels good about that. They also feel good about the general economic conditions, and they’re employed. Obviously, very low unemployment. And that drives a lot of the remodeling spending, which has been a big part of our growth over the last several years. So we haven’t seen any change in the trajectory there other than what’s been driven by weather. Demand seems strong. And really looking at it by market, not a lot of differences there when you factor weather out. So fairly consistent, Ken. If you look – if we look at our building material sales, we said that they were up for the year about 11%. Fourth quarter building material sales were also up about 11%.

Okay, good. And then one last housekeeping, sorry. Mark, interest expense, other, you said it was going to be – it had risen for a variety of reasons. Is that – it sounds like it’s going to be flat perhaps in the second half. How much headwind are we kind of facing in the first half, I guess?

Well, there’s two components to it. One is the interest on debt. So we ended the year with higher debt, with higher inventory levels, and interest rates are up year-over-year. So that’s the headwind that we faced on interest on debt. And then, as we lower our inventory and bring debt down in the second half of the year, then we should get some pick up there. And I mentioned the swap valuation change. That hurt us in the comparison for the fourth quarter. I expect that in the first quarter as well. And then that essentially goes away, based on what we know today, in, call it, the second quarter and the rest of the year. So a number of different moving parts there for a relatively minor line in our P&L, but it will be a headwind at least in the first quarter; and to a little bit lesser extent, in the second quarter. And I feel good about that in third and fourth quarter.

Thank you.

You’re welcome. Thank you.

The next question is from Blake Hirschman of Stephens. Please go ahead.

Yes, good morning, guys. First off, Pete, with you taking over the reins here from Manny, the business has been all about organic growth, market share gains. With your operational background, it seems as though you’re kind of honing in on capacity creation and efficiency. I know it’s still pretty early days here, but kind of curious as to whether or not you’ve identified any initiatives or anything like that you’d be willing to touch on.

Sure. I mean, remember, the hallmark of the company has been organic growth, organic growth, and that won’t change. Organic growth is driven by a couple of areas. It’s driven by tapping a value proposition that is better than your competitors, so we’re certainly focused on that. But to keep up with that, given the escalating cost that we have on labor and transportation and real estate and purchased services, you have to have things in place that can help mitigate the impact on that part of the business. For us, we’re focused on a couple of areas. One, you see the results we have with POOL360. So we’re working very hard to make that an even bigger part of our business. Two, I would tell you that we’re spending a fair amount of time with our warehouse procedures and making modifications to the layout and some minor changes in the equipment that we used to make us more efficient and help offset some of the inflation that we have. We’re also looking at merchandising our counters a little bit better. Because if you think about – about 70% of our business from a transaction perspective happens at the counter. So we have tremendous traffic in our counters every day, and I think we can do things with how we utilize that space to make them more productive. And I guess the last thing I would tell you, a big focus area for us, is transportation, obviously, and looking at ways to do more market-based transportation, and we’re measuring and driving truck utilization. All of those things, I think, will just keep us in line with the progress that we make, which is improving the operating leverage of the business every year. So none of them in and of themself are step-function changes. They will simply allow us to keep pace with how the business has historically performed, becoming more efficient every year.

Got it. And I think you guys closed on an acquisition in January, W.W. Adcock. I could have missed it, but I haven’t heard anything about it. Just kind of curious if you could shed any light on the rationale behind the deal, any rough kind of financials, anything like that.

Sure. It was – we closed in mid-January. There’s four locations in the Northeast; a couple in Pennsylvania, one in Huntington Valley and one in Harrisburg. We don’t have a presence in Harrisburg. We don’t have a presence in Harrisburg, so good strategic moves for us up there adding a location. Also, we acquired a location in Raleigh, which is another very strong market for us with a lot of growth potential and growth. And then the last one was in Virginia Beach or Norfolk area. Again, a good market for us, where we see continued growth prospects. So it strategically aligned very well with us because it’s in the sweet spot of the – of our blue business. From a revenue perspective, it’s in the $40 million range top line impact on the business this year. From bottom line, as you know, it is typically limited. When we do an acquisition, it usually takes us a couple of years to bring them in line with traditional operating results for POOLCORP branches. So I wouldn’t expect a ton on the bottom line this year, but going forward, we think it will be a very good acquisition for us.

Got it, it makes sense. I’ll hope back in queue. Thank you.

Thanks.

The next question is from Brennan Matthews of Berenberg. Please go ahead.

Hi. Thank you very much for taking my question. I just wanted to ask really quickly about international. It looked like it performed pretty strongly in the quarter. I mean, is there any more kind of color you can give there? And then, again, I mean, I think, in the past, you’ve talked about your approach there being a little bit more opportunistic. I mean, is that still the case? Is there – are you seeing kind of any new opportunities on that kind of geographic expansion front?

Yes. The way I would characterize Europe is our team has been very focused over the last several years on improving our operations every year. So we had a very strong year in Europe this year. Primarily, we were the beneficiary of some of very, very good weather. It was an extremely good weather year in Europe, and our team was able to capitalize on that. So no strategic change with our outlook internationally. We’ll continue to grow that as we do the rest of the business. But it was a very, very good year. Couple of reasons. The team executed exceptionally well, and the weather pattern for them was very, very good.

Awesome. Thank you so much guys.

Yes.

The question-and-answer session has concluded and so has our conference. Thank you for attending today’s presentation. You may now disconnect.