Good day, and welcome to the Pool Corporation Second Quarter 2019 Earnings 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 Chief Financial Officer, Mark Joslin. Please go ahead.

Thank you, Ben. Good morning, everyone, and welcome to our second quarter 2019 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.

Thank you, Mark, and good morning to everyone on the call. I'm pleased to report Pool Corp delivered solid financial results for the quarter and the demand for Pool and outdoor living products remained strong. Despite the effects of very challenging weather conditions, our total sales were up 6% to a record $1.12 billion for the quarter, while our base business sales grew by 4%, including a 1% negative currency exchange impact for the quarter. Before discussing how weather affected our four largest markets, we think it is important to remind our listeners of our often repeated statement that weather is the most significant factor affecting sales in our industry in the short-term. So I'll start my comments by quantifying the weather conditions that our builders, remodelers, retailers, and homeowners have contended with in the 2019 season and what effect it has on various parts of our business. There are two major factors that affect weather, precipitation, and temperature, and they both impact our business in different ways. Wetter-than- normal weather can delay the construction and remodel process because contractors generally don't work during inclement weather and saturated earth is unstable and unsuitable for excavation which stalls new Pool projects and prevents significant work on remodels such as pool finish, coping, and decking from being completed. This affects the timing of building materials and equipment as projects are delayed deferring sales of our projects. Extensive rain also delays landscaping and irrigation projects as well as equipment purchases and associated repairs. Consider that this is further exacerbated by a tight labor supply, so typically there is only limited ability to make up any lost days in the season because their crews have so much capacity in finding additional labor to add new crews is extremely challenging in this economy. In year-round…

Thank you, Pete. I'm going to start by revisiting comments, I made earlier in the year related to our gross margin expectations for the year. As I said we had expected a meaningful Q1 margin gain due to the carryover of pre-price increase inventories from 2018 and then our margin gains should moderate substantially in Q2 and Q3 and become a headwind in Q4 based on our strong Q4 2018 results giving us relatively flat gross margins for the year in line with our long-term expectations. Now that the second quarter is behind us, I can update you about how these expectations have evolved. Q1 turned out to be largely as expected with 90 basis points of margin improvement as seen in our results. Those gains moderated in Q2 to 30 basis points as we work through the remaining pre-price increase inventories. This was better than we had expected for Q2 primarily because of slower start to the year, push the sales of some of this product out. Where our expectations will likely change is in the back half of the year where we now expect lower gross margin than in Q3 2018 as well as in Q4 which is up against a much tougher 100 basis points margin increase over Q4 2018. The reason for this lower gross margin forecast for the back half of the year than previous is due to our reduced sales and purchase expectations for the full-year based on our first half results and the impact that has on our volume-based vendor purchase incentives for the remainder of the year. The bottom line here is that we expect our gross margins to be relatively flat for the full-year with second half declines offsetting first half gains. Moving down to expenses, our $11 million operating expense…

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions]. My first question is from David Manthey of Baird. Please go ahead.

Hi, good morning guys. First off, I was hoping you could give us the price and volume components of both the blue and green base businesses.

Yes, well roughly speaking, David, this year was an unusual year from an inflation standpoint. So that impacted the price and gave us a little more price than volume. Don't want to be real specific in what that looks like but I'll figure that -- that's little more than half of the growth is price related and volume was more modest in general certainly more on the blue side than on the green side. We saw little higher inflation on blue and green, green had some inflation as well but not as significant as on the blue side.

Okay. That makes sense. And then given your outlook and the way you're seeing things, I guess the comparisons in the second half of last year are pretty tough, but based on the great detail you gave us thank you as well as your exit velocity, you're coming out of the quarter, it seems like if you have normal weather, couple points of price, the extra selling day, high-single-digits growth in the third quarter sounds reasonable; is that a fair statement?

I think that's a fair statement. Yes, we're just looking at roughly 6% to 7% growth for the entire year, first half included. And that growth depends on weather largely, so lower end based on kind of normal weather and hopefully weather is our friend and we can do a little bit better.

Weather, so for the beginning of July, finally it seems that most of the weather issues have abated, so we're encouraged.

Yes, and then just one harder question here on the cost side. By my math, if you would have hit Street expectations for gross profit, I think the SG&A that you reported even without assuming any kind of increased variable costs would have been about 70% of the gross margin growth. So I'm just -- I wanted to flag that and just ask you as we look to the second half of this year assuming trends are more favorable in terms of growth trends, do you think that we should see SG&A trend more consistently with that 60% target formula?

That's a good, quick math Dave and that is true. It certainly is more of a challenge. Going into the season, we're expecting normal weather and we staff for that, and when sales are more modest, then we expect and it makes getting that SG&A leverage more difficult. So, look more normal in the second half which is more of that 60% and again as I said 20 to 40 basis points of operating margin improvement for the year is where we expect to end up.

Dave, consider that in the first half of the year, we opened up seven locations, and many of those didn't come online until late into the quarter. So, those will start to, remember those mature over time. But certainly, in the second half of the year, those will be much more productive than they were in the first half of the year.

Our next question is from Ryan Merkel of William Blair. Please go ahead.

Hey thanks everyone and thanks again for all the great details. So my question is for the second half of the year, are you making an explicit estimate for deferred sales and how much you think you can make up from the first half?

It's not -- we don't have an exact number, Ryan, on what we think we can make up. I mean remember when we exited the first quarter; we thought that it was $10 million to $15 million. Second quarter looks more like call it $25 million to $35 million. How much of that we make up really is going to be a function as we've said before of how late in the year the builders and remodelers are able to work weather permitting. So very tough at this point to say what we'll be able to make up. I think we'll have a much better view of that at the end of third quarter. But right now, I think it's a little premature to call a number on how much of that we think we can make up. What I can say is that demand is good. Everybody is working. So, as long as the sun stays out and rain stays away, then we're encouraged. But I think it's -- given what's happened in the first half of the year with weather, I think I would be premature on calling a number right now.

Yes, that makes sense. That's helpful. All right. Then secondly on the second half gross margin commentary, I just want to dig in a little bit more. The third quarter, should we think about gross margins being down kind of in the 20 to 30 basis point range and then 4Q seeing a bigger decline just due to the comparisons. Just trying to hone in on exactly how we should think about modeling that?

Yes, well, as I guess the bottom line was that margins would be relatively flat for the year. So think of a relative inverse to the first half of the year. And one way of looking at it, fourth quarter is a smaller quarter, less volume than first quarter, third quarter is a little smaller than second quarter. So as you get back to relatively flat for the year, you kind of have to factor that in and look at from a modeling standpoint, how to get -- how third and fourth quarter down to get you back to flat for the year.

But I guess fourth quarter you would expect to be down more year-over-year than the third quarter; is that fair statement?

Yes, generally more because of the 100 basis points of inventory gains we had in the fourth quarter last year. Yes, so on a relative basis third quarter will be down, fourth quarter will be down a lot more.

But remember it's a smaller quarter in revenue.

Right, right, right. Okay. And then just lastly I wanted to ask a longer-term question on in-ground pool market potential size and rate of penetration. Could you just revisit that for us? Where do we stand today in terms of the in-ground pool market and longer-term what do you think the growth is?

So I would tell you that the number today on in-ground pools is somewhere in the neighborhood of 5.3 million pools. Last year remember we said we added about 80,000 pools, this year we thought that we would be up slightly above the 80,000 we were thinking it would look more like 85,000 pools for the year given the slow start to the season and the inclement weather, I think we'll be somewhere between 75,000 and 80,000 pools in the 2019 season depending on what happens with weather between now and year-end. We see that continuing to grow back to more normal levels. So I think what we've called out in our investor information is that we think more normal pool construction assuming the economy stays healthy and housing holds up. We think it could -- new pool construction could come back to the low 100s would be a more normal run rate. But again the biggest limiting factor we have on that is a) weather, b) followed by labor. So the good news is that their labor supply hasn't really changing for our builders, so they're not losing labor but they're also not gaining them. So I think demand may be better but it's going to be a function of a) weather for them, and b) being able to get pools in the ground. Now there are a lot of factors so play here. So calling out a number on where we think it could get to, I would just take a look at the growth rate that we have been on and don't look for any significant spikes in the growth rate. I'd like to think about the industry is kind of being pressurized and that demand is better than supply right now. So we'll continue to build over time.

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

Hi, good morning guys. Just one quick clarification, Mark, to lead-off. Just the ASU benefit of $0.40 is in your guidance but nothing further as we go forward, correct?

That's correct, Steve.

Okay great. And then can we just talk a little bit about the price cost side. What are you seeing with respect to costs from your suppliers? We've obviously had a little bit more of a tariff ramp-up in certain things. I'm just curious how that's sort of manifesting for you guys. And I assume you'll just sort of try to price for that over time but just any discussion would be helpful.

Sure. It's a little bit early because we're now thankfully this year doesn't look like we're going to see midseason increases like we had last year. So it looks to be a more normal year on timing. So this is the time of year when our major suppliers are formulating what their pricing strategy is going to be for next year. I would tell you that what -- from what I'm hearing and we really don't have firm numbers from anybody but I would tell you that the general sentiment is that it will be a more normal year in terms of price increase but perhaps slightly above that but not like we had for the 2019 season.

Okay, great. And then as we think about sort of the gross margin trajectory obviously we're going to sort of end the year little bit weaker than we started but sort of flat overall as you've said. Is there any reason not to think about that flat overall? I know that's kind of your long-term hope. Is there any reason to think that 2020 wouldn't be kind of flattish overall?

Looking ahead to 2020 already Steve, it's just mid-2019.

I don't want to get caught fleeting here.

I think you're going to steal from my third quarter commentary but I would say first half 2020, I can tell you this that's going to be a challenge from a gross margin standpoint. Second half should be okay but first half given the gains we've had certainly without, as Pete said, we're early on in the pricing discussions but it's unlikely we'll have the kind of inventory buying opportunities that we had last year and the inventory gains that we had in the first year. So I think that first half of this year, so it's going to be tough in the first half of next year.

Okay great. Definitely make sense. If I can just sneak in one more. Are you going to continue to open more stores? In other words that we should sort of think about this run rate of kind of bringing on new stores that are going to take some time to ramp is kind of the normal or the store openings fade and then we start to get the actual benefits in the numbers of the improvement?

I think we're going to continue. So we'll continue on the pace that we're on. So for the balance of this year, we have four more plan to open. So a typical year for us is in the 4 to 8 range and this year will be slightly above that. But I think that reverts back to a more normal rate after that. But remember when we are opening typically when we're opening because there are many markets that we are not in already. So when we open it's out of the need for capacity. So and if you take the larger markets as they grow and they grow further into the suburbs, our current facilities become tapped out. Now, as Mark said, we have and as I said in my comments we are spending a lot of effort and some money on improving our capacity creation within the existing four walls. And in fact if you look at our expense growth for the first half of the year, the reason we're able to achieve that and including the new locations is because of the work that we're doing. So I think the pace of new facilities may slow a little bit but we're doing those out of the need to add capacity but we're also working on the internal tools as well.

Our next question is from Blake Hirschman with Stephens Incorporated. Go ahead.

First one just some clarification on the top-line outlook commentary. I think you said 6% to 7% growth is now the expectation for the year is that base business or overall top-line and what's kind of the FX, I know it’s been a bit of a drag through the first half. What was the expectation built in for that through the rest of the year?

Yes, 6% to 7% is overall, so including acquisitions. In terms of FX, it's obviously been a headwind for us through the first half of the year. But looking out to the second half, if we end the year about where we are now from an exchange which is primarily Euro, we would not have much of a headwind there.

Yes. And then on inventory in the channel, I know there was some noise coming into the busy part of the year and just with the weather we've seen and everything else just wanted to get an update on how inventories in the channel stack up as far as you can tell?

Well when you say in the channel, I mean we were -- I guess we're in the middle of the channel from a distribution standpoint. So we are kind of well-positioned where we are in terms of inventory they're up over last year which were also up over the year before because of some mid-year purchases we did last year. So we're in pretty good shape in terms of getting us through the third quarter. We'll see how demand plays out with weather and what kind of opportunities there are when we look at the vendors and their pricing for the 2020 season. So I guess we'll give you an update on that in the third quarter.

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

Yes, good morning guys. Thank you for taking the questions. And thanks for providing all the details in regards to the weather impact. So just wanted to follow-up on the previous question as far as the opening of new sales centers in your market, so just wondering and I assume you probably haven't seen too much of any cannibalization effect as you've opened new sales centers in existing markets; is that a safe assumption?

Yes, so what happens when we open we because again remember these are not new areas. So we find that as the areas are growing and we need more capacity typically when we open a location, we take a chunk of business from a donor location, if you will, and that seeds the new location. And then what we have seen in the past and is really part of our pro forma model as we bring these up for approval is the whole market has to continue to grow. So what we found historically is that the locations are out of capacity. We add a new location. We take a portion of the business that has been shipped to the adjacent market that we now operate in with a facility. And then the new location continues to grow and the old location will eventually grow back to where we started from in terms of anticipating the need for a new location. But that's been historically how we have done these Greenfields for many, many years. But our pro forma model includes the entire market, new and recovery of the sales that we removed from the donor center.

Got it, okay, understood. Okay. And you mentioned before that retail was up around 1%. So does that imply that your sales of chemicals were up around 1% as well?

Chemicals were up 3%.

Okay, so a little bit better. Okay. Got it, okay and then I noticed that there were no share buybacks in the second quarter. Anything to read into that or is that just timing of when you expect to be in the market?

I guess the only thing you can read into it is we have plenty of capacity for future share repurchases.

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

Thank you. I just wanted to follow-up on gross margins in the second half of the year. Just wanted to be clear, the only thing that's really changed in your outlook the timing of the vendor discounts, and can you remind us when do you usually see those discounts. Is it really in the -- just in the fourth quarter or do you tend to take advantage of them throughout?

Yes, well it's a good question and really it's not so much timing. We anticipate what those discounts will be. Obviously, every year we're talking to our vendors and they're putting their programs out there and then we're looking out ahead for the coming year and saying what our expectations of what our purchases will be with our various vendors and we're forecasting that out. And then as we go through the year, we make adjustments to that forecast. And so there's some adjustments along the way but it's based on what we expect to do for the entire year. So that's kind of how the process works for us.

I wanted to ask on commercial, you had a nice step-up in the quarter; I think you were tracking about 2% in the first quarter. Now you're up at 8%. How much of that was catch-up from 1Q deferrals and versus strength in the overall market versus share gains?

I think it's more reflective of strength in the overall market. So in the first quarter of the year because of the weather, there were several projects that were impacted. But again it goes back to capacity, there's only so much capacity and if you look at the quarters, the capacity -- the quarter with the least amount of capacity to catch-up is really the second quarter because the crews are busiest. So I think it's more indicative of the health of that space and the opportunity that we have versus catching up.

Okay, thanks. And then just lastly on inflation you had previously talked about inflation running about two points above normal. It sounds like that's pretty much where you're still at for the year. I just want to see if you can confirm that?

Well, yes. It is for the year but remember in the fourth quarter, we had the fourth quarter of 2018 is really when our inflation took hold and we were able to push price increases through. So when you get back to fourth quarter of this year then that lacks the inflation we saw last year. And as Pete said, going forward, still very early but probably more or like -- and the 2% was over normal, let's call it 1% has been historic inflation. So this year was 2% on top of that which is more like 3% overall. And then going back to more modest historic levels plus I guess I would say so maybe 1% to 2% is what we're looking at this point for 2020 but still very early.

Our next question is from Ken Zener with KeyBanc. Go ahead.

Hopefully you can hear me clearly. So Pete it's -- you guys have your Analyst Day coming up in September. I guess probably that's two years that when you were there at the last Analyst Day. And you described -- just for perspective what this question is about you described the demand is pressurized, so the weather is there you're going to have good sales is what you're effectively saying. Can you talk about perhaps how that is different or how you're thinking about your demand environment given your prior industry and whether you guys handle it very well at Pool Corp. How is your kind of thinking changed about the volatility of the weather in the two plus years that you've really been at Pool and you've obviously taken leadership of it?

Yes, it's the demand, here is what's different between here and where I was previously. Demand is very consistent here. The industry is healthy, people want pools, people are remodeling pools, the whole outdoor living lifestyle is very healthy and in high demand. There is a finite amount of capacity in the industry. And when the weather is good, everybody is working very hard and when the weather is bad, it puts everybody behind. What we're working on at Pool Corp though is making sure that we are doing everything we can to extend and expand the capacity of not only ourselves but our contractors and remodel and retailer customers by giving them tools that allow them to spend less time with us and less time procuring material and more time on the job. So part of, if you remember, we mentioned that we remodeled our showrooms and we changed many of our picking processes and we're actually now looking at and monitoring the amount of times that customers actually spend in our facility in hopes of driving that down and allowing them to be more productive. So they're more productive. And we think we will also be rewarded with share for doing that. So I mean, as I said, the industry is pressurized and what that means from my perspective and what that means is that, there's more demand for pools and remodel than there are people to do it. So when the weather is good, it's good but when the weather is bad then things are going to back-up. And like I said, we're working on things to make -- to allow the contractors to be more effective and to create some capacity by doing that.

Right, and I apologize if I'm breaking up and part of the reason I ask that is this preceded your view but, Mark, you were there in 2015 I believe Texas was very wet, California was very wet, you had flat volume you actually took down revenue guidance. What happened a quarter or two later is in fact because demand was there it actually came back and I'm not asking you obviously your guidance is out there. But does the volatility in weather, I mean you're obviously trying to make people more efficient. Are you seeing it where it really could kind of be extended in terms of -- the labor is there and the weather is there? I mean are you guys seeing more of those customers productivity perhaps change the balance of sales like it was in 2015 and you guys actually ended up beating guidance?

Yes. I mean going back to 2015, if I remember correctly, Ken, we had a very mild fall and winter season that year. And what we've seen if we look back over the last four or five years when we have mild winters whether it's end of the season or the start of the season, we can have very good finishes or starts to the year, some of our best quarters from a growth -- of sales growth operating profitability growth, contribution margins happen on the balance of the year or the start of the year based on mild weather conditions. And as Pete said, the demand is really pretty consistent and strong. And so the mild weather allows our contractors to really extend their work and their ability to meet the demand that that comes to them. So that answers your question, that's really what we've seen and continue to expect to see with milder weather conditions on the shoulders of the season.

[Operator Instructions]. Our next question comes from Alex Maroccia of Berenberg. Please go ahead.

Hi guys. Good morning and thanks for taking my questions. On the previous quarters call, you outlined the $20 million to $30 million impact on revenue from Easter and then the $10 million to $15 million from cold and wet weather. I was wondering if you could just do a similar quantification for this quarter in terms of the deferred sales.

Yes. And Alex I think we covered that briefly. What Pete mentioned earlier is the weather impact estimate for the second quarter for us was $25 million to $35 million. And then the first quarter $10 million to $15 million. We really didn't get to the second quarter and didn't really expect to because of capacity on the part of our builders. So the total deferred revenue, if you will and I don't know that I characterize as deferred revenue as much as revenue that we had expected to get in the first half of the year that we didn't get is more in the kind of $40 million to $50 million range.

Okay, got it. That's great. And then the second one is just a clarification point because you said that inventory pre-buying opportunities might be a little limited early next year. So do you expect the levels to remain relatively confident now? Looks to me they're about 250 basis points higher than the average over the past three years?

I'm sorry; you're talking about inventory levels or you talking about --

You're right. Inventory as a percentage of sales?

Yes, I mean that should certainly come down. Assuming of course no significant buying opportunities, we're very strategic in our purchasing process and when we feel that we can take advantage of pricing, we do that and that's beneficial for us. So it's hard to say but we certainly don't expect the kind of environment going into the next year to be similar to the one we had in last year which would mean as a percent of sales, inventory should be lower.

Got it.

And consider that part of the inventory gain was from acquisitions number one and two from the new locations that we opened. And when obviously we load them first with inventory and then start to sell.

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

Great. Thank you. Thank you all for joining us today. Our next call will be October 17th, 2019, where we will discuss our third quarter results. Have a great day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.