Good day, and welcome to the Pool Corporation Fourth Quarter 2019 Conference Call. [Operator Instructions] Please note, today’s 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, sir.

Thank you, Rocco. Good morning, everyone, and welcome to our year-end 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 2020 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, the latest edition of which will be filed at the end of this month. 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. 2019 was another solid year for POOLCORP. Overall demand remained healthy and our dealer base optimistic. While the weather caused some challenges early in the year, the team’s focus on execution, capacity creation and organic growth drove record sales and profitability while helping our customers be more productive as well. For 2019, total sales came in at $3.2 billion. This represents a $200 million or 7% increase over 2018. In the fourth quarter, our revenue also increased by 7%, which was on top of the 6% overall growth we saw in the fourth quarter of 2018 and the 15% growth that we saw in 2017. From a base business perspective, sales increased 7% in the fourth quarter, bringing the total year base business increase to 5%, which is a nice recovery from earlier in the year. For reference, we reported a 1% base business sales growth in the first quarter and a 4% in the second quarter. So through the first half, we had posted a 3% gain, which highlights the significance of the 5% base business growth for the full year 2019. Looking at just the year-round market, the base business grew by 6% for the quarter. And on a full year basis, we saw revenues up 5%. Again, poor weather in the first and seasonally significant second quarter weighed heavily on the total year, particularly in California and Texas, where it was colder and wetter than 2018. The resilience of our team and the markets allowed us to make up significant ground as the year went on. Our dealers are reporting a very solid backlog for 2020 season, which is yet another positive sign of the overall market conditions. Moving on to a few notable end markets.…

Thanks, Pete. I’m happy to say that with 2019 now in our rearview mirror, we met the majority of the expectations we communicated to you for both the quarter and the year overall. I’ll recap a few of those expectations here. First, our reported EPS for the year, excluding tax benefits, was in the middle of the range we provided on our Q3 earnings call and down only 3% from the middle of the range we provided at the start of the year, despite the impact from weather in the first half of the year. As Pete mentioned, looking out from our midyear results, this was a very good outcome. We said throughout the year that our gross margin would be relatively flat on a full year basis, which was the case: Flat for base business and down 10 basis points in total with our acquisitions added in. We had a tough gross margin comp in the fourth quarter, and because of this, said that on our third quarter call, that our fourth quarter operating income would be down year-over-year, which it was, but only slightly as very good expense management with flat base business operating expenses mitigated the gross margin hit in the quarter. For the year, we targeted base business operating expense growth of 60% of the rate of gross profit growth and we’re right on target with that objective. This allowed us to post base business operating margin improvement for the year of 40 basis points, which was at the high end of our expected 20 to 40 basis points of base business operating margin improvement. One final P&L metric I’ll quote is our base business contribution margin for the year, which was 17.1%. This is the ratio of the incremental operating income generated by our incremental…

Thank you. [Operator Instructions] And today’s first question comes from David Manthey at Baird. Please go ahead.

Hi. Good morning, guys.

Good morning.

First off, can you discuss any strategic buy programs entering this year that you may have participated in? And I guess you gave us the implications for the quarterly gross margin trends, but it doesn’t feel like there’s much of anything. But with the gross margin for the year being stable last year, expected to be stable this year, can you broadly outline the biggest moving parts there in terms of what’s pushing it up, what’s pushing it down, to lead you to this net zero area?

Sure. Sure. Let me handle that, Dave. So first of all, in terms of strategic buy, you’re really probably referring to what we did in 2018 and the pre-price-increase purchases. And in 2018, as in 2019, we also do our normal seasonal buy-in with vendors. So we commit to purchases in the fall for delivery at the vendors’ convenience throughout the fall and into the spring. And then we pay for those in the late spring and summer. So for 2019, inflation – I’m sorry, for 2020, inflation expectations were a return to normal, and that’s what we’ve seen. And so we did our normal kind of fall buy that we’ve done in years past. And nothing unusual from that perspective. In terms of gross margins and the comment about them being flat for the year, I provided some kind of highlights in my commentary, but just to recap those. Going back to 2019 first quarter, we had the benefit of the pre-price-increase inventory that we had purchased. Selling prices increased at the start of the year for all of our customers, and so we were able to sell that lower-priced inventory in the first quarter and a little bit into the second quarter, which gave us a margin benefit, which was 90 basis points in the first quarter last year and 30 basis points – 20 to 30 in the second quarter. At the same time, because those purchases that we did were in 2018 instead of 2019, that affected the vendor incentives that we received, and those were higher in 2018 and a little bit lower in 2019. And so that impacted our margins overall for 2019 and left us with a flat margin in 2019, considering the big comp difficulty that we had in the fourth quarter. So 2020, we have that tough comp in Q1, tough comp in Q2. We’ll benefit from getting back to normal vendor incentives, which gives us that flat expectation for the year. So a lot of background there. So if you have any follow-up on that, Dave, let me know. But that’s how it lays out.

Yes, it’s very helpful. Thanks Mark. Could you also talk about product mix and customer mix? And where you’re seeing the strength? I think you mentioned some of the renovation and construction products. You’ve got commercial moving up the curve. Any puts and takes there as it relates to the gross margin for the company, maybe offset by the core day-to-day maintenance and minor repair products?

Sure, Dave. I’ll take that. When I look at our product groups that are growing, if you consider that building material for us has been an area of strength. Over time, it continues to build. So we had a very good year with building materials last year. As I said in my commentary, it was up 9%. The margin profile on building materials is good. Of course, your cost to handle building materials sometimes can be a little bit more expensive than the lighter boxes. Commercial is another area that we continue to gain traction in. And commercial – the margin profile in commercial is going to be a little bit lighter on the very large projects. So that is an area that we’re continuing to grow, and that has a slight impact on our overall margin mix. If I think about the chemical portion of our business, the – that’s more of a discretionary – or nondiscretionary part of our business that will follow the weather and how often that – when the pool opens and how often it gets used. And if I think about the inflation that we’re looking at this year on chemicals, if we have a normal weather year, inflation is normal. So from a mix perspective, I don’t look for any overall impact. And equipment this year from a margin profile, so equipment follows, obviously, the maintenance and repair and in new construction. Last year, construction, we think, was down year-over-year – I’m sorry, the – yes, the new pool construction, we think was down about 3%. Although the numbers are still preliminary, this year, assuming a normal year and without having the benefit of price increases on equipment, I think our margin profile on that returns back to normal.

All right. Appreciate the color guys. Thank you.

Thank you.

And our next question today comes from Ryan Merkel with William Blair. Please go ahead.

Thanks. So a couple of questions. First off, sticking with the gross margin. In the fourth quarter, the decline of 170 basis points, how much of that was the price/cost goodness not repeating? And then how much was lower rebate? I think that’s what you said.

Ryan, I can’t break that out precisely – or I won’t break it out precisely. But it was – probably 80% is – was the tough comp, and the smaller piece of it was the incentive piece, maybe 90%, 85%. But most significantly was just the tough comp from the year before.

Okay. That’s really what I was getting at, so that kind of gets me there. And then I want to get a little more specific on gross margins in 1Q 2020, if we can. I just want to get a sense of what should the decline be year-over-year? Is down 100 basis points sort of the right range? You’ve got the price/cost issue again, and then you mentioned the early buy that may move into 1Q. So I’m just trying to think about those two pieces.

Yes. I mean, that’s a reasonable expectation. So the 90 basis points from last year plus the early buy maybe brings it down another 10 to 20 basis points. So you’re in the neighborhood there.

Okay. So the early buy is not that impactful at 10, 20 bps.

Yes, that sounds about right.

Okay. Okay. And then I realize I’m getting a little picky with this question. But 2020, the guidance for 10% to 15% EPS growth, that’s a little below your goal for mid-teens. I’m just trying to figure out what’s really the difference? Is it some of the investment, Mark, that you talked about? And then you mentioned a non-repeat of some SG&A tailwinds. Just what’s different? And why isn’t 15% or better? Because it sounds like an easy weather comp and the market’s healthy.

Yes. Well, one difference, first of all, Ryan, is share repurchases which have been stock and trade for us for a number of years and add generally a couple of percent to earnings per share. And we’re – we really didn’t have any to speak of in 2019, so no benefit there moving into 2020 from 2019 purchases. And at this point, we’re not anticipating that, that will happen. We don’t generally reflect those in our guidance in any case. So that’s probably a bigger impact there. But yes, a little bit of caution on expenses, given some investment in non-recurring that we had – non-recurring benefit that we had last year. So generally, we have constraints on industry labor. So we think we have good opportunity from a demand standpoint, but we have to wait and see how well the contractor base can deal with that given the labor constraints that we and other building industry participants have so.

Okay. Great. That’s helpful. I’ll pass it on. Thanks.

And our next question today comes from Anthony Lebiedzinski of Sidoti & Company. Please go ahead.

Yes. Good morning and thank you for taking the question. So just wondering, so with the higher capacity that you have, just wondering, are there any new – potentially new product categories that you guys could get into? Or do you think 2020 sales growth will be more or less kind of more from the same types of product categories that you’re in already?

Yes, good morning. I’ll take that one. So when I think about new categories, I wouldn’t characterize it as new categories. As we said during our Investor Day presentation, there is an opportunity with automation. So instead of a time clock – mechanical time clock, to have IoT-type products that you can see and control your pool from your phone, we think there’s an opportunity to continue to move from the single-speed pumps to variable-speed pumps. We think that there’s some new product opportunities as it relates to some of the green products, and if you think about UV systems on pools which contribute to a healthier pool and less chemicals. So I wouldn’t say that there’s a lot of new categories. What I would say is that there’s a big opportunity with automation because of the 5.5 million in-ground pools, over 3 million of them essentially have no automation. So what we see in the market is as those pools need to be repaired and maintained, that the dealers are starting to offer the automation instead of just a one-for-one replacement, or instead of changing out the halogen light like-for-like, talking to the homeowner about moving that to an LED. So I don’t think it’s new categories, I just think it is a switch towards higher-technology products. And if you look at our building material products, we’re continuing to see growth in outdoor lighting and some of our other hardscapes, which are newer for us, certainly as compared to the legacy pool products. So I think that’s what you’re going to see driving our growth.

Okay. Thank you for that color. So what’s the margin profile of these products that you – that Pete, you just mentioned, whether it’s automation or LED? Can you give us any color?

Yes, I think it’s similar overall. I think the margin profile on lighting is very similar. When I think about pumps, for instance, single speed to variable speed, probably a little bit lighter on the variable speed than a single-speed pump, but that’s nothing unusual that we haven’t seen that trend growing over time. And then when I look at the overall automation margin profile on that, very similar to the items that it would be replacing.

Got it. Okay. So next year, there’s some new regulations taking effect that requires variable-speed pumps. Is there any other new regulation that you are aware of that could impact you guys?

No, I don’t think so. And that one on the variable-speed pump replacement for all single speed, remember, that takes effect next year, mid-July of 2021. And honestly, manufacturers are all trying to figure out which pumps they have that could hit the DOE specification. Some of the manufacturers think that they can do it with single-speed pumps. Others are saying no and will have to be switched to variable speed. And then, of course, you have – it happens later in the season anyway, or midway through the year. And then by the time inventories are worked through, I really see that as a 2022 play. There will be limited impact in 2021. I see it taking effect more in 2022. But honestly, I think we’ll have a better view of the impact on that as the manufacturers sort through their product portfolio and figure out what they’re going to do to meet those regulations.

Got it. Okay. And lastly, as far as new sales centers, what’s kind of the breakdown you guys are thinking for blue versus green for this year?

I think it will be a similar number this year. We had one – in 2018, we had one new green center. We had one in Canada, blue; one in Europe; and then the rest were in U.S., blue. I would think it’s probably going to be a similar profile going into the 2020 season.

Okay. Thank you and best of luck.

And our next question today comes from Ken Zener with KeyBanc. Please go ahead.

Good morning, all. Glad you’re not charging more for those mixed up products, as a potential customer of yours.

Only for you.

So given your comments about 1Q gross margins because of prebuys, et cetera, in 2018, since you’re addressing the gross margin, Mark, could you talk to if you expect the base operating leverage to degrade by the amount you said in gross margin? Just so no one’s surprised.

Yes, for sure, there will be a reduction in operating leverage in the first quarter.

Would the EBIT change be similar to the gross margin change?

I will let you model that out, Ken. But it’s…

You want to say 50-50 just so we can understand the SG&A actions you’ll be taking?

I’m not going to comment, Ken. I’d have to pull out my model and go through it.

Oh, boy. Oh, boy.

I’m prepared to, but I think you can figure that out.

Well, there’s no reason SG&A operating leverage would change at all just because the gross margin’s swinging around, right? I mean in short.

No. For the year, no. I believe we would expect similar kind of performance as we’ve had. And as I said, we look for 20 to 40 basis points of operating margin improvement. That our contribution margins last year was 17%, so that’s well above our operating margin, and it provides a healthy ramp opportunity for us to continue growing operating margins over time.

All right. General question, Peter, about the backlog comment, I mean, with new sales down last year. I mean, is there anything really changing? You keep bringing up labor constraints. But there’s no new – the contribution or the level of backlog in your comments thinking today seems to be very similar to where we were last year, which is supporting 6% to 8% base growth. I mean, is that a simple way to assess it? Or is it stronger?

Yes. I would tell you that the backlog is good. I just attended a bunch of industry shows and dealer meetings in the last month. And I will tell you that my sense is, is that optimism is very, very high with the dealers. And I mean – and from just my take on it is, everybody is upbeat and there is a fair amount – or good backlog that everybody is sitting on right now. So…

So about financing? Are people talking about – when you’re out there with the dealers or folks, I mean, just give us a context for how much is paid out of cash as opposed to borrowed? And is there any easing of credit that – any commentary you picked up there.

Yes. I mean, I don’t see any significant shift in financing, Kenneth. Still banks are skewed towards better creditworthy the borrowers and the lower end of the credit spectrum is more challenged. So if you look at it from an industry standpoint, we had a big middle market business years ago that really never came back after the recession. And that really hasn’t changed.

Then the last area, buybacks. If you’re not buying back and you’re not going to necessarily tell us when you’re buying back, can you give us some more thinking? I mean, you talked about opportunity. Can you just expand on that? That is a little bit of a – I want to say a shift. But I mean, you guys have pulled back what would at least be a very steady cadence, right? You’re going to invest in the business, you’re going to do dividends, and the rest is coming back to shareholders. It seems like it’s eased up a little bit, please clarify if that interpretation is wrong. And what does an opportunity look like, I guess? I mean, if you could expand on that a little bit.

Yes. I mean, really, Ken, there’s no change in our long-term capital allocation strategy, always very, very consistent over time. Which is, invest everything in the business, make acquisitions, what we have done and we will continue to do. And we think, by the way, there’s good opportunities in this market environment for acquisitions. So that will get some attention. And then a dividend program which should grow with earnings over time. And then excess cash going to share repurchases. It just so happens that in the short term, with the 43% run-up in stock price last year and where we sit today, we think that saving some capacity for a time when we’re not competing with shareholders is going to be good for us. But that’s not going to be two, three years down the road. That should be in the foreseeable future. So that’s about as specific as I want to get. But there’s really no change in long-term strategy, just how we’re executing in the short term.

Okay. Thank you very much.

And our next question today comes from Blake Hirschman with Stephens. Please go ahead.

Good morning, guys. First off, within the top line outlook for 2020, curious to hear how you’re thinking about the relative growth between new pool construction because you mentioned – I think you said it was down most likely in 2019. If you expect that to come back kind of versus the large and small R&R work.

Yes. Good question, Blake. As I said, the preliminary numbers show that the new pool construction year-over-year is probably going to be down 2% to 3%, and they’re still buttoning that up, so that’s why I cautioned that was a preliminary comment. I think that is almost 100% driven by weather. And consider that there’s only a certain number of buildable days during the year as where weather permits. And we lost many of those days in the first half of last year. And then there’s only a certain amount of labor that can be applied to those projects. So I say that demand is very solid for new pools. I see nothing that would indicate that there’s any softening of demand in – for new pools and new construct or remodel. So when I think about the mix, I think it returns to our normal – if you look at us, our new pool construction probably makes up 15% to 16% of our total business. And reno is another 25%. And then you’ve got the maintenance and repair, the nondiscretionary part, makes up the balance. And I think that from a mix perspective, 2020 is probably going to look an awful lot like that. I don’t see people saying, I’m not going to do remodel, I’m going to do this or that. I think it really – I think there’s general pent-up demand for both, and I don’t see any of the dealers changing their profile of work.

Got it. And then I could have missed it, but did you guys say what the top four market growth looks like versus the seasonal markets? Or anything along those lines?

Yes. When we look at the overall, I think the top four markets, we had relative strength in Florida. Florida was very good. Arizona had a tough – so above the total business, Arizona was lighter simply because of a very poor first half. The back half of Arizona was strong. Texas was probably about in line with the business, but again, much skewed towards the back half of the year. And California, stronger in back half than the first half because they were very cold and wet. But in California, the fourth quarter was, specifically in Southern California, they got a fair amount of rain which kind of dampened things out. So they were slightly below the total.

Got it. And then just lastly on M&A, are you guys still pretty focused on green, commercial, international? Are those kind of some of the bigger spots that you’re looking to expand in now?

Well, yes, domestic blue as well. So we look across all aspects of the business and we see a fairly active market. We’ve been in 10 years of economic growth. So if there’s someone out there looking to sell their business, now it’s probably not a bad time for them in their minds. And so we’ll see what happens, but we think there will be some good opportunities for us.

Got it. Thanks so much. I will get back in queue.

And our next question today comes from Alex Maroccia of Berenberg. Please go ahead.

Hey, good morning, guys. So I’m looking at the commercial business right now, and you’ve stated in the past that it typically grows around 4% a year. So how are you beating that market at the moment?

I think we’ve invested in salespeople. We’ve invested in inventory. I mean, on the commercial business, you have to have – it’s a different expertise because it’s largely a bid and spec job for a portion of it on the new construction. And then when it comes to maintenance and repair, when you have competition pools, you have to have it in stock. So if there’s a competition pool that has a pump go down or a heater go down, it’s not a question of, well, who’s got the best price? It really is a question of, hey, do you have it in stock? So we’ve invested in regional inventory to make sure that we have kind of all the important inventory within a reasonable lead time to where the concentration of pools are, and like I said, we’ve invested in talent. And I think we’ve gotten a lot smarter and a lot better in tackling that business. So I think it’s just – it’s share gain based on our investments in people and products.

Got it. And just a follow-up on that. Given that it’s about 5% of total sales currently, how much larger do you think that could get in the future?

Well, I think our overall market share on commercial pool, we’re in the 10% range. And if you look at what our overall market share is on the rest of the business, that implies that there’s a fair amount of room for us to grow. So – but there’s also a portion of that business that we don’t participate in that has to do with bulk chemicals. So of what we consider the addressable market, I think we could easily double the business that we have.

Okay. Got it. And then second question for me is, I’m just looking at the inventory number from 2018 and 2019, you’re around 22% as a percentage of sales there, trying to think of free cash flow for 2020. Do you see that inventory number dropping anywhere near the historic 20 or so percent range any time soon?

Yes. In terms of the percent, I’m not as – I would say that the inventory growth should be modest this year. We have an opportunity to grow that a little bit less than we have the last couple of years. We’ve had an impact from acquisitions. Of course, we had an impact this year-end from vendors who shipped a bit more on early buys than they normally do. Now those were on dated terms, so it didn’t impact cash flow, but that helped push up inventory growth a little bit. And then we had the big inflation on inventory from 2018 into 2019. So add 4% to the inventory levels for inflation which pushed it up a little bit. So given all those factors and really a focus on our part to look at making sure that we’re managing that well, I don’t expect to see the same kind of growth, and probably getting back closer to the historic levels that you’re talking about.

All right, great. Thanks for the answer, guys.

[Operator Instructions] Today’s next question comes from Garik Shmois of Loop Capital. Please go ahead.

Hi. This is Jeff Stevenson on for Garik. And yes, my first question is just on the 6% to 8% base business forecast. Anything you could call out on differences between the blue and green businesses as far as expectations for next year?

Yes, good question, Jeff. I think about growth opportunities for both businesses a little bit differently. The green business is – has a big irrigating component. Irrigation is tied to new construction, and new construction has been relatively strong and continues to look that way. So from a base business growth, probably the green business growth profile in that area is a little bit better than blue, but not significantly different.

Got it. No, that makes sense. And then at your Investor Day, you mentioned that cost inflation will be more modest in 2020, in that kind of 1% to 2% range. Just wondering, is that still a good way to look at it? And have there been any changes that you would call out that are more or less than original expectation?

Yes. No, I think that’s still the way we’re viewing things based on the feedback from suppliers and the increases that were announced, it looks to be a much more normal year in that regard.

Got it. And the last one, I know you only called out the first quarter ASU tax benefit. But just when you look at 2020, is there anything you could call out? Do you think it could be more front half loaded? Or anything as far as steady cadence here to help with modeling purposes?

Well, we gave some guidance. If your parse our comments, I think we gave some guidance throughout the P&L, starting with the top line and the revenue growth expectations, greater in the first quarter due to the easier comps we have. Really, first quarter, first half with less growth in the back half. Some early buy from a customer standpoint, moving from Q2 into Q1, gave quite a bit of color on margins, on expenses, didn’t really provide a lot of modeling color other than overall for the year. So I think that we’ve given about as much – or more than we normally do in terms of kind of how the year looks like it’s going to shape up at this point. So I’ll leave it at that, I think.

Understood. Thanks and best of luck.

And ladies and gentlemen, this concludes the question-and-answer session. I’d like to turn the call back over to Mr. Arvan for any closing remarks.

Yes, thank you. Thank you all for joining our call today. Our next call will be scheduled for April 30, where we’ll discuss the first quarter results for 2020. Have a great day.

Thank you. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines, and have a wonderful day.