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Good morning, and welcome to the POOL Corporation First Quarter 2018 Earnings 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 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, Rocko. Good morning, everyone, and welcome to our first quarter 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 2018 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 measure is posted to our corporate website in our Investor Relations section.
Now I'll turn the call over to our President and CEO, Manny Perez de la Mesa. Manny?
Thank you, Mark, and good morning to everyone on the call. In the first two months of 2018, we were off to a very strong start, only to be hit by a multiple storms in March, which reduced our customer's ability to get work done, as well as delayed pool openings in seasonal markets.
This weather headwind has carried over into April, although fortunately we should be able to recover most of the sales over the balance of the year. Despite this headwind, we still realized 5.4% base business sales growth, 6.2% base business profit growth and an 11.2% increase in base business operating income, all of which are solid.
Our base business sales growth in our four largest markets; California, Florida, Texas, and Arizona was 6.4%, while the growth in the rest of the markets that we serve was 3.7%, as these markets were the most affected by the weather.
These base business sales results include our green business, which had a 10% base business sales increase in the quarter, as our network is largely in the sunbelt and less impacted by the weather.
On the product side of sales, building materials continued its strong performance with 9% growth while commercial had 15% growth. In addition, pool equipment growth was 7%. The growth in these product categories reflect both the ongoing recovery in the remodel and replacement sectors of our business, as well as consistent market share gains and are especially noteworthy, given the inclement weather.
The retail product side of our business decreased by 3% in the quarter, which is where the impact of delayed pool openings is most apparent. There should be some catch up here in the second quarter when pools are opened.
Our gross margins were up modestly due to minor product and customer mix differences. These differences in mix should largely work themselves out during the course of the year. Our expenses in the quarter were largely as expected, reflecting our ongoing investments in different technology and fleet assets together with volume related costs increases.
Our base business operating margin increase of 40 bps, is a testament to our operating disciplines and continuous process improvements. We increased our annual guidance by $0.09 to a new range or $5.45 to $5.70 to recognize the benefit from ASU 2016-09.
We're cognizant that we are just now entering the seasonally busiest time of the year, which is when our service level and value proposition are most extensive as we work to help our customers succeed.
All results are only possible because of the commitment of our people throughout the company to our customers, our suppliers and to each other. We are extremely fortunate to be involved in a business where our 4,000 employees worked every day to help people realize their dreams of a better home life, while simultaneously assisting over 120,000 customers realize success.
We look forward to making 2018, another successful year as we continue to create exceptional value. Now I'll turn the call over to Mark for his financial commentary.
Thank you, Manny. As you can see from our results, our base business gross profit increased 6% in the quarter, while base business operating expenses increased 5% resulting in 40 basis points of base business operating margin expansion.
We think this is a good result, particularly given the weather driven fall off in sales that we experienced late in the quarter. Acquisitions had a bigger than normal impact on our results in the quarter, given that we completed 6 of them in the last year, bringing in 10 new locations which resulted in a combined operating loss of $1.3 million for the quarter.
Moving down to the P&L, you can see that interest in other non-operating expenses rep were relatively flat year over year. This line is composed of interest expense, which was up nearly $1.5 million dollars year over year due to higher interest rates and higher debt.
And other gains and losses included - including interest rate swaps elements that offset the higher interest costs in the quarter. For modeling purposes, I would not expect that offset to continue and would use a 75 basis point year over year higher interest rate on debt for the balance of the year.
Moving on to taxes, I think we covered this pretty well in our press release, but we'll reiterate a few points here. As we discussed on our year-end call and mentioned in the release, tax reform lowered our historical annual tax rate of about 38.5% to a projected 25.5% excluding the impact of ASU 2016-09, although this may vary some by quarter, that is where we expect our tax rate to be at the end of the year.
On our year end call, we had also discussed our approach to providing guidance on ASU 2016-09, which was to include in our projections only the known impact from vested options that would expire, if not exercised, as well as the impact investing if any restricted stock grants.
We had estimated this known the impact from ASU 2016-09 to reduce our 2008 income tax expenses by $5.4 million and add $0.13 to EPS, all in the first quarter. Given both the increase in our share price falling that estimate, as well as pull forward a future option exercises into Q1 that would have expired in 2019 in later years, we instead and recorded and $9 million reduction in tax expense in the quarter, which added $0.22 to our earnings per share. This $0.09 EPS improvement was added to our guidance range for the year, as noted.
Moving on now to the balance sheet and cash flow, our total receivables grew 8% year over year, while inventory grew 9% both slightly ahead of our 7% revenue growth in the quarter, but reasonable when adjusted for acquisitions. The quality of these assets remain strong as they have historically.
Turning the cash flow, you can see that are $44 million seasonal use of cash to fund operating activities. [Audio Gap] more than 2017 including an approximate $4 million benefit from our lower tax rates this year compared to last.
One factor accounting for the additional cash usage and which we referenced in our press release was an inventory payment not only made in Q2 that because of favorable terms was instead paid in Q1.
Factoring this in, our cash flow from operations would have improved in the first quarter from last year which should be evidenced in our Q2 cash flow results. Note as well that our capital expenditures are down $4.5 million this year from last reflecting the early year timing of vehicle purchases last year, but also an expectation that our capital expenditure should be more modest this year than last.
One final comment which is on modeling of our results for the balance of the year, as we have mentioned, we have competence in our earnings guidance range for the year and expect that much of the business loss in Q1 due to weather conditions including delayed pool openings and lower construction and remodeling activity, will be recaptured later in the year.
Although the impact from delayed pool openings will be pushed to Q2 given April weather conditions and the capacity constraints of our customers. Overall, we expect Q2 results to be more modest with some pickup in the back half of the year.
Now I'll turn the call over to our operator to begin our question and answer session. Rocko?
[Operator Instruction] Today's first question comes from Anthony Lebiedzinski of Sidoti & Company. Please go ahead.
Good morning. Thank you for taking the questions. So Mark, just to follow up on your last comment, as far as 2Q and the capacity constraints, are you seeing, as far as capacity constraints in all your markets, or is it you know more so in some of your year round markets? Maybe you could just to touch on that first?
Sure. Anthony, I mean, we have a higher demand in really all our markets and the peak part of the season, which is May, June, July, a little bit in April, although that's certainly more pronounced in the seasonal markets.
And so, that'd be constraints throughout the network, but more predominant in the seasonal markets. So as I mentioned, you know, the openings, of course there are going to happen and that's pushed into Q2, but where the construction and renovation activities are generally strong, demand is good. We’ll see some impact from that capacity constraint throughout.
As far as your operating expenses of, obviously you called out the components of that. I was just wondering if it, was there any something's timing issues or was this kind of more or less in line with what you expected?
Well, the timing issues is more, you know, we're ramping up for a little bit higher sales activity in the quarter. So, but otherwise the expenses are pretty well as expected. So, no issues there from our standpoint.
I'll just add there that, we have the acquisitions that came into the equation during the course of the year. And Mark mentioned the six acquisitions, the first one of note happened or came into play in the second quarter of last year and the last ones came into a late in the fourth quarter.
So what you've got is, you've got that playing into it as well as the opening of a several new locations as well. So that's, our overall expenses are pretty much in line with what we expected.
So as the season progresses, I imagined that you'll start to see benefits from those acquisitions?
Well, definitely, yes. In fact, if you look at the negative in the quarter are, part of that is the nature of where the locations are, where obviously the fourth and first quarter and seasonal markets are a drive, but then you have the pickups in the second and third.
Okay. And lastly, as far as for me, share repurchases were rather modest the first quarter and they were rather modest last year in the first quarter as well. So should we expect the similar kind of pattern of share buybacks this year versus some of the gum to be kind of similar to last year?
Our objective here, we finished the quarter well on the lower end of our target debt to EBITDA in terms of capital structure. And given the strong cash flow expectations that we have for the year, it's reasonable to expect that we're going to buy a million or so shares back during the course of the year.
And that will happen during the course of the year. It's hard to project when that'll happen, exactly. But that's our objective.
Okay, thanks very much.
Thank you.
And ladies and gentlemen our next question comes from Garik Shmois of Longbow Research. Please go ahead.
Thank you. I'm just wanting to about your outlook for base business growth I think coming out of 4Q, you're looking at about 6% to 7% for the year. And just given the slow start to the season, just wondering if, how you're viewing the base business guidance that you provided previously?
The same 6% to 7%, probably closer to 6% and 7%, but largely unchanged. The expectation is, as we've mentioned, pool openings just a delayed a little bit, a few weeks. And, but those happen and there's injection of products that pool owners consume when they open up their pools and balance the chemistry and the water.
And then secondly, in terms of the increment weather and delaying, our customers that are working outside, the expectation is that over the course of the year that are largely a balanced out with a less rainfall.
And to that end, there'll be able to catch up a, they won't be able to catch up as Mark mentioned in the second quarter unnecessarily because they're, you know, pretty well booked. And that's typically a capacity hoarder. But the expectation is that the demand is strong and there'll be able to catch up at some point during the course of the year.
As it relates to OpEx leverage, moving in the next three quarters of the year, you know, is it fair to assume, just, given your commentary around how 2Q is looking at, you'll see an, a bounce-back in leverage in the second half of the year in, in conjunction with when you're expecting to see the acceleration sales growth?
Sure. So there's two parts here. One part is base business and we had operating leverage of 20 bps in the first quarter, plus 20 bps from gross margins. So we have overall operating margin leverage of 40 bps year on year in base business. That's consistent with our expectations for the year of 20 to 40 bps all together. And then, that's part one.
Part two in terms of the acquired revenues, our flyer businesses that flow into - that are not included in base business. Obviously, the leverage point there will be in the second and third quarters and then there'll be a little bit of a hit in the fourth. But again, it's, it's relatively small numbers, although on the margin it does affect it by a couple of pennies here and there.
And just lastly, just on inflation, you had called out in the release, the lease labor freight as some items that had been headwinds and these have been headwinds for some time, but you also indicated in the prepared remarks that you know these were tracking in line.
So is there, is there anything you know else to call out on inflation that you're viewing is maybe problematic for the rest of the year? Is it truly, just something that you feel that you have within your control, you don't need any additional pricing or anything like that to offset.
Sure. So, I'm going to take the question, but I'm going to also shift gears afterwards. In the case of expenses, expenses are pretty much as expected. We -- we've known for awhile there has been a, a very tight market on the freight side, particularly when we're talking about third party freight carriers and the cost for those services. So that's kind of rolled into our expectation from an, from an expense standpoint.
When you look at it in a year on year comparison it is higher, but that's again within our expectation. And, and that's so that part is, I'll call it okay. My pivot here is with respect to our costs of products and there has been some raw material cost pressures on our suppliers specifically, I had mentioned I think last quarter about some of the components that are used for the manufacturing of the basic sanitizer for pools.
And most recently I saw, recently I saw that one manufacturer announced a 5% price increase effective in June. And I expect that others will follow as their costs pressures are driving them to do that.
I also expect later in the year to be additional price increases products that are affected by one raw material or another. And while that - when you look at the 2018 year in our general perspective of inflation being 1% to 2% certainly this year, I think with some of the increases that'll take place again, mainly back of the year weighted. We'll still be within 1% to 2%, although probably culture the 2s into 1 given some of that activity again with back end weighted.
When you look at the next year though, it could very well be a little higher than that. Too early to make that call for ‘19, but it could certainly be a year that, that we see some, you know, a year that maybe, north of 2% from our price inflation standpoint.
Thanks for all the color. And best of luck.
Thank you.
[Operator Instruction] Today's next question comes from Matt Duncan of Stephens Inc. Please go ahead.
Hey, good morning guys. This is Will on the call from Matt.
Good morning, Will.
Good morning. I'm wondering if any pre-buy activity had an impact on growth in the quarter and how you’d compare relatively to the past few years from an early purchasing perspective?
Sure. In terms of the orders that we have on early buys that heavily weighted to retail customers in terms of stocking their stores for the upcoming season. Those orders in that activity was a little bit ahead on the order side vis-à-vis prior year.
But we didn't ship as much this year, so we build actually less sales in the first quarter of this year than last year because of the, of the weather and the fact that a lot of this is in seasonal markets and a number of retail stores at the end of March did not have a desire to necessarily take their full orders by that time.
And also, we had - the weather certainly affected our ability to make that a priority to shift to them because again, they weren't pushing for it. So, and that been - those orders have been largely shaped by now. So that, that was just the timing from a latter part of March to the early part of April.
Okay. Then on growth rate between the businesses, you mentioned that 10% growth in the green business, but when it calibrate for the blue and the international business, how growth in the first quarter change by the different segments? And then your expectations for the year on each, green still...
Sure. If you look at our four big markets, as I mentioned, we were up 6.4%, the Texas got a little bit of a weather hit there in the quarter, but were not - we would have been certainly 7% in those four markets.
And the expectation is that, that will be a - that went to anticipate will happen during the course of the year. And the seasonal markets are obviously the ones that are most affected and they were up by 3.7 that's what we will see, their catch-up in the balance of the year and those should get to 6-ish percent, as we - for the whole year with the catch up in the second, third and fourth quarters.
Great. And then on operating EPS this year, do you still expect gross margins to be relatively flatter then maybe we should be thinking about kind of coming back to the operating expense leverage in the back half of the year, maybe that, that growth on the OpEx dollar amount is closer to 75% of GP dollar growth relative to your 50% target. Is that kind of how we should be thinking about it this year?
I missed that 75 versus 15...
You target the OpEx growth at 50% of that GP Dollar growth...
Okay, I'm sorry. On base business that's still and I think as we talked about in the February call, it'll be between 50% and 60% of our GP dollar growth for the year on base business. On the acquire businesses, that's a different animal altogether.
And as I think we've mentioned many times, the great majority of the acquisitions that we make, just like the lion-share of those that we compete with, have very modest, if any, operating margins. So therefore those businesses that are acquired come with little to no contribution.
So, therefore it's a matter of instilling the right practices and doing the right things over the course of time that enable us to get to a double digit operating margins. And, that'll play out. But again, the acquired businesses don't come with any profit, so to speak up. So I partial that out and isolate that separately.
And stated in another way, you said earlier, the 20 to 40 basis point...
On base business operating margin expansion is expected. Yes.
Right. With a little more in the back half of the year than the first half of the year...
Given the constraints of the capacity and things of our customers on...
Okay, that’s helpful. Then last thing for me on the January acquisition, can you discuss the size and location and what that brings, the deal?
We did - in the January acquisition was the one that we did in Australia and that’s one small location in Australia. More, significant though, the acquisition we made in Northern California that it closed at the end of December. And that team with five locations and are now being incorporated into our Northern California operations.
Great. Thank you, guys.
Thank you.
This concludes the question-and-answer session. I want to turn the conference back over to the management team for any closing remarks.
Well, today appears to be a short day and we have plenty to do. So I appreciate that. Thank you all for listening. Our next conference call is scheduled for July 19 when we will discuss our second quarter 2018 results. Thank you.
Thank you, sir. This concludes today's conference. Thank you for attending today's presentation. You may now disconnect your lines and have a wonderful day.