Pool Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 20, 2022

There are 10 speakers on the call.

Operator

Good day, and welcome to the Pool Corporation Second Quarter 2022 Conference Call. All participants will be in listen only mode. After today's presentation, There will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Melanie Hart, Vice President and Chief Financial Officer, please go ahead.

Speaker 1

Thank you, and welcome to our Q2 2022 earnings conference call. Our discussion, comments and responses to questions today may include forward looking statements, including management's outlook for 2022 and future periods. Actual results may differ materially from those discussed today. Information regarding the factors and variables that could cause actual results to differ from projected results are discussed in our 10 ks. In addition, we may make references to non GAAP financial measures in our comments.

Speaker 1

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. I'll now turn the call over to our President and CEO, Peter Arvan. Pete?

Speaker 2

Thank you, Melanie, and good morning to everyone on the call. This morning, we proudly recorded another record quarter with net sales coming in at $2,100,000,000 an increase of 15%, marking our first ever $2 plus 1,000,000,000 quarter and beating last year's very strong Q2 where we saw sales increase by 40%. These results prove exceptional given the challenges that we faced this past quarter in weather, the supply chain and recognizing The second quarter is where growth capacity industry wide is most limited. There were many factors that came into play this quarter when taken in totality demonstrate the strength of the company and the resilience of the industry. First off, I would say that demand for new pools is solid and not surprisingly the backlog on new pool construction is somewhat smaller than this time last year.

Speaker 2

Our builders are reporting leads have slowed a bit, but that they have plenty of work on new construction and renovation projects on the ever expanding installed base of pools. 2nd, following 2 years of very favorable weather in the second quarter, we experienced a cooler and wetter start this year in our seasonal markets that delayed many projects impacting the demand and timing of sales of many products from packaged pools and equipment to chemicals. As we would have expected, when the weather improved later in the quarter, sales for these products increased to fulfill the strong demand. 3rd, supply chain constraints have improved in many areas, but persist in several products that contain computer chips like the variable speed pumps and automation. Our Trifor inventories have improved tremendously, but the availability of granular Cal Hypo used to shock swimming pools is very tight affecting sales for that product.

Speaker 2

4th, we have seen a continuation of the demand for connected and smart technology products like automation, Fluorination, variable speed pumps, robotic cleaners and customizations, which positively impact revenue on repair and replacement as well as new construction and remodel and we expect that will continue. 5th, without a doubt, our inventory management program has helped us keep Paced with the strong demand and fluctuating lead times as the installed base of pools grows and favorable market dynamics continue. At the same time, we have seen a decline in the demand of some categories that were supercharged by the pandemic, such as above ground pools and heaters as mentioned on previous calls. Fortunately, the decline represents a very small percentage of our total sales. Lastly, the inflation that has worked its way into the We are seeing is driven by structural cost increases by our suppliers making these new price levels permanent in nature.

Speaker 2

To summarize, we would characterize the current situation and near term outlook as positive with mix and price more than offsetting some declines in unit volumes that are driven by supply chain Turning back to more normal levels, but the installed base, which is where we derive over 80% of our revenue continues to grow, are performing extremely well adding 5% to our revenue during the quarter. Excluding revenue from new franchise locations, our Acquired Pinch operations grew by 14% in the quarter. Pinch has a very proven and unique value proposition, which allows We saw last year in the same quarter. Texas saw revenues grow by 17%, while Arizona saw sales grow by 20%. Our Florida business continues to benefit from a very robust economy and grew by 23%.

Speaker 2

Overall, our year round markets grew by 16% and We were very pleased with what we saw during the quarter. Equipment, which grew by 35% in the Q2 of 2021, grew by an additional 7% in the And it is worth noting that last year in the same quarter, we were still working through the Texas freeze impact. Additionally, keep in mind that seasonal market Experienced unfavorable weather this year, which is very different than the favorable weather and early start that positively impacted their results in the previous 2 years. Chemical sales increased by 25% in the quarter. A better inventory position on Trichlor helped, but we were hampered by the shortage in calypo this year.

Speaker 2

Not surprisingly with this year's weather pattern, volumes particularly in the retail sizes were softer in the quarter when compared to last year. As mentioned, retail sales improved as the weather turned more favorable as the quarter progressed. Building material sales increased by 22%, which is on top of the 33% growth in this category that we saw in the Q2 of 2021. Our ability to grow this category is strong. We are adding and refreshing NPT centers and capabilities to bring the most complete product offering in this category or closer to our customers and help them showcase these products to the millions of pool owners and thousands of new or prospective pool owners across North America.

Speaker 2

Our capabilities in this area are unmatched as we offer the most complete line of product, expert advice and training and the best customer Additionally, our digital catalog and augmented reality tool called the NPT Backyard app I'll bring the showroom to the homeowners' own backyard virtually. Retail sales, which retail sales excluding pinch a penny grew by 7% In the quarter, clearly feeling the effects of the weather in our seasonal markets. For comparative purposes, we grew retail sales 20% in the same period last year. It is noteworthy that the results on a year to date basis are up 13%. Looking at the results on a regional basis, we see a clear bifurcation That is weather driven with the year round markets posting results similar to pinch and penny, which is highly concentrated in Florida and Texas.

Speaker 2

Commercial pool product sales are up 23% and that is on top of the 45% growth that we saw in the same period of 2021. With leisure travel bouncing back and strong demand in this category, we are encouraged with this trend and no one is better positioned to serve this than Poolcourt. We have deep expertise and an expansive inventory for the critical time sensitive nature of this business. Now let me add some color on our European business results. After a tremendous 2021, Europe is facing a difficult 2022, Driven by very unfavorable weather, uncertainty on the continent because of the war in Ukraine and a slowing economy that is grappling with surging energy And food costs, we saw sales decline 18% in the quarter.

Speaker 2

On a constant currency basis, it was negative 8%. For perspective, this compares with the same quarter in 2021 where we thought sales surge 42%. Our European team is very seasoned and is managing the business appropriately, and we remain very committed to our European strategy over the long haul. Turning to Horizon, once again, we are very pleased with the results. Base business sales grew by 14% and total sales including acquisitions increased by 15%.

Speaker 2

Once again, I'd like to point out that this compares with 2021, which in the same period, we saw sales increase by 31%. Jeff Clay and his team continue to execute our strategic plan with very strong results. We remain very committed to the industry and highly confident in our At this juncture, let me add some commentary on gross margin Starting off with gross margins, I'm very pleased to show that overall gross margin percent increased 150 basis points to 32.4%. This marks the first time that we have ever exceeded 32%, so yet another milestone for the POOLCORP team. For our base business, gross margin percent increased 100 basis points to 31.9 percent, many factors combined to drive the increase.

Speaker 2

Pricing management, our supply chain activities, product and customer mix all help drive the increase in gross margin percent. Additionally, we are in the early stages of vertically integrating certain chemical lines with Corpus Pool and Patio, which is helping drive the increase. Conversely, we face headwinds in some of our vendor incentive programs as growth tiers are impacted by the timing of our purchases. Furthermore, the rapid pace of vendor price increases has subsided. Again, none of this is a surprise and we have planned and executed accordingly.

Speaker 2

As you can see, our gross margin improvement is driven by a multitude of levers that when combined more than offset the headwinds that we face. Looking at operating expenses, we are very pleased to see that our capacity creation activities continue to drive results. Our operating expenses as a percentage of sales in our base business fell 40 basis points, while overall operating expenses increased 20 basis points reflecting the acquisition of Corpus Considering the tremendous inflation that we have seen almost across the board from wages and salaries to fuel leases and transportation, We are very happy with how the team has remained focused and executed at the highest levels. Pool 360 sales grew by 9% in the quarter, making up 12% of total sales. I would also like to point out that we have released our next generation of POOL360, which contains a long list of customer driven enhancements that we believe will result and higher adoption rates of this capacity creating tool.

Speaker 2

Wrapping up the income statement, we posted operating income of 4 $15,000,000 and operating margin of 20.4%, respectively. These results reflect a 24% increase in operating income and 150 basis Improvement in operating margin. We are extremely proud of these spectacular results, all made possible by the combined efforts Our extraordinary team here at Foolcorp, our dedicated and loyal vendor partners and our tremendously creative and hardworking customers, all of whom work together to help more people enjoy outdoor living. We could not be more thankful for this teamwork. Pool Corp.

Speaker 2

Is a unique well managed company in a resilient industry. Technology to modernize the millions of pools that make up The installed base and build pools of the future continues to be developed and released by our supplier partners and adoption of such is in the early stages at best. Our own technology to make the entire supply chain from the manufacturers to the customers more productive and bring us closer together, giving everyone back valuable time continues to get better. The future is bright and more connected than ever. We are balanced in our approach and have always been very strategic with capital allocation Investments looking out at the changing landscape and positioning the company to have a value proposition that is second to none and create additional capacity for growth.

Speaker 2

Our latest investment in Porpoise Pool and Patio is only just starting to realize its true potential now that we have integrated and our one team. We will continue to expand the footprint, extract the synergies and leverage the industry leading technology to improve our value proposition to the thousands of independent specialty retail stores that we serve, giving them world class capabilities. This is a very powerful combination that we know accelerates our growth and the ability to gain share even in an uncertain business environment because each business is made better by the combination. We have always been an organic growth oriented company with the ability to select, acquire and integrate accretive businesses where we see value. Additionally, no one is better or has a more proven track record with Greenfields than POOLCORP.

Speaker 2

We have successfully opened in 31 locations in the last 4 years and will open an additional 10 to 12 this year. We are a performance based company that attracts, Retains and develops industry leading talent creating vibrant career paths for our employees. We have a deep loyal or we have deep loyal customer relationships and strong vendor partnerships that when combined with our team produce great financial results that are durable. Unlike most other building products distributors, Cool Corp. Enjoys a unique advantage of essentially maintaining a lifelong relationship with every pool that is built and remains in service.

Speaker 2

We provide the construction material and the maintenance supplies and the remodeling products required during the entire existence of each pool, whether it is a DIY maintained pool or one that is serviced by one of our professional customers. It is an annuity industry and business model that grows upon itself as more pools are built or products are demanded forever. With all of this in mind and half of the year behind us, we are raising our full year guidance to $18.38 to $19.13 per share. I will now turn the call over to Melanie for her financial commentary and balance sheet update.

Speaker 1

Thank you, Pete, and good morning, everyone. As expected, Q2 2022 continued with robust 15% sales growth over 2021, comping last year's phenomenal growth in our seasonally significant quarter, which is a tremendous accomplishment. This represents a 22% sales growth increase year to date. Inflation impact for the quarter was around 10%. Additional vendor price increases, primarily in the equipment area, occurred during the quarter, having just a partial impact on the current quarter due to the timing of the increases.

Speaker 1

Our recent acquisitions added 5% to our sales growth in the quarter. Overall volume growth was in line with our expectations, lapping the remaining impact of the Texas freeze that benefited sales growth in 2021. However, We did see negative impact on sales activity from weather in Canada, the Upper Midwest and the Northeast, which we believe slowed sales growth by 1% to 2% during the quarter. The weather impact was evident in the April sales growth rate being the lowest month of the quarter. But as Pete mentioned, the growth rate improved throughout the quarter with sales growth in the year round markets continuing to be strong.

Speaker 1

Europe experienced some negative weather and macro impact resulting in an 8% local currency decline from 2021 during the quarter compared to a local currency 31% growth in Q2 2021. As they represented only 5% of net sales in 2021, The estimated impact on the consolidated financials for the quarter is approximately 2%. A negative 1% impact from foreign currency also brought down results. In summary, for the quarter, Q1 included an early buy shift of approximately 1% of sales that would have normally taken place in Q2. We experienced a negative 1% to 2% from North American weather, a 2% drag in Europe from weather and macro events and a 1% foreign currency impact.

Speaker 1

Gross margins hit an impressive 32.4 percent for the quarter and 32.1% year to date. During the Q2, we realized a 100 basis point improvement on base business activity with 150 basis point consolidated increase over 2Q 2021. 2nd quarter typically has higher gross margins than we report for the full year as a result of seasonality. This increase over prior year moderated in Q2 from the increase reported in Q1 as we face significant improvements achieved in the same quarter last year. We reported an accretive benefit from our acquisitions.

Speaker 1

We also continue to see gross margin dollar benefits from product mix as items such as variable speed pumps, LED lights, automation and custom features experienced higher sales growth than their more traditional nonautomated counterparts. We saw increased activity through our CSLs or centralized shipping locations. This provides a significant benefit to our network in order to manage inventory in a tight supply environment and ensure we can replenish our locations timely to avoid lost sales from stockouts, while enhancing our gross margins on certain products. Better inventory positions on faster moving products and increased selling prices made necessary from vendor cost increases also provided an incremental benefit. Operating expenses increased only 16% on a gross profit dollar increase of 21%, as our continued ability to manage seasonal sales volume, Coupled with our capacity creation efforts resulted in increased operating leverage even while experiencing above historical levels inflationary increases in compensation expense, rent and freight costs.

Speaker 1

This includes an additional $21,000,000 in operating expenses in the quarter from recent acquisitions. Operating margin increased 150 basis points in the quarter and operating income increased to 419,000,000 The power of our operating model is that it provides us the ability to make incremental improvements as we grow and also the flexibility to ensure that we Staying operating margin as a significant portion of our compensation expense is comprised of our performance based incentive program, and that our employees are rewarded along with our shareholders series of operating income improvement. Our strategic planning process and proven operating capabilities and Management discipline developed over our 40 year history and 27 years as a public company provides us the agility to respond in changing macroeconomic Interest expense for the quarter increased $6,600,000 from prior year Q2 to $8,500,000 due to higher debt levels compared to last year. Our trailing 4 quarter leverage ratio was 1.1x, a continued conservative position even with higher average debt from working capital investments, acquisitions and increased share repurchasing activities and remains well below our overall targeted range of 1.5 to 2 times. We recorded an ASU benefit of $1,600,000 or $0.04 per diluted share compared to $7,700,000 or $0.19 per diluted share that we realized in the same period in 2021.

Speaker 1

As the timing of when these benefits are realized are related to restricted stock vesting and option exercises and computed based on the stock price in effect at the time of the transaction, this tax benefit has and will continue to fluctuate from quarter to quarter and year to year. I would now like to turn our discussion over to our balance sheet and capital allocation. Receivables increased 29%, reflecting higher sales growth in June than the full quarter, additional amounts due from vendor programs as a result of higher sales year to date and 5% from acquisitions. Product inventories have decreased from our peak in March 2022 as we prepared well and ordered inventory early to to be fully stocked for the season. Inventories that were in short supply at this time last year, in particular, Tricore Tablets are now in a position to allow for consistent Apply to customers versus the rolling stock outs we experienced last year.

Speaker 1

As a result, we have realized approximately 20% increased sales volume for these products. The overall balance includes approximately $90,000,000 in higher cost inventory from inflation, which we expect to realize an additional selling price and approximately $50,000,000 from acquisitions. We are pleased with the quality of the inventory on hand and do not expect any negative margin impacts resulting from managing inventory. We actively monitor inventory levels related to chemicals, pipe and rebar, areas where we have seen higher inflation. We review inventory levels and turns by sales center at the individual SKU level and believe current on hand amounts are appropriate in relation to expected future sales.

Speaker 1

Net cash provided by operations was $28,700,000 year to date, down from the 187 point $87,200,000 generated in the same period last year. The current year period includes an $80,000,000 cash payment that was deferred from 2021 as a result of Hurricane Ida and $136,000,000 more cash outlays in the first half of the year on inventory. In In 2021, we continue to build inventory through the second half of the year in order to keep up with sales demand and added approximately $430,000,000 in base business in the second half of twenty twenty one. As we have seen improved lead times, we would expect to seasonally bring down inventory in Q3 2022 in order to take advantage of early buy opportunities that we expect to arrive as normal in Q4 2022. For the year, we are expecting to generate significant free cash flows.

Speaker 1

The Board authorized a 25% increase to our quarterly dividend rate beginning in the Q2 of 2022. Our quarterly dividend rate of $1 per share represents the 12th consecutive year we have increased our dividend rate. We now expect to return approximately $150,000,000 to shareholders in cash dividends for the year. Also in May, the Board increased our share buyback authorization to $600,000,000 from the $404,000,000 available under our previous share repurchase authorization. We have taken full advantage of the increased authorization and completed $216,000,000 in share repurchases during the quarter, acquiring 547,000 shares and bringing our year to date total share repurchases to $268,000,000 This is the highest ever commitment from the company on both the dollars invested in the annual period and the number of shares purchased.

Speaker 1

Earnings guidance for the year increased to $18.38 to $19.13 includes $0.22 ASU tax benefit realized to date. This reflects a growth range of 20% to 25%, excluding the impact of the tax benefit. Inflation expectations for the year are largely unchanged at an estimated 10% to 11%. Inflation in the second half of the year will moderate from what we have reported year to date as we begin lapping the increases that were realized in the second half of twenty twenty one. Our sales growth expectations for the year remain consistent with the net sales guidance range of 17% to 19% we discussed on our February call.

Speaker 1

Additional vendor price increases in 2nd quarter not factored into our previous guidance are offset by slight decreases in volume as a portion of the business related to consumables was impacted by negative weather in Q2. Our guidance also factors in updates for Europe and foreign currency impacts. Our estimate for the 5% contribution from acquisitions is unchanged. We will also have one less selling day in Q3 and with the additional selling day we reported in Q1, we will have the same net number of days for the year. Forecasted gross profit margin for the full year may be slightly up from our previous guidance as comparable to 2021 as part of the revised inflation announced in Q2.

Speaker 1

We realized 2 40 basis points and 2 60 basis points improvement in margins in Q3 and Q4 of 2021 and so expect these gross margin numbers in the back half of the year to moderate more in line with our longer term guidance. The increases we have in the interest rate environment along with our revised average debt outstanding resulted in an updated estimate to the interest expense line of $35,000,000 to $40,000,000 We expect our year end leverage to be less than 1.5 times. No changes are expected in our income tax rate for the full year and we continue to expect the 3rd quarter rate to be slightly lower than the annual rate. With the effect of the shares we have repurchased to We are updating our year end estimate for share outstanding to approximately 40,300,000 shares. We continue adding to our future growth capacity with 5 Greenfield sales centers openings year to date and an acquisition completed early in 2nd quarter in West Virginia, a state we haven't previously had a physical presence in.

Speaker 1

With this acquisition, we now have sales centers operating in 40 states. We have also added 1 new pinch a penny franchise store during the quarter, bringing year to date new franchise openings to 3 stores. We still expect to open around 10 new franchise locations this year. One area that has been in the headlines lately There's a significant shortage of lifeguards across the country, preventing some community pools from opening this season. We are passionate about expanding the enjoyment from swimming and the outdoor living lifestyle.

Speaker 1

As part of our ongoing partnership with the YMCA, we recently donated $1,000,000 to 8 YMCAs choosing locations throughout the country with strong aquatic programs. These donations will provide training for more than 900 lifeguards and swimming lessons for 8,600 children who otherwise would not have had the opportunity to learn basic water skills. We are very pleased with our results for the first half of twenty twenty two and expect continued growth in the second half as our industry begins to see some relief from the supply chain challenges. I will now turn the call back over to the operator to begin our Q and A session.

Operator

We will now begin the question and answer session. And then re queue for additional questions. The first question comes from Ryan Merkel with William Blair. Please go ahead with your question.

Speaker 3

Hey, thanks and good morning everyone.

Speaker 4

Good morning.

Speaker 3

So I wanted to start with unpacking sales guidance a little bit. So it sounds like I think 5% volume growth was your original guide. It sounds like maybe that's a bit lower, The main drivers there being weather in Europe. Do I have that right? And what is the new outlook for volumes for 2% to 2%?

Speaker 1

Yes. So if you look at it, we were originally at 4% to 5%. It kind of included in that 17% to 19% guidance. And so we believe we lost a little bit to weather in Q2, as well as we've updated for Europe. As we go through the year, when we updated the Guidance for Q1, we kind of reiterated that the overall range for the year would be similar to what we had originally indicated, recognizing that We had higher growth than that in Q1.

Speaker 1

And so the two other factors that play into that is when we look at Q3, we will have one less selling day. And then also when we get to Q4, the overall expectation for inflation for the year at 10% to 11% Will be less in the Q4 because we'll be lapping some of those costs that were already embedded in the prior year numbers for Q4.

Speaker 3

Got it. That's helpful. Okay. And then maybe you could comment on July and how organic volumes are tracking. My sense is based on the guide that it would be down low single digits.

Speaker 3

And if I'm right there, could you just rank order The main drivers of why volumes would be a bit lower. I think Europe might be at the top of the list, but it would be helpful to get that color.

Speaker 1

Yes. So we haven't seen a significant change other than Europe is having a heatwave. So we've seen a little bit favorable promise in the weather over in Europe. But overall, when we updated our guidance for the full year, we do expect Europe to be down and be a contributor to that from a volume standpoint. But as we look at the rest of the business, July activity is Coming in pretty much in line with June.

Speaker 1

And so it looks like a lot of the unfavorable weather that we saw in April is behind us. We'll choose to call for the rest of the quarter, but we're hoping that things remain warm and dry And we have a good weather for the Q3.

Speaker 2

It's encouraging, Ryan.

Speaker 3

Okay. Good. Well, thanks. I'll pass it on.

Operator

Our next question comes from David Manthey with Baird. Please go ahead with your question.

Speaker 5

Thank you. Good morning, everyone. Melanie, thanks for giving us a rough update on the full year gross margin. But I believe Last quarter, you said that 3rd quarter and 4th quarter gross margin would both be lower year over year. Is there any update you can provide us With a finer point on the 3rd Q4?

Speaker 1

Yes. No, so we do still looking at the comparable from last year, we had that significant Growth, so the 240 basis points and 2 60 basis points. And so we will expect those margins to kind of moderate Off of those levels, but certainly be well above the 2020 levels.

Speaker 5

Okay. And then, in the case that if sales were lower in 2023, could you remind us, you've given us some numbers in the past about incentive That would automatically kind of reverse out. And could you also talk about the percentage of SG and A that would flex down with sales, Sort of your variable costs in the cost stack?

Speaker 1

Yes. So if we look at the breakout between the variable and fixed Cost, it's primarily about fifty-fifty. And we take a look at the when we look at compensation, we consider that to be component of the variable piece. And then as we look at the incentive comp that is included in the current numbers with the higher growth that we've seen, If and when we return to kind of that relative normal growth, we would expect the compensation expense to decrease by about $30,000,000

Speaker 5

Okay. $30,000,000 but the $30,000,000 is in the 50%.

Speaker 6

Yes.

Speaker 2

Yes. Okay. Thank you very much.

Operator

Our next question comes from Susan Maklari with Goldman Sachs. Please go ahead with your question.

Speaker 7

Thank you. Good morning, everyone. Good morning. My first question is, just thinking about underlying consumer demand as the macro shifts and housing potentially moderates a bit. Can you just talk a little bit about what you're hearing from your customers in terms of consumer interest in new pool construction and even some of the R and R projects in there?

Speaker 7

And Any thoughts on how that may trend as home prices potentially flatten out?

Speaker 2

Sure. What we're hearing from the builders right now As I said in my prepared comments that backlogs are smaller, which is to be expected given the Flurry of activity during the pandemic. I need a pool, I need one need a pool right now, right now, right now. But I think what people sometimes don't understand is because backlogs are smaller. It doesn't translate into less work being done.

Speaker 2

So the builders that we talk to, obviously on a daily basis are still factors to that is from a renovation and remodel perspective, frankly, and new construction is housing values. So housing values are strong. So although Housing sales maybe flattening out because of the rising interest rates. Everybody that has a home today that Purchasing in the last several years is setting on a tremendous amount of equity as the home values have appreciated. So that makes the likelihood of investing in the home, whether it's the addition of a pool or renovating and remodeling a pool that's already there, Very good.

Speaker 2

And that's essentially the feedback that we're getting from builders. So there's the installed base of pools, which as you know is in excess of 5 point $3,000,000 most of which has very little technology on it, right? So there's nothing there yet. Most especially newer homeowners are looking for a connected backyard experience to be similar to the way the inside of your home operates. Additionally, when you look at the age of the installed base of pools Being in the approximately 25 years across North America, it shows that there is a when you look at the timing on when those pools were built, It shows that there is a lot of pools that are in need of and will be in need of modernization and update.

Speaker 2

So whether our builders Our building new pools or whether they are remodeling and renovating, they are busy and the guidance that we're getting from them is That they will stay busy. Now having said that, as I mentioned, the leads have slowed. So what that doesn't Hey, we're going to build less pools. In fact, I would tell you the biggest limiting factor on new pool construction right now is weather. During the Q2, which is prime building pool starts, especially in the upper Midwest and through the Northeast, That's prime time for to get projects started in Canada as well.

Speaker 2

New pool constructions are behind in those areas, because the weather was not conducive to construction, especially early in the quarter. So most of our builders in those areas, it's They are behind in the number of units that they've constructed, but they're not behind in the amount of work that they have. Now how many of those are completed in the 2022 season really is going to be a function as you know of the shoulders of the season, right? There's more surplus capacity In the first and fourth quarter that will dictate how many pools actually get done. So although it's too soon with only 6 months Into the year to tell you how many pools I think are going to get built.

Speaker 2

I think that will largely depend on The amount of buildable days that exist between now year end.

Speaker 7

Okay. That's incredibly helpful color, Peter. Thank you. My follow-up question is, you clearly bought a lot of stock back this quarter. I think that you bought more back this quarter than you ever have on a full year basis.

Speaker 7

As you think about the inventories normalizing, your commentary that you plan to work that down through the Q3. Can you give us any update on how you're thinking of uses of cash? Anything around maybe a programmatic sort of repurchase approach or Anything else, especially as the valuations are where they are for the stock?

Speaker 2

Yes. I mean, we had we mentioned that Our share repurchase program this year has been very strong. And it's strong because we have tremendous confidence in the company And in the industry and we look at the price and say it's a very attractive price and we're a buyer. We were granted an authorization by the Board, which we've taken advantage of as Melanie mentioned and we still have additional authorization left, which we will continue The rest of our capital allocation model is really unchanged. We have always been very disciplined in how we deploy capital, whether it is for expansions and greenfields and operating the business, whether it's new trucks, new facilities.

Speaker 2

We increased Our dividend program, we are still active in the M and A market, although I don't know that there's any big deals out there that would consume a tremendous amount of cash. And then there is the share buyback. And as Melanie mentioned, we believe that as we bring down inventories between now year end that our free cash Flow is going to be tremendous this year. And with that, we will take advantage of the opportunities that were given.

Speaker 7

Okay, great. Thank you very much for that and good luck.

Speaker 3

Thank you.

Operator

Our next question comes from Andrew Carter with Stifel. Please go ahead with your question.

Speaker 6

Hey, thanks. I just want to unpack Europe. I realized small portion of the business, But ex weather constant currency down 6% in the quarter, where do you project that goes throughout the year in terms of The decline that's in your guidance and just could you remind us is how different Europe is versus kind of the U. S. Blue business?

Speaker 6

Is that a good proxy or is just These markets are too very different to where that kind of decline if we did endure some pretty heavy macro pressure here in the U. S, we couldn't see those kind of numbers. Thanks.

Speaker 2

Thank you. So Europe, we said on a constant currency basis, Europe is down 8% and that comps off of a very, very, very strong quarter, 2nd quarter and year that they had last year. So the European market is strong. There is about 5,000,000 pools across Europe. There are different pools than they are in North America.

Speaker 2

They tend to be smaller pools with less features and less automation because the real estate That surrounds most homes in Europe tends to be smaller than what you find in North America. Having said that, there still is a nice opportunity. As I mentioned, Europe had some tremendous headwinds this year. First, it started with the war and the uncertainty that that creates on the continent. It's Crazy to think about in 2022 that we have another war in Europe, but there is a war in Europe that is on people's minds, number 1.

Speaker 2

Number 2, you would pound that with tremendous inflation on energy and frankly uncertainty on energy prices, which makes the inflation even worse and that Extends on to food and other basic items in Europe, which is on people's mind. And then lastly, If that's not enough for the Europeans to contend with, their weather this spring, or through the second quarter Was just dreadful. What I'm very encouraged with though is that when the heat wave, the heat dome that is over in North America that is now extended into Europe when that Hit. We saw an immediate reversal of the sales trend in Europe and sales picked up nicely. So we are very encouraged.

Speaker 2

We are very We are very excited about the future prospects in Europe, but we're having to work through Some market dynamics that we hadn't anticipated. However, our team in Europe is rock solid. Our management team knows what to do. They're operating the business appropriately. And as Ayit mentioned, we are no less optimistic about The future in Europe than we were before.

Speaker 2

We think we have a tremendous opportunity to continue to grow and take share and bring new products to the market.

Speaker 6

Thanks. 2nd question, I wanted to shift gears a little bit. I know that you mentioned that the inventory situation is still tight and that's kind of reflected in what you're doing. What do you see the risk as the supply chain eases and a lot of your smaller competitors potentially over correct and they could be over inventory just as you're in a position to manage it. And one thing within that question, could you remind us how much exposure you have To potentially transitory inflation that could be a deflationary risk in the out years?

Speaker 6

Thanks.

Speaker 2

Yes. From Transitory inflation, it's actually a very small portion of our business. I made the point in my comments that most of the Inflation that we have seen from our suppliers on products is structural. With labor being a huge component in everything that our manufacturers make. And with the increase in labor cost, that translates Likely into what we believe to be a permanent price level.

Speaker 2

I don't see a scenario where for the vast majority of our business, we're going to see any Deflation. Having said that, there are a couple of items in our inventory, whether it's rebar or whether it's PVC pipe, where we they're more commodity in nature. So Less labor, more raw material and commodity pricing driven where there could be some movement, but it represents such a small portion of our inventory that it's really not anything that we contemplate and it's a small portion of the inventory in dollars and just the Percentage of the inventory in total is so small that even if it swings one way or the other, I don't really see that happening. As it relates to oversupply of inventory, I think what happened is last year when you had Hang ups in the supply chain and you had lead times extending that led to distributors ordering because you were ordering Your restock or your stocking levels and distribution are typically a function of your lead time usage plus your safety stock. Well, if lead time continues to get bigger, then you're having to order more and more product because you think it's going to take you longer to get it.

Speaker 2

The good news is, is that on many products that were in short supply last year, the lead times have come down considerably, which is allowing us to bring down inventory. What I did mention though is that there are still several products out there that are in very short supply, both on the equipment side and on the chemical side. So last year, I was essentially flush with CalHyto and short on Trichlor. This year, I'm flushed with Trichlor and I'm short on CalHyto. When it comes to equipment, it's a similar dynamic.

Speaker 2

So last year, we were short on heaters. This year, I have plenty of heaters, but the backlog on chip items that have a chip embedded in them, whether it's Soft cell or whether it's a motor, variable speed motor drive or whether it's an automation center or an LED light, That's still we still see significant supply chain issues and inconsistency in deliveries. Thanks. I'll pass it on. Thanks.

Operator

Our next question comes from Trey Grooms with Stephens. Please go ahead with your question.

Speaker 4

Hi, good morning. This is actually Noah Merkowsko on for Trey. So my first question, I was hoping you could talk about the sustainability of EBIT margins longer term. We've seen significant improvement over the last couple of years, but longer term top line growth may Moderate to more normal levels, seeing less inflation from suppliers, etcetera. Just how do you get confidence in in sustaining this level of profitability.

Speaker 1

Okay. It's 2 items. So first of all, as it relates to our capacity creation initiatives that we focus We know that as we continue to roll that out to additional sales centers, as we continue to expand what we're doing in those areas, that we continue to work and operate more effectively and so we can push more volume growth through the based on the model that we have in place. The other component that is probably the One item that's kind of most significant individually is going to be the reference to the performance based compensation that the additional dollars that are Included in the current expense line, at a kind of a normalized level within our 69% long term organic growth It would be about $30,000,000 less than where it is currently.

Speaker 4

Right, right. Thanks. That makes sense. And then For my follow-up, what are you seeing on the commercial side in terms of demand? I know it's a smaller part of the overall business, but There's been some recent forecast calling for big growth in hotel construction next year.

Speaker 4

I'm just curious what percentage of your overall business Would go into hotel pools.

Speaker 2

Yes. It's still a very small percentage. And honestly, it's one of the larger Opportunities that we have because our market share in commercial pool is smaller than what we would see in the residential area. So, we are very encouraged by the demand that we see, the amount of projects that are being bid and are put out to bid right now. And with the frankly with the boom in travel, as everybody has seen by watching the news, there's a ton of people traveling and the resorts are all busy.

Speaker 2

They're investing money in their aquatic areas, which is very good for us. So whether it's maintenance and repair, whether it's new construction, We see a significant opportunity to continue to grow in that area. We've invested heavily in inventory. We've invested in specialists Programs which we think positions us best to capitalize on the rebound that we've seen after a at the beginning of the pandemic, Certainly that part of the business slowed considerably, but we are very happy with the bounce back and the outlook.

Speaker 4

Thanks. That's really encouraging. I'll leave it there. Thank

Operator

you. Our next question comes from David MacGregor with Longbow Research. Please go ahead with your question.

Speaker 2

Yes. Good morning, everyone. Can you just talk about vendor programs and what changes you may be seeing, if any, with vendor offers on rebate programs, So volume thresholds, dollar rebates for certain unit volumes, how is that evolving in this environment? Yes, the programs really don't Change in structure, right? They're all predicated upon there is a baseline and then there's growth, which is what I mentioned in my comments.

Speaker 2

One of the tailwinds that we had last year as it related to our gross margin has turned into a headwind this year and it has with the timing of the purchases and when we buy. So obviously as lead times come down, I'm going to buy less. So if I'm going to buy less, then that's certainly going to affect the vendor programs, Construct of which really doesn't change. So but again, as I mentioned, that wasn't a surprise to us. We knew it.

Speaker 2

We contemplated it. It was in our calculus of what we were going to do to manage our gross margins. And we would Season winds down and we burn off some inventory and we get into a normal early buy season that the opportunities from a vendor program will continue to be attractive to us. Okay. The second question for me, we've talked a little bit about price cost here in couple of different questions, but maybe coming out of it slightly different way.

Speaker 2

Just ask you, maybe Pete, how your view on second half Price cost may be different now from where it was 90 days ago and what's changed in that few since your last earnings call? Yes. I would say, you asked me on the last call what I The likelihood of future price increases was going to be, I would have said it was more likely than not. And from where I sit today, I don't think we're going to see much more Inflation at least until the early buy program. So I think the pricing environment is more stable, It is which is not necessarily a bad thing.

Speaker 2

I think predictability and stability certainly for our customers is a good thing, but that would be the major change. I don't think it's affected demand, right? So that's the good news. It hasn't affected demand, but I don't really see much change between now and the early buy programs in the fall. Got it.

Speaker 2

Great. Thanks very much. Thank you.

Operator

Our next question comes from Steven Volkmann with Jefferies. Please go ahead with your question.

Speaker 8

Hi. Thanks for squeezing me in. I appreciate it. Just a couple of follow ups, if I could. Is it possible to quantify what you think Mix and share have added to growth over the last couple of years.

Speaker 1

So as we go as we look at those 2 different Really, as you look at mix, we look at that in 2 different pieces. So some of the mix is kind of on the traditional products where we can see that we're Selling more of certain products. So in particular, the individual quarters when we call out, We're building material growth is higher than growth per quarter, chemical growth, those types of things. But as you look at the other way Look at it is the gross margin dollar impact. And so that as it relates to a lot of the variable speed pumps, the LED and really that more automated those automated products that are coming out and more readily available, certainly than they were several years ago.

Speaker 1

We see the increase in sales activity in those particular products. That is actually driving a significant portion of the gross margin dollar increases.

Speaker 8

Okay, thanks. And any thoughts on how much share you've gained through this Kind of COVID situation?

Speaker 1

Yes. We look at that by market. And so the other component of that when we look at the share gains When we go back and reference the number of greenfields that we've opened, as part of every greenfield opening, the expectation there is that we're continuing to capture market share. And so that is one of the strategic purposes behind opening those new locations. So the expansion of the kind of our overall share gains are have been very favorable, but we've done that through our increased investments, and then also our focus on serving the new customers that have come to us looking for the product.

Speaker 1

And so with that, we focus on the options that we have, in particular, our B2B software, the POOL360, that some of our competitors don't have And making sure that those relationships are sticky as we go forward.

Speaker 2

I think it's pretty balanced, Steve, in terms of how much of our growth Product mix, I think it's pretty balanced. And as Melanie says, it varies by market.

Speaker 8

Okay. All right. Fair enough. And maybe a quick follow-up for you, Pete. I know it's not your view here, but obviously the market is taking Sort of a risk off view of 2023 2024.

Speaker 8

So if there were a downturn and I characterize that as meaning a down year or 2 For POOLCORP, what would be your playbook? How do you get more aggressive on M and A? Do Put more greenfields out there or do you kind of batten down the hatches and wait for the storm to pass. How do you view Sort of managing through a downturn and again with the caveat that I don't think that's your view, but I'm just curious, you must have a playbook. Yes.

Speaker 2

I mean, as I mentioned, I think Foolcorp is a very unique company in a very unique industry. And A downturn in one industry doesn't translate to the same results as another. And as we mentioned and I'm not sure everybody has Appreciated is that most of our business is derived from the installed base of pools, which has to be maintained. So whether the new pool construction turns out to be 115,000 or 110,000, 95,000 or 120,000 It's going to have some impact on our business, but most of our business is non discretionary. Over 60% of our business is non Discretionary and that it's tied to the maintenance and repair of the existing installed base, which has to happen.

Speaker 2

And even during the Great Recession, That didn't move. So even if there is some apocalypse scenario from an economic environment, we would expect that part of the business to continue to perform. And if I look at the other two portions of our business, the second one being what we would call semi discretionary, that portion of the business Given home values, which I don't think are going to drop very much because I think home values are being driven as much by supply demand as anything else, There is a net housing shortage. Most people that have purchased a house in the last 5 years are in at very attractive interest rates that would They would pay a significant amount of money if they were to sell their house and refinance. So I don't really think we're going to see a lot of houses change hands given the Interest rate environment, but that translates into stable home equity value.

Speaker 2

So the people that are in a home, we think are going Continue to invest in homes. So we think that our renovation market is again going to be very, very stable. If I look at the new construction business, I would tell you that new construction could swing one way or the other based on a variety of factors, some economic, Weather is always going to be a big factor in how many pools get built and labor, which the labor environment given the current unemployment That we all see every month wouldn't lead any of us to believe that there's going to be a bunch more capacity brought into the industry for new cool construction. So I would say that that portion The business is good and stable. So opportunities that may persist, we're going We continue to run our playbook.

Speaker 2

So we have a very disciplined capital allocation strategy. We're going to continue to invest In the portions of our business necessary to add capacity where we need it. And we don't invest ahead of the capacity need. We use Our capacity creation to expand capacity as much as we possibly can and when we need more than we go out and invest in additional capacity. So that portion of our business will continue.

Speaker 2

We'll continue to invest in technology, which we think is going to improve the customer experience. We think it's going to give And back to everybody involved, whether it's the dealers or whether it's us. So, that's also an important part of our capital allocation strategy. From an M and A perspective, we are a very strategic buyer. We're also a very well capitalized buyer.

Speaker 2

So we're always on the lookout for businesses that I think are valuable and could be valuable to us. And we Certainly have the balance sheet strength to execute on anything out there that we see makes sense. We have a very proven track record of being very with our acquisitions. We don't have to buy anything simply because of our expensive footprint and the infrastructure and the know how that we have. If we see something that is attractive, we certainly have the balance sheet to do it.

Speaker 2

From a valuation perspective, if we think it It makes sense, we do it. If we think that the value that is being requested is beyond what the business is worth in our minds, we certainly have the option unlike Others to simply open a greenfield to capitalize on the opportunity. So we are mindful of the economic environment. We've been leaning into capacity creation before the pandemic, during the pandemic and we'll continue to lean into capacity creation after the pandemic because we think that makes us Better business. We're focused on the customer experience, and making sure that we provide the best level of service, so that Even in a market that may be less robust in the future, we continue to take share and were rewarded for taking care of our customer.

Speaker 2

So could there be opportunities on the M and A side? Certainly. Are we in a position To jump on them if we like them, absolutely. But our overall plan doesn't really change.

Speaker 8

Super. I appreciate all the detail. Thanks so much.

Operator

Our next question comes from Garik Shmois with Loop Capital. Please go ahead with your question.

Speaker 9

Hi. Thanks for squeezing me in. First question is, I was wondering if you could provide how the seasonal market sales progressed throughout the quarter. I'm wondering to the degree they put us back to more comparable levels after weather improved after April.

Speaker 2

Yes. So here's what happens. You have to look at the nature of the business in the seasonal markets, right? So the portion of the business that you won't get back Is the consumables right for when the pool is being used. So if the pool opens up a month later than it would have because it was cold We don't get those back unless on the end of the season that you end up with an extended summer or a late fall, then you sometimes can get those days back, which is why for us it's very early to call the year and say, well, Here's what the seasonal markets are going to look like because so much of it depends on the beginning and the end.

Speaker 2

The good news is in the middle, the capacity is almost at MAX anyway and there's very little growth capacity. So most of our growth comes on the shoulders of the year. On the construction side, Those days you can get back. So if the weather stays good and there is certainly demand for renovation and remodel and new construction, If the weather stays good later in the fall, early in the winter in some cases, then our builders are going to keep working because they have backlogs and customers that they need to satisfy.

Speaker 9

Got it. Appreciate that. My follow-up question is just on the upcoming early buy. You referenced a few times. I know it's a little bit early, but just hoping for some of your thoughts the level of inflation you could see into next year, would it be in the more normal 1% to 2% range?

Speaker 9

Would it be above normal? Or could you see Deflation as you work through your upcoming negotiations due to some of the destocking that's occurring?

Speaker 2

I wish I could tell you more clearly what I think inflation is going to be next year, but unfortunately I don't think anybody knows. What's important is what I mentioned is that I think the inflation that we got meaning that the price I'm paying for products today is it's not going to get any cheaper, meaning that what I'm paying this year is probably cheaper than I'm ever going to pay going forward because I think We'll continue to escalate. How much they escalate going forward remains to be seen. Remember, this is an industry that typically would move prices 1%, sometimes 2% on the inflation side and then we went through a couple of years where inflation was obviously well above the industry norm. Factors that affect us are affecting our manufacturers as it relates to their operating costs, whether it's people, whether it's real estate, whether it's raw material.

Speaker 2

So I would tell you, I guess thematically that I think inflation next year is going to be above the norm. I don't I guess I'm not convinced that it's going to be as much as we saw this year, but it's again Very soon to tell, but I think that inflation is going to be well above the norm next year as well.

Speaker 9

Great. No, I appreciate that. Thanks.

Operator

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

Speaker 2

Thank you everyone for joining the call today. We look forward to reporting our 3rd Order 2022 results on October 20. Have a great day and we will talk to you then. Thank you.

Operator

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

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Earnings Conference Call
Pool Q2 2022
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