Pool Corporation

Good morning and welcome to the Poole Corporation first quarter 2020 conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Mark Joslin, Senior Vice President and Chief Financial Officer. Please go ahead.

All right. Thank you. Good morning, everyone, and welcome to our first quarter call. I'd 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 made therefor 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 measures is included in our press release and posted to our corporate website in our investor relations section. I'll turn the call over now to our president and CEO, Peter Arvin. Pete?

Thank you, Mark, and good morning to everyone on the call. After a very solid start to the season, driven by favorable weather and strong underlying demand, we started to see things slow or level off in the latter half of March as our North American and European businesses grappled with the effects of the COVID-19 pandemic and the associated stay-at-home orders. You should note that we have been designated as an essential business in most of our markets, allowing us to remain open in almost all areas. I am extremely proud and thankful For our team at Fullcorp, their professionalism, dedication, and creativity has led to a new level of service and safety protocols throughout our network. Additionally, our experienced management team and strong balance sheet position us well to weather these tumultuous times. Under normal circumstances, I would take you through our performance results for the quarter and provide some color on what happened and why. These are clearly not normal circumstances, so I'm going to spend very little time commenting on the first quarter and talk about the current environment, how we are dealing with it, and what we are seeing for the future. Mark will provide more information about the first quarter shortly. Recapping our first quarter, revenues rose 13% in both our base and total business to a record $677.3 million. driven by an early spring, which, as you know, results in pools opening sooner and customers getting a jump start on construction and remodel activities. While we did have a strong start to the season, and that has continued in several areas, including Florida and the southeast, we saw a definite shift midway through March as certain municipalities, particularly in California, the northeast, and the midwest, implemented stay-at-home orders that limited our customers' ability to operate. Looking at our year-round markets, we saw revenue growth of 11 percent, driven by very strong performances in both California and Arizona, with 14 and 15 percent growth, respectively. Florida posted solid gains, with revenue up 8 percent, while Texas felt the effects of a colder and wetter spring and saw 6 percent sales growth. From an end-market perspective, commercial sales were modestly better, with sales up 5 percent. This follows the 8 percent growth that we saw in 2019. Commercial projects can be somewhat cyclical and represent about 30% of our total commercial business. Bid and spec activity has been healthy, but we have seen slower demand through the latter part of March and into April for maintenance and repair of these pools, as many have been closed due to the pandemic. Keep in mind that the commercial business only represents 5% of our total revenue. Turning to residential demand, retail sales were strong in the first quarter and were up 14% in line with the overall business. Again, the earlier opening of pools and the shift in growth in early buy deliveries no doubt helped drive the increase. Like other parts of our business, current activities vary from very strong to somewhat soft in areas where retail store traffic has been limited. From a product perspective, chemical sales were up 16 percent for the quarter, while equipment sales rose 18 percent in the same period, both a good sign that demand for maintenance, repair, and replacement products are strong. Sales of building materials were also strong for the first quarter, growing 14%, which is encouraging as it shows that there is solid demand in the construction and remodel markets. It is worth pointing out again that we also saw slowing construction and remodel activities starting in late March in several markets that were affected by state and local orders halting or curtailing pool renovation, construction, and openings. Spending on maintenance and repair is continuing at normal levels across most of our markets based on April activity. Our international operations experienced more significant effects during the end of the quarter as Europe felt the effects of the pandemic earlier than North America. In response to government orders, we closed or curtailed operations for several weeks in France, Spain, Italy, and throughout the continent, resulting in revenues being down 8% for the quarter, after being up double digits through the end of February. Horizon sales ended the first quarter flat with the previous year, again driven by the effects of various stay-at-home orders and delays in projects as contractors and municipalities navigate the current situation. We also welcome Jeff Clay as our new president of Horizon. He brings a solid background and a skill set to this important platform, and his focus is to continue improving and expanding our green business. I want to thank Dave Cook for his leadership of Horizon over the last two-plus years. Dave implemented numerous improvements during his Horizon tenure and is returning his full-time focus to leading our Western U.S. swimming pool operations and our sourcing team. Also in the quarter, we closed on the acquisition of Master Tile Network, a seven-location distributor of swimming pool tile at Hardscape. This will continue to strengthen our portfolio in this strategic product area. Operating income for the first quarter, excluding non-cash impairments, was $42.5 million, which is an 11% increase over the first quarter of 2019. Excluding impairments and tax benefits, recognizing the quarter diluted earnings per share were $0.71, up 20% over last year. As we enter the second quarter, we are confronted with a far different environment than we enjoyed coming into the first quarter. The remainder of my prepared comments will focus on how we are altering our operations and adapting to this new and uncertain environment, and how we are preparing for what may lie ahead. First and foremost, the safety of our employees and customers is the highest priority. We have implemented rigorous sanitization and hygiene protocols in all facilities, providing sanitization supplies, personal protective equipment, and establishing physical distancing procedures for safely serving our customers. I'm happy to report that while one is too many, we have only had 10 reported cases amongst our worldwide team of over 4,500 people. We will continue to observe and reinforce these protocols in line with public health official direction. As we survey our customers, we are finding that most have plenty of work to do and are continuing to provide their services to their customers within the local restrictions. Anecdotally, we have heard many reports of homeowners accelerating projects while sheltering in place at home. However, we have also heard in some markets construction projects are slowing down, being deferred, or in some cases canceled altogether for at least the short term. Permitting office closures, subcontractor availability, and retail store closings are all currently contributing to a more challenging business environment. Despite this, we are continuing to find innovative ways to serve our customers and assisting them in rethinking their customer service processes to deal with these new circumstances. As we continue to feel our way through these unprecedented times, we are anticipating a variety of different scenarios of how the rest of 2020 will play out. Here is what to expect at this point. We think consumer spending on swimming pool maintenance products will be close to normal levels with a potential upside from increased pool use as families stay at home in lieu of vacation travel and other leisure activities. We expect that discretionary spending could be somewhat suppressed on new pool construction and remodeling activities during the second and third quarters. It is likely that as restrictions are gradually lifted, we will see an improvement in market conditions as we move into May and June. There is the potential for increased pricing pressure as competitors fight to maintain cash flow, which could result in gross margin headwinds during 2020. We will, as we always have, intelligently manage our costs in response to these market conditions. In summary, we have a very strong business led by a seasoned management team. No one in our industry is better positioned to weather the economic uncertainty than Poole. We believe that as the economy begins to reopen, families may choose to invest in a backyard pool and outdoor living, opting for the safety and security it can provide versus the uncertainty of cruises, global travel, and resorts. We have taken the necessary steps to weather the short-term uncertainties by trimming our operating costs and have the benefit of a robust balance sheet with more than ample liquidity. Additionally, we have reduced and refocused our CapEx spending, prioritizing those items with the quickest payback while delaying other expenditures until we have more clarity around when the economy fully reopens. While some markets have seen the negative effects of the stay-at-home orders, others are faring much better. This uncertainty brought on by the COVID-19 pandemic has prompted us to update our guidance to reflect the impact it may have on our 2020 results. We are revising our 2020 Earnings per share guidance to $5.30 to $5.90, including the impact of the tax benefit of $0.19 and the $0.15 non-cash impairment that we recorded in the first quarter of 2020. Excluding the impact of non-cash impairments, adjusted 2020 diluted earnings per share would be $5.45 to $6.05. Before I turn the call over to Mark, I'd just like to thank the men and women of PoolCorp for their dedication and passion to be the best distributor for our customers and the best channel to market for our valued suppliers. Our team has once again shown why they are simply the best. Now I will turn the call over to Mark for his commentary. Thanks, Pete.

I'm going to discuss four topics in my prepared remarks this morning. I'll start with comments on our balance sheet followed by a few highlights of our first quarter performance. Then I'll discuss short-term actions we are taking now to rein in expenses and finish with our expectations for the future as we see them today. I'll begin by reiterating statements made in our press release related to our balance sheet. We are in the fortunate position of having entered 2020 with a very strong balance sheet. We have secure, low-cost access to capital with substantial untapped availability at our disposal. We began the year with low leverage that has been trending lower, which at 1.49 at the end of March was just below the bottom of our targeted leverage range of 1.5 to 2 times. Add to this that we have substantial inventory positions as we enter the annual peak pool season with supply chain dynamics that should meet our customer needs into and through the season. Also important to keep in mind, as with most wholesale distribution businesses, our cash flow is counter-cyclical to sales and should do well in a downturn. Our balance sheet provides us with a lot of opportunity and flexibility, as well as a significant competitive advantage compared to our substantially smaller competitors, who in many cases will be cash constrained. We are doing what we need to do to protect our position and direct continuing investments where returns are shorter term and clear. We've reworked our 2020 capital plan to reduce spend by about 50 percent or $20 million, while continuing to pursue investment and growth opportunities with near-term benefits such as those that provide safer and more efficient interactions with our customers. We will continue to pay a dividend, as communicated in our press release this morning, and we will buy back shares opportunistically, as we did in the first quarter. In summary, we believe our balance sheet position gives us a distinct advantage that we will be able to utilize throughout the economic cycle, however it progresses. Now just a few comments on our first quarter results. Let me remind you that on our year-end call to very long months ago, I stated that our Q1 sales and margins would be impacted by a pull forward from Q2 of lower margin customer early buy sales that I estimated to be $10 to $15 million, and that margins would be further impacted by a 90 basis points headwind from margin gains in Q1 2019. The early buy sales increase was larger than expected at $28 million and along with the tough calm from 2019, the primary cause for our 120 basis point margin decline in Q1. As noted in our release, we benefited from an extra selling day in the quarter, which is the only quarter this year with a difference in selling days compared to 2019. Our operating expenses increased 8% over last year, excluding the asset impairment charges of 6.9 million. Given our sales growth, this was a very good result. As a percent of sales, our operating expenses were 21.7%, down 110 basis points from 2019. Note that our interest in other line was down 1.8 million year-over-year, as we benefited from lower debt, which was down 16% from last year, as well as the lower interest rates. On the tax line, if you exclude the ASU benefit and the tax impact of the impairment charge, our tax rate for the quarter was in line with our projected 25.5% for the year. On our balance sheet, growth in net receivables of 10% reflects our sales growth in the quarter, while our inventories grew at a more modest 5%. On our cash flow statement, the growth in our receivables was the main reason that cash flow from operations fell short of last year by 9 million. Now I'll give you a view into some of the actions we've taken to improve our cost position given the current state of our business as we've described it, as well as the uncertainty about future conditions. We've taken immediate actions to reduce our operating expenses in the short term and retain options for further reductions in the future as warranted. I'm not going to quantify the impact of most of these here as the net savings is included in our guidance range, but I wanted to give you an idea of some of the short-term actions we're taking. Employee-related costs were 15% of our SG&A spend in 2019, and certainly one area we're looking at for cost reductions. One self-regulating part of this spend is incentive-based compensation. Base pay at Pool Corp is generally modest, with more paid-type performance as positions increase in responsibilities. In total, we see a potential cost reduction in the range of $10 million in this area in 2020 compared to 2019. For our senior management team, Pete and I included, the fixed component of our compensation is about 15% of our total compensation, and we expect our total cash compensation to be about 50% of our targeted cash compensation this year, based on the company's expected performance. In addition to this, one of the first steps we took was to put a hiring freeze in place, excluding new hires for our management development program that we will continue to invest in. In our domestic business, we had 4,100 employees at the end of March, with our salaried employee count down 3% and an hourly employee count up 8% from last year. This includes the impact of nine new location openings since last March and four net locations purchased as part of our master tile acquisition in February. Largely through attrition and targeted action where warranted, we expect our labor cost savings to grow over the course of the year depending on conditions. Other areas we expect to see cost savings include overtime pay and outside labor, travel and entertainment expenses, and advertising, to name a few of the many discretionary cost areas we are cutting back. In addition, lower capital spending will have a positive impact on depreciation costs, as will lower fuel costs for delivery and administrative vehicles. One area that will be a challenge for us to impact is facility costs as the industrial lease market remains fairly stable, and we work through existing leases signed in the past with locked-in rate increases. Looking forward to the rest of the year, we've provided guidance for the year that is wider than normal to encompass a range of economic outcomes impacting the discretionary parts of our business. Both ends of our guidance range anticipate Q2 sales that are down approximately 5% from 2019, with social distancing restrictions easing gradually beginning in May. In the second half of the year, the top of our range anticipates sales growth of 2.5%, as we believe softening of demand for discretionary products would have an impact on our previously expected sales growth, while the bottom end of our range anticipates second-half sales that are down 7%, as the economic toll on homeowners has the potential to rein in discretionary spending more significantly. This results in sales growth of 2% for the year in the top of our range and 2.5% down for our bottom of the range case. In both cases, gross margin would be impacted by the tough comp in Q2, where 2019 gross margin was up 30 basis points from 2018, and by slightly lower purchase volume incentives for the remainder of the year. In the downside case, we have also factored in more aggressive price competition as capital-constrained competitors may seek to convert inventories to cash. As mentioned, actions taken to reduce operating expenses should help mitigate the softening sales and margin environment with the expectation that we would have a modest expense growth for the year in our top of the range case and modestly lower expenses for the remainder of the year in our bottom of the range case. For those of you looking to model the impact of the coming recession to the last one, let me leave you with a couple of thoughts. The first is that the origin and nature of the two recessions are very different. The Great Recession was brought on by a collapse in the housing market, which triggered avoidance of housing-related investments. The current economic decline, as you know, has been brought on by social distancing and is characterized by families staying at home. a fact of life that in some fashion will remain for some time. As opposed to avoidance, this recession has the potential to spur housing investment for those who can afford it. The other significant consideration, which I covered at our Investor Day meeting last fall, is that our business today is larger but similar in many respects to our business in 2016, with a primary difference being the mix of our sales. We have a greater mix of non-discretionary sales and lower mix of fully discretionary sales today than we did preceding the last recession. This is best exemplified by looking at the most discretionary parts of our business, which are construction of new pools and irrigation system installations. In 2006, there were approximately 215,000 new pools constructed in the U.S., That fell by more than 80% to about 40,000 pools in 2009 and has since recovered to about 80,000 new pools built in 2019, still down 60% from peak. Similarly, irrigation system installations have not recovered to pre-recession peaks as new home construction, a leading indicator of irrigation system installations, is about half of what it was in 2006. This is the primary reason that our horizon business sales in 2019 were 9% of total company sales, down from 13% in 2006. To sum this discussion up, we think that our business today is in a better position than it was before the Great Recession and less likely to have as adverse an outcome, assuming similar economic conditions. With that, I'll turn the call back to our operator to begin our question and answer session.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from David Mancy with Baird. Please go ahead.

Hey, good morning, guys. This is Quinn Fredrickson on for Dave. Morning, Quinn. So you guys mentioned, you know, the pool builders have started to see some instances of cancellations for new pools going in. And I think, you know, you had mentioned earlier, previously that the backlog entering this year was pretty strong and had been strong in the early part of the year prior to obviously the COVID. With that in mind, the existing backlog and then the cancellations that have already occurred, how are customers characterizing the environment for new pool construction this year?

Yeah, Good question. The answer to the question, it varies by region. Overall, I would tell you that there is still plenty of work in the system. Builders entered the season with very good, very solid backlogs. I was talking to one in the southeast this morning who's already out till August for new pool construction. So I think it depends on what part of the country that you're in. But overall, I would tell you that the backlogs are good. The cancellations at this point have been relatively minor. And I've not heard of any cases where cancellations have builders and subcontractors standing around with no work to do. So part of the slowdown, I think, is simply a function of, as I said, the availability of subcontractors, and then some reticence on some homeowners' parts to have people in the yard working. But overall, I would tell you that the backlogs are still good, still solid, and our builders at this point are still optimistic about the amount of work that is out there and what is likely to come out of the back half of this.

Okay, thank you. And then just any thoughts right now on DSOs, quality of receivables, past dues?

Yeah, this is Mark. And really, first of all, at the end of the first quarter, we were in great shape, actually improved on past dues from where we were a year ago. You know, in some cases where our customers are not working in the short term, there are some issues that we're working through. but we feel very good about the state of our customers, the health of our customers, and our ability to work with them through the season on collections. So not a concern for me at this point.

Okay, thank you very much. The next question is from Anthony Libidzinski with Sidoti & Company. Please go ahead.

Yes, good morning, and thank you for taking the questions. So just first on the Q1, Would you guys be able to perhaps quantify the estimated impact of the mild weather on Q1? And also, I know you mentioned that sales of discretionary products were up in Q1. I'm just wondering if you think that there was any potential pull forward of demand?

Anthony, in terms of the weather impact, I mean, 13%, you know, compared to a modest growth in the first quarter of last year. you know, how much of that 13% was weather related. If I had to throw a number out there as a guess, maybe 3%, something like that. So it wasn't insignificant. In terms of pull forward, I mentioned that the $28 million or so in early buy sales increased, which is To some extent, due to the warmer weather, a little bit earlier Easter this year, and just a good solid start to the season, which had our customers busy earlier than last year.

Got it. Okay. And then a couple of more questions, if I may. So you mentioned that April to date sales are down somewhere between 5% and 10%, depending on the region. Just wondering if you could give us some more color about if you were to break down the That's sales maintenance versus the discretionary product sales trends?

Yeah. Here's what I would say. So in April, we said we saw numbers that were down 5% to 10%. I would tell you that that has actually gotten better as the month has gone on. So we see a more positive trend towards the upper end of that range, if you will, in terms of being down closer to 5 percent than the 10 percent. Maintenance and repair business is strong, you know, as the pools are open and being used and chemical usage as there's a lot of kids in the pool. In terms of construction, again, it really is a function of where the folks are working. So, in the areas where the contractors, in some parts of the country, the contractors really never miss the beat and are working and have been working and construction material sales have been have been very good it's only in certain pockets where the government has local municipalities I should say have shut down shut down construction and we see that changing almost almost daily as more areas are being permitted to work okay got it okay and then mark you mentioned that you lowered your capex outlook so how should we think about capex now for 2020

You know, roughly half of what it was last year in the $20 million range.

Got it. Okay. And last question for me, as far as the write-down of a long-term note for $2.5 million, can you give us a little bit more color on that, please? No.

But thanks for asking it.

Okay.

Thank you. All right. The next question is from Blake Hirschman with Stevens. Please go ahead.

Yeah, good morning, guys. Morning.

Good morning.

I think you said something about your expectation for pricing being a little bit less. I think it had to do with just the expectation that the competition might get a little bit more aggressive as activity slows. Can this still be a normal situation? pricing year? Or, I mean, should we be thinking like a step change, like hundreds of basis points in the Delta versus, you know, what you guys were thinking a few months back?

Yeah, Blake, this is Mark. And what I mentioned was that really two scenarios, top of our range scenario and bottom of the range scenario. And in bottom-of-the-range scenario, we tried to anticipate that this year is very unusual. Even compared to the last recession, we're seeing a very sudden slowdown in the economy, and that could have an impact on some of our competitors, as I mentioned, cash-constrained, generally speaking. And if for some reason the economy softens more than what we anticipate in the top of our range guidance, they could be some of them that are looking to monetize inventory. And in terms of the impact, you know, it's relatively modest in the scheme of things and certainly nothing like, you know, hundreds of basis points and pricing and really just a temporary phenomenon that's not going to be an ongoing issue.

Okay, got it. Perfect. And do you have any rough guess as to how much of like your contractor customer base is still up and running or just any color you can give on to what degree they've kept their people versus, you know, kind of cutting the staff or cutting their hours or anything along those lines. Because I know labor capacity can be an issue for you guys just in trying to meet the level of underlying demand. So I'm trying to get a better feel for that for the season. Thanks.

Yeah, good question. I would tell you in my conversations with builders across the country and our team, You know, I guess the way to characterize this is the vast majority of the dealers are still working, right? I mean, they break their work down into maintenance, repair, and construction. So certainly in the areas where there has been a very hard stop to pool construction, that would be a very small percentage of our business in total. And if I look at the geographies, you know, that I had mentioned earlier, Some parts of Northern California, for instance, very, very tough. New York, Pennsylvania have been very tough. But again, we just, for instance, in Pennsylvania, New Jersey, and Connecticut, we found out this morning that they have now released pool construction. So that will start to open up. So as I think about it across the country, It's not been a huge step function of people that were unemployed. I think a lot of them slowed down, idled, shifted some of their activities, but I didn't see a whole bunch of folks being put on the street as a result of that.

Okay, got it. That makes sense. I'll hop back into you. Thanks.

Thank you. The next question is from Paul Dirks with William Blair. Please go ahead.

Hey, good morning, everyone. Good morning. Morning. Just a few quick ones for me, if I may. First of all, I appreciate all the extra transparency and color on how you're thinking about the year. You know, contemplating both the high and low ends of the range for sales and gross margin performance, maybe you could put a little bit of a finer point on how you're thinking about your commercial business and European business, which, while each of them is relatively small as a percentage of the year, sales and earnings could at least have a bit of a disproportionate effect here in the near term. If you could talk a little bit about those two parts of the business.

Yeah, so for perspective, as I quantified the commercial business, remember it is about 5% of our total revenues. And 30% of it is bid and spec activity. You know, that is, the bid and spec activity is still going on. How many of those projects actually get built, it's still very early to tell. Where we have seen the curtailment is on the consumables, if you will. So, for instance, if you have, you know, the big competition pools and resort pools, it's not – you really can't drain them, right, for a very long period of time. So they basically could be drained for maintenance. But for the most part, the same three things that you always have to do with water, which is move the water, filter the water, and treat the water, have to happen, right? The difference is that the amount of chemicals that the pools will use is really a function of the bather load they call the number of people in the pool. So we think that we'll see a compression in that depending on what they decide with pools. What's interesting is the problem is actually really not the pool itself. The pool is – they're really – You know, as the CDC has mentioned, a properly maintained pool doesn't represent the risk. It's really the surrounding areas that have the municipalities and hotels and motels concerned about the pool. But in terms of quantifying it, again, given that it's 5% of our revenue and wouldn't be in our highest margin category, I don't know that there is a number in there that's worth you quantifying. You know, when I think about Europe, on the other hand, Europe is – we saw the slowdown earlier. It's coming back. I was on the phone with our European folks yesterday, and there is quite a bit of pent-up demand. The weather is good, and Europe is starting to open up. But again, in terms of a revenue perspective, it's about 4% of our revenue in total. So again, in terms of the percentages of our profits, it's relatively low. So again, I don't know as far as modeling that I would take the time to go out that far in decimal places.

Got it. No, that's a very helpful call. I appreciate that. You know, on the technology side, obviously you guys continue to invest in those initiatives. Maybe you could talk about how your online ordering, Pool 360, trended in the quarter. And are you able to ramp the Blue Streak mobile order processing technology to more and more service centers in this environment?

Yep. So let me talk about Pool 360 first. So Pool 360, again, as you know, has been a hot button for me and a focus area for the whole business really very intently for the last 15 months. And we have seen progressively more usage on the tool. In fact, for the first quarter, sales through the tool were up 32%, I believe. So we've seen continued adoption of the tool, and our team is getting better at, frankly, getting customers comfortable with the tool. So that continues to roll. What we didn't see, and if you go back to my earlier comments on previous calls, the growth rate, you know, we've been in that 20% to 30% growth range. So what we didn't see this last quarter, and again, as far as the impact on the third quarter or first quarter was still relatively late, But we didn't see a huge spike, and I look at it weekly. So it's up. It continues to be up, but it's not like there was a step function change. And the reason for that is the nature of our business, and it's one of the beauties of our business in that 70% of our transactions still take place at the counter. So there is a lot of value that our teams provide the customers. Certainly, adoption of the tool is growing, but most of our customers still prefer to go into the sales center to make their purchases. Blue Streak, on the other hand, enables and speeds the customer experience at the sales center because we use it in two ways. One is we use it for where we're selling bulk chemicals of bleach and acid outside. The customers don't even have to come in. They scan a card, sign the name with their finger, and they're on their way. We are scaling up in that by the end of the year, we hope to have about half of our centers live with Blue Streak, and we are ramping up, obviously, in these times because we view it as something that is beneficial for our safety program and also beneficial for the customers.

A very helpful caller. Lastly, Mark, you know, on the buyback activity, how should we think about that in terms of the fact that I certainly appreciate the reduced capex here and M&A discussions could be a little bit harder to complete in the near term given so much uncertainty. Should we expect to see any pause or perhaps could we see a little bit more of a meaningful ramp in that over the course of the year depending on how the sales and earnings trends go?

Yeah, Paul, good question. And certainly that is not an area where we are going to be withholding capital. We will continue to buy opportunistically, as we have done in the past, and have a substantial capacity to do that. So you'll be seeing more activity there as we move forward.

Very good. I'll pass it on. Thanks, guys. Thank you. Thanks.

The next question is from Stephen Volkman with Jefferies. Please go ahead.

Hi. I actually had a couple of cash flow questions, but can I just follow up quickly on the blue streak thing, Peter? In the stores where you have that running well, does it result in quicker throughput or higher margins? What kind of early returns are you seeing there?

Yeah, it doesn't change the margin profile of the business because it doesn't have an impact. Gross margins, I should say. But what it does do, it adds capacity for us. So it certainly speeds the throughput in the branches. So what we've done, if you remember last year, we talked about speed at the counter. And it simply eliminates the folks having to go get in line at the counter for things that they pull up, load their truck, sign with their finger, and leave. So, basically, it adds capacity and lowers our OPEX to serve that same sale.

Okay. Great. Thanks. And, Mark, what should we be thinking about, you know, relative to your new guidance range in terms of working capital?

In terms of our investment in working capital, well, first of all, you know, cash flow overall, I seem to have, like, Tren, my comments, some of what I meant to say ended up on the cutting room floor related to cash flow from operations. When I looked at our 2007 to 2009 cash flow from operations, it was 190% cumulatively over that time period. So, you know, if there is a downturn or significant downturn, we expect cash flow to be very strong. From a working capital standpoint, we started the year, as I said, pretty well inventoried, if you will, and expect to trim that as we get into the end of the season. And really, from a receivable standpoint, as I mentioned, I feel good about our customers and their ability to maintain payments. So I think we're going to have a very strong year from a cash flow perspective.

Okay, and then just the final one for me. It sounds like you're expecting some of your competitors to have some operating issues, and I guess it strikes me that that could free up some acquisition targets. And I don't know if maybe you want to talk about sort of previous recessions and if that is an opportunity there or if it's smarter to just kind of wait it out and see – if you can maybe take the share organically or something.

Yeah, and I would say a couple things. I do think that, in general, our competitors are cash-constrained. In fact, I know they are. And what that means more than anything is we have the ability to invest in the products and services and staff effectively. You know, we should, as we did in the last recession, be able to take even more share than we would during normal times. And so I think it's a very good share gain opportunity for us. In terms of acquisition targets, you know, companies don't like to sell necessarily at the bottom of the price range. And so for... You know, earnings dips, that makes it sometimes harder for them to justify that. We didn't see a lot of businesses come up for sale in 2008, 2009. But at the same time, I do think there will be some opportunities and we will be, you know, looking at those opportunities that make sense for us, particularly in areas where we have market share opportunities that we want to capitalize on.

Great. That's helpful. And actually, I just thought of one more, if I can sneak it in. Peter, you talked about social distancing and extra cleaning and all that kind of stuff. Does that drive any type of a productivity hit in terms of margin at the existing stores?

No, we really haven't seen that. I mean, we've equipped the folks with the proper PPE, and that doesn't really have an impact on, you know, how they conduct their job. They spend a little more time cleaning, you know, between customers, wiping down counters and doors and things like that. You know, for some of our locations where the showrooms are, in fact, closed, it may actually speed things up because in those cases the orders are being phoned in. and they're put in priority pick and they basically pull their truck up, we load their truck and they leave. So I would say there's not a huge gain or a huge drag because there are things that benefit just as much as there are a little more time spent on housekeeping.

I understood. Thank you so much.

Yep.

Thank you. The next question is from David McGregor with Longbow Research. Please go ahead.

Yes. Good morning, everyone. I hope you're all keeping well. I wanted to just a few questions. First of all, thanks for all the granularity around the operating expenses. That was really helpful, but maybe just coming at it from a slightly different direction. Is there any way you can characterize fixed versus variable for us?

Well, yeah. So let me first of all, just give you a little more color into how our costs break down. I mentioned some of it in the comments. So if you look at our SG&A costs, 57% of those are employee related, 13% are facility related, and 9% are freight, with the remaining 21% being everything else. On the employee side, the 57%, the biggest part of that is You've got, I mentioned the incentive comp, and there is certainly a lot of hourly labor that is somewhat flexible given the volume of business. So of that 57%, I would say less than 20% of that, I would say, is more variable in the short range. and certainly variability exists more in the longer term. The facility cost, 13%, very inflexible in the short range until leases come up for renewal. We have our leases generally are five-year terms, so each year about 20% of our leases are coming up for renewal, and that's the opportunity to make changes there. And then freight is very variable, of course. And then the 21%, everything else, It's a mix there, but I would say maybe 20% of that has more variability to it than the rest of it.

Okay. That's great. That's very helpful. Thanks very much. With respect to a previous question with regard to the online sales, and you had talked about the fact that the gross margins aren't that much different, but obviously lower op-ex is lower cost to serve. Is there any way you can help us understand just how it may differ, a store sale versus an online dollar sale at the EBIT line?

Let me think about that for a moment. So it really, if I think about the amount of time that is spent by the customer service folks entering the order versus the customer entering it online, at the end of the day, there is certainly some productivity, but it comes really in the form of we're continuing to grow. So it really is a capacity add for the business, right? So it's not as much as, hey, as more business shifts to online, we're not releasing people as a result of that. Frankly, it's just freeing up capacity for us to grow. So it basically slows the rate at which we have to add cost because, as you know, when you add labor and when you add cost in the facilities – It goes in step function. You can't add it on a percentage-by-percentage basis. Over time, we get better because we add less cost in order to serve the incremental sales dollars.

Got it. That makes sense. Again, in responding to a previous question, you had noted that there was a tremendous organic growth opportunity right now, just given you've got competitors that are feeling duresque. Is there anything that you can do in terms of tweaking your internal incentives that would help you accelerate on that organic growth opportunity?

Yeah, I think the way our incentive plans are laid out today, they're fine. There's nothing that we would need to do to say, hey, go out and grow, because we're an organic growth-based company. That's what all of our plans are driven around, and it's a complete add-em-up from the sales center level all the way up to Mark and myself. So it's not like, you know, that the folks aren't rewarded for growth. They're rewarded for profitable growth today. And the situation that we may be in right now as it relates to potential upside, I don't think warrants any change in our comp plan. I think we're very fortunate that we are a, A, we're an organic growth company that's really in our fiber and DNA. And that's what drives everybody every day. And the incentive plans over time have evolved around that same thing.

Last question for me on that point is just your plans with respect to new store openings over the next year or two and how you should think about first-year productivity.

Yeah, so for this year, we have one location that is on the books that will open up in the next 60 days-ish, assuming we can get the proper inspections that we need to open up. After that, when we talked about deferral of CapEx and tapping the brakes until we see how things shake out from an economic perspective, we planned on opening more. Last year we opened up, I think it was nine facilities, and we said there would be a similar number this year. On balance, we're actually very pleased with the ones that we opened up. The class of 19 and the class of 18 are all doing very well, actually ahead of expectations. But given the uncertainty in the economic future right now, we said we got one that was ready to go. We kept going with that. And we have several others approved in other geographies. And if we see that there is still the need and to add that capacity, then we'll move forward with those. We're certainly in a position from a from a capital strength and balance sheet to forge ahead. But we've decided at this point, let's just tap the brakes and see what happens over the next quarter and then decide how fast we ramp that back up. That makes sense. Thank you very much.

Sure. The next question is from Ken Ziener with KeyBank. Please go ahead.

Morning, everybody. Good morning. Morning, Ken. You still like this industry versus your old one, don't you? Absolutely. I appreciate the range. It's a wide range. I think that's wise. Mark, if you could just kind of go through this high and low. We're currently at the lower end of the estimates, and part of that issue is from assumptions. What is your assumption on that high and low for new construction? And if stuff doesn't pick up, in May, i.e. less social distancing. How are you, I mean, is that, how much social distancing, I mean, I'm just trying to get sensitivity around each of these inputs, because you guys have obviously a lot of insight, and the industry structure is good, but nobody really knows. So how can you kind of affirm your confidence in this high-low range as it relates to the new and discretionary categories?

Yeah, Ken, you know, First of all, in terms of the second quarter, we don't see a big impact on the discretionary parts of the business, given that there's a lot of pent-up demand entering the season. There are jobs that are in process that have been halted in some areas by government order. But once the government restrictions lift, then those jobs will certainly continue. So the variability really is more in the second half of the year, and we believe it's likely that construction and remodeling will have some softening demand associated with it. And just really varied our expectations between that base case and downside case around that part of the business. The discretionary. Yeah, the discretionary. The maintenance business during the Great Recession actually went up in the range of 5% a year in 2009.

Okay, so if I could, the discretionary. 15% of sales was new pools in FY19. Because there's a backlog, you actually have more confidence on that kind of, let's say, flat or slightly up market versus the discretionary, which has less visibility backlog and, you know, there's less discussion in terms of how much physical work needs to be done. Is that accurate?

Yeah. I think it's accurate that, yeah, we have backlog coming in, and actually, you know, we're getting a lot of anecdotal input about dealers that are getting more calls from homeowners who are looking to add pools as they have more time at home. and it's just a little unclear as to what will happen with those as the season progresses into the back half of the year. So we've been cautious in our guidance in the back half of the year.

Okay. Just housekeeping then. What would the interest expense be? And then could you just comment the lag effect that, you know, I think obviously homeowners, school owners specifically, tend to be more affluent in terms of the composition and job stability than the headline job claims that we've been seeing, which are devastating. So could you kind of talk about your comments around what you know or try to quantify homeowners, pool owners, medium income, home values, that type of thing, as well as the interest expense for the year? Thank you very much.

Yeah, well, interest expense, as I mentioned, rates are down. Our debt is down, so I'll let you model out what you think our debt will be, but we're paying around 2% all in on interest at this point in time, which is down from what it was last year, and certainly the year-over-year interest cost will be lower going forward than what it was a year ago. In terms of the typical Pool owner and, let's say, potential pool owner, there should be less impact, generally speaking, on those individuals. Certainly homeowners in general are less impacted than, I would say, renters in general. If you look at industries and the employees in those industries that are are not working right now and where, you know, there's going to be more of a drag going forward. And so we feel like, you know, the economic sensitivity is less in our customer base than in the economy overall and should be good for our industry as it will be for us.

Thank you.

All right. Thank you, Ken. Thanks, Ken.

The next question is from Garrick Schmoys with Loop Capital. Please go ahead. Hi, thanks. Thanks for squeezing me in.

I just want to ask on the non-discretionary part of the business. It seems like it's holding up pretty good right now, but have you seen any signs of residential pool owners deferring at all on non-discretionary? I think you talked a little bit about it, but how did this hold up in prior recessions?

I'm sorry, can you repeat that again? What was your question about?

Yeah, the non-discretionary piece. Are you seeing people defer or extend out how often they need to use the chemicals and the cleaners in their pools right now?

Yeah, I got it now. No, again, that's the beauty of our business. There's three things that have to happen when you have a pool. You have to move the water, filter the water, and treat the water. And the amount of treatment that goes into the pool really is a function of how much the pool gets used. The more you use the pool, the more chemicals it will take to maintain the balanced water. Given the cost to do that versus the damage that can be done to the pool and the investment and, you know, nobody wants a green mosquito swamp in their backyard. So, I mean, that's, again, one of the beauties of the business is that as the installed base grows, every time a pool goes in the ground, we gain a potential customer for life. So we've seen no reduction. And even if you look at, you know, as Mark said, look at when you contrast the economic conditions of the Great Recession and today and how very different they were, even in that, which I would argue was far worse from an economic condition that would be far more long-lasting than I think the one we're in now, the non-discretionary part of our business continued to grow. And we expect that same thing to happen today. Well, and you have people staying at home, right? Right, and of course they're using the pool more because you've got a bunch of, it's funny, I got a note from a friend of mine this morning and said, hey, I for one am helping you out because my grandkids are in the pool every day because they're all stuck here and can't go to school. So he says, my pool spend is going up. You're welcome.

That's helpful. One of the, just to go back around on gross margins, maybe I missed it, but If you just talk about the gross margin expectations within your guidance range, you're looking for generally flat gross margins coming into the year, down in the first half, up in the second half. It seems like mixed could be positive for you, but then you talked about pricing being a little bit uncertain. So how should we think about gross margins as we move through the rest of the year?

Sure. Yeah, and let me just kind of recap what I said previously. Second quarter, we have a headwind, as I think I mentioned coming into the year. We had 30 basis points of gross margin improvement in the second quarter of 2019, largely driven by some continuing pre-inventory purchases, pre-price increase purchases in 2018 that we were still selling in 2019. So that is a headwind, as it was in the first quarter, and we expect continue to expect, as we did coming into the season, that that would be difficult. And let's just assume that we're down 30 basis points in the second quarter. And then really the back half of the year, instead of being up, I would say more flattish. I mentioned purchase volumes being down. That affects our purchase price, and that's in both cases. But really the downside case, or the one that gets closer to the bottom of our range, anticipates that there could be some competitive pricing pressures as our competitors look to convert Dory to cash. So that's relatively modest, but factored into the lower end of our range. Is that clear? Great.

No, that's helpful. Very much so. Thanks. Last question for me. You know, you helped us out with your view on April. You talked about some of the more restricted markets versus, I guess, less restricted markets. So I was wondering if there's any way that you can remind us the percentage of sales in the restricted versus non-restricted markets. So, say, California, the Northeast and the Midwest that are a little bit kind of shut down, if you will, versus the Southeast and other regions that are operating a little bit more smoothly. Yeah.

Yeah, so consider that our four main markets, which would be California, Arizona, Texas, Florida, that makes up about 50% of our revenue, right? And as I mentioned, Florida is very good, but I would also extend Florida all the way up or extend the good times, if you will, all the way up through the Carolinas and, frankly, coming west through the Panhandle and Louisiana and into Texas. It actually has been very strong. Now, there's some parts of Texas, really, so I can't even talk about it at the state level because there are some parts of Texas that are very good and very busy and don't have a lot of restrictions, and there's other parts of Texas. For instance, Austin and San Antonio were among the most restricted parts in Texas that we've had to deal with. And as I mentioned, in the Northeast and the Midwest, you know, we have seen just this morning we got released, or our dealers, I should say, got released to build. Earlier in the week, New York added pool openings as an essential business, so the dealers were allowed to go back and start opening pools again. They haven't released it for construction, but on the other hand, Connecticut, New Jersey, and Pennsylvania that had it locked down have now released them for construction. You know, California is, again, a little bit different depending on where you are. You know, if you're in the Bay Area, it's very restrictive. If you move into the Central Valley, it's a little bit easier to operate. And the further south you go into California, then it can get a little more restrictive. But I can't really do it at the state level because the local municipalities have quite a bit of variation. But we are encouraged... by the trends that we have seen in April. As we mentioned, we put it in the press release that we thought we could be down 5% to 10%. We've been encouraged about what we have seen in the last week, and we think that we'll be at the better end of that range if the trends that we have seen continue. And I expect, given the releases that we've gotten in the last couple days, that that only gets stronger.

Yeah, and just to clarify, when we talk about shutdowns, We're not talking about our facilities, and we're not talking about the majority of our customers at any of our facilities. It's really just a small part of the customer base in some jurisdiction, which is really the part that's serving construction, had been in a couple of locations, pool openings. Those are now cleared now. It's really a very limited part of our overall customer base.

Yeah, consider, you know, that it's the discretionary part of our business that we're referring to because the non-discretionary part, you know, the maintenance and repair, in almost all scenarios, they were allowed to continue to work.

Helpful. Thanks again. Sure. The next question is from Alex Marocchia with Berenberg. Please go ahead.

Hey, good morning, and thanks for taking my question. The first question involves the industry and its recessionary inventory pricing. And I know that it's a bit different now, but can you explain what you generally saw in 2008 and 2009 in regards to inventory price increases or decreases and how you're thinking about it looking into next year?

Yeah, I mean, this is Mark. And really, you're talking about industry-wide, we did not see, as you would expect, a lot of price increases during the recession. Those were harder to justify, but we didn't see deflation either. So pricing was relatively stable, and you look at our margins over that period of time, they were relatively stable. So not a lot of change up or down in that 2007 to 2009 time period.

Okay, and then similarly, do you think there's going to be any impact to your vendor programs due to this?

I think the vendor programs, as Mark mentioned earlier, it's a function of revenue, right, in terms of the more we buy, then the better the discounts are. And that, again, is factored into our guidance.

Okay, that makes sense. And then secondly, you touched on how the new pool construction market is much lower today than it was in the last recession. Do you have any numbers around the split of new pool construction for new homes versus older homes?

Yeah, typically a pool is not something that's added at new construction. That's something that's added after the fact. There's a few markets that we have, like in Florida, where it can be more commonplace to to have the pool transfer with title of the new home sale. But for the most part, builders don't want to wait for or the complication of having a pool infringe upon them being able to close and move on because it's generally subbed out to somebody else. So what we've seen by and large across the country is that it really isn't a function of one-for-one. It's something that's added after the homeowners take possession of and then they put their own spin on it and customize the backyard. I mean, pools are very personal. If you look at, you know, there's not a lot of pools that are exactly the same. Everybody wants a little bit different, a little bit different feature. So the builders pretty much have said, look, buy the home, then you call your pool builder and have them build whatever you want. So it's not something that we see being attached early on or at the transfer of title for the initial new home.

Okay, that's great and very helpful.

Thanks, guys. Sure, thank you. This concludes our question and answer session. I would like to turn the conference back over to Peter Arvan for any closing remarks.

Yes, thank you all for joining us today. We'll next speak with you on July 23rd when we will review the second quarter results. Stay safe and have a great day. Thank you.

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