Pool's (POOL) CEO Manuel Perez de la Mesa on Q3 2016 Results - Earnings Call Transcript

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Pool Corporation (NASDAQ:POOL)

Q3 2016 Earnings Call

October 20, 2016 11:00 A.M. ET

Executives

Mark Joslin - Senior Vice President and Chief Financial Officer

Manny Perez de la Mesa - President, Chief Executive Officer

Analysts

Matt Duncan - Stephens

Ken Zener - KeyBanc

Garik Shmois - Longbow Research

David Mann - Johnson Rice

Ryan Merkel - William Blair

David Manthey - Robert W. Baird & Co.

Anthony Lebiedzinski - Sidoti & Company

Al Kaschalk - Wedbush Security

Operator

Good day everyone and welcome to the Pool Corporation Third Quarter 2016 Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded.

I would now like to turn the conference over to Mr. Mark Joslin, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Mark Joslin

Thank you. Good morning, everyone, and welcome to our Q3 2016 earnings call. As usual 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 2016 and future periods.

Actual results may differ materially from those discussed today. Information regarding the factors and variables that could cause actual results to differ materially from projected results is discussed in our 10-K.

Now, I'll turn the call over to our President and CEO, Manny Perez de la Mesa. Manny?

Manny Perez de la Mesa

Thank you Mark and good morning to everyone on the call. We experienced a solid third quarter with results of bit better than plans. While the mild September temperatures helped the Northern markets, the major benefit in the quarter came from improved execution in various facets of supply chain management, which enables us to increase gross margin by 30 bips on our base business.

Our 17% year-to-date growth in operating profit and 20% year-to-date increase in earnings-per-share are the result of the commitment and drive of our people throughout the company to provide exceptional value to our customers and suppliers.

Our blue base business sales were up 5% in the quarter and 7.5% year-to-date. The four largest states California, Florida, Texas, and Arizona were up 4% in the quarter, while the rest of the markets were up 6%. The only major market that had somewhat soft sales in the quarter was Texas, although year-to-date its sales were up 7.5%.

As you may recall, Texas had a strong third quarter in 2015 as our customers try to catch up on lost days from the heavy rains in the second quarter of 2015. Without the same motivation to catch up, this year’s sales were relatively softer in the quarter in Texas although on track year-to-date.

On the green side of our business, our base business sales were also up 5% in the quarter and were up 6% year-to-date. In essence, sales were as expected as we continue to grow share in strategic product and customer segments. Building material sales increased 8.4% in the quarter and 10.6% year-to-date, reflecting both continue market share gains as well as the moderation of the Texas market in the quarter.

Commercial product sales increased 12.8% in the quarter and 16.7% year-to-date, reflecting our ongoing trajectory of market share growth as we increased the resources assigned to this product and customer segment. The retail product side of our business increased by 3.1% in the quarter, and 6.7% year-to-date with our performance once again reflecting market share gains.

As you may recall, the season got off to a strong start in the first quarter with earlier than normal pool openings, but once the pools are open the ongoing industry sales are driven by the growth of the install base, which is about 1% and inflation, which is virtually nil in retail products.

With our consistent discipline in the management of expenses and our drive for continuous improvement and execution, we were able to increase our base business operating margin by 60 bips in the quarter and 80 bips year-to-date. We have a good shot at 10% operating margin for the year, which is pretty remarkable as new pool construction is still down roughly 70% versus the peak levels of 10 years ago, and we model replacement behavior is not quite yet at normalized levels.

As we look to the fourth quarter, we are mindful of the fact that weather in 2015 was extremely favorable and that it is unlikely to recur in 2016. With this in mind we established our updated 2016 guidance as a reasonable expectation in terms of diluted earnings per share. In addition, with 22% trailing 12 months return on invested capital it certainly will surprise our objective of 20% in return on invested capital for 2016

A foot note to our return on invested capital, it is calculated on a trailing 12 month basis after tax and includes goodwill and other intangible assets in the denominator. We are extremely fortunate to be involved in a business where every day we help people realize their dreams of a better home life, while simultaneously assisting over 100,000 customers realize success. It is the commitment of our people that make all of this success a reality.

Now I will turn the call over to Mark to for his additional financial commentary.

Mark Joslin

Thank you, Manny. As we begin our seasonally slow fourth quarter we are happy to report that we have made great progress through the first three quarters of the year in all aspects of our business, meeting or exceeding our own expectations for profitable growth effectively managing our balance sheet and generating strong cash flow, while growing our return on invested capital.

For both the third quarter and year-to-date periods, our operating expenses grew at half the rate of our gross profit growth. For the quarter, this was 3% operating expense growth on 6% gross profit growth, and for the year 4% operating expense growth on 8% gross profit growth. That’s our base business operating expense and gross profits.

By growing operating expenses at our targeted rate of 50% of gross profit growth we are able to leverage our gross profit growth into nearly twice the rate of operating income growth, while for our base business, which for our base business was 11% for the quarter and 15% for the year-to-date. This also helps us expand our operating margins, which year-to-date are up 80 basis points over last year to 11.6%.

While this will come down when our fourth-quarter results are included, as Manny mentioned, we should be close to achieving our short-term stretch goal of double-digit operating margins for the year. One item of note in our results for the quarter was that they included a goodwill impairment charge related to an underperforming Canadian acquisition made in 2003. This charge which was 600,000 and nondeductible was included in our operating expenses and resulted in a reduction in our reported earnings per share of $0.02 for the quarter.

One other item of note about our P&L is our tax rate which at 37.7% was consistent with our Q3 2015 rate. As is normally the case our third quarter tax rate was lower than our rate in other quarters as we passed the stature of limitations on certain reserve items.

Turning to our balance sheet and statement of cash flows, as we noted in our press release our cash flow from operations at the end of third quarter was positively impacted by the deferral of our normal September Federal income tax payment, which will instead be made in the fourth quarter.

Even without this benefit, our cash flow from operations remains on track to exceed net income for the year as our working capital composed primarily of trade receivables and inventory as net of trade payables do iterate to support our business growth, but no more. One measure of the improvement in our balance sheet management is a metric called the cash convergent cycle, which is a rough calculation of the time it takes to convert working capital into cash.

Our cash conversion cycle at the end of September was 63 days, which was an improvement of 4% year-over-year. We've also made good progress on our share repurchase program. For the quarter, we repurchased 394,000 shares on the open market at an average price of $94.96 and a total use of cash of $37.4 million. Since the end of the quarter we’ve repurchased an additional 375,000 shares at an average price of $94.25 for an additional use of cash of $35.3 million.

Year-to-date we’ve repurchased 1.8 million shares at an average price of $85.69 for a total use of cash of 150.6 million leaving us with 71.6 million under our existing board authorization. Based on our repurchases to date, we estimate that our fourth-quarter fully diluted share count will be 42.6 million shares and our fully diluted full-year share count will be 43.2 million shares.

As we approach the end of 2016, I'm going to take a few minutes now to give you a preview of a change coming in 2017 related to how we account for employee stock options that could have a material impact on a reported earnings per share and operating cash flow. Please bear with me as I walk through this, as it is a bit complicated, but I think important enough to spend a few minutes on now.

In March 2016, the FASB issued ASU 2016-09, which is ironically titled improvements to employee share based payment accounting. This new requirement amends several aspects of the accounting for share-based payment transactions, including the income tax consequences of the awards and classification on the statement of cash flows.

As you may know when a company issues stock options to employees it records compensation expense over the option vesting period based on the black shoals value of the options at the time of the grant, and a corresponding deferred tax benefit to record the impact of the tax impact of the compensation expense.

Some years later if and when the employee exercises their option award at the then current market price, the actual value of the option is realized and there is a true-up in the tax benefit from what was recorded originally.

Under current accounting rules this tax true-up is recorded to additional paid in capital, which is a component of equity, while the cash flow impact of the tax true-up is recorded as a financing activity on the statement of cash flows. Under the new FASB rules, which take effect next year, the tax true-up will be recorded to the tax line on the P&L instead of the balance sheet and the cash flow impact of the tax true-up will be recorded to operating cash flow.

To give you an example of how this works, assume an employee has issued stock options with an estimated value based on black shoals valuation modeling of $500,000 when they are issued. This $500,000 is recorded as compensation expense over the vesting period by the company and assuming a 40% tax rate the company records the deferred tax benefit from the expense of $200,000.

If the employee exercises those options 8 years later, the realized value will be different than what it was estimated to be. Assuming the realized value based on the growth in stock price of the company over that time was double the estimated value or $1 million then the company would take an additional 200,000 tax benefit at the time of exercise.

Under the new accounting rules this additional tax benefit would increase the company’s reported earnings per share and add to reported operating cash flows in the period in which the exercise occurs. Lower earnings and cash flow from operations will be reported if the realized value of the option was less than the original forecasted black shoals value.

I raised this issue because we have historically granted stock option awards as part of our compensation plan and because at the moment at least our unexercised stock options have value well in excess of their original reported value. This could have a material positive impact on our earnings-per-share and operating cash flow for the year in 2017 and future years, as well as for any individual quarters of the year in which employees elect to exercise their vested stock options, while we will report our results in accordance with these new rules beginning in 2017 we will also report the impact due to this change if and one it is material so that our results remain comparative to our historical results. I’ll provide another reminder and an update on this issue on our year-end call in February.

Finally, many of you will recall that we have been involved in antitrust class action litigation following an FDC investigation that was settled in 2011. This class litigation proceeded to a point where he filed summary judgment motions requesting the judge on the case to dismiss the plaintiff’s claims as being without merit. We are happy to report that the judge reviewed our motions and agreed that the claim should be dismissed.

At this point, I’ll turn the call back to the operator to begin our question-and-answer session. William, are you there?

Question-and-Answer Session

Operator

[Operator Instructions] And our first questioner today is Matt Duncan with Stephens. Please go ahead.

Matt Duncan

Good morning guys. Mark I am still awake, but just barely. So mainly I want to start by talking about the stronger discretionary spending commentary around construction of pools, can you expand on that a little bit maybe talk about how much that’s adding to your growth? Is this specific to any particular geography or are you seeing it across the business, just curious just to see what’s happening there?

Mark Joslin

Okay there is two elements. First, the discretionary element that has been the most impactful over the past six years has been in the renovation and replacement sector. As we - as I mentioned a number of times before, during the, particularly 2008 and 2009 timeframe those two years pool owners deferred the replacement and remodeling of pools much like they deferred painting and changing up floors and things of that nature that that were somewhat discretionary. And on a dollar weighted basis from normalized behavior to the trough in 2009 that was close to 40% impact. That recovery began in 2011 and that recovery continues to date and then on top of that recovery, given our focus on of building materials is a category of products and are increasing our sales efforts, as well as stocking efforts there.

We’ve gained significant share and then complimented that with many factors on the equipment side, especially developing and investing in the development of new products and new technologies that have enhanced the equipment offering motivating replacement activity there as well. So that’s the biggest impact for discretionary expense standpoint is on the remodeling and replacement side.

In addition, we have also seen some recovery on the new pool construction side, but as I mentioned in my prepared remarks the industry is still close to 70% below peak levels of 2005. So therefore that recovery have not been as strong over that period of time, but we still have some levels of recovery there and we expect that this year the recovery or the increase in new pool construction will be close to 10% year-on-year. So again, not as the recovery of new pool construction over the past six years has not been as strong as the recovery or impactful as the recovery and remodeling replacement activity, but that recovery has and is taking place.

Matt Duncan

Okay. So the pool construction side than it is adding maybe a point to your growth that’s a little over 10% of your revenue if I recall it is like 13% on a new construction, so …

Mark Joslin

That’s correct.

Matt Duncan

10%, okay. Alright just making sure I understood that correctly. As we look to the fourth quarter, I know you guys typically don’t get into the game of quarterly guidance but Manny you made a comment about reminding us about the difficult comparison that you are up against, so would it be safe to assume that that may have an impact on the growth rate relative to the 7% number you put up in the 3Q?

Manny Perez de la Mesa

Yes. In fact, when you look at the overall number given the baseline that we had and everything else, I mean we would be looking for low single-digit growth, still growth, but low single-digit growth in the fourth quarter because of the very mild weather last year that resulted in pool staying open longer period of time and therefore that’s driving additional sales. So that dynamic again assuming it’s difficult to project the weather, when those that do it for a living can do that very well. So therefore I am not going to try, so we assume normal weather and based on normal weather we should still have positive year-over-year topline, but it will be very modest.

Matt Duncan

Okay. And then last thing from me and I will hop back in the queue, on gross margin, this is two quarters in a row of 40 basis points of improvement year-over-year, I don’t know if we can call it a trend yet, but should we assume that you're going to be able to continue to see some gross margin improvement out of the actions you guys have been taking here?

Manny Perez de la Mesa

Matt that is a good question. I would look at it this way, there are positives and negatives affecting gross margin. From a product mix standpoint to the extent that remodeling and replacement activity and new construction activity increase given the mix of products that are sold for remodel replace and new construction that mix of products has generally speaking a lower gross margin percent, although much higher gross margin dollars than maintenance and repair type products. So to the extent that those product categories grow faster than maintenance and repair, which we expect them to do over the next five years that they have over the last six years that’s an adverse product mix impact.

To offset that adverse impact we continue to make improvements in every facet of our execution. And I think what's happening here is that there are quarters where the adverse product mix is more than offset as it has happened in the second and third quarter by the process improvements and supply-chain management initiatives that we’ve been able to execute on that offsets that and those areas include for example private label products and the growing factor of private label products which have higher gross margin percents and dollars than non-private label products.

The improvements that we have in purchasing execution, the improvements that we have in logistics management to reduce freight in cost, those are examples of areas that we continue to make improvements in and then in certain quarters it'll result in a, I’ll call it in the big picture modest margin percent impact, but it could just as well have been maybe just to make sure we are talking about a 20 bips to 30 bips decline. I wouldn’t look at either one of the trends. I would just say that, on an overall long-term standpoint gross margins will stay percentagewise about where they are. Having said that, we are going to continue to focus on what our internal efficiencies, our internal processes to improve our disciplines, and work to operate more efficiently, so that we realize the two to one relationship that Mark talked about in his commentary in terms of our growth of GP dollars in contrast for our growth of expenses.

Matt Duncan

Very helpful, thank you Manny.

Operator

Our next questioner today is Ken Zener from KeyBanc. Please go ahead.

Ken Zener

Good morning gentlemen.

Mark Joslin

Good morning.

Manny Perez de la Mesa

Good morning.

Ken Zener

So, your business is very steady 65% on discretionary, you went over the new construction which laves kind of a quarter of your business being discretionary, I just wonder since you are doing well and you know there is kind of some signs out there indicating this cycle might be slowing, I wonder if you could take us through what you would look for and what you can see in relation to that discretionary spend, you know the refurbishment side that you are seeing that’s helping lead the growth of the business, just to start their Manny. I mean like what your guys kind of forward indicators, those are kind of projects that require bids I assume and - but you are kind of, how much visibility do you have into those drivers?

Manny Perez de la Mesa

Sure, couple of elements here. First of all, close to 90%, 87% approximately of our sales are for products for existing pool owners, and you can appreciate the demographics there are favorable in a big picture sense, so therefore those pool owners – there’s a certain component of products that they need at which, again during the downturn we’re proving to be very resilient by virtue of the fact that our sales of chemicals, accessories, and parts increased every single year. You switch over to the somewhat discretionary as a pool owner you know this first hand, but there is the items on the equipment pad that pump the filter the heater, the heater being certainly a lot more discretionary than the pump or the filter, with lights being very similar to heaters in that regard.

Then the renovation is the actual pool surface itself and what we are seeing there are two things, first what we are seeing is that because of the investments in innovation on the part of our supplier base and this includes I mentioned equipment earlier, but also includes on the building material side, the innovation there from an aesthetic value, what we’re seeing is better or more attractive products and I don't see any impediments for that recovery, which is at this point on its last leg because it’s kind of like been recovery now for few years, but we could see that very healthy on a go forward basis, and no real impediments - again we're not talking about huge dollar items in the big picture particularly for this pool owner demographics.

When you look at new pool construction, new pool construction is heavily tied to financing and we believe that the lack of financing availability for perspective pool owners has been the biggest impediment to that recovery not following for example the recovery that's taking place in the single family home construction. So therefore, while single-family home construction has recovered in part over the last seven years we haven't seen that same connection with new pool construction. And again new pool construction is a home improvement for existing homes and it’s very subjective or subject to the availability of financing using in most cases home equity as the source of financing whether that is in the form of a first mortgage or second mortgage or home equity loan. So…

Ken Zener

And what have you seen on that? I know you guys had done some lending type, you know what you see on that specifically, because I think that's what a lot of people think that the RNR cycle is not fully unfolded on the credit side relative to those HELOC’s or loans, I mean is that what you see, I mean any information about credit scores or dollars? Thank you.

Manny Perez de la Mesa

And by the way just to clarify, we don't - we do not do any lending. We do facilitate lending in terms of having the ability for our customers when they are meeting with perspective pool owners to link through our sites to lending sources, but coming back to the point, we began to see in 2014 financial institutions begin to come into play and begin to open up lending, but we began to see that again through this year, but it’s not anywhere near the behavior that existed in the 1980s or 1990s.

So that has really been very slowly coming back, I think from a return standpoint, financial institutions have been hit very hard on the regulatory side, they are still in some respects licking the losses from the going overboard and doing some frankly crazy things in the early to mid-2000's, but as they revert back gradually to normal behavior we expect new pool construction to recover, and in fact industry survey is done of pool owners that fit the demographics - homeowners that fit the demographics of being perspective pool owners at the addition of a in ground pool is still viewed as a very attractive home improvement.

Ken Zener

Thank you.

Operator

Our next questioner today is Garik Shmois from Longbow Research. Please go ahead.

Garik Shmois

Thank you. First question is just on energy inflation, if we are going to see a rise in oil prices continue, just wondering how you're thinking about the potential impact as we get into 2017 on OpEx expenses?

Mark Joslin

In the big picture to the extent that - for example the energy prices go from say $50 to $60 a share, I mean a barrel that would not translate to a super significant number in the big picture. Is it adverse, yes, but again it is diluted significantly in the overall scheme of things. We recover some of that in terms of freight out charges and things of that nature. Now it goes from $50 to $100 a barrel in the next 12 months, I don't think anybody is expecting that, but if that were to happen that could amount to maybe $0.02 or $0.03 a share again to next year.

Garik Shmois

Okay that's helpful. So, now in a normal banned based case probability your confidence in being able to grow margin well in excess of deflation.

Mark Joslin

Yes, it’s not, again if it stays in the - probably in the $40 to $60 range over the next 12 months, I don't think it will ground to an impact of a penny one way or the other.

Garik Shmois

Got it, thank you. And my next question is on the commercial market, good growth this year, good growth in the quarter double digits, just wondering if you could talk about the opportunities that you still have ahead of you on the commercial sides, seems like there is a still long tail of opportunity there, just wondering if you can provide some color on how you work [ph]?

Mark Joslin

Sure. If I may, I’m going to take a little - provided everyone on the call a little perspective and background. Through 2006 and you can argue 2007, we were growing at a double-digit organic rate about twice the industry growth rate focusing strictly on the residential marketplace. There were a number of customers of ours that participated in both the residential and commercial side, but given what we had in our plate we had all we could do just to keep up with the demand that we were creating and the service levels that we were trying to live by in terms of supporting our customers and their businesses.

As the market contracted in 2008 and 2009, we began with a more aggressive effort to look at complimentary revenue sources and obviously we’ve talked a lot about building materials and the results speak for themselves in terms of how that’s grown over the course of time. A second complementary revenue source was the commercial sector. There are some nuances related to the commercial sector as distinguished from the residential sector, first of all the sales process is usually a little longer, it requires more technical know-how and in having the right inventory in place, it’s certainly important as it is for residential, but it’s different inventory in the sense that it’s largely larger equipment in more specialized equipment.

So, we began investing in the talent and the inventory and the programs to increase our penetration of that market segment and we've been successful. We are on track and if we don't hit it, we were very, very close to $100 million in products that are sold primarily to the commercial sector. In other words, there are products that crossover between residential and commercial and we don't capture that as part of our commercial business. What we’re capturing here are the products that are primarily or only exclusively in the commercial sector, that's our measurement base and that’s been growing now at a mid teens rate for the past 5, 6 years.

We continue to grow share, while we are now established firmly as the number one distributor on a national basis of commercial products. Our share position is nowhere near what it is on the residential side, so we have plenty of upside for many years and as we did the residential side, we focus on growing share the right way. We don't try to under bid the market. We don't try to do things that are short-term oriented. We try to earn our customer's business by providing them a value and a service that is better than anyone else's value and service, and that involves having products usually at the same or modestly higher prices, but having the full suite of servers and tools and everything else that enable our customers to succeed and enables us to again progressively go a share.

Garik Shmois

Thanks for that. One last quick question, on the 10% expected new construction growth for this year, just wondering if you could provide may be some geographic color if there is any regions or states that are standing out is outperforming the market?

Mark Joslin

Of the major states nothing really stands out, I mean California and there were some concerned about the drought there a year ago or two years ago, that continues to be a positive year-over-year Florida is positive year-on-year, those are the two largest markets in the country. There is no one market that stands out and says well they are growing at a huge rate vis-a-vis all of the others. So they are all there, they are all part of the equation.

Operator

Our next questioner today is David Mann from Johnson Rice. Please go ahead.

David Mann

Yes, thank you good morning. Question about inventories, the growth in the quarter was a little higher than sales growth, just curious if you could elaborate on what’s going on there.

Mark Joslin

Hi David when you look at inventories you also have to be looking at accounts payable because there is an interplay there, so sometimes we may buy something, but have extended inventory terms. When you look at the net growth in inventory and accounts payable year-over-year I think it was closer to 5%. So much closer to our sales growth.

Manny Perez de la Mesa

And the big picture it’s rarely nothing earthshaking, it’s about two days more receipts. When you look at our daily receipt levels, typically in September, October we are receiving about $5 million $6 million a day of product from the 2000 vendors that we buy from a worldwide basis and sometimes they ship our couple days earlier and I mean through August we were running in about 4% or 5% year-on-year on inventory, so those are just plus or minus two days where there something is shipped a little - a week earlier or three days earlier or whatever comes in calendar-wise captures in one side or the other.

David Mann

I understood, just we've gotten so custom to some of your strict standards for supply chain management.

Manny Perez de la Mesa

Yes. Well they are still in place.

David Mann

Very good to hear that. Curiously on Texas, it sounds like you are assessing that as more of a year-on-year kind of issue with how the markets playing out are there any other signs that it’s - some of the issues in Texas that others are talking about in terms of consumer weakness, any other signs of that showing up in your business or any signs in terms of what they are buying in the mix of the market or are you seeing it shift more towards maintenance in away from construction and remodel?

Manny Perez de la Mesa

Nothing significant. Two things, first of all, the lion’s share of the market whether it’s Texas or Florida or anywhere else is the existing pools. So that's whether it’s, you know on a national it’s 87% of our business, when you look at individual markets it’s in almost all cases between mid-80s and 90% of our business. So, by individual market or state. So it’s not - the existing pool owners are doing what they do. When you look at markets like a Texas and back when the oil prices began and had their real big decline in the latter part of 2014, we looked internally and tried to gauge what impact that could have on our business in 2015 and there is really deminimums impact in the big picture.

And the reason for that is, first of all a lot of the areas where a lot of that activity was taking place we are not established neighborhoods where people had bought a home and then 5 years, 10 years later maybe home improvement of adding in a pool. So these where, I’ll call it temporary communities or very new communities where the pool install base wasn't really germain. So again big picture, nothing overly significant year-to-date sales this year were up 7.5% in Texas and again that’s consistent with the total blue business being up 7.5% year-to-date, so that kind of gives you, they are kind of following the pattern with everybody else.

Mark Joslin

By the way as Manny said, earlier we had a very good growth quarter in 2015. Texas was up 10% for the quarter in third quarter 2015. So high rate of growth following the heavy rains in support to the second quarter. So what we are seeing this quarter as Manny said is largely just a result of tough comps for Texas.

David Mann

That’s very helpful. One last questions, appreciated the commentary about the key four comparison, curious if you could jump a little further into the future. Q1 obviously a great quarter that had some unusual weather benefit, can you just sort of talk a little bit about how we should frame that for next year, whether base business growth could be up revenues, how should we think about thing like that, you know revenue based growth in EPS.

Mark Joslin

Obviously we provide our guidance in February, but at this juncture I can anticipate that top line for the year would be in the mid to a little bit better than mid-single digits much like this year. Now from a year-on-your standpoint obviously as you mentioned and will remind everybody on the call or when we do the February call, our first quarter comp is a very tough comp, so therefore that would be probably very low year-on-year growth similar to the fourth quarter of this year, low single digits, and then you’d have, call it 5% to 7% the second, third and fourth quarter of the year.

David Mann

Very helpful.

Mark Joslin

And then when you take that through our P&L you would expect our base business expenses to grow at approximately half the rate of our topline and therefore result in certainly comfortably double-digit operating profit growth, you throw in the accretive benefit of the share repurchases and you get back to a decent teens type number earnings per share, again we will have that more refine when we get to February, but David and you know what’s very, very well having followed us for fair number of years, I think you may have a kidding colleague probably was born after he started following us. The point is, that we, it’s something that’s, I think I find personally remarkable is the fact that we are so fortunate to be in a space that we have an installed base, a great majority of our business is extremely predictable and resilient and therefore we do what we are supposed to do and execute on our responsibilities throughout the organization, myself included obviously. You know for us to not have these numbers that we have every year would be a real surprise. So, it’s kind of boring, but we’re a boring company that grows earnings per share comfortably mid-teens every year.

David Mann

Appreciate the insights. Good luck for the rest of the year.

Mark Joslin

Thank you, David.

Operator

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

Ryan Merkel

Hi guys, thanks, another good quarter.

Mark Joslin

Thank you, sir.

Ryan Merkel

So, first question, I’m surprised you are planning to make money again in the fourth quarter, what is the main driver for this?

Mark Joslin

Well what happens here is as our business grows Ryan and it continues to grow every year, our – we surpassed our breakeven last year and there is no reason why we won’t be able to surpass that again this year given the fact that, I mean we still expect sales growth, it will be modest, but we still expect sales growth, we have a very good control on our expense and our infrastructure, so when it is all said and done, it will be another year of positive EPS and again that also ties into our operating margin expansion. I mean you heard both Mark and I talk about the fact that we should be closer not at 10% operating margin for the year that improvement is consistent every quarter in terms of increasing operating margins by virtue of the fact that our gross profits grow at a rate not much higher than on a expense growth.

Ryan Merkel

Well, so is this a secular change that you are now going to make money in the fourth quarter, every year is that what you are saying, because my understanding was last year you made money because the weather was favorable, if I look at the prior fewer years before that you didn’t make money. So, is this secular?

Manny Perez de la Mesa

Yes, I don’t know if I would use the word secular, but basically as our sales in GP dollars have increased right and continue to increase leveraging a certain infrastructure, our operating margin increased and they improved every quarter of the year and obviously for the full year. So with that I don’t want to envision ever again having a loss quarter, and the only caveat I would make to that because I also have caveat if not Mark would be very upset. If our business mix change significantly where we have a lot more Snowbelt business, I don’t anticipate that happening, but if our waiting of our business change in a significant way to more northern markets than that would be a seasonal drag in the fourth and first quarter, but take that aside, again I don’t anticipate that with our - certainly with the business that we have at hand and what we expect to be doing from a future growth and everything else standpoint, we should be profitable by the quarter from now one.

Ryan Merkel

Got it. Okay, I didn’t appreciate that change, but I’m happy to hear it.

Manny Perez de la Mesa

Thank you.

Ryan Merkel

Secondly, you mentioned low single digit growth in the fourth quarter, which is consistent with what most of us were thinking, can we assume October it started at this level?

Manny Perez de la Mesa

Yes.

Ryan Merkel

Okay. And then lastly, in the green business, can you remind us again why you are not pursuing an aggressive roll-up strategy in the irrigation part of your business similar to one of your public peers?

Manny Perez de la Mesa

Well, two things, first of all we are focused on irrigation as distinguished from landscape products. That’s one key distinction. The dynamics are different and our focus is the irrigation space, A. B, we are also in that business focused on, the Snow, I mean the Sunbelt given all the other macro dynamics as we look at the business over the next 10 years, 15 years, 20 years. So that’s another distinction. So therefore, while they are looking at a much broader universe we're looking at a much more refined or focused universe, and we will cross pass occasionally on the acquisition front, but a lot of where there are hunting as areas we're not going to. That’s item 1. Item 2 is we do have an ongoing effort, but we have a certain discipline. That comes through in our process and we are very long-term oriented. We are not looking at buying something and then selling it later.

We're looking at buying something and keeping it in perpetuity, so therefore our thought process may very well be different than somebody else that may be focused on a more buy at x price and sell at x price. So therefore and in that vein we're looking at long-term organic growth and we're looking at long-term return on capital, invested capital filters that are certainly higher than the market norms and that's evidenced by the fact that our ongoing portfolio has a 22% return on invested capital in contrast with the S&P 500 that’s just over 9%. So, I mean we are more than double the S&P 500 return on invested capital rate on the same apples to apples basis. And again our filter is not quite as high as that 22% because we improve internally to get there, but it is higher than most other companies would have.

Ryan Merkel

And by the way just to clarify one thing Manny, correct me if I'd - when you say we're focused on irrigation and not landscape products really talking about the plant material perishable as part of landscape products, we do supply landscape contractors that are doing residential and commercial maintenance and we do call that landscape products as well, so just…

Manny Perez de la Mesa

Yes, there is a distinction there, yes.

Ryan Merkel

Got it. Thank you.

Operator

Our next questioner today is David Manthey from Baird. Please go ahead.

David Manthey

Thank you. Hi guys forgive my ignorance on this, if you’ve talked about this before, but in the commercial business remind me do you sell through an intermediary or service company there or are you selling directly to the institution that owns the pool.

Mark Joslin

Both. Depending on the product or depending on the need. For equipment that is sold to a contractor that installs that equipment. In certain cases where it’s what I’ll call basic products, I’ll call it do it yourself products where that hotel or resort may have their own staff of people that put the chemicals in and do the basic maintenance then that would be a direct sale.

David Manthey

Okay, thank you. And just on the theme here of the first quarter seasonality and how unusual was last year, Manny where you said low single digits in the fourth quarter, it seems that the year-to-year comp gets about four percentage points harder in the first quarter, I'm wondering why wouldn't we expect revenues to actually be a bit lower year-to-year because of that, I think you had 14% base business growth there that’s a pretty tough, not to get over the top off?

Manny Perez de la Mesa

You make a very good point David and certainly it will be tougher, I would rather have a little bit more time to give you better insight. Again, from an annual standpoint we would be looking at call it 5% to 6% topline growth for the year. A lot of fit frankly in the first quarter depends on how mild the weather is in the Snowbelt in February March and how, when people start opening their pools and the rush of business that happens as people open up their pools. So, but you make an excellent point and it could very well, when we refine our commentary in February, we could very well be coming out and saying expect flattish type numbers, but put, it doesn't change anything for the year, it just changes how it plays out of the quarter given the seasonality of the business.

David Manthey

Right. I’m with you on that. I don't want to get to my OpEx here but when you look at where the Street expectations are for higher EPS, I think if you run the numbers through at down slightly on the revenue line, you can end up somewhere in the 20s for EPS. I just want to make sure that people are gauging the expectations correctly as it relates to how the full year looks.

Manny Perez de la Mesa

Thank you.

David Manthey

Okay. All right, we’ll explore that later. Thank you very much.

Operator

Our next questioner today is Anthony Lebiedzinski from Sidoti & Company. Please go ahead.

Anthony Lebiedzinski

Hi yes, good morning again. Thanks for all the color. So just wanted to follow up on one of the previous questions in regards to pool construction, so it looks like 5%, 10% is what you are expecting this year Manny, so if the economy continues to slowly increase and the housing stays in decent shape, I mean would it be reasonable to see another 10% increase next year for pool construction, how do you see that?

Manny Perez de la Mesa

I would see that there will be the ongoing very, from my standpoint, very slow gradual recovery of new pool construction and what will change is when finance institutions begin to open up a little bit of their horizons for home improvement lending using existing or to existing home owners and that’s when it will really kick up and recover at a more accelerated rate. Until then it will continue to grow at a modest call it 10-ish 5%, 5000 to 7000 more pools per year.

Anthony Lebiedzinski

Got it, okay thanks for that color. And also when you are looking at the new sales center additions whether organically or through acquisitions, just broadly speaking how do you see the number of openings for next year both on the blue side and the green side?

Manny Perez de la Mesa

Between blue green and international, probably we will end up being another 5 to 7 locations for 2017 and so that will add close to 1% of call it new sales not necessarily base business. Acquisitions at this juncture that’s very speculative, certainly always talking to people and trying to figure something’s out there that would make sense, for us long term as I talked about a few minutes ago and a lot of those transactions historically were time as you know happened in the winter timeframe after the season is over and before the next season.

Anthony Lebiedzinski

Got it, okay. And then actually good, can you actually touch on your international segment how that’s done and I was just curious always specifically in the U.K. post Brexit how they translate in that business?

Manny Perez de la Mesa

Overall, very solid throughout all of Europe, in fact the - in Euros and in Canadian dollars which are collectively Europe and then Canada are by far are two biggest international markets representing well over 90% of what we do internationally. Both of those markets grew at a modest modestly faster rate than the U.S. market so they are both doing well. The UK is doing fine, in fact I reviewed those numbers. We’re on track to be able to be a little bit more profitable this year than last year in Europe.

So although - and we have a good chance of fitting our budgeted profit there as well. So, we're moving right along, I think the impact from Brexit will be more in the medium-term in the next several years as certain industries and the finance sector and IT relocate, but the existing pools are the existing pools they will need to be maintained things break down they’ll need to be repaired and after a while the product need to be replaced or the pools remodeled. So I don't see any of that changing. On an annual basis, just to give you a little context in the U.K. they build less than 2,000 new pools per year and if you compare that that would be analogous to a medium size market in Florida. Like, for example I would say I mean they build more pools than that in Miami, Fort Lauderdale, West Palm, Tampa and Orlando as an example. That's more like a Pensacola type market.

Anthony Lebiedzinski

Okay thanks a lot.

Mark Joslin

Thank you.

Operator

The next questioner today is Al Kaschalk from Wedbush Security. Please go ahead.

Al Kaschalk

Good morning guys.

Mark Joslin

Good morning.

Manny Perez de la Mesa

Good morning Al.

Al Kaschalk

Most of my questions have been answered but just to touch on one, on the commercial side it sounds like there could be some M&A, maybe not, but maybe talk about why that market is growing or what particular portion of the market that you're interested in participating in?

Manny Perez de la Mesa

The market is growing just like the residential market is growing, but our growth is primarily - our growth rate has been primarily driven by our growing market share. There is certainly the opportunity for M&A there, they were a certain established distributors that’s focused on the commercial sector, we have talked to several of them over the course of time, but like we have done with the residential side of a business if you look back on our history there was a time, way back when there were a number of acquisitions down to enter new markets, we’ve pivoted of that about 15 years ago, and the lion’s share of our growth since then has been organic.

Once we enter a market the return on capital is far greater doing it organically and we've also entered in open locations in over hundred new markets over the course of time. So, we can do it every which way. And in the case of the commercial sector, location is not as important because the key there is the specialized talent that you need on working with the customers are a technical front, as well as having the ability to create the bill of materials and then separately having the right stocking so they can be delivered same day next day. And then so we can do that organically, I can't rule out an acquisition, but we can certainly get to our objectives organically.

Al Kaschalk

Okay, very helpful. I think I guess, not likely to answer this question, but worth a shot, I imagine the institutional or approval owner market versus third party there are different margin profiles on that business given what’s sold to.

Manny Perez de la Mesa

The nature of the beast Al you asked a good question, and this applies to residential products, as well as commercial. Generally speaking when you were telling a higher price product I would say when you are selling a variable speed pump versus a single speed pump and that goes with a higher price, generally speaking the higher the price of the item the lower the margin percent is.

Again, it is important to decide between margin percent and margin dollars, so much the same applies, so when we are selling equipment for example to commercial customers and you are talking about larger filters and larger pumps that is sold at lower margin percent than when we are selling a residential-sized pumping filter. Certain product categories, I’ll call it accessories, which are lower dollar items, the cost to serve from a percentage of sales price standpoint higher tend to have higher margin percents. And that applies to commercial as well as residential and that applies also to parks, residential, and commercial.

Al Kaschalk

Okay, thanks. And then Mark just a loose end there to tie, and I know it kind of straightens so far, but the tax dollars that were deferred what type of cash benefits does that have in the quarter, or how much are we talking, is it minimal?

Mark Joslin

When you are talking about cash dollars deferred I think you are talking about the long discussion that I had on the, I’m sorry you're talking about the fixed tax payment dollars, that was around $37 million. It was our expected cash tax payment in the third quarter, which will be made in the fourth quarter instead.

Al Kaschalk

Sorry, that was three 37 million.

Mark Joslin

37, yeah.

Al Kaschalk

Okay. Alright guys, thanks good luck.

Mark Joslin

Alright. Thank you Al.

Operator

This concludes our question-and-answer session. I would now like to turn the conference back over to Manny Perez de la Mesa, President and CEO for any closing remarks.

Manny Perez de la Mesa

Thank you, William and thank you all for listening. I think we set a record in terms of time and I appreciate everyone's questions. I apologize for sometimes rambling on too long, but hopefully give you a color were appropriate. Our next conference call is scheduled for February 16 in 2017 when we will discuss our final 2016 results. Thank you again and have a great day.

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