Pool Corp (POOL) 2016 Q3 法說會逐字稿

Good day, everyone and welcome to the Pool Corporation third-quarter 2016 conference call and webcast. (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

Good morning, everyone. Welcome to our Q3 2016 earnings call. As usual, I would like to remind our listeners that our discussion, comments and responses to questions today may include forward-looking statements including management's outlook for 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 10K. Now I'll turn the call over to our President and CEO Manny Perez de la Mesa

Thank you, Mark and good morning to everyone on the call. We experienced a solid third quarter with results a bit better than planned. While the mild September temperatures helped in northern markets, the major benefit in the quarter came from improved execution and various facets of supply chain management which enabled us to increase gross margin by 30 BIPS on our base business. Our 17% year-to-date growth and 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 tried 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 continued 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 continued 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 in 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 ten years ago and remodel 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 looks like we'll surpass our objective of 20% in return on invested capital for 2016.

A footnote 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's the commitment of the our people that make all of the success a reality. Now I'll turn the call over to Mark for his additional financial commentary.

Thank you, Manny. As we begin our seasonably slow fourth quarter we are happy to report that we've 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're 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 year-to-date period. This also helps us expand our operating margins which year-to-date are up 80 bases 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 under performing Canadian acquisition made in 2003. This charge, which was $600,000 and non-deductible, 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 statue 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 the 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 inventories net of trade payables, grew at a rate to support our business growth but no more. One major of the improvement in our balance sheet management is a metric called the cash conversion 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 our reported earnings per share and operating cash flow. Please bear with me as I walk through this as it's a bit complicated but I think important enough to spend a few minutes on now. In March of 2016, the FASBs 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's 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 FASBs 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 is 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 a 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. Lowering earnings and cash flow -- I'm sorry, lower earnings and cash flow from operations would be reported if the realized value of the option was less than the original forecasted black shoals value. I raise 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 recorded 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 in the year in which employees elect to exercise their invested 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 when it is material, so that our results remain comparative to our historical results. I'll provide another reminder, 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 a FDC investigation that was settled in 2011. This class litigation proceeded to a point where we 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? My apologies. We will now begin the question-and-answer session. (Operator instructions).

I hope I didn't put everyone to sleep with my discussion on stock options

Our first questioner today is Matt Duncan with Stephens. Please go ahead

Good morning, guys. Mark, I'm still awake but just barely.

( Laughter)

Manny, 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 as cross the business, just curious what's happening there.

There's two elements. 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 time frame, those two years, pool owners deferred the replacement and remodeling of pools much like they deferred painting and changing out floors and things of that nature 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 recover continues to date. And then on top of that recovery, given our focus on building materials as a category of products and our increasing our-- sales efforts as well as stocking efforts there, we've gained significant share. And then complemented 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 offerings motivating replacement activity there as well. So that's the biggest impact from 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 has 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.

okay. So the pool construction side then, it's adding maybe a point to your growth but that's a little over 10% of your revenue if I recall, it's like 13% is new construction

That's correct.

All right. 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?

Yes, in fact when you look at the overall number given the base line that we had and everything else, 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 pools staying open a longer period of time and therefore that's driving additional sales. So that dynamic, again assuming, difficult to project the weather when those that do it for a living can't do that very well. So therefore, I'm not going to try. So we assume normal weather. And based on normal weather, we should still have positive year-on-year top line but it will be very modest.

Okay. And last thing for me and I'll hop back into the queue on gross margin. This is two years in a row of gross improvement year-over-year. I don't know if we can call it a trend yet. 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?

Matt, that's a good question. I would look at in this way. There are positive and negatives affecting gross margin. From a product mix standpoint to the extent that remodel 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, we expect them to do over the next five years as 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 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 growth margin percents and dollars than non-private label products. The improvements that we have in purchasing execution, the improvements 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 will result in I'll call it in the big picture modest margin percent impact but it could just as well have been maybe--at this time this year we're talking about a 20 BIPS or 30 BIPS decline.

I would look at either one of the trends. I would just say on an overall long-term standpoint, gross margins will stay percentage-wise about with they are. Having said that, we're 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 to our growth of expenses.

Very helpful. Thank you, Manny.

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

Good morning, gentlemen.

Good morning,.

Morning.

So your business is very steady, 65% non-discretionary. You went over the new construction which leads kind of, a quarter of your business being discretionary. I was just wondering since you're doing well and there's some signs out there indicating the 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, the refurbishment side that you're seeing that's helping lead the growth of the business just to start there, Manny. I mean what are your forward indicators? There are projects that require bids, I assume, and what's your -- how much visibility do you have into those drivers?

Sure. A 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 which again during the downturn were proven 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 firsthand, but there's the items on the equipment pad, the 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're seeing there are two things. First, what we are seeing is that because of the investments in innovation in the part of our supplier base and this includes I mentioned equipment earlier but it also includes on the building material side. The innovation there from an aesthetic value, what we're seeing is better and more attractive products and I don't see impediment for that recovery which is at that point on its last legs because it's been recovering new for a few years. We continue to see that very healthy on a go-forward basis and no real impediment. Again we're not talking about huge dollar items in the big picture, particularly for this pool owner demographic.

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 prospective pool owners have been the biggest impediment to that recovery, not following, for example, the recovery that's taking place in 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 a second mortgage or a home equity loan.

And what have you seen on that? I know you guys had done some lending -- what do you see on that specifically? Because I think that's what a lot of people think that the R & R cycle is not fully unfolded on the credit side relative to those HELOCs or loans. Is that what you see in any information about credit scores or dollars? Thank you.

Yeah. And by the way just to clarify, we do not do any lending. We do facilitate lending in terms of having the ability for our customers when they're meeting with prospective pool owners to link through our sites to lending sources. But coming back to the point. We begin to see in 2014 financial institutions begin to come into play and begin to open up lending and we begin to see that again through this year. But it's not anywhere near the behavior that existed in the 1980s or the 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're still in some respects licking their losses from the going overboard and doing some frankly crazy things in the early to mid 2000s. But as they revert back gradually to normal behavior, we expect new pool construction to recover. And in fact industry surveys done of pool owners that fit demographics of the homeowners that fit the demographics of being prospective pool owners, at the addition of an in-ground pool is still viewed as a very attractive home improvement.

Thank you.

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

The first question is on energy inflation, if we're 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.

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's 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's expecting that, but if that were to happen, that could amount to maybe $0.2 or $0.03 a share hit to next year.

Okay, that's helpful. So in normal band base case probability, you're confidence in being able to able to grow margins well in excess of OpEx inflation?

Again, if it stays in the-- I'll call in the $40 to $60 range over the next 12 months, I don't think it will amount to an impact of a penny one way or the other.

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 side. It seems like there's still a long tail of opportunity there. Just wondering if you can provide some color on how you --

Sure. And if I may, I'm going to provide 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 on our plate, we had all we could do to just 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 having the right inventory in place is certainly important as it is for residential. But it's different inventory in the sense that it's largely larger equipment and 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 will be very, very close to $100 million in products that are sold primarily to the commercial sector. In other words, there are products that cross over between residential and commercial and we don't capture that as part of our commercial business. We're capturing here is our 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 five or six years. We continue to grow share while we are now established firmly as the No. 1 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 underbid the market. We don't try to. We don't try to do things that are short-term oriented. We try to earn our customers' business by providing them a value and a service that is better than anyone else's value and service and that involves selling products usually at the same time or modestly higher prices but having the full suite of service and tools and everything else that enable our customers to succeed and enables us to again progressively grow share.

Thanks for that. One last quick question. On the 10% expected new construction growth for this year, just wondering if you could provide maybe some geographic color, if there's any regions or states that are standing out as outperforming the market.

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

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

Thank you, good morning. Questions about inventories. The growth in the quarter was a little higher than sales growth. Just curious if you can elaborate what's going on there.

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

And in the big picture, it's really nothing earth shaking. It's about two days more of receipts. When you look at our daily receipt levels typically in September and October, we're receiving about $5 million, $6 million a day of product from the, 200o vendors that we buy from on a worldwide basis and sometimes they ship a couple of days earlier and I mean through August, we were running at about 4% or 5% year-on-year on inventory. Those are just plus or minus two days whether something is shipped a week earlier or three days earlier or whatever and comes in and calendar-wise catches it on one side or the other.

Understood. We've gotten so many accustomed to some of your strict standards for supply chain management.

Yes. Those are still in place.

Very good to hear that. Curious on Texas. It sounds like you're assessing that as more of a year-on-year kind of issue with how the market's playing out. Are there any other signs that it's, some of the issues in Texas that others were 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're buying in the mix of the market? Are you seeing it shift more towards, maintenance and away from construction and remodel?

Nothing significant. Two things. First of all, you know, the lion's share of the market whether it's Texas or Florida or anywhere else, the existing pools. So that's whether it's, on a national, it's 87% of our business. When you look at individual markets, it's almost in all cases between mid 80% and 90% of our business by individual market or state. 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 try to gage what impact that could have on our business in 2015. And as, there was really diminuous impact in the big picture and the reason for that is that first of all, a lot of the areas where a lot of that activity was taking place where not established neighborhoods where people had bought a home and then five, ten years later, made the home improvement of adding in a pool. So these were 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 are up 7.5%, in Texas and again that's consistent with the total blue business being up 7.5% year-to-date --they're kind of following the pattern with everybody else.

By the way, as Manny said earlier, we had a very good growth quarter in 2015. Texas was up 10% for the quarter, third quarter of 2015. So high rate of growth following the heavy rains and so forth in the second quarter. So what we're seeing this quarter as Manny said was largely just a result of tough comp for Texas.

That's very helpful. One last question. I appreciated the commentary about the Q4 comparison. Curious if you could jump a little further into the future. Q1 obviously you had 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, you know, base business growth, could be up, revenues,--how should we think about things like that revenue growth and EPS?

Obviously we provide our guidance in February. But at this juncture, I can anticipate that topline 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-year standpoint, obviously as you mention and we'll remind everybody on the call 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 would have call it 5% to 7% the second, third and fourth quarter of the year.

Very helpful.

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 top line and therefore result in certainly, comfortably double-digit operating profit growth. You show in the accretive benefit of a share repurchases and you get back to a decent teens type number earnings per share. Again we'll have that more refined when we get to February. But, you know, David, and you know us very, very well having followed us for a fair number of years. I think you may have a kid in college that probably was born after you started following us. The point is that, we -- it's something that I think I find personally remarkable is the fact that we're so fortunate to be in a space that we have an install base, a great majority of our business is extremely predictable and resilient and therefore, we do what we're supposed to do and execute on our responsibilities throughout the organization, myself included obviously. For us to not have these kind of 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.

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

Thank you, David.

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

Hey, guys, thanks. Another good quarter.

Thank you, sir.

So first question, I'm surprised you're planning to make money again in the fourth quarter. What's the main driver for this?

Ha ha. Well, what happens here is as our business grows, right, and continues to grow every year, we surpassed our break even last year. And there's 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 control on our expense and on our infrastructure so when it's all said and done, it will be another year of positive EPS and again that also ties into our operating margin expansion. 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 our operating margins by virtue of the fact that our gross profits grow at a rate not much higher than our expense growth.

Well, so is this a secular change that you're now going to make money in the fourth quarter every year? Is that what you're saying? Because my understanding is last year you made money because the weather was favorable. If I look at the few years before that, you didn't make money. So this secular?

Yes. I don't know whether I would use the word secular but as our sales and GP dollars have increased, right, and continue to increase, leveraging certain infrastructure, our operating margins increase and they improve 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 always have to have a caveat, if not, Mark would be very upset. If our business mix changed significantly where we have a lot more snow belt business. I don't anticipate that happening but if our weighting of our business changed in a significant way to more northern markets, then that would be a seasonal drag in the fourth and first quarter. But take that aside, again I don't anticipate that. Certainly with our -- 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 every quarter from now on.

Got it. Okay. I didn't appreciate that change. But I'm happy to hear it.

Thank you.

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?

Yes.

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

Well, two things. First of all, we're 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're also in that business focused on the snow belt -- I mean the sun belt. Given all of 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 are looking at a much more refined or focused universe.

And we'll cross paths occasionally on the acquisition front. But, a lot of where they're hunting is areas that we're not going to. That's Item 1. Item 2 is we do have ongoing effort but we have a certain discipline that comes through -- in our process. And we are very long-term oriented. We're 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. That's evidenced by the fact that our ongoing portfolio has a 22% return on invested capital in contrast to the S&P 500 that's just over 9%. So I mean we're more than double the S&P 500's 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's higher than most other companies would have.

And by the way just to clarify one thing, Manny's comment, correct me, but when you say we're focused on irrigation and not landscaped products, you're really talking about the plant material, perishables, part of landscape products. We do supply landscape contractors that are doing, residential and commercial maintenance. We do call that landscape products as well.

There's a distinction there, yes.

Got. Thank you.

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

Thank you. Yeah, hi, guys. Forgive my ignorance on this if you've talked about this before. In the commercial business, remind me, do you sell through an intermediary or service company there are you selling directly to the institution that owns the pool?

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 will 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.

Okay, thank you. And just on the theme here of the first quarter seasonality and how unusual it was last year, Manny, where you said low single digits in the fourth quarter, it seem that is the year-to-year comp gets about 4 percentage points harder in the first quarter and 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 and that's a pretty tough nut to get over the top of.

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 it ,frankly in the first quarter depends on how mild the weather is in the snow belt in February/March and how, when people start opening their pools and then the rush of business that happens as people open up their pools. 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, it doesn't change anything for the year. It just changes how it plays out over the quarter given the seasonality of the business.

Right. I'm with you on that. I don't want to get too myopic here but when you look at where the street expectation are for higher EPS, if you run the numbers through a 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 gaging the expectations correctly as it relates to how the full year looks.

Thank you.

Okay. We'll explore that later. Thank you very much.

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

Yes, good morning and thanks for all of the color. Just wanted to follow up on one of the previous questions in regards to pool construction. It looks like 10% is what you're expecting this year, Manny. So if the economy, continues to slowly increase and, 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?

I would see that there would be the ongoing very -- from my standpoint, very slow gradual recovery of new pool construction and what will change is when financial institutions begin to open up a little bit, their horizons for home improvement lending to existing homeowners, and that's when it will really kick up and recover at an accelerated rate. Until then it will continue to grow at a modest, call it 10ish type percent, 5,000 to 7,000 more pools per year.

Got it. Thanks for that color. And also when you're 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?

Between blue, green and international, probably it would 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 some things out that would make sense for us long term as we -- I talked about a few minutes ago and a lot of those transactions historically over time happened in the wintertime frame after the season is over and before the next season.

Got it, okay. And actually can you also touch your international segment, how that's done and I was just curious also specifically in the UK post Brexit, how the trends in that business.

Overall, very solid throughout all of Europe. In fact, in euros and in Canadian dollars, which are, collectively Europe and then Canada are by far our two biggest international markets representing well over 90% what we do internationally. Both of those markets grew at a modestly faster rate than the US market. So they're both doing well. The UK is doing fine. In fact I reviewed those numbers. We're on track to be a little bit more profitable this year than last year in Europe. So although -- and we have a good chance of hitting 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 finance sector and IT relocate. But again, the existing pools are the existing pools. They'll need to be maintained. Things break down, they'll need to be repaired and after a while, the product will 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 UK, they build less than 2,000 new pools per year. And if you compare that, that would be analogous to a medium-sized market in Florida like for example I would say -- I mean they build more pools in that Miami, Fort Lauderdale, West Palm and Tampa and Orlando. That's more like a Pensacola-type market.

Thanks a lot.

The next questioner today is Al Kaschalk

Good evening. 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.

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. There are certain established distributors that focus 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 our business, if you look back at our history, there was a time way back when that there were a number acquisitions done to enter new markets. We pivoted off 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 and opened locations in over 100 new markets over the course of time. So we can do it every which way. 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 on a technical front as well as having the ability to create the bill of materials. And then separately having the right stocking so that it can be delivered same day next day. And so we can do that organically. I can't rule out an acquisition. But we can certainly get to the our objectives organically.

Okay. Very helpful. I guess not likely to answer this question but worth a shot. I imagine the institutional or pool owner market versus third party, there are different margin profiles on that business given where it's sold to?

The nature of the beast here, Al, and you ask a good question. And this applies to residential products as well as commercial. Generally speaking when you are selling a higher priced product, let's say when you're 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. Again, and I can point to the margin percent and margin dollars. So much the same applies. So when we are selling equipment for example to commercial customers and you're talking about larger filters and larger pumps, that is sold at lower margin percent than when we are selling a residential sized pump and 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 parts, residential and commercial.

Thanks. And then Mark, just a loose end there to tie it up and I know it's going to straighten itself out. But the tax dollars that were deferred, what type of cash benefit did that have in the quarter? How much are we talking there? Is it minimal?

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

Sorry, that was $37 million?

$37 million, yeah.

Thanks, guys. Good luck.

Thank you, Al.

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

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 gave you color where 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.

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