Pool Corp (POOL) 2004 Q3 法說會逐字稿

Good afternoon. My name is Brandy, and I will be your conference facilitator today. At this time I would like to welcome everyone to the SCP Pool Corp. third quarter earnings release conference call.

(OPERATOR INSTRUCTIONS)

Thank you. Mr. Joslin, you may begin your conference.

Thank you, Brandy. Good morning, everyone. Before we get started in earnest this morning, 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 2004 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 are discussed in our most recent Form 10K as filed with the SEC.

At this time I'd like to turn the call over to our Chairman, Rusty Sexton.

Yes, thank you, Mark, and good morning to all for our third quarter report.

Well, sales were up 7% for the quarter with base business up 5%, and that's on top of a strong double-digit increase last year. Gross profits up 13% and earnings per share up 18%, all in a less than a favorable environment for sure. Seldom do I talk that much about the weather. We've tried to avoid that, as you well know, those of you that have been around a while. The weather was really less than favorable for the third quarter. The upper Midwest virtually had no summer. The New England east had, I think, one day of 90 degrees or better. The Southeast had rain and some of them at record levels. And the Southwest had more of the same. Seventy-degree days in July in Texas, that's unheard of.

And then the hurricanes came, all four of them. One, Ivan, we couldn't get rid of --with flooding all the way up to Western Pennsylvania. New Orleans Metro was evacuated for a couple of days and the corporate office was shut down.

The only area that had decent weather was the West. So really it's remarkable that our results are as good as they are. My hat is off to all of our employees for what they have accomplished during this time period.

To borrow a slogan from the Post Office, quote, "Rain or shine, we deliver," end quote. Well, you can't take that literally, obviously, but I think it sets the tone for the third quarter.

So with that little brief deal I'll turn it over to Manny Perez, our President and CEO, who will fill in the details. Manny?

Thank you, Rusty. And thank you all for joining us today for our third quarter conference call.

Well, its apparent and as Rusty said, based on the reported financial results, we continue to make progress on many fronts. Despite not having the benefit of particularly good weather and feeling the short-term disruption of the four hurricanes, we managed to increase our base business sales by 5% on top of last year's 15% base business sales growth.

The really remarkable effort put forth by our people to serve their customers in adverse weather conditions is reflective of how much they care about our customers and our suppliers.

The continued, strong contribution of complimentary products up over 30% in the quarter and year to date is also a positive reflection of the many long-term opportunities available to us by becoming an efficient one-stop distributor for our customers.

Our ongoing expansion of operating profits and gross margin is an area of great focus for us as that is how we are compensated by our customers and suppliers. Our dedicated team continues to do that by better utilizing the full breadth of tools and resources available to them. Specifically, we have also benefited in 2004 in our ability to execute price increases coupled with our private label and strategic sourcing initiatives.

Our cooperating expenses remain under good control and under budget overall, except for the results based compensation of the dedicated team share in the financial results that they make happen.

The expansion of operating margin is consistent with our track record as it progressively provides more value and get compensated for it while leveraging our infrastructure and resources.

In an uncertain economic and political environment, our core base of business comprised of existing pools that need to be maintained and remodeled, provide us a solid foundation for growth. This year's price increases in raw materials including steel, plastics, and chemicals should also contribute to sales growth in 2005.

We are very fortunate to be part of a young industry with a recurring revenue stream and favorable supply chain dynamics staffed with a dedicated team that provide exceptional value to our customers and suppliers.

Now I'll turn the call over to Mark Joslin for more financial commentary.

Thank you, Manny.

I'm going to talk a little about our balance sheet and cash flow then address a couple of additional issues.

First the balance sheet and how we're managing the major components, starting with receivables.

On receivables we continue to do a good job of managing collections with average DSO of 34 days both this year and last. We've also improved our aging with 92% of receivables at the end of September classified as either current or less than 30 days past due, which is a 4% improvement over last year.

Moving on to inventories, we're averaging 4.4 turns on a trailing 12-month basis, which is a slightly better than last year. However, if you look at inventory levels at the end of Q3 they're up $25 million or 18% year over year. Of the $25 million increase, $6 million is due to the inventories that came with the October '03 Litehouse acquisition while the rest is attributable to pre-buying product ahead of price increases and to the growth in our business.

On a payable side, we're paying on average a bit faster this year than last. Thirty days is our average payment period this year versus 32 days last year. We've done this to take greater advantage of purchase discounts available to us and in fact we've increased by 29% the amount of discount we've recognized this year over last, which equates to about a million dollars in additional discounts taken.

Switching over to the statement of cash flows, and looking at cash flow from operations, we've generated $31 million in cash year to date, which is a bit behind our target mainly due to the additional investment in inventories and more aggressive position on payables already mentioned.

Our objective is for operating cash flow to meet or exceed net income for the year and we expect to meet this objective by year-end.

I have three other topics to cover, the first of which is share buybacks.

In the third quarter, we acquired 189 thousand shares at a total price of just over $5 million or an average of $26.49 a share.

In October, through yesterday, we acquired 671 thousand additional shares or $17,589,000 or $26.22 on average.

That brings us year to date to 1,543,000 shares acquired at $26.04 for a total of $40,169,000.

Our next discussion topic is our revolving credit facility. Our current facility expires at the end of November and we are in the process of putting a new facility in place. We expect to complete this process just after the end of this month.

I don't want to comment on the specific terms of the new facility at this time, but I will say that the timing of this new facility is working in our favor.

Finally I'd like to take a moment to focus on our Section 404C internal controls review. As with most large companies, this process has been a time consuming one for the company.

At this point, we are nearly complete with our own review and assessment of internal controls. And we are working with our auditors, Ernst & Young, to complete their review of our assessment. We believe that we will complete this process on schedule in the fourth quarter and we will have no material deficiencies in our internal controls to report to shareholders.

At this time I'll turn the call back over to Brandy to begin our question and answer session.

Brandy?

[OPERATOR INSTRUCTIONS]

Your first question comes from the line of Kathryn Thompson from BB&T Capital Market.

Hi, great quarter guys.

Thank you.

I know weather was obviously the big finger especially with the onslaught of hurricanes in Florida. And I understand that sales with that state were pushed back. And you had indicated that net this could actually be a positive for SCP Pool. Can we assume that sales that would have been recognized in, say, September are pushed into the fourth quarter and may actually provide a modest lift to the top line?

Let me give you the question in various ways, Kathryn.

If you look at this year through September there are varying dynamics. The most impactful to our business is the generally speaking very mild weather in the Northern half of the country of the lack of a genuine summer. And that affects us more so in the sense of the delaying of the opening of pools in those markets as well as the closing of pools in those markets. And those sales are lost sales.

Correct. Correct. I understand that.

So that is history.

There's also a temporary phenomena with the impact from flooding and winds on every area that was affected by the hurricanes. To that end there is some pent up demand created by virtue of the need to replace pumps and to a lesser degree filters as well as more shock treatment to pools and increased chemicals.

That is going to be of modest benefit in the fourth quarter and going into 2005.

OK.

So that benefit, I would say, is modest in the overall picture of the company and probably in aggregate it's not going to enhance our total sales by significant amounts.

It wouldn't be material is kind of what you're driving at?

Exactly.

OK. In the past you had indicated that early buys do not necessarily influence growth margins. Is this still the case?

Generally speaking the off-season purchases from primarily equipment manufacturers have been a way for them to balance out their manufacturing and operate a little bit more efficiently. And to that end they provide certain incentives to the distribution base.

Through that end we'll participating in this year as generally speaking as we have in the past. And when it's all said and done, while that certainly helps us as a distributor as that transfer of value takes place, that difference for 2005 or 2004 is not going to be materially different.

OK. And do you still expect complimentary sales to be about $100 million this year? And also to that end could you also provide a little color and update on how that program is progressing?

Complimentary products, as you know Kathryn, has been one of our initiatives that we've built on every year.

Yes.

And in 2004 we expect complimentary products to exceed, break through the $100 million sales mark, which was frankly when we launched the program a 2005 objective. So we're one year ahead of schedule in that regard.

And the fact that we've realized 30% sales growth, over 30% sales growth, not only in the quarter but also year to date is again reflective of our continued focus and opportunities within the context of complimentary products.

For 2005, we will continue to expand our opportunities with complimentary in two ways. First, by furthering the number of locations and the resources assigned to raise awareness and sell complimentary products within our organization.

And secondarily through a modest broadening of the offering in terms of additional complimentary products geared to serve our customers.

And then, and I'll throw in one third piece, and that is that as we've grown in complimentary products and specifically one major category being construction supplies for the pool builder, we have wrestled with how do we do that best and most efficiently. And one alternative that we're pursuing and putting into place on a trial basis in California and looking at in Arizona and then looking to expand further throughout the country, is to instead of adding additional space to existing locations, doing one central location to serve multiple service centers as a stocking point. And therefore enable us to serve our customer base on the pool building side, specifically with construction supplies, in a more efficient manner.

OK. Great. And I guess my last question is noticed that you didn't provide or didn't have any talks about your outlook for the remainder, actually going into '05. Any comments on '05 numbers?

In terms of '05 we are in the midst now of doing our individual budgets and business plans by market. That's something that will be consummated in the course of the next 60 to 90 days. So it would be premature for us to give specific ranges. Although from a long-term standpoint, it is a safe assumption and a valid assumption as we communicated in the past that we believe that on a long-term basis, excluding the benefit of acquisitions, we should realize a mid teens percent EPS growth year on year. So I would say that that's a, that's as far as we can provide at this juncture. On our February call we'll provide more, a little bit more color in terms of our more specific expectations for 2005. But it'll be no less than mid teens percent.

And your '04 guidance remains unchanged?

It remains unchanged.

OK. Great. Thank you very much.

Your next question comes from the line of Jill Caruthers (ph) with Johnson Rice.

Good morning. I was wondering if you could talk about expenses. I know we're up about 50 basis points year over year. And I know sales were slightly than maybe what you were looking for. But could you just explain why there was a lack of leverage in the quarter? If there was any maybe one time cost increases or?

That's a very good observation very quickly in the morning. There are a couple of reasons for that. If you turn a couple of pages to the base business versus acquisitions, contributions to our business, you will find that the base business component is a slight drag in terms of SG&A as a percentage of sales. Having said that, there is still within the context of base business a still small drag of SG&A growing a little bit faster than our top line sales growth.

There is, I'll tell you that the overwhelming primary reasons for that is when you look at our components of SG&A, our number one cost is payroll related. And the way we structure our systems of compensation is that we have everybody tied to performance. To the extent that for the year we as the individual location, region, division, or aggregate company level meet or exceed certain objectives, which we are doing this year, the incentive component of compensation increases proportionately. And I think as a shareholder personally that's a good way of making sure that two things happen. One is that you have a management team and employee base that is rewarded based largely on their performance. And secondarily as a shareholder, making sure that those performance objectives translate to the appreciation of shareholder value.

OK. All right, and then maybe if you could touch upon product sourcing? I know that you currently outsourcing about less than 2% of your SKUs. I was just wondering if you've put more focus into that area? And if maybe that's somewhat helped a big boost in your gross margins in the next quarter? You had quite a big increase in gross margins.

That's an excellent point, our strategic sourcing initiative, which is now several years in its development, it one which continues to bear fruit. But it's not something that we, like anything, we don't jump at anything very quickly. We are very cautious and calculated in our approach as to how we handle these things. And at first and foremost our focus is the customer. And by virtue of our focus on the customer we want to make sure that those customers receive service in terms of the in-stock position with products that are of quality comparable to if not better than whatever was provided previously. So therefore we work with manufacturers both domestically and internationally to identify opportunities for new products or enhanced products. And to the extent that we do that over time we roll that out on a gradual basis, again, the focus being service to the customer and complete value. And sometimes we could be chastised for perhaps our approach being very deliberate. But we'd rather err on the side of being deliberate and successful than perhaps pushing it at a too fast a rate and therefore compromising either service or ultimate performance with the customer.

OK. And have you looked at addressing more than 2% of the SKUs or is that kind of the going rate right now?

Potential is huge. We believe that a significant number of product opportunities are available to us. And in many cases we are working with and doing trials in certain markets. And as we learn from those trials and those markets we then expand the volume base over progressively larger territories.

It would not be unreasonable for strategic sourcing to encompass 10% of our purchases at some future date within the next three to five years.

OK, and then this last question, maybe some insight into the gross margin increase this quarter?

The gross margin this quarter came about from several factors. as many of you are aware, we have you know operated and focused on a number of initiatives on the operational slide as well as the sales and marketing side to progressively provide more value and do that more efficiently. And our compensation for that comes in the form of our gross margin and gross profits. So therefore, the effort made here, our continuation of what's been taking place over the last few years. There is also this year the fact that very unique in our industry, given that historically there's been virtually no price inflation, this year we've had price inflation in terms of manufacturers passing on raw material price increases. And as they have done that, we have also, in turn, passed those on in the marketplace. To the extent that we use our resources to buy a little bit ahead of those increases, from a sourcing standpoint, has enabled us to realize some additional margin there as well.

OK, thanks so much.

Thank you.

Your next question comes from the line of Chris Joseph from SunTrust Robinson .

Hey Manny, it's Chris Joseph at SunTrust Robinson Humphrey.

How are you sir?

Good, how are you?

Great.

Just wanted to kind of follow-up on what you had just said. Have you been able to fully recover price increases that you've seen in products? I think you kind of mentioned steel, chemicals and plastics.

By virtue -- Chris, good point. By virtue of our ability to buy a little bit further ahead of the market, and also our sourcing in general, the answer is yes, we've been able to not only recover that, but also recover that plus a shade more.

Got you. And complementary product sales in 05, are you guys comfortable talking about what a growth rate for those sales might be? Is it comparable to what we saw in '04?

In terms of complimentary products, last year in 2003, complimentary products represent approximately six percent of our total sales. This year, they will represent approximately eight percent of our total sales. That growth, two percent of our total sales mix, being derived from complementary products is something that we expect to take place into the future, and specifically for 05, we would be looking at something approaching or approximating 10 percent of our total sales coming from complimentary products.

OK, great. Thanks.

Thank you.

Your next question comes from the line of Doug Lane , from Avan---Avondale Partners .

Hi good morning everybody.

Good morning day.

I want to get on the complimentary products. What was the number a year ago? If I use six percent, it was somewhere around 70 million, but I thought it was a little bit more than that in 2003.

It was a little bit more in the 70s -- I can't recall the exact number at this point in time, but it was a little bit over $70 million.

OK, and approaching 110 this year if I remember right.

Correct.

OK. ... couple of other more detailed questions, just on the numbers here. The stock buyback, what do you have remaining on your authorization there?

Doug, this is Mark Joslin. We have 27 1/2-million dollars remaining on the recently reauthorized 50 million in August from the Board.

Got it. And then, Mark, on the working capital here, which is, you know, just on page four of the release, it looks like through nine months it's been a 46 million use of cash versus a four million use a year ago, which is a big swing, and you address it with the inventories and payables, and that all makes sense. I guess my question is seasonably, how does the fourth quarter impact that? How much cash do you think you'll get back in so I can sort of come up with a full year number for '04 use of working capital?

You can assume for the full year, that cash flow from operations will approximate net income. And the major change there from where we are now to year-end is that fact that the Lions share of the receivables is comprised of the prior -- is from the prior month sales. As Mark mentioned, 92 percent is basically either current or within less than 30 days past due, so therefore when you look at our December sales being a lot less than our September sales, that's the biggest change net-net from September to December.

OK. That's a big gap to make up because you're trailing net income by almost $40 million through nine months.

Sure, but that's because the September sales aren't collected until October.

OK.

And net income dropped a little bit in the fourth quarter as well.

No I understand that. But I mean last year you were actually ahead in net income. You know, 58 versus 53 and this year it's 31 versus 70, so I just didn't know ...

That's a good point and one of the things that we had in our favor last year was if you recall we acquired in August of 2002 Fort Wayne and from that acquisition, which encompassed 22 locations, we made a decision to consolidate 13 with existing superior locations, so therefore from that consolidation of 13 locations, we were able to eliminate redundant inventories and to that end, gain that benefit largely in the first half of 2003.

I see, that's right. That's right; working capital was actually a source of cash last year. OK, that's helpful. And then lastly, on the reserves here for receivables and inventory, they went down a little bit. Are these new levels sustainable? And is there a corresponding P&L entry for the reduction in doubtful accounts and in inventory reserves?

There is, Doug, it's not a large adjustment to the P&L, but we've had continued sustained improvement in our working capital management and so we think the kind of trend that we're showing is one that we will continue to stay on. We focus on that a lot internally, not just at the corporate level, but down at the branch level, and so it gets a lot of attention and it's included in the targets that people are looking to hit, so I think you'll see continued good work there.

OK, thank you.

OK.

At this time, I would like to remind everyone in order to ask a question, please press star then the number one on your all phone keypad. We'll pause for just a moment to compile the Q&A roster.

Your next question comes from the line of Jeff Chamanado (ph), with William Blair.

Good morning.

Good morning Jeff.

Could you shed a little color on the average daily sales trends by month for July through September and maybe some anecdotal evidence on what October's shaping up to be?

In terms of the July August and September trends, generally speaking they all hovered in the daily basis in the mid single digit range last year to this year. I would say all in the four to six percent on a daily basis. On a monthly basis, we had one less sales day in July, which was recovered in August, so on a monthly sales July looked artificially lower and August looked officially higher, but overall, for the three months, they were all in the mid single digits. And that's on top of last year's mid teens numbers that were realized.

So you had pretty good comps last year too?

Very. Very -- last year was -- and Jeff, you're living in Chicago, you can appreciate this very well, you know, cool season has not gotten off to a particularly early start. In fact, it's have a very late start for now a few years running in the last good weather year for the pool industry was really 1999, but having said that, what happened last year was that there was a little bit of an Indian summer, with milder weather extending a little bit further out, and this year, that really hasn't taken place. Rusty cited a couple of examples in markets where they had one or only two days of over 80-degree weather. Well, last year the third quarter weather-wise in northern markets was I would say pretty good, and helped us realized very strong mid teens type of sales growth. And obviously resulted in top comps for this year, but despite all that, and despite mediocre weather at best, we were still able to do reasonably well.

And with only a few weeks into October, how's that shaping up?

October is shaping up well. I would say that the sales to date in the month of October will be mid to a little bit better than mid single digits, top line growth versus last year.

And can you comment on program sales, how those did in the quarter vis-a-vis company overall and the industry?

Great question. Unfortunately, I don't have those readily available here, but I will tell you that -- and as you're aware of, Jeff, given your knowledge of the company, our program sales in the key component for us and our ability to help provide additional value to our customers, and to that end, their growth continues to exceed the average growth of the rest of the customers and certainly the rest of the industry. You know, when you look at our sales growth vis-a-vis the pool marketplace, one distinguishing component where we are outperforming the market is driven in part by -- or in large part by our program customers and our channeling leads to them, our providing them additional tools to have them be more effective and sell a more complete pool for retailer to have greater source traffic as well as having more sales per lineal foot. So those are the kinds of things that our programs and the value that our programs provide together with our business development resources that altogether helped our customers sell more product and get a greater share of the total.

The other component thereto, which I touched on earlier, is that because of that value that we're providing, not only the service we're providing but also the value with the programs, we also receive a premium in terms of the gross margin.

Right, and can you -- is there any industry data out on the quarter yet? And how does that compare to your results?

There is no industry data. Generally, the industry data lags significantly. Perceptions are and this is not I'll call it hard references, but I know of a number of distributors in northern markets whose sales for the quarter were down 10 to 20 percent, and also in general, where distributors in northern markets their sales are no better than flat year on year, in contrast to our overall 10 percent based business sales growth on a year-to-date basis.

Thank you very much, keep up the good work.

Thank you Jeff.

Your next question comes from the line of Richard Leader (ph), with Barnum Securities (ph).

Good morning.

Good morning.

Earlier this year there had been various reports, and not just about price increases in concrete and aggregates, but also shortages. Can you comment on that as a potential limiting factor in the pool development by your customers?

We are very aware specifically of some of those -- some of that information that took place in the earlier part of the year. I would say that in general, there was little to no impact on the pool building side other than the fact that pool builders and their distribution sources had to do a little bit better planning to make sure that they have the products in hand when needed, where as perhaps in years past, they didn't have to do as much planning, but when it's all said and done, my perception is that it will not impair and has not impaired in any significant way the rate at which pools are being added. And one of the areas where that was concentrated the most and to a degree was more of an issue, call it, in the March April timeframe, was Florida. And certainly because a certain amount of disruption back then in terms of being spot shortages of -- you know, the biggest impact is price, but the price has been basically passed on all the way to the consumer. But the spot shortages what they did was it basically you know resulted in what I'll call unproductive days back in the spring on the part of builders, but as they adjusted their planning and communication to their sources, as their sources in turn altered their buying behavior, things came back into place and, you know, then it's just a matter of working a little bit longer hours and more weekends to catch up.

So if it hadn't really been a factor in the past, it'd be fair to say that you would suggest that what you know now would not anticipated to be a limiting factor going forward, correct?

In a generic statement, no. I mean you've got a number of dynamics planning into this equation. When you look at raw materials overall, be it cement or steel, as another example, what you've got is you've got a growing international demand in certain sectors of our economy, home-building being very strong for an extended period of time. That's also driven, you know, increasing demand. So with increasing demand and manufacturers of some of those products not really adding to their capacity over the last -- during the recessionary period, over the last few years, there's an adjustment. You know, the first part of that adjustment is spot shortages, but the other part of that is price increases. And given the nature of the pool industry and the value that pools provide to consumers, in contrast to alternative major household discretionary expenditures, at the end of the day, the industry is able to basically pass those costs on to the consumer with virtually no impact on ultimate demand.

Got you, thanks a lot.

Thank you.

At this time I would like to remind everyone in order to ask a question, please press star than the number one on your telephone keypad. Your next question comes from the line of Dan Mendoza from OMT Capital .

Hi, Manny, I had a couple of questions cash flow related. Where would you expect inventory to finish up the year on a year over year basis? And what is the potential impact if we get near the end of the year if you've got some suppliers that are eager to rid themselves of some of their own inventory? Is there a chance that that could impact your cash flow in Q4 and for the year, and that you might not end up where you've got it to today?

Great point, Dan. Great questions. I anticipate that at year-end our inventories will be modestly higher than they were at year-end 2003. Modestly being somewhere at or approximating our sales growth for 2004 versus 2003, which will be -- through nine months it's been 10 percent, so five to 10 percent over last year's year and is a reasonable expectation at this juncture. To the extent it's any more than that because of a phenomenon where a supplier wants to ship in December versus January or February, that would be offset with accounts payable. So therefore, really not impacting per se our cash flow.

Right.

The bigger impact to cash flow would be where a manufacturer has a certain desire to get paid this year for whatever reason as opposed to later, in the normal buying or payment stream for those early buy or early season purchases. But given the liquidity, the debt markets and the ability for debt at very low cost, I would anticipate that there will be very many opportunities for us in that vein, so again, I come back to we should be OK from a cash flow from operations standpoint.

OK, and then my other cash flow related question is longer-term. As you continue to pay down debt, what is the appetite on the Board for paying a dividend, either an ongoing dividend or a onetime dividend or both?

Well, as you know, we now have a dividend in place, which was instituted from the May board meeting and a date in June and September, anticipate will be paid again in December and every quarter thereafter. A special dividend is one that's a separate topic of discussion. It's one that we're certainly aware of an alternative, but at this point in time, I think we started with a regular quarterly dividend that provides a yield that's approximating 1% and we will -- that'll be reevaluated by the board periodically. But we also are buying back shares on weakness, as Mark mentioned earlier what we've done so far, and I think that those combination of events plus our ongoing opportunistic acquisition within the industry are very good uses of cash.

Great, thanks.

Thank you.

At this time there are no further questions.

Thank you again for participating in our third quarter 2004 results conference call. We look forward to providing you another update in February when we will discuss our fourth quarter results. Thank you very much.

This concludes today's conference call. You may now disconnect. Mr. Joslin, I'm now transferring your group back to the sub-conference.

Thank you, Brandy.

Mr. Joslin?

Yes?

Your other participant, Mr. Sexton, he disconnected already.

OK, great. Thank you very much, Brandy.

OK, thank you.

Bye, bye.

Bye.