Pool Corp (POOL) 2004 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the SCP Pool Corporation Fourth Quarter 2004 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer period. (CALLER INSTRUCTIONS). Thank you. Mr. Joslin, you may begin your conference.

Thank you Bonnie. Good morning, and welcome everyone. Before we get started in earnest this morning, I’d like to remind our listeners that our discussions, comments, and responses to questions today may include forward looking statements, including management’s outlook for 2005 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 point, I will turn the call over to our Chairman, Rusty Sexton.

Yes, thanks Mark. And good morning again all to our 2004 year-end conference call. It was really an overall very good year, as you can tell, with net sales up 13% for the year, and especially with base business continuing double digit at 10%, and margins especially, when you have 100 basis points improvement there. And then earnings, as a result, up 31% to $1.19.

We had a really strong fourth quarter, which was very encouraging and, to some extent, it helped make up for some of the problems in second and third quarters, even though we had good quarters. But the weather in the second quarter, particularly in the upper Mid-West, and hurricanes in the third quarter, especially in Florida, we had a lot of rain. So it was an up and down year overall.

Certainly the weather was not cooperative, as I have just described. But we were able to manage, I think, very well. And to some extent it was also offset by the improving economy that we’re experiencing, and the increasing discretionary income. So overall, we’re very pleased with the results. And with that, I will turn it over to Manny Perez, our CEO, who is going to give you the details. Thanks. Manny?

Manuel Perez de la Mesa: Thank you Rusty. Thank you all for joining us today for our fourth quarter and final 2004 results conference call. Well, Pool Corp completed another successful year, as noted in our earnings release earlier today. While the numbers speak for themselves, I will just restate some of the things that I think come together here in terms of our story.

Generally poor pool weather in Northern markets, which were mitigated in part by good pool weather in the West. We still increased our base business sales by 10%. That’s in contrast to the industry’s growth of very low to perhaps mid, but more closer to low single digits.

Our more effective delivery of our value proposition to our customers, and our doing that more efficiently from an operational standpoint, converted that sales growth to 28% base business operating profit growth. And then that converted, in turn, to the 31% earnings per share growth that Rusty just referenced, which was more than double the earnings per share of 2001.

In summary, we continue to make progress on many fronts. But really, I am even more excited about our future. Even with our successful past. To start with, in our young industry, we are now beginning to realize more of our potential, as stronger companies, with talented management, increase their presence in the industry. This increase in talent and capital will foster continued industry growth, with higher performing and new products, as well as raising standards for all.

This also speaks volumes about the future of our industry, as pools become progressively more of a staple for U.S. households in the twenty-first century. The macro demographic and economic dynamics for the next 20 years are very favorable for the swimming pool industry.

To further our value proposition, our sales and marketing programs continued to gain strength. We continue to invest to promote the growth of the industry, and the growth of our customers’ businesses. A recently tactic in our deployment of those strategies was the release of SwimmingPool.com as our consumer education web site, speaking to the merits and benefits of pool ownership.

SwimmingPool.com will be supported by our 2005 targeted media campaign, with the objectives of increasing top of mind for swimming pools, educating consumers, and ultimately generating leads for our customers. Our full array of programs, tools, and marketing resources have also been strengthened to further the success of our customers.

From a product standpoint, we continue to see strong growth potential for all of our product lines, but especially for complimentary products, and target complimentary products to represent 10% of our 2005 sales, up from 8% of our 2004 sales. This level of accelerated growth will result from both the further rollout of existing complimentary products offerings, throughout our two networks, as well as the gradual introduction of new complimentary products to our system.

From a systems standpoint, we have also enhanced those tools. Starting with our B2B site, the launch of a new Sourcedisk tool for our customers, as well as ONTRAC. ONTRAC is a point of sale system especially focused and developed for swimming pool retailers, done in conjunction with Microsoft. These are just some of the highlights of our strategic initiatives.

It would take me the better part of the day to go through all of our initiatives to realize our mission, particularly the part about providing exceptional return to our shareholders. Before turning the call back to Mark, I would like to make a comment regarding our transaction in December of 2004.

Although their tenure under the Pool umbrella was brief, the Fort Wayne and industry RP manufacturing activities provided us a unique insight into manufacturing in our industry. I believe that as those businesses got stronger during our watch, we also became a better distributor, because of the knowledge gains. Our strategic investment in Latham, who is an important supplier to us in many markets, and our extended network in Canada, will both serve to further enhance shareholder return.

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

Thanks you Manny. I’d like to discuss our 2004 working capital management and cash flow, then address a few other issues. In general, the management of working capital in 2004 improved compared to 2003. To start, accounts receivable management was a success story for us in 2004, as we improved our day sales outstanding by a day from 34 days outstanding in 2003 to 33 days in 2004.

At the same time, we significantly improved the quality of our receivables, with 72% of our receivables at year-end 2004 classified as current, compared to 66% at the end of 2003, and improve dour percentage of receivables in all aging categories. This allowed us to lower our bad debt reserve balance by $700,000 or 17% on receivables, that are 15% higher at the end of 2004 than 2003.

On inventories, we improved inventory turns 4.5 times in 2004 from 4.3 times in 2003, without any deterioration in the quality of our inventories. This allows us to keep our inventory reserves at a comparable level in 2004 to 2003. On accounts payable, we traded cash flow for earnings in 2004 by lowering our average payment period from 51 days in 2003 to 43 days in 2004. This allowed us to take advantage of cash discounts and other dealer incentives, which were included in our operating margin improvements and, we believe, was a value added trade-off for the Company.

Our cash flow from operations in 2004 was $56m, which was $22m lower than 2003, and $11m below our target of $67m, which we set to be equal to our net earnings. Our change in vendor payment philosophy in 2004 was a significant factor, a contributing factor, to this mix, using $7m in cash. The other significant factor stems from the timing of fourth quarter sales, which were very strong in November and December, as a result of favorable weather, and some delays for hurricane repairs. This was a temporary timing issue, which should benefit our first quarter 2005 cash flow.

I’d like to quickly cover stock share repurchases. In the fourth quarter, we purchased 670,722 shares of our stock, at an average price of $26.23 per share, for a total of $17,591,000. This leaves us with $27,400,000 leave under our August, 2004 Board of Director Authorization of $50m. You can expect that we will continue to buy shares opportunistically in 2005. And we will periodically evaluate the price at which we will be buying.

An issue for 2005 that I wanted to update you on is stock option expensing. As you probably know, we will be required to begin expensing stock options by the third quarter of 2005, and have some decisions to make about the method of adoption and the model to use to calculate our options expense.

While we don’t plan on making some of these decisions for a few months, we expect that the full year effect of expensing stock options in 2005 would be $0.06 per share if we use the Black-Scholes model, based on option grants for the past five years. That contrasts with $0.05 per share in 2004.

Finally, I will make a few comments about our progress on Section 404 of Sarbanes-Oxley related to the audit of our system of internal controls. This audit will not be complete until we file our 10K, which we expect to do by March 1. However, at this point, we are not aware of any issues that will require management or our auditors to bring to your attention as it relates to our internal control environment.

At this point, I will turn the call back over to Bonnie, who will begin our question-and-answer session.

(CALLER INSTRUCTIONS). Your first question comes from Doug Lane.

Yes, good morning everybody. Mark, on the $0.06 a share stock options, is that an annual run rate for 2005?

That is an annual run rate for 2005. Yes.

So $0.03 this year, and then another incremental $0.03 next year. Is that considered in your $1.37 to $1.40 expectations?

When you say $0.03 this year, no. It’s $0.06 in 2005.

Okay. When do you start expensing the stock options?

Well, we have a choice of when we begin expensing. We have to begin expensing by the third quarter. But we can do that any time between first, second or third. So we haven’t made a decision yet as to what quarter we’ll begin expensing. So we also have a method of adoption.

And we can either do it prospectively, which if we begin expensing let’s say in the third quarter, we’d only have half a year’s worth of expense in 2005. The other method is to do a restatement, in which case you’d expense the full $0.06 in 2005. But you’d also restate prior periods. So it really depends on the method to determine the actual impact on 2005.

I see.

Doug, for that reason specifically is why I referenced in the press release a 15% to 18% sales growth, because -- I mean profit growth, since that’s an apples to apples comparison. So if -- and we haven’t defined which method we use. But knowing Black-Scholes, since it’s being referred to as a footnote to the financial statements for the last several years, under the Black-Scholes method, the one-nineteen as reported would be one-fourteen. And therefore the 15-18 would be on either one of those two numbers, whether it’s with or without options expense.

I got it. That makes sense. Okay.  I wasn’t aware -- okay. So it sounds like you are -- well, you haven’t decided yet. So I can’t even really say that you’re leaning one way or the other.

Right.

So the two options are to restate everything and just lower the base in prior periods, or just start incrementally layering them in, beginning in the third quarter.

That’s right.

Okay. Enough on that. Can we talk a little bit about margins, which were -- I mean this is the biggest margin expansion of recent times, over 100 basis points. The operating income, can you give us sort of some color on what drove that in ‘04, and what the outlook is in ‘05, and then maybe also incorporate some discussion on pricing and the impact of revenues and margins there?

Sure. Let me start with one of the issues that we’ve had in terms of how our operating margins are reflected is the fact that whenever we do an acquisition they undoubtedly tend to water down our internal organic operating margin expansion. Given that the level of magnitude in 2004 from acquisitions was less than it had been for the prior three years, that resulted in a more pure sense of basically seeing our efforts to improve how we execute and deliver value to our customers.

And I would say that while we look back historically, and I’ve made this statement many times, you go back a number of years where we were, for example, in 1997, in the 4% to 5% type operating margin, those entities or those locations, on that structure that existed back then, the operating margins are well into the double-digits at this juncture. And again, that speaks to how we execute and work to enhance every facet of our business.

On a go-forward basis, obviously as you get to higher numbers, it gets progressively more difficult. I will say that the acquisitions for the past three or four years have still some ways to go to catch up to the branches that we had in place back in the mid to late 1990s. So, having said that, there’s still a long ways to go.

And particularly as we get better with some of the initiatives, whether it be the marketing initiatives, the systems initiatives, (indiscernible) initiatives, all of those will continue to help us expand operating margins many years (from now) (ph).

Okay. Can you tell us a little bit about what your pricing is, the average pricing impact of the top line, and what you think it will do to your margins?

In terms of pricing on gross margins, that impact will be relatively negligible. In the past 12 months or so, it’s been a very unusual environment within the industry, that after many years of basically flat pricing from our supplier base, they have had to pass on raw material increases.

And that began to happen last year, to a degree, particularly on products that were chemical or resin based. And in the case of 2005, it happened with chemicals, and then some catch-up in the fuel side as well from 2004 not passed on. Having said all that, we pass those on in the marketplace and, generally speaking, have not been adversely impacted from a gross margin or operating standpoint.

I didn’t see a sales growth forecast. Do you have a sales growth target for 2005?

We don’t normally, Doug, go through that. I would say that to get to the 15-18% earnings per share growth, the normal expectation would be, as we have historically, a higher end of the single digit type of top line growth.

Shouldn’t it be higher than normal in 2005 Manny, because of the price increases?

Manuel Perez de la Mesa: No, because that’s not across the board with all products. That’s just selective to a few product categories. There’s a lot of items that the prices are flat.

Okay. Thank you.

Your next question comes from Kathryn Thompson.

Hi. Nice quarter. Just following up on the gross margin question prior, could you just give a little bit more color, and particularly touching on the role of complimentary products. In the past you had said that this wouldn’t have much meaningful impact on margins. But that’s now appearing not to be the case, and actually to provide a boost to earnings, a boost to margins. Could you give us a little color on that?

In terms of complimentary products Kathryn, the overall margins are very, very similar, when it’s all said and done, to our core products. And therefore, that’s not really what’s driving that. I think one of the factors driving it here is that we are delivering a more complete distribution offering to our customers. When one looks at distribution models, there are various levels of services that a distributor can provide.

We have, over the past five years, expanded that offering, given our scale and size, and our ability to do certain things more efficiently than our customers can do for themselves. And that’s in part reflected in our pricing. As opposed to having discreet service charges for certain things, we’ve chosen to bundle that with our product pricing and how we factor that into our complete offering to our customers.

And that speaks in part to the growth of gross margins, but also at the same time it masks some of the improvements in the SG&A side, because of the fact that obviously these expanded services also involve a certain level of cost.

Okay. Great. Could you also elaborate a little bit more on your vendor payment program? And also, I assume that you are still buying in advance in order to take advantage of certain cost savings for certain inventory items. If you could talk about that too I’d appreciate it.

Well, in terms of the off-season programs that primarily equipment manufacturers have to help them balance their production for the year, we participate in those, as we have historically, albeit with a greater degree of discipline in terms of really focusing in on those that are higher velocity items, that we are comfortable will be moved out early on in the upcoming season.

In terms of vendor payments, really our thrust there has been one of making sure that we fully exhaust every possibility to take every terms discount possible. And in cases where no terms discounts are offered, working to negotiate with suppliers to incorporate a terms discount. And obviously when that happens, the trade off is that we have to pay a little factor, which in fact we’ve done.

In terms of the bottom line impact from that, I think our terms discount as a percentage of sales is approximately .4% of sales. So -- and that’s up marginally from where it was historically.

Okay. As far as that, also for the quarter, SG&A as a percentage of sales has increased, as it did in the previous quarter. Will this trend continue in the future? And could you talk a little bit about the drivers of this increase?

The primary driver of the SG&A increase, fortunately, are incentive payments. The way our structure works is that we have a fair amount of our compensation for all of our management and those involved in sales and operations and purchasing -- a fair amount of our compensation is tied to performance. And it’s variable in nature. To the extent that we beat certain objectives defined by the Board, we begin to share on a more progressive basis. And therefore, given the fact that in 2004 we realized strong earnings growth on basically an almost entirely organic basis, that is when those incentive payments kick in accordingly.

Okay. And one follow-up with gross margins, which I meant to ask --actually operating margins. I meant to ask you earlier. Is it still your goal to get to 10% operating margins within the next 2-3 years?

I would not like to use that as a –

Or do you think it’s feasible? How about that?

I don’t want to limit the number. I think 10% is a step along the way. Part of when we realize that result will be based on, in fact, how many acquisitions we do. If we don’t do acquisitions, probably we’ll get there a little bit faster than if we do acquisitions. But, having said that, I think that’s certainly a very reasonable target in the next several years.

Okay. And my last question. You gave a full year number for complimentary product sales. Do you have a number for the fourth quarter, at least to what extent the sales increased in fourth quarter?

Kathryn, honestly I don’t have that right here. But it would be a number that would be very similar to the annual number.

Okay great. Thank you very much.

Your next question comes from [Toby Summer].

Actually it’s [Chris Joseph] for [Toby Summer]. Good morning. Could you remind us, was there particularly favorable weather in the first quarter of last year that kind of drove that strong top line growth? And secondly, can you kind of update us as to how it looks, how sales look through the first month and a half of this quarter? Thanks.

To be honest Chris, I have a vague recollection of the first quarter of last year. I believe it was reasonably mild winter. But I don’t remember specifically. I know that we had a very strong first quarter. And so I would say that, if nothing else, March was probably, since that’s the biggest month of the quarter, was probably decent. It didn’t stay that way. It didn’t get particularly warm in the Spring in the North until very much into the July time frame.

In terms of the first month and a half of this year, although frankly it’s very early, and most of the business obviously in this time of year is done in the Southern half of the country, we are doing fine. I mean everything is pretty much as expected for the first 47 days or whatever.

Your next question comes from David Mann.

Yes, good morning. Could you talk a little bit on the complimentary products, what with some of the new products you plan to introduce in ‘05?

David, it sounds like you have a cold.

Yeah, we’re part of the flu bug down here. Surprised you don’t have it.

I am in Florida.

Good for you.

In the case of complimentary products, as you know our first focus was when we looked at over 30 different product segments that our customers were buying, we focused on those that we felt would be of greatest value to them, given the input they provided to us.

And therefore, on the builder side, we focused on items like building materials, pipes, conduits, things of that nature, rebar, plaster. For our retailers, we focused on items like, for example, hot tubs, as well as toys and games. And on the service side, it was more related to certain tools and things that helped them, saved them time, and helped them become more efficient in what they do.

As we continue to explore that list, we are test-marketing a few new items. We’ve expanded our range. And we’ll be rolling that out on a selective basis during the course of this year, of drainage products. And this is not particularly sexy. But drainage products are important when you have any kind of water or flow.

Another aspect of product lines is fiberglass pools that we’re going to be test marketing in a few areas. Fiberglass pools are another form of pool construction. There are certain efficiencies to be had from the builder standpoint. On the other hand, there are some inefficiencies in terms of logistics and distribution. So we’re fermenting with that as well.

There are a few others that we are doing in various markets. And what we try to do, David, is experiment. And as those experiments provide us information, we then roll that out more and more. Another one that we’re doing, I’ll just maybe ramble on a little bit, is in a few markets, patio furniture. While patio furniture is very widely available through many channels, a number of our customers are interested in becoming a backyard destination for consumers in their areas, in their neighborhoods. And, to that end, we try to fill that niche.

We’ve also learned a few things about, for example, the distribution of something as basic as artificial Christmas trees that we’ve experimented with in certain markets, and done, frankly, well with. And also, billiard tables as well, in certain markets. So what we do is, again, try to identify and see what it is that our customers are currently buying from other source of supply or, alternatively, what they believe they can be selling in their markets, and work with them to be that distribution source for them.

Okay. If I could ask you to elaborate a little bit on this new Internet site that you have, and how that perhaps enhances what you’re trying to do in that area, versus what you were doing before, and maybe a little elaboration on the media campaign that you’re embarking on, and how is all of that going to sort of impact the bottom line?

Manuel Perez de la Mesa: Well, great question. When we started with our programs in 2000, we began that rollout and advertised in a number of markets, using a combination of various media. Over time we’ve figured out that cable TV is the most effective in terms of return for our investment, given the dynamics of the attraction of the pool, having a visual moving environment that stimulates consumer reaction, as well as being seen by cable. We’re able to focus on certain demographics that have a greater propensity to put in a pool or enhance their pool.

The SwimmingPool.com is our next evolution in that process. It’s a website that you are aware of that we’ve had for several years. And we were waiting for the right time to launch it. Frankly, the starting point is the fact that it’s a lot easier to remember SwimmingPool.com as a URL. The other thing that we’re doing is we’ve enhanced the site. And I would encourage all listeners to go on the site, particularly those that don’t have a pool, in order to become more educated on pool ownership, and also some of the opportunities to enhance the whole backyard environment.

There is a build a pool feature that is consumer friendly, very consumer friendly, that enables a homeowner to basically imagine and dream what their backyard could look like. And they can do that, and go as far as sending that to several builders to request a quote. And again, what we’re trying to do here is really make pools something more top of mind in the eyes of consumers, and secondly create a means to really further their education, so that pools become more of a staple in U.S. households.

Now, having said all that, the impact on cost for us is obviously part of our ongoing investment. And when we initiated the program in 2000, over the course of 2000 and 2001, we increased our investment to roughly 1% of sales. And basically we are operating within those same parameters. And that includes not only the 80,000 or so TV ads that we’ll be placing this year in well over 80 markets, but also all of the other associated campaigns that we have to raise that visibility or that top of mind of swimming pools with consumers, as well as providing them further education.

And Manny, that 80,000 ads in 80 markets, how does that compare to what you did in ‘04?

Manuel Perez de la Mesa: In ‘04, we did approximately, I am trying to remember the exact number, but close to 70,000 ads in I believe 74 markets.

Okay. And one last question, just sort of a general question, looking out ‘05 and beyond. If we look at the base business on its own, it seems like we should expect that you would be able to lever SG&A maybe a little bit on normal sales growth, for normal weather years. Is that reasonable, that you’re kind of out at a point now where you’re starting to benefit a little bit more from your investments than maybe in the past?

Manuel Perez de la Mesa: We have, in fact, done that. At the same time though, one factor that has contributed to our gross margin expansion has been increasing the breadth of our service offerings. Obviously our marketing programs is one aspect of that. But also, for example, with ONTRAC, the retail point of sale system that we announced in December to the trades, those kinds of tools and resources require progressively more support.

We maintain over 2,000 web sites for our customers. Those kinds of tools and resources and services, unfortunately, cost money. But we believe we get that back and more by virtue of providing that complete series of values to our customers, in a fashion and way, efficiency levels, that they can’t do themselves.

Okay great. Congratulations on a great year.

(CALLER INSTRUCTIONS). Your next question comes from Anthony Lebiedzinski.

Good morning. I had a couple of questions. The 10% increase in base business sales, how much of that was related to a pricing increase?

In terms of 2004, I would say that the weighted impact of pricing increase was probably in the low to mid single digits. Specifically, some of that pricing came through, based on pricing increases to us in the Spring of last year. And some came in the latter part of the year. But I would say from a weighted average for the year, it was in the neighborhood of low to mid single digits. And currently at least half or more than half of that was unit growth.

Okay. Got you. And in terms of for ‘05, you said, I think, earlier on the call you expect some price increases related to chemicals?

Chemicals certainly. And also, some of the latent increases that did not get passed on from manufacturers in 2004. And that will be, when it’s all said and done, it will be, again, probably closer to mid single digits and low single digits. But again, that’s the type of number. It’s tough to gauge how that plays out in the marketplace during the course of the year, and what happened in terms of some of that pricing not being passed on.

Mmm-hmm. Okay. That’s helpful. And in terms of the complimentary products, you’re expecting that obviously to continue to grow. As you look at the complimentary products right now, is that --? Do you have those products available in old service centers right now? Or are you just expanding the number of SKUs? I know you’re doing some test marketing with certain products. Maybe you could just talk about that a little bit more.

At this juncture, and this is nothing really unique, it’s been a gradual rollout from $3m in complimentary product sales as recently as 1999, when we were just doing it at a few test locations on a test basis, to over $100m last year.

When you look at that though, and you look at our 198 locations that we had in place at the end of 2004, when you look at that basis, you find that probably the top 50 locations represented a good 70, perhaps even closer to 80% of our total complimentary product sales. And that, again, speaks volumes about the opportunity and the rollout of complimentary products for us.

The fact that we crossed -- it took us five years to get from $3m to a little bit over $100m, I think we’re going to get to $200m in a lot less time than it took us to get to the first $100m. Again, that’s just building momentum, increasing awareness, and also, frankly, our being more effective in our execution, in everything from our buying of complimentary products to our selling of complimentary products.

Mmm-hmm. Okay. In terms of your plans for capital spending for ‘05, it looks like it will -- that went down. Any idea where CapEx will be for 2005?

CapEx is projected to be between one-half and three-quarters of 1% of our sales. And it will fluctuate within those two levels on a year to year basis, based on basically the timing of our modernizing our facilities, and upgrading our computer systems, which are the main two destinations of our capital.

Okay. Last question related to acquisitions. Are you still – ? How much are you focused on building up your international presence? Or are you still more focused on the U.S. side of the acquisitions?

We try to be everything to all people. We have a responsibility to the current 201 locations to make sure that we run those very well, and provide our customers progressively more value, and run operations more efficiently. But we continue to expand our network.

The international market presents more of an opportunity for us, given that our share of market is smaller than it is domestically. An example of that was our Pool Tech acquisition at the end of 2003. That added three locations in Greater Ontario. We continue to look for opportunities in Europe and in other markets. And there are also opportunities domestically as well.

There’s a few pockets, a number of markets, where our presence is a lot less than we want it to be, or in some cases a negligible presence. So, therefore, we have plans underway to further that. That could happen through either acquisitions or our opening of new locations. And, as you know, we’ve done a lot of both. And we constantly evaluate both as alternatives, and do that in a fashion that is disciplined and full, and ultimately successful.

Okay. Thank you.

At this time, there are no further questions. Mr. Perez de la Mesa, are there any closing remarks?

Manuel Perez de la Mesa: Yes. Thank you Bonnie. And thank you all again for participating in our final 2004 results conference call. We are very fortunate to be in the swimming pool industry, and to hold such a privileged position within our industry. We are humbled by the opportunity, and by your trust in us. You have our commitment that we will honor our responsibility and continue to execute. Thank you.