Pool Corp (POOL) 2005 Q1 法說會逐字稿

Good morning. My name is Shannon and I will be your conference facilitator. At this time, I would like to welcome everyone to the SCP Pool Corp. first-quarter 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. (Operator Instructions). Thank you, Mr. Joslin, you may begin your conference.

Thank you Shannon, good morning everyone and welcome to SCP Pool's first-quarter conference call. I need to remind you that our discussions, comments and responses to questions today may include forward-looking statements, including management's outlook for 2005 and future periods. Please be aware that our actual results may differ materially from those discussed today, that factors and variables that could cause actual results to differ materially from projected results are discussed in our most recent form 10-K as filed with the SEC. At this point, I would like to turn the call over to our CEO, Manny Perez de la Mesa.

Thank you, Mark, and thank you all for joining us today for our first 2005 results conference call. As indicated in our press release and our financials, we continued to make progress on many fronts. Despite generally colder than normal weather in northern markets and wetter than normal weather in the West, we still increased our base business sales by 13%.

The loss of manufacturing profits from our disposition of our manufacturing assets in Fort Wayne, Indiana and in Québec contributed to the 60 basis points decrease in gross margin. In fact, for the year, that translates -- those manufacturing assets represented approximately 50 to 60 basis points of our gross margin and therefore, from a modeling standpoint for all on the call, will translate to a 50 to 60 basis point decrease from a reference standpoint in terms of 2004 to 2005.

In addition, changes in product and market mix and some modest erosion of margin in the pass-through of price increases contributed to our decrease of gross margin. Especially notable in that is that certain competitors of ours sold products below replacement cost in the quarter. In fact in a few cases, we even purchased product from competitors selling below replacement cost.

Let me digress here for a minute. The pool industry has historically witnessed very modest price inflation with certain product categories -- chemicals, for example -- in fact down over the past 10 to 15 years. Generally, we are provided adequate notice from our suppliers, which in turn, enables us to pass the increases on to our customers and remain margin neutral. In certain markets and with certain competitors, we are adversely impacted if they continue to price product based on their old cost instead of their new cost. This normally works itself out in a few months as the old cost inventory is depleted. To mitigate this issue, we buy ahead opportunistically, limited usually only by warehouse capacity.

Going back to the P&L, more effective value delivery with our operating expenses going up only 6% and effectively more efficient operations, converted sales and gross profit growth to 47% operating profit growth.

In summary, progress continues on many fronts but I am even more optimistic about our future. To start with, our new consumer lead generation vehicle, www.swimmingpool.com, has already provided 20,000 leads to our customers and the advertising just got started in March. Together with our marketing programs and other sales tools, we are providing unique value-add in our young industry.

On the service front, we have opened up two new locations, added two new redistribution facilities, expanded 14 locations and redesigned nine other locations to further our customer service and operational performance. These investments in our future, much like our investments in sales and marketing, are the foundation for growth in future years.

While all of this is good, we are very cognizant about execution and are logically very focused as our busiest time of the year approaches. We are confident that our ongoing investment in people, systems and technology will result in another successful year in 2005 while we plant the seeds for the future. Now I will turn the call over to Mark for more financial commentary.

Thank you, Manny. I will keep my remarks brief this morning, reflecting a relatively uneventful first quarter. Let me turn your attention to our statement of cash flow for Q1. And for those listeners that may not be as familiar with our business as others, I should explain that the first quarter is our period of heaviest cash usage in the year. This is due to the seasonal nature of our business and the need to fully stock our warehouses ahead of the peak second-quarter selling season.

In addition to this, our inventories are a bit higher than usual this year as we have purchased product ahead of unusually high vendor price increases which Manny referred to. In the quarter, you can see that net cash used for operating purposes was 51.1 million, which was almost 19 million less than we used in the first quarter of 2004. While inventory levels are higher this year to support the higher sales volume and as mentioned to stock up ahead of vendor price increases, we have used less cash this year due to longer vendor payment terms. Some of our vendors this year were not as willing to provide early paid discounts as they were last year, so we have extended our payment terms, driving up our payables balance at quarter end. This timing issue should really normalize in the second quarter. In addition, you may recall I mentioned on our year-end conference call that some collections anticipated in the fourth quarter were pushed to Q1, so our Q1 2005 cash flow benefited from this as well.

Finally I will comment on a new line on our income statement, which is entitled Equity Loss in Unconsolidated Investments, which is where we posted an expected after-tax loss of $1.5 million for the first quarter. This loss results from the equity accounting treatment of our 42% interest in Latham, which we acquired in December 2004. Latham's business, supplying packaged pool components, is like ours, highly seasonal. We expect this business to be profitable for the year and the transaction as a whole to be mildly accretive in 2005. As we had stated at the time of the acquisition, Q2 will be the strongest quarter for Latham, followed by Q3 and then Q4. At this point, I will turn the call back over to our operator, Shannon, who will begin the question and answer process.

(Operator Instructions). Jeff Germanotta, William Blair.

Good morning. I would like to explore two issues in a little more detail, the first would be gross margin and the second would be Latham. Can you give us a little more color on specifically the impact of the divestitures and what kind of normal gross margin range we can look towards heading to?

Secondly with respect to Latham, can you talk about the specific seasonal factors and the action plans to improve profitability?

Good morning, Jeff. Let me take one at a time. In terms of gross margin, if you look at our 2004 results and if you were to on a pro forma basis exclude the manufacturing components of those 2004 results, you would find that 50 to 60 basis points of our gross margin came from manufacturing and the fact that a lot of that manufacturing was sold internally and therefore consolidated or eliminated in consolidation. So therefore if you reflect, if this year for example -- if this year's gross margin ends up being equal for the year to last year's gross margin, that means that we in fact improved our distribution gross margins by 50 to 60 basis points. Again that's pure accounting where the 20-plus million -- largely from $20-plus million of our manufacturing -- our previous manufacturing operations, those sales being -- eliminating consolidation and those gross margins now going away and in fact folding into the Latham equity interest. Does that answer that part of the question?

Yes, if I could just clarify. So we should probably be thinking about gross margins in the 26.5 to 27.5% range -- or excuse me -- the 27.5 to 28% range for this year?

Yes. The logic would be that you would just adjust last year's numbers by about 50 to 60 basis points as a point of reference.

And you mentioned also in gross margin, the temporary pricing pressure from competitor discounting.

Right. And with that happens, and this is very unique in this industry on a relative standpoint, because the industries have had historically very modest price increases, but in this particular case as those price increases are coming through, we've tried to pass them on to be at least margin neutral. Some competitors I will say drag their feet in passing those increases on. And to the extent that we need to, we also have to do the same. And there is some marginal hit for us in the quarter for that that's probably in the neighborhood of 10 to maybe as high as 20 basis points of the decrease year-on-year.

So 10 to 20 basis points from competitor price pressure, reduced margin in the first quarter. As you've moved into the second quarter, has that continued or do you see it alleviate?

That should be alleviating over time because that old inventory, that is their cost reference as they price products, that inventory is by March-April time frame is largely depleted.

And what kind of average selling price increases are you seeing from vendors?

When you look at the overall mix of all of our products, it probably ranges around the mid-single digits overall.

So kind of 4 to 6%?

4 to 6% would be what the weighted average number would be. It depends on market and mix of products.

And then, could we go to the second issue, which was Latham I guess, what is the timing and the action plan for the change there?

Latham, in fact their results were very, very close to within $100,000 of their plan for the first quarter. The Latham business is a little bit -- well, it's certainly seasonal like ours, it's even more weighted towards the north because of the operations in Canada. So overall what happens there is that their second and third quarters are proportionately even more significant than ours and their worst quarter of the year is the first quarter with the fourth quarter being virtually or very close to breakeven.

So when we look at the transaction overall, we exchanged, if you recall, we exchanged our interest in manufacturing in Fort Wayne and in Québec and in return, we received distribution assets in Canada as well as a 42% interest in Latham. The net-net of that is for the year is marginally accretive on the -- when you look at it by quarter, it's certainly worse in the first quarter and certainly better in the second with the third, the difference in the third and fourth quarter being relatively negligible.

So as we think about better integrating Latham into our forecast, should we be looking for more variability to earnings in the first and the fourth quarters and a positive boost in the second and third?

Exactly. You would see the negative, which would be reflected in the first quarter, that being the reference point. You have a compensating offset in the second quarter with the differences in the third and fourth quarter being less significant. A little bit positive in the third, a little bit negative in the fourth, but overall, much less significant.

Thank you very much.

David Mann, Johnson Rice.

Good morning, Manny and Mark. If I could follow up on the competitor issue or competitors. Can you just verify which markets you saw that in, how many competitors and what products are you primarily having to -- it sounds like match price on?

There is no specific one market per se. Where we have the biggest issue specifically unique to this year was in the line of chemicals. Chemicals have historically had very modest price increases and -- no, in fact, decreases over the past 10 to 15 years. So therefore, there was almost a catch-up that took place given the legislation and the tariffs imposed by the ITC on Chinese material coming into the country. That resulted in the manufacturers of the basic raw materials bumping up their pricing and then those that package the product in turn doing the same. Some of those involved in that business chose to and in fact continue to sell well into the first quarter based on what I will call pre-increase pricing. And we in fact bought product from competitors based on that.

And the actual timing of the increase?

The timing of the increase basically from manufacturers to us took place in the late January, early February time frame. We in turn raised our prices to our customers in the mid-February time period. And again, some of our competitors still haven't figured it out.

In terms of the outlook for the chemical prices, are you anticipating additional price increases this year?

There is a review because some of those buyers (ph) were challenged and that, the expectation is that there will be a further clarification and a more definitive tariff statement sometime in the May/June time frame. In the interim, everybody is certainly operating with the higher cost. Many in the market have done like us and passed those costs on. So we anticipate that normal, good business sense will prevail and basically everything will return back to normal.

Okay. In terms of markets, it sounds like Florida was really good for you in the quarter. Can you just talk a little bit, given it's probably the first more normal quarter since the hurricanes or starting to build towards the season, what the demand has been like there in general?

I would say, I would expand that definition, David, to say that basically Texas, East, and that basically southeast quadrant of the country from Texas through to the Carolinas and down to Florida had more normal weather and they are the ones that carried the flag in terms of our first quarter.

In terms of Florida specifically, the disruption, business disruption caused by the hurricanes are largely history. They impacted certainly the rate at which new pools were added for a period of time. On the other hand, there were compensating positive factors such as the increased replacement of motors, pumps and the more extended use of chemicals to rebalance pools.

One last question. You talked about the weather issues in the first quarter. How would you characterize the second quarter? It looks like the rain has stopped in California and warm weather is picking up?

Three weeks into the quarter, it is looking very good.

Great, thank you.

Kathryn Thompson, BB&T Capital Markets.

Thanks. A couple quick questions. Just to clarify on the gross margin issue, from your comments, it sounds like basically essentially almost the entire difference in gross margins for the quarter is attributable to the manufacturing basis. Is that a correct assumption?

Certainly, a great majority of it is, yes.

And would you say that maybe 5 to 10 basis points is related to the pricing issue?

More 10 to -- I said 10 to 20, probably closer to 10 to 15 basis points.

Okay, I just wanted to clarify on that. As far as -- how much of the base of business sales are related to the price increase?

I would say that probably -- again, the average for the quarter would probably be somewhere around low to 2 to 5%. It has varied significantly by market. The price increases really do not begin to take hold into the second half of the quarter because most increases did not come into place until like February or March. So it would be lower than the complete impact, the second quarter would have more of a complete impact of 4 to 6% --.

So you say more 4 to 6% going into --.

For the rest of the year.

For the rest of the year? Okay. As far as -- speaking of the price increases, when you are increasing prices, are you doing it as the cost increase, a one for one increase, or are you raising prices just up a little bit more than the actual increase in cost?

We generally speaking try to, with price increases, remain margin-neutral.

Okay. Alright, that just wasn't the case during this quarter.

In a number of cases in certain markets for certain products, we have to defer the increases. So therefore for, whether it be a week or a month depending on the customer, depending on the situation.

So if this is anyone who might have a concern about that going to Q2, it's really a non-issue?

I would think so.

I know that you're going to be making a decision on options. Are you going to expense options, I guess you have to have the decision by the third quarter?

Actually Kathryn, the SEC has delayed implementation on options expensing. So that has moved to the first quarter of next year unfortunately. Just kidding.

Alright, there you go. Any other color on the second quarter or coming quarter? It would be nice just to get your thoughts on just sales trends, what you are seeing in terms of weather. I'm hearing good things out of the Midwest. Just any -- a sneak peek into the second quarter would be greatly appreciated?

Let me give you the perspectives on the various segments of our business. If you look at the builder segment, north or south, the demands for new pool installations has been for a number of years, continues to be very strong. And therefore, good builders are as busy as they want to be as they have been for several years. In the South, that means that good builders are building year-round. In the North, they're building as soon as they can. This year, builders could not start as early as they did last year because of the colder winter with increased periods of frost in the ground. So therefore, they have to delay the beginning of their building period by as much as a month versus last year. That does not really affect the second quarter at all or the third quarter, for that matter. The only real variable there is what happens at the other shoulder of the season as we come out of the season is when does it start getting cold in the North, and that is when they have to stop building.

In terms of remodeling segment, which is in fact bigger than the new build segment for us, that remodeling segment continues strong and there's really, that's growing naturally very nicely. The maintenance and retail segments of our business are generally very predictable. The biggest variables there are again in the North and those variables are based on when does it get warm and people open up their pools and when does it get cold and people close their pools. Again in the second quarter, there is some impact there in April but the larger impact is May and June. And while I cannot predict the weather for the next 30 days, the first three weeks have certainly of the quarter are certainly positive. So overall, I would say that the second quarter and really the rest of the year looks positive.

If I can then go back in and for all on the call that follow us and have very detailed models, the only components I would say that you would change to your model is the one I mentioned earlier, which is that from a reference standpoint, having a lower gross margin because of not having the manufacturing business in the gross margin segment, but when you look at the bottom line at the EPS level, those EPS numbers are basically consistent. And as stated in the press release again, we reiterate our -- I will call it estimate -- that our earnings for 2005 will be 15 to 18% greater than they were in 2004 at the diluted EPS line.

Okay, great. Thank you very much.

Doug Lane, Avondale Partners.

Good morning everybody. Mark, Manny, I'd just like to drill down a little bit on the top line here, because the first quarter, your base business grew 13% on a 16% comparison. And even if you take out say three or four points for inflation, that's still high-single digits. On a 16 comparison ex-inflation, you're comp in the second quarter is 12. It's a bigger quarter, but it's still a good number. But I guess what I'm driving at is, if you're going to add 5 for inflation and your core business ex-inflation is high singles, then I can get into the low to 12, 13, 14% without too much difficulty. And it seems like -- I don't know if you have articulated a sales number for this year, but it seems like well into the double digits is where you're pointing.

Well, certainly the unusual levels of price increases would mean that our sales line should grow. And we anticipate that from a GP dollar standpoint, we'll be more than covered. So that's another observation that's very well stated on your part.

The other side of the equation is that we clearly are continuing to gain share of market as well as the continued added benefit of the growth of complementary products and the fact that those continue to grow at a very accelerated rate, given the fact that we are still scratching the surface of our potential with the product lines that we have much less what we have to roll out over the next few years.

Yes, let’s talk about complementary products because you said they were up 27% in the first quarter, and that's consistent with '04. But if I remember right, you're articulating a goal of 10% of your sales this year being complementary products, which implied an acceleration of that growth. So I'm wondering if you're expecting the complementary products component really to accelerate from the 27% as the year progresses?

Well, modestly different from 27, but not significantly. Last year, complementary products represented approximately 8% of our total sales and our objective is for them to represent approximately 10% of our total sales this year, which is not significantly different than 27% versus a basic high single-digit core business growth.

The core business, the pool industry growth is 4 to 5%, and then if I layer on the inflation, even the core business should be around 10% this year, no?

Obviously you're doing a very good job of trying to get us to state a bigger number. But I would think that, yes, the core business is certainly unit-wise 4 to 5% at the norm. The impact of price inflation unique to this year is going to take that to the high-single digits in and of itself. So if you layer in complementary products and you layer in some market share growth for us to get into double-digit percent growth this year is certainly not out of the question. So that's very logical and appropriate.

So I guess the question mark, and let me probe this, because I understand your thought process that at some point, your competitors are going to feel the cost squeeze. But how confident are you that that pricing will come through as you expect, or is there some probability that your competitors will not respond to the cost increases and just eat the margin?

They can't. Their bottom-line margins do not allow them to do that on a sustained basis.

Fair enough, thanks.

Tobey Sommer, Suntrust Robinson Humphrey.

Good morning. I joined the call a little bit late, so I apologize if you've gone over this. But could you talk to us about your plans to expand in terms of branches and so forth over the next couple of years - how should we think about that in terms of the opportunity to kind of accelerate or pick and choose your spots? Thank you.

That's an excellent question. As most of you know, and if not, you can quickly figure out, we analyze and on a very calculated basis do what we do. When we look at markets, we're looking at markets where they are today and where we anticipate them to be over time. Given that most of our revenues come from the installed base of pools, that's the primary basis for any decision that we make in terms of expanding into a market, whether it be entering it or expanding our presence. To do that, we have many alternatives. From a basic point of entry, we look at both acquisitions as well as the opening of new locations and over time, we've done a lot of both. Once we're in the market, then we look at avenues or ways to grow our participation in the market.

Sometimes, depending on the market and the market size and the competitive landscape, that means that we open up multiple locations in a market. There are markets for example like Houston where we have between the two channels five locations. In other cases, we decide that we're better served in terms of bottom-line contribution and return on assets to simply expand an existing location. And in my comments, I mentioned the fact that this year, we have opened to date two new locations. And on top of that, we have also expanded 14 locations. So in effect, in each of the cases where we expanded the locations, we evaluated, would we be better served by having a second or another location in that market, or are we better served from a service level, efficiency and everything else standpoint, are we better served by simply increasing the size of our facility. And that's how we go about it.

When you look at the U.S. market as the largest pool market in the world, we have a presence in well over 90% of the U.S. market. Now that doesn't mean that we have approached anywhere near our potential because in many of those markets, our share of market is very, very modest, particularly where we've only entered the market in the last year or two. So we continue to evaluate that and look at that on a market-by-market, case-by-case basis and consider all of the myriad of alternatives to provide long-term optimized shareholder return.

Two follow-ups. What sort of a service center expansion should we think about for even going beyond this year, maybe like in '06 or in '07? And then I was curious -- in terms of Sarbanes-Oxley expenses for '04 and maybe even in the first quarter, how much do you think that is going to trail off in '05, in terms of an ongoing expense? And maybe if you could give us the value you spent on 2004. Thanks.

I'm going to turn the Sarbanes-Oxley question to Mark. He's obviously closer to how much more we spent on that than I am, unfortunately. But in terms of openings, historically, we have said that we would look to have five to 10 new locations per year. And the only change to that is to the extent that we are better served in every facet -- service as well as return on assets and delivery efficiency by having a bigger location than an additional location, we will do that. And that is the, I think, the key variable. And again, it goes back to market-by-market, case-by-case. We are a young industry and in this young industry, we have many, many opportunities to expand our presence over time and we’ll participate in every facet and probably, not probably, we will definitely lead the way in terms of expanding our network and expanding our service offering to capture progressively more share of this young, growing market.

Just to answer your question on Sarbanes-Oxley, there's really two components of cost there, one which I can quantify for you to some extent and the other which I can't. There's really direct out-of-pocket costs which we pay to third parties, our auditors being the primary one where they have to perform an audit of the controls and we have other service providers that we have gone to to help in various areas like IT and tax. And when you look at the direct out-of-pocket costs in 2004, they were in the range of $0.5 million. And that should go down, probably be about 60% of that or so in 2005.

The part that I cannot quantify for you is the opportunity cost. There is a significant amount of management time spent on documenting controls and preparing for the audit and discussions with the audit committee and the board. And that is an ongoing cost for us in terms of the need to continue to keep our process documentation in order. We do look for some relief. Hopefully this year, there has been some discussion with the SEC about the Sarbanes-Oxley process and the cost companies are incurring. And potentially, they're looking at making some adjustments which will make it more feasible for companies going forward. So we will wait and see how that rolls out.

Thank you very much.

Jeff Germanotta, William Blair.

I was hoping you could give us the sequential monthly sales trends in the quarter, and then maybe kind of a run rate for April at this point?

When you look at it, there were on a daily basis, adjusted daily basis, this quarter is not particularly good because we had a higher than normal February to the extent that we announced price increases to be effective in February. A number of customers to the extent they could, which is really the retail side, they bought in some of their normal March buys in February. So February was abnormally good and really taking away from March. But if I look at natural sales growth on a daily rate basis for the quarter, they were all in the low to mid-teens adjusted for that aberration of some customers trying to beat our price increase to them and taking delivery of product in February as opposed to March.

And April's off to a comparable start?

And April is -- it's too soon to tell because daily sales rates are continuing to build. I would say that April at this juncture is not quite at that same rate percentage-wise, but not too far behind.

Thank you.

(Operator Instructions) Dan Mendoza, OMT Capital.

Hi, I’ve got a couple of questions. Can you talk a little bit more about the complementary product rollout? How many of the service centers are you selling complementary products in?

That continues to be part of, a major part of our strategy over time, Dan, and we're still not yet anywhere near our potential. At this juncture, I would say more than half of our service centers in the U.S. are participating to any significant degree in complementary products. And if you go back over time, that means that about 20 to 30 more locations are beginning to really get into the complementary products segments this year that weren't really into it last year. The ones that are -- have been in it for as much as five years. It's becoming a more and bigger part of their business. In fact, there are already a handful of locations, in fact more than a handful, maybe perhaps a dozen locations, that complementary products represent more than 20% of their sales. And that means that those branches, those locations, are three to four years ahead of the norm. Certainly, that's something that is possible for all of our locations.

And what do you think that number does over time, that 20% number?

Those are -- there's a handful -- not a handful, a few -- several that are already over 30. So when you look at it long-term, and this varies to a degree by market, but when you look at it long-term, we stated that we believe that complementary products will grow as a percentage of our total sales by approximately 2% per year. That means 8% of our total sales in 2004 becoming 10% of our total sales in 2005. We believe that number should grow again by a factor of 2% per year. So if you go out to 2010, that would lead you to think that by 2010, 20% of our sales will come from complementary products. I believe that's very feasible, given what we're seeing in some of the leading branches that have taken those on and have really embraced it and are providing that additional value to their customers.

Great. And then the other question is, do you guys have a buyback authorized, and do you have any plans to authorize one if you don't?

We have had an open buyback authorized since 1998. I believe we are either the fourth or fifth buyback over that period of time. Every time that, the number is either exhausted or gets low, the Board increases the amount. The last time that was done was in May of 2004. At that point, the Board increased the remaining authorization to $50 million. At present, we have $27 million left over from that authorization and that is certainly something that's evaluated by the Board in terms of what the buyback authorized price is on a periodic basis. And given everything, that continues to be certainly a tactic that we have to opportunistically buying in at the right price in the marketplace.

Okay. Did you buy any in the first quarter?

We bought a very marginal amount in the first quarter.

Really only for option exercises, not open market purchases.

Okay, thank you very much.

Thank you.

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

Thank you all again for participating in our first 2005 results conference call. We fully understand the opportunities that are available to us in this young industry and are certainly committed to realizing the results. We thank you for listening and appreciate all of your questions and your comments. Thank you very much.

This concludes today's SCP Pool conference call. You may now disconnect.