Pool Corp (POOL) 2005 Q3 法說會逐字稿

Good morning. At this time I would like to welcome everyone to the SCP Pool Corporation third quarter 2005 earnings release conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Mark Joslin, Chief Financial Officer. Please go ahead, sir.

Good morning everyone, and welcome to SCP Pool's third 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. The 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 will turn the call over to our Chairman, Rusty Sexton.

Good morning all. A pleasure to speak to you today. We had celebrated -- many of you may know we have celebrated our 10th year anniversary as a public Company, October 1995, when we did our IPO. The Company has grown dramatically and has made constant improvement in its operational execution since that time. The shareholders have greatly benefited with share values approximately 40 times that of the IPO. With that said, the more we work on our business the more opportunities we seem to discover.

Those with the most potential, that is that add value to our customers, or improve the way we do business, or add shareholder value, or do all three, are carefully evaluated and are integrated into our business plan. This is something that we will continue to do for the next 10 years.

2005 for three quarters at least presented some unusual problems, which our release indicated, but the most important one of which has been tropical storm season, which end has not yet come unfortunately. I am sure Manny will talk to you details about some of these issues. Anyway, our executive and management team has really worked their way through these problems with outstanding results, as we have shown you and will tell you more about today. Certainly with that my hat is off to all of our people for their performance during these times.

So with that I would like Manny Perez to take it and tell you the details of the quarter.

Manny Perez de la Mesa: Thank you all for joining us for our conference call. As Rusty just mentioned this quarter certainly provided us with new challenges and opportunities, katrina, Rita, unprecedented price increases, and also the opportunity of the Horizon acquisition.

The financial results speak for themselves, although we got to the desired results differently than in years past. Specifically, our industry has operated for years in an environment of virtually no price inflation. In that environment we have been able to grow both market share and gross margins by progressively increasing our service levels, expanding our value-add in the channel, and improving our operating disciplines.

In the past year the industry has witnessed unprecedented levels of price increases. This dynamic was further complicated by in season price increases which are sometimes difficult to pass through all the way to the consumer. In this new environment though our competitive dynamics have changed. In some cases our competitors have passed on price increases on a dollars per unit basis instead of on a percentage basis. In other cases, price increases have lagged as competitors continue to use historical instead of replacement costs as the basis for their pricing.

The product category that has witnessed the greatest turbulence has been chemicals, where combining the above factors we have seen competitors pricing at 20% or more below what they would have been had they factored in and corporated replacement cost into the equation. Despite this kind of irrational behavior, we have selectively taken the necessary actions to retain and grow profitable business, resulting in our 12% gross profit and 23% net income growth in the quarter. The bottom line is that we continue to grow our market share, and our margin dollars per unit continue to increase.

Our actions will be modestly different on a go forward basis in this new price inflation environment. Specifically, we will utilize our financial strengths to buy into price increases as we factor price increases into our purchasing algorithms. In addition, again utilizing our financial strength, we will selectively take advantage of negotiated terms for prepayment of those purchases as we have in previous years. Again, the bottom line is that our competitive position is further enhanced in this new price inflationary environment.

From an industry standpoint, these price increases will have a negative, if any, impact on demand. For the majority of the industry's and our own sales, comprised of products used to maintain and repair existing pools, these sales are nondiscretionary products. In terms of the building of new pools or the remodeling of existing pools, we may see no slowdown in demand, given the low share that the industry currently has, and the relative value that swimming pools provide in contrast to other major household discretionary expenditures. Again, the bottom line is that we see unit growth consistent with prior years that, combined with price increases, should results in our realizing low double-digit percent sales growth in 2006 on our base business. Complementary products and our new irrigation and landscape initiatives could grow at an accelerated rate, as we continue to expand our offering on the former and expand our network on the latter.

In closing, the 2005 pool season represented another solid year of improved execution and growth for Pool Corp. We are better positioned and stronger than ever as we prepare for the 2006 season.

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

I will start off by making a couple of comments about our investments in Latham, then move onto the balance sheet and cash flow. Pool's equity earnings in Latham, as reflected on the equity earnings line on the P&L, was as expected in the quarter at $1.9 million after tax. As a reminder, we acquired a 42% interest in Latham, which is a manufacturer of packaged swimming pool and related products, in September of 2004 in exchange for our interest in Fort Wayne Manufacturing. For the fourth quarter, we continue to expect breakeven or slightly positive contribution from Latham, reflecting the seasonality of their business.

During the third quarter Latham completed the acquisition of Viking Pools, a leading manufacturer of fiberglass pools. Fiberglass pools have a small, but growing, presence in the pool industry. And we believe Latham's acquisition of Viking will add significant value to their business over time. Latham's acquisition of Viking was funded in part with equity, which reduced our ownership interest in Latham from 42% to 36%. Our equity interest in Latham will reflect this change in ownership interest going forward.

Moving on to the balance sheet. The changes you see in our major working capital accounts mostly reflect the increased level of business activity over last year, with total receivables up 17% over Q3 2004, and inventories up 18%. We did take advantage of special tax payment deferrals offered to companies in the Katrina impact area, which enabled us to defer estimated Q3 tax payments until February 2006. We will make a similar tax deferral in the fourth quarter.

Overall, our working capital management improved slightly from Q3 2004, with inventory turns this quarter of 4.5 times on a trailing twelve-month basis, versus 4.4 times last year, and DSO improvement to 33 days this year from 34 days last year.

Turning to cash flow, you'll see that our annual big turn has taken place, with year-to-date cash generated from operations at $51 million through September, compared to a $50 million -- $52 million use of cash that we reported at the end of Q2, which is a change in our operating cash position of $103 million in the quarter. The improvement in our cash flow from operations by $21 million from 2004 is primarily a result of higher income this year combined with the tax deferral.

Looking ahead to the cash flow expectation for the fourth quarter, you can expect to see a more significant use of cash this year than last, to support favorable payment terms on early buy purchases, as Manny mentioned. Excluding this and the deferral of our fourth quarter estimated tax payment, we should be close to our goal of generating operating cash flow at the level of our net income for the year. In addition, you'll see that we funded the Horizon acquisition, and as I will discuss next, share repurchases by drawing on our revolving credit facility.

Finally, let me update you on our share repurchase activities. In the third quarter we purchased 26,000 shares of our stock for a total cost of $894,000, at an average price of $33.95. Since the end of the quarter we have stepped up our share repurchase activity, having purchased an additional 707,000 shares through market close yesterday, for a total cost of $23,260,000 at an average price of $32.89. Our current $50 million Board authorization for share repurchases has $3.2 million available currently. This will be a discussion topic at our next Board meeting in early November.

Now I will turn the call back over to our operator to begin our question and answer process.

(OPERATOR INSTRUCTIONS). David Mann with Johnson Rice.

Nice quarter guys in a tough environment. A couple of questions on the gross margin issue. First, if you can remind me on what happened last year in the third quarter. Obviously, you had a big gross margin improvement. And you talked last year about vendor negotiated price concessions. Can you give us a sense on how much that helped you last year and perhaps hurt your comparison this year, and whether that is something that is going on again now?

Manny Perez de la Mesa: You have great information. First of all, one of the factors affecting gross margin is the fact that we exchanged our manufacturing assets for our interest in Latham. So therefore some of that margin that was previously captured in gross margin is now captured as part of our equity earnings in Latham falling below operating profit. And that represents on a year-to-date basis about 60 basis points.

That is point number one. Point number two, is when you look at gross margins last year, your memory is correct. We did a number of things last year that enabled us to creep up our margins more so than the norm. And this year, given the turbulence in the market that I talked about in my comments, we were not able to fully execute that to the same degree. And also in part we wanted to make sure that we sent a strong message to all in the marketplace that we will not forego profitable business, and in so doing made sure that we establish greater price discipline in the channels.

Are you seeing in any of the markets where you're sending this message any kind positive response from your competitors?

Manny Perez de la Mesa: In a number of markets we are. And certainly in a few other markets we're not. I think some of that though worked itself out as manufacturers -- I mean as manufacturers shipped at that new higher pricing and the replacement costs go up, and that becomes then their historical cost. And that is really a key consideration.

And just for the sake of -- I know you understand this, and I think everybody else on the call does -- but I think what happened here is that in many cases given the nature of the industry and the information systems that many of our competitors have, they look at the cost in their system as their reference point for their pricing instead of replacement costs. And when they're selling at what appears to be a satisfactory margin based on historical cost, they don't fully capture the fact that they should be using replacement cost for their pricing. And therefore there is somewhat of a lag impact in that process. That is really something that just works itself out gradually over a one or two month period.

When you talk about the new reality that suggests -- or can you elaborate on what it suggests in terms of your gross margins going forward, and the kind of impact that we should expect to see?

Manny Perez de la Mesa: On a go forward basis, I would expect our gross margin dollars per unit to increase as they have historically. When you had basically a price static environments, that came through in the gross margin percent. The better metric is really on a unit basis. And on a go forward basis, I will stick by the basis that, as we have done historically, we will increase our gross dollars per unit, albeit, it may not come across as clearly by virtue of the fact that maybe it will adversely impact our gross margin percent. And that is -- that all depends on the order of magnitude of price increases in the next one to two years.

And then one question on the SG&A line. Were there any material costs related to the hurricane in terms of all of the remote activity you had to and things like that?

We did not have any really material costs related to the hurricane activity. And we did not have material losses either. We have insurance, which will take care of some loss in inventory and other expenses. But really from a materiality standpoint they didn't show up in the quarter.

Brent Rakers with Morgan Keegan.

I just want to make sure I heard you correctly. You talked about 2006 revenue targets on a same-store basis being low double digits. First of all, did I hear you right with that?

Manny Perez de la Mesa: That is correct.

Can you maybe elaborate in a little bit more detail on how you're getting to that? Is there a certain level of baked in price increase on that? Maybe just elaborate a little bit more.

Manny Perez de la Mesa: That is a great point. Thank you for the opportunity. If you go back in the industry, the industry has had I will say something in the neighborhood of 4 or so percent unit growth historically per year -- 4 to 5%. We historically on top of that have grown our market share incorporated to complementary product which have grown at a factor of 2% of our total business, as well as opening of new locations. So as that our total revenues on an historical basis have been in the high single digits. And that really assumed very little to no inflation.

When you factor in several point of inflation on an overall basis, that takes a 8% type number to like an 11% type number. And that is kind of order of magnitude that we see overall. In certain product categories, and I will just use chemicals, that number is significantly greater. On the other hand, in other product categories, the number impact and the pricing impact is down, or the cost is down and the pricing is in part down.

Overall we're looking at 3 to 4% type overall, perhaps maybe as much as 5% as everything works itself out over the next three to six months type of price inflation. And that is what adds to that typical 8 to 9% unit growth that we've had historically.

I was hoping you could elaborate within the -- you talked about complementary product a bit. Are you planning on rolling some of the Horizon SKUs through the traditional SCP Pool branches, and would that flow through that number in there as well?

Manny Perez de la Mesa: That is something that in fact we're looking at. For 2006 there would be, I would say, no real expectation of us doing that in any significant way, form or or fashion. I think when you look at it over time, up that is certainly in opportunity in selected markets, but I don't see that for 2006 necessarily.

Just two more questions. Can you give us a sense for -- I know in the first quarter we had some of the issues with passing on the higher price points and from a competitive situation, and it sounded like in Q2 that it kind of fixed itself, if you will. Have there been -- could you quantify maybe the additional layers of price increases that have happened over the last lets say three or four months, and then maybe more address the competitive response within there?

Manny Perez de la Mesa: What has happened, and this is -- I tried to mention it -- but what is easier to do is the pricing -- to the extent of our price increases do those in the off-season. We had the very unusual events that in certain product categories, chemicals again being a top of mind, having in season price increases. And what happened there is because of the nature of them being in season it is very difficult to have that pass all the way through the consumer. So given the fact that there was more push back at the dealer level from our customer base in general, some of that was borne by distribution.

And distribution really -- part of that again was driven by the fact that they still had historical costs as their reference point for their pricing. So there were some rationalizations that took place. And where necessary we made sure we sent the message that we're not going to walk away from profitable business. So when it is also and done that further complicated matters this year. And again that is extremely unusual. It is easier to pass on price increases when you have some lead time and notice, and can communicate that properly all the way through accounts.

And last question. That is very helpful. Do you have a sense for what the total, I guess your total -- your price increase was in the quarter in terms of the year-over-year contribution to revenues? Or possibly what the cost increase of your average product was year-over-year?

Manny Perez de la Mesa: I would say that it is difficult because of the breadth of product, and the fact that some of (indiscernible) has to go down, not all of them go up. But I would venture to say no different than we had stated, I think, in the prior quarter conference call that we're talking about low to mid single digits in terms of the average price increase impact on a year-to-date basis across all product lines.

There are some product lines that for example their pricing is in fact down or flat. And that obviously waters down the impact, whereas another product load of categories prices maybe up 15, 20%. So when you look at blended everything it is low to mid single digits.

Kathryn Thompson with BB&T Capital Markets.

Nice quarter in a tough environment. Just tagging onto the revenue question, could you quantify how much of the revenue -- because you definitely beat our expectations on the top line -- how much of the increase in revenues is attributable to price increase versus just a stronger business environment?

Manny Perez de la Mesa: Probably something again in the quarter maybe more towards the single digits than the low single digits. But I think the better number to focus on in my opinion is the fact that we had 12 -- almost 13% gross profit growth on the base business. And that is really the impact that we work with in terms of what we have actually realized. And the rest of that is really price inflation.

Mid single digits is related to the price increase, and the remainder is just decent business?

Manny Perez de la Mesa: Exactly.

Any contribution from Horizon?

Manny Perez de la Mesa: No, Horizon closed on October 3.

I didn't think so. I just wanted to triple check on that. Could you also remind us, or update us, what percentage of your sales were complementary products in the quarter?

Manny Perez de la Mesa: Great question. I will tell you that for the year, and in fact even for the quarter, it wouldn't be that dissimilar. We're tracking -- not counting Horizon, which is obviously not incorporated into the first nine months of the year -- we're tracking right at 10% of our sales being from complimentary products.

Okay. So just kind of the usual.

Manny Perez de la Mesa: Yes, we went from 8% last year to 10% this year. We're tracking just a shade ahead of 10% right now.

Moving to gross margins, in the past you had said, and you reiterated earlier in the call, that about 50 to 60 basis point drag is generally attributable to an divesture of your manufacturing operations. Is it correct to assume that the 180 basis points decline versus last year, that about 130 basis points can be attributed to the pricing environment?

Manny Perez de la Mesa: Yes, 120 to 130 would be on a percentage basis would be attributed to the pricing environment. Obviously with the offset being that interestingly enough in those products that had the biggest price increase and biggest margin drop, our actual gross margin dollars per unit went up.

Okay.

Manny Perez de la Mesa: The presumption there is that without price inflation, we would have seen in fact a margin increase as we have in years past.

And digging a little bit further as far as the price increases, chemicals has obviously been a big subject in the year. But what were really the top three products? And if you can even provide a little bit more detail at the contribution of those three that really were nagging issues when it came to pricing in the quarter?

Manny Perez de la Mesa: If you look at margin, if you take out chemicals, our actual margin percent -- if you take out chemicals and you take out manufacturing, our margin percent on a year-to-date basis is in fact slightly up. But really the actual percentage drop in margin is entirely attributable -- I think we said it would be entirely to chemicals.

And feeling any pressure in terms of transportation costs?

Manny Perez de la Mesa: Yes. Overall when you net out freight-in/freight out with freight out recovery, the net of that is about 7 basis point increase in our expenses as a percentage of sales versus last year. And again 7 basis points is not a lot in the overall scheme of the P&L, but certainly for us it represents something that we're focused on.

And I assumed that you have put a surcharge for freight?

Manny Perez de la Mesa: Yes, in a number of markets we have incorporated a surcharge, as well as raising our freight minimums for free delivery.

My understanding is that you are able to pass it on in certain markets, but not in others. It is just basically passed on where the market gives?

Manny Perez de la Mesa: Exactly.

Finally, I guess this is more focused on Contura -- I guess the old Great Lakes. They had said -- they attributed of the weakness in their quarter to the legacy Great Lakes business. I was wondering if you -- I was a little puzzled by that, and I was wondering if you have any comments? They specifically cited softer pool chemicals sales. I was wondering if you had any comments on that?

Manny Perez de la Mesa: I can only have limited commentary. But I do know that they -- the BioLab side of what was Great Lakes has had significant issues in terms of their ability in the first -- before the Contura purchase -- in their ability to on a timely enough basis pass on their cost increases, given the market dynamics were probably their key competitor has been the biggest fan of using historical cost as opposed to replacement costs in their pricing.

Once again this is just a pricing issue with them more than anything else. Okay, great. Thank you very much.

Anthony Lebiedzinski with Sidoti & Co.

I have got a couple of questions. Manny, you mentioned earlier that you expect a low double-digit increase in your base business sales next year. How does that translate into bottom line growth expectations for 4 '06?

Manny Perez de la Mesa: In terms of expectations, earnings per share-wise, we communicated past and for the past seven years almost I have been with the company, is that our basic business model provides us with the opportunity to increase our earnings per share by 15% per year.

Part two of that is you layer on top of that acquisitions, which in this case the most significant of which would be Horizon, and second share buybacks, which are also accretive. So when you factor those two components in -- when we did the Horizon acquisition at that point we indicated that our expectations for 2006 was a $0.05 accretion from that transaction. And then from the recent share buybacks that has been done it is a little bit over $0.01 to $0.015 '06. So therefore the fundamental guidance has not changed, with the caveat that you have got those other two components to layer on, specifically for 2006.

And as far as looking at the --.

One more factor there is the options expensing. I know you have taken that into account I think in your model. But just a reminder that we will be expensing options next year. And so that would need some restatement I guess of 2005 results to be comparable. But the $0.05 to $0.06 kind of estimate of option estimate on our earnings next year.

Now in terms of the base business sales, 16% increase in the quarter, can you comment as far as the regions where you saw the greatest strength and perhaps maybe a little bit of less business in?

Manny Perez de la Mesa: From a market standpoint, there is no significant difference region to region of the country, and particularly in the third quarter. It was pretty widespread and pretty consistent, with the exception of Europe. Europe has had a number of issues, whether in some countries economics that have tempered their growth versus the others, but on a base business level. But in terms of the domestic operations, it is I would say pretty consistent all the way around.

That's helpful. And then I know you opened a couple of new construction service centers. I was wondering if you could comment on performance of those, and whether or not you planned to open more of those in 2006?

Manny Perez de la Mesa: Thank you. That's great. In fact, through September our sales of complementary products in the West, specifically in Southern California and Arizona, where we opened up our first two construction service centers, the sales of construction supplies in those markets through September were up 56%. And that certainly contributed to the fact that our sales growth of complementary products in total, the basis are up 30%. So that just speaks volumes about how that program is working, and the fact that it is now tracking at 10% of our sales -- overall Company sales -- versus 8% last year.

In addition to that, just to complete the answer, yes, we're looking at opening one more of those facilities. It will be in Texas for 2006 season. And we're looking at at least one more for 2007, if not two more for 2007.

Last question. You mentioned obviously that the chemicals has seen huge price increases, but then I also heard a comment that you have seen pricing come down in some other products. I was just wondering what those products are?

Manny Perez de la Mesa: Certainly. When you look at, for example, certain maintenance products, certain controls products, certain lighting products their average net pricing has come down.

Doug Lane with Avondale Partners.

Can you characterize -- we have had two years in a row of pretty bad hurricane seasons -- can you just give us a comparison of this year's versus last year's with regards to the impact on your business?

Manny Perez de la Mesa: Well we are very fortunate in many respects. And certainly I was going to have that my closing comments. But from a business standpoint the hurricanes are disruptive for usually several days. It usually there are a couple of days preceding the hurricanes, or where the hurricanes is supposed to go through, and usually the couple of days after the hurricane. And that was the case last year as it was this year in those markets. What happens shortly thereafter is that there's almost like a pent-up demand from those several days worth of lost business. So when it is all said and done, usually within I would say 60 to 90 days after a hurricane, the lost business is recovered.

Now Katrina is an exception to that. The devastation of Katrina is -- I can't say unique -- because certainly it was very similar to what happened with Andrew -- but certainly unique versus last year, because there is some long-standing adverse impact from in fact pools that are essentially put out of use. Now there aren't that many, but there are a few. And that is something that will in a couple of isolated cases affect us.

When you roll that up into the entire organization, it gets lost in the rounding. And it doesn't round up to be 1% (indiscernible) number, or round up to be $0.01 per share on the earlier question on the impact to our financials. There is an impact certainly, and the impact is not as significant in the overall scheme of things, it is more significant on the personal side, as it was last year in Florida.

Excellent, that's helpful. You mentioned you closed Horizon on October 3. Can you give me the number of service centers that you had opened at the third quarter end, and then what that number will be at the end of the fourth quarter with Horizon?

Manny Perez de la Mesa: At the end of the third quarter we had 204 locations, selling locations. We added 40 with the Horizon transaction. There are a handful of other locations that we are in the process of the opening on both the pool side and on the irrigation side for the 2006 season. Some of those will open in the fourth quarter; some will open in the first quarter. At this juncture I will tell you that we're looking at, for the 2006 season -- and instead of using December as my cut off, if you can bear with me and use March as the cut off -- we will go from 244 to 255 to 260 locations. We will have somewhere between 255 and 265 by March. And it will be very closer to 260 certainly by April.

Now Horizon, I assume is also a seasonal business. What do you expect the impact to be on your fourth quarter?

Manny Perez de la Mesa: Their seasonality is very similar to our seasonality, with the lion's share of the earnings taking place in the second and third quarters of the year, very similar to our business. The fourth and first quarters are call it close to breakeven. And that is the expectation there. The impact in the fourth and first quarters from Horizon will be negligible.

Even after interest expense?

Manny Perez de la Mesa: After incremental interest and after amortization (inaudible).

That nickel that you have lost in the last couple of years is still as good a guest as any at this point?

Manny Perez de la Mesa: Yes, the fourth quarter, the popular consensus for the fourth quarter will not be affected by the Horizon acquisition.

But we should expect, it sounds like you're going to be building inventories in the fourth quarter, so we should have -- we should see that in the fourth quarter balance sheet, correct?

Manny Perez de la Mesa: Yes. On the December balance sheet you probably will see inventory levels growing at a slightly I will say -- let's a 5% -- 5 to 10% greater than our sales growth would normally dictate. If our sales growth for the year is in that tune of 12, 13% you would expect to see 15 to 20% type inventory growth versus December of last year. Now some of that also depends on when manufacturers ship their goods.

As you know, in our industry certain product lines, particularly equipment, manufacturers, try to flat line their production as much as possible for their own efficiencies. We place those orders in September and October, and manufacturers have the discretion of shipping that at any time from November through February. And it is really their discretion as to when those goods are shipped.

The order of magnitude of our orders is such that we would expect that the inventory dollars will increase 15 to 20% versus what they were in December of last year. But again, the manufacturers have that discretion. It could be a little bit less or a little bit more than that based on when it is convenient for them to ship.

Just two more questions. Do you expect your operating margin percentage to increase in 2006?

Manny Perez de la Mesa: Yes.

Lastly, year-over-year -- we started talking about price increases this time last year, if not a little bit before, cost increases that you saw coming down the pike. Can you characterize what you are seeing this year for the next year's pool season versus what you saw last year for these year's pool season on the cost front?

Manny Perez de la Mesa: We are seeing a little bit more aggressive price increases for next season versus this season. It is not in the order of magnitude of 3 to 4 becoming 8 or 9. It is more like 3 to 4 maybe becoming 4 to 5 when everything is weighted averaged out. Again some products -- in fact, some product costs are going down. And the most -- and the one going up most significantly is chemicals based on the tariffs that were imposed on overseas manufacturers, and how the (indiscernible) manufacturers have reacted as a result of this new tariffs being imposed. As well as obviously anything that is oil-based products -- those oil-based products, and that cost is coming through us as well.

Kathryn Thompson with BB&T Capital Markets.

Just to clarify earlier when you said that you are looking for a 15% increase in earnings into '06, does that 15% include stock options expensing?

Manny Perez de la Mesa: That is on our same as basis. So therefore if you do have to take option expensing into the base for '05, which would be, as Mark mentioned as reported on our Q and Ks forever, about $0.05 to $0.06 a share. So you would have to knock off $0.05 to $0.06 off the base, and then add the 15%, add the Horizon, add the share buyback benefit to get the 2006 estimate. And that is basically consistent with what we have done it and reported in past years.

Larry Raider (ph) with LAR Management.

A quick question. Somebody had asked you about operating margins, and you gave a brief answer. You have an operating format. You have product line extensions. How much room do you have in operating margins over the next two or three years, given that you'll continue to run the business the same way?

Manny Perez de la Mesa: That is a great question. I don't know what the limits are. I can only tell you that we have a long, long ways to go. And let me just go back and provide a perspective over time. Back in 1997 our gross margins were I believe 4.7% for the year. Operating margins were (multiple speakers) for the year. Those locations that we had as part of our business then, after factoring in all of the corporate overhead and everything else, are well over 10% today and continuing to grow.

Now when you look at our operating margins this year versus last year, they were up I believe 30 basis points. But that also is masked by the fact that we transferred out the value captured with Fort Wayne, and that comes through on the share of earnings from our Latham investment, and therefore our expansion in fact is more like 50 to 60 basis points on a pretax basis.

So having said that, that is the kind of order of magnitude that we have been able to realize despite, for example, the opening of new locations, which always waters that down since those new locations have inevitably lower margins -- operating margins than --.

But on a large base, the watering down of new locations is a lesser factor?

Manny Perez de la Mesa: That's correct.

So arithmatically or mathematically you could have as much as 100 plus basis points?

Manny Perez de la Mesa: 100 basis points in one year would be --.

No, no. Over the next two or three years.

Manny Perez de la Mesa: Over the next two or three years, yes.

Thank you Carl Rowe.

Manny Perez de la Mesa: Thank you.

(OPERATOR INSTRUCTIONS) Paul Sharke (ph) with Harvey Investment Company.

I wondered if you could educate us a little bit more about the irrigation business with regard to market share versus Deere and the others, and what it would mean to SCP Pool if John Deere Landscapes were sold through a big-box retailer?

Manny Perez de la Mesa: First in the market in which Horizon competes, Horizon has an estimated 7 share -- 7% share of those markets in those eight states. Certainly within that there are certain markets where their share it is greater, and other markets, for example, Southern California, where their marketshare is lower. In all of those markets John Deere is to one degree or another -- John Deere Landscapes is to one degree or another a competitor.

You're asking for me to speculate as to what would be the impact is if a mass merchant bought John Deere Landscapes? Is that --? Do I understand the question right?

Yes, I heard some rumblings.

Manny Perez de la Mesa: I don't know -- it would be really out of line for me to have a comment, because I don't know what that mass merchant, whether it be Depot or Lowe's or whomever it would be, would do to change the John Deere Landscape's business and how that business was run. So not knowing that, I'm not sure what variables will come into the equation. Frankly, my perception would be that would not be in any way a negative. If anything, it would be a positive.

Because it seems to me that you have done a really good job at dominating the industry you are in. And if a force -- if a competitive force the size of someone like were to enter irrigation, and they have made some inroads so far, if it would turn out differently?

Manny Perez de la Mesa: We believe that the opportunities in irrigation and landscape are very similar to the pool space. And in fact, having a good company like a John Deere I think leads to better operating discipline, more pricing discipline. I welcome it as a distributor.

You always, in my mind, like to compete in the marketplace with others that have similar objectives of growing the industry, growing their customers' businesses, continuously adding more value. Those are very positive things. And that leads to very rational and very strong competitive dynamics, which is at the end of the day good for all parties. Good for manufacturers, good -- certainly good for the customers in the long term. And that is in fact I think a better competitive environment then competing against sometimes small operators that don't have that level of sophistication or those same levels of long-term objectives of return to shareholders and growth of earnings and growth of their business.

At this time there are no further questions. I would now like to turn the comes back over to Manny Perez de la Mesa for closing remarks.

Manny Perez de la Mesa: I would like to close with some comments. We have had the situation happen of a number of hurricanes hitting us in Florida last year, and we had flooding in California earlier this year. We even had some flooding in the last week or so up in the Northeast. And much more of an accentuated hit from the people standpoint to our operations this year when Katrina hit us in the Gulf Coast and disrupted our business operations in both Louisiana, Mississippi, and to a lesser degree, Alabama.

Our business that we do in those markets is relatively nominal in the overall scheme of things. It represents somewhere in the neighborhood of 2% of our total business. On the other hand, we do have our primary administrative office in Covington. And it was really gratifying to see how our people stepped up. We have had -- and have been practicing faster recovery and business continuity planning for years. And we have been deploying assets to make sure that we didn't miss a beat as a business.

And it is extremely gratifying when August 29 came around, August 30 came around, and the 31st that our service centers throughout not only the U.S. but also throughout the world continued to operate to serve their customer, to serve their suppliers in a very effective fashion. It is also extremely gratifying that our people stepped up wherever they evacuated from to reengage themselves with the business, and operate in many cases from remote locations so as that their support services to our people in the field were not in any way adversely affected.

It takes -- and it says a lot about the qualities of our people. And I am very proud of our organization for their ability to step up. In some cases our employees lost their homes. In many other cases they have varying levels of damage to their homes. And then again, in other cases there was impact to those that they cared for, whether it be their parents or brothers or sisters or very strong friends. But through all that our people came through frankly with flying colors. And again I am very proud to be part of this organization and very proud of our team.

Thank you again to all of you on the call for joining us. On our next call will be in mid-February when we will discuss our fourth quarter results.

This concludes today's SCP Pool Corporation third quarter 2005 earnings release conference call. You may now disconnect.