Pool Corp (POOL) 2006 Q3 法說會逐字稿

Good morning. My name is Page, and I will be your conference operator today. At this time I would like to welcome everyone to the Pool Corporation third quarter earnings results 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 session. (OPERATOR INSTRUCTIONS). Thank you. I will now turn the call over to Mr. Mark Joslin, Chief Financial Officer. Please go ahead, sir.

Thank you, and good morning everyone. Welcome to Pool Corporation's third quarter 2006 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 2006 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 those from the projected results is discussed in our most recent 10-K and 10-Q as filed with the SEC.

At this point I will turn the call over to our Chairman, Rusty Sexton who has a few opening remarks.

Thanks, Mark, and welcome again to our conference call. I have just a couple remarks to give you a little perspective. 2006 actually marked my 50th year to be in the swimming pool industry in one fashion or another, and I have seen a lot of change; as a matter of fact I have seen a whole industry emerge from a few builders building pools across the country to a multibillion dollar industry now, and yet the pool industry is a very young business, and the opportunity is tremendous. It is just really beginning.

2006 also begins Pool's 12th year as a public company. The first ten years was spent primarily on geography and market share. And now the next 10 years is really a kind of a focus on market opportunity and expanding our presence in a continuing market share but trying to help grow that market. For example, our program selling and our swimming pool.com are creating thousands of leads for builders around the country. As a matter of fact, in some builders in some markets have more leads than they can accommodate. So if you're worried about housing, which many people are and worried about cost of money, you may be focusing in on the wrong things. As Manny Perez, our adequate CEO, said at the conference in New York, execution is the biggest worry we have in this business. And in that regard we are doing pretty well.

The nine-month sales up 27% with base business up 12% and operating income up 29% we have made a lot of progress in 2006. And with that for detail I turn it over to our CEO, Manny Perez.

The thank you, Rusty. Thank you all for joining us for our third quarter result conference call. As noted in our press release we continue to improve our business execution and furthered our channel value add utilizing our sales and marketing programs. Our 9% base business sales increase was on top of last year's third quarter 16% sales increase. Our year-to-date base business 12% sales growth is on top of last year's 13% base business sales growth. Horizon continued to perform well with 15% base business sales growth, consistent with its year-to-date results.

The three price increase inventory purchases in the second quarter contributed roughly half of the 70 basis point expansion in gross margin, similar to the contribution from the late 2005 purchases positive impact on first-half gross margin. We continue to invest in the future as the 11 new Pool sales centers impacted earnings per share by about a penny in the quarter and about $0.03 year-to-date. Summarizing the above, our base business operating earnings expanded again in the quarter with 50 basis point expansion and operating margin year-to-date. Bottom line, another successful season for our Company.

On the marketing front, our primary website destination, www.swimmingpool.com, ranks in the top one-third of 1% of all active websites with a seasonal high of 220,000 unique visitors in the month of July, and an average of 1,600 hard leads being generated per week for builders and remodelers.

On the product front, complementary products, especially construction related products, continue to grow at a very strong pace. The disruption in spot supply reported last quarter has been rectified with three new sources added to help us regain momentum in this category for 2007. The addition to our Horizon network of 14 centers in Texas and Georgia from the Wickham acquisition now brings us to 59 centers in Horizon, up from just 37 centers in mid 2005.

I've stated previously, we see many of the same long-term opportunities in irrigation and landscape distribution products, as we see in the swimming pool product distribution. Both industry sectors are very young in their evolution with major long-term favorable macroeconomic and demographic dynamics providing wind at our back.

The only issue is our customers being capacity constrained given the labor shortage in this country which is only going to become a bigger issue for service companies that cannot import capacity as manufacturers do. Returning to the present, our seasonally slow fourth quarter will likely reflect more modest topline growth as last year's Indian summer contributed to our 20% base business growth in the fourth quarter.

For 2007 our internal growth target and objectives are consistent with prior years as execution remains by far the most important factor for results, with weather being the most significant external factor. Also with respect for 2007 I have already approved todate 16 new pool and irrigation sales centers with a few others being now evaluated for 2008.

In closing, we are better positioned and stronger than ever as we prepare for the 2007 season. Now I will turn the call over to Mark for his financial commentary.

Thank you, Manny. First I will comment on a couple of P&L items, and then I will move on to the balance sheet and cash flow. Looking at our sales and operating expenses, you will notice that they are up a bit as a percent of sales for the quarter and year-to-date periods. There are two primary reasons for this. The first is the inclusion of Horizon in this year's results will not in last year until Q4. As we've discussed, given the regional scope of this business, it's cost structure is not as efficient at this point at the Pool side of the business.

Second, as Manny mentioned, there is a short-term negative impact on our results from the 11 new pool sales centers opened in 2006. This impact is seen on the expense line, as well as in earnings. We estimate that the added expenses beyond our normal expense to sales ratio are $1.2 million in the quarter and $3.3 million year-to-date from these 11 new centers.

Looking at interest expense, you will see a $3 million cost increase over Q3 2005. Most of this increase is due to the increase in our debt levels over last year to fund the Horizon and Wickham acquisitions and our share repurchases. Our total debt is $259 million at the end of Q3, which is an increase of $175 million over 2005. Also, as you know, short-term interest rates have increased since last year adding to our higher interest cost this year.

Latham results, which are reflected on the equity earnings line, include the additional tax cost this year that was not recognized in last year's results until the fourth quarter as we've explained on previous calls. Excluding this, Latham results improved over last year for both the quarter and year.

Moving onto the balance sheet, our trade receivables excluding $42.5 million in receivables from Horizon and Wickham grew 11% year-over-year which is in line with our base business sales growth. Our days sales outstanding or DSO excluding Horizon and calculated on a trailing twelve-month basis, improved to 32.8 days in 2006 from 33.1 days in 2005.

Our inventories, which ended the second quarter at a high-level due to the buy in ahead of price increases, are back down close to seasonally normal levels. Excluding Horizon and Wickham inventories of $46 million and also excluding $9 million in inventory for new locations and $18 million for product line expansions for certain higher margin and new products, our inventory levels at the end of the quarter were in line with our base business sales growth.

On our cash flow statements you will see the year-to-date cash from operations of $81.5 million is an improvement of $29.2 million from the $52.3 million we generated this time last year. As mentioned, the third quarter results this year reflect the working down of product inventories from the second quarter, such that year-to-date cash used to fund inventories for business growth is consistent this year with last. The tax deferral granted by the IRS to Hurricane Katrina impacts on companies like us finally ran out on October 16, which was earlier this week. That was one month later or longer than we had previously expected and resulted in our $61 million payment to the IRS on that date.

For the full-year we expect to generate about $100 million in cash from operations. As mentioned in our press release, we've used $88.1 million this year through September, including $44.3 million in the third quarter to repurchase company shares. The third quarter purchases of 1,170,000 shares were at an average price of $37.85. In addition, we purchased 204,000 shares in October at an average price of $38.33, leaving $4.1 million under our current board authorization. This will be a topic for discussion with our board at our next meeting in November.

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

(OPERATOR INSTRUCTIONS) Kathryn Thompson, Avondale Partners.

Thank you. First question on Horizon, in the previous call you had indicated the accretion for the year would be closer to say $0.06 or $0.07 for fiscal '06. Has that changed? And also, do you have any outlook for overall rising contribution going into fiscal '07?

Good morning, Kathryn. The expectation remains consistent with what we reported last quarter of $0.06 to $0.07 accretion between Horizon with a very -- that includes a little marginal contribution but very negligible from Wickham in 2006. That should improve and expand next year as with everything we do, improve in subsequent years.

Just in terms of improvement is it something that is in line with what your bottom line improvement has been in general, so in other words --

Yes, if you look at our perspective and you assume that our long-term organic growth is at least 15% earnings per share growth, that would be consistent for Horizon as well. We are continuing to open up new locations which are a short-term drag on the Horizon side as they are on the Pool side, but when it is all said and done you've also got the maturing of the relatively new locations that we've added this year, as well. So when it's all said and done, their contribution will be marginally greater in 2007 versus what it is in 2006.

Also you said you expect cash flow from operations to be around $100 million for the year. Are we to assume that your expectation that cash flow from operations will still approximate that income -- is that still the case.

Yes.

So that would lead to believe that your $1.80 guidance is unchanged also.

Exactly.

If you could just give a little bit more color on the SG&A line; I know you had already discussed that. Most of the increase is because of (indiscernible) acquired companies but in your experience in the past, and rolling in newly acquired pool centers, what type of progression should we expect going forward thinking more in terms of 12 to 24 months an improvement in that line item?

One of the biggest contrasts there, Kathryn, is that we've opened up on the Pool side 11 new locations for this year, for the 2006 season. And that is a step up from the three to five startup locations we were doing the last several years prior. So it is because of the change that that causes a little bit of a blip. As indicated in my comments, I've already approved 16 new locations for next year. Now that 16 includes both pool and irrigation, and that is similar to what we are doing this year. So from a 2007 standpoint on a comparable basis you will not have the same type of comparable drag in the short-term as you see between '06 and '05 on the SG&A line because of that.

Should we see any improvements?

Sure, everything goes with it. Usually new locations are a drag, a net drag the first year and then begin to turn positive in year two. And as you know by year four, we are expecting at least a 30% return on assets, pretax.

That's all I have for right now. Thank you very much.

David Mann, Johnson Rice.

Good morning, gentlemen and Rusty, congratulations on 50 years.

Thank you, sir.

I guess along the lines on the SG&A question, if I look correctly at the base business addendum you have in the release, it looks like your EBIT growth in the base business was a little slower in this quarter than the last couple of quarters. Is it the same answers you are giving in a different way here or there are some other factors?

It is the same answers, David. Two things. One is, 16% sales growth last year is a very tough comp, obviously. In fact, when we looked back over time quarter-on-quarter if you look at a two-year scenario our top line generally runs around the mid-20s percent. So if you take 9 out of 16 that is pretty consistent with that much like the year-to-date numbers are also consistent with that. In terms of everything else, just everything else just flows from it. But part of it is driven by the 16% from last year being a tough comp and the other part of that is continuing investment in the future.

Manny, when we look to future quarter should we assume that at the higher single digit kind of level of base business growth we are at that sort of a threshold, to where you start potentially leveraging and having increase in EBIT? Or EBIT margin I should say?

Yes, in fact you still have even with the 9% top line growth we still had a margin expansion despite the accelerated level of investment in new locations and other ventures. The question -- really the comparison there is again we are penalized a little bit this year because we've ramped up the opening of new centers. And expansion of some of the initiatives that we have underway in contrast to the prior two or three years. So therefore you would see normally at a high single digit top line growth, base business top line growth, you would see probably a little bit more modest expansion in a typical scenario than you do in this third quarter.

Okay.

It will be more in line or perhaps not quite as aggressive but more in line with the year-to-date numbers.

Okay, and then on the Horizon business I guess two questions about the base business growth; number one, when will Horizon start hitting your base business numbers that you report?

In the first quarter of 2007.

And then secondly, what are some of the key drivers of that base business growth that you can elaborate on?

First of all, you got a very predictable base of business in terms of the maintenance repair and replaced with the additional pools each year. That is a very predictable base of growth in the market, which we estimate to be a pretty consistent 4% a year.

Manny, if I can interrupt, I was more specifically asking on the Horizon business.

Oh, on Horizon.

Yes, what is driving now that you have taken it over, what is driving, what are you doing that is driving that base business?

Sorry. In much the same way almost half of that business is maintenance repair replace, and the fact that there are -- there is growth in their markets. The second component is marketshare growth, and the third is there are complementary products initiative which they coined four legs initiative very similar to ours enables them to provide more value to their customers and capture a greater share of their total consumption of customers' total consumption. It's very similar to ours. The numbers break out a little differently, but not much.

Thank you very much.

Anthony Lebiedzinski, Sidoti & Co.

A few questions. Relating to the base business sales growth of 9%, how much of that was because of inflation?

Inflation would have been 3 to 4%.

3 to 4%, okay. And do you have any idea how much of the 16% last year was because of inflation?

3 to 4%.

Okay so that is consistent. And in terms of sales by region, anything that you saw unusual in the third quarter?

That is a great question, Anthony. In the Sunbelt, which is more predictable on a year on year basis the weather variables there are less than in northern markets. The growth was not as strong last year and therefore this year a comp is a little better proportionately. Whereas in the northern markets where they had very much of an Indian summer extending in September, October, and then had very, very strong results in those months driving the third quarter and to some degree the fourth quarter. Their year-on-year growth is a lot more modest.

And previously you've talked about doing a store within a store combining a pool service branch with a Horizon branch. Do you have any locations now open like that or in -- what are your thoughts on '07?

We have not done that yet. We have worked out because a lot of background work from data mapping to logistics to establishing the people and everything else and the operating procedures to make that happen. We are planning to begin to roll that out in 2007, and that would not be considered a new location from our standards. That will be basically allocating a certain available space that we will carve about with an existing Pool distribution locations for the irrigation landscape products.

And in your earlier comments you mentioned that part of the inventory buildup was because you are looking to branch out into new lines of business and that these new lines are considered higher margin. Can you give us an example of what that is?

Sure, one prime example that addresses specifically the higher margin component is that we are, had a change -- a modest change but it's a change nonetheless, in our philosophy on parts stocking. Historically our philosophy on parts were geared primarily to the products, the equipment lines that we sold. We've expanded that definition and expanded our parts stocking to include parts, all parts related to the products hold in this industry to capture some of that service business which is naturally higher margin. The equipment lines that we don't typically sell.

By the way Anthony, when I was talking those were two separate things, new line and higher margin products. So Manny mentioned the higher margin was the parts; the new lines was really in the complementary product areas. The two biggest categories there are construction products and plumbing products, and those we've expanded the rollout of those product categories to new locations, and we've grown our inventory to support that at a faster rate than we've grown our sales. So that's what I was quoting there.

That helps. And lastly, with respect to Latham, what do you expect the full-year contribution from Latham to be?

The full-year contribution would be modestly better than last year's full-year contribution. As you recall, Anthony, in the fourth quarter of last year we recognized approximately a 40% reserve on our equity component of the income. And this year we've been doing that through each one of the four quarters so when we look at the full-year the expectation is that the, our share of their net income after tax is going to be modestly greater than last year.

Or they will have a very small contribution in the fourth quarter so the year-to-date results are pretty reflective of what we will see from Latham for the year.

Okay. Thank you.

Michael Cox, Piper Jaffray.

Thanks a lot for taking my questions. The first questions on the 16 new centers for next year, I was wondering if you could give us a breakdown of how those will shape out between Pool and the Horizon segment and if you have any plant closings in that as well.

Ten are Pool and six are Horizon including Wickham.

Okay and my second question is on new center productivity as you continue to build out the Pool segment. I was just wondering if you are seeing anything new in terms of new center productivity and also how that compares to the ramp up of new Horizon branches.

In both cases the results are pretty much as expected. By and large most of them have a negative contribution in the first 12 months. But then as time goes on the they begin to build an increased customer following and work out some of the kinks that are typical in any new operation. So they begin to be positive contributors in year two and continue to build on that for years three and four. Nothing unusual from prior experience.

The margin differential between the base business and the acquired businesses narrowed significantly in the quarter. I was just wondering if there was something seasonal there that drove that or if there was some structural improvement within that.

Yes, the seasonal difference there is that in the case of the Horizon business the third quarter is relatively comparable to the second quarter in terms of, if not a little bit better, than the second quarter on the Horizon side. Whereas the volumes and therefore the profit leverage is about twice as great in the second quarter versus the third quarter on the Pool side.

And my last question, perhaps I missed this, but stock option expense in the third quarter.

Mark.

Let me get back to you on that in a second, Mike.

Okay, thanks.

[Perry Vickrey], Morgan Keegan.

Thanks for taking my question. It is first of all on the gross margin side, when I look back historically other than last year, sequentially from Q2 to Q3 it looks like gross margins drop about 30 to 80 basis points. I understand some of the issues that went on last year but is there anything this year that happened in the second quarter or in the third quarter like product mix shift or anything like that, that would have affected the gross margins?

Perry, nothing significantly. As I mentioned in my comments at the outset, and also touched on in my comments when we did our second quarter earnings call, it was very unusual to have an in season price increase from the three major equipment manufacturers and to the extent that we bought into those increases, we had a benefit primarily in the third quarter which contributed to the gross margin expansion that we realized. Outside of that, it is pretty much apples-to-apples.

Okay, great. Could you -- what was the interest rate on the share buybacks borrowing?

The average interest rate is approximately 6%.

All right. Thanks a lot.

Michael Cox, just to respond to your question on stock option expense for the quarter, it was 1.450 million compared to 963 in the third quarter of 2005, so a half-million dollar increase, which by the way I believe on the year-to-date basis it is maybe a couple million dollars year-to-date over last year. And again, it is -- we discussed this early in the year in the implementation you have accelerated expensing for retirement eligible employees. So that kind of increase we've had this year over last year we wouldn't expect to see again next year over 2006.

(OPERATOR INSTRUCTIONS). Keith Hughes, Suntrust.

My question has been answered. Thank you.

Gary Chinnaro, JPMorgan.

Just a quick one. Can you remind me of the seasonality of the Horizon business?

The Horizon business is similar to the Pool business with very, very marginal profitability roughly breakeven in the fourth and first quarter. In the Pool side the first quarter is a little bit better than the fourth although neither one is particularly good. Seasonally Horizon is a little bit better in the fourth than the first. In the second and third, as I mentioned earlier, the Pool side is heaviest in the second and about half the contribution in third as in the second. In the case of Horizon it is more comparable second versus third with the third being a little bit better than the second.

It sounds like the inventory should be a little bit smoother for Horizon.

I'm sorry?

The inventory level should be a little bit smoother for Horizon than Pools?

Yes, by virtue of the fact that the bell curve is not quite as accentuated in the second quarter, yes.

Great. Thanks, Manny.

Thank you.

[John Christensen], [Cain, Anderson,Rudnick]

Of your 16 new centers planned for next year, how many would be new territory, how many would be infill?

One second. On the Pool side eight out of the ten are what I will call satellites. Call it within an hour of existing locations. And two are in markets that we are largely not serving at all. On the Horizon side, those numbers would be up to six on the Horizon side. They would be right now three are satellites, and three are markets that they are essentially not serving at all.

I think that you said that the satellites are an hour away in general.

Yes.

How much cannibalization do you get, and what are the economics for you of opening a satellite?

The economics -- the difference between the two are that in a satellite we transfer business, and let me give you an example. If you go to -- we are serving the North Dallas, North of Dallas marketplace from our Plano location. We are looking at opening in Frisco. Frisco, there are some customers that are in the Frisco market today that are again being served by Plano. We will carve out those customers and those will be shifted over and served out of the Frisco location in 2007 and beyond. The economics are that on a marginal basis, very similar. The caveat, though, is that given you have already an existing customer base in that market, it is a lot easier to ramp up than it is where you are going into a completely new market where the people and the customer base is generally speaking not as familiar with us as a distributor. So therefore there is a lot of more, I'll call it new ground that we have to lay in terms of educating the marketplace in terms of what our service levels are and the potential for us to add value.

If we look at your 273 sales centers today, what is the potential number you need to serve your markets? How much more opportunity is there?

That is a great question. Let me take it in pieces. If you look at the Pool side, domestics, and by the way the Pool side openings for next year eight out of the ten are domestic and two are international. If you look at the U.S. market and you assume the market does not change at all, we would probably need another 25 to 30 locations to have the kind of coverage that we're looking for. The ideal coverage.

The dynamic, though, is that the market is changing, the market is growing, and as we bring in more products and to call it roll out fully, more fully complementary products, we run into the equation of simply running out of space in existing facilities. And go through then decision-making process do we expand where we are, or do we open up a satellite an hour away? And those decisions -- and we do a lot of both. So if everything were static we didn't extend our productline, we didn't extend our product and the market did not grow, it would be -- we are 25 to 30 centers away from, I'll call it optimum in the U.S. market. But with expansion of our productline and product offering the natural growth and our market share growth on top of that in the industry, that number will continue to grow to some degree each year probably to the tune of another 10 or so potential locations.

On the Horizon side there are a little bit over 1,000 distribution centers or sales centers in the irrigation landscape business domestically. We, in order to have national coverage will probably -- well not probably -- we would need to have roughly 200 or so locations when it is all said and done. Now our focus as in the Pool side is heavily weighted towards the Sunbelt given the predictability of revenues, the long-term macroeconomic and demographic dynamics that play in the Sunbelt. So therefore while 200 -- I can think today's market, today's everything, 200 may be the optimum number on domestic irrigation landscape, the focus is more the Sunbelt at least for the next five years.

Internationally, the international business, which is part three of the equation, part three of the answer to your question the international business is roughly 30% or so of the Pool market. We have not really explored the irrigation landscape market there just yet. That is some time off in the future. But given the fact that it's 30%, we could very easily ultimately have upwards of 75 to 100 distribution locations for the Pool side internationally, as well. In a long-winded answer we've got a long, long ways to go.

We're in Los Angeles and when I drive down the street I don't see any Pool Corporation service centers but I keep seeing a lot of independents. How fragmented does this market remain? How much more opportunity, what is your share now, what could it be?

That is a great point. The market remains very fragmented. We believe that if you look at pure pool products via distribution in the U.S. market where obviously we have the strongest presence, we have just over a 30% share. So that just speaks volumes about the opportunity. And you're right, we do have a fairly significant presence with an aggregate in Southern California between SEP and Superior, approximately 20 locations -- excuse me, over 20 locations -- but there are a number of other distributors we compete against in that market. I can just name a handful in Southern California alone. So again, we have a 30 share, although we are by far the largest in this industry; on a national basis we are just over a 30 share of pure pool. When you roll in complementary products into the discussion, we're just scratching the surface.

Last question, you mentioned that your website is bringing in 1,000 hard leads a week. How do those break out between new home construction and someone who has already got a home there and wants to build a pool?

The number is 1600 average per week, and that is all for existing homeowners. That does not tie into at all to people building new homes. These are all home improvement related.

Thank you.

Michael Cox, Piper Jaffray.

Thank you, just one quick follow-up on the inflation component. I was just wondering what your expectations were as you look out the next six months now that crude oil has come back.

I believe Michael, that is a great point. There is going to be some moderation in all likelihood, although I will tell you that understanding the cost dynamics for most of our major manufacturers, whether it be equipment or chemicals or package pools, they to date have not fully recovered all of their raw material cost increases in the price increases that they put through to date. So what I would expect is that that moderation would really begin to be seen in the latter part of '07 going to '08.

And in terms of deflation, is this an industry that has experienced deflation at some point, or are these price levels generally kept from --.

Generally speaking they stick. There is some level -- there are a number of products, in fact, where the top have come down. And in fact, this industry for an extended period of time up until about two years ago, was basically in a price neutral environment for the better part of 10 to 15 years. That has changed in the last two or three years or so. But my expectation would be that with moderating oil costs and what I will call a softer economy in the U.S. having less demand on items like steel and cement, and those costs perhaps moderating. Although international demand seems to be very strong given the increase of manufacturing and the overseas economies, well the U.S. economy. What I would see is that all that moderation may in fact revert back to a more neutral inflationary state for this industry.

Thank you.

At this time we have no further questions. I will now turn the call back over to Mr. Perez de la Mesa.

Thank you, Page, and thank you all for joining us again today for our third quarter results conference call. Our next call is scheduled for February 15th when we will discuss our full year 2006 results. Look forward to speaking to you then. Thank you very much.

Thank you. This does conclude the Pool Corporation third quarter earnings results conference call. Thank you for your participation. You may now disconnect.