Pool Corp (POOL) 2008 Q2 法說會逐字稿

Good morning. My name is Ashley and I will be your conference operator today. At this time I would like to welcome everyone to the Pool Corporation second-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. Joslin, Chief Financial Officer. Please go ahead, sir.

Thank you, Ashley. Good morning and welcome everyone. As usual I'd like to remind our listeners that our discussion, comments and responses to questions today may include forward-looking statements including management's outlook for 2008 and future period. Actual results may differ materially from those discussed today. Information regarding the factors and variables that could cause actual results to differ materially from projected results is discussed in our most recent Form 10-K as filed with the SEC.

Now I'll turn the call over to our President and CEO, or Manny Perez de la Mesa. Manny?

Thank you, Mark. Well to have the results that we reported earlier today in these challenging times is a reflection of the talent and the dedication of our people. In 2008, more than ever, our people have stepped up to provide outstanding service. It is humbling for me to witness their day to day execution in every facet of our business.

Our results are also a reflection of the resiliency inherent to our industry perhaps measured by the 80% of our sales being derived from maintenance, repair and replacement activity.

Now I'll review the sales results by channel and major market, all on a base business basis which excludes acquisitions. The blue or SCP superior channels of our business were down 5% in the quarter versus being up 1% in the second quarter last year. Overall, we estimate that new pool construction was down roughly 30% in the quarter and year to date while maintenance, repair and replacement sales continue to grow as reflected in our increased chemicals and parts sales. As I mentioned, over 80% of sales on the blue side are being derived from maintenance repair and replacement activity in 2008.

On the green or horizon side of our business, sales were down 15% which was on top of last year's 2% decrease in the quarter. As many of you know, the green side of our business is more closely tied to new construction and these results are evidence of that.

We believe that in all channels we continue to gain market share albeit we believe that our share gains in 2008 will be more modest than last year's gains as we have been more deliberate with extending credit and taking lower margin sales this year than in previous years.

In terms of our performance by major market, I will start with California which is the largest pool and irrigation market in the country. Here our sales were down 11% on the blue side and 13% on the green side in contrast to our sales being up in both cases last year. For reference, the California market started to weaken in the spring of 2007 but it wasn't until the second half of 2007 that the decrease in new pool and irrigation construction overtook the natural increase in maintenance, repair and replacement activity to result in negative sales comps. That is this is why our comps get easier as we progress through 2008 since the 2007 falloff in new construction is weighed primarily on the second half.

Moving on to Florida, the second largest market. Here it's only on the blue side and our sales were down 8% in the quarter on top of last year's 12% decline. The reason for the moderation is that Florida started its decline in new construction earlier in the second half of 2006 and we are beginning now to lap somewhat easier comps. Since Florida has the best industry recordkeeping in terms of new pool construction and the numbers are so remarkable, allow me to review what has been happening the last couple of years.

First, going back to the late 1990s, there were roughly 35,000 new pools being built each year in Florida. This volume increased at roughly 6% per year to peak at 48,000 pools in 2005, declined to 43,000 pools in 2006, and then plummeted to 23,000 pools in 2007, a level not seen in a generation. The challenging times of 2008 have further reduced the build rate in Florida to 13,000 pools this year. We are now talking about build rates not seen in Florida in over 40 years. Fortunately, the install base enables the industry to realize over $800 million in sales despite these very low new pool build rates.

Going back to market-by-market or state-by-state review, moving onto Texas, the third largest market. Here our sales were up 11% yet up 11% on the blue side and up 4% on the green side in the quarter in contrast to last year's 3% decline. Here it's a case of a better weather comp and a more resilient or down less new construction market. Plus, clear evidence we are gaining market share as Texas is not oblivious to the challenges that we all see in the credit and real estate markets in 2008.

Arizona is the market that has been most affected by the current environment with sales down 19% on the blue side and 17% on the green side on top of last year's 3% decline. Here the weight of the new construction is greater as it's a younger market than California or Florida with a proportionately smaller install base to mitigate the impact from the declines in new construction.

In the rest of the markets, our sales were down 6% on the blue side and 27% on the green side versus being up 4% last year. Here the later than normal start to the season with a colder weather April, May and the new construction market challenges were approximately mitigated by clear evidence of market share gains.

Turning to gross margins, the efforts of late 2007 and early 2008 coupled with better discipline and improved execution speak for themselves. To realize improvements in gross margins in this kind of challenging environment is truly outstanding performance by our team. Expenses are clearly in good control as headcount is down 8% year on year excluding acquisitions to offset higher real estate, fuel, and other costs. Again it's a credit to our team that as we've adjusted our team, our service levels continue in fact to improve.

Our asset management is progressing very well with receivables and inventory at projected levels. Again without compromising service as stock outs this year are lower than ever before, critical to defining value for a distributor.

Now let me cover the underlying assumptions behind our updated earnings projections for the year. At the beginning of the year, I had estimated that new construction would be down 20% to 30% in 2008. At this juncture, my assessment is that new construction will be down more like 25% to 30% or at the lower end of my range. When you take that and you factor in the natural growth of maintenance, repair and replacement activity, this lower rate of new construction will translate to sales being down closer to a negative 5% for the year. That is within the 0% to 5% range provided early in the year back in February so it will be closer to the low end of that range.

Part of the logic for the fact that these results in terms of negative comps will be more modest in the second half of the year than in the first half, are the fact that we will be lapping easier comps as well as the fact that maintenance, repair and replacement activity progressively becomes a bigger part of our sales mix as the year progresses.

With expenses running as expected, the wildcard of selling margin with progress here offsetting the modestly weaker than expected new construction activity.

Now a couple of additional footnotes. Our NPT and Canswim acquisitions from early in the year are progressing as expected. We have consolidated six of the lower volume NPT facilities into neighboring SCP superior facilities and we will be looking at doing one or two additional consolidations after the season. Overall, we are doing very well in what is truly an unprecedented time in the industry. Again, the resiliency provided by the install base enables us to whether this downturn better than many expected. In addition, the caliber and commitment of our team members is unique and it's my privilege to serve them and see them provide these outstanding results given these very challenging times.

With that, I'm going to turn the call back over to Mark for his financial commentary.

Thank you, Manny. First off, I'll discuss our operating expense management in a little more detail before moving on to the balance sheet and cash flow. As you can see from our press release, we are on track with the goal we discussed in our first quarter call of holding base business expenses flat year over year excluding performance-based management incentives.

As noted in the supplementary schedule, our base business expenses this year were $1.5 million or 1% below last year for the second quarter and more than $4 million or 2% below last year on a year-to-date basis. The six-month period includes management's incentive expenses and accrued bad debt reserves that are roughly even with the first six months of 2007.

Our reported expenses were a bit better than it would appear as higher product delivery costs included in operating expense were largely offset by collections from customers which are included in net revenues. Our lower costs are primarily being driven by reduced headcount which excluded employees gain through acquisitions, as mentioned earlier by Manny, were down 8% from June 2007 to June 2008.

Employee-related costs are our largest operating expense component followed by facility costs which are up about 10% year over year due to rent cost increases and facility relocations over the last 15 months offsetting some of the labor savings. The bottom line on expenses is that we continue to manage this area tightly and expect to achieve or exceed our goals here for the year.

Moving onto the balance sheet, our net receivables as noted, decreased roughly in line with sales while the quality of our receivables has remained stable. Our allowance for doubtful accounts of $9.7 million at the end of June was relatively unchanged since the third quarter of 2007 and reflects our ongoing aggressive credit and collection efforts under difficult market conditions. We will continue to monitor this closely as we approach the seasonal fall slowdown.

Inventories, as mentioned in our previous calls, have been a positive competitive factor for us helping to maintain high service levels and capture market share as many of our competitors have scaled back. As we approached our seasonal peak sales in June, we have been working inventory levels down and excluding acquired inventories, have dropped inventory levels from what was an 11% year-over-year increase at the end of the first quarter to a 5% decrease year-over-year at the end of Q2. With [higher amounts] than expected, vendor price increases in the months ahead, we will continue to use our strong balance sheet to maintain service levels and enhance profitability.

Through the six months of 2008, our cash used to fund operating activities decreased $19 million from last year as lower net earnings were more than offset by favorable working capital management. As we round the corner of the season and begin to generate positive cash flow in the second half of the year, we expect to continue to have improved cash flow results excluding the impact of any significant buying opportunities that arise.

To comment briefly on the consumer financing market and its impact on new poll construction, I think I can safely say that we are witnessing the bottom of this market at this point in time. Home equity loans which have long been the primary financing vehicle for new pools have essentially vanished from the pool financing marketplace. Home owners constructing pools on borrowed funds are now primarily tapping first mortgage refinances where the home owner has a strong credit history and something not prevalent in major pool markets, substantial home equity. Given the relatively favorable repayment history of pool buyers historically, this creates an opportunity for new entrants to this market although I expect it will take some time before the market stabilizes and the supply of funds begins to meet demand.

Now I will turn a call back over to our operator. Ashley, could you begin the question-and-answer session, please?

(OPERATOR INSTRUCTIONS) Curt Woodworth, JPMorgan.

Good morning. In terms of looking at the MRO side of the business for Pool, would that have grown about 1% to 2% this quarter?

It would have grown a little faster than that, Curt, 1% to 2% would be at least the unit growth. When we look at our part sales growth and we look at our chemical sales growth, those numbers are at least mid-single digits.

So if 20% of your business is down 30, that would be negative 6. And if 80 was up mid-single digits, you'd get to a number that would be better than the down 5 you mentioned on the call.

The only difference in your math is that the reference point when I refer to the 80% is '08. The reference points really from last year, it would be closer to 72%, 74%.

Okay, okay, I understand, great. In terms of looking at the SG&A structure with clearly the headcount is a major moving piece of the improvement but then there is some other factors and you mentioned facility rationalization and just higher I guess lease cost expenses. What was the amount of that headwind this quarter and how much of those costs would you characterize as nonrecurring? In terms of just pure relocation type costs?

The increase in real estate expenses in the quarter, just bear with me a second, are in fact largely recurring given the fact that we have the same facilities with rent increases built into the long-term leases that we have as well as facilities that we relocated into during the course of the past 15 months, as Mark mentioned. In the quarter, the increase in rent expense is just in rent expense alone is a shade over $1 million.

Okay. And then just thinking about raising the low end of your guidance yet you are saying that you think your top line is going to come in at that percentage. Is essentially the only thing that has changed, Manny, is that the gross margin performance that wildcard you mentioned is -- you have a lot more clarity and visibility into that number right now?

That is correct, Curt.

And just for the third quarter thinking sequentially relative to the second quarter, what are some of the moving pieces and what kind of typical progression do you get in gross margins sequentially?

Well, you have the history over time and really what happens is typically our best growth margin quarter is when our customers who -- to their customers and consumers are selling items that are very much impulse items with and therefore the best quarters in that respect are usually the second and to a lesser degree the third quarters of the year. And that pattern should remain consistent this year as it has in past years in terms of absolute margins out the door.

Okay. And then for 2Q, the MRO market for Pool, your kind of I guess more mid-single-digit type growth, would -- I guess intuitively you would expect that that number should be higher in the back half of the year just because of the easier comparisons?

The MRO component is pretty steady, last year and this year.

Right, but I guess just thinking about 5% growth on the MRO side in 2Q. Now you are getting into 3Q which is a much easier comparison. So wouldn't just the growth rate number -- it should be higher I would think in 3Q.

Right. The MRO component is not necessarily any easier but it does weigh more in the second half because new construction dropped down during the course of 2007. So the mid-single-digit type number improvement or increase in MRO will remain relatively speaking constant but it will become a bigger part and it will weigh heavier in the second half of the year as part of the pool and sales mix than it did in the first half.

Okay. And just one last question. Can you give us a sense for how July is tracking thus far?

July is tracking certainly within the range that we provided in terms of our guidance. When we refreshed our forecast for 2008, we had results through last week and nothing has changed in the last two or three days to make us think otherwise. So it is well within the range that we are talking about. And as you can well appreciate, Curt, given the nature of our business, July is our biggest month in the second half.

Right, I mean, right July would be roughly maybe 50% of sales for the quarter? 45%?

Oh no, nowhere near that. It would be in the high 30s but it's still the most significant month in the second quarter and the second half of the year.

Okay. Great, thank you very much.

Anthony Lediedzinski, Sidoti & Company.

Good morning. I had a question regarding -- what is your view about the sustainability of the gross margin expansion? And also if you could just talk about how much of the gross margin expansion in the quarter benefited from the mix shift of between the construction products and the maintenance repair and so on products?

I believe that a fair share of the improvement year on year from a relative standpoint is sustainable as we proceed during the course of the year. There is some range there incorporated in our projections for the second half and, therefore, for the entire year. But we feel fairly good that it will be largely sustainable.

Having said that, in terms of answering your second question, the major -- the single largest factor -- and it's very tough to tear it apart and pin a number down. But given the fact that when you look at various product categories or markets or customer segments, any which way you slice it, our gross margins are up year-on-year. We believe that the lion's share of the improvement is driven by, in fact, the efforts made throughout the organization to improve our discipline and improve our margin management, and that includes both pricing as well as sourcing.

To the extent that we shift more to our own private label products, our margins tend to creep up a bit. The more we sell preferred vendor products, our margins tend to creep up a bit as well. So all of those are positive factors.

There is logically a factor by virtue of the fact that some of our larger customers that were in the building of pools and building or developing irrigation systems, that that weighting is smaller and the overall mix plays into it, but that is a secondary component. It's mainly all of the efforts made on many individual components throughout basically the universe of our locations to improve every aspect of what feeds into gross margin.

As far as your comment about sourcing, can you give us a little bit more details on how much of your business is now private label and some of these vendor exclusive type of products, compared to last year?

I would say, and I don't have the number at the top of my finger right now, but two years ago when we measured it last, precisely at the end of '06, it was about 15%. That is creeping up at a rate at about 1% to 2% per year, and therefore we will probably -- at this juncture when we finish 2008, we will be very close to, I'd say between 18% and 20% of our total business will come from private-label business.

Also, in regard to your SG&A expense cuts on the base business level, do you feel there is any other ways that you can reduce costs, or have already all the headcount reductions taken place?

Well, there's two factors there. One is driven by volume and the other is driven by performance. We certainly have made all of the changes that we need to make from a variable standpoint, other than the seasonality of our business component. But the base level is what it is. Obviously, we constantly review performance and address that as needed.

I would say that to go significantly further, again other than addressing the seasonality of volume and everything else, would begin to put at risk service levels. One of the opportunities that we have here in this type of environment is to continue to gain share. We can do that both with not compromising our service levels and having the inventory when and where we need it, but also it comes from being -- our ability to provide that inventory to our customers when and where they need it.

So, therefore, as we combine both the inventory component and also the customer service side of the equation, we want to make sure we take full advantage of this market environment to maximize the market opportunities that are available to us.

Lastly, what is your outlook for cash flow for the year, and also CapEx?

In terms of CapEx, the number will be more modest than it has been in the last several years, given the fact that the rate of new openings, new location openings is reduced, and relocations in the overall sense are also (technical difficulty) CapEx will be south of $10 million for the year. And in terms of cash flow from operations, that will be -- historically, we've tracked very close to net income, and I don't see that being any different this year.

Okay. All right, thank you.

Kathryn Thompson with Avondale Partners.

Hi, thanks. I just wanted to clarify on operating expense that you talked about earlier. In the past, I believe you had said you thought that SG&A in aggregate on a dollars basis could be flattish in fiscal 08. Were you talking just about base business or on an aggregate level for SG&A on a dollars basis only?

We are talking base business. Acquisitions would be on top.

Okay. And so how much of a contributing factor do you see acquisitions adding on top of base business this year?

Sure, well to date as Mark mentioned, we are tracking for the first six months 2% on a base business level below last year's first six month's rate. So we are in fact ahead of our goal there. The acquisitions really, the main one there was the NPT transaction and we have taken a fair amount of cost out of that but that business itself had close to $20 million of SG&A. The number will be nowhere near that when it is all said and done. But you can see in the second quarter specifically and the increments provided by or caused by (technical difficulty) and Canswim, that number will moderate a little bit in the second half but not significantly.

When you say $20 million in SG&A, that was prior to your acquisition, just on an annualized basis normally for them?

The $20 million is basically the SG&A for NPT and Canswim.

Okay. And so that is a run rate we should think about for the year, is that correct?

No, our actual run rate as you can see by virtue of the numbers reported in the second quarter is a little bit more modest than that given the fact that we've done some facility consolidations shortly after the transaction. And we will probably do one or two more in the fourth quarter of the year.

As far as -- we've done a couple of surveys recently and we're definitely getting the sense there is going to be a next round of OEM price increases and hear they are going to be hitting late summer or early fall. Could you talk about that pricing environment and what type of price increases you are expecting and your ability to pass those prices along?

Great point, Kathryn. First of all, just to give everybody a perspective since obviously raw material costs, anything that is petroleum-based has certainly increased in the course of the last six months or so. By and large in the first few months of the year, manufacturers have absorbed those increases. There are some spot product categories where manufacturers announced price increases about two months ago and we're beginning to roll those in into our pricing.

But the lion's share of the products will in fact have price increases coming through in the fall. And as those happen, we will be raising our prices into next year. There will be some again increases in the second half of the year but most of them will be rolling from a price increase standpoint in the early part of next year.

The order of magnitude is all over the place. There are some product categories that price increases are up 7%, 8% and there are some product categories that are not up at all given in some cases the oversupply nature of those products where the manufacturers continue to absorb the raw material cost increases.

So what I'd like to do is it just, Kathryn, defer the answer to that until such time as we get better visibility. A number of those announcements are going to be coming to us in the August/September/October timeframe as manufacturers begin to factor in what the increase for 2009 and at that point perhaps when we do our third-quarter call, I'll be able to have more intelligent -- offer a more intelligent answer.

As it relates to gross margin, had some definite improvement year-over-year. What were the components for the improvement ranging from the most important to the least important?

I would say that the most important overriding component is margin management and that's not one component --.

Exactly (multiple speakers) is it product pricing, comps? --

I'm sorry?

I made just clarify what that means, margin management.

Margin management is all of the individual components that we do in terms of improving gross margin. For example, that includes making sure that our regional pricing is what it needs to be for all of the SKUs that are sold in that region and specific to each market. It includes that any customer specific pricing is appropriate for the market and for that customer. It includes the fact that you look underneath that and making sure that we are selling each -- in each market and in each region the products from the preferred vendors and private label products that provide the highest margins for us.

It incorporates also the fact that on the buy side we take advantage of buy opportunities that present themselves whether it be a truckload discount or any kind of discount of that nature and doing that more effectively in the buy side. It's working all of those components, maximizing prepaid freight type of conditions from vendors and stepping up and buying another two or three days worth of product on a particular PO to get to that freight qualifying order level.

It's all of those individual components that when you look at it individually are nits and gnats, but it's when you add it altogether that yields the kind of improvement that you are seeing this year and you've seen typically in years past as well.

I kind of understand that but you could argue you were kind of taking some of these headwinds last year. I guess kind of the point I'm getting to it just appears that you were able to pass on price increases better this year than you were able last year and that would be a meaningful contributor to your gross margin improvement this year. Am I off on that?

No, I think the discipline and our margin management execution is certainly better this year than ever before. And that's been a point of emphasis that began last year. We had specific training for all of our managers and sales people at our national meeting in October. Those sessions were followed through with what we refer to as poolinars, what you would maybe call a webinar session. We had ongoing management and regional management and general management follow up on a weekly and sometimes at least weekly basis. There is individuals that we have in our organization that specifically run reports and ferret out issues and quickly bring those to light of management to be addressed.

So there's a lot of activity that drives that. I would also tell you that there is -- we have also been to some degree selective and in some cases have chosen not to take business for one of two reasons. One of which is sometimes the margins aren't appropriate but we also factor both margins and credit into the equation. And given the challenging times, there are some customers that we may not choose to sell to at the same pricing as we may have chosen to sell them a year or two ago when collections were I will say less at risk than they are now.

So therefore, it's a combination of creditworthiness or credit exposure better said than creditworthiness, credit exposure and the margins that in some cases we say we will pass on that and that has also been contributed to the mix overall.

Okay and just -- I got on the call just a little bit late. Just to clarify housekeeping, your maintenance business was roughly 80% of your revenues and that segment was up 5%? Is that correct?

No, the maintenance, repair and replacement component of our business overall this year will be about 80% of our total business. Last year it was in the 72%, 74% of her business was maintenance, repair and replace.

I was talking for Q2, how much was that segment up?

It was up in the mid-single digits.

Okay, so it is around five. Okay, great, thank you very much.

[Tom Hayes], Piper Jaffray.

Good morning. I was wondering if you could just maybe provide a little detail as to what you saw as the monthly sales progression as we move through the quarter with a weather obviously getting a little better later in the quarter?

Sure. On a daily sales rate basis, comp versus previous year, it progressed a little bit in June in part driven by the easier comps of June last year as well as the fact that weather was more normal in June. It was a little bit easier so that the negative comps got progressively less negative as we went through the quarter and have gone through the year on a daily sales rate basis.

Okay. And then a little bit on Kathryn's question on product pricing. Did you, in 2Q, did you get any benefits from any inflation on the product pricing?

No, not in Q2. There were no discernible price increases that we passed on in 2Q. There were some that we received in 2Q but we had the inventory in place to cover customer commitment through the end of June.

Okay. And if you look at the updated guidance that you provided, could you provide a little more detail as to what you are seeing as far as a same-store sales decline or what is built into the guidance?

Sure. Basically at the outset of the year if you look at the [fourth-quarter] P&L, we have looked at zero to negative 5 in terms of base business sales. Our indications are given that the new construction segment is at the lower end or the weaker end of the spectrum, we're looking at being closer to 5 then we will be to zero as an example.

In terms of gross margins, expectations there are that there will be a year-on-year improvement for the balance of the year and then in terms of expenses that we pretty much got that under control and will be very similar to last year on a base business level.

Okay and again just lastly, could you just provide a little insight as to what you are seeing on the margin trends on the horizon part of the business?

In terms of gross margins?

Yes.

Gross margins or margins out the door with horizons are closer to flat. That market environment is as you can see by the numbers, a little bit more challenging with a greater weighting towards new construction and more of that construction obviously being more aggressively priced than the marketplace. So overall, there is -- out the door margins or selling margins are very much the same as last year overall despite the improvements made on their maintenance, repair and replacement components of the business, the and new construction segment is down a bit.

Are you expecting any improvement in the back half of the year on that?

Not significantly, no.

Okay, great, thank you.

Brent Rakers, Morgan Keegan.

Good morning, this is [Nicky Prather] for Brent Rakers. Manny, in the past you've talked about market share gains and actually disclosed numbers from suppliers. I was wondering if you could talk about how you are gauging your marketshare gains so far this year?

We have some of that data although the data is [vast] and typically we've hesitated from communicating specifics until the season is largely over given the delta in inventory year-on-year. So -- but we will do that, intend to do that as we report the third quarter when we have the pool season, the October through September time period fully covered.

In terms of the information is look at the numbers. I mean you look at a market like Texas where on the SCP superior side, we're up 11%. We know that new pool construction in Texas is down, so therefore to have that kind of growth in a market like Texas is frankly outstanding. We have a great team there.

When you look at even a market like Florida, the fact that we are down single digits when new pool construction is down over 40% from what it was last year and albeit it's a smaller portion of the total business every year as the numbers have come down the last two or three years, the fact that we are still down only single digits is again a reflection of our performance in the marketplace.

You look at other markets where we continue to make progress and capture -- I mean there is -- we have evidence of business gains and whether it be the Carolinas, Georgia, New York, etc., we continue to gain traction and build share. So we will have the specifics in terms of the major components and major suppliers and information sharing that we have with them in terms of aggregate numbers but we have pretty clear evidence to date of in fact share gains universally.

Okay, thank you. And have you all seen any adverse impact from the timing of the Fourth of July holiday this year versus last year?

Not significantly so.

Okay, thank you very much.

David Manthey, Robert W. Baird.

This is actually Kyle O'Meara for David Manthey. Could you quickly remind us what the gross margin difference is between private label and other products, please?

Sure. Kyle, that varies all over the place. On certain products, for example chemicals, that difference may be only 2%, 3% whereas on certain other product categories which are less price sensitive, and in fact the sourcing in many of those cases is in fact overseas, the delta would be well to double digits. So it's all over the place. If you want a specific roundabout number, you can certainly assume 3% to 5% as a good ballpark weighted number.

Great. You had talked about some consolidations coming through the rest of the year on the NPT acquisition, one or two more branches. Looking out to maybe later into year after the pool season, are there any plans to consolidate any branches further?

We are looking at that and there would certainly be several more but not very many. It's a great question. When you look at our business, in this kind of environment, we are kind of caught between a rock and a hard place because the lion's share of our locations virtually those that have been part of Pool Corporation for more than three or four years are very nicely profitable. And to the extent that sales are flat or down marginally, there is -- it's very difficult to consolidate two without walking away and in fact making in aggregate a lot less profit.

So what you do is you cut what you can in terms of certain of variable expenses and you work on your margins and you work on your sales execution and at the end of the day still are nicely profitable albeit and perhaps not quite as profitable as you may have been a year or two ago. But one of the tough things here is it would be real easy and obviously some companies have that luxury to go in and close down a lot of locations. But if we did that, that would be disastrous because again, even in this environment, the lion's share -- lion's share being 95%, 98% of our locations are very nicely profitable. So to do so would be again in aggregate make a lot less money.

Keith Hughes, SunTrust.

Yes, just on the year given your discussion on inventory before, it seems as though working capital will be a source of cash. Is that correct?

Certainly receivables would look to be a source of cash from that standpoint provided that our December sales year-on-year year are lower since multiple receivables is really comprised of the last 30 days sales. Inventories and accounts payable certainly given sales trends would not net net would be -- I don't see that as being a use of cash as it would be in a normal growth type of environment where we are trying to lever that. So Keith, that is very perceptive and frankly when you look at the results in the first six months, the fact that we are -- our use of cash during this period is $19 million less than last year in the first six months is part evidence of what you just are leading to.

Okay, and given that and given that your earnings expectations what we've already done for the year, we're going to have a pretty good cash year for you. What would be the use of those proceeds given your CapEx use?

Well, certainly if you go through our priorities as stated in our 10-K, first priority is internal use. Again, that is more modest given the fact that we don't have the same urgency to open up these locations or for that matter relocate to bigger facilities in the current environment, so that number is obviously more modest.

Second is acquisitions. And we are always in dialogue with prospective acquisitions in domestic pool, international pool, as well as the irrigation landscape side of the business and that is next in priority. We have a dividend and that is not an issue.

And then as you move further downstream, you have share repurchase and debt repayment. We are currently in almost the perfect place from a capital structure standpoint at 2 to 3 EBITDA in terms of capital structure that we aspire to have. So in that vein, we may be paying down a little bit of debt but that is something that we will be looking at as we progress during the course of the year.

All right, thank you.

Curt Woodworth, JPMorgan.

Hi. Manny, thinking longer-term about the SG&A cost structure of the company, what do you think once you start to get more kind of trend line sales growth that you want, what do you think is the optimal SG&A as a percent of sales for the company?

The way I look at that, Curt, is again assuming no acquisitions because that would be a different component. You look to have leverage as you go forward and leverage comes from SG&A growing at a rate faster than your sales growth -- excuse me -- slower than your sales growth and slower than your GP dollar growth. So to the extent that that relationship is positive, then we are making progress.

So if you look at let's say a high single digit type topline growth compounded over the next five years, we would be looking at a more like a mid-single digit type SG&A growth to support that sales growth. In part because we progressively over time need larger facilities and secondly, and more people to support that as well has some factor of inflation built in to both the sales number as well as the cost of real estate and the cost of people.

Okay. Just thinking about it this quarter and I know it is not completely like for like because of NPT, but the SG&A as a percent of sales hurt the margin for the company by 120 basis points. I'm just trying to think hopefully the back half of the year '09 you start comping positively. Can you get that type of reverse levers like -- could it be -- under a more normal environment, could it be 50 basis points improvement? Could it be 100? Is it just really not -- I know there's not probably just a linear calculation to make but it was a big negative this quarter, right? Not out of line but I'm just trying to think about really looking forward what the incremental leverage could be. It seems like it was a big opportunity.

Curt, two things, one it is certainly a very big opportunity. Particularly given the fact that we are in the past two years gone backward in that regard. When we have a facility of a certain square footage and we have a manager and we have an office manager, we have a salesperson in a certain facility, if the market is down 5%, those people are still there. And therefore, there is -- and the real estate if anything it went up from year-on-year from just a pure inflation standpoint.

So when you factor that in the equation, there is a drag that has impacted us adversely in the last two years. As the market reverts to normal over the next several years, we're going to get that back plus. I would like to also make a statement that if you look at the addendum to the financials in the press release which incorporate or segregate base business from the excluded components, the drag was 80 bps in the quarter and that is a reflection of the fact that our SG&A expenses were in absolute dollars down 1% in contrast to the sales being down a little bit more than that.

Okay, great. Thank you.

Joan Storms, Wedbush Morgan.

(technical difficulty) a question on some comments that were made earlier about some potential pricing increases coming from vendors and I was wondering if you could comment on that particular by category and what is expected and whether you may be doing some buy-in purchases affecting inventory?

Sure. Well, we've only got indications in many cases and the hard numbers haven't really come out yet in most of the categories. We know that equipment is going to be going up. We know that chemicals are going to be going up and we know that some products are not going up at all. So we will evaluate that, Joan, as those come out and we will factor that into what we do and when we do it.

We would try to -- obviously we factor that in and we use time as the valuation component in terms of what is the differential in price and how much time is that price differential worth from an inventory time and sell time -- sell through standpoint. And we also mapped in against each other because we also are limited from a space standpoint as to what we buy into and when. And last in the case of chemicals, specifically there are also some storage limitations given the nature of those products.

That is all weighed together. Again, I think it's premature at this juncture to really -- it would be very speculative on my part to give you any indication on that other than to say that we'll be looking at it and that will happen really in the August through October time period is when we will be making those types of -- we will be looking at hard data on making those decisions and we will have a better sense when we communicate our results together with the third-quarter call.

Okay fine and then on your geographic comments, and Florida obviously was the worst first and then California obviously more important. Are we seeing any trend say over the last three quarters where things might be bottoming out in any of those markets?

Yes, I mean you look at Florida specific Florida was the one that started weakening the earliest and last year's decline was 12% in the second quarter; this year's decline was 8%. Part of that is the fact that new construction is progressively smaller and smaller as a percentage of the total business in the state of Florida. So we are what we see, we are very close to the bottom here. That is a point that Mark when he touched on the pool financing, new pool financing market and the fact that there is very little capital that is made available this year in that vein, the fact that new pool construction is down to about half of what it was in 2006.

We believe that we are very close to the bottom overall and to the extent there is any further deterioration, the weighting of that deterioration from the overall business is also diluted by virtue of the fact that's already half of what it was in terms of our total business two years ago.

Great, thank you.

David Mann, Johnson Rice.

Good morning. Manny, can you just expand on that last comment about what kind of pool demands you perhaps are seeing out there that is not being fulfilled?

That is a great question, David. When you actually look at demands in terms of natural demand on a consumer level, the demand hasn't changed. What has changed is the ability for consumers to execute on that demand by getting the funds or the financing to make that home improvement. So in effect, I think as Mark mentioned, it will take a while but as the financing market reverts to normal, as those that have vacated the space begin to take advantage of the opportunities out there to make very profitable lending given the nature and the history of the consumers and the households that borrow for those home improvements and the repayment rates and the very low default rates that apply. As that market reverts back, that number will revert back to a more normalized level.

And again, I will use of Florida as the example given that that state has the best and highest quality information. It wasn't as if Florida went from 20,000 pools being built in 1999 or the year 2000 and skyrocketed to 48,000 in 2005. No, it was 35,000 in '99 and 2000 and it grew gradually at 6% per year to peak at 48,000. The fact that that number is down from 48,000 to 13,000 is in my mind a real aberration.

I think anyone can question what the normal number would be whether it is 35, 40 or 45 in the state of Florida given the population and households that are currently in Florida. But certainly the number is much greater than 13 and frankly much greater than last year's 23. So that is a real opportunity and again, at the natural demand is there. It's just a matter of there's a certain segment of consumer -- the consuming public that is currently not able to get financing and when they are able to get financing, that build rate of pools will revert back to normal and the same applies by the way to irrigation systems.

Okay. On the existing installed base, are you seeing any change in the behavior of the pool owner as it pertains to the using a pool service company versus do-it-yourself given the environment?

No, we have not seen anything significant one way or the other in that regard.

Okay. And then one last question. As you start to look out toward next year, if you assumed another let's say significantly down year in terms of pool construction and perhaps a down year in base business growth or at least not as robust a recovery, how do you prepare for that in terms of anything you can do in SG&A or any other levers that you would want to pull if you expect this weak environment to continue?

Well, two things. First of all, that is an ongoing management process much like we've done forever but again with more emphasis on the more constrained environment of the past 12 to 18 months. So therefore, we would do much like we have done -- that is part of our review process that we are undergoing as we speak and we will be making those decisions in the next 30 to 60 days. And then executing on that between a course of the fourth quarter and some may drag into the first, but basically in the fourth quarter.

But it's not going to be overly significant and it comes back in the SG&A side and it comes back to the simple fact that we are very fortunate in that the lion's share of our locations are very profitable and therefore to make any radical changes would not be appropriate. But are there opportunities to improve our efficiencies and are those being addressed? And the answer is yes and yes.

I guess I'm not sure if you answered this question directly but as you look to next year then, given the rent increases and other inflationary pressures that sort of flowed through your SG&A line, what type of base business growth would you need to have to lever that?

If the unit volumes are flat with this year, then you would expect that SG&A would be about flat. And in other words, what would happen is that we would have enough efficiency pickups throughout our structure to offset real estate and other increases going through.

Very good, thank you, Manny.

Eric Elbell, Fenimore Assets.

First question would be around this time last year, you talked about from the standpoint of competitor behavior some competitors acting irrationally. Can you update us on what is going on with that environment this year?

That's a great memory. Given the fact that there was very little gain realized by some of that irrational behavior, the marketplace has been a little bit more rational this year. And while we are never free of that behavior, it has been certainly more rational and that has certainly enabled us to realize the margin improvement that we've been able to realize.

Okay, good. And then just secondly, any commentary you might have on how things are trending in your international businesses?

Sure. The international markets have many of the same overhang in terms of economic slowdown and financing market turbulence. So therefore, that same impact is weighing on the international side which is mainly for us Europe and to a lesser degree Canada. So there is spillover impact and the behavior is or the impact is similar if not quite as striking as a Florida or Arizona were. But it would more be reflective of what is happening in the rest of the US.

Okay, good. And then finally, are there any new centers expected for this year?

We are always looking at that and if there are, it will be very modest.

Okay, very good. Thank you.

But we are certainly looking at that, yes.

Okay.

Brent Rakers, Morgan Keegan.

Real quick, do you all have the average debt number for the quarter? During the quarter?

Mark, do you have that?

Or the actual bad debt expense in the quarter also?

Oh, bad debt.

Both of them, both of them, sorry.

Bad debt is primarily a reserve at this juncture because the actual bad debt write-offs is a very low number at this time of the year. Usually those happen in the forth and the first quarter as people are out of the season. Cash flow is generally peaking pretty positive in the second quarter so actual bad debt write-offs are negligible in the second quarter. So it's basically a reserve type of number and our pool there is not that significant.

As I mentioned in my comments, it's relatively even with last year. And on the -- I have a average debt but if you take first-quarter and second-quarter ending debt, you can come up with the average pretty easily there.

Okay and last real quick. Is there anything that would be considered one time in nature for the gross margins this quarter?

No.

Okay, thank you.

There are no further questions at this time. Do you have any closing remarks?

Thank you, Ashley. And thank you again all for listening to our second-quarter 2008 results conference call. Our next call will be October 23 when we will discuss the third-quarter results. Thank you again.

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