Pool Corp (POOL) 2010 Q3 法說會逐字稿

Greetings, and welcome to the Pool Corporation third-quarter 2010 earnings release conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Mark W. Joslin, Vice President, Chief Financial Officer for Pool Corporation. Thank you, Mr. Joslin. You may begin.

Thank you, Claudia. Good morning, everyone, and welcome to our third-quarter 2010 conference call. I would once again like to remind our listeners that our discussion, comments and responses to questions today may include forward-looking statements, including management's outlook for 2010 and future periods.

Actual results may differ materially from those discussed today. Information regarding the factors and variables that could cause actual results to differ materially from projected results is discussed in our 10-K.

Now I will turn the call over to our President and CEO, Manny Perez de la Mesa. Manny.

Thank you, Mark, and thank you all for joining us on the conference call. I am going to focus on three areas in my prepared remarks. First, our base business sales growth; second, our contribution margin; and third, our cash flow.

Regarding our sales, our base business sales growth in the Blue business was 4% in the quarter, much like the 5% growth realized in the second quarter, increasing our year-to-date Blue business sales growth to 3%.

While many of our investors and many of you on the call live in snowbelt markets where we realize significantly higher sales growth, Sunbelt markets did not experience the same kind of weather benefit as in the snowbelt during this pool season. In fact, in the three largest markets, California, Florida and Texas, our sales were down 0.7% in the quarter, in contrast with our sales increase of 2.9% in the second quarter in these three states.

The three primary reasons for this drop-off are that we had some deflation of chemical prices that, combined with effectively no inflation elsewhere, resulted in our overall net deflation for this pool season. This was coupled with a rush early in the season due to carryover pent-up demand from 2009, and we also had more pricing and credit discipline as we progressed during 2010.

Our Green business had a sales decrease of [9%] in the third quarter and was down 11% year to date. We believe that we continue to increase our market share in the 2010 pool season with progressively better sales and service execution, as well as the use of marketing and technology tools utilized to help grow our customers' businesses.

While it's early to make comments for 2011, by every indication, 2010 is proving to be the transition year that we expected. As communicated in our September 13 Investor Day presentation, we believe that the macro economic factors, including the depressed valuation of residential real estate, will continue to challenge sales growth in the near term. Nonetheless, we believe that sales growth, albeit modest, is attainable by us, particularly given the strength and quality of our people.

It bears repeating at this point that our success in growing sales and market share, both historically and in the future, is based on our collective execution to provide exceptional value to both our customers and our suppliers.

Regarding contribution margin, I have stated over the past two years that our organic contribution margin should approximate 20% for the next $500 million to $600 million of sales growth. While we have realized a modest $25.8 million in base business sales growth year-to-date 2010, as noted in our base business addendum, our base business operating income is up $6.4 million, or a 25% contribution margin. We believe that incorporating a 20% contribution margin on future years' base business sales growth is reasonable until we get to $2.1 billion to $2.2 billion in sales, after which the marginal contribution will approximate 15%.

Logically, operating margin from acquisitions will be much less, as we don't have the same kind of infrastructure leverage as we do with our base business.

In terms of cash flow, our free cash flow should once again exceed net income in 2010. This is attributable largely to improved execution in every facet of working capital management. While having free cash flow exceeding net income may not be attainable every year, we believe that in an environment of modest sales growth -- and modest, I mean low to mid single digits -- and high infrastructure leverage, as we anticipate 2011 will be, is certainly achievable.

Before turning the call back over to Mark, I'd like to note the high level of commitment on the part of every member of the POOLCORP team. While the past several years have been the most challenging in our industry's history, and in most of our careers, our commitment to our industry and to our customers has resulted in our earning a greater share of our customers' businesses, while simultaneously improving every facet of our own execution. The excitement of our team to continue providing progressively more value to our customers and our suppliers is contagious. Our work on the 2011 pool season was kicked off at our sales conference two weeks ago, and we, the POOLCORP team, are very excited about 2011.

With that, I will turn the call over to Mark for his financial commentary.

Thank you, Manny. I will make a few P&L related comments before moving on to the balance sheet and cash flow, starting with SG&A costs.

To restate our objectives for 2010 as they related to SG&A expenses, which we discussed on our first conference call of the year, we wanted to continue to focus this year on targeted cost reductions and leverage our existing infrastructure, which we assumed would result in lowering SG&A costs as a percentage of sales for the year, given our expectation for a modest sales increase.

Through three quarters, this has played out pretty much as expected as SG&A costs down 60 basis points as a percent of sales for the quarter and down 44 basis points for the year.

Looking at our base business SG&A costs, they are down slightly for the quarter compared to last year as higher incentive and freight costs were offset by lower facility and other costs. We have also continued to manage our collections process well, as I will discuss further later, resulting in a reduction in our provision for doubtful accounts for the year. I'm sorry, provision for doubtful accounts from last year.

Overall, we are happy with the way our organization has responded to the challenge of doing more with less. This is a theme that you will continue to hear from us in the quarters ahead.

One other line item on our P&L that bears comment is the interest expense line. While we continue to benefit from reduced debt levels and the low interest rate environment, we have also included on this line a net $1.3 million pretax foreign currency translation gain on repayment of loans from outside the US that was $1.1 million greater than the gain we recorded in Q3 2009. I wanted to point this out, given the greater than usual magnitude of this item.

Moving on to the balance sheet, beginning with receivables, we continue to see very strong performance here, driven by improvements in both our customers' health generally, as well as our own credit management practices. These improvements, as well as the usual write-offs of accounts deemed uncollectible, have allowed us to reduce our reserve for uncollectible accounts over the last year to $7.3 million from $12.2 million, as noted in the footnote on our balance sheet.

Our percentage of slow-paying accounts has dropped considerably over this time, with greater than 60 day past-due balances down to 9.7% of our September 2010 Accounts Receivable, compared to 13.6% last year.

Our days sales outstanding, or DSO, have likewise improved to 32.2 days from 35.5 days at Q3 2009, which is a 9% improvement.

Inventory management also continues to be a good story for us as we have been able to reduce inventory balances compared to last year by $12 million, or 4%, despite adding $12 million in inventory and acquisitions. At the same time, we've expanded our stocking of tile, pool finishes and replacement parts over the last year, which has helped us achieve some of our market share gains and positioned us for the growth we see coming in the refurbishment market.

These working capital gains and our expected increase in net income should enable us to reach our cash generation expectations this year, which, as Manny mentioned, are for free cash flow to exceed net income. Through Q3, we have generated $59 million in free cash flow, and we expect positive contributions to this in Q4. For reference, we generated $25 million in free cash flow in Q4 2009.

We have continued to focus on deleveraging with excess cash flow and have reduced total debt to $231 million at the end of September compared to $273 million last year. Our leverage ratio, as calculated on a 12-month trailing average debt divided by adjusted EBITDA, dropped to 2.14 at September 2010 from 2.93 a year ago and 2.36 at June 2010.

One final comment I wanted to make is a reminder that in our seasonally slow fourth and first quarters, we expect to report a net loss for these quarters, which means we will be using basic shares outstanding to calculate EPS, rather than fully-diluted shares, with share counts expected to be similar to what I outlined on the last call.

That concludes my prepared remarks, so I will turn the call back over to our operator to begin our question-and-answer period.

(Operator Instructions) Daniel Garofalo, Piper Jaffray.

This is Dan on for Tom Hayes. Congrats on the quarter, guys.

Just in terms of geographic strength or weakness, we've talked in the past about some of the pricing pressure that is in the marketplace. Are there any geographies that you are noticing particular strength or weakness, just in terms of pricing?

From a pricing standpoint, every market is competitive, certainly. You tend to have a little bit more irrational pricing in the larger markets since there are more competitors, and therefore, more likely for one or several competitors to be more irrational in their pricing.

Okay, but nothing in particular in a certain market that stands out?

Nothing stands out. I mean, if you look at the larger markets, California, Florida, Texas, Arizona, those four states represent a little over half of our total business. And that is -- those are logically the largest markets. And where, although we have a very good share in those markets, we still have a great many competitors. And given the competitive environment, there is usually at least one player that is irrational in their pricing.

Okay. Thanks. That's helpful. The other thing -- you mentioned some new product introductions. I think tile was one of them and kind of some parts. Is there any additional color you can offer as far as the nature of those introductions and what they might mean moving forward for the business?

Sure. Two things, coming from different angles. Over the course of the last several years, we've had renewed emphasis on making sure that we stock at our centers what our customers need. And to that end, we have increased our breadth of offering from both parts, to make sure that they have a full complement of their needs served by us; and secondly, we've also taken the opportunity to, as we got into NPT, a transaction we closed on in March 2008, to further broaden that product offering with new tile models and samples to further accentuate the aesthetic appeal of a pool.

Got it. And so in terms of just -- you had mentioned kind of taking that end of stock up. In terms of a level of inventory just heading into kind of the slow period, any color, or are you comfortable with the level of inventory you have heading into the slow period in the first and fourth quarters?

Yes, if you look at our numbers and you look at the fact of where inventory is, you can see both with respect to inventory and receivables, as Mark noted in his comments, we've made significant progress in working capital management and continue to do that.

So where we finished the September was, relatively speaking, clean. And we are poised to move further and as the years go on to provide what our customers need, when and where they need it, and do that progressively more efficiently from a working capital standpoint, which includes, obviously, inventories.

Okay. And just lastly, quickly, in terms of just the foreign currency gain, that was a one-time expense, right? And then just going forward, what would you say -- and you've probably touched on this in the past -- what would you say is the tax rate for modeling? And thanks for taking the questions.

Sure. On the foreign currency, it was a gain, not a loss, and that was relatively one time in terms of the magnitude, and relates to payment of an intercompany loan. We made acquisitions back a number of years ago, made loans from the US to fund those acquisitions and then paid those back as cash built up over time. So we do that routinely, but the magnitude of the gain was certainly unusual.

Okay.

From a tax rate standpoint, we did lower our tax rate for this year, as we had some prior years' tax returns close from an audit standpoint. And I would expect the rate going forward to be back up around what it has been historically, 39, 39.2, 39.3, 2011.

Okay, great. Thank you.

(Operator Instructions) Anthony Lebiedzinski, Sidoti & Company.

Just a follow-up on the inventory question. In the past, sometimes the Company has from time to time bought inventory prior to year-end, whether it was opportunistic purchases of inventory or ahead of price increases or for other reasons. Do you expect to be making such inventory purchases before the year wraps up?

Anthony, good morning. Two parts. Traditionally -- and this applies primarily to the equipment manufacturers that supply our industry, but to a lesser degree in other sectors. They typically -- the manufacturers like to level load their factories, and therefore shift volume from the peak summer period to the off-season, again, reducing their cost of doing business. And to that end, they offer what is referred to in the industry as early buy programs.

Those programs are offered every year, and we participate, to varying degrees, every year. And that is typically why you would see our inventories in December being a little bit higher than September, even though they are really -- the inventory is not necessary until really sometime later on in the March/April timeframe.

In addition to that, depending on what the incentives are provided by the manufacturers -- and those incentives usually come in the form of avoiding price increases -- we are more aggressive or not in terms of buying in on those early buy programs. In this particular case, given the current environment, they have announced very modest price increases. Which is also important to note for all on the call, because while 2010 is proving to be a year where we've had net-net very modest, but still modest deflation, our expectations are that in 2011, we will have modest -- and modest, I'm using 1% to 2% -- overall inflation.

But given the order of magnitude of the price increases by the manufacturers, we will not be doing any extraordinary buying in, as we did, for example, in the latter part of 2008, going into the 2009 season. So this year, it is pretty much a normal year from an early buy standpoint as opposed to a higher than normal year.

Okay, thanks. And also, I was wondering if you could comment on what currently is your penetration of private label products, and how do you see that going forward, and also in the margin implications?

Sure. Private label, as you know, has been an initiative we've had for many years. And, I mean, it used to be 10 years ago several percent of our total sales. Currently, when we last ran the report a couple months ago, it was approximately 21%. I think when the year is done, it will be closer to 22% for 2010. And that has been growing at a rate of 1% to 2% of our total business for the last 10 years.

And yes -- and to that end, one of the motivations -- one of several motivations, but one of the motivations we have for private label or POOLCORP-branded products are to enhance our gross margins. And every time that mix improves, that helps contribute to margin improvement.

Okay. I know you are not providing guidance for 2011, but is it safe to say that if you have a period where you are seeing modest increases in your sales, that your expenses will grow at a slower rate than your sales?

Yes. In fact, if you look at our business overall, we don't need to grow sales that much to have much better growth in terms of our earnings. Specifically, if our sales grow in the order of, let's say, 4% to 5%, our expense growth will be very modest. And therefore, with that kind of sales growth, we should have approximately 10%, 12% type operating income growth.

And certainly, when you roll in the benefits of our cash flow generation and the further reduction of interest expense, we should be able to realize certainly double-digit earnings per share growth, again, on what I will consider very modest 4% to 5% type sales growth.

Okay. Thank you.

Dave Manthey, Robert W. Baird.

Hi, guys. It's Jackie on for Dave, actually. Just kind of following up on your 2011 outlook, are you thinking pool construction and irrigation kind of remain lackluster, but you are expecting to see growth in maintenance, repair and renovation?

Right. Let me give you some color there. Let me give you the components. If you look at the maintenance and repair segment of our business, which is, again, the biggest portion of our entire business, the installed base continues to grow. In terms of units, the addition of pools this year will add approximately 1% to the installed base.

Now I mentioned weather earlier, and weather was certainly beneficial in the snowbelt, but it was very negative in particularly California. And therefore, when you look at the weather impact this year, it was probably a net neutral overall. Particularly, again, when you weigh not only the fact that California is by far the largest pool market in the country, but also the fact that our share of market in California is much greater than it is in the snowbelt. So when you weight it to our business, not necessarily the industry, but to our mix of business, and again, our Sunbelt weighting, that means that the weather benefit was negligible, if at all.

So therefore, we have a 1% growth in the installed base, coming back to that. We will have 1% to 2% inflation. And then on top of that is our execution, and we have historically demonstrated an ability to grow our share of market or, in essence, grow faster than the market because of the value and the tools and the resources that we provide to our customers to help them grow in their business.

So that's the maintenance and repair segment, which, again, is by far the largest segment of our business.

Second, in terms of remodeling and replacement activity -- and this is in the pool sector, or Blue space -- remodeling and replacement activity is down approximately 30% from normalized levels. And while we don't see that increasing in any significant way in 2011, we do see the fact that there is a greater aging of the installed base. And that aging of the installed base, in other words, more pools that are now seven, eight, 10 years old, these are pools that were built, again, seven, eight, 10 years ago, those are being added to that installed base that is trying for replacement of equipment or remodeling of the pool surface itself.

And as that base grows, that should grow and add to the unit sales growth in that sector at a level much like, if not greater than, the growth -- the 1% unit growth of the installed base.

New construction, frankly, we don't -- we're not optimistic about that in 2011, and we see that not being significantly different than it was in 2010. But again, given the order of magnitude of where that is in the overall scheme of things, I think the Blue side of our business, what will carry that will be the maintenance and repair, as well as the remodeling and replacement sectors.

Now, the Green side of our business, which is down 11% year-to-date, and it was down 9% in the quarter, we believe that for 2011 -- we believe that 2010 will mark the bottom of that cycle, given the tie that has to new home construction, and the fact that it lags new home construction by approximately one year. So therefore, we believe that 2010 marks the bottom of that cycle and that will not be a drag on our base business sales growth in 2011, as it has been the last -- well, certainly, this year and last year as well.

So given those factors give you kind of a perspective in terms of what we are anticipating for 2011.

That sounds great. Thanks for the question.

Thank you. We have no further questions at this time. I will now turn the floor back over to Mr. Perez de la Mesa for any closing remarks.

Thank you, Claudia. And thank you all for joining us for our third-quarter 2010 results conference call.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.