Pool Corp (POOL) 2010 Q4 法說會逐字稿

Greetings, and welcome to the Pool Corporation year-end 2010 earnings conference call. At this time, all participants are in a listen-only mode. A brief 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 Joslin, Vice President and Chief Financial Officer for Pool Corporation. Thank you, Mr. Joslin. You may begin.

Thank you. Good morning, everyone, and welcome to our year-end 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 2011 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.

With that, 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 our 2010 results conference call. After several years of unprecedented market contraction, during which new swimming pool construction decreased by almost 80% and replacement/remodel activity declined approximately 30% from normalized rates, 2010 was a welcome transition year for the industry. We believe that overall industry activity in 2010 was flat to very modestly up, which, after what the industry has gone through, was certainly welcomed.

In our case, after a decline in the first quarter of 2010, our business registered its third consecutive quarter of base business sales increase to finish with positive sales growth for the year. This growth was realized despite modest deflation, -- that's deflation with a D-E, and a Green business that was still contracting, albeit at a moderating rate, during 2010. Overall, our Blue base business sales growth was 3.4% in 2010, including 5% growth in the fourth quarter.

As many of you know, weather is the most significant external factor affecting the maintenance and repair segments of our business, which represents approximately 70% of our domestic Blue business sales. Here, an extended cold spring and summer resulted in California and Arizona, our first and fourth largest markets, respectively, having base business declines, with California down 2.3% and Arizona down 5.9% for the year.

Florida and Texas, our second and third largest markets, with pretty normal weather, were up 3.2% and 3.7%, respectively, for the year. The rest of the markets were up 6.3% in 2010, as favorable weather in several markets, especially in the Northeast and Midwest, contributed to strong sales growth. Overall, we believe that we continued to gain profitable share in 2010.

Competition in our industry has always existed at the local market level, where we and our competitors vie for share. Given the contraction of the industry at every level of the supply chain, from manufacturer to distributor to dealer, over the past several years, increasingly there have been cases of competitive activity becoming irrational. This includes dealers that price their services below cost, as well as distributors that do the same, in their urgency to convert inventory into cash.

Fundamentally, irrational competitive behavior is not healthy for any industry, with our industry certainly not an exception. In that vein, our focus is and always has been on profitable market share involving instances where we cede unprofitable sales to competitors.

It is primarily because of our pricing discipline, coupled with progressively better sales and purchase execution, that we were able to maintain flat gross margins in 2010 despite the very competitive marketplace.

Expense management is an area that we have become much better at over the past several years, with 2010 being an example of our progress, as we had flat base business expenses despite a $9 million increase in incentive costs. This increase in incentives is tied directly to our improved results in every facet of our business, with profit as the most significant factor in our incentive programs.

Our improved execution also extended to working capital management, as evidenced by reduced DSOs and improved turns. Altogether, our cash flow from operations was $94 million, or more than 160% of net income, which is excellent for a distribution business with sales growth. Overall, I believe that we realized solid results in the transition year of 2010.

For 2011, we believe the worst is behind us, even in the Green business. While there are not yet any definitive signs of recovery in the macroeconomic factors that affect the replacement, renovation and new construction segments of our industry, the aging and nominal growth of the installed base should translate to industry growth in 2011.

Another positive variable is that the industry should have price inflation compared to price deflation that took place in 2010. For us, this situation should translate into low to moderate single-digit base business sales growth, some gross margin improvement and the significant leveraging of infrastructure to result in double-digit profit percent growth.

Beyond 2011, we believe that eventually consumer behavior and macroeconomic conditions will revert to normal. As that happens, we are poised to grow at an accelerated rate, leveraging our infrastructure, while consistently improving execution and growing profitable market share.

Our team of over 3400 employees in nine countries are the ones who make all of this a reality every day with their talent, dedication and commitment to our customers. It is our team that provides me the greatest confidence in our future growth and success.

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

Thank you, Manny. I will start with a few additional comments on our SG&A costs, before moving on to the balance sheet and cash flow.

Looking back at the entire year, we achieved what we set out to do in managing expenses in 2010, which was to be flat overall, excluding acquisitions, with moderating year-over-year expense improvements as the year progressed. We did this by entering 2010 with a lower cost base due to reductions made throughout 2009, then targeting specific areas for additional reductions in 2010, while investing in other areas that supported our growth, including incentives, as Manny mentioned.

This resulted in the leveraging of our base business sales increase of $34.1 million in 2010 into operating profit growth of $11.4 million, as you can see in the base business addendum to our press release. As we have discussed in the past, we expect a normalized contribution ratio of 20% on incremental sales. We were quite a bit above that in 2010, as the cost reductions we achieved allowed us to hold expenses flat year-over-year, but we expect the 20% ratio to be a good benchmark for the future, including 2011.

Another line on the P&L statement that I wanted to comment on is net interest expense. This has come down as we've reduced our debt levels throughout the year, resulting in a contribution of $3 million to the increase in pretax income compared to 2009. Looking at just the fourth-quarter activity, you need to keep in mind that the fourth quarter of 2009, we booked a $1.5 million currency gain, so the year-over-year change in the fourth quarter was not indicative of the annual trend. For 2011, I would expect debt and interest expense to decline modestly overall.

As for debt, this is a good time to recap the success we've had in paring this back since we began a more concerted effort to do this in 2009. From the end of 2008, when we had $327 million in debt outstanding, we've brought our debt level down by $128 million to $199 million at December 2010, including having used $18 million for acquisitions over this time and $14 million for share repurchases, which I will touch on more in a few minutes.

That brought our year-end leverage level to 1.99, as measured on a trailing 12 month debt to EBITDA basis, which was the target we had been aiming for. Our longer-term objective is to maintain leverage at between 1 and 2 times EBITDA, with opportunistic variations around that range.

Moving on to receivables, I would like to highlight once again the tremendous results we achieved here in 2010. Our days sales outstanding declined from 34.9 days in 2009 to 31.7 days in 2010 as a result of efforts made throughout the organization to focus on working out problem accounts. This resulted in a decline in our balances greater than 30 days past due from 29.4% of total trade receivables at December 2009 to 21.1% at December 2010, which marks great progress by the organization, particularly in our highly competitive market environment.

Inventory management was another positive working capital story for us in 2010, as inventories, excluding acquired inventories, declined 4% despite the increase in sales, and our inventory turns improved by 10% for the year. The rebalancing efforts mentioned in our press release focused in part on driving down slower-moving inventories, which resulted in a 44% reduction in inventory in our slowest-moving inventory class in our domestic pool business.

Concerning cash flows, we had another good cash generation year in 2010, which was helped, of course, by the working capital improvements I just discussed. For the year, as Manny mentioned, we reported cash flow from operations of $94 million. We used $15 million of this for acquisitions and CapEx, $26 million for dividend payments, $14 million for share repurchases and the bulk of the remainder to pay down debt. For 2011, we will again target cash flow from operations to exceed net income.

In the fourth quarter, we restarted our share repurchase program, as our cash generation and reduced leverage over the last couple of years have given us the comfort level needed to do this. For the quarter, we repurchased 563,000 shares at an average price of $21.57. Since the end of the year, through yesterday, we have purchased an additional 660,000 shares for an average price of $23.80. This leaves us with $25 million open on our existing $100 million Board authorization.

Another area that I will comment on is our forecasted share count for 2011, as there is some confusion about this from time to time. Based on where we are today, and with expected equity grants, option exercises and share repurchases under our existing authorization, we would expect to have quarterly and year-to-date share counts as follows.

March, in which we use basic shares, given the expected loss for the quarter, would be 49.0 million shares. June, the fully-diluted share projection for the quarter is 49.5 million; and for the year-to-date, 49.8 million. For the September quarter, the fully-diluted share projection for the quarter is 49.6 million. And for the year-to-date, it is 49.9 million. And for December, where we use basic for the quarter and fully-diluted for the year-to-date, it is 48.6 million for the quarter and 50.0 million for the year-to-date.

Finally, I would like to make a comment to the sell side analysts about their projections for 2011. While the consensus forecast for the year is within the range we announced today, I would like to remind you that the first quarter of last year was our worst in terms of year-over-year performance, with declines in gross margins from the year before. We therefore expect our first quarter of 2011 to be our best quarter in terms of year-over-year performance, which is something you might consider in your modeling when you fine-tune your quarterly projections.

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) Mark Rupe, Longbow Research.

This is actually Andy in for Mark. First off, on the pricing, I just wanted to maybe sort of -- maybe you could sort of reiterate what you mentioned in your prepared remarks. I think maybe I was a little bit confused. Maybe if you could reword it.

I think you previously had indicated maybe 1% to 2%, but it sounded like from your comments, it might be a little greater than that. Any color you could give there.

In terms of price inflation, Andy?

Yes.

We are looking at for 2011, it should average out about 1% to 2%. There are certain commodities that are up double-digits, but that gets diluted heavily as those commodities flow through in terms of the actual products. On equipment, it is up a little bit more than that. But other areas are -- there is still a little bit of deflation.

So overall, we expect, based on a reasonable mix, that our -- that the price inflation this year will be about 1% to 2% overall average. Again, some deflation and certainly inflation, but that looks like a pretty good number.

Okay. And I think on your third-quarter call, you mentioned that the Green business won't be a drag on base business sales in 2011. Is that still kind of what you are thinking as you look ahead to this year?

When we look at our Green business, we saw a moderation of declines during the course of 2010, very much like we saw in the Blue business during the course of 2009. So our expectations are that in 2011, they will be in the same type of transition year that the Blue business was in 2010, and therefore overall, there should be, from a sales standpoint, positive year-on-year comps during the course of the year.

Okay. What would you say in terms of profitability in your Green business? Maybe -- is there sort of maybe a -- sort of a benchmark that you would look at in terms of what would be sort of the breakeven sales level for the Green business?

To be honest, we don't look at it that way, because we look at our business on a location-by-location basis. And therefore, the breakeven thresholds or the return on capital thresholds that we have are more on an individual business unit level.

But if you were to look at the Green business overall, we still had a loss in that business in 2010. We expect us to certainly significantly improve results in 2011. That would come in two forms. That will come in part from certain actions taken during the course of 2010 to further reduce costs in a number of the individual locations, as well as from some modest growth in sales and gross profits.

Okay. That's it for me, guys. Thanks a lot. Good luck.

Ryan Merkel, William Blair.

This is David Mandel on for Ryan. I was hoping you could talk a little bit about -- give some color on this quarter's gross margins, and kind of how we should think about gross margins heading into 2011. Thank you.

Overall, David, we are looking for -- as I mentioned in my prepared remarks -- for the year very modest improvement in gross margins overall; perhaps something to the tune of say 10 to 30 bps. Now, when you look at that by quarter, the quarter where we are the most likely to have the best results in that regard will be in the first quarter.

So I would expect that our first-quarter results would be the best year-over-year comp and then that will moderate as we go through the year.

Thank you.

Jill Carruthers, Johnson & Rice.

I have a question regarding pent-up demand for pool equipment replacement business. It seems as though with the equity markets up and unemployment stabilizing that consumers seem to be willing to spend more on higher ticket items. Wondering if -- how can that relate to consumers being more comfortable in spending on pools as the season progresses?

Jill, that is an excellent observation. And when you have a situation where consumers have been deferring expenditures, whether it be the replacement of their pool pump or pool heater -- or not so much pool pump, but more so pool heater -- and other like discretionary type items, you would expect that to come back.

Given where we are in the seasonal cycle, there is no evidence of that just yet. There is certainly the aging of the installed base that is something that we are factoring into our expectations for the year, but we haven't seen that yet. We will probably begin to see that in earnest in April or May. And therefore, before we bank on that for 2011, we would like to see some of that activity actually taking place.

And where it would be most likely to happen is if you look at the nature of remodel and replacement in our industry, there are certain items that are nondiscretionary, and a pump falls into that scenario.

On the other hand, there are items that are more discretionary or have some level of discretion, which are, for example, the pool heating. And therefore, the real expectations are for those -- for us to see that really in the March/April/May timeframe.

So when we talk about and we provide our first-quarter results, I expect to be at least giving you some indication of that at that time.

Okay, and then just a follow-up from a previous question on the irrigation business. It looks as though you made a small acquisition in this division in the quarter. Maybe if you could talk about kind of your thoughts on the growth potential as this business recovers.

Sure. If you look at the irrigation landscape business, that business is very heavily weighted by new single-family home sales. In fact, if you look at over time and history, there is a very strong correlation of sales in that segment with new single-family home sales. If you look at new single-family home sales over the past 50 years, we are certainly at very much of a low point in that cycle. In fact, a very unique and heavily accentuated low point in that cycle. So therefore, there is the expectation that that will recover to a more normalized level.

Specific to the transaction that we made and consummated in December, the distributor there was the -- had the number one share in the Las Vegas market, having been there for basically the longest any of the distributors that participate there. In fact, their results in Vegas were far better than ours, since we had just opened in Vegas in the past 10 years, which is -- we were kind of like the last guys coming to the party. So therefore, our results were the worst. But theirs having been there the longest, they had the number one share.

And it was just a matter of our understanding their market position, our understanding that we are at a unique trough in the market, and given the nature of just about everything we do being medium to long-term in perspective, and that medium to long-term being five to 10 years out at the very least, we look at this as an attractive point to increase our presence in markets where we don't have presence or where we have very low presence. And that applies especially to the irrigation landscape side.

I appreciate it. Thank you.

Thomas Hayes, Piper Jaffray.

It is Dan on for Tom this morning. Most of my questions have been answered. Just a question on kind of the product cycle for 2011, specifically, kind of the pool pump retrofits. With kind of the variable-speed options being widely available, I know there is some utilities that have offered incentives for homeowners to go ahead and make that swap, just based on the electric savings.

I'm just wondering if you get comments on whether you are seeing that in any of the main markets that you deal in.

Yes, Dan, several years ago California passed Title 20, which created an impetus from a regulatory standpoint, as well as incentives from the power company standpoint, to migrate and replace single-speed motors and pumps to variable-speed, or at least two-speed and then ultimately variable-speed motors and pumps that provide significant, significant energy savings to the consumer. And in the case of California, given the rates there, provide a payback usually inside of one year.

So we have been selling -- certainly migrating and working with our customers to migrate them to communicate that opportunity to consumers in California. And we have made a fair amount of progress there.

We have also taken that to a number of other markets, particularly markets like Texas and Florida, where pools are open and pumps are utilized year-round. So that effort is very much under way. There are some regulatory -- there is some regulatory activity in some of those other markets as well to create either incentives or requirements for two-speed and variable-speed pumps. As that happens, that certainly provides an opportunity for us.

And now what we haven't seen to date -- and this is really where the discretion plays -- what we haven't seen to date is a lot of activity where consumers are replacing pumps that are still functioning properly to take advantage of the energy savings. We are seeing that a lot of the replacement activity still is prompted by the pump breaking down, and then at that point, the consumer making a decision of whether they replace it with a single-speed pump or a variable-speed pump.

Very good. That's all I have. Thanks.

Luke Junk, Robert W. Baird.

Just first question, as it relates to the fourth quarter, I know you had mentioned that the Blue business was up approximately 5%. Could you maybe talk a little bit about what you saw between maintenance trends versus -- call it the major renovation and construction? And then just what the Green business was.

Sure. Green business was down. I can't remember the exact number. In fact, hold on one second. Green business was down 5% in the quarter, which is their best quarter during the course of 2010, again, reflecting the moderating decreases, much like took place with the Blue business the year earlier.

In terms of the composition, if you look at the major markets -- and here, we are looking at California, Florida, Texas, Arizona, and we also throw in Vegas -- or Nevada, I'm sorry, as a major Sunbelt market -- those five markets overall in terms of new pool construction was up like, I think, 1% or 2%, if I recall correctly, for the year.

So really, new pool construction is still at very, very depressed levels, and that is a combination of consumer psychology in 2010, as well as just the availability of financial resources to make that kind of investment in their home, be it because of lack of equity in their homes or because of the financial markets being -- consumer levels still being pretty tight.

And by the way, one other comment there is that there is typically -- in various studies done, there is about a 12-to 24-month what I will call gestation period in the decision-making process of the consumer before they put in a new pool. So therefore, when you look at that, we are not looking at any significant effect of recovery in new pool construction, if at all, in 2011.

Where we expect some recovery -- and that is going back to Jill's question a few minutes ago -- is we're expecting a little bit of a recovery in the replacement/remodel, largely driven by the aging of the installed base, not so much by the rate changing in a significant way in terms of the consumer behavior, at least not yet, because we haven't seen evidence of that just yet.

Okay. That's helpful. Then as it relates to the acquisition environment and how you think about going into next year, can you maybe just discuss, with a couple acquisitions late in the fourth quarter and some share repurchase, just how you are thinking about balancing between those two things in 2011 with a pretty healthy balance sheet?

Sure. I mean, given where we are from a balance sheet standpoint, we have the flexibility to do pretty much whatever we like. And it goes back to the same fundamental priorities that we've had all along.

First -- I will just reiterate them here. They are also stated in our K, have been for at least 10 years. First is always internal opportunities, provided they meet the return thresholds that we establish, or they are required because of safety or some other regulatory requirement. That is first. And that would be about one-half to maybe 0.6% of sales in the current environment.

Second is our acquisitions. Again, acquisitions have to make sense. Primarily, we are looking at acquisitions in markets where we have little or no share. And again, given the local nature of business in this industry, just because we are strong in one market, you may go 200 miles away and we are a nonentity.

So therefore, it's those markets 200 miles away where we are a nonentity that are the ones that we look to establish a presence. And again, we look at opening our own locations all the time, and we also look at acquisitions. And we kind of balance the two in terms of our decision process.

But certainly that is the focus. Given our current position, the bigger -- or the more likely opportunities are going to come in the irrigation landscape side, as well as international. Once we have a strong share in that local market -- call it a good to strong share in that local market -- what we look to do is just build on that by providing our entire value proposition to the customers in the marketplace and grow share organically. That has really been the key to our success over time.

And in many cases, we come in and we buy a business that may have a 20 share of that market, and you fast forward five years to seven years, and our 20 share has become 50 or 60. And that happens -- again, it is in the local market -- that happens because of just providing our execution, sales execution, providing our programs to our customers to help them grow and succeed in the marketplace.

It's providing better service to the customers in terms of our product availability, our delivery, providing tools to help them grow in terms of technology tools to help them run their businesses. Also, to link up better with us, tools -- like we have Pool 360. By providing extensive training programs to help them grow. So it's because of all that we do is that once we have a decent position, we just build on that through execution over time.

But acquisitions is, again, there and always are after our internal -- funding of internal capital, is the next priority. And then after that, what is left over either goes back to shareholders in the form of dividends or in the form of share repurchases. And given where we are on debt, as Mark mentioned in his comments, we are pretty comfortable with where we are. So that can stay pretty much where it is and we return the rest to shareholders.

Thanks a lot, Manny.

(Operator Instructions) Anthony Lebiedzinski, Sidoti & Company.

I was hoping that you guys could comment first on the performance in your international markets.

Internationally, I am going to give you a little walk-through. Europe did very well. Europe met its profit objective for 2010. That was led by our results in France. France is our strongest operation in Europe. We have five locations there. And certainly, France took share of market.

Italy was our second strongest operation. They also met their profit objective, as did France, and they also gained share and are doing well.

In the case of Portugal, which is third, then UK and then Spain, we did not meet our profit objectives there, but I think that we certainly held our own. As you know, those markets have been hard hit from the economic contraction, and therefore have suffered a little bit more so than France and Italy have.

In the case of Canada, which is really up there with France as our two most significant international operations, in Canada, we did not meet our profit objectives for 2010, but we did reasonably well. That market had a little bit of an impact from the macro environment. But overall, we were looking for improvement -- all our objectives factor in improvement, and while there was certainly improvement in Canada, it was not to the levels that we had a set of objectives.

We also did a transaction there in the spring of last year, 2010, where we acquired a two-location distributor in the province of Quebec, and that is now operating as a Superior vehicle in that market, and complements the two SCP locations we have also in the Quebec (inaudible).

Overall, from a sales standpoint, the growth internationally was greater than the Company overall growth. And we also, by the way -- last point, before I forget -- we also opened up a new location in Guadalajara in Mexico. And given the direct connection -- Canada and Mexico are very close, and we did that opening in the summer of last year.

And then the last thing that took place from an international standpoint is we made a small acquisition in Belgium, in the French part of Belgium. And now we are poised to begin serving the Benelux countries from that base in Belgium.

Okay. That's very helpful. Also, could you comment -- the impact of the weather on your Q4 results and the early part of 2011?

Really I would say the weather was not a significant factor in Q4. Our Blue business sales were up 5%. If you look at the weather, particularly you are sitting in New York City, you've had some major storms, beginning right around Christmas and running through the better part of January, with record snowfalls and all that good stuff. That is -- it's fortunate that it is happening in December and January because we don't do a lot of business in the pool business in those snowbelt markets in December and January. I would be concerned if it was snowing in June.

But given what has happened and what is happening, really it is pretty much normal, and weather is really a disjuncture, a nonissue. It was in the fourth quarter and it is in the first.

Got it. Also, you've done a good job with rationalizing your cost structure, and now as the business recovers, what areas of the business are you seeing perhaps the greatest cost pressures?

We really don't have any specific cost pressures, per se. Certainly, as sales grow, we will have to increase -- we start with overtime first and then temporary labor and then we add permanent headcount. But labor will certainly go up as sales grow.

And also, we will have, to some degree, additions to the fleet that will be -- we will have to add back some delivery vehicles and drivers. And again, we will -- we gauge that just like we do with labor. Whether we make a permanent hire in the warehouse or a permanent hire as a driver or inside sales support, we do those on a calculated basis.

And whether we hire them seasonally or hire them from -- whether we add overtime or we make a permanent hire, we are very judicious in that process in much the same way, whether we add delivery vehicles for -- seasonally or hire them for the whole year. Some of that is driven by the market, but also, some of that is driven by what we believe our sustained needs are.

And outside of that, really, I don't see anything that jumps out. I think all of industry, all of business has suffered with increased cost of regulations over the past 10 years or so, if not more. And certainly, that has accentuated itself in the last four or five years -- really since 2002. So therefore, we don't see that stopping anytime soon, unfortunately, and that is just an overall drag. But we try to keep some limits on that and not let it drag us down too much.

Okay. Thank you.

Brent Rakers, Morgan, Keegan & Company.

This is Anjali Voria] in for Brent Rakers. I was wondering if you could comment on operating expenses in the fourth quarter. Specifically, how much of the increase in expenses resulted from the impact of maybe higher variable expenses tied to gross margin improvement? And also, if you could provide the bad debt expense number, that would be great. Thanks.

And then --

And I'm looking, by the way, at base business. Certainly, when you have acquisitions that -- if you look at that base business addendum, that is probably the key area to focus on. And really the only area we had any increases to speak of was in incentives.

Okay, thanks. And then also, could you provide maybe some clarity on the year-over-year growth margin improvement. How much of that 150 basis point was maybe tied to vendor incentives versus your ongoing price and purchasing discipline?

When you look at the fourth quarter -- I presume you're talking about -- in the fourth quarter, it was really -- we had, I'll call it, better discipline, is probably the first factor. And from a pricing standpoint, we had done a very good job during the course of the year working down our slow-moving inventories. And typically what happens in the fourth quarter is that you have some what I'll call fire sales. The items that we had to sell on the fire sales were lower, given the significant reduction we made in our slow-moving inventory during the year. So by the end of the year, we didn't have that much inventory to fire sale.

So that caused less of a drag than in previous years. And then the overall is just the ongoing discipline and improvement in every facet of our execution.

All right. And then just very quickly, lastly, just to clarify -- for the fourth quarter, your Blue base business was up 5% and Green was down 5%. Is that correct?

That's correct.

Okay. Perfect. Thank you.

There appear to be no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Thank you, Jody, and thank you all for listening and for participating in our 2010 results conference call. And a special thank you to all the members of our team for all that they do every day on behalf of our customers and our suppliers.

Our next call will be on April 21, when we will discuss our first-quarter 2011 results. Thank you again. Have a good day.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.