Pool Corp (POOL) 2013 Q2 法說會逐字稿

Good morning and welcome to the Pool Corporation second-quarter 2013 results conference call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note that this event is being recorded. I would now like to turn the conference over to Mark Joslin, Vice President and Chief Financial Officer. Please go ahead.

Thank you, Chad. Good morning, everyone, and welcome to our 2013 second-quarter earnings call. 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 2013 and future periods. Actual results may differ materially from those discussed today. Information regarding factors and variables that could cause actual results to differ materially from projected results is discussed in our 10-K.

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

Thank you, Mark, and good morning to all on the call.

The second quarter reflects two distinctly different results. In the year-round blue markets, in our green business, results were at or modestly better than expectations. Here our blue business sales were up 8.3%, and our green business sales were up 10.2%. So far, so good.

Our blue business sales and seasonal markets, though, were affected by much cooler than normal temperatures, coupled with higher precipitation levels that deferred pool openings and both remodeling replacement and new construction activity. Altogether, these market sales were up only 0.3%.

At this juncture, it's safe to assume that the lost sales from the weather impact in the seasonal markets are largely if not entirely lost for the year. The second half, though, should be intact with our revised expectations assuming average weather as the great majority of pools ultimately have been opened.

Turning to gross margin, a significant factor for the margin percent decrease was product mix both in terms of higher growth, lower margin percent discretionary items, and higher priced, lower margin percent products being sold, accentuated by the lower sales of higher margin percent nondiscretionary items.

While the higher growth of lower margin percent items was expected, we also had expected growth on higher margin percent items as well. The difference here is entirely attributable to the late start of the season. These same conditions affect customer mix with a greater percentage of sales to larger customers compared to customers that focus on pool maintenance and repair. Geographic mix with a higher percentages total sales in year-round markets also contributed to the margin decline. This adverse mix impact should moderate in the second half of the year, although the lower margin percent discretionary items and higher priced, lower margin percent items should continue to grow at a faster rate than nondiscretionary items.

Given the circumstances, sales to our focused customer segment retail were down 3.6% year-to-date, while our strategic priority product segment of build materials were up 14.4% year-to-date. We believe that both the retail customer segment and the building materials product segment provide us the opportunity for accelerated sales and profit dollar growth. Expenses were under control and reflective of the challenging sales environment in seasonal markets. Overall, base business expenses were up 1.1% in the quarter, despite our investment in 10 new centers since last June, including seven new centers opened this year to further our local service level in existing markets. These investments demonstrate our ongoing commitment to addressing market opportunities, given our focus on long-term return on invested capital, while understanding that these investments may adversely affect short-term results.

Year-to-date, base business expenses were flat as was our operating margin, despite the headwinds of adverse weather and our ongoing investments. We expect base business operating margins to expand in the second half and in future years as we leverage our infrastructure and continuously strive to operate more effectively.

Mark will cover the balance sheet and cash flow, but before closing my prepared comments, I would like to commend our entire team. While the results in the year-round markets speak for themselves, our people in the seasonal markets continue their resolve to provide exceptional value to our customers and suppliers, despite the challenges presented this year. It is through all of their outstanding commitments served that we are able to realize record results.

Now I'll open the call for questions. Chad?

Before you do, the prices? Let me make a few comments, if I may. Looking at our results for the quarter, there's three areas I think worth comment from me.

First of all, as you can see from our results, our tax rate is a tad higher this quarter than it was last year Q2, which negatively impacted our earnings-per-share by about $0.01 in the quarter. This higher rate this quarter is a result of deduction timing differences, which we would expect to offset in Q3, resulting in a full-year tax rate of approximately 39%, which is consistent with our 2012 effective tax rate, excluding the impact of the 2012 goodwill impairment charge.

On the balance sheet, you can see that cash dropped by $23 million from last year, while accounts payable increased by $28 million. These changes largely offset each other, and related to timing differences and vendor payments between years that will normalize in Q3, the same AP timing issue also impacted cash flow from operations for the quarter. Our expectations for cash flow from operations for the year is that the timing differences between years will even out, and our cash flow from operations for 2013 will meet or exceed net income.

Before we begin our Q&A, I'll comment on our share repurchase and share count. During the quarter, we repurchased 130,000 shares on the open market at an average price of $50.62 for a total use of cash of $6.6 million. This leaves us with $81.8 million available under our current board authorization. The 47.9 million shares outstanding at the end of the second quarter is perhaps a bit higher than some had anticipated and reflects both the level of our share repurchases, as well as the dilutive impact from the growth in our stock price over the last year. While we expect to be actively repurchasing shares in the second half of this year, the impact on shares outstanding will naturally be less. So for modeling purposes, I would use 47.7 million diluted shares outstanding for Q3 and 47.5 million shares for the full 2013 year.

That concludes my prepared remarks, so I'll turn the call over to our operator and begin our question-and-answer period. Chad?

(Operator Instructions). David Manthey, Robert W. Baird.

Good morning. First off, I was wondering if you could give us maybe some anecdotal information on how bad you saw it in your blue seasonal markets. I think on previous calls you given us maybe growth rates in Florida, California, things like that. I'm just wondering if you can sort of juxtapose the growth in some of your key sort of year-round blue markets versus your seasonal blue markets like maybe Ohio, Illinois, something like that. Is that something you can do for us, Manny?

Sure. It sounds like you're calling from somewhere not in your office. But hopefully your travels are going well. In terms of the 8.3% that I mentioned earlier in terms of -- those are the results in terms of the quarter for the biggest four states -- California, Florida, Texas, Arizona -- And they were all up and pretty consistent.

In terms of the seasonal markets, as I mentioned, overall they were up basically just very modestly up 0.3% in the quarter. And there was some variation, but again nothing overly significant. Nobody had a big drop off or anything along those lines from a year-to-year standpoint. You could have some states maybe down minus 3% or 4%, some other states up 3% to 4%, but in the overall scheme of things, the seasonal markets were pretty much flat. So there's nothing earthshaking or outstanding. They all suffered the same headwinds from a weather standpoint.

Thank you. Just as a follow-up here, in terms of how this is all translating to the bottom line, it's looking like the contribution margin, despite this hiccup, could still be in that 20% plus kind of range for the year. And I am just looking for a refresh on that thought. I know in the past you said that 2014 you might transition to maybe 15% to 20% contribution margins versus 20% plus. Could you give us your thoughts on that? Has that changed at all for any reason?

Sure. Great question. On a year-to-date basis, our contribution margin from base business sales growth was 13%. And here, I want to reiterate the fact that that 13% includes the short-term drag from the investment in a number of satellite centers that we've opened up in the past year or so. And this is just another way for us to better reach our customers. So this investment we've made, given that they are in existing markets, does cause a little bit of a drag.

But with that being said, I think when the year is said and done, we should be close to 20%. Again, that factors in the fact that the back half of the year it will be a little bit more normal from a weather standpoint since the pools that were just opened, they were just opened late, maybe 6 weeks later than normal and about maybe 8 weeks to 10 weeks, maybe 8 to 12 weeks later than last year in the seasonal market. So that's really the factor. Obviously as sales grow beyond 5%, 6%, the leverage becomes even better. But at a 6% type growth in the back half of the year, a 20% contribution margin is reasonable again for the back half of the year.

Great. Thanks, Manny.

Ryan Merkel, William Blair.

So I wanted to dig into the guide first. Manny, maybe you could just walk us through how you are kind of arriving at high single-digit organic growth rate in the third quarter.

I didn't mention getting to high single digits in the third quarter.

Well, it's kind of imputed if the year is going to be 5% to 7%.

I'm sorry. I think the -- let me just refresh that a second. The 5% to 7% was the guidance we provided earlier in the year. Given the results that we've experienced, particularly in the second quarter with the season coming to a late start, it's going to be very difficult for us to get to the high-end of that number. We, in all likelihood, could still get to 5% for the year, but I'm looking at 5% to 7% for the back half of the year with the middle of the range being more like 6%. And, therefore, to that end, if we do 6% in the back half of the year, the overall number should be about 5%. But again, that's 5% to 7% for the year. Much beyond 5% would be stretch given what we have realized to date.

Okay. And that makes sense. I kind of had 5% in my model. You got kind of a tougher comp in fourth quarter, so I was thinking maybe 5%, 5.5% growth there. And then in order to get to the 5%, you still need 8%, 9% in 3Q. It sounds like my math might be a little off. You're thinking kind of 6% and 6%?

Basically looking at 6% for the back half of the year.

Okay. And then you kind of talked about the incremental margin, but just to touch on the gross margin for a second, is the expectation in the second half of the year that gross margins are kind of flat year over year versus being down in the first half?

I would say that they would be down modestly, not down as much as the 50 BPS that we've had in the first half. Probably somewhere about half of that rate. And the factor there is that we have a much higher growth, particularly in discretionary items. Example of reference in our press release was heaters. But when you look at higher priced, higher value items, whether it be a variable speed pump versus a single speed pump, or whether it be a heater type product, which is a higher priced product, those products generally go with lower margins.

Now we get some of that back in terms of efficiencies when you look at expensive sales and stuff. But -- so, therefore, there is still a headwind there with those categories growing a little faster.

Well, that's a good transition because I wanted to talk about that. Why is it that these discretionary products are growing so much faster than the nondiscretionary products? What is the underlying driver there?

The main factor is the gradual recovery in the macro economic environment. And just for color and perspective, and Ryan, you know this very well, but we -- when the market was turning down, particularly in '08 and '09, replacement and remodeling activity took a big, big hit. And, in fact, pool owners deferred -- we estimate north of 30% of what would normally have been replaced and remodels in the 2008/2009 time period. And in our models, what we have done is we expected beginning in 2011 a gradual recovery of replacement remodeling activity reverting back gradually to normal consumer or pool owner behavior so they would be normalized by 2018.

So what we have seen and witnessed over the last I would say last year and certainly this year is that recovery is taking hold where behavior is reverting more to normal. So, therefore, those consumers that may have had a broken heater and did not do anything with it back in 2008/2009, those consumers, those pool owners are now replacing that heater. And that is certainly helping us from a sales standpoint, and that's getting factored into our expectations. But that sale is coming in at a significantly more modest margin than the overall spectrum of products that we sell.

Makes sense. Just last one for me. Just kind of curious how you can have the base business expenses up only 1%, particularly if you are opening up branches. So is the answer that branches just don't cost that much money, incentive comp is down, and then we are really just looking at variable expense?

Yes. Certainly incentive comp is down, and there is a cost for these locations. It probably year-to-date has cost a couple of pennies and probably for the year will cost us about $0.03. But, again, that's -- those should pay out. That's not an issue, and again, from a business thought process business, just making thought process, we do that knowingly.

So yes, incentive comp is down. Some of these expenses are higher. These investments are driving things a little higher. We are disciplined in terms of how we manage our business, and people throughout the organization take things to heart. And, therefore, to that end, again, it's only up 1.1% from a big business standpoint in the quarter and flat year-to-date. I think that's reflective of the disciplines of the organization and, frankly, how our managers care.

Great. Thank you very much.

Anthony Lebiedzinski, Sidoti & Company.

Good morning. I was wondering if you could actually comment on the magnitude of the change in your incentive compensation expenses for both the second quarter and year-to-date?

Second quarter is just over $2 million, year-to-date just over $3 million.

That's helpful. And on your last conference call in April, you guys talked about some competitive pricing pressures. Did you also see that in the second quarter, or was it less or more, and then what's your outlook for the balance of the year?

Sure. Typically that dynamics plays out during the soft part of the season where our customers have more time on their hands. Once it gets busy, that tends to become secondary since having the product and providing the service becomes paramount, and they are very busy.

This year, in contrast with last year given the later start to the season, they had a little bit more idle time a little bit later on into the year than normal. So that's a little bit of a drag for us. But once season got going, albeit not to the strength and liking that we would normally have, that basically went on the back burner. And it will resurface again towards the latter part of the year as it does every year.

Got it. And also can you comment on your European sales?

Our European sales were down 7% on a year-to-date basis. That's a little bit better than they were down in the first quarter. So they were -- they're hit. Those are all seasonal markets, by the way, and their results are incorporated into our seasonal market results. Since for us, it doesn't matter whether it's Paris, Texas or Paris, France. It's all pools and business. So they're all seasonal markets, and they have been hit just as bad if not worse than the US from a weather standpoint with -- I mean I was there several weeks ago, and it was 50 degrees and raining in the first week of July. Not particularly conducive for spending time around the pool.

So in any case, same headwinds, but despite that, I would say we are only down 7% in -- local currency in US and dollars are the same this year. And that's a little better in the second quarter than it was in the first.

Got it. Also, last question. During your analyst day last year, you guys talked about some of your so-called focus centers. Now with -- now almost a year later, can you give us kind of an update as to what you've seen from those locations?

Sure. Just for all those on the call, what we do is we have a certain threshold which is a 30% return on invested capital as our target return. And the centers that -- or branches that fall below that threshold are the ones that we have -- pay additional attention to. And those are referred to internally as focused locations or focused sales centers because they get additional focus from a management standpoint.

We continue to make progress. Last year was an exceptional in terms of progress made. We continue to make progress this year with those locations, and there were a number that will fall off. Typically, though, new locations are on the list because they tend to be obviously below that 30% threshold until typically the third or fourth year. So as well as acquisitions are typically below for three or four years.

So all that being said, in fact, I went through that earlier this week, and approximately 70% of the focus sales centers are, in fact, tracking ahead of last year, and progress is being made. We'd like for that to be 100% tracking ahead of last year and progress being made, but we are only batting 70% this year. Part of that certainly has been the weather. Part of that is that we always have to find ways to improve, and fortunately there's plenty of opportunities to do that.

Thank you, Manny.

David Mann, Johnson Rice.

Thank you. Good morning. Manny, when you look back at the history of periods where you've seen this kind of weather in the seasonal markets or in some subset of seasonal markets, what's going to happen in the following season, let's say if you had normal weather in terms of any pent-up demand on some of the discretionary side of the business?

That's a very good question because you've got to delineate discretionary versus nondiscretionary. The biggest hit here really from a dollar standpoint is on the nondiscretionary side. For example, chemicals. Chemicals sales are down. That's the largest product category within our retail component. So when you look at that, the expectation is that discretionary sales will grow at a faster rate than seasonal markets. Nondiscretionary sales will grow at a faster rate in the seasonal markets next year as it reverts back to normal.

The discretionary side is and the impact on nondiscretionary -- on discretionary sales this year have been relatively muted. Something got pushed out a bit, but again, as evidenced by our 14% growth in building materials by strong double-digit growth in products like heaters, it's evident that discretionary is strong across the board. Could it have been maybe 1% higher? Perhaps. But the biggest factor by far is nondiscretionary. Items like chemicals, maintenance items, things of that nature. Tools.

Got you. And then in some of the seasonal markets, what was sort of the trend in above ground pools? How impactful was that, and are there margin implications there that we need to think about?

Sure. Above ground pools were down significantly. Above ground pools, again for color, for those on the call, in terms of new pools being sold, represent about 1% of our sales. And above ground pool sales this year were down about 20% year on year. Last year was a particularly good year on above ground given the early very mild winter and early start to the season. So I would say that last year was a little higher than normal, and this year was certainly lower than normal. Probably the industry is down 25%, 30% in terms of above ground pools for the year. Above ground pool sales for us happen to be a decent margin product, in part because of the short window to the season, and all the products that we sell together with the above ground pools.

And then one last question. When we think about the margin that you get on some of these higher-priced products, you talked about it being generally a group of lower margin relative to your average. Has the margin you have been earning on that mix of products, has that changed the whole lot this year?

Yes to the extent -- yes. And there's two reasons for that. One reason, two primary reasons for it. One is, as consumers are buying those products, they are tending to buy up a bit more. So examples there, for example, would be LED lighting versus fluorescent lighting. Another example would be a variable speed pump versus a single speed pump. So as they are buying a more expensive version of the product, that's driving higher GP dollars but lower GP percent.

The second factor is geography. Given the mix of sales of those products this year versus, let's say, last year or the normal year, that also has an impact. Again, given the fact that the margins are higher in seasonal markets, given the fact that by virtue of them being seasonal, the cost to serve for us in the industry are proportionally a little higher percent of sales, and therefore, that's recovered in part with higher margins. Those are the two primary reasons.

When you look at those product categories, which is interesting because we do look at it and we look at it by state, there is no clear evidence on a year-to-year basis, for example filters. You'll have filters with in some states our margins are a little bit up, other states the margin is a little bit down. So that's more of a mixed bag, so it's not -- the two factors that I mentioned it certainly plays into it.

I would also be remiss if I didn't mention that there is some factor as well for the Internet. And that's more of because of the visibility of the Internet, it creates a reference price in the eyes of the marketplace. And to the extent that we were able to sell a product at a somewhat higher price in smaller markets, to smaller customers, that may be constrained a bit in terms of given the reference price that's generally available. But I think the first two factors are the primary factors that affect margins year on year.

Great. Thank you very much.

David MacGregor, Longbow Research.

Good morning, everyone. Given the seasonal distortions this year, could you just talk about inventories in the channel overall, and what you are seeing, and just the impact that might be having competitively on the business?

Sure. If you look at the product category -- the significant product categories, probably the one that's been most affected is chemicals. So what you have is you already have from an industry standpoint and oversupplied market environment and with far more capacity both at the basic level, as well as the pressing and packaging levels of an industry standpoint. And that's especially true when you incorporate readily available international sources of supply. So when you have a late-season start and you have chemical consumption down, from an industry standpoint, probably -- we are down about not quite 4% year-to-date on chemicals and suspect the industry is probably down somewhere between 6% and 10%. When you have that environment, it just puts a little additional pressure.

And to that end, given the nature of that product and everything else, it would be hard-pressed to think that there would be any kind of price inflation anytime soon. So that's probably the most significant product category with impact.

Now in the case of chemicals, given their classification, whether it be Class I or Class III or whatever they may be, there are certain space limitations. So there isn't a lot of package ready to go inventory in the channel. So, therefore, really that pressure is borne primarily by the manufacturers.

Okay. Are you -- I guess I'm just wondering if you're concerned at all about the upcoming quarter in terms of it's approaching the end of the season, there's a quick move to get inventories down, and the impact that could have on gross margins.

No, not in any particular way. If you look at equipment for example, equipment sales are doing well. So the equipment manufacturers are fine. So I think the pressure here is on items that really -- chemicals, again, is the one that's most sensitive and chemical inventories -- there's not a lot of fluctuation. You can't build or buy head from a distribution standpoint. Chemicals, again, too much storage capacity limitations. Accessories, parts, things of that nature are too low-dollar with not the rate of frequency of sales that would drive a particular dumping taking place.

Okay. On market share, could you talk about where you may have gained share within the mix of product groups, and just remind us again your share gain goals for the full year?

Sure. When you look at -- we believe that we are gaining share -- I can't say in every market because that would not be true. But we are gaining share in certainly a great majority of markets this year as we have in -- this is my 15th season. So every year we continue to gain share. That's largely driven by the investments we have made. We are dealing in local markets with local competitors and a great variety of competitors. But we made significant investments in people, in products, in service levels, in marketing, in IT, investments that, by and large, our competitors -- no competitors made anywhere near the levels of investments we have made. And to the extent they've made investments, they are usually limited to one or two areas and not broad spectrum. That's enabled us to really differentiate ourselves from a value proposition standpoint in the marketplace, both to our customers and suppliers.

So having said that as a precursor, our execution has been what makes it or breaks it in terms of that happening. And generally speaking, we have a pretty good batting average and in an typical year gain share in 80% to 90% of the markets. And when we don't, it's typically an execution issue.

Our -- the areas that we are growing share the most typically are the product areas where we have less share in. So, for example, building materials. Building materials is an area that we began getting into back in 1999 on a trial basis in 2000 and more so gradually over time. We now have a broader array of products that we serve and sell on the building of material side. We have approximately 80 centers that are designated as building material centers within our sales centers whether it be branded SCP or Superior.

So to that end, that's an area of focus. We also have a typical benefit there as well from recovery of remodeling activity. So, again, the fact that year-to-date we are up over 14% I think speaks volumes to what we are doing there.

I think in other product categories we are growing share. I mentioned chemicals for example. We believe we are growing share in chemicals. We may be down in sales by 4%. But I am confident that when I tabulate and get the results from the major manufacturers that participate in the chemical category, I think are being down 4% will certainly be better than their performance in the first half the year. So we are growing share there, and the same thing can be said about equipment, parts, accessories, etc.

For the year, are we thinking 100 basis points or 200 basis points of share gain overall?

I think for the year we will grow 200 basis points to 300 basis points faster than the industry, and we've averaged that or better every year.

Private label. How does private label do in the quarter as a percentage of revenue and contribution to margin?

We don't have that for the quarter. But I would say that that continues to grow as part of our mix. It was 25% of our GP dollars last year. I expect it to be 26% perhaps this year.

So by about a point. And contribution to margin, is that still above fleet average?

Definitely.

Okay. Then last question, just on the green business, we haven't talked much about the green business. But the drought helped 2012, so you've got some tougher comps that you're facing this year. Can you talk about growth year over year within the irrigation installation business and secondly within the power equipment business?

Sure. Overall our green business is up 10%. And, in fact, that was for the quarter and year-to-date is up 11%. So green is doing well. That is primarily driven by the construction sector, which is gradually recovering and also by our taking share.

We are deploying some of the same tools and resources on the green side of our business that we have in blue. And to that end, that's enabled us to differentiate our proposition there as well. In terms of equipment versus irrigation, it's more -- the growth is a little faster on the irrigation side than the equipment side. The equipment side is more back half of the year weighted. So that will happen more in the third and fourth quarters.

Thanks very much. Appreciate it.

Keith Hughes, SunTrust.

Hi, there. It's Rohit sitting in for Keith Hughes. You guys answered most of my questions on discretionary, but I wanted to ask if you are seeing any remodeling activity in pools?

Yes, big time. That's recovering at a rate much like we expected it to with pool owner behavior reverting gradually back to normal. Although still a long ways from normal, it is recovering back to more normalized behavior.

Great. Thank you.

(Operator Instructions). Ken Zener, KeyBanc.

Good. I just wondering if you could talk, Mark, the irrigation discretionary, the trend you are seeing there. What are the characteristics? Is it places where home prices are moving? Is it where you are seeing kind of -- if it was Texas, just kind of really steady and now improving economics that never really fell? And to the extent it is related to those, what do you see in terms of the lending environment in terms of home equity lines being used to do these type of projects, and what's the average project spend, if you will?

Sure. The recovery is certainly tied to a much tighter single-family home market, including the gradual recovery of single-family home construction. When you look at the green side of our business, again, up pretty much across the board. We are heavily weighted there to the Sun Belt. So, therefore, the weather was not as significant. The only real drag we had was heavier rainfalls than normal in Texas but in April and May. By the time it got to June, it normalized a bit. So overall, they didn't have the weather headwinds that the blue side had in the seasonal market.

In terms of activity, again, it's recovery tied to single-family home construction and recovery of single-family home values. Not seeing anything significant from a home equity or second mortgage market standpoint, that is not really a factor at this date. In fact, our expectations internally are that that will not come back in vogue until the back half of this decade. So it's not a mistake. The cost for putting irrigation systems in to a home, including both materials and labor, generally speaking run from $3000 to $7000, which, again, more weighted toward labor than materials. So that just gives you a little perspective. And it's not unlike somebody doing some -- replacing the pool equipment from a discretionary spend standpoint.

Okay, I appreciate that. Now, Mark, I guess to the interest expense, would that be following the similar trend that we had towards kind of last year where it kind of burns off as you work in to the year-end?

Yes. It follows our working capital build in the early part of the year, and then that falls off a little bit in the third quarter and stabilizes for the fourth quarter. So, it sure does.

Thank you.

There appears to be no further questions at this time. So I'd like to turn the conference back over to Manny Perez de la Mesa for any closing remarks.

Thank you, Chad, and thank you all, again, for listening to our second-quarter results conference call. Our next call, so you can mark on your calendars, will be on Thursday, October 17, 11 a.m. Eastern, 10 a.m. Central, 8 am Pacific time when we will discuss our third-quarter results. Have a great day.

Thank you very much. The conference has now concluded. Thank you for attending. You may now disconnect.