Pool Corporation (POOL) Q1 2011 Earnings Report, Transcript and Summary

Greetings and welcome to the Pool Corporation First Quarter 2011 Earnings Call. [Operator Instructions] It is now my pleasure to introduce your host, Mr. Mark 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 Q1 2011 conference call. I'd like to once again 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. Now I'll 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 today on our first quarter 2011 results conference call. As evidenced by our first quarter results, the industry downturn that began in 2006, by every measurable indication, is now behind us. As it has been the case throughout our history, we continue to generate above market results, given our ongoing investment in talent, resources and tools, to enable us to provide value for our customers and our suppliers. But we should not get carried away with our first quarter results, as this year's favorable weather compared to last year's adverse first quarter weather, and industry dynamics provided us an easy comparison. For those of you who live in Snow Belt markets that have just suffered through a brutal winter, there's very little sales activity in the winter for our business, with the lion's share of our sales in these months being in Sun Belt. In reviewing our first quarter sales results by major market, please keep in mind that we had unusually cold and wet weather last year from Texas Oklahoma, East through the Carolinas, and South to Florida. Into the quarter, our overall Blue business sales increased 15%, with our Green business increasing 12%. Our first positive year-on-year quarter in the Green business since the industry downturn began, as that customer segment generally lags the Blue customer segment by roughly one year. Within the Blue business largest markets, Texas was the headline with 27% growth, with Florida at 14% and other markets, primarily in the Southeast United States, up 17%. Clearly a reflection of the easy weather comparison in these markets. In contrast, in California, which had a pretty normal weather in last year's first quarter, we realized 4.4% sales growth. This reference is important as weather in the balance of 2010 was, on average, pretty normal overall. So mid-single digit year-on-year sales growth for the balance of the year, we believe, is a reasonable expectation. This is further demonstrated by our heavy dependence on the more stable maintenance and repair source revenue segments that are driven by the install base of pools. The aging of the install base is providing some opportunities in remodel replacement revenue growth, but the more discretionary new pool construction segment is still very depressed, with very marginal increases in pool permit activity. As usual, we continue to grow profitable share organically as we've done consistently for many years. Moving to gross margin. The easy comparison from last year's first quarter accounts for most of the change this quarter with ongoing improvement expected for the balance of the year, albeit at a more modest rate. One recent question is the impact of raw material cost increases on our business. To date, that impact is muted, although we do expect some increases as the year progresses, which will pass on in the normal course. Fuel cost increases of 30% plus are an example outside product cost that we'll also seek recovery of, in the form of new or higher freight surcharges and deliveries in this case. On the expense side, no surprises other than higher fuel cost impacted us by approximately $0.01 a share, which cost increase will seek to recover as indicated before. Bottom line is that we still generated a 20% contribution margin in the sales increase, as is our guidance for the next several years as we grow into existing infrastructure. On working capital, I would like to highlight that our inventory and accounts payable increased somewhat more than normal, as recent sales trends grow higher replenishment rates. But as sales growth moderates, so will the increase in inventory and accounts payable. To that end, our free cash flow should approximate net income for the year. Overall, I believe we had a strong quarter and are on our way to another year of solid earnings per share growth. As many of you know, we believe that with a reasonable recovery in the macro-economic environment, we have the opportunity to grow earnings per share at over a 20% rate per year for the next five years. That we have a good shot at doing that in 2011, as we did in 2010, without a notable increase in new construction and with still depressed consumer confidence is evidence of the underlying resiliency of the industry and our team's ability to execute in a still challenging macro-environment. Now I'll turn the call over to Mark for his financial commentary.

Thank you, Manny. I'll start with a few comments on our SG&A before moving on to balance sheet and cash flow. As was the case for our 2010, our goals for expense management in 2011 are to leverage the infrastructure and capacity that we have in place to grow our expense base at a slower rate than sales. Doing this well, combined with modest gross margin expansion over time, will allow us to contribute $0.20 or so to operating income for every dollar of sales growth. Our start to 2011 has put us right on track with that objective. We increased Q1 operating earnings by $8.5 million over Q1 2010, which was right at 20% of our $43 million of sales growth. This certainly won't be the case every quarter, but do expect to achieve this over time. We also had greater than normal gross margin growth and a higher expense growth this quarter, both of which has normalized over time. Specific to our 8% expense growth for the quarter, there were two primary reasons this was a bit higher this quarter than what we expect going forward. One reason is the impact of acquisitions, which added $1.2 million or 1.4% to expense growth for the quarter. Our Metrinox acquisition, which lapsed in Q2 was the biggest component of this. Incentive accruals of the other area, which added to our expenses for the quarter. For the full year of 2011, we expect, at this point, that our incentive expense will be higher than 2010 by $5.5 million. We booked $2.1 million of that increase in Q1, given the results for the quarter, which accounted for 2.5% of the 8% expense growth. Moving down to P&L to interest expense, you can see that we picked up $700,000 here compared to last year, which was due to a combination of lower average debt and lower interest cost. I would not expect that benefit to continue beyond the first quarter, as debt levels increase to support the greater level of business activity, as well as share repurchases, and as interest rates flatten up. In fact, even though our average debt was lower, our quarter end debt was up slightly at $280 million, compared to $278 million last year. $100 million of this debt is moved to current on the balance sheet, which is our note that is due in February of 2012. We expect to refinance this capacity in 2011. Our leverage at the end of the quarter is measured by trailing 12-month average debt to EBITDA was 1.81, which was down from 1.99 at year-end. Moving on to receivables. We had a lot of success over the last couple of years, managing the flow of credit to our credit-worthy customers, while tightening up on collections where needed. This is continued into Q1 with our days sales outstanding have a decline to 31.0 days, from 34.2 at Q1 2010 and 31.6 at year-end 2010. This improvement in collections allowed us to grow receivables just 10% year-over-year, compared to our 16% growth in sales for the quarter. Inventory of $439 million was up 15% from a year ago, with the highest velocity items in our domestic Blue business growing 22% year-over-year, while the value of our slowest moving inventory dropped from last year. From a cash flow perspective, you can see that our accounts payable was up 21% year-over-year, nearly offsetting the increase in inventory, as much of the inventory received in Q1 was purchased on extended payment terms. Overall, considering the increase in business activity, as well as the seasonal nature of our working capital needs, the $37 million use of cash in operations was a good result, with increase over Q1 2010 due mainly to cash used to fund the growth in our accounts receivable. To give you an update on our share repurchase activity, we repurchased 1.3 million shares during the quarter at an average price of $24.19. We also repurchased an additional 173,000 shares since the end of the quarter at an average price of $24.48. This leaves us with 4.2 million available for repurchase under our existing $100 million board authorization. On our last call, I gave you a forecasted share count by quarter for the year, which had anticipated our share repurchase activity at the end of the current authorization. At this point, I believe that forecast is still accurate, and I would suggest referring to it for modeling purposes. I want to take a minute now to reiterate a point I made on the last call related to our quarterly performance in 2011, which was that our Q1 comps are, by far, the easiest of the year. To put that in perspective, let me remind you that our sales in Q1 of 2010 declined from Q1 2009 by 2.5%, which compares to sales growth of 6.4% for the rest of 2010, and our gross margins in Q1 2010 declined by 108 basis points, which compares to gross margin gains of 21 basis points over the balance of 2010. The point I'm making here, and I may be starting to sound a bit redundant, is that sales and margins growth rates that we reported for Q1 need to be tempered by the tougher [ph] comps for the remainder of 2011. That concludes my prepared remarks. So I'll turn the call back over to our operator to begin our question-and-answer period. Claudia?

[Operator Instructions] Our first question is coming from the line of Tom Hayes with Piper Jaffray.

Manny, I was just wondering. A couple of questions. I was wondering if you could kind of maybe talk about some of the products that you're seeing coming out of the quarter with some higher growth rates than either maybe you expected or than maybe that kind of pinch the year out?

Sure. First of all, it was pretty much across the board. There was no particular product category that declined or had significantly less growth than our overall numbers. I would like to highlight the fact that we continue to grow share and one product category that did grow a little more than the norm, although it's hard to do that given the numbers reported, was in the area of building materials, and that will be primarily related to share gains.

Okay. One more. I was just wondering if you could talk about, what you talked about this last year, the growth that you're seeing in the private label product as far as where that is? And roughly what percent of sales that is?

That continues to grow at the rate a bit faster than our overall growth. And turning to building materials as an example, a lot of the aggregates that we sell, that blend in with plaster to have a higher end finish on the pools, the tile, a lot of those products are private label, as well as our chemicals. Overall, I believe we're probably getting very close and if not this year, next year, should be in the mid-20s in terms of what percentage of our overall sales are related to our own products.

And just lastly if I could. You guys had a press announcement on March 21 with your relationship with Lending Club. I was just wondering if you could provide, maybe a little bit more color in your expectations, or what that could do to the business this year or maybe next year?

Sure, Tom. First of all, I should point out that we have been active in looking at various ways for our consumers to finance pools, and we have a number of financial institutions that we've recommended to our folks and to our customers that they connect with. Most of those are regional in nature. Lending Club was a little bit unique in that they have a more broad, across the U.S. platform, although there is a few states that are excluded. We see this as a very good financial tool for consumers at this point in the banking and housing market recovery, in that it's unsecured product, it's relatively easy to sign up the approval rates that we're seeing for people who apply for these loans as fairly high at around 50%. Volume has been picking up, and we think it'll have a really relatively modest impact, but from a customer standpoint, it's very helpful for our customers when they ask homeowners coming in and looking at the kind of products that they can buy from that customer, whether it's a new pool or above-ground pool or a spa, the bigger ticket items. Pool refurbishment is a very good use for this kind of loan product. It really helps our customer in having that tool available to offer to consumer. And so it's just one more of the types of things that we try to do as a company to help our customers be successful. And we think, again the timing is good for us to be able to promote that a bit to our customers and to homeowners this year.

I know it's not a big dollar month, but it says you're going to invest up to $2 million. Is that an investment or you're just kind of -- I guess, again this time we can take it off line.

Well just a comment on that, it is an investment from our standpoint. We really don't expect to lose that. Lending Club has a pretty good track record of returning a positive investment to people who invest in the loans that they underwrite. We don't take a majority. We take a small portion of the loans that are done in the pool area. So we'll spread that $2 million across a large number of borrowers. And so the more pertinent issue there is that we want to send a message to our customers that we support them, we support the industry. And by taking an investment in their customers, we think that's a positive message that we want to send to our customer base.

Thank you. Good luck through the year.

Our next question is coming from the line of Mark Rupe with Longbow Research.

This is actually Andy in for Mark. First question is on the inventory side. How much would you say, of the increase in inventory, was related to acquisitions versus maybe related to anticipation of higher purchase levels for 2011?

Approximately $10 million was related to acquisitions, and the balance was base business.

Got you. Okay, that's helpful. Thanks. And I guess similarly on the SG&A front. How much would you say, if you could break that up for us maybe a little bit -- how much was kind of related to, I think you mentioned incremental freight cost versus incremental payroll, if you could maybe break that down for us.

Sure. If you take out the year-on-year SG&A increase, and Mark touched on some of the elements in his comments, but essentially, you take out acquisition, you take out incentive and you take out freight, and at the end of the day you're talking about something in the neighborhood of closer to 3%.

Okay. Got you. Okay, that's helpful. On the pricing side, have you been notified by any vendors? Or do you expect any further price increases on the equipment side in 2011? Or has that not been an issue at this point?

Well, first of all, in terms of price increases, commodities, items like pipe, rebar, that are used typically in new construction, those have been going up during the course of the year and pretty much as we expected to take place. But the impact there is negligible because a new construction is still very small segment of our total business and therefore, that's the littlest number. In terms of the equipment sector, there is one of the top three vendors in the category that has announced a price increase that's effective June 1. And therefore, that'll have some impact this year. Again, diluted by the fact that it's only one of the top three vendors. And then on the chemical side, which is the largest product category by far. On average, prices there are a tad lower than last year. So there's a little bit of deflation there. So net-net, I think all the 1% to 2% that we estimated for the year is still reasonable, net-net, and again probably the run rate will be a little bit higher in the latter part of the -- no, in the third and fourth quarter. But overall for the year, 1% to 2% seems to be still a reasonable number.

Okay. Got you. And on the equipment side with that vendor, I'm assuming you just intend to pass along that price.

Yes.

Okay. Got you. And then just finally for me. I guess on the competition front, I know you mentioned in the past that you maybe expect to see some share gains related to some of your competitors not really being able to keep up with sort of inventory requirements, when you're still serving up ticket. Has that been a positive benefit for you at all at this point? Or do you expect to maybe see that as you kind of get into 2Q? Or is that not really an issue at this point?

That is not so much a factor in the fourth and first quarter. That's more a factor in the heat of the season. And so therefore, that benefit that we began to see a bit last year, we expect to see a little bit more of that this year as well. And that's basically service levels in the middle of the season.

Our next question is coming from the line of Ryan Merkel with William Blair. Ryan Merkel - William Blair & Company L.L.C.: So my first question, it sounds like the year is playing out like you've thought with growth mostly coming from maintenance and repair. But I'm wondering if 2012 is still a year where new pool builds kick in or maybe major refurbishments?

We believe that other than the aging of the install base of pools, which is certainly helping to some degree on the remodeling replace side. But the real change in behavior on the consumer, be it refurbishment, replacement or new construction, we began -- we expect moves well[ph] . And that impact, if any, will be very, very modest this year. Ryan Merkel - William Blair & Company L.L.C.: And then what is the recovery in refurbishments in new pools look like? I mean is there pent-up demand? Do you have any historical precedence to tell us how that might look?

Well unfortunately, there is no historical precedent. We have, in this industry, enjoyed over 40 years of growth independent of what was happening to the rest of the world through 2006. And then it kind of -- it changed. So there is no history or reference you can point to. From our own internal calculations, is that it will take about five years before replacement, remodeling activity from a consumer standpoint through our customer to us reverts to normalized behavior. And there is certainly some pent-up demand there and that will come in, we believe, over the course of the next five years, we're not far enough [ph] to figure out what year that'll be or over, in which years it will be concentrated. And then in the case of new pool construction, we believe it could very well take 10 years, up to 10 years, before that reverts to normal behavior. And that's what we baked into our five and 10-year models. Ryan Merkel - William Blair & Company L.L.C.: Yes, the point is there is a sizable recovery opportunity ahead, the timing is just pretty tough to call.

Yes. The interesting thing, Ryan, is that without -- again, using those kind of expectations, which somewhat challenged me as being too conservative, we can still get to 20% plus earnings per share growth. And as evidenced last year, and I think we have a good shot of doing this year, we can still realize 20% earnings per share growth without that tail wind at our back. Ryan Merkel - William Blair & Company L.L.C.: Right. Ok then just one more for me. What did trend look like on swimmingpool.com in terms of inquiries and contract or lease, that sort of thing. I mean any lead there? Or is it just too early in the season?

Well the lead is misleading. And especially because over the course of the past two years, we've made a fairly significant investment in some of the ways that the site works, as well as our other websites, as well as the way that we use to reach consumers using social media and other investments that we've made that are more efficient. So our actual activity is up significantly, both in terms of unique visitors, as well as how long they stay on the site and how many page views they have. So in context, I would say that -- I believe, and certainly our director of social media will tell you that, that's primarily driven by how we reoriented our resources to leverage that, as opposed to inherent demand. But I believe that, I think, both factor in, but I would tend to agree with him that most of it is driven by the efforts we've made and the investments we've made in that area. Ryan Merkel - William Blair & Company L.L.C.: Sounds very positive. Thanks very much.

Our next question is coming from the line of Anthony Lebiedzinski with Sidoti & Company. Anthony Lebiedzinski - Sidoti & Company, LLC: I was wondering if you guys could quantify the base business sales improvement by product category, maintenance, repair, remodels, construction type of products?

We don't have it captured that way. We have it by individual product line category. And in the case of equipment, for example, while it's primarily driven by replacement activity, there's some factor or similar, obviously that goes into new construction. But if you bear with me, Anthony, what I would estimate is that of the 15% base business sales growth, I would say probably something in the 12% to 15% range would be maintenance and repair, as well as replacement remodeling. And then it would be a little higher than that, call it more 20% plus tied to new construction. And that new construction, we know, is driven heavily by market share gains with the building materials' product category. Anthony Lebiedzinski - Sidoti & Company, LLC: Okay. That's helpful. And also looking at your floating rate, senior notes that you have upcoming next February at $100 million, any sort of idea as to what type of interest rates you will be able to refinance that? Would it be similar to the current terms or any different? If you could provide any outlook for that, that would be helpful.

Sure. Unfortunately, the market isn't quite as robust for borrowers as it was when we did that back in 2007. So the terms will be a little higher. But having said that, and given the order of the increase of the $100 million everything else, it'll probably be contained to impact us by no more than a $0.01 for 2012.

Our next question is coming from the line of David Mann with Johnson Rice. David Mann - Johnson Rice & Company, L.L.C.: Yes. Thank you. Great regard to the season. First question was on the performance of the Green business. Can you just elaborate on how much of that 12% gain in revenues there was perhaps related to the weather, pulling some business forward versus sustainability of that kind of gain. And also, Mark, could you update sort of your loss projection or perhaps with this division get to break even this year.

Sure. Two parts. Given the waiting of the Green business in terms of geography, the weather impact there was not as significant on the positive side as it was on the Blue business. And just to make the point, the Green business is heavily weighted towards the west, with the actual network spanning from Texas West to California and up through the Pacific Northwest in the state of Washington. So therefore, when you look at the weather impact there, it was not as big a factor as it was in the Blue business. And therefore, we believe that while certainly there were some benefit certainly in Texas from the weather, it will probably be outperformed from a year-on-year standpoint, the Blue business, in terms of sales growth. With that sales growth plus some of the actions we've taken and the business from SG&A and other elements, we feel that for that business to have a positive contribution this year, albeit modest, is very reasonable at this juncture. David Mann - Johnson Rice & Company, L.L.C.: So that will be an improvement versus what you thought on the last conference call?

Yes, that will be a little bit of an improvement. But again, it's not -- on the order of magnitude, it's not, maybe a penny or two. David Mann - Johnson Rice & Company, L.L.C.: Great. In terms of the gross margin guidance you gave on the last call, do you still believe that we should be looking for about 10 to 30 basis point improvement for this year?

I would say given -- well what happened in the first quarter, it probably would be more like 20 to 30, as suppose to -- I'd take the 10 out. I think more 20 to 30 is reasonable. David Mann - Johnson Rice & Company, L.L.C.: And what's driving that?

Our ability to manage our business, both on the buy and sell side. Execution, a little better. The gradual but ongoing migration to private label products and exclusive products. Those are the major drivers that drive that change. David Mann - Johnson Rice & Company, L.L.C.: Okay. And then one last question. Going back to sort of the comments you made about spending on higher ticket items, sort of that you saw somewhat higher consumer discretionary expense in this quarter, can you help to quantify what you mean by that? And I guess you're not including that in your full-year guidance. Can you give us a sense on what impact might be if that sort of spending level in the first quarter continue for the rest of the year?

Well part of that is the comparison with the first quarter of 2010. And again, when it's cold and bleak outside, whether it be in Texas or Georgia or Florida, people don't tend to focus so much on their pools. And this year, when the weather was a little better, they did and they ended up replacing some of the equipment that may have otherwise been repaired or replaced one or two or three months later. So I think that's -- they may have used the pool a little more. So that goes into considerations that play into the behavioral change that we saw in the first quarter. Again, part of it is the easy comparison, both weather-wise as well as from a macroeconomic standpoint, we continue to move along overall. There's still no headlines in terms of genuine change. But certainly, if nothing else, consumers are feeling more comfortable in this status quo. David Mann - Johnson Rice & Company, L.L.C.: Great. Thank you Manny. Good luck.

[Operator Instructions] Our next question is coming from the line of Luke Junk with Robert W. Baird.

First on the updated EPS guidance, I know -- previously you've disclosed that you kind of had a low to mid single-digit growth rate better than that guidance. We see good trends that we saw in the first quarter, and based on the range above what you had previously, fair to say that we're probably looking at more of a mid single digit growth right now?

Yes, for the balance of the year we're looking at mid single-digit, 4% to 6% for the balance of the year.

Okay. And then as it relates to early trends in April, I'm not sure if you want to comment on that. But...

Consistent with our expectations for the balance of the year.

And then second, as it relates to -- proven in the market, obviously last year, we had again the recovery, it looks like things have may be accelerated a little bit here in the beginning of 2011, as it relates to your acquisition pipeline, do you feel -- are more people interested in coming to the table at this point? Or is still depressed somewhat?

We have ongoing dialogues with a number of people all the time. We primarily waited on the international and Green side of our business. So therefore, that dialogue continues. It's a matter in some cases of the emotional thought process to sell. In some cases, it's more an issue of valuation and then in some cases it's when we look under the covers, we may not be as interested. So in any case -- but that dialogue continues and certainly when we have something of significance, we'll report it.

It appears we have no further question. I will now turn the floor back over to Mr. Perez de la Mesa for closing questions.

Thank you, Claudia, and thank you, all, again for listening to our first quarter results conference call. Our next call is scheduled for July 21 -- mark your calendars, July 21, same time: 11 o'clock Eastern, 10 o'clock Central, 8 o'clock Pacific. When we will discuss our seasonally most important second quarter 2011 results. Thank you again.

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