Pool Corporation (POOL) Q4 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the Pool Corporation Fourth Quarter 2012 Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Mark Joslin, Vice President and Chief Financial Officer. Mr. Joslin, the floor is yours, sir.

Thank you, Mike. Good morning, everyone and welcome to our 2012 Year-End Conference 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 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 good morning, to everyone on the call. 2012 was another year of strong performance in a still challenging market environment. We estimate that industry sales increased by 3% to 4% compared to our 7% base business sales growth and greater than 8% base business sales growth when excluding the impact of currency. This sales growth in turn, resulted in 23% diluted earnings per share growth, combining a 21% earnings flow-through on base business sales growth with a reduced share count deploying our strong cash flow outstanding. The credit year rests with our over 3,400 employees, whose talent and commitment is without par in the industry. I am continuously humbled by their dedication, perseverance, attitude and initiative as they strive to provide exceptional value to our customers and suppliers. I am very fortunate to work with them and very grateful as a shareholder. In terms of the base business sales, our Blue business was up 6.6% for the year or 7.4% excluding the adverse currency impacts. And our Green business was up 9.6% as a competitor exited the market and the housing recovery began to take hold. The 2 best-performing Blue markets for us in 2012 were Florida and Arizona, with both up 10.7%. The rest of the North America Blue business was up 7.3%, building on 2011's strong growth. For 2013, we anticipate that base business sales will increase 5% to 7% with tougher comps through May given the early start to the 2012 season in snow belt markets, relatively easier comps in June and July when the season normalized in 2012 and average comps the balance of the year. With similar industry growth as in 2012, we expect to again gain share given our unprecedented investments in our people and their development, together with our investments in technology, marketing, products, best practices and other initiatives that provide value to our customers and suppliers. With respect to gross margins, we'll continue to have the ongoing headwind of both customer and product mix, as successful customers become more successful and higher-value products sell with higher-margin dollars but lower margin percent. On the other hand, the normal timing of price increases, 1% to 2% net, and our execution on sales, sourcing and purchasing, should marginally mitigate this pressure to result in a negligible impact either way. Base business expenses will increase at a modest pace, enabling us to realize operating leverage. To this end, 2013 will likely mark our last year of 20% base business earnings flow-through as we will have largely absorbed the capacity available from the industry contraction. In future years, we should continue to realize positive operating leverage but the earnings flow-through will be slightly lower. Overall, our base business operating income increased $26 million in 2012 even with the adverse impact of currency and the challenges in Europe. Free cash flow was 125% of net income or $2.14 per share as we effectively managed the working capital. We also continued to invest in our networks, acquiring 5 locations and opening another 9 locations, primarily satellite centers. All of these investments were made with the same discipline for return on capital that we've demonstrated for many years. Given the references made already to 2013 sales, gross margin and expenses, we forecast another year of positive results with 15% to 20% diluted earnings per share growth to $2.13 to $2.23 per diluted share. Beyond 2013, we expect that the macro environment will gradually improve, enabling the gradual recovery of replacement, remodeling and new construction activity to normalized levels by 2020. Independently, we are ready to succeed as our people give me the greatest confidence in our future success. I'll now turn the call back over to Mark for his financial commentary.

Thank you, Manny. I have a number of areas that I'll be commenting on this morning starting with operating expenses. To recap our performance here, you can see in our base business addendum that our base business operating expenses in the fourth quarter grew 3.6% from a year ago on 11.6% revenue growth, while our base business expenses for the year were essentially flat on base business sales growth of nearly 7%. We were certainly very happy with these results, which reflect excellent expense management by our team and utilization of the excess capacity in our networks. In addition, as we've discussed on past calls, we benefited in 2012 in a couple of areas that we don't expect to continue, including lower incentive costs compared to 2011, the favorable impacts on expenses from the weaker U.S. dollar compared to the euro and pound, and improvements in collections resulting in lower bad debt expense. In total, these benefited our 2012 expenses by about $8 million compared to 2011. Also, lower gas prices and lease renegotiations and renewals and lower rates enabled us to hold freight and lease costs relatively flat year-over-year. For 2013, we expect more normalized levels of expense growth with inflationary increases and some additions to support our sales growth expectations. Overall, I'd expect expenses to grow at about 1/2 the rate of our sales growth this year with contributions margins from sales growth at or approaching 20%. I'll take a moment here to comment on taxes. Our effective tax rate for the year was 41%, which was a bit higher than normal. However, if you exclude the nondeductible third quarter goodwill impairment of $7 million, our tax rate would have been just over 39% for the year, which is similar to what I expect for 2013. Moving on to the balance sheet and cash flow, we believe our results here for 2012 were solid with minimal growth in receivables at inventory for the year, more than offset by payment deferrals. This resulted in cash flow from operations that were 145% of net income and $44 million higher than last year. For 2013, we expect more modest performance. Our aim as always, for cash flow from operations to exceed net income. This high level of cash generation helped us reduce debt levels with net debt of $218 million at year end, down $11 million from the end of 2011. This puts us in excellent financial position with year-end leverage as calculated on a trailing 12-month debt basis at just under 1.5x. I'll turn now to share repurchases. In the fourth quarter, we repurchased 620,000 shares at an average price of $41 per share for a total use of cash of $25,436,000. That gave us 2,084,000 shares repurchased in total on 2012 for total use of cash of nearly $79 million. Finally, I'll provide a few comments on our expectations for quarterly performance in 2013 starting with our billing day comparison to 2012. Looking at the calendar for 2013, we have the same number of billing days overall, though we lose 1 day in Q1 and gained a day in Q3. Our sales performance last year, as most of you will recall, was strongest in the first quarter given the exceptionally favorable weather with a relatively strong Q4 and weaker growth in the middle second and third quarters as the industry came to a standstill in June. We, therefore, expect our Q1 2013 sales growth to be the weakest for the year or even flat year-over-year with modest growth in Q4 and better growth in the middle of the year. All of this assumes relatively normal weather, which of course, is never given. That concludes my prepared remarks. So I'll turn the call over to our operator to begin our question-and-answer period.

[Operator Instructions] The first question we have comes from David Manthey of Robert W. Baird. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: First off, I was hoping you could address international markets and maybe talk about areas of strength and weakness there and if you're seeing any incremental acquisition opportunities, particularly in Europe.

David, let me take it. In 2012, we brought into the fold, an acquisition that we made in British Columbia, which has 4 locations and 1 in Germany that has 1 location. Frankly, British Columbia, was fine, Germany was a bit of a disappointment. Having said that, obviously, the pressures in Europe are great with the economic environment. With all of that being said, in local currency, we had flat year-on-year sales in Europe. In Canada, logically, our sales increased with the acquisition that we made plus good performance in Ontario. Altogether, I think when you look at Canada, we are in a strong position there and that, in fact, operates under our North America business unit and that is pretty much along the same lines from a development and maturity standpoint. In terms of Europe, we have a very strong position in France and we are gaining strength gradually in other countries. France, though, represents the largest market in Europe and we are always in dialogue with prospective acquisitions but having said that, my focus in the near term, in the next couple of years, would be in strengthening what we have as opposed to adding more to our existing base in Europe. David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division: And then just one other question on -- at the Analyst Meeting, you had mentioned something about these focus centers, where you had underperforming Blue locations. And I was wondering if you could just update us on the progress there and opportunity remaining to improve these underperforming locations.

Sure. The premise of focus centers that we covered at that meeting is something that we've done for now 14 years. So we capture those that are performing below our expectations, and by the way, that's below a 30% return on invested capital. Approximately 1/3 of our locations operate below that level and those are the ones that we view as focus. Approximately, I can't remember the exact number off the top of my head right now, but approximately 10% of what were focus centers in 2012 graduated, as their returns improved and got over that 30% hurdle. Having said that, the new acquisitions and the new locations backfilled that. So we still have almost 30% of our locations in that mix. Every year, there's additional management attention dedicated to those locations to look at ways to improve their performance and looking at every aspect of managing the business, obviously every line in the P&L and inventory and receivables management as well, to look at the total packaging and better define what they need to do and how do they need to do it. People are a big part of that and our investments in developing people through all myriads of developing program from what we do in recruiting kids out of college and putting them through our, what we call, manager in training program, through all of the development programs that we have in place throughout the organization, are a big part of how that performance improvement happens and get those centers graduated off the list and on to the, call it, good list that's not being focused on so much.

And the next question we have comes from Ryan Merkel of William Blair. Ryan Merkel - William Blair & Company L.L.C., Research Division: The first question I had is the 12% base business growth in the fourth quarter was a nice positive surprise. I'm just wondering what was the source of that upside even versus your expectations?

You know what Ryan, it's -- we continue to make progress. I think it's certainly a little better than what we expected but I think it goes back to our people and the fact that our people, despite the traditional season being over at the end of the third quarter, continued to work and really hand-in-hand with our customers to help them, and we got rewarded for that effort throughout the organization. There is no one single reason or cause. The weather was not particularly better year-on-year. I think it's just a credit to our people and what they're doing. Ryan Merkel - William Blair & Company L.L.C., Research Division: Was there any product categories that jumped out or was that pretty consistent as well?

In terms of product categories, the 2 product categories that really improved the most year-on-year would be building materials. Building materials for the year was up 16.5% in terms of GP dollars. And again, we are making significant headways there. We have a great team in place and progressively, we're adding more value in that regard. And then the other area where we had very strong growth was commercial. We have increased over the last several years our focus on commercial customers, and that segment was up over 20% in 2012, part of that was due to some regulatory requirements for commercial pools to have chairlifts in place for the disabled. But independent of that, we still outperformed the industry pretty significantly. So I think those are 2 areas that contributed to our growth in terms of sales, not only for the fourth quarter, but for the entire year. Ryan Merkel - William Blair & Company L.L.C., Research Division: Yes, that's great color. Okay. And then the second question is on the gross margin, which was disappointing as far as I'm concerned. Did you match competitor prices? You mentioned some price competition. Or did you avoid some of these lower margin sales. Just kind of how did you manage through that?

Part of that is, just to give you more color on both customer and product mix. What's been happening gradually on, I'll talk first about product mix, is that over the last several years, more energy-efficient products have come to market. For example, variable speed pumps, LED lighting. And those products are sold at a higher price point, but from a content standpoint, they're a box. So what tends to happen in distribution, not unique to us, is that those higher value products in the same box contents tend to be sold at a lower margin percent although they are generating more margin dollars. So that's continuing to take hold. We're a big advocate of it obviously because it translates to more profitability, the cost for us to move that box is pretty similar, so therefore, the additional GP dollars are the right high leverage but that's one factor. In terms of customer mix, that's also been playing as the better customers that are more progressive in terms of marketing merchandising in the case of retail stores, builders and our upselling more and more, modelers that are upselling more and more. Those customers, as they capture more share, then they tend to have better pricing. So, therefore, that's king of -- that's kind of another headwind that we have. The competitive landscape is obviously there. It's extremely challenging. We have a lot of tools to offer our customers. We provide extensive value-added services, and what tends to happen is our competitors that have not made the same investments over the course of time, feel compelled to use price as their only option. And so we try to sell through that and try to get our customers to appreciate all the tools and value of services that we provide that are just make us distinctive from our competition. And evidence is the fact that we continue to gain share. Having said that, do we sometimes have to close the gap that we have with some of our competitors? And the answer is yes, and we'll do that on a case-by-case basis as we need to. But I think those are all the factors that weigh into the margins and I think at the end of the day, the driver here, is what are we doing to grow our gross profits and at what rate are those gross profits growing. And when I look at 2013 as an example, I'm looking at 5% to 7% sales growth. I'm also looking at 5% to 7% GP dollar growth. And that's all factoring in all that we need to do. Again, the local competitor, because again every market in this industry is unique, so we're talking about local competitors on a market-by-market, customer-by-customer scenario because, again, their views are also unique. And that weighing all that together, again, with the top-level headwinds of product mix as they go to more energy-efficient products and higher-value products, as well as customer mix as the better customers get better. Ryan Merkel - William Blair & Company L.L.C., Research Division: Okay. It makes sense. And then last one for me. It looks like the credibility of the housing recovery is getting better and I want to ignore new pools for a minute, just what are the trends in the refurbishments and remodeling market, and then also the irrigation and landscape market? I mean, are you actually seeing that flow through into those markets in terms of housing starting to be a tailwind there?

We are seeing some lift in the remodeling and replacement sector overall and it varies by market. We are seeing some lift as well as in new construction. But let me just give you a perspective. Florida, which is the largest pool market in the country. Florida in 2012 had 12,000 -- approximately 12,000 pools built. New pools. That compares with 48,000 new pools built in 2005. So we're still only at 25% of the peak rate. And even more striking is the fact that in 1999, when -- that was before the real estate boom, that was before financing got out of hands, in 1999, there were 37,000 new pools built in Florida. So in 2012, the industry was at less than 1/3 the new pool rate that existed in 1999 when you had a more normalized real estate environment and approximately 25% the rate that it was in the peak year. And I guess, it goes back to how, I could say pleased from my perspective, of how good I feel about us, our execution, because our execution can have record results in an environment that is still very challenging is still, I think, it's a credit to our team, throughout the organization.

And next, we have David MacGregor of Longbow Research. It looks like there is a disconnect in there. We'll proceed to our next question, it looks like it comes from Kenneth Zener of KeyBanc Capital Markets.

Manny, just to be clear, I know with the gross margins, SG&A, product mix, the way I've thought about your business is your 15% incremental is on the EBIT. So if you're margin -- gross margin falls a little bit, you're picking up that mix in your SG&A. Is that the correct way to think about it sympathetically?

That is correct.

Now can you give us color on the Florida, Arizona up 11% versus 7% for the others. You have so many SKUs but as you looked at it and thought about it, is it product replacement that you're seeing there? Was it a different type of mix, was it -- obviously as you just highlighted, there wasn't a resurgence of new construction necessarily in Florida? So could you give us a little color on that. And then how you think about that proceeding or the spread into this year, please?

Sure. Well, Florida and Arizona were 2 markets that were extremely hard hit in the market contraction as those that retired -- because there are less retirees moving down to both those 2 states for several years. That began to recover to some degree in '11, a little bit more so in '12 and with that happening, it kind of cleans up a lot of the market. And therefore, while new construction haven't taken off in a major way, that cleaning up of the market from a real estate standpoint created a base of stability to give those home owners, particularly those pool owners, the confidence to reinvest in their homes. And to the extent that they needed, maybe they have deferred some remodeling of their pool or maybe defer on replacing a heater, something along those lines, that began to happen a little more so than perhaps in California market that didn't have that same type of behavior just yet. Just as a refresher, for those of you that may have been on the call with us for years, back in the first market that really began to feel the impacts of the downturn was Florida and California lagged. And on the recovery, Florida also saw the recovery first and California lagged. So I think what's happening here is that Florida and Arizona, but Florida especially, they're kind of leading the way from a market -- overall real estate market recovery standpoint and then California is going to follow in the next 12 months or so.

Okay, appreciate that. And then the sales commentary given the weather last year did not sound like you said 1Q is going to be negative. Is that correct in terms of sales growth? Is your expectation?

Right. The first quarter of last year was exceptional. And in fact, it was -- in fact, 2 exceptional first quarters back-to-back. Last year was exceptionally mild and pools were opened a couple of weeks, in fact, a month before they normally would be opened. So a lot of that impetus activity that takes place when pool owners and similar markets open their pools, happened again 3 weeks, 4 weeks earlier than normal last year. It's hard to call the weather. In a normal weather year, those pools are going to be opening, again, about a month later than last year and therefore, those sales will happen in April as opposed to March. Now the difference between February and March doesn't matter because that's well into the quarter. But certainly March to April, there will be some migration there in the normal course. I would say at this juncture, we should have some positive year-on-year sales in GP dollars but it will be very modest. It will be very, very modest and certainly, will be from a year-on-year standpoint, the most modest top line results that we will have in the entire year.

Okay. Good. And then my last question, your free cash flow relative to that net income, the premium that you've been having tied to working capital and efficiencies, how do you look at that spread given your guidance, so free cash flow above net income? And when do you see those 2 normalizing or should you be in a perpetual state of doing free cash flow, let's say, 110% or 115% of net income.

Right. And that's -- I would say that the 110%, 115% in this particular case, where we had 120%, 125% is exceptional. Our objective is 100% and I think that, that is achievable in the normal course in a normal year. We should do better than that in some years as we continue to improve with every facet of our working capital management. But I will tell you that at this juncture, the levels that we are managing accounts receivable are extraordinary in the context of trade distribution. To have less than 29 days DSO is thankfully unheard of. And so I can't realistically see DSOs improving from where we are. I said that last year and I was wrong. But at this juncture, it was hard to phantom DSOs getting any better. On the inventory side, I think we have opportunities there for improvement. Certainly working on that. And that will give us, I think, a little bit of positive above the 100% level over the course of the next several years. But again, I think from a long-term standpoint for our business to manage its -- our distribution business to manage itself, where free cash is 100% of net income, is really top-notch given the traditional need for increased working capital to support increased sales.

And next we have David MacGregor of Longbow Research.

A question on the private label and exclusive products. Can you just give us a sense of what they represent as a percentage of revenue and how they comped versus other sort of elements of the assortment?

Sure. In -- we don't have the final data for 2012 but in 2011, it represented a 25% of our gross profit dollars. I expect it to be approximately 26%, it may round up to 27% for 2012. And the logic there is that our growth in private label and exclusive products is greater than our overall growth. We have gone and made investments in that area, in part, that has helped insulate us from a margin standpoint. Also, it enables us to provide a differentiated offering to our customers and also protect them in their markets as well. So again 25% was the number on 2011, we haven't finalized or we haven't seen the finalized number for 2012, but I expect it to be 26%, 27%.

Do continue you invest disproportionately in that part of the business? In other words, does the growth there kind of accelerate versus the overall consolidated growth?

There are 2 factors that play here. One factor is in the building materials side of our offering, a good part of that offering is private label to us. So therefore -- or exclusive. So therefore, that's a key component. On the -- on other parts of our business, for example, chemicals, a significant majority of the chemicals that we sell, the dry chemicals that we sell, are private label. So that's another element there as well. On equipment, which is another broad category, most of what we sell in equipment is manufacturing, branded products. We do have some individual exclusives in that regard and those are increasing a little bit. But to the end, we have to weigh how we go-to-market there. Where we have exclusives, it's certainly very beneficial for us how to protect our margins, especially, and help us protect our customers' margins, especially. So to that end, we continue to evaluate that. But again, we're pretty deliberate in that side of the equation.

Maybe I could just ask you about uses of cash in 2013. Can you just remind us on your priorities?

Yes. From a priority standpoint, the funding of the business is obviously the first and that includes our internal growth opportunities whether it'd be broadening our product offering or expanding our network organically like the opening of new satellite centers. That's first. At the end of the day, that is not a big dollar number. The second factor is acquisitions, provided they make sense. And again, the acquisitions are primarily focused on markets where we have little or limited presence. In the overall skim of things, given our current size and given our current breadth, that is also not significant. Third, would be dividends and that's a steady, long-term commitment that we made to our shareholders. And then after that, it goes to share repurchases. When you look at the past 2 years, in 2011, 2012 combined, we bought approximately $150 million worth of shares. And that's another way that we return, in this case, excess capital. Mark highlighted in his comments that our trailing 12 months debt-to-EBITDA is just under 1.5x, that's a very conservative debt posture and we wouldn't look to making significant further reductions in that regard. So I mean that 1.5x debt levels are very comfortable debt levels. We could end up 2013 at 1.2x or 1.3x, but that's not really the objective. So at the end of the day, what you'll probably see from us is certain, very targeted investments in priority 1, which is internal; priority 2, which is acquisitions. We'll have our dividend discussion with the board at the May board meeting. And then in all likelihood, a big chunk of our cash will be given back to shareholders in the form of share repurchases.

Then as you to get into the cyclical recovery, does that -- do acquisitions become a bigger part of the growth story?

Acquisitions, again, are driven by, and from the outset for us, were primarily motivated by the opportunity to enter a market that we were not in. This industry, like other industries -- in fact that's about this industry, each market is unique. The customers, whether they're a retail customer, a builder customer, customer that focuses on remodeling, and customer that focuses on commercial or customer that really focuses on maintenance, or is another that really focuses on repair, these individual types of customers have their own unique needs. And whether that -- and the markets therefore, whether it be a Nashville versus a Knoxville, are radically different markets. And again, you go to Atlanta, you go Orlando, you go to Dallas, these are all different markets. So understanding that, we specifically look for acquisitions as an alternative to the opening of new locations over the course of time to build on our network. And by the way, if you look at history, about 1/3 of our locations, where new or de novo openings in our part, and about 60%, 65% came via acquisitions, although the lion's share of our earnings and earnings growth have come internally once we've acquired or opened a location. So therefore, the motivation was really to enter a market as an alternative to opening our own location. And to the extent that we already have a presence in a market, the value of that acquisition is less. So if you look at the new part of our business, the swimming pool part of our business, and you look at North America, which when include Canada represents upwards of 65%, 70% of the world market. We are pretty well established in the lion's share of the markets since we started that process almost 20 years ago. In the case of Europe, we have a little bit ways to go. So if we're going to do acquisitions in the Blue side of the business, it's going to be more like the international than domestic. On the Green side of our business, same logic, same approach, we obviously have a lot more to go as we have a much smaller share there of the business and we don't have a presence in many significant markets. So acquisitions will be heavily weighted towards international in the Green part of our business. But when you look at the dollars, given our size and scale, the acquisition cost may represent $10 million to $20 million a year on average. And that really is a small percentage of our total cash flow generated per year. So that's when I talk about that being a modest use of cash over the course of time.

That's a pretty thorough answer. Just finally, the guidance did not include any share repurchase activity, is that correct?

That is correct.

And the next question we have comes from Keith Hughes of SunTrust.

This is actually Judy in for Keith. Given your comments in your press release about the improvement you saw in consumer discretionary expenditures, is there anything else that you can add to that on whether how much improvement you've seen or was that just certain products like the building materials you referenced earlier?

It will be very anecdotal. We look at our product category, for example, building materials. Again, I mentioned the 16.5% growth that we realized in gross profit dollars in 2012. And I know that, that -- a lot of that was share gains, certainly the market was favorable as well but a lot of that was share gain. When you look at other product categories, for example, on equipment, pumps for example, the dollars there grew at a rate faster than the overall, but that is not so much in units but more so in the higher value sales or variable speed pumps as opposed to single speed pumps. So therefore, the absolute units did not grow significantly more than expected or overall, but it was the better mix. Same thing could be said about lighting products. So my anecdotal perspective is that the headwinds on some of the discretionary spend have abated but there's are certainly no tailwind to speak of, at least nothing that we've experienced to date.

Okay. So are you seeing more consistent spending versus that kind of choppy results we've seen earlier? Is that part of it as well?

I'm sorry, restate the question.

Have you also seen more consistent consumer discretionary spending versus kind of the uneven results? Is that a part of your outlook, too?

Yes, we're not expecting, in '13 -- I mean, we have, from a consumer discretionary side, obviously, consumers at every level, with probably the pool owners paying disproportionally greater taxes. So therefore, there's going to be some hit to consumer discretionary spend and we don't see any significant change in the near term in that regard.

Next we have a Brent Rakers of Wunderlich Securities.

Manny, I was hoping maybe first we could focus a little bit more on the revenue guidance for 2013. You're giving a 5% to 7% range, which is I guess, at the low end of the Analyst Day kind of intermediate long-term guidance of 6% to 10% I was hoping maybe you could talk specifically about some of the areas, the price, market recovery, share gain and where you think -- what components that may be bringing that down from what you think the multi-year averagees are ultimately going to be?

Right. Great question, Brent. And when I look at the long term, over the course of the next 5 years, I think 6% to 10% is very reasonable. What's baked into that is some level of genuine recovery in consumer discretionary spend. I am cautious, given the tax increase that was just passed, that, that's going to take some hit and some hump out of consumer discretionary spend. And when you look at the demographics of pool owners, particularly in-ground pool owners, which have a greater percentage or spend on remodeling and replacement activity. That consumer is obviously or logically at a higher income level and therefore, more inclined to pay more taxes. So therefore, that reflects that level of caution. We see a lot of macro information, all of us do multiple times every day, and I think that -- I think you'll see some settling over the course of '13 to really build a base for the future. So I'm still looking at 6% to 10% as the compounded number over the course of the next 5 years, but as I've mentioned in the past, it will be at the low end of that 6% range in early years and it will be towards the higher end over time as hopefully the macro environment improves and consumer behavior return to normalized levels.

And then maybe a similar type of exercise on the gross margin, because when you go back to the early part of the last decade when the prevailing housing environment was more supportive to your business, you did have more consistent expansion of gross margins. You've given us indication of kind of flat again next year after the disappointing gross margins in 2012 and you talked about mix and such. Can you maybe reconcile, is that gross margin, is that something that, in subsequent years, you expect to build that back to this 20 bps to 30 bps a year or possibly more? And will that be helped by the cyclicality of the housing market overall?

Well, I think in part, Brent, it's apples and oranges. And the reason I say that is that a number of years ago, and I'll use 14 as a point of reference, we began our process to identify what was most profitable for us to sell and then gear our efforts to selling what was most profitable. And that starts with not only selling the stock, and that process, again, catering to each local market, in each customer type, but it's helping to find what was most profitable for us to sell. When you look at where we were in 2012, approximately 95%, almost 96% of our sales in North America were from either private label, exclusive or preferred vendors. So in other words, we have gone to the point where that level was in the 70s or roughly 70% back 14 years ago, to today being 95% almost 96% of our sales being, again, private label, exclusive and preferred vendor products. And so therefore, there was a huge opportunity that we have then to become more profitable in how we geared our efforts, every aspect of our business to become more profitable. And therefore, we were able, as we put those things in place, we began -- we became progressively more successful in improving our gross margins. We are at a point now where that aspect of it is largely behind us, not to say that we aren't still working opportunities because even in the context of builder's classifications, there are still varying levels of profitability, but we are operating in a more finer level in terms of process improvements, things of that nature, that help us improve that. So therefore, that's there. When I look ahead, I'm also cognizant of the market environment. And it's a difficult market environment. A number of our competitors have struggled. Their sales came down with the market. They have barely been able to recover. They see us gaining share with every quarterly report and the only thing they can do, given the decision not to invest like we did over the course of many years, is resort to price. And frankly, I think it's not the best business decision they could make. I would certainly do things different as we have. But that creates that market environment. So when it's all said and done, we are wrestling with that, we are wrestling with the product and customer mix headwinds that I've talked about, which by the way provide opportunities for the bottom line. I mean, the bigger and better customers are more efficient to serve. The higher value products, on a per box basis, we're generating more GP dollars. So this results in greater efficiencies for us as a service provider. So therefore, I'm focused more on what's generating more for the bottom line. And we'll address the market issues on a case-by-case basis and the competitive issues on a case-by-case basis, but we're making, I think, the right decisions for the business and I think the results speak for themselves.

Manny, just as one quick follow-up. That's a great answer, but maybe one quick follow-up on that, if you can think back to, I guess, 2004, 2005, maybe 2006 even, and think about the overall competitive landscape and how things have changed from then to now, do you have any sense for maybe how much that's weighed on gross margins for not only you guys but maybe this industry? And over what time frame could that possibly -- that competitive pressures ease to the point where you can recover some of that?

Well, that was -- you can refer to that as the glory years. Distribution in general, basically just tries to keep up with demands. So in that kind of environment, when not only us but our competitors are just trying to keep up with demand and the customers had as much business as they wanted to have, in that environment pricing was not really a big deal. The contraction put a lot of pressure on a lot of people and that has really not gone away. So to the point of comparing 2004, '05, '06, I mean, in those days, I mean in 2005, they built 48,000 pools in Florida. Everybody was just trying to keep up, whether it be manufacturers, distributors or end customers, our customers are very selective in what business they took because they had as much business as they wanted. So again in that environment, pricing was not anywhere near as much of an issue.

And next we have David Mann with Johnson Rice. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: Just taking that last question another step, Manny, can you talk about the Internet as both a threat and an opportunity. And in terms of a threat, how much do you think Internet competition has become a source of some of this price competition in gross margin pressure? And then secondly, how can you use the Internet as a channel to improve your business?

Sure. Internet retailers have been in place in this industry about 15 years. They have grown their sales at a rate a little faster than the industry growth rate and my estimate is that they represent -- or our estimate is that they represent approximately 10% of the equipment sales in the industry. It certainly put pressure on our retail store customers, particularly on products that require little to no installation support. So that's a factor. And in fact, some of the pools that we've made on the equipment side toward private label or exclusive has been motivated by that as a way to protect our customers to give them something that would not be available on the Internet. So that is the factor. I think that is one weighting on overall pricing environment. But if I look at pricing specific to 2012, the area that we have the greatest pressure on overall was chemicals. And chemicals is a -- it's like milk and eggs for a segment of our customer base and those of them involved in retail or service. And therefore, for that customer base, that was a way that primarily a number of our competitors work to or use to attract business. The second factor that's played into our margins was on the -- on certain products, in terms of Internet, probably the biggest impact would be on cleaners and secondarily on heaters. And then to that end, we will look to have exclusive brand offerings that enable us to insulate us a bit from that environment, as well as our insulate our customers from that as well. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: And then in terms of the opportunity for you to use the -- some Internet -- the Internet or Internet customers to drive your business, is there something going on there?

Not really. Our focus is the professional trade. As a value-added distributor, we look to see what we can do for different customer segments. For example, a very significant customer segment in this industry is the mass merchants, whether it be home centers like Home Depot or Lowes or a Walmart, they sell pool chemicals, they sell basic accessories, and they've done that for 40 years. But when we look at serving that customer base and what it takes to serve that customer base and what the opportunities are from a margin and return on capital standpoint, they aren't anywhere as attractive as being a local service provider to the trade where that customer needs to have that inventory when and where he needs it, he needs to have not only 1 or 2 items but a full breadth of items, that customer needs a partner that helps them market to the consumers that are pool owners, our prospective pool owners. That customer needs assistance in terms of technical support, they need tools from a technology standpoint to better run their businesses. So it's that customer base that enables us to add the greatest amount of value. And that value, given our scale and given our investments and best practices enables us to do that progressively more efficiency is what enables us to realize a favorable return. And therefore, that's the key customer segment that we're focused on and that's what really is the key to our results. David M. Mann - Johnson Rice & Company, L.L.C., Research Division: Great. And then one other question on the Green business, can you -- can either of you quantify the EBIT performance of the Green business in '12, how much that improved over '11? And then what kind of base business growth in the Green side do you expect in '13 and similarly, even improvement in '13?

Sure. The Green business, to report, after several years of losses, although last year was almost breakeven, this year had a positive result. The operating margin on that part of the business was approximately 3%. So from a small negative to a positive 3 is a good move. We look for continued improvement there. The performance in that side of the business will be like the Blue business in North America. And by the way, be aware of the fact that it might climb to 7%, going back to Brent's question earlier -- my 5% to 7% also factors in a very challenging environment in Europe where we expect more modest growth. So when you turn to North America, our expectations there are a little better and the Green business will be similar to our North American Blue business in terms of our top line performance and similar operating leverage due to the result in bottom line improvement. And looking for about 3% -- almost 3% operating margin in 2012, closer to 5% in '13.

Next, we have David Mandell of William Blair.

Did you guys provide base business growth in the quarter by the Blue and Green businesses?

Yes, we did. That was in my prepared remarks, David. Our Blue business -- sorry, not for the quarter, we did it for the year. For the quarter our Blue base business was up just a shade under 11% and our Green business was up 17%.

And next we have a follow-up from Brent Rakers of Wunderlich Securities.

I think, Manny, I wanted to -- I think it was Mark who talked about earlier the incremental margins and once you get beyond 2013, there's a feeling that the incrementals will drop back down maybe that 15% to 20% range in the future. Could you maybe articulate a little better why that pace would slow? Is it additional branch opening strategies that would drive that? Or is it are you kind of busting at the seams in terms of existing capacity -- being reaching capacity at some of the facilities? Or maybe just talk me through that real quick.

Sure. We were pretty well set in 2007 for a volume of business that was not quite what it is now but -- and therefore when the market contracted, as you know, we basically stayed the course. And therefore, we had, call it available -- created or available -- capacity was created in the process. We have grown into that capacity over the last 3 years, 4 years and although we improved our best practices and processes in a way that we do more volume to the same box of sorts, there's a certain limit to that. So what will happen, and it's starting to happen a little bit now but more so as we get into '14, '15, '16, is that we will be looking at either moving to larger locations, as well as opening progressively more satellite centers. In fact, in 2012, we opened up 9 locations. And some of that -- well -- and most of those are satellite centers. That was really a reflection of the fact that we were pretty much at saturation at the optimum point of efficiency in our existing location and instead of expanding to a bigger location, in that particular case, we decided to make the investment and open up a satellite center, maybe 0.5 hour away to better serve the walk-in business and thinking that, that was a better way to capture share in the market as opposed to just moving to a bigger box. So that, with it comes as less -- from a contribution margin standpoint, less contribution margin to make those investments over the course of time.

Well it appears that we have no further questions at this time. We'll go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks. Gentlemen?

Mike, thank you very much, and thank you all for listening to our 2012 results conference call. Our next call will be on April 18, when we'll discuss our first quarter 2013 results. Happy Valentine's Day to all. Thank you.

And we thank you, sir, and to Mr. Joslin, for your time. You also have a great day. The conference call has now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you, and take care.