Q3 2022 Pool Corp Earnings Call
[music].
Good day and welcome to the Pool Corporation third quarter 2022 conference call.
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I would now like to turn the conference over to Melanie Hart Chief Financial Officer. Please go ahead.
Welcome to our third quarter 2022 earnings conference call, our discussion comments and responses to questions. Today may include forward looking statements, including management's outlook for 2022 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 from projected results are discussed in our 10-K.
In addition, we may make references to non-GAAP financial measures in our comments a description and reconciliation of our non-GAAP financial measures is included in our press release and posted to our corporate website in our Investor Relations section.
I will now turn the call over to our President and CEO Peter Art Van.
Thank you Melanie and good morning to everyone on the call.
This morning, we were pleased to report another solid quarter for the business net sales, including acquisitions came in at $1 6 billion, a 14% improvement with base business posting a 10% improvement over the same period in 2021.
Our results were fueled by solid demand for non discretionary maintenance and repair products continued new pool construction activity strong renovation and remodel activity and inflation in the 9% to 10% range.
Now that we have closed the third quarter, we are fairly certain that new pool construction activity in 2022 will be down when compared to 2021, we would estimate that new pool construction units. This year will be 10% to 15% less than the previous season as expected remodel activity has tapped into the free capacity of our.
Builders to keep them busy.
From a macro perspective inflation adoption of smart pool products consistent demand for non discretionary maintenance on the installed base of pools and the leveraging of our operating network are all enabling continued share gain and growth.
Now let me provide some specifics on what we have seen in our four largest base business year round markets as expected, Florida continues to be very strong with base business revenue up 20% for the quarter.
Arizona also posted strong results with revenue up 18%, while Texas, and California finished the quarter with solid results up 10% and 16% respectively. Our year round markets grew 15% for the quarter and seasonal markets grew 5% as less favorable weather impacted the billable days and pool.
<unk> in the northern seasonal markets.
Looking at end markets I'm pleased to report that commercial pool product demand remains strong with sales up 28% for the quarter. This is in line with the total year to date growth rate of 27% retail sales, excluding <unk> were up slightly at plus 4%, which reflects some inventory correction.
In the channel and less favorable weather in the seasonal markets.
Looking at Pinchpenny as a stand alone and we continue to be very pleased with the results retail sales through the franchise stores are up 16% over prior year third quarter.
From a product perspective equipment sales growth is solid posting gains of 9% for the period. This category includes pumps heaters light filters and automation chemical sales were up 32% for the quarter as the tricor shortage in inventory issues have abated at this point the only chemical.
<unk> that remain in short supply, our liquid bleach and count Hypo, which are used to shock the swimming pool.
Lastly building material grew 14% in the quarter, reflecting solid demand and a still labor constrained market.
Let me now add some commentary on our European operations that as a reminder, make up about 4% of our total revenue after a tremendous year last year. The teams in Europe have been impacted by less than favorable weather, a very tough economy spiraling energy costs and the war in Ukraine. This is <unk>.
To create a significant headwind for our team as we saw sales declined 24% in the quarter, 11% on a constant currency basis. This follows two solid years of growth in the quarter were combined sales grew approximately 44% in the same quarter.
Horizon team continued to perform well as we posted base business revenue growth of 12% in the quarter, bringing the year to date sales growth to 17%. We continue to expand this platform and remain confident in our ability to grow.
Turning to gross margins for the quarter. Our overall gross margin was 31, 2%, which is a decline of 10 basis points when compared to last year. Generally we are pleased with the stability of our gross margins with a year to date results being a very solid 31, 8%, which is a 140 basis point improvement over prior year.
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From an expense perspective, the team again delivered incredible results, our operating expenses for the quarter were up 17%, which slightly exceeds our revenue growth, but is in line with expectations given the acquisitions, new location and investments in growth from a base business perspective operating expenses were up 8% with revenue.
Up 10% in the period.
You can see clearly that our capacity creation activities continue to deliver value for our customers team and supplier partners alike pool, $3 60, and our other digital platforms continue to grow in the third quarter for 360 sales increased 14% as previously mentioned, we released a new version of <unk> hundred 60. This year are and are in the rollout phases.
Yeah.
As a percentage of our revenue sales through full 360 are at 12%. This is an area that we expect to expand as more and more customers experienced the benefit of using this improved app and other <unk> tools in our Arsenal.
Wrapping up the income statement you will note that our operating income came in at a solid $264 million, which is an 11% increase over the previous year same period operating margins came in at 16, 3% for the quarter with our year to date operating margin at a strong 18, 1%.
Finally, with three full quarters behind us and a favorable outlook for the balance of the year. We are updating our earnings guidance for the full year 2022 to $18 50 per share to $19 <unk> per share excluding the ASU adjustment the range of $18 26 to $18 81 per share.
This represents an incredible 22% improvement at the midpoint on top of a tremendous year in 2021.
As you can see the pool Corp team continues to raise the bar within the industry and deliver very strong results in a dynamic economic environment. The last two and a half years have been both challenging and at the same time to transformative for the industry. No single company was or is better positioned to capitalize on these challenges and opportunities in pool.
The depth of our team our expansive footprint, our strong balance sheet and sheer grit and determination have allowed us to not only gain share but gain efficiencies at the same time.
The industry has transformed as well and is now larger driven by one a higher installed base, which is approximately 6% larger when compared to the 2019 installed base of in ground swimming pools.
Two structural inflation that has increased the size of the industry by approximately 30%.
Cool owners continue to upgrade their equipment pads with new technology as normal repairs are needed and replacements are made this two increases the size of the market as people invest in technologies that make their lives easier and may not have been available when theyre pools were built.
Consider the average age of a pool in North America is around 25 years old with about half of those pools operating with little to no automation or modern features.
Clearly the jump in new pool construction activity in 2020 in 2021 helped drive our growth at the same time, however, the non discretionary maintenance and increasing content on the replacement items as well as the structural inflation on the growing installed base have allowed us to grow this year. Despite the fact that new pool construction.
Activity may be down from the previous year by as much as 15%.
With the announced inflation from the major equipment manufacturers in the 4% to 5% range for 2023, we expect this to mitigate potential declines in new pool construction and a less robust renovation market should those market conditions occur. Additionally, we are confident that the strategic investments that we made with the acquisition of corpus.
Pool, and patio to improve our value proposition for the retail and DIY segment that we serve through our thousands of independent retailer customers will drive continued growth.
We also continue to expand the number of Pinchpenny franchise locations in the sunbelt markets, gaining an even stronger foothold in key year round markets as we added seven franchised locations. This year with more in development for next year. This.
This acquisition also brought us a strategic capabilities and chemical packaging, making us more vertically integrated and improving our margins and capabilities.
We further gained incredible customer technology platforms and applications that we intend to leverage across our entire business to grow our independent retailers customers businesses.
We have remained disciplined in our capital allocation, maintaining a leverage ratio well below the one five to two times target that we have historically observed.
And we have returned $572 million to our shareholders. This past year in the form of share buybacks and increased dividends.
Our industry is somewhat unique given the high recurring revenue nature of the business.
We also enjoy a market leading position expanding capabilities and an unmatched track record.
While no one is certain about what challenges we will face in the future. We can be certain that we will rise to the occasion our mix of business is most heavily weighted on non discretionary spending and we provide best in class service and value for our customers. Additionally, we do not believe that inflation across most of our product categories will revert to previous levels as this would be.
Unprecedented and not sustainable given the historic cost increases that our manufacturer partners have absorbed thank you and I will now turn the call over to Melanie Hart, Our Vice President and Chief Financial Officer for her commentary.
You Pete and good morning, everyone third quarter finished with a record $1 6 billion in sales representing 14% growth over the 24% growth realized in 2021 for a two year cumulative increase of 42%.
In comparing the quarterly growth of 14% to the full year expectations of 17% to 19%, we saw third quarter growth of approximately 10% on pricing or percent on acquisitions and net overall domestic volume growth. This was offset by unfavorable impact of 1% each for Europe operation.
Foreign currency and one less selling day in the quarter. We also had some sales center closure during hurricane and so it was the last few days of the quarter historically big weather events have resulted in short term disruption with a slight positive impact in the subsequent quarters.
Gross margins at 31, 2% came in slightly below prior year margins of 31, 3% base business margin decreased 80 basis points over prior year, where we saw a 250 basis point increase in the third quarter 2021 over 2020 level.
<unk> pricing efforts supply chain initiatives and product mix, all contributed to sustaining higher margin levels during the quarter as prior year benefited from our strong ability to pass through price as we saw multiple in season price increases from our vendors.
Base business operating expenses as a percentage of net sales decreased from 14, 5% in prior year to 14, 2% as our capacity creation efforts continue delivering operating margin leverage as we manage through the inflationary cost impact of our business.
Acquisitions added $20 million in expenses during the third quarter compared to last year.
Our quarterly operating margins remained strong at 16, 3%, we continue to invest in growth strategies, while being focused on our disciplined expense management.
Interest expense for the quarter increased $9 4 million as we have higher debt levels compared to the same time last year, reflecting our investments in acquisition share buyback and working capital our average interest rate increased from two 8% to three 2%, reflecting higher borrowing costs. We continue.
To maintain a conservative trailing four quarter leverage ratio of one to five fell well below our target leverage range of one five to two times.
For the quarter, we recorded an ASU benefit of $1 6 million or <unk> <unk> per diluted share the same quarter last year had a higher level of activity, resulting in a $4 2 million or 10 cents per diluted share benefit with our current stock price. We estimate that we would recognize approximately <unk> an additional benefit.
<unk> in either the fourth quarter 2022, or the first quarter 2023 remaining options that expire in first quarter 2023.
The effective tax rate, excluding <unk> issue for the quarter was 24, 9% compared to 23, 2% for the prior year period, consistent with our historically slightly lower rate in third quarter than for the full year.
Net income for the quarter represents an improvement of $5 4 million, excluding the ASU. It reflects an improvement of $9 million or 5% driven by revenue growth healthy gross margins and continued strong execution.
This resulted in a 7% earnings per share growth, excluding the ASU in both periods.
Moving into our balance sheet and cash flow discussion.
Accounts receivable increased consistent with sales growth compared to last year days sales outstanding finished the quarter at 27 days, a slight improvement when compared to more historical levels that were in the 28 to 30 day range.
Inventory increased to $1 5 billion compared to slightly over 1 billion in Q3 2021.
We have seen incremental growth in inventory year over year decrease from 77% at second quarter to 48% or 43% base business as we wrapped up third quarter.
Approximately $140 million of a year over year increase relates to inflation $52 million was added to support acquisitions and $13 million for the five new U S locations that were not open in third quarter of last year.
We have realized strong returns from our investments in inventory and supply chain initiatives and the value of the inventory on hand will continue to provide incremental gross margin benefits as we have seen additional vendor cost increases in the 4% to 5% range heading into next season.
During the fourth quarter 2022, and first quarter 2023, we expect to begin receiving inventory placed on early by terms consistent with 2019 in prior years to prepare for the upcoming season.
Our resulting inventory balances at year end will vary depending upon the timing of shipments as those orders by the vendors. However, any orders placed on early buys have all been strategically evaluated.
We have reduced the dollar value of <unk> by approximately 60% from peak levels as lead times have improved from vendors.
Year to date cash flow from operations was $307 million compared to $359 million in 2021. The increase in net income of $134 million was offset by increases in working capital.
Recall that 2022 cash flow also reflects $80 million of income tax payments that we deferred from 2021 as a result of hurricane either.
In the fourth quarter 2021, we continue to add to base business inventory and so this year in the fourth quarter, we would expect to generate more cash as the number of our inventory receipts expected in fourth quarter will include extended early by payment terms, we anticipate finishing the year with solid adjusted cash flows around eight.
Percent of net income, excluding the either tax payment well positioned to benefit from inventory investment going into 2023.
Our inventory balance at year end could range from plus 10% to plus 25% depending on the timing of vendor early buy shipments. This is slightly ahead of the plus 5% we were expecting earlier in the year before we had the opportunity to evaluate the early buys.
We have paid $112 million to date in dividends to shareholders of 27, and a half increase over last year of three third quarter. Additionally, we have purchased $192 million worth of shares on the open market during the quarter for a total of $461 million year to date and have $230 million available under our current authorization.
Leverage at the end of third quarter was $1 two five times and is well managed within our stated capital allocation model, while investing first in the working capital of the business and providing strong returns to our shareholders, we expect to be at or below our target range at the end of the year.
As we look out for the balance of the year with just the fourth quarter remaining we still expect our sales growth to range from 17% to 19%, reflecting a 5% contribution from acquisitions and 10% from inflation, we are not expecting Europe to recover during the remainder of the year. So project that to be a 1% drag on the full year with.
An additional 1% from foreign currency.
Whether in the extent of repair activity that takes place in the Florida area May impact, how we close out the year.
Inflation impacts for fourth quarter are expected to be approximately 8% compared to the 10% for the full year.
Selling days for fourth quarter, and the full year will be the same as last year.
As we lap the 260 basis point gross margin improvements realized in fourth quarter 2021, we would expect gross margins in the fourth quarter to decline sequentially due to seasonal timing and also be negatively impacted by lower inflation from vendor price increases this year in the fourth quarter compared to last year and lower incentive.
Earned under our volume based vendor programs.
Resulting in 150 to 200 basis points decline in Q4 gross margins compared to last year.
Focus mainly on full year gross margins and we will finish the year up from prior year.
Considering future expected rate increases during the balance of the year and a higher borrowing levels interest expense for the fourth quarter is expected to be significantly higher than last year, resulting in interest expense for the year of $43 million to $44 million.
But from our previously estimated $40 million.
With our overall capital allocation, we have a conservative position on debt management and currently have in place $300 million or 20% of our outstanding debt covered under interest rate swap agreement that convert our line of credit debt to fixed rates that are currently below market rates.
Integrating the full impact of our debt exposure to rising interest rates.
The share repurchase activity during the year reduced overall share that standing and we expect full year weighted average diluted shares to be approximately $41 million, including participating securities.
Any further share repurchase activity in the fourth quarter is not expected to have an impact on our share forecast for the year based on the time remaining in the year.
We have narrowed our earnings guidance range and reflected the additional ASU benefits recorded during third quarter. This brings our guidance range for the year to $18 50 to $19 five.
Including the <unk> ASU tax benefit added in the quarter for 24 year to date.
This represents expected earnings per share growth of 20% to 24%, excluding the impact of ASU benefit.
As mentioned above the impact from expiring options and first quarter will be expected to provide a <unk> <unk> benefit. However, timing is uncertain and thats not considered in the guidance range for Q4, but will be included in the 2023 guidance for any unexercised amounts as of year end.
As we wrap up another successful full season, we are extremely proud of the hard work. The team has done to continue to grow the industry and we look forward to finishing the year strong.
We will now begin our Q&A session.
We will now begin the question and answer session.
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At this time, we will pause momentarily to assemble our roster. Thank you.
Yeah.
Our first question is coming from David Manthey from Baird. David. Please go ahead.
Yes. Thank you good morning, everyone. Good morning.
First off Melanie I think you just said that the fourth quarter gross margin would be somewhere in the 29.
You did say that you are focused on the annual amount I just wanted to gauge your current confidence.
In that prior view about holding the line on a 30% annual gross margin in 2023 and beyond.
Yes, so certainly our long term guidance, we still hold to that and we will reiterate that when we give our 2023 guidance in February .
You look back at our quarterly the impacts of the margin quarter over quarter fourth quarter, certainly is historically less than some of the quarters within season, because we have the ability within season, our customers are typically not as price sensitive.
So the decline in margin going from third quarter to fourth quarter.
Is consistent with what we historically would have expected.
Right Okay.
Then as a follow up.
How should we think about earnings leverage in the model I mean, you've had years of successful capacity creation and this recent inflation, taking things to a higher price level.
Now your operating margins at least this year are probably shake out in the 17 range will contribution margins in the future B B.
The higher than the mid to upper teens level, you've typically seen in the past.
Just trying to understand earnings leverage from this point given contribution margins versus reported margins.
Yeah. So as we take a look at just kind of our operating model and our expense leverage.
As we've seen over the last two years, we've certainly seen higher levels of sales growth.
With that we've seen.
Lower than those the sales growth on expenses, but certainly growth.
And so as we continue to look forward from a long term standpoint.
We would always expect that we would grow expenses less than the overall sales growth and so I do believe that within our model. We have many types of expenses that are variable and flexible based on volume and so we do still believe that we have some ability to to maintain our current operating margins and to continue to grow those.
Long term with sales growth.
Got it thank you so much.
Our next question is coming from Ryan Merkel from William Blair.
Brian . Please go ahead.
Hey, good morning, everyone and thanks for taking the question good morning.
First off can you just talk about volume growth.
Through the quarter and into October and really what I'm driving at is are you seeing any signs of weakness anywhere in your business.
Yeah.
Good question, Ryan as we said.
We are.
Forecasting at this point that new pool construction is going to be down as I said in the in the 10% to 15% range.
A little bit the shoulders of the year as you know are the the time that are most affected by weather.
It may be.
At the higher end of the declined if weather closes up sooner and maybe a little bit better if.
The seasonal weather stays buildable I guess, what I would say is that when I look at volumes considering the decline in new pool construction.
When you look at what we what we posted for the quarter.
I'm actually pretty.
I'm pretty happy with the fact that volumes are holding up and then remember theyre holding up off of an elevated level.
Compared to where we have historically grown and that's partially because the installed base is growing partially because we believed that there was some pent up demand in in renovation.
And it is offsetting a decline in new pool construction, so on balance to.
To say that new pool construction is going to be off it.
Likely at least double digits. The fact that volumes are still.
Flattish.
<unk> is actually a pretty good position we think.
Yeah, I agree can I follow up on that new pool comment.
Is that down 10 to 15 is that in units or dollars and then another question is I thought they were backlogs out there. So I'm a little surprised right that we're seeing this kind of dip here.
What I would say is that the.
It is for your first question is it is in units.
And dollars will be higher of course, because of the structural inflation and I think the backlog really are you really have to kind of take that apart. So first of all.
<unk> had a slow start to the season, especially in the northern climates, where builders got a got a late start.
So they got less pools in the ground and as you know when you lose those days early on you typically don't get those back I think that.
The builders would tell you that there is they are.
Seeing more pressure in the seasonal markets in the year round markets. I think are are in better shape and I think higher end pools tend to be in better shape than the than the lower end pools I think.
A pullback will be skewed in my mind to the lower end pools. The higher end pools I think are in good shape. So if you look across our customer base I think there is.
And adequate.
Backlog is it as high as it was last year no.
But I think given the given the state of the economy.
I think that there is plenty of work out there exactly how many again, we're we still have almost no quarter to go. So we're we're estimating the minus 10 to minus 15, but I.
I think most builders would tell you that the frenzy has died off but there's still plenty of work out there.
Okay. That's helpful. And then just lastly, I wanted to ask a high level question. That's on everyone's mind. So we've got a situation we've got rising rates slowing housing market.
Really Pete I, just want your high level views on how to think about each segment of your business.
Over the next couple of quarter, so maintenance upgrade Reno and new pools, how do you see that trending in this environment.
Yeah. Good question, if you look at our if you look at the new.
Let's let's start with the maintenance and repair of the installed base of pools historically that segment.
Has has grown with the installed base.
Inflation, because as you know and we've said it many times once you have a pool you have to move the water filter the water and treat the water.
You are using it seven days, a week or whether youre using it two days a week those those activities have to happen. So we would consider that that portion of the business, which has historically been the norm that that part of the business is going to continue to grow as the installed base of pools grows.
New pool construction, we think is going to be down this year as we said and I think we started the year, saying we felt based on input from our dealers that there was a backlog in renovation and remodel projects that people were waiting to have done as the builders focus on new pool construction.
I think that portion of the business is.
Held up well and I think has benefited from the available labor as evidenced by the fact that even with new pool construction down volumes are still flattish.
So we like that and I would tell you that the new pool construction.
Is down this year could it be down next year.
Oppose it could I mean, we're certainly not not forecasting that Ryan, but I guess, when we think about it from a macro perspective, new pool construction makes up roughly 20% of our business.
Renovation and remodel make up roughly 20% of the business and the balance is the maintenance and repair the 60% that continues to grow so really.
We're certainly not forecasting to this but let's say new pool construction fell another 20% next year, if new pool construction fall, 20%, that's 20% of 20%. So that's 4% of revenue and if you said while that same that same pain would be felt broadly across the renovation.
Market.
20% low 20% as an additional four and then if you take the inflation, which from the major equipment guys is already been announced in the 4% to 5% range and I think.
If you look across.
Our portfolio in total that's probably a good number to look at if you look at plus four to five on the <unk>.
60% of the business so that gives you.
A minus one.
Our a plus one there right and then a plus one net right because you are up five minus four so.
So even with a 20% I mean to be conservative if those two markets are down 20% I think youre still looking at a flattish sales number.
Our next question comes from Susan Mcclary from Goldman Sachs. Susan. Please go ahead.
Thank you and good morning, everyone.
Morning, Mike.
My first question is I wanted to follow up a little bit about the inflation point you made the comment that you see the $4 to 5% for next year can you talk about the sources of those inflationary items.
How we should think about them going forward and how we should think about that relative to perhaps some commodities or some other areas that may deflate on a relative basis next year.
Sure.
Good question. So the four 4% to 5% that's really that's kind of a composite number that we see assembling from the from the major equipment folks right, which.
Which is a very very big the biggest part of our business.
In total.
Pure commodity things like.
Rebar and PVC pipe to some degree.
Do I think that there could be.
More more deflation on those items there could be I mean, there's so many factors that go into that but when I look at those items in total our exposure in terms of dollars to those items is relatively small because theres just not in.
In the Grand scheme of things and not a whole lot of dollars associated with that and if you move into another category that somewhat consider more commodity like would be chemicals.
<unk> got <unk> got really three different parts of the chemical business right you've got the three inch tab.
A portion of the business right. So the two biggest parts of your of chemicals are going to be the tricolore tablets.
And.
I would say that given the given the inflation that we saw this year.
The tariffs that are in place the additional supply that's coming on next year I mean, we're not at this point, we've not put a forecast together for chemicals for next year, but is it conceivable that we could see some decline on that portion of the business.
Which makes up let's call it.
Third ish of our chemical spend could there be some decline there, yes, but youre talking about.
2% two to two 5% of our overall business. So even if that were to decline.
10%, 15% Youre still talking.
A very small impact overall, yes next biggest part of chemicals is going to be your shock right. So chlorine at Cal Hypo and frankly, both of those are still net short.
I don't really see prices in that area doing anything, but probably going up and then there are some specialty chemicals, which makes which would make up the balance and I think that pricing will be will be fairly solid in those areas, but that from a from a very high level, that's kind of how we think about it.
Okay.
Very helpful color.
I also wanted to dig into the balance sheet, a little bit can you talk about inventory, how youre thinking of the ability to work through that as we get to the end of this year and then into next year and perhaps with that too just in general as we move to this sort of newer macro environment that we may be in over the next couple of quarters, how youre thinking about.
The balance sheet and leverage and the relative opportunities there.
Yes, so as I mentioned, when we took a look at all of the early buy opportunities.
We evaluated it down on an individual location standpoint, and by SKU. So we knew what we were buying when we place those purchase orders and so we're very comfortable with the <unk> that we've executed on the early buys and that we've done so to position ourselves as we go into 2023 to ensure that we have some margin benefit.
So very comfortable with that as we move into the fourth quarter and first quarter.
You look at the inventory that we have on hand, we probably have about three weeks more than we normally would have and kind of ordinary supply environment.
And so when you roll forward to kind of at the end of Q Q1, typically that would be our peak inventory period as we prepare for the second quarter and the increases in sales for the second quarter.
And so based on our projected purchases between now and then.
We would expect that our inventory would normalize over the next couple of quarters as we come out of second quarter next year.
Okay. Thank you that's very helpful and good luck.
Okay.
Our next question is coming from Andrew Carter from Stifel.
Andrew Please go ahead.
Hey, Thanks, Good morning, So I appreciate the commentary Pete you walked us through on the different business lines and almost putting out almost a worst case scenario down one in that kind of scenario what would be your flex at the SG&A level I mean would the gross margin be higher than your 30% could you kind of could you kind of help us what the what it takes across the <unk>.
<unk> are that would help you mitigate some of that kind of sales decline.
Yeah, So gross margins will be better positioned to be able to provide a little bit more color on that when we talk again in February but as we look at the expense line item, we've already talked about specifically, we've called out incentive compensation is one of the areas over the last two years with our higher than historical growth.
Although we've seen some increases in there and so we talked about that moderating on a normal growth year from a 6% to 8%.
But if sales expectations are lower than that we would have some additional amount of.
Additional ability to flex that but really outside of just the incentive compensation.
There are several areas when you look at the overall contributions to our expense line.
The biggest expense is really in the people area and so where we are from a staffing standpoint with the 17% to 19% growth that we have this year.
Certainly added some temporary and encourage and overtime expenses that.
In a time, where sales would not be growing as they are this year, we would have the ability to flex that as well and then really kind of after those two components. There's just many of the natural items and as it relates to delivery expenses.
And even discretionary expenses when you start getting into travel and entertainment.
I think that when we looked at kind of our expectations and the expense flex that we did in 2020 to me is just kind of a good model to show that we do have the ability to take some of those discretionary expenses out of the business.
Thanks.
Second question.
That I would ask us there going on too.
Yeah.
Thinking about kind of your branch network and kind of your managers what they can do in terms of I mean, you just said it earlier you went through everything how quickly are they able to adjust and how quickly are they able to say hey, I don't want to Miss sales in this environment and why the tradeoff between that and.
Too much staffing too much whatever and then having where salesforce profits how quickly can you make that transition and and and how are they incentivized at the local level to make the correct decision there.
Yeah.
Introduce what I, Here's I would say we have we have.
Very fortunate to have very experienced operators that have been through many cycles. So if you look at our if you look at our management team really all the way down to the branch level.
Very very experienced years' of experience when you look at our the depth of experience that our general manager level and our regional manager level.
Some degrees of sales center manager level, we've been we've been developing the team for many many years. So this is not a.
This is not a new thing for them they've been through the cycles. So they understand the trade offs on on.
Expenses, you know they don't they don't typically wait and say well I'll wait if it if things look like they're going to they're going to cool.
They have a the experience and frankly every incentive.
With basically the pool Corp system. The operating system is a total add them up the way that the whole company and frankly the way Melanie are measured it really is that same way all the way down to the individual P&L level. So there is no incentive for them to be late there is no incentive for them not to capitalize on our sales opera.
<unk> and the flip side is there is no incentive for them to wait and say Wow things are going to cool off I'll.
I'll just carry this incremental expense because I don't know that I did I need I mean, the operating model is time tested and well thought out and it is executed by a very experienced team. So if and again, we're not we're not suggesting that the environment next year is going to be.
Bad frankly, we don't know at this point, but are we prepared for.
Any any occurrence so as I said, we I kind of gave you a worst case model from a from a revenue perspective, if new construction, where there were two really.
Drop off again, which basically would take you back to 2019 levels.
If that were to happen.
And the renovations followed the topline sell then as Melanie mentioned there are numerous areas that we would see immediate benefits from an SG&A perspective, whether it's people, whether it's incentive comp whether it is transportation trucks.
You name it the model will the model will flex almost immediately with those.
Thanks, I'll pass it on.
We have now a question from David Macgregor from Longbow Research.
Please go ahead David.
Yes, good morning, everyone and thanks for taking the question I guess, just again thinking about 2023, how much of a drag on horizon <unk> Europe .
I think if you look at Europe , we said that it is.
4% of the business overall right and it is having a very tough year. This year. So I mean, if things get sequentially worse again, and they're off another 25% you are talking about.
1% right.
I think about horizon.
In terms of their size their footprint and where they are they're going to be slightly there'll be slightly bigger than that but I also think that given.
The areas that we are building in horizon, because again, when I think about the economy in general.
And housing specifically, which obviously is more important the housing market is more important to the horizon folks then it would be.
Blue a couple of things to consider number one is over time, we have been working to expand the <unk>.
Maintenance and repair portion of our business and horizon. So that it is not so fully dependent on new construction now clearly in that business new construction is important but when I when I look at it in terms of.
The impact in total I mean, youre talking about a business that is less than 10% of our total I think we've been moving more and more of that business focus to the maintenance and repair piece, which should mitigate.
A cooling off in new construction number one and number two we've invested in the markets that even if there is a cooling.
Those markets are still going to be good Florida is still going to be good. So we've invested in growth in Florida. The Carolinas that the housing market. There are still are still good. So I mean, I look at it and say could there be a drag if theres a catastrophic drop in those areas, yes, but given their.
Tivoli small percentage of our total I don't think it's going to be a.
A terribly meaningful impact.
Okay. Thanks for addressing that.
Question is really around.
Corpus pool in patio, and the acquisition and just how youre thinking about accretion next year and I guess I'm wondering it's kind of at a higher level.
If you are a pool owners that are feeling kind of economic pressure do they switch from having a pro maintain their pool going DIY and if so does that create.
Maybe.
A stronger sense of optimism around what that accretion might look like next year.
Yes.
I think that I think that is something that could very well happen now obviously.
We're not providing guidance on next.
Next year at this point, but if I just think thematic Lee about it. So yes, so conceivably if the economy slows and you have homeowners that are making a decision that says well you know what I'd, rather just take on the maintenance and repair of the pool myself.
Frankly that was part of the reason for the strategic reason for the acquisition of Pinchpenny are purposeful and patio is that.
They have they have great retail.
Great retail network.
That the franchisees operate and embedded in that are some great tools and capabilities that we can now leverage for the independents. So I think looking forward. If there is a switch from.
<unk>.
Professionally maintained to DIY.
I don't think anybody is better positioned to capitalize on that and quite frankly.
The way we look at it is the customer is the pool right. So what we're focused on so we know where every pool is in the country and what we're focused on is from a market share perspective and from a service perspective is alright. If the pool is of homeowner wants to do with DIY. Great. Then we want to make sure that we are working with.
A retailer or a franchise.
<unk> franchises I E that is catering to that part of the geography, where that pool is so that we're best positioned to.
To continue to gain <unk> to grow in share and provide the equipment.
In chemicals and supplies needed to maintain that pool.
Great. Thanks Pete.
Our next question is coming from Trey Grooms from Stephens, Inc.
You May proceed.
Thanks. This is actually normal accounts go on for Trey.
My first question I wanted to touch on commercial demand.
It's a small part of your business, but it sounds like that's still an area for growth as you look out over the next few quarters do you think that's a and.
In end market that continue to show growth and can you just remind us how much of the business that is.
Yes, it's about I think in total it's in the 4% to 5% range.
And.
That business is is remember went through a really tough spot during COVID-19 right when people start traveling again.
People are back to traveling there back to vacation. So there is a considerable amount of money being spent in those areas as evidenced by our sales growth rate. So we were up 28% for the year.
Project deck that we get to look at because remember theres two parts of that business right. There is the.
There is the <unk>.
Project right new construction major renovation those are that's typically a bid and spec they're larger many times municipal projects. So there's a lot of visibility to those so we get a pretty good look at the pipeline of that and I can tell you that the pipeline is very healthy in that area and then theres, just the maintenance and repair thats tied to <unk>.
Using Av.
Of those pools and given the fact that.
Travel the travel season this year was very good.
We don't really see that letting up.
That all that much anytime soon.
And the fact that it's a relatively small part of the business when I look at it.
That there is upside there.
Is it is it tremendously going to reshape our future no, but I am encouraged by the by our ability to continue to grow.
Take share in that market as well.
Thanks, That's helpful. And then just for my follow up you know if we if we think about that you know.
Pretty conservative case.
You made for demand next year for for new pool construction and renovation if that were to take place does that change your appetite at all for M&A.
No not at all really.
We were very strategic acquirer, if you look historically back on the acquisitions that we made.
We have.
We have been very.
And judicious and also strategic so am I willing to overpay for an asset and the answer is absolutely not and the reason is is because in most cases those acquisitions. We don't we're not in a position where we have to overpay for every for anything because in frankly in most markets were already there. So it is.
Perhaps some additional capacity that we would be picking up.
And some additional business and then a synergy opportunity on the on the back side, but.
When asset prices.
Inflated, we get the choice to sit back and say am I willing to pay an inflated price for an asset that I, probably don't really need to acquire because if I need additional capacity we have the.
The muscle memory, if you will and the capabilities to Greenfield very quickly. So this year, we're going to open up.
Approximately 10, new Greenfields next year, we're looking at a similar number of Greenfields.
If I if I made an acquisition in in some markets that I had.
Teed up for Greenfield might that change.
Appetite to Greenfield if there was something that made sense strategically from a business perspective and from a cultural perspective, because that was one of the other things that we look at when we do acquisitions is what is the culture that we're acquiring.
Because we have a very good culture in the company and there has to be a fit there. So I think we have we have an appetite we certainly have the balance sheet to do it we have a strategic plan that is really done at an individual MSA area. So if.
Good assets become available and.
There.
Our value perspective. It makes sense then absolutely we would move forward. The flip side is that if we needed additional capacity in an area. There was no asset that made sense to acquire than we would simply do what we've always done and that is greenfield and we can do that relatively quickly and if you look at our our success rate with with <unk>.
Greenfields. It is it is just tremendous.
That makes sense I'll leave it there thank you.
Yeah.
And we have a question now from Jill all of US Meyer from Deutsche Bank. Please go ahead Joe.
Okay.
Joe.
Go ahead Joe.
Yes can you hear me, yes, Sir.
Okay, sorry about that yes, I'd like to go back to the gross margin guide for <unk>, if I could I think it might be helpful.
Okay.
I'm, sorry, you're breaking up a little bit thought I can't hear your question.
Okay I'll take it offline.
Okay, sorry about that.
Okay, we'll move on with US Stephen Volkmann from Jefferies. Please go ahead Steven.
Great Hi, guys Im here.
Most of my questions have been answered actually but I was just hoping you could maybe explain to me a little bit how.
Sort of the vendor rebates work and I guess I'm trying to figure out I assume theyre, probably volume related rather than price related.
So if we had.
Maybe a base case of sort of flat volumes next year, what would be how should we think about the headwind from vendor rebates.
Yes, so the majority the vast majority of all of our programs are volume related and so they also do reset every year and with typically having targets in there for growth target. So in the years, where we've had kind of a higher than normal purchases and sales growth. We typically will benefit from that on the.
The vendor rebate a portion of our gross margin.
Right I guess, that's where I'm going because I'm, assuming you benefited from that over the past couple of years and maybe as we normalize you won't going forward I'm, just trying to figure out what kind of headwind that might be.
Yes, we can we can take a look at that and maybe provide some more comments commentary in February as we look at kind of our because it's really it is going to be tied to our sales expectations.
So what we think that impact might be going into next year.
The programs are negotiated on an individual basis and we're just in that process right now so hard for us to quantify that because again, we haven't we haven't guided from a from a revenue and volume perspective, and the programs are still are still in flux, but I mean.
Rest assured this is part of this is part of normal business practice for US there are some years, obviously that that vendor rebates are better and it.
Than others and it really depends on the individual vendor.
And how the programs are constructive, but we'll have we'll have more color for that when we provide our full year guidance.
Into for next year, but I can tell you that it's contemplated in our long term guidance, which is really the way that we would we would ask you to think about it.
Understood. Okay. Thanks, and then maybe a quick follow up Pete I think you mentioned in your comments that retail was up 4%, but pinch opinion was up 16%, it's a pretty big difference, what's what's driving the pinchpenny growth.
I think as we mentioned, we certainly have some great retailers.
In our traditional independent retail business I think if you look at our retail business from a geographic perspective, it would be very similar right.
He is a great operator, we certainly have great operators that perform equally as well, but I would also tell you look at the footprint that were Pinchpenny operates its primarily Florida, Texas, Louisiana and.
Our location in Georgia.
As compared to our entire retail basket, which goes all the way up into the seasonal markets, which as you know.
At a much tougher year given the late start to the season. They are a large early buys that they made hence my comment on on.
Inventory correction.
We have a question from Ken Zenner from Keybanc. Please go ahead.
Just good morning to you guys. How are you good how are you.
Well.
Melanie the interest expense I believe you said $17 million in <unk> <unk>.
Implied.
I'm sorry go ahead finish up your question.
Okay.
Interest expense you said 43 for the year. If my model is correct that implies roughly $17 million in the fourth quarter is that correct, yes, that's correct.
And should we annualize that so were $68 million next year.
Again, we'll provide a little bit more color on that two things on that.
We are at higher inventory levels.
And so we would not expect for the full year of next year that we will be carrying a debt at the same level that we have currently.
Okay.
But obviously even sequentially it was a pick up.
In terms of Peter you talked about valuations and your ability to do greenfields et cetera, et cetera could you maybe give us some parameters.
How you think about valuation in this space for EBITDA, you would be the sales if you would within the context of deals you guys have done.
Yes.
<unk>.
They have been.
Hey, Pat.
Hi, traditionally I would tell you that valuations in industrial retail and industrial distribution.
<unk>.
Four.
A good business youre talking about multiples.
A multiple that would traditionally have been in the 5% to 7% range or five to seven times range.
What we've seen in the last year with the frenzy of capital coming into the spaces, we've seen some.
We would consider just crazy numbers being paid and again.
<unk> of not having to par.
Participate.
What we would consider.
The valuations so traditionally for us.
5% to seven times is what we have seen.
And from a Greenfield perspective.
<unk> really on a case by case basis, but we can typically greenfield.
Four.
At least a couple of turns or more below that.
Yes, I was just kind of taking a look back obviously the stocks had a large decline of which by our estimates.
A good chunk of that 60, 70% devaluation, right, so that which youre kind of referring to you in the broader market.
Great.
Yes.
Revenue at or if you will of 60%.
Discretionary new whether its down 10 25.
It doesn't seem to be thats the issue.
In terms of what is in investor's mind, so much as much as perhaps the.
And I know you guys went over this at your at the Analyst day, and Melanie that you talked about the gross margin just recently, a 30% perhaps but.
But I mean, it seems to be that margin, it's really the big mover.
For this evaluation is quite a bit lower for the group.
Yes.
At the analyst day that you guys did a very good job outlining why you think the dramatic margin expansion.
This sustainable could.
Could you maybe talk to your understanding of how you've obviously gained a lot of share.
Other companies have talked about down volumes can you talk about perhaps how the competitive landscape might.
We do get these but I don't know if its worst case scenario, but what are you kind of laid out how do you think smaller operators, what's your experience with how smaller operators respond to.
Kind of a draconian demand world versus in terms of the margins.
First you guys.
Just so we can understand how the competitive landscape might shift if demand does decline significantly.
Yes, certainly win.
In very tough operating conditions when cash is a big issue then the ability for the smaller guys to be able to maintain inventory and maintain the service that the customers have become accustomed to become a challenge and typically in those markets the bigger.
Sure.
There are bigger players.
10 to get stronger because we have far more resources.
We bring to bear to continue to provide exceptional customer service that I think has allowed us to take share and again.
Certainly don't want to overplay the.
The draconian what could happen, but it seems that theres a lot of concern in the market that says Wow.
Pool construction went way up and it's going to go down in the numbers that we picked basically.
Would take you back to a new pool construction number similar to where we were pre.
Pre pandemic, but I think the part that is worth mentioning again is the fact that the industry is structurally larger now so it's not like we're depending on and hoping that well new pool construction is going to continue at this elevated level look if Newport construction is flat next year or up a couple.
<unk> 10, or minus 10, or minus 15, again, we kind of or.
Or even minus 20, we kind of outlined what that means for the business, but at the same time you have to consider.
That the industry is structurally bigger because of the because of the inflation now when your expenses are going up and business is slowing down certainly you have the smaller players are the first ones to feel the pinch.
And they are the ones that have.
The least capital reserves in order to continue to provide the level of service that they had been providing so our expectation would be if history were to repeat that in a market like that that you were larger players like us would do better.
Right and you wouldn't see discounting similar to your old roofing industry, perhaps where.
They would go for cash flow.
Create extra pressure as they liquidate their inventory, yes. So your gross margins were fairly stable in those seven I mean, you did 27, 5%.
One from 'twenty three kind of in that.
Getting compressed so much back then your gross margins right and very very good point. So look we have to compete in individual markets right. So we don't we certainly don't have a national price on everything we compete in individual markets. If there was an independent.
Decided that they needed cash and had a lot of a particular product that they wanted to.
Drop the price on to try and grab some immediate revenue to generate some cash flow could that happen absolutely.
And but the way we would look at that is there is a finite amount of product out there. They can't do that for a very long because none of these players are very large so might they discount.
I might say discounts of excess inventory if they have it in order to raise cash yes, but you are talking about a de minimis amount of product in the Grand scheme of things frankly, we compete we compete with that all day every day anyway. So.
If you look at the operating margins of our competitors and obviously through all the years of acquisitions, we've seen a lot of the.
Yes.
<unk> of these guys there isn't a whole lot of room, there to do anything on a sustained basis, it's not like they were.
We're operating at high double digit margins and they can say well lets discount.
And frankly, it doesn't really change the demand curve right and right cost on inventory is is high there isn't there frankly is an opportunity over the long term to do anything in regards to that.
Alright, guys are tight enough that they simply don't have the.
The checkbook to say well I'll, just I'll take it on the Chin.
Alright, they can't whether it is I apologize about pursuing this line of questioning.
With you, but I mean your margins in <unk> were about.
$5 six were about 9% they fell to about 6% would you say those margin ranges are consistent with the comments you made about.
Competitors given the environment.
Hey.
Tough question to answer I can tell you I've seen much worse than that.
Thank you very much.
We have a question from Gary Smalley.
<unk> from loop capital.
Eric go ahead.
Oh, hi, thanks, Thanks for squeezing me in I'll try to be brief here just on the comment that you made the contract terms are switching more to renovation work.
Some of the new construction has slowed so should we read into this that backlogs on the renovation side are still strong and the outlook. There is still quite good into next year I'm just trying to.
Maybe kind of bridge that with maybe an earlier comment when you were trying to provide some sensitivities have the renovation work relative to new construction in 'twenty three.
Yes, I mean the.
Yes.
Information that we're getting from dealers right now is that they still have plenty of work right. So I can tell you. We believe as I said, new construction is going to be down. So you can see that our volumes are flattish and frankly, if you look at the seasonal markets as I mentioned versus the year round markets, you see a pretty big dip.
So the year round markets Sunbelt markets.
Where we saw growth in population and where people are moving those markets are still very strong as we mentioned, Florida was up 20, which is obviously way more than <unk>.
Way more than inflation for the for the year, Texas is up California, Arizona, the big year round markets are up so our conclusion is that we are.
Pools are being built.
Still strong in those areas, although permits are down.
Still pools being built in those areas and renovations in those markets.
The demand there is still strong as evidenced by what we're seeing from a from a revenue perspective.
Okay. Thanks for that follow up question is just if you could speak a little bit too.
And if theres been any recent evidence at all.
Or any trade down or if it's.
You haven't seen that just yet.
Yes, I don't think we've seen that in fact, we don't know for sure because the year is still is not complete and once a year gets wrapped up and we have some more.
Forensics on the on the construction account.
Such.
Sure.
What I think is happening is youre, not really seeing trade down at the component level because it is a component level. It really is de minimis for something that is a longer term investment right. So if I'm buying a pump and it's going to last seven to 10 years I don't know that you see people, saying I'm going to trade down because over the course of owner.
Ship not that not that not that big a deal the same thing when it comes to <unk>.
High efficiency heater. If you will people I think are still making longer term decisions on larger purchases, where I think we would see.
The contraction is really at the entry level right I think at the entry level, that's where youre likely to see more pain before you see trade down at the component level.
Decision of <unk>.
Do I build the pool or not if I was <unk> was on the edge of whether it made financial sense for me to build a pool.
Those are the ones that I think probably maybe tap the brakes and see what happens in the in the broader economy, but I think at the upper end of the scale I think those projects still continue hence the value that we're talking about not just pool accounts, but value being.
Still being healthy.
Understood. Thank you.
And this concludes our question and answer session.
I would like now to turn the conference back over to Peter Arvind for any closing remarks. Thank you.
Yes. Thank you all for your support and for joining US today. We hope you all have a safe and happy holiday season, we look forward to reviewing our fourth quarter and full year results for 2022 on February 16th at which time. We will also provide preliminary guidance for the 2023 year. Thank you very much.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your thought.