Pool Corporation (POOL) — Q2 2022 Earnings Call Transcript

Thank you and welcome to our second 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 Arvan. Pete?

Thank you, Melanie and good morning to everyone on the call. This morning, we proudly reported another record quarter with net sales coming in at $2.1 billion, an increase of 15% marking our first ever $2 billion quarter and beating last year's very strong second quarter where we saw sales increase by 40%. These results are exceptional given the challenges that we faced this past quarter in weather, the supply chain and recognizing that the second quarter is where growth capacity industry-wide is most limited. There were many factors that came into play this quarter that, when taken in totality, demonstrate the strength of the company and the resilience of the industry. First off, I would say that demand for new pools is solid and not surprisingly, the backlog on new pool construction is somewhat smaller than this time last year. Our builders are reporting leads have slowed a bit, but that they have plenty of work on new construction and renovation projects on the ever-expanding installed base of pools. Second, following two years of very favorable weather in the second quarter, we experienced a cooler and wetter start this year in our seasonal markets that delayed many projects impacting the demand and timing of sales of many products from packaged pools and equipment to chemicals. As we would have expected, when the weather improved later in the quarter, sales for these products increased to fulfill the strong demand. Third, supply chain constraints have improved in many areas, but persist in several products that contain computer chips like variable speed pumps and automation. Our Trichlor inventories have improved tremendously, but the availability of granular chlorine used to shock swimming pools is very tight, affecting sales for that product. Fourth, we have seen a continuation of the demand for connected and smart technology products like automation, variable speed pumps, robotic cleaners and customizations, which positively impact revenue on repair, replacement as well as new construction and remodel, and we expect that will continue. Fifth, without a doubt, our inventory management program has helped us keep pace with the strong demand and fluctuating lead times as the installed base of pools grows and favorable market dynamics continue. At the same time, we have seen a decline in the demand for some categories that were supercharged by the pandemic, such as above ground pools and heaters as mentioned on previous calls. Fortunately, the decline represents a very small percentage of our total sales. Lastly, the inflation that has worked its way into the industry is passing through the channel, which is reflected in our revenue and gross profit performance. We believe that most of the inflation that we are seeing is driven by structural cost increases by our suppliers, making these new price levels permanent in nature. To summarize, we would characterize the current situation and near-term outlook as positive with mix and price more than offsetting some declines in unit volumes that are driven by supply chain constrained items and weather-related delays for both construction and pool maintenance products. As I mentioned, the reported backlog may be returning back to more normal levels, but the installed base, which is where we derive over 80% of our revenue continues to grow ensuring that demand for our products, including maintenance and repair and remodel items remain strong. Acquisitions, most notably Porpoise Pool & Patio as projected, are performing extremely well contributing 85% to our revenue during the quarter. Excluding revenue from new franchise locations, our acquired Pinch operations grew by 14% in the quarter. Pinch has a very proven and unique value proposition, which allows the individual owners to operate best-in-class stores while the business continues to attract new franchisees. Looking at the base business in our four largest markets, California saw sales increased 9% in the quarter. This is on top of the 33% growth that we saw last year in the same quarter. Texas saw revenues grow by 17%, while Arizona saw sales grow by 20%. Our Florida business continues to benefit from a very robust economy and grew by 23%. Overall, our year-round markets grew by 16% and our seasonal market by 5% as they were impacted by the weather pattern that I mentioned above. Continuing to base business product sales results, we were very pleased with what we saw during the quarter. Equipment, which grew by 35% in the second quarter of 2021, grew by an additional 7% in the second quarter of 2022. As mentioned, supply chain disruptions and shortages of key components continue to impact this area, and it is worth noting that last year, in the same quarter, we were still working through the Texas freeze impact. Additionally, keep in mind the seasonal markets experienced unfavorable weather this year which is very different from the favorable weather in early parts that positively impacted their results in the previous two years. Chemical sales increased by 25% in the quarter, a better inventory position on trichlor helped, but we were hampered by the shortage in calcium hypochlorite this year. Not surprisingly, with this year's weather pattern, volumes, particularly in the retail sizes were softer in the quarter when compared to last year. As mentioned, retail sales improved as the weather turned more favorable as the quarter progressed. Building Materials sales increased by 22%, which is on top of the 33% growth in this category that we saw in the second quarter of 2021. Our ability to grow this category is strong. We are adding and refreshing NPT centers and capabilities to bring the most complete product offering in this category closer to our customers and help them showcase this product to the millions of pool owners and thousands of new or prospective pool owners across North America. Our capabilities in this area are unmatched as we offer the most complete line of products, expert advice and training, and the best customer experience in the industry. Additionally, our digital catalog and augmented reality tool called the NPT backyard app, helped bring the showroom to the homeowners' own backyard virtually. Retail sales, which exclude Pinch A Penny, grew by 7% in the quarter, clearly feeling the effects of the weather in our seasonal markets. For comparative purposes, we grew retail sales 20% in the same period last year. It is noteworthy that the results on a year-to-date basis are up 13%. Looking at the results on a regional basis, we see a clear bifurcation that is weather driven with the year-round markets posting results similar to Pinch A Penny, which is highly concentrated in Florida and Texas. Commercial pool product sales are up 23%, and that is on top of the 45% growth that we saw in the same period of 2021. With leisure travel bouncing back and strong demand in this category, we are encouraged with this trend and no one is better positioned to serve this than PoolCorp. We have deep expertise and an expansive inventory earned in the critical time-sensitive nature of this business. Now let me add some color on our European business results. After a tremendous 2021, Europe is facing a difficult 2022, driven by very unfavorable weather, uncertainty on the continent because of the war in Ukraine and a slowing economy that is wrapped with surging energy and food costs. We saw sales decline 18% in the quarter. On a constant currency basis, it was negative 8%. For perspective, this compares with the same quarter in 2021, where we saw sales surge 42%. Our European team is very seasoned and is managing the business appropriately, and we remain very committed to our European strategy over the long haul. Turning to Horizon, once again, we are very pleased with the results. Base business sales grew by 14% and total sales, including acquisitions, increased by 15%. Once again, I'd like to point out that this compares with 2021, when in the same period we saw sales increase by 31%. SetPay and his team continued to execute our strategic plan with very strong results. We remain very committed to the industry and highly confident in our team's ability to grow and take additional share. At this juncture, let me add some commentary on gross margin, expenses and operating income. Starting off with gross margins, I am very pleased to show that overall gross margin percent increased 150 basis points to 32.4%. This marks the first time that we have ever exceeded 32%, so yet another milestone for the PoolCorp team. For our base business, gross margin percent increased 100 basis points to 31.9%, many factors combined to drive the increase. Pricing management, our supply chain activities, product and customer mix all helped drive the increase in gross margin percent. Additionally, we are in the early stages of vertically integrating certain chemical lines with Porpoise Pool & Patio, which is helping drive the increase. Conversely, we faced headwinds in some of our vendor incentive programs as growth tiers are impacted by the timing of our purchases. Furthermore, the rapid pace of vendor price increases has subsided. Again, none of this is a surprise and we have planned and executed accordingly. As you can see, our gross margin improvement is driven by a multitude of levers that, when combined, more than offset the headwinds that we face. Looking at operating expenses, we are very pleased to see that our capacity creation activities continue to drive rebuilds. Our operating expenses as a percentage of sales in our base business fell 40 basis points while overall operating expenses increased 20 basis points, reflecting the acquisition of Porpoise in our results. Considering the tremendous inflation that we have seen almost across the board from wages and salaries to fuel leases and transportation, we are very happy with how the team has remained focused and executed at the highest levels. Pool360 sales grew by 9% in the quarter, making up 12% of total sales. I would also like to point out that we have released our next generation of Pool360 which contains a long list of customer-driven enhancements that we believe will result in higher adoption rates of this capacity-creating tool. Wrapping up the income statement, we posted operating income of $419 million and an operating margin of 20.4%, respectively. These results reflect a 24% increase in operating income and a 150 basis point improvement in operating margin. We are extremely proud of these spectacular results, all made possible by the combined efforts of our extraordinary team here at PoolCorp, our dedicated and loyal vendor partners and our tremendously creative and hard-working customers, all of whom work together to help more people enjoy outdoor living. We could not be more thankful for this teamwork. PoolCorp is a unique well-managed company in a resilient industry. Technology to modernize the millions of pools that make up the installed base and build pools of the future continues to be developed and released by our supplier partners, and adoption as such is in the early stages at best. Our own technology to make the entire supply chain from the manufacturers to the customers more productive and bring us closer together, giving everyone back valuable time continues to get better. The future is bright and more connected than ever. We are balanced in our approach and have always been very strategic with capital allocation and investments looking out at the changing landscape and positioning the company to have a value proposition that is second to none and create additional capacity for growth. Our latest investment in Porpoise Pool & Patio is only just starting to realize its true potential now that we have integrated and are one team. We will continue to expand the footprint, extract the synergies and leverage the industry-leading technology to improve our value proposition to the thousands of independent specialty retail stores that we serve, giving them world-class capabilities. This is a very powerful combination that we know accelerates our growth and the ability to gain share even in an uncertain business environment because each business is made better by the combination. We have always been an organic growth oriented company with the ability to select, acquire and integrate accretive businesses where we see value. Additionally, no one is better or has a more prudent track record with greenfields than PoolCorp. We have successfully opened 31 locations in the last 4 years and will open an additional 10 to 12 this year. We are a performance-based company that attracts, retains and develops industry-leading talent, creating vibrant career paths for our employees. We have deep loyal customer relationships and strong vendor partnerships that when combined with our team produced great financial results that are durable. Unlike most other building product distributors, PoolCorp enjoys a unique advantage of essentially maintaining a lifelong relationship with every pool that is built and remains in service. We provide the construction material and the maintenance supplies and the remodeling products required during the entire existence of each pool, whether it is a DIY maintained pool or one that is serviced by one of our professional customers. It is an annuity industry and business model that grows upon itself as more pools are built or products are demanded forever. With all of this in mind and half of the year behind us, we are raising our full-year guidance to $18.38 to $19.13 per share. I will now turn the call over to Melanie for her financial commentary and balance sheet update.

Thank you, Pete and good morning, everyone. As expected, second quarter 2022 continued with robust 15% sales growth over 2021, surpassing last year's phenomenal growth in our seasonally significant quarter, which is a tremendous accomplishment. This represents a 22% sales growth increase year-to-date. Inflation impact for the quarter was around 10%. Additional vendor price increases, primarily in the equipment area, occurred during the quarter, having just a partial impact on the current quarter due to the timing of the increases. Our recent acquisitions added 5% to our sales growth in the quarter. Overall volume growth was in line with our expectations, lapping the remaining impact of the Texas freeze that benefited sales growth in 2021. However, we did see negative impact on sales activity from weather in Canada, the Upper Midwest, and the Northeast, which we believe slowed sales growth by 1% to 2% during the quarter. The weather impact was evident in the April sales growth rate being the lowest month of the quarter. But as Pete mentioned, the growth rate improved throughout the quarter with sales growth in the year-round markets continuing to be strong. Europe experienced a negative weather and macro impact, resulting in an 8% local currency decline from 2021 during the quarter compared to a local currency 31% growth in Q2 2021. As they represented only 5% of net sales in 2021, the estimated impact on the consolidated financials for the quarter is approximately 2%. A negative 1% impact from foreign currency also brought down results. In summary, for the quarter, Q1 included an indiscernible shift of approximately 1% of sales that would have normally taken place in Q2. We experienced a negative 1% to 2% for North American weather, a 2% drag in Europe for weather and macro events and a 1% foreign currency impact. Gross margins hit an impressive 32.4% for the quarter and 32.1% year-to-date. During the second quarter, we realized a 100 basis point improvement on base business activity with a 150 basis point consolidated increase over Q2 2021. The second quarter typically has higher gross margins than we report for the full year as a result of seasonality. This increase over the prior year moderated in Q2 from the increase reported in Q1 as we faced significant improvements achieved in the same quarter last year. We reported an accretive benefit from our acquisitions. We also continue to see gross margin dollar benefits from product mix as items such as variable speed pumps, LED lights, automation, and custom features experienced higher sales growth than their more traditional non-automated counterparts. We saw increased activity through our CSOs or centralized shipping locations. This provides a significant benefit to our network in order to manage inventory in a tight supply environment and ensure we can replenish our locations timely to avoid lost sales from stockouts while enhancing our gross margins on certain products. Better inventory positions on faster-moving products and increased selling prices made necessary from vendor cost increases also provided an incremental benefit. Operating expenses increased only 16% on a gross of dollar increase of 21% as our continued ability to manage seasonal sales volume, coupled with our capacity creation efforts resulted in increased operating leverage, even though experiencing above historical level inflationary increases in compensation expense, rent, and freight costs. This includes an additional $21 million in operating expenses in the quarter from recent acquisitions. Operating margin increased 150 basis points in the quarter and operating income increased to $419 million. The power of our operating model is that it provides us the ability to make incremental improvements as we grow and also the flexibility to ensure that we sustain operating margin as a significant portion of our compensation expense is comprised of our performance-based incentive program so that our employees are rewarded along with our shareholders a series of operating income improvement. Our strategic planning process and proven operating capabilities, along with management discipline developed over our 40-year history and 27 years as a public company, provides us the agility to respond to changing macroeconomic times. Interest expense for the quarter increased $6.6 million from prior year second quarter to $8.5 million due to higher debt levels compared to last year. Our trailing four-quarter leverage ratio was 1.1 times and a continued conservative position even with higher average debt from working capital investments, acquisitions, and increased share repurchasing activities, and remains well below our overall targeted range of 1.5 times to 2 times. We reported a benefit of $1.6 million or $0.04 per diluted share compared to $7.7 million or $0.19 per diluted share that we realized in the same period in 2021. As the timing of when these benefits are realized are related to restricted stock vesting and option exercises and computed based on the stock price in effect at the time of the transaction, this tax benefit has and will continue to fluctuate from quarter-to-quarter and year-to-year. I would now like to turn our discussion over to our balance sheet and capital allocation. Receivables increased 29%, reflecting higher sales growth in June than the full quarter, additional amounts due from vendor programs as a result of higher sales year-to-date and 5% from acquisitions. Product inventories had decreased from our peak in March 2022 as we prepared well and ordered inventory early to be fully stocked for the season. Inventories that were in short supply at this time last year, in particular, trichlor tablets are now in a position to allow for consistent supply to customers versus the rolling stockouts we experienced last year. As a result, we have realized approximately 20% increased sales volume for these products. The overall balance includes approximately $90 million in higher cost inventory from inflation, which we expect to realize an additional selling price and approximately $50 million from acquisitions. We are pleased with the quality of the inventory on hand and do not expect any negative margin impacts resulting from managing inventory. We actively monitor inventory levels related to chemicals, pipe, and rebar, areas where we have seen higher inflation. We review inventory levels and turns by sales center at the individual SKU level and believe current amounts are appropriate in relation to expected future sales. Net cash provided by operations was $28.7 million year-to-date, down from the $187.2 million generated in the same period last year. The current year period includes an $80 million cash payment that was deferred from 2021 as a result of Hurricane Ida and $136 million more cash outlays in the first half of the year on inventory. In 2021, we continue to develop inventory through the second half of the year in order to keep up with sales demand and added approximately $430 million in base business inventory in the second half of 2021. As we have seen improved lead times, we would expect to seasonally bring down inventory in third quarter 2022 in order to take advantage of early buy opportunities that we expect to arise as normal in fourth quarter 2022. For the year, we are expecting to generate significant free cash flows. The Board authorized a 25% increase to our quarterly dividend rate beginning in the second quarter of 2022. Our quarterly dividend rate of $1 per share represents the 12th consecutive year we have increased our dividend rate. We now expect to return approximately $150 million to shareholders in cash dividends for the year. Also in May, the Board increased our share buyback authorization to $600 million from the $404 million available under our previous share repurchase authorization. We have taken full advantage of the increased authorization and completed $216 million in share repurchases during the quarter, acquiring 547,000 shares and bringing our year-to-date total share repurchases to $268 million. This is the highest ever commitment from the company on both the dollars invested in the annual period and the number of shares purchased. Our earnings guidance for the year increased to $18.38 to $19.13, which includes a $0.22 ASU tax benefit realized to date. This reflects a growth range of 20% to 25% excluding the impact of the tax benefit. Inflation expectations for the year are largely unchanged at an estimated 10% to 11%. Inflation in the second half of the year will moderate from what we have reported year-to-date as we begin lapping the increases that were realized in the second half of 2021. Our sales growth expectations for the year remain consistent with the net sales guidance range of 17% to 19% we discussed on our February call. Additional vendor price increases in the second quarter, not factored into our previous guidance are offset by slight decreases in volume as a portion of the business related to consumables was impacted by negative weather in Q2. Our guidance also factors in updates for Europe and foreign currency impacts. Our estimate for the 5% contribution from acquisitions is unchanged. We will also have one less selling day in the third quarter and with the additional selling day we reported in the first quarter, we will have the same net number of days for the year. Forecasted gross profit margin for the full year may be slightly up from our previous guidance of comparable to 2021 as part of the revised inflation announced in Q2. We realized 240 basis points and 260 basis points improvement in margins in the third and fourth quarter 2021 and so expecting gross margin numbers in the back half of the year to moderate more in line with our longer-term guidance. The increases we have in interest rate environment, along with our revised average debt outstanding, resulted in an updated estimate of the interest expense line of $35 million to $40 million. We expect our year-end leverage to be less than 1.5 times. No changes are expected in our income tax rate for the full year and we continue to expect the third quarter rate to be slightly lower than the annual rate. With the effect of the shares we have repurchased to date, we are updating our year-end estimate for share to be approximately 40.3 million shares. We continue adding to our future growth capacity with five greenfield sales centers opening year-to-date and an acquisition completed early in the second quarter in West Virginia, a state we haven't previously had a physical presence in. With this acquisition, we now have sales centers operating in 40 states. We have also added one new Pinch A Penny franchise store during the quarter, bringing year-to-date new franchise openings to three stores. We still expect to open around 10 new franchise locations this year. One area that has been in the headlines lately is a significant shortage of lifeguards across the country, preventing some community pools from opening this season. We're passionate about expanding the enjoyment from flowing and the outdoor living lifestyle. As part of our ongoing partnership with the YMCA, we recently donated $1 million to YMCA's tubing locations throughout the country with strong aquatic programs. These donations will provide training for more than 900 lifeguards and swimming lessons for 8,600 children who otherwise would not have had the opportunity to learn basic water skills. We are very pleased with our results for the first half of 2022 and expect continued growth in the second half as our industry began to see some relief from the supply chain challenges. I will now turn the call back over to the operator to begin our Q&A session.

Hey, thanks and good morning everyone.

Good morning.

I wanted to start by discussing the sales guidance a bit more. It seems that the original forecast of 5% volume growth might be lower now. The main reasons for this change are related to weather conditions in Europe. Is that correct? What is the updated outlook for volumes?

Yes. So if you look at it, we were originally at 4% to 5%, it kind of included in that 17% to 19% guidance. And so we believe we lost a little bit to weather in Q2 as well as we've updated for Europe. As we go through the year, when we updated the guidance for the first quarter, we kind of reiterated that the overall range for the year would be similar to what we had originally indicated, recognizing that we had higher growth on that in Q1. And so the two other factors that play into that is when we look at Q3, we will have one less selling day. And then also when we get to Q4, the overall expectation for inflation for the year at 10% to 11% will be less in the fourth quarter because we'll be lapping some of those costs that were already embedded in the prior year numbers for the fourth quarter.

Got it. That's helpful. Okay. Could you comment on July and how organic volumes are tracking? My understanding is that based on the guidance, they would be down low single digits. If that's correct, could you rank the main drivers of why volumes might be a bit lower? I believe Europe could be at the top of the list, but it would be useful to get more detail on that.

Yes. We haven't observed a significant change except for a heat wave in Europe, which has shown some positive weather conditions. However, we anticipate that Europe will experience a decline in volume, contributing to our updated guidance for the full year. Looking at the overall business, activity in July is aligning closely with June, suggesting that the unfavorable weather we encountered in April is now behind us. While we are hosting this call for the remainder of the quarter, we hope that the warm and dry weather continues into the third quarter.

It’s encouraging Ryan.

Okay, good. Thanks. I will pass it on.

Thank you. Good morning everyone. Melanie, thanks for giving us a rough update on the full year gross margin. But I believe last quarter, you said that third quarter and fourth quarter gross margin would both be lower year-over-year. Is there any update you could provide us with a finer point on the third and fourth quarter?

Yes, we are looking at last year's performance, which showed significant growth of 240 to 260 basis points. We do expect those margins to moderate from those levels, but they will still remain well above the 2020 levels.

Okay. If sales were to decrease in 2023, could you remind us of the incentive compensation numbers that would automatically reverse? Also, could you discuss the percentage of SG&A that would decrease with sales and how that affects your variable costs?

Yes. The breakdown between variable and fixed costs is roughly equal at about 50-50. We view compensation as part of the variable costs. Additionally, with the recent growth we've experienced, the incentive compensation included in the current figures may decrease by approximately $30 million if we return to a more typical growth rate.

Okay. $30 million, but the $30 million is in the 50%.

Yes.

Okay. Thank you very much.

My first question is just thinking about underlying consumer demand as the macro shifts and housing potentially moderates a bit. Can you just talk a little bit about what you're hearing from your customers in terms of consumer interest in new pool construction and even some of the R&R projects in there? And any thoughts on how that may trend as home prices potentially flatten out.

What we're hearing from builders is that backlogs are smaller, which is expected given the recent surge in activity during the pandemic. However, it's important to note that smaller backlogs do not mean that less work is being done. The builders we communicate with regularly are still quite busy, and there remains a significant amount of work for new pool construction. Additionally, the backlog for renovation and remodel projects is also very robust. One of the major factors contributing to this is the strength of housing values. Even though housing sales might be plateauing due to rising interest rates, homeowners who purchased in recent years are sitting on substantial equity because of increased home values. This situation makes them more likely to invest in their homes, whether by adding a pool or renovating an existing one. The feedback from builders indicates that there is a high demand for both new builds and renovations. Also, the installed base of pools exceeds 5.3 million, with most lacking advanced technology. Many newer homeowners desire a connected backyard experience similar to their indoor environments. Moreover, with the average age of pools being around 25 years in North America, there is a significant need for modernization and updates. Despite some slowdown in leads, this does not imply reduced pool construction. The weather has been the primary limiting factor for new pool construction. During the second quarter, which is the optimal time for starting pool projects, particularly in the upper Midwest and Northeast, unfavorable weather conditions have delayed constructions. Builders in those regions are behind on unit completions but not on overall work. The number of completed pools for the 2022 season will largely depend on the available building days as the year progresses, particularly in the first and fourth quarters when there is typically more surplus capacity. While it's still early to predict the exact number of pools that will be built this year, it will ultimately depend on the construction days available until year-end.

Okay. That's incredibly helpful color, Peter, my follow-up question is, you currently bought a lot of stock back this quarter. I think that you bought more back this quarter than you ever have on a full year basis. As you think about the inventories normalizing, your commentary that you plan to work that down through the third quarter. Can you give us any update on how you're thinking of uses of cash? Anything around maybe a programmatic sort of repurchase approach or anything else, especially as the valuations are where they are for the stock?

We have had a very strong share repurchase program this year, driven by our significant confidence in the company and the industry. We believe the current stock price is very attractive, so we are buying back shares. The Board granted us additional authorization, which we are utilizing, and we still have some that we will continue to use. Our capital allocation strategy remains consistent, and we are disciplined in deploying capital for expansion, operations, new trucks, and facilities. We have also increased our dividend program and are still active in the M&A market, though there aren't any major deals that would require a large amount of cash at this time. Additionally, we anticipate that as we reduce inventories by the end of the year, our free cash flow will be substantial, allowing us to seize the opportunities that arise.

Okay, great. Thank you very much and good luck.

Thanks. I just want to unpack Europe. I realize it's a small portion of the business, but ex weather, constant currency down 6% in the quarter. Where do you project that goes throughout the year in terms of the decline within your guidance? And just could you remind us is how different Europe is versus kind of the U.S. pool business? Is that a good proxy? Or is it just the markets are too different to where that kind of decline, if we did endure some pretty heavy macro pressure here in the U.S., we couldn't see those kinds of numbers?

Thank you. So Europe, we said on a constant currency basis, Europe is down 8%, and that comps off of a very, very strong quarter and year they had last year. So the European market is strong. There are about five million pools across Europe. They are different pools than they are in North America. They tend to be smaller pools with fewer features and less automation because the real estate that surrounds most homes in Europe tends to be smaller than what you would find in North America. Having said that, there is still a nice opportunity. But as I mentioned, Europe had some tremendous headwinds this year. First, it started with the war and the uncertainty that that creates on the continent, it's crazy to think about in 2022 that we have another war in Europe, but there is a war in Europe that is on people's minds number one. Number two, you would compound that with tremendous inflation on energy and frankly, uncertainty on energy prices, which makes the inflation even worse. And that extends onto food and other basic items in Europe, which is on people's minds. And then lastly, if that's not enough for the Europeans to contend with, their weather this spring or through the second quarter was just dreadful. What I'm very encouraged with, though, is that when the heat waves, that heat now over in North America has now extended into Europe when that hit, we saw an immediate reversal of the sales trend in Europe, and sales picked up nicely. So we are very encouraged. We are very excited about the future prospects in Europe, but we're having to work through some market dynamics that we hadn't anticipated. However, our team in Europe is rock solid. Our management team knows what to do. They're operating the business appropriately. And as I mentioned, we are no less optimistic about the future in Europe than we were before. We think we have a tremendous opportunity to continue to grow and take share and bring new products to the market.

Thanks. Second question, I wanted to shift gears a little bit. I know that you mentioned that the inventory situation is still tight, and that's kind of reflected in what you're doing. Where do you see the risk as the supply chain eases and a lot of your smaller competitors potentially overcorrect and they could be over-inventory just as you're in a position to manage it? And one thing within that question, could you remind us how much exposure you have to potentially transitory inflation that could be a deflationary risk in the out years?

From a transitory inflation perspective, it is actually a very small part of our business. I noted earlier that most of the inflation we have experienced from our suppliers on products is structural, with labor being a major factor in everything our manufacturers produce. The rise in labor costs is likely to lead to a permanent increase in price levels. I do not anticipate a situation where, for the majority of our business, we will see any deflation. However, there are a few items in our inventory, such as rebar or PVC pipe, that are more commodity-based. These items, which have less labor involved and are driven more by raw material and commodity pricing, might see some fluctuations, but they make up such a small percentage of our inventory that we do not consider them significant. Additionally, regarding the overall inventory situation, last year’s supply chain disruptions led to longer lead times, resulting in distributors ordering more stock to account for safety needs. Fortunately, lead times for many previously short-supplied products have decreased significantly, allowing us to reduce our inventory. That said, there are still several products in short supply, both in terms of equipment and chemicals. For example, last year I had an abundance of calcium hypochlorite but was short on trichlor. This year, the situation is reversed. The equipment side is similar, as last year we lacked heaters, while this year we have plenty. However, we continue to face considerable supply chain challenges and delivery inconsistencies with items that have chips, such as salt cells, variable speed motor drives, automation centers, and LED lights.

Thanks. I will pass it on.

Thanks.

Hi, good morning. This is actually Noah Merkousko on for Trey. So my first question, I was hoping you could talk about the sustainability of EBIT margins longer term. We've seen significant improvement over the last couple of years, but longer term, top line growth may moderate to more normal levels, seeing less inflation from suppliers, etc. Just how do you get confidence in sustaining this level of profitability?

Okay. It's two items. So first of all, as it relates to our capacity creation initiatives that we focus on, we know that as we continue to roll that out to additional sales centers as we continue to expand what we're doing in those areas that we continue to work and operate more effectively. And so we can push more volume growth through the sales centers based on the model that we have in place. The other component that is probably the one item that kind of moved significant individually is going to be the reference to the performance-based compensation that the additional dollars that are included in the current expense line at a kind of a normalized level within our 6% to 9% long-term organic growth would be about $30 million less than where it is currently.

Right, right. That makes sense. And then for my follow-up, what are you seeing on the commercial side in terms of demand? I know it's a smaller part of the overall business, but there's been some recent forecasts calling for big growth in hotel construction next year. I'm just curious what percentage of your overall business would go into hotel pools?

Yes, it's still a very small percentage. Honestly, it's one of our larger opportunities because our market share in commercial pools is smaller than in residential areas. We're encouraged by the demand we see and the number of projects currently being bid. With the increase in travel that everyone has noticed, many people are traveling and resorts are busy, investing in their aquatic areas, which is beneficial for us. Whether it's maintenance, repair, or new construction, we see significant opportunities for growth in that area. We've invested heavily in inventory and specialists and programs, positioning us well to take advantage of the rebound following the considerable slowdown at the beginning of the pandemic. We're very pleased with the recovery and the outlook.

Thanks, that’s really encouraging. I will leave it there.

Thank you.

Yes, good morning. Can you just talk about vendor programs and what changes you may be seeing, if any, with the vendor offers on rebate programs, volume thresholds, dollar rebates for certain unit volumes? How is that evolving in this environment?

Yes. The structure of the programs remains unchanged. They are based on a baseline with growth, and one of the tailwinds we experienced last year regarding our gross margin has shifted to a headwind this year due to the timing of purchases. As lead times decrease, I will be purchasing less, which will impact the vendor programs, although the overall structure remains the same. However, this was not unexpected for us; we anticipated it and included it in our strategy for managing gross margins. Looking ahead to next year, as we resolve some inventory and enter a typical early buying season, we believe the vendor program opportunities will still be appealing to us.

Okay. Second question for me. We've talked a little bit about price cost here and a couple of different questions, but maybe coming out of a slightly different way. I just ask you, Maybe, Pete, how your view on second half price cost may be different now from where it was 90 days ago? And what's changed in that view since your last earnings call?

Yes. I would say, if you asked me on the last call what I thought the likelihood of future price increases was going to be, I would have said it was more likely than not. And from where I sit today, I don't think we're going to see much more inflation, at least until the early buy program. So I think the pricing environment is more stable, which is not necessarily a bad thing. I think predictability and stability certainly for our customers is a good thing, but that would be the major change. I don't think it's affected demand, right? So that's the good news. It hasn't affected demand, but I don't really see much change between now and the early buy programs in the fall.

Got it. Thanks very much.

Thank you.

Hi, thanks for squeezing me in, appreciate it. Just a couple of follow-ups, if I could. Is it possible to quantify what you think mix and share have added to growth over the last couple of years?

As we analyze those two different components, it's important to look at the mix in two ways. Some of the mix relates to traditional products where we notice an increase in sales of certain items. Specifically, if we consider individual quarters, growth in building materials is outpacing growth for the quarter in chemicals and similar categories. Additionally, we assess the impact on gross margin dollars. This is connected to many variable speed pumps, LED lighting, and more automated products that have become more available compared to a few years ago. We are observing heightened sales activity in these specific products, which is contributing significantly to the increases in gross margin dollars.

Okay. Thanks and any thoughts on how much share you've gained through this kind of COVID situation?

Yes, we analyze that by market. When we assess our share gains, we reference the number of new locations we've opened, with the expectation that each new location helps us capture more market share. This is one of the strategic reasons for expanding. Overall, our share gains have been quite positive, driven by increased investments and a focus on new customers seeking our products. We concentrate on our available options, particularly our B2B software, Pool360, which some competitors lack, ensuring those relationships remain strong as we move forward.

I think it's pretty balanced, Steve, in terms of how much of our growth is product mix. I think it's pretty balanced. And as Melanie says, it varies by market.

Okay. All right. Fair enough. And maybe a quick follow-up for you, Pete. I know it's not your view here, but obviously, the market is taking sort of a risk-off view of '23 and '24. So if there were a downturn, and I'd characterize that as meaning a down year or two for PoolCorp, what would be your playbook? Do you get more aggressive on M&A? Do you put more greenfields out there? Or do you kind of batten down the hatches and wait for the storm to pass, how do you view sort of managing through a downturn? And again, with the caveat that I don't think that's your view. But I'm just curious, you must have a playbook.

Yes. As I mentioned, PoolCorp is a very unique company in a distinct industry. A downturn in one sector doesn't necessarily lead to the same results in another. Most of our business comes from the existing pool installations, which require maintenance. So whether new pool construction numbers are $115,000, $110,000, $95,000, or $120,000 will have some effect on us, but over 60% of our business is nondiscretionary and is linked to maintaining current installations. This maintenance is essential and even remained steady during the Great Recession. Therefore, regardless of economic conditions, this part of our business is expected to remain stable. For the semi-discretionary segment, home values are unlikely to decline significantly due to a supply-demand imbalance. There is a net housing shortage, and homeowners who purchased in the last five years have attractive mortgage rates that would deter them from selling and refinancing. Thus, we anticipate continued investment in home renovations. Regarding new construction, its performance can fluctuate due to various economic factors, weather conditions, and labor availability. Given current unemployment rates, it seems unlikely there will be a significant increase in workforce capacity for new pool construction. Thus, we view that business as stable. We will stick to our disciplined capital allocation strategy, investing where necessary to add capacity without overcommitting ahead of demand. We will maximize our capacity before seeking additional investments. We’ll continue to focus on technology improvements to enhance customer experience, benefits for dealers, and ourselves, which is an essential aspect of our capital strategy. From an M&A standpoint, we are strategically positioned and well-capitalized. We continually seek valuable businesses and have the financial strength to pursue sensible opportunities. Our track record shows we are disciplined in acquisitions; we don’t feel pressured to buy, thanks to our established infrastructure. We will consider acquisitions if they make sense financially. If the asking price exceeds our valuation, we can opt for greenfield investments instead. We are aware of the economic environment and have focused on capacity creation both before and during the pandemic, which we believe improves our business. Our commitment to enhancing customer experience remains strong, ensuring that even in a less favorable market, we can capture market share and reward ourselves for prioritizing our customers. Thus, should M&A opportunities arise, we are ready to act if we find them appealing, but our overall strategy will remain unchanged.

Super. I appreciate all the details. Thanks so much.

Hi, thanks for squeezing me in. First question is, I was wondering if you could provide how the seasonal market sales progressed throughout the quarter? I'm wondering to the degree they push back to more comparable levels after weather improved after April.

Yes. So here's what happens. You have to look at the nature of the business in the seasonal markets, right? So the portion of the business that you won't get back is the consumables, right, for when the pool is being used. So if the pool opens up a month later than it would have because it was cold and rainy where people are using it less than your maintenance and repair products are going to be less. And those days when they're gone, they're gone, you typically don't get those back. Unless on the end of the season, you end up with an extended summer or a late fall, then you sometimes can get those days back, which is why for us, it's very early to call the year and say, well, here's what the seasonal markets are going to look like because so much of it depends on the beginning and the end. The good news is in the middle, the capacity is almost at max anyway, and there's very little growth capacity. So most of our growth comes on the shoulders of the year. On the construction side, those days, you can get back. So if the weather stays good and there is certainly demand for renovation and remodel and new construction, if the weather stays good later in the fall, early in the winter, in some cases, then our builders are going to keep working because they have backlogs and customers that they need to satisfy.

Got it. I appreciate that. My follow-up question is just on the upcoming early buy you've referenced a few times. I know it's a little bit early, but just hoping for some of your thoughts on the level of inflation you could see into next year, would it be in the more normal 1% to 2% range? Would it be above normal? Or could you see deflation as you work through your upcoming negotiations due to some of the destocking that's occurring?

I wish I could provide a clearer prediction about inflation for next year, but I don't believe anyone has a definitive answer. The key takeaway is that the prices I'm currently paying for products are unlikely to decrease. What I'm spending this year is probably the lowest I'll pay in the future, as prices are expected to keep rising. How much they will rise is still uncertain. Historically, the industry typically adjusts prices by 1% or 2% in response to inflation, and we have recently experienced inflation significantly above those levels. The same factors impacting us are also affecting our manufacturers, including labor costs, real estate, and raw materials. Overall, I think inflation next year will be above the historical norm. While I'm not certain it will match this year's rates, it is still too early to say, but I anticipate inflation will remain high next year as well.

Great. I appreciate that. Thanks.

Thank you, everyone, for joining the call today. We look forward to reporting our third quarter 2022 results on October 20. Have a great day, and we will talk to you then. Thank you.