Title

Presentation

Pool Corporation beats earnings expectations. Reported EPS is $3.51, expectations were $3.41.

Operator: Good day. And welcome to the Pool Corporation Third Quarter 2023 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Melanie Hart, Vice President and Chief Financial Officer. Please go ahead.

Melanie Hart: Thank you. And welcome everyone to our third quarter 2023 earnings conference call. Our discussion, comments and responses to questions today may include forward-looking statements, including management’s outlook for 2023 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 at — in the Investor Relations section. We will begin today’s call with comments from Peter Arvan, our President and CEO. Pete?

Peter Arvan: Thank you, Melanie, and good morning to everyone on the call. Our third quarter results came in largely as expected. As the 2023 swimming pool season winds down, we consider our results to be solid on a standalone basis, particularly when considering the dynamic conditions we have been operating in. The third quarter carried down with typical summer weather conditions overall, allowing us to evaluate our performance in the industry environment on a mostly weather-neutral basis. Our third quarter 2023 sales of $1.5 billion is a 9% decline compared to 2022, with one less selling day, but exceeded 2021 third quarter sales by 63 million or 4%. As expected, sales declines continue to moderate in the third quarter, showing sequential improvement versus the 10% and 15% declines we saw in the second quarter and first quarter of 2023.

In view of the neutral weather conditions during the third quarter, our sales trends across our major markets were relatively consistent. Starting with year-round markets, sales declined 5% for the quarter in Florida compared to the third quarter last year, with Arizona finishing down 8%, California down 10% and Texas down 11%. For context, last year in the same quarter, Florida sales were up 20%, Arizona was up 18%, California was up 16% and Texas was up 10%, respectively, versus the third quarter of 2021. This simply highlights the difficult comps that we were up against this year. Year-round base business declined 8%, while seasonal base business markets declined 10%, a slight sequential improvement from the 9% and 11% decline in the second quarter of 2023.

Again, for comparison, last year in the same period, we saw growth in our year-round base business markets of 15% and 5% in our seasonal base business markets. Moving on to product category results. Chemical sales increased 5% in the third quarter, mostly driven by increased volume as chemical pricing came in relatively flat for our collective offering. Our strong footprint, leading proprietary products and enhanced technology tools gives us an unmatched value proposition and contributed to our share growth. Building material sales for the quarter were down 13%. This category includes products necessary for both new pool construction and renovation and remodel projects. The building material trend continues to suggest that renovation and remodel demand is stable and outperforming new pool construction and our NPT footprint and product offering enables us to outperform the industry in this category.

Equipment sales declined 9% in the quarter. As you can see, this implies solid demand for maintenance and repair despite the softer demand for new pool construction and renovation and remodel. Looking at end markets, commercial pool product demand remained strong in the third quarter, with sales up 10%. Sales to our independent retail customers were down 8% for the third quarter, an improvement from the 11% decline and 16% decline we saw in the second and first quarters of this year. Pinch A Penny franchisees collectively reported sales growth of 1% for the quarter. The franchisees generated solid sales for their maintenance products, but weaker sales of discretionary items in line with what we are seeing across our distribution business. Europe’s third quarter sales showed a 2% decline in local currency, a notable improvement from the 7% and 22% decline in the second and first quarters of 2023.

Europe has been challenging for the past 15 months to 18 months and we are encouraged by this more favorable trend. For Horizon, sales declined 7% during the quarter. Consistent with prior quarters, sales activities for commercial projects remained stronger than residential. Moving on to gross margins, where we ended the third quarter at 29.1%, consistent with our past thinking, we believe gross margins for the full year will be an approximate — will be approximately our long-term guidance of the 30% range. As is typical, Melanie will provide more details on what to expect in the fourth quarter gross margins in her comments. Even while continuing to invest in new locations, acquisitions and technology during the quarter, we reduced operating expenses by 2% compared to last year.

The team did a good job managing expenses that typically ramp up during the season in light of the softer demand environment. Thankfully, the team has been focused on capacity creation for many years and that helps us offset inflationary headwinds and leverages our fixed expenses, leading to a 15.9% operating expense percentage. POOL360, our B2B tool, saw sales increase 5% over the prior year, a higher growth rate than our overall sales activity. The line volume growth for the same period was 3% and demonstrates the tool’s contribution to our capacity creation effort, while also improving the customer experience and productivity and adding value to our business and our customers. We view this tool as best-in-class, providing multiple benefits for both our customers and the local operating teams.

Operating income for the third quarter of 2023 was $194 million, down $69 million compared to last year. This however represents an 85% improvement over 2019. Our reported third quarter operating margin of 13.2% is 10-basis-point expansion from 2019 and a 20-basis-point expansion from 2020, showing the sustainability of our fixed cost leverage initiatives. During the third quarter, we added two new greenfield locations. This puts us at 10 new greenfield locations for the 2023 season, a further testament to our strong bent and refined expansion process. In addition to our organic openings, we added four new locations through acquisitions this year. Additionally, we expanded our Pinch A Penny franchise network by adding two new franchise customers in the quarter, bringing the new franchise store count to 11 for this year.

We continue to prioritize organic growth investment as the future of the business, which not only expands our customer reach, but also creates capacity for additional products and service offerings at our existing locations. Melanie will be commenting on most of the balance sheet items, but I would like to highlight one significant accomplishment that is the work that the team did on rightsizing our inventory. Because of the tremendous effort of our team, in conjunction with our vendor partners, the team surpassed our inventory reduction goal and delivered a reduction of over $216 million year-to-date. This was done while expanding our footprint, integrating acquisitions and maintaining best-in-class inventory availability. This achievement helped us generate $750 million in operating cash flow through September 30th, a company record and nearly 2.5 times that of this time last year.

As we move into the final quarter of the year, we have proven that even in the most difficult operating conditions, our experienced team delivers an unmatched value proposition, which enables us to outperform the industry and expand our share. We have built the largest fully integrated network of sales centers in the industry and we are adding new locations faster than anyone with a proven process that delivers a solid ROI. We have a vertically integrated chemical packaging operation and the broadest selection of proprietary building material products from pool tile to finish, over 135 NPT showrooms and design centers, four centralized shipping locations for importing consolidation, industry-leading technology solutions for our customers and our own use and best-in-class retail franchise development and support operations, perhaps most importantly, we have over 6,000 employees that operate in a performance based culture that know how to compete and win.

While new pool construction is likely to finish down with — with units down 30% in 2023, we still expect about 70,000 additional pools will be [Technical Difficulty] expanding ever growing installed base of pools where we derive over 80% of our revenue. No doubt, the current macroeconomic environment is tough, but the desirability of swimming pools and outdoor living has never been stronger and we do not see that changing. We firmly believe that even with fewer pools being built, our share and the value of our products on a per pool basis has grown. We know that renovation activity will continue as homeowner’s upgrade both services and pool technology to enhance their backyard oasis. We believe that our relentless focus on delivering a second-to-none customer experience positions us better than anyone in the industry to serve the pool professional and support the specialty retailers that cater to the DIY owner.

Aerial view of a swimming pool with outdoor furniture surrounding it.

In short, we believe in the long-term growth characteristics of the industry, the strength of our company and we believe in our team. As I look back on the pool season, I am very proud of our team that has remained focused on innovation, execution and collaborative partnerships to deliver a customer experience that, as I said, is second to none. Lastly, with over three quarters of the year behind us, we have narrowed our annual earnings guidance and now expect diluted earnings per share in the range of $13.15 to $13.65, including the impact of year-to-date tax benefits of $0.15. Melanie will now provide additional details in our financial commentary. Melanie?

Melanie Hart: Thank you, Pete. Net sales for the quarter finished at $1.5 billion, a 9% decrease from prior year record sales in the third quarter. We estimate a year-over-year quarterly sales decline in the range of 5% related to new pool construction, which is trending as expected, with units likely to show a 30% decline for the year. Remodel activity with a roughly 3% year-over-year comparative decrease effect on our topline is outperforming new pool construction, but still at lower levels from prior year and in the range of our previously estimated down 10% to 15%. We also saw several other areas, which each represented an approximately 1% decline in net sales. First, we had one less selling day in the quarter compared to last year.

Secondly, selling prices on commodities, including trichlor. Pricing on trichlor is showing recent signs of stabilizing. But during the quarter, selling prices were approximately 20% lower than third quarter of last year. Third, volumes on certain discretionary products, such as above-ground pools, heaters and cleaners reflected weakness, suggesting consumer hesitation on these more discretionary items. Outside of these products, maintenance spend remains relatively stable. Inflation continued to provide an overall advantage, resulting in a benefit of approximately 2% to 3% for the quarter. Net sales from acquisitions or new market openings contributed less than 1% in the quarter, and therefore, we have not broken out these activities from base business separately in the press release, as they had an insignificant impact on the financial information for the quarter.

Gross margin was 29.1% in the third quarter, reflecting a typical sequential decrease from second quarter. Gross margin was 210 basis points less than prior year, resulting from the expected decrease in inventory gains realized in 2022 that benefit from investments in inventory ahead of the multiple inflationary price increases. Other items impacting margins in the quarter, our product mix, including the lower selling prices on trichlor and new construction and remodel activity, which resulted in building materials seeing a higher year-over-year decrease than other products. Customer mix, such as a higher proportion of sales to larger customers, also had a negative impact on margins when comparing to 2022. Weaker industry demand and wrapping up of channel inventory rationalization contributed to a more competitive pricing environment, causing some modest additional pressure on gross margins during the quarter.

We also saw lower purchasing incentives than a normal year in conjunction with our inventory reduction plan. SG&A expenses continue to be very well managed, reflecting a 2% decrease year-over-year after seeing a 3% decrease in the second quarter as these two seasonally larger quarters have the most ability to benefit from reductions of volume related expenses. Operating expenses compared to prior year also includes the impact of four locations added from acquisitions and 14 new sales center openings since third quarter of last year. Additionally, expenses for the third quarter include a $550,000 goodwill impairments. Operating margin of 13.2% was 300 basis points less than prior year, reflecting the 210 basis points impact from gross margin and effects of lower topline revenue.

We reported 11.6% operating margin in third quarter 2019. So we have been able to maintain benefits in our operating margin. Interest expense on a comparative basis for the third quarter resulted in a $1.9 million increase in expense as a result of higher rates, offsetting a significant reduction in debt outstanding. As is consistent with prior years, our third quarter tax rate is generally the lowest quarterly rate, with all other quarters being slightly higher and averaging to our full year rate. Third quarter EPS, excluding ASU of $3.50, compares to $4.78 in third quarter 2022. Despite the decline from our record 2022 results, these earnings highlight our ability to retain the majority of the significant growth seen throughout the 2020 to 2022 period as Q3 2023 results are higher — 90% higher than the third quarter of 2019.

Our credit and collections process and management of trade receivables remains a business advantage, with DSO of 26.3 days at the end of the quarter, comparable to prior year. I was confident in our ability to execute when I stated our inventory reduction goal at the beginning of the year to bring down inventory by $260 million. In fact, we were able to reduced inventory $332 million from December 2022, even with acquisitions, new locations and current year inflation exceeding our goal. In the fourth quarter, we plan to selectively participate in vendor early buys that we determine to make strategic sense for us. As we look ahead to the 2024 season, we are expecting to see a range of price increases for next season of around 3% to 4% based on some equipment vendor pricing announcements to-date.

This will result in dollar growth in inventory from third quarter to fourth quarter as we would normally build inventory to be ready for next season. There will be no cash flow impact in 2023 from early buy shipments we received before year-end as these purchases will be done on deferred payment terms. We generated $750 million in cash flow from operating activities year-to-date. We have also completed $137 million of open market share repurchases during the quarter, leaving $463 million available under our authorization. We have also reduced debt by $479 million from the same time last year and $353 million from year-end 2022. Our debt leverage ratio remains conservative at 1.48 times and at the low end of our stated target expectations of 1.5 times to 2 times.

As we finish out the year, we are confirming that our sales expectations for 2023 is to be down in the range of negative 10%. For the fourth quarter, we would expect to see sales down mid-to-high single digits, mostly dependent on the weather and how the level of new pool construction finishes out the year. The one less selling day that we reported in the third quarter will not be made up in the fourth quarter and so we will have one less selling day for the full year. Gross margin for the full year will approximate our long-term guidance of 30%. Fourth quarter is seasonally expected to be less than the full year rate. Our range for margin for fourth quarter is expected to be around 29%, but could vary in either direction. Margins in the fourth quarter will be reduced by the year-over-year increase in average cost we have seen to-date as we compare against last year’s fourth quarter that benefited from lower cost inventory.

From a comparative view, this will primarily offset the 120 basis points negative impact recorded in fourth quarter 2022 for the additional import tax expense. Additionally, we would expect to see some continued pressures on margins from product mix, similar to what we saw in the third quarter. The other structural benefits we have discussed on gross margin all remain. Our target for full year operating expense growth is still to limit base business expense growth to 1%. Fourth quarter will not see the year-over-year decrease in operating expenses we saw in second quarter and third quarter due to the lower volume related expenses in the smaller quarter, but the year-over-year increase will not be as high as we saw in first quarter. Full year interest expense is expected to be approximately $61 million.

Our fourth quarter tax rate will be consistent with our rate in first quarter and second quarter to result in our full year expected rate of between 25% to 25.2%. The expected annual rate is similar to our prior year rate excluding ASU. Our guidance on uses for capital allocation are the same as those discussed at the end of the second quarter, with a use of cash of approximately $25 million on acquisitions, $60 million on capital expenditures and $170 million on cash dividends, reflecting the 10% quarterly increase approved in the second quarter. We will continue to retire debt and repurchase stock opportunistically throughout the balance of the year, with the remaining excess cash flow. We have completed $180 million of share buybacks to-date, leaving our expected share count for fourth quarter to be 39.3 million shares and weighted average diluted shares outstanding for the full year will also be 39.3 million, down 700,000 from last year.

We have narrowed our range for our EPS guidance for the full year 2023 to $13.15 to $13.65, including the $0.15 ASU tax benefit realized to-date. Providing a narrower range in the third quarter after completion of the full season is consistent with our historical process. Third quarter came in very much in alignment with our latest expectations. Our focus on operational improvements and customer experience will allow us to continue to support our customers and provide them the broadest product selection with continued opportunities to grow their business. We will now begin our Q&A session.

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Operator: Thank you. [Operator Instructions] Our first question comes from Ryan Merkel with William Blair. Please go ahead.

Ryan Merkel: Thanks. Good morning. Thanks for taking the questions.

Peter Arvan: Good morning.

Ryan Merkel: I wanted to start off with a big picture question. Pete, it seems that perhaps the worst might be over for the pool declines, can you just walk us through the puts and takes as you think about 2024, I am not looking for specific guidance, just the positives and negatives that you see heading into next year?

Peter Arvan: Yeah. Sure. So, 2023 was no doubt a kind of a crazy year, which followed a couple of years crazy, but for different reasons. So it was — we had bad weather in the beginning of the year, we had interest rates that continue to rise and that we think put a crimp on new pool construction, which was actually — is turning out to be lower than what we thought it was when I was talking to you a year ago, and frankly, when we initiated guidance at the beginning of the year. I think new pool construction this year, as I mentioned, is going to be down 30%. I think it depends on the — that’s an average, right? So I think if you look at entry level pools in some markets, it’s actually down more, and in some cases, significantly more.

The flip side is that the higher end pools remain solid. The builders that build the higher end pools for the more affluent people that have less financing connected or no financing connected to, that business is good. So when I look at the steps back and look at the macro economic environment, based on what we see today, I would tell you that, I don’t think new pool construction is going to drop much more. Could it drop a thousand — a couple of thousand, it could, way too soon to tell because the builders are frankly just putting together their plans and pricing and starting their selling season for next year. But I have talked to many builders in the last couple of months and everybody is fairly optimistic that this year the new pool count is down.

They don’t really expect it to fall much more than where it is today. The other comment I would make on the market is on renovation. Renovation is again that plays a little bit of that same pattern, right? The renovations that would require financing are going to be under the most pressure because of interest rates. Now I read the same things that you guys do on interest rates. If there is moderation in interest rates next year, then that will bode well for both new pool construction and for large renovations. Smaller renovations, most of those are paid for in cash and it really doesn’t have a big impact on whether the jobs get done or not. From a maintenance perspective, maintenance is maintenance. It has to happen. The overall desirability of the pool, outdoor living is still very high, people still want pools.

There would be more pools being built if they were frankly more affordable. So those that have a pool, like them, use them when the weather is good, then they are in them. If I look back at the beginning of the year, a couple of the headwinds we had was very tough weather in the beginning of the year and we also had some of the inventory hangover from the previous year that was in the channel. So as I look forward, and again, too early to give you a guidance, but I am more optimistic about next year than this year, but I also want to be clear with the setting expectations. I am not looking for a material, it’s — new pool construction, it’s not going to take off, it’s not going to grow, but I look at the headwinds that we faced, the stability of the market and I remain confident that I think next year will not be another year of down, down, down.

Ryan Merkel: Got it. That’s helpful. Appreciate that. And then it was good to hear that the inventory is rightsized. Can you just talk about the early buy, would you call that normal, are you being aggressive and how does that impact gross margins in the first half of next year?

Peter Arvan: I would say that our early buys, Ryan, we are going to participate in early buys as is normal, because now we have created the headroom in the inventory where we can participate. So that certainly helps, and as does the price increases, that will be rolling out effectively next month. So for the first half of the year, I mean, remember, our gross margin, as Melanie said, our gross margins are not consistent quarter-to-quarter. They vary from quarter-to-quarter. So they are generally higher peak in the — towards the middle of the season and then they come down. What I would also say is, I would draw your attention to the comment Melanie made about gross margins and the inventory drawdown. When you draw down inventory like we did and you are buying less product like we are that’s also going to impact volume related incentives.

So we don’t anticipate inventories dropping significantly from where we are, therefore we would expect volume incentives to be more in line with what we would see traditionally. But again, very early. I can tell you, from a macro perspective, we will be participating in early buys, but we will give you guidance on how that should flow through the P&L when we initiate guidance next year.

Ryan Merkel: Got it. Thanks, Pete. I will pass it on.

Operator: Our next question comes from Susan Maklari with Goldman Sachs. Please go ahead.

Susan Maklari: Thank you. Good morning, everyone. My first question…

Melanie Hart: Good morning.

Peter Arvan: Good morning.

Susan Maklari: Good morning. Can you talk a bit about the competitive landscape now that we are sort of through the bulk of the pool season? How you are thinking about the different dynamics on the ground, your ability to react to those and any thoughts on the setup as we think about next year?

Peter Arvan: Yeah. Thanks, Susan. Good question. The competitive environment today is really no different than it would have been in a similar year in the past. Meaning that it is a — volumes are down this year. So when we have competitors that and we believe that we have taken share this year, so we have competitors that are probably in rougher shape than we are. But that’s nothing new. We have taken share virtually every year that we have been in existence. We will continue to do that going forward. Now what does that mean for competitive actions? There’s times when we have competitors that do some things that are pretty desperate and when that happens, we have to react. The good news is, is that none of those things have really any staying power.

So might we have to react to a certain inventory position that somebody has that they are trying to liquidate, yes. Is there any material amount that makes that sustainable? No. So it’s — the competitive dynamics today really are in terms of what competitors do in this environment are no different than they have been. I would tell you that we are stronger today than we have ever been. We have more locations. We are opening up more locations. We have more locations already. We are opening more locations than anybody else too and really it comes down to our relentless focus on the customer experience that I think allows us to win.

Susan Maklari: Okay. That’s helpful. And then any thoughts on capital allocation, perhaps, your willingness to step up on the buybacks, just given the improvement you made in the inventories and the cash flows that we saw during the quarter as we think about the full year here and any other sort of thoughts around some of the strategic initiatives and investments there?

Melanie Hart: Yeah. So, overall, for capital allocation, as we mentioned for the bulk of the year, we would really be looking at share repurchases opportunistically. Certainly, historically, we would expect that this year fourth quarter would continue to be a positive cash flow quarter and so we would have even more cash to spend that we currently have and when you look at just our total capacity on all of our debt arrangements, we have a significant amount of capacity. So really, we are very fortunate from a positioning standpoint that we have the ability to make decisions throughout the quarter to invest in what makes sense whether it be anything related to acquisitions, new sales center openings or continued share buybacks.

Susan Maklari: Okay. Thank you for all the color and good luck.

Peter Arvan: Thank you.

Operator: Our next question comes from David Manthey with Baird. Please go ahead.

David Manthey: Hi. Thank you. Good morning.

Peter Arvan: Good morning.

David Manthey: Is it fair to say that you have now lapped any strangeness or variability in the minor repair and maintenance volume situation, I mean, we had shortages, we had coded pull forward. Just trying to gauge if there’s any puts or takes remaining that would lead you to believe that MR — minor repair and maintenance business wouldn’t return to a typical kind of low single-digit growth rate next year? And I am not asking you for guidance, I am just saying is there anything in the past that would lead to variability as we look forward?

Peter Arvan: Yeah. No. I think that’s a fair question, Dave. I think the maintenance business should be normal. The only thing that I would tell you, impacted — we started to see an impact in the fourth quarter that carried a little over into first quarter from a maintenance perspective is the storm in Southwest Florida, but relatively minor from the total company perspective. But when I look at normal demand patterns for everything, I would tell you the maintenance and repair business has the highest predictability and stability, where it gets a little bit subjective is when it comes down to a repair versus an upgrade. So, and again, it really kind of depends on the market that you are talking about. In some cases, repairs may be choice number one.

In other cases, repair and replace or replace would be choice number one. But by and large, I don’t really see much different. In fact, I look at it and say that there’s — as I mentioned in my comments, there’s 70,000 new pools that are in the ground that have to be maintained next year that didn’t exist this year. There was likely some things that were put off this year that next year are going to have to be done. So the good news about a swimming pool in the market is there are certain things that I have to do every week, as you know, as a pool owner. There are some things that I could defer, but you can only defer things for so long when they turn into I’d like to a must have. So that part of the market, we remain confident in.

David Manthey: Right. Okay. Yeah. Don’t I know it. And then second, Melanie…

Peter Arvan: Yeah.

David Manthey: … does the inventory reduction effort in the back half of this year have any implications at all for the pre-buy, and therefore, your gross margin next year?

Melanie Hart: Yeah. Well, it certainly was able to allow us to clear out physical space or pre-buys and make the determination really on a vendor-by-vendor basis, depending upon what their individual incentives were of what we wanted to participate in. And so, I would say, if you had to characterize it compared to 2019, we would say that early buying season was relatively normal and so when you look at what that benefit that might bring for margin for next year, certainly, we will have better color on that once we take a look at what we have received kind of first quarter. We typically will receive early buys either in fourth quarter or first quarter. So we will have a better sense for that when we talk again in February. So the one thing that we did mention that will be slightly ahead of where it has been historically is typically, we would be looking at those kind of one to two price increases in the pre-2019 period, and so for next year, we are looking at those being slightly higher at kind of the 2% to 3% range.

David Manthey: Got it. Thank you very much.

Operator: Our next question comes from Scott Schneeberger with Oppenheimer. Please go ahead.

Scott Schneeberger: Thanks very much. Peter, you talked in the past about maybe a handoff from new pool construction where there was a backlog and then folks moving to remodel and we have heard your guidance on it. But I am curious just to get an updated commentary from you of, do you see that trend pursue — occurring and likely persisting? Could there be upside as you enter 2020 in the remodel category. And in that question, just what you are seeing with higher tech offerings and discretionary purchases there and propensity to pursue those items? Thanks.

Peter Arvan: Sure. As I mentioned, we believe that the renovation and remodel business is holding up better than new pool construction and that’s for a couple of reasons. People with pools tend to be more affluent in general than people that are deciding whether they want a pool or not certainly at the entry level. So our survey of the builder community would say, builder remodel community, because most people do both, right? Most of our customers that are builders are also doing remodel. And I think there with probably very few exceptions, our builders would tell you that their remodel business is better than the new construction business. I think there was a bigger backlog in renovation and remodel a year ago, 18 months ago, because of people that were focused on building new, new, new.

I think with new pool construction being down 30%. I think the backlog of new pool renovation and remodel has been worked down. But also remember, we — the industry kind of views renovation and remodel is about 10% of the industry, right? So if you have 5.4 million in-ground pools, there might have been a little more than 10% in pent-up demand and backlog that today may be back down in the 10% range. So that business is good. It was probably a little bit ahead of itself addressing the backlog, now I would tell you that it’s probably back down to more normal and I think that’s good and that’s healthy for the industry. Your question on the technology adoption, again, it comes down to, I guess, during the height of COVID when people were home and they said, hey, I am spending a lot of time.

I am staring at a swimming pool with no technology. I want, I want, I want. We saw a big request where I want technology, I want technology. We see with new pool construction, the trend towards higher ticket items and technology is still continuing, right? People are still — the pools that are being built today still have the new features and the new technology behind it. Oftentimes, when there’s a replacement necessary, again, it is an opportunity for an upgrade. So maybe during COVID, some of the upgrades were pulled forward, meaning the time clock still works, but I’d actually like to do this from my phone versus going out to the pad. So now when there is failures of equipment we still see adoption of the higher tech product, because frankly, it’s just — it’s a better experience for the consumer.

When pumps fail and they are putting in a variable speed pump, there’s still a lot of single speed pumps in the industry that we are working and people weren’t going to change them. But when they do change them, because of the DOE regulations, they are going to variable speed and they are recognizing a significant benefit in their energy cost. The same opportunity exists when it comes to the heaters, high efficiency heaters versus standard efficiency heaters, and cleaners, there’s types of cleaners that are far more efficient. And again, the consumer trends for those products continue, they are — when people are spending money, those that are replacing most often are replacing for the newer product versus looking at old technology.

Scott Schneeberger: Great. Thanks for that. And Melanie, really nice SG&A efficiencies in second quarter and third quarter. I heard the guidance on fourth quarter that less leverage and the less seasonal activity. But looking ahead to next year, how are you feeling about margin. I know it’s very dependent on what you see on revenue, but how are you feeling on margin on some of these efficiencies you gained? How sustainable will they be into next year? Thanks.

Melanie Hart: Yeah. We are very proud of what we have been able to do on the expense side and it’s a really good indicator of the quality of management and their ability at each individual sales center level to adjust expenses according to the volumes at each location. So as we look forward for next year, we would certainly continue to do that, regardless of whether or not is a significant upswing or just kind of a continued moderating of where we are from a sales standpoint. And so we continue to have work throughout the season, and one of the things that we said earlier on, that we weren’t cutting the base of our expenses, because we wanted to take the opportunity from a volume standpoint and reinvest in our employees in our operational initiatives and our training, and we have been very successful in those things that we wanted to do for this year and so our expectation would be that, that would be a benefit for us as we move forward.

Scott Schneeberger: Thanks.

Operator: Our next question comes from Noah Merkousko with Stephens. Please go ahead.

Noah Merkousko: Good morning and thanks for taking the questions.

Peter Arvan: Good morning.

Noah Merkousko: First — good morning. I know there’s been a lot of discussion about gross margins already, but hopefully, I can squeeze one more in here. I think longer term you have talked about 30% gross margins, and so I guess as we sit here today, is that still the right way to think about it? And you are now — as we look at the medium-term, you are benefiting from early buy for manufacturers plus higher than normal inflation for next year. So could that potentially influence gross margins a little bit higher than that 30% target in the medium-term?

Melanie Hart: Yeah. So thank you for acknowledging that we are still consistently stating that our long-term margins will be — will approximate 30%. When we look at kind of the structural things that made up those margins, we are continuing to benefit from the acquisition-related margins that we did from the Pinch A Penny and Corpus acquisition. And as Pete mentioned in his comments, they are trending overall very well as it relates to kind of compared to the traditional retail market within our industry. We have also seen some benefits from our private label products. That is an area where we would expect to continue to expand as we move forward. We are continuing to add capacity there to serve more of our locations. We have been — had made great strides in what we have done on our procurement and our logistics and so that continues to provide benefits, as well as pricing.

We would say that we are definitely not done from the pricing area. We have some new things that we will talk about when we talk again in February and what we are doing as it relates to pricing. And so really, the only thing this year that will be a little bit out of what we have seen historically is kind of that product mix, particularly as it relates to the building materials. So we are seeing a little bit more of a drag on the new construction on the sell-through of some of those products, which we did talk about that has been a significant growth opportunity for us. So as that normalizes, we would see that, that normalizes as part of our overall longer term margins, and then again, we did also mention the vendor incentives for this year will be less than what they would be in a normalized year.

Peter Arvan: No doubt, margin is a very important focus area for us. It can be hard to predict when you have a dynamic market that you are playing in, right, with mix — customer mix, new pool construction, weather, all of those things factor into the overall product mix and the overall customer mix. But rest assured that the drivers behind that, which is a very effective supply chain, a customer product offering that is very desirable, focus on the — our private label and exclusive brands. a dynamic pricing environment, leaning very heavily into our vertically integrated chemical packaging facility. All of those things help and they are all factored into our long-term plan and our long-term guide. Certainly, as we mentioned, the vendor incentives this year is a — it’s different this year and a year where you are drawing down inventory, then a year when you are increasing inventory.

So a lot of factors go into gross margin. I can tell you that it is a big focus area for the entire business and we believe that will continue to pay dividends for us.

Noah Merkousko: Got it. That’s helpful. And then for my follow-on, just a clarifying question. The language in the press release noted the low end of the revised EPS guidance range $13.15 would be a solid result. Should we read into that to mean that you are pointing to the low end of the guidance?

Melanie Hart: Yeah. That really wasn’t intended to guide one way or the other. I think it was more of just taking a big step back and acknowledging where we are ending up for this year. So, again, as we sit here today, we don’t want to be telling you that sales are down 10%. But it’s really just putting in context of taking out the last two years of extraordinary growth and seeing that from an incremental standpoint, we have certainly accomplished a lot from where we were when we reported 2019 results and so we are proud of the results that we will be presenting to you for this year.

Peter Arvan: Yeah. The fourth quarters are seasonally…

Noah Merkousko: Got it. That make sense.

Peter Arvan: Yeah. The fourth quarters are seasonally least significant quarter. It also is the quarter that has affected the most in terms of a percentage of the quarter by things like weather. So if the season shuts down early and construction drops off sooner, because it gets cold, it magnifies itself because of the size of the quarter. So I think all we were pointing to is the potential variability.

Noah Merkousko: Yeah. Yeah. Okay. That all makes sense. And if I could just squeeze in one other quick one. What was the expected inflation next year from price increases, was it 3 to 4 or 2 to 3?

Melanie Hart: So we had 3 to 4 from an equipment vendor standpoint. We are expecting on the — based on the current run rate on trichlor, we still will have a first quarter and second quarter that we will be lapping some year-over-year pricing. So it could blend kind of within that. We are also still waiting to get kind of final pricing on Horizon. The current look is that, that will probably be something less than what we are seeing on the blue side on the equipment. So we will have a better definitive answer for that when we talk again in February.

Noah Merkousko: Got it. That make sense. Well, thanks for taking my questions and good luck going forward.

Peter Arvan: Thank you.

Operator: Our next question comes from Andrew Carter with Stifel. Please go ahead.

Andrew Carter: Yeah. Hey. Thanks. Good morning.

Peter Arvan: Hi.

Andrew Carter: I think you said this is more of a weather neutral quarter, but I kind of wanted to understand the jump in chemicals, because I would assume had to be volume related, because I think the pricing was steady. So was there any weather impact in that? And then regarding, I know that you called out product mix as a headwind, but would chemicals be accretive or dilutive to gross margin overall? So I will stop there.

Peter Arvan: Yeah. So the chemical sales growth that we saw, Andrew, as I mentioned, is a result of a couple of things. So it was a weather neutral quarter, which it’s been a long time since we have been able to say that it’s a weather-neutral quarter and we weren’t saying that it was extraordinary. Now was it hot in — was it hot in Texas? Yes. It was hot in Texas. But frankly, I have lived in Texas and Texas is hot every summer. So from a weather perspective, we would say neutral. I would tell you that we have been focused on our chemical business and we have been focused on providing our customers with a product offering that is second to none. And with technology tools that allows them to be — to frankly sell more chemicals and I think that bodes well for us, and we are participating and so I think our ability to take share on the chemical basis is evident within the quarter, and that, as you know, is a focus area for us.

So from a margin perspective, when you are talking about our private label and exclusive brands, remember on the chemical side, there’s three different parts of chemicals, right? You have the trichlor part of the business. Remember, we have always said it’s about a third, third, third. You have specialty, you have bouncers and then you have trichlor. On the trichlor, as Melanie mentioned, we did see some deflation on trichlor, but there was offset by some inflation on the other two areas. So, in general, it is margin accretive for us, but it really depends on the chemical trail that you are talking about.

Andrew Carter: Got it. Switching gears a little bit. I know you kind of talked a little bit in sales and not kind of putting a firm line in the sand. But as far as like EPS goes next year, do you have other drivers to grow EPS in a more tepid environment? I know this year has been a story about maintaining SG&A investment. Do you see a world where you can get more flex on SG&A? Do you see perhaps more meaningful gross margin increases, anything along those lines? Thank you.

Peter Arvan: Yeah. Again, too early to put together an outlook for next year. But if you think back about the themes that we have consistently discussed, that are going to have an impact on our EPS, right? One is we have a relentless focus on growth. Sometimes the market helps you in that area with — from a demand perspective, but this year, for instance, with new pool construction, it certainly was of no help. In times like that, we lead into other areas like our capacity creation, which is something, again, we didn’t just start this year, we didn’t start it last year, frankly, was something that was started pre-COVID and it’s a good thing we did because that allowed us to ramp up very quickly and handle the surge in business and the increase in activity without adding significant amounts of cost.

So from an EPS leverage perspective, obviously, in a business like ours, your biggest leverage points are going to be volume. So we have if we grow more then that certainly helps. Margin is an area too. As we mentioned, gross margin is something that is a focus area for us, it’s an area that we still see opportunity in, and of course, as I mentioned, capacity creation and SG&A leverage is something that we always work on. But at the same time, too, in order for us to provide a best-in-class customer experience in order to provide the best technology tools that requires some investment, too. So we tend to be very long-term focused on our investments and deliver it with where we are investing capital on recognizing that sometimes you spend money this year to reap rewards next year or the year after or the year after.

But I think if you look back historically on the investments that POOLCORP has made, that’s one of the things that has allowed us to continue to grow and to continue to expand the operating leverage.

Andrew Carter: And finally, just real quickly, you said something about increased competitive activity during the script. Was that isolated to chemicals or were there any other significant pockets out there beyond just normal course of business that you kind of talked about?

Peter Arvan: Yeah. Andrew, I think, it’s really in a lot of areas, right? When you have a demand environment that is markedly different year-over-year, you have competitors that are going to do things, they are going to react, because they need cash and they need to liquidate inventory. So I can’t tell you that it was — the only place we saw competitive pressure was in chemicals, we saw in chemicals, we saw it in equipment, we have seen it in building materials, and again, the good news is that, those — none of those are sustainable. Do they cause us to react? Yes. Is there a short-term impact when we have to react on that? Yes. Is anybody better positioned to withstand that? Yes. And frankly, what we really focus most of our attention on is providing the best customer experience so that it doesn’t come down to having to match a desperate price in the market.

Andrew Carter: That’s all I got. Thank you, guys. I will pass it on.

Peter Arvan: Thank you.

Operator: Our next question comes from Joe Ahlersmeyer with Deutsche Bank. Please go ahead.

Joe Ahlersmeyer: Hey, everybody. Good morning. Hope you are well.

Peter Arvan: Hey, Joe. Good morning.

Joe Ahlersmeyer: Yeah. Forgive me, I just I need to follow up a little bit on the prior question about the competitive environment. Maybe first, if I am looking at the comment from earlier around the typical sequential decline in gross margin. I think it’s a little larger than the typical sequential decline, and of course, you listed out some unique items. I am just wondering if ex those items, you were down sequentially maybe in the like 50 bps to 70 bps range and the rest of it would be sort of the implied quantification of all those other things?

Melanie Hart: Are you looking at kind of a typical change from second quarter to third quarter and then suggesting that the individual items that we listed out accounted for about 70 basis points? Is that what your question is?

Joe Ahlersmeyer: That’s right. Yeah. Because 150 basis points sequentially. I think the last time you did that was in 2007 and the average had kind of been around the 50 basis points to 70 basis points.

Melanie Hart: Yeah. I would say that we don’t quantify each of the individual items specifically. Once we get to the end of the year, we will be better able to quantify kind of the full impact of, specifically, as it relates to the building materials on the margins. The customer mix, that does vary quarter-over-quarter, because you will see from — depending upon the first quarter or the second quarter, some of those early buy purchases and the shift from a timing from that. So I think that, that definitely impacts the comparison quarter-over-quarter. So those types of things are very hard to in visually at that detailed level assess. Yeah, when we actually — when we go through the list of things that we talked about today, when we look at margins internally, there’s probably 20 things that we are seeing that fluctuates quarter-to-quarter, year-over-year and so we are really just trying to kind of narrow it to the things that are more impactful to be able to give you a better picture of what’s going on with the business.

Joe Ahlersmeyer: Yeah. That makes sense. I guess I just — I am curious the call out of it being typical, maybe that was a directional comment and not so much on the magnitude, but we can take that one offline as well. The other question I have was related to the first answer. There was a particularly pointed comment there that new pools more would be built if, frankly, they were more affordable, I think, to paraphrase. Interest rates seem to be what you are calling out as the main bad guy there, but if I am thinking about the other side, certainly, there’s just the price and cost of the pool. And I am just wondering, what is sort of the probability you would assess to the chance that we just have gone too far on pricing, and 10 years from now, when we say that the pool industry typically gets 1% to 2% pricing year except for 2024, when the industry did have to experience a reset. Is there probability you would assess to that?

Peter Arvan: Yeah. I would tell you the probability of that is really low. Let me expand a little upon my comment about the affordability. As I mentioned, I believe on the second quarter call. What we — where we are seeing the biggest headwind on swimming pool construction in terms of units is in the entry level pools, right? The smaller pools, the cheaper pools, which the builders will tell you that the conversation takes place at the kitchen table to close that deal. Prior to the run-up in interest rates. So for the previous couple of years, when interest rates were very low, a pool could be had for $750 a month to $800 a month and homeowners were signing deals based on that as their monthly payment. But with a significant increase in interest rates, and frankly, less lending in that area in the last 12 months to 18 months, it has driven up the cost — of borrowing cost and availability of that — of those funds to build a swimming pool.

So that has really taken a chunk out of the lower end pools. As it relates to the higher end pools, which are paid for, as we have mentioned many times in cash, those tend — those — the demand for those pools is good. Now it was good before and the builders are telling me that the outlook for that is still strong. So that really is the comment as it relates to affordability of new pools. Now remember, the inflation that we are seeing. So Melanie is talking about, she had mentioned that prices could be up 3% to 4% this year. So 3% to 4% on the rest of the industry on something that is non-discretionary in nature doesn’t really change the demand curve. So if — and frankly, if the price of a swimming pool, if you said that an equipment set for swimming pool is in the $15,000 range now, if the equipment set came down 5%, which we are not suggesting and I don’t think that’s going to happen at all.

In fact, I think, there’s virtually zero chance of that, in my opinion. But if it were, that really isn’t going to change the homeowner’s decision on whether they should start building pool, because in the grand scheme of things, material makes up 25% of the project. So it just isn’t enough to move the needle. It’s really everything else that factors in. And on non-discretionary items, it doesn’t really — if there was a decline from the manufacturers, which we have had zero indication of, if there were, it wouldn’t change the demand curve for the non-discretionary purchases, because nobody buys any of those items until such time as they need them.

Joe Ahlersmeyer: Understood. If I could just squeeze in one more follow-up. If there are…

Melanie Hart: Yeah. I am sorry, but as you think we are over our time for the call. Do you want to follow back up with me?

Joe Ahlersmeyer: Sure. Sounds good.

Melanie Hart: Okay. Thank you. Pete, did you want to close this up?

Peter Arvan: Yeah. I want to thank you all for joining us today. We look forward to discussing our fourth quarter and full year results on February 22, 2024. If we don’t talk to you before then have a very happy and safe holiday season. Thank you.

Melanie Hart: Thanks, everyone.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.