Pool Corp

NASDAQ:POOL

Earnings Call Transcript 2020-Q2

[Operator]

Good morning, and welcome to the Pool Corporation Second Quarter 2020 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mark Joslin, Senior Vice President and Chief Financial Officer. Please go ahead.

[Mark Joslin]

Thank you. Good morning, everyone, and welcome to our second quarter 2020 earnings call. I would like to remind our listeners that our discussion, comments and responses to questions today may include forward-looking statements, including management's outlook for 2020 and future periods. Actual results may differ materially from those discussed today. Information regarding the factors and variables that could cause actual results to differ materially from projected results is discussed in our 10-K.

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'll turn the call over now to our President and CEO, Peter Arvan. Pete?

[Peter Arvan, President and Chief Executive Officer]

Thank you, Mark, and good morning to everyone on the call. Where Outdoor Living Comes to Life, that’s one of our registered trademark which happens to characterize the work product and aspirations of our nearly 4500 employees worldwide. And frankly, I can think of no better description for what has taken place in the first half of this year.

We’ve managed to navigate through an unprecedented combination of events in our business this year, which I’ll briefly summarize for you. As you know, despite the effects of the COVID-19 pandemic, which began to impact our business in mid-March, we started off the year very strong with 13% growth in revenue for the first quarter and adjusted EPS growth of 20%.

On our first quarter call, we explained that our April sales were trending down 5% to 10% year-over-year, due to the COVID-related restrictions put in place and that we were pulling back on discretionary and capital spending in anticipation of a more normal – more cautious consumer spending environment in the months ahead.

Then, as we moved into May, government restrictions in many jurisdictions began to ease, and we saw new trends emerging above and beyond our normal seasonal trends. These were driven by the new stay at home and social distancing restrictions further complemented by favorable weather.

First, seasonal market pool owners who typically delay pool openings until warmer weather arrives wanted to use their pools sooner rather than later, which drove a significant increase in demand for repairs and equipment purchases like heaters and cleaners.

Most of our dealers quickly became inundated with repair and upgrade requests from pool owners who wanted to enjoy the safety and fun of their own backyard earlier in the season.

It should be noted that due to this, we believe many dealers shifted resources to maintenance and repair and away from construction, which was delayed by the closing of permitting and inspection offices in many parts of the country.

Second, as consumers sheltered in place, interest in and demand for new pools picked up significantly. But as consumers soon found out, many people had the same idea which quickly soaked up builder capacity in this labor-constrained industry. This was further exacerbated by the already compressed building season resulting from the COVID-related delays.

At the same time, homeowners were turning to other ways to turn their backyard into a recreational oasis, seeking out above ground pools and spas. Early on, these products were readily available, but with the unpredicted surge in demand, they quickly became scarce as the supply chain was stretched beyond its capacity.

All combined, these trends caused accelerated growth for our business throughout May and June, which continues now into the third quarter, and we believe the renewed interest in swimming pools and outdoor living is not only great news for our industry, but also for homeowners who will benefit from a safe, happy environment for their families now and for years to come.

This story would not be complete without commenting on just how exceptional our employees are performing in these challenging and uncertain times.

Considering the initial confusions surrounding government restriction and their impact on our sales centers and customers, the ensuing work/life balance issues that our teams encountered, the new procedures put in place to safeguard our employees and our customers together with the environment of accelerating demand which stretched our customers, employees, and our supply chain.

The obstacles our employees faced over the last several months and the determination to rise above them is truly remarkable. I am very proud of our team and their ability to stay focused on delivering outstanding customer service in a safe and effective manner throughout this challenging and unprecedented period. Their dedication and resiliency is second to none.

The outcome of all of this is one of the best quarterly operating results in the history of our business. The rare combination of significant sales growth and intense expense management drove substantial growth in income and cash generation. From where we started the quarter and how our business environment has progressed, I believe our results are truly exceptional.

Even more encouraging is the fact that our builders, remodelers, and retailers are all reporting continued strong demand with many builders reporting that their backlogs will take them out into next year.

I mentioned earlier that the unprecedented demand has strained our supply chain, but the strength of our balance sheet and our scale has allowed us to keep back orders and stock out to a minimum, which has also helped drive our results.

For the quarter, our total revenue was a record $1.28 billion, an increase of 14% which is truly amazing considering how the quarter started out. In our year-round blue markets, revenue was up 11%, while the seasonal markets grew an impressive 18% as pools opened sooner than normal.

Florida was up 9% for the quarter and on a year-to-date basis, as well. Arizona saw a 21% increase in revenue for the quarter to bring the year-to-date number to 20%. Texas was up 14% in the quarter bringing the year-to-date number to 12%.

California saw 6% growth in the quarter as they were impacted by a wet start to the quarter coupled with the lingering effects of the COVID shutdown. On a year-to-date basis, California is up 9%.

From an end-market perspective, retail sales were up 22% for the quarter and 20% year-to-date. Strong demand for swimming pool maintenance supplies, above ground pools, spas, and automatic pool cleaners drove most of this increase. The resilience of our retailers allowed them to successfully navigate the pandemic and its associated challenges as many adapted to the restrictions and concerns by devising touchless service and curbside pickup.

Commercial revenue, which accounts for about 4% of our U.S. Blue business was down 21% for the quarter and down 10% year-to-date driven by the COVID-related closures and the decline in both business and leisure travel and the continuing health directives limiting commercial pool operation.

Chemical demand has waned and new projects have slowed. We are anticipating continued softness for this market for the foreseeable future. From a product perspective, equipment sales were up 22% quarter-to-date and 20% year-to-date, again driven by people opening pools sooner and using them more frequently. Heaters, pumps, lights, and filters are all seeing strong demand.

A very encouraging sign we are seeing is that more and more homeowners are opting for some level of automation during construction and remodel and repair, which is providing added sales opportunities and convenience for the pool owner.

Chemical demand was up 5% for the quarter and 8% for the year with results being impacted by stronger than normal residential and service side chemical demand being somewhat offset by softer commercial chemical demand.

Building materials in the quarter were up 7% reflecting the pause in construction we saw in the first half of the quarter driven by the restrictions and shutdowns in permit offices in many markets. As mentioned, this caused many pool contractors to divert resources to serve the surge in maintenance and repair requests.

Demand for building materials accelerated as the quarter progressed reflecting a resumption in construction and strong demand for new pools.

Switching to Europe, we saw a remarkable comeback in the latter half of the quarter, as sales rebounded from the drag created by numerous mandate and closures throughout most of the EU. For the quarter, Europe posted a 21% gain in revenue, bringing the year-to-date revenue growth to 11%. France, Spain and Germany were all strong, as were most of the other markets.

We believe that demand across Europe is being increased by similar COVID-related changes in consumer behavior. Horizon saw a second quarter base business revenue growth of 5% bringing the year-to-date growth to 5% as well. Demand in the Sun Belt has come strong while Northern California and the Pacific Northwest have seen only modest recovery in demand.

Turning to gross margins, overall gross margins for the quarter was 29.2%, 30 basis points lower than the same period last year where we recorded 30 basis points of margin improvement. Mix certainly contributed slightly to the decline, but overall we are happy with the stability here.

Operating expenses were favorable in the quarter, up a modest 6%. Clearly, the actions we put into place early in the quarter together with the benefits of our capacity creation activities contributed to these strong results. Our teams focus on execution has allowed us to create significant operating leverage, while still providing unparalleled service to our customers.

POOl360, our B2B tool, along with BlueStreak, our remote sales counter application, both experienced significant growth during the quarter. POOl360 saleshas increased 32% year-to-date, while the number of transactions processed on BlueStreak has surpassed 30,000.

Our other digital applications like the NPT Backyard App and Search Results SwimmingPool.com also gained significant traffic and traction in the quarter. Mark will provide more details in his commentary on operating expenses.

Moving on to operating income. I am very pleased to report that for the quarter, operating income was a record $205.9 million representing a 19% increase. Operating margin was 16.1% which was 70 basis point improvement over the previous year.

As you can see, the second quarter was extraordinary and I am extremely proud of what our team has accomplished. Current demand trends remains strong and contractors are reporting significant backlog. We are optimistic about the outlook for the remainder of the year, but remain cautious regarding the potential impacts of the pandemic on business conditions.

With this in mind, and assuming similar conditions for the remainder of the year, we are updating our full year 2020 adjusted diluted earnings per share guidance to $6.90 to $7.30 per share or $7.05 to $7.45 excluding impairment charges. Our previous 2020 earnings guidance range disclosed in our April 23, 2020 call was $5.30 to $5.90 per diluted share or $5.45 to $6.05 excluding the impact of non-cash impairments.

Thank you. And I will now turn the call over to Mark Joslin, Senior Vice President and Chief Financial Officer for his commentary.

[Mark Joslin]

Thanks, Pete. I will mark my 16th year at Pool Corp in a couple of weeks, which makes this my 64th earnings call and without a doubt, this quarter has been the most remarkable and not just for the stellar results, but also for how we got here.

When we announced our first quarter results in the middle of April, we were facing significant uncertainty around the pandemic, around how the pandemic would impact our upcoming critical pool season and the rest of the year. So we took a cautious approach by locking down both capital and operating expenses as we discussed on our first quarter call.

Within the next few weeks, as our markets rebounded and then accelerated, and we ran the risk of falling short of resources needed to meet customer demand, while also adapting to a challenging new operating environment.

While we have been stretched very thin by the confluence of these forces, as Pete also stated and I wanted to reiterate here, our field and support teams did a truly remarkable job of keeping their focus and rising to all challenges, delivering outstanding financial results in the process.

I have a few specific comments on these results, as well as what we expect to come for the balance of the year. Pete already discussed sales and margin highlights. So I will start my commentary with expenses. I went into some detail on our first quarter call about the specific actions we’re taking to tighten up our purse strings amid the pandemic uncertainty.

But in summary, back in March and early April, we drilled down on all discretionary spending and locked into a lower spending trajectory as we entered the peak of our season.

The impact from our expense control efforts is visible under the covers in our Q2 results. Given the change in our outlook, both for the quarter and the year, we’ve recorded a substantial $13 million increase in our performance-based compensation in the quarter. Without this, our operating expenses would have been down 2% from last year as a percent of sales and would have been down 190 basis points.

As reported, including the additional incentive compensation, we still brought expenses down 100 basis points as a percent of sales providing us with substantial 70 basis points of operating leverage in the quarter.

Expense savings realized were in a number of areas. Some of the bigger bucket items included labor-related costs with headcount down about 1% at the end of the quarter compared to last year, energy-related expenditures, travel and meeting costs, advertising and bad debt expenses where we recorded – or where we experienced strong collections and good management of aged receivables.

Given the change and the level of our business activity from where we started the quarter, we’ve loosened up the strings somewhat. So I – while I still expect our expense management to be good for the remainder of the year, I wouldn’t expect it to be as good as we reported in the second quarter and we’ll include a continuing impact from higher performance-based compensation costs.

These costs are very broad based as we tie some portion of pay to performance for virtually everyone in the company. For example, in the second quarter alone, our hourly employees in the field, including drivers, warehouse associates and customer sales associates were paid incentive pay at $2.2 million, which was on average over $1000 per employee for the three months period.

Moving down the P&L, we picked up $3.8 million, compared to last year on the interest line with benefit coming from lower debt and lower interest rates. Our average debt for the quarter was $493 million, down 24% from last year, while our average interest expense on debt was 1.82%, down 174 basis points from last year. I expect to see continued favorable comparisons on this line for the remainder of the year.

Moving to taxes, our effective tax rate, excluding ASU benefit remains stable at 25.5%. Given the growth in our share price over the quarter, we had some pull forward of option exercises resulting in the $6.2 million or $0.15 per share ASU tax benefit, which was less than the $7.8 million benefit reported last year.

With this, our effective tax rate was up 160 basis points to 22.5% for the quarter this year, compared to 20.9% last year. As most of you know, given the unpredictability of the ASU tax benefit, we don’t include further gains – further ASU gains in our guidance for the remainder of the year.

I should note however, we estimate we’ll have $5 million of tax benefit for options that will expire in the first quarter of next year, which I would expect to recognize sometime between now and then.

Moving over to the balance sheet and cash flow, growth in our total net receivables of 9% reflects our sales growth in the quarter, as well as improved collections from last year. Our DSO at the end of the quarter was 28.5 days, down a full day from last year.

Looking at inventory, we fortuitously entered the season fully stocked and sold down 10% compared to last year with higher than normal stock outs. Notably in e-related products and above ground pools. Our inventory turns calculated on a trailing four quarter basis were 3.5 times this year, which was a 13% improvement over a year ago.

One other notable item was the impact of the deferred tax payments as a part of the Federal and State relief and stimulus measures and resulted in $18 million in tax payments that were deferred from Q2, most of which will be paid in the third quarter instead.

Driven by our inventory performance and net income growth for the year and aided by the tax deferral, our cash flow from operations was an exceptional $221 million year-to-date, an improvement of $124 million over last year and 18% greater than net income.

We will give some of this back over the next few months as we rebuild inventory and pay taxes, but I expect a very good year for cash generation for us in 2020, which is always a key focus area for us.

One other thing to point out is our capital spending, which I noted on our first quarter call, I had expected to be down 15% for the year as we re-prioritized spending for short-term payback items and preserve capital on other areas.

We made good progress towards that objective with $13 million in spend year-to-date, down 32% from last year again with a markedly improved business outlook, we are retooling our spending plans and now expect CapEx to be down roughly 35% from last year to a range of $20 million to $25 million for the full year.

With our cash generation in the quarter largely reflect a debt reduction, our leverage is measured by trailing 12 months debt-to-EBITDA came down to 1.26 at the end of the quarter, which is a multi-year low.

Looking ahead, our revised guidance makes a couple of assumptions that I wanted to point out. First, the growing spread of the coronavirus in the U.S. brings with it the threat of reimposition of business lockdowns, particularly in key southern markets that have a more significant share of our business as we move through and out of the summer months.

Further lockdowns could threaten our construction and renovation business if imposed and not been factored into our guidance. Second, as always, weather plays a significant role in our results, particularly when looking at year-over-year changes in temperature and precipitation.

This benefited us by comparison in the first half of this year as poor weather in last year’s first half resulted in 3% base business growth and much better second half 2019 weather when we posted 8% base business growth.

Our guidance assumes normal seasonal weather overall with our range reflecting a little better than normal weather at the top and a little bit worse weather at the bottom-end of the range. With these caveats, our guidance range today assumes we’ll have full year revenue growth of 11% to 13%, a modest decline in gross margins in the first half of the year and expense growth for the year at 6% to 8%.

During this we’d generate mid-teens op income growth for the year, 30 to 50 basis points of operating margin expansion and excluding the ASU benefits in both years and the first quarter impairment charge this year, we expect EPS growth of 15% to 22% for the full year.

With that, I’ll turn the call back over to our operator to begin our question and answer session.

[Operator]

[Operator Instructions] And our first question comes from Anthony Lebiedzinski of Sidoti & Company. Please go ahead.

[Anthony Lebiedzinski, Sidoti & Company]

Good morning. Okay. So, yes, obviously, the quarter came in significantly better than expected. Just wondering if you guys could talk about your updated outlook for new pool construction and maybe -- perhaps maybe just discuss the growth rate for above ground pools versus in-ground pools?

[Peter Arvan, President and Chief Executive Officer]

Sure. The outlook that we see as of now, which is based upon, obviously numerous conversations with our builders across the country is very positive. Everybody has very large backlogs. Phones are still ringing off the hook, and everybody has plenty of work we believe to take them through the end of the year and into next year.

Your question on above ground versus in-ground, for perspective, so we mentioned above ground pools being up significantly. But above ground pool is slightly over 1% of our revenue in total. So, it’s – above ground pools were up about 50%, but it’s still a relatively small number in the whole grand scheme of things.

When I look at new pool construction for the balance of the year or for the full year, I expect it to be somewhere in the 8% to 10% range, maybe a little better if weather stays good and the season is longer, and maybe at the lower-end of that if it gets very cold and rains and freezes up sooner.

[Anthony Lebiedzinski, Sidoti & Company]

Got it. Thanks for that. And then I don’t know if there is any way for you to distinguish, but as far as the impact of the government stimulus checks, do you think that had much of an impact on your business or do you think your end consumers are not really impacted by, what they spent on pool-related equipment or new pools?

[Peter Arvan, President and Chief Executive Officer]

It’s very hard to tell, Anthony, and what I believe is that, if it impacted anything significantly, it might have been the above ground and spa business. Just in terms of the dollar amount of what an above ground pool would cost and a spa, maybe it impacted that, I don’t think it really has a big influence on the in-ground market.

[Anthony Lebiedzinski, Sidoti & Company]

Got it. Okay. And my last question, so, as you mentioned, Mark, that your leverage ratio was only at 1.26 times. So, with that in mind, what’s your expectation for that? How should we think about – how you are thinking about the leverage ratio by the end of the year?

[Mark Joslin]

Yes. And that’s good question. I mean, we have our capital allocation priorities, which are investing everything in the business that we need to for maintenance and growth. We have a dividend, which we will grow over time with earnings. And then we use share repurchases to keep leverage in our target range, which is 1.5 to 2 times.

Now, as you mentioned, we are a little bit below that right now. Between now and the end of the year, I am not sure that that’s going to change much and then it may come down more, leverage may come down more. But over time, we are going to get our share repurchases in and we’ll get back to that target leverage at some point if not this year.

[Anthony Lebiedzinski, Sidoti & Company]

Got it. All right. Well, thank you and best of luck.

[Mark Joslin]

Thank you, Anthony.

[Peter Arvan, President and Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from David MacGregor of Longbow Research. Please go ahead.

[David MacGregor, Longbow Research]

Yes. Good morning everyone. Congratulations on a really strong quarter. Great to see the sort of performance there. I guess, I’d like to better understand gross margins and you mentioned down 30 basis points, just wondering if we could unpack that and sort of talk about some of the puts and takes. I mean, I am guessing it was less promotional activity.

You’d talked last quarter thinking that there could be a little more price competition from some of the smaller players. I am guessing that didn’t play out. Private label is probably pretty strong. Maybe just, it was more big ticket, obviously that was the fact, but maybe just to understand some of the puts and takes behind that 30 basis points.

[Mark Joslin]

Yes, well, on the 30 basis points, if you went back to our first quarter call, what we highlighted was that we expected gross margins to be down in the second quarter, primarily because of 30 basis points of improvement that we had in 2019, which was related to selling out lower priced inventory that we purchased at the end of 2018.

[David MacGregor, Longbow Research]

Right.

[Mark Joslin]

So, the 30 basis points that we ended up was actually a little better than our expectations, and in our market update that we did at the end of May, we mentioned that we are selling a lot of these higher ticket items which have a very nice gross profit, but gross margin is a little bit lower.

And that was going to add to the – we thought that would add to the decline slightly of 30 basis points that we are expecting. So, again, the 30 basis points, this reflects the tough comp from last year but very stable margins beyond that and similar to what we had in 2018.

[David MacGregor, Longbow Research]

Private-label, I guess, it was strong. How much of a contribution would you say private-label contributed?

[Mark Joslin]

Yes, private label has over time continued to take more share of our total business. We are up to – now, more than 25% of our revenue and even higher percent of our margin is from private-label business. So, the gains there. They continue, they inch forward, I would say is not dramatic, but they certainly help contribute to the results in a small way.

[David MacGregor, Longbow Research]

Okay. And just a follow-up question, can you quantify lead generation growth looking forward to the second half?

[Peter Arvan, President and Chief Executive Officer]

Yes. It’s – again, it’s very tough, right, because it has to do with what the builders are telling us across the country. So, I guess, very hard to put a number on it, but virtually in every market across the country, the builders would tell you that their backlogs are very high.

The number of leads that they have, like I heard I was talking to a builder just yesterday, they told me they have so many leads and now, that before he actually puts a sales person on the lead, he has people call them back to qualify the lead just to make sure it wouldn’t be a waste of the sales resource time. It is significant. It’s just hard to put a number on because it’s the summation of thousands of small business.

[David MacGregor, Longbow Research]

Okay. Last question from me, just on the stock outs. So, how much of a headwind should we think about the third quarter from stock outs, top-line headwind?

[Peter Arvan, President and Chief Executive Officer]

It’s in our guidance between now and the end of the year. So I don’t anticipate a huge uptick in stock outs. They are higher than they would normally be with this level of activity as you could imagine.

[David MacGregor, Longbow Research]

All right. Thank you very much.

[Peter Arvan, President and Chief Executive Officer]

It’s also something that we spend a lot of time on with working at the very highest levels with our key suppliers to make sure we understand production schedules and that we are getting product to the right location. The other thing to consider is, again, just because of our scale and our size, we may not have it in one location.

We may have it another location in the same market. So, with a few exceptions, few key products that we’ve been able to keep those at minimum. So I wouldn’t anticipate – I wouldn’t bake anything in as far as a big increase in that area.

[David MacGregor, Longbow Research]

Got it. Thank you very much.

[Peter Arvan, President and Chief Executive Officer]

Yes. Thank you.

[Operator]

Our next question is from Stephen Volkmann of Jefferies. Please go ahead.

[Stephen Volkmann, Jefferies]

Hi. Good morning guys. Pete, maybe just a quick one, you said above ground pool was less than 1%. That lower than I guess I would have thought. I don’t think it was huge, but does that include everything, chemicals, pumps, whatever else people need for those things?

[Peter Arvan, President and Chief Executive Officer]

No. That’s just the above ground category. The water vessel itself.

[Stephen Volkmann, Jefferies]

I got you. So, maybe a few more percent than in total then?

[Peter Arvan, President and Chief Executive Officer]

Yes, I mean, it would be a little higher, but remember that the pumps and filters were in above ground pool are much, much, much cheaper than what you look at when you compare those to the in-ground equipment. And as they typically don’t if needed, if they don’t have life, so most of the cost is in the pool itself.

[Stephen Volkmann, Jefferies]

Got it. Okay. Thank you. And then, I am wondering if I can just ask for your sort of opinion or maybe Mark can chime in given his longevity here. But as we think out to next year, we are obviously going to have some sort of tough comps, but it looks like there is still a lot of backlog for the builder channel. I don’t know how to think about it.

Are we going to have a situation where like most of the remodeling and kind of the equipment upgrade is kind of done and we won’t have that until we’ll have a big mix shift to kind of more new build. Or do you think this is sustainable and sort of as we layer that on, do the operating expenses kind of bounce back because you’ve obviously made a lot of headway on in this year.

But in a more normal environment, maybe you would be spending more. I am just trying to think about kind of the big picture, broad brush strokes for next year.

[Peter Arvan, President and Chief Executive Officer]

Yes. That’s a good question. That’s a big question. There is a lot in there. So let me see if I could piece that together. So, when we look at overall demand and how the year shook out for the quarter in particular, as we said that the – there was a lot of call for maintenance and repair, because construction was timely certainly in the beginning of the quarter.

So, the half ended with a lot of resources get diverted to the maintenance and repairs. So the people that bought heaters for instance this year, they are probably not going to go buy a heater again next year. But the dealers were spending on maintenance and repair with diverted away from as we said construction.

Now demand for construction is very strong. Lot of people believe that a swimming pool is the best way for a safe family recreation activity that will be long lasting. So, there has been a lot of interest in swimming pools. So, the dealers are getting a lot of calls. Along with that, is the people that have the pools and remember the install base is the real gem in this industry.

The install base which is somewhere in the neighborhood of 5.5 million pools with people spending more and more time in their pools now are looking at upgrades and remodel. So, in the beginning, I think, what we saw is pools opening sooner in the Northeast.

Remember when I gave you the growth rates on seasonal versus year round market, the seasonal markets had a higher growth rate, because pools opened sooner. But at the same time I think there has been and what they dealers are reporting is a greater interest in the backyard, whether it’s building a pool, if you don’t have one or if remodeling adding features and upgrading what they have.

So the builders are reporting a significant amount of activity on new pools, as well as remodel. Now, you have to wrap all of that with the labor constraints that hasn’t gotten any better in the industry. There is only so much labor. So, as I’ve mentioned before, the system is somewhat pressurized that there is more – there is more demand and there is labor and that certainly hasn’t changed.

In fact, what’s happened now is there is even greater demand, which I think further pressurizes and elongates this season and will take us into next year. So, we will have a tough comp certainly for next year, but I am very confident that the demand will sustain and that the builders are going to remain busy right through next season.

So, one of the biggest impacts you have to put on that as Mark put in his comments is weather, right. So the number of building days will affect remodel and construction. But assuming normal weather, I would think that next year should be another strong year.

Now, the last part of your question was OpEx. And we certainly have realized some gains this year in OpEx. But remember, this is not a new phenomenon that we just started. We started our capacity creation initiatives last year to try and create capacity to slow the rate of inflation that we would see by increasing the throughput in our sales centers and that has paid great dividends for us.

So, I would expect that the tremendous performance on OpEx that we had this year, when I look at going forward, I think that the same ratio of incremental OpEx to GP dollars back in that 60% range is what I would expect in terms of incremental going into next year.

[Stephen Volkmann, Jefferies]

Great. Okay. That’s very comprehensive. You got every part of that. I am impressed. Thank you so much.

[Operator]

Our next question comes from Quinn Fredrickson of Baird. Please go ahead.

[Quinn Fredrickson, Robert W. Baird & Co.]

Hey. Good morning guys.

[Peter Arvan, President and Chief Executive Officer]

Good morning.

[Quinn Fredrickson, Robert W. Baird & Co.]

So, I think you mentioned 5% base business growth for Green in the quarter. Did I hear that correct? And then, also in your outlook, for the second half of the year would your expectation be that Blue continues to outpace Green base business growth or would you expect that Green see some catch-up and starts to benefit from those same stay at home and backyard living trends that Blue has been benefiting from?

[Peter Arvan, President and Chief Executive Officer]

Yes. I think that the Green will pick up in the back half of the year. I don’t know that would be as big as what we are seeing on Blue. Because we simply have a different footprint in the Green business as we do in the Blue business.

When I look on a market-by-market basis, as I mentioned, the Sun Belt was good with the Green business, but we were impacted by the COVID-related slowdown in California, particularly in the Northern California market up into the Pacific Northwest.

But when I look at the Sun Belt markets, when I look at Arizona, and when I look at Texas, the Green business is actually in good shape and strong. So we have a new leader in the Green business that we brought in. They started right at the end of the first quarter and he is getting his arms around it. We like the outlook for the Green business.

We think that there is ample opportunity to grow. But I don’t think for the balance of this year that the growth rate will match in total what we are seeing in Blue, simply because of the footprints and the lack of the install base that we see with the Blue business.

[Quinn Fredrickson, Robert W. Baird & Co.]

Okay. Thank you. That’s helpful. And then, last quarter you had mentioned potential for increased competitive pressures. Obviously, given how strong things have rebounded. I am guessing it’s not something you are seeing, but could you give us a sense for what expectations around pricing contribution might be in the back half of this year with demand being as strong as it is and the stock-outs that you are seeing?

[Mark Joslin]

Yes. Let me, grab that one Quinn. So, what I said on the last call, which seems different people have heard differently. I’ve had a number of questions about it was that, our expectations for discretionary purchases by consumers might be softer, given the economic conditions.

And that that could be a end of season issue with competitors getting stuck with more inventory than they wanted to have and lowering prices to sell out that inventory, convert that to cash at the end of the season. And the end of the season being kind of the August, September timeframe. So that was potential that we had factored into our guidance, bottom-end of our guidance when we said it back in April.

That obviously, first of all, we are not at the end of the season. Second of all, the conditions are much different than what we thought they could be. And so, that pricing competition and need to sell-off inventory for panic too much is certainly not an issue.

And in terms of margins expectations for the back half of the year, to give a bit of guidance in my remarks, prepared remarks that we expected, margins overall for the year to be down a little bit, but that’s all first half-related. So, second half, we are looking for stable margins with prior year.

[Quinn Fredrickson, Robert W. Baird & Co.]

Right. Thank you very much.

[Mark Joslin]

Sure.

[Operator]

Our next question comes from Paul Dircks of William Blair. Please go ahead.

[Paul Dircks, William Blair & Company]

Hey. Good morning everyone and congrats on a good quarter.

[Peter Arvan, President and Chief Executive Officer]

Thank you. Good morning.

[Mark Joslin]

Good morning, Paul.

[Paul Dircks, William Blair & Company]

So, just a few for me. I know you’ve covered a lot of ground. Mark, could you remind us in a typical third quarter what percentage of sales you would see on a by month basis, July, August, September?

[Mark Joslin]

Yes. I mean, it’s a downhill trend. July is the biggest month of the quarter. I would say, it’s in the range of 40% to 45% of the quarter. August maybe in the 30%, 35% range and September being the lowest month in the quarter kind of 20% to 25% something in that range.

[Paul Dircks, William Blair & Company]

Okay. I appreciate that. Thank you. On capital allocation, obviously, you guys generated very strong cash flow, maybe could you talk about how you are thinking about allocating over the back half of the year?

And specifically, when do you anticipate some of your discussions with M&A targets resuming into that a little bit? Has the appetite for investment abroad increased given the strength of your U.S. business and what you are also seeing in Europe? How well are you seeing those markets recover?

[Mark Joslin]

Yes. Let me address that and then if Pete has additional comments, he can jump in. So, in terms of our capital allocation, no change to what was done historically there. Certainly, we did best everything that we need to for business growth, which primarily is organic.

But inorganic as a part of that equation, we did take a brief pause in terms of really what we were trying to get a handle on where the industry was going back in the March, April time period and that was a brief pause. Since then, we’ve kind of gotten back into gear and as always, we are active in the M&A part of our business looking to grow share particularly in markets where we have lower share.

And that is domestically in the Blue and Green business and internationally in the Blue business. And Europe is part of the equation. Pete mentioned very strong results there. We have a great team that is really executing well and we are underpenetrated in certain markets in the Europe. France, we are the number one share in Europe.

But outside of France, we have lot of opportunities to grow, Spain, Germany, big markets where we have lower share and there is some others, as well. So, that’s our part of the equation and lots of opportunities for us to all question of timing and meeting expectations of sellers and us coming to agreement. So back to normal. Pete, if there is anything to add?

[Peter Arvan, President and Chief Executive Officer]

No. I think you covered it. It’s part of our strategic plan. So, we don’t sit back and wait. So there is areas as Mark said that we are interested in. Those are the ones that we pursue and as far as our appetite for those that, as he said, the business is usual right now.

[Paul Dircks, William Blair & Company]

Now that’s encouraging to hear. Lastly, you guys touched upon earlier on growth in POOL360 and BlueStreak. Over the last few months, have you seen the competitive gap between you and some of your local competitors widen. Or how would you characterize their performance in the current market?

[Peter Arvan, President and Chief Executive Officer]

Well, I don’t think our competitors have the tools and the resources that we have. So, whether it’s the POOL360, whether it’s the density of sales centers that we have across our markets, whether it’s the deep inventory, and wide inventory breadth that we have in all of our locations. I think our value proposition is second to none.

And in an environment that has very – a big uptick in growth in a very compressed period of time, you have to be in a position where you can capitalize on that and service that. And I think that our resources and our capabilities are simply unmatched.

[Paul Dircks, William Blair & Company]

Indeed. Thanks so much.

[Peter Arvan, President and Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from Garik Shmois of Loop Capital. Please go ahead.

[Garik Shmois, Loop Capital Markets]

Hey, great. Thanks. And congratulations on the quarter. It doesn’t sound like it, but I just wanted to be clear, are you seeing any strain in the supply chain and any extended lead times to any product given the big surge in demand? And just a follow-up to that, can you provide your view on information going into next year if there is any pricing you think you will need to get in the funnel?

[Mark Joslin]

Yes. Let me address that. So, as I mentioned, the supply chain in certain areas has certainly been put to the test. And we have things like above ground pools and spas, we sold out in the second quarter in many areas and the suppliers at a max capacity for what they are going to be able to ship for the balance of the year. So – but again, those categories for us, although represents nice growth.

They are relatively small. When I look broadly across our categories, we have our stock-outs are up, but it is something that I look at on a weekly basis and when I look at it in total, what is outstanding if you will, it’s still a relatively small number. I think the team – our supply chain team has done just an outstanding job of working with the suppliers.

Now, if the supplier simply doesn’t have it, the good news is, is with many of these products, if one manufacturer doesn’t have a - and you were waiting for a heater, for instance, which there is obviously been a huge run on demand for heater. If you don't have one heater in stock, we, A, may have that heater in another location that we can draw from or we may have another brand of heater and/or the conversion kit, so that we can keep the customer working.

So I think the team is very creative, very resourceful and the strength of our entire organization has certainly helped us from a growth perspective and helped the customer. As it relates to inflation, inflation for this industry in a typical year is 1% to 2%.

I would think that next year and the reason I qualified that with, I would think it’s because all the manufacturers are not out with their numbers for next year. But I would think that next year it’s probably going to be a little bit higher, maybe 2% to 3% instead of 1% to 2%. But I don’t think anything crazy.

[Garik Shmois, Loop Capital Markets]

Okay. Thanks. And then just my follow-up is on gross margins. I know you talked about, it sounds like pretty stable gross margins in the second half of the year. But just kind of given the negative variance in the product lines that you are selling grew any mix considerations that we should be cognizant of as we move through the next two quarters?

[Mark Joslin]

Yes. And not from a gross margin perspective. So, stable gross margins even with mix maybe putting a little bit of pressure on. We have other things there offsetting that. And believe that overall, we’ll have good stable gross margin performance in the back half of the year.

[Garik Shmois, Loop Capital Markets]

Got it. Thanks guys.

[Mark Joslin]

Thank you.

[Peter Arvan, President and Chief Executive Officer]

Thank you.

[Operator]

[Operator Instructions] And our next question will come from Alex Maroccia of Berenberg. Please go ahead.

[Alex Maroccia, Berenberg]

Hi, good morning guys.

[Mark Joslin]

Good morning, Alex.

[Alex Maroccia, Berenberg]

Turning on just one on inventory, what level of inventory would you be comfortable with at the end of the year considering your days inventory were down two days in Q2?

[Mark Joslin]

Well, that’s a good question. I think, different ways of measuring that, we are a little bit light right now as we said, we’ve had shortage in certain areas. And really want to beef those up. We are also looking at growth as we move into next year.

So, inventory, just one reminder, inventory is a little bit variable at the end of the year, because it’s based on when our vendors ship to us. In the pool industry, we have, what’s called early buy, where we place orders in the late September, early October timer period, big orders with our major vendors.

And then, they ship those orders at their convenience. So, it keeps them working and fully engaged throughout the off part of the season, the lower part of the season. And then as they produce products, they ship it out to the – based on the orders they have and to all their customers. And so, it varies quite a bit in terms of when we receive that product they come in November, December, January, February.

So, really, we look at trying to get inventory to a level at the start of the season, February, March of next year, we want to be fully stocked as we were this year and prepared for strong season. Our service is certainly one of the most important aspects of our culture.

And that has helped us over time to take share and so we are planning on growing our business and growing our inventory levels by the time we get to the start of next season.

[Alex Maroccia, Berenberg]

It all makes sense. Thank you. And just a second one then, if I heard correctly during the prepared remarks, Pete noted that chemicals demand waned in Q2. What do think was driving that? And is a reversal possible given the fact that the number of installed pools might be higher next year than what’s previously forecasted?

[Peter Arvan, President and Chief Executive Officer]

Yes. No what I said was the chemical demand for the commercial segment waned. Residential chemical demand was – we saw the decrease was in commercial as the municipal pools and public pools, many of them remain closed because of the COVID restrictions. Residential chemical demand is actually up. On the retail side, our chemical sales are up about 9%.

[Mark Joslin]

Yes. And in terms of growing install base is certainly something that would be happening as Pete mentioned, we are looking for growth in the install base this year with new pools construction going up possibly 10% in that range and expect that grow next year, as well.

So that adds the install base which is building maintenance business for us. Chemicals is a major maintenance product. And so, that’s good for growth in that category for us over the long-term.

[Alex Maroccia, Berenberg]

Alright. Great. Thanks for the clarification and good luck for the rest of the quarter.

[Peter Arvan, President and Chief Executive Officer]

Yes. Thank you.

[Mark Joslin]

Thank you.

[Operator]

This concludes our question and answer session. I would like to turn the conference back over to Peter Arvan for any closing remarks.

[Peter Arvan, President and Chief Executive Officer]

Yes. I want to thank everybody for joining us on the call today. We look forward to reporting our third quarter results on October 22. Have a great day. Thank you.

[Operator]

The conference is now concluded. Thank you for attending today's presentation and you may now disconnect.