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Pool Corp
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Good day, and welcome to the Pool Corporation's Third Quarter 2022 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, Chief Financial Officer. Please go ahead.
Welcome to our third quarter 2022 earnings conference call.
Our discussion, comments and responses to questions today may include forward-looking statements, including management's outlook for 2022 and future periods. Actual results may differ materially from those discussed today. Information regarding the factors and variables that could cause actual results to differ from projected results are discussed in our 10-K.
In addition, we may make references to non-GAAP financial measures in our comments. A description and reconciliation of our non-GAAP financial measures is included in our press release and posted to our corporate website in our Investor Relations section.
I will now turn the call over to our President and CEO, Peter Arvan.
Thank you, Melanie, and good morning to everyone on the call.
This morning, we were pleased to report another solid quarter for the business. Net sales including acquisitions came in at $1.6 billion, a 14% improvement, with base business posting a 10% improvement over the same period in 2021.
Our results were fueled by solid demand for non-discretionary maintenance and repair products, continued new pool construction activity, strong renovation and remodel activity and inflation in the 9% to 10% range.
Now that we have closed the third quarter, we are fairly certain that new pool construction activity in 2022 will be down when compared to 2021. We would estimate that new pool construction units this year will be 10% to 15% less than the previous season. As expected, remodel activity has tapped into the free capacity of our builders to keep them busy.
From a macro perspective, inflation, adoption of smart pool products, consistent demand for non-discretionary maintenance on the installed base of pools, and the leveraging of our operating network, are all enabling continued share gain and growth.
Now, let me provide some specifics on what we have seen in our four largest base business year round markets. As expected, Florida continues to be very strong with base business revenue up 20% for the quarter. Arizona also posted strong results with revenue up 18%, while Texas and California finished the quarter with solid results up 10% and 16% respectively. Our year round markets grew 15% for the quarter, and seasonal markets grew 5% as less favorable weather impacted the buildable days and pool usage in the northern seasonal markets.
Looking at end markets, I'm pleased to report that commercial pool product demand remains strong with sales up 28% for the quarter. This is in line with total year-to-date growth rate of 27%. Retail sales excluding Pinch A Penny were up slightly at plus 4%, which reflects some inventory correction into channel and less favorable weather in the seasonal markets.
Looking at Pinch A Penny as a standalone, we continue to be very pleased with the results. Retails sales through the franchise stores are up 16% over prior year third quarter.
From a product perspective, equipment sales growth is solid posting gains of 9% for the period. This category includes pumps, heaters, lights, filters, and automation.
Chemical sales were up 32% for the quarter as the trichlor shortage and inventory issues have abated. At this point, the only chemicals that remain in short supply are liquid bleach and Cal Hypo, which are used to shock the swimming pool.
Lastly, building material grew 14% in the quarter reflecting solid demand in a still labor constrained market.
Let me now add some commentary on our European operations that as a reminder make up about 4% of our total revenue. After a tremendous year last year, the teams in Europe have been impacted by less than favorable weather, a very tough economy, spiraling energy costs, and the war in Ukraine. This is combined to create a significant headwind for our team as we saw sales decline to 24% in the quarter, 11% on a constant currency basis. This follows two solid years of growth in the quarter where combined sales grew approximately 44% in the same quarter.
The Horizon team continued to perform well as we posted base business revenue growth of 12% in the quarter, bringing the year-to-date sales growth to 17%. We continue to expand this platform and remain confident in our ability to grow.
Turning to gross margins for the quarter. Our overall gross margin was 31.2%, which is decline of 10 basis points when compared to last year. Generally, we are pleased with the stability of our gross margins with the year-to-date results being a very solid 31.8%, which is a 140 basis point improvement over prior year.
From an expense perspective, the team again delivered incredible results. Our operating expenses for the quarter were up 17% which slightly exceeds our revenue growth, but is in line with expectations given the acquisitions, new location and investments in growth. From a base business perspective, operating expenses were up 8% with revenue up 10% in the period.
You can see clearly that our capacity creation activities continue to deliver value for our customers' team and supplier partners alike. POOL360 and our other digital platforms continue to grow. In the third quarter POOL360 sales increased 14%. As previously mentioned, we released a new version of POOL360 this year are entering the rollout phases. As a percentage of our revenue sales through POOL360 are at 12%. This is an area that we expect to expand as more and more customers experience the benefits of using this improved app and other b2b tools in our arsenal.
Wrapping up, the income statement, you will note that our operating income came in at a solid $264 million, which is an 11% increase over the previous year same period. Operating margins came in at 16.3% for the quarter with our year-to-date operating margin at a strong 18.1%.
Finally, with three full quarters behind us, and a favorable outlook for the balance of the year, we are updating our earnings guidance for the full-year 2022 to $18.50 per share to $19.05 per share . Excluding the ASU adjustments, the range is $18.26 to $18.81 per share. This represents an incredible 22% improvement at the midpoint on top of a tremendous year in 2021.
As you can see, the POOLCORP team continues to raise the bar within the industry and deliver very strong results in a dynamic economic environment. The last two-and-a-half years have been both challenging and at the same time transformative for the industry. No single company was or is better positioned to capitalize on these challenges and opportunities in POOLCORP. The depth of our team, our expansive footprint, our strong balance sheet, and sheer grit and determination, have allowed us to not only gain share but gain efficiencies at the same time.
The industry has transformed as well and is now larger, driven by: one, a higher install base which is approximately 6% larger when compared to the 2019 installed base of in-ground swimming pools; and two, structural inflation that has increased the size of the industry by approximately 30%. Pool owners continue to upgrade their equipment pads with new technology as normal repairs are needed and replacements are made. This too increases the size of the market as people invest in technologies that make their life easier and may not have been available when their pools were built.
Consider the average age of a pool in North America is around 25 years old, with about half of those pools operating with little to no automation or modern features.
Clearly the jump in new pool construction activity in 2020 and 2021 help drive our growth. At the same time, however, the non-discretionary maintenance and increasing content on the replacement items as well as the structural inflation on the growing installed base have allowed us to grow this year despite the fact that new pool construction activity may be down from the previous year by as much as 15%.
With announced inflation from the major equipment manufacturers in the 4% to 5% range for 2023, we expect this to mitigate potential declines in new pool construction and a less robust renovation market should those market conditions occur. Additionally, we are confident that the strategic investments that we made with the acquisition of Porpoise Pool & Patio to improve our value proposition for the retail and DIY segments that we serve to our thousands of independent retailer customers will drive continued growth.
We also continue to expand the number of Pinch A Penny franchise locations in the Sunbelt markets gaining an even stronger foothold in key year round markets as we added seven franchised locations this year with more in development for next year. This acquisition also brought us strategic capabilities in chemical packaging, making us more vertically integrated and improving our margins and capabilities. We further gain incredible customer technology platforms and applications that we intend to leverage across our entire business to grow our independent retailers, customers businesses.
We have remained disciplined in our capital allocation maintaining a leverage ratio well below the 1.5x to 2x target that we have historically observed. And we have returned $572 million to our shareholders this past year in the form of share buybacks and increased dividends.
Our industry is somewhat unique given the high recurring revenue nature of the business. We also enjoy a market leading position, expanding capabilities, and an unmatched track record.
While no one is certain about what challenges we will face in the future we can be certain that we will rise to the occasion. Our mix of business is most heavily weighted on non-discretionary spending, and we provide best-in-class service and value for our customers. Additionally, we do not believe that inflation across most of our product categories will revert to previous levels as this would be unprecedented and not sustainable given the historic cost increases that our manufacturer partners have absorbed.
Thank you. And I'll now turn the call over to Melanie Hart, our Vice President and Chief Financial Officer for her commentary.
Thank you, Pete, and good morning, everyone.
Third quarter finished with a record $1.6 billion in sales, representing 14% growth over the 24% growth realized in 2021 for a two year cumulative increase of 42%. In comparing the quarterly growth of 14% to the full-year expectations of 17% to 19%, we saw third quarter growth of approximately 10% on pricing, 4% on acquisitions, and net overall domestic volume growth. This was offset by unfavorable impact of 1% each for Europe operations, foreign currency, and one last selling day in the quarter. We also had some sales center closures during Hurricane Ian during the last few days of the quarter. Historically, big weather events have resulted in short-term disruption with a slight positive impact in the subsequent quarters.
Gross margins at 31.2% came in slightly below prior year margin of 31.3%. Base business margin decreased 80 basis points over prior year, where we saw a 250 basis point increases in the third quarter 2021 over 2020 level. Focused pricing efforts, supply chain initiatives, and product mix all contributed to sustaining higher margin levels during the quarter, as prior year benefited from our strong ability to pass-through price, as we saw multiple in-season price increases from our vendors.
Base business operating expenses as a percentage of net sales decreased from 14.5% in prior year to 14.2%, as our capacity creation efforts continue delivering operating margin leverage, as we manage through the inflationary cost impacts of our business. Acquisitions added $20 million in expenses during the third quarter compared to last year.
Overall, our quarterly operating margins remained strong at 16.3%. We continue to invest in growth strategies while being focused on our disciplined expense management.
Interest expense for the quarter increased $9.4 million as we have higher debt levels compared to the same time last year, reflecting our investment in acquisitions, share buybacks and working capital. Our average interest rate increased from 2.8% to 3.2% reflecting higher borrowing cost. We continue to maintain a conservative trailing fourth quarter leverage ratio of 1.25. They are well below our target leverage range of 1.5x to 2x.
For the quarter, we recorded an ASU benefit of $0.6 million or $0.02 per diluted share. The same quarter last year had a higher level of activity, resulting in a $4.2 million or $0.10 per diluted share benefit. With our current stock price, we estimate that we would recognize approximately $0.04 in additional benefits in either the fourth quarter 2022, or the first quarter 2023, for remaining options that expire in first quarter 2023.
The effective tax rate excluding ASU for the quarter was 24.9% compare to 23.2% for the prior year period consistent with our historically slightly lower rates in third quarter than for the full-year.
Net income for the quarter represents an improvement of $5.4 million. Excluding the ASU it reflects an improvement of $9 million or 5%, driven by revenue growth, healthy gross margin and continued strong execution. This resulted in a 7% earnings per share growth excluding the ASU in both periods.
Moving into our balance sheet and cash flow discussion. Accounts receivable increased consistent with sales growth compared to last year. Days sales outstanding finished the quarter at 27 days a quite improvement when compared to more historical levels that were in the 28 to 30 day range.
Inventory increased to $1.5 billion, compared to slightly over $1 billion in Q3 2021. We have seen incremental growth and inventory year-over-year decrease from 77% at second quarter to 48% or 43% base business, as we wrapped up third quarter. Approximately a $140 million of the year-over-year increase relates to inflation, $52 million was added to support acquisitions, and $13 million for the five new U.S. locations that were not open in third quarter of last year.
We have realized strong returns from our investments in inventory and supply chain initiative. And the value of the inventory on hand will continue to provide incremental gross margin benefits as we have seen additional vendor cost increases in the 4% to 5% range heading into next season.
During fourth quarter 2022 and first quarter 2023 we expect to begin receiving inventory placed on early buy terms consistent with 2019 and prior years to prepare for the upcoming season. Our resulting inventory balances at year-end will vary depending upon the timing of shipments of those orders by the vendors. However, any orders placed on early buys have all been strategically evaluated. We have reduced the dollar value of both POs by approximately 60% from peak level as lead times have improved from vendors.
Year-to-date cash flow from operations was $307 million compared to $359 million in 2021. The increase in net income of $134 million was offset by increases in working capital. Recall that 2022 cash flow also reflects $80 million of income tax payments that we deferred from 2021 as a result of Hurricane Ida. In the fourth quarter 2021 we continue to add to basis of inventory. And so this year's fourth quarter we would expect to generate more cash as the number of our inventory receipts expected in fourth quarter will include extended early buy payment terms. We anticipate finishing the year with solid adjusted cash flows around 80% of net income excluding the IDA tax payment, while positioned to benefit from inventory investments going into 2023. Our inventory balance at year-end could range from plus 10% to plus 25% depending on the timing of vendor early buy shipment. This is slightly ahead of the plus 5% we were expecting earlier in the year before we have the opportunity to evaluate the early buys.
We have paid $112 million to-date in dividend to shareholders, a 27.50% increase over last year, three third quarter. Additionally, we have purchased 192 million worth of shares on the open market during the quarter for a total of $461 million year to-date and have $230 million available under our current authorization.
Leverage at the end of third quarter was 1.25x and is well managed within our dated capital allocation model, while investing first in the working capital of the business and providing strong returns to our shareholders. We expect to be at or below our target range at the end of the year.
As we look out for the balance of the year with just the fourth quarter remaining, we still expect our sales growth to range from 17% to 19%, reflecting a 5% contribution from acquisitions and 10% from inflation. We are not expecting Europe to recover during the remainder of the year, so we project that to be a 1% drag on the full-year with an additional 1% from foreign currency.
Weather and the extent of repair activity that takes place in the Florida area may impact how we close out the year.
Inflation impacts for fourth quarter are expected to be approximately 8% compared to the 10% for the full-year.
Selling days for fourth quarter and the full-year will be the same as last year.
As we lapped the 260 basis point gross margin improvement realized in fourth quarter 2021, we would expect gross margins in the fourth quarter to decline sequentially due to seasonal timing, and also be negatively impacted by lower inflation from vendor price increases this year in fourth quarter compared to last year. And lower incentive earned under volume-based vendor program, resulting in a 150 to 200 basis points decline in Q4 gross margin compared to last year. We focus mainly on full-year gross margin and will finish the year up from prior year.
Considering future expected rate increases during the balance of the year and our higher borrowing levels interest expense for the fourth quarter is expected to be significantly higher than last year, resulting in interest expense for the year of $43 million to $44 million up from our previously estimated $40 million. Consistent with our overall capital allocation we have a conservative position on debt management and currently have in place $300 million or 20% of our outstanding debt covered under interest rate swap agreement. That converts our line of credit debt to fixed rate that are currently below market rate mitigating the full impact of our debt exposure to rising interest rates.
The share repurchase activity during the year reduced overall shares outstanding and we expect full-year weighted average diluted shares to be approximately $40.1 million including participating securities. Any further share repurchase activity in the fourth quarter is not expected to have an impact on our share forecast for the year based on the time remaining in the year.
We have narrowed our earnings guidance range and reflected the additional ASU benefits recorded during third quarter. This brings our guidance range for the year to $18.50 to $19.05, including the $0.02 ASU tax benefit added in the quarter or $0.24 year-to-date. This represents expected earnings per share growth of 20% to 24%, excluding the impact of ASU benefits.
As mentioned above, the impact from expiring options in first quarter will be expected to provide a $0.04 benefit. However, timing is uncertain and that's not considered in the guidance range for Q4, but will be included in the 2023 guidance for any unexercised amounts as of year-end.
As we wrap up another successful pool season, we are extremely proud of the hard work the team has done to continue to grow the industry, and we look forward to finishing the year strong.
We will now begin our Q&A session.
We will now begin the question-and-answer session. [Operator Instructions].
Thank you. Our first question is coming from David Manthey from Baird. David, please go ahead.
First off, Melanie, I think you just said that the fourth quarter gross margin would be somewhere in the 29%, and that you did say that you're focused on the annual amount. I just wanted to gauge your current confidence in that prior view about holding the line on the 30% annual gross margin in 2023 and beyond.
Yes. So certainly our long-term guidance, we still hold to that and we will reiterate that when we give our 2023 guidance in February. If you look back at just our quarterly -- the impacts of the margin quarter-over-quarter, fourth quarter certainly is historically less than some of the quarters within season. Because we have the ability within season, our customers are typically not as price sensitive. So the decline in margin going from third quarter to fourth quarter is consistent with what we historically would've expected.
Right. Okay. And then as a follow-up, how should we think about earnings leverage in the model? I mean, you've had years of successful capacity creation and this recent inflation taking things to a higher price level. And now your operating margins at least this year are probably shake out in the 17% range. Will contribution margins in the future be higher than the mid to upper teens level you've typically seen in the past? Just trying to understand earnings leverage from this point given contribution margins versus reported margins.
Yes. So as we take a look at just kind of our operating model and our expense leverage, as we've seen over the last two years, we've certainly seen higher levels of sales growth. And with that we've seen lower than those the sales growth on expenses, but certainly growth. And so as we continue to look forward from a long-term standpoint, we would always expect that we would grow expenses less than the overall sales growth. And so do believe that within our model, we have many types of expenses that are available and flexible based on volumes. And so we do still believe that we have some ability to maintain our current operating margins and to continue to grow those long-term with sales growth.
Our next question is coming from Ryan Merkel from William Blair. Ryan, please go ahead.
First off, can you just talk about volume growth through the quarter and into October? And really what I'm driving at is, are you seeing any signs of weakness anywhere in your business?
Yes. Good question, Ryan. As we said, we're forecasting at this point that new pool construction is going to be down, as I said in the 10% to 15% range. A little bit the shoulders of the year, as you know, are the time that are most affected by weather. That it may be at the higher end of the decline if weather closes up sooner and maybe a little bit better if the seasonal weather stays buildable.
I guess what I would say is that when I look at volumes considering the decline in new pool construction, when you look at what we posted for the quarter, I'm actually pretty happy with the fact that volumes are holding up. And that remember they're holding off of an elevated level compared to where we have historically grown. And that's partially because the installed base is growing partially because we believe that there was some pent-up demand in renovation.
And it's offsetting at the client in new pool construction. So on balance, to say that new pool construction is going to be off likely at least double digits. The fact that volumes are still flattish is actually a pretty good position we think.
Yes. I agree. Can I follow-up on that new pool comment? Is that down 10% to 15%? Is that in units or dollars? And another question is, I thought there were backlogs out there, so I'm a little surprised, right, that we're seeing this kind of dip here.
What I would say is that the -- it is on -- to your first question is, it is in units and dollars will be higher of course because of the structural inflation. And I think the backlogs really are -- you really have to kind of take that apart. So first of all, we had a slow start to the season especially in the northern climates where builders got a late start, right?
So they got less pools in the ground. And as you know, when you loop those days early on, you typically don't get those back. I think that we -- the builders would tell you that there's -- they are seeing more pressure in the seasonal markets and the year round markets I think are in better shape. And I think higher end pools tend to be in better shape than the lower end pools.
I think that any pullback will be skewed in my mind to the lower end pools. The higher end pools I think are in good shape. So if you look across the -- our customer base, I think there is an adequate backlog as it as high as it was last year, no, but I think given the state of the economy I think that there is plenty of work out there, exactly how many again we're -- we still have a almost a quarter to go, so we're estimating the minus 10, the minus 15. But I think most builders would tell you that the frenzy has died off, but there's still plenty of work out there.
Okay. That's helpful. And then just lastly, I wanted to ask a high-level question that that is on everyone's mind. So we've got a situation. We've got rising rates. We've got a slowing housing market. Really, Pete, I just want your high-level views on how to think about each segment of your business over the next couple quarters. So maintenance, upgrade, rental, and new pools. How do you see that trending in this environment?
Yes, good question. If you look at our -- if you look at the new -- let's start with the maintenance and repair of the installed base of pools. Historically, that segment has grown with the installed base plus inflation because as you know, and we've said it many times, once you have a pool, you have to move the water, filter the water and treat the water. Whether you're using it seven days a week or whether you're using it two days a week, those activities have to happen. So we would consider that that portion of the business, which has historically been the norm that that, that part of the business is going to continue to grow as the installed base of pools grows.
So, new pool construction, we think is going to be down this year as we said. And I think we started the year saying we felt based on input from our dealers that there was a backlog in renovation and remodel projects that people were waiting to have done as the builders focused on new pool construction. I think that portion of the business is -- has held up well and I think has benefited from the available labor as evidenced by the fact that even with new pool construction down, volumes are still flattish. So we like that. And I would tell you that the new pool construction is down this year, could it be down next year. I suppose it could. I mean we're certainly not forecasting that, Ryan, but I guess when we think about it from a macro perspective; new pool construction makes up roughly 20% of our business. Renovation and remodel make up roughly 20% of the business. And the balance is the maintenance and repair the 60% that continues to grow. So really, we're certainly not forecasting to this, but let's say new pool construction fell another 20% next year. If new pool construction falls 20%, that's 20% of 20%, so that's 4% of revenue.
And if you said, well that same pain would be felt broadly across the renovation market 20% on another 20% is an additional 4%. And then if you take the inflation, which from the major equipment guys has already been announced in the 4% to 5% range. And I think if you look across the -- our portfolio in total, that's probably a good number to look at. If you look at plus 4% to 5% on the 60% of the business, that gives you a minus one or a plus one there, right? And then a, a plus one net, right? Because you're up five minus four. So even with a 20%, I mean, to be conservative, if those two markets are down 20%, I think you're still looking at a flattish sales number.
Our next question comes from Susan Maklari from Goldman Sachs. Susan, please go ahead.
My first question is, I want to follow-up a little bit about the inflation point. You made the comment that you see the 4% to 5% for next year. Can you talk about the sources of those inflationary items, how we should think about them going forward and how we should think about that relative to perhaps some commodities or some other areas that may deflate on a relative basis next year?
Sure. Good question. So the 4% to 5%, that's really -- that's kind of a composite number that we see assembling from the major equipment folks, right? Which is a very, very big, the biggest part of our business in total. Pure commodity things like rebar and PVC pipe to some degree, do I think that there could be more deflation on those items? There could be. I mean, there's so many factors that go into that, but when I look at those items in total, our exposure in terms of dollars to those items are -- is relatively small because there's just not a in the grand scheme of things and not a whole lot of dollars associated with that.
And if you move into another category that some would consider more commodity like would be chemicals, you've got really three different parts of the chemical business, right? You've got the 3 inch tab portion of the business, right? So the two biggest parts of your -- of chemicals are going to be the trichlor tablets. And I would say that given the inflation that we saw this year, the tariffs that are in place the additional supply that's coming on next year, I mean, we're not -- at this point, we've not put a forecast together for chemicals for next year. But is it conceivable that we could see some decline on that portion of the business, which makes up let's call it a 3-ish of our chemical spend. Could there be some decline there? Yes. But you're talking about 2%, 2% to 2.5% of our overall business. So even if that were to decline 10%, 15%, you're still talking very small impact overall.
The next biggest part of chemicals is going to be your shock, right? So chlorine and Cal Hypo and frankly, both of those are still net short. So I don't really see prices in that area doing anything, but probably going up. And then there's the specialty chemicals which make -- which would make up the balance. And I think that the pricing will be fairly solid in those areas, but that -- from a very high-level that's kind of how we think about it.
Okay. That's very helpful color. I also wanted to dig into the balance sheet a little bit. Can you talk about inventory, how you're thinking of the ability to work through that as we get to the end of this year and then into next year? And perhaps with that too, just in general, as we move to the sort of newer macro environment that we may be in over the next couple quarters, how you're thinking about the balance sheet and leverage and the relative opportunities there?
Yes. So as I mentioned, when we took a look at all of the early buy opportunities, we evaluated them on an individual location standpoint and by skew. So we knew what we were buying when we placed those purchase orders. And so we're very comfortable with the POs that we've executed on the early buys and that we've done so to position ourselves as we go into 2023 to ensure that we have some margin benefits.
So very comfortable with that. As we move into kind of the fourth quarter and first quarter, when you look at the inventory that we have on hand, we probably have about three weeks more than we normally would have in kind of ordinary supply environments. And so when you roll forward to kind of the end of Q1 typically that would be our peak inventory period as we prepare for the second quarter and the increases in sales for the second quarter. And so based on our projected purchases between now and then, we would expect that our inventory would normalize over the next couple of quarters as we come out of second quarter next year.
Our next question is coming from Andrew Carter from Stifel. Andrew, please go ahead.
Hey, thanks. Good morning. So I appreciate the commentary, Pete, you walked us through on the different business lines and almost putting out a almost a worst case scenario down one. In that kind of scenario, what would be your flex at the SG&A level? I mean, would the gross margin be higher than your 30%? Could you kind of help us what the takes across the P&L are that would help you mitigate some of that kind of sales decline?
Yes. So gross margins will be better positioned to be able to provide a little bit more color on that when we talk again in February. But as we look at the expense line item, we've already talked about specifically we've called out incentive compensation as one of the areas over the last two years with our higher than historical growth or where we've seen some increases in there.
And so we talked about that moderating on a normal growth year from a 6% to 8%. But if sales expectations are lower than that we would have some additional money -- additional ability to flex that.
But really, outside of just the incentive compensation, there's several areas when you look at the overall contributions to our expense line. The biggest expense is really in the people area. And so where we are from a staffing standpoint with the 17% to 19% growth that we have this year, we've certainly added some temporary and encouraged some overtime expenses that in a time where sales would not be growing as they are this year, we would have the ability to flex that as well.
And then really kind of after those two components there's just many of the natural items as it relates to delivery expenses and even discretionary expenses when you start getting into travel and entertainment. I think that when we looked at kind of our expectations and the expense flex that we did in 2020 to me is just kind of a good model to show that we do have the ability to take some of those discretionary expenses out of the business.
Thanks. Second question, the -- that I would ask there, kind of going on to thinking about kind of your branch network and kind of your managers, what they can do in terms of I mean you just said it, Melanie, you went through everything. How quickly are they able to adjust and how quickly are they able to say, hey, I don't want to miss sales in this environment and weigh the tradeoff between that and ordering too much, staffing too much whatever, and then having worse sales, worse profits. How quickly can you make that transition and how are they incentivized at the local level to make the correct decision there?
Yes. Andrew, here's what I would say, we have -- we have -- we're very fortunate to have very experienced operators that have been through many cycles. So if you look at our management team, really all the way down to the branch level it's a very, very experienced, years of experience, when you look at our the depth of experience at our general manager level and our regional manager level some degree, the sales center manager level, we've been developing the team for many, many years.
So this is not a new thing for them. They've been through the cycles. So they understand the tradeoffs on expenses. They don't -- they don't typically wait and say, well, I'll wait if it -- if things look like they're going to cool. They have a) the experience and frankly, every incentive because with basically the POOLCORP system, the operating systems are total add them up. The way that the whole company is like, frankly, the way Melanie and I are measured is really is that same way all the way down to the individual P&L level. So there is no incentive for them to be late. There is no incentive for them not to capitalize on a sales opportunity and the flip side is there is no incentive for them to wait and say, wow, if things are going to cool off, I'll just carry this incremental expense that I don't know that I -- that I need.
I mean, the operating model is, is time tested and well sought out, and it is executed by a very experienced team. So, if -- and again, we're not suggesting that the environment next year is going to be bad. Frankly, we don't know at this point. But are we prepared for, any occurrence. So as I said, we -- I kind of gave you a worst case model, from a revenue perspective, if new construction were to really drop off again, which basically would take you back to 2019 levels. If that were to happen, and the renovations followed, the top-line sell then, as Melanie mentioned, there are numerous areas that we would see immediate benefits, from an SG&A perspective, whether it's people, whether it's incentive comp, whether it is transportation, trucks, fuel, you name it, the model will flex almost immediately with those.
We have now a question from David MacGregor from Longbow Research. Please go ahead, David.
Yes. Good morning, everyone and thanks for taking the question. I guess just again, thinking about 2023, how much of a drag could Horizon or SCP Europe be?
I think if you look at Europe, we said that it is 4% of the business overall. Right. And its --
Right.
And it's having a very tough year this year. So I mean, if things get, sequentially worse, again, and they're off another 25%, you're talking about 1%. Right. And when I think about Horizon, in terms of their size, their footprint and where they are, they're going to be slightly -- they'll be slightly bigger than that. But I also think that given the areas that we are building in Horizon, because again, when I think about the economy in general, in -- and housing specifically, which obviously is more important -- the housing market is more important to the Horizon folks than it would be to Blue, a couple of things to consider. Number one is, over time, we have been working to expand the maintenance and repair portion of our business in Horizon so that it is not so fully dependent on new construction. Now clearly in that business, new construction is important. But when I look at it in terms of the impact in total, I mean, you're talking about a business that is, less than 10% of our total, I think we've been moving more and more of that business focused to the maintenance and repair piece, which should mitigate a cooling off in new construction, number one.
And number two, we've invested in the markets that even if there is a cooling, those markets are still going to be good. Florida is still going to be good. So we've invested in growth in Florida and the Carolinas that, the housing market there, are still good. So, I mean, I look at it and say, could there be a drag if there's a catastrophic drop in those areas, yes, but given their relatively small percentage of our total, I don't think it's going to be a terribly meaningful impact.
Okay. Thanks for addressing that. My follow-up question is really around Porpoise Pool & Patio, the acquisition and just how you're thinking about accretion next year. And I guess I'm wondering, it's kind of at a higher level. If your pool owners that are feeling tight economic pressure, do they switch from having a pro maintain the pool to going DIY? And if so does that create maybe a stronger sense of optimism around what that accretion might look like next year?
Yes. I think that is something that could very well happen. Now obviously, we're not providing guidance on next year at this point, but if I just think thematically about it, so yes, if so, conceivably, if the economy slows, then you have homeowners that are making a decision that says well, what, I'd rather just take on the maintenance and repair of the pool myself. And frankly, that was part of the reason for the -- strategic reason for the acquisition of Pinch A Penny or Porpoise Pool & Patio is that, they have a great retail network that the franchisees operate. And embedded in that are some great tools and capabilities that we can now leverage for the independents.
So I think looking forward, if there is a switch from professionally maintained to DIY, I don't think anybody is better positioned to capitalize on that. And quite frankly, the way we look at it is the customer is the pool, right? So what we're focused on -- so we know where every pool is in the country. And what we are focused on is from a market share perspective and from a service perspective is, all right, if the pool is -- the homeowner wants to do a DIY, great. Then we want to make sure that we are working with a retailer or a franchise -- a franchisee that is catering to that part of the geography where that pool is so that we're best positioned to continue to gain tank to grow and share and provide the equipment and chemicals and supplies needed to maintain that pool.
Our next question is coming from Trey Grooms from Stephens, Inc. Trey, you may proceed.
Thanks. This is actually Noah Merkousko on for Trey. So my first question, I wanted to touch on commercial demand. I know that's a small part of your business, but it sounds like that's still an area for growth. As you look out over the next few quarters, do you think that's an end market that can continue to show growth? And can you just remind us how much of the business that is?
Yes. It's about -- I think in total, it's in the 4% to 5% range. And that business is -- remember, it went through a really tough spot during COVID, right, when people stopped traveling. And people are back to traveling. They're back to vacation. So there is a considerable amount of money being spent in those areas as evidenced by our sales growth, right? So we are up 28% for the year. The project deck that we get to look at -- because remember, there's two parts for that business, right? There is the project, right, new construction, major renovation. Those are -- that's typically a bid-and-spec. They're larger, many times municipal projects. So there's a lot of visibility to those. So we get a pretty good look at the pipeline of that, and I can tell you that the pipeline is very healthy in that area. And then there's just the maintenance and repair that's tied to using of those pools.
And given the fact that travel -- the travel season this year was very good, don't really see that letting up all that much anytime soon. And the fact that it's a relatively small part of the business, when I look at it, I think that there is upside there. Is it tremendously going to reshape our future? No, but I'm encouraged by the -- by our ability to continue to grow and take share in that market as well.
Thanks. That's helpful. And then just for my follow-up, if we think about that pretty conservative case you made for demand next year for new pool construction and renovation, if that were to take place, does that change your appetite at all for M&A?
No. Not at all, really. I think our -- we're a very strategic acquirer. If you look historically back on the acquisitions that we made, we have been very prudent and judicious and also strategic. So am I willing to overpay for an asset? And the answer is absolutely not. And the reason is, is because in most cases, those acquisitions, we don't -- we're not in a position where we have to overpay for every -- for anything because, frankly, in most markets, we're already there.
So it is perhaps some additional capacity that we would be picking up and some additional business and then a synergy opportunity on the backside. But when asset prices become inflated, we get the choice to sit back and say, am I willing to pay an inflated price for an asset that I probably don't really need to acquire because if I need additional capacity, we have the muscle memory, if you will, and the capabilities to greenfield very quickly.
So this year, we're going to open up approximately 10 new greenfields. Next year, we're looking at a similar number of greenfields. If I made an acquisition in some markets that I had teed up for a greenfield, might that change my appetite to greenfield if there was something that made sense strategically from a business perspective and from a cultural perspective because that was one of the other things that we look at when we do acquisitions is what is the culture that we're acquiring. Because we have a very good culture in the company, and there has to be a fit there.
So I think we have an appetite. We certainly have the balance sheet to do it. We have a strategic plan that is really done at an individual MSA area. So if good assets become available and their value perspective, it makes sense, then absolutely, we would move forward.
The flip side is that if we needed additional capacity in an area, there was no asset that made sense to acquire, then we would simply do what we've always done and that is greenfield, and we can do that relatively quickly. And if you look at our success rate with greenfield, it is just tremendous.
And we have a question now from Joe Ahlersmeyer from Deutsche Bank. Please go ahead, Joe.
Joe?
Go ahead, Joe.
Yes. Can you hear me?
Yes, sir.
Okay. Sorry about that. Yes, I'd like to go back to the gross margin guide for 4Q, if I could. I think it might be helpful [indiscernible]?
I'm sorry. You're breaking up a little bit, so I can't hear your question.
Okay. I'll take it off-line.
Okay.
Sorry about that.
Okay. We'll move on with Stephen Volkmann from Jefferies. Please go ahead, Stephen.
Great. Hi guys, I'm here. Most of my questions have been answered actually, but I was just hoping you could maybe explain to me a little bit how sort of the vendor rebates work. And I guess I'm trying to figure out -- I assume they're probably volume-related rather than price-related. So if we had maybe a base case of sort of flat volumes next year, what would be -- how should we think about the headwind from vendor rebates?
Yes. So the majority -- the vast majority of all of our programs are volume-related. And so they also do reset every year and with typically, having targets in there for growth targets. So in the years where we've had kind of higher than normal purchases and sales growth, we typically will benefit from that on the vendor rebate portion of our gross margin.
Right. I guess that's where I'm going. Because I'm assuming you benefited from that over the past couple of years and maybe as we normalize, you won't going forward. I'm just trying to figure out what kind of headwind that might be.
Yes. We can take a look at that and maybe provide some more commentary in February as we look at kind of our -- because it's really -- it is going to be tied to our sales expectations as to what we think that impact might be going into next year.
Yes. And Steve, the programs are negotiated on an individual basis, and we're just in that process right now. So hard for us to quantify that because, again, we haven't guided from a revenue and volume perspective and the programs are still in flux. But I mean, rest assured, this is part of the normal business practice for us. There are some years, obviously, that vendor rebates are better than others, and it really depends on the individual vendor and how the programs are constructed. But we'll have more color for that when we provide our full-year guidance into -- for next year. But I can tell you that it's contemplated in our long-term guidance, which is really the way that we would ask you to think about it.
Understood. Okay. Thanks. And then maybe a quick follow-up, Pete, I think you mentioned in your comments that retail was up like 4%, but Pinch A Penny was up 16%. It's a pretty big difference. What's driving the Pinch A Penny growth?
Yes. I think as we mentioned, we certainly have some great retailers in the -- our traditional independent retail business. I think if you look at our retail business from a geographic perspective, it would be very similar, right?
Pinch A Penny is a great operator. We certainly have great operators that perform equally as well. But I would also tell you, look at the footprint that where Pinch A Penny operates. It's primarily Florida, Texas, some Louisiana and a location in Georgia as compared to our entire retail basket, which goes all the way up into the seasonal markets, which, as you know, had a much tougher year given the late start to the season, the large early buys that they made, hence my comment on inventory correction.
We have a question from Ken Zener from KeyBanc. Please go ahead.
Just good morning to you guys. How are you?
Good. How are you?
Well. Melanie, the interest expense, I believe you said $17 million in 4Q implied?
I'm sorry, go ahead finish up your question.
The -- no. No, no. The interest expense, you said $43 million for the year. If my model is correct, that implies roughly $17 million in the fourth quarter. Is that correct?
Yes, that's correct.
And should we annualize that, so over $68 million next year?
Again, we'll provide a little bit more color on that. Two things on that. As we are at higher inventory levels, and so we would not expect for the full-year of next year that we will be carrying debt at the same level that we have currently.
Okay. But obviously, even sequentially, it was a pickup. In terms of -- Peter, you talked about valuations and your ability to do greenfields, et cetera, et cetera. Could you maybe give us some parameters how you think about valuation in the space of EBITDA easy to sales, if you would, within the context of deals that you guys have done?
Yes. I mean valuations of late have been high, right? Traditionally, I would tell you that valuations in industrial retail -- sorry, industrial distribution for a good business, you're talking about multiples which traditionally have been in the 5% to 7% range -- or 5 to 7x range. What we've seen in the last year with the frenzy of capital coming into the space is we've seen some what we would consider just crazy numbers being paid, and again, luxury of not having to participate in what we would consider crazy valuations.
So traditionally, for us, 5x to 7x is what we have seen. And from a greenfield perspective, it varies really on a case-by-case basis, but we can typically greenfield for at least a couple of turns or more below that.
Yes. And I was just kind of -- just taking a look back obviously, the stocks had a large decline of which by our estimates, a good chunk of that 60%, 70% valuation, right, so that -- which you're kind of referring to in the broader market. But the revenue ladder, if you will, 60% maintenance discretionary new, whether it's down 10%, 25%, it doesn't seem to be that's the issue in terms of what is in investors' mind so much as much as perhaps the -- and I know you guys went over this at your -- at the Analyst Day, Melanie, you talked about to gross margin just recently at 30% drop. But I mean, it seems to be that margin is really the big mover for this valuation, is quite a bit lower for the group. And I -- at the Analyst Day, you guys did a very good job outlining why you think the dramatic margin expansion is sustainable. Could you maybe talk to your understanding of how -- you've obviously gained a lot of share. Fluidra, other companies have talked about down volumes. Can you talk about perhaps how the competitive landscape might -- if we do get these? And I don't know if it's a worst-case scenario, but what you kind of laid out. How do you think smaller operators -- what's your experience with how smaller operators respond to kind of a Draconian demand world versus in terms of the margins versus you guys, just so we can understand how the competitive landscape might shift if demand does decline significantly?
Yes. Certainly, when -- in very tough operating conditions when cash is a big issue, then the ability for the smaller guys to be able to maintain inventory and maintain the service that the customers have become accustomed to becomes a challenge. And typically, in those markets, the bigger -- your bigger players tend to get stronger because we have far more resources to bring to bear to continue to provide the exceptional customer service that I think has allowed us to take share.
And again, I certainly don't want to overplay the Draconian what could happen. But it seems that there's a lot of concern in the market that says, wow, new pool construction went way up, and it's going to go down. And the numbers that we pick, basically, would take you back to a new pool construction number similar to where we were pre-pandemic. But I think the part that is worth mentioning again is the fact that the industry is structurally larger now. So it's not like we're depending on and hoping that, well, new pool construction is going to continue at this elevated level. Look, if new pool construction is flat next year or up a couple or up 10% or minus 10% or minus 15%, again, we kind of -- or even minus 20%, we kind of outlined what that means for the business. But at the same time, you have to consider that the industry is structurally bigger because of the inflation.
Now when your expenses are going up and business is slowing down, certainly, you have the smaller players are the first ones to feel the pinch. And they are the ones that that have the least capital reserves in order to continue to provide the level of service that they have been providing. So our expectation would be if history were to repeat that in a market like that that your larger players like us would do better.
Right. And you wouldn't see discounting similar to your old roofing industry perhaps, where they would go for cash flow and create extra pressure as they liquidate their inventory?
Yes. So --
So your gross margins were fairly stable in 2007. I mean you did 27.5%, down from 28.3%. It's kind of in that -- didn't compress so much back then, your gross margins.
Right. And very -- very good point. So look, we have to compete in individual markets, right? So we don't -- we certainly don't have a national price on everything we compete in individual markets. If there was an independent that decided that they needed cash and had a lot of a particular product that they wanted to drop the price on to try and grab some immediate revenue to generate some cash flow, could that happen? Absolutely.
And -- but the way we would look at that is there's a finite amount of product out there. They can't do that for very long because none of these players are very large. So might they discount some excess inventory if they have it in order to raise cash? Yes, but you're talking about a de minimis amount of product in the grand scheme of things. Frankly, we compete with that all day, every day anyway. So -- and when if you look at the operating margins of our competitors and obviously through all the years of acquisitions, we've seen a lot of the P&Ls of these guys, there isn't a whole lot of room there to do anything on a sustained basis. It's not like they were operating at high double-digit margins and they could say, well, let's discount. And frankly, it doesn't really change the demand curve, right?
Right, right.
And inflation cost on inventory is high, there isn't -- there frankly isn't an opportunity over the long-term to do anything in regards to that. And their operating margins are tight enough that they simply don't have the checkbook to say, well, I'll just -- I'll take it on the chin.
Right. They can't weather it. And I apologize about pursuing this line of questioning with you. But I mean your margins in 2006 were about -- about 2005, 2006 were about 9%. They fell to about 6%. Would you say those margin ranges are consistent with the comments you made about competitors in the environment today?
Tough question to answer. I can tell you I've seen much worse than that.
We have a question from Garik Shmois from Loop Capital. Garik, go ahead.
Well, hi, thanks. Well, thanks for squeezing me in. I'll try to be brief here. Just on the comment that you made, the contractors are switching more to renovation work as some of the new construction has slowed. Should we read into this that backlog on the renovation side are still strong and the outlook there is still quite good into next year? I'm just trying to maybe kind of bridge that with maybe an earlier comment when you were trying to provide some sensitivity on the renovation work relative to new construction in 2023.
Yes. I mean the information that we're getting from dealers right now is that they still have plenty of work, right? So I can tell you, we believe, as I said, new construction is going to be down. So you can see that our volumes are flattish. And frankly, if you look at the seasonal markets, as I mentioned, versus the year round markets, you see a pretty big difference. So the year round markets, Sunbelt markets, where we saw growth in population where people are moving, those markets are still very strong. As we mentioned, Florida was up 20%, which is obviously way more than inflation for the year. Texas is up, California, Arizona; the big year round markets are up. So our conclusion is that where pools are being built, still strong in those areas. Although permits are down, still pools being built in those areas and renovations in those markets that the demand there is still strong as evidenced by what we're seeing from a revenue perspective.
Okay. Thanks for that. Follow-up question is just if you can speak a little bit to mix and if there's been any recent evidence at all to any trade-down or if it's -- that we haven't seen that just yet.
Yes. I don't think we've seen that. In fact, we don't know for sure because the year still is not complete. And once the year gets wrapped up and we have some more forensics on the construction count and such. What I think is happening is, you're not really seeing trade-down at the component level because at the component level, it really is de minimis for something that is a longer-term investment, right? So if I'm buying a pump and it's going to last 7 to 10 years, I don't know that you see people saying I'm going to trade-down because over the course of ownership, not that -- not that -- not that big a deal. The same thing when it comes to high-efficiency heater, if you will, people, I think, are still making longer-term decisions on larger purchases. Where I think we would see contraction is really at the entry level, right? I think at the entry level, that's where you're likely to see more pain before you see trade-down to the component level. So it's the decision of do I build the pool or not. If I was on the edge of whether it made financial sense for me to build a pool, those are the ones that I think probably maybe tap the brakes and see what happens in the broader economy. But I think at the upper end of the scale, I think those projects still continue, hence the value that we're talking about, not just pool counts, but value being -- still being healthy.
And this concludes our question-and-answer session. I would like now to turn the conference back over to Peter Arvan for any closing remarks. Thank you.
Yes. Thank you all for your support and for joining us today. We hope you all have a safe and happy holiday season. We look forward to reviewing our fourth quarter and full-year results for 2022 on February 16, at which time; we will also provide preliminary guidance for the 2023 year. Thank you very much.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your phones.