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Pool Corp  (NASDAQ:POOL)
Q3 2018 Earnings Conference Call
Oct. 18, 2018, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the Pool Corporation Third Quarter 2018 Conference Call. (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. Mr. Joslin, please go ahead.

Mark Joslin -- Senior VP & CFO

All right. Thank you. Good morning, everyone and welcome to our third quarter 2018 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 2018 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 posted to our corporate website in our Investor Relations section.

Now I'll turn the call over to our President and CEO, Manny Perez de la Mesa. Manny?

Manuel Perez de la Mesa -- President, CEO & Director

Thank you, Mark and good morning to everyone on the call. In terms of the 2018 season, after a slow start in March and April, activity reverted to expected levels since then with the main constraint being customer capacity and reduced workdays due to higher rainfall in selected markets.

We are expecting ongoing growth in the fourth quarter as demand remains strong with builder customers presently working on 2019 contracts. As mentioned in previous calls, we were expecting greater and earlier than normal manufacturer price increases in 2018, given materials and operating cost pressures. Those increases have largely been communicated and are being passed on through the channel. While the impact will be felt primarily in 2019 given the late 2018 season timing, there will be some impact on sales and noise on gross margins in the fourth quarter of '18 and early 2019.

For 2018, the bottom line impact should be fairly mute, but it should add to our sales in 2019 and beyond. As I look at our business, we are stronger and better across the board. Our ongoing investments in people, facilities, product lines, fleet, technology, marketing and service continues to separate us in the marketplace which have enabled us to consistently grow market share and through ongoing improvements and execution also increase our operating margin and ROIC.

As I close my prepared remarks for my 80th and last quarterly earnings call, it's important to recognize all of the individuals in the investment community that have contributed to our success with your questions and perceptions, which ultimately lead us to challenge ourselves to becoming a progressively better company.

Of course, our people are the heart of our business and it is they that have generated our success each and every day.

With that I'll turn the call over to Pete for his business commentary.

Peter Arvan -- Executive VP & COO

Thank you, Manny and good morning to everyone on the call. As you all saw in our announcement, we had a good third quarter, the overall revenue growth was 9% with 8% coming from our base business which is encouraging. This is on top of last year's 8% overall and 6% base business growth for the same period. Like third quarters in the past, we had to contend with severe weather this year as our markets were affected by Hurricane Florence in the Carolinas, significant September rains in Texas and wildfires in California early in the quarter.

In spite of this, the team has performed well delivering strong results for the period. Our four largest markets, California, Texas, Florida and Arizona continue to do well with a combined base business growth of 7% for the quarter. Of the four largest markets, Arizona continues to lead the way with an outstanding 13% base business growth rate. Our green business continues to grow posting a 7% growth rate for the quarter, continuing the trend from Q2. Please note that the 7% growth is all organic. These numbers reflect solid demand across both the blue and green businesses.

Turning to our international business. Europe led the way with 20% sales growth in the quarter with the rest of the country posting results in line with plan. Looking at gross margins, you will note we finished the quarter at 29% overall down 10 bps from last year. As you have seen in previous years, small fluctuations between quarters are normal, this would be no exception.

With good top line results, solid gross profit margins combined with good execution on expenses, we realized a 13% overall increase in operating income with base business realizing a 12% increase. Mark will provide more financial commentary after my remarks.

Turning to product sales, we continue to see strong demand for our building materials with sales up 16% in the quarter, again reflecting strong underlying demand for our products, equipment sales were up 8%, where chemical sales increased 10% for the same period. As mentioned on the previous call, our B2B sales have been a focus area for us. Year-to-date our B2B sales are up 11% but even more encouraging is that sales from our POOL360 app are up 25% for the quarter and 21% year-to-date. We believe this tool provides value to our customers by simplifying the ordering and payment process allowing them to be more productive with less time spent away from the job.This value add service is a key differentiator for us allowing us to take share in a competitive environment. All total year-to-date our B2B sales make up 12% of total revenue.

As mentioned last quarter, we continue to see inflation pressures on transportation, purchase services and wages but the teams are working very hard to drive productivity plan that will allow us to see increases that are aligned with volume growth. This reflects the talent and hard work of our team. Of course, our most important asset is our team and we work very hard to make sure that we recruit the very best, inspire them to do their very best and recognize and reward them for their efforts. The key measure of our effectiveness is turnover and again in a highly competitive environment, our turnover is down.

Thank you for your time. I will now turn the call over to Mark for his financial commentary.

Mark Joslin -- Senior VP & CFO

Thank you, Pete. I'll start with an update to my margin commentary from our second quarter conference call where I reviewed our expectations for both gross margins and operating margins for the remainder of the year. As I mentioned on that call and in line with our long-term guidance, our expectation for 2018 has been that gross margin will be relatively flat for the year with some variability by quarter. That guidance remains intact. While we had a modest mix related gross margin decline in the third quarter and for the year-to-date period, we expect to see growth in gross margin in Q4, leaving us flat to up (inaudible) for the year.

On operating margins, I discussed our expectation for improved expense leverage in the back half of the year and ending the year with 20 to 40 basis points of base business operating margin improvement. Again, we are very much on track with that expectation. As you've heard already, our selling and admin expenses in Q3 improved 60 basis points as a percent of sales resulting in base business operating margin improvement of 30 basis points for the quarter. This puts us in the bottom end of our targeted full year guidance with 20 basis points of improvement through three quarters with 12% operating margin compared to 11.8% last year. We expect to make further progress here in Q4 getting this toward the upper end of our targeted 20 to 40 basis points of operating margin improvement for the year.

As it relates to expense management, we're right where we expected to be with continued improvement as the year has progressed. We discussed some of the factors driving our operating expense results for the quarter in our press release, I won't repeat that here, other than to point out that on our Q2 call, I discussed some changes to our incentive compensation arrangements that would shift the timing of expense recognition by quarter. The result of that shift was to provide a lower compensation expense in both the third and fourth quarters. That was the case for Q3 and it's one of the factors that we believe will help us achieve additional operating margin improvement in Q4.

We also covered taxes in some detail on our press release, so I'll just reiterate that in Q3 our tax rate excluding the ASU benefit was slightly lower than in other quarters which is typical and consistent with past years. I'll also reiterate that we are on track to hit our previously communicated 2018 full year tax rate of 25.5%. Also, consistent with past practice, we have not forecast any additional benefit from ASU 2016-09 in our guidance range for the remainder of the year.

On the balance sheet and cash flow statements, I have one meaningful item to highlight, which is the impact of pre-price increase purchases that we began making in Q2 as discussed on our second quarter call and that continued into Q3. As we have discussed, this was a significant departure from the last several years, both for us and the industry, where we have historically experienced a steady progression of modest price increases for most of the last decade and which were normally passed on after the season in the fall time period. The result of this as that we made significant pre-price increase purchases that along with acquisitions and normal business growth resulted in the $126 million or 26% increase in inventory levels at the end of the quarter, as well as our $61 million reduction in operating cash flow. While we will sell off some of that inventory over the next few months, we expect to have higher than normal inventories at year end and as I mentioned on our Q2 call, our cash flow from operations will very likely be less than our net income for the year. This is a timing issue on cash generation that will reverse by Q2 next year as this inventory is sold.

One of our planned uses of cash this year is for share repurchases. While we did not repurchase any shares in the quarter, we have been active buying shares after the end of the quarter. And in October, we repurchased 150,000 shares at an average price of $151 a share resulting in the use of cash of $22.7 million. For the year, we've repurchased 400,000 shares at an average price of $144 a share for a total use of cash of $57.7 million. Our goal for the year was to spend $100 million to $150 million in the year for share repurchases and we hope to be in that range by the end of the year.

One additional topic that I wanted to update you on is lease accounting. As most of you probably know, the accounting gurus have changed the reporting rules on leases and beginning in 2019, companies will be required to record a right of use asset and an offsetting lease obligation liability on their balance sheets for lease commitments that historically had been unrecorded, but disclosed in the financial statement footnotes. As we lease substantially all of our facilities worldwide, this change will result in a material addition to both assets and liabilities, which we estimate will be in the range of $150 million. You'll get your first look at this in our Q1 2019 statements. There will be no material impact from this accounting change to our income statement or cash flow and it will have no impact on our debt arrangements, which already anticipate changes in Generally Accepted Accounting Principles.

Now I'll turn the call back over to our operator to begin our question-and-answer session.

Questions and Answers:

Operator

(Operator Instructions) The first question today comes from Ryan Merkel with William Blair.

Ryan Merkel -- William Blair -- Analyst

So I want to start with the hurricanes and rain. Can you just give us a sense, was there a big impact in September and then how is it looking so far in October? Should we expect that that would be bouncing back?

Mark Joslin -- Senior VP & CFO

Okay, the two hurricanes, one we just had in October, Michael, hitting the Panhandle of Florida and then Florence hit the Carolinas. Both were disruptive, but given the timing of the year, given the size of those markets, the overall impact when you factor in the overall company, it's fairly mute. So no big impact, I mean, they did impact us, yes, but for example the rains in Texas, as an example, all the wildfires in California impacted us more in the third quarter than Florence did.

Ryan Merkel -- William Blair -- Analyst

And then obviously you mentioned you thought you'd have a nice fourth quarter, so should we assume that organic growth is sort of continuing at a similar pace as the third quarter?

Mark Joslin -- Senior VP & CFO

Yes.

Ryan Merkel -- William Blair -- Analyst

And then Manny, going back to last quarter you mentioned some possible noise on gross margins as potentially there'd be some gamesmanship on supplier price increases. Can you just give us an update there, what have you seen and should we be worried about gross margins in the fourth quarter?

Manuel Perez de la Mesa -- President, CEO & Director

Well, you should not be worried, first of all. The increases have been announced, communicated and are largely now effective on the part of the manufacturer, certainly on the equipment side, they've been effective now for one to two months or 1 to 2.5 months. And we have been passing those on, so that the noise here is that as Mark indicated, we buy into these price increases depending on the velocity of the individual SKU, depending on the amount of the increase and other considerations we determine how far we buy into on a SKU level. And therefore the noise is what we do vis a vis what others do in the marketplace. Typically, the order of magnitude of these increases are less than they were this past couple of months and therefore the impact is negligible. Here, there may be a little bit of a pick up in gross margin in the fourth quarter and first quarter, which is when Mark talks about getting back to flat margins for the year, that's our expectation is that we'll have a little bit of a pick up in the fourth quarter from these inventory gains and the fact that we bought into these increases and we'll have a little bit of a benefit as well in the first quarter.

Ryan Merkel -- William Blair -- Analyst

And then just lastly on price inflation, can you just give us a sense of what was price in the quarter, what do you think it will be in the fourth quarter? And then any update on 2019 now that you've seen a lot of the price ladders at this point?

Manuel Perez de la Mesa -- President, CEO & Director

Sure. Because it's a big -- some -- for example, an equipment -- certain product categories and equipment have gone up several percent more than normal. In other product categories, pricing is flat or maybe down. So I would say that at this juncture for 2018 collectively, the price increases will be in the normal 1% to 2% range and given the timing of the impact of the increases that have just been communicated and we're passing through, it'll still round down to probably 1% for the year. In terms of next year, the expectations at this juncture is that overall price increases will be roughly 2% more than normal. So that will certainly affect our sales growth and your model when you do that for 2019.

Ryan Merkel -- William Blair -- Analyst

Right, normal being 1%.

Manuel Perez de la Mesa -- President, CEO & Director

Yes, exactly.

Ryan Merkel -- William Blair -- Analyst

And I think Manny is this your last live conference call?

Manuel Perez de la Mesa -- President, CEO & Director

This is my last live conference call.

Ryan Merkel -- William Blair -- Analyst

Well, congratulations. It's been a great run. Best of luck and I know this isn't goodbye forever. You're still going to be involved. So appreciate it and thanks for over the years.

Manuel Perez de la Mesa -- President, CEO & Director

Thank you, sir. Appreciate it.

Operator

The next question comes from David Manthey with Baird.

David Manthey -- Baird -- Analyst

And I'll add to that Manny, thanks for your comments, we'll miss your presence on these calls for sure. As it relates to the commentary here, Mark I believe that you said year-to-date you're on the low end of the 20 to 40 basis point operating margin improvement, which is true. You also made some comment about a better fourth quarter and then expecting to get to the high end of the year overall, did I hear that correctly?

Manuel Perez de la Mesa -- President, CEO & Director

Yes. You did.

David Manthey -- Baird -- Analyst

Second, could you break down the base business growth, I'm not sure if I missed that, but between green and blue business and if you could also talk about price and volumes in each of those as well?

Mark Joslin -- Senior VP & CFO

Sure. In the green business we've said that the organic growth was 7% and then in the blue business, we said it was 8% to 9% within the quarter.

David Manthey -- Baird -- Analyst

And then the price?

Manuel Perez de la Mesa -- President, CEO & Director

Price on that was about 1% in both sides. So it's mainly volume driven.

David Manthey -- Baird -- Analyst

And then a final question, give you a softball here. We saw recently that Zodiac is prohibiting a sale of about 400 SKUs of their Pro series, of the Jandy Pro Series on the Internet. Any thoughts you have on that move and anything else that might emanate from that?

Manuel Perez de la Mesa -- President, CEO & Director

Well, that's been a natural progression and yes we're very, very, very well aware of that. That's probably an understatement, let's say very (inaudible) you like to repeat yourself, very clear. Yes there's not a natural progression, manufacturers in the swimming pool sector realized a number of years ago that the Internet channel while certainly provided another vehicle for pool owners to buy certain do it yourself products, a very limited number of SKUs have really applied, were concerned about some people buying items online and not doing the installations properly as an example. And to that end, virtually all of them have over the course of time change warranty policies to acknowledge the fact that pool owners like me should be trying to put in a pump and I've never tried to do that myself personally or change a heater and blow up a house in the meantime and I haven't done that either. So therefore because of their very legitimate concerns, they have altered warranty policies, they have come out, now it's been about four or five years with products, equipment specifically, but products in general that have been specific for the trade, professional trade and Zodiac made the natural next step in that progression which is, hey, look we're selling very few over the Internet channel. It's a constant hassle. We have issues with pool owners that are upset because they believe that they can buy a pump and then when it's all said and done, they have to return it because they installed it wrong or the guy that they -- the handyman they hired to put it in didn't know what he was doing. So it was just too much noise, too much disruption, didn't create any value, anything good for the industry. So they've taken the next natural step and I commend them for being the first ones. They were the first ones on doing the number of these things and they continue to be the first ones in this initiative as well.

Peter Arvan -- Executive VP & COO

And very well received by the dealers.

Operator

Blake Hirschman, Stephens Inc.

Blake Hirschman -- Stephens Inc. -- Analyst

I know you guys don't have a crystal ball, but with all the talk in the market about the cycle and housing, I was hoping you guys could kind of shed some light on what you're hearing in the field and I guess maybe touch on where it is that you would expect to really drive growth whether it's the major versus kind of more small R&R work or discretionary versus non-discretionary, just any color there?

Manuel Perez de la Mesa -- President, CEO & Director

Well, let me just take it by segment. Maintenance and repair is very consistent and that will grow on the normal course both driven by the growth in the installed base, a little bit of inflation, a little more than normal inflation in 2019 and then our capturing share. Remodel and replace, again there's some discretion there, not a lot depending on some elements there, replacement is easier from a labor standpoint than remodel or take up less labor proportionately. So that is going to continue doing well and again, same pattern. When you look at new pool construction, which is the one that has the biggest labor constraint issues, which we've talked about for a number of calls, that is a definite factor this year together with lost days because of weather but certainly been a factor this year for the fact that new pool construction being roughly flat year-on-year. It isn't because of demand, demand is extremely strong and if you were to call a handful of builders in your market to get a quote on building a new pool, I'd be surprised if you get more than two call backs out of the five you made. And those two will probably give you a date sometime in 2019. So the demand is very strong, so there's no issue whatsoever with demand. The fundamental issue is capacity that is a constraint that affects every contractor trade, certainly affects home builders, new home builders. When I looked at the numbers that were just reported earlier in the week that caused all this market dynamic here for anybody tied to home construction, some of that was noise given the lost work days. And the fact that that just pushes out everything including (inaudible). And then the other reality there is that labor is extremely tight and it is a constraint to our customers and their ability to be able to try to satisfy all the demand that they have in front of them.

Blake Hirschman -- Stephens Inc. -- Analyst

And then just one more I guess is probably for Mark. On the base business OpEx growth last quarter you kind of walked us through a bridge with some of the moving pieces like FX, new locations, the performance based comp that kind of stuff. Do you have those numbers again?

Mark Joslin -- Senior VP & CFO

I don't have that specifically. The FX was really no impact on the quarter. So the rate changes occurred was called early in the second quarter and then kind of settled out there. On the new locations, we do acquisitions, base business versus acquired, that's on a table in the back of the press release and there was a little bit of additional impact from new locations that we don't break out there but that was relatively small so most of that you'll see in the back. And then the other piece was really on changes to our incentive plans which impact the timing of recognition, not so much the total expense. For the year, we are down a little bit year-over-year which really in incentive compensation which was really the third quarter and then we'll be down again a little bit more in the fourth quarter as I mentioned, so that will be helpful for us as we look to increase our expense leverage and grow our operating margin in the fourth quarter and getting back up into that range that I mentioned, the 20 to 40 basis points for the year.

Manuel Perez de la Mesa -- President, CEO & Director

And just for color and I think we talked about it last time for our hourly -- for the lion's share of our hourly employees and some other management employees, in the case of the hourly employees, we shifted their bonus programs from quarterly to the major five months of the year. And that's the main impact that Mark is alluding to when we shifted out a small portion of some of the management staff also from quarterly to the five months of the year. So therefore what that does is it's just a shift and basically whereas in prior years we would recognize that piece of incentive comp every quarter, basically there's, there is no or very little of that in the first and fourth and it's all focused on the second and to a lesser degree, third.

Mark Joslin -- Senior VP & CFO

And that simply just aligns everybody together.

Operator

Anthony Lebiedzinski, Sidoti & Company.

Anthony Lebiedzinski -- Sidoti & Company -- Analyst

So Manny, it's been a pleasure working with you all these years and congrats on your pending retirement and look forward to working with you, Pete. So I guess the follow-up on one of the previous questions, just want to take -- get your take, Manny, so as far as the movement and interest rates being higher, it sounds like you don't see that as being an issue for pool construction going forward?

Manuel Perez de la Mesa -- President, CEO & Director

Not at all. And just for context, when you go back in the history of this industry going back to the 1960s, when there were changes in interest rates that had no impact on the demand for inground pools. Just like for history there is no -- GDP didn't impact demand, unemployment didn't impact demand, the only thing that impacted demands most severely was two factors, one was the decline in single family home values that happened 10 or 11 years ago and second was the financing markets not being available. So even when interest rates were well into the teens back in the late 70s early 80s, that did not deter the ongoing growth of new pool construction then, because financing was available albeit at those levels. I frankly believe that, and this maybe a little bit counterintuitive, but I think that that higher interest rates within reason, not to go from 5% to 15%, but interest rate to 6%, 7%, 8% from a pool standpoint are fine, because what it will do, it will attract more lenders to a market that have been staying on the sidelines because they didn't get the returns on lending given what the interest rates were.

Mark Joslin -- Senior VP & CFO

So what additional plan, just keep in mind we're still 60% below what we consider the kind of normalized level of pool construction somewhere in the 75,000 pools a year, so that's relatively small part of the business today.

Anthony Lebiedzinski -- Sidoti & Company -- Analyst

So looking forward, how are you guys thinking about the new sales center growth, whether it's organic or through acquisitions both the green and blue side of the business?

Mark Joslin -- Senior VP & CFO

I think we'll continue on what we've done in the past. If you look back historically, we would open four to six centers a year and I think you'll continue to see that going forward. And acquisitions of course, are something that we look at all the time, then when we find one that fits and we're certainly in a position to execute on those. But we continue to look all the time.

Anthony Lebiedzinski -- Sidoti & Company -- Analyst

And then as far as the share repurchases, I was a little bit surprised by the third quarter lack of purchases. Was that just really a function that you were spending money on inventory and now that you have that out of the way you'll be more -- it sounds like you'll be more aggressive in 4Q?

Manuel Perez de la Mesa -- President, CEO & Director

No, independent events. We have a lot of -- fortunately, we have a lot of financial capacity and we could very well have done both. But as many of you know, we have a price grid or repurchase price grid for share repurchase and when the price is above that grid temporarily, we were on the side line then when it falls into that grid, we're buying within the parameters that are allowed under the repurchase rules. So it was just a little bit above our grid and then it started coming in, we started buying.

Thank you, Antony.

Operator

The next question comes from Steve Volkmann with Jefferies.

Stephen Volkmann -- Jefferies -- Analyst

Maybe a couple of new guy questions, if I may. You talked about the impact of sort of the pre-buy on your gross margins in 4Q and 1Q. Are you willing to put some sort of bookends around what impact that might have?

Manuel Perez de la Mesa -- President, CEO & Director

It would be when you look at the overall number is fairly diluted right, because there are a lot of product categories that are operating in the normal course. So I would just say, context for the year, it'll be a little bit of a benefit in the fourth quarter and obviously help us on a year-on-year basis for the year and maybe get us from the down 0.1 to the hopefully down to flat year-on-year. That's the kind of -- somewhat of the expectation. And then when you look at the first quarter of next year again, there will be a little bit of a benefit in the first quarter, but when you look at the full-year, it's going to be fairly diluted and probably more looking like flat year-on-year by year by the time the year is done.

Stephen Volkmann -- Jefferies -- Analyst

And then in your press release you talk a little bit about negative mix impact on the margin in the third quarter. Would margin have been up if mix were sort of stable?

Manuel Perez de la Mesa -- President, CEO & Director

Margins would have been, yes, marginally up if some categories grow faster than others, for example, equipment has had very strong growth during the year and the overall margins on equipment are a little bit less or less than they are in other product categories that have a higher cost to serve.

Stephen Volkmann -- Jefferies -- Analyst

And then the final one, nobody's brought it up, so maybe it doesn't matter, but our tariffs, if we go to 25% on the Section 301 tariffs, do we have anything to worry about here?

Manuel Perez de la Mesa -- President, CEO & Director

Nothing to worry about, just some juggling again. Most of the products we sell have a fair amount of value-add. And although there is certainly raw materials that go into the equation, nothing to that order of magnitude gets diluted in the overall package. But there are some and in the overall part of the business let's say, 1-ish to 2% of our business -- a little over 1% of our business where the value add is not as great, and therefore, there would be more of a direct impact. And like everything else, we would -- if that is in fact happening in the drop dead day happens, we will buy into that price increase or the tariff in that particular case as we should, based on the velocity and based on the price increase or tariff increase and everything else.

Operator

Next question comes from Garik Shmois with Longbow Research.

Garik Shmois -- Longbow Research -- Analyst

Most of my questions have been answered, but I just wanted to ask just around the full-year guidance in Q4, but you still have a pretty wide range of $0.20 on the upper and lower end of the guidance range. But sounds like base business growth is continuing at high levels, you have visibility on gross margin improvement given the pre-buys and you're guiding toward the upper end of the OpEx margin for the year. So I just -- kind of wondering the thought process behind that wide range of the guidance for effectively Q4 and what could bookend the upper and lower balance?

Manuel Perez de la Mesa -- President, CEO & Director

Sure. We look at it at two ways, Garik. One way is, from an absolute number, $0.20 represents 2% or 3% on both sides of the midpoint. And second, what's still open is, how well the weather holds up, so our customers involved in new construction, renovation and replacement, how long they're able to work. And you can basically look at it from this standpoint, if the season were to shut down today, we probably are going to be near the low end. If the season is normal, we'll be more like toward the midpoint and if you can be out there without a sweater on in New York City on Christmas Day, we're probably going to be at the high end.

Garik Shmois -- Longbow Research -- Analyst

I just wanted to ask a follow up on any pent-up demand from some of the weather disruptions that you saw in Q3 if that has contributed to some of the strength here earlier in the quarter?

Manuel Perez de la Mesa -- President, CEO & Director

Again, the impact is not just unique to those one-off -- the hurricanes, but it's just across the board. I mean, labor is very tight and you probably hear that from other companies whether they're directly employing labor or in our case as a distributor, we're selling to our customers that are working to attract labor and keep labor in order to grow and build their businesses. So that's really the main constraint and that's not a new constraint, but when you have weather impact that just pushes everything a little bit further back.

Operator

The next question comes from Ken Zener with KeyBanc.

Kenneth Zener -- KeyBanc Capital Markets -- Analyst

If we could -- I'll make a suggestion, I think you guys could put your repurchase graph in your Investor Relations deck that would be insightful for us all, I think. And Manny, hopefully, you can learn how to install a pool since you're going to have some more free time?

Manuel Perez de la Mesa -- President, CEO & Director

Yes.

Kenneth Zener -- KeyBanc Capital Markets -- Analyst

So my first two questions are, Arizona 13% growth, put some context around that in terms of the categories that were growing or is it just a comp issue and then why the chemicals grow so strong?

Manuel Perez de la Mesa -- President, CEO & Director

Arizona, they didn't have any weather issues, so there was less inhibitors from a weather standpoint to enable our contracted customers to meet demand, together with our naturally growing share. And in terms of chemicals, there were some catch up in the third quarter from the second quarter of the year.

Kenneth Zener -- KeyBanc Capital Markets -- Analyst

And then in terms of the pricing that was mentioned around where you guys buy in, is there going to be any impacts that you'll see in terms of gross margin and/or any other cost or you guys still structurally looking for that give or take 15% incremental EBIT, just trying to figure out if we need to model gross margin next year or we can just stick with incremental EBIT margin?

Manuel Perez de la Mesa -- President, CEO & Director

The expectation is that the gross margin percents will remain intact and the contribution margins will retain intact, albeit on modestly higher numbers.

Kenneth Zener -- KeyBanc Capital Markets -- Analyst

And then Manny, since you have been there a while and this will be the last time you're speaking, about a decade ago, we were really entering the deep, deep roads of the economic cycle, which go back another 10 years, we'd have been kind of during the cleansing times late 90s, because people are so concerned about the cycle affecting your business, which on the blue side you would obviously not agree with, but what is -- if you can use what you started 10 years ago today, this is the kind of handoff for the question, potentially I guess Peter will be asked about why your business isn't cyclical, if you could just give us that broad perspective, I would appreciate that, realize it's a broad question, but we need to understand why it's not as cyclical as it was in the past?

Peter Arvan -- Executive VP & COO

So, thank you, Ken. If you go back to 2006 and you looked at the make up of the products that we sold and where they went, at that time 35% to 40% of our sales were tied to new pool construction and then the remainder were reasonably split, a little bit more for maintenance and repair and then remodel and replacement. So the dynamic there is that 35% to 40% is now between 13% and 15% of our business. And that's the one that's most exposed from a discretionary standpoint. As Mark mentioned earlier from an industry standpoint, we're still running about 65%, 70% below 2005, 2006 new pool build volumes. So the market really hasn't recovered because of the things we talked about, the financing markets not being as open at any interest rate to lending for home improvement like it were historically pre 2008 before the regulations came on and had a significant dampening effect on that, together with the fact that there was the decline in single family home values which have since recovered plus, but I think at this juncture the main constrains are the financing markets as well as the lack of available labor for our contractor customers to be able to build those pools. You know it's very -- there's no crystal ball here, but I would say that this year domestically the industry is going to have like 75,000 new inground pools built. Given some of the comments we get from our customers, that number could easily probably be north of 100,000. So it's not a demand issue whatsoever. But in context to your question and our overall business, it's simply a matter of mix with a much smaller percentage of our total business being subject to that level of discretion and therefore -- and even then there's other factors that tell me that that adverse impact even in a normal recession would be fairly new on that sector.

Operator

Next question comes from Brennan Matthews with Berenberg.

Brennan Matthews -- Berenberg -- Analyst

I wanted to ask about the building materials which grew -- continued to grow very strongly this year. I mean are you seeing any margin pressure to that category potentially related to higher transportation cost?

Manuel Perez de la Mesa -- President, CEO & Director

That's a very good question, very perceptive question because certainly third-party freight rates have gone up in the mid teens from a market standpoint. We pass those on and certainly there's competitive pressures everywhere, but given that the cost inputs are the same for our competitors, there's no way that anybody could eat that or absorb that. And so that -- those are generally passed on to the marketplace.

Brennan Matthews -- Berenberg -- Analyst

And then, I just wanted to ask about international expansion. I mean is this -- how are you guys kind of thinking about that more longer term? Is it more opportunistic or do you think that's something you're thinking about maybe could accelerate in the coming years?

Manuel Perez de la Mesa -- President, CEO & Director

Well, that's another very good question. We have just for color and context, approximately 9% of our sales are outside the United States, that's primarily weighted toward Western Europe and Canada, as well as Australia. That's -- those are long term investments, we consider those markets to be markets we should be in. In fact, when you look at, as an example, Europe, given our proportionally smaller installed base in the US, the organic growth in Europe is -- from an industry standpoint is 1% to 2% better than the United States, more like you know from a proportionate standpoint it was in the US back in the 80s and 90s. And part two is, we continue to grow share in those markets. And in fact our organic growth on the profitability side is very strong internationally. So very important, but it's all part of a certain discipline and we're not going to just do things and jump on bandwagon because a particular economy is hot. I mean there are countries that we have looked on -- looked at and passed on because of our longer term view of things and weighing things on a risk weighted basis. So, I think you're going to see growth at maybe a fraction higher, but when you look at that being 9% of our sales, could it be 10% of our sales in three to five years? Yes. Is that going to be 20% of our sales in three to five years? I strongly doubt it.

Brennan Matthews -- Berenberg -- Analyst

And then just -- I have one more question for you. You did a great job talking about how -- you know there's a downturn and how you're relatively better protected than you were previously. But I guess considering the scope of competition, I would think that you guys would be significantly better positioned than other competitors. And as you think about that, if there were a downturn, could you see (inaudible) an opportunity to maybe purchase more of some of the faltering competitors or do you think there could even be a greater kind of maybe some of these more independents just decide to shut down and you guys would come out of it with an even greater share of the market?

Manuel Perez de la Mesa -- President, CEO & Director

Well, in the last downturn, from a market share standpoint, it worked out well for us because, our ability to serve our customers was not impeded whatsoever by the downturn and some of our competitors certainly were impeded. So that enabled us to have a further separation in terms of our level of service. The fact that we continue to invest in a number of tools and programs during the downturn that further serve to distinguish ourselves. I think, I don't know that we necessarily will be opening up our checkbook and buying guys up, they are in the next downturn, I agree with the thesis that we're well positioned than anybody else as we have been historically as we are today and we'll continue to grow share during the downturn. But I do see that opportunistically, I'd rather grow organically, the return on capital there is faster or better and the acquisitions do provide some speed and sometimes in some cases, an entry into a market that otherwise we would take us longer to build a presence in. But I'd say, the bottom line, yes, much better than our competition, yes, grow share faster, but I would say, the only twist there is, the lion's share of that growth will be organic.

Operator

(Operator Instructions) The next question comes from Tony Rosenthal with Times Square Asset Management.

Tony Rosenthal -- Times Square Asset Management -- Analyst

Hey, Manny, I just wanted to offer my thanks as well. Thank you for your operational and financial stewardship. You've helped make our clients a lot of money and I appreciate it. So thanks again and good luck.

Manuel Perez de la Mesa -- President, CEO & Director

Thank you, Tony, very much.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Manny Perez de la Mesa for any closing remarks.

Manuel Perez de la Mesa -- President, CEO & Director

Thank you all for joining us today. Our next call will be on Valentine's Day, February 14th, mark your calendars, when Pete and Mark will discuss our full year 2018 results. Thank you all very much.

Operator

This conference is now concluded. Thank you for attending today's presentation, you may now disconnect.

Duration: 52 minutes

Call participants:

Mark Joslin -- Senior VP & CFO

Manuel Perez de la Mesa -- President, CEO & Director

Peter Arvan -- Executive VP & COO

Ryan Merkel -- William Blair -- Analyst

David Manthey -- Baird -- Analyst

Blake Hirschman -- Stephens Inc. -- Analyst

Anthony Lebiedzinski -- Sidoti & Company -- Analyst

Stephen Volkmann -- Jefferies -- Analyst

Garik Shmois -- Longbow Research -- Analyst

Kenneth Zener -- KeyBanc Capital Markets -- Analyst

Brennan Matthews -- Berenberg -- Analyst

Tony Rosenthal -- Times Square Asset Management -- Analyst

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