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Pool Corp (NASDAQ:POOL)
Q2 2020 Earnings Call
Jul 23, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Pool Corporation Second Quarter 2020 Conference Call. [Operator Instructions]

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

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

In addition, we may make references to non-GAAP financial measures in our comments. A description and reconciliation of our non-GAAP financial measures is included in our press release and posted to our corporate website in our Investor Relations section.

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

Peter D. Arvan -- President and Chief Executive Officer

Thank you, Mark, and good morning to everyone on the call. Where Outdoor Living Comes to Life, that's one of our registered trademark, which happens to characterize the work product, aspirations of our nearly 4,500 employees worldwide. And frankly I can think of no better description for what has taken place in the first half of this year. We've managed to navigate through an unprecedented combination of events in our business this year, which I'll briefly summarize for you. As you know, despite the effects of the COVID-19 pandemic, which began to impact our business in mid-March, we started off the year very strong with 13% growth in revenue for the first quarter and adjusted EPS growth of 20%.

On our first quarter call, we explained that our April sales were trending down 5% to 10% year-over-year due to the COVID-related restrictions put in place and that we were pulling back on discretionary and capital spending in anticipation of a more normal more cautious consumer spending environment in the months ahead. Then as we moved into May, government restrictions in many jurisdictions began to ease, and we saw new trends emerging above and beyond our normal seasonal trends. These were driven by the new stay at home and social distancing restrictions further complemented by favorable weather.

First, seasonal market pool owners who typically delay pool openings until warmer weather arrives, wanted to use their pools sooner rather than later, which drove a significant increase in demand for repairs and equipment purchases like heaters and cleaners. Most of our dealers quickly became inundated with repair and upgrade requests from pool owners who wanted to enjoy the safety and fun of their own backyard earlier in the season. It should be noted that due to this, we believe many dealers shifted resources to maintenance and repair and away from construction, which was delayed by the closing of permitting and inspection offices in many parts of the country.

Second, as consumers sheltered in place, interest in and demand for new pools picked up significantly. But as consumers soon found out, many people had the same idea, which quickly soaked up builder capacity in this labor-constrained industry. This was further exacerbated by the already compressed building season resulting from the COVID-related delays. At the same time, homeowners were turning to other ways to turn their backyard into a recreational oasis, seeking out above-ground pools and spas. Early on, these products were readily available, but with the unpredicted surge in demand, they quickly became scarce as the supply chain was stretched beyond its capacity.

All combined, these trends caused accelerated growth for our business throughout May and June, which continues now into the third quarter. And we believe the renewed interest in swimming pools and outdoor living is not only great news for our industry, but also for homeowners who will benefit from a safe, happy environment for their families now and for years to come. This story would not be complete without commenting on just how exceptional our employees are performing in these challenging and uncertain times. Considering the initial confusions surrounding government restriction and their impact on our sales centers and customers, the ensuing work-life balance issues that our teams encountered, the new procedures put in place to safeguard our employees and our customers, together with the environment of accelerating demand which stretched our customers' employees and our supply chain, the obstacles our employees faced over the last several months and their determination to rise above them is truly remarkable.

I am very proud of our team and their ability to stay focused on delivering outstanding customer service in a safe and effective manner throughout this challenging and unprecedented period. Their dedication and resiliency is second to none. The outcome of all of this is one of the best quarterly operating results in the history of our business. The rare combination of significant sales growth and intense expense management drove substantial growth in income and cash generation. From where we started the quarter and how our business environment has progressed, I believe our results are truly exceptional. Even more encouraging is the fact that our builders, remodelers and retailers are all reporting continued strong demand, with many builders reporting that their backlogs will take them out into next year.

I mentioned earlier that the unprecedented demand has strained our supply chain, but the strength of our balance sheet and our scale has allowed us to keep back orders and stock-outs to a minimum, which has also helped drive our results. For the quarter, our total revenue was a record $1.28 billion, an increase of 14%, which is truly amazing considering how the quarter started out. In our year-round blue markets, revenue was up 11% while the seasonal markets grew an impressive 18% as pools opened sooner than normal. Florida was up 9% for the quarter and on a year-to-date basis as well, Arizona saw a 21% increase in revenue for the quarter to bring the year-to-date number to 20%. Texas was up 14% in the quarter, bringing the year-to-date number to 12%. California saw a 6% growth in the quarter as they were impacted by a wet start to the quarter coupled with the lingering effects of the COVID shutdown. On a year-to-date basis, California is up 9%.

From an end market perspective, retail sales were up 22% for the quarter and 20% year-to-date. Strong demand for swimming pool maintenance supplies, above-ground pools, spas and automatic pool cleaners drove most of this increase. The resilience of our retailers allowed them to successfully navigate the pandemic and its associated challenges as many adapted to the restrictions and concerns by devising touchless service and curbside pickup. Commercial revenue, which accounts for about 4% of our U.S. blue business, was down 21% for the quarter and down 10% year-to-date, driven by the COVID-related closures and a decline in both business and leisure travel and the continuing health directives limiting commercial pool operation. Chemical demand has waned and new projects have slowed. We are anticipating continued softness for this market for the foreseeable future.

From a product perspective, equipment sales were up 22% quarter-to-date and 20% year-to-date, again, driven by people opening pools sooner and using them more frequently. Heaters, pumps, lights and filters are all seeing strong demand. A very encouraging sign we are seeing is that more and more homeowners are opting for some level of automation during construction and remodel and repair, which is providing added sales opportunities and convenience for the pool owner. Chemical demand was up 5% for the quarter and 8% for the year, with results being impacted by stronger-than-normal residential and service size chemical demand being somewhat offset by softer commercial chemical demand. Building materials in the quarter were up 7%, reflecting the pause in construction we saw in the first half of the quarter, driven by the restrictions and shutdowns in permit offices in many markets.

As mentioned, this caused many pool contractors to divert resources to serve the surge in maintenance and repair requests. Demand for building materials accelerated as the quarter progressed, reflecting a resumption in construction and strong demand for new pools. Switching to Europe. We saw a remarkable comeback in the latter half of the quarter as sales rebounded from the drag created by numerous mandated closures throughout most of the EU. For the quarter, Europe posted a 21% gain in revenue, bringing the year-to-date revenue growth to 11%. France, Spain and Germany were all strong as were most of the other markets. We believe that demand across Europe is being increased by similar COVID-related changes in consumer behavior.Horizon saw second quarter base business revenue growth of 5%, bringing the year-to-date growth to 5% as well. Demand in the Sunbelt has come back strong, while Northern California and the Pacific Northwest have seen only modest recovery in demand.

Turning to gross margins. Overall gross margins for the quarter was 29.2%, 30 basis points lower than the same period last year where we recorded 30 basis points of margin improvement. Mix certainly contributed slightly to the decline, but overall we are happy with the stability here. Operating expenses were favorable in the quarter, up a modest 6%. Clearly, the actions we put into place early in the quarter, together with the benefit of our capacity creation activities, contributed to these strong results. Our team's focus on execution has allowed us to create significant operating leverage while still providing unparalleled service to our customers.

POOL360, our B2B tool, along with BlueStreak, our remote sales counter application, both experienced significant growth during the quarter. POOL360 sales have increased 32% year-to-date while the number of transactions processed on BlueStreak has passed 30,000. Our other digital applications like the NPT backyard app and swimmingpool.com also gained a significant traffic and traction in the quarter. Mark will provide more details in his commentary on operating expenses.

Moving on to operating income. I'm very pleased to report that for the quarter, operating income was a record $205.9 million, representing a 19% increase. Operating margin was 16.1%, which was a 70 basis point improvement over the previous year. As you can see, the second quarter was extraordinary, and I'm extremely proud of what our team has accomplished. Current demand trends remain strong, and contractors are reporting significant backlog. We are optimistic about the outlook for the remainder of the year, but remain cautious regarding the potential impacts of the pandemic on business conditions.

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

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Thanks, Pete. I will mark my 16th year at POOLCORP in a couple of weeks, which makes this my 64th earnings call. And without a doubt, this quarter has been the most remarkable and not just for the stellar results, but also for how we got here. When we announced our first quarter results in the middle of April, we were facing significant uncertainty around the pandemic, around how the pandemic would impact our upcoming critical pool season and the rest of the year. So we took a cautious approach by locking down both capital and operating expenses as we discussed on our first quarter call.

Within the next few weeks as our markets rebounded and then accelerated, and we ran the risk of falling short of resources needed to meet customer demand while also adapting to a challenging new operating environment. While we have been stretched very thin by the confluence of these forces, as Pete also stated and I wanted to reiterate here, our field and support team teams did a truly remarkable job of keeping their focus and rising to all challenges, delivering outstanding financial results in the process. I have a few specific comments on those results as well as what we expect to come for the balance of the year.

Pete's already discussed sales and margin highlights, so I'll start my commentary with expenses. I went into some detail on our first quarter call about the specific actions we are taking to tighten up our purse strings amid the pandemic uncertainty. But in summary, back in March and early April, we drilled down on all discretionary spending and locked into a lower spending trajectory as we entered the peak of our season. The impact from our expense control efforts is visible under the covers in our Q2 results. Given the change in our outlook both for the quarter and the year, we recorded a substantial $13 million increase in our performance-based compensation in the quarter. Without this, our operating expenses would have been down 2% from last year as a percent of sales, and would have been down 190 basis points.

As reported, including the additional incentive compensation, we still brought expenses down 100 basis points as a percent of sales, providing us with substantial 70 basis points of operating leverage in the quarter. The expense savings realized were in a number of areas. Some of the bigger bucket items included labor-related costs, with headcount down about 1% at the end of the quarter compared to last year; energy-related expenditures; travel and meeting costs, advertising, and bad debt expenses where we recorded or where we experienced strong collections and good management of aged receivables.

Given the change in the level of our business activity from where we started the quarter, we've loosened up the string somewhat. So while I still expect our expense management to be good for the remainder of the year, I wouldn't expect it to be as good as we reported in the second quarter and will include a continuing impact from higher performance-based compensation costs. These costs are very broad-based as we tie some portion of pay to performance for virtually everyone in the company. For example, in the second quarter alone, our hourly employees in the field, including drivers, warehouse associates and customer sales associates, were paid incentive pay of $2.2 million, which was on average over $1,000 per employee for the three-month period.

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

Moving to taxes. Our effective tax rate, excluding the ASU tax benefit, remain stable at 25.5%. Given the growth in our share price over the quarter, we had some pull-forward of option exercises, resulting in the $6.2 million or $0.15 per share ASU tax benefit, which was less than the $7.8 million benefit reported last year. With this, our effective tax rate was up 160 basis points to 22.5% for the quarter this year compared to 20.9% last year. As most of you know, given the unpredictability of the ASU tax benefit, we don't include further gains further ASU gains in our guidance for the remainder of the year. I should note, however, we estimate we'll have $5 million of tax benefit for options that will expire in the first quarter of next year, which I would expect to recognize sometime between now and then.

Moving over to the balance sheet and cash flow. Growth in our total net receivables of 9% reflects our sales growth in the quarter as well as improved collections from last year. Our DSO at the end of the quarter was 28.5 days, down a full day from last year. Looking at inventory. We fortuitously entered the season fully stocked and slowed down 10% compared to last year with higher-than-normal stock-outs, notably in heat-related products and above-ground pools. Our inventory turns calculated on a trailing four-quarter basis were 3.5 times this year, which was a 13% improvement over a year ago.

One other notable item was the impact of deferred tax payments as a part of the federal and state relief and stimulus measures and resulted in $18 million in tax payments that were deferred from Q2, most of which will be paid in the third quarter instead. Driven by our inventory performance and net income growth for the year and aided by the tax deferral, our cash flow from operations was an exceptional $221 million year-to-date, an improvement of $124 million over last year and 18% greater than net income. We'll give some of this back over the next few months as we rebuild inventory and pay taxes, but I expect a very good year for cash generation for us in 2020, which is always a key focus area for us.

One other thing to point out is our capital spending, which I noted on our first quarter call I had expected to be down 15% 50% for the year as we reprioritize spending for short-term payback items and preserve capital in other areas. We made good progress toward that objective with $13 million in spend year-to-date, down 32% from last year. Again, with a markedly improved business outlook, we are retooling our spending plans and now expect capex to be down roughly 35% from last year to a range of $20 million to $25 million for the full year. With our cash generation in the quarter largely applied to debt reduction, our leverage, as measured by trailing 12-month debt to EBITDA, came down to 1.26 times at the end of the quarter, which is a multiyear low.

Looking ahead, our revised guidance makes a couple of assumptions that I wanted to point out. First, the growing spread of the coronavirus in the U.S. brings with it the threat of reposition of business lockdowns, particularly in key southern markets that are a more significant share of our business as we move through and out of the summer months. Further lockdowns could threaten our construction and renovation business, if imposed, and have not been factored into our guidance.

Second, as always, weather plays a significant role in our results, particularly when looking at year-over-year changes in temperature and precipitation. This benefited us by comparison in the first half of this year as poor weather in last year's first half resulted in 3% base business growth, and much better second half 2019 weather when we posted 8% base business growth. Our guidance assumes normal seasonal weather overall, with our range reflecting a little better-than-normal weather at the top and a little bit worse weather at the bottom end of the range.

With these caveats, our guidance range today assumes we'll have full year revenue growth of 11% to 13%, a modest decline in gross margin all in the first half of the year, and expense growth for the year of 6% to 8%. Doing this would generate mid-teens op income growth for the year, 30 to 50 basis points of operating margin expansion. And excluding the ASU benefits in both years and the first quarter impairment charge this year, we expect EPS growth of 15% to 22% for the full year.

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

Questions and Answers:

Operator

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

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

Hi, good morning everyone. And Mark, congratulations on your 64th anniversary.

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Thank you, Anthony.

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

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

Peter D. Arvan -- President and Chief Executive Officer

Sure. The outlook that we see as of now, which is based upon obviously numerous conversations with our builders across the country, is very positive. Everybody has very large backlogs. Phones are still ringing off the hook. And everybody has plenty of work, we believe, to take them through the end of the year and into next year. Your question on above-ground versus in-ground, for perspective so we mentioned above-ground pools being up significantly. But above-ground pools is slightly over 1% of our revenue in total. So it's above-ground pools were up about 50%, but it's still a relatively small number in the whole grand scheme of things. When I look at new pool construction for the balance of the year or for the full year, I expect it to be somewhere in the 8% to 10% range. Maybe a little better if weather stays good and the season is longer. And maybe at the lower end of that if it gets very cold and rains and freezes up sooner.

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

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

Peter D. Arvan -- President and Chief Executive Officer

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

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Yes, that's a good question. I mean we have our capital allocation priorities, which are investing everything in the business that we need to for maintenance and growth. We have a dividend, which we will grow over time with earnings. And then we use share repurchases to keep leverage in our target range, which is 1.5 to 2 times. Now as you mentioned, we're a little bit below that right now. And between now and the end of the year, I'm not sure that that's going to change much. And it may come down more, leverage may come down more. But over time, we're going to get our share repurchases in, and we'll get back to that target leverage at some point, if not this year.

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Thank you, Anthony.

Operator

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

David MacGregor -- Longbow Research -- Analyst

Yes, good morning, everyone, congratulations on a really strong quarter. Great to see that sort of the performance there. I guess I'd like to better understand gross margins, and you mentioned down 30 basis points. I'm just wondering if we can unpack that and sort of talk about some of the puts and takes. I mean I'm guessing there was less promotional activity. You had talked last quarter thinking that there could be a little more price competition from some of the smaller players. I'm guessing that didn't play out. Private label was probably pretty strong. Maybe just there was more big ticket. Obviously, that was a factor. But maybe just to understand some of the puts and takes behind that 30 basis points.

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Yes. Well, the 30 basis points, if you went back to our first quarter call, what we highlighted was that we expected gross margins to be down in the second quarter, primarily because of 30 basis points of improvement that we had in 2019 which was related to selling out lower-priced inventory that we purchased at the end of 2018. So the 30 basis points that we ended up was actually a little better than our expectations. In our market update that we did at the end of May, we mentioned that we're selling a lot of these higher-ticket items, which have a very nice gross profit, but gross margin is a little bit lower.

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

David MacGregor -- Longbow Research -- Analyst

And private label, I'm guessing, was strong. How much of a contribution would you say private label contributed?

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

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

David MacGregor -- Longbow Research -- Analyst

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

Peter D. Arvan -- President and Chief Executive Officer

Yes. It's again, it's very tough, right, because it has to do with what the builders are telling us across the country. So I guess very hard to put a number on it, but virtually in every market across the country, the builders would tell you that their backlogs are very high. The number of leads that they have like I heard, I was talking to a builder just yesterday that told me they have so many leads now, that before he actually puts a salesperson on the lead, he has people call them back to qualify the lead just to make sure that it wouldn't be a waste of the sales resource time. It is significant. It's just hard to put a number on because it's the summation of thousands of small businesses.

David MacGregor -- Longbow Research -- Analyst

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

Peter D. Arvan -- President and Chief Executive Officer

It's in our guidance between now and the end of the year. So I don't anticipate a huge uptick in stock-outs. They're higher than they would normally be with this level of activity as you can imagine. It's also something that we spend a lot of time on with, working at the very highest levels with our key suppliers to make sure we understand production schedules and that we are getting product to the right location. The other thing to consider is again, just because of our scale and our size, we may if we may not have it in one location, we may have it in another location in the same market. So with a few exceptions of a few key products, we've been able to keep those at a minimum. So I wouldn't anticipate I wouldn't bake anything in as far as a big increase in that area.

David MacGregor -- Longbow Research -- Analyst

Got it. Thank you very much.

Peter D. Arvan -- President and Chief Executive Officer

Yeah.

Operator

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

Stephen Volkmann -- Jefferies -- Analyst

Hi, good morning guys. Pete, maybe just a quick one. You said above-ground pools of less than 1%. That's lower than I guess I would have thought. I didn't think it was huge. But does that include everything, chemicals, pumps, whatever else people need for those things?

Peter D. Arvan -- President and Chief Executive Officer

No, that's just the above-ground category or the water vessel itself.

Stephen Volkmann -- Jefferies -- Analyst

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

Peter D. Arvan -- President and Chief Executive Officer

Yes. I mean it would be a little higher. But remember that the pumps and filters were, in above-ground pool, are much, much, much cheaper than what you look at when you compare those to the in-ground equipment. And above-ground pools don't have they typically don't have heaters, they don't have light. So most of the cost is in the pool itself.

Stephen Volkmann -- Jefferies -- Analyst

Got it. Okay. And then I'm wondering if I can just ask for your sort of opinion. Or maybe Mark can chime in, given his longevity here. But as we think out to next year, we're obviously going to have some sort of tough comps, but it looks like there's still a lot of backlog for the builder channel. I don't know how to think about it. Are we going to have a situation where like most of the remodeling and kind of the equipment upgrades is kind of done, and we won't that? And so we'll have the big mix shift to kind of more new build? Or do you think this is sustainable? And sort of as we layer that on, do the operating expenses kind of bounce back? Because you've obviously made a lot of headway on it this year, but in a more normal environment, maybe you'd be spending more. I'm just trying to think about kind of the big picture, broad-brush strokes for next year.

Peter D. Arvan -- President and Chief Executive Officer

Yes, that's a good question. It's a big question. There's a lot in there, so let me see if I can piece that together. So when we look at overall demand and how the year shook out for the quarter, in particular, as we said that the there was a lot of call for maintenance and repair because construction was stymied certainly in the beginning of the quarter. So what happened is a lot of resources got diverted to the maintenance and repair. So the people that bought heaters, for instance, this year, they're probably not going to go buy a heater again next year. But the dealers were spending on maintenance and repair was diverted away from, as we said, construction.

Now demand for construction is very strong. A lot of people believe that a swimming pool is the best way for a safe family recreation activity that will be long-lasting. So there's been a lot of interest in swimming pools, so the dealers are getting a lot of calls. Along with that is the people that have the pools, and remember the installed base is the real gem in this industry, the installed base, which is somewhere in the neighborhood of 5.5 million pools, with people spending more and more time in their pools now are looking at upgrades and remodel. So in the beginning, I think what we saw is pools opening sooner in the northeast.

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

Now you have to wrap all of that with the labor constraint that hasn't gotten any better in the industry. There's only so much labor. So as I've mentioned before, the system is somewhat pressurized that there is more there's more demand than there is labor, and that certainly hasn't changed. In fact, what's happened now is there's even greater demand, which I think further pressurizes and elongates this season and will take us into next year. So we'll have a tough comp certainly for next year, but I'm very confident that the demand will sustain and that the builders are going to remain busy right through next season. So one of the biggest impacts you have to put on that, as Mark put in his comments, is weather, right? So the number of building days will affect remodel and construction. But assuming normal weather, I would think that next year should be another strong year.

Now the last part of your question was opex, and we certainly have realized some gains this year in opex. But remember, this is not a new phenomenon that we just started. We started our capacity creation initiatives last year to try and create capacity to slow the rate of inflation that we would see by increasing the throughput in our sales centers. And that has paid great dividends for us. So I would expect that the tremendous performance on opex that we had this year. When I look at it going forward, I think that the same ratio of incremental opex to GP dollars back in that 60% range is what I would expect in terms of incrementals going into next year.

Stephen Volkmann -- Jefferies -- Analyst

Great. Okay. That was very comprehensive. You got every part of it. I'm impressed. Thank you so much.

Operator

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

Quinn Fredrickson -- Baird -- Analyst

Hey, good morning guys. Good morning, Mark. So I think you mentioned 5% base business growth were green in the quarter. Did I hear that correct? And then also in your outlook for the second half of the year, would your expectation be that blue continues to outpace green base business growth? Or would you expect that green sees some catch-up and starts to benefit from those same stay-at-home and backyard-living trends that blue has been benefiting from?

Peter D. Arvan -- President and Chief Executive Officer

Yes. I think that the green will pick up in the back half of the year. I don't know that it will be as big as what we're seeing on blue because we simply have a different footprint in the green business as we do in the blue business. When I look on a market-by-market basis, as I mentioned the Sunbelt was good with green business, but we were impacted by the COVID-related slowdown in California, particularly in the Northern California market, up into the Pacific Northwest. But when I look at the Sunbelt markets, when I look at Arizona and I look at Texas, the green business is actually in good shape and strong.

So we have a new leader in the green business that we brought in. He started right at the end of the first quarter, and he's getting his arms around it. We like the outlook for the green business. We think that there's ample opportunity to grow. But I don't think for the balance of this year that the growth rate will match in total what we're seeing in blue, simply because of the footprint and the lack of the installed base that we see with the blue business.

Quinn Fredrickson -- Baird -- Analyst

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Yes. Let me grab that one, Quinn. So what I said on the last call, which seems different people have heard differently, I've had a number of questions about it, was that our expectations for discretionary purchases by consumers might be softer given the economic conditions and that, that could be an end-of-season issue with competitors getting stuck with more inventory than they wanted to have and lowering prices to sell out that inventory, convert that to cash at the end of season. And the end of the season being kind of the August-September time frame. So that was a potential that we had factored into our guidance, bottom end of our guidance when we said it back in April that obviously first of all, we're not at the end of the season.

Second of all, the conditions are much different than what we thought they could be. And so that pricing competition and need to sell off inventory for having too much is certainly not an issue. In terms of margins, expectations for the back half of the year, I did give a bit of guidance in my remarks, prepared remarks that we expected margins overall for the year to be down a little bit, but that's all first half related. So second half, we're looking for stable margins with prior year.

Quinn Fredrickson -- Baird -- Analyst

Thank you very much.

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Sure.

Operator

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

Paul Dircks -- William Blair -- Analyst

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Thank you. Good morning.

Paul Dircks -- William Blair -- Analyst

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

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

Paul Dircks -- William Blair -- Analyst

Okay. I appreciate that. On capital allocation, obviously you guys generated very strong cash flow. Maybe could you talk about how you're thinking about allocating over the back half of the year? And specifically when do you anticipate some of your discussions with M&A targets resuming into that a little bit? Has the appetite for investment abroad increased, given the strength of your U.S. business and what you're also seeing in Europe, how well you've seen those markets recover?

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Yes. Let me address that. And then if Pete has additional comments, he can jump in. So in terms of our capital allocation, no change to what we've done historically there. Certainly, we invest everything that we need to for business growth, which primarily is organic, but inorganic is a part of that equation. We did take a brief pause in terms of really what we were trying to get a handle on where the industry was going back in the March-April time period, and that was a brief pause. Since then, we kind of gotten back into gear. And as always, we are active in the M&A part of our business, looking to grow share, particularly in markets where we have lower share. And that is domestically in the blue and green business and internationally in the blue business.

And Europe is part of the equation. Pete mentioned very some results there. We have a great team that is really executing well. And we are underpenetrated in certain markets in Europe. France, we're the number one share in Europe. But outside of France, we have lots of opportunities to grow. Spain, Germany, big markets where we have lower share, and there's others as well. So that's all part of the equation and lots of opportunities for us. It's all a question of timing and meeting expectations of sellers and us coming to agreement. So back to normal. I don't know, Peter, if there's anything you want to add?

Peter D. Arvan -- President and Chief Executive Officer

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

Paul Dircks -- William Blair -- Analyst

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

Peter D. Arvan -- President and Chief Executive Officer

Well, I don't think our competitors have the tools and the resources that we have. So whether it's the POOL360, whether it's the density of sales centers that we have across our markets, whether it's the deep inventory and wide inventory breadth that we have in all of our locations, I think our value proposition is second to none in an environment that has very a big uptick in growth in a very compressed period of time. You have to be in a position where you can capitalize on that and service that. And I think that our resources and our capabilities are simply unmatched.

Paul Dircks -- William Blair -- Analyst

Thanks so much.

Peter D. Arvan -- President and Chief Executive Officer

Thank you.

Operator

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

Garik Shmois -- Loop Capital -- Analyst

Hey, great, thanks. Congratulations on the quarter. It doesn't sound like it, but I just want to be clear, are you seeing any strain in the supply chain and any extended lead times to any product, just a big surge in demand? And just a follow-up to that, can you provide just a view on inflation going into next year, if there's any pricing you think you'll need to get in front of?

Peter D. Arvan -- President and Chief Executive Officer

Yes, I'll let me address that. So as I mentioned, the supply chain in certain areas has certainly been put to the test. And we have things like above-ground pools and spas, we sold out of in the second quarter in many areas. And the suppliers are at a max capacity for what they're going to be able to ship for the balance of the year. So but again, those categories for us, although represent nice growth, they're relatively small. When I look broadly across our categories, we have our stock-outs are up, but it's something that I look at on a weekly basis. And when I look at it in total, what is outstanding, if you will, it's still a relatively small number. I think the team our supply chain team has done just an outstanding job of working with the suppliers.

Now if the supplier simply doesn't have it, the good news is with many of these products, if one manufacturer doesn't have if you were waiting for a heater, for instance, which there's obviously been a huge run on demand for heater, if you don't have one heater in stock, we, a, may have that heater in another location that we can draw from or we may have another brand of heater and/or the conversion kit so that we can keep the customer working. So I think the team is very creative, very resourceful. And the strength of our entire organization has certainly helped us from a growth perspective and helped the customer.

As it relates to inflation. Inflation for this industry in a typical year is 1% to 2%. And I would think that next year, and then the reason I qualify that with "I would think" is because all the manufacturers are not out with their numbers for next year. But I would think that next year, it's probably going to be a little bit higher, maybe 2% to 3% instead of 1% to 2%, but I don't think anything crazy.

Garik Shmois -- Loop Capital -- Analyst

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

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

Garik Shmois -- Loop Capital -- Analyst

Got it, thanks.

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

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

Alex Maroccia -- Berenberg -- Analyst

Hi, good morning guys. I just had one on inventory. What level of inventory would you be comfortable with at the end of the year, considering your days inventory were down two days in Q2?

Peter D. Arvan -- President and Chief Executive Officer

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

So inventory, just one reminder, inventory is a little bit variable at the end of the year because it's based on when our vendors ship to us. In the pool industry, we have what's called early buy, where we place orders in the late September, early October time period. Big orders with our major vendors, and then they ship those orders at their convenience. So it keeps them working and fully engaged throughout the off part of the season, the lower part of the season. And then as they produce product, they ship it out to based on the orders they have into all their customers. And so it varies quite a bit in terms of when we receive that product. It can come in November, December, January, February.

So really, we look at trying to get inventory to a level at the start of the season, February, March of next year. We want to be fully stocked as we were this year and prepared for a strong season. Our service is certainly one of the most important aspects of our culture, and that has helped us over time, take share. And so we're planning on growing our business and growing our inventory levels by the time we get to the start of next season.

Alex Maroccia -- Berenberg -- Analyst

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

Peter D. Arvan -- President and Chief Executive Officer

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

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Yes, and in terms of growing the installed base is certainly something that we see happening. As Pete mentioned, we're looking for growth in the installed base this year with new pool construction going up possibly 10%, in that range, and expect that to grow next year as well. So that adds to the installed base, which is building maintenance business for us. Chemicals is a major maintenance product. And so that's good for growth in that category for us over the long term.

Alex Maroccia -- Berenberg -- Analyst

Great, thanks for the clarification. And good luck on the rest of the quarter.

Peter D. Arvan -- President and Chief Executive Officer

Yes, thank you.

Operator

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

Peter D. Arvan -- President and Chief Executive Officer

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

Operator

[Operator Closing Remarks]

Duration: 53 minutes

Call participants:

Mark W. Joslin -- Senior Vice President and Chief Financial Officer

Peter D. Arvan -- President and Chief Executive Officer

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

David MacGregor -- Longbow Research -- Analyst

Stephen Volkmann -- Jefferies -- Analyst

Quinn Fredrickson -- Baird -- Analyst

Paul Dircks -- William Blair -- Analyst

Garik Shmois -- Loop Capital -- Analyst

Alex Maroccia -- Berenberg -- Analyst

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