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Edited Transcript of POOL earnings conference call or presentation 17-Oct-19 3:00pm GMT

Q3 2019 Pool Corp Earnings Call

COVINGTON Oct 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Pool Corp earnings conference call or presentation Thursday, October 17, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mark W. Joslin

Pool Corporation - Senior VP & CFO

* Peter D. Arvan

Pool Corporation - CEO, President & Director

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Conference Call Participants

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* Alexander Rocco Maroccia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Anthony Chester Lebiedzinski

Sidoti & Company, LLC - Senior Equity Research Analyst

* Blake Anthony Hirschman

Stephens Inc., Research Division - Research Analyst

* David John Manthey

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Garik Simha Shmois

Longbow Research LLC - Senior Research Analyst

* Kenneth Robinson Zener

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* Ryan James Merkel

William Blair & Company L.L.C., Research Division - Research Analyst

* Stephen Edward Volkmann

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Pool Corporation Third Quarter 2019 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. Please go ahead.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [2]

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Okay. Thank you. Good morning, everyone, and welcome to our third quarter 2019 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 2019 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.

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

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Peter D. Arvan, Pool Corporation - CEO, President & Director [3]

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Thank you, Mark, and good morning to everyone on the call. I'm happy to report that POOLCORP delivered strong results in the third quarter with total revenue up 11% to a record $899 million, while our base business grew 9%. Revenue in the quarter was positively impacted by approximately 1% for the additional selling day in the third quarter of 2019 versus 2018. Base business sales for swimming pool products were up 10% for the quarter, while landscape and irrigation products were up 6%.

Our major year-round swimming pool markets performed well with 8% base business sales growth. California, Florida and Arizona each posted approximately 7% sales gains, while Texas grew 9% for the quarter as it recovered from unfavorable weather conditions earlier in the year.

Our seasonal pool markets also benefited from the nice weather and posted base business sales gains of 12%, showing the demand for pool and outdoor living products remained strong across our markets.

Looking at couple of our end markets. Retail and commercial, we also saw a robust recovery from slower growth earlier in the year. Sales in the retail segment rebounded from a late start to the season, posting a 9% gain during the quarter and bringing year-to-date sales growth to 4%. Commercial sales were up 17% for the quarter and 9% year-to-date as we continued gaining traction in this important segment.

Strong demand and favorable weather drove solid growth across product categories with chemicals up 7% for the quarter, much stronger than we had seen earlier in the year and an encouraging trend which brought year-to-date chemical sales up 4%. Equipment sales increased by 13% for the quarter and 6% year-to-date. And building material sales were also strong, showing 10% revenue growth in the quarter and 9% growth year-to-date, reflecting strong replacement and refurbishment demand activity.

Demand in Europe remained solid, and our team continues to executive well as we saw our revenue grow 11% for the quarter in local currency. France, Germany and Spain, the 3 largest markets in Europe, all posted solid gains with combined sales growth of 12% in local currency.

Moving on to our Horizon business. In the third quarter, overall sales grew by 10%, with the base business growing 6%, a nice improvement over the second quarter and reflecting a healthy market and good execution by our Horizon team. In terms of gross profit margins, we are encouraged that our overall gross profit grew by 10% in the quarter, while our gross margin rate declined 26 basis points to 28.7% when compared with the same quarter last year. The decline in gross margin was expected and largely driven by the benefit from inventory prebuy activity in the second half of 2018.

Turning to operating expenses. Total operating expenses increased 7.5%, while base business operating expenses increased 5% after excluding the impact of expenses associated with acquisitions. The strong execution and expense management generated improved operating leverage even while investing in new enabling technologies, opening 7 new sales centers and integrating 4 acquired locations so far this year. Our ongoing focus on capacity creation initiatives, efficiency improvement and customer service enhancements should continue this trend into the future.

Looking at profitability. I'm happy to report that for the quarter, operating income is up 13% in both total and base business. Operating margins also expanded 25 basis points for the quarter overall and 42 basis points in our base business. One area that continues to help create capacity and operating leverage for us and our customers is our B2B app, POOL360. As POOL360 continues gaining adoption by our customers, it improves our operating efficiency, reduces order processing time, eliminates ordering errors and shortens the time for our customers to fulfill their order. At the end of Q3, this tool accounted for 10% of our revenue process, using -- and revenues processed using POOL360 have grown by 29% year-to-date compared to last year.

Finally, EPS for the quarter increased 17% to $1.95 per share, including an 11% (sic) [$0.11] per share benefit from ASU 2016-09. Excluding the ASU benefit in both years, the increase was 16%.

Moving on to the balance sheet. We delivered an exceptional quarter and cash flow as we saw cash flow from operating activities increase by $192 million compared to the same 9 months last year. Mark will provide more comment on this in his prepared remarks.

All in all, POOLCORP achieved strong results for the third quarter. All indications are our markets are healthy and growing demand for outdoor living products is solid, and we have a team that is focused on growth, execution and providing exceptional customer service.

With 2.5 months left in the year, we are narrowing and raising our guidance for 2019 from $6.09 to $6.34 to the new range of $6.20 to $6.40 per share.

In closing, I'd like to recognize and thank our customers, suppliers and the stellar team at POOLCORP for everything they do to bring out more living to life.

I will now turn the call over to Mark for his financial commentary.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [4]

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Thank you, Pete. I'll start my commentary on the P&L, beginning with margins. As I stated on our second quarter call, we believe that our margin gains in the first half of the year would largely reverse in the second half of the year and leave us with a relatively flat gross margin overall for the full year. Q3 results were right in line with that guidance and we believe Q4 will be as well, meaning you should expect a more significant year-over-year margin decline in Q4 to get us level with 2018 gross margin for the year. This is primarily a result of the impact from the pull-forward of inventory purchases from 2019 into the second half of 2018.

Our total operating expense growth of 8% in the quarter was impacted by acquisitions and the addition of new locations as well as the additional business day in the quarter compared to Q3 last year.

Our base business expense growth was 5% in the quarter and 4% year-to-date, including the impact of new locations, which added about 1% to our expense growth in both the quarter and the year-to-date as well as an additional billing day, which also added about 1% expense growth in the quarter.

On the other hand, currency translation gains, resulting from our non-U. S. operations, offset year-to-date expense growth by about 1% with little impact on the quarter.

Given our expected Q4 gross margin decline compared to the large gains recorded in Q4 last year and the impact from seasonal market acquisitions, which will have operating losses in the offseason, we expect a decline in operating income in Q4, right in line with our expectations as discussed on our last call. As a reminder, our Q4 2018 operating income grew 50% over Q4 2017, so a very difficult comp this year.

We remain on track to finish the year with our targeted base business operating margin improvement range of 20 to 40 basis points for the full year. Following the weather-challenged first half of the year, we think this is -- this would be an excellent outcome for the year and reinforces the potential of our capacity creation initiatives.

Our tax rate was 24.3%, excluding the ASU benefit and also in line with our expectations and keeps us on track to finish the year with an effective tax rate of just over 25%, excluding the ASU tax benefit.

For the quarter, we recorded a $4.5 million ASU benefit, which reduced our Q1 2020 remaining benefit by $3 million, leaving approximately $3 million of benefit left to be recognized by Q1 of next year.

Moving on to the balance sheet and cash flow. No surprises here as total receivables grew to 7% in the quarter, modestly below our sales growth, while inventory levels grew 1%. As most of you are aware, we've been carrying higher inventory levels than normal since our preprice increase purchases last year, but are now down to appropriate levels to support our normal business needs, just as we begin to gear up for seasonal early buy purchases from our vendors. As we mentioned at our Investor Day event, we expect a more normalized level of inflation in the range of 1% to 2% for the 2020 season. And therefore, we'll have more normalized levels of early buy commitments. As these purchases will be done on deferred payment terms, there will be no cash flow impact from early buy shipments that we received before year-end.

The result of the anticipated Q3 inventory reduction was an increase in our operating cash flow, which at $243 million for the year, is up $192 million over the same period last year. Excess cash has been used to pay down debt, which was $548 million at the end of the quarter, down from $581 million at this time last year. Our leverage, as measured on a trailing 12-month debt-to-EBITDA basis, was 1.69 at the end of Q3, so comfortably within our 1.5 to 2.0 target range.

Finally, I wanted to let you know that we sold a nonstrategic golf cart business in September that had come with one of the Horizon acquisitions we made a number of years ago. This business generated $12 million in revenue over the last 4 quarters, including $3 million in the fourth quarter of 2018, which should be factored into your projections. This business was only marginally profitable, so expect no impact from the sale on operating income.

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

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Questions and Answers

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Operator [1]

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

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [2]

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Nice quarter. So a couple of questions. First, the 9% base business growth is really impressive, and thanks for all the salient detail. I'm curious though, what do you estimate this was boosted by for the favorable weather that we had this quarter, but also maybe some catch-up from this lower 2Q?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [3]

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Yes. Good question, Ryan. I think the way we look at it is probably $8 million to $12 million that would -- it's a combination of catch-up and good weather that we saw in the quarter compared to the awful first half, really.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [4]

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Got it. Okay. And then your sense of what sort of the blended blue market is growing this year, is it still kind of in that 3% range?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [5]

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Yes, I think that's a good number.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [6]

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Okay. Okay. And then moving to gross margin. I think we all understand 4Q. But if I can look forward just a little bit just we have the models right, should we think about flat for 2020 with sort of a lower first half and then maybe a better second half just based on how the comps work?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [7]

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You got it, Ryan. That's just how we model.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [8]

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Okay. And then just lastly, I noticed that debt-to-EBITDA is pretty low here, maybe the lowest in a few years. What sort of the plan is for capital allocation?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [9]

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Well, our capital allocation is really the same, Ryan. No changes there. So we invest everything that we need to in the business, and that includes capital at 1% to 1.5% of revenue. We have a dividend program, which grows with earnings over time, so that will continue. And then -- we're really close to the middle of our range on debt in terms of where we want to be. And then we use excess cash for share repurchases, which we do opportunistically. And opportunistically means that can be a little chunky over times, so we don't do that on the same quarter-to-quarter basis. So we'll have our opportunities over time. And when we do, we'll make sure we execute on that. So no changes overall in terms of how we allocate our capital.

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Operator [10]

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Our next question comes from David Manthey with Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [11]

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First off, it looks like you hit your base business SG&A growth as a percentage of gross profit dollar growth target this quarter. But for the full year, it might be a little short. I'm not sure if that's due to the variability of sales or was that -- what the reason for that would be. But as we roll the calendar forward to next year, are there factors that will change in 2020 versus what you saw in 2019 that will get you more comfortably into that 60% targeted base business range?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [12]

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Yes. Just -- you said at the end there, and I assume that you're referring to the 60% gross profit growth than our expense growth. And we may end up a little bit short there, so we use that as a guide. And really the result of that, that we're shooting for is the 20 to 40 basis points of operating margin improvement, and we do expect to be in that range. That won't necessarily be at the high end of that range, but we'll -- we should be in the range.

So in terms of next year, I don't see -- well, and part of the reason that's a little bit lower perhaps is because of the first half of the year, our sales growth this year was a little bit less than we expected going into the year, although we've made up for some of that in the third quarter. But really, for the year, down a little bit from our expectations because of the start to the year. So next year, we always assume normal weather going into the year, and doing that should give us the opportunity to get that operating expense leverage that we're looking for and keep us in our targeted operating margin range of 20 to 40 basis points improvement.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [13]

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Got it. Okay. And as we're looking at modeling the fourth quarter, I just went back and looked, your growth and profitability in the fourth quarter has been surprisingly strong for the past several years. And obviously, with the volume gains you've seen overall, that's helped you go from an operating loss to a profit situation.

But when you look at the fourth quarter revenues, we're talking probably averaging double digits overall for the past 7 or 8 years. I'm just curious that outsized growth seemingly in the fourth quarter, was there something going on there? Mixed factors? Geographic factors? Or what do you think drove that outsized growth rate in the fourth quarter relative to the first through third for the past several years?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [14]

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Yes. That's a good question, Dave. And I think if you go back and look at it, it's a little bit variable in terms of some years, we do great, and some years, we do good in the fourth quarter. A lot of it has to do with weather. So because it's a smaller quarter, weather makes a pretty big difference, particularly in the seasonal markets. So when weather is favorable, the demand is there, and it allows our customers to catch up on that demand or to fulfill more of that demand, which gives us the opportunity to grow better both in the fourth quarter and the first quarter. So it's very weather dependent. And obviously, it's early. And I don't know what the quarter is going to look like when it's all said and done from a weather standpoint. So we don't get too enthusiastic about the growth. And even so, it's still a marginal quarter when you look at the full year in terms of the seasonality even in a good weather year so...

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Peter D. Arvan, Pool Corporation - CEO, President & Director [15]

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Yes. Dave, I think last year was about 18% of total revenue, and I think this year looks to be in a similar range. The good news is, is that backlogs with the builders are still very strong, and they're working hard to catch up. But as you know, having followed us for so long, the biggest factor that we face is how long they'll be able to work, specifically in the seasonal markets. There's a lot of work in the seasonal markets that they're trying to get done. So as we always say on this call, if it's -- if you're walking around New York with a sweater on for Christmas shopping, it'll be a really good fourth quarter. If you got boots and gloves, it'll be a little bit shorter.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [16]

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Okay. I just wondered if there was something else because, as you point out, 18% of full year sales right now. If I go back to 2011 or 2012, it was 15% and change and it just seems like that's a -- it's more of a structural change than just a string of weather conditions. But I think we can discuss it further offline.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [17]

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Yes. One other point there is the Horizon business has generally less seasonality in the fourth quarter. And so you go back right after the downturn where that business was a smaller percent, I can't remember, it's probably 7% of our business, something like that, now it's 9-plus percent. So that is maybe a little bit of a structural change if you're thinking about there.

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Operator [18]

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Our next question comes from Stephen Volkmann with Jefferies.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [19]

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This is probably just a rounding question more than anything else. But just sort of based on your guide and kind of how it works with the tax and so forth, it looks like the base business guidance was a little bit lower in the fourth quarter than what we had been looking for. Obviously, third quarter is a little bit higher. It's probably just timing and rounding. But I just wanted to make sure that there's nothing you're seeing that you're particularly kind of focused on in terms of something that may be slowing or some trend that might account for somewhat lower fourth quarter look.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [20]

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Yes. Not at all. We kind of look at it as really no change in terms of our expectations. When we go back to our second quarter and call them and what we're looking at for the rest of the year, things are playing out as expected. So I guess it's what you said, rounding and that kind of thing. So there, nothing's structurally changing.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [21]

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That's kind of what I thought. And then just back to capital allocation a little bit. I mean I know you like to be picky around share repurchases. But of course, none of us is particularly able to forecast too well. I mean this may or may not be a good time. I'm just curious how you think about -- how much cash or -- sorry, how much debt paydown would you do? How low would you let the debt levels go before you sort of come back to that if the stock keeps working?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [22]

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Yes. It's a good question, Steve. I don't know that I can give you a specific answer there. But just to kind of reiterate the point I made earlier, we're opportunistic in our repurchases. We've got election coming up next year, which who knows what impact that could have on the market. We've been in a long bull run here. So we certainly want to make sure we have cash available if there's a market correction that takes place, and we'll be ready to participate in repurchases. So we'll just see how things play out over the next several quarters, and we will get our share repurchases in, although opportunistically.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [23]

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Understood. And then just one quick follow-up, and this is maybe more kind of theoretical. But I'm curious of how you are looking at kind of the new build market. I know it's not a huge part of your business, but it feels like a lot of the strength that we're seeing in housing is kind of at the low end and in multifamily, and I don't know that those are necessarily as natural pool customers as maybe the high end and maybe you disagree with that. But I'm just curious kind of how you see the new builds kind of going into 2020 and whether that mix is something that we should be thinking about.

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Peter D. Arvan, Pool Corporation - CEO, President & Director [24]

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Yes. Good question. I guess the way I think about it is new builds, prior to the downturn, were a much bigger portion of our business. Today, it's, call it, in the 15% to 18% range of what we do in a year. And then the overlay on top of that, the underlying capacity constraint in that there's more demand for the pools that will be built just based on labor capacity.

So overall, even if you're correct with the housing shift, and I'm not sure that I agree when you look at it geographically, specifically in the markets where new construction is very strong, Florida and Texas, which are very, very good pool markets, I don't really think it's a big factor for us. Just simply, it goes back to the underlying demand being more than what the labor is. The biggest factor we had this year to contend with, as you all know, is weather. But as I have said before, I view it as the system is pretty pressurized in that there's some more demand than there is capacity to build them.

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Operator [25]

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Our next question comes from Blake Hirschman with Stephens Inc.

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Blake Anthony Hirschman, Stephens Inc., Research Division - Research Analyst [26]

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Yes. On the top line, I believe you're kind of thinking something like 6% to 7% top line growth for this year. And your typical kind of 6% to 8% going into next year, I don't think they've been explicitly touched upon yet. If they have, I apologize. But are both of those kind of still the expectation as you sit here now?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [27]

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Yes, that's correct.

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Blake Anthony Hirschman, Stephens Inc., Research Division - Research Analyst [28]

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Got it. And then on gross margins in the 4Q. I mean should we be thinking about 4Q gross margins giving up the entirety of that 100 basis point expansion they saw last year? Or just that the year-over-year decline is going to be greater than what we saw this quarter? Just kind of trying to frame that up a little bit more.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [29]

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Yes. Just to kind of reiterate what I said earlier, looking for gross margins to be flat overall this year with last year. And if you model that in, that gives you that more significant margin decline in the fourth quarter compared to the third quarter and basically giving up the gains that we saw last year in the fourth quarter.

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Blake Anthony Hirschman, Stephens Inc., Research Division - Research Analyst [30]

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Got it. That makes sense. And then lastly, just on M&A. Kind of curious to hear where you're most focused now? I mean it sounded like from the Investor Day that you're pretty interested in additional green business M&A. Just wanted to ask about commercial, international, and just if you could kind of rank those areas in terms of M&A priority for you guys now, that'd be great.

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Peter D. Arvan, Pool Corporation - CEO, President & Director [31]

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Sure. So the way I think about M&A, as we said during the Investor Day, that's certainly part of our growth strategy. If I look at it, it's on the green business, and you look at our map. So from a coverage perspective, we had very good coverage Pacific Northwest through California. We have good density in Texas. But one of the areas that is of interest to us, where we have the weakest presence, would be in the Southeast. So that's an area that, specifically on the green side, it doesn't really make sense that we can achieve our goals by doing simply greenfields on the green business. So that would be -- that would certainly be a priority for us.

On the commercial side, there, we've done some great acquisitions in the past that have given us a nice platform that we've been able to leverage across the entire platform. When I think about what's in our M&A deck for commercial, we're interested. There's nothing that I am -- that we are looking at now saying, boy, this is a must-have. There are really no large -- very large players that we would do. So it would be more regionally and opportunistic that we would participate in the commercial area.

And then on the international side, what I would say is, in Europe, the market is primarily France being the largest, Spain and Germany. We have a very good presence in France. I think we have opportunity to grow in all of those 3 countries. But specifically, if I look at Spain and I look at Germany and I look at the density, I would tell you that same opportunity exists for us that we should be looking in those areas as well. But they are relatively small as a percentage of our total when you look at overall pool. But certainly, to grow Europe, acquisitions are going to be part of it. But we're not looking to significantly shift the mix of business by making very large acquisitions in Europe, if that makes sense.

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Operator [32]

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Our next question comes from Anthony Lebiedzinski with Sidoti & Company.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [33]

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So I guess, first, I just wanted to get a better sense of when you look at your base business sales, overall, kind of breakdown of -- just give us some color if you can, just in terms of unit volume versus pricing, how is that? And kind of your -- I know you said inflation you expect to be more modest next year, but I know there are some new equipment coming into play where some new regulations were -- as far as variable speed pumps come into play. So how should we think about that dynamic?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [34]

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Sure. So when we look at unit volumes, I would tell you -- let's go back to your original question about inflation. So inflation, let's say, it's in the 2% range. So the base business unit volume is good. Demand is good. So we are encouraged by what we're seeing. It's not like our growth is being driven by overall inflation, unit volume is up. And then we talked about the variable speed pump legislation that's coming which will take effect in 2021, that will be a nice opportunity for us because the price difference between a single-speed pump and variable speed pump is about 2x.

We also made mention of -- if you look at the pools that are being done today versus pools that were done 5 or even 10 years ago, there is a lot more bling and automation is becoming a more standard part of pool package. So we're seeing a lot of those, wherein the past, there wasn't a lot of automation. So we're seeing things like automation. We're seeing UV lights. So I think the -- those things will help drive the overall base business growth as they're trying to make pools more user-friendly for the homeowner.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [35]

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Yes. And just to clarify one thing there on the timing of the variable speed legislation. It's time to go in place in the midyear 2021. So we just really don't see any impact on 2020, it's really a 2021 event, and really, late 2021, most likely end of 2022. So...

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Peter D. Arvan, Pool Corporation - CEO, President & Director [36]

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I mean there's been a slow shift over time from single speed to variable speed, but it's nothing like what will happen in the mid-2021. And then as you think through that, it's a function of what the manufacturers decide to do with -- when they cut over from single speed to variable speed.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [37]

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Are there any other regulations out there that could potentially help you guys in the future? Or is that the only one?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [38]

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I think that's the only major one that will help. I think there is a -- take California for instance. The California is -- has an electrification trend. So we -- things like heat on the West Coast, which traditionally have been gas heaters, I think you're going to see more opportunity or we'll see more opportunity for heat pumps and electric, which is just, again, will be a slow trend, but nothing seismic. I mean the one that is legislated is the variable speed. That's the only one I know that will -- has a hard start to it.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [39]

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Got it. Okay. And just switching gears. I just wanted to -- just to clarify. So as far as 4Q, you guys are not expecting any meaningful impact from ASU 2016-09 for 4Q?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [40]

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No. We're not forecasting that. As I said, we have $3 million in unexpired benefits that would have to be recognized between the fourth quarter and the first quarter. We don't know when or how much of that $3 million, so we aren't including any of that in our forecast.

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Anthony Chester Lebiedzinski, Sidoti & Company, LLC - Senior Equity Research Analyst [41]

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Got it. Okay. And lastly, what is your expectation now for pool construction overall for the industry in 2019? And perhaps any early read for 2020?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [42]

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Yes. Still hard to tell. I don't know that I can give you a really good number. I think overall -- so last year was about 80,000 units. Again, I think it'll probably be flat, maybe down slightly, really depending on what happens with the weather in the fourth quarter in the seasonal markets. And again, it's a function of everybody got behind. Demand is there. Backlogs are good. But it really -- and in order for me to tell you exactly what it would be I'd have to tell you -- we'll be able forecast the weather for the fourth quarter.

So normal fourth quarter, I would tell you that they're working very hard to catch up, which probably makes the number flattish. Next year, we would expect to see some -- just mild growth. I guess it's maybe in the 5,000 pool range. So maybe 80,000 to 85,000 pools next year.

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Operator [43]

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Our next question comes from Garik Shmois with Longbow Research.

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Garik Simha Shmois, Longbow Research LLC - Senior Research Analyst [44]

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Couple of follow-up questions for me. Just first off, the seasonal market growth in the quarter, the 12% and my assumption is that a lot of that is just really favorable weather and some catch-up. Was -- is that right? Or was there any maybe mix or geographic items that we should pay attention to?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [45]

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No. The weather was very good in the third quarter in the seasonal markets. Everybody had great weather conditions to work in.

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Garik Simha Shmois, Longbow Research LLC - Senior Research Analyst [46]

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Okay. And then just around the fourth quarter guide. Is the mean variable from the low to the high end really just again -- not to harp on weather but really just the volatility and the lack of visibility around the weather. Is there anything else that we should pay attention to?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [47]

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No. As I said, what's encouraging is demand is good. And builder backlogs are good because everybody got behind in the beginning of the year. So I think they're -- they have a lot of work to get done, and they're working very hard to get to it.

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Garik Simha Shmois, Longbow Research LLC - Senior Research Analyst [48]

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Okay. And just lastly, just on the commercial just because the growth is 17% in the quarter, I think it's 9% year-to-date, how much do you think you're outperforming the market right now? And how much more legs do you have to have this outperformance on the commercial side moving forward?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [49]

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I guess I would say that I think we're probably about 2x. Last year, I think we were up about 11% for the year. This year, after a very strong quarter, we're up 9%. But I would tell you, I think we're about 2x and I think we are -- our teams are getting very good and it, and we're gaining traction on it every month.

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Operator [50]

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Our next question comes from Ken Zener with KeyBanc.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [51]

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So thinking about your tax rate, just as we look into next year, I think you'd mentioned 25.5% in the past. I mean should we be using that for next year's?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [52]

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That is a good estimate. And you have a good recall. Yes, 25.5%. It's right in line with my expectations, Ken.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [53]

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Okay. Mark, you're not really all that enthusiastic about the fourth quarter or the election year, prospects for volatility, I guess. Found that interesting, but that's more of an aside. What are seasonal markets as a percent of total sales, generally speaking? And I apologize if you told us this at the Analyst Day.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [54]

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Well, the top 4 markets are a little better than 50%. Now that's not all of the year-round markets. So maybe 60% is year-round and 40% is seasonal when you look on a basis.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [55]

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Okay. Good. Now I appreciate how you laid out the categories, chemicals 7%, 4% year-to-date, et cetera. If we can just hone in on how chemical, up 7%; equipment, up 13% compares to -- what might drive the chemical versus the equipment? I mean is it similar volume and it's really equipment price that is driving the upside there, I guess, is my first question.

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Peter D. Arvan, Pool Corporation - CEO, President & Director [56]

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No. I would say, the -- if you look at equipment pricing, it certainly doesn't account for the difference. I think on a year-to-date basis with chemical -- remember, the amount of chemicals that you use in your pools is a function of how often you are using your pool and how much sun that you have that's burning chlorine. So given the slow start that we had for the year, the fact that pools open late and didn't get a lot of use because it was unseasonably cool in many of our traditionally strong markets, I think that's what kind of tamped down the chemical.

If you look at equipment on the other side, that's a function of a strong remodel and renovation market. And if you look at the third quarter specifically, it's -- there's a bit of catch-up in there, too.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [57]

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Right. So okay, it is -- well, could you perhaps -- this variable speed pump 2021, realizing it's not an FY '20 event, you probably start loading inventory in at the end of next year, I assume. Could you maybe -- and I know this is just -- it buttresses your growth rates. But could you quantify perhaps how you think about the market penetration of variable speed? And that refreshes, is that a federal regulation, state -- I mean state adopted? Or kind of quantify what that would mean in terms of the number of pumps that are not variable speed.

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Peter D. Arvan, Pool Corporation - CEO, President & Director [58]

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Okay. Very good questions. The -- when I think about the mix shift that will have to happen, so it's not all pumps. So the thing you have to remember is that the smaller pools, specifically above-ground and some very small in-ground pools, the single-speed pumps are still going to be in place. So they're not going to go away entirely. So the variable speed is really for the larger pools, and it is going to be a nationwide program. I think the cutover is going to start to have -- manufacturers are going to have to start to decide when they're going to flip the plants. And my suspicion is, is that there'll be inventory sold into 2021, and then we'll be selling through that inventory. So you won't see a full year impact really until 2022, and that's a function of how much inventory gets put in the channel.

If I look at the price difference between variable speed, single speed, it's about 2:1. So overall, as far as our equipment, I think pumps are our second-largest item in the equipment category. Yes, so...

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [59]

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And what is that ratio? When you sell through, I mean, are you doing -- excluding these above-ground pools, I mean, is it 30% variable? 70% nonvariable? I thought it was -- just because of the electronic or the electricity cost differential, I figured it'd be closer to 50-50 today. Can you just...

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Peter D. Arvan, Pool Corporation - CEO, President & Director [60]

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It's about 50-50 in terms of dollars because of -- they're a lot more expensive, right?

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [61]

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Right. But that means 2/3 are actually nonvariable speed pumps today, unit-wise.

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [62]

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Yes, yes, yes.

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Peter D. Arvan, Pool Corporation - CEO, President & Director [63]

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Yes.

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Operator [64]

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(Operator Instructions) Our next question comes from Alex Maroccia with Berenberg.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [65]

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So on the tech front, I guess the biggest recent items would be POOL360 and the new NPT backyard app. I guess can you discuss, number one, where you see revenues processed going in the next couple of quarters through POOL360? And then the follow-up is, can you touch on the adoption of the NPT app, and if that started driving any store traffic?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [66]

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Yes. Your question on POOL360, I want to make sure I understood that. Can you repeat that?

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [67]

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Yes. So the -- you said that revenues processed in Q3 was about 10% of total revenues through POOL360, right?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [68]

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Yes, correct.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [69]

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Okay. So where do you want that to be in the next couple of quarters? I mean do you want 100% in the next year, 2 years, et cetera?

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Peter D. Arvan, Pool Corporation - CEO, President & Director [70]

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No. It'll never be 100%. I mean consider that in our business, about 70% of our transactions happen at the counter. So there's a portion of our business and segments of our business that are very tied to POOL360 because they are ordering in advance for construction projects or our large retailers. But for the maintenance folks, a lot of those -- a lot of our customers are coming into the branch because they have to come to pick up chemicals and such that they use on a daily basis, and many of them just walk up to the counter and order. Do I think it can double from 10% to 20% of revenue? Yes. Do I ever think it'll be above 50% of our revenues? Likely not.

To your second part of your question about the backyard app, we are very encouraged by the adoption rate. So far, the number of downloads that we had -- and our sales folks, we introduced it at our International Sales Conference a couple weeks ago. So they're just getting familiar with it to take it out and roll it out to customers. So it's kind of too soon to tell what the impact is. I can't tell you that I -- we've seen a sales spike because of it.

But remember, it's a -- part of it is a passive tool as well, which allows the homeowner to envision and specify and design the pool and then get with the pool builders. So the cycle on that process is not immediate. That's a I've designed the pool, this is exactly what I want, this is the look I want then I have to go start interviewing builders. So I wouldn't look for a big spike because of it. We just think that, that's something that will continue to fuel market growth. And then the pull-through demand, we should see.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [71]

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Okay. I got it. And then second question is just on the backlog. Are you able to give us a split of what we're seeing right now in resi versus commercial? And then on the product side, what the backlog would be in materials versus equipment?

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Mark W. Joslin, Pool Corporation - Senior VP & CFO [72]

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Yes. I mean backlog is a very -- we hear about it. Customers tell us about it, but there's really no way to kind of track and know what that is. So they're busy, and weather allows them to be as busy as they can be. But in terms of tracking that on a more formal basis and how much is resi versus commercial, all of our contractor customers are busy. So that's the best that we can tell you. They're optimistic as well about what they see coming in the year ahead, as are we. And other than that, not much we can say.

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Peter D. Arvan, Pool Corporation - CEO, President & Director [73]

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Yes. We have better visibility on commercial because some of those are build-to-suit projects. It's a portion of our business. But on residential, consider that we're expected to have that product in stock. So if they're going to build the pool, they don't order a couple weeks in advance or a month in advance, they just expect us to have it in stock. They either come by and pick it up or say that needs to be delivered on a next-day basis.

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Operator [74]

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

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Peter D. Arvan, Pool Corporation - CEO, President & Director [75]

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Yes. Thank you all for attending the call this morning. The next time we speak will be February 13, 2020, where we will cover our full year 2019 results and discuss expectations for 2020. Thanks, again, and everybody, have a great day.

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Operator [76]

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