Good afternoon and welcome to the Third Quarter of Fiscal 2023 Conference Call for Leslie’s, Inc. At this time, all participants are in a listen-only mode. Following the prepared remarks, management will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded and will be available for replay later today on the company’s website. I will now turn the call over to Caitlin Churchill, Investor Relations. Please go ahead.

Thank you and good afternoon. I would like to remind everyone that comments made today may include forward-looking statements, which are subject to significant risks and uncertainties that could cause the company’s actual results to differ materially from management’s current expectations. These statements speak as of today and will not be updated in the future if circumstances change. Please review the cautionary statements and risk factors contained in the company’s earnings press release and recent filings with the SEC. During the call today, management may refer to certain non-GAAP financial measures. A reconciliation between the GAAP and non-GAAP financial measures can be found in the company’s earnings press release, which was furnished to the SEC today and posted to the Investor Relations section of Leslie’s website at ir.lesliespool.com. On the call today from Leslie’s are Mike Egeck, Chief Executive Officer; and Steve Weddell, Chief Financial Officer; and Scott Bowman, Chief Financial Officer Designate. With that, I will turn the call over to Mike. Mike?

Thanks Caitlin and good afternoon everyone. Thank you for joining us. Please note that we have posted a Q3 2023 earnings deck to the Leslie’s IR site and that we will be referring to certain pages in that deck during our call. As we shared in our pre-release three weeks ago, it was a difficult quarter. Low double-digit traffic declines resulted in a 12% comparable sales decline and a 9% total sales decline. In addition to fixed cost deleverage associated with these sales, we faced unexpected in season product cost increases and higher distribution expenses that significantly impacted gross margins for the quarter. Our ongoing analysis points to three primary drivers of our Q3 traffic and sales results. First is weather. Our weather reporting service, Planalytics, calculated that weather was a 5% year-over-year to sales in the quarter. Weather headwinds were held across most of our store base and most significantly in California, Texas, and Arizona. The weather in Florida was relatively normal in the quarter as it has been all year, and our business in Florida is significantly outperformed in the quarter year-to-date. Sales in Florida were plus high single digits in the quarter and are plus mid-teens year-to-date. The second driver was increased consumer price sensitivity. After three years of significant price inflation, consumers were not willing to absorb price increases during the quarter. This prevented us from taking the pricing actions required to maintain margins as product costs increased and also prevented us from maintaining our pre-June 1st pricing on core chemicals. As we have discussed before, we generally aim to maintain a relative price point that is above mass and just below specialty. That relative price position was out-of-balance for some weeks in third quarter, which we addressed with our June 1st price actions. Those actions…

Thank you, Mike. Leslie’s has carved out an admirable leadership position in an attractive industry and based on my initial observations, I see plenty of areas where I can leverage my experience to help drive Leslie’s strategic priorities. As I continue getting up to speed on the business, I look forward to digging into areas such as supply chain, product margin management, forecasting, and capital allocation to help deliver continuous improvement in the business. It’s an exciting time to join the team as we drive the next chapter of the company’s growth and I look forward to speaking with all of you in the coming weeks months. Now, I’ll turn it over to Steve to share more detail on the Q3 financial results and outlook.

Good afternoon, everyone and thank you, Mike and Scott. I know I’m leaving the team in good hands and I look forward to ensuring a smooth transition over the next few months. As Mike noted, it was a challenging quarter. While we have seen slow starts to pool season in prior years due to unfavorable weather conditions, historically, performance has improved around Memorial Day. This year, our third quarter performance was impacted by industry-wide headwinds due in part to continued unfavorable weather along with atypical consumer purchasing behavior. For the third quarter, we reported sales of $611 million, a decrease of 9% or $63 million when compared to the third quarter of fiscal 2022. Our comparable sales decreased 12% or $79 million. Our comparable sales on a two-year stack basis decreased 4% and on a three-year stack basis grew 15%. Our non-comparable sales totaled $16 million in the third quarter of fiscal 2023, which was driven by nine completed acquisitions that added 25 stores, as well as 19 net new store openings since the end of the second quarter of fiscal 2022. With respect to trends by Consumer Group, comparable sales declined 10% for Residential Pool, 13% for PRO Pool and 23% for Residential Hot Tub. On a two-year stack basis, comparable sales declined to 5% for Residential Pool, increased 4% for PRO Pool, and declined to 7% for Residential Hot Tub. While our third quarter sales declines were unprecedented, they were in line with industry trends. Gross profit decreased 17% or $52 million compared to the third quarter of fiscal 2022, and gross margin rate was down 390 basis points to 41.2% from 45.1% in the prior year period. Page 11 of our supplemental deck illustrates our third quarter gross margin rate bridge in more detail. During the quarter,…

Thank you, Steve. Despite the challenging headwinds we are navigating in this highly unusual pool season, the aftermarket pool and spa industry has proven over time to be one of the most durable and advantaged consumer products categories, and we have a long track record of profitable growth in the industry. We remain laser-focused on the execution of our long-term growth initiatives, market share gains, and shareholder returns. With that, I will hand it back to the operator for Q&A.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our first question comes from Simeon Gutman with Morgan Stanley. Please go ahead.

Good afternoon everyone My first question, Mike, you mentioned some market share from credit card data. Thanks for that. We don’t see that data. So, you adjusted your price, you said price is June 1st and so my first question related to that is your product costs are much higher. You try -- you’ve taken price down because you weren’t getting the sell-through. Does that mean that a lot of the industry is just accepting a much lower margin for selling product or chemicals? And then related to it is if you were holding or growing share even in that scenario, which maybe you can parse out, then why even take down the price?

Yes, Simeon, thanks for the questions and good questions. First, on the margins, as we’re active in M&A with specialty retailers, we do see that we operate at higher margins than they do. And we can back that in pretty specifically to product cost and feel comfortable that we still have a cost advantage versus specialty retail. Though we do need to say that, that gap has narrowed from 2021 and 2022 when we had some, I would say, extraordinary advantaged prices on some core chemicals. With regards to market share, we look at market share in a couple of ways. The aggregated credit card data we use is Bank of America. As you can see on the slide, that shows we were basically flat to the industry in the quarter. We also listened very carefully to our pool peers and the largest distributor in the industry showed sell-in to their pool specialty retail at minus 11%. So, also a flat comparison to, I would say, a flat growth rate and flat market share based on that comparison. Now, look, that’s a deceleration from the market share gains we’ve had consistently for the last eight quarters, so we’re not pleased with that. But that’s the situation we are in for the quarter.

And then a quick follow-up on margin. Pre-COVID, we had a couple of years of, I guess, pre-COVID history. It looks like our model is a 13% EBIT margin and now you have $500 million and more in sales. So, I know this is -- you’ve had a deceleration, and it’s hard to commit to where the clearing margin of this business is. I assume its higher, at least 13% on the sales base, but is there any reason why it shouldn’t be? Or is there any reason it should be even higher than that 13%?

Well, look, I think we it’s early to talk about 2024. But in terms of where we were pre-pandemic with our gross margins and our operating margins, we feel that the headwinds we’ve got this year and particularly in this quarter, do abate and feel like we’ve got a pretty clear path to recover to those levels, at least those levels.

Right. okay. Thank you.

Our next question comes from Steven Forbes with Guggenheim Securities. Please go ahead.

Good evening, Mike, Steve, Scott. I wanted to maybe expand on Simeon’s question, but in particular, focus on the customer file dynamic. So, Mike, maybe you could just expand on your learnings from the quarter as it pertains to the customer file down 8%. And specifically looking for any insight into what’s really driving the reduction. Is the consumer is migrating back to maybe its legacy provider or outlets? Is it marketplace disruption? Is it mass? And on that also, when should we expect Leslie’s to return to positive file growth?

Yes, Steven, thanks for the question. I think the way we’re thinking about the file or the lack of file growth, the file shrinking 8%, has a lot to do with the two surveys that we ran, which showed a larger-than-normal amount of product left over in the industry in the consumers’ hands. We’ve turned in calling it the garage and shed inventory internally. And one of those surveys we conducted on our own through a third-party, and one after we prelease, we were contacted by one of our chemical partners who had run a similar survey of a similar size and come up with remarkably similar results. So, we have some idea of what that size is now. And though they came at the number in different ways, again, the final impact in terms of a headwind is quite similar. So, there’s definitely some of that going on. And when you think about need-based industry, right, that’s predominantly nondiscretionary spend. The question is, well, how can nondiscretionary spend be down, and nondiscretionary spend for the quarter was down 6%. While it’s only down if need is impacted, and two things impacted need in the quarter. The first was weather. It’s coldest weather in a decade according to Planalytics. Coldest weather in 19 years in June, the start of the pool season from Weather Trends International. So colder weather means less need for sanitizers, means less people needing to come in and purchase, and that impacts our file because our file is active members. And then when you look at the surveys that were conducted and found left over inventory, which is, first of all, highly unusual, I’m going to say unprecedented in our experience, that also decreases the need to purchase. We’ve got some -- we’ve got some feedback…

And I’ll add on as well, you answered the question with regard to non-discretionary items, given the discretionary decline as well, had a material impact on overall traffic. So, that’s another contributor if you get outside of the nondiscretionary product and look at the total decline in the customer count.

Yes, that’s a good point.

Thanks Steve. Maybe just a quick follow-up on PRO, right, sort of a similar question, down 3%. But as we think about the growth in PRO stores and we think about the growth in PRO partner contracts on a year-over-year basis, anything specifically to note that helps explain what’s transpiring within the PRO segment? Is that just chemical mix or are you seeing some -- are you seeing less engagement from your affiliate contracts? Any color on the PRO segment would be helpful.

Well, I would say the PRO business has become more competitive. And some others have reported. We have seen Trichlor deflation in that category, and that was a pretty significant headwind to the PRO business in the quarter and year-to-date.

Thank you.

Our next question comes from Ryan Merkel with William Blair. Please go ahead.

Thanks. Good afternoon. Mike, I was hoping you could address the risk that chemical prices keep falling. And have you seen competitors cut prices when you cut in June?

Yes, Ryan, thanks for the question. Yes, I think it’s important to understand that the price actions we took on 6/1 were to get ourselves level with specialty retail. And since we’ve done that, we haven’t seen any reaction from specialty retail to take prices lower, list prices. And in addition, we haven’t seen any outsized promotional activity in the business. So, right now, it looks like we have a stable pricing situation and a stable promotional environment in the residential pool space.

Okay. That’s good to hear. And then my follow-up, do you have any goals for inventory reduction, cost savings and COGS, cost savings and SG&A that you can share with us?

Yes, we’re not sharing any specific inventory goals at this moment. As we said, as Steve said in his script, we will be lower than we were last year. We’re obviously working to work that number down as low as we can, but we haven’t -- we’re not going to comment on what our internal targets are. With regards to SG&A , as we talked about SG&A in my comments in the script, we look to be $15 million to $20 million lower in Q4 this year versus the prior year, also working diligently on reducing cost run rate as we go into 2024. And we think we have a pretty good path there as well. Obviously, the inventory buildup and the associated costs with that offsite storage additional labor, increased transportation. Those costs are in our margin. Those also were flexed up given a rather extraordinary inventory levels we took to ensure supply and we’re unwinding those now. It will start in the fourth quarter and should be completed by the end of the year.

That’s helpful. Best of luck.

Thanks.

Our next question comes from Dana Telsey with Telsey Advisory Group. Please go ahead.

Hi, good afternoon everyone. As you think about the sales decline of around 9% this quarter and you think about the cadence going through as we go into the next fiscal year, are there any puts and takes of how you’re planning the business and how you’re thinking about whether it’s traffic, whether it’s i.e., transaction or discretionary, nondiscretionary? How you plan to market it or how you’re reassorting the stores in order to minimize gross margin erosion and working to drive demand and seeing demand? Thank you.

Yes, Dana, thanks for the question. Look, we start out each year planning weather to be normal. This year was clearly an aberration of that. We do believe that weather should be at least neutral in a comparable basis, should be a bit of a tailwind going in next year. The same with consumer inventory. That gets worked through the channel. That should be a tailwind for us as well. The headwinds into next year in terms of sales is -- we got a little out of our normal lane in terms of pricing going into the quarter. We’re a little bit above especially retail. We’ve done that in the past and had those prices come up. We’ve been able to move up in price and have others follow. That didn’t happen this year, so I think that’s a good learning from us and we will keep our historical price position just below or equal to specially and just above mass. And then as we think about additional puts and takes in the next year, in a need-based industry, the way we think about marketing is it doesn’t drive need. Need comes from the install base. It does drive market share gains. The challenge we’ve had with marketing this year is with the headwinds of weather and some excess inventory in the consumer channel, we weren’t getting our typical ROI on marketing spend and therefore haven’t been as aggressive. We would expect that to normalize next year and then our ability to market at a high spend marketing, invest in marketing, sorry, at a high ROI should drive should get us back on track with market share gains.

Got it. And then just as you finished out this quarter, was there any change in the quarterly progression or the cadence of the quarter?

June was very tough in Q3 for us. I quoted that it was the toughest quarter overall in terms of weather from Planet Olympics in a decade. And Weather Trends International had it as the coldest June in 19 years. So we came into the season as we always do, waiting to see what kind of reaction we get over the Memorial Day weekend. And it was very disappointing just to see no lift in the business. And that’s when we started both surveying customers as well as speaking more directly to our district managers and store owners about what was going on and started to take the price actions that we did on 6-1. So it was a challenging traffic situation for the entirety of the quarter.

Got it. Thank you.

Our next question comes from Elizabeth Suzuki with Bank of America. Please go ahead.

Great. Thank you very much. So, I guess you mentioned you’re seeing some of the same factors impacting the PRO business as the retail business. I mean, does that include the pantry loading behavior of folks using chemicals they stored up from last year? I mean, are pros doing that, too? And then, is there anything you can do to educate the customer about issues that they might experience if they’re using expired chemicals?

Yes, Liz, thanks. Good questions. We did not see that behavior on the pro side. Now our survey was just to residential consumers, but I don’t believe we’re seeing that on the pro side. I think the pros went into the season believing that Trichlor pricing should come down, and they were correct. I think residential consumers came out of last year wondering where price and where availability would be and ended up stockpiling based on the prior two years that they had experienced. Was there a second part to your question? Sorry.

Oh, no, just about educating the customer about what could happen if they’re using these older chemicals and if there’s anything from a marketing standpoint you can do to kind of get that message across?

Yes, very good point. And yes, we’re doing that in our blogs and that’s why this is so unprecedented. It’s not, these are not chemicals you want to store. And look, it’s predominantly Trichlor and Cal Hypo. And Trichlor loses its efficacy if not stored properly and will lose it, within a year depending on temperature and ventilation. And Cal Hypo is a little more dramatic because the granular turns to solid and it also has combustible properties. So not something that consumers should be storing and not something we’ve seen them store in the past.

Great. Thank you.

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

Hi. Thanks. You touched on the SG&A reductions that you’re expecting in the fourth quarter, $15 million in lower costs compared to the prior year period. I’m just wondering if you could provide maybe some more color on the steps that you’re taking and how you’re viewing SG&A at this point as we’re moving closer into fiscal 2024.

Yes, Garik, good question. We’re, look, the way we’re thinking about SG&A is we’re going to reduce it both in Q4 and in our run rate into 2024 to help make our P&L more durable against some of the shocks that we experienced this quarter. And in terms specifically of SG&A areas we are addressing in the fourth quarter into next year, I can tell you overall it is up and down the P&L. I spoke a little bit earlier about marketing. Marketing comes down naturally when we can’t get the ROI that we expect on our investments. Marketing has come down in Q3 and Q4 and for the year, but we would expect that to recover in the next year when the consumer inventory is absent. With traffic being down as much as it has, driven by weather and consumer inventory, we’ve taken out labor hours in the stores accordingly. In terms of just being more efficient, we are de-layering our corporate organization, more efficiency, more optimization, and then little things like travel, supplies, all-out push across those categories. And then finally, a big chunk of it is performance compensation. This is not a year where we will be paying ourselves or our associates.

Understood. I wanted to follow-up on inorganic growth. Does the challenging environment right now change your view on either M&A or new store expansion?

No it doesn’t because we think weather over time tends to normalize and if consumers have inventory in their garages and sheds as it appears they do that’s a very unusual inventory or very unusual situation and the catalyst for it which is three years of spotty availability and increasing price, that catalyst is gone. Inventory is readily available, and it’s readily available across all sizes. So we would expect that to be transitory as well. And the challenges that we’re facing in the quarter and this year, so is specialty retail. I think you can see that in some of the distributors’ results. So, it actually makes M&A more attractive in terms of the multiples that we’re able to execute against. But given the results in this quarter and our outlook for the year, as we said in our prepared remarks, we’re going to be prudent about it and we’re going to watch the pace of M&A, but we still think it’s an important initiative for Leslie’s over the long-term.

Okay, understood. Thanks again.

Our next question comes from Jonathan Matuszewski with Jefferies. Please go ahead.

Hey, good afternoon. Thanks for taking my questions. The first one was on pricing actions. Mike, I think you mentioned the guidance assumes no change in pricing. Is there anything that would lead you to deviate from current pricing? I guess another way of asking, if traffic or transactions is softer, would you further reduce pricing to try and stem the excess transaction decline? Thanks.

Yes, when I said no change in current pricing in the prepared remarks, that was specifically for Pro, where we have seen some Trichlor pricing come down. Offset a little bit by Cal Hypo which is up. In terms of residential, I think currently we view the demand in the industry at this moment as fairly inelastic. Now when we think about what’s driving the traffic declines, and the traffic declines we don’t think are being driven by price sensitivity, they’re being driven by weather and consumer inventory, which we believe are transitory, so we need to we need to wait those out. The price actions we took was because we had gotten, as I mentioned, above specialty retail and that’s not a position that our consumers are used to seeing us in and not one that we want to be in. So, we took our actions on 6-1, we lined up with the industry, we are where we want to be from a price standpoint, and now we need to let this year play out, the weather normalize, consumer inventory normalize, and we should be back to our regular cadence of growth.

Got it. That’s helpful. And then just my follow-up, it sounds like the customer insights work picked up on some price sensitivity. Curious to what extent you think equipment upgrades and related spend that didn’t materialize in the second half of this year could potentially benefit revenue next year? Thanks.

Yes. It’s also a good question. Just the general macroeconomic situation, year of customer price sensitivity across industries. In the survey that we did, and the one that we had access to, it was also mentioned very specifically by customers. And I just think that, look, I think the entire industry took an awful lot of price over the last three years. And there is still cost pressures. So there’s some opportunity to take price, but I think the industry has got to be very mindful and thoughtful about how much price we take, because we certainly don’t want to create any demand destruction. I think when you look at the equipment business, we reported ours was down 8%, I think Poolcorp reported theirs was down 8% as well. That’s predominantly volume at the moment. And I think the read on that is that, yes, people with a certain heightened sense of price sensitivity might be delaying some upgraded purchases, but certainly the break-fix business, that is durable and continuing on.

Best of luck.

Thanks.

Our next question comes from Andrew Carter with Stifel. Please go ahead.

Yes. Hey, thank you. So a couple questions I wanted to ask are really about visibility into the business. First is in terms of pricing, like getting out over your skis relative to specialty retail. I mean, how good are your real-time insights into kind of your price levels? I know you do channel checks, but is, can a DIYer know that they get listened to if they say, hey, it’s cheaper down the street, and second to that, how quickly do you respond to feedback? And then just a second kind of point, putting all the consumer work, survey work aside, have you looked at considering how many pounds of chemicals went out the door from various locations over the last four years, and what a reversion to the mean would look like considering market share gains, just to kind of give you a sense of where you could land? Thanks.

Yes, thanks, Andrew. So, a few questions in there. I’ll talk about price visibility first and how we think about price. We -- in 2021 and 22, we were able to influence pricing in the residential market. We came into the pre-season, I would say April, May period, kind of pushing price, taking price, and had the market follow us. When we went in this year, our pricing coming into the quarter and into the year was our Q4 pricing. So our intent was to hold that pricing for the balance of this year. We knew prior to Memorial Day that our pricing was a little buff. specialty, we thought specialty might come up and meet us. They did not. And it was after that on 6-1 that we took our price actions. And we have good visibility into pricing. I mean, we understood what that dynamic was. We thought we’d be able to move price up, and we weren’t able to. We use a combination of web scraping, and with over a thousand stores, and store managers, and DMs out there, we have a fairly fulsome ability to track our mom-and-pop competitors as well. And then I think on the last question about the pounds analysis, we are looking at that. I think the surveys we did were not specific to Leslie’s. We think that’s an important component of how we think about the headwind we created for this year, because our growth, as you know, is a combination of crop growth and a typical year, but also market share gains, and both become more difficult when there is excess inventory in the channel.

I’ll go ahead and pass it on since I asked to. Thanks.

Our next question comes from Peter Benedict with Robert W. Baird. Please go ahead.

Yes, good afternoon, guys. It’s Justin Kleber on for Pete. Mike, I just wanted to ask, I imagine you’re having discussions today with your vendors regarding the 2024 policies. I’m just curious, what does the costing backdrop look like sitting here today, particularly on these non-discretionary products? Do you think product costs are still going to move higher next year? Just trying to understand, this product margin pressure, could it linger if you in the industry just can’t pass through any more price that’s my first question?

Yes, I appreciate the question. It’s too early for us to talk about that we have not really started price discussions with our vendors yet. Typically that takes place 30 to 60 days from now. I think it’s important for both sides to understand kind of how the season wraps up a little further through our Q4 and their Q3 and then we will sit down and talk about the dynamics that we see. There’s certainly some cost pressure, but I think there’s also after three years of consumers absorbing a lot of inflation, there’s definitely some more price sensitivity from customers. I mean, we have 85,000 consumers a day coming through our doors and our stores. We are ears to the ground, I would say, the first line on hearing from consumers. And I think the message has been pretty clear that, their appetite for continuous price increases is a little more nuanced than it has been in the past.

Got it. Okay. Now that makes sense. And then an unrelated follow-up on leverage, Steve mentioned the three times target. Just in terms of the path to get there, is that more about natural deleverage as EBITDA recovers and starts to grow again, or are you foregoing some store growth and M&A opportunities in the near term and deploying capital into debt pay down?

Yes, thanks for the question, Justin. I think there’s a couple different ways to think about it. We would expect to reduce leverage by a combination of growth in the business, so just naturally, and potentially allocate some cash towards debt pay down. If you think about cash flow for this year, it’s been impacted by working capital primarily. If you look at our CapEx, it’s kind of in line with how we talked about it. We talked about kind of a 3% of total sales. I might come in a little shy of that this year. From an M&A perspective, certainly slower pace this year from a dollar’s perspective, but continue to do attractive deals and acquire businesses at great multiples. Expect that to continue through Q4 as well at a modest clip. And so when it comes down to 2023, think about the cadence for working capital last year. We were buying a lot of inventory late in the season, led to accounts payable and other accrued expenses that ended up getting paid off in the first quarter of 2023. At this point, we’ve talked about bringing inventory down pretty aggressively into year-end, but as a result, we’ll have lower accounts payable and certainly some accrueds from performance incentives. So, don’t expect a big cash flow year in 2023, but do see opportunity for improvement in 2024, which could lead us to continue to deploy capital towards debt pay down, as well as invest in stores and M&A. Last comment I’d make on that, as you think about new store growth, fairly modest capital requirements for a new store location or a conversion, as we convert stores to pros. And if you look at the M&A that we’re executing in the current environment, it’s a lot of specialty retailers in the Sunbelt, smaller locations, not a big cash drain from an M&A perspective. But a clear opportunity to continue to deploy capital towards growth, but it will probably look a little different than it has the last couple of years.

All right. Thanks for that, Steve. And best of luck, guys.

There are no further questions at this time. I would like to turn the floor back over to the management for closing comments. Please go ahead.

Yes, I’d like to thank everybody for joining us today and your continued interest in Leslie’s. And we look forward to sharing our Q4 near-end results. Thanks.

This concludes today’s conference call. You may disconnect your lines at this time. Thank you for your participation, and have a good day.