Leslie’s, Inc. (NASDAQ:LESL) Q4 2023 Earnings Call Transcript

Leslie’s, Inc. (NASDAQ:LESL) Q4 2023 Earnings Call Transcript November 28, 2023

Leslie’s, Inc. misses on earnings expectations. Reported EPS is $0.14 EPS, expectations were $0.16.

Operator: Good afternoon and welcome to the Fourth 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 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.

Caitlin Churchill: 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 will 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 Scott Bowman, Chief Financial Officer. With that, I will turn the call over to Mike.

Michael Egeck: Thanks, Caitlin, and thank you all for joining us this afternoon. I hope that everyone had a good Thanksgiving holiday. To start, I’d like to express my sincere appreciation to all of the Leslie’s associates whose contributions allowed us to serve our residential pool, PRO pool and residential hot tub customers at a consistently high-level throughout fiscal 2023. Because of their efforts, the foundation of Leslie’s business remains solid. For the year, our brand awareness in-stock service levels and corresponding NPS scores were at all-time highs. Our loyalty program grew for the year, and our customer lifetime value also increased. We remain the largest specialty retailer in our industry, with unmatched capabilities and clear long-term growth opportunities.

And the industry credit card data indicate that we gained market share again in fiscal 2023. While our financial results for fiscal 2023 were not what we expected heading into the year, we are well-positioned for future success as the pool industry continues to normalize from the temporary challenges of this year’s pool season. We entered the fiscal fourth quarter facing three headwinds, which are the same ones that broadly impacted our full fiscal 2023 results. First, unfavorable weather. Second, a macroeconomic environment that resulted in decreased retail chemical pricing and discretionary spend, especially on high-ticket items and finally, customer stockpiling of core sanitizers resulting from three years of supply uncertainty and price inflation.

While the latter two factors were largely in-line with our expectations for the quarter, weather was better than we originally anticipated and helped us to deliver sales at the high-end of our implied fourth quarter revenue guidance. Profitability in the quarter fell short of our expectations, driven entirely by gross margin. Gross margin performance was impacted by larger-than-expected inventory adjustments made after the completion of our annual physical inventory count. Scott will discuss the inventory adjustments in more detail when he goes over our financial results, but they explain the entire delta between our implied fourth quarter guide and our actual gross margin, and are the reason that EPS came in at the low-end of our guidance range.

As we navigated these dynamics, we remain disciplined on costs and reduced fourth quarter SG&A expenses year-over-year as planned. Drilling down into our Q4 sales performance. Total sales were down 9% in the quarter, with residential pool down 9%, PRO pool down 5% and residential hot tub down 17%. We were up against some tough comparisons from the prior year’s quarter when total sales were up 16%, with residential pool up 10%, PRO pool up 18% and residential hot tub up 80%. As weather normalized, traffic improved to down high-single-digits in the quarter. Total transactions were down 5%, which was also an improvement from down 12% in the third quarter. Average order value was down 4% versus plus 3% in Q3. Equipment sales were down 17%. We saw a continued weakness in high-ticket discretionary categories.

And we had a full quarter’s impact of the chemical retail price decreases we implemented in June of this year. Total chemical sales were down 4%. Discretionary product sales were down 23% and contributed roughly half of the quarter’s total sales decline. Non-discretionary product sales were down 6%. Across our geographies, sales remain challenged with the exception of Florida. We saw a 3% increase in sales in the quarter and was up 11% for the year. Our analysis of credit card data shows that our sales underperformed the industry by 250 basis points in the quarter, but outperformed the industry by a total of 130 basis points for the year. Turning to our results for the full year. Sales of $1.45 billion were down 7%, with comp sales down 11%.

Non-comp sales added 4%. Residential pool sales were down 9%, PRO pool sales were flat and residential hot tub sales were down 6%. Gross margin decreased 530 basis points, driven by the June chemical retail price actions, year-end inventory adjustments, DC costs associated with higher inventory levels, lower rebates based on decreased equipment purchases and occupancy deleverage. We believe the majority of these headwinds are specific to this fiscal year, and Scott will discuss how we expect these to significantly abate in fiscal 2024. Adjusted EBITDA for the year was up $168.1 million and adjusted diluted earnings per share was $0.28. In the face of the transitory headwinds this year, the fundamentals of the industry have not changed. New pools continued to be built and the growing installed base of pools need to be maintained.

In addition, we believe the secular tailwinds that drive industry demand remain intact, including ongoing investment in homes and backyards, migration to the sunbelt and excerpts, pursuit of outdoor lifestyles, increasing attention to safety and sanitization and the adoption of new technologies. The pool industry has a long track-record of consistent growth, and Leslie’s has consistently grown faster than the industry. We remain the leading direct-to-consumer pool and spa retailer with scale, capabilities and brand awareness that our competitors do not have. While our team navigates the current headwinds, we remain focused on executing the strategic initiatives that underpin our competitive advantages, and then, we expect to continue to drive our success as industry conditions normalize.

Turning to our strategic growth initiatives. First, our customer file was down 6% in the quarter and for the full year due to the weather and traffic trends we experienced. Second, average revenue per customer was down 3% in the quarter and 1% for the year, driven primarily by decreases in big ticket items, specifically, hot tubs, heaters and above ground pools. With regard to our PRO initiatives, we ended the year with more than 3,900 PRO contracts in-place and completed the conversion of 15 residential stores to our PRO format. We currently operate 98 PRO locations. PRO sales were flat for the year, which we consider a solid outcome given the overall environment. Trichlor pricing was a more pronounced headwind to our PRO sales and to overall Company gross margin performance as competition in the distributor channel drove prices down.

Trichlor pricing now appears to have stabilized. M&A and new store growth remain important initiatives for Leslie’s. For fiscal 2023, M&A and new stores drove $60 million in non-comp sales. During the year, we opened 12 new stores and acquired 12 stores, and now operate 1,008 total locations. We remain confident in the long-term store expansion opportunity and have identified over 800 opportunities for store densification. We will continue to address each of these opportunities with a buy or build analysis. Though we will be prudent with the pace of expansion, as we balance store growth with our other capital allocation priorities. For AccuBlue Home, we were excited to launch the program in May and I’ve been very pleased with the consumer response and demand we have seen to date, even with limited marketing.

AccuBlue Home member spend is averaging $1,000 per year. And we believe members see value in experience as evidenced by an average review rating of 4.8 out of 5 stars. They comment that the program pays for itself and site convenience, greater confidence in our water treatment routine and overall water quality as core benefits of the program. While demand during the pool season was strong, manufacturing capacity at our third-party vendor limited sales and we deferred launching our consumer marketing campaign due to insufficient supply. We have worked with our vendor to ramp-up production during the off-season to meet our expected 2024 pool season consumer demand. We continue to have confidence in the long-term industry outlook and remain focused on prudently executing our strategic initiatives to capture the opportunities in front of us and extend our industry leadership.

At the same time, we are taking actions to improve our near-term performance. Number one, we are pricing based on current market conditions. And after our June price actions, we are at our relative historical price position, up slightly above mass and at or slightly below specialty. We expect this positioning to hold for 2024. Number two, we are aggressively managing inventory and expect to reduce our 2024 peak and year-end inventory by approximately $100 million and $50 million respectively. Number three, we are managing costs throughout the P&L, including utilizing strict ROI criteria on our marketing investments. Number four, we continue to evaluate, develop and elevate our processes and people to help improve our efficiency. And number five, we are utilizing consumer insight surveys to further improve our understanding of evolving consumer behaviour.

I will now hand it over to Scott to discuss our results and outlook in more detail. Scott?

Scott Bowman: Good afternoon, everyone, and thank you, Mike. I’ll review our fourth quarter and fiscal 2023 performance, and then, provide details about our outlook and assumptions for fiscal 2024. Turning to fourth quarter results. We reported sales of $432 million, a decrease of 9% compared to the fourth quarter of fiscal 2022. Comparable sales decreased 11%. Comparable sales decreased 1% on a two-year stack basis, increased 15% on a three-year stack basis and increased 38% on a four-year stack basis. Non-comparable sales totaled $9 million in the quarter, which was driven by a total of 18 net new stores, including 12 through acquisitions and six net new store openings during fiscal 2023. With respect to trends by consumer group.

Comparable sales for residential pool declined 9%, PRO pool declined 13% and residential hot tub declined 23% compared to the prior year period. On a two-year stack basis, comparable sales were flat for residential pool, increased 4% for PRO pool and declined 10% for residential hot tub. These declines were in-line with our expectations and continuation of recent trends in the business. Gross profit was $160 million compared to $217 million in the fourth quarter of fiscal 2022 and gross margin rate declined approximately 860 basis points to 37%. Page 11 of our supplemental deck illustrates our Q4 gross margin rate bridge in more detail. During the quarter, gross margin was impacted by the following factors. First, product gross margin declined 385 basis points in the quarter.

This was primarily driven by our June 2023 chemical pricing actions and the negative impact of 70 basis points due to lower rebates. Second, we incurred unexpected incremental inventory adjustment cost that resulted in a 260 basis point headwind in the quarter. This increase was mainly due to excess shrink and scrap due to higher levels of inventory and third-party storage locations, higher movement of goods between facilities and higher levels of unsellable returns. Additionally, gross margin rate was negatively impacted by 120 basis points due to the expensing of capitalized DC cost associated with the drawdown of inventory. And finally, occupancy costs deleveraged by approximately 95 basis points, mainly due to the decline in comparable sales.

SG&A was $122 million, down 9% or $12.5 million compared to the fourth quarter of fiscal 2022. Excluding non-recurring items, including costs incurred from the discontinued use of certain software subscriptions and executive transition costs associated with restructuring, SG&A decreased $18 million, driven by lower sales, lower incentive compensation and expense management actions. Adjusted EBITDA was $60 million compared to $100 million in the fourth quarter of fiscal 2022. Interest expense increased to $17 million from $10 million in the fourth quarter of fiscal 2022, due primarily to higher interest rates, and our effective tax rate increased to 22.9% compared to 21.2% in the fourth quarter of fiscal 2022. Adjusted net income was $26 million compared to $64 million in the fourth quarter of fiscal 2022.

And adjusted diluted earnings per share was $0.14 compared to $0.35 in the fourth quarter of fiscal 2022. Diluted weighted average shares outstanding were 185 million in both the fourth quarters of fiscal 2023 and fiscal 2022. Moving to our full-year results. Total sales for fiscal 2023 were $1.45 billion, a decrease of 7% compared to the prior year, with comparable sales down 11%. Comparable sales were flat on a two-year stack basis, increased 21% on a three-year stack basis and increased 39% on a four-year stack basis. Non-comparable sales totaled $60 million in fiscal 2023. Gross profit was $548 million for fiscal 2023 compared to $674 million in the prior year and gross margin rate was 37.8%, a decrease of 530 basis points compared to the prior year.

As shown on page 11 of the supplemental deck, 205 basis points of the rate decline was due to chemical pricing actions and lower rebates, 215 basis points was due to DC costs and inventory adjustments and 110 basis points was due to occupancy deleverage. SG&A was $446 million for fiscal 2023 compared to $435 million in the prior year. Excluding non-recurring items and non-comp expense from acquisitions and new stores, SG&A decreased $15 million compared to the prior year. Adjusted EBITDA was $168 million for fiscal 2023 compared to $292 million in the prior year. Interest expense was $65 million for 2023 compared to $30 million in the prior year. Adjusted net income was $51 million for fiscal 2023 compared to $176 million in the prior year and adjusted diluted earnings per share was $0.28 for fiscal 2023 compared to $0.95 in the prior year.

Moving to the balance sheet. We ended fiscal 2023 with cash and cash equivalents of $55 million compared to $112 million in fiscal 2022. The reduction was primarily due to the decline in net income. At the end of fiscal 2023, we have no balances outstanding on our revolver and availability of $239 million. Year-end inventory was $312 million, a decrease of $50 million or 14% compared to fiscal 2022 and a sequential decrease of $125 million or 29% compared to the third quarter of fiscal 2023. This reduction was possible due to fewer supply chain disruptions, implementation of our new inventory management system and strong execution out of DC locations. Importantly, we are maintaining strong in-stock positions at the store-level to support a high-level of customer service, which is reflecting in our higher NPS scores.

At the end of fiscal 2023, we have $790 million outstanding on our secured term loan facility compared to $798 million of fiscal 2022, which translated into a leverage ratio of 4.4 times. The applicable rate on our term loan was SOFR plus 275 basis points in the fourth quarter and our effective interest rate was 8.1% compared to 4.3% in the prior year quarter. Now, for our fiscal 2024 outlook. In fiscal 2024, we expect an uncertain macro-environment and a more cost-conscious consumer especially in discretionary categories to continue affecting sales. We anticipate this to be more acute in the first-half of the year, though we expect positive comps in the back-half of the year due to the lapping of the June 2023 chemical pricing actions and easier compares.

With fiscal 2023 being an anomaly from a seasonality standpoint, we are planning for seasonality be more comparable to fiscal 2022 and expect to deliver more than all of our profitability in the second half of the year during our peak pool season. We expect sales of $1.41 billion to $1.47 billion, which assumes normal weather over the course of the year and non-comp sales contribution of approximately [$7 million] (ph). The low-end of our outlook assumes comparable sales growth of approximately negative 3%, while the high-end of our outlook assumes comparable sales growth of approximately 1%. For the full year, we expect to see gross margin rate improvement of approximately 100 basis points compared to the prior year, driven by lower DC costs and fewer inventory adjustments due to reduced inventory levels and improved supply chain efficiencies.

That said, we don’t expect to see the majority of these benefits until Q4, and we start to lap the unusual items that impacted Q4 fiscal 2023. Additionally, we expect higher impact of deleverage in the first half of the year due to lower sales compared to the prior year. We expect adjusted EBITDA of $170 million to $190 million and expect a slight decline in SG&A expense as we drive efficiency in our cost structure, while making prudent investments in the business. We expect net income of $32 million to $46 million, adjusted net income of $46 million to $60 million and diluted adjusted earnings per share of $0.25 to $0.33. Our outlook assumes an average interest-rate on a floating rate debt of 8.2% and assumes interest expense will be approximately $7 million higher than fiscal 2023.

Our outlook also includes an effective tax rate of 26%. We estimate the diluted share count of approximately 185 million shares, which assumes no share repurchases during fiscal 2024. Now, as you’ll see on page 14 on our supplemental deck, along with the full-year guidance, we have provided an outlook for Q1. While it has not been our historical practice to provide quarterly guidance, nor do we intend it to be our practice going forward, given the unique dynamics related to Q1 in the comparison to the same period in fiscal 2023, we believe it is appropriate to provide a view of Q1. For the first quarter, we expect total sales of $166 million to $172 million, adjusted EBITDA of negative $27 million to negative $24 million, net income of negative $43 million to negative $41 million, adjusted net income of negative $39 million to negative $37 million and adjusted EPS of negative $0.21 to negative $0.20.

Underlying this outlook is our expectation of comp trends will be similar to Q4 of fiscal 2023 and non-comp sales will contribute approximately $3 million. In addition, we expect a significant gross margin decline compared to the prior year quarter, driven by the expansion of capitalized DC costs and occupancy deleverage. Turning to CapEx. We expect to invest $50 million to $55 million in fiscal 2024, of which approximately $20 million is expected to be invested in our existing assets and the remainder is expected to be invested in growth. These investments include new store openings, improving the capacity of our distribution and manufacturing facilities and investing in IT and other projects to improve the business. We also expect a meaningful improvement in working capital and plan to reduce inventories by approximately $50 million.

Regarding capital allocation, we expect significant improvement in free cash flow due to higher net income and lower inventory. And our first priority will be to pay-down debt, with the goal of achieving the leverage ratio of 3.5 times to 3.7 times in fiscal 2024. Longer term, our goal is to achieve the leverage ratio of 3.0 times. Our second priority is to invest in growth. This will include organic growth through the opening of 15 new stores and the conversion of six residential stores to the PRO format. We have not included any M&A activity in our fiscal year guidance at this time. The final priority is to return excess cash to shareholders. While we do not expect to repurchase shares in the near term, we will continue to evaluate this based on our financial position and market conditions.

Before I turn it back to Mike, I want to address two items that will be covered in greater detail in our Form 10-K. In short, we have identified two material weaknesses in internal controls over financial report. One weakness relates to insufficient controls over an internal database that is used to calculate vendor rebates. And the other weakness related to controls over the performance of fiscal inventories. As a result, we are designing and implementing new processing and enhanced control to address the underlying causes of the material weaknesses and expect remediation to be completed during fiscal 2024. And with that, I will hand it back over to Mike. Thank you.

Michael Egeck: Thank you, Scott. After three years of unprecedented growth, the pool industry and Leslie’s faced multiple transitory headwinds in fiscal 2023. Despite these headwinds and their impact on our results, we continued to deliver exceptional service to our customers as evidenced by brand awareness, in-stock levels and corresponding NPS scores that are all at all-time highs. Taken together, these serve as a testament to the focus and execution of our team members. As the industry continues to normalize, we remain focused on leveraging the competitive advantages from our scale and capabilities and executing our strategic initiatives to continue to drive growth and market share gains. With that, I’ll hand it back to the operator for Q&A.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Ryan Merkel with William Blair. Please proceed with your question.

Ryan Merkel: Hey, everyone. Thanks for taking the questions today. First off, I just wanted to ask about sales guidance for ’24. I’m a little surprised with the guidance of flat to down. Mike, can you just walk through some of the pieces there, because it was a pretty rough year in ’23, we had horrible weather and your business is largely to non-discretionary aftermarket. So, kind of, explain why we’re not seeing a bit more growth in ’24?

Michael Egeck: Yeah. Thanks for the question, Ryan. The first assumption is, we don’t see any recovery in discretionary sales, and at the midpoint of our guidance, we have discretionary sales, which, as you know, is about 20% of our business, planned down an additional 10%. Non-discretionary sales, we do have growing plus 1.5%. But we also have the headwind of the chemical price actions we took in June, which through the first seven periods of the year are definitive headwind. So, with the discretionary sales being down, which are predominantly high ticket items and with the headwind from the chemical, we have — there is about 400 basis points of headwind in those two items prior to any growth. So, that’s why we’re — that’s why we’ve got the midpoint and the guidance basically flat for the year.

Ryan Merkel: Okay. That’s helpful. And then just a question on trends. It looks like 1Q sales are also coming in a little bit below where the Street was modeling. What do you sort of seeing out there? You’ve seen consumer slowdown, what’s happened with traffic in the last couple of months?

Michael Egeck: Yeah. The way the quarter played out, September, first of all, let me back up, in Q4, July was the best month, August was a little weaker, and September was tough. October, we saw a continuation of that trend. In November, we are seeing some turnaround on some of the categories and some increases in traffic. So, it’s a slow turn, and it’s not definitive yet. But the real change in the business has been as traffic has normalized or excuse me, as traffic has improved with improved weather, we are seeing transactions start to recover. But at the same time, we’re seeing the average order value down and that’s really being driven by the equipment business and the discretionary business, the high ticket items. And equipment is — it’s been a tough trend for equipment, it was down 17% in the quarter, 12% for the year, starting to see it turn now, but the more discretionary parts of the equipment business, particularly our heaters and robotic APCs, has been a little challenging.

Ryan Merkel: Got it. Very helpful. I’ll pass it on. Thanks.

Operator: Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

Simeon Gutman: Hey, good evening, everyone. Hey, the first question, I guess, it could go to either way. I think, Mike, you said that the biggest gap in the guidance you gave was the inventory adjustments. Can you talk about why those were not observable in July?

Scott Bowman: Yeah. I can start with that, Simeon, and Mike can tag on if needed. The main reason is, as we kind of step back and look at the issue on inventory adjustments, the main issue, we’re just having too much inventory. We peaked close to $500 million, then it started to come down, but it’s more inventory than we’ve had in the past, and that required us to use several third-party off-site storage facilities with a lot of movement of product between those facilities. We had some higher and sellable returns. And so, it just created a lot of movement of goods, and goods not in our — inside of our four walls. And so, that is the root of the problem. And so, as we’ve kind of thought about it and talked about it, the problems that we had with inventory adjustments are really not systemic.

They’re fixable and we’re kind of on that path to improvement. And the first step in that direction was just to get out of all those off-site warehouses, and kind of get it inside our four walls. And so, we’ve worked really hard over the last several weeks to do that, and as we stand here today, we’re out of those additional off-site storage facilities. And so, that’s a great first step for us. So, we can put eyes on the inventory. It’s inside of our four walls. We don’t have the movement of goods that we had before. And so just the extra visibility and having that there is the first step for us to improve that whole process. Along with that, we — there’s some improvement we can do just to improve controls on our scrap, just outsized, but just the sheer volume of inventory.

We had to add to our excess and obsolete reserves on inventory, because we had so much. As we have now brought that inventory down, we should be able to release some of that. And we also just put more focus on kind of monthly processes, just identify any major variances that come along in early warning signs, but before we built up that inventory, we actually controlled it pretty well. And so, now that we’re backed down, we have a really good DC team, some new talent, we feel like we’re in a much better position to manage it going forward.

Simeon Gutman: Okay. A follow-up, it’s maybe a bit broader, it’s your approach to your guidance. And I heard some of the components, and then, the answer to the last question. And thinking about the industry, your assumption to the grower contract, the units get better. I heard what Mike said around discretionary stays weak, are you doing that assumption at a prudent or it could happen that way. And then, even in your gross margin, you’re not even recouping what you gave back this year on inventory adjustment, right? It’s a very mild level of gains. So, your approach seems conservative, but, I mean, it’s a tough argument to make given this miss, but curious how you thought about it?