Leslie's Inc (LESL) 2023 Q3 法說會逐字稿

Good afternoon, and welcome to the Third Quarter of Fiscal 2023 Conference Call for Leslie's, Inc. (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; 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 prerelease 3 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 3 primary drivers of our Q3 traffic and sales results.

The first is weather. Our weather reporting service Planalytics calculated that weather was a 5% year-over-year headwind to sales in the quarter. Weather headwinds were felt 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 significantly outperformed in the quarter and 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 3 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 1 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 the third quarter, which we addressed with our June 1 price actions. Those actions resulted in essentially flat year-over-year chemical pricing despite higher costs.

And the third driver was that a portion of our customers had a greater-than-normal amount of chemicals left over from last year. This driver was validated by 2 separate consumer surveys, one conducted on our behalf and another that was conducted on behalf of one of our chemical partners. This consumer behavior is not something we have seen before, and was surprising given the hazardous nature and useful life of these chemicals.

Transactions were down 12% in the quarter, reflecting double-digit traffic declines that offset solid conversion rates. Average order value increased 3%. The traffic decline was broad-based and impacted both nondiscretionary and discretionary product sales. For the quarter, nondiscretionary sales were down 6% and discretionary sales were down 24%.

Total chemical sales for the quarter were down 6% as increases in cal hypo and select specialty chemicals, partially offset a 16% decrease in Trichlor sales. Equipment sales were down 8% in the quarter, driven primarily by volume. The decrease in discretionary product sales was driven by hot tubs and above-ground pools as macro factors continue to impact demand for these highly discretionary, high-ticket items. Non-comp sales contributed plus 3% to the quarter, driven by acquisitions and new store builds.

The data we analyze suggests that the top line trends we are seeing are an industry-wide issue. Aggregated credit card data for the pool supplies retail category on Slide 7 indicates that the industry sales ex Leslie's were down 7.1% for the quarter. Based on total company sales, our declines were 220 basis points more than the category for Q3. That said, aggregated credit card data for the pool supplies retail category does not include hot tubs or marketplaces. And when we adjust out those 2 categories from our sales for a more comparable review, Leslie's performed slightly better than the industry.

We are clearly experiencing a highly unusual pool season following 3 years of strong growth. However, the long-term fundamental advantages of the pool industry remain the same. New pools continue to be built and the growing installed base of pools need to be maintained. As you can see on Slide 8, the 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. So while our team navigates the current industry headwinds, we also remain focused on executing the key strategic initiatives that underpin our competitive advantages and that will continue to drive our long-term success as industry conditions normalize.

Turning to our strategic growth initiatives. First, given the traffic challenges in the quarter, our customer file was down 8% versus the prior year's quarter. Second, average revenue per customer was down 1% in the quarter, driven primarily by decreases in big ticket items, specifically hot tubs and above-ground pools. Our Pool Perks loyalty members continue to outperform. Loyalty member sales were down 3% in the quarter.

With regard to our Pro initiative, we ended the quarter with more than 3,700 Pro contracts in place and completed the conversion of 15 residential stores to our Pro format prior to the start of the season. We currently operate 98 Pro locations. Pro Consumer Group sales declined 3% in the quarter, with comp sales down 13% as our PRO comps were impacted by the same factors as our overall business. In addition, Trichlor pricing has been more pressured on the PRO side as compared to the residential channel and contributed an outsized headwind to our overall gross margin performance. Our guidance for the remainder of the year assumes no change from current pricing levels.

M&A and new store growth remain an important initiative for Leslie's, though we will be prudent with the pace of this initiative in the near term as we balance it against our other capital allocation priorities. M&A in new stores drew up $16 million in non-comp sales in the quarter. We also completed 2 acquisitions in the quarter that added 5 locations in the Sun Belt. Year-to-date, we have closed on 5 acquisitions that added 12 locations, and we have another acquisition under LOI. In the quarter, we opened 7 new stores, bringing the year-to-date total to 12. We remain confident in the total store expansion opportunity available to Leslie's over the long term and have identified over 800 opportunities for store densification. We will continue to address each of these opportunities with a buy or build analysis.

For AccuBlue Home, we were pleased to launch the program in May and have been very pleased with the consumer response and demand we have seen to date, all despite nominal marketing. While demand has been strong, we are facing supply chain constraints as we ramp up, and we're working with our vendor to increase production in order to meet consumer demand.

With regards to our outlook, our guidance for Q4 assumes no improvement to the top line trends we experienced in Q3. For gross margin, we expect Q4 to have a full quarter impact from the chemical price actions we took on June 1, which will be partially offset by the wind down of distribution costs associated with our peak inventory levels. We have also aggressively initiated cost management actions that, coupled with some unique SG&A comparisons should result in Q4 SG&A being approximately $15 million to $20 million lower versus the prior year quarter.

In summary, we continue to have confidence in the long-term outlook for the industry, and we remain focused on prudently executing our strategic initiatives to capture the opportunities in front of us and further our industry leadership. At the same time, we are focused on taking immediate actions to improve our performance.

Let me reiterate the actions we are taking. Number one, we have adjusted pricing to reflect current market conditions and are now at a relative historical price position, which is slightly above mass and home improvement and at or slightly below specialty retailers. Number two, we are aggressively managing inventory through receipt reductions. Number three, we are focused on cost management throughout the P&L, including being disciplined on our marketing investments, utilizing strict ROI criteria. Number four, we continue to evaluate, develop and elevate our processes and people. And number five, we are enhancing our consumer insight efforts to further improve our understanding of evolving consumer behavior.

Before Steve discusses our results and outlook, I want to acknowledge our CFO transition. I'm very pleased to welcome Scott Bowman as our new CFO effective August 7th. Scott's depth and breadth of public company experience spans both financial and operational areas and will be a huge asset as we return the business to growth. I would also like to thank Steve for his leadership and partnership as well as his commitment to ensuring a smooth transition.

I'll turn it over to Scott to say a few words.

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 and 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 2-year stack basis decreased 4%, and on a 3-year stack basis grew 15%. Our noncomparable sales totaled $16 million in the third quarter of fiscal 2023, which was driven by 9 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 2-year stack basis, comparable sales declined 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, gross margins were impacted by 4 primary factors. First, incremental distribution expenses, including those related to capitalized distribution costs and investments in labor, offsite storage and transportation costs, lowered gross margin by 150 basis points. Approximately 50 basis points of this rate decline was due to deleverage of fixed distribution costs from lower comparable sales.

Regarding higher capitalized costs, as we built up inventory in prior periods, we capitalized more distribution costs. And during this quarter, we recognized some of those costs as we sold through the inventory. We have also continued to invest in our distribution network to ensure it operated smoothly at significantly higher capacities, with improved service levels to support better in-stock positions across our businesses. We expect the gross margin headwind from distribution expenses to be smaller in the fourth quarter.

Second, higher product costs had a 140 basis point impact on gross margins in the quarter. While we experienced higher product costs across categories, the largest impact was in our chemicals categories. We initially increased our selling prices for chemicals at the start of the season, but we were unable to successfully maintain those higher pricing levels. And as Mike discussed, we reduced prices on June 1. We expect greater product margin rate pressure in the fourth quarter as we experienced a full quarter impact of those price changes.

Third, occupancy and other costs deleveraged by 70 basis points, predominantly due to the decline in comparable sales. We expect continued rate pressure in the fourth quarter related to occupancy and other costs deleverage given our comparable sales expectations.

And finally, business mix impacted gross margins by 30 basis points, primarily due to M&A completed during the last 12 months. We expect a smaller impact on rate from business mix in the fourth quarter. Looking at the numbers in a different way, deleverage of fixed costs impacted gross margin rate by 115 basis points in the quarter, with the remaining 275 basis points of margin compression due to lower product margin, higher distribution costs, and business mix.

Now I'll turn to SG&A. SG&A increased 3% or $4 million compared to the third quarter of fiscal 2022. We continue to focus on managing costs in the business, generating cost savings and driving ongoing organizational optimization. During the quarter, we were able to partially offset higher SG&A from acquired businesses and new stores, investments in our associates and nonrecurring costs with $6 million of like-for-like expense reductions compared to last year. We have taken additional actions to reduce our SG&A in the fourth quarter and into fiscal 2024.

Adjusted EBITDA was $129 million compared to $183 million in the prior year. Interest expense increased to $18 million during the quarter from $7 million in the prior year, and our effective tax rate increased to 26.1% compared to 25.7% in the prior year. Adjusted net income was $76 million in the third quarter of fiscal 2023 compared to adjusted net income of $126 million in the prior year. And adjusted diluted earnings per share was $0.41 in the third quarter of fiscal 2023 compared to $0.68 in the prior year. Diluted weighted average shares outstanding were 185 million in both the third quarter of fiscal 2023 and fiscal 2022.

Now I'll turn to year-to-date results. Total sales for the first 9 months of fiscal 2023 decreased $68 million or 6% to $1.019 billion from $1.087 billion in the prior year. Our comparable sales decreased 11% or $118 million. On a 2- and 3-year stack basis, our comparable sales were flat and up 23%, respectively.

Gross profit for the first 9 months of fiscal 2023 decreased 15% or $69 million to $388 million from $457 million in the prior year. Gross margin rate decreased by 390 basis points to 38.1% from 42.0% in the prior year, of which 140 basis points was due to negative comparable sales growth in the first 9 months of fiscal 2023.

Adjusted EBITDA was $109 million in the first 9 months of fiscal 2023 compared to $193 million in the prior year. Interest expense increased to $48 million during the first 9 months of fiscal 2023 from $21 million in the prior year. Adjusted net income was $25 million in the first 9 months of fiscal 2023 compared to $112 million in the prior year. And adjusted diluted earnings per share was $0.14 in the first 9 months of fiscal 2023 compared to $0.60 in the prior year.

Moving to the balance sheet. We finished the third quarter of fiscal 2023 with cash of $19 million, and we had $31 million outstanding on our ABL. This compares to cash of $193 million and no amounts outstanding on our ABL at the end of the third quarter of fiscal 2022. The reduction in net cash was primarily due to investments in inventory and higher M&A activity during the past 12 months. Currently, we do not have any amount outstanding on our ABL, and we have availability of approximately $240 million.

We ended the third quarter of fiscal 2023 with $437 million of inventory, an increase of $75 million compared to the third quarter of fiscal 2022, and a sequential decrease of $56 million compared to the second quarter of fiscal 2023. The increase in inventory compared to the prior year period was primarily related to core sanitizers. Consistent with our commentary last quarter, inventory levels have peaked, and we continue to look for opportunities to further reduce our inventory.

During the third quarter and so far in the fourth quarter, we have and we will continue to aggressively manage purchase orders and receipts. We expect to end fiscal 2023 with less inventory than we had at the end of fiscal 2022.

At the end of the third quarter of fiscal 2023, we had $792 million outstanding on our secured term loan facility compared to $800 million at the end of the prior year period. The applicable rate on our term loan increased to LIBOR plus 275 basis points in the third quarter, and our effective interest rate was 7.6% compared to an effective interest rate of 3.0% in the prior year.

In June 2023, we amended our term loan credit agreement to replace the existing LIBOR-based rate with a term SOFR-based rate as an interest rate benchmark. Other material terms of the facility remain substantially unchanged, including the maturity date of March 2028. Our ABL and term loan agreements do not have quarterly financial maintenance covenants.

Our outlook remains unchanged from the revised outlook we shared on July 13, the details of which are in today's earnings press release. As we only have one more quarter left in the fiscal year, I will be discussing each metric in the context of our implied fourth quarter outlook. Our fourth quarter outlook assumes a sales decline in the range of 9% to 14%, with comparable sales declines of 12% to 16%. Our outlook also assumes a gross margin range of 39.1% to 39.7% compared to 45.7% in the prior year period.

In the fourth quarter, we expect additional rate pressure from product costs, continued impact from occupancy cost deleverage, but a lower impact from distribution costs and business mix compared to what we experienced in the third quarter. We expect fourth quarter adjusted EBITDA to be in the $61 million to $71 million range and adjusted diluted earnings per share to be in the $0.14 to $0.18 range. Our outlook for the fourth quarter includes interest expense of $17 million, and our diluted weighted average shares outstanding does not assume any incremental share repurchases.

On capital allocation, our prioritization has not changed. Our first priority is and has been our capital structure, and we are targeting a leverage ratio of approximately 3 turns. Our second priority is to invest in growth, both organically and through M&A. In the first 9 months of fiscal 2023, we invested $27 million in capital expenditures, and we deployed $16 million towards acquisitions.

Mike noted we will continue to be prudent in our pursuit of M&A opportunities. Our focus remains on acquiring pool supply retailers in the Sun Belt, and we will be disciplined around acquiring high-quality businesses at attractive purchase multiples.

Our final priority is to return excess cash to shareholders. While we do not expect to repurchase shares in the near term under our existing authorization as we focus on our other priorities, we will continue to evaluate opportunities to repurchase shares based on available investment opportunities, our financial position, and market conditions.

And with that, I will hand it over to Mike. Thank you.

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.

(Operator Instructions) And our first question comes from Simeon Gutman with Morgan Stanley.

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 1. 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 '21 and '22 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 8 quarters, so we're not pleased with that. But that's the situation we are in with the fourth 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 it's 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 '24. But in terms of where we were prepandemic 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.

Our next question comes from Steven Forbes with Guggenheim Securities.

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, right? Is it -- 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 2 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 to 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 prereleased, 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 a 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 2 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 feedback from our stores. They were hearing that from customers as they were coming in, particularly with regards to our water tests. Even in a down quarter, we ran more water tests than the prior year's period, but the conversion of those tests was lower. And what we were hearing from the stores when we questioned it was that they were hearing that people had -- already had those chemicals.

So it's a highly unusual situation when we think of what the duration might be. I will say that both of those surveys, there was no mention from consumers in their self-reporting that they had supplies that would last past the season. So we believe this is a one-season occurrence based on 3 years of highly unstable supply and price inflation, leading people to stockpile.

Now the truth is we won't be able to know that for sure. Our way to size that will be with additional consumer surveys. We'll do them at the end of this season, and we'll do them before the start of next season. And that will be our way of confirming that what we believe, which is that extra inventory will be out of the consumers' hands by next pool season.

And I'll add on it as well, you answered the question with regard to nondiscretionary items. You've 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.

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.

Our next question comes from Ryan Merkel with William Blair.

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 the 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, though those 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.

Our next question comes from Dana Telsey with Telsey Advisory Group.

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?

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 were a little bit above specialty 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 specialty and just above mass.

And then as we think about additional puts and takes into next year, in a need-based industry, the way we think about marketing is it doesn't drive need. Need comes from the installed 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 spend marketing -- investment 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 Planalytics 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 starting to take the price actions that we did on 6/1. So it was a challenging traffic situation for the entirety of the quarter.

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

Great. 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 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 customers 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 2 years that they had experienced. Was there a second part of your question? Sorry.

No. Just about like educating the customer about what could happen if they're using these older chemicals, and just 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.

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

You touched on the SG&A reductions that you're expecting in the fourth quarter, (inaudible) and lower costs compared to the prior year period. Just wonder if you could provide, maybe some more color on the stuff that you're taking and how you're viewing SG&A at this point as we're moving closer into fiscal '24.

Yes, Garik, good question. 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're addressing in the fourth quarter into next year, I can tell you, overall, it's up and down the P&L. We spoke a little bit earlier about marketing. Marketing comes down naturally when we can't get the ROI that we expect on our investments. So 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 down labor hours in the stores accordingly. In terms of just being more efficient, we are delayering 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 shed, as it appears, they do, that's a very unusual inventory -- a very unusual situation. And the catalyst for it, which is 3 years of spotty availability and increasing price, that catalyst is gone. Inventory is readily available, and that'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. And 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 are 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.

Our next question comes from Jonathan Matuszewski with Jefferies.

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?

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 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 options 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.

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.

Yes, it's also a good question. Just the general macroeconomic situation, you have customer price sensitivity across industries. In the survey that we did and the 1 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 3 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%. 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.

Our next question comes from Andrew Carter with Stifel.

So a couple of questions I wanted to ask 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 a DIY. I don't 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 survey work aside, have you looked at considering how many pounds of chemicals went out the door from various locations over the last 4 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.

Yes. Thanks, Andrew. So a few questions in there. I'll talk about price visibility first and how we think about price. In 2021 and '22, we were able to influence pricing in the residential market. We came into the preseason, 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 above 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 1,000 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 -- the surveys we did were not specific to Leslie's. And 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 comp growth in a typical year, but also market share gains. And both become more difficult when there is excess inventory in the channel.

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

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 '24 pool season. Just curious what does the costing backdrop look like sitting here today, particularly on the nondiscretionary 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 and the industry just can't pass through any more price? That's my first question.

Yes, Justin. 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 3 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.

And then an unrelated follow-up on leverage, Steve mentioned the 3x 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 paydown?

Yes, thanks for the question, Justin. I think there's a couple of 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 paydown.

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 you talked about it, we talked about kind of a 3% of total sales by coming a little shy of that this year. From an M&A perspective, certainly slower pace this year from a dollars perspective, but continue to do attractive deals and acquire businesses at great multiples. I expect that to continue through Q4 as well at a modest clip. And so when it comes down to 2023, you 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 in the year-end. But as a result, we'll have lower accounts payable and certainly some accrues from performance incentives. So don't expect a big cash flow year in '23, but do see opportunity for improvement in 2024, which could lead us to continue to deploy capital towards debt paydown, as well as invest in stores and in 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 Sun Belt, smaller locations if not a big cash drain from an M&A perspective. But clear opportunity to continue to deploy capital towards growth, but it'll probably look a little different than it has the last couple of years.

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.

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 and year-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.