Leslie's, Inc. (LESL) Earnings Call Transcript & Summary

Okay. Great. Well, good morning, everyone. Welcome to the Baird conference in person. Thank you all for showing up. I'm Peter Benedict, senior research analyst covering retail, consumer products and services. Really pleased to have the management team with Leslie's with us this morning. Leslie's is the largest consumer-facing omnichannel brand in the U.S. aftermarket pool and spa care industry. They operate over 950 stores across 38 states. Joining us from the company, we have CEO, Mike Egeck; and CFO, Steve Weddell. Mike is going to start off with some opening slides and remarks, and then we're going to kick into some Q&A. During the conversation, if you have any questions, you can e-mail me on the iPad [email protected], and we'll do our best to work it into the conversation. So with that, I'll turn it over to Mike.

Thanks, Peter. And thanks everyone in the room for joining us today and also those joining via webcast. It's great to be here. This is actually Steve and mines first live conference since we went public. If you would, please note that we put a brief deck, just a few slides on our Leslie's IR site to supplement this discussion. And also note on there, Page 2, is the requisite disclaimer. I'm going to start by saying, I know on top of mind for many of you is kind of Memorial Day has passed and ran to the start of the pool season, how does the business trending? There's 2 things I want to point out on the start of this year's pool season. First of all, many of you will remember last year at the start of the season, there was a probation, I'm going to say, and a significant media coverage of pooling choice. And that media coverage really drove this line of business. In Q3 of last year, our Q3 chlorine sales doubled, and we had an all-time record. This year, in comparison, it's been a relatively slow start to the season due to the cold and wet weather in the Northeast, which I'm sure many of you are familiar with, and also on the West Coast concerning the unseasonably cool start to the season. Both of these factors are part of the timing. And as we've discussed before, at the beginning of the season and also the end of the season can be a few weeks either way. The important thing to understand is the demand is recurring in nature. So even with those moves, it doesn't impact the entirety of the season. But this is what we want to point out. Our Q3 historically is 60% to 70% of our second half profitability. Last year in Q3 with the chlorine, media coverage in that site, it was toward the high end of that range. This year, given the factors we've just discussed, we expect our Q3 to be low at the midpoint of that range. To be clear, this doesn't change anything in our full year guidance that we offered on May 5. With that out of the way, Steve is going to cover a few slides. For those of you aren't familiar with Leslie's, we are the largest D2C brand in the pool and spa care industry. We operate now 970 physical locations, which is more than our total largest competitors combined. Our digital sales across our proprietary and marketplace sites are 5x larger than the next largest digital competitor. We've grown every year since we were founded, and we went public in October of 2020. Our fiscal 2021 record year, which ended October 2, 2021, sales growth of 21% to $1.3 billion and adjusted EBITDA growth of 48% to $271 million. Fiscal 2021 was our 58th consecutive year of growth, which is something the company is very proud of. When we think about the business and what makes us unique in this space, there's really 3 pillars. The first is that we operate in 1 of the most advantaged consumer products industries. It's large. It's based on 14 million bodies of water, and in general, it's about $14 billion in our aftermarket sales. It has nondiscretionary and recurring annuity-like demand, because once you put a pool on the ground, you have to maintain it. There really are no other options. And it has predictable growth. The installed base has grown every year for 52 years. We take advantage of that industry dynamics. We built a consumer-centric integrated network assets and capabilities, has unmatched in scale and reach and it allows us to provide full pool and spa care solutions to all customers, whether they need, wherever, whenever and however they want to engage with us. Important to note, none of our competitors have that capability. The third unique pillar is that despite being the largest D2C brand in the space, we have significant white space opportunities available to us across all the consumer groups we address and of all the channels we operate in. And we've got the talent, capabilities and 6 tangible growth initiatives to take advantage of those opportunities. I'm going to ask Steve to cover the finances.

Thanks, Mike. So I'm going to cover some financials real quick. First half highlights on Slide 6. You can see we generated strong results in the first half of the year. Sales were up 22% to a record $413 million, with broad-based strength across the 3 consumer groups: Residential Pool, up about 15%; PRO Pool, up 27%; Residential Hot Tub, up 68%. Comp sales of 16% on a 2-year stack basis, that's a 48%. And gross profit for the first half was a record $153 million, with margin rates expanding 40 basis points to 37%. Adjusted EBITDA was positive $10 million. Historically, if you look back, this business has been kind of flat to somewhat negative in the first half. So pleased with the positive $10 million start to the year. Most of our earnings obviously come in the back half. If you look on the right-hand side, you can see as well from an M&A perspective, we completed 2 transactions this year. We have 3 more under LOI. With those completed, we will have 8 transactions in the last 1.5 years. We've talked a lot about it being a key lever of growth for our business and certainly have some momentum behind us. On Slide 7, I'll cover some guidance based on what we provided back on May 5. You can see sales growth of 17% to 20%, which compares favorably to our long-term growth algorithm of mid- to high-single digits. Gross profit guidance implies a small improvement in gross margin, which compares to our long-term growth algorithm of flat to positive 25 basis points. Adjusted EBITDA increase of 16% to 22% year-on-year, which compares favorably to our long-term growth algorithm of low double digits. And finally, adjusted net income growth of 20% to 27%, which compares to our long-term growth algorithm of mid- to high-teens. And with that, I'll turn it back over to Peter, and we'll get started on the Q&A.

Perfect. So I guess just following up on Mike's comments, so 60%, 65% of second half profits probably flow into the third this year versus maybe 70% last year. How do we think about that from a revenue standpoint? Is it going to be a similar split there? Or can you give us a sense of maybe the revenue split 3Q, 4Q as you see it?

I think that's...

Can we get his mic on, please? Thank you. There you go.

I'm on. Perfect. The -- yes, I think you can look at that 60% to 70% historically in Q3. Last year was at the high end for what the reasons we talked about. This year that will be towards the lower end, and you can see that pretty much up and down the P&L.

Okay. All right. Great. And I guess the other question would just be maybe on inventory. So I mean, inventory has been a popular topic in retail for the last couple of weeks. How does inventory look for you guys? How do you feel about that given the flow of business?

Sure. Yes. We took a strategic -- we've made a strategic decision last year to heavily invest in inventory. If you remember, most of the inventory that we have is nondiscretionary. It's not something fashion risk or obsolescence. If you look at the end of Q2, our fiscal Q2, effectively at the end of March, up $70 million or up 25%. So we worked very hard and closely with our vendors to procure effectively as much inventory as we can to meet the heightened demand that we see today, and it's a competitive advantage. So I feel very good with our inventory position today. I do expect there'll be some spot outages though. I think supply chain is still a little challenged with certain vendors, and we're working through it, but feel very good going into the season.

Okay. Great. So before we dive a little bit more into the business, there's kind of 3 macro questions. We're going to try to ask each of our companies that are presenting with us over the course of the next 3 days. And just got a quick response here, and then we'll get into the more detail. So first is on inflation, maybe how would you characterize the overall pace of inflation in your business today versus maybe a few months ago? Is it accelerating, decelerating or pretty much the same?

Yes. So we've seen an acceleration over the last 6 months and over the last few months as well. We do feel like it's going to peak into the current quarter. So it's a -- we've seen inflation in our business for the last 1.5 years. But I think fairly idiosyncratic with some of the products that we have, primarily in chemicals and major equipment. But as we said, we feel like it's going to stabilize with where we're at going to the back half of the year.

Great. Supply chain, how would you characterize the current state of your supply chain versus a few months ago? Is the flow of product getting better, worse or pretty much the same?

Yes. Great question as well. So tighter than pre-pandemic, much better than last year. So again, back on inventories feel good with product flow, still have our opportunities, but that's typical as we get into the season.

Great. And then the last is on consumer behavior. You guys very needs-based recurring revenue. But are there any notable changes you've observed in your consumer and how they behaved here over the last few months?

Yes, good question. We really haven't seen any significant change. And we think that's for 2 reasons. The recurring nondiscretionary nature of the demand, right, once you put the pool in, you have to maintain it. And pool owners tend to be middle-class, upper-middle-class or higher, and we haven't seen inflation really impact them yet.

Got it. Okay, great. So let's talk a little bit about the pool industry. Maybe give us a sense for the key macro dynamics that investors need to think about what drives demand in this sector. We're thinking installed base, population trends, usage, what could you -- set the stage here for us?

Yes. There's really 5 big macro secular trends that are driving demand in the industry. The first is people continue to invest in their homes and backyards. Second is they're wanting a healthy outdoor lifestyle, which pools are part of that. The third is, and this is important and significant, is the migration to the Sun Belt. When you look at population trends across the country, the West and the South are growing 10x faster than the Midwest or the Northeast. And then work-from-home or hybrid schedules, where people are just spending more time in their homes and using their pools more often, very important to us. And also, the pandemic really just heightened everybody's sense of safety and sanitization, particularly around families. In our AccuBlue water testing, which actually puts a number on pool safety, it's proprietary and unique to us, really a distinct advantage and it gives pool owners that peace of mind that they can invite families, friends, put their own kids into the pool. A couple of other interesting things we've seen lately is that with people spending more time at home, there has been, for our business, a little bit shift back to do-it-yourself. People are home, they're spending more time with their pool and they're taking an increased interest in the safety and sanitization that pools, a little more increased in DIY. And with that, we also see people shopping in the specialty channel a little bit more. There's been some specialty share capture from mass. And it makes sense if you're doing it yourself, because in the specialty channel, you can get that expert advice, you can get the education, you can get that hands-on experience in mass and club channel, that's not really available.

That's helpful. A lot of investors ask us about the state of the Trichlor market implication for chlorine tab prices. I mean you've talked a lot about it. But maybe give us your view of the situation. You gave a good update on the last earnings call, where they'd be helpful for this group to hear your view of it and what your crystal ball says about the outlook.

Yes. We get this question a lot, and it's a little bit complicated. So I apologize to begin with. But this much for sure, chlorine prices are still elevated and supply is still constrained. And by prices being elevated, we mean 2 years ago, a 35-pound bucket of chlorine tab, which will get a midsized pool through a pool season, was $99. Today, that's $199. So the question is, top of everybody's mind, what happens when that reverses? And our view on that is that there are several factors in play that could keep them elevated. And to understand that you got to go back a little bit and understand that what consumers call chlorine tabs are actually Trichlor. And Trichlor is made out of 3 components: there's the raw chlorine, there's caustic soda and there's urea. And those get combined to make Trichlor granules and then those granules get compacted into the tabs. So there was a plant fire in 2020 that took a lot of the Trichlor capacity out of the market. That was the first shortage situation and the first increases in prices. But what we're seeing now is that the actual raw chlorine component is also in a constrained supply and increasing cost situation. And 2 things going on there. One of the major manufacturers took about 7% of raw chlorine production in North America off-line, and then the other is that raw chlorine also goes into PVC. And with the housing industry being strong, it's competing with its use in Trichlor. And it's a higher value in PVC. So you take those 2 together, and now all of a sudden, the raw chlorine that's available to North American manufacturers is down 20%. The way that gets made up is with imports. But imports are very expensive, a combination of tariffs, antidumping duties and also specialized shipping and transportation. Urea, the other component in Trichlor, happens to be that the major exporter is Russia. So that has its own challenges, and we've seen urea quadruple in price. It's now come down some, but it's been very volatile. So when you take all that together, the plant that was down should come online sometime late this year. But when it does, any absolute increase in Trichlor to the market, is going to have to use either imported Trichlor or high-cost imported chlorine. And when you take all those factors together, we think there's a scenario where prices would remain elevated through 2023 and maybe longer. Well, it's a long response.

Not at all. You do a nice job of breaking it down. That's why we asked. So the last sector question I have, people ask a lot about saltwater sanitation systems. The penetration of saltwater pools out there and what that means if someone goes to a saltwater pool system. Is that good for Leslie's? Is that bad? Are you in different?

Yes. We are indifferent. So when you think about saltwater pool penetration, kind of high teens. Certainly, from build remodel, you're seeing more interest in it. There are many ways to sanitize you pool: UV, ozone, mineral-based, salt, traditional Trichlor. We find when Trichlor tabs are available, consumers tend to gravitate towards it. When you think about cost of saltwater pool, to install a salt chlorine generator, it's about $2,000 to $2,500. They're spending $700 to $1,000 on a salt every 3, 5, 7 years. In many ways, it is a build-out as kind of a maintenance-free pool. There's a lot of balancing that's required to make sure that, that chlorine being produced as you break the salt down into the sodium and the chlorine to make sure that it's being effective. And so for us, we've set ourselves up that we can serve all these customers. You come into our store, you do a water test, we can test your water if you have a traditional chlorine tab pool or a saltwater pool or other forms of sanitization. So we've actually found in Leslie's that saltwater customers are actually some of our better customers. They spend more, which makes sense when you think about the cost of putting a system like that in place in your pool. I think you tend to spend more money on the equipment, as well as some of the balancers as you test your water on a regular basis.

Great. No, thanks for that. So let's -- when we first did our due diligence on Leslie's prior to the IPO, I think we were struck by just how resilient the business is. We were new to the pool industry. And so maybe talk a little bit about how Leslie's in the pool industry has performed through past economic downturns.

Yes. So it's actually really interesting. If you go back to our earnings deck that we had back in May, Page 14, we talked about, over the last 21 years, and I'll break it down in a little bit more detail. Sales CAGR of 7%. EBITDA CAGR of 14%. If you look at that during 2006 to 2009, business was up 16%. EBITDA at sales, EBITDA was up 47%, comped every year positive. Out of the 21 years, 17 positive comp years. The non-positives were minus 1% 3 times and minus 2% the fourth time. EBITDA up 19 out of 21 years. So when you think about rising rates, higher inflation, declining consumer spending, decline in pool builds, decline in housing starts, all these macro indicators that I think are on people's mind today, and for the right reasons, this business is one that has just performed through. And again, you get back to that aftermarket, 14 million bodies of water, 80% nondiscretionary, it's not an option to take care of your pool. If you don't sanitize it, if you don't move the water, if you don't filter it, you're going to have an algae problem, you need even more help. So it's a different business, and it's the reason why the business has grown 58 years in a row.

Yes. So clearly, good business. But when you look at the competitive landscape, you're the big national player. There's really -- the material #2 there, it's a lot of small mom-and-pops and regional. So talk about the competitive landscape in residential, and then maybe a thought on where you think you could take your units and what's the unit growth opportunity.

Yes, and I mentioned earlier, even though we're the largest brand in the space, D2C brand, there is a lot of white space opportunities. We have internal studies and external studies that show 700 underserved residential markets and 200 underserved PRO markets. And the way we look at those markets is once they're identified, we go in with 3 options. First option is to build a Leslie's residential store; build a Leslie's PRO store; and the third option is to geo-target it, geo-fence it with digital capabilities and go after the consumers with our digital sites. And those aren't mutually exclusive. Depending on the opportunity, we can do all 3. And the other option when we go in is to look at those sites for M&A, right? It's interesting. The largest shareholder in the pool and spa space is actually 8,000 independent specialty retailers. And they tend to be quite small, 1 to 3 units. And I'm going to generalize this, but it's pretty accurate, tends to be husband and wife teams who have been in the business for a number of years. Their children aren't interested in taking over the business. And even though the pool industry has had 2 great years, it's been tough on independent operators. First year, they're dealing with the pandemic, right? Instead of just running their little shop or there are a couple of stores, now they're trying to find PPE and figure out how to do curbside service or how to get a hold of the local county officials to make sure that they can stay open as an essential business. And in the next 2 years, they're fighting the larger companies, like ourselves, for supply, and they're finding it difficult to get products. So it's a very prime M&A landscape right now with the independent specialty retailers.

Yes. So let's pivot over to customer acquisition and loyalty, 2 kind of big initiatives for you guys. Maybe give us a sense of the background of these initiatives, where you kind of stand today and what's the outlook?

Yes. It was really in 2020, we started looking at the business and establishing our 6 strategic growth initiatives. And the first 2 are really to grow the consumer file, basically add customers, whether through acquisition or retention or reactivation and to deepen our relationships with them, meaning, have them buy more from us very simply, average revenue per consumer. And it's been very satisfying these last 2 years, our progress there. And I'll say there was a lot of low-hanging fruit, right? The company had really just focused on direct mail marketing and not a lot of it. We switched to digital and social marketing. There was a loyalty program, the only one in the industry, but we updated it with our Pool Perks program, which we launched in May of 2021. And the results from those kind of low-hanging opportunities were pretty rapid. Since beginning of 2020, our active consumer file has grown 35%, our loyalty file has grown 50% and our average revenue per consumer has grown 18%. So, I mean, in just kind of the simplest terms, and we like to break it down simply in the business as we talk to the associates and our marketing teams, we've got more people spending more with us. Now lately, if you've listened to our last earnings release, those have both been growing at a double-digit pace. They're now starting to decelerate a little. That's expected in our long-term growth algorithm that we put out with the IPO, we really expect to get 100 to 300 basis points of growth from each of those initiatives over the long-term because there was a lot of low-hanging fruit there. We were able to come out of the gate really strong. So it's a gratifying result, I want to say, to date.

Sure. Absolutely. One other thing that struck us during the initial due diligence was the importance of in-store water tests. And I had no idea that, that was even a thing. But maybe talk about AccuBlue in-store. Why is that a key differentiator for Leslie's? Why is that really a competitive lever for you?

Yes. So it's a -- I'll tell a personal story on this one because we -- before I took the position with Leslie's, I was went on a secret shop with my wife to see what was going on. And we've had pools. And typically, test pools, they put the little test strips, reagents, right? Little test tube water and they hold it up. Some of our competitors talk about the theater of the water test that kind of go like this and tell you, you need some chlorine or you need this outside. And what we have is a digitized, gamified water testing system that prints out step-by-step instructions, how much needs to be added at what time and what order. It's really like a prescription is the best way to think about it. But the real key to what we've discovered is that it gives you a pool score from 0 to 100. And here's where I get back to shop in the first time with my wife. So I'm walking around the store, trying to pace off linear fee, how much of each type of products in the store, what's it look like, are the associates paying attention. Meanwhile, she's getting the water tested. And I hear this, "Oh my God." I turned around and our water score was 30. And anyway, we walked out with $250 worth of chemicals. And now we have someone who takes care of our pool. But my wife goes every week and has the water tested and hands it to our pool guy like a report card, and says, "We're going to have to have this score over 85." It's just part of the deal. And that certainty putting a number on a pool score versus kind of the ambiguity of test trips, that color that fade over time are incredibly inaccurate. It has been a total game changer for us in the industry. And it's really at the base of our competitive advantage because that's what allows us to give a total pool solution. And when we think of our end product is a clean, safe, beautiful pool. It's not about just selling products. We've got lots of betters who can sell products. But the expert advice, the water testing, the prescription that gets you the desired end product, clean, safe, beautiful pool, that's what's important, and that's what AccuBlue allows us to do.

Sounds fantastic. Up until really the last couple of years, there wasn't a lot of omnichannel sophistication or even tie-in between stores and online. It's kind of come together maybe at the right time, but you're still in your early stages. So talk maybe about Leslie's Connect, your omnichannel positioning and what that can do for you going forward?

Yes. Personally, I came out of the apparel industry. A lot of sporting goods and outdoor apparel. And for those of you who follow that industry omnichannels, it's certainly not new news, right? It's been in place for a while. In the pool industry, there really wasn't any one with those capabilities. So we set off on a long-term plan to get omnichannel capabilities. The full suite, buy online, pick up in store, buy online, return in store, ship from store, ship to store. And as we're working on this, the pandemic hits, and now all of a sudden buy online, pick up in store, ship from store, ship to store, all those become critically important as we're trying to manage inventory and ship from our stores, do curbside service. So we accelerated our efforts there, worked very nicely for the last couple of years. But Peter, to your point, we're still pretty early stage there. And we will continue to work on it. We call those omnichannel capabilities Leslie's Connect. Our app is an important part of that process as is our sites. So we feel good about the progress we've made. We certainly did it at the right time. But still more work to do there.

PRO is just 15% of your sales, but it is 1 of those growth pillars for you. Maybe talk about how you're going after the PRO. A lot of people in the audience are probably familiar with Poolcorp. So maybe I'd give people a sense for maybe how you're going after PRO versus how they do it and your PRO affiliate program, what kind of success you're seeing there?

Yes. Good question. An interesting evolution for the company. I've been there 2.5 years. Steve, 5 to 6 years?

Yes.

For years before that, the company actually treated the PRO customers as competitors because they define themselves as a DIY business. In 2016, the company got into the PRO business with an acquisition of a small chain in Las Vegas. And what we do with our acquisitions is, we're buying a business, and we're buying talent, but we're also buying a window into new capabilities. And so we learned about the PRO business from there. And in 2020, we really formalized our PRO initiative, which has 3 parts. One is to open PRO stores or convert residential stores to PRO stores. The second one is what we call our PRO affiliate partner program, and then the third is a PRO website. And we're moving pretty quickly here. We now operate 77 PRO stores. We have over 2,500 PRO partner contracts. And we -- and the website is up and running. So good start. Our space in PRO, it's Poolcorp's, large company, it does a tremendous job servicing, in particular, the larger PROs. We've really focused on the smaller PROs. 1 to 3 trucks, maybe 500 to 200 pools. And we did a lot of focus group work with those professionals. And what came out really clearly was what's most important to them is speed and convenience, right? Basically, being where the pools are. And that's our whole real estate strategy. 80% of the pools in the Continental U.S. are within 20 miles of a Leslie's store. And these operators are not that sophisticated, right? They carry their inventory in their truck or in their van, and when they need something, they need it right now. So with almost 1,000 locations, we are just, by definition, almost always the closest store for a PRO. And once we've kind of embraced them and put up the site and given them the PRO affiliate membership, which is preferred pricing, some co-branding opportunities, and also importantly, referrals because we get a lot of people come in the store asking for PROs, that's proven to be a good combination.

And real quick. It's important to note, too, that the PRO stores aren't that much larger than residential stores. PRO consumers can shop in PRO stores, as well as residential, same pricing, a little bit smaller inventory selection. And residential consumers can shop in both as well. So we've actually found that residential consumers, we've seen higher growth in PRO locations than surrounding stores in the district. In like a combination of longer hours, better inventory selection, larger inventory selection and they're shopping more in the PRO shop, right? So it's one where we're identifying more opportunities to convert faster because it's powerful for both the PRO consumer as well as residential consumers as well.

Well, terrific. Well, listen, I've got a lot -- several more questions, but we've run out of time. So we will cap it there. We do have a breakout session. So if folks want to jump over to that and ask some questions, that's great. But let's thank Mike and Steve for joining us today.

Thank you.

Thank you.