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

Good morning, everyone. Thank you for attending the second day of Goldman Sachs 31st Annual Global Retailing Conference. My name is Kate McShane. I'm very happy to introduce the members of the management team of Leslie's full supplies. Today, we have Matthew Skelly from Investor Relations, John Strain, Interim CEO; and Scott Bowman, Chief Financial Officer, with us today. Thanks for joining us. You had a big announcement a couple of weeks ago, and I wondered if we could maybe start the conversation there with your change in CEO and what we can expect to see.

Thanks, Kate. We had a change. We're really excited to have Jason McDonell on our team. He starts on Monday. So happy to put him in a position. This was a very thoughtful change. We've been working on this for quite a while. When Mike joined us back in 2020, I was part of the team who hired him. We're excited to bring him on and he gave us a 5-year window. We're at 4.5 years, so kind of at that point in time. And about a year ago, Mike urged us to start that process looking for his successor. And as a result, we went through a very structured process, very disciplined. We went through a bake-off for our retained search firms. We picked Spencer Stewart. We had a tremendous experience with them. For the most part, we're through everything you'd expect us to go do. What's the right profile for us at this time? What's the next CEO look like, job descriptions, market survey, top 25 from their perspective. We went through in detail and as an entire Board, Mike participated going through that process. And we found Jason. We're super excited to have him. We're excited for him to have an opportunity to meet with you all. What are we looking for? We're looking for somebody with scale. Somebody who's at the right scale for us. Mike ran the PepsiCo Foods Canada, which is a $2.5 billion business. He moved on to Advanced Auto Parts, $11 billion business with 4,000 stores. The retail aspect of it was pretty important to us for obvious reasons, but the fact that he had run stores, e-commerce, omnichannel, merchandising, marketing, [Technical Difficulty], all things that are really critical for us at this stage we are as a company, he brought that from advance. So that was fantastic.  But on top of that, the advanced business model for us fit very well when you look at both business lines and product lines. From a business line standpoint, in as much as they have B2B, B2C, pro service, all of those things very much parallel what we do. So that was a great fit. And then from a product line basis, the idea to have hard goods, soft goods for them, the consumables being motor oil for us, it's chemicals for them, auto parts for us, pool parts. So there's a lot of dynamic there that I think made a ton of sense for us in that context. But what really separated Mike, from the rest of the candidates was the softer skills and coming out of a P&G and PepsiCo, 2 of the best management development training programs that are out there, he obviously was a quick study. Through our interactions and through all of our references, just everything from communication, collaboration, general leadership, his ability to build and retain a team. These are all things that made us feel really great about Jason through the process. And the other question we've been getting is, well, why now? will happen with Mike. There's 2 things that typically drive an executive change, one being a personal side, one being on the professional side. From a personal side, you'd have to ask Mike, why 5 years, what does that look like? Well, that's for Mike to answer. But on our side, from a business perspective, why now, once we initiated that search, we're going to take the time that it took to hire the right person. And we think we've found the right leader, in Jason. We're super excited to have him comment on board. We're excited for him to have a chance to meet with you.

Great. Thank you. I thought maybe we could start and back up a little bit just about what we've been through the last couple of years and what it has meant for Leslie is on the most recent earnings call, you talked about the pool industry, just going through a period of normalization post the pandemic and Leslie's is not alone. There's quite a few hardline retailers that are still normalizing from what we saw. And there's also been extraordinary events that have impacted the pool industry, like with what happened in chlorine. So can you maybe walk us through some of those events and where you think the industry is today versus historical growth rates that we've seen?

Yes, sure. Sometimes it's hard to define normal these days, but been through a lot. So starting back with pandemic, Leslie and a lot of companies saw similar things where people were spending a lot more time at home. And they weren't traveling and going out as much. And so they wanted to improve their home. And so we did a lot of home improvement and they installed a lot of pools. And so the average kind of pool growth on the installed base over time has been 1% to 2% and close to 6 million new pools today in the ground. And during the pandemic, that spiked to about 2%. And where we are right now is about 1% growth. And so over index, for sure, on the pool installed, but also buying new equipment. So at that time, people spend more time with the pools, and a lot of them notice that, hey, my pool pad is outdated and my pumps making a noise. And so there was an upgrade cycle there, too. And there was a lot of new technology out at the time too, with variable speed pumps than automation where you could control your pool equipment from your phone. And so there was a lot of that kind of technology upgrade at the same time. And so equipment sales did really well during that time period as well. And then during that same time period, there was supply chain disruptions that we've all heard about. And one of the major ones in our industry was a fire at one of the major Trichlor producers at BioLab. So plant caught on fire based in Louisiana. And so that caused, or actually complicated the problem of supply chain disruptions that were already in place. Fortunately, with our scale, we were able to procure more Trichlor more chlorine than other retailers. And so we got the benefit of that. And so we over indexed on our chlorine tab sales for a time because we had the supply and many others did not. Also caused a price spike. And so I think the overall chemical volumes went up because the installed base and people are using their pools more, but prices went up as well, and those prices have kind of stayed high. And so that was all the activity post-pandemic and from 2020 to 2022, our sales at Leslie increased about 70%. So clearly, over-indexed. And then when we got into 2023 and this year, we saw some reversion back to what was normalized. And if you put kind of that 5-year time period together 2019 through today, the actual CAGR growth rate is about 7%, which is close to normal, but you just see a big spike and then a dip, okay? And so what we're seeing today in the industry is our chemical business, that's more kind of a near-term need, okay? And so that is more normalized than other categories, okay, which kind of makes sense. And for us, we've seen some positive signs there. Just in the third quarter, it was kind of a good example, and it really solidified our thought that we're not losing market share. So if you look at the third quarter, April and May, weather was bad, it was cold or wetter than usual. A lot of analyst reports tell us that as well. And our sales were down. And so in April, for example, our traffic was negative 10%. It was negative 3% in May and then positive 3% in June. So nice progression. And the good thing that we saw was, once we hit June and the weather normalized and it was better, our sales instantly turned around, especially in the chemicals business. So chemicals were up 5% in June. So very encouraging for us that it was weather related and not a share loss. And then to kind of solidify that thought, we get credit card data from BofA. And it's not technically market share, but it's our growth versus the industry, so it's a good proxy. And for the first time in several quarters, Q3 was actually positive versus the industry of about 30 basis points. But if you just look at the month of June, we were up 670 basis points. So we felt really good about that. And so that gave us confidence that when the weather turned weather was good, we were getting at least our fair share, if not more, the chemicals business. So I feel good about that. Now the equipment business is a little bit different story. We do think that there's been some normalization of equipment, but equipment actually underperformed our expectations. We thought it'd be down about 10%, is down 15%. And so kind of looking into that difference, a lot of that is macro related and related to higher interest rates, inflation, cautious consumer, okay? And so as we look at the categories within equipment, things like heaters are down significantly and average price of a heater or pool heater is $4,000 to $5,000. So high-ticket item. These robotic automatic pool cleaners, $1,500 average price point are down. Salt systems, $1,500 to $2,000 are down. And so those are all kind of more nice to have items because you don't have to spend $1,500 on a pool cleaner. You can buy one for a lower price, and it still does the job. So we view those as more kind of our discretionary equipment purchases. Some of the more nondiscretionary equipment like pool pumps and filters did better. And so that gave us a pretty good indication that people are just being cautious on some of those more discretionary items. Another big category for us is hot tubs. It's about 10% of our business and about half of our discretionary business. And that's actually been a pretty good story. So the hot tub business was gangbuster joined the pandemic. It was up 79% in 2022. So everybody that wanted a hot tub during that time period. But then we saw a dip in hot tubs after that cooled off. And just in the third quarter, we're seeing some evidence of good progression, good sequential improvement. So in the first quarter, our hotted business was down 18%. Second quarter, it was down 14%. And then in Q3, it was down 4%. So really good progression in that business. And I think our hot tub business is more kind of the premium price point. Our average price point is about $13,000, and we carry the premium brands. And so it's more, I think, comparable to kind of a higher-end pool. So when you look at kind of the pool industry and installs, the higher end is doing better, less prone interest rates in the middle and the low is doing worse. And we're seeing that with our hot tub business. It's a higher-end product, and so we're seeing less resistance because of interest rates. And so that's a positive story for us. And so where do we go from here? And as far as the outlook, I think the outlook for us for equipment longer term is good because anybody that owns a pool, you have to replace your equipment every so often. And I think when they do replace their equipment, there's this new technology that's an additive incentive for people to replace, okay? And so I think that will continue. And so I think for us, we have to look for ways of how we can take advantage of that customer and gain more market share of just that area of the business. It's about 25% of our business, so it's an important piece. And the way that I think about it is when you buy equipment, the top 3, there's 3 top equipment providers, and they have met pricing, okay? And so there's always some violators out there, but for the most part, is sold at that map price and they control that. And so the advantage for us in that scenario is that's kind of a level playing field. So all of the sellers are online and everything else are really tied to that map pricing. But for us, we have a couple of advantages. One is we can offer installs and many of the online sellers cannot. And so that's a big advantage for us that I think we need to amplify, buying from Leslie's versus a lesser-known online seller, I think, is an advantage for us as well. We can also repair the equipment. So if you buy a piece of equipment for us a popcorn or an automatic cleaner, you can bring in into our store and we can repair that unit if need be. So there's those advantages which we have, which I think we just need to amplify and I think that can lead to a higher share. And then when you think about things like Trichlor and chemicals, chemicals are about half of our business. We are really important to our suppliers. And so we have really good conversations with them. The overall supply/demand dynamics are really good right now in the chemicals business. And so we've been able to have good conversations about how do we both win together. How do we sell more products. So both of us, us and our suppliers are motivated by selling more. And so there's good conversations there because the supply is there to be able to do that. And so we've actually gotten some lower cost Trichlor that we bought earlier in the year that we're now starting to recognize the benefit of that. Next year, we'll benefit even more from that. And then negotiations for next year actually start within the next 30 to 45 days. And we're cautiously optimistic about how those conversations may go. But just to let everybody know when we get a better cost on Trichlor, it doesn't realize itself in the financials right away because we have these layers of inventory. It's a weighted average cost model. So if we get a lower price today, it takes time to roll through that weighted average cost model, okay, 6 to 8 months, just depending on our terms. And so that's what we're now starting to see in the fourth quarter is some of that benefit that is product that we bought earlier in the year, okay? And so we think that will continue. So overall, looking forward, I think chemicals good situation, good supply dynamics, good relationship with their suppliers, same with equipment. I think equipment has a little bit longer tail in terms of normalization and kind of calling that bottom, but we're working through that. We're getting there. And then the hot tub business is encouraging with the uptrend we've seen.

So I just have a couple of follow-up questions for each product category. First, with chemicals, I know maybe a year ago, you weren't priced exactly where you thought you should be with chemicals. How should we be thinking about where you're priced today?

Yes. I think we're in the sweet spot today. So what happened back in 2023, the pricing kept going up and up. And so we kind of were raising prices along the way as well. But back in June of last year, we actually reduced our prices. And the reason that we did that is because we realized that we were higher than where we needed to be in terms of other retailers, okay? And our loyalty members were telling us this, "Hey, we think we're a little bit overpriced." So we took a look at it. And what we saw was we raised prices and our competition didn't follow, okay? And so where we want to be from a positioning standpoint in terms of price is at or below other specialty retailers that are like Leslie's, pool supply retailers, but slightly above the math and home channels, okay? And so we can be below the other specialty pool supply retailers because we operate at a lower cost, we have more scale until we can still be more profitable in that scenario. We think we can be slightly above the math and home channel just because of all of the other advantages that we have with the quality of our product, with our water testing, with our expertise, and all of that. And that has played well in the past. And so that is kind of our sweet spot in terms of positioning. And so we reduced prices back in June of last year in order to get back to that positioning. And so since then, we were overlapping higher prices, and it impacted our sales. But once we overlapped that in June of this year, then our sales comparisons got better, okay? And so that's one of the reasons why we're up 5% in chemicals in June. But we're also up in pounds, which was encouraging, but we've got that extra boost because we were no longer overlapping those higher prices.

Okay. And then within equipment, I think it's helpful to understand that there is a more discretionary element to some of the equipment and big-ticket that you listed that I don't know is fully appreciated. So I wondered if you could maybe talk about the mix differential between maybe what's needed equipment or more versus truly discretionary, where we are maybe in the replacement cycle for equipment and how much of a role does innovation play?

Yes. So innovation plays a big role. And so if you look at kind of the discretionary piece versus the nondiscretionary, the nondiscretionary is slightly bigger because it's got all the pumps and filters and things like that. But the more discretionary is an important part of that whole mix. And so where we are in the replacement cycle, all those people that bought new equipment during the pandemic, so equipment does have 5-plus year life, a little longer for pumps, a little shorter for pool cleaners. And so we're kind of mid-cycle there. But I think going forward, people will continue to pursue innovation. And so even though their equipment may be working okay, the ability to control your equipment from your phone is pretty enticing. And so that does drive some of that replacement cycle a little more quickly than you would usually see.  One of the things that we're also seeing too is with that cautious consumer kind of mindset is we have seen more repairs of equipment than replace. And so that kind of service business and repair business has actually picked up a little bit for us because we repair equipment in-store. And so we've seen that pick up a little bit and that tells us that some people are still delaying some of that replacement and just repairing their equipment for the time being. But eventually, they'll need to replace it if they're starting to repair.

I wondered if we could pivot to the competitive environment. You talked a little bit about where you like to be priced versus your competitors. But I wondered if there were more points of distribution selling tool supplies today than there were pre-pandemic.

Yes, Kate, I think on the margin, there may be a few other points of distribution, but the magnitude is fairly small, I think. So for example, in some places, you can buy liquid chlorine in the grocery store, right? I don't think that's a big piece of market share, but you see on the margin, some of those locations that sell some sort of pool supplies that you didn't see a few years ago. And from an online standpoint, there's been sellers that come and go there as well. But overall, I don't think there's been a huge expansion of more distribution points.

And how do you think about just your overlap with some of the broadlines and home improvement retailers? Has there been more overlap or more encroachment from that competitive set over the years?

Yes, I don't think there's been a big change there. The only change that I would point out is, in some cases, some of those home improvement club stores may hold on to chlorine tabs a little bit longer in the season. But outside of that, I haven't really seen major changes because most of those businesses are seasonal in nature and they'll switch out chlorine tabs and then bring in more holiday or Halloween or things like that to build that seasonal space.

I wondered if we could talk a little bit about the PRO market. I know when you came public in 2021 that the Pro was a big growth opportunity. It continues to be a big growth opportunity. You've added new locations. I think you've converted some stores. Could you remind us about how Leslie's is thinking about the PRO, how big it is as a percentage of sales? And how much wallet share do you get from the PRO today?

Yes, it's a good question. And I think it continues to be an opportunity. So I'll start off by saying about 30% of pool owners use a PRO to take care of their pool. Our mix internally is 15% of our sales, okay? And so my first team to the company a little over a year ago, I said, "Well, that seems low." And I've worked for Sherwin-Williams Paint Company for about 10 years. And so similar models. They have the PRO DIY in lots of stores. Their mix is about 60% PRO. And so I'd like to be at 60% but it's a different business, but I think there's opportunity there. And so as we kind of look at our wallet share and our opportunity and our value proposition for the PRO. It comes back to a couple of things I mentioned a little bit earlier, is we have to be priced right because the alternative to the PRO is come to Leslie's or go to a distributor. And so we have all those benefits I mentioned convenience. You can get in and out of our store, you can call ahead. So tons of opportunities and convenience factors for the PRO that make us a better option, but we have to be priced right. And so we've taken a closer look at that pricing, making sure that we're kind of on par with those distributors. And we want to sign more of those PROs up into that PRO Partner program because that gets them that good pricing that's equivalent to a distributor. But also, for us, they need to buy at least $10,000 worth of a product to get that good pricing. And so it's kind of a win-win there. And actually, those PROs that are in that program spend closer to $15,000 a year. So every PRO that we sign up, we get that benefit. And we've grown that base. It's a little over 4,200 PROs that are in that program. It's up about 15% year-over-year, but I think there's room for a lot more. The other benefit of having the PROs in that program is that they're very sticky. And their level of spend is much more consistent and it doesn't ebb and flow as much because that's more of a stable business anyway. And with that commitment of the $10,000 a year, they're more likely to stay with us once we get them into that program. So that's a benefit that we're going forward. The parts assortment is really important as well, make sure that we have the parts that they need. So they don't have to go to a distributor for that, they can get it all at Leslie. And so that was the feedback that we've taken in, and we've taken some actions on. So I think that's an opportunity as well. And then the PRO conversions that you mentioned. So we have about 108 stores now that are the PRO format. And as we kind of look about across the landscape of the stores that aren't in the PRO format, a lot of those stores have a very high PRO penetration. And so, we continue to look at those stores for candidates to upgrade to the PRO format. And for us, it's a pretty easy conversion. What we do is we know that the SKUs that are very important to the PRO. We make sure we have job lock quantities of those SKUs. We put a PRO sign up instead of a Leslie sign, so that's an easy fix. We make sure that the hours are consistent with what the PRO's need are. So we open earlier and sometimes we're open a little bit later. And we take a hard look at the staffing to make sure that staffing is in place to make sure that those PROs can get in and out quickly beyond the way.

And along with the PRO opportunity, you've talked about growth opportunities, 700 new market opportunities, which would be an opportunity for expansion, whether it be stores or digitally. I wondered if you could update us on how you're viewing that opportunity. And just given some of the challenges that we've seen over the last year, 1.5 years, if there's any thought around refining the store base or taking a look at the overall store base?

Yes. So we continue to look for those opportunities and 700 to 800 stores opportunity is still out there, right? And so as I kind of mentioned, 55% of the market share is those independent pool supply retailers to do what we do. And so more recently, especially on the M&A side, we've kind of taken a pause on that to generate more cash because our first priority right now is to pay down debt. That's number one from a capital allocation standpoint. But that doesn't mean that we stop. So what we've been doing is we've, number one, been building the pipeline of those M&A targets, potential targets. And so we have over 100 targets kind of in that pipeline that we're kind of researching right now. And so when we do reengage that activity, the time line will be much shorter to pull that trigger. And then from a new store standpoint, we're looking at those opportunities as well, to understand where we do well today and where there is opportunity to build more stores. And I think an important fact here, too, is just how we look at the build versus buy decision. And so as we look at those 700 or 800 opportunities by market across the country, the way that we look at that is basically by density. And what I mean by that is how many pool supply retailers are there in a market versus the number of pools, okay? And we know where all the pools are, right? So that's the easy part. And so if a market is highly saturated with pool supply retailers relative to pools, that's more of an M&A play to take out the competition. If it's more of an underserved market, then that's a market that would be more likely to build a new store because there's room to do that, okay? And so that's how we kind of size up each market to get an idea of what that mix may be from an M&A versus new store. For us, over a 3- to 5-year time period, we're really agnostic because we make really good returns on M&A targets as well as new builds.

And then in our last few minutes here, one of the questions that we get from investors is focused on your margins. And if you can return to the gross margins, you're at previously, maybe you could talk to just how much the cost structure has changed over the last couple of years? And if this does prohibit you from getting back to the level of gross margins we've seen in the past?

Sure. Yes. On the last earnings call, I mean, we talked about kind of what our targets for gross margin and SG&A and operating income are for the future and what we're really driving towards. The gross margin, we're trying to get back to 40% gross margin, midpart of our guidance, but this at about 37% for this year. We're also trying to get back to about 30% SG&A. And so that would give us about a 10% operating margin, which would translate into a low teens adjusted EBITDA number, okay? And so that's what we're driving towards. So just to address the gross margin piece of that, a couple of components there. Number one is just the costing side, right? And so I mentioned the relationships we have with our main suppliers. And those dynamics today are actually very good, and they're willing to work with us on product costs, they're willing to work with us on things like co-funded promotions, map holidays, to drive sales, okay, because they have the capacity to do it, and we both want the same things. We're in a good place there. We've already gotten some of those concessions already, which has helped us, but there's more to come, I think, in this coming year. So negotiations will start to occur in the next 30 to 45 days, but we're optimistic of where that could go for us. Then over the last year or so, we've made dramatic improvements in our cost structure, specifically in our distribution costs in our supply chain as well as inventory adjustments. Last year, we had way too much inventory and a lot of off-site facility to store all this excess inventory. So now that at the end of the third quarter, we were $130 million lower in inventory than we were in the prior year. And so that simplifies things a lot. We're no longer in offsite warehouses. We're much more efficient with our labor, much more efficient with our freight and the team has done just an outstanding job from a planning standpoint, but from an execution standpoint in our distribution centers. So those costs are way down. Our scrap is way down. And so structurally, that will carry forward into next year because we've already made those process improvements. And that process has been throughout this year. And so where we stand today, we're much more efficient than we were at the beginning of this year. So we'll actually have the full year effect of that next year, plus any incremental improvements that we make, okay? And so we're in good shape there, and that cost structure will help us for the foreseeable future. Another thing I would point out is the way that the accounting works for DC cost is when you build inventory, you put cost on the balance sheet. And then when you sell through that inventory, you bring those costs to the income statement. And from an accounting standpoint, that's just to match the cost of distribution to the selling of the product, okay? So with us pulling down inventory so much, you're dropping more expenses to the income statement, right? Once we get to a more normalized state, in a normal scenario, you will build inventory in the first part of the year and then you would sell it in the back half of the year during pool season, okay? If your inventory is relatively the same, beginning and ending, then you shouldn't really have a big effect of those capitalized costs because they ebb and flow during the year. For this year, it'll costs us about 80 basis points in Q3 because we're bringing down inventory, you know, more than we were building. In the future, that will virtually go away if we keep inventory at relatively normal levels throughout the year. And the last thing I would mention is the other impact that we're seeing right now with lower sales is just deleverage on fixed cost. And that's on our occupancy expenses for the most part. And so for the third quarter, that was about 50 basis points of headwind. That again, once we get back to that more long-term mid-single-digit growth number, that goes away as well. And so, you add all those pieces/parts together, and that's kind of the path that we're looking at to get back to 40%.

Okay. Well, thank you. Thanks for joining us today. I appreciate the time.

Thank you.