Leslie's, Inc. Q3 FY2021 Earnings Call

Good afternoon, and welcome to the Third Quarter of Fiscal 2021 Conference Call for Leslie's, Inc. 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.

Thank you, and good afternoon. I would like to remind everyone that comments made today may include forward-looking statements, which are subject to significant risks and uncertainties that could cause the company's actual results to differ materially from management's current expectations. These statements speak as of today and will not be updated in the future if circumstances change. Please review the cautionary statements and risk factors contained in the company's earnings press release and recent filings with the SEC. During the call today, management will refer to certain non-GAAP financial measures. A reconciliation between 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, Inc. is Mike Egeck, Chief Executive Officer; and Steve Weddell, Chief Financial Officer. With that, I will turn the call over to Mike.

Thanks, Caitlin, and good afternoon, everyone. Thank you all for joining us today. I'd like to start by saying that we hope all of you and your families are staying healthy and safe in this current phase of the pandemic. With regards to Leslie's, I am pleased to report that our Q3 performance was both a record third quarter and also the largest sales, gross profit and EBITDA quarter in our history. Sales for the quarter were a record $597 million. Comparable sales increased 24% for the quarter on a reported basis. And on a calendar basis, which adjusts for the shift created by the 53rd week in 2020, the comparable increase was 19%. For both the quarter and year-to-date, the 2-year stack comparable was 39%. Gross profit for the quarter was a record $284 million and margin rate expanded 364 basis points in the quarter. EBITDA for the quarter increased 50% to a record $179 million. Our Q3 results exceeded our expectations embedded in the increased guidance we announced in June. They also reflect the tremendous efforts and contributions of our associates and vendor partners to meet strong consumer demand in the face of constrained supply chains, especially in core chemicals and equipment. Chlorine tabs are a prime example of the demand and supply dynamic we saw in Q3. Despite proactive steps to increase supply and instituting purchase quantity limits across channels to manage demand, we experienced periodic shortages and stock-outs in some locations. Our data showed that Leslie's, due to our scale and long-term supply contracts, was the most consistent supplier of residential tabs in the quarter, but we were not able to meet the entirety of consumer demand. Sales of tabs doubled in the quarter, and we could have sold more. Price was about 1/3 of the increase, and volume represented about 2/3 of the increase. The demand we are seeing is being driven by the continuation of the macro trends that accelerated with the onset of the pandemic and were further elevated by remote work, showing no signs of slowing. Consumers are continuing to focus time and investment on their homes, pursue healthy outdoor lifestyles, move to the suburbs and exurbs, particularly in the South and Southwest, and increase their attention to safety and sanitization. These macro trends are resulting in elevated levels of pool usage as evidenced by increasing sales of core and alternative sanitizers. Interest in pool ownership, one of the most searched options on multiple real estate apps, is, does the house have a pool? New pool installations have increased from an average of 70,000 per year from 2014 through 2019 to nearly 100,000 last year, and are estimated at 110,000 this year. New pool installations are projected to stay at these levels for the next 5 years, with pool construction backlogs now reaching into 2023 in some markets. The strong results being reported by suppliers to pool construction and remodeling are a particularly good sign for us because when a pool is completed, our business of water and equipment maintenance starts, and that annuity-like demand continues for the life of the pool. Against this robust background of demand, the competitive advantages derived from our integrated system of physical and digital assets and our growth strategies continue to gain traction. Our omnichannel capabilities, including buy online pickup in store, ship from store, ship to store, and buy online return in store, allowed us to utilize the inventory in our locations to fulfill digital orders that we would not otherwise have been able to. Our omnichannel capabilities, which we call Leslie's Connect, enabled more than 29% of Leslie's digital orders in Q3. The total target file growth was 16% in the quarter, which was particularly gratifying as we are now able to lap our shift from direct mail to digital marketing from last year's third quarter. Our new omnichannel capabilities also accelerated omnichannel consumer growth, with new omnichannel consumers growing 285% in the quarter. In Q3, we launched our new loyalty program, Leslie's Pool Perks. The launch drove loyalty file growth of 17% in the quarter, representing a 700 basis point improvement over the Q2 growth rate. We are now operating 10 converted and 3 new build pro locations, continuing to outperform our pro forma expectations. Based on those results, we have identified 25 additional pro conversion and targeted 5 additional pro new build locations for next pool season. Our pro affiliate program also continues to scale, with more than 500 pro affiliate agreements and we are continuing to sign up new affiliates across our locations. Year-to-date, our pro affiliate partner comparable sales have increased 90%. The last component of our pro initiative, our pro e-commerce site went live in the quarter and has been well received by our pro consumers. The new and converted pro locations, our expanding pro affiliate program and the launch of our dedicated pro site helped grow our total pro business 59% in the quarter. On the M&A front, we closed on the acquisition of Hot Spring Spas of Southern Oregon during the quarter and, in the current quarter, we closed on the acquisition of Capital Hot Tubs, which operates in the Greater Washington, D.C. metro area. We continue to see an abundance of acquisition opportunities across the fragmented pool and hot tub industry and are managing an active pipeline of targets. Accordingly, we expect to close on 2 additional opportunities in the fourth quarter. Regarding our residential white space opportunity, we opened 6 new locations in the third quarter and will open an additional 5 new locations in the fourth quarter. We now expect to close the year with more than 950 locations. Importantly, we launched AccuBlue Home, our connected pool technology solution and subscription service in the quarter. Despite launching somewhat late in the pool season, we are pleased with the reaction from our consumers to Version 1.0 of the device and service. Version 2.0 is currently in the prototyping stage and is planned for launch next pool season. Our Sustainability Working Group, comprised of internal resources and external advisers, continues to make progress on our inaugural ESG report, which we plan to complete by the end of our fiscal year. To wrap up, we are pleased with our record results for the quarter and our outlook for the balance of the pool season and our fiscal year. We are encouraged by the durable demand we are seeing from our consumers and the momentum we have across our growth initiatives. Looking ahead, we do believe challenges across portions of the supply chain will continue into our fourth quarter and likely the first half of 2022. However, we are confident that our associates, our organization and our vendor partners will continue to mitigate those challenges with superior execution. We will continue to provide our growing consumer base the products and services they need to confidently and safely enjoy their pools and spas. Therefore, we are raising guidance for the year. With that, I will hand it over to Steve to discuss the quarter and our revised guidance in more detail.

Thank you, Mike, and good afternoon, everyone. Our business strength continued into the third quarter as we generated record sales and profits. We're incredibly proud of all of our associates, as they continue to deliver against our strategic priorities and generate the results we're reporting today. Today, we'll review our third quarter of fiscal 2021 performance, our performance for the first 9 months of fiscal 2021, and our upward revision to our full fiscal 2021 guidance that we provided in June. Before I get started, just a reminder on the calendar this year. As a result of fiscal 2020 having 53 weeks, there are calendar shifts in fiscal 2021 that impact our quarterly comparisons on a year-over-year basis. In the third quarter of fiscal 2021, we replaced a lower volume week at the end of March with a higher volume week at the end of June, positively impacting sales by approximately $18 million. In the fourth quarter, the shift will reduce comparable sales growth by approximately $20 million. Combined with the 53rd week in fiscal 2020 that will not repeat this year, the total sales impact in the fourth quarter will be approximately $38 million. It's also important to understand that the calendar shift and the 53rd week will reduce adjusted EBITDA in the fourth quarter by approximately $11 million compared to the prior year. These impacts on sales and adjusted EBITDA have been factored into our raised guidance that I will cover in a few minutes. But first, I'll cover our third quarter results. Our third quarter included 13 weeks and ended on July 3, 2021. Total sales for this period increased 24.3% or $116.6 million to $596.5 million compared to $479.9 million in the third quarter of fiscal 2020. Our comparable sales growth on a reported or unshifted basis increased 23.9%. Due to the 53rd week in fiscal 2020, this growth is impacted by that 1 week shift. Using the realigned period in 2020 for comparability, our comparable sales growth on a shifted basis for the third quarter of 2021 increased 19.4%. This increase is on top of comparable sales growth of 19.4% in the third quarter of fiscal 2020 and represents comparable sales growth on a 2-year stack of 38.8%. We generated strong results across consumer types and saw particular strength in the core sanitizer and equipment product categories during the quarter. We also continue to see elevated retail price inflation, primarily related to chemical products, channel management by major equipment manufacturers as a result of higher input costs and less discounting across product categories. Gross profit increased 34.6% or $72.9 million to $283.7 million compared to $210.8 million in the third quarter of fiscal 2020. Our gross margin increased by 364 basis points to 47.6% from 43.9% in the prior year, primarily due to product margin improvements and occupancy leverage, partially offset by business mix. SG&A increased 18.2% or $18.1 million to $117.3 million compared to $99.2 million in the third quarter of fiscal 2020. While SG&A increased at a lower rate than our sales and profit growth, the increase was driven primarily by our sales increase and investments to support our growth. Higher compensation accruals and an increase in noncash equity-based compensation were also drivers of the increase over the prior year. SG&A as a percentage of sales decreased 101 basis points to 19.7% in the current quarter compared to 20.7% in the third quarter of fiscal 2020. It's also important to note that during the current quarter, we absorbed public company costs in our reported results versus the prior year period when we were still privately owned. Adjusted EBITDA increased by 49.7% or $59.5 million to $179.3 million compared to $119.8 million in the third quarter of fiscal 2020. Adjusted EBITDA as a percentage of sales increased 510 basis points to 30.1% compared to 25.0% in the third quarter of fiscal 2020. During the current year quarter, we converted the increase in sales at a higher gross margin and leveraged our costs even as we invested against our key strategic priorities. Adjusted net income increased by 68.8% or $50.7 million to $124.4 million compared to $73.7 million in the prior year. The improvement was primarily due to the increase in adjusted operating income, a reduction in interest expense, and was partially offset by an increase in income tax expense. Our lower interest expense compared to the prior year was the result of our repayment of outstanding senior unsecured notes in November of 2020, lower LIBOR on our floating rate debt, and no borrowings on our revolver in the current year quarter. Adjusted diluted net income per share improved by 36.2% or $0.17 to $0.64 in the current quarter compared to $0.47 in the third quarter of fiscal 2020. Now I'll turn to our year-to-date results. Total sales for the 39-week period increased 28.1% or $204.7 million to $934.0 million compared to $729.3 million in the prior year. Our comparable sales growth on a reported or unshifted basis increased 27.2%. Using the realigned period in 2020 for comparability, our comparable sales growth on a shifted basis increased 23.4%. This increase is on top of comparable sales growth of 15.5% in the prior year period and represents comparable sales growth on a 2-year stack basis of 38.9%. Gross profit increased 39.5% or $115.3 million to $407.1 million compared to $291.8 million in the prior year. Our gross margin increased by 358 basis points to 43.6% from 40.0% in the prior year. Adjusted EBITDA improved by 83.6% or $85.9 million to $188.6 million compared to $102.7 million in the prior year. Adjusted EBITDA as a percentage of sales increased 611 basis points to 20.2% in the current year compared to 14.1% in the prior year. Adjusted diluted net income per share improved by $0.46 to $0.59 in the current year compared to $0.13 in the prior year. Moving to the balance sheet. We finished the third quarter of fiscal 2021 with cash and cash equivalents of $309 million compared to $149 million at the end of the third quarter of fiscal 2020, an increase of $160 million. On inventory, we finished the third quarter with $224 million compared to $181 million at the end of the third quarter of fiscal 2020, an increase of $43 million. Our team continues to proactively work with our vendor partners to manage the flow of inventory and to identify opportunities to strategically invest in inventory to meet heightened consumer demand across product categories. Even with our higher inventory balances, the tight industry supply situation and long lead times across multiple product areas have driven periodic supply shortages that we expect to continue into our fourth quarter and likely through the first half of fiscal 2022. With regard to debt, at the end of the third quarter of fiscal 2021, total funded debt was $808 million compared to $1.2 billion at the end of the third quarter of fiscal 2020. The $397 million reduction was due to the repayment of our senior unsecured notes and quarterly amortization payments on our outstanding term loan. As previously announced, during the third quarter of fiscal 2021, we amended our $200 million ABL credit facility to reduce our rate to LIBOR plus a range of 125 to 175 basis points based on percentage utilization. Previously, our rate was LIBOR plus a range of 175 to 200 basis points. We also reduced our unused fee from 37.5 to 25 basis points, and the maturity on our revolver remains August 2025. No amounts were outstanding on our ABL credit facility as of July 3, 2021. Next, I'd like to turn to our outlook. Today, we're raising our full-year fiscal 2021 guidance for the fourth time this year. The 2 primary contributors to our guidance raise this quarter include: first, our third quarter results exceeded our expectations embedded in the full-year guidance that we shared in June. And second, while we expect our fourth quarter to be better than our previous expectations, we do expect our growth potential in the quarter will be impacted by the availability of certain products, particularly concerning chlorine tabs. Before I review the updated guidance figures, it's important to note, as I mentioned earlier, that the calendar shift in the 53rd week effectively reduced fourth quarter sales by approximately $38 million and adjusted EBITDA by approximately $11 million compared to our prior year performance. The tireless efforts of our associates and our business performance gives us confidence today to raise our guidance, which incorporates both sales and adjusted EBITDA growth in the fourth quarter on a year-over-year basis despite the nonoperational headwinds of the calendar shift in the 53rd week in the prior year. For fiscal 2021, we're providing the following guidance: sales of $1.305 billion to $1.325 billion, representing a total sales increase of 20% year-over-year after excluding the impact of the 53rd week in the prior year. This compares to our long-term growth algorithm of mid to high single digits. Our increased sales outlook for fiscal 2021 incorporates comparable sales growth of 36% on a 2-year stack calendar basis. Second, adjusted EBITDA of $260 million to $270 million represents a 54% increase year-over-year, excluding the impact of the 53rd week in 2020 and adjusting for public company costs. This compares to our long-term growth algorithm of low double digits. Finally, adjusted diluted net income per share of $0.80 to $0.85. You'll also note that we now expect 192 million weighted average shares outstanding on a diluted basis for fiscal 2021 compared to our year-to-date fully diluted share count of 190 million shares. In summary, the third quarter of fiscal 2021 was a record quarter by all measures. We drove strong financial results throughout our P&L. Our entire organization is making great strides against our key growth initiatives, and with the partnership of our long-term vendors, we're successfully navigating the tight supply chain in this environment of heightened consumer demand. We will continue our relentless focus on enhancing our consumers' experience and executing our initiatives to continue to drive growth and market share gains. With that, I'll hand it over to the operator to open the line for Q&A.

The first question is from Jonathan Matuszewski of Jefferies.

First one is on chlorine availability. You mentioned some periodic shortages and stock-outs in some locations. Sounds like supply chain issues will persist maybe into the first half of next year. Do you think out of stock issues will sequentially worsen in this final quarter? And what alternatives are you pursuing as you think about potentially heightened demand for chemicals next pool season? That's my first question.

Jonathan, it's Mike. First of all, we're at a bit of a low point in the flow of chlorine granules into our manufacturing, so we do expect the fourth quarter to be constrained to demand. We will have a nice comp in our chlorine tab sales, but we're not going to be able to drive the 100% comp that we saw in Q3. So that's the first comment. The second comment is, we've been working very hard to secure additional chlorine for our next fiscal year. That pipeline is growing nicely, and we expect to have somewhere in the 40% to 50% increase in chlorine granules and pounds for next year. So I think to sum it up, tight in the fourth quarter, for sure, better next year, but we don't expect supply to really normalize until after pool season 2022.

That's super helpful color. And just as a follow-up, you mentioned a 40% to 50% increase in chlorine granules and pounds for next year. A question we get from investors a lot is how to think about that long-term sales growth trend of 6% to 9% after two record years. So not looking for formal guidance for 2022, but is it fair to say that kind of those building blocks are still on the table even after 2 record years, and we should see growth year-on-year?

Yes. Well, look, it's too early for us to provide guidance. But here's how we're thinking about 2022. The first thing is, the secular macro trends that we're experiencing show no signs of slowing down. The recurring demand for our essential products and services is growing along with the installed base. The industry continues to be able to pass cost through to the consumer. So if you look at that setup for the industry, it looks great from a demand perspective. We also know we have great collaborative vendor partners. But that being said, there likely will be some shortages of product into next year, I would say, especially chlorine. So we feel very confident in the momentum we have in our growth strategies. We're confident we're gaining share this year, and we'll gain share next year, but we're not providing any more specific guidance for 2022 yet.

The next question is from Steven Forbes from Guggenheim Securities.

Mike, maybe just to start, a follow-up question on the shortage, just the outlook here, right? Curious if you can comment on the behaviors of those customers that were underserved per se during the quarter and whether you think it's impacting your customer file growth trends? As you think about the traditional sort of funnel and wallet share capture in the customer journey, right, that you see, how is the shortage impacting the journey today? And what are you sort of doing to prevent migration right away from Leslie's in '21 and thinking about '22 as well?

Yes. Steven, I think the first thing to note is that we're comping at very high rates in our tabs sales. We worked very diligently beginning last October to secure additional chlorine granules. So we feel good about the work we've done there. I did say we weren't able to meet all the demand, and that's correct. But we are definitively gaining consumers by having tabs when others don't. I mentioned the file growth of 16% in the year, in the quarter. The new customer file was up plus 30%, and about 1/4 of that 30% came from new customers who bought tabs. So we're actually seeing a boost to file growth from tabs currently. It's not the preponderance of the growth, but it is a positive. We expect with the work we've done now to secure additional supply for next year, we'll be able to keep or accelerate that dynamic.

And then just a quick follow-up. You've given us a stat in the past, right, just the percentage of sales generated by the loyalty members. When we look at sort of the growth here accelerating sequentially, any sort of update on the percentage of sales or percentage of transactions being generated by the loyalty members?

Yes. I will say this: with the launch of Pool Perks, we saw loyalty file growth grow. We also saw engagement grow. And we saw penetration increase about 500 basis points, penetration as a percent of total transactions. So we just feel really good about the dynamics we have in the regular file as well as the loyalty file. One of the things I'm particularly encouraged about is new customers this quarter are spending 7% more than new customers did last year in the same quarter. Our retained customers, basically last year's new customers, are buying 14% more this year than last year's retained customers. So the dynamic that we've been talking about, where we launch loyalty, it improves engagement, membership grows, total file grows, we get our consumer in a file, and then we're very good about laddering them up. On a 3-year look-back basis, our customer lifetime value on contribution, not revenue, Q3 '21 versus Q3 '20 is up 14%. So we are really encouraged by the metrics.

The next question is from Kate McShane from Goldman Sachs.

My question is around pricing power. Just with the amount of inflationary headwinds there seems to be across all of retail right now because of different drivers, could you remind us just how much pricing power you think you have? What actions you may have taken during the quarter and what we could expect for the rest of the year?

Yes, Kate. We have said we expected inflation for the quarter to be around 6%. It's 6% to 7% as far as we are calculating it. We haven't seen any resistance to passing that cost through. We're also doing fewer promotions. At this point, when we say we've been able to pass costs through, we haven't seen anything that would tell us we cannot continue to do that, meaning we haven't seen any hesitancy from the consumers to buy at a higher price. And if you take tabs just as an example, chlorine tab pricing is up almost 40%. So a 35-pound bucket of tabs, that's maybe $35 versus the prior year. A homeowner with a pool, who typically has a little higher income, is looking at a pool that costs $50,000 to $100,000 plus, and they're spending $30 or $50 more to maintain a portion of it; I think that's very reasonable. It makes sense to think about it that way.

Yes. And I'd add to that as well. When you look across our categories, given the nondiscretionary nature, we've seen inflation and those price increases throughout our business. So Mike is calling out sanitizers and trichlor because it's the largest increase in Q3, but we saw increases across our entire portfolio of product categories.

The next question is from Garik Shmois of Loop Capital.

Great. Just given the gross margin expansion this year and recognizing you're not providing guidance for 2022, but just how should we think about the step-up and how sustainable this new elevated level of gross margin is?

Yes. You're right; we're not going to provide guidance on gross margins going into next year and historically haven't done so either, even for the current year. But we're pleased with being up 358 basis points year-to-date over last year, which is well above our long-term growth algorithm. When you think about our performance this year and what the core drivers were, you saw rate improvements and occupancy leverage given the sales increase, partially offset by business mix with the growth of other portions of our business, including the wholesale channel and the hot tub business. Gross margins are very important to our model. But ultimately, we're looking to drive EBITDA and earnings growth. So it's a balanced formula that we'll continue to focus on.

Okay. And then just on the M&A front, you made the 2 acquisitions in the quarter. Can you just provide any more color on those acquisitions and how the pipeline is looking?

Yes, Garik. I would characterize them as tuck-in acquisitions. As I said in the remarks, there are abundant opportunities out in the industry at very attractive multiples. So we're doing 2 things; we're actively managing that pipeline, and we're also staffing up internally to increase our throughput because there's more opportunities available right now, and we'd like to be in a position to take advantage of those, both through the balance of this year and into next year.

The next question is from David Bellinger from Wolfe Research.

So my first one is just a follow-up on the inability to meet customer demand you highlighted. Is there any way to quantify the level of sales you missed out on in the quarter? And is that dynamic leading to some type of sales deceleration early into the fiscal Q4 period?

Yes, David. It's a good question, and we thought about it internally. We can't come up with a number for demand that we missed. When I say we've had periodic outages, that has indeed been the case. I'm proud of the team's work and our suppliers' work on keeping us in stock most of the quarter. However, there were periodic outages in some locations. When you look at the next quarter, we spoke to the fact that we will have some supply chain challenges, particularly earlier in the quarter, which is right now around chlorine availability. We doubled chlorine sales in the third quarter, but we won't be able to do that in the fourth quarter.

Understood. Okay. And then my follow-up here. You mentioned the omni business flexing well, growing very nicely this quarter. Can you talk about whether you view those sales as largely incremental in areas without a store presence? Are you reaching a new customer there? Are these somewhat cannibalistic to store sales? And also any color on the margin profile of online, if you could?

Yes. First of all, with regard to omni, we can track how much of it is pure incremental. The way we currently have that set up is we ship from stores when we don't have inventory in the DCs for a digital order, which is running in the 10% to 15% range just on pure incremental. So we're quite pleased with that. We don't see any trade out. It was advantageous in the third quarter to have buy online pickup in the store because when you manufacture chlorine tabs, they need to be individually wrapped to ship online, taking longer to make. So we made the decision to manufacture fewer wrapped tabs to maximize throughput on unwrapped tabs, while still offering them online with buy online pickup in store. This was a key capability in the last quarter.

Yes. More broadly, when we talk about profitability by channel, we don't give specifics. But when you consider the total contribution, past the gross margin line to total contribution, it's a very attractive business. Ultimately, we're focused on serving consumers how they wish to be served. As Mike mentioned, we're seeing great traction through our omni initiatives and benefiting from having these capabilities in the market right now.

The next question is from Ryan Merkel from William Blair.

So my first question is on labor shortages. Has this been an issue at all for you? And if so, how you managed it?

Yes. Good question, Ryan. We have faced challenges across the country regarding staffing. I think we're very happy with the staffing levels across the organization. I think we've managed through a bit more turnover in certain markets at certain times. As you know, there’s been an uneven reopening of the economy. Our team has worked through the challenges, and we're appropriately staffed throughout our network to serve consumers, although it's been an area of focus for us. I expect that to continue, but I'm not concerned about the level of labor availability to serve consumers.

Yes, Ryan. I would give a bit more color on that. We're fully staffed, as Steve mentioned. The nuance is we are utilizing a bit more temp labor than we would like. So with schools resuming, we believe and hope that the labor market will improve somewhat. But overall, we're pleased with how we've managed through tightness this year-to-date.

Okay. Good to hear. And then secondly, peak pool is a concern for some. Mike, based on your comments, it doesn't sound like it's a concern for you as we sit here today. But I know you're not giving guidance for next year, but any reason that the industry wouldn't see its normal mid-single-digit growth? Is there any puts and takes that you can call out here today?

Yes, Ryan. I don't see any. The elevated level of pool builds seems very intact. There was some concern last year regarding backup in permits and some backlog at construction, with people potentially getting tired of waiting and cancelling. We haven't seen that. If anything, construction backlogs appear to be growing, and permits and installations are increasing. The installed base of pools has grown every year for 50 years and seems to be growing faster now. We feel good about the industry's setup for next year.

The next question is from Liz Suzuki from Bank of America.

Are you finding that pool owners are able to stretch the life of their existing chlorine because they just don't really have a choice if there's that much of a shortage? What kind of lasting damage do you think underchlorination causes? Does that represent an opportunity for future sales of corrective measures?

Yes. Steve, do you want to talk about underchlorination? You know more about that than I do.

Sure. Yes. It's pretty clear when there's underchlorination because you end up with algae blooms that need to be addressed. More likely, consumers are finding alternatives. We’re seeing growth in alternative sanitizers, although that growth isn't as large as what we've seen in chlorine tab growth. We sell all solutions, so if a consumer wants a salt cell generator, we can provide it for them. If they want to buy alternative sanitizers beyond traditional trichlor, we carry that as well. Consumers are not ignoring their chlorine need. We've communicated effectively with our consumers about how to optimize their chlorine usage. Balancers are required to keep chlorine effective and can limit your need for excessive chlorination. So there are processes that can be utilized to extend the life of chlorine, providing benefits to our consumers and deepening the relationship we have with them.

Great. As you plan to enter the off-season, which is usually a time of investment, what are the biggest areas of opportunity that you'll be focused on for next season? Could you talk a bit more about AccuBlue Home 2.0?

Sure, Liz. First, our slow seasons are certainly not as slow as before. Steve and I recently toured our distribution centers and noted that they are busy year-round, which is encouraging. Regarding next year, we're working to secure sufficient supply. We're buying forward deeper into next year than we ever have before, specifically for equipment and chlorine commitments and other key categories. With regards to AccuBlue, we launched in mid-July, which is late in the pool season. It was a soft launch—no marketing beyond a couple of emails and not sold in stores. Despite minimal marketing, we've sold through more than 80% of what we produced, which was a small amount. The purpose was to see a gradual build. Overall, it was well-received, and we're getting excellent feedback. It works well, and despite some initial concerns, it matches in-store results. We’re fine-tuning customer onboarding and learning materials. Version 2.0 is in prototyping and will have a much better user experience. We’re excited about scaling it next year without providing specific guidance yet on what to expect for Version 2.0. As we give our formal 2022 guidance, we will include it.

The next question is from Peter Keith from Piper Sandler.

Mike, you talked about the installed base growing, which we can see with that backlog of adding 100,000 new in-ground pools every year. What about the above-ground pools purchased during 2020 and 2021? Do you think there could be some elevated level of abandonment that might reduce the total pool installed base over the next year or 2?

It's an interesting question, and we're monitoring it. The first thing is over history, there's been a high abandonment percentage of above-ground pools. It’s tough to quantify, but 1/4 is not uncommon, maybe more. We expect some abandonment, typically within the industry. However, many people buying above-ground pools are waiting for in-ground pools, so some of those abandoned pools are actually when they transition to in-ground pools. It’s a challenging number, but we do expect a bit more abandonment than usual. Our above-ground pool and hot tub sales for the quarter doubled, but still represent less than 5% of our total sales for the quarter.

I'm sorry, Mike. Just to clarify, I was asking about the in-store testing since you collect pretty good information regarding pool sizes, etc. Where do you think you stand now as a percentage of your loyalty program or customer base that owns above-ground pools?

Yes, we are gathering rich data from devices, but it’s early days; our launch was only three weeks ago. We’re very interested in that number but aren’t able to quote it now.

We do have some overall percentages, but I can’t recall that specific number. Less than 5% of sales is in above-ground pools, so it’s not a large proportion of the file.

The next question is from Simeon Gutman from Morgan Stanley.

I wanted to ask you about the updated guidance. It looks like the top line change is in line with the beat this quarter, but net income change is a little below. Can you bridge the quarter's beat versus the updated guidance for the full year?

Yes. Great question, Hannah. When we gave our guidance in early June, we had a strong visibility on what Q3 expectations were going to be. Now we performed better, finishing strong, which affected our Q4 expectations. The calendar shift in Q4 will reduce profitability due to the lost peak week in July, approximately 75 basis points in percentage reaching EBITDA margin. We're also pulling forward some investments into Q4 to drive future growth, which will impact margins. These are the key factors impacting the updated guidance for net income.

The next question is from Joe Feldman from Telsey Advisory Group.

Great. I wanted to ask about chlorine. Why can't it be produced faster? I thought last quarter you had new relationships with suppliers and could procure more than the competition. Did that change over the past quarter, or is their supply just gone away?

Yes. We secured a significant amount more this year, around 30%, and have been able to manufacture it. We did not anticipate the level of demand. We will have a strong comp in chlorine tab sales in Q4, but we don't have enough inventory in the raw chlorine to reach the same levels as in Q3. The business remains healthy and growing, and we continue to work on acquiring more.

I think, Steve, you mentioned the shift toward other alternatives like saltwater. Did you see an increase in that this past quarter? I thought you said you were starting to see that.

Yes, we are seeing alternative sanitizers increase year-over-year in the quarter, but not compared to the chlorine tab market. We’re agnostic and will provide any solution our consumers want.

This concludes the question-and-answer session. I would like to turn the conference back over to Michael Egeck for any closing remarks.

Thanks, Sachi. We appreciate you all joining us today and your interest in Leslie's. We look forward to speaking with you again at our year-end call. In the meantime, stay safe. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.