Good afternoon and welcome to the Third Quarter of Fiscal 2023 Conference Call for Leslie’s, Inc. At this time, all participants are in a listen-only mode. Following the prepared remarks, management will conduct a question-and-answer session. As a reminder, this conference call is being recorded and will be available for replay later today on the company’s website. I will now turn the call over to Caitlin Churchill, Investor Relations. Please go ahead.

Thank you and good afternoon. I would like to remind everyone that comments made today may include forward-looking statements, which are subject to significant risks and uncertainties that could cause the company’s actual results to differ materially from management’s current expectations. These statements speak as of today and will not be updated in the future if circumstances change. Please review the cautionary statements and risk factors contained in the company’s earnings press release and recent filings with the SEC. During the call today, management may refer to certain non-GAAP financial measures. A reconciliation between the GAAP and non-GAAP financial measures can be found in the company’s earnings press release, which was furnished to the SEC today and posted to the Investor Relations section of Leslie’s website at ir.lesliespool.com. On the call today from Leslie’s are Mike Egeck, Chief Executive Officer; and Steve Weddell, Chief Financial Officer; and Scott Bowman, Chief Financial Officer Designate. With that, I will turn the call over to Mike. Mike?

Thanks Caitlin and good afternoon everyone. Thank you for joining us. Please note that we have posted a Q3 2023 earnings deck to the Leslie’s IR site and that we will be referring to certain pages in that deck during our call. As we shared in our pre-release three weeks ago, it was a difficult quarter. Low double-digit traffic declines resulted in a 12% comparable sales decline and a 9% total sales decline. In addition to fixed cost deleverage associated with these sales, we faced unexpected in-season product cost increases and higher distribution expenses that significantly impacted gross margins for the quarter. Our ongoing analysis points to three primary drivers of our Q3 traffic and sales results. First is weather. Our weather reporting service calculated that weather accounted for a 5% year-over-year decline in sales for the quarter. Weather headwinds were felt across most of our store base with significant impacts in California, Texas, and Arizona. The weather in Florida was relatively normal during the quarter as it has been all year, and our business in Florida significantly outperformed during the quarter year-to-date. Sales in Florida rose by high single digits in the quarter and are up mid-teens year-to-date. The second driver was increased consumer price sensitivity. After three years of significant price inflation, consumers were not willing to absorb price increases during the quarter. This prevented us from taking the pricing actions required to maintain margins as product costs increased and also prevented us from maintaining our pre-June 1st pricing on core chemicals. As we have discussed before, we generally aim to maintain a relative price point that is above mass and just below specialty. That relative price position was out of balance for several weeks in the third quarter, which we addressed with our June 1st price actions. Those actions resulted in essentially flat year-over-year chemical pricing despite rising costs. The third driver was that some of our customers had a greater-than-normal amount of chemicals left over from last year. This was confirmed by two separate consumer surveys, one conducted on our behalf and another by one of our chemical partners. This consumer behavior is unprecedented and surprising, given the hazardous nature and useful life of these chemicals. Transactions were down 12% in the quarter, reflecting double-digit traffic declines that offset solid conversion rates. Average order value increased by 3%. The traffic decline was broad-based and impacted both non-discretionary and discretionary products. Non-discretionary sales were down 6% and discretionary sales were down 24%. Total chemical sales for the quarter were down 6% as increases in Cal Hypo and select specialty chemicals partially offset a 16% decrease in Trichlor sales. Equipment sales were down 8% in the quarter, primarily driven by volume. The decrease in discretionary product sales was predominantly caused by hot tubs and above ground pools, as macro factors continue to impact demand for these highly discretionary high-ticket items. Non-comp sales contributed 3% to the quarter, driven by acquisitions and new store builds. The data we analyze suggests that the top line trends we are seeing are an industry-wide issue. Aggregated credit card data for the pool supplies retail category indicates that industry sales, excluding Leslie’s, were down 7.1% for the quarter. Based on total company sales, our declines were 220 basis points more than the category for Q3. That said, aggregated credit card data for the pool supplies retail category does not include hot tubs or marketplaces. When we adjust those two categories out from our sales for a more comparable review, Leslie's performed slightly better than the industry. We are clearly experiencing a highly unusual pool season following three years of strong growth. However, the long-term fundamental advantages of the pool industry remain intact. New pools continue to be built, and the growing installed base of pools need to be maintained. As you can see on the slide, the industry has a long track record of consistent growth and Leslie’s has consistently grown faster than the industry. We remain the leading direct-to-consumer pool and spa retailer with scale, capabilities, and brand awareness that our competitors do not have. So, while our team navigates the current industry headwind, we also remain focused on executing the key strategic initiatives that underpin our competitive advantages and will drive our long-term success as industry conditions normalize. Turning to our strategic growth initiatives. First, given the traffic challenges in the quarter, our customer file was down 8% versus the prior year’s quarter. Second, average revenue per customer was down 1% in the quarter, primarily driven by decreases in big ticket items, specifically hot tubs and above ground pools. Our pool purchase loyalty members continue to outperform. Loyalty member sales were down 3% in the quarter. Regarding our PRO initiative, we ended the quarter with more than 3,700 PRO contracts in place and completed the conversion of 15 residential stores to our PRO format prior to the start of the season. We currently operate 98 PRO locations. PRO Consumer Group sales declined 3% in the quarter with comp sales down 13% as our PRO comps were impacted by the same factors as our overall business. In addition, Trichlor pricing has been more pressured on the PRO side compared to the residential channel and contributed an outsized headwind to our overall gross margin performance. Our guidance for the remainder of the year assumes no change from current pricing levels. M&A and new store growth remain an important initiative for Leslie’s, though we will be prudent with the pace of this initiative in the near term as we balance it against our other capital allocation priorities. M&A and new stores drove $16 million to non-comp sales in the quarter. We completed two acquisitions in the quarter that added five locations in the Sunbelt. Year-to-date, we have closed on five acquisitions that added 12 locations, and we have another acquisition under LOI. In the quarter, we opened seven new stores, bringing the year-to-date total to 12. We have identified over 800 opportunities for store densification. We were pleased to launch the program in May and have received positive consumer response and demand to date. While demand has been strong, we are facing supply chain constraints as we ramp up. Our guidance for Q4 assumes no improvement to the top-line trends we experienced in Q3. For gross margin, we expect Q4 to have a full quarter impact from the chemical price actions we took on June 1st, which will be partially offset by the wind down of distribution costs associated with our peak inventory levels. We have also aggressively initiated cost management actions that, coupled with some weak SG&A comparisons, should result in Q4 SG&A being approximately $15 million to $20 million lower versus the prior year quarter. In summary, we continue to have confidence in the long-term outlook for the industry, and we remain focused on prudently executing our strategic initiatives to capture opportunities in front of us and further our industry leadership. At the same time, we are focused on taking immediate action to improve our performance. Let me reiterate the actions we are taking. First, we have adjusted pricing to reflect current market conditions and are now at our relevant historical price position, which is slightly above mass and home improvement and at or slightly below specialty retailers. Second, we are aggressively managing inventory through receipt reductions. Third, we are focused on cost management throughout the P&L including discipline in our marketing investments, utilizing strict ROI criteria. Fourth, we continue to evaluate, develop, and elevate our processes and people. Finally, we are enhancing consumer insight efforts to improve our understanding of evolving consumer behavior. Before Steve discusses our results and outlook, I want to acknowledge our CFO transition. I’m very pleased to welcome Scott Bowman as our new CFO, effective August 7th. Scott’s depth and breadth of public company experience spans both financial and operational areas and will be a huge asset as we return the business to growth. I would also like to thank Steve for his leadership and partnership, as well as his commitment to ensuring a smooth transition. I’ll turn it over to Scott to say a few words.

Thank you, Mike. Leslie’s has carved out an admirable leadership position in an attractive industry and based on my initial observations, I see plenty of areas where I can leverage my experience to help drive Leslie’s strategic priorities. As I continue getting up to speed on the business, I look forward to digging into areas such as supply chain, product margin management, forecasting, and capital allocation to help deliver continuous improvement in the business. It’s an exciting time to join the team as we drive the next chapter of the company’s growth, and I look forward to speaking with all of you in the coming weeks and months. Now, I’ll turn it over to Steve to share more detail on the Q3 financial results and outlook.

Good afternoon, everyone and thank you, Mike and Scott. I know I’m leaving the team in good hands and I look forward to ensuring a smooth transition over the next few months. As Mike noted, it was a challenging quarter. While we have seen slow starts to pool season in prior years due to unfavorable weather conditions, historically, performance has improved around Memorial Day. This year, our third-quarter performance was impacted by industry-wide headwinds due in part to continued unfavorable weather along with atypical consumer purchasing behavior. For the third quarter, we reported sales of $611 million, a decrease of 9% or $63 million when compared to the third quarter of fiscal 2022. Our comparable sales decreased 12% or $79 million. Our comparable sales on a two-year stack basis decreased 4% and on a three-year stack basis grew 15%. Our non-comparable sales totaled $16 million in the third quarter of fiscal 2023, driven by nine completed acquisitions that added 25 stores, as well as 19 net new store openings since the end of the second quarter of fiscal 2022. With respect to trends by Consumer Group, comparable sales declined 10% for Residential Pool, 13% for PRO Pool and 23% for Residential Hot Tub. On a two-year stack basis, comparable sales declined to 5% for Residential Pool, increased 4% for PRO Pool, and declined to 7% for Residential Hot Tub. While our third-quarter sales declines were unprecedented, they were in line with industry trends. Gross profit decreased 17% or $52 million compared to the third quarter of fiscal 2022, and gross margin rate was down 390 basis points to 41.2% from 45.1% in the prior year period. During the quarter, gross margins were impacted by four primary factors. First, incremental distribution expenses, including those related to capitalized distribution costs and investments in labor, off-site storage and transportation costs, lowered gross margin by 150 basis points. Approximately 50 basis points of this rate decline was due to deleverage of fixed distribution costs from lower comparable sales. Regarding higher capitalized costs, as we built up inventory in prior periods, we capitalized more distribution costs, and during this quarter recognized some of those costs as we sold through the inventory. We have also continued to invest in our distribution network to ensure it operated smoothly at significantly higher capacities with improved service levels to support better in-stock positions across our businesses. We expect the gross margin headwind from distribution expenses to be smaller in the fourth quarter. Second, higher product costs had a 140 basis point impact on gross margins in the quarter. While we experienced higher product costs across categories, the largest impact was in our chemicals categories. We initially increased our selling prices for chemicals at the start of the season, but we could not successfully maintain those higher pricing levels. As Mike discussed, we reduced prices on June 1st. We expect greater product margin rate pressure in the fourth quarter as we experience a full quarter impact of those price changes. Third, occupancy and other costs deleveraged by 70 basis points predominantly due to the decline in comparable sales. We expect continued rate pressure in the fourth quarter related to occupancy and other costs deleverage given our expectations for comparable sales. Finally, business mix impacted gross margins by 30 basis points, primarily due to M&A completed during the last 12 months. We expect a smaller impact on rate from business mix in the fourth quarter. Looking at the numbers in a different way, deleverage of fixed costs impacted gross margin rate by 115 basis points in the quarter, with the remaining 275 basis points of margin compression due to lower product margin, higher distribution costs, and business mix. Now I’ll turn to SG&A. SG&A increased 3% or $4 million compared to the third quarter of fiscal 2022. We continue to focus on managing costs in the business generating cost savings and driving ongoing organizational optimization. We have made additional actions to reduce our SG&A in the fourth quarter and into fiscal 2024. Adjusted EBITDA was $129 million compared to $183 million in the prior year. Interest expense increased to $18 million during the quarter from $7 million in the prior year, and our effective tax rate increased to 26.1% compared to 25.7% in the prior year. Adjusted net income was $76 million in the third quarter of fiscal 2023 compared to adjusted net income of $126 million in the prior year. Adjusted diluted earnings per share was $0.41 in the third quarter of fiscal 2023 compared to $0.68 in the prior year. Diluted weighted average shares outstanding were $185 million in both the third quarter of fiscal 2023 and fiscal 2022. I’ll turn to year-to-date results. Total sales for the first nine months of fiscal 2023 decreased $68 million or 6% to $1.019 billion from $1.087 billion in the prior year. Our comparable sales decreased 11% or $118 million. On a two and three-year stack basis, our comparable sales were flat and up 23% respectively. Gross profit for the first nine months of fiscal 2023 decreased 15% or $69 million to $388 million from $457 million in the prior year. Gross margin rate decreased by 3.90 basis points to 38.1% from 42.0% in the prior year, with 140 basis points attributed to negative comparable sales growth in the first nine months of fiscal 2023. Adjusted EBITDA was $109 million in the first nine months of fiscal 2023 compared to $193 million in the prior year. Interest expense increased to $48 million during the first nine months of fiscal 2023 from $21 million in the prior year. Adjusted net income was $25 million in the first nine months of fiscal 2023, compared to $112 million in the prior year. Adjusted diluted earnings per share was $0.14 in the first nine months of fiscal 2023, compared to $0.60 in the prior year. Moving to the balance sheet, we finished the third quarter of fiscal 2023 with cash of $19 million and had $31 million outstanding on our ABL. This compares to cash of $193 million and no amounts outstanding on our ABL at the end of the third quarter of fiscal 2022. The reduction in net cash was primarily due to investments in inventory and higher M&A activity during the past 12 months. Currently, we do not have any outstanding amounts on our ABL and have approximately $240 million in available credit. We ended the third quarter of fiscal 2023 with $437 million of inventory, an increase of $75 million compared to the third quarter of fiscal 2022 and a sequential decrease of $56 million compared to the second quarter of fiscal 2023. The increase in inventory compared to the prior year period was primarily related to core sanitizers. Consistent with our commentary last quarter, inventory levels have peaked, and we continue to look for opportunities to further reduce our inventory. During the third quarter and so far in the fourth quarter, we have, and will continue to aggressively manage purchase orders and receipts. We expect to end fiscal 2023 with less inventory than we had at the end of fiscal 2022. At the end of the third quarter of fiscal 2023, we had $792 million outstanding on our secured term loan facility compared to $800 million at the end of the prior year period. The applicable rate on our term loan increased to LIBOR plus 275 basis points in our third quarter and our effective interest rate was 7.6% compared to an effective interest rate of 3% in the prior year. In June 2023, we amended our term loan credit agreement to replace the existing LIBOR-based rate with a term SOFR-based rate as an interest rate benchmark. Other material terms of the facility remain substantially unchanged, including the maturity date of March 2028. Our ABL and term loan agreements do not have quarterly financial maintenance covenants. Our outlook remains unchanged from the revised outlook we shared on July 13th, the details of which are in today’s earnings press release. As we only have one more quarter left in the fiscal year, I will be discussing each metric in the context of our implied fourth quarter outlook. Our fourth quarter outlook assumes a sales decline in the range of 9% to 14% with comparable sales declines of 12% to 16%. Our outlook also assumes a gross margin range of 39.1% to 39.7% compared to 45.7% in the prior year period. In the fourth quarter, we expect additional rate pressure from product costs, continued impact from occupancy cost deleverage, a lower impact from distribution costs, and business mix compared to what we experienced in the third quarter. We expect fourth quarter adjusted EBITDA to be in the range of $61 million to $71 million, and adjusted diluted earnings per share to be in the range of $0.14 to $0.18. Our outlook for the fourth quarter includes interest expense of $17 million, and our diluted weighted average shares outstanding do not assume any incremental share repurchases. On capital allocation, our prioritization has not changed. Our first priority has been our capital structure. We are targeting a leverage ratio of approximately three turns. Our second priority is to invest in growth, both organically and through M&A. In the first nine months of fiscal 2023, we invested $27 million in capital expenditures, and we deployed $16 million towards acquisitions. Mike noted we will continue to be prudent in our pursuit of M&A opportunities. Our focus remains on acquiring pool supply retailers in the Sunbelt, and we will be disciplined about acquiring high-quality businesses at attractive purchase multiples. Our final priority is to return excess cash to shareholders. While we do not expect to repurchase shares in the near-term under our existing authorization as we focus on our other priorities, we will continue to evaluate opportunities to repurchase shares based on available investment opportunities, our financial position, and market conditions. And with that, I will hand it over to Mike. Thank you.

Thank you, Steve. Despite the challenging headwinds we are facing in this highly unusual pool season, the aftermarket pool and spa industry has proven over time to be one of the most durable and advantaged consumer product categories, and we have a long track record of profitable growth in the industry. We remain laser-focused on executing our long-term growth initiatives, market share gains, and shareholder returns. With that, I will hand it back to the operator for Q&A.

Thank you. We will now be conducting a question-and-answer session. And our first question comes from Simeon Gutman with Morgan Stanley. Please go ahead.

Good afternoon everyone. My first question, Mike, you mentioned some market share from credit card data. Thanks for that. We don’t see that data. So, you adjusted your price, you said the price change was on June 1st, and my first question related to that is your product costs are much higher. You’ve reduced prices because you weren’t achieving the sell-through. Does that imply that a significant portion of the industry is accepting much lower margins for selling products or chemicals? Additionally, if you were either holding or increasing market share even under those circumstances, which you might clarify, then why lower the price?

Yes, Simeon, thanks for the questions and good questions. First, on the margins, as we’re active in M&A with specialty retailers, we do see that we operate at higher margins than they do. And we can back that in pretty specifically to product cost and feel comfortable that we still have a cost advantage versus specialty retail. Though we do need to say that, that gap has narrowed from 2021 and 2022 when we had some extraordinary advantageous prices on some core chemicals. With regards to market share, we look at market share in a couple of ways. The aggregated credit card data we use is from Bank of America. As you can see on the slide, that shows we were basically flat to the industry in the quarter. We also listened very carefully to our pool peers and the largest distributor in the industry showed sell-in to their pool specialty retail at minus 11%. So, that’s also a flat comparison to what I would say is a flat growth rate and flat market share based on that comparison. Now, look, that’s a deceleration from the market share gains we’ve had consistently for the last eight quarters, so we’re not pleased with that. But that’s the situation we are in for the quarter.

I would like to follow up on margins. Before the pandemic, we had a couple of years of historical data. It appears that our model indicates a 13% EBIT margin, and we now have over $500 million in sales. I understand that there's been a deceleration, making it difficult to determine the optimal margin for this business. I believe it should be at least 13% based on sales, but is there any reason it shouldn’t be? Or is there a possibility that it could be even higher than 13%?

Well, look, I think it’s early to talk about 2024. But in terms of where we were pre-pandemic with our gross margins and our operating margins, we feel that the headwinds we’ve got this year, particularly in this quarter, do abate and feel like we’ve got a pretty clear path to recover to those levels, at least those levels.

Right. okay. Thank you.

Our next question comes from Steven Forbes with Guggenheim Securities. Please go ahead.

Good evening, Mike, Steve, Scott. I wanted to maybe expand on Simeon’s question, but in particular, focus on the customer file dynamic. So, Mike, could you just expand on your learnings from the quarter as it pertains to the customer file down 8%. Specifically looking for any insight into what’s really driving the reduction. Is the consumer migrating back to maybe its legacy provider or outlets? Is it marketplace disruption? Is it mass? And on that also, when should we expect Leslie’s to return to positive file growth?

Yes, Steven, thanks for the question. I think the way we’re thinking about the file or the lack of file growth, the file shrinking 8%, has a lot to do with the two surveys that we ran, which showed a larger-than-normal amount of product left over in the industry in the consumers’ hands. We’ve turned in calling it the garage and shed inventory internally. One of those surveys we conducted on our own through a third-party, and one after we pre-release, we were contacted by one of our chemical partners who had run a similar survey of a similar size and come up with remarkably similar results. We have some idea of what that size is now, and though they came at the number in different ways, again, the final impact in terms of a headwind is quite similar. There’s definitely some of that going on. And when you think about a need-based industry, right, that’s predominantly nondiscretionary spend. The question is, how can nondiscretionary spend be down? Nondiscretionary spend for the quarter was down 6%. It’s only down if need is impacted, and two things impacted need in the quarter. The first was weather. We experienced the coldest weather in a decade according to our reports. Cold weather means less need for sanitizers, which means fewer people purchasing, impacting our file because our file consists of active members. Looking at the surveys conducted revealed that consumers indicated they already had chemicals. Even in a down quarter, we ran more water tests than the prior year’s period, but conversion of those tests was lower. We were hearing from stores that customers came in stating they had those chemicals. It’s been a highly unusual scenario. We believe this is a one-season occurrence based on three years of highly unstable supply and price inflation leading people to stockpile. We plan to conduct further consumer surveys at the end of this season and before the next season to confirm our beliefs about shifting inventory out of consumers’ hands by next pool season.

I’ll add as well that the decline in customer count was materially impacted by the discretionary declines as well.

That's a good point.

Thanks, Steve. Maybe just a quick follow-up on PRO, sort of a similar question, down 3%. As we think about the growth in PRO stores and the growth in PRO partner contracts on a year-over-year basis, anything specifically to note that helps explain what’s transpiring within the PRO segment? Is that just chemical mix or are you seeing less engagement from your affiliate contracts? Any color on the PRO segment would be helpful.

Well, I would say the PRO business has become more competitive. Others have reported seeing Trichlor deflation in that category. That was a significant headwind to the PRO business in the quarter and year-to-date.

Thank you.

Our next question comes from Ryan Merkel with William Blair. Please go ahead.

Thanks. Good afternoon. Mike, I was hoping you could address the risk that chemical prices keep falling. Have you seen competitors cut prices when you cut in June?

Yes, Ryan, thanks for the question. It’s essential to understand that the price actions we took on June 1st were to align ourselves with specialty retail. Since then, we haven’t seen any reaction from specialty retail to decrease list prices. Additionally, we haven’t observed any outsized promotional activity in the residential pool space. Currently, it appears we have a stable pricing situation and a stable promotional environment.

That’s good to hear. And then my follow-up: do you have any goals for inventory reduction, cost savings in COGS, or SG&A savings that you can share?

We’re not sharing any specific inventory goals at this moment. As we said, as Steve noted, we will end the year with lower inventory compared to last year. We’re actively working to bring that number down as low as possible; however, we won’t comment on our internal targets. Regarding SG&A, we talked about it in our script; we expect to see $15 million to $20 million lower in Q4 this year versus the prior year, and we are diligently working on reducing the cost run rate as we go into 2024.

That’s helpful. Best of luck.

Thanks.

Our next question comes from Dana Telsey with Telsey Advisory Group. Please go ahead.

Hi, good afternoon everyone. As you think about the sales decline of around 9% this quarter and consider the cadence going forward into the next fiscal year, are there any puts and takes of how you’re planning the business and how you’re thinking about traffic, transaction volume, or discretionary versus nondiscretionary products? Additionally, how are you planning to market this or how you’re reassorting the stores in order to minimize gross margin erosion and drive demand?

Yes, Dana, thanks for the question. Look, we start out each year planning for weather to be normal. This year was clearly an aberration of that. We believe weather should be neutral on a comparable basis and should be somewhat of a tailwind going into next year. Similarly, consumer inventory will get worked through the channel, which should also be a tailwind for us. The headwinds into next year include the fact that we got a little out of our normal lane concerning pricing going into the quarter. We were slightly above specialty retail. In the past, we’ve been able to push that up and have others follow; however, that was not the case this year. We learned from that and will maintain our historical price position just below or equal to specialty and slightly above mass. As for additional factors going into next year, in a need-based industry, we believe marketing doesn't drive need; rather, need comes from the install base and purchasing frequency. The challenge we encountered with marketing this year was that due to weather and excess inventory in the consumer channel, we felt we weren't getting our typical ROI on marketing spend and thus were less aggressive. We expect that to normalize next year, allowing for higher marketing spends associated with a better ROI, which should drive market share gains.

Got it. And then just as you finished out this quarter, was there any change in the quarterly progression or cadence of the quarter?

June was particularly difficult in Q3 for us. I noted that it was the toughest quarter overall in terms of weather in a decade. We entered the season, as always, waiting to see the reaction over Memorial Day. Unfortunately, it was disappointing with no lift in business. We began surveying customers and consulting directly with district managers and store owners about what was happening, leading to the price actions we took on June 1st. Overall, it was a challenging traffic situation throughout the quarter.

Got it. Thank you.

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

Great. Thank you very much. I guess you mentioned you’re seeing some of the same factors impacting the PRO business as the retail business. I mean, does that include the pantry loading behavior of folks using chemicals they stored up from last year? Are pros doing that too? Additionally, is there anything you can do to educate the customer about issues they might experience if they’re using expired chemicals?

Yes, Liz, thanks. Good questions. We did not see that behavior on the pro side. Our survey focused on residential consumers, but I don’t believe we’re observing pantry loading on the pro side. Pros likely entered the season believing that Trichlor pricing would come down, which they were correct about, while residential consumers arrived at the start of the year stockpiling based on prior years. As for the second part of your question regarding education, we’re actively doing that in our blogs. It’s critical to highlight that these are not chemicals you want to store. Mostly concerning Trichlor and Cal Hypo, Trichlor loses efficacy if not stored properly and will degrade within a year depending on temperature and ventilation. Cal Hypo can solidify and has combustible properties, so it’s not something that consumers should be storing, and we haven’t seen this behavior in the past.

Great. Thank you.

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

Hi. Thanks. You touched on the SG&A reductions that you’re expecting in the fourth quarter, $15 million in lower costs compared to the prior year period. I’m just wondering if you could provide maybe some more color on the steps that you’re taking and how you’re viewing SG&A at this point as we’re moving closer into fiscal 2024.

Yes, Garik, good question. We’re, look, the way we’re thinking about SG&A is we’re going to reduce it both in Q4 and in our run rate into 2024 to help make our P&L more durable against some of the shocks that we experienced this quarter. Specifically, areas we are addressing in the fourth quarter into next year include marketing, which naturally decreases when we can’t achieve the ROI we expect from our investments. Marketing has reduced in Q3, Q4, and for the year, but we would expect recovery next year when consumer inventory normalizes. With traffic down as much as it has been due to weather and consumer inventory, we’ve reduced labor hours in stores. Also, we are simplifying our corporate organization for increased efficiency and optimization, along with reductions in travel and supplies. Finally, a significant portion comes from performance compensation; this is not a year for us to be paying ourselves or associates.

Understood. I wanted to follow up on inorganic growth. Does the challenging environment right now change your view on either M&A or new store expansion?

No, it doesn’t change our view because we believe weather tends to normalize over time. If consumers have inventory in their garages and sheds, as we believe, that’s an unusual situation, and the catalyst for it, consisting of three years of spotty availability and increasing prices, is gone. Inventory is now readily available. We expect the situation to be transitory as the challenges we’ve faced in the quarter are mirrored in specialty retail. Overall, it makes M&A more attractive in terms of the multiples we’re executing against. However, given the results in this quarter and our outlook for the year, we will be prudent and watch the pace of M&A, but we still think it’s an important initiative for Leslie’s over the long term.

Okay, understood. Thanks again.

Our next question comes from Jonathan Matuszewski with Jefferies. Please go ahead.

Hey, good afternoon. Thanks for taking my questions. The first one was on pricing actions. Mike, I think you mentioned the guidance assumes no change in pricing. Is there anything that would lead you to deviate from current pricing? I guess another way of asking, if traffic or transactions are softer, would you further reduce pricing to try and stem the excess transaction decline? Thanks.

Yes, when I stated no change in current pricing in the prepared remarks, that was specifically for PRO, where we have seen reduced Trichlor pricing, offset a bit by an increase in Cal Hypo pricing. Regarding residential, we currently view demand in the industry as fairly inelastic. The traffic declines we’re experiencing are not driven by price sensitivity but by weather and consumer inventory, which we believe are transitory—so we need to weather these challenges. The price actions we took were because our prices had exceeded specialty retail, a position consumers are not used to and not one we want to maintain. We made those adjustments on June 1st, aligned ourselves with the industry, and now must let this year unfold while weather and consumer inventory normalize to return to our growth patterns.

Got it. That’s helpful. And then just my follow-up, it sounds like the customer insights work picked up on some price sensitivity. Curious how you view equipment upgrades and related spending that didn’t materialize in the second half of this year could benefit revenue next year? Thanks.

Yes, that’s a good question. The general macroeconomic situation signifies customer price sensitivity across industries. We highlighted this in our surveys. The industry, overall, experienced significant price increases over the last three years, coupled with enduring cost pressures. While there may be opportunities to increase prices, the industry must be delicate in how much we raise them to avoid destroying demand. Our equipment segment was reported down 8%, similar to competitors. We believe heightened price sensitivity has encouraged some customers to delay equipment upgrades, but the break-fix business remains durable and ongoing.

Best of luck.

Thanks.

Our next question comes from Andrew Carter with Stifel. Please go ahead.

Yes. Hey, thank you. A couple of questions I wanted to ask are really about visibility into the business. First is about pricing, like getting out over your skis relative to specialty retail. How good are your real-time insights into your price levels? I know you do channel checks, but can a DIYer know that they get listened to if they say, hey, it’s cheaper down the street? And second to that, how quickly do you respond to feedback? Putting all the consumer survey work aside, have you evaluated how many pounds of chemicals went out the door from various locations over the last four years, and what a reversion to the mean could look like considering market share gains, just to provide a context of where you could land? Thanks.

Yes, thanks, Andrew. We have good visibility into pricing dynamics. In 2021 and 2022, we were able to influence pricing in the residential market. Heading into this year, our pricing at the beginning of the quarter was aligned with our Q4 pricing from last year. Our intent was to hold pricing; however, it became evident in April and May that our pricing was slightly above specialty. After Memorial Day, we took actions on June 1 to address the misalignment. We utilize web scraping and feedback from over a thousand stores, including store managers and DMs, allowing us to track our competitors effectively. Regarding the chemical analysis, we are currently investigating that. The surveys we conducted were not specifically targeted at Leslie’s, but understanding those dynamics is crucial. Our growth typically hinges on both core growth and market share, both of which become challenging when excess inventory exists in the channel.

I’ll go ahead and pass it on since I asked enough. Thanks.

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

Yes, good afternoon, guys. It’s Justin Kleber on for Pete. Mike, I wanted to ask about your discussions with vendors regarding 2024 pricing policies. What does the costing backdrop look like for non-discretionary products? Do you think product costs will continue to rise next year? I’m trying to understand whether product margin pressure may linger if the industry can’t pass further price increases.

I appreciate the question. It’s still early to talk about 2024 as we haven't yet initiated price discussions with our vendors, which typically occur 30 to 60 days from now. It’s important for both sides to gauge how the season concludes a bit further into Q4 and their Q3. There is some cost pressure, and after three years of consumers absorbing price increases, there’s definitely more price sensitivity from customers. We serve around 85,000 consumers each day in our stores, allowing us to be attuned to consumer sentiment regarding their willingness for further price increases.

Got it. Okay. That makes sense. And then an unrelated follow-up on leverage. Steve mentioned the three times target. Just in terms of the path to get there, is that more about natural deleverage as EBITDA recovers, or are you foregoing some store growth and M&A opportunities in the near term to focus on reducing debt?

Thanks for the question, Justin. There are a few different paths to think about it. We expect to reduce leverage through a combination of business growth, which should naturally occur, along with potentially allocating excess cash towards debt repayment. This year, cash flow was impacted primarily by working capital issues. We've been consistent relative to our CapEx targets, which are expected around 3% of total sales. I might come in a bit shy of that this year. From an M&A standpoint, we expect a slower pace this year regarding dollar amounts, but we will continue to execute attractive deals, focusing on acquiring businesses at appealing multiples. In terms of the working capital cycle, last year we purchased a lot of inventory late in the season, resulting in accounts payable and accrued expenses getting paid off. We’ve talked about reducing inventory aggressively by year-end, but this will lead to lower accounts payable and accrued expenses from performance incentives, so don’t expect a significant cash flow year this year. However, we see improvement opportunities emerging in 2024, potentially allowing for a continued focus on debt repayment alongside investments in retail and M&A opportunities. It's worth noting that new store growth requires modest capital for store locations or conversions, especially as we transition locations to PRO formats. Our M&A activity primarily involves smaller specialty retailers in the Sunbelt, involving light cash expenditures, so we can continue to pursue capital growth while adjusting our approach to align with current business conditions.

All right. Thanks for that, Steve. And best of luck, guys.

There are no further questions at this time. I would like to turn the floor back over to management for closing comments. Please go ahead.

Yes, I’d like to thank everyone for joining us today and for your continued interest in Leslie’s. We look forward to sharing our Q4 near-end results. Thanks.

This concludes today’s conference call. You may disconnect your lines at this time. Thank you for your participation, and have a good day.