Good afternoon and welcome to the Fourth 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 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 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 Scott Bowman, Chief Financial Officer. With that, I will turn the call over to Mike.

Thanks, Caitlin, and thank you all for joining us this afternoon. I hope that everyone had a good Thanksgiving holiday. To start, I'd like to express my sincere appreciation to all of the Leslie's associates whose contributions allowed us to serve our residential pool, PRO pool and residential hot tub customers at a consistently high level throughout fiscal 2023. Because of their efforts, the foundation of Leslie's business remains solid. For the year, our brand awareness in-stock service levels and corresponding NPS scores were at all-time highs. Our loyalty program grew for the year, and our customer lifetime value also increased. We remain the largest specialty retailer in our industry, with unmatched capabilities and clear long-term growth opportunities. And the industry credit card data indicate that we gained market share again in fiscal 2023. While our financial results for fiscal 2023 were not what we expected heading into the year, we are well-positioned for future success as the pool industry continues to normalize from the temporary challenges of this year's pool season. We entered the fiscal fourth quarter facing three headwinds, which are the same ones that broadly impacted our full fiscal 2023 results. First, unfavorable weather. Second, a macroeconomic environment that resulted in decreased retail chemical pricing and discretionary spend, especially on high-ticket items and finally, customer stockpiling of core sanitizers resulting from three years of supply uncertainty and price inflation. While the latter two factors were largely in line with our expectations for the quarter, weather was better than we originally anticipated and helped us to deliver sales at the high-end of our implied fourth quarter revenue guidance. Profitability in the quarter fell short of our expectations, driven entirely by gross margin. Gross margin performance was impacted by larger-than-expected inventory adjustments made after the completion of our annual physical inventory count. Scott will discuss the inventory adjustments in more detail when he goes over our financial results, but they explain the entire delta between our implied fourth quarter guide and our actual gross margin, and are the reason that EPS came in at the low end of our guidance range. As we navigated these dynamics, we remain disciplined on costs and reduced fourth quarter SG&A expenses year-over-year as planned. Drilling down into our Q4 sales performance. Total sales were down 9% in the quarter, with residential pool down 9%, PRO pool down 5% and residential hot tub down 17%. We were up against some tough comparisons from the prior year's quarter when total sales were up 16%, with residential pool up 10%, PRO pool up 18% and residential hot tub up 80%. As weather normalized, traffic improved to down high-single-digits in the quarter. Total transactions were down 5%, which was also an improvement from down 12% in the third quarter. Average order value was down 4% versus plus 3% in Q3. Equipment sales were down 17%. We saw a continued weakness in high-ticket discretionary categories. And we had a full quarter's impact of the chemical retail price decreases we implemented in June of this year. Total chemical sales were down 4%. Discretionary product sales were down 23% and contributed roughly half of the quarter's total sales decline. Non-discretionary product sales were down 6%. Across our geographies, sales remain challenged with the exception of Florida, where we saw a 3% increase in sales in the quarter and was up 11% for the year. Our analysis of credit card data shows that our sales underperformed the industry by 250 basis points in the quarter, but outperformed the industry by a total of 130 basis points for the year. Turning to our results for the full year. Sales of $1.45 billion were down 7%, with comp sales down 11%. Non-comp sales added 4%. Residential pool sales were down 9%, PRO pool sales were flat and residential hot tub sales were down 6%. Gross margin decreased 530 basis points, driven by the June chemical retail price actions, year-end inventory adjustments, DC costs associated with higher inventory levels, lower rebates based on decreased equipment purchases and occupancy deleverage. We believe the majority of these headwinds are specific to this fiscal year, and Scott will discuss how we expect these to significantly abate in fiscal 2024. Adjusted EBITDA for the year was up $168.1 million and adjusted diluted earnings per share was $0.28. In the face of the transitory headwinds this year, the fundamentals of the industry have not changed. New pools continued to be built and the growing installed base of pools need to be maintained. In addition, we believe the secular tailwinds that drive industry demand remain intact, including ongoing investment in homes and backyards, migration to the sunbelt and pursuit of outdoor lifestyles, increasing attention to safety and sanitization and the adoption of new technologies. The pool 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. While our team navigates the current headwinds, we remain focused on executing the strategic initiatives that underpin our competitive advantages, and then, we expect to continue to drive our success as industry conditions normalize. Turning to our strategic growth initiatives. First, our customer file was down 6% in the quarter and for the full year due to the weather and traffic trends we experienced. Second, average revenue per customer was down 3% in the quarter and 1% for the year, driven primarily by decreases in big ticket items, specifically, hot tubs, heaters and above ground pools. With regard to our PRO initiatives, we ended the year with more than 3,900 PRO contracts in place and completed the conversion of 15 residential stores to our PRO format. We currently operate 98 PRO locations. PRO sales were flat for the year, which we consider a solid outcome given the overall environment. Trichlor pricing was a more pronounced headwind to our PRO sales and to overall Company gross margin performance as competition in the distributor channel drove prices down. Trichlor pricing now appears to have stabilized. M&A and new store growth remain important initiatives for Leslie's. For fiscal 2023, M&A and new stores drove $60 million in non-comp sales. During the year, we opened 12 new stores and acquired 12 stores, and now operate 1,008 total locations. We remain confident in the long-term store expansion opportunity and have identified over 800 opportunities for store densification. We will continue to address each of these opportunities with a buy or build analysis. Though we will be prudent with the pace of expansion as we balance store growth with our other capital allocation priorities. For AccuBlue Home, we were excited to launch the program in May and I've been very pleased with the consumer response and demand we have seen to date, even with limited marketing. AccuBlue Home member spend is averaging $1,000 per year. And we believe members see value in the experience as evidenced by an average review rating of 4.8 out of 5 stars. They comment that the program pays for itself and site convenience, greater confidence in our water treatment routine and overall water quality as core benefits of the program. While demand during the pool season was strong, manufacturing capacity at our third-party vendor limited sales and we deferred launching our consumer marketing campaign due to insufficient supply. We have worked with our vendor to ramp-up production during the off-season to meet our expected 2024 pool season consumer demand. We continue to have confidence in the long-term industry outlook and remain focused on prudently executing our strategic initiatives to capture the opportunities in front of us and extend our industry leadership. At the same time, we are taking actions to improve our near-term performance. Number one, we are pricing based on current market conditions. And after our June price actions, we are at our relative historical price position, up slightly above mass and at or slightly below specialty. We expect this positioning to hold for 2024. Number two, we are aggressively managing inventory and expect to reduce our 2024 peak and year-end inventory by approximately $100 million and $50 million respectively. Number three, we are managing costs throughout the P&L, including utilizing strict ROI criteria on our marketing investments. Number four, we continue to evaluate, develop and elevate our processes and people to help improve our efficiency. And number five, we are utilizing consumer insight surveys to further improve our understanding of evolving consumer behavior. I will now hand it over to Scott to discuss our results and outlook in more detail.

Good afternoon, everyone, and thank you, Mike. I'll review our fourth quarter and fiscal 2023 performance, and then, provide details about our outlook and assumptions for fiscal 2024. Turning to fourth quarter results. We reported sales of $432 million, a decrease of 9% compared to the fourth quarter of fiscal 2022. Comparable sales decreased 11%. Comparable sales decreased 1% on a two-year stack basis, increased 15% on a three-year stack basis and increased 38% on a four-year stack basis. Non-comparable sales totaled $9 million in the quarter, which was driven by a total of 18 net new stores, including 12 through acquisitions and six net new store openings during fiscal 2023. With respect to trends by consumer group. Comparable sales for residential pool declined 9%, PRO pool declined 13% and residential hot tub declined 23% compared to the prior year period. On a two-year stack basis, comparable sales were flat for residential pool, increased 4% for PRO pool and declined 10% for residential hot tub. These declines were in line with our expectations and continuation of recent trends in the business. Gross profit was $160 million compared to $217 million in the fourth quarter of fiscal 2022 and gross margin rate declined approximately 860 basis points to 37%. During the quarter, gross margin was impacted by the following factors. First, product gross margin declined 385 basis points in the quarter. This was primarily driven by our June 2023 chemical pricing actions and the negative impact of 70 basis points due to lower rebates. Second, we incurred unexpected incremental inventory adjustment costs that resulted in a 260 basis point headwind in the quarter. This increase was mainly due to excess shrink and scrap due to higher levels of inventory and third-party storage locations, higher movement of goods between facilities and higher levels of unsellable returns. Additionally, gross margin rate was negatively impacted by 120 basis points due to the expensing of capitalized DC costs associated with the drawdown of inventory. Finally, occupancy costs deleveraged by approximately 95 basis points, mainly due to the decline in comparable sales. SG&A was $122 million, down 9% or $12.5 million compared to the fourth quarter of fiscal 2022. Excluding non-recurring items, including costs incurred from the discontinued use of certain software subscriptions and executive transition costs associated with restructuring, SG&A decreased $18 million, driven by lower sales, lower incentive compensation and expense management actions. Adjusted EBITDA was $60 million compared to $100 million in the fourth quarter of fiscal 2022. Interest expense increased to $17 million from $10 million in the fourth quarter of fiscal 2022, due primarily to higher interest rates, and our effective tax rate increased to 22.9% compared to 21.2% in the fourth quarter of fiscal 2022. Adjusted net income was $26 million compared to $64 million in the fourth quarter of fiscal 2022. And adjusted diluted earnings per share was $0.14 compared to $0.35 in the fourth quarter of fiscal 2022. Diluted weighted average shares outstanding were 185 million in both the fourth quarters of fiscal 2023 and fiscal 2022. Moving to our full-year results. Total sales for fiscal 2023 were $1.45 billion, a decrease of 7% compared to the prior year, with comparable sales down 11%. Comparable sales were flat on a two-year stack basis, increased 21% on a three-year stack basis and increased 39% on a four-year stack basis. Non-comparable sales totaled $60 million in fiscal 2023. Gross profit was $548 million for fiscal 2023 compared to $674 million in the prior year and gross margin rate was 37.8%, a decrease of 530 basis points compared to the prior year. As shown on page 11 of the supplemental deck, 205 basis points of the rate decline was due to chemical pricing actions and lower rebates, 215 basis points was due to DC costs and inventory adjustments and 110 basis points was due to occupancy deleverage. SG&A was $446 million for fiscal 2023 compared to $435 million in the prior year. Excluding non-recurring items and non-comp expense from acquisitions and new stores, SG&A decreased $15 million compared to the prior year. Adjusted EBITDA was $168 million for fiscal 2023 compared to $292 million in the prior year. Interest expense was $65 million for 2023 compared to $30 million in the prior year. Adjusted net income was $51 million for fiscal 2023 compared to $176 million in the prior year and adjusted diluted earnings per share was $0.28 for fiscal 2023 compared to $0.95 in the prior year. Moving to the balance sheet. We ended fiscal 2023 with cash and cash equivalents of $55 million compared to $112 million in fiscal 2022. The reduction was primarily due to the decline in net income. At the end of fiscal 2023, we had no balances outstanding on our revolver and availability of $239 million. Year-end inventory was $312 million, a decrease of $50 million or 14% compared to fiscal 2022 and a sequential decrease of $125 million or 29% compared to the third quarter of fiscal 2023. This reduction was possible due to fewer supply chain disruptions, implementation of our new inventory management system and strong execution out of DC locations. Importantly, we are maintaining strong in-stock positions at the store level to support a high level of customer service, which is reflected in our higher NPS scores. At the end of fiscal 2023, we had $790 million outstanding on our secured term loan facility compared to $798 million in fiscal 2022, which translated into a leverage ratio of 4.4 times. The applicable rate on our term loan was SOFR plus 275 basis points in the fourth quarter and our effective interest rate was 8.1% compared to 4.3% in the prior year quarter. Now, for our fiscal 2024 outlook. In fiscal 2024, we expect an uncertain macro-environment and a more cost-conscious consumer especially in discretionary categories to continue affecting sales. We anticipate this to be more acute in the first half of the year, though we expect positive comps in the back half of the year due to the lapping of the June 2023 chemical pricing actions and easier compares. With fiscal 2023 being an anomaly from a seasonality standpoint, we are planning for seasonality to be more comparable to fiscal 2022 and expect to deliver more than all of our profitability in the second half of the year during our peak pool season. We expect sales of $1.41 billion to $1.47 billion, which assumes normal weather over the course of the year and non-comp sales contribution of approximately $7 million. The low end of our outlook assumes comparable sales growth of approximately negative 3%, while the high end of our outlook assumes comparable sales growth of approximately 1%. For the full year, we expect to see gross margin rate improvement of approximately 100 basis points compared to the prior year, driven by lower DC costs and fewer inventory adjustments due to reduced inventory levels and improved supply chain efficiencies. That said, we don't expect to see the majority of these benefits until Q4, when we start to lap the unusual items that impacted Q4 fiscal 2023. Additionally, we expect higher impact of deleverage in the first half of the year due to lower sales compared to the prior year. We expect adjusted EBITDA of $170 million to $190 million and expect a slight decline in SG&A expense as we drive efficiency in our cost structure, while making prudent investments in the business. We expect net income of $32 million to $46 million, adjusted net income of $46 million to $60 million and diluted adjusted earnings per share of $0.25 to $0.33. Our outlook assumes an average interest rate on floating-rate debt of 8.2% and assumes interest expense will be approximately $7 million higher than fiscal 2023. Our outlook also includes an effective tax rate of 26%. We estimate the diluted share count of approximately 185 million shares, which assumes no share repurchases during fiscal 2024. Now, as you'll see on page 14 of our supplemental deck, along with the full-year guidance, we have provided an outlook for Q1. While it has not been our historical practice to provide quarterly guidance, nor do we intend it to be our practice going forward, given the unique dynamics related to Q1 in the comparison to the same period in fiscal 2023, we believe it is appropriate to provide a view of Q1. For the first quarter, we expect total sales of $166 million to $172 million, adjusted EBITDA of negative $27 million to negative $24 million, net income of negative $43 million to negative $41 million, adjusted net income of negative $39 million to negative $37 million and adjusted EPS of negative $0.21 to negative $0.20. Underlying this outlook is our expectation of comp trends that will be similar to Q4 of fiscal 2023 and non-comp sales will contribute approximately $3 million. In addition, we expect a significant gross margin decline compared to the prior year quarter, driven by the expansion of capitalized DC costs and occupancy deleverage. Turning to CapEx. We expect to invest $50 million to $55 million in fiscal 2024, of which approximately $20 million is expected to be invested in our existing assets and the remainder is expected to be invested in growth. These investments include new store openings, improving the capacity of our distribution and manufacturing facilities and investing in IT and other projects to improve the business. We also expect a meaningful improvement in working capital and plan to reduce inventories by approximately $50 million. Regarding capital allocation, we expect significant improvement in free cash flow due to higher net income and lower inventory. And our first priority will be to pay down debt, with the goal of achieving a leverage ratio of 3.5 times to 3.7 times in fiscal 2024. Longer term, our goal is to achieve a leverage ratio of 3.0 times. Our second priority is to invest in growth. This will include organic growth through the opening of 15 new stores and the conversion of six residential stores to the PRO format. We have not included any M&A activity in our fiscal year guidance at this time. The final priority is to return excess cash to shareholders. While we do not expect to repurchase shares in the near term, we will continue to evaluate this based on our financial position and market conditions. Before I turn it back to Mike, I want to address two items that will be covered in greater detail in our Form 10-K. In short, we have identified two material weaknesses in internal controls over financial reporting. One weakness relates to insufficient controls over an internal database that is used to calculate vendor rebates. And the other weakness related to controls over the performance of fiscal inventories. As a result, we are designing and implementing new processing and enhanced control to address the underlying causes of the material weaknesses and expect remediation to be completed during fiscal 2024.

Thank you, Scott. After three years of unprecedented growth, the pool industry and Leslie's faced multiple transitory headwinds in fiscal 2023. Despite these headwinds and their impact on our results, we continued to deliver exceptional service to our customers as evidenced by brand awareness, in-stock levels and corresponding NPS scores that are all at all-time highs. Taken together, these serve as a testament to the focus and execution of our team members. As the industry continues to normalize, we remain focused on leveraging the competitive advantages from our scale and capabilities and executing our strategic initiatives to continue to drive growth and market share gains. With that, I'll hand it back to the operator for Q&A.

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question comes from the line of Ryan Merkel with William Blair. Please proceed with your question.

Hey, everyone. Thanks for taking the questions today. First off, I just wanted to ask about sales guidance for '24. I'm a little surprised with the guidance of flat to down. Mike, can you just walk through some of the pieces there, because it was a pretty rough year in '23, we had horrible weather and your business is largely non-discretionary aftermarket. So, can you explain why we're not seeing a bit more growth in '24?

Thank you for the question, Ryan. Our primary assumption is that we do not anticipate any recovery in discretionary sales. According to the midpoint of our guidance, we expect discretionary sales, which make up about 20% of our business, to decline by another 10%. On the other hand, we project non-discretionary sales to increase by 1.5%. However, we are also contending with the challenges from the chemical price changes we implemented in June, which have been a significant burden during the first seven periods of the year. With discretionary sales falling, especially in higher-priced items, coupled with the pressures from chemicals, we are facing about 400 basis points of headwind from these two factors before considering any growth. This explains why our guidance remains essentially flat for the year.

Okay. That's helpful. And then just a question on trends. It looks like Q1 sales are also coming in a little bit below where the Street was modeling. What are you sort of seeing out there? You've seen consumer slowdown, what's happened with traffic in the last couple of months?

The quarter unfolded in a way where July was the strongest month, followed by a weaker August, and a challenging September. We observed that trend continue into October. However, in November, we are noticing some improvement in certain categories and an uptick in traffic. While this recovery is gradual and not yet clear-cut, we have seen transactions begin to rebound as traffic levels stabilize. On the downside, the average order value has decreased, largely due to struggles in the equipment and discretionary segments, particularly with high-priced items. The equipment sector has faced significant challenges, declining by 17% in the quarter and 12% for the year, though we are starting to see signs of recovery. Still, the discretionary aspects of the equipment business, such as heaters and robotic APCs, remain somewhat tough.

Got it. Very helpful. I'll pass it on. Thanks.

Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

Hey, good evening, everyone. Hey, the first question, I guess, it could go to either way. I think, Mike, you said that the biggest gap in the guidance you gave was the inventory adjustments. Can you talk about why those were not observable in July?

Sure, I can address that. The primary issue we've encountered with inventory adjustments is that we have excess inventory. We reached a peak of nearly $500 million, which has since decreased, but it remains more than we typically hold. This situation necessitated the use of multiple third-party off-site storage facilities, leading to significant product movement between these locations. We experienced an increase in higher and sellable returns, resulting in further movement of goods outside of our main premises. This is essentially the core issue we are dealing with. After careful consideration, we believe that the problems with our inventory adjustments are not systematic; they are manageable, and we are actively working on improvements. The initial step towards resolving this was getting out of those off-site storage facilities and relocating everything within our main premises. We have exerted considerable effort over the last few weeks to achieve this, and as of today, we have vacated those additional storage facilities, which is a positive first milestone for us. This allows us to monitor our inventory closely since everything is now within our control, significantly reducing the previous movement of goods. This increased visibility lays the groundwork for enhancing our inventory management process. Additionally, there are opportunities for improvement in our controls regarding scrap and managing the large volume of inventory. We had to boost our excess and obsolete reserves due to the high levels of inventory. Now that we have reduced that inventory, we should be able to release some of those reserves. We are also focusing more on our monthly processes to spot any major variances early on. Before we built up our inventory, we were managing it effectively, and now, with a solid distribution team and new talent, we believe we are in a much stronger position for future management.

Okay. A follow-up, it's maybe a bit broader, it's your approach to your guidance. And I heard some of the components, and then, the answer to the last question. And thinking about the industry, your assumption to the grower contract, the units get better. I heard what Mike said around discretionary stays weak, are you doing that assumption out of a prudent or it could happen that way. And then, even in your gross margin, you're not even recouping what you gave back this year on inventory adjustment, right? It's a very mild level of gains. So, your approach seems conservative, but, I mean, it's a tough argument to make given this miss, but curious how you thought about it?

Yeah.

Yeah. Go ahead, Scott.

I can begin by discussing the gross margin, and Mike can add his insights on the sales side. The situation is largely influenced by our comments regarding discretionary purchases, which remain limited. Interest rates are still elevated, particularly affecting the hot tub segment, which involves significant expenditures. We haven't observed much improvement from consumers in terms of their capability to increase discretionary spending yet, although it could happen. We're approaching this with the understanding we have today. In terms of gross margin, we are optimistic about recovering most of the inventory adjustments we experienced in Q4, which we anticipate will translate into a notable improvement. However, we do face some additional challenges, including the price reductions for chemicals that took effect in June to align our pricing appropriately. As we head into the New Year, we expect some repercussions from that. We increased prices in January last year, which will also have a more substantial impact as we move into Q2 and affect Q1 as well. Additionally, with reduced sales, we anticipate significant deleverage on occupancy costs. Overall, we believe gross margin will improve as the year progresses, but the first half will remain constrained.

Thank you.

Simeon, regarding the sales guidance, we are expecting a positive growth of 3% at the midpoint. We've observed an increase in traffic, and we're optimistic about our conversion rates and our chemical business, which represents 45% to 50% of our overall business. These trends have shown improvement. However, we anticipate an average order value decrease of 4% at the midpoint, primarily due to changes in product mix and a lack of recovery in discretionary purchases like hot tubs, above ground pools, and more recently, heaters and robotic APCs. To summarize, we see recovery in traffic and transactions, but there's pressure on the average order value. This shapes our midpoint guidance.

Yeah. That's helpful. Thank you.

Thank you. Our next question comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with your question.

Good afternoon, Mike, Scott. I wanted to maybe start with the performance of the assets acquired during the past few years. Just trying to get a better understanding of how much of a headwind those newly acquired assets are on both sales and profitability as we look out to 2024 or if you've seen some stability to the point where those assets are sort of neutral to sales and profitability? Any context on just how you think through the more recently acquired assets?

Thank you, Steven. If we focus on the hot tub business first, we have seen challenges in this sector, particularly with big-ticket discretionary items that are often financed. On a comparable basis, the hot tub business was down 22% for the year. However, it remains quite profitable, and we are optimistic about its long-term prospects. Regarding our total adjusted EBITDA ratios, this segment is not negatively impacting the overall business.

Helpful. And then maybe just a follow-up for Mike or for Scott. I think it was Mike, who mentioned the inventory reduction of $100 million from the peak, right, and $50 million at year end. As we think through the guidance here, any help with sort of working capital needs for the first half of 2024 just as we sort of think through the interest expense implications and free cash flow sort of on a quarterly basis?

Sure, I can address that. Due to the seasonality of our business, we generally start using our credit line in late first quarter as we begin building our inventory. We expect this year to follow a similar pattern. As we approach the end of this calendar year, we will likely rely on that line of credit. Our inventory ramp-up usually occurs in late March to early April, marking our peak period. We typically draw from the credit line during our peak selling seasons, and in the final months of the year, we focus on increasing cash reserves on the balance sheet. This year, we anticipate this trend continuing. Notably, our peak inventory plan is approximately $100 million lower than last year, reflecting the effectiveness of our merchandise planning team and the new tools we've implemented. We have a solid strategy to navigate the season smoothly. Additionally, we are benefitting from a more normalized supply chain with shorter lead times, and our distribution center team is becoming increasingly efficient. From a working capital perspective, at the start of 2023, we had about $160 million in payables, but we've reduced that by nearly $100 million throughout the year. This year, we are beginning with under $60 million in payables, which prevents the significant cash outflow we experienced last year due to settling that payables balance. This improvement stems from our inventory reduction at the end of last year compared to our inventory build at the end of 2022, positioning us favorably to generate free cash flow this year. Combined with higher net income and effective working capital management, we expect a significantly better free cash flow outcome than last year.

Scott, that's very helpful. Given that you provided first quarter guidance, can you elaborate on what that implies for liquidity at the end of the first quarter?

The quarter end 1Q, yeah, our total liquidity will be close to $200 million at the end of the quarter.

Thank you, both.

Thank you. Our next question comes from the line of Peter Benedict with Baird. Please proceed with your question.

Hi, good evening. Thanks for the question. Can you talk a little about inflation? I think I heard that Trichlor is stabilizing. I'm curious about the inflation outlook that's included in the forecast for 2024. That's my first question.

Thank you for the question, Peter. This year, the variation in pricing is evident across different product categories, and we anticipate this trend to be even more pronounced going into 2024. We have received pricing information for 2024 from our equipment suppliers, which typically includes price increases of 3% to 5%, alongside corresponding increases in minimum advertised prices. This will not negatively impact our margins, and our purchasing plans are already in place, making this straightforward. Regarding chemicals, for each guidance level—low, mid, and high—we have accounted for a small decline in average selling prices. Currently, we are not observing that decline in chemical prices, which remain stable compared to the fourth quarter's pool season. However, we find it prudent to anticipate a slight price decrease. If that does not materialize, we could experience a beneficial impact instead. Overall, we're seeing inflation in the equipment sector and slight deflation in chemicals. When considering all categories, we expect the year to be relatively flat in terms of inflation.

That's helpful, Mike. Regarding the promotional tone, could you share your thoughts on how it has changed in the industry over the past few months and what your outlook looks like for promotions in 2024?

It varies across different sections of the business. In the residential sector, we believe that this past pool season was fairly typical concerning promotions. We were satisfied to see that our promotions aligned with our expectations. As we approach the residential business for fiscal year '24, we anticipate a standard promotional environment and normal weather, which we hope will continue. We think we can plan our promotions slightly lower, but still enough to manage the necessary inventory, including any items that are more price-sensitive. On the PRO side, there has been increased price competition, as I noted in my earlier remarks regarding fiscal year '23. This year saw a return of domestic chemical production, particularly Trichlor, coming back online, along with a significant amount of imports entering the market, which seems to have stabilized. Supply and demand for the PRO sector currently appear to be in a good position. Prices have remained stable over the last quarter, and we expect this normalization of pricing for PRO to continue into next year.

That's great. And then, maybe, one for Scott, just on the margin profile of the business. And, obviously, you're just coming on board here. So, maybe, premature, but pre-COVID, this business was kind of, call it, 17% on the EBITDA line. I think your outlook this year is somewhere mid-12, so I think at the midpoint. How are we thinking about maybe the profitability of the business kind of in a stabilized environment? I mean, you talked about SG&A dollars being down a little bit, I think, for this year. Any more color on kind of your view on the opportunities to build back the margin kind of longer-term? Thank you.

Sure, I’ll begin by discussing the product gross margin. Recently, it has been affected by some pricing changes we implemented, but I believe it was necessary to maintain a balance between price, volume, and market positioning. Looking ahead, I see opportunities in a few areas. For instance, concerning distribution center costs and the inventory adjustments we've mentioned, the burden of excess inventory will improve. For 2023, we were impacted by more than 200 basis points due to distribution center costs, which also included expenses related to capitalized distribution costs. Essentially, as we reduce our inventory, we need to move those capitalized costs onto the income statement to align with the flow of goods. As you can imagine, while we are accumulating inventory, those costs remain on the balance sheet until we reduce the inventory. Currently, we're facing significant challenges as we draw down inventory and recognize those capitalized costs. However, once we reduce inventory further, that burden will lessen. This is crucial because, without it, distribution center costs will significantly decrease in 2024, benefiting from better talent management and improved metrics at those facilities. The team has done an excellent job enhancing efficiency at our distribution centers, though we haven't fully realized the benefits yet due to the ongoing costs. As sales improve, we've experienced over a 100 basis point deleverage in occupancy over the past year. With increased sales, we will naturally leverage occupancy. Additionally, regarding selling, general, and administrative expenses, we have a solid plan for enhancing general and administrative expenses. We encountered some non-recurring costs last year, which will not continue. Therefore, we anticipate a favorable path for improving SG&A next year since we have streamlined the organization and eliminated those one-time costs. We expect to gain leverage in SG&A as well.

All right. Great. That's helpful. Thanks so much, guys. Good luck.

Thank you. Our next question comes from the line of Kate McShane with Goldman Sachs. Please proceed with your question.

Hi. Good afternoon. Thanks for taking our question. We wondered if you could talk a little bit more about any differences you're seeing between demand in the PRO versus residential market and what your survey work is telling you today about the level of stockpiling chemicals? And as a second question, could you maybe comment on your share commentary in the quarter?

Thank you for the question, Kate. Regarding demand, we've observed that price competition in chemicals has intensified. Our PRO business, which largely relies on chemical sales, has faced more significant pressure than our residential business. This explains the differing performance results for both the quarter and the year. For the year, PRO pool sales were down 11%, while residential pool sales decreased by 9%, primarily due to the chemical challenges impacting PRO. We haven't noticed any significant shift from DIY to DIFM; that metric has remained relatively stable over the past decade. On stockpiling, we conducted surveys in September and November, which revealed that fewer consumers have excess chemicals compared to last year. However, we can't quantify this change based on the current data, so we've factored in no expected impact from stockpiling in our guidance. We will continue to monitor consumer behavior every 60 to 90 days. Right now, it doesn't appear to be a significant headwind, and it could potentially serve as a tailwind, although we can't measure it accurately. In terms of market share, we acknowledged that we did not keep pace with industry growth in the fourth quarter, lagging by 250 basis points, which is disappointing for us. We attribute some of this to the full quarter impact of chemical price reductions we implemented. We felt compelled to lower prices after receiving feedback from consumers indicating our products were perceived as expensive and not a good value, which is not sustainable for our brand positioning. We also noticed a decline in our chemical volumes. Therefore, we decided to reduce prices. While this led to a rise in volume, it wasn’t sufficient to offset all the challenges we faced. Nonetheless, I believe this decision was beneficial for the long-term health of our brand and business, even though it did hinder our sales growth in comparison to industry peers in Q4.

Thank you.

Thank you. Our next question comes from the line of Garik Shmois with Loop Capital Markets. Please proceed with your question.

Hi, thanks. Just wondering if you could provide maybe a little bit more hand-holding on how to think about gross margins in the first quarter, just given that you're providing a little bit more near-term visibility and just given all the moving parts just around the business here in the near-term?

Yeah. So, let me kind of break it down, just kind of first-half of the year versus the back half. So, what I would see in the first and second quarter of the year is some pressure on product gross margin as we kind of lap those chemical price changes that we did back in June. It will be more impactful actually in Q2, because back in January, we raised prices on several items. And so, it will be a little more acute in Q2 on those chemical price changes, but still in effect in Q1. DC costs will be slightly unfavorable mainly because of the expensing of those capitalized expenses that I talked about as we reduce inventory. And then, with a little bit lower sales, we should see some occupancy deleverage mostly in first quarter. Second quarter, not as much deleverage. And then, as we get into the back half of the year, Q3, probably more flattish. Q4, we should see the biggest improvement as we start to lap those extremely high inventory adjustments that we saw and as DC costs are more moderate without all the off-site storage facilities and movement of goods, and the DC capitalization expensing should be much lower in Q4 as well.

Got it. Thanks for that. And then, just on the discretionary piece. It sounds like you're expecting sales to be down 10% through the year. I mean, you talked a little bit about the buckets there, but any additional color as to how you expect discretionary sales to track and maybe kind of where you're seeing the largest incremental change in fiscal '24?

Yeah. Garik, the hot tubs have been soft, and the higher priced hot tubs have been softer. We haven't seen that have any material change either in Q4 or so far through Q1. So that's been relatively consistent. The one change we have seen is, in some of the more discretionary equipment businesses, specifically heaters and some of the robotic APCs, that was more challenging in fourth quarter. Equipment sales were down 17% versus 12% for the year, starting to see some improvement there, which is encouraging, but not enough for us to plan discretionary sales other than we have planned them, which is down 10% at the midpoint.

Understood. Thanks for that and I'll pass it on.

Thank you. Our next question comes from the line of Jonathan Matuszewski with Jefferies. Please proceed with your question.

Great. Thanks for squeezing me in. First question was on the 2024 sales guidance. So, this past year, PRO was an outperforming customer segment, flat relative to kind of residential down in the mid to high-single-digits. So what is your topline guidance assumed in terms of relative performance between PRO and residential?

Yeah, Jonathan, thanks for the question. We've got PRO and residential planned fairly similarly for 2024, really based on the forecast of increased transactions, as I talked about, with some continued pressure on AOV.

Got you. That's helpful. And then just a follow-up in terms of SG&A for next year. Scott, I think you mentioned that the opportunity for slight decline year-over-year. Can you just expand on kind of the areas you see to kind of further rationalize that line item in a potentially soft demand environment? What are the buckets that you haven't used yet, the levers you haven't pulled? Thanks.

Yeah, so as I kind of look at SG&A for this next year, you know, we've done a really good job of kind of tightening up labor, and so we'll see some benefits from that come through. Our marketing will be a little bit lower this year as we continue to test and learn on marketing and understand kind of best uses of the dollars and continue to optimize that. There's some room to bring that down a little bit. Really the biggest pressure for SG&A that I hope that comes true is incentive compensation. That was extremely low in 2023. So if it would come back to more of a normalized incentive payout, then that's actually the biggest pressure point that we have. Outside of that, our expenses are down, just kind of on the core SG&A. And then we'll have the added benefit of about $14 million of what I would call non-recurring, with some severance costs and some other write-offs. So as we lap that and kind of unadjusted the SG&A, we'll actually be lower than the prior year.

Very helpful. Best of luck.

Thank you.

Thanks, Jonathan.

Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Please proceed with your question.

Hey, good afternoon, everyone. So, it sounds like on the M&A front, you're not anticipating any acquisitions. But could you just comment on what you're seeing with the M&A backdrop? It seems like it's been pretty good the last couple of years. Has anything changed on that front?

Thanks for the question, Peter. Scott, you can follow on if needed. Look, we think M&A is still very attractive, and we're pleased with the prices, we're pleased with the returns we're getting. In our current situation and with our debt and with the interest rates, as Scott had mentioned, our first priority is going to be debt pay-down in terms of capital allocation. In terms of M&A, our focus this year is really going to be on building the pipeline and finishing the integration of last year's acquisitions. So we still think it's a big opportunity, and we're going to work on building the pipeline. A lot of these deals with entrepreneurial-minded founders and owners, they take some time to work through. So that will be the focus. And then now, get ourselves in a position from debt levels and leverage where we can get back on the M&A cycle.

Okay. Helpful. And then, I guess, I am intrigued with this 200 basis points of inventory adjustment that you are referencing with regard to your previous question. It seems like a big recovery opportunity, but I'm trying to size it up, if it's a multi-year. I guess, looking, at Q4 is when we hit the inflection, do you start to see full recovery by Q4 or is this something that, it might take through FY'25 or even longer to fully recoup?

Good question. I would say that we can recoup most of that this year. And the reason I say that is, mainly because just like I was saying about having our inventory inside our four walls is the biggest step that we can take in that process. So, we're not moving product around, we're not in off-site storage, third-party storage, and just having better control of that inventory goes a long way and avoiding a lot of that cost. There are improvements we can do on scrap, just outsized, but just the sheer volume of inventory we had to add to our excess and obsolete reserves on inventory, because we had so much. As we have now brought that inventory down, we should be able to release some of that. And we also just put more focus on kind of monthly processes, just to identify any major variances that come along in early warning signs, but before we built up that inventory, we actually controlled it pretty well. And so, now that we're backed down, we have a really good DC team, some new talent, and we feel like we're in a much better position to manage it going forward.

Okay. And just to verify that, Scott, there is a recoup this year, but you don't start to recoup it until Q4, and then, I guess, in the following quarters, you'll recoup the rest on an annualized basis?

That's the way to think about it. Predominantly, it was the fourth quarter impact for us. As we move past the fourth quarter this year, we should see that benefit.

Thank you very much, guys. Good luck.

Thank you.

Thanks.

Thank you. This concludes our question-and-answer session. And with that, this will conclude today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.