Earnings Call Transcript - LESL Q2 2022

Operator, Operator

Good afternoon and welcome to the Second Quarter of Fiscal 2022 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 on the company's website. I will now turn the call over to Caitlin Churchill, Investor Relations. Please go ahead.

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 on 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.

Mike Egeck, CEO

Thanks, Caitlin and good afternoon, everyone. Thank you all for joining us. Please note that we have posted a brief deck on the Leslie's IR site to supplement our discussion and we will be referring to two specific pages as we present. I'm going to start by highlighting our key results and performance drivers for Q2, and then Steve will walk you through our financial results and increased full-year guidance. Before we get into our results, I want to remind everyone about the Texas Freeze in the second quarter last year. In February 2021, an unprecedented cold weather event damaged thousands of pools and pool pads in Texas. This event spiked sales of several product categories, most specifically, equipment, parts, and sanitizers. As you will remember, we estimated at the time that the freeze and accompanying spike in demand increased sales in the quarter by approximately $10 million. It is very gratifying for us to be able to report a positive comparison in this year's quarter, despite the extraordinary circumstances in Q2 last year. I would like to thank our team for driving these results with superior execution across the organization. For purposes of demonstrating what we believe to be our core underlying performance, we will be noting in our remarks some key metrics excluding the impact of the freeze. I am pleased to report that our Q2 performance continued our streak of record results and illustrates our competitive advantages in serving the non-discretionary annuity-like demand of the aftermarket pool industry. Sales for the quarter increased 19% to a record $228 million with broad-based strength across our three consumer groups. Residential pool grew 12% for the quarter, residential hot tub grew 70% and PRO pool grew 17%. Comparable sales increased 13% for the quarter and the two-year stack comparable for the quarter was 49%. The comparable and two-year stack comparable for the quarter excluding Texas was 20% and 48%, respectively. Gross profit for the quarter was a record $85.6 million and margin rate expanded 30 basis points. Adjusted EBITDA was $9 million for the quarter as we continue to make investments to grow our business. Moving to the industry backdrop. We continue to see the pool and hot tub industry benefit from strong consumer demand in the quarter. This demand is being fueled by consumers continuing to invest in their homes and backyards, the desire for a healthy outdoor lifestyle, migration to the Sunbelt, a heightened sense of safety and sanitization, and hybrid and work-from-home schedules. We have seen no evidence of these macro trends abating. With regard to inflation, in the quarter product cost inflation was more than 10%. We passed those costs through and as is our practice implemented additional pricing actions to maintain product margin rates. Consumers have accepted the increased retail prices, and we did not see any associated slowdown in demand as evidenced by our 20% comparable for the quarter excluding Texas. For the full year, we now expect product cost inflation of 10% and remain confident in our ability to both pass costs through and utilize pricing actions to maintain product margins if inflation trends higher.

Steve Weddell, CFO

Thank you, Mike and good afternoon everyone. Today we're pleased to report strong results for our fiscal second quarter. Our performance illustrates our competitive advantages in serving the nondiscretionary annuity-like demand of the aftermarket pool industry and our business continues to demonstrate a differentiated ability to grow in all economic environments. Our dedicated team of associates continues to deliver exceptional service to our consumers each and every day and we thank them for their contributions. Today, I'll review our second quarter and year-to-date fiscal 2022 performance and our upward revision to our outlook for the full year fiscal 2022. Second quarter results. Our second quarter included 13 weeks and ended on April 2nd, 2022. We reported record sales of $228.1 million, an increase of 18.5% or $35.7 million when compared to the second quarter of fiscal 2021. Our comparable sales growth increased 13.3% or $25.5 million. This increase is on top of calendar adjusted comparable sales growth of 35.5% in the second quarter of fiscal 2021 and represents comparable sales growth on a two-year stack basis of 48.8%. You will recall in Q2 last year, we explained the shifts created by the 53rd week in fiscal 2020 and spoke to comparable sales growth on both a reported and shifted basis given that dynamic. As Mike mentioned, in the second quarter of last year, the Texas Freeze positively impacted performance by approximately $10 million. After excluding the impact of the Texas Freeze in fiscal 2021, sales grew 25% and comparable sales grew 20% in the second quarter of fiscal 2022. We generated strong results across all consumer types and we continue to see solid performance in the core sanitizer and equipment product categories during the quarter. Inflation remained elevated and primarily related to chemical products and equipment. We expect higher retail prices and costs to continue. We remain confident in our ability to pass costs through annualized pricing actions to maintain product margins. Gross profit increased 19.5% and gross margin rate increased by 30 basis points to 37.5% from 37.2% in the prior year, primarily due to occupancy leverage and product margin improvements. Gross margin improvement was partially offset by business mix, including strong growth with both our PRO pool and residential hot tub consumers.

Mike Egeck, CEO

To ensure we continue our track record of growth, Leslie's has a high-powered offense, with four important attributes. First, we have tangible strategic growth initiatives and unique to our industry omni capabilities that are driving meaningful results and are still early stage in their development; second, our multipronged PRO initiative continues to scale; third, we have set ourselves up to capitalize on robust M&A opportunities we continue to see in the pool and spa industry; and fourth, great execution by our merchandising team has put us in a favorable and advantaged inventory position. With both a strong defense and a strong offense operating in a unique and advantaged industry, with a track record of 58 consecutive years of growth, in all types of macroeconomic conditions, we believe Leslie's is uniquely qualified positioned and advantaged to continue to win in the market. With that, I'll hand it back to the operator for Q&A.

Operator, Operator

At this time, we will be conducting a question-and-answer session. Our first question is from Ryan Merkel of William Blair. Please go ahead.

Ryan Merkel, Analyst

Hey, guys. Congrats on the quarter.

Mike Egeck, CEO

Thanks, Ryan.

Steve Weddell, CFO

Thanks, Ryan.

Ryan Merkel, Analyst

So, first off, thanks for all the details in the deck. It's really helpful. I was hoping you could address the pull-forward question, again, because from a high level, it looks like your COVID winner your top line has been very strong, stronger than typical history. So have you tried to calculate, a potential pull-forward estimate, or is this just not your view because of the macro drivers and share gain in price?

Mike Egeck, CEO

Yeah, Ryan, I would say, it's not our view both for the reasons you stated and also due to the fact that, we track that very carefully. We're able to see by consumer what they purchased prior years versus what they've purchased year-to-date. It's one of the things that we try to pay a lot of attention to. And we just haven't seen any indication of any meaningful pull-forward?

Ryan Merkel, Analyst

Okay. You see robotic cleaners up 74%. That, sort of, jumps off the page. You don't think people are, sort of, pull forward in some of that?

Mike Egeck, CEO

No, I believe robotic cleaners are simply a superior product. All the manufacturers have done an excellent job with them. My neighbor recently reached out to me asking for recommendations on cleaners. I directed them to our website, mentioning that there was no discount, and told them to consider one of the robotic models. They responded by saying that they seemed pricey. I reassured them that they needed to see it in action. After purchasing, they even sent me a short video of their robotic cleaner in use. The robotic cleaner essentially has a natural replacement cycle, which I think has been hastened because it is such a much better product.

Ryan Merkel, Analyst

Okay. Well, thanks for that. It's still a question I get so I wanted to ask. And then weather hasn't been great here in the north. Was there any impact to April there? And if so, is that something you can make up through the season?

Mike Egeck, CEO

Yes. In the second quarter, the weather was somewhat positive, but I would describe April as slightly negative, though it didn’t have a significant impact overall.

Steve Weddell, CFO

Not a typical shoulder season for us, right? So from late March into April. Then as we approach late September and early October, there can be weekly weather trends that affect performance week-to-week. We always mention that it eventually warms up and pools open, and it always cools down and pools close in some of those seasonal markets. However, from a maintenance standpoint, it's about the core season rather than the specific day a pool opens or starts being used or closes.

Ryan Merkel, Analyst

Great. Thanks. Best of luck.

Michael Kessler, Analyst

Hi, guys. This is Michael Kessler on for Simeon. Thank you for taking our questions. First I wanted to ask about the updated and raised guidance on top-line. I think if you add the updated inflation view plus the M&A view that I think basically gets you to the updated sales and raised sales guide. I guess, number one is that right? And I guess that would imply relatively unchanged, I guess, go forward underlying volume consumption I guess assumptions. Is that just, I guess, general kind of prudent conservatism as we move through the year, or anything to call out as far as thinking about anything ex those two discrete factors?

Steve Weddell, CFO

Yes. Great. Thanks for the question. Yes so as we look at inflation that five percentage point increase from 5% to 10% it's going to contribute $50 million to $60 million of top line. We talked about the M&A at about $15 million contribution with the remainder coming from the Q2 beat. So you're right. And we've talked about this in prior years where we're at the doorstep of season. And so we've largely left the go-forward look unchanged in just updated guidance for those three discrete factors.

Michael Kessler, Analyst

Thank you. You mentioned that there are currently no signs of consumer response despite positive macroeconomic tailwinds. What indicators are you monitoring to determine if there might be a trade down or pull back, especially considering that most of your business is nondiscretionary? Are there specific areas where consumers might choose to trade down or reduce spending? Also, how are you approaching this situation given the current pressures on consumers? Thank you.

Mike Egeck, CEO

Yes, what we're observing in our business is that most of it is non-discretionary and has recurring demand. We mention this frequently, but it really becomes evident in situations like this. Currently, if there is one area that is not performing as well as the others, it would be our recreation business, which includes products like floats, pads, and basketball games. We have experienced some weakness in that sector, but it represents only a small percentage of our overall business. In our core areas of chemicals, equipment and parts, and repair and maintenance, we have not noticed any signs of decreased demand.

Michael Kessler, Analyst

Right. Thank you. Good luck for the rest of the year.

Steven Forbes, Analyst

Good evening, Mike, Steve. I wanted to focus on loyalty member behavior or data. I would appreciate an update on average spend per member or average wallet share penetration. Any insight would be helpful as we consider how your member base, particularly loyalty members, is engaging with Leslie's value proposition in terms of their spending.

Mike Egeck, CEO

Thank you for the question, Steven. Let me share a couple of numbers regarding the file growth, excluding the Texas impact, which was quite significant in terms of dynamics as well as comparisons and sales. For the quarter, excluding Texas, the target file growth was just above 8%, and the loyalty file growth was just above 6%. While this is not as high as the double-digit growth we've experienced in the past, we had indicated that these two particular initiatives would begin to moderate at some point. We identified some opportunities to switch to digital marketing from direct mail early on, and we've seen strong performance in the first eight quarters. Although that performance is moderating slightly, we are still very pleased with the results. Regarding the loyalty file, spending remains about twice that of our non-loyalty file, and this is contributing to the growth of customer lifetime value, which increased by another 7% in the quarter when looking back over three years. We feel positive about the dynamics surrounding our loyalty customers.

Steven Forbes, Analyst

Maybe just a quick follow-up on the PRO affiliate program given the growth that we saw here in the number of agreements. Any update on the volume commitments from those partners? And any updated thoughts on the optimal number of affiliates you see across the network?

Mike Egeck, CEO

Yes, we haven't disclosed the specific sales terms of the PRO affiliate vendor agreements, but those remain unchanged and we are seeing positive momentum. We reported 2,100 at the end of the quarter, and that number has continued to grow; currently, we're over 2,300. The demand in the PRO business is very strong. If we have encountered some supply chain issues, particularly with equipment, it has been in the PRO channel. We are actively addressing this with our vendor partners for PRO equipment and could benefit from increased supply.

Andrew Carter, Analyst

Hey, thanks. Good evening. First thing, I wanted to ask about gross margin. You did give some product higher occupancy leverage against kind of the business mix. Any way to quantify how big the business mix drag is? And within that kind of the product, I'm guessing private label penetration overall is still growing, but I would also guess a year ago you comped higher equipment sales, because of Texas therefore a margin benefit. So any extra added color you can give us there?

Steve Weddell, CFO

Yes. Great question, Andrew. Interesting looking back to last year second quarter actually inverse happened. So we actually saw less private label penetration as a result of the need for any and all equipment available in that Texas market to get equipment pads back up and running. So we saw a good kind of normalization such increases over 2020 levels from a penetration perspective for proprietary products in the second quarter of this year 2022. And then from an overall perspective, on occupancy versus product margins that kind of point you back to roughly $25 million per quarter from an overall occupancy perspective. And so you can kind of do the math on the occupancy impact for second quarter. Again, remember first half, first and second quarter are lower volume sales quarters. So it has an outsized impact. And as we get into the back half of the year, it will certainly moderate from a magnitude perspective.

Andrew Carter, Analyst

Thanks. Switching gears just a little bit to the days inventory. I think I got 160. It's up from the prior year. Some of that's inflation, I would assume, the 10% product. But what is kind of the right level? And I know it's kind of a mixed bag. You're carrying a lot of strategic inventory, but there's probably areas you wish you could. Any kind of right level, what you think the right level of days inventory is for this business?

Steve Weddell, CFO

Yes, that's a great question. In the current environment, having more inventory is advantageous. We're pleased to see an increase of almost $70 million year-on-year, which is about 24%. As Mike mentioned, there have been times when we've wanted to stock up on more inventory. We're looking for opportunities with our vendors to expedite the inventory process. As we consider seasonality and examine our inventory figures at the end of the second quarter, we are actively pre-buying and pulling in inventory to utilize our self-distributed network. This is one of our competitive strengths. We have inventory either stored in our distribution centers or at our store locations, allowing us to quickly restock and allocate inventory where it is needed most, whether through physical stores or digital channels. In the second quarter, our focus is less on days sales on hand and more on operational efficiency to maximize our channel management as we transition into the season.

Jeff Stevenson, Analyst

Hi. This is Jeff Stevenson on for Garik. Thanks for taking my questions today. My first question was about mix. Previously, you highlighted hot tubs and PRO being more front half of the year weighted. My question is how was mix in the second quarter? And is that front half weighting still the right way to think about it?

Steve Weddell, CFO

Yeah, it's a good question. Absolutely, still true. When you think about both PRO as well as hot tub, but it's going to be a little more consistent throughout the year when you think of professionals taking care of bodies of water more likely to be open year-round and have more stable business throughout the year as well. And so it's going to have an outsized weight in the first half of the year. We've certainly grown that part of the business at a faster rate so that has had some impact, not overly material. And then when you look at hot tubs, primary selling season kind of late fall and through early spring, so it certainly has an impact as well. Still the right way to think about it from a seasonality perspective and with the growth in both of those businesses and some acquisitions that we've completed a little more heavily weighted in the first half, but no more than a few percent.

Jonathan Matuszewski, Analyst

Thanks for taking my questions and thanks for all the color in the prepared remarks. First question, average sales per customer is growing faster than inflation. Maybe if you could just unpack that a little bit. On the chemical side, it makes me think that the frequency of water testing is likely rising at a faster rate than active file growth. And you rolled out AccuBlue water testing in the stores several quarters ago. But is that kind of the gift that keeps on giving, or just if you could elaborate on that a little bit.

Mike Egeck, CEO

Sure, I can do that. The average order value in the second quarter increased by 18%, and we saw a 1% rise in transaction count, which explains the 19% sales growth. Regarding AccuBlue Home, the average order value reflects some product cost inflation. Our pricing is supported by an increase in units sold per transaction, and we are seeing greater adoption of AccuBlue in stores, with strong double-digit growth in tests. We observe that nearly all prescriptions contain multiple components, and our conversion rates are aiding in increasing units per transaction. As more customers test the water, their continued use, supported by the prescription, leads to a comprehensive solution that includes multiple elements.

Peter Benedict, Analyst

All right guys, thanks for taking the question. I guess, Steve you had mentioned kind of systems as part of your SG&A discussion. It didn't sound like it's a big number of dollars, but I just thought I'd ask you about maybe what you're doing on the systems front and what you're investing in and what maybe some of the payouts are expected to be I don't know new stuff coming on for next year, or what have you? That's my first question.

Steve Weddell, CFO

Thanks, Peter, for the question. We are investing in several systems related to omni, including ongoing improvements from Leslie's Connect. We are also focusing on AccuBlue Home for merchandising, as well as enhancing our information systems, including inventory planning and financial systems. Additionally, we are looking for opportunities to invest in supply chain technology to boost efficiencies and manage the volume of business in the current environment.

Dana Telsey, Analyst

Good afternoon, everyone. As you think about the chlorine market and the percentage of Trichlor that's coming from international, what is that percentage? How has it changed? And it sounds like that price differential is much higher. Is that accounted for in the price increases they are taking? And when do you expect to be in a comfortable spot with the availability of chlorine? Thank you.

Mike Egeck, CEO

Yes. Great questions. Our take on the amount of imported Trichlor that came to the market this year is about somewhere between 90 million pounds and 100 million pounds. And we don't have exact data on that, but we think it's pretty close working with the different manufacturers and the importers. Tabs across what is a total supply of somewhere between 230 million pounds to 250 million pounds. So not quite a third of the purchase price factoring. And as we've said in the past, some Trichlor imports could come down when additional Trichlor capacity comes up in the US, but the kind of newer information that we have is what I went through in the script that, the chlorine input from North America is now a limiting factor and chlorine imports from China, which is the biggest exporter or Spain, are tough economics. So what I would say is that, the current pricing in the market reflects where people have become comfortable with margins at those higher imported prices. So I think, when we look out to next year, supply will continue to be tight, inputs will continue to be high. They could potentially go higher, but we certainly don't see them coming down.

Operator, Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session and I would like to turn the call back to management for closing remarks.

Mike Egeck, CEO

Thank you, operator. Thank you, everybody, for joining us. We're really looking forward to pool season 2022. As we talked about, we feel we're in a great position with our inventory. We just had a bit of a town hall in our retail store leadership in here. Everybody is fired up. We're getting great returns as we mentioned on our digital marketing. So we feel like we're set and certainly looking forward to the season and for sharing the Q3 results when we get them. Thank you.

Operator, Operator

This concludes today's conference. Thank you for joining us. You may now disconnect your lines.