Q3 2022 Leslie's Inc Earnings Call
Good morning, and welcome to the fiscal 2022 third quarter conference call for unless leasing.
At this time all participants are in a listen only mode.
Following their prepared remarks management will conduct a question and answer session.
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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 with Investor Relations. Please go ahead.
Thank you and good morning.
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 FCC.
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 SEC today and posted to the Investor Relations section of website at IR adult last lease pool Dot com.
On the call today from Leslie think it's Mike E check Chief Executive Officer, and Steve Wardell, Chief Financial Officer.
That I will turn the call over to Mike E check right.
Thanks, Caitlin and good morning, everyone. Thank you all for joining us and please note that we have posted a deck on the legislature IR site to supplement our discussion.
I'm going to discuss three things today.
Number one the overview of our Q3 results underlying performance drivers.
Number two the execution challenges in one of our distribution centers that was the primary driver of our Q3 sales and margin shortfall and the steps we have taken to correct the issue.
Number three supply chain challenges and increased industry promotions, which also impacted results for the quarter.
After that Steve will review in detail, our financial results and change in full year guidance.
Our Q3 performance continued our streak of record results, but it fell short of our internal expectations.
Our organization and leadership team fully understands that this outcome is not acceptable and that we missed a significant opportunity to serve more customers in the quarter.
There was a heightened sense of urgency and accountability across our organization and we are hyper focused on the actions necessary to rapidly and sustainably improve our execution.
Spider disappointment underperforming our expectations our year over year performance illustrates our continued market share growth driven by our competitive advantages in servicing the aftermarket cool industry.
Sales for the quarter increased 13% to 674 million with broad based strength across our consumer groups.
Residential pool grew 7% for the quarter co pool grew 17% and residential hot tub grew 94%.
Comp sales increased 7% for the quarter and the two year stack comp for the quarter was 27%.
Page 15 of the supplemental deck utilizing third party credit card data to compare our year to date sales performance by quarter versus our competition.
As you can see from the chart, we continue to gain share.
Gross profit for the quarter was a record 304 million.
However margin rate decreased 250 basis points, driven by business mix product margin headwinds in D C expense.
<unk> EBITDA was a record 183 million for the quarter.
Moving to the industry backdrop, the pool and hot tub industry continued to benefit from strong consumer demand in the quarter and the secular trends driving that demand remain intact.
First consumers investing in their homes and backyards.
Second the desire for healthy outdoor lifestyle.
Third migration to the sunbelt.
For a heightened sense of safety and standardization.
Finally hybrid work from home schedules.
With regard to inflation product cost inflation was approximately 8% in the quarter.
For Q4, we are now planning product cost inflation to be in the high single digits and we will continue to manage our suggested retail prices to offset the increased costs.
No I would ask you please turn to page seven of the supplemental deck.
Given the noise in our results. This quarter. We've included a bridge between our third quarter expectations and our actual performance to help explain the moving parts.
As you can see a significant driver of the sales and margin Miss was the result of challenges at our New Jersey D C.
We operate six distribution centers in total and the New Jersey D C fulfill store and digital demand for our northeast region.
The New Jersey D C shipped about 30% fewer units than planned in the third quarter, which resulted in significant store out of stocks throughout the northeast and also impacted our ability to serve digital demand in the region.
A confluence of factors contributed to the facilities underperformance.
First the northeast experienced wet and cold weather through April and May which resulted in a late start to the pool season and concentrated demand into June at an unprecedented level.
Concurrently supply chain disruptions moderated, which resulted an unforeseen levels of vendor shipments in D C receiving.
Quite simply we didn't have the staffing and plan in place to support this combination of factors.
As a result of this concentrated demand an unprecedented volume of receipts, we faced operating challenges that significantly impacted our ability to serve customers.
As you can see relative to our expectations. The challenges in our New Jersey D. C impacted sales by $35 million and margin by a total of 21 million in the quarter.
We reacted quickly the situation by increasing temporary head count and adding work shifts by the second week of July the facility was back shipping plan, but it was operating with twice the head count at the prior year.
Creasing head count in the facility that quickly is highly inefficient.
As a result, the facility both underperformed and added cost there.
<unk> expense was approximately $3 million in Q3, and we are playing in the initial 7 million for Q4.
We are taking action to ensure that we can manage through potential issues like this in the future.
Prior to the start of the 2023 pool season, we plan to implement a seven day a week to shift operating model for all of Rbcs and add additional three PL partners in specific trading areas, including the northeast.
This will ensure that we have the additional capacity to navigate potential headwinds like this in the future.
Outside the impact of the D C. The balance of the business outperformed our internal sales expectations by approximately $14 million.
Two other points to note on the bridges on page seven.
First decreases in product margin rate impacted margin by $8 million in the quarter.
Decrease consisted primarily of two factors.
Supply shortages from planned vendor receipts in season that required higher cause substitutes to serve consumer demand.
And an increase in industry promotions.
Second the strong sales performance of our lower margin pro and hot tub businesses resulted in an unfavorable mix and drove an $8 million reduction in gross margin for the quarter.
This mix headwind is not new but in the past we've been able to counter that with margin growth in each of our businesses.
The current macroeconomic and operating environment is challenging.
And while we would certainly prefer them in a more favorable backdrop, our historical performance during challenging times gives us confidence in our future performance.
As you can see summarized on page 14 in the deck.
Over the last two decades Leslie has been successful in profitably growing sales in periods of rising interest rates inflation housing industry slowdowns GDP contraction declines in consumer spending.
Reduced rates of new builds.
With the addition of blood please connect.
The focus on our six strategic growth initiatives and our investments in talent and capabilities. We believe we are better equipped today to grow profitably and challenging macroeconomic conditions and at any other time in our history.
Now, let's review the performance of our six strategic growth initiatives in the quarter.
Year to date contribution of each initiative is also summarized on page nine of the supplemental deck.
First our consumer file total target ball growth was minus one 7% a quarter.
Personal last year was distorted by outsized file growth in Q3, 2021, driven by the pervasive media coverage of the chlorine shortage.
Adjusted for that event, while growth was five 5%.
Unadjusted two year stack was 14% for the quarter.
Next we continue to deepen our relationship with our consumers.
Our pool perks loyalty file grew 1% for the quarter and now has an 18, 7% more members year over year.
The program's key benefits, 5% reward earn rate increased shipping continue to resonate with our consumers.
Average revenue per consumer grew 13, 7% in the quarter.
Growth in average revenue per consumer exceeded the impact of inflation and reflects our growing wallet share.
Third our pro initiatives are driving strong results.
During the quarter, we finished converting 29 residential stores to our pro format.
And building five new <unk> stores.
We are now operating 79 total closed doors.
Oh affiliate program continues to scale.
We have over 2600 agreements in place and our pro affiliate partner sales grew 38% in the quarter.
The new and converted pro locations are expanding core affiliate program and our dedicated Leslie Pro E Commerce site.
The girl co pool of 17% in the quarter.
Moving to M&A in the quarter, we closed on the acquisition of spring dance, which operates four residential hot tub locations in the greater Philadelphia area.
Shortly after the end of the quarter. We also closed on the acquisition of Tech Sun, which operates six retail pool locations in the greater Houston area.
We continue to see a wealth of attractive acquisition opportunities in the industry and we have entered into two additional LOI is that we expect to close by the end of our fiscal year.
With regard to our white space initiative.
Year to date, we have opened a total of 14, new store locations and we continue to successfully address underserved markets with targeted digital marketing.
Our current store count, including the recently acquired Tech sudden locations is 987.
Finally, thank you blew home.
We are scheduled to receive just over 2000 units of the version two point of load devices. This year.
These devices will be used primarily for incremental refinement of our app interface additional consumer testing.
We're not planning for any significant sales from this initiative in 2022.
Now I'll turn it over to Steve to share more detail on our Q3 financial results and revised fiscal 2022 guidance. Thank.
Thank you, Mike and good morning, everyone.
As Mike discussed our third quarter performance was impacted by difficult year over year comparisons as well as discrete execution challenges within our distribution network, which are now behind us.
Right. These challenges demand for our core non discretionary product remains solid and we are focused on delivering against our updated outlook for the year.
Before I discuss our outlook I will review, our third quarter and year to date fiscal 2022 performance.
For the third quarter, we reported record sales of $673 6 million, an increase of 12, 9% or $77.1 million when compared to the third quarter of fiscal 2020 one.
Comparable sales increased seven 4% or $44 $6 million.
This increase is on top of our calendar adjusted comparable sales growth of 19.4%.
In the third quarter of fiscal 'twenty, and 'twenty, one and represents comparable sales growth on a two year stack basis of 26, 9%.
Our non comparable sales increased by $32 5 million driven by for completed acquisitions in 21, new store openings in the last year.
We continue to see broad based strength across our three consumer groups in the quarter as we generated comparable sales growth of 6% for residential pool 17 per cent for protocol and 10% for residential hot tub on.
On a two year stack basis, we generated comparable sales growth on a calendar adjusted basis of 21% for residential pool 78 per cent per protocol and 33% for residential hot tub.
Weather for the full quarter was neutral to slightly positive, but the cadence of the start to the season impacted our performance in the northeast.
Gross profit increased 7.0% or $19 $9 million when compared to the third quarter of fiscal 2021 and gross margin rate decreased by 250 basis points to 45, 1% from 47, 6% in the prior year.
During the quarter there were three main headwinds to gross margin rate.
Impact from business mix.
Lower product margins related to promotions and product costs and incremental distribution expenses.
First as we've noted in prior quarters the impact of business mix is primarily driven by faster growth in our pro pool and residential hot tub businesses, which operated at lower gross margins.
In the third quarter business mix accounted for 115 basis points of the decline in gross margin.
Second.
A higher promotional cadence in our residential pool business and higher product costs associated with supply chain disruptions accounted for an additional 115 basis points of the decline in gross margin.
We believe the promotional cadence in the third quarter represents a more normalized level of promotions when compared to the prior year.
Also strategic efforts to procure product to offset supply shortages from existing vendors in season led to higher than expected product costs and we expect this to continue through the end of the fiscal year.
Third.
During the current quarter, we incurred additional distribution expenses, mainly related to higher head count and compensation costs.
The additional costs negatively impacted gross margin by 45 basis points.
Total distribution costs increased by $5 million when compared to the prior year period, and we estimate the incremental expense due to the issues at our New Jersey distribution center totaled approximately $3 million during the quarter.
We will continue to incur additional costs through the remainder of the fiscal year, but we are pleased that the new Jersey distribution Center is now shipping to plan.
And as we've noted in prior quarters occupancy leveraged during the quarter favorably impacted gross margin.
In the current quarter occupancy leverage improved gross margin by 25 basis points.
So to summarize the two key changes in margin drivers during the current quarter when compared to our recent performance and our internal expectations, where the change in product margins and higher distribution expenses.
Now I'll turn to SG&A.
SG&A increased 12.1% or $14 $2 million when compared to the third quarter of fiscal 2020, one and decreased as a percentage of sales by 15 basis points.
While we continue to invest in information technology and merchandising systems to support our growth we were very disciplined with expense management, considering our execution challenges and the heightened inflationary environment during the quarter.
We estimate inflation impacted SG&A by approximately $10 million, primarily related to payroll and digital marketing spend.
The current year quarter also has an additional $4 million of non comparable SG&A associated with acquired businesses.
We generated record adjusted EBITDA of $182 9 million compared to $179 3 million in the third quarter of fiscal 2020 one.
Adjusted net income increased to $125 $7 million in the third quarter of fiscal 2020 two.
<unk> to net income of $124 $4 million in the prior year period.
And adjusted diluted earnings per share was 68 cents in the third quarter of fiscal 2022 compared to 64 cents in the prior year period.
Now I'll turn to year to date results following are a few highlights.
For the first nine months of fiscal 2022 we reported sales of $1 $1 billion, an increase of 16, 3% or $152 $5 million when compared to the prior year period, our comparable sales increased 10, 7% or $100 million.
This increase is on top of our calendar adjusted comparable sales growth of 23, 4% in the first nine months of fiscal 2021 and represents comparable sales growth on a two year stack basis of 34, 1%.
Non comparable sales increased $52 $5 million.
Gross profit increased 12.1% or $49 5 million when compared to the prior year period, and gross margin rate decreased by 160 basis points to 42.0% from 43, 6% in the prior year period.
Adjusted EBITDA improved by $4 1 million to $192 7 million from $188 6 million in the prior year period.
Adjusted net income was 112.0 million in the first nine months of fiscal 2022 compared to adjusted net income of 111 points are $1 million in the prior year period.
And adjusted diluted earnings per share was 60 cents in the first nine months of fiscal 2022 and.
59 cents in the prior year period.
Moving to the balance sheet.
We finished the third quarter of fiscal 'twenty, 'twenty, two with cash and cash equivalents of $193 million compared to $307 million at the end of the third quarter of fiscal 2020 one.
Reduction in cash and cash equivalents was primarily due to share repurchases investments in inventory and higher M&A activity.
On inventory, we ended the third quarter of fiscal 'twenty, 'twenty, two with $361 million up $137 million or 61% compared to $224 million at the end of the prior year quarter.
The increase in inventory is primarily related to equipment and chemicals.
Product categories or non discretionary in nature and are not subject to technology or fashion risk.
We have seen some recent improvements in supply chain availability as we received a significant amount of backward product during the third quarter. However, we would still characterize the current environment is mixed.
As a result, we view our current inventory position is appropriate given the uncertainty of supply for the balance of the year and into fiscal 2023.
On debt at the end of the third quarter of fiscal 2022 we had $800 million outstanding on our secured term loan facility comparative $808 million at the end of the prior year period the.
The applicable rate on our term loan during the quarter was LIBOR plus 250 basis points, our effective interest rate was 3.02% and the facility matures in March of 2028.
Funded debt less cash towards $607 million at the end of the third quarter of fiscal 2022.
With regard to our outlook.
Today, we're revising our full year fiscal 2022 outlook the details of which are included in our earnings press release as.
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.
Fiscal fourth quarter sales growth will be in the range of 13% to 18%.
With comparable sales growth of 6% to 9%.
Changes, where our outlook since may include two items.
First we lowered fourth quarter performance expectations by $21 million to reflect performance more in line with third quarter trends.
In the third quarter, we generated comparable sales growth of 27% on a two year stack basis.
And our outlook reflects a range of 22% to 25% for the fourth quarter.
We don't currently see a catalyst to give us comfort to accelerate our comparable sales growth in the fourth quarter at a rate faster than the third quarter, given the uncertain macro environment.
And second we increased sales by $10 million related to completed M&A transactions.
Our fourth quarter gross margin outlook includes a range of 42, 8% to 44, 2% compared to 46.0% in the prior year period.
At the midpoint, our gross margin expectations assume a decrease of 250 basis points, which is consistent with our results in the third quarter.
Our outlook includes continued margin headwinds related to business mix product margins and additional distribution center costs.
Our outlook also factors then continued occupancy leverage in the fourth quarter.
We expect fourth quarter, adjusted EBITDA to be 94 million to $104 million and we expect fourth quarter adjusted diluted earnings per share to be 30 to 36 cents.
Our outlook for the fourth quarter include interest expense of $9 million. This is approximately 2 million higher than the third quarter any increase reflects current rates on our floating rate debt.
And finally.
Our diluted weighted average shares outstanding and does not assume any incremental share repurchases.
It is important to note that we are encouraged with our preliminary July performance, which is in line with our outlook.
On capital allocation, we have a balanced and disciplined approach and our priorities remain as follows our first priority is capital structure.
Our second priority is to invest in growth through both capital expenditures and M&A in.
In the first nine months of fiscal 2022 we deployed $41 million towards acquisitions, and we invested $26 million in capital expenditures over.
Over the last year, we've accelerated the pace of M&A and our pipeline of M&A opportunities continues to grow.
Our final priority is to return excess cash to shareholders.
In the first nine months of fiscal 2022 we repurchased shares totaling $152 million and we have $148 million remaining under our existing share repurchase authorization.
We will continue to evaluate opportunities to repurchase shares based on investment opportunities to drive growth.
Our financial position and market conditions.
And with that I'll hand, it back over to you Mike. Thank you.
Thanks, Steve.
I want to wrap up by saying that we acknowledge our third quarter results reflect execution challenges that we should've been able to manage better.
For our organization and leadership team that will never be acceptable.
With that being said, we want to communicate three important points.
The first one that we understand what happened with our New Jersey D C and we have taken the actions to fix it.
We have also implemented plans to improve the entirety of our supply chain and its ability to support our future growth.
The second is that our year over year results and market share gains are evidence that the fundamental drivers of the pool industry. The durable competitive advantages of our lessees operating model and the effectiveness of our strategic growth initiatives remain intact.
The third is that we have a long and successful history of profitable growth in the face of all kinds of macro economic headwinds and that we are better equipped today than we have ever been to continue that success and win in the market.
With that I'll hand, it back to the operator for Q&A.
Thank you.
At this time, we'll be conducting a question and answer session.
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So that we may address questions from as many participants as possible. We ask that you. Please limit yourself to one question and one follow up question.
One moment. Please so we poll for questions.
Thank you and our first question is from Peter Benedict with Baird. Please proceed with your questions.
Oh, Hey, guys. Thanks for taking the questions.
First just around the increased promotional activity, Steve I think you mentioned or Mike do you think it's back to kind of normalized levels, but how do you. How does that make you think about the stickiness of pricing that has lifted sales.
Now in the industry here over the last couple of years and then the related kind of follow up is I'm curious about the tricor inventory levels across the industry. We're.
We're seeing more promos in that area suggests that those levels are healthy at least relative to demand. So just help us understand your thoughts around the future of promotions the stickiness of price and then a little color on Tricor. Thank you.
Yeah, Peter Thanks.
Thanks for the question.
Let me kind of walk through how Q3 worked as.
It's been pretty well documented I think it was a cold and wet start to the season.
Particularly in two key markets, North East and the West Coast.
This was going on at the same time that the industry was comping chlorine shortage news from the prior year and a relatively strong Q3 for the industry.
At the same time macro pressures intensified for the consumer and what we saw was some increased price sensitivity.
You've got retailers coming off of a cold start to the season trying.
Trying to comp the core.
Maureen Spike from the prior year.
I see a a more price sensitive customer and yeah. We saw some more promoting in the industry in which we participated you know we have a price position in the marketplace and we want to hold that our price positioning.
I think it's important to to make the distinction between promotions and the way we look at this as promotions are.
Our.
Measure and our way to get our share of our industry traffic.
It's actually not related to inventory promotions that are not distressed inventory markdowns.
And to your question on Tricor.
Tricor is in much much better supply this year than it was the prior year.
It's at elevated costs for us and for everyone else.
But promotions do tend to focus on chemicals in the industry because they have a broad use across the industry.
And because they are the I would say the most effective traffic.
Traffic driver for us and for the industry.
That being said I would characterize the level of increase promotion, which across the entirety of my revenues.
Third and 20 basis points.
As more normalized versus last Q3, where there was a lot of shortages of products and chemicals, particularly and very very little discounting.
That's the that's helpful. I guess my fault that there might be as you think about next year.
And the price just the inflation levels for Tricor and that type of thing you said in the past do you think that that those levels are unlikely to come back down are you rethinking that here how should we how should we think about treichler inflation.
And there's inflation more broadly across the the product portfolio for the next 12 months. Thank you.
Yeah, I'll speak to Tricor, specifically, we still think there's a lot of cost pressure on the tricolore across the.
During base, particularly in North America, So we don't see.
But it's been establishes the new retail prices coming down, but we would expect a more normalized promotional rate, which is what we believe we saw in Q3 I'll make the point to that Q3 is traditionally the most promotional quarter for the industry really memorial day through the fourth of July .
And as Steve mentioned.
In the month of July we've done preliminary results in that promotional level has come down.
Next year I wouldn't expect Q3 to be somewhat similar.
I don't think we're going to see.
Any significant decrease in tricolore costing and based on that I think the industry pricing will hold.
Okay.
Got it thanks, so much.
Thank you.
Our next question comes from the line of Ryan Merkel with William Blair. Please proceed with your questions.
Hey, guys good morning.
Good morning.
Steve you mentioned that a higher product costs, we're going to attack the rest of the year. I think you also said uncertain supply was going to be a factor can you just walk us through those again and maybe when do you think youre going to be clear those issues.
Sure happy to thanks, Ryan Yeah, and again part of the commentary was very mixed environment. So as we talked about some of the pressures in the northeast in our D. C. We talked about elevated receipts.
I you know when you look year on year from an inventory perspective, most of the inventory growth is in tricolore as well as our equipment, but not all equipment now some equipment and when you think about the challenges we had kind of in season, making sure. We stayed replenished across our network alright really related to kind of non tricor chemicals and.
Cases, those are D. S D. You'll go on straight to stores other cases, working through our own our own distribution network as well right. When you have shortages in the vendor does not provide product I, we are going to serve our customers, even if that product we procure it comes from different sources.
And now it can be through our traditional contracts or at traditional pricing. So we're going to pay a premium to get those products into our stores on an expedited basis from vendors, who we do not necessarily consolidate all of our spend with we really saw that happened kind of post memorial day I at a if you look at the quarter. When you talk about that 115 basis points of.
Our product margin pressure.
I'd characterize it as a most related to promotions, but some product cost it feels like in Q4 that as Mike just talked about promotions feel like they've moderated a product costs will stay a little elevated as we stay in stock through the rest of the year and so when you think about longer term and and you know kind of working into next year and again not not.
Providing guidance today, but.
But I do think that are you in a promotional environment and if they were normalized at current levels should moderate I in the inventory product costing we should work through over the next couple of quarters and as we prepare for next season.
We'll look at our opportunities to to ensure that we don't have similar issues as we did this year with outages.
Got it that's helpful. Okay and then my second question is just on the <unk> Guide just so I understand it it sounds like you're extrapolating what you saw in <unk>. It sounds like it might be a little conservative we are in uncertain macro you saw July that sounds pretty decent you said promotions are not getting worse.
It was the right read here that underlying industry demand is not slowing down dramatically you know the industry outlook is still pretty good and you think that promotions door. So that's behind you.
Yeah, Ryan I'll take that one.
Do you think you described it correctly.
Correctly, we were we.
We were pleased to see promotions stabilize in July .
And when you look at industry demand.
The issue, we had with our D C.
There's about 700 basis points of comp in our residential business.
So instead of running a 6% comp we were gonna would've run a 13% comp.
So when there's demand we think is a very much alive.
And stable the change we really saw in Q3 was as I described before given the slow start to the season and Comping, the chlorine shortage and media coverage from last year.
Consumer that blinked, a little there was some price sensitivity and the industry reacted with some promotions.
Typically a promotional driven industry, we don't expect it to become one and we think we saw that recovery in July .
Perfect. Thanks.
No.
Okay.
Our next question is from the line of Kate Mcshane with Goldman Sachs. Please proceed with your questions.
Hi, good morning, Thanks for taking our question I wanted to ask quickly about <unk>.
Some of the incremental cost that you discussed, particularly around <unk>.
Distribution center issues I know some are.
Persistent into fourth quarter is that mostly head count related and given that the situation seems to be somewhat of.
Our backup mm.
With regards to the supply chain is that head count being considered more temporary or is this now in the base.
Yeah. Good question, Kate and good morning, I think the right way to think about it is that for the quarter and for Q3 as well as for Q4. It is primarily payroll head count related as we have more and more individuals to get the capacity that we need to serve both stores as well as digital demand as.
As we get into next year, Mike talked about setting up a different approach, particularly in a market like the northeast where a need I mean, you know seven days a week double chefs third parties to kind of assist with the volume. So I would characterize the spend I as being reallocated most likely as we go forward.
Again, if if that's been stays at current levels with the incremental demand that we did not serve this year it isn't necessarily you're going to be a headwind from a margin rate perspective. So I think from a dollar perspective, I again too early to say exact but it will be higher than our previously expected coming into the quarter.
But I it would be good spend to to serve incremental demand.
Okay. Thank you.
My second question.
Can you talk to a.
Ticket versus traffic during the quarter in terms of how it drove the comp.
Yeah, I'll answer that one good morning.
If you look just at our comp residential business transactions were down just over 1% about 1.3.
Average order value the ticket was up about 9%.
Put those together and you get to a 7% comp.
And I'll note again, the D C cost us about 700 basis points of our comp there. So that was a big impact across the total business. The transaction count was plus 3% in the quarter and the average order value was 10% those two combined get us to our 13% sales growth.
Thank you.
Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your questions.
Great. Thank you I'm just curious how much market share you think you could have gained if you hadn't had the issues with the northeast D. C. And then what percentage of your stores is that they serve.
Yeah.
The northeast is it is an outsized portion of our business in Q3, because it's a very concentrated season are in the best of years and this year was more so with the slow start.
And I think I think the way to characterize it is you know $35 million.
About 700 basis points of comp in our residential business.
Would it increase the share we had.
As we show on page 15.
By by that amount.
Great. Thank you and I'm just curious you know a lot of things has obviously been around for a while companies founded in 16. So this wasn't the first time you had a cold spring why do you think the north Eastern D. C was caught off guard by this increase in demand as the weather warmed up.
Yeah that's.
Well, that's a great question and it's a question that we've asked ourselves a lot internally.
We.
The season got a late start we were well positioned with inventory in the stores to start to season.
It starts to Memorial day weekend was I'm going to say okay.
More promotional on the normal but okay. The first week of shipping replenishment shipping following memorial day weekend. The D. C had some issues. That's that's not unusual for a D. C than ours, we have D. C have bad weeks, they tend to get caught up.
And in this case, we saw that reverse and that performance deteriorated.
The way through June and you know, it's a combination of a very tough staffing environment.
And when you add people and shifts quickly to the situation to rectify it which we did you run into a lot of progress a lot of problems and challenges in getting the right supervisory talent to manage those additional shifts. So it was just a it was a highly inefficient process.
But to be clear.
We should have managed it better and we should have seen it coming it's a.
Very disappointing internally for us not to manage that better.
Okay. Thank you.
Yeah.
Thank you. Our next question comes from the line of Jonathan messages with Jefferies. Please proceed with your questions.
Great Hey, Mike Hey, Steve Thanks for taking my questions first one on gross margin you know with the shortfall. This quarter can you just help us think about the low end and the high end of the implied.
Gross margin forecast are in guidance I guess, you know what's embedded in each of those beyond the impact of higher or lower sales. So what is your low end and high end imply in terms of maybe promotion ality indie industry from here it sounds like maybe it stabilized in July .
But are you planning for any incremental promotions in <unk>. Thanks.
Yeah. Good morning, Jonathan I'll take I'll take the part on promos and Steve you can talk about the the building blocks of the margin.
We think promotions have settled down we've got.
We've got labor day weekend coming up we expect it to be fairly.
Fairly normalized two next year.
The second part of the product margin challenge of Steve mentioned. This earlier is some unexpected short shipments from vendors.
And particularly specialty chemicals, that's a very active situation.
We're managing it day to day.
And I'll note that it's completely different than last last year last year.
The shortages and supply challenges, we're focused on tricor and equipment Treichler inventory is in good shape equipment inventory for the most part is in good shape, but things like shock liquid chlorine dry acid Alger sides.
You know, we got short shipped 30% to 40% from some of our proven vendors on those products and to meet consumer demand. We have gone to the open market to purchase and that has been that's come in at a much higher cost so that pressure.
We see continuing into Q4 as part of the product margin promotions, we think will stabilize and become less of a factor.
Yeah, and Jonathan and with respect to the margin rate change in in Q4 kind of midpoint implies 250 basis point decline, which was consistent with Q3 and again I had made a comment that a you know a little bit different mixes we think about how it will play out in Q4 more perspective, a little little more business makes impact than in Q4.
Given some of the M&A and I you know the strength of the hot tub business and in Q4 relative to Q3, and then when you think about what might just kind of walk through our promotional you feel like it's a little less impactful, but but still higher than last year, I, and then product product margin related to product costs.
It's really dependent on our ability to get our incremental product from existing vendor. So partially why we have the range. We have is is the uncertainty of of you know when or if we get to replenish from some of those existing vendors or if we have to rely on our newfound partners or existing or new relationships to drive more product into the.
And to the network.
And then my follow up question just in terms of the customer mix it looks like pro percentage residential five.
Yeah curious, whether youre seeing any indications that homeowners looking to engage more in.
DIY maintenance of their pools as maybe they tightened their health expenditure.
Are you hearing that from from store Associate Pro partners anything like that presumably work to your advantage.
Yeah.
Yeah, Jonathan I would say that.
In past.
Macroeconomic slowdowns, there has been an uptick in DIY pool maintenance from residential consumers.
I believe we would have seen that this quarter without the without the challenges associated with the New Jersey D C.
On the pro side, we haven't really seen any slowdown in that business.
A much smaller player in that business to the to the total so we've got lots of room to grow.
And.
That business was all very positive, but I think the only challenge. We had there was similar to what Steve was mentioning we did have some periodic shortages of supply trying to service the pro business, but outside of outside of that we're very pleased with how the affiliate program is working.
And the pro initiative overall.
Sure.
Thank you.
Our next question comes from the line of Andrew Carter with Stifel. Please proceed with your question.
Sorry, I was on mute.
Just want to make sure and because I'm a little confused here. So early June the commentary was adverse weather, which you alluded to in the late start.
Then suggested that would've been a neutral to positive impact so to be clear. So I understand this correctly. The D. C issue didn't allow you to fully capitalize on the favorability.
And to that end would you know that there were kind of issues with this D. C. If there wasn't a kind of a change in the end market demand that was bad abrupt and finally I'll just ask kind of all in one I appreciate you're viewing the remainder of the network, but how can you kind of assess this risk at other locations and could there be any stepped up.
Investment SG&A Capex, whatever next year to fix any other deficiencies. Thanks.
Yeah, Andrew Thanks for the question the.
When we were at the first week of June .
Speaking to investors.
Like I said earlier, we'd come to the Memorial day weekend. It was it was slow but not a not terrible it was more promotional but we had a lot of momentum.
In the business the northeast region in particular was outperforming at that time, the rest of our the rest of our store fleet.
And.
The situation with the D C.
Started when they had trouble fulfilling the replenishment shipments into the stores. They serve that first week of June .
And like we like.
I've said before and we've seen not unusual for one of our D. C has to have a poor week of shipping. So we were concerned but not.
Overly concerned.
The challenge was there was it wasn't a recovery from that and the situation got worse and worse for several weeks so.
Caught us by surprise should not caught us by surprise should've been able to manage through it better and as you can see in the results. It was a big was a big hit to the quarter.
And in regards to the D CS.
You know we've grown it.
We will have grown in the last three years 60 plus percent we've invested in our Dcs will need to continue to invest in our Dcs and the situation with New Jersey has put us on high alert from a learnings perspective and evaluating the balance of our our network that's for sure.
Yeah, Andrew this is Steve.
I think the other thing to think about it in the northeast. It does have the most acute change even with a normalized cadence as you go from Q2 to Q3 really are kind of peaking in into end of May early June from a volume perspective. So I don't have the same acute volume changes at other facilities.
But as Mike said, we we've certainly seen those facilities operate well and then they may have a day or two or a week, where there's challenges but to kind of pick themselves back up and I continue operating as normal so I. It as Mike said, you know we've talked a lot about our investments and in distribution and supply chain. It's part of what we've been talking about all year from an investment.
Prospective as well and given the pace of growth in and the fact that we continue to have kind of six full line distribution centers across our network.
Even with the elevated sales volume you know it is an opportunity for us to revisit our efficiencies and opportunities to supplement in season.
Thanks, I'll pass it on.
Our next question is from the line of Peter Keith with Piper Sandler. Please proceed with your questions.
Hi, Thanks, good morning, everyone.
Just wanted to get clarity on the sales outlook for the fourth quarter. I believe you said you've reduced your prior outlook by $21 million.
But at the same time it sounds like the D. C issue is now resolved.
Also you did comment on macroeconomic challenges, which obviously, we're aware of but at the same time, you've talked in the past about 80% of the business being non discretionary. So just help me understand a little bit better about that reduced sales outlook or is there something we should be concerned about going forward.
Thanks Lynn.
Got it Mike.
Yeah.
Alright, good morning, Keith Yeah from an outlook perspective, so we're looking at a a basically growth of 13% to 18% comp of kind of 6% to 9%.
Think about Q3, where we were at a 7% are you basically mid point of that outlook is consistent with Q3 as you pointed out D. C is behind us and the north east and kind of shifting to plan, which is which is good.
But I again, given the macroeconomic uncertainty doesn't feel like you know now's. The right time on you know to basically accelerate the pace of of expectations and in Q4 I'm. We're pleased with July as we talked about but I think at this point you know folks are comfortable with our current outlook, which overall for the year is 15% to 17% topline growth.
And comp of you know call it 99 or 11%.
Okay.
And.
Just look at the Q4 gross margin. So I think he also said at the midpoint Youre down to 50, so it's down.
Now, there's a as Q3, but at the same time that the promos are abating how are you.
Just trying to give yourself some cover here hum on the promos.
The issue with the elevated product cost.
Because it seems like the gross margins sequentially should have less pressure.
Yeah, it's it's different different pressure as I talked about.
More business makes headwind in Q4.
Promotions less headwind and product costs more headwind is probably the right way to think about it but I you know it feels like a <unk>.
Consistent with last quarter is the right place to be at the midpoint.
Okay. Thank you.
Our next question comes from the line of Simeon Gutman with Morgan Stanley . Please proceed with your question.
Great Hey, guys. This is Michael Kessler on for Simeon Thanks for taking our questions.
First I was hoping you could maybe help distinguish them a bit more I guess between the challenges that you had at the New Jersey D C, which had weather issues supply chain moderating at the same time coming in relative I guess to other regions, where they're also shipment issues from vendors like across the country more widespread and then relate.
Can you speak to just the northeast region.
<unk> performance relative to the rest of the country and also versus your plan.
Yeah sure the.
The combination of a late start to the season.
Combined with a really significant peak in receiving from vendors.
Packed at all of the D CS.
And it wasn't expected, but we were able to manage through it and all but the new Jersey D. C. So that was a similar pressures I would say across our network.
Amplified in New Jersey with as Steve has explained you know a very strong peak in that region.
In terms of replenishment season happens very quickly there and with the slow start of it concentrated demand and at the same time, we had a siem.
It seems like most of the vendors are caught up at the same time in the supply chain and we took on those receipts, but it made for a very crowded any problematic challenge, particularly in the New Jersey D C.
The northeast region, we don't really break out.
<unk> performance in size by region, but.
It was the only region in our network.
Seven regions that had a that had a negative comp and that was very specifically the impact of the D. C that serves that region.
Yeah.
Got it okay. That's helpful.
Follow up just on margins and starting to turn the page a little bit next year thinking about normalized margins for the business. So theres. Some moving pieces now with maybe potentially some higher costs in D. C. As you have the mix shift.
He has to grow maybe promotions have to be annualized at a lower rate. So can you talk about.
I guess, where do you see that all normalizing and any I guess you know on the other side offset that from.
From a tailwind standpoint, it's just as we're trying to kind of calibrate where margins are going off of this year, then relative to where you were at pre COVID-19.
Yeah. Good question.
I'll take this Mike.
Guidance for 2023 today, and we're not changing our long term growth algorithm either so when you think about and step back you know longer term the aftermarket pull industry fundamentals remain intact or when you think about our algorithm and in how we we've talked about it we have business mix headwind. That's been there since we went public a it'll continue to be as we we.
Hi, Dave.
Develop relationships with new consumers and new channels.
We generally drive product margins higher in each of our businesses, we do that through our direct vendor relationships, which is unique in the industry relative to most of the competition. Our proprietary brand strategies, we've talked about our ability to continue to expand in that area.
And then again, our vertical integration around distribution and manufacturing so that those should provide efficiencies in and leverage across the business kind of your it over the long term and then again expect a continued occupancy leverage. So those are kind of the core drivers that are continuing to what we think are going to continue to drive gross.
And in the future I think we do have some noise over the next few quarters and look forward to providing guidance as we get through Q4.
Yeah, the only thing I would add is with.
With a stabilized supply situation and it's getting better though as Steve described and it is still mixed.
And a stabilized promotion situation, which will be reset more normalized and I think we've seen that happen in the fourth quarter. We can we can manage margins, we can manage margins to our long term growth algorithm.
We got surprised by some factors in this quarter.
And that really are really led to the product margin degradation that you saw.
Thank you.
Our next question is from the line of Garik <unk> with loop capital. Please proceed with your questions.
Oh, hi, Thanks for taking my question I'm, just wondering how you're viewing some of your growth initiatives.
The poll conversion acquisitions.
New store openings as well just given the more uncertain macro.
Yeah, Garik I would say we are we.
We feel very good about the pro initiatives like I said, 17% for the quarter would have been higher without some periodic shortages of products, particularly our larger sizes up shock so feeling very confident there on.
On the M&A side continue to see lots of opportunities, we're going to look to look to accelerate that.
Residential stores that we are opening new stores are performing well as is our marketing digital marketing efforts.
Underserved areas, we had talked about the file growth starting to moderate.
That this quarter.
I also point out that that just this year. It was a very unusual year between the Texas freeze, which impacted the entire industry and the chlorine media.
Media coverage of the Korean shortage last year to really extra ordinary events that put a lot of noise in the year with regard to our consumer acquisition.
But if you look at our two year stacks in the quarter plus 14, we feel.
We feel good about that and plus 16 for the year. So it's bumpy ride on the consumer file growth, but believe with those events behind us we'll get back to a.
Steady.
Growth in the file at a lower level. We've said 100 to 300 basis points I think that's where that's where you'll see us next.
Next year.
Got it.
I wanted to follow up one more time on the New Jersey D C.
You mentioned, you're shifting to sudden day, a week two shifts a day a model and just kind of curious how does that compare to before and how universal is that model across our network.
Yeah, well that's a that's the model we're gonna put.
In place across the network.
Had an acute problem within New Jersey D C. But we were running all of our G sees a REIT at Max capacity for the season.
Seven day a week.
With a large e-commerce business like we have I'm going to say is the norm.
Currently operating about five and a half to six days a week, we had run a second shifts in most of the D. C's over the over the course of the season. However, it was not a not a seven day a week and that the.
The challenge here is really.
You can add temporary D C staff and you can train them up for a season.
What what we learned this season is the challenge is really around supervision and we're going to make the investment and second shift and weekend shifts to supervision that will just put in place in the D. C is year round and then they will.
It would really have their specific task during season.
Got it thanks for that.
Thank you. Our final question today comes from the line of Dana Telsey with Telsey Advisory. Please proceed with your questions.
The next question is from the line of Dana Telsey. Your line is life for questions.
Hi, everyone. As you think about inventory levels, given what's happened in the New Jersey D. C. I mean should we be thinking.
Employee levels, perhaps.
Florida.
And then b.
Changes in product.
You mentioned, Mike how much of that continues going forward and how much New Jersey DC costs.
Continue I sticky and that's the way.
He needs to operate but how much is permanent.
Danielle thank.
Thank you.
Yeah. Good morning, Dana I'll take the first part of that on on inventory right.
As we think about year end are not going to guide to specific numbers, but we expect inventory to remain elevated again. The two primary areas of increase year on year for Q3 were tricolore in equipment.
On Tricolore increases relative to last year, which was which was more depressed are more difficult to come by and so we're in we're in a much better position from a trade perspective across our network Oh, all stages raw material. That's produced goods are in our Dcs and in our stores. When you think of equipment equipment is where we've had a lot of the uncertainty around.
Timing of of I tie supplier.
Our supply of receipt.
And it does feel like that area of the supply chain is moderating it is getting better. It has resulted in elevated levels, but when you think about the nature of our our inventory. It. It doesn't have the same level of obsolescence as are many other retailers. This is good product and if the choices to take inventory at a little bit higher.
[noise] level today going into the end of the year and to start off next year in a better position I you know versus try to run leaner, we will take the former in the current environment.
So it's something we expect to actively manage our into year end and in through next year don't don't necessarily view these levels as as permanent increases, but in the current environment, it's the appropriate level of inventory.
Yeah, Good morning, Dave and I apologize I had some trouble hearing the second part of your question I believe it was around how much of a D. C. The elevated expenses in the D C would be permanent.
The way I would answer that is the Dcs will be more expensive to operate on a go forward basis, but it will also give us increased capacity, we need and we should be able to gain leverage on the D. C expense as it goes up just through just through our standard growth profile.
Thank you.
Thank you that concludes our question and answer session I'll turn the floor back to management for closing remarks.
Yeah.
Thank you operator, and thank all of you for joining us today.
We appreciate the continued interest and Leslie.
This will conclude today's conference you may disconnect. Your lines at this time and we thank you for your participation and have a wonderful day.