Leslie's, Inc. (LESL) Q3 2022 Earnings Call Transcript

Leslie's, Inc. (LESL 0.23%)
Q3 2022 Earnings Call
Aug 05, 2022, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the fiscal 2022 third quarter conference call for Leslie's, Inc. [Operator instructions] 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.

Caitlin Churchill -- Investor Relations

Thank you, and good morning. 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, Inc. is Mike Egeck, chief executive officer; and Steve Weddell, chief financial officer.

With that, I will turn the call over to Mike Egeck. Mike?

Mike Egeck -- Chief Executive Officer

Thanks, Caitlin, and good morning, everyone. Thank you, all, for joining us, and please note that we have posted a deck on the Leslie's IR site to supplement our discussion. I'm going to discuss three things today: number one, the overview of our Q3 results and 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 understand that this outcome is not acceptable, and that we missed a significant opportunity to serve more customers in the quarter. There is 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. Despite our disappointment in underperforming our expectations, our year-over-year performance illustrates our continued market share growth, driven by our competitive advantages in serving the aftermarket pool industry.

Sales for the quarter increased 13% to $674 million with broad-based strength across our three consumer groups. Residential pool grew 7% for the quarter, PRO 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 utilizes 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, and DC expense. Adjusted 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 a healthy outdoor lifestyle.

Third, migration to the Sun Belt. Fourth, a heightened sense of safety and sanitization. And finally, hybrid and 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. Now I would ask that you please turn to Page 7 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 DC. We operate six distribution centers in total, and the New Jersey DC fulfills store and digital demand for our Northeast region. The New Jersey DC 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 in unforeseen levels of vendor shipments, and DC receiving. And 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 and 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 DC impacted sales by $35 million and margin by a total of $21 million in the quarter. We reacted quickly to this situation by increasing temporary headcount and adding work shifts. By the second week of July, the facility was back shipping to plan, but it was operating with twice the headcount of the prior year, increasing headcount in the facility that quickly is highly inefficient. As a result, the facility both underperformed and added cost.

The additional expense was approximately $3 million in Q3, and we have planned an additional $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, two-shift operating model for all of our DCs and add additional 3PL 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 DC, the balance of the business outperformed our internal sales expectations by approximately $14 million. Two other points to note on the bridges on Page 7. First, decreases in product margin rate impacted margin by $8 million in the quarter. The decrease consisted primarily of two factors.

Supply shortages from planned vendor receipts in season that required higher cost 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 that 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 it with margin growth in each of our businesses.

The current macroeconomic and operating environment is challenging. And while we would certainly prefer 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's has been successful in profitably growing sales in periods of rising interest rates, inflation, housing industry slowdowns, GDP contraction, declines in consumer spending and reduced rates of new pool builds.

With the addition of Leslie's 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 than any other time in our history. Now let's review the performance of our six strategic growth initiatives in the quarter. The year-to-date contribution of each initiative is also summarized on Page 9 of the supplemental deck.

First, our consumer file. Total target file growth was minus 1.7% a quarter. The comparison to last year is distorted by outsized file growth in Q3 2021, driven by the pervasive media coverage of the chorine shortage. Adjusted for that event, file growth was 5.5%.

The 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, a 5% reward earn rate and free shipping continue to resonate with our consumers.

Average revenue per consumer grew 13.7% in the quarter. The 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 PRO stores.

We are now operating 79 total PRO stores. Our PRO affiliate program continues to scale. We now have over 2,600 agreements in place, and our PRO affiliate partner sales grew 38% in the quarter. The newly converted PRO locations, our expanding PRO affiliate program and our dedicated Leslie's PRO e-commerce site helped to grow PRO pool 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 Texsun, 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 LOIs 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 Texsun locations, is 987. Finally, AccuBlue Home.

We are scheduled to receive just over 2,000 units of the version 2.0 devices this year. These devices will use primarily for incremental refinement of our app interface and additional consumer testing. We are 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.

Steve Weddell -- Chief Financial Officer

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. Despite these challenges, demand for our core nondiscretionary 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 2021. Our comparable sales increased 7.4% 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 2021, and represents comparable sales growth on a two-year stack basis of 26.9%. Our noncomparable sales increased by $32.5 million, driven by four completed acquisitions and 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% for PRO pool and 10% for residential hot tub. On a two-year stack basis, we generated comparable sales growth on a calendar-adjusted basis of 21% for residential pool, 78% for PRO pool 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% 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, continued 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 headcount 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 leverage 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, were 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 2021, 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 noncomparable 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 2021. Adjusted net income increased to $125.7 million in the third quarter of fiscal 2022, compared to net income of $124.4 million in the prior-year period.

And adjusted diluted earnings per share was $0.68 in the third quarter of fiscal 2022, compared to $0.64 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% 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 $111.0 million in the prior-year period. And adjusted diluted earnings per share was $0.60 in the first nine months of fiscal 2022 and $0.59 in the prior-year period. Moving to the balance sheet.

We finished the third quarter of fiscal 2022 with cash and cash equivalents of $193 million, compared to $307 million at the end of the third quarter of fiscal 2021. The 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 2022 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.

Both product categories are nondiscretionary 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 backordered products during the third quarter. However, we would still characterize the current environment as mixed. As a result, we view our current inventory position as 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, compared to $808 million at the end of the prior-year period. 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 totaled $607 million at the end of the third quarter of fiscal 2022.

With regard to our outlook. Today, we are revising our full year fiscal 2022 outlook, the details of which are included in our earnings press release. As we only have one more quarter left in the fiscal year, I will be discussing each metric in the context of our implied fourth quarter outlook. Fiscal fourth quarter sales growth will be in the range of 13% to 18% with comparable sales growth of 6% to 9%.

Changes to 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% 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 in 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 $0.30 to $0.36. Our outlook for the fourth quarter includes interest expense of $9 million. This is approximately $2 million higher than the third quarter, and the increase reflects current rates on our floating rate debt.

And finally, our diluted weighted average shares outstanding 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 the first nine months of fiscal 2022, we deployed $41 million toward acquisitions, and we invested $26 million in capital expenditures. 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.

Mike Egeck -- Chief Executive Officer

Thanks, Steve. I want to wrap up by saying that we acknowledge our third quarter results, reflect executional challenges that we should have 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 is that we understand what happened with our New Jersey DC, 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 the Leslie's 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 macroeconomic 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.

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question is from Peter Benedict with Baird. Please proceed with your question.

Peter Benedict -- Baird -- Analyst

Hi, guys. Thanks for taking the questions. First, just around the increased promotional activity, Steve, I think you mentioned -- or Mike, that 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 in the industry here over the last couple of years? And then the related kind of follow-up is, curious about the Trichlor inventory levels across the industry.

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 promotions, the stickiness of price and then a little color on Trichlor. Thank you.

Mike Egeck -- Chief Executive Officer

Yeah, Peter. Thanks for the question. Let me kind of walk through how Q3 worked. It's been pretty well documented.

I think it was a cold and wet start to the season, particularly in two key markets, Northeast and the West Coast. This was going on at the same time that the industry was comping the 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. So you've got retailers coming off of a cold start to the season, trying to comp the chlorine spike from the prior year.

They see a more price-sensitive customer. And yes, we saw some more promoting in the industry in which we participated. We have a price position in the marketplace, and we want to hold that price positioning. I think it's important, too, to make the distinction between promotions, and the way we look at this is promotions are measure and our way to get our share of our industry traffic.

It's actually not related to inventory. Promotions are not distressed inventory markdowns. And to your question on Trichlor. Trichlor 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 broad use across the industry and because they are, I would say, the most effective traffic driver, for us and for the industry. That being said, I would characterize the level of increased promotion, which, across the entirety of our revenue, was 120 basis points, is more normalized versus the last Q3 where there was a lot of shortages of product in chemicals, particularly, and very, very little discounting.

Peter Benedict -- Baird -- Analyst

That's helpful. I guess my follow-up, Mike, would be as you think about next year and the price -- just the inflation levels for Trichlor and that type of thing, you've said in the past you think that those levels are unlikely to come back down. Are you rethinking that here? How should we think about Trichlor inflation and the inflation more broadly across the product portfolio for the next 12 months? Thank you.

Mike Egeck -- Chief Executive Officer

Yeah. I'll speak to Trichlor specifically. We still think there's a lot of cost pressure on the Trichlor across the manufacturing base, particularly in North America. So we don't see what has been established as 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, too, 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 got our preliminary results in that promotional level has come down. Next year, I would expect Q3 to be somewhat similar. I don't think we're going to see any significant decrease in Trichlor costing.

And based on that, I think the industry pricing will hold.

Peter Benedict -- Baird -- Analyst

Got it. Thanks so much.

Mike Egeck -- Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Ryan Merkel with William Blair. Please proceed with your question.

Ryan Merkel -- William Blair -- Analyst

Hey, guys. Good morning.

Mike Egeck -- Chief Executive Officer

Good morning.

Ryan Merkel -- William Blair -- Analyst

Steve, you mentioned that higher product costs were going to impact 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 you're going to be clear of those issues?

Steve Weddell -- Chief Financial Officer

Sure. Happy to. Thanks, Ryan. Yeah.

And again, part of the commentary was a very mixed environment. So as we talked about some of the pressures in the Northeast, in our DC, we talked about elevated receipts. When you look year on year from an inventory perspective, most of the inventory growth is in Trichlor, as well as equipment, but not all equipment, some equipment. And when you think about the challenges we had kind of in-season, making sure we stayed replenished across our network.

It really related to kind of non-Trichlor chemicals. And in some cases, those are DSD going straight to stores, other cases working through our own distribution network as well. When you have shortages and a vendor does not provide product, we are going to serve our customers, even if that product we procure comes from different sources and not going to 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 happen kind of post Memorial Day. If you look at the quarter, when you talk about that 115 basis points of product margin pressure, I'd characterize it as most related to promotions, but some product cost, feels like in Q4 that, as Mike just talked about, promotions, feel like they've moderated. 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 kind of working into next year and again, not providing guidance today, but I do think that the promotional environment, if we're normalized at current levels should moderate.

In the inventory product costing, we should work through over the next couple of quarters. And as we prepare for next season, we will look at opportunities to ensure that we don't have similar issues as we did this year with outages.

Ryan Merkel -- William Blair -- Analyst

Got it. That's helpful. OK. And then my second question is just on the 4Q guide, just so I understand it.

It sounds like you're extrapolating what you saw in 3Q. It sounds like it might be a little conservative. We have an uncertain macro. You saw in July, that sounds pretty decent.

You said promotions are not getting worse. So is the right read here that underlying industry demand is not slowing down dramatically, the industry outlook is still pretty good and you think the promotions or so that's behind you?

Mike Egeck -- Chief Executive Officer

Yeah. Ryan, I'll take that one. I do think you described it correctly. We were pleased to see promotions stabilize in July.

And when you look at industry demand, if you -- the issue we had with our DC costs us about 700 basis points of comp in our residential business. So instead of running a 6% comp, we would have run a 13% comp. So in this demand, we think, is 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, and a consumer that blanked a little, there was some price sensitivity, and the industry reacted with some promotions.

It's not typically a promotional-driven industry. We don't expect it to become one, and we think we saw that recovery in July.

Ryan Merkel -- William Blair -- Analyst

Perfect. Thanks.

Operator

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

Kate McShane -- Goldman Sachs -- Analyst

Hi. Good morning. Thanks for taking our questions. I wanted to ask quickly about some of the incremental costs that you discussed, particularly around the distribution center issues.

I know some are persisting into fourth quarter. Is that mostly headcount related? And given that the situation seems to be somewhat of a backup with regards to the supply chain. Is that headcount being considered more temporary? Or is this now in the base?

Steve Weddell -- Chief Financial Officer

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 headcount related as we have more individuals to get the capacity that we need to serve both stores, as well as digital demand. As we get into next year, Mike talked about setting up a different approach, particularly in a market like the Northeast where you need seven days a week, double shifts, third parties to kind of assist with the volume.

So I would characterize the spend as being reallocated most likely as we go forward. But again, if that spend stays at current levels with the incremental demand that we did not serve this year, it isn't necessarily going to be a headwind from a margin rate perspective. So I think from a dollar perspective, again, too early to say exact, but it will be higher than previously expected going into the quarter, but it will be good spend to serve incremental demand.

Kate McShane -- Goldman Sachs -- Analyst

OK. Thank you. And then my second question is, can you talk to ticket versus traffic during the quarter in terms of how it drove the comp?

Mike Egeck -- Chief Executive Officer

Yeah. Kate, I'll answer that one. Good morning. The -- 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 our 7% comp. And I'll note again the DC cost us about 700 basis points of 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.

Kate McShane -- Goldman Sachs -- Analyst

Thank you.

Operator

Our next question comes from the line of Liz Suzuki with Bank of America. Please proceed with your question.

Liz Suzuki -- Bank of America Merrill Lynch -- Analyst

Great. Thank you. Just curious how much market share you think you could have gained if you hadn't had the issues with the Northeast DC. And then what percentage of your stores does that DC serve?

Mike Egeck -- Chief Executive Officer

Yeah. That -- the Northeast is an outsized portion of our business in Q3 because it's a very concentrated season in the best of years, and this year was more so with the slow start. And I think the way to characterize it is $35 million, about 700 basis points of comp in our residential business would have increased the share we had, as we show on Page 15, by that amount.

Liz Suzuki -- Bank of America Merrill Lynch -- Analyst

Great. And Thank you. I'm just curious, Leslie's has obviously been around for a while, company was founded in the '60s. So this wasn't the first time you've had a cold spring.

Why do you think the Northeastern DC was caught off guard by this increase in demand as the weather warmed up?

Mike Egeck -- Chief Executive Officer

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 the season.

The start to Memorial Day weekend was, I'm going to say, OK, a little more promotional than normal, but OK. The first week of shipping -- replenishment shipping following Memorial Day weekend, the DC had some issues. That's not unusual for a DC in ours. We have -- DCs have bad weeks.

They tend to get caught up. And in this case, we saw the reverse, and the performance deteriorated all the way through June. And it's a combination of a very tough staffing environment. And when you add people in shifts quickly to the situation to rectify it, which we did, you run into a lot of problems and challenges in getting the right supervisory talent to manage those additional ships.

So it was just -- 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 very disappointing internally for us not to manage that better.

Liz Suzuki -- Bank of America Merrill Lynch -- Analyst

OK. Thank you.

Operator

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

Jonathan Matuszewski -- Jefferies -- Analyst

Great. Hey, Mike. Hey, Steve. Thanks for taking my question.

First one on gross margin. 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 in guidance, I guess 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 promotionality in the industry from here? It sounds like maybe it stabilized in July, but are you planning for any incremental promotions in 4Q? Thanks.

Mike Egeck -- Chief Executive Officer

Yeah. Good morning, Jonathan. I'll take the part on promos and Steve, you can talk about the building blocks of the margin. Within promotions have settled down.

We've got Labor Day weekend coming up. We expect it to be fairly normalized to next year. The second part of the product margin challenge, though, and Steve mentioned this earlier, is some unexpected short shipments from vendors on 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 year. Last year, the shortages and supply challenges were focused on Trichlor and equipment. Trichlor inventory is in good shape.

Equipment inventory for the most part is in good shape. But things like shock, liquid chlorine, dry acid, algicides, we got short ship 30% to 40% from some of our proven vendors on those products. And to meet consumer demand, we've 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.

Steve Weddell -- Chief Financial Officer

Yes. And, Jonathan, with respect to the margin rate change in Q4, kind of midpoint implied 250-basis-point decline, which is consistent with Q3. Again, I had made a comment that a little bit different mix as we think about how it will play out in Q4 from our perspective, a little more business mix impact in Q4 given some of the M&A and the strength of the hot tub business in Q4 relative to Q3. And then when you think about what Mike just kind of walked through, promotionally, feel like it's a little less impactful, but still higher than last year.

And in product -- margin related to product cost is really dependent on our ability to get the incremental product from existing vendors. So partially why we have the range we have is the uncertainty of when or if we get to replenish from some of those existing vendors or if we have to rely on our new found partners existing or new relationships to drive more product into the network.

Jonathan Matuszewski -- Jefferies -- Analyst

That's helpful. And then my follow-up question. Just in terms of the customer mix, it looks like PRO percent of residential [inaudible]. Curious whether you're seeing any indications of homeowners looking to engage more in DIY maintenance of their pools as maybe they tighten their house expenditure.

Are you hearing that from store associates, PRO partners, anything like that, presumably work to your advantage?

Mike Egeck -- Chief Executive Officer

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 challenges associated with the New Jersey DC. On the PRO side, we haven't really seen any slowdown in that business.

We're a much smaller player in that business to the total. So we've got lots of room to grow. And that business was all very positive. 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 that, we're very pleased with how the affiliate program is working in the PRO initiative overall.

Jonathan Matuszewski -- Jefferies -- Analyst

Thank you.

Operator

Our next question comes from the line of Andrew Carter with Stifel. Please proceed with your question.

Andrew Carter -- Stifel Financial Corp. -- Analyst

Sorry, I was 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. You then suggested that would have been a neutral-to-positive impact.

So to be clear, if I understand this correctly, the DC issue didn't allow you to fully capitalize on the favorability. And kind of to that end, would you have known that there were kind of issues with this DC if there wasn't a kind of a change in the end market demand that was that abrupt? And finally, I'll just ask kind of all in one. I appreciate your 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 efficiencies? Thanks.

Mike Egeck -- Chief Executive Officer

Yeah, Andrew. Thanks for the question. The -- when we were at the first week of June speaking to investors, like I'd said earlier, we'd come to Memorial Day weekend. It was slow but 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 store fleet. And the situation with the DC started when they had trouble fulfilling the replenishment shipments into the stores they serve that first week of June.

And like I've said before, and we've seen not unusual for one of our DCs to have a poor week of shipping. So we were concerned, but not overly concerned. The challenge was there wasn't a recovery from that, and the situation got worse and worse for several weeks. So caught us by surprise, should not have caught us by surprise, should have been able to manage through it better.

And as you can see in the results, it was a big hit to the quarter. In regards to the DCs, we will have grown in the last two years, 60-plus percent. We've invested in our DCs. We need to continue to invest in our DCs.

And the situation with New Jersey has put us on high alert from a learning perspective in evaluating the balance of our network. That's for sure.

Steve Weddell -- Chief Financial Officer

And, Andrew, this is Steve. I think the other thing to think about in the Northeast, it does have the most acute change, even with a normalized cadence, as you go from kind of Q2 to Q3, really kind of peaking into end of May, early June from a volume perspective. So you don't have the same acute volume changes at other facilities. But as Mike said, we've certainly seen those facilities operate well, and they may have a day or two or a week where there's challenges, but kind of pick themselves back up and continue to operate in that as normal.

So as Mike said, we've talked a lot about investments in distribution and supply chain. It's part of what we've been talking about all year from an investment perspective as well, and given the pace of growth and the fact that we continue to have kind of six full-line distribution centers across our network, even with the elevated sales volume, it is an opportunity for us to revisit efficiencies and opportunities to supplement in season.

Andrew Carter -- Stifel Financial Corp. -- Analyst

Thanks. I'll pass it on.

Operator

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

Peter Keith -- Piper Sandler -- Analyst

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 DC issue is now resolved. You 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 nondiscretionary.

So just help me understand a little bit better about that reduced sales outlook. And is there something we should be concerned about going forward?

Steve Weddell -- Chief Financial Officer

Hey, good question. Go ahead, Mike.

Mike Egeck -- Chief Executive Officer

Go ahead.

Steve Weddell -- Chief Financial Officer

Good morning, Keith. Yeah. From an outlook perspective, we're looking at a basic growth of 13% to 18%, comp of kind of 6% to 9%. If you think about Q3, where we were at 7%, basically midpoint of that outlook is consistent with Q3.

As you pointed out, DC is behind us in the Northeast, and kind of shipping to plan, which is good. But again, given the macroeconomic uncertainty, it doesn't feel like now is the right time to basically accelerate the pace of expectations in Q4. We're pleased with July as we talked about. But I think at this point, folks were comfortable with our current outlook, which overall for the year is 15% to 17% top-line growth in comp of, call it, 9% to 11%.

Peter Keith -- Piper Sandler -- Analyst

OK. And if I just look at the Q4 gross margin, so I think you also said at the midpoint, you're down 250.So it's down a similar amount as Q3. But at the same time, the promos are abating. Are you just trying to give yourself some cover here on the promos, and then this mix issue with the elevated product cost? Because it seems like the gross margins sequentially should have less pressure.

Steve Weddell -- Chief Financial Officer

Yeah. It's different pressure. So I talked about likely more business mix headwind in Q4, promotions less headwind and product costs more headwind is probably the right way to think about it. But it feels like consistent with last quarter is the right place to be at the midpoint.

Peter Keith -- Piper Sandler -- Analyst

OK. Thank you.

Operator

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

Michael Kessler -- Morgan Stanley -- Analyst

Great. Hey, guys. This is Michael Kessler on for Simeon. Thanks for taking our questions.

First, I was hoping you could maybe help distinguish a bit more, I guess, between the challenges that you had in New Jersey DC, which had weather issues, the supply chain moderating at the same time coming in relative, I guess, to other regions. Were there also shipment issues from vendors like across the country, more widespread? And then relatedly, can you speak to just the Northeast region sales performance relative to the rest of the country, and also versus your plan?

Mike Egeck -- Chief Executive Officer

Yeah, sure. The combination of a late start to the season, combined with a really significant peak in receiving from vendors impacted all of the DCs. And it wasn't expected, but we were able to manage through it in all but the New Jersey DC. So there was a similar pressures, I would say, across our network, amplified in New Jersey with -- as Steve has explained a very strong peak in that region in terms of replenishment, season happens very quickly there.

And with a slow start, it concentrated demand. And at the same time, we had -- it seems like most of the vendors 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 DC. The Northeast region, we don't really break out comps and performance and size by region. But it was the only region in our network of seven regions that had a negative comp.

And that was very, specifically, the impact of the DC that serves that region.

Michael Kessler -- Morgan Stanley -- Analyst

Got it. OK. That's helpful. A follow-up just on margins, and starting to turn the page a little bit to next year, thinking about normalized margins for the business.

So there's some moving pieces now with maybe potentially some costs in DCs. You have the mix shift as the [inaudible] used 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 in any -- I guess, on the other side, offset in -- from a tailwind standpoint, just as we're trying to kind of calibrate where margins are going off of this year than relative to where you were at pre-COVID.

Steve Weddell -- Chief Financial Officer

Yeah, good question.

Mike Egeck -- Chief Executive Officer

Yes. Go ahead.

Steve Weddell -- Chief Financial Officer

I'll take this, Mike. We're not providing guidance for 2023 today, and we're not changing our long-term growth algorithm either. So when you think about and step back longer term, the aftermarket pool industry fundamentals remain intact. But when you think about our algorithm and how we talked about it, we have business mix headwinds.

It's been there since we went public. It will continue to be as we develop relationships with new consumers and new channels. We generally drive product margins higher in each of our businesses. We do that through our director 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 those should provide efficiencies and leverage across the business kind of year over the long term. And then again, expect continued occupancy leverage.

So those are kind of the core drivers that continue to -- we think are going to continue to drive gross margin in the future. I think we do have some noise over the next few quarters, and we look forward to providing guidance as we get through Q4.

Mike Egeck -- Chief Executive Officer

Yeah. The only thing I would add is with a stabilized supply situation, and that's getting better, though Steve described, and it's 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 manage margins.

We can manage margins to our long-term growth algorithm. We got surprised by some factors in this quarter, and that really led to the product margin degradation that you saw.

Michael Kessler -- Morgan Stanley -- Analyst

Thank you.

Operator

Our next question is from the line of Garik Shmois with Loop Capital. Please proceed with your question.

Garik Shmois -- Loop Capital Markets -- Analyst

Oh, hi. Thanks for taking my question. Just wondering how you're viewing some of your growth initiatives, the pace of the PRO conversion, acquisitions, new store openings just given the more uncertain macro.

Mike Egeck -- Chief Executive Officer

Yeah. Garik, I would say we feel very good about the PRO initiative. Like I said, comp 17% for the quarter, would have been higher without some periodic shortages of product, particularly larger sizes of shock. So feeling very confident there.

On the M&A side, we continue to see lots of opportunities. We're going to look to accelerate that. The residential stores that we are opening, new stores, are performing well, as is our marketing -- digital marketing efforts to underserved areas. We had talked about the file growth starting to moderate.

You saw that this quarter. I also point out that this year was a very unusual year between the Texas freeze, which impacted the entire industry, and the chlorine -- the media coverage of the chlorine shortage last year, two really extraordinary events that put a lot of noise in the year with regard to consumer acquisition. But if you look at our two-year stacks in the quarter, plus 14, we feel good about that, and plus 16 for the year. So 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 you'll see us next year.

Garik Shmois -- Loop Capital Markets -- Analyst

Got it. Just wanted to follow up one more time on the New Jersey DC. I think you mentioned you're shifting to a seven day a week to shift a day model. I'm just kind of curious, how does that compare to before? And how universal is that model across your network?

Mike Egeck -- Chief Executive Officer

Yeah. Well, that's the model we're going to put in place across the network. We had an acute problem with a New Jersey DC, but we were running all of our DCs right 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.

We're currently operating about 5.5 to six days a week. We had run second shifts in most of the DCs over the course of the season. However, it was not a seven day a week. And the challenge here is really you can add temporary DC staff, and you can train them up for a season.

What we learned this season is the challenge is really around supervision, and we're going to make the investment in second shift and weekend shift supervision that will just put in place in the DCs year-round. And then they will -- they will really have their specific tasks during season.

Garik Shmois -- Loop Capital Markets -- Analyst

Got it. Thanks for that.

Operator

Thank you. Our final question today comes from the line of Dana Telsey with Telsey Advisory. Please proceed with your question. The next question is from Dana Telsey.

Your line is live for questions.

Dana Telsey -- Telsey Advisory Group -- Analyst

Hi, everyone. As you think about inventory levels, given what happened in the New Jersey DC, should we be seeing inventory levels perhaps at the end of the fourth quarter? And then the changes in product procurement that you mentioned, Mike, how much of that continues going forward? And how much of the New Jersey DC costs can continue or sticky, and that's the way the business continues to operate? And how much is permanent versus how much is variable? Thank you.

Steve Weddell -- Chief Financial Officer

Yeah. Good morning, Dana. I'll take the first part of that on inventory. As we think about year end, I'm 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 Trichlor and equipment. On Trichlor, the increase is relative to last year, which was more depressed, more difficult to come by. And so we're in a much better position from a Trichlor perspective across our network, both -- all stages, raw materials, produced goods, in our DCs and in our stores. When you think of equipment, the equipment is where we've had a lot of the uncertainty around timing 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. When you think about the nature of our inventory, it doesn't have the same level of obsolescence as many other retailers.

This is a good product. And if the choice is to take inventory at a little bit higher level today, going into the end of the year and to start off next year in a better position versus try to run leaner. We will take the former in the current environment. So it's something we expect to actively manage in the year end and through next year, don't necessarily view these levels as permanent increases.

But in the current environment, it's the appropriate level of inventory.

Mike Egeck -- Chief Executive Officer

Yeah. Good morning, Dana. I apologize. I had some trouble hearing the second part of the question.

I believe it was around how much of the DC -- the elevated expense in the DC 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 the increased capacity we need, and we should be able to gain leverage on the DC expense as it goes up, just through our standard growth profile.

Dana Telsey -- Telsey Advisory Group -- Analyst

Thank you.

Operator

Thank you. That concludes our question-and-answer session. I'll turn the floor back to management for closing remarks.

Mike Egeck -- Chief Executive Officer

Thank you, operator, and thank all of you for joining us today. We appreciate the continued interest in Leslie's.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Caitlin Churchill -- Investor Relations

Mike Egeck -- Chief Executive Officer

Steve Weddell -- Chief Financial Officer

Peter Benedict -- Baird -- Analyst

Ryan Merkel -- William Blair -- Analyst

Kate McShane -- Goldman Sachs -- Analyst

Liz Suzuki -- Bank of America Merrill Lynch -- Analyst

Jonathan Matuszewski -- Jefferies -- Analyst

Andrew Carter -- Stifel Financial Corp. -- Analyst

Peter Keith -- Piper Sandler -- Analyst

Michael Kessler -- Morgan Stanley -- Analyst

Garik Shmois -- Loop Capital Markets -- Analyst

Dana Telsey -- Telsey Advisory Group -- Analyst

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