Q4 2023 Leslie's Inc Earnings Call
Participants
Caitlin Churchill; IR; Leslie's, Inc.
Mike Egeck; CEO & Director; Leslie's, Inc
Scott Bowman; CFO & Treasurer; Leslie's, Inc.
Ryan Merkel; Analyst; William Blair & Company
Simeon Gutman; Analyst; Morgan Stanley
Steven Forbes; Analyst; Guggenheim Securities
Peter Benedict; Analyst; Baird
Kate McShane; Analyst; Goldman Sachs
Garik Shmois; Analyst; Loop Capital Markets
Jonathan Matuszewski; Analyst; Jefferies Group LLC
Peter Keith; Analyst; Piper Sandler
Dana Telsey; Analyst; Telsey Advisory Group
Presentation
Operator
Good afternoon and welcome to the fourth quarter of fiscal 2023 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, Investor Relations. Please go ahead.
Caitlin Churchill
Thank you and good afternoon. I would like to remind everyone that comments made today may include forward-looking statements, which are subject to significant risks and uncertainties that could cause the company's actual results to differ materially from management's current expectations. These statements speak as of today and will not be updated in the future if circumstances change. Please review the cautionary statements and risk factors contained in the company's earnings press release and recent filings with the SEC.
During the call today, management may refer to certain non-GAAP financial measures. A reconciliation between the GAAP and non-GAAP financial measures can be found in the company's earnings press release, which was furnished to the SEC today and posted to the Investor Relations section of Leslie's website at ir.lesliespool.com.
On the call today from Leslie's are Mike Egeck, Chief Executive Officer; and Scott Bowman, Chief Financial Officer. With that, I will turn the call over to Mike. Mike?
Mike Egeck
Thanks, Caitlin, and thank you all for joining us this afternoon. I hope that everyone had a good thanksgiving holiday. To start, I'd like to express my sincere appreciation to all of L associates whose contributions allowed us to serve our residential pool proteins and residential hub customers at a consistently high level throughout fiscal 2023. Because of their efforts, the foundation of was lease business remained solid in service levels and corresponding NPS scores were at all-time highs.
Our loyalty program grew for the year in our customer lifetime value also increased. We remain the largest specialty retailer in our industry with unmatched capabilities and clear long-term growth opportunities. And industry credit card data indicates that we gained market share again in fiscal 2023. While our financial results for fiscal 2023 were not what we expected heading into the year, we are well positioned for future success is the pool industry continues to normalize from the temporary challenges of this year's pool season.
We entered the fiscal fourth quarter facing three headwinds, which are the same ones that broadly impacted our full fiscal 2023 results. First, unfavorable weather, second macro economic environment that resulted in decreased retail chemical pricing and discretionary spend and especially on high ticket items. And finally, customer stockpiling.
Of course, sanitizers resulting from three years of supply, uncertainty and price inflation. For the latter two factors were largely in line with our expectations for the quarter, weather was better than we originally anticipated and helped us to deliver sales at the high end of our implied fourth quarter revenue guidance. Profitability in the quarter fell short of our expectations, driven entirely by gross margin.
Gross margin performance was impacted by larger than expected inventory adjustments made after the completion of our annual physical inventory count. Scott will discuss the inventory adjustments in more detail, but when it goes over, our financial results for the explained the entire delta between our implied Q4 guide and our actual gross margin, another reason that EPS came in at the low end of our guidance range.
As we navigated these dynamics, we remain disciplined on costs and reduced fourth quarter SG&A expenses year over year as planned. Drilling down into are down 8% in the quarter with residential pool down 9%, pool down 5%, and residential hot tub down 17%. We were up against some tough comparisons from the prior year's quarter when total sales were up 16% with residential pool of 10% pool of 18% and residential had to have 80%.
As weather normalize traffic improved to down high single digits in the quarter. Total transactions were down 5%, which was also an improvement from down 12% in the third quarter. Average order value was down 4% versus plus 3% in Q3. Equipment sales were down 17%. We saw continued weakness in high ticket discretionary categories, and we had a full quarter's impact of the chemical retail price decreases we implemented in June of this year. Total chemical sales were down 4%.
Discretionary product sales were down 23% and contributed roughly half of the quarter's total sales declining. Non-discretionary product sales were down 6%. Across our geographies, sales remain challenged with the exception of Florida, which saw a 3% increase in sales in the quarter and was up 11% for the year. Our analysis of credit card data shows that our sales underperformed the industry by 250 basis points in the quarter, but outperformed the industry by a total of 130 basis points for the year.
Turning to our results for the full year, sales of $1.4 billion or $1.5 billion were down 7% with comp sales down 11%. Non-comp sales added 4%. Residential Pool sales were down 9%. Pro-pool sales were flat. In residential hot tub sales were down 6%. Gross margin decreased 530 basis points, driven by the June chemical retail price actions, year-end inventory adjustments, DC costs associated with higher inventory levels, lower rebates based on decreased equipment purchases and occupancy deleverage.
We believe the majority of these headwinds are specific to this fiscal year, and Scott will discuss how we expect these to significantly abate in fiscal 2024. Adjusted EBITDA for the year was $168.1 million and adjusted diluted earnings per share was $0.28. In the face of the transitory headwinds this year, the fundamentals industry to have not changed. New pools continued to be built in the growing installed base of pools need to be maintained.
In addition, we believe the secular tailwinds, the drive industry demand remain intact, including ongoing investment in homes and backyards migration into the Sun Belt and excerpts pursuit of outdoor lifestyles, increasing attention to safety and sanitization and the adoption of new technologies. The pool industry has a long track record of consistent growth. And Leslie's has consistently grown faster than the industry. We remain the leading direct to consumer pool and spa retailer with scale capabilities and brand awareness that our competitors do not have.
While our team navigate the current headwinds, we remain focused on executing the strategic initiatives that underpin our competitive advantages. And then we expect to continue to drive our success as industry conditions normalize.
Turning to our strategic growth initiatives. First, our customer file was down 6% in the quarter and for the full year due to the weather and traffic trends we experienced. Second, average revenue per customer was down 3% a quarter and 1% for the year, driven primarily by decreases in big ticket items, specifically hot tubs heaters and above-ground pools. With regard to our pro initiative, we ended the year with more than 39 hundred Pro contracts in place and completed the conversion of 15 residential stores to our pro forma. We currently operate 98 pro locations.
Pro sales were flat for the year, which we consider a solid outcome given the overall environment. Tricor pricing was a more pronounced headwind to our Pro sales and to overall company gross margin performance as competition and pricing now appears to have stabilized. M&A and new store growth remain important initiatives for Leslie's. For fiscal 2023, M&A and new stores drove $60 million in non-comp sales. During the year, we opened 12 new stores and acquired 12 stores and now operate 1,008 total locations.
We remain confident in the long term store expansion opportunity and have identified over 800 opportunities for store densification. We will continue to address each of these opportunities with a buy or build analysis, so we will be prudent with the pace of expansion as we balanced store growth with our other capital allocation priorities. Frank, you go home. We were excited to launch the program in May and have been very pleased with the consumer response in demand we have seen to date, even with limited marketing.
Occupied, home member spend is averaging $1,000 per year, and we believe members see value in experience as evidenced by an average review rateing of 4.8 out of 5 stars. They commented, the program pays for itself and site convenience, greater confidence in our water treatment routine and overall water quality as core benefits of the program. While demand during the policies have a strong manufacturing capacity at our third party vendor limited sales, and we deferred launching our consumer marketing campaign due to insufficient supply.
We have worked with our vendor to ramp up production during the off-season to meet our expected 2024 policies and consumer demand. We continue to have confidence in long-term industry outlook and remain focused on prudently executing our strategic initiatives to capture the opportunities in front of us and extend our industry leadership. At the same time, we are taking actions to improve our near-term performance.
Number one, we are pricing based on current market conditions and after June price actions, we are at our relative historical price position of slightly above mass and at or slightly below, especially for 2024. We expect this positioning to hold to aggressively managing inventory and expect to reduce our 2020 for peak and year end inventory by approximately $150 million, respectively.
Number three. We are managing costs throughout the P&L, including utilizing strict ROI criteria on our marketing investments. Number four, we continue to evaluate and develop and validate our processes and people to help improve our efficiency. And number five, we are utilizing consumer insight surveys to further improve our understanding of evolving consumer behavior. I will now hand it over to Scott to discuss our results and outlook in more detail. Scott?
Scott Bowman
Good afternoon, everyone, and thank you, Mike. I'll review our fourth quarter and fiscal 2023 performance and then provide details about our outlook and assumptions for fiscal 2024. Turning to fourth quarter results, we reported sales of $432 million, a decrease of 9% compared to the fourth quarter of fiscal 2022. Comparable sales decreased 11%.
Comparable sales decreased 1% on a two year stack basis increased 15% on a three year stack basis increased 38% on a four year stack basis. Non-comparable sales totaled $9 million in the quarter, which was driven by a total of 18 net new stores, including 12 through acquisitions and six net new store openings during fiscal 2023.
With respect to trends by consumer group, comparable sales for residential pool declined 9%, pro pool declined 13% and residential hot tub declined 23% compared to the prior year period. And a two year stack basis, comparable sales were flat for residential pool, increased 4% for pro tool, and declined 10% for residential hot tub. These declines were in line with our expectations and continuation of this recent trends in the business. Gross profit was $160 million compared to $217 million in the fourth quarter of fiscal 2020, approximately 60 basis points to 37%.
Page 11 of our supplemental deck space, our Q4 gross margin rate to add some more detail. During the quarter, gross margin was impacted by the following factors. First, product gross margin declined 385 basis points in the quarter. This was primarily driven by June 2023 chemical pricing actions and a negative impact of 70 basis points due to lower rebate. Second, we incurred unexpected incremental inventory adjustment costs resulted in a 260 basis point headwind in the quarter. This increase was mainly due to excess shrink and scrap in a higher levels of inventory and third-party storage locations, higher movement of goods between facilities and higher levels of unsolvable returns.
Additionally, gross margin rate was negatively impacted by 120 basis points to the expensing of capital. I see costs associated with the drawdown of inventory. And finally, occupancy costs deleveraged by approximately 95 basis points, mainly due to the decline in comparable sales.
SG&A was 122 million, down 9% or 12.5 million compared to the fourth quarter of fiscal 2022, excluding nonrecurring items, including costs incurred from the discontinued use of certain software subscriptions and executive transition costs associated with restructuring. SG&A decreased $18 million, driven by lower sales, lower incentive compensation and expense management actions.
Adjusted EBITDA was $16 million compared to $100 millions in the fourth quarter of fiscal 2022. Interest expense increased to $17 million from $10 million in the fourth quarter of fiscal 2022 due primarily to higher interest rates. And our effective tax rate increased to 22.9% compared to 21.2% in the fourth quarter of fiscal 2022.
Adjusted net income was $26 million compared to $64 million in the fourth quarter of fiscal 2022. And adjusted diluted earnings per share was $0.14 compared to $0.35 in the fourth quarter of fiscal 2022. (technical difficulty)
Moving to our full year results, total sales for fiscal 2023 were $1.45 billion, a decrease of 7% compared to the prior year with comparable sales down 11%. Comparable sales were flat on a two year stack basis increased 21% on a three year stack basis and increased 39% on a full year stack basis. Non-comparable sales totaled $60 million in fiscal 2023.
First, profit was $548 million for fiscal 2023 compared to $674 million in the prior year. Gross margin rate was 37.8%, a decrease of 530 basis points compared to the prior year. As shown on page 11 of the supplemental deck 205 basis points of the rate decline was due to chemical pricing actions and lower rebates to 115 basis points for you to DC costs and inventory adjustments from 110 basis points was due to occupancy deleverage.
Sg&a was $446 million for fiscal 2023 compared to $435 million in the prior year. Excluding nonrecurring items and non-comp expense from acquisitions and new stores, SG&A decreased $15 million compared to the prior year. Adjusted EBITDA was $168 million for fiscal 2023 compared to $292 million in the prior year.
Interest expense was $65 million for 2023 compared to $30 million in the prior periods. Adjusted net income was $51 million for fiscal 2023 compared to $176 million in the prior year. And adjusted diluted earnings per share was $0.28 for fiscal 2023 compared to $0.95 in the prior year. Moving to the balance sheet, we ended fiscal 2023 with cash and cash equivalents of $55 million compared to $112 million in fiscal 2022. Reduction was primarily due to the decline in net income.
At the end of fiscal 2023, we had no balances outstanding on our revolver availability at $239 million, a decrease of $50 million or 14% compared to fiscal 2022 and a sequential decrease of $125 million or 29% compared to the third quarter of fiscal 2020. This reduction was possible due to fewer supply chain disruptions, implementation of our new inventory management system, and strong execution at DC locations.
Importantly, we are maintaining strong in-stock positions at the store level to support a higher level of customer service, which is reflected in a higher NPS scores. At the end of fiscal 2023, we have $790 million outstanding on our secured term loan facility compared to $798 million of fiscal 2022, which translated into a leverage ratio of 4.4 times. The applicable rate on our term loan with a sulfur plus 275 basis points in the fourth quarter, effective interest rate was 8.1% compared to 4.3% from the prior year quarter.
Now for fiscal 2024 outlook. In fiscal 2024, we expect an uncertain macro environment and a more cost conscious consumer, especially in discretionary categories to continue affecting sales. We anticipate that to be more acute in the first half of the year. So we expect positive comps in the back half of the year due to the lapping of the June 2023 chemical pricing actions and easier compares. Fiscal 2023 been an anomaly from a seasonality standpoint, we are planning for seasonality be more comparable to fiscal 2022 and expect to deliver more than all of our profitability in the second half of this year during our peak pool season.
We expect sales of $1.41 billion to $1.47 billion, which assumes normal weather over the course of the year non-comp sales contribution of approximately $7 million. The low end of our outlook assumes comparable sales growth of approximately negative 3%, while the high end of our outlook assumes comparable sales growth of approach maximum 1%. For the full year, we expect to see gross margin rate improvement of approximately 100 basis points compared to the prior year driven by lower DC costs and fewer inventory adjustments due to reduced inventory levels and improved supply chain efficiencies. (technical difficulty) we start to lap the unusual items that impacted Q4 fiscal 2020 through.
Additionally, we expect higher impacts of deleverage in the first half of the year due to lower sales compared to the prior year. We expect adjusted EBITDA of $170 million to $190 million and expect a slight decline in SG&A expense as we drive efficiency in our cost structure while making prudent investments in the business. We expect net income of $32 million or $46 million, adjusted net income of $46 million to $60 million and diluted adjusted earnings per share of $0.25 to $0.33.
Our outlook assumes an average interest rate on a floating rate debt of 8.2% and assumed interest expense will be approximately $7 million higher than fiscal 2023. Our outlook also includes an effective tax rate at 26%. We estimated diluted share count of approximately $185 million shares, which assumes no share repurchases during fiscal 2024.
Now, as you'll see on Page 14 on our supplemental deck, along with a full year guidance, we are providing an outlook for Q1. While it has not been our historical practice to provide quarterly guidance, nor do we intend it to be a practice going forward, given the unique dynamics related to Q1 in comparison to the same period in fiscal 2023, we believe is appropriate to provide a view of Q1.
For the first quarter, we expect total sales of $166 million to $172 million, adjusted EBITDA of negative $27 million to negative $24 million, net income of negative $43 million to negative $41 million, adjusted net income of negative $39 million to negative $37 million, and adjusted EPS of negative $0.21 to negative $0.2.
Underlying this outlook is our expectation that comp trends will be similar to Q4. Fiscal 2023 to non-comp sales will contribute approximately $3 million. In addition, we expect a significant gross margin decline, expense, capitalized DC costs and occupancy deleverage. Turning to CapEx, we expect to invest $50 million to $55 million in fiscal 2024, of which approximately $20 million is expected to be invested in our existing assets and remainder is expected to be invested in growth. These investments include new store openings, improving the capacity of our distribution and manufacturing facilities and in investing in IT and other projects to improve the business.
We also expect a meaningful improvement in working capital and plan to reduce inventories by approximately $50 million. Regarding capital allocation, we expect significant improvement in free cash flow through to higher net income and lower inventory and our first priority will be to pay down debt with the goal of achieving a leverage ratio of 2.5 to 3.7 times in fiscal 2024. Longer term, our goal is to achieve a leverage ratio of 3.0 times.
Our second priority is to invest in growth, which will include organic growth through the opening of 15 stores in the conversion of six residential stores for the pro forma. We have not included any M&A activity in our fiscal year guidance at this time. Our final priority is to return excess cash to shareholders. While we do not expect to repurchase shares in the near term, we will continue to evaluate this based on our financial position and market conditions.
Before I go back to Mike, I wanted to address two items that will be covered in greater detail in our Form 10-K. In short, we have identified two material weaknesses in internal controls over financial reporting. one weakness relates to insufficient controls over an internal database that is used to calculate vendor rebates and the other weakness really to controls over the performance of physical inventoriesor. As a result, we are designing and implementing new processes in enhanced controls to address the underlying causes of the material weaknesses in fiscal 2024. I will hand it back over to Mike. Thank you.
Thank you, Scott. After three years of unprecedented growth, the pool industry and Leslie space multiple transitory headwinds in fiscal 2023. Despite these headwinds and their impact on our results, we continued to deliver exceptional service to our customers as evidenced by brand awareness, in-stock levels and corresponding NPS scores is that are all at all-time highs. Taken together these serve as a testament to the focus and execution of our team members.
As the industry continues to normalize, we remain focused on leveraging the competitive advantages from our scale and capabilities and executing our strategic initiatives to continue to drive growth and market share gains. With that, I'll hand it back to the operator for Q&A.
Question and Answer Session
Operator
(Operator Instructions) Ryan Merkel, William Blair
Ryan Merkel
Thanks for taking the questions today. First off, I just wanted to ask about sales guidance for '24. I'm a little surprised with the guidance at flat to down. Mike, can you just walk through, you know, some of the pieces there because it was a pretty rough year in '23, we had horrible weather and your business is largely, you know, to nondiscretionary aftermarket. So kind of explain why we're not seeing a bit more growth in '24?
Mike Egeck
Yeah. Thanks for the question, Ryan. The first assumption is we don't see any recovery in discretionary sales. And at the midpoint of our guidance, we have discretionary sales, which as you know, it's about 20% of our business plan down an additional 10%. Non-discretionary sales that we do have growing plus one of the head of the chemical price actions we took in June, which through the first seven periods of the of the year, our definitive headwind.
So with the discretionary sales being down, which are predominantly high ticket items and with the headwind from the chemical. we have -- there's about 400 basis points of headwind in those two items by our prior to any growth. That's why we're that's why you've got the midpoint of guidance basically flat for the year.
Ryan Merkel
Okay. That's helpful. And then just a question on trends. It looks like one whose sales are also coming in a little bit below where the Street was modeling. What do you start seeing out there? You've seen the consumer slowdown? What's happened with traffic the last couple of months?
Mike Egeck
Yes, the way the quarter played out September, so let me backup. And in Q4, July was the best month of August, was a little weaker and September was tough. October, we saw a continuation of that trend. In November, we are seeing some turnaround on some of the categories and some increases in traffic. So it's a slow turn and not definitive yet.
But the real change in the business has been as traffic is, has normalized or excuse me, as traffic has improved with improved, whether we are seeing transactions start to recover. But the same time, we're seeing the average order value down. And that's really being driven by the equipment business and the discretionary business in taken items. And equipment is it's been a tough trend for equipment was down 17% in the quarter, 12% for the year, starting to see it turn now. But the more discretionary parts of the equipment business, particularly our heaters and robotic APC's could be a little challenging.
Ryan Merkel
Got it. Very helpful to pass it on. Thanks.
Operator
Simeon Gutman, Morgan Stanley.
Simeon Gutman
Hey, good evening, everyone. Hey, the first thing, Mike, you said that the biggest gap in the guidance you gave was the inventory adjustments. Can you talk about why those were not observable in July?
Scott Bowman
I can start with that, Simeon and Mike can tag on if needed. The main reason is we kind of step back and look at the issue on inventory adjustments. The main issue, which is having too much inventory. We repeat close to $500 million to start to come down, but it is more inventory than we've had. In the past, I mean that required us to use several third party off-site storage facilities with a lot of movement of product between those facilities. We had some higher and sellable returned. So we just created a lot of movement of goods on goods, not in our inside our four walls.
And so that is the root of the problem in. So as we've kind of thought about it and talked about it beyond the problems that we had with inventory adjustments are really now systemic. They're fixable. And there were some kind of on that path to improvement. And the first step in that direction was just to give you now have all those outside warehouses in kind of get it inside our four walls.
And so we've worked really hard over the last several weeks to do that. And you know, as we've seen I'm here today, we're out of those traditional on-site storage facilities. And so that's that's a great first step for us. So we can put eyes on the inventory. It's inside our four walls. We don't have the movement of goods that we had before. And so just extra visibility and having that there is the first step for us to improve that whole process.
Along with that, we had there. There's some improvement. We can do just improve some of them. We had to add to our excess and obsolete reserves on inventory because we had so much. As we have now brought inventory down, we should be able to repeat some of that. I'm also just put more focus on kind of monthly processes, just identifying the major variances that come along in early warning signs.
But before we build up that inventory, we actually control look pretty well. And so now that we're back down, we have a really good DC team, some new talent. We feel like we're in a much better position to manage it going forward.
Simeon Gutman
Okay. A follow up, maybe a bit broader Europe, your approach to your guidance. And I heard some of the components and then the answer to the last question. Thinking about the industry and your assumption to the grower contracted units get better. I heard what Mike said around discretionary stays weak. Are you doing that assumption at a prudence to or, you know, it could happen that way? And then even in your gross margin, you're not even recouping what you gave back this year and inventory adjustment, right? It's a very mild level of game. So your approach seems conservative, but I mean that's a tough argument to make given this miss, but curious how you thought about it?
Scott Bowman
Yes, I can start off on the gross margin side and Mike can chime in on the sales side discretionary. The purchases still constrained and street still high, especially in the hot tub business, very high ticket items. And so we just haven't really seen a ton of relief yet from the consumer side and their ability to ratchet that discretionary purchases that may happen.
We haven't seen, you know, meaningful signs of that yet. And so we're kind of taking it would kind of knowledge today. As we look at and gross margin on, we feel like we'll recover the lion's share of new inventory adjustments that we saw come true in Q4. So that is kind of a Q4 benefit.
If we if we kind of fix the problem, we should see a big improvement in Q4. And we fully expect to see now we do have a couple couple of other headwinds as well. We've talked about the chemical price reductions that we took back in June, which was needed, you know, just to get our pricing kind of a line where it needed to be in. So as we kind of roll into the new year, we'll see some impacts of that.
We did take some prices up in January of last year on So kind of coming into key to note, that will be a little bit more of an impact. Q1 and will be an impact as well. But we'll also have with lower sales volume will have some pressure on occupancy was well. We feel like the gross margin will get better as the year goes on. But in the first half of the year, it'll be it'll be constrained.
Yes, a little more color on the sales guidance. We are planning transactions positive plus three at the midpoint. We have seen a recovery in traffic. We feel good about our conversion rates and we feel good about the chemical business, which 45%, 50% of our business in those trends will turned to positive. We are, however, planning that in the mid point and that lie the mix and a trend we haven't seen term yet in discretionary purchases, hot tubs, above-ground pools and more recently heaters and robotic APCs. So that's how we're thinking about the business recovery in traffic, recovery and transactions, but pressure on the AOV. And that's how we get to the midpoint of the guide.
Simeon Gutman
Yeah, that's helpful. Thank you.
Operator
Steven Forbes, Guggenheim Securities.
Steven Forbes
Good afternoon, Mike, Scott. I wanted to maybe start with the performance of the assets acquired during the past few years. Just trying to get a better understanding of how much of a headwind those newly acquired assets are on both sales and profitability as we look at the 2024 or if you've seen some stability to the point where those those assets are sort of neutral right to sales and profitability? Any context on just how you think through the more recently acquired assets?
Scott Bowman
Yes. Thanks, Steven. If we think specifically about the the hot tub businesses and I'll talk to those first because as we've talked about big ticket, discretionary items often financed, that business has been has been challenging. We were down for on a comp basis with the hub businesses, 22% for the year. That being said, there is still very good levels of profitability and we feel good about the businesses long term. And in terms of a mix on our total adjusted EBITDA ratios, they are not a drag on the business.
Steven Forbes
Helpful. And then maybe just a follow-up for Mike on for Scott. I think, as Michael mentioned, the inventory reserves at year end as we think through the guidance here, any help with sort of working capital needs for the first half of 2024? Yes. Just as we sort of think through the the interest expense implications and free cash flow sort of on a quarterly basis?
Scott Bowman
Yes, you're correct. And I can take that one. So just just given the seasonality of our business, we typically start to use our revolver usually in the late first quarter as we start to execute our inventory build. And so we kind of see this year playing out in a similar way. And so as as we start to get into the end of this calendar year, we'll probably be on the revolver new as we ramp up.
Usually, we ramp up our inventory late March, early April. It's kind of waiting. We hit our peak and then we may handsets kind of restoring the pool season and our peak selling periods. And that's when we've drawn the revolver down some. And then the last few months of the year is when do we build cash on the balance sheet.
And so we see it happening on a similar kind of way new this year be it will play into our benefit that our peak inventory, at least what we're planning on for Tom. As Michael mentioned, will be close to $100 million less than what we saw this past year from. So that' really a testament to kind of merchandise planning team and to new tools we have in place. But we really have a good plan of how we are coming into the season and come out with it.
I think we have some some other things kind of on our side. You know, the supply chain is operating to more normalized lead times are shorter. So that's certainly helping us our DC team, you know, it's getting more and more efficient, feel like that. That's how it's going to play out. And so, you know, from kind of a working capital standpoint.
I think one thing to keep in mind is that when we started 2023, we had almost $160 million of net payables. We paid down Houston, $100 million of the payables during the course of 2023. This year, we're starting at less than $60 million and payables. And so we will not have that huge cash green that we saw last year on just the pain that net payables balance down. Reason for that is we reduced inventory towards the end of the year in the prior year at the end of 2022 building inventory in.
So that is the cause of that. But it puts us in a much better position to generate free cash flow this year that, along with higher net income from entitlement management on working capital, give us much better free cash flow number then levels unless you.
Steven Forbes
That's super helpful. And maybe just to get given that you guys provided first quarter guidance in any case, can you sort of marry that together and give us a thought on sort of what the guidance implies for liquidity as of quarter-end 1Q through the quarter in 1Q?
Scott Bowman
Yes. In. So yet our total total liquidity, we'll be close to or close to $200 million at the end of the quarter.
Operator
Peter Benedict, Baird.
Peter Benedict
All right, guys, good evening. Thanks for taking the question on. First, just a minute and talk a little bit about inflation. I think I heard ViaCord stabilized occupancy slipped the inflation review that's embedded, I guess the question. Thanks for the question. It varies by product category this year, but like it does most years, but a little more pronounced we think going into '24. The pricing we have the pricing on 24 from the equipment companies, as is typical in their practice, there are 3% to 5% increases in price ICE with corresponding increases in MAP prices.
Mike Egeck
So it's not the it's not margin dilutive for us and that's well planned and our purchases have been made. So very, very easy to follow on terms that the chemicals at each of the levels of guidance, low, mid and high, we have planned a low single digit ASP decline. We're not seeing that at the moment. In Chemicals, chemical prices are holding from where they were during the pool season in Q4, but we think it's prudent debt that we plan some slight decrease in prices. And if we don't get that, then we should then we should see a little bit more of a tailwind.
So inflation in the equipment business, slight deflation in the chemical business taken all together with the other categories. We think it's a pretty flat year inflation overall. And that's our.
Peter Benedict
That's helpful. Mike, just related to that, just the promotional town, I guess that your promotional time, but also what's happening in the industry, how that's evolved here sits on since over the last several months and what you're kind of thinking as you as you look out to 24 in terms of promotions?
Mike Egeck
Yes. Again, it differs by section of the business in the residential business. This last pool season we think was a very normalized in terms of promotions. We were we were pleased to see that our promotions where as we plan on them going into the resident bit dental business for fiscal year '24, we again expect the normal promotional environment which we have assumed should make sure that stays intact. We know we believe we can plan our promo slightly down some but not sufficient to move the inventory that we need to move in, including any rec Adams or other items that are a little more price sensitive.+ In terms of the pro side, there was more competition on price, as I mentioned in my script, on the pro side, in fiscal year 20, we were kind of the convergence of domestic production of chemicals, specifically TriCor coming back online.
At the same time, there was a fair amount of imports in the market that looks to have stabilized from a supply and demand on the pro side now looks to be in pretty good place from prices have been stable for the last call. Quarter, and we expect that to them. We expect that kind of normalization, if you would have pricing in Pro now to be up to be set for the next year. Well, it's great for them.
Peter Benedict
Maybe one for Scott, just on a march margin profile of business, and obviously, you're coming on board here. So maybe premature. But you know, pre-COVID, this business was kind of, call it, 17% on EBITDA line. I think to your outlook this year is somewhere mid twelves, I think at the midpoint, how are we thinking about maybe the profitability of the business kind of at a stabilized environment? I mean, you talked about SG&A, dollar thinker. Any more color on kind of your view on on the opportunities to build back the margin kind of longer term? Thank you.
Scott Bowman
Yes, yes, sure. Start with just the product gross margin. So has been impacted here lately with some of the price changes that we've made. I think it was the right thing to do in order to make sure we have that balance price and volume and positioning from the sale. So I think that there's definitely right thing to do. And I think our opportunity is in a couple of areas. When you look at DC costs for the inventory adjustments that we talked about from the burden of the excess inventory you will improve in.
So we have we were impacted by about over 200 basis points to DC costs from 2023. And that does also include the expensing of capitalized DC costs. And so the way that that it works is as we drive down our inventory, we have to bring those capital IDC cost to the income statement to kind of matched with the flow of U.S. goods.
Peter Benedict
Okay. And so as you can imagine, when you're building inventory, you put those costs on the balance sheet until you draw it down into what we're seeing is a big headwind now and we draw down inventory as we and as we expense those capitalized costs came to once we get that inventory down are still going to draw down further.
Scott Bowman
That headwind will tail off. I think that is a key issue because without that the DC costs are going to be weighed down in 2020 for that is just on just better talent and management of those facilities, you know, more from metrics and dialing in the expenses to run those facilities. And so the team has done a greasy. Unfortunately, we haven't seen the full effect of that yet because we have had the burden of expense these capitalized costs as sales improve.
Peter Benedict
Your occupancy has been deleveraged on used deleverage over a hundred basis points last year. And so as sales improve, we'll get some that natural leverage on occupancy. And then from an SG&A standpoint, we see a pretty good path, you know, on improving SG&A so we had some nonrecurring costs that came in this past year. Does go away. So you did the path to improve SG&A?
Scott Bowman
No, for this next year, it would be really good on because Tom, we've kind of delayered the organization we streamline on. We've gotten some of these non-recurring items data the way in. So we expect that we'll get on some decent leverage out of SG&A as well.
Peter Benedict
Great. That's helpful. Thanks so much, guys. Good luck.
Operator
Kate McShane, Goldman Sachs.
Kate McShane
Hi, good afternoon. Thanks for taking our question from me. Wondering if you could talk a little bit more about any differences you're seeing between demand and the pro versus residential market and what your survey work is telling you today about the level of stockpiling chemicals? And as a second question, could you maybe comment on your care commentary in the quarter?
Scott Bowman
Yes. Thanks for the question, Kate. In terms of demand, residential versus Pro, as we said, there was there was context in chemicals and our Pro business is really dominated by chemical sales for the most part. So that pressure in the chemical side of the Pro business impaired as a headwind, more predominant pro business than I did on our residential business.
That's the reason for the differential in performance for both the quarter end the year for the year, the comp was down 11. Pro pool was down 9% in residential pool and was really the the chemical headwind in Pro that drove that difference. We haven't seen any switch from DIYDIFM., not really over the course of the last decade that that number hasn't moved a lot and we don't see it moving a lot in terms of funding stockpiling that it's a good question.
We put out surveys additional surveys in September and also in November. And our most recent results from that show definitively that fewer consumers have access carryover chemicals than they did the prior year. I'm going to say employees between the two surveys were not confident that we can size that we haven't assumed any tailwind or headwind from customer stockpiling.
We're going to continue to test every 60 to 90 days to get smarter about how the consumers are acting. But for right now, we can say doesn't look to be any more of a headwind, could possibly be a tailwind, but we're not able to size it with the current data we have. And in terms of share, we mentioned that we did not grow as fast as the industry in fourth quarter 250 basis points. That's a big miss for us. We bridge all of that with the full quarter of the chemical price reductions that we put in place question is should we have reduced the chemical prices.
So you understand our thinking on that two things that were around that were very strong signals. One was directly from our consumers, no through post purchase, um, surveys that we were too expensive and we were not a good value and we can have that long term. That's not the brand positioning. That was one. The second one's we were seeing our volume in those chemicals dropped. So we made the decision to take the prices down.
We did see an increase in volume, not enough volume to make up the entirety of the headwind, but believe it was the right thing to do long term for the brand in the business. However, it did cost us some sales growth versus the industry in Q4.
Operator
Garik Shmois, Loop Capital Markets.
Garik Shmois
Hi, thanks. I'm wondering if you could provide maybe a little more hand holding out how to think about gross margins and in the first quarter, just given that you're providing a little bit more near term visibility. And we are just given all the moving parts of different routes of the business here in the near term.
Scott Bowman
Yes. So let me kind of break it down kind of first half of the year versus the back half. So what I would see in the first and second quarter of the year is some pressure on product gross margin. No, as we kind of lap those chemical price changes that we did back in June, it'll be more because back in January, we raised prices on certain items in.
So it will be a little more acute in Q2 on this chemical price changes, but still in effect in Q1, DC costs will be likely unfavorable, mainly because of the expensing of those capitalized expenses that I talked about as we reduce inventory. And then with a little bit lower sales, we should see some occupancy deleverage mostly in first quarter second quarter, not as much deleverage is. And as we get into the back half of the year, Q3 probably more flattish. Q4, we should see the biggest improvement as we start to lap. You know, those are extremely high inventory adjustments that we saw and as DC. cost or more moderate, you know, we've done on the outside storage facilities in movement of goods and the DC calculation capitalization expensing should be much lower in Q4 as well.
Garik Shmois
And then just on the discretionary piece, it sounds like you're expecting sales to be down 10% through the year. I think you talked a little bit about the back of the buckets there. But any additional color as to how you expect discretionary sales to track? Jack, maybe kind of where you're seeing the the largest maybe incremental change in fiscal 20 work?
Scott Bowman
Yes, Garik, the hot tubs have been soft and the higher priced hot tubs have been softer. You haven't seen that have any material change either in Q4 so far through Q1. So that's been relatively consistent. The one change we have seen is in some of the more discretionary equipment businesses, specifically heaters and some of the robotic KP ceased that was more challenging in Q4.
Equipment sales were down 17% versus 12% for the year. Artisoft. We're starting to see some improvement there, which is encouraging, but not enough for us to to plan discretionary sales other than we had planned them, which is down 10% at the midpoint.
Garik Shmois
Understood. Thanks for that, and I'll pass it on.
Operator
Jonathan Matuszewski, Jefferies.
Jonathan Matuszewski
Great. Thanks for squeezing me in. Our first question was on the 2020 for sales guidance for this past year Pro with an outperforming customer segments flat relative to kind of residential down in the mid to high single digits. So what is your our top line guidance assume in terms of relative performance between our Pro and residential?
Scott Bowman
Yes, Jonathan, thanks for the question. We've got Pro and residential planned a fairly similarly for 2024, really based on the forecast of increased transactions because I talked about with some continued pressure on ALD.
Jonathan Matuszewski
Got you. That's helpful. And then on just a follow-up in terms of SG&A for next year, I thought I think you mentioned that the opportunity for slight decline year over year. Can you just expand on kind of the areas you see to kind of further we rationalized that, that line item in a potentially soft demand environment? What are the buckets that you haven't used yet the levers you have recalled? Thanks.
Scott Bowman
And yet because as I kind of look at SG&A for this next year, we we've been really good job of kind of tightening up labor. And so we'll see some benefits from that come through. Norm or marketing will be a little bit lower this year as we continue to kind of test and learn on marketing than understated after that, there's room to bring that down a little bit on really the biggest pressure from for SG&A. And I hope to come through as incentive compensation that was extremely low in 2023. And so if it will come back to more of a normalized incentive comp payouts in that, that's actually the biggest pressure point we have outside of that.
You know, our expenses are down on just kind of on the core SG&A and then we'll have the added benefit from of about $14 million of what I would call nonrecurring now with some severance cost and some other write-offs on. So as we lap that, you know, and kind of unadjusted, that SG&A will actually be lower than in prior year.
Jonathan Matuszewski
Very helpful. Best of luck. Thank you.
Operator
Peter Keith, Piper Sandler.
Peter Keith
Good afternoon, everyone. So it sounds like on the M&A front, we're not anticipating any acquisitions, but could you just comment on what you're seeing with the M&A backdrop? It seems like it's been pretty good the last couple of years. Has anything changed on that front?
Mike Egeck
Yes, yes. We can fund it. Look, we think M&A is still very attractive and them we're pleased with the prices were pretty pleased with the returns we're getting in our current situation and with our debt and with the interest rates, as Scott had mentioned, our first priority is going to be debt paydown in terms of capital allocation in terms of M&A, our focus this year is really getting be on building the pipeline and finishing the integration of last year's last year's acquisition.
And so I still think it's a big opportunity going to work on building the pipeline in on a lot of these deals with entrepreneurial minded, founders and owners, they take some time to time to work through. So that will be the focus and then now get ourselves in a position from our debt levels and leverage where we can get back on an M&A cycle.
Peter Keith
Okay, helpful. And then I guess I'm intrigued with the 200 basis points on inventory adjustment that fits you are referencing in FY 23. Seems like a big recovery opportunity, but I am trying to size it up if it's a multi year on. I guess I keep looking at Q4 is when we hit the inflection, can you start to see full recovery by by Q4? Is this something that might take up through FY 25 or even longer to fully recoup?
Scott Bowman
Good question. I would say that we can recoup most of that this year in the region. That is mainly because just like I was saying about having our inventory inside our four wall is the biggest step that we can take in that process. And so we're not moving product to recorded in this having better control that inventory on goes a long way in avoiding a lot of that cost
There's continued improvements will do on on scrap, you know, and so on. But it was it was in control even before we start to this big inventory build to not a ton of work to do, but just further refinement of that on the one piece that I didn't really go into what we did have some additional unsolvable returns, just returns coming back in certain that those returns were a little bit elevated from a little bit.
And so as we continue to refine our process of going through those returns and making sure that we're taking all the advantage of all opportunity to sell those products either as new or other outlets on that, a bit of an opportunity for us. And so Tom, the returns you did tick up a little bit. I don't know if that from a long-term thing or just an anomaly, but that wasn't the major portion of the spend there. And so what I would say is you basically 80% of what we saw over the last quarter are fixable in 2024.
Okay. And just to verify that's got to be recouped this year, but it does start to recur, but it until Q4 and I guess in the following quarters, as you'll recall that last on an annualized basis, that's yes, that's the way to think about it yet. And we predominantly use a Q4 impact floors. And so as we lap fourth quarter this year, we should see that benefit.
Peter Keith
Thank you very much, guys. Good luck. Thank you.
Operator
Dana Telsey, Telsey Advisory Group.
Dana Telsey
I see with your question. Hi, good afternoon, everyone. On a big picture basis when you think about the pool season in 2020 full or are you expecting a positive $4 million in the second half of the year? That was the guidance and fares and how you're thinking about it. And then breaking down the components of sales, even compared to last quarter, you talked about equipment sales and what made it more capital this quarter than last quarter. How you're thinking about AOV. and how you're planning a lot of ongoing solid?
Mike Egeck
Yes. Thanks, Dana. Look, we expected 2024 pool season based on what we know right now to be fairly flat. Like I had mentioned earlier, we will see some inflation equipment, but we think the units might be challenged likely to see a little bit of deflation in chemicals that we think the volumes will be higher and mixing those together. We think that's a fairly flat season. We're showing a big recovery.
As Scott walked through from first half to second half, that has more to do with our internal decision on the price adjustments and when we made last year. But overall for the for the industry and for ourselves from a demand standpoint, we expect the pool season to be relative relatively the relatively flat. Again, discretionary items in there being down nondiscretionary being positive in terms of AOB. at the midpoint, we're planning a will be down about 4% for the year and transactions up about 3% with normal weather, which we've seen now in the fourth quarter and also into the first quarter, we're seeing traffic recover.
Conversions are holding steady. That's giving us a transaction boost. But the mix out of high ticket discretionary items in some of the more discretionary equipment categories is challenging. Aov.
Dana Telsey
Got it. Thank you. And just following up on the competitive front, what are you seeing from your from your competitors have any change distilling store closings, but what are you seeing there?
Scott Bowman
Yes, no, there hasn't been any new scale competitors that have come on the scene either in the pro side or on the residential side. On the pro side, we've got two big distributors that continue to go about their business, running very nice businesses and a little bit challenged this year by their own reporting EBITDA, but still very, very healthy businesses.
And then on the residential side of the one scale competitor, Pennsylvania and Florida seems to be having a fairly flattish year and we would expect correct them to be continue to be good competitors for next year. And I can say how they're thinking about it, not sure. The situation of Florida is much different than the rest of the country in terms of how we're thinking about it.
Operator
This concludes our question-and-answer session. And with that, this will conclude today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.
