Q3 2022 Snap One Holdings Corp Earnings Call
Good afternoon, welcome to snap one holdings Corporation's fiscal third quarter 2022 earnings conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need to press star one on your telephone.
Phone you will then hear an automated message advising your hand is raised.
I would now like to turn the call over to snap one's senior Vice President of Finance, Eric Steel Sir. Please proceed.
Great. Thank you good afternoon, and welcome to snap ons fiscal third quarter 2022 earnings Conference call. As a reminder, this call is being recorded joining us today from snap one are John Hayman, CEO and Mike <unk> CFO .
Before we begin we'd like to remind everyone that our prepared remarks contain forward looking statements and management may make additional forward looking statements in response to your questions, including but not limited to statements of expectations future events or future financial performance. These statements do not guarantee future performance and therefore undue reliance.
It should not be placed upon them.
Although we believe these expectations are reasonable we undertake no obligation to revise any statements to reflect changes that occur after this call.
Actual events or results could differ materially.
These statements are based on current expectations of the company's management and involve inherent risks and uncertainties, including those identified in the risk factors section of our annual report on Form 10-K for the annual period ended December 31, 2021 filed with the SEC.
All non-GAAP financial measures referenced in today's call are reconciled in our earnings press release to the most directly comparable GAAP measure.
This call also contains time sensitive information that is accurate only as of the time and date of this broadcast November nine 2022.
Finally, I would like to remind everyone that this conference call is being webcast and a recording will be made available for replay on our investor Relations website.
Investors dot snap on Dot com.
In addition to the webcast we have posted a supplemental earnings presentation accompanying these results, which can also be found on our investor Relations website.
I'll now turn the call over to our CEO John Havent John .
Eric welcome everyone and thanks for joining us this afternoon.
Everyone wants to hear our perspective on results and we will get to that quickly.
However to begin today's discussion I will give you some company background review our recent performance and then turn the call over to Mike <unk>, our CFO to discuss financial results for the quarter in more depth as well as to provide our outlook for the remainder of the year.
After that I'll share some closing remarks before opening the call for questions let's.
Let's get started.
To begin as snap one we provide a smart living platform that empowers professional integrators to deliver joy connectivity and security to discerning and customers on a global scale as a leading distributor to these integrators, we worked with our growing network of approximately 20000 professional do it.
For me integrators to distribute our proprietary and third party products through our E Commerce portal and local branches. We further support our integrator partners with our proprietary software platforms and workflow solutions to allow them to successfully serve that residential and commercial customer.
Across the project lifecycle.
This is the essence of our only hear strategy here at snap one we're positioning our integrators and our company to capitalize on the tremendous and durable growth opportunity in front of US. We believe it is arguable that homes and businesses will become smarter over the next decade and require.
<unk> will help to integrate and support the technology and that is the number one driver of our long term growth.
No company is better positioned for this future than snap one.
Turning now to the business update we acknowledge that our Q3 results were below our expectations I just wanted to call out some highlights before we get into it for their number one we grew approximately 8% and a tough climate despite supply chain issues are softer <unk>.
<unk> foreign currency headwinds and delays in local branch openings.
We have successfully managed through the inflationary cost environment as evidenced by sequential contribution margin rate increases, which we expect to sustain in 2023.
And finally, we wowed at the recent <unk> Expo, the smart living industry's flagship tradeshow with new product launches that positioned us well for the future.
During the year our team has successfully navigated the ongoing impacts of the global pandemic supply chain and logistics challenges and an economic backdrop complicated by inflation the war in Ukraine, and rising interest rates. While some of these challenges have started to subside. The overall market environment is.
Clearly grabbing more uncertain.
While we cannot ignore the impact of these elements on near term performance, we remain steadfast in our view of our long term prospects. We continue to believe growth in smart living adoption, the central role of the integrator and providing holistic solutions and our competitive differentiation positions snapped one for long.
Term success, we will continue to execute against our growth strategy, which remains unchanged.
Why have we hit a bit of a speed bump.
Here's what we're seeing in the current environment.
We began to observe a moderated pace of daily sales in the second half of the quarter, we anticipated a normal acceleration at the end of the quarter, but did not see that in October trends have continued to be a bit softer than previously forecast.
Two as we dug in to the underlying demand trends and analyze feedback from our integration partners.
Reality is they remain busy their activity levels and near term pipeline visibility remain healthy however, certain integrators, who hold inventory are starting to work through elevated levels of that inventory purchased in response to their own supply chain challenges.
<unk>. It's also important to remember that through our partners, we serve discerning and buyers who are more insulated from economic slowdowns and inflationary cost pressures on a relative basis. While this enhances the resiliency of our end markets high end customers are still becoming more.
Cautious we are starting to observe some changes and thereby in behavior, such as project D. Scoping project delays and product trade downs to manage the overall cost of an installation of course as you would all expect we continue to monitor the broader macro uncertainty.
As we look ahead.
The 2023 and beyond we remain highly convicted in the secular trend of smart living adoption, which will propel our long term growth.
We're also encouraged by a strengthening contribution margin rate did that due to the benefit of pricing adjustments and then put cost beginning to normalize together. This gives us confidence that we have a durable business that is poised for sustainable long term growth.
Let me take a few minutes to reflect on the past quarter as mentioned earlier net sales were lower than our expectations in September and for the quarter and this slowing of growth flowed through to our profitability.
<unk> of this slowdown was faster than what we have experienced previously and is partially partially attributable to the inventory Destocking and project tightening dynamics I spoke to earlier demand has stabilized at current levels, but given the macro uncertainty we are taking a cautious tone to our near term forecasts.
Cost.
Despite the end of the quarter slowdown, we believe our position in the industry remains very strong.
In Q3, we delivered on many operational commitments as we continue to enhance the smart living experience by improving both hardware and software for our integrators and end consumers at the recent CD Expo, we announced the upcoming launch of several of those innovative products.
Which we expect will drive a positive impact on 2023 results, including the following.
First we announced the upcoming 2023 launch of Halo, a new family of control for remotes with an elegant industrial design, a refined user interface and packed with new features that will enhance the end customers automation experience.
<unk> represents a meaningful upgrade opportunity for our installed base.
We are also now in market with the new <unk> wireless access point, which enables enhanced connection speeds with Wi Fi six technology benefiting, but then could consumers and our partners. This product will provide improved network efficiency for our customers and due to built in oversea monitoring and management will.
Simple for our integrators to set up and maintain everyone once fastener networking.
To bolster our lighting portfolio, we announced the upcoming launch of vibrant linear lighting, which integrates color temperature and brightness and a personalized automated scenes for a fully immersive lighting experience lighting is a big growth category for us.
Finally building on our suite of outdoor entertainment products, we announced the launch of episode Radiance modular.
All in a single wire outdoor audio and lighting system Radiant is a unique product that will drive new opportunities for our integrators to delight their customers, we changed outdoor audio years ago and with radiance, we are changing it again.
In addition to these exciting announcements, we launched the white box power product internationally and strategically started to merchandise our access networks access points on the snap one portal.
They can be more easily purchased by integrators.
Moving to our strategic initiatives, we had a few key accomplishments in the third quarter first as part of our ongoing strategy to grow and security and commercial we expanded our product offerings across both markets and security, we announced the upcoming launch of the new Luma <unk> IP.
<unk> surveillance solution, which is M. D. A compliant product that delivers AI powered security features providing end customers with greater peace of mind, while simplifying installation and long term maintenance.
Our commercial we launched the carbon series ceiling mounts, which are designed for commercial applications like menu boards and digital signage.
As referenced in last quarter's call, we acquired Claire controls a provider of home automation and security products previously distributed by that one.
<unk> hybrid automation and security solution addresses the attractive middle market opportunity between lightly featured conventional security systems and luxury level whole home control systems.
Third we continued our strategic Omnichannel presence expansion by opening a new domestic local branch in St. Louis Missouri in July .
This branch brings the company's domestic footprint to 33 locations.
Two more in Canada as of quarter end.
We look forward to further branch openings in the coming quarters to better serve our integrators and additional markets.
Following the close of the quarter. We also completed the acquisition of parasol.
Household 24 by seven remote support service based on oversee creating new opportunities for our integrator partners to focus on running their business, while increasing profitability productivity and service levels to their customers. The acquisition builds on our strategic investment in parasol announced last year.
And increases our capabilities to provide an RMR service to the industry. In addition to our fore sight product line and other efforts.
I'll now comment briefly on our outlook before turning the call over to Mike <unk>.
As we prepare for the rest of 2022 and 2023, we are focused on continuing to manage the business to deliver strong profits and drive operating leverage.
<unk>. The challenge is referenced earlier, we are reducing both our net sales and adjusted EBITDA guidance for 2022, which Mike will discuss in further detail.
As we think about 2023, we expect the operating environment to remain challenging in response, we are constructing an operating plan that reflects the continued execution of our growth strategy.
We remain focused on controllable strategies consistent with our long term growth algorithm that will enable us to outperform including the following.
One increasing our share of wallet with existing integrators through the adoption of our ecosystems.
Two continuing to innovate and launch the exciting products I referred to earlier.
Three opening new local branches.
For adding new partners across our business, including in security and commercial markets.
And finally, we will moderate our expenses to drive efficiency and optimize productivity, which will generally which will generate enhanced profitability.
And of course, we'll endeavor to enhance our balance sheet, while doing all of this.
We believe our resilient integrator partners, our diversified business model and consistently strong execution.
<unk> us to prosper in dynamic macro environments.
We are observing an interesting dynamic in our supply chain.
Over the past couple of years, we have incurred tens of millions of dollars and additional costs from supply chain inefficiencies. We are now seeing a return to normal and freight logistics and componentry expenses that we believe will be a material tailwind to our proprietary.
Margins in 2023.
With that I will turn the call over to Mike <unk>, our CFO to discuss the quarter's results.
More detail as well as our 2022 outlook.
Mike Thanks.
Thanks, Sean.
Turning now to our financial results for the fiscal third quarter ended September 32022.
Again net sales in the third quarter increased seven 9% to $281 2 million up from $267 million in the comparable year ago period.
The growth in net sales during the quarter reflects organic growth, including the continued ramp of local branches opened this past year.
The cumulative impact of proprietary product price adjustments taken in the past year.
<unk> was also driven by the incremental sales benefit of stop which was acquired in late January of this year.
<unk> growth was moderated on a year over year basis due in part to greater than anticipated sales pull forward in late Q2 and response for June 2022 price adjustment.
We go direct to manage call larger than expected in Q3.
Additionally, our pace of local branch openings, a key driver of growth has been delayed this year further moderating our growth. However, we do anticipate several additional local branch opening in Q4.
While the quarterly growth rate is down sequentially on a three year pro forma CAGR basis. The growth is in line with our consistently communicated long term target of low double digit growth.
Contribution margin a non-GAAP measurement of operating performance increased 4% to $113 8 million or 45% of net sales in the fiscal third quarter.
That's changed from $109 5 million or 42% of net sales in the comparable year ago period.
We did see a second consecutive sequential quarter over increase in contribution margin as a percentage of net sales, which I'll discuss in a moment.
As expected the year over year decrease in contribution margin.
<unk> of net sales was primarily related to our local branch expansion and growth strategy, which drove a change in product mix as our local branch footprint skews towards third party product sales and.
In the fiscal third quarter third party product sales represented 31% of total net sales compared to 29, 2% from the comparable year ago period.
As a reminder, third party products typically have a lower contribution margin as a percentage of net sales relative to our proprietary products.
The strategic expansion of our local branch footprint and curated third party product portfolio remains an important part of our value proposition over the longer term as we aspire to be a one stop shop program integrator partners.
As referenced above on a sequential quarter over quarter basis, we were pleased to drive an increase in contribution margin as a percentage of net sales from 37, 9% in Q1 39, 2% in Q2 to 45% in Q3.
Approximately 130 basis point increase in contribution margin for Q2 was primarily driven by the full quarter benefit of the June price increase in March.
Improvement was further aided by improved supply chain dynamics, including a reduction in the use of air freight sequentially decline in inbound freight costs, partly offset by product mix.
Selling general and administrative expenses in our fiscal third quarter decreased 14, 9% to $89 4 million or 31, 8% of net sales from $105 million or 43% of net sales in the comparable year ago period.
This decrease in SG&A expenses during the quarter was primarily due to lapping onetime expenses associated with our IPO that occurred in Q3 last year.
After adjusting for ironbark items, selling general and administrative expenses increased five 8% to $81 9 million or 29, 1% of net sales from $77 5 million or 29, 7% of net sales.
The increase in adjusted SG&A expense is related to increased costs associated with operating as a public company.
<unk> investments to support strategic growth, where your completion and the required cost of <unk>, which we did not own for the full period of the prior fiscal year third quarter.
Our net loss totaled $1 million in the third quarter compared to a net loss of $21 5 million and comparable year ago period.
Adjusted EBITDA, a non-GAAP measurement of operating performance decreased 8% to $31 9 million or 11, 3% of net sales in the third quarter of 2002 compared to $32 1 billion or 12, 3% of net sales in the comparable year ago period.
Adjusted EBITDA declined in the quarter was primarily attributable to operating expense growth prescribed about outpacing growth of our contribution margin.
Adjusted net income a non-GAAP measurement of operating performance decreased 11% to $14 9 million or five 3% of net sales from $16 7 million or six 4% of net sales in the comparable year ago period.
And free cash flow a non-GAAP measurement of operating performance totaled negative $25 4 million for the nine months ended September 32022, compared to negative $18 $1 million in the comparable year ago period.
The decrease in free cash flow was primarily attributable to a modest year over increase in net cash used in operating activities and purchases of property and equipment.
Net cash used in operating activities for the nine months ended September 32022 was negative $15 4 million.
The use of cash have been primarily driven by investments to protect us against the supply chain, resulting in the use of net working capital including increases in inventory.
We've seen sequential improvement in our change in working capital, including moderated inventory growth of $22 million in the quarter, which we expect to continue to moderate.
At the end of the fiscal third quarter 2022, we had approximately $74 $7 million in liquidity, including cash and cash equivalents for $35 5 million and undrawn revolver capacity of $39 2 million.
After the quarter, we secured an incremental $55 million term loan to provide additional liquidity for general corporate purposes.
We used most of the proceeds about loan to pay down our existing revolving credit facility with the remaining cash added to the balance sheet.
Pro forma for the incremental term loan total liquidity of approximately $125 million.
We do not anticipate needing to tap into this incremental liquidity, but we want to be very conservative given the macro environment and we'd like to be able to be opportunistic.
Tuitions arise and deploy capital towards organic growth drivers or strategic acquisitions that generate high rates of return.
Now before I turn the call back over to John I will take just a few minutes to provide an update on our financial outlook for the remainder of the year.
As a reminder, snap one provide annual guidance for net sales as well as adjusted EBITDA.
Those metrics are the key indicators for the overall performance of our business.
Our fiscal 2022 guidance concludes our year to date performance pricing adjustments acquisition unclear.
We expect to have a modest dilutive impact on consolidated results in the short term ongoing FX headwinds and our anticipation of continued market uncertainty.
With these inputs in mind, we are adjusting our annual net sales adjusted EBITDA guidance ranges.
We now expect net sales in the fiscal year, ending December 32022 to range between $1, one <unk> and $1 $1 5 billion, which would represent an increase of 9% to 11% compared to the prior fiscal year on an as reported basis and 11% to 13% after adjusting fiscal 2021.
The impact of the 50 <unk> week.
We believe a contributing factor for 2022 net sales growth on a 52 week adjusted basis are as follows.
8% to 10% of our growth derived from organic growth, which includes volume local branch openings historical quite some adjustments.
And supply chain challenges that we've mentioned.
3% of our growth.
The impact of recently completed M&A, including access networks and as Bob Electronics.
On an as reported basis, the lapping of the 50 <unk> week in 2021 represents a 2% net sales growth headwind for the year.
It might have a softening demand environment. We also revising our adjusted EBITDA guidance range to $109 million to $113 million roughly in line with prior year on an as reported basis.
John has already.
Comment on the demand outlook, we remain confident in our gross margin trajectory.
The proactive steps to manage our expense structure to drive profitability.
Now one final update before I pass the call back over to John as a reminder, snap one board of directors approved a stock repurchase program that authorized potential repurchases of $25 million of our common stock on the date of approval, which was may 12 through the end of 2023.
As of September 32022, we have repurchased approximately 222000 shares of our common stock.
Aggregate value of approximately $2 4 million.
Consistent with our capital allocation policy, we will continue to prioritize and this order.
Alex sheet shrink.
Organic growth investments accretive M&A, and then opportunistic share repurchases.
That completes my summary, I will now turn the call back over to John for any additional commentary.
Thanks, Mike just a few closing thoughts before we hit Q&A.
First even in this environment.
<unk>.
We remain bullish around our growth aspirations and the longer term operating model.
'twenty three we have confidence in our proprietary product launches are growth in adjacent markets, such as commercial and security local branch opening strategy.
And the benefit of.
<unk> 2022 pricing adjustments carrying over to 2023.
We also anticipate continuing our favorable contribution rate.
Margin rate trajectory as costs related to the supply chain alleviate.
Second our focus remains on our only hear strategy. This includes new product launches software investments and platform investments all in service of supporting our integrators to capitalize on the implant opportunity in front of us and them even in a moderated investment environment, we continued to strive.
To be the one partner that our integrators trust to support and grow their business and third as I said earlier, we believe that all homes and businesses will become smarter over the next decade driving demand for the types of experiences we offer today and those that we can only imagine in the future the slow.
Then we have recently seen is temporary and we will continue to strengthen our company during this period.
We've invested in scale and platforms that will drive better solutions for the end customer more capacity for the integrator and growth for snap one in a way that increases operating margin overtime or accidents in the first three quarters of the year have set us up to succeed in the current environment, while also preparing.
For longer term sustainable credits.
And with that operator, please open the call for Q&A.
Thank you at this time, we will conduct a question and answer session. As a reminder to ask a question you will need to press star one on your telephone and wait for your name to be announced please standby, while we compile the roster.
Our first question comes from the line of Chris Snyder from UBS. Your line is open.
Thank you.
We should all the updates I was hoping for some more color on the integrator inventory digestion.
Is there anything you can provide to kind of quantify the headwind realized in the back half of 'twenty two.
And then also at what point do you think this destocking headwind will be in the rearview and the <unk>.
And you can kind of continue to grow in line with the activity that youre seeing at the integrator level.
Thanks, Chris.
Historically.
Our partners have not carried much inventory.
And what we've become aware of it.
Is that.
Many have been responding to the supply chain challenges that are out there.
Hi.
By reversing kind of that practice that they've had.
We.
Have triangulated the numbers through surveys analysis of our own.
Data in terms of for instance, when we see systems being turned on by ever say et cetera, and we would estimate that our partners are currently sitting on what we would say is about $40 million to $60 million.
Inventory that we would call kind of sold in versus sold through inventory.
And the channel relative to prior year.
<unk> practices.
Through that analysis have.
Have seen that that was primarily built in the second half of 'twenty one in the first half of this year.
That likely drove a couple of percentage points higher revenues during that time.
Over the past few months, what we've noted with our.
Partners again through surveys is that a minority of partners continue to build inventory.
And.
And most have.
We have started to unwind that inventory.
Good point by the way just to the new cycle and interest rates et cetera that we all start to seen in August and September .
We actually don't believe this practice has gone away from the channel like.
We see the supply chain alleviating, but in some spots. They don't there are other suppliers that are still having supply chain issues and that's not lost on our integration partners, but we are seeing.
It start to unwind.
And so we believe that.
They'll start to burn down kind of that inventory over the next three to six months and that would include the period we're in in that.
I will say this this was something that because it's been a non standard practice by the channel.
Something that really started tippett, we became aware of that stadium.
As we started to talk to.
<unk> partners.
Service companies that provide services to our partners.
And.
<unk>.
That's that's where it is so couple of points of growth.
Last half of last year first half of this year.
Starting to see it unwind and I think based on the activity et cetera.
<unk> through.
Next quarter, probably into the second quarter a bit.
And thank you for that John really appreciate all the color.
And generally.
The communication matches up with what we have seen a lot with just.
The end market slowdown combined with improving kind of supply chains.
I've seen a lot of Destocking, So I guess I just want to confirm that.
So the.
The integrators, maybe sitting on an extra $40 million to $60 million.
Did that get worked down at all in Q3 or is there not really an impact in Q3 and then the idea is over the next two or three quarters that will unwind, maybe like somewhere like maybe $20 million.
On a revenue headwind per quarter over the next two or three.
I think it definitely started to unwind in Q3, it's hard for me to put an actual number on it.
I don't think it's more than $10 million.
I consider it to be a $10 million to $20 million kind of headwind for us over.
Fourth first and second quarter and.
Hopefully it'll just worked its way out by the end of the first quarter.
Thank you John I appreciate that.
Thank you.
The company requests that each participant limit their comments to one question and one follow up.
Our next question comes from the line of Stephen Volkmann from Jefferies. Your line is open.
Good evening, it's actually true.
Sure Steve This evening.
Wanted to kind of hit on Christmas comment on the inventory side with the integrator and move it to your own inventory how much do you feel is.
Sure.
What's kind of the real carry number they really need at this point how much are you going to be looking to draw that down.
And over what period of time, and then I think the my next question will be regarding just pricing in general but start here.
Sure. Thanks, Rob it's Mike.
Obviously as sales have seen a little bit of a slowdown in a given a little bit longer supply chain inventories built up a little bit more than we expected even in this quarter. We were on top of it so our supply chain right now we feel comfortable that by the middle of next year, assuming a run rate of sales base of the current levels and as we forecast that we would expect inventory to come down about <unk>.
We went to $25 million between now and the middle of next year as we manage through it.
Obviously as we have to think about the demand for urban whether that grows or shrinks.
If we're better forecasting horizon, we feel pretty good about thinking about $25 million out of the system over the next six to nine months.
And on the pricing point I think if youre I think we've definitely seen.
Costs moderate into supply chain.
And I think as we think about next year.
We see.
Targeted versus larger price increases as we sit here today with the current.
Cost perspectives, we have in the business.
Should we see cost increase then we will of course respond from a pricing standpoint.
No that's excellent.
I guess the other part of that but I was kind of looking for is just the idea of.
Given the increases that have been happening over the last couple of quarters here within your own portfolio whats.
<unk>.
A fair way to think about the carryover impact for next year is there is a low single digit kind of an idea or is it little bit higher than that even.
Yes, the pricing impact next year on what we've already done is about 3%. So just the carryover. So if we did no incremental pricing.
Next year the timing as you go through it's different in different quarters for the full year would be a 3% lift on partner sales.
Appreciate that.
Thank you.
Our next question comes from the line of Qatar.
Montara from BMO capital markets. Your line is open.
Thank you and good evening.
John is it possible to provide just a little more.
Color around kind of trends.
Through the third quarter and into a program I know you mentioned in your prepared remarks that in the back half of Q C. You thought the impact and I'm curious if you can provide any additional color around.
How that trended through the quarter.
How does October look if it is kind of in line with September and actually a bit better or less worse.
Sure. Thanks.
Thanks for the question I would say that.
The biggest.
Trend that we saw during the quarter.
Was.
Generally speaking that our business is pretty linear throughout the quarter.
And that's always been the trend.
And the reason for that is always been our partners don't carry inventory. So it's very much a sell through business.
The exception to that is the last month of the quarter. When we have certain rewards and rebate programs that theyre all stretching to try to meet.
So.
And those those generally happen at various levels.
We had expected that to be once again significant in September .
And so I would say and.
August we.
In the first part of the quarter, what we had with don't forget we had a 9% price increase.
Second half. So we knew there were some buy ahead of inventory for that that we saw a little bit of a lag.
In Q3 that was expected.
Then sales.
<unk> started to recover and we expected a strong finish in September just like we have in every.
Yes.
Quarter, and that's what we didn't see in the first quarter, we haven't seen that in my.
Almost eight year tenure with the company.
<unk>.
We happen to be at CDF, the last week of the quarter.
And that's where we were able to start having discussions with either service providers to the industry or.
Or our partners directly.
And as we started to inquire was pretty clear that.
There was inventory being unwound now I think thats part of it I think the second part of it is again I'm going to come back to the new cycle like if you've been first of all the supply chain is alleviating with many vendors not all but with many including us.
Second if you are a small business person and you're reading all the news and you're sitting on a bunch of inventory youre going to start to think about liquidated that faster.
Specially when you think the supply chain is catching up to your business and so.
September was just not what we expected.
And in October in October .
Typically talk about the quarter. We're in on these calls, but what I'll say is.
As we look at the guidance Mike's given we're very comfortable with that based on kind of the sales.
We are seeing in.
October and early November .
Alright, Thats helpful. Jonathan as my follow up how do you think about.
The pace of.
Investments in branch openings as we move through this startup dynamic and uncertain environment.
I think about it prudently.
I think we'll.
It's a great question. It's one we're asking ourselves as we put together our budget for next year.
Especially as we have.
Very strong outlook over the next three to five years.
We're going to probably be a bit more targeted with our investments next year, which means we'll moderate them in other areas.
And we are continuing to assess the various revenue scenarios for next year.
We believe we can grow through.
A slower environment based on all the things I talked about the products opening local sites share of wallet strategies new partner acquisition.
Both we see the outsized growth, we see in the commercial and security markets, which continue to grow at a much faster pace than our.
What I would call core residential.
Technology market.
And so.
We are very optimistic frankly about our growth in those areas and then the question. We always ask ourselves is what's happening in the market and so as we assessed that we assess where we're going to be willing to invest with the notion that we're going to increase profitability while doing so so that's one piece.
The second piece of that is core to that strategy is the opening of local branches.
We're working on some internal technology early in the year and so we've got plans to open a bunch out local.
Branches in the fourth quarter of this year, which should have been opened earlier this year, but permitting and supply chain affected local branch openings as well this year, which affected revenues this year.
And.
What I would say about next year is we'll get these sites opened in the fourth quarter.
We've got some technology work internally that we're working on we'll keep an eye on revenues and then we target opening more sites in the second half of next year.
Yes.
Thank you that's very helpful John and good luck.
Thank you.
Thank you.
Our next question comes from the line of Keith Hughes from Truest. Your line is open.
Thank you given kind of the outlook, we've discussed here, particularly in the short term does that shift your thinking on the use of free cash flow and mortgage more towards debt reduction or are we still going to go with the same the same pace we've seen for some time.
Thank you Mike.
It doesn't substantially shifted our view, obviously, we're paying attention to the macro environment that's out there.
And I would say that.
We the reason, we went out and that additional term debt pay down the revolver was to provide flexibility. We wanted two things it probably goes to raise the bar quite frankly from an ROI standpoint, if we look at investment opportunity, whether those are organic or external on what we want to make sure. We can underwrite and very good timeframe. We've got a lot of certainty if we're going to deploy that capital.
But I don't think it changes our view because I think we still feel really comfortable long term Brooklyn.
And we've talked before our cash flow generation. So obviously.
Heart failure on that we feel less certain about that we'll think about re prioritizing but for right. Now I think we're really comfortable from a liquidity standpoint, we'll be prudent on how we play it but it doesn't change our prioritization of how we think about it.
Okay. Thank you.
Thank you.
Our next question.
Comes from the line of Erik Woodring from Morgan Stanley . Your line is open.
Hey, guys. Thanks for thanks for taking my questions I have two as well maybe.
Maybe just to follow up on the on the first question. John Obviously, you mentioned a number of kind of emerging headwinds flowing average daily sales growth elevated customer inventory some pull forward into Q and a delayed branch opening.
I thought the color that you provided on channel inventories those are customer inventories was very helpful. Can you maybe help us understand it seems like that is the biggest headwind right now if we put that to the side, maybe just help us kind of maybe qualitatively better understand which of the other factors are kind of having the most significant.
Impact on the business today in <unk>, and then I have a follow up after that thanks.
Thanks, Eric.
Hi.
I know you guys and I would love to have it just be one thing I think it's more of a combination of a few smaller things.
On the controllable side.
What I would just say is the supply chain just does it is it doesn't only affect how much inventory we carry because of course, we're carrying enough inventory. It also.
<unk> when we launch products. So I would say some of the product launches that we showed at <unk>, we would've hoped to launch more quickly. So that's number one.
Number two I think that.
The integrators are busy, but and I said it in my opening comments.
But.
There are some things we don't control as much.
We can't control when a local entity.
Local government entity gives us a permit opened a local store.
That causes delays when those times like them.
The second piece, though is the market and I don't.
I don't want to leave this call with everyone thinking that worst aimed at the markets.
It's been over the past couple of years and what I would just say to that is.
I I read.
Kind of.
I have lots of friends and.
Colleagues and business.
Lots of.
Builders.
And I think there is a conservatism that's going on with buying today that is resulting in.
The scope of.
Projects that might mean to speakers in a room and set up for it might mean for speakers, but theyre cheaper speakers.
And we're I think we're seeing that in lots of places in the businesses and.
And builders I talked to are seeing that and they're in there.
In there.
Customer base.
And so I think there's just a little bit of that going on right now and a little bit of that.
Few percent.
<unk> creates some softness and so I think it's a combination.
All of those things that lead us.
Having a more cautious outlook around the rest of the year and as we plan for our budgets into next year. So we think about our expense structure.
That's really fair. Thank you John I appreciate all that commentary.
And then maybe a follow up.
I think you guys have made it very clear and proven yourself in the market.
Your proprietary product is very highly regarded obviously, winning a number of different awards you continue to launch product at a fairly rapid pace.
But then in the quarter, we did see more of the slowdown in your proprietary product rather than the third party products can you just maybe help us parse that out why would we be seeing more of a slowdown in <unk> products versus three.
<unk> I understand there is probably some branch openings that impact, but just love to understand kind of the puts and takes there between those two and that's it from me. Thank you. So much yes. Thanks Eric.
I think when you look underneath that if you did it on a.
These couple of same store sales basis, you would see growth rates that are almost equivalent between both product lines.
Happens because historically most of our proprietary product distributed nationwide throughout the U S. E Commerce platforms, we had coverage all of them.
And E Commerce platform historically did not carry our third party products. So we don't want open our local branch network.
It adds that third party product availability towards integrator partners in that market and so we know what's going to happen as we add more local branches. The impact from third party product is greater than our proprietary because what we see is we're already in market with our proprietary product. If you are in the.
The most recent stores delivers so if youre going to St. Louis prior to our store openings you could buy some full four products you can buy oversee product to combine our strong balance sheet combined with speakers through our e-commerce platforms, which you couldnt buy local.
TV from us or you can buy some other third party products that we only carrier, but before we open up a local store in St. Louis.
Folks will shift there won't be purchasing from our ecommerce platform several before we do get some lift.
Opening I hope with one of our proprietary.
It's much greater on the third party products because now.
It's available in the market that weren't there.
The dynamic that we're dealing with as expected we know about it we model. It we continue to happen Tvs by far the biggest one.
<unk>.
As we go forward. So that's the dynamic we're on the same store sales underneath it.
The growth rate of 310.
Zero.
Okay Super helpful. Thanks for the thanks for the color Mike.
Thank you.
Our next question comes from the line of Ryan Merkel from William Blair. Your line is open.
Hey, guys.
I wanted to ask about new residential construction you didn't list that as a reason for the slowdown that you're seeing I'm curious are you seeing any softness there.
What is your outlook for that business as we think about the next couple of quarters.
Well I think we thanks Ryan.
I think our general perspective on.
That is.
Hope to what I thought was a.
And overall caution from us in terms of.
Kind of the market.
Just a bit ago.
In terms of construction itself like our integrators.
Tenure to be Super busy.
And.
The penetration of our solutions in the housing market is very low.
So I think it certainly creates and.
I think so.
Softer economy and higher interest rates certainly creates.
A bit of an overhang on the market, but there is tons of opportunity to for our integrators to go find other business and so when builders are building homes, it's very easy for the integrator by Gore and when builders slow.
Down building homes.
It may take a tiny bit of time for the integrated a pivot, but they'll pivot they'll go find commercial work they'll go find work in their installed base.
And they will go find work and kind of what we call the more the renovation market and.
<unk>.
If our products were much more widely penetrated in the market I'd be more concerned about near term.
Structuring trends, but I think it just creates.
What I'll call up a light layer of softness.
As I look at it today.
Got it that's all for me thanks.
Thank you.
Thank you.
Our next call comes from the line of Paul Chung from Jpmorgan. Your line is open.
Hi, Thanks for taking my question so just on the <unk>.
On the gross margin bridge it looks like you saw some benefits from.
Lower air freight expense this quarter.
Can you kind of expect a similar amount of gross margin uplift.
Move throughout the next coming quarters.
The benefit even higher as we think about airfreight.
Anticipating and then on the gross margin to end the year and into next year.
How do we think about the pricing benefits that you've implemented to lower freight and product mix.
About the puts and takes.
Gross margins as we kind of think about 'twenty three.
And the shape of performance for the year.
Hey, Paul.
So we don't guide specifically on our contribution margin or gross margin, but I'll give you some color around the numbers.
And how we think about it.
If we think about Q4 year over year for Q3, yes, it should be more performance.
Spectation.
The trends that we're seeing aren't going to really change we're getting the benefit of that pricing. We expect that to continue and so if you think Q4 will probably look pretty similar as it looks in Q3.
And as we think about next year as John mentioned during our call. The scripted portion of the call. We do continue to see some of those cost pressures and supply chain moderate so whether thats the.
Cost of Ocean freight whether that is.
Of that.
Purchase price variance PPV that we've had to pay to ensure supply chain. Those things are definitely moderating and we do see over the next year, our margin rate returning back to where historically back in 'twenty, one and 'twenty.
As we see.
<unk> seen a moderation in the price impacts that we've had quarter will still continue to have a little bit of mixed moving against us as we talked about earlier, but we think all of that will put us back again pretty similar to where our margin rates have been historically.
Okay, Great and then just to follow up on that.
The.
Large amount of new products, you kind of released during CDI.
Where are you seeing relative strength across the portfolio of products. If you might be the radiance product is attracting a lot of attention just any any comment on your product portfolio and I know you have some near term headwinds there, but maybe longer term. How these new products are expected to perform thank you.
Alright. Thanks.
We're super optimistic.
Thank integrators can't wait to get their hands on them.
Kayla is going to differentiate our entire control system offering.
Frankly, the remote the remote itself, it's been an area, where we feel like we've been a bit behind where we needed to be so I think.
Integrators can't wait to get their hands on them and that will be early next year. We had hoped it would be this year.
The lighting.
<unk>.
Lighting is up.
Continues to be a big growth area for the industry and.
For our customers.
And radiance you saw you saw the reaction to radiance. So we think in terms of audio in terms of lighting.
Very exciting the outdoor products typically.
They are big time is in the spring as the weather gets a bit warmer.
So those are all.
Really important releases for us in some cases will generate new revenues in some cases, both generate just more attachment.
Of other systems.
And then.
Wi Fi access points that are out now and being very well received.
And we've got more behind that we've got more behind that.
Okay great.
Thanks.
Thank you.
Our next question.
It comes from the line of.
Brian written bar from Imperial capital Your line is open.
Yes. Thank you very much quick question I think I picked up on you're saying that you may be pursuing.
More commercial business is that correct moving forward.
Well, we have we have.
We do Brian .
Well over a couple of hundred million dollars in the commercial and security.
Markets have been.
Fastest growing markets for the company.
Generally speaking kind of.
Double the growth that we see in our more conventional residential technology market.
Okay can you talk about how you plan to do that to see that pivot I'm hearing a lot of.
Companies out there, making those kind of comments about wanting to go in from a retail maybe market or consumer driven market into the commercial commercial security.
What would you have to do in order to get bigger market share in that area. Our biggest dwell I think we have to do two things that we've done very successfully.
Sure.
First I think it's a very adjacent market for us number one.
And the reason I say that is our integrators just for everybody's information generally speaking about a third of our core customers business comes from commercial work anyway.
So we already have products that are fit for.
For commercial.
Yes.
We've.
Extended that with go to market activities to go recruit integrators, who identify themselves as commercial integrators as opposed to residential we've been quite successful with that strategy. We have been launching new products, we did a.
Our release.
A little less than a year ago around our control.
<unk> four platform.
Not fully fit for all commercial settings, but it's fit for some and I think we now have about 1000 implementations of that.
We have also noted that.
Our commercial customers about half of them are using oversea.
And so we are continuing to look at.
How do we continue develop our go to market with business development resources.
Continue to attract more channel partners and continue to feed those channel partners with new products those could come from us or those could come from a third party.
We just signed a relationship that we announced with digital watchdog.
Surveillance space and so we're doing it just like we kind of built our company 20 years ago by acquiring customers in.
And listening to them and building more products for them.
We are.
Our fortunate that we've got a product team.
That.
<unk> is developing a much better understanding of that market.
And we have a distribution capability that other commercial product companies find attractive. So those are the things. We're building then the question for US is of course in this environment, how fast to build it.
And how fast to invest there how fast to investing.
Security market and of course, how fast to continue to drive wallet share in our market and those are the things. We're balancing in this year's budget cycle and those are the things that make us all really excited about the next three to five years.
Great and then just one final question.
Are there any planned.
Reductions in staff in the near term I think your revenue in the fourth quarter. According to guidance is down 6% to 8% is there any plan.
No changes to the staffing levels, yes.
Based on our view of where the performance of the business is there is no planned reductions in.
And.
Our workforce, we do have.
I would call a hiring freeze for all but the most essential positions.
And we feel like we've made significant investments.
That are ongoing.
That are sufficient to continue to grow our business.
Thank you.
Hey, Brian one thing just real quickly on top of that when you talked about our Q4 guidance.
You have the 50 <unk> week last year, so on them.
Just about a real guide for Q4 is down a couple of points off a couple of points on a comparable basis. So just make sure everybody hears that.
Thank you.
At this time. This concludes our question and answer session I would now like to turn the call back over to Mr. Hany <unk> for his closing remarks.
All right everyone.
We really appreciate your time today I want to.
Especially thank our team members who continue.
Work their butts off delivering on behalf of our partners and our shareholders I want to thank our partners for all the great work they are doing out there.
And of course, our investors for their continued support and we will.
Continue to keep you guys informed but I appreciate it and wish everybody a great Thanksgiving.
Thank you.
Thank you for joining us today for snap ones fiscal third quarter 2022 earnings Conference call you may now disconnect.
The conference will begin shortly to raise your hand during Q&A you can dial one one.
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