Snap One Holdings Corp. (NASDAQ:SNPO) Q4 2022 Earnings Call Transcript

Snap One Holdings Corp. (NASDAQ:SNPO) Q4 2022 Earnings Call Transcript March 14, 2023

Operator: Good afternoon. Welcome to Snap One Holdings Corp.’s Fiscal Fourth Quarter and Full Year 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. I would now like to turn the call over to Snap One’s Senior Vice President of Finance, Eric Steele. Sir, please proceed.

Eric Steele: Great. Thank you, operator. Good afternoon and welcome to Snap One’s fiscal fourth quarter and full year 2022 earnings conference call. As a reminder, this call is being recorded. Joining us today from Snap One are John Heyman CEO; and Mike Carlet, CFO. Before we begin, we would 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 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 latest Annual Report on Form 10-K 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, March 14, 2023. 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 at investors.snapone.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 will now turn the call over to our CEO, John Heyman. John?

John Heyman: Eric, thank you and welcome everyone, and thanks for joining us this afternoon. To begin today’s discussion, I’ll give some company background, followed by a review of our recent performance and then I’ll turn the call over to our CFO, Mike Carlet. Mike will discuss our financial results for the quarter and year in more depth as well as provide our outlook for 2023. After that, I’ll share some closing remarks before opening the call for questions. Let’s get started. To begin, at Snap One, we provide a smart living platform that empowers professional integrators to deliver joy connectivity and security to discerning residential and commercial customers on a global scale. As a leading distributor to these integrators, we work with our network of approximately 20,000 professional do-it-for-me integrators to distribute our proprietary and third-party products through our e-commerce portal and growing local branch network.

We further support our integrator partners with our proprietary software platforms and workflow solutions to allow them to successfully serve their customers across the project life cycle. We are confident there is a tremendous and durable growth opportunity in front of us and we are positioning our integrator partners to realize this growth with us. We believe homeowners will continue to upgrade their existing technology. We know the US is under housed by millions of homes that will be built in the future and we are confident small business formation will continue to be the backbone of the economy. It is inarguable that homes and businesses will become smarter over the next decade and many will require professional help to integrate and support the technology they need.

This is the number one driver of our long-term growth and no company is better positioned for this future than Snap One. Our growth algorithm is simple. Continue to attract more integrator partners and capture more of their spend by building new products and driving adoption of our ecosystems. This formula will drive our growth over the next decade and we will remain focused on executing this strategy, while managing through the near-term uncertainty. Turning now to our recent performance. Our team delivered solid fourth quarter results and despite a challenging macro environment, we achieved strong growth in net sales and adjusted EBITDA for fiscal year 2022. I am proud of what the entire team has accomplished as we navigated the ongoing impacts of a dynamic operating environment, while continuing to deliver for integrator partners.

For the fiscal year, we delivered $1.124 billion in net sales and generated $114 million in adjusted EBITDA, representing year-over-year growth of 11% and 3% respectively. Our fiscal fourth quarter results exceeded the guidance we shared last time we spoke. While the industry continues to reduce inventory levels in the channel, we saw integrator partner activity remain steady through Q4 as they worked against healthy backlogs in their own businesses. The channel inventory buildup helped sales in the first half of 2022, but has been a continuing headwind for us since then as integrators deplete inventory. Mike will elaborate on this dynamic in his remarks. Looking back on 2022, a major focus for us was enhancing the smart living experience by improving both hardware and software offerings for our integrators and end consumers.

At year end and early 2023, we successfully introduced exciting new products across our outdoor entertainment lineup, linear lighting, control, surveillance, and/or networking product categories. We’re particularly excited about Halo, our new family of Control4 remotes; Araknis wireless access points which enable enhanced connection speeds with Wi-Fi 6 technology; Vibrant Linear Lighting, which provides a fully immersive lighting experience; and Episode Radiance, which builds on our suite of outdoor entertainment products. Importantly, many of our new products will drive upgrade opportunities for our installed base of end customers. Our products and services garnered significant industry recognition in 2022 including 17 CE Pro Quest for Quality Awards out of 22 identified subcategories; 40 Top Three brand rankings across 62 identified product subcategories in the 2022 CE Pro 100 Brand Analysis Awards; and two Mark of Excellence Awards at the Consumer Electronics Show in January of this year.

I’d also like to highlight a few strategic accomplishments across our business this past year. We continue to invest in and bolster our software and service offering. We released the Control4 OS 3.3.0 update; introduced the OvrC Connect app; and completed the acquisition of Parasol, a powerful 24/7 remote support service based on OvrC. Two, our commercial and security growth markets remain important long-term opportunities for us, and we displayed continued progress in these areas in 2022. In commercial, we executed on product development, including the Control4 multi-display manager functionality that was voted in AV Technology Best of InfoComm 2022 Award winner. In security, we acquired home automation and security products provider Clare Controls, and announced the upcoming launch of the new Luma x20 IP surveillance solution, which is now shipping.

Three, we expanded our omni-channel presence by opening eight net new local branches in 2022, including several in Q4 and acquiring two new branches in Canada through the acquisition of Staub. This brings the total number of North American branches to 41 as of year-end. Four, further enhancing our omni-channel initiative. We have begun to convert our e-commerce customers to a single e-commerce portal, which will drive efficiencies in our business, make our integration partners’ lives easier, and allow us to drive marketing programs with higher efficacy. We believe that we made significant progress with our strategy in 2022 and are increasingly well positioned for a long-term smart living evolution over the coming years. Our position in the industry remains quite strong, and we are confident that growth in smart living adoption, the central role of the integrator in providing holistic solutions and our competitive differentiation will propel our long-term success.

As to the economy and its impact on our business, as we discussed last quarter, we saw some softening around our residential end market resulting in lower sales volumes relative to the first half of 2022. We continue to see signs of end consumer cautiousness and elevated levels of channel inventory, which impacted our integrator partners’ purchasing habits. Anecdotally, project delays and descoping are occurring, as integrators seek to value engineer projects in response to a more price-conscious end consumer. Last quarter, we described our integrator partners had accumulated additional inventory in response to supply shortages. And we expected an impact of about $40 million to $60 million over the subsequent quarters, as they rebalanced their own inventory positions.

Since our last call, we have leveraged our OvrC software to see when products purchased by the integrator are actually put into service. With the benefit of this added visibility, we now believe inventory in the channel peaked towards the end of Q2 of 2022, but well above the high end of the range we’ve previously communicated. Since then, we have seen strong signs of destocking across the channel and expect to reach a normalized state in the second half of 2023. While the residential market remains a bit soft our diversified business model allows us to serve integrator partners across a variety of end markets. These partners do remain busy and continue to prove their resiliency, showcasing their ability to pivot projects, and adapt to the current environment.

Historically, their capacity has been a governor on our growth, particularly given the tight labor market, with demand for their services exceeding supply. So some contraction in end consumer demand can be absorbed by the channel, given the ongoing capacity constraints. Meanwhile, we continue to invest in the long-term growth of the business, to extend our leadership position. However, given the uncertain macro backdrop, we have reviewed our long-term operating plan and prioritized investments in areas that we believe will position us for sustained long-term growth, while curtailing spend in other places. Here are some actions we’ve taken. Number one, we’re eliminating inefficiencies in the business from the COVID time period. As input costs, freight rates and other supply chain factors normalize, we are driving an improvement in our contribution rate — contribution margin rate, excuse me.

Two, we expect more research and development efficiency by not having to redesign products in response to componentry availability challenges. Three, we completed a strategic repositioning of our sales force to increase integrator partner coverage and identified other areas of efficiency in the business. And four, we’re being diligent with costs in our business, ranging from warehouse, operation, consolidation, to reducing travel expenses. Collectively, these changes resulted in a modest workforce reduction of about 3% in our business in the first quarter of 2023. I’m going to now comment briefly on our outlook and then I’ll turn the call over to Mike. As we look to the rest of 2023, we expect the operating environment to remain challenging, particularly in the residential end market.

In response, we have constructed an operating plan that reflects a heightened focus on delivering strong profitability and driving operating margin expansion. We are executing on controllable strategies consistent with our long-term growth algorithm that will enable us to outperform. These include: one, increasing our share of wallet, with increased — with existing integrators through the adoption of our ecosystems and new products; two, continuing to innovate, invest in and launch exciting new smart living products; three, open new local branches; four, adding new integrator partners across our business, including in security and commercial markets where we continue to see outsized growth; and finally, enhancing our software platform capabilities and introducing new software and service-based solutions.

Further, we intend to deliver this relative growth, while driving scale in our operating model through improving our contribution margin rate, as input and supply chain costs such as freight, logistics, commodities and componentry costs continue to normalize; moderating our investment pace to drive efficiency and optimize productivity; and finally, strengthening our balance sheet. We remain confident in our operating model. And still, while demand has stabilized at current levels, persistent macro uncertainty causes us to take a pragmatic approach to our near-term forecasts. We are therefore setting our net sales and adjusted EBITDA guidance for 2023 accordingly and Mike will discuss this in further detail. We believe our resilient integrator partners, our diversified business model and consistently strong execution will continue to position us to prosper in a dynamic macro environment.

Mike, with that, I’ll turn the call over to you, to discuss the fourth quarter and full year financial results and 2023 outlook in greater detail.

Mike Carlet: Thanks John. So I’ll turn now to our financial results for the fiscal fourth quarter, and for the full year ended December 30th 2022. Net sales in the fiscal fourth quarter decreased, 1.9% to $268.2 million from $273.5 million in the comparable year ago period. The extra week in fiscal fourth quarter 2021 added approximately $17.9 million in net sales and excluding that extra week net sales increased approximately 5%. For the full year ended December 30th, net sales increased 11.5% to $1.124 billion, up from $1.008 billion in the comparable year ago period. Again the extra week in fiscal 2021, added $17.9 million. So excluding that extra week, net sales increased approximately 14%. The growth in net sales during the quarter and year reflects several drivers.

First, organic growth, including higher selling prices, resulting from price adjustments enacted across our product portfolio in 2022. The collective ramp of eight net new local branches opened in 2022, also contributed to organic growth. Several of these branches were opened in the most recent quarter, bringing the company’s total local branch count to 41 as of year-end. Additionally, the company benefited from incremental sales contributions from Staub, which is acquired early in 2022. Now let me talk for a minute about the impact of channel inventory. As John noted in his comments, we have performed additional analysis to refine our view and channel inventory amount and the timing of that inventory coming in and flowing out. Based upon our visibility into the timeline from when a product is shipped from our warehouse to when it is installed and activated within our OvrC software, we now estimate that channel inventory began to build in 2021 and peaked at over $100 million towards the end of the second quarter of 2022, before beginning a steady unwind.

For full year 2022, we estimate the in-year impact was a net $25 million to $30 million benefit to our top line results as the sell-in that occurred during the first half of the year was partially offset by the sell-down in the second half of the year. On a year-over-year basis, the channel inventory impacts were approximately the same in 2021 and 2022, meaning there was an insignificant impact to the top line growth rate. However, the channel inventory impact was much more pronounced in the fiscal fourth quarter. We believe between $15 million and $20 million of destocking that occurred in Q4 of 2022, representing an approximate 10% to 15% headwind to year-over-year growth in the quarter as we lapped inventory loading activity in Q4 2021. As John noted earlier, we anticipate continued channel destocking of about $15 million to $25 million per quarter over the first three quarters of 2023, before reaching a normalized state in the second half of the year.

Turning now to contribution margin, one of the most significant drivers of our 2022 financial performance was the impact of a challenging supply chain environment. Inbound freight rates, ship shortages and other supply chain challenges persisted throughout the year and required significant effort and expense to overcome. We began to see an improvement in the second half of 2022 and anticipate supply chain normalization in 2023. With that said, our contribution margin a non-GAAP measurement of operating performance decreased 0.1% to $105.8 million or 39.4% of net sales in the fiscal fourth quarter, from $105.9 million or 38.7% of net sales in the comparable year ago period. On a dollar basis, the flat year-over-year contribution margin performance reflects the modest decline in net sales and continued product mix shift to third-party products, which typically carry a lower contribution margin as a percentage of net sales relative to our proprietary product.

These factors were partially offset by the higher selling prices and improvement in the supply chain environment in the fourth quarter as compared to the remainder of the year. In the fiscal fourth quarter, third-party product sales represented 35.3% of net sales, compared to 32.2% in the comparable year ago period. Contribution margin as a percentage of net sales improved by 70 basis points on a year-over-year basis, driven by higher selling prices net of product costs, mix and supply chain impacts. For the full year 2022, contribution margin increased 8.1% to $441.2 million or 39.3% of net sales, up from $408.1 million or 40.5% of net sales in the comparable year ago period. On a dollar basis, the increase in contribution margin was driven by the net sales growth, partially offset by the continued product mix shift to third-party products.

For the full year 2022, third-party product sales represented 32.2% of net sales, compared to 30.3% in the comparable year ago period. Contribution margin as a percentage of net sales declined on a year-over-year basis due to product cost mix and supply chain impacts, which was offset by the higher selling prices that were enacted. Selling, general and administrative or SG&A expenses in our fiscal fourth quarter decreased 9% to $83 million or 31% of net sales from $91.2 million or 33.4% of net sales in the year ago period. The decrease in SG&A expenses was primarily attributable to the lapping of the extra week in last year’s fiscal fourth quarter and lower variable compensation expense. For the full year ended December 30, 2022, SG&A expenses increased 1.2% to $354.3 million or 31.5% of net sales, up from $350.3 million in the prior year or 34.7% of net sales.

The increase in SG&A expenses during the year was primarily attributable to higher personnel expenses due to increased headcount from new local branch openings and M&A, a resumption in pre-COVID travel and ongoing investments to support strategic growth initiatives offset by lower variable compensation. In fiscal year 2022, we also incurred the full year burden of public company costs and absorbed other costs associated with recently acquired businesses. Our net loss totaled $4.1 million in the fourth quarter, compared to a net loss of $7.8 million in the comparable year ago period. And for the full year 2022, net loss totaled $8.7 million, compared to a net loss of $36.5 million for the full year of 2021. Our adjusted EBITDA, a non-GAAP measurement of operating performance, totaled $26.9 million or 10% of net sales in the fourth quarter 2022, compared to $26 million or 9.5% of net sales in the comparable year ago period.

And for the full year ended December 30, 2022, adjusted EBITDA increased 3% to $114.1 million or 10.2% of net sales, up from $110.8 million or 11% of net sales for the full year 2021. These changes in adjusted EBITDA were primarily attributable to net sales and contribution margin growth offset by increased SG&A expenses. And a decrease in adjusted EBITDA as a percentage of net sales in the year is primarily attributable to the contribution margin as a percentage of net sales declining on a year-over-year basis. Adjusted net income, a non-GAAP measurement of operating performance decreased 24.9% to $10.5 million or 3.9% of net sales from $13.9 million or 5.1% of net sales in the year ago period. And for the full year ended December 30, 2022, adjusted net income decreased 1.9% to $52.6 million or 4.7% of net sales from $53.6 million or 5.3% of net sales, again in the comparable year ago period.

Finally, free cash flow, a non-GAAP measurement of operating performance totaled negative $44.6 million in the fiscal year ended December 30, 2022, compared to negative $40.4 million in the comparable year ago period. The decrease in free cash flow was primarily attributable to capital expenditures associated with the build-out of our new corporate office in Lehi, Utah, new local branch openings and capitalized IT cost. Net cash used in operating activities for the fiscal year ended December 30, 2022, was negative $23.1 million. This use of cash was primarily driven by an increase in inventory to protect against supply chain uncertainty. Our target inventory level based upon our current demand remains at approximately $275 million. And while we anticipate continued modest inventory growth in the first quarter of 2023, we remain confident in our plan to rightsize inventory levels this year.

At the end of the fiscal fourth quarter and full year 2022, we had approximately $104.1 million of liquidity including cash and cash equivalents of $21.1 million and undrawn revolver capacity of $82.9 million. And just a few other KPIs that we had talked about on an annual basis. We introduced a few annual key performance indicators or KPIs after fiscal Q1 of last year to provide enhanced visibility into key operating metrics. These KPIs regard the count of transacting domestic integrators in the spend per transacting domestic integrator. And we’ll continue to present these metrics on an annual basis. In fiscal year 2022, we transacted with approximately $20,100 different domestic integrators who spent on average $45,500 each. On a year-over-year basis, the number of transacting domestic integrators and spend per transacting domestic integrator increased 0.5% and 9.6% respectively.

Over time, we have demonstrated the consistent ability to grow both our number of domestic integrators and our spend per domestic integrator. Now before I turn the call back over to John, I’ll take a few minutes to provide our financial outlook for fiscal 2023. As a reminder, Snap One provides annual guidance for net sales as well as adjusted EBITDA, as we believe these metrics to be key indicators for the overall performance of our business. Our fiscal 2023 guidance considers our full fiscal year 2022 performance and our expectation that market uncertainty will persist throughout 2023. As such, we’re taking a pragmatic approach to our outlook for the year as follows: first, we expect net sales in the fiscal year ending December 29, 2023 to range between $1.05 billion and $1.09 billion which represents a decrease of 6.6% to a decrease of 3% compared to the prior fiscal year on an as-reported basis.

We believe the contributing factors to 2023 net sales change are as follows: first, an 8% to 10% headwind from the channel inventory destocking that we previously mentioned; second, we expect to see 2% to 5% organic growth which includes pricing carryover from last year local branch ramp-up and new openings; and three, a small 1% impact from recently completed M&A. We expect adjusted EBITDA to range between $107 million and $115 million, representing a decrease of 6.2% to an increase of 0.8%, compared to the prior fiscal year on an as-reported basis. Our adjusted EBITDA guidance reflects our commitment to drive incremental adjusted EBITDA margin expansion in 2023. We expect to achieve this, both through contribution margin rate improvement as supply chain and input costs normalize, as well as continued disciplined operating expense management.

And as we think about quarterly trending in 2023, we expect our year-over-year net sales change in Q1 to be down mid-to high teens on a percentage basis, and our top line growth rate to sequentially improve each quarter over the course of the year. We anticipate a return to year-over-year growth in the second half of the year, as we work through this channel destocking. We expect contribution margin rate to improve quarter-over-quarter in Q1 2023 versus Q4 2022, and to continue to sequentially improve during the year. This contribution margin rate improvement reflects the realized and additional anticipated supply chain and input cost normalization. From an adjusted EBITDA perspective, we expect adjusted EBITDA margin compression year-over-year in Q1 2023 to mid-single digits given the lower net sales followed by a return to year-over-year adjusted EBITDA margin improvement for the remainder of the year, as we realize the contribution margin rate expansion.

And finally, before I pass the call back over to John, as a reminder last year Snap One’s Board of Directors approved a stock repurchase program that authorized potential repurchases of up to $25 million of our common stock from the date of approval, which was May 12, 2022 through the end of 2023. As of December 30, 2022, we had repurchased approximately 269,000 shares of our common stock at an aggregate value of approximately $2.9 million. Consistent with our capital allocation policy, we will continue to prioritize in this order: a, our balance sheet strength; b, our organic growth investments; c, accretive M&A opportunities; and finally, our opportunistic share repurchase program. That completes my summary. John, I’ll turn the call back over to you for any additional commentary.

John Heyman: Thanks, Mike. A few concluding thoughts, before we take Q&A. First, for 2023, just to reiterate, we have confidence in our proprietary product launches, the growth in adjacent markets such as commercial and security, our local branch opening strategy, and the benefit of last year’s pricing adjustments. We also anticipate returning to our favorable contribution margin rate trajectory, as costs related to the supply chain, continue to alleviate, and we execute in line with a disciplined operating expense model. Second, we remain committed to our strategy. This includes new product launches. This includes software investments and platform developments, all in service of supporting our integrators to capitalize on the opportunity in front of us and them.

Even in an uncertain operating environment, we continue to strive to be the one partner that our integrators trust to support and grow their business. And third, as I’ve said before, we believe all homes and businesses will become smarter over the next decade, driving demand for the types of experiences we offer today and those we can only imagine in the future. We’re investing in scaling our operations and platforms, to drive better solutions for the end consumer, more capacity for the integrator and growth for Snap One in a way that increases our operating margins over time. We believe the actions that we took at the close of 2022 and so far in 2023, have prepared us to succeed in this environment while also positioning us for longer-term sustainable growth.

And with that, operator, please open the call for Q&A.

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Q&A Session

Operator: Thank you. At this time, we will open the line for questions from the company’s publishing analysts. Our first question comes from Erik Woodring with Morgan Stanley. You may proceed.

Erik Woodring: Hey, guys. Good afternoon. So, maybe just to start on the annual disclosures that you provided. The 1,000 net new integrators in 2022, can you maybe just unpackage that a little bit and help us understand maybe where some of those integrators were added, maybe where some that you transacted with in 2021 didn’t come back in 2022, and then how you plan to kind of accelerate that growth on an absolute basis in 2023. And just — I’ll include my follow-up with that too is when we think about your guidance for 2023, kind of what underlies that guidance when we think about the number of transacting integrators and then spend per integrator? Thanks so much.

John Heyman: This is…

Mike Carlet: Erik — go ahead, John.

John Heyman: Go ahead, Mike.

Mike Carlet: Well Erik, first, good to see you last week. I’ll start John and then you feel free to jump in. First of all, just to be clear the number increased by 100 from 20,000 to 20,100, not by 1000. So, a relatively small increase year-over-year in the number of transacting integrators. As we think about that growth, we continue to see good growth in security and commercial. We actually saw a little bit of contraction in the home AV side of the transacting integrator account, which is not surprising given the market that was out there, given the way the supply chain moves, and knowing that we have a long tail of integrators that spend relatively small dollars with us. So that number in there with the churn of that lower integrator count doesn’t really concern us.

Last year we were more focused on spend per and pricing with all the supply chain challenges that were there. And as we think about next year and how it flows through, as John mentioned, clearly next year we’re prioritizing our share of wallet and growing our base — our sales with our existing partners. We’re certainly not giving up on adding more tiers. In fact, just given the normal churn in the business every year somebody is going to retire, somebody is going to sell their business. And so we know that we need to add over 1,000 integrators just to stay flat and we expect to see that happen. But when we build our model for this year coming up, we’re expecting integrated count to be relatively flat most of our sales increase to be coming from spend per integrator and share of wallet.

But for the future as we think about our long-term growth algorithm we do expect both to be equivalent contributors to our long-term growth.

Erik Woodring: Awesome. Thank you for that color, Mike and good to see you as well last week.

Mike Carlet: Thanks.

Operator: Thank you. Our next question comes from Paul Chung with JPMorgan. You may proceed.

Paul Chung: Hi. Thanks for taking my questions. So, just wanted to ask about some of the feedback from integrators for the year ahead, I guess some competitors were kind of talking about rebounding order kind of growth in February and March. Are you seeing that? And then, what are new products our integrators like the most excited about from kind of the new product portfolio and which areas are they seeing some softening demand?

John Heyman: Sure. This is John. The — you had a few questions packed in there, but let me try to answered them all. I’d say, we saw — rather than rely on anecdote, we try to rely on survey data. And we saw a, what I would call, mild decline in integrator sentiment that translated into their backlogs, but the backlog still remain healthy and the sentiment still remains positive. That decline we saw at the end of last year into January, we saw it turn upwards in February. So that’s a positive signal number one. Number two, and that’s on the industry as opposed to our product. I think on our products, the excitement that we’re seeing around our new Luma surveillance product our previous Luma product was a bit old in the tooth.