Latham Group, Inc. (NASDAQ:SWIM) Q1 2023 Earnings Call Transcript May 13, 2023

Operator: Good day, and welcome to the Latham Group First Quarter Fiscal 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Nicole Harlowe, Investor Relations representative. Please go ahead and begin.

Nicole Harlowe: Thank you. Earlier this morning, we issued our first quarter fiscal 2023 earnings press release, which is available on the Investor Relations portion of our Web site, where you can also find the slide presentation that accompanies our prepared remarks. On today’s call are Latham’s President and CEO, Scott Rajeski; and Interim CFO, Mark Borseth. Following their remarks, we will open up the call to questions. During this call, the company may make certain statements that constitute forward-looking statements. Such statements reflect the company’s views with respect to future events as of today and are based on our management’s current expectations, estimates, forecasts, projections, assumptions, beliefs and information.

These statements are subject to a number of risks that could cause actual events and results to differ materially. Such risks and other factors are set forth in the company’s annual report on Form 10-K and subsequent reports filed or furnished with the SEC as well as the earnings release for this quarter posted to its Investor Relations Web site. The company expressly disclaims any obligation to update or review publicly any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law. In addition, during today’s call, the company will discuss non-GAAP financial measures, which we believe could be useful in evaluating our performance. Reconciliations of historical adjusted EBITDA to net loss and adjusted EBITDA margin to net loss margin calculated under GAAP can be found in our earnings press release and will be included in our Form 10-Q for Q1 of 2023.

Reconciliations of net debt and net debt leverage to the comparable GAAP measure can be found in the slide presentation that accompanies our prepared remarks, which can also be found on the Investor Relations Web site. I’ll now turn the call over to Scott Rajeski.

Scott Rajeski: Thanks, Nicole. Good morning, everyone. Thank you for joining us for our first quarter fiscal 2023 earnings call. I’ll begin today’s call with a review of highlights from Q1 and a discussion of the momentum we’re seeing in our dealer training and onboarding, direct-to-homeowner marketing, fiberglass material conversion and auto cover awareness strategies. I will then turn it to Mark to review our financial results and outlook for 2023. We delivered net sales of $138 million and adjusted EBITDA of $11 million in the first quarter. As we discussed on our last earnings call, the pool market has returned to pre-2020 seasonality versus the demand patterns of the preceding three years. In fact, Q1 2022 set a particularly high record for Q1 net sales for our business as we benefited from elevated backlogs and increased production levels following a period of supply chain issues and challenges.

Despite this difficult year-over-year comparison, due to our strong operational execution, we delivered stronger than expected sales performance across all three product lines; in-ground swimming pools, covers and liners. We’ve recognized that 2023 will be another tough year for the pool market and have taken deliberate actions to adjust our cost structure. In November, we announced several cost reduction initiatives that we expect to yield annualized savings of about $12 million in fiscal 2023. This is further supported by our ongoing lean and value engineering work aimed at continuous improvement of our manufacturing processes. We have also right-sized our inventory to align with current demand, while still ensuring excellent delivery lead times across our product portfolio.

All these efforts supported Q1 adjusted EBITDA of $11 million and adjusted EBITDA margin of 8%, exceeding our expectations on both an absolute dollar and margin basis. Turning to an update on our strategic initiatives. Late last year, we set an ambitious goal to recruit new dealers ahead of the selling season in 2023, and I am pleased to say that we’ve achieved that milestone. We are also actively continuing to recruit new dealers throughout 2023, and we’ll continue to train and ramp them up. While most of these new dealers are small for now, they will we believe set us up well for future growth. Our dealers continue to recognize the value proposition of fiberglass and more specifically, of working with Latham as we invest in our lead generation efforts, dealer education and training.

We continue to see strong demand for Latham University, where we hosted numerous fiberglass boot camps year-to-date. Concerns of an economic slowdown in the interest rate environment continue to weigh on consumer spending, which is reflected in our Q1 results and fiscal 2023 guidance. However, our lead generation engine and digital tools continue to point the strong underlying consumer interest in pool ownership, giving us confidence in the long-term outlook of our business and industry. In light of our strong lead times and enhanced manufacturing capacity, we have been able to ramp up our lead generation efforts, which is translating into momentum in website activity and leads to dealers. We saw strength across our website in digital tools and apps in Q1.

The number of sessions, pages and average session duration across our website all increased year-over-year. We grew users on our My Latham platform by 100% versus Q1 of 2022 and a number of submissions to our pool cost estimator and downloads for our augmented reality app, both grew over 40% year-over-year in the first quarter. This supports our ability to drive leads and orders. In fact, the number of leads we sent to dealers in Q1 of 2023 was actually greater than Q1 of 2022 levels. As we expand our dealer base and deepen our existing partnerships, enhance our manufacturing capabilities and continue to execute our direct-to-homeowner strategy, we feel well positioned to drive consumer demand in a difficult macro environment. We remain confident in the ability of fiberglass pools to outperform the total U.S. new pool installation market as we again demonstrated in 2022.

Fiberglass pools are vastly underpenetrated in the U.S. compared to more mature markets like Australia, where fiberglass represents 70% of in-ground swimming pools. In 2019, we acquired the largest tool manufacturer in Australia-New Zealand, Narellan because we admired how they drove the conversion from concrete pools to fiberglass in Australia. Our North American market growth strategy is led by a similar focus on marketing the benefits of fiberglass pools versus concrete pools directly to both homeowners and dealers. We are still early in our journey of driving the conversion from concrete to fiberglass in the U.S., but we are seeing strong momentum driven by Latham. We are pleased to report that fiberglass penetration grew to 21% share of U.S. in-ground pool installations in 2022.

This was a gain of 3 points of share versus the prior year, despite U.S. in-ground pool installations being down 16%. We see this as a testament to the momentum we are building for fiberglass and reinforces our confidence in our strategy. Since we launched our rebrand and B2B2C strategy in 2019, we have now driven 5 points of share gain for fiberglass in three years. Another product line I’d like to highlight is covers. We’ve told you before about the winter safety covers, which go on pools after the swimming season is over, help protect pools from winter weather and provide Latham with a steady revenue stream for both new installations and replacements. Winter safety covers need to be replaced every 8 to 10 years across all types of in-ground pools, whether they are Latham pools or not.

Today, I’d like to also talk to you about automatic safety covers. Automatic safety covers help keep children and pets safe when the pool is not in use. They help keep pools clean and they lower homeowners’ cost of maintenance and energy, water and chemicals. In Q1, we grew automatic safety covers net sales even when compared to strong net sales levels of the prior year’s first quarter. In fact, we doubled net sales for our automatic safety covers in fiscal 2022 versus fiscal 2019. We take pride in our auto covers. Each one of Latham’s automatic safety covers is made to order to precisely fit a homeowner’s exact pool dimensions. Separately, we are excited about the launch of Measure by Latham, a new AI-powered digital measuring tool that will modernize and simplify the measurement experience for dealers for winter safety covers and for in-ground liners.

This technological breakthrough allows dealers to measure the entire pool perimeter and to capture interior renderings of the pool shape and unique features. With Measure, dealers have precise specifications for winter safety covers and in-ground liners within minutes, saving them time and labor. We have launched the initial rollout of Measure by Latham for winter safety covers to select dealers. While we’re now in the early innings, we believe Measure will be a growth opportunity for winter safety covers and in-ground liners as we look into 2024 and beyond. Before I hand the call off to Mark, I’d like to touch on what gives us the conference to reiterate our fiscal 2023 outlook today. First, we delivered Q1 performance that beat expectations in spite of a continued challenging macro environment and a difficult year-over-year comparison.

Second, based on what we’re seeing in the market, much of the softness in overall U.S. pool starts this year is in a concrete pool market driven by weakness for newly constructed houses, especially in many states where we are underpenetrated. We view this as an exciting opportunity to convert what would otherwise be a concrete pool than fiberglass pools in those markets down the road as we target these homeowners, build their awareness of fiberglass and support their pool purchase journey. Third, and most importantly, we’re seeing momentum in our website activity and lead generation tools. Given the results that we are driving, we will continue to focus our efforts in lead generation to drive increased demand in the second half of the year and into 2024 as dealers start to plan for next year.

With that, I’ll turn the call over to Mark to review our first quarter 2023 results in greater detail. Mark?

Mark Borseth: Thank you, Scott, and good morning, everyone. Please note that all comparisons we discuss today are on a year-over-year basis compared to the first quarter of fiscal 2022, unless noted otherwise. Net sales for the first quarter of fiscal 2023 were $138 million, which is down $54 million or 28% as compared to Q1 of 2022, a quarter in which we delivered 29% year-over-year growth. This year’s 28% sales reduction was comprised of a 30% decline in volume, partially offset by a 2% increase in price. As expected, year-over-year comparisons reflect similar trends to what we saw in Q4 of 2022, notably a return to pre-2020 seasonality in the pool market. Q1 of 2022 was a tough comparison for us as those results benefitted from elevated backlogs and increasing production levels.

You may recall in the second half of 2021, our lead times extended as we saw strong demand, coupled with raw material supply shortages, which limited our production. As we took action to resolve our supply chain challenges, we entered Q1 of 2022 well positioned to fulfill customer orders at an accelerated rate, leading to a quarter in which we delivered 29% growth. In Q1 of this year, we experienced continued destocking in our packaged pools product line as our wholesale distribution partners normalized their inventory levels, which has taken on greater urgency as interest rates make inventory carrying costs more expensive. Lastly, macroeconomic challenges, driven in part by those higher interest rates, persistent inflation and ongoing recessionary concerns, have continued.

Looking at our net sales results across our product categories for the quarter. In-ground pool sales declined 30% to $79 million, driven by the combination of continued wholesaler destocking in packaged pools and lower year-over-year fiberglass pool sales compared to the unseasonably strong sales levels in Q1 of 2022. Liners declined 44% to $26 million, also driven by strong sales in the year ago period due to elevated backlogs and improved production levels. Lastly, we’re pleased to see our cover product line sales flat year-over-year at $33 million, reflecting the strength of our market leading automatic safety covers. We see auto covers as a growth opportunity as we continue to drive awareness of the economic and environmental benefits of this product.

We had anticipated that sales will decline sharply in Q1, and we’re pleased the actual level of sales that we delivered was above our expectations. Gross profit of $33 million decreased by $38 million or 53% compared to Q1 of 2022, primarily driven by the lower level of sales. Gross margin decreased to 24.2% compared to 36.9% for the prior year period. More than two-thirds of the gross margin decline was driven by negative fixed cost leverage due to volume declines, driven in part by the pool markets returned to pre-2020 seasonality and the sell-through of higher cost inventory due to inflation we experienced throughout 2022. We expect to see noticeable improvements in both of these headwinds going forward as we head into the peak pool selling season in Q2 and Q3, during which we see our highest level of net sales and with inflation moderating in several of our raw materials, our year-over-year comp becomes less of a drag on gross margin.

We also reduced inventory in the first quarter, negatively impacting our gross margin. We expect this to continue as we right-size our inventory to better align with current demand levels. We will, of course, maintain sufficient inventory to maintain our industry leading lead times. Selling, general and administrative expenses decreased to $33 million from $45 million in Q1 of 2022. This decrease was primarily driven by a $9 million decrease in non-cash stock-based compensation expense. SG&A, excluding non-cash stock-based compensation expense, decreased $3 million, reflecting benefits from the cost reduction actions taken in the fourth quarter of fiscal 2022. As a percentage of net sales, SG&A, excluding non-cash stock-based compensation, increased to 19.4% from 15.4% for Q1 last year.

As a result, adjusted EBITDA for the first quarter was $11 million, a decrease of $37 million or 77% from Q1 of 2022. Adjusted EBITDA margin decreased to 8% from 25% in Q1 of 2022. Both our adjusted EBITDA dollars and margin exceeded our expectations driven by better net sales and the resulting impact on profit. We continue to work to improve margins by focusing on operational efficiency and prudently managing our costs. We took deliberate cost actions in response to the market conditions, including a reduction in our workforce and streamlining our cover and liner manufacturing footprint. We continue to manage our cost structure to align with the demand environment, including gating hiring, optimizing our production and staffing levels and managing down our inventory.

We are pleased to have begun production in both our Kingston and Oklahoma fiberglass manufacturing plants. As part of our continued evaluation of the demand environment, we are slowing the production ramp up in these two facilities while ensuring we are positioned to maintain lead times and capitalize on the long-term growth and distribution cost reduction opportunities these regions present. We continue to feel comfortable with our balance sheet health and remain disciplined in our capital allocation strategy. As of April 1, we had cash and cash equivalents of $55 million and $27 million of borrowing availability remaining on our $75 million revolver, giving us total liquidity of $82 million, which is more than sufficient as we head into the time of the year our operations typically generate the majority of our cash.

Net cash used in operating activities was $14 million for Q1 ’23 versus $57 million last year, driven by year-over-year decreases in working capital. Total debt was $360 million at the end of Q1. And as expected, we saw our net debt leverage ratio increase to 2.9x at the end of the quarter, primarily as a result of the year-over-year reduction in adjusted EBITDA. As we head into the peak pool building season and the time of year our business normally generates the majority of our cash, we would expect our net debt leverage ratio to moderate in the second half of the year. Looking at CapEx spend, capital expenditures were $10 million compared to $7 million in Q1 last year, primarily driven by investments in our Kingston and Oklahoma manufacturing facility projects.

With our solid Q1 performance and as we gear up for pool building season, we are pleased to affirm fiscal year 2023 outlook for net sales of $565 million to $615 million, adjusted EBITDA of $90 million to $110 million, and capital expenditures of $35 million to $40 million. Our outlook reflects our first quarter performance as well as continuing macroeconomic challenges, driven by the interest rate environment and concerns of an economic slowdown, weighing on consumer spending and demand. This is resulting in anticipated declines in the industry for new U.S. in-ground pool installations in 2023. We expect the normalization of packaged pool inventory in the wholesale distribution channel from elevated levels to remain a headwind at least through the first half of 2023.

At the same time, we continue to make progress executing our strategy to drive material conversion from concrete to fiberglass swimming pools, supported by our continued momentum on our lead generation efforts and digital tools and would expect this to enable us to outperform the market again this year. We’re also realizing the benefits from previously announced cost reduction actions and continuous improvement initiatives, and we continue to closely monitor, manage and adjust our cost structure. Lastly, we continue to take a disciplined approach to capital investments with a focus on the completion of our Kingston and Oklahoma fiberglass manufacturing facilities with the majority of spend weighted in the first half of the year. Scott, with that, I’ll turn it back to you for closing remarks.

Scott Rajeski: Thanks, Mark. Looking ahead, we remain confident in the long-term fundamentals and growth opportunities of our business. As I discussed earlier, U.S. fiberglass penetration expanded to 21% in 2022, proving fiberglass’ ability to take share even in down markets as U.S. in-ground residential pool installations in 2022 were down 16% year-over-year. We continue to position ourselves well to capture opportunities with fiberglass with enhancements to our manufacturing capabilities. Notably, our new Kingston fiberglass manufacturing facility began producing the first pools in April, enabling us to continue to grow in the Eastern Canadian and U.S. Northeast and Upper Midwest regions and to better balance our manufacturing footprint.

We are also now shipping orders out of our Oklahoma fiberglass manufacturing facility, which will allow us to better service existing dealers in the U.S. Southwest as well as to significantly ramp up dealer recruiting efforts in that market. We are driving a similar awareness-driven strategy with our automatic safety covers, which has translated to momentum in net sales. As the installed pool base continues to grow and age over time, we see strong opportunities for the recurring revenue portion of our business, replacement covers and liners. We believe we can further capitalize on growth opportunities in winter safety covers and in-ground liners as we continue with the launch of Measure by Latham. Our rollout plan is quickly ramping up for covers, and we will continue to accelerate it throughout 2Q and 3Q as we head into the key cover season in late 3Q.

We continue to benefit from our lead generation efforts and are seeing strong performance across our website in digital tools. This indicates continued consumer interest in pool ownership that we can tap into over time. We are focused on deepening and expanding our relationships with dealers by enhancing our lead generation and on training and providing value-added resources. All of this gives us strong confidence in our long-term growth strategy, which we believe positions us to capitalize on the attractive trends in our industry over time. We will now open the line to questions.

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And the first question will come from Sean Callan from Bank of America. Please go ahead.

Operator: And the next question will be from Matthew Bouley from Barclays. Please go ahead.

Operator: And the next question is from Susan Maklari from Goldman Sachs. Please go ahead.

Operator: [Operator Instructions]. The next question is from Andrew Carter from Stifel. Please go ahead.

Operator: Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Scott Rajeski for any closing remarks.

Scott Rajeski: And so, again, thanks everyone for your continued interest and support of Latham. We look forward to meeting with many of you at upcoming conferences this spring and into the summer and providing further updates on the next earnings call. I hope everyone has a great day. Take care. Bye.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.