Traeger, Inc. Q2 FY2022 Earnings Call

Good afternoon and thank you for joining Traeger’s Second Quarter Earnings Call. My name is Jason and I will be your moderator today. All lines will be muted during the presentation, but there will be a chance for questions and answers at the end. I will now hand the conference over to our host, Nick Bacchus with Traeger. Please proceed.

Good afternoon, everyone. Thank you for joining Traeger’s call to discuss its second quarter 2022 results, which were released this afternoon and can be found on our website at investors.traeger.com. I am Nick Bacchus, Vice President of Investor Relations at Traeger. With me on the call today are Jeremy Andrus, our Chief Executive Officer; and Dom Blosil, our Chief Financial Officer. Before we get started, I want to remind everyone that management’s remarks on this call may contain forward-looking statements that are based on current expectations, but are subject to substantial risks and uncertainties that could cause actual results to differ materially from those expressed or implied herein. We encourage you to review our annual report on Form 10-K for the year ended December 31, 2021, our quarterly report on Form 10-Q for the quarter ended June 30, 2022, once filed and our other SEC filings for a discussion of these factors and uncertainties, which are also available on the Investor Relations portion of our website. You should not take undue reliance on these forward-looking statements, which speak only as of today and we undertake no obligation to update or revise them for any new information. This call will also contain certain non-GAAP financial measures, which we believe are useful supplemental measures. The most comparable GAAP financial measures and reconciliation of the non-GAAP measures contained herein to such GAAP measures are included in our earnings release, which is available on the Investor Relations portion of our website at investors.traeger.com. Now I’d like to turn the call over to Jeremy Andrus, Chief Executive Officer of Traeger. Jeremy?

Thank you, Nick. Thank you for joining our second quarter earnings call. Today, I will discuss our second quarter results and our near-term strategic priorities. I will then turn the call over to Dom to discuss details on our quarterly financial performance and to provide an update on our fiscal 2022 guidance. During the second quarter, our business was negatively impacted by several macro-related headwinds, which drove materially lower than anticipated topline results for the quarter. These pressures and other headwinds are negatively impacting our outlook for the balance of the year. Despite a very challenging backdrop, I remain confident in the positioning of the Traeger brand as a disruptor and innovator in the grilling category, and in our ability to navigate current challenges. Our long-term business thesis has not changed. We continue to believe the Traeger brand is an incredible one, and that we have a large opportunity to meaningfully grow our household penetration. However, we are also fully aware that our near-term trajectory has changed and that it will take us longer to achieve our previous goals. As such, we are taking decisive action with a high level of urgency in order to position the company for future growth, profitability and to drive long-term shareholder value. On the last two earnings conference calls, I reviewed our progress on each of our four strategic growth pillars. Given the rapidly evolving backdrop and the change in our outlook for the year, I would like to instead focus on our assessment of the near-term dynamics that are pressuring the business and the actions and strategies we have implemented to navigate the environment. Then I will discuss why I continue to be confident in Traeger’s long-term growth opportunity. In the second quarter, our sales were $200 million, down 6% from the prior year, with particular weakness in our grill business, which was down 25%. While we expected moderated growth in grills in the quarter, given we were lapping a 40% increase from the prior year, results were lower than anticipated. As we noted earlier in the year, we began to see a deviation from our previously forecasted sell-through starting in March. In order to arrive at our prior full-year sales guidance of $800 million to $850 million, we assumed the continuation of this softer sell-through trend for the balance of the year. However, as we moved through the second quarter, which includes some of our most important retail sales weeks of the year, sell-through trends deviated even more than what guidance assumed. We believe there are a few factors that are contributing to softer sell-through trends. First, we believe that after a two-year period of accelerated spending on home-related durable goods, the consumer is shifting discretionary expenditures toward experiences. This shift is driving strong growth in demand in sectors such as hospitality and travel at the expense of goods like grills, appliances, and furniture. This shift in consumer behavior is occurring at a time when we were lapping abnormally strong sell-through trends from the second quarter of 2021, when consumer spending greatly benefited from government stimulus. Furthermore, consumer sentiment declined in the quarter to record lows as elevated inflation and talk of a looming recession weighed on consumer psychology. While we understood these factors were likely to continue to pressure our sell-through earlier this year, their impact deepened as we moved through the second quarter. The combination of declining consumer sentiment and the spending shift away from durables in the face of heightened comparisons is driving an unprecedented decline in the grill category. To put this into perspective, during the 2008 to 2009 great financial recession, the grill category was down in the low double-digit range. We believe the grill category is down to below 20% range year-to-date through May on a revenue basis and down in the 30% range on a unit basis. This is the largest decline in the grill category that we have seen in our data sets. In particular, grills under $1,000 are seeing immense pressure industry-wide and are down significantly more than the category average year-to-date. We believe that this likely reflects greater sensitivity to macro pressures and inflation amongst consumers that are shopping at the sub-$1,000 price point. Compounding the issue of lower than planned sell-through are heightened levels of inventory at retail. In an effort to ensure adequate stock, given the volatility in the supply chain environment over the last two years, our retail partners have been replenishing product more aggressively and holding more inventory than is typical. As sell-through of our grills missed forecast in the peak selling season, in-channel inventories increased to levels greater than we target. Higher inventories, in combination with a slowing macroeconomic backdrop and the specter of recession, have led to a sharp shift in retailer’s ordering behavior. Often referred to as a bullwhip effect, our retail partners are now heavy on inventory in our product category, which is negatively impacting our replenishment order activity for the second half of the year. These factors are driving a substantial reduction in our revenue outlook for the balance of the year and in particular will pressure third quarter sales, which tend to be a replenishment-based quarter. We are keenly aware that the consumer and the macroeconomic backdrop are in the process of recalibrating after a two-year period of outsized growth and while we hope for stabilization, we are focused on positioning the business for this environment. This includes resizing our cost structure for the current revenue run rate, right-sizing inventories, and doubling down on our efforts to drive gross margin. Let me walk through our key tactical priorities as we navigate the near-term environment. Our first near-term priority is to reduce our cost structure. Earlier this year, we discussed strategically reducing and deferring certain non-essential expenses and reprioritizing SG&A to manage the P&L. Given the lower revenue run rate we experienced in the second quarter and in an effort to protect profitability and drive efficiencies in the business, we implemented a broader cost reduction and streamlining plan in late July. We believe these actions will drive operational efficiencies and will allow the organization to focus on initiatives that are best positioned to drive the highest return on investment and the best experience for our consumers. As Dom will discuss, we expect to realize meaningful cost savings from these actions. First, we have aggressively reduced certain discretionary expenses across the organization. This includes reductions in travel and entertainment, non-critical professional services and top-of-funnel marketing. Second, we initiated a reduction in workforce in late July, which impacted approximately 14% of the global full-time salary workforce. While this was a very difficult decision, we believe this was the right thing to do for our business. Our process focused on identifying roles that could be consolidated, reductions in areas of the business that are lower priority, as well as the removal of head count in the Provisions business. Over the last several quarters, we have added a significant amount of talent across all departments of the company and we move forward with an incredibly strong team. We value the dedication of our impacted colleagues and I would like to thank these team members for their contributions to the business. Finally, we decided to suspend operations of Traeger Provisions. While customers have been delighted with the provisions offering since its launch in November of last year, the business would have required significant continued investment in internal resources in order to scale. Despite its potential, Provisions was unprofitable and given the current constraints on the P&L, we believe this is not the appropriate moment for us to be incubating new business given the large runway of profitable growth in our core business. Our next strategic priority is to right-size inventories, including both our balance sheet inventory, as well as in-channel inventories. As we have discussed, over the last several quarters, we have leaned into inventory given supply chain constraints and volatility. Given the lower sales forecast, we are working to aggressively reduce our balance sheet inventories. This includes materially lowering production volumes in our Asian manufacturing facilities, as we work through existing inventory. While our grill inventory carries very little obsolescence risk, it is critical that we align working capital with the current revenue picture. As part of this effort to align supply and demand, we also decided to postpone our near-shoring efforts and to halt plans for production in Mexico. While we believe manufacturing closer to our core U.S. market remains a long-term strategic objective, current supply and demand dynamics diminish the benefits of production of what would initially have been only a couple of grill SKUs in Mexico. In terms of channel inventories, we are working in partnership with our retailers to actively manage days on hand, including selectively using promotional efforts to drive sell-through. It is important to note that we will use promotions thoughtfully and strategically with the priority of not compromising the health of the brand. We will continue to collaborate with our retail partners on the goal of right-sizing inventories in-channel, such that our retailers are positioned to return to a more normalized replenishment cadence versus the current destocking. Finally, we remain focused on driving improvement to gross margin. Our gross margin task force continues to identify and execute on cost savings across the supply chain. Opportunities for cost reductions have been identified in areas including product input costs, packaging, logistics and warehousing. This cross-functional collaboration is an ongoing effort and we expect that the team will continue to identify new savings and efficiencies as we move forward. Furthermore, we are seeing favorability in spot container rates, as well as in currency. While we expect that these favorable cost dynamics, as well as our gross margin initiatives will not materially impact 2022 margins, as we first must work through higher cost inventory, we do see building tailwinds for 2023 and beyond. Overall, I believe we are taking the right steps to position Traeger to best navigate the unprecedented macroeconomic challenges that we face. Despite these challenges, my confidence in the Traeger story remains incredibly strong. Let me walk through some of the factors that are driving my confidence. First, the energy around the Traeger brand remains extremely strong. In May, we held our fifth Annual Traeger Day, a holiday, which is dedicated to bringing the global Traeger community together to cook outdoors and to share wood-fired food with friends and family to kick off the grilling season. Traeger Day 2022 was the highest single day for user-generated content in the history of the brand. Overall, for the second quarter, user-generated content posts and organic video views were both up significantly versus last year, indicating that consumer engagement with the brand and social media is stronger than ever. Moreover, our consumers continue to love using their Traeger and act as evangelists for the brand. Our NPS score leads the industry and remains at an all-time high. We continue to delight consumers with the innovation we are bringing to market with our new Timberline Grill having some of the highest NPS scores in our entire assortment. Importantly, awareness of the Traeger brand continues to grow in core markets, despite the tough backdrop for grill this year. For example, brand awareness in the West is up over 30% versus last year, despite this geography including some of our most penetrated markets. Increasing awareness is the largest driver of growing our household penetration and remains a meaningful long-term opportunity. Furthermore, our key merchandising efforts at our most important retail partners continue to drive our brand presence and increase penetration and productivity. For example, after resetting 350 stores at The Home Depot earlier this year, we now have nearly 900 Home Depot locations with a broader and higher end Traeger grill assortment, including double the number of grill SKUs and an expanded assortment of accessories. In the third quarter, we will be adding over 300 additional Home Depot doors with high end fixturing. These fixtures elevate our brand at The Home Depot. They sit above the floor on wooden decking, have prominent signage and brand messaging, and include up to 6 grill SKUs, as well as an assortment of Traeger accessories and consumables. Next, I am as excited as I have ever been about our product pipeline. The recent launch of our game-changing Timberline has been well-received and has brought significant energy to the brand. This model is a halo product which brings innovation to the market at a much higher than average price point. As we have mentioned, we will look to cascade innovation from this recent launch across our grill assortment in the coming years. While it is too early to discuss details, I am extremely bullish on our product roadmap for both 2023 and 2024, and look forward to providing an update on upcoming launches over the next few quarters. Considering the challenging backdrop, I am encouraged by the trends in the consumable side of the product portfolio. Our pellet sell-through is trending close to 2021 levels and maintaining strong growth over 2020. This performance speaks to the resiliency of the pellet business and its recurring revenue nature. Sales of our sauces and rubs benefit in the second quarter from increased distribution and consumer acceptance in the grocery channel subsequent to our rollout at Kroger. We continue to believe our consumables business is a strong complement to our core grill business, which drives recurring revenues and consumer engagement with the Traeger brand. Lastly, I remain confident in the secular growth of the outdoor cooking category. The grill category has proven to be resilient over time and data shows that Americans love to cook outdoors and are cooking more at home even as the world has normalized after the height of COVID. In fact, our connected cooking data shows that Traeger owners are growing at a similar pace to last year, implying that our consumers remain highly engaged with our product. In summary, we are not satisfied with our near-term financial results and we are acting decisively and swiftly to position ourselves for the challenging backdrop and to emerge stronger when the environment normalizes. We are taking proactive steps to put Traeger back on its historic path of growth and profitability, and to drive shareholder value. Despite facing challenges, the Traeger brand will continue to disrupt the outdoor cooking sector. And with that, I will turn it over to Dom. Dom?

Thanks, Jeremy, and good afternoon, everyone. As Jeremy discussed, we faced macroeconomic headwinds in the second quarter that negatively impacted our topline performance and will continue to pressure our results for the balance of the year. While the challenging consumer backdrop was built into our thinking when we provided guidance earlier this year, economic conditions worsened during the second quarter and the corresponding impact to sales in our peak season was greater than anticipated as consumers shifted spending away from our category. Shifts in consumer behavior and the deteriorating economic conditions have led to higher levels of channel inventories, resulting in a dramatic shift in retail ordering patterns that we anticipate will pressure sales in the second half of 2022. Given pressures on the topline during the second quarter, we accelerated our expense reduction efforts. We are taking swift and aggressive actions to mitigate pressures on the P&L and to drive efficiencies in our business, with a focus on positioning Traeger to successfully navigate today’s economic cross currents. I will outline these actions after reviewing our second quarter results and then we will provide an update on our 2022 outlook. Second quarter revenues declined 6% to $200 million due to the decline in grill revenue. Grill revenue declined 25% to $118 million. Grill revenue was impacted by lower unit volumes, partially offset by higher average selling prices, driven by price increases taken in the second half of 2021 and the first quarter of 2022, as well as a mix shift to higher ASP grills. Consumables revenue increased 2% to $42 million, with growth driven by increased distribution in our rubs and sauces business. Finally, accessories revenue increased 157%, driven by incremental revenue from the acquisition of MEATER. Geographically, second quarter North American revenue was pressured by the aforementioned challenges in our U.S. business along with negative growth in Canada, which is experiencing similar headwinds as in the United States. Our Rest of World business was positive year-over-year in the second quarter driven by incremental revenue from the acquisition of MEATER. We are anticipating pressure in our second half sales internationally given ongoing macroeconomic challenges impacting the consumer across many of our international markets. Gross profit for the second quarter decreased to $74 million from $83 million last year. Gross profit margin was 36.7%, down 240 basis points from last year. This decline was largely driven by; one, an unfavorable shift in grill mix, which impacted gross margin by 325 basis points; and two, higher inbound freight costs that resulted in 180 basis points of margin pressure. These pressures were offset by 315 basis points of favorability driven by our pricing actions. Second quarter gross margin was modestly better than our expectations, driven by favorability in outbound freight and a higher than forecasted mix of orders fulfilled via our direct import program. Sales and marketing expenses were $44 million compared to $47 million in the second quarter last year. The decrease was driven primarily by a reduction in top-funnel marketing and lower professional fees, offset by higher employee expenses. During the quarter, we proactively reduced certain selling and marketing expenses given the lower revenue run rate. General and administrative expenses were $29 million, compared to $25 million in the second quarter of last year. The increase in general and administrative expense was driven primarily by equity-based compensation expense, as well as personnel-related expenses associated with MEATER, which was not reflected in the comparable period last year. In the second quarter, we recorded an $111 million non-cash impairment charge to our goodwill related to the adverse impacts from macroeconomic conditions, as well as the market price of our stock. Please note that this amount is an estimate and will be finalized prior to filing our second quarter 10-Q. As a result of these factors, net loss for the second quarter was $132 million, as compared to net loss of $5 million in the second quarter of last year. Net loss per diluted share was $1.12, compared to a loss of $0.05 in the second quarter of last year. Adjusted net income for the quarter was $5 million or $0.04 per diluted share, as compared to an adjusted net income of $17 million or $0.15 per diluted share in the same period of last year. Adjusted EBITDA was $18 million in the second quarter, as compared to $27 million in the same period of last year. Now turning to the balance sheet, at the end of the second quarter, cash and cash equivalents totaled $14 million, compared to $17 million at the end of the previous fiscal year. We ended the quarter with $392 million of long-term debt. Additionally, as of the second quarter, we had drawn down $84 million under our receivables financing agreement and $3 million under our revolving credit facility, resulting in total net debt of $465 million and a net leverage ratio of 7 turns. Inventory at the end of the second quarter was $164 million, compared to $86 million at the end of the second quarter of last year. Two factors contributed to the year-over-year growth in inventory. First, the landed cost of grill inventory increased with higher inbound transportation and other material input costs. Second, inventory includes approximately $14 million related to MEATER, which is not in the comparable inventory base last year. Last, lower than anticipated second quarter sales led to sustained higher inventory levels at the end of Q2. It is important to note that our grill inventory carries very little obsolescence risk. We are actively pursuing strategies to reduce our grill inventory levels, which I will describe later. In response to deteriorating macroeconomic conditions and the corresponding pressure on demand, we have implemented measures to manage near-term profitability, protect liquidity, and simplify our strategic focus. First, we quickly responded to softening demand in Q2 by reducing planned expenses and by prioritizing initiatives with a predictable return on investment. Second, we identified and subsequently actualized material cost-saving measures that included a reduction in workforce, the suspension of operations of Traeger Provisions, and the closure of our Mexico factory. These measures were implemented in July and are expected to result in annualized savings of approximately $20 million. We will continue to evaluate expense levers as we reposition the business for 2023 and beyond. We also remain focused on driving gross margin improvements. Our gross margin task force continues to identify cost improvements that span product sourcing to supply chain optimization. This is a core capability that will catalyze continuous improvements to gross margin independent of macro dynamics. We are seeing improving macro conditions in inbound container rates from Asia, as well as favorability in currency. We don’t anticipate these emerging tailwinds to materially impact 2022 margins given expected inventory turns, but we are optimistic that they could benefit our 2023 margins. Finally, we are actively working through excess inventory levels that remain elevated both in-channel and on our balance sheet. To rebalance in-channel inventory with current demand trends and correspondingly work down on-hand inventory to normal levels, we are focused on demand and supply levers. First, we are strategically pulling some promotions to drive incremental sell-through. Second, we are addressing softer demand trends sub-$1,000, with a change to opening price points. Last, we are managing our factories to minimum production levels as we work down excess on-hand inventory. We expect these actions to result in substantially normalized inventory levels by the end of 2022. Turning to our guidance for fiscal year 2022, we are lowering our full-year revenue guidance to $640 million to $660 million and our adjusted EBITDA guidance to $35 million to $45 million. There are three factors that influence our lower guidance range. First, we are flowing through the lower-than-projected second quarter results. Second, we are forecasting sustained pressure on demand through the second half of 2022. Last, we are anticipating significant retailer destocking, which will result in lower replenishment orders. These factors will pressure sell-in in the second half of 2022 and will have an outsized impact on our third quarter sales performance, which we are forecasting to be down as much as 50% compared to the third quarter of 2021. In terms of gross margin, we are increasing our outlook to the high end of our prior guidance range of 34% to 35%. Consistent with our previous forecast, we are expecting gross margin in the second half of the year to track below first half results. We expect Q3 to represent the low point in the year and to be materially lower than full-year guidance. On SG&A, although we initiated certain cost measures in late Q2, the largest operating expense reductions were actualized in late July. As a result, we expect these expense reductions to have the most impact on the fourth quarter. Please note that our guidance for gross margin and EBITDA is exclusive of the $6 million to $7 million of pre-tax charges we expect to incur in conjunction with the cost reduction measures implemented in July. Guidance also excludes the $111 million impairment charge we recorded in the second quarter. Overall, the macroeconomic backdrop is presenting significant near-term challenges to our business. However, I believe we have put the right actions in place to position the company to navigate this dynamic environment. While we are expecting a highly challenging second half of the year, I remain confident in the long-term opportunity for Traeger to gain share and penetration. And with that, we will open the call to questions. Operator?

Our first question comes from Simeon Siegel with BMO. Your line is now open.

Thanks. Hey, everyone. Good afternoon. In light of everything else, the raised full-year gross margin expectations are interesting. All things considered, I think you did beat this quarter’s gross margin. Can we delve deeper into the reasoning behind raising that gross margin? Specifically, could you address the comment about selective promotions you might undertake and your thoughts on freight in the latter half of the year? Additionally, could you provide more detail on the cadence of the third quarter versus the fourth quarter and the corresponding rates? Lastly, what was the shift in grill product mix that you mentioned impacted this quarter? Thanks a lot.

Hi, Simeon. I'm doing well, thanks. Regarding gross margins, we're building confidence in our forecasts and the predictability we're seeing. We've refined our approach to forecasting gross margins as well as the initiatives from our gross margin task force. While we still face macro pressures on gross margins, they are stabilizing, and we aren't experiencing additional headwinds. Additionally, we are beginning to realize some benefits in the cost of goods due to currency fluctuations, which should be a positive factor for us going forward. Our task force continues to identify savings that affect our future profitability, providing a strong foundation as we refine our inventory management and promotional strategies. We've noted improvements in predictability driven by direct import advantages that offset some transportation costs, as well as enhancements in areas like dilution. The price increases we've implemented in the past three quarters are achieving their intended effect, giving us room to manage promotions without negatively affecting gross margins. We’re confident we can reach the higher end of our guidance even with plans for additional promotions this year. Importantly, these promotions won't only aim to counterbalance their associated costs; we’ll also adjust our operating expenses, including scaling back our top funnel marketing, to support these initiatives. Overall, we're optimistic about maintaining the high end of our range despite these promotions and see it as a positive trend for gross margin projections for the rest of the year. On the product mix side, the introduction of our new Timberline Grill, priced above $3,000, is still in early stages, so we're not yet achieving economies of scale with it, which is negatively impacting our overall grill mix.

Great. Thanks. And then, hey, Jeremy, just sticking on that, the marketing comment. So recognizing the challenges now, but also noting your comments about the long-term opportunity. How do you want us to think about it or how are you thinking about, I guess, approaching lower or pulling back on marketing now to which makes sense with revs versus the notion of brand awareness, which is, obviously, as you think about the Traeger brand going forward?

Yes, Simeon. A couple of thoughts. The first is that, it became clear to us as we came into the spring that consumers were focused elsewhere, notably on sort of travel, leisure, experience-driven spend and so that was the first sort of strong indication that we should be pulling back. But I think also, as we think about the mix, let’s say, six months to 12 months, until we start investing again more meaningfully in top of funnel for customer acquisition. There are two things that we are focused on. The first is execution at retail. We have a field sales team of 50 individuals in ensuring that the brand is set well at retail that we are really training retail associates to capture the captive traffic that is walking into their stores is important. The second is an investment in, I would say, community engagement, which is more sort of mid-funnel, ensuring that the brand stays strong, the metrics around engagement, cooking, social engagement. The leverage we get on that is not only long-term brand strength, but it’s evangelism in the near-term. We feel like that’s a better and more predictable investment until we feel like we both have investment capacity and the consumer who’s more focused on this category.

Great. Thanks a lot, guys. Best of luck for the rest of the year.

Thanks, Jeremy.

Our next question comes from John Glass with Morgan Stanley. Your line is now open.

Thanks. Good afternoon. First, can you discuss the size of the inventory in the retail channel? Do you have a good metric, either in terms of days outstanding or an absolute dollar amount?

We are not going to provide specific details regarding that, but generally speaking, the inventory levels are higher than we would like. In the past, we have discussed our joint planning process with the supply planners at our main retail accounts, where we aim to keep inventory levels within a comfort range that aligns with our retail partners' strategies for managing on-hand inventory to support future growth. Heading into the year, in-channel inventory levels were likely slightly above normal, primarily because our retail partners, following the pandemic, overcorrected after previously being understocked. This created a bullwhip effect, which became evident as we approached our peak selling season. By late May, we noticed demand signals indicating a more significant in-channel inventory issue than anticipated. Our team started to collaborate with retail partners to understand their situation, and they were slower to respond than we were. By June, they began a significant destocking effort, which we expect will continue through the year, targeting lower inventory levels than pre-pandemic norms. We are working together to navigate this situation and aim to reduce excess inventory levels throughout the year. Ultimately, we believe this is a manageable issue and not something that will last through the end of 2023. We expect to correct in-channel inventory levels with our larger accounts by year-end. It's important to note that this is not a widespread issue; our specialty retail accounts typically maintain about 30 days of inventory due to their storage limitations. Most of the excess inventory is concentrated with our larger accounts, and we are actively addressing this to ensure a better position by year-end.

Thanks for that. Can you discuss the leverage ratio, which is around 7 turns? I'm interested in understanding the covenant risk or access to additional liquidity if needed. I assume this was a period when you expected to generate cash from reduced inventories, which hasn’t happened. Can you explain the current situation regarding liquidity?

Certainly. Our main priority right now is liquidity, and we feel secure in that position through the end of June. We have a good amount of capacity on our cash flow revolver and some cash on the balance sheet. However, much of our liquidity is tied up in inventory, and it will take time to resolve that, which has led us to adjust our cash flow generation expectations for this year. On the covenant side, we're actively managing our balance sheet, as we always do. In the second quarter and moving into the third quarter, we initiated an amendment holiday on our credit agreement, which allows us to increase our covenant ratio from 6.2 turns to 8.5 turns. This change gives us significant relief and a sufficient cushion as we manage our trailing twelve-month EBITDA as defined by that agreement through the end of the year. This approach provides us with additional flexibility to navigate this higher leverage period and offers a buffer against our covenant. Ultimately, our priority is to safeguard our liquidity and take the right steps during this challenging time. As we work through these excess inventory levels, we expect to be in a stronger liquidity position at the beginning of 2023. Overall, we are optimistic about the initiatives we have set in motion, and we are fortunate to have supportive partners on the credit side to help us transition until the amendment holiday concludes at the end of the second quarter of 2023.

All right. Thank you. That’s helpful.

Our next question comes from Kaumil Gajrawala with Credit Suisse. Your line is now open.

Hi, guys. Could you talk a little bit about kind of inventory in the supply chain versus number of units? You have already talked quite a bit about inventory at actual retail partners and such, but not that long ago, we had the capacity constraint in the supply chains and stuff. So do you still have a lot of units, I guess, coming over and how do you account for that given the new environment?

Good question. We have discussed our strategy to reduce higher inventory levels, which starts with managing in-channel inventory. We are taking a mixed approach that includes implementing additional promotions, which have shown to increase sell-through based on our data. Additionally, we have returned to our original price points for entry-level products to stimulate growth under $1,000, where consumer sensitivity is higher, and we are seeing an increase in sales there. We are also collaborating with our retailers to ensure product movement aligns with their destocking efforts. On the supply side, we are coordinating with our factories to decrease production to minimum levels, allowing us to focus on our existing inventory. We plan to significantly reduce in-transit inventory, which should help us manage on-hand inventory more effectively. This will put us in a stronger position at the start of 2023 to balance sell-in with sell-through and replenishment in order to achieve a steady state based on this balance. We are confident in our ability to reach this goal by year-end.

Got it. And then from a demand perspective, have you guys thought about or is there anything maybe you can add on, perhaps what we are seeing right now is just a little bit of demand pull-forward and the replacement cycle if it was a typical, I think we were using kind of four years or something as a typical replacement cycle. Maybe that shrunk coming out of the pandemic and if you were to think of maybe what a run rate would look like. Can you maybe just give some context on is some of this just demand pull-forward as opposed to some of these bigger macro things that we are worried about across a whole series of industries?

It’s a great question. It’s not easy to really identify all the factors driving demand. Since March, there has been quite a bit of noise. It's clear that there was some pull-forward. The outdoor cooking category is fairly steady, with growth in the low single digits, but saw mid to high teens growth in 2021. While there may have been some slight increase in U.S. household penetration, there has likely been a pull-forward of replacement cycles. It's hard to determine the extent to which what we are experiencing now is due to that pull-forward, especially in light of general consumer weakness and the tendency for consumers to prioritize discretionary spending on travel. We are monitoring this closely at a category level. Another notable trend in the category is the increased softness in lower price points, which likely reflects the trend of consumer weakness, resulting from a combination of three factors.

I would add that with some of that pull-forward, the advantage of this business model is that when we increase the number of grills installed, it boosts growth in our consumables and accessories businesses. However, when you look at our sell-in figures for Q2 and the sell-through trends for consumables and accessories, the impact is not as significant. Over two-year and three-year comparisons, and even year-over-year, the sell-through trends for pellets, accessories, and other consumables show only a slight decline, which aligns with what we reported in our GAAP financials. Ultimately, this helps mitigate some of the challenges we face due to the pull-forward and its effects on future growth in the grill category. This stabilization is something we want to embrace. Our consumers' behavior, as indicated by our IoT data on attachment rates for pellets, remains steady and consistent with normal trends. These are encouraging signs ahead of a potential rebound in grill growth, which we are capitalizing on and believe in the long-term sustainability and durability of our broader portfolio. Currently, we are navigating a more challenging environment with our higher-priced products, especially in the grill category.

Okay. Great. That’s useful. Thank you, guys.

Our next question comes from Peter Benedict with Baird. Your line is now open.

Hi, guys. A couple of questions, so, Dom, can you maybe give us some help here, what level of inventory or dollar inventory on the balance sheet would align with this normalization of goal that you have? And then how are you thinking about free cash flow this year or CapEx spend, just trying to understand, given the dynamics you have got here laid out in the back half of the year, where is the good job those metrics by the end of the year?

Certainly. As we consider our inventory management strategies, I want to clarify the inventory levels for Q2. About $14 million of that inventory is associated with MEATER, which we need to exclude from our baseline. If we adjust Q2 to reflect pre-pandemic inventory levels and take into account the challenges posed by increased costs from inbound transportation, inflation on raw materials, and historical currency issues that are improving, we find that the excess inventory contributes significantly to our overall inventory for Q2 when compared to the same period in 2021. The ratio of excessive inventory versus higher burdens likely leans more towards excess. I'm estimating that about 30% to 50% is due to excess inventory, with the rest related to higher carrying costs. Currently, our inventory levels are elevated due to these higher costs, but we expect this situation to improve as macroeconomic factors stabilize and we implement better purchasing from Asia. Our main focus now is the excess component of our inventory. MEATER has its needed stock, and the current costs of carrying inventory will persist until macro conditions improve. Our approach is to aim for around 90 days of forecasted revenue for inventory management, though this may vary based on trailing inventory days. By year-end, we anticipate operating closer to 100 or 110 days of inventory, which will likely exceed our normal expectations in a more stable environment. While we expect our reported inventory days for Q2 to remain above historical levels, we are optimistic as we approach the peak season. We believe we can move inventory quickly starting in Q1 of 2023, which should substantially improve our days in inventory targets. Even if our year-end days in inventory appear high due to lower anticipated sales in Q3 and Q4, we expect to be in a much stronger position heading into peak season. We anticipate that our days in inventory will remain relatively stable through the end of the year, but we are confident that our position for peak season is much improved, enabling us to optimize our inventory management strategy moving forward.

Okay. That’s helpful. Anything on CapEx or free cash flow as you think about the full year?

Free cash flow? Yeah. We expect free cash flow to be negative by year-end.

Okay. And how about…

Just given the fact that we will have cash tied up in inventory. Say that again?

Yeah. Yeah. No. Understood. Just to add the level of CapEx spend you are expecting for the year and if that’s been adjusted at all?

Yeah. We are adjusting that down. We have a few commitments that we are locked into. But we are probably targeting between $4 million and sort of $6 million a quarter through year-end...

And then as you think about…

Some of that tied to capitalized, oh, go ahead.

Yeah. No. No. That’s great. And then how are we thinking about just grow revenue, I guess, over the back half of the year 3Q versus 4Q? And what are you guys seeing in terms of market share, I mean, obviously, there’s not a lot of demand in the segment right now, but are there any reads on market share that you guys can share with us?

I believe Traeger's market share has remained stable on a year-to-date basis. While we are observing a decline in market share among some competitors, it’s encouraging that Traeger is sustaining its share despite the overall downturn in the category. Although we don’t have a specific number to provide for the rest of the year, we are confident that we are maintaining our market share through at least Q2, which is a positive sign for the brand.

Okay. And then last question I would just have is around gross margin, you are eyeing around 35% for this year, you talked about some benefits from direct import program, obviously, the container rate dynamics, which could end up playing out next year. How do you think about that longer term, a lot of factors that itch you this year? If you just think about things not necessarily getting any better than where they are today, but the container rates start to come in. I mean how much of a benefit could that be next year, is that 100 basis points, is it 200 basis points, is it 50? Just how would you help us frame that potential benefit in 2023 to your gross margin?

Yeah. It’s a little too early to speak to that right now. But what I would say is that, as you look at spot container rates to the East and the West Coast, compared to like peak levels in the back half of last year, they are off about 50% and I would say they are off probably 20% to 25% relative to the H2 2021 average and that’s a meaningful improvement, right? It’s not getting anywhere near where we were paying pre-pandemic levels. But if you think about a dynamic where inbound transportation is sort of hovering kind of 20% to 25% below those leverages last year and that trend seems to be improving from here through the end of the year. And the fact that at least year-to-date, inbound transportation is probably driving 200 basis points to 300 basis points, 400 basis points of margin compression, it was much larger in the back half of last year, it could be a substantial tailwind to gross margin and so something that we are watching and believe that will be a tailwind for 2023, but a little bit too early to speak specifically to what that could mean.

Our next question comes from Sharon Zackfia with William Blair. Please limit yourself to asking one question and one follow-up, please. Thank you. Your line is now open.

Hey, guys. This is Alex on for Sharon. And yeah, so we would just wondering if you could maybe talk through the $20 million of annualized savings. How much of that is in SG&A versus cost of sales and then do you guys have any plans to reinvest part of those savings into sales driving initiatives going forward?

Yeah. Good question. So to answer your first question, it’s mostly SG&A and just to reiterate, it is a run rate number, right? So that’s not what we anticipate capturing in our run rate economics through the remainder of the year. That’s sort of the annualized component or the extended annualized savings based on those initiatives and they are largely, if not a really a majority of those savings will be in SG&A. In terms of to answer your second question, I think right now the focus is more on profitability than growth. We are pulling levers to drive and stimulate growth to the extent that we can, where we have controls. One of those is posting of promotions, as I had mentioned earlier, and obviously, adjusting price at entry at opening price points for the brand, as well as a host of other initiatives that our sales team is constantly focused on. But as of right now, I think we need to really prioritize profitability, which in turn prioritizes liquidity and we aren’t planning to take those savings and reinvest them anywhere else. We want those to flow through down to profitability.

Okay, great. I have one more quick question. You mentioned that some consumers are slowing down their purchases of grills priced under $1,000. Can you discuss the sales momentum for the higher-priced grills? You noted the Timberline XL is not performing economically, but what are you observing qualitatively with the higher-priced grills?

We are observing a decline in growth for grills priced below $1,000, which is somewhat balanced by growth in the segment above $1,000, primarily driven by the new Timberline Grills. The pressures we face do not seem to be present in the higher price range, resulting in some growth above $1,000 that partially offsets the significant decline below that threshold. This trend is consistent across both sell-in and sell-through metrics, contributing to the overall decline in our grill category for the quarter.

Okay. Great. Thanks for that color. I will pass it on.

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.