Traeger, Inc. Q3 FY2022 Earnings Call

Hello, and welcome to today's Traeger Third Quarter Fiscal 2022 Earnings Conference Call. My name is Bailey, and I'll be your moderator for today's call. I would now like to pass the conference over to our host, Nick Bacchus, Vice President of Investor Relations. Please go ahead.

Good afternoon, everyone. Thank you for joining Traeger's call to discuss its third quarter 2022 results, which were released this afternoon and can be found on our website at investors.traeger.com. I'm 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 I 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 and 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 and our quarterly report on Form 10-Q for the quarter ended September 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. We 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 reconciliations of the 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 third quarter earnings call. Today, I will discuss our third quarter results, our near-term strategic priorities and our progress on our key growth pillars. 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. As we anticipated, the third quarter was a highly challenging period. After 2 years of record growth in 2020 and 2021, the grill industry is contracting in 2022. Consumers are shifting expenditures towards services and leisure, away from discretionary big-ticket goods, and decades-high inflation and ongoing geopolitical uncertainty are negatively impacting sentiment. Moreover, retailers are increasingly cautious in their ordering behavior given heightened levels of channel inventories as well as the risk of a recessionary slowdown. These factors drove a 42% decline in our third quarter sales, with particular softness in our grill sales, which were down 64% versus last year. Despite these challenges, we are making progress on our near-term priorities as we navigate the current environment. We believe that our ongoing efforts to rationalize inventory, reduce costs and bolster our balance sheet and liquidity profile will allow Traeger to navigate the current operating environment and position the company for strong improvement as the macroeconomic pressures subside. Having said that, we acknowledge that the pace at which we can drive certain of these improvements will be influenced by the broader economic environment, which remains highly volatile. The third quarter largely played out as we anticipated. Sell-through of our grills in retail was lower than last year, but consumer demand was roughly in line with our forecast coming into the quarter. While demand was lower than 2021, the year-over-year decline in sell-through during the quarter moderated from the declines we experienced in the first half of the year and grew a strong three-year CAGR. We continue to view near-term sell-through trends as challenging. However, we are seeing a modestly higher level of predictability in terms of consumer demand relative to earlier in the year. Sell-through in the quarter benefited from our strategy to drive incremental consumer demand with strategic promotions. The consumer responded favorably to promotional discounts, with both our Smoke and Summer and Labor Day promotions driving healthy consumer demand, allowing our retail partners to further work through on-hand inventory. Despite sell-through trends that were in line with our projections in Q3, excess inventories across both the grill category and other product categories, as well as cautious sentiment around the consumer and the macroeconomic environment, are causing our retail partners to be highly conservative in their ordering behavior. This is impacting our fourth quarter and we now expect our full-year results to come in at or slightly below the low end of our prior guidance at $635 million to $640 million in sales and $33 million to $35 million in EBITDA. It is important to understand the magnitude of retailer destocking, which is the largest driver of the decline in our grill sales in the second half of 2022. We believe that more than two-thirds of the anticipated decline in grill sales in the second half of the year can be attributed to retailer destocking as opposed to lower levels of consumer demand. Despite this near-term rebalancing of supply and demand, we do not believe retailers are retrenching from the growth category or from Traeger. The outdoor cooking category is resilient and historically has experienced fairly predictable growth. We believe our retail partners remain committed to outdoor cooking and in particular to our brand, as we are long-term caretakers and drive premiumization of the grill category. The trade organization is committed to ensuring that the company is positioned for long-term profitable growth. At the same time, we are keenly aware of the near-term challenges that face our industry as well as the overall economy, and therefore, our focus on executing our key tactical priorities. These near-term priorities will preserve profitability in cash flow while also creating a healthier marketplace. Specifically, as we discussed last quarter, our key near-term priorities are reducing our cost structure, rightsizing inventories, and driving improvement in gross margin. In July, we implemented a restructuring plan in an effort to both drive operational efficiencies and to streamline organizational focus on our highest return initiatives. These actions include the closure of Traeger provisions as well as a reduction in force. We realized meaningful savings from these actions in the third quarter and are reiterating our target of run rate annualized savings of $20 million. We are aggressively managing our expenses and we'll continue to stay highly disciplined as we move into 2023. Additionally, we have also taken steps to reduce our near-term outlook for capital expenditures as we look to enhance cash flow and liquidity. Our next near-term priority is rightsizing inventories, which remain elevated, both in-channel and on our balance sheet. In terms of in-channel inventory in the third quarter, we strategically increased our promotional cadence, adding two promotional periods with a focus on discount SKUs with excess channel inventory. In terms of inventory on our balance sheet, we have materially lowered production in Asia to give us the opportunity to work through our on-hand inventory. These actions, combined with our retailers' destocking efforts, resulted in some progress on our inventories. However, this remains an ongoing effort, which we expect to continue into the first half of 2023. Our next strategic priority is to drive gross margins. Recapturing gross margin is a key focus across the organization. Our gross margin task force continues to work to identify and execute on cost savings across the supply chain. Notably, the team's efforts have led to expected improvements in product, packaging, and transportation costs in 2023 across our grill assortment, as well as additional cost savings associated with lower pellet and packing costs in our pellet business. We're also seeing substantial reductions in certain input costs, including inbound freight rates and commodities like steel. We are optimistic that our cost savings efforts and lower input costs should be margin tailwinds in 2023. However, it is important to note that we do not expect to see a material impact flowing through our income statement until we've worked through our higher cost inventory in mid-2023. Moreover, we expect we will look to strategically and selectively reinvest some of these input cost improvements back into product and into pricing as we move into 2023. Our tactical priorities are of critical importance. However, we remain committed to our long-term strategic growth pillars. Let me discuss the progress we've made in each of these areas. Driving awareness of the Traeger brand remains our largest long-term growth opportunity at 3.5% household penetration across the U.S. and mid-teens penetration in our most mature markets. We believe there is substantial upside to be realized in driving brand awareness. It is a testament to the momentum of our brand that we continue to make strong inroads in driving awareness despite a highly challenging market backdrop and lower top-of-funnel marketing investment capacity. In fact, our unaided brand awareness hit an all-time high in the third quarter, improving by 15% versus the beginning of this year and up 50% versus two years ago. The continued growth and awareness of the Traeger brand in one of the most difficult periods in grilling history speaks to the energy behind the brand and the strong connection we have with our user base. Our grill owners are passionate about Traeger and act as evangelists, organically driving brand recognition. This is evident when we look at our social media KPIs in the third quarter with our user-generated content posts up nearly 50% and video views more than tripling year-over-year across social platforms. We also continue to drive awareness of the Traeger brand to enhance merchandising and product presentation in retail. In September, we rolled out a new merchandising treatment called Flex Wall across 871 Home Depot doors. Flex Wall is a Traeger branded in-bay backing that allows for branding, shelving, and hanging space for our products and is featured in Home Depot doors with premium Traeger merchandising. Additionally, we added 314 Traeger Islands at Home Depot doors in the third quarter. These new merchandising enhancements further add to Traeger's visibility on Home Depot floors. Now, onto product innovation, our next growth pillar. In the third quarter, we had significant innovation on the consumables side. In late September, Traeger partnered with WhistlePig to collaborate on new products at the intersection of smoke and whiskey. WhistlePig Whiskey is one of the most awarded craft distilleries in the U.S., and so we are thrilled to launch our Whiskey Barrel Pellet brand, Whiskey Hog BBQ Sauce, and Whiskey Dust Rub in collaboration with WhistlePig. DTC orders have had good momentum, and the launch has picked up positive PR in various media outlets. In terms of grill innovation, we are extremely excited about the new product pipeline as we move into 2023. We expect to launch two new grills next year, both of which are planned to be on retail floors in the first quarter. We have shown these new grills to some of our key retail partners, and the early response has been fantastic. It is too early to discuss these new products; however, we will be able to provide more details when we report fourth quarter in March next year. Suffice it to say, we expect Traeger to continue to deliver game-changing innovation in 2023 and beyond. Our next growth pillar is in driving recurring revenues. While our consumables business was down versus the prior year in the third quarter, sell-through pellets were only slightly below the prior year and in line with 2020 levels. As we look at sales data, the number of cooks continues to increase strongly as we grow our installed base of grills. In fact, there were over 1 million more cooks in the third quarter versus the prior year and almost 3 million more cooks versus the third quarter in 2020. This gives us confidence in the long-term recurring revenue nature of the consumables business. In the third quarter, we continued to expand our pellet offering with the introduction of 30-pound value-sized bags. Furthermore, we continue to expand distribution of our pellets into the grocery channel and remain on track to gain 600 additional grocery doors for the year as we sell into grocers like Meijer, Giant Eagle, Harris Teeter, and Albertsons. Our fourth growth pillar is to expand the Traeger brand globally. Similar to the U.S., our international markets faced challenges in the third quarter as geopolitical turmoil and inflation negatively impacted consumer sentiment. Despite these near-term challenges, we continue to see evidence that the Traeger brand has meaningful upside outside of our core U.S. market. For example, we are seeing Traeger success with the Home Depot in the U.S. translate to the Canadian market as well. The Home Depot Canada has leaned into the wood pellet grilling category, allowing Traeger to increase sell-through by strong double digits in the third quarter. Contributing to increased sell-through was an increase in the assortment and floor space of Traeger products along with marketing investments behind the brand. In summary, we are highly focused on executing upon our near-term strategic priorities as we navigate the current environment while remaining committed to our key long-term growth pillars. As a disruptor in outdoor cooking, we are positioned extremely well for long-term success and I remain highly confident in the growth potential for Traeger. In the near term, we will focus on the variables that are within our control, and we remain agile given the volatile environment. With that, I'd like to turn the call over to Dom. Dom?

Thanks, Jeremy, and good afternoon, everyone. Today, I will review our third quarter performance before providing an update on our outlook for fiscal year 2022. I will also discuss some initial thoughts on 2023. Second quarter revenues declined 42% to $94 million. Grill revenue declined 64% to $39 million, impacted by materially lower unit volumes as our retail partners aggressively reduced replenishment orders in an effort to lower end channel inventories, partially offset by higher average selling prices related to price increases taken in the second half of 2021 and in the first quarter of 2022. Consumables revenue decreased 10% to $25 million due to lower sales of pellets as retailers reduced on-hand inventories, offset by higher sales of rubs and sauces, which benefited from increased distribution. Accessories revenue increased 18% to $30 million, driven by strong growth at MEATER, offset by lower sales of Traeger branded accessories. Geographically, North American revenue was pressured by the aforementioned challenges in our U.S. business along with the negative growth in Canada. Our rest of world business grew 10%, driven by growth in MEATER revenues in international markets. Gross profit for the second quarter decreased to $26 million from $54 million last year. Gross profit margin was 27.7%, down 580 basis points from last year. Excluding $1.6 million of one-time costs related to restructuring actions, gross margin was 29.4%. The decline in gross margin was driven by: one, higher logistics costs due to decreased leverage and increased outbound freight costs, which resulted in 400 basis points of margin pressure; two, accrued discounts related to promotional activity, which resulted in 240 basis points of margin pressure; three, one-time costs related to restructuring activities in the third quarter, which resulted in 170 basis points of margin compression; four, higher grill costs and mix impact of 140 basis points; and five, the negative impact of provisions inventory liquidation, which impacted margins by 90 basis points. These pressures were offset by 440 basis points of favorability driven by our pricing actions. Sales and marketing expenses were $25 million compared to $49 million in the third quarter last year. The decrease was driven primarily by lower stock-based compensation and a reduction in top of funnel marketing and lower professional fees. Third quarter sales and marketing expense benefited from restructuring and cost savings actions taken in the third quarter in response to the lower revenue run rate. General and administrative expenses were $71 million compared to $76 million in the third quarter of last year. The decrease in general and administrative expense was driven primarily by lower professional fees and performance compensation expense, offset by higher stock-based compensation expense, largely due to the expense related to the accelerated investing of RSUs and PSUs. Excluding stock-based compensation, general and administrative expense was down $11 million versus prior year. In the third quarter, we recorded a $110 million noncash impairment charge to our goodwill related to the adverse impacts of macroeconomic conditions. Please note this amount is an estimate and will be finalized prior to filing our third quarter 10-Q. As a result of these factors, the net loss for the third quarter was $210 million as compared to a net loss of $89 million in the third quarter last year. Net loss per diluted share was $1.75 compared to a loss of $0.78 in the third quarter of last year. Adjusted net loss for the quarter was $26 million or $0.21 per diluted share as compared to adjusted net income of $7 million or $0.06 per diluted share in the same period last year. Adjusted EBITDA was a loss of $12.5 million in the third quarter as compared to adjusted EBITDA of $4.1 million in the same period last year. Now turning to the balance sheet. At the end of the third quarter, cash and cash equivalents totaled $8 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 end of the quarter, the company had drawn down $13 million under its receivables financing agreement and $47 million on its revolving credit facility, resulting in total net debt of $444 million and a net leverage ratio of 8.9%. From a liquidity perspective, we ended the third quarter with total liquidity of $86 million. Inventory at the end of the third quarter was $162 million compared to $115 million at the end of the third quarter last year. Three factors contributed to the increase in inventory versus prior year. First, the landed cost of the grills increased versus prior year, driven by higher inbound freight and other input costs. Second, grill units in inventory remained elevated given lower-than-anticipated sales in 2022. Finally, MEATER accounted for approximately $5 million of the increase, with this level of growth aligned with its strong top line momentum versus last year. As Jeremy discussed, we are actively working to optimize our on-hand inventory, and we have materially reduced production to better align supply with the reduced demand forecast. With respect to channel inventories, we continue to be highly focused on rightsizing excess supply in channel in collaboration with our retail partners. During the quarter, sell-through of grills remained negative to last year. However, the decline moderated relative to the first half of the year. This improvement was partially driven by the addition of two promotions, which resulted in stronger sell-through and allowed our retail partners to accelerate the reduction of their existing inventories. While the improvement in sell-through combined with the retailer destocking efforts drove a sequential reduction in inventory weeks of supply, channel inventories remain elevated, and we expect retailer destocking to continue into the first half of next year. Turning to our outlook for the full year 2022, we now anticipate full-year sales of $635 million to $640 million and EBITDA of $33 million to $35 million. Our updated guidance anticipates pressure on fourth quarter sales, driven by retailers' destocking actions, which will negatively impact both grill and consumable sales in the quarter, offset by expected strength in our MEATER business. Furthermore, we are also expecting pressure on our pellets business as a large customer introduces a private label pellet offering. Excluding this customer, our pellet business is healthy, and we are expecting pellet sell-through to be flat to up year-over-year in the fourth quarter. Shifting to gross margin, we continue to forecast full year gross margin of approximately 35% when adjusting for the $1.6 million of one-time restructuring costs we incurred in the third quarter. We expect that fourth quarter sales and marketing and general and administrative expenses will benefit from the cost reduction efforts, and we reiterate our target of $20 million in run rate annualized savings. Last, while it is too early to discuss specific guidance for 2023, I'd like to provide some initial high-level thoughts as we look forward to and plan for next year. We believe that retailer destocking will continue to pressure our sell-in during the first half of 2023 as channel inventories remain elevated and retailer sentiment is cautious. As we exit our peak selling season in Q2 and move into the second half of 2023, we believe inventory and replenishment dynamics should be more normalized and furthermore, we will be lapping the large destocking that occurred in the second half of 2022. The pace at which inventory dynamics normalize will be governed by consumer demand. Given the wide range of outcomes in terms of inflation, GDP growth, and employment next year, we will remain nimble and we will plan our business prudently. For gross margin, we are expecting a more favorable cost backdrop in 2023 as we are seeing tailwinds in input costs, including inbound freight rates and commodities. Furthermore, we will begin to realize some savings related to our efforts to reduce supply chain and input costs. However, as Jeremy noted earlier, we do not expect to see the benefit of these margin tailwinds flow through the P&L until we work through our existing high-cost inventory. We will also look to selectively reinvest some of the savings from input cost reductions back into pricing and into product. Given the volatility of the environment, we will continue to manage our expenses tightly with a focus on investing into our highest return initiatives in conjunction with cost reduction efforts to drive efficiency and to enhance profitability and cash flow. Furthermore, next year's expenses will benefit from the annualization of the restructuring and cost savings actions we took earlier in the third quarter of 2022. In summary, we are taking the necessary actions to rightsize inventories and to optimize our cost structure to enhance profitability and liquidity. These actions will allow Traeger to successfully navigate the current environment as well as position the business for strong growth and profitability for the long term. And with that, we will open the call to questions.

Our first question today comes from Simeon Siegel from BMO.

So I’m just wondering how you assess what constitutes too much supply leading to pricing pressure versus perhaps just a lower level of demand as you navigate post-pandemic replenishment cycles. Additionally, how do you plan to approach the need for future promotional discounts? Lastly, could you provide a like-for-like version of the average selling price to address some of the mix dynamics?

Thanks, Simeon. Yes, I think I can answer some of those. So on the demand question, I think it's pretty straightforward in terms of the dynamics between sell-through and this concept of destocking. And you can see it in our seasonality, right? Like we've never seen or experienced seasonality shift this low in terms of the trough and in Q3 and the slight uptick in Q4. And as you kind of marry that dynamic with sell-through trends, what we're seeing is sequential improvements in terms of the year-over-year comp coming out of peak season in the first half of the year. And on top of that, as we post a few incremental promotions in Q3, we've actually seen nice comps even over the prior year in the data. And so we're seeing some stability from a sell-through standpoint. The growth rate, as you measure that against prior year, is very different than what you're seeing from a sell-in standpoint. And so effectively, consumer demand is holding relative to our expectations in the back half of the year. It has found some steadiness over the first half of the year. And the three-year comp is still holding really well as you compare this year versus kind of pre-pandemic norms. So those, I think, are positive signals that from a demand standpoint, although there's softness, it's still positive from our perspective. But the challenge is the fact that we have too much inventory in channel. And I think that's contributing to the sell-in dynamic as retailers destock, and we kind of take some of that impact from a revenue standpoint this year, which we're obviously deliberately willing to do. And I think that's what you're kind of seeing in our P&L relative to what we're seeing from a demand standpoint. From a promotional standpoint, I mean, yes, we'll continue to think through the promotional lever. Like I said, we do see a real uptick and kind of uplift in sell-throughs. And that helps advance the cause in terms of just cleaning up in-channel inventory levels. Like I said on the prior call or one of us said that there are limits to how aggressive we'll be from a promotional standpoint. But to the extent that they're within reason, we will pull promotions to help kind of move excess inventory through the channel so long as it checks the box on profitability as well as just the health of the brand. And then can you just maybe ask your question one more time on the ASP front?

I think you pointed out that the average selling price has been influenced by the introduction of higher-priced products. Can we consider how the average selling price appears on a like-for-like basis if we eliminate the impact of product mix?

Yes, I would say that the only significant change in our product mix is the introduction of our Timberline XL and the new Timberline launch, which are priced quite high. This has contributed to an increase in our average selling price. However, the primary driver for this increase has been the price hikes we implemented, which included three increases: two last year and one earlier this year. This was partially offset by additional promotions and by slightly lowering prices on some of our entry-level models, specifically the Pro 22 and the Pro 34, as we exited Q2.

The next question today comes from the line of John Glass from Morgan Stanley.

Can you discuss what the channel inventory looks like currently, and how it has changed from quarter-to-quarter due to promotional activities? Do you have a good understanding based on what you've sold to them and their sell-through, or are you uncertain about the exact inventory levels?

No, we do. I mean at least for our larger accounts, we have good visibility into in-channel inventory levels. Some of our smaller accounts, like specialty, we talked about in the past, where they don't have the capacity to carry a lot of inventory. And so we're less concerned with that long tail of specialty. But as we measure in-channel inventory levels across our largest accounts, which obviously make up a majority of the business and where we have the best information within kind of the sell-through data that we collect, we are seeing sequential improvements over Q2 on that front. And it really varies from SKU to SKU or certain SKUs are heavier, and other SKUs are actually finding a path toward a more kind of rightsized level. And so it's a continued kind of progression as we help our retailers work through these inventory levels and channel, posting promotions helps accelerate that. But part of this is really going to be about time, right? And kind of letting these inventory levels work through accordingly at the cost of some revenue. And that will be the biggest lever, especially when we head into Q1 and Q2 of next year where we start to really ramp up volumes. And that will, in turn, accelerate the bleed down of in-channel inventory levels as well as help improve our own balance sheet.

Right. You mentioned that there was a large retailer that started a private label pellet business. How important is that retailer to your overall pellet sales? And how do you think about that maybe becoming a bigger issue over time if there's other possibilities you see private label and other retailers, for example? How do you sort of frame what happened and why it happened and how big a retailer that is that's doing that?

Yes, John. First and foremost, that retailer is significant to us. However, I want to share a few insights. We consistently observe stable attachment and strong loyalty regarding Traeger pellets among our existing customers. Additionally, we believe that understanding our retailers, their strategies, and their scale suggests that this is likely an isolated incident. We actually witnessed another large retailer trying to introduce a private label, which remained on the shelf for 6 to 8 months but didn't perform well, leading them to discontinue it. While we occasionally see some private label efforts, we honestly don't observe a considerable impact on our business. The situation seems to stem from the retailer's strategy, and if we exclude this particular customer, our pellet sales are generally flat to increasing outside of that one account. Therefore, we feel confident about our pellet business in both the near and long term.

The next question today comes from the line of Randy Konik from Jefferies.

Can you provide some insight on your CapEx guidance for this year and your plans for CapEx next year? Additionally, I’m curious about your free cash flow generation. With the recent cost cut of $20 million that you mentioned, do you see this as just a starting point for further reductions, or do you believe this amount is sufficient to improve cash flow and begin deleveraging? What is your strategy for deleveraging moving forward?

Yes, those are excellent questions. I anticipate that capital expenditures will trend similarly to the levels we observed in Q3, which we significantly reduced. We've done a good job of pausing certain investments, including a planned rollout of new fixtures for 2023. Instead, we will leverage existing assets and update their appearance without incurring additional costs. We're implementing various measures to further reduce capital expenditures, including halting certain initiatives or delaying them altogether. As a result, our capital expenditures have decreased considerably, and we expect them to remain at similar or lower levels compared to Q3. This focus is crucial for managing our liquidity in the short term. Regarding future plans, we will definitely realize the $20 million in annual savings, but that is just the beginning. This amount was linked to a restructuring effort, and now we're in a position to carefully manage our budget for 2023, allowing us to deliberate on cost reductions and adjustments to our short-term plan. These adjustments may slightly deviate from our long-term strategy to ensure we're optimizing controllable factors. For instance, we will significantly reduce hiring and postpone large expenditures that were typical over the past few years, shifting our focus to more effective middle and lower funnel marketing strategies. We're currently in the middle of the budgeting cycle, but the main theme remains: we have a long-term plan we update yearly, guiding our strategy over the coming years. The immediate focus for this year is on austerity, using that principle to adjust our expenses and align our cost structure with our current liquidity conditions and potential demand risks in 2023. This moment allows us to approach these changes more deliberately instead of reacting in the moment as we did during the restructuring adjustments in Q3.

I think it would be beneficial for you, Jeremy, to share your insights on the current state of the industry cycle. We experienced significant growth followed by a sharp spike during COVID, and now we are emerging from that. Can you provide your perspective on when the industry is expected to stabilize and what you consider to be appropriate volume levels? Additionally, could you outline your expectations for the timeline regarding stabilization and what you believe the normalized growth rate for the industry will be, keeping in mind that your company is likely to gain market share during this growth? Your thoughts on this would be greatly appreciated.

This is something we focus on extensively, considering size, growth, and the return to a more normalized replacement cycle. As you mentioned, this category has been fairly stable and resilient over the years. Americans have been cooking outdoors for decades, a trend that will likely continue. We did experience a double-digit decline in 2009, with the industry falling by about 10% and an additional 1% decrease the following year. However, it grew consistently for the next decade. We are working to understand the math surrounding replacement cycles while taking into account macroeconomic conditions to gauge when consumer buying will return to more normal levels. Currently, the industry is down about 11% in dollars and about 20% in units year-to-date. It's important to note that the dollar decline is largely due to inflation and price increases. As Dom mentioned, growth rates have begun to stabilize year-over-year, and we anticipate this trend will continue, partly because of easier comparisons, but also due to catching up on replacement cycles and demand that was accelerated during the pandemic. The timing of this stabilization will depend on the economy, but we believe that over the next 12 months, replacement cycles will remain flat. We have an advantage with a slightly shorter replacement cycle compared to the industry, driven by usage and innovations that shorten ownership periods. We expect the industry to return to pre-pandemic levels sometime between 2024 and 2025, historically seeing low single-digit growth. We will continue our established approach to enhancing the brand by introducing innovative products to the market and capturing market share through product experience and brand development.

The next question today comes from the line of Peter Benedict from Baird.

What are your thoughts on distribution and any plans to expand it? You mentioned Home Depot is doing well in Canada. Are there domestic opportunities to help with moving some of the products you currently have? Additionally, is there anything you could do internationally over the next 12 months to speed up the process? That's my first question.

Yes, Peter. To start, I believe our biggest opportunity lies in deepening our presence in our current distribution channels. Last week, while on the East Coast for meetings, I spent a couple of days in the market and clearly saw that within our existing channels, there are significant chances to enhance our assortment, improve merchandising quality, and provide better training for retailers. This approach has been foundational to our brand's development. Analyzing sales data from various retailers reveals that Traeger's market penetration aligns closely with regions where we've historically invested. We have the opportunity to make more substantial investments. I mentioned some of this in my earlier remarks; we've made progress, but there's still much more to achieve. We frequently highlight our advancements with Home Depot, the world's largest retailer, as it exemplifies our market strategy and retail productivity. Additionally, outside of Home Depot, we have great partnerships where we can guide them toward improved merchandising tiers. This is our focus. We're also expanding our reach by adding more local and regional partners, particularly in furniture, appliances, and barbecue specialties. If we look at a market like Utah, for instance, which has high penetration, our number of distribution doors is similar to other areas, but we have effectively filled those stores with the right products. This remains our priority. We're consistently evaluating our channel strategy and opportunities while committing to depth and productivity at every point of sale. We believe this lays a strong foundation. Regarding international markets, we see potential, particularly in Europe, focusing on Germany and the U.K., which are promising areas. Our current strategy is grounded in retail and merchandising, focusing on the fundamentals that have built our brand, plus leveraging local brand assets and influencers on social media. We're nurturing these international markets, which are gradually growing. However, in the long run, we plan to increase marketing investments in these regions, similar to our approach in the U.S. over the past few years. Considering the size of our platform here, especially in comparison to other markets, the growth potential is considerable, which is why we will continue to prioritize investments in the U.S. and Canadian markets.

Got it. And then I guess, maybe, Dom, just a follow-up on Randy's question, just can you maybe talk to us about the deleverage process? I'm not sure very much there where you stand with the debt covenants currently, just an update on that front? And with respect to the CapEx, it looks like maybe the second if we just annualize the second half rate, are we talking $10 million to $12 million or so for next year? Is that a level that you think you can pull the CapEx down to? Just curious on that outlook for '23.

The focus on reducing leverage primarily depends on EBITDA in the short term. Right now, our main priority is to enhance our liquidity position. The second priority is to start boosting profitability in the business, which will lead to increased EBITDA and facilitate our deleveraging efforts. In the short term, we expect that improvements in profitability will drive deleveraging. However, if we can enhance liquidity and free cash flow next year, that will also aid in reducing leverage, particularly in paying down our revolving capacity. We do not anticipate deleveraging from the term loan in the near future. Those areas are our main focus regarding leverage improvement. As for capital expenditures, we are not ready to disclose next year's targets yet, but we are aggressively prioritizing investments to ensure long-term business health. An example of our focus is investing in tooling or future product roadmaps while deprioritizing other expenditures, such as new fixtures planned for 2023. Although we cannot provide a specific CapEx figure for next year, it is expected to be lower than this year's total.

Our final question today comes from the line of Joe Feldman from Telsey Advisory Group.

So wanted to ask, you guys made a comment during the prepared remarks about really focusing on the highest return initiatives to invest in. And I was just hoping maybe you could share an example or two of what that exactly means to you guys?

I believe the underlying principle here is to focus on the highest returning investments that are immediate and predictable. A prime example is how we allocate funds for demand creation. When we invest in demand creation, like search engine marketing or digital advertising, it is highly measurable in terms of the relationship between our spending and the resulting revenue. This creates a clear one-to-one correlation, allowing us to allocate limited resources to areas with the most predictable returns in the short term. We also believe in longer-term investments, such as prospecting marketing, which aims to build brand awareness and attract more consumers into the funnel. However, these require more time and efforts to convert, so we aren't in a position to invest in them right now. That's why we're focusing on reallocating funds to middle and lower funnel marketing efforts that deliver quicker returns. Additionally, regarding capital expenditures, we're being resourceful with our existing assets and will postpone certain investments until we can afford them. Overall, we're prioritizing initiatives that yield immediate benefits while delaying those important for long-term growth that aren't as measurable.

Joe, the only thing that I would add to that is that product is one of the long lead time investments that we believe we need to continue to make. It also to Dom's comment about predictability, we see a very predictable return on our product investment with healthy channels, strong brand, a good community that is very anxiously looking at whatever we launch. We continue to invest in products. I think this has actually been a nice forcing mechanism to make sure that we are simplifying our product investments and making investments in the most important opportunities that really drive outsized returns, and it's a long lead time. So it continues through good times and bad.

Got it. That's really helpful. And then if I could just follow up with one other question. I fully appreciate the decision to slow down the production of new grills until you manage the inventory on your balance sheet. I'm curious if there are any minimum production requirements from your factory partners in China and Vietnam to maintain operations, or is that not a concern at this time?

Yes. So yes and no. I mean, if we had to completely pause production, we could do that. But we don't necessarily want to, right? I mean our motivation is to ensure that we're also good partners to our factories, and we're protecting continuity for those factories. Because there's disruption if you turn off production, they scale down labor and that comes at a cost to our factories, both in the short term as well as when we need to ramp production, which is both a little bit more cumbersome for Traeger as well as for our factories where they have to go back and find the labor to keep up with the demand that we're producing against from a supply standpoint. And so we're motivated independent of any contractual obligations to keep them at minimum production levels that allow them to keep the lights on and protect continuity and sort of navigate and minimize the disruption to them, which in turn will extend kind of the length of time at which we're able to ramp down our own inventory levels. But obviously, it helps dramatically because we are operating at those min levels that allow us to naturally and progressively improve our inventory position through the end of this year and obviously through part of next year.

Our final question today comes from the line of Peter Keith from Piper Sandler.

I have a question for Peter regarding gross margin. I understand that the benefits may not be realized until you address the higher-cost inventory. How confident are you that this will be resolved by the second quarter of 2023? Additionally, could you provide any estimates for the gross margin expectations in 2023?

Yes, we're quite confident that by the middle of the year, we will begin to experience some benefits from the favorable macro trends. It will take time to address the high-cost inventory currently on our balance sheet. However, both the news and our perspective indicate that as we collaborate with our freight forwarders to negotiate new contracts at varying rates, we've observed a significant decline in spot rates. Once our inventory levels are normalized and we start purchasing at lower costs, we anticipate seeing those benefits reflected in our profit and loss statement around the midpoint of next year, with a greater impact in the following years. This will create a positive tailwind for us. Additionally, foreign exchange is expected to positively influence the profit and loss as well as gross margin once we've managed our higher inventory levels. We're optimistic about reaching this point. We might not fully realize the impact in the latter half of the year, but we expect to see consistent improvements in gross margin throughout 2023.

And the gross margin path for us. Is there any way to quantify the expectations?

Yes. So I don't know that we're necessarily going to share the total dollars, but these things take shape weekly, monthly. And it's something that will be core and fundamental to our strategy for the long term. So it's not necessarily something where you pull a lever and suddenly, you found millions and millions of dollars. This is kind of continuous improvement in the progression as we work through cost structure, negotiations with factories, to how we improve land side movements in inventory and how we optimize our footprint, whether it be warehousing or outbound transportation to ensure that we're moving product in the most efficient way. We've talked earlier about launching direct import with a couple of customers, which is contributing nice gross margin enhancements really all throughout the course of this year. So it's one where we'll continue to work at it. And we have longer-term levers as you think about how we develop a product roadmap that optimizes margin structure. It will be interesting to see what happens in this macro dynamic and how we navigate price strategy to optimize both gross margin and volumes as we see these commodity prices and inbound transportation rates decrease. So I think what I would say to you is there's a long list of items that we're focused on and kind of the partnership between the ops team and the finance team is very tight. And we're really excited about the opportunities that are in front of us, some of which will take some time to mature, but it is something that we're bullish on, and we'll start to realize this year as well as over the course of next year. And without quantifying, I will say that it is something that will contribute to gross margin over time, and we'll continue to build on that strategy, not only through this year, but obviously over '23 and beyond.

There are no further questions waiting at this time. So I would like to pass the conference back over to Jeremy Andrus for any closing remarks. Please go ahead.

Great. Thank you for joining our call. We look forward to speaking with you again in March when we update on our fourth quarter earnings. Take care. Thanks.

Thank you all for your participation.