Earnings Call Transcript - ONEW Q3 2023

Operator, Operator

Good day and thank you for standing by. Welcome to OneWater Marine's Fiscal Third Quarter 2023 Conference Call. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to the speaker today. Please go ahead.

Jack Ezzell, Chairman

Good morning and welcome to OneWater Marine's fiscal third quarter 2023 earnings conference call. I'm joined on the call today by Austin Singleton, Chief Executive Officer; and Anthony Aisquith, President and Chief Operating Officer. Before we begin, I'd like to remind you that certain statements made by management in this morning's conference call regarding OneWater Marine and its operations may be considered forward-looking statements under securities law and involve a number of risks and uncertainties. As a result, the company cautions you that there are a number of factors, many of which are beyond the company's control, which could cause actual results and events to differ materially from those described in the forward-looking statements. Factors that might affect the future results are discussed in the company's earnings release, which can be found in the Investor Relations section on the company's website and in its filings with the SEC. The company disclaims any obligation or undertaking to update the forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made, except as required by law. And with that, I'd like to turn the call over to Austin Singleton, who will begin with a few opening remarks.

Austin Singleton, CEO

Thanks, Jack and thank you everyone for joining today's call. I would like to start by commending our team for doing a tremendous job driving increased sales and maintaining flat same-store sales in this dynamic and changing environment, especially as we lap a comparable period of double-digit same-store sales growth in the biggest quarter of the year. The selling environment deteriorated in the third quarter. However, our team rose to the challenge. In the face of double-digit declines in industry unit sales, we delivered flat unit sales and same-store sales. With our sales pace outperforming the industry, we believe these results indicate increased market share for OneWater. We also maintained a very healthy inventory level of 17 weeks on hand. The industry average is approximately 28 weeks, and as it continues to build, some believe the industry inventory levels will grow to 35 weeks to 40 weeks on hand. This will undoubtedly lead to a more promotional environment and put further pressure on new boat margins. Our proactive approach of reducing inventory early will pay dividends in future quarters by reducing floorplan costs and other carrying costs. More importantly, going forward, we will have a good supply of 2024 inventory which had a very modest price increase this year. We believe this puts us in a competitive position compared to an industry overloaded with 2023 models headed into the fall and winter. We are increasingly cautious as demand signals are pointing towards a retail slowdown. Traffic at the height of the season slowed, as evidenced by declining industry units in what is considered the prime selling season. As we move out of the summer into the fall, customers may delay their purchases, especially because inventory is plentiful, and there may be better deals to be had in the spring. In addition, with interest carrying costs continuing to rise and expected to stay higher for longer, this will cause a significant headwind for certain industry participants. As margins and interest rates are starting to settle into the new normal, we must start to look inward, mainly at SG&A, to get back to our target EBITDA goal. While our SG&A costs as a percentage of revenue are reasonable at 16%, we have identified several areas to help offset these gross margin declines and outsized interest costs. Given all of those factors, we are taking a very cautious approach to our outlook and are lowering our full-year guidance. Our business is resilient, and we are taking prudent action to ensure that we can capitalize on the new normal and emerge stronger. We believe that our strategic approach to exiting the season with clean inventory positions us well for the quarters to come. Additionally, the M&A deal pipeline is getting more and more attractive, and there could be some opportunities for favorable acquisitions in the future. We are looking at all levels of the business and are confident that by accepting the short-term pain of the industry adjustment, we have set course for a solid future and attractive free cash flow generation. And with that, I will turn it over to Anthony.

Anthony Aisquith, President & COO

Thanks, Austin. Our teams remain active during the selling season to drive solid revenue growth in a challenging market. Results were driven by double-digit growth in pre-owned boat sales, supported by increased trade-ins over the last few quarters. For customers looking to finance their boat purchases, credit remains widely available, in line with what we've been seeing throughout the year. As rates go up, the average customer does become a little more interest rate sensitive, which led to the flat finance and insurance income year-over-year. Our parts and service business continues to grow nicely, and sales are up 23% in the quarter and 38% year-to-date. Our dealerships are executing well, and the distribution business is starting to turn the corner on the destocking that has occurred at big box retailers over the last several months. While it has not had a material impact on our results this quarter, we are beginning to see orders from these retailers trickle in and expect them to ramp up this winter. Moving to inventory, as Austin mentioned, we are hyper-focused on carrying appropriate inventory levels through the end of the selling season and into the seasonally slower winter months. Inventory as of June 30, 2023, is down modestly compared to the end of Q2, and we expect the seasonal decline to continue. We are continually operating at 17 weeks of inventory on hand compared to an industry average of 28 weeks. We will enter the 2024 selling season with a fresher inventory mix than many of our competitors. This coupled with a more moderate price increase from the manufacturers allows us to be extremely competitive as the 2024 models will be easier to sell than prior year models. While we are comfortable with our inventory position, some industry information suggests that inventory and the overall dealer channel has built up past 2019 levels. As we move forward, we believe this will give us a competitive advantage against other dealers. The higher carrying costs and the interest expense for dealers with aged and non-current inventory creates a significant drag on their earnings and cash flows. Thus, we believe our proactive approach will benefit us significantly in the long-term. As we have said before, there are many levers to pull as we adjust to the new sales levels and margin expectations. We are focused on adapting our SG&A expenses to support the current operating environment. We also expect the SG&A expenses to continue moderating as we further integrate acquired parts and service businesses. We remain focused on executing our playbook and positioning OneWater for continued success in any environment. I will now turn the call over to Jack to review the financials.

Jack Ezzell, Chairman

Thanks, Anthony. Fiscal third-quarter revenue increased 4% to $594 million in 2023 from $569 million in the prior year quarter, yielding same-store sales that were flat for the quarter. New boat sales decreased 1% to $372 million in the fiscal third quarter of 2023 and pre-owned boat sales increased 14% to $111 million. Service parts and other sales continue to positively impact our results, climbing 23% to $92 million, driven by the contributions of our recently acquired businesses and dealer operations. Overall, gross profit decreased 13% to $159 million in the third quarter compared to the prior year, driven by the normalization of gross margins on boats sold. Gross profit margin fell to 27% as a percentage of total sales. As expected, the investments made in the service parts and other businesses have softened the decline in overall gross margins as boat margins normalize. Third quarter 2023 selling, general and administrative expenses increased to $93 million from $88 million in the prior year. SG&A as a percentage of sales was 16%, which was flat compared to the fiscal third quarter of 2022. The increase in SG&A expense on a dollar basis was primarily driven by the higher expense structure of our acquired parts and service businesses, as well as higher advertising expenses compared to the prior year, which supported our increase in sales. These increased costs were mostly offset by a variable cost structure where expenses have started to adjust down with the declining gross margins. As the industry normalizes, our flexible SG&A expense structure is a lever we can pull to drive future profitability. Operating income decreased to $60 million compared to $88 million in the prior year and adjusted EBITDA was $60 million compared to $95 million in the prior year. The decline in adjusted EBITDA was due to the reduction in both gross margins and same-store sales being at the bottom of the expected range, combined with higher floorplan borrowings and related interest costs. Net income for fiscal third quarter totaled $33 million or $1.95 per diluted share from $64 million or $3.86 per diluted share in the prior year. Contributing to this decline was an increase in interest expense, which was $17 million in the quarter, up from $4 million in the prior year. This increase is the result of rising interest rates and increased average borrowings on our debt facilities. Turning to the balance sheet, as of June 30, 2023, total liquidity continues to be in excess of $100 million, including cash on the balance sheet, availability on a revolving line of credit, and floorplan facility. Total inventory as of June 30, 2023 was $573 million and has increased year-over-year as the supply chain has come back online and as we integrate our recent acquisitions. Our inventory remains healthy at approximately 17 weeks on hand, and we expect inventory will continue to decline sequentially until we begin the seasonal build in the fall. Total long-term debt as of June 30 was $458 million, adjusted net debt, or our long-term debt net of cash, was 2.2 times trailing 12 months EBITDA. Our liquidity and leverage position remains in a comfortable range, and we continue to use cash to pay down our floorplan, which has the highest interest rate, providing us with financial flexibility as needed. Moving to our outlook, we're updating our guidance as a result of the accelerated normalization of the industry. We are guiding same-store sales to be flat to the prior year and expect adjusted EBITDA to be in the range of $160 million to $170 million with earnings per diluted share to be in the range of $4.45 to $4.70 per diluted share. These projections exclude any acquisitions that may be completed later this year. We will continue to maintain our current capital allocation strategy supported by our strong free cash flow generation. The M&A pipeline is robust and deals are beginning to look very attractive. As we continue to navigate this dynamic environment, we remain focused on positioning OneWater for the continued long-term success and maximizing value for our shareholders. This concludes our prepared remarks. Operator, will you please open the line for questions?

Operator, Operator

Our first question comes from Joe Altobello of Raymond James.

Joseph Altobello, Analyst

First question for you, Austin and sort of a big picture question. Maybe where do you see pricing and margins going next year across the industry, particularly if inventory continues to build? If I look at your new boat margins today, yes, they're down, but they're still above where we were pre-COVID. So I guess, do you think we ultimately go back there at some point?

Austin Singleton, CEO

Pricing is something we're encouraged about. Pricing doesn't seem to have risen that much for the manufacturers this year. So it's a pretty modest price increase from the majority of our manufacturers—probably 3% or less—and a lot of that is content or engines. So we're optimistic that the 2024 price increases will give us a little bit of room to be more competitive if this inventory stays as high as it is from 2023. As for margins, we didn't expect this outcome from the last quarter, it really started right before Memorial Day, and I found myself thinking about why it happened so fast. The realization kicked in for most of the industry when they got that April interest bill from the floorplan manufacturers in late May and they saw how much they were spending every month on inventory carrying costs through the summer and into the fall. That's when discounting began. What we have seen is some promotional activity from some manufacturers which is starting to come on board, which may help ease some of the downward trend to margins. However, I would say our comfort level in maintaining margins where they are now is low. I suspect that margins may deteriorate a little bit more, and the hope is that we do get some promotional activity out of manufacturers and that we get this inventory cleaner so we can start selling 2024 models at higher margins compared to 2023 models. Inventory remains a concern; however, we are comfortable with our position. The industry inventory is high, and it will take time to flush through. There are positive trends for July, and we had a good July. We're hearing some preliminary results from Wells Fargo regarding what the industry did in July, so maybe it will trim down, but it's going to be a fine thread to needle over the next six to nine months.

Joseph Altobello, Analyst

And maybe a second question on M&A. You sort of alluded to a very attractive pipeline. It's been a while since you've done a deal or acquisition, for example. So help us understand how you're thinking about your M&A strategy, here in late fiscal '23 and maybe into fiscal '24?

Austin Singleton, CEO

Yes. If we look back at the deals we've done in the past, it's pretty much like a high-level math equation. When we assess the deals, we’ve done in the past and take the revenues into account adjusted for pricing increases we've seen on new boat sales, and keep in mind that the majority of these deals we do are from smaller businesses, where 90% to 95% of their revenue comes from new boat sales. If they aren't making north of 5% in net profit, they'll run out of cash. We think there will be some good deals on the horizon. We've already started looking at a couple of opportunities where businesses are almost ready to hand over the keys—saying, if you take over my inventory obligation and give me a lease, it's yours. We believe that this will become more common as we go through this winter, as we haven't seen many deals of this nature. Currently, we’re around 8% interest on our floorplan. The majority of the industry is above 10%. That rate is going to put pressure on dealers as we progress through winter, with some considering selling. It will be interesting to see what the M&A landscape looks like over the next six to nine months.

Operator, Operator

Next question comes from Michael Swartz of Truist Securities.

Michael Swartz, Analyst

Maybe just one for you, Jack, quickly. The flat same-store sales in the quarter: what was the composition of that in terms of units versus pricing?

Jack Ezzell, Chairman

Yes, so that was units were just ever so slightly negative, while price was slightly positive.

Michael Swartz, Analyst

Okay. So it does sound like you gained market share, but it also sounds like at least directionally you're talking about things getting worse through the quarter—particularly since when you gave guidance in early May. But I mean we've obviously seen the SSI for May, June, and your commentary for July seems pretty positive. So I guess is this just more of a broader concept where pricing promotions have gotten worse, and you're planning to take it on the chin a little more than you maybe thought while reducing inventory so that you're in a better environment going into fiscal year '24? Did I frame that correctly?

Austin Singleton, CEO

100%. This is a more competitive landscape; we could feel it going into Memorial Day. By the time we reached June, we were fighting hard for every deal. It got to the point where a customer would come in, we’d build a relationship, give them a price, they’d leave, and then return with a competitor offering a significantly better price. We worked on every deal until there was nothing left, that's exactly what we saw.

Jack Ezzell, Chairman

Yes, Michael, I would also say, as we exited last quarter, we had a double-digit same-store result that we achieved in the quarter and felt it was going to also pull back. I think coming in flat was below our expectations at the time. Like Austin said, the market has slowed, price sensitivity has escalated, and we've been fighting to keep unit sales roughly flat.

Michael Swartz, Analyst

Okay. It sounds like in terms of overall inventory, it doesn't sound like you're uncomfortable with where you sit necessarily today with 17 weeks on hand, but it sounds like you're more targeted on or concerned around maybe model mix within that inventory. So do you have any metrics or targets by the end of your fiscal year or calendar year in terms of other weeks on hand or just the percentage of your new inventory that's model year '23?

Austin Singleton, CEO

Yes, that’s what we're focused on. Jack, you take that. Let me say this real quick: inventory weeks on hand is not really the metric we measure compared to the industry. But we are getting truckloads of 2024 inventory from the manufacturers already. Manufacturers are screening for orders, and we're already receiving a lot of '23 boats. So that 17 weeks on hand, if you look at the inventory that's actually costing us money, that's the '23 inventory. As long as that continues to run down fast, we can't hand-save 17, but if we're receiving 2024s, that's fine with me because that doesn't have a carrying cost to us. Jack, do you have anything to add?

Jack Ezzell, Chairman

Yes, I would say we're very comfortable with the composition of that inventory. The '23 versus '24 is key because, as we move through the rest of the calendar year, the '23s still feel current when selling them in 2023. When we get into springtime, many dealers will still carry '23s into the spring boat shows. Our '23 inventory will be lean as we work through it over the next several months. So, it's that composition that makes a significant difference. Additionally, when Austin mentioned pressure on other dealers, as their inventory ages, they have to incur carrying costs while cash flows are low. Paying more than 10% interest plus curtailments in the off-peak months like November and December will pressure them to liquidate inventory at lower prices. Thus, we are comfortable with our position; we just aren't entirely sure where the industry will be.

Operator, Operator

This question is from Kevin Condon of Baird.

Kevin Condon, Analyst

I wanted to ask a little bit about if you're seeing anything across different categories or I guess value versus premium parts of your offerings. I think earlier this year you noted that the premium end was faring a little bit better. And I just wanted to ask if that was still the case. And then on a related note, if you've been seeing any pushbacks from customers around just the affordability of boats given the last 2, 3 plus years of price moves and just if there's anything that manufacturers or dealers are doing to try to address those affordability concerns?

Austin Singleton, CEO

Yes, I'll jump in on the pricing. As far as categories go, I mean, the SSI data is the best way to look at that. I mean, we're not seeing anything that's different from what the SSI data shows from a category perspective. We're a big pontoon dealer, and pontoons have been very good for us. I think the SSI data shows that down a little bit. When it comes to the premium value, that's a tricky one because what is classified as premium? We consider the majority of our brands premium for where we're selling. However, there is this perception that premium simply means larger vessels; it's complex. But when you look at a 25-foot pontoon boat that costs 200 grand, we consider that premium. Overall, the premium category has held up well, with the longer build times for certain boats also indicating strong demand. On the other hand, if we look for a quicker build, we have more inventory and some of those models are selling slower. The premium segment is definitely strong because it tends to have longer build times, while inventory across brands and segments remains challenging.

Anthony Aisquith, President & COO

I would say the premium offerings are holding up very well. The entry-level segments, where buyers are more sensitive to financing, have seen more caution. Sales have not shut off; they're still happening, but our premium inventory is selling very well.

Austin Singleton, CEO

Regarding pricing, manufacturers seem to recognize what's been happening. The price increases we've observed this year are mostly in the minority and tend to be below 3%, which is encouraging. However, we need to acknowledge that boat prices over the last 3 years have become tough to handle.

Operator, Operator

This is our last question coming from Griffin Bryan of DA Davidson.

Brandon Rollé, Analyst

Hi, this is Brandon Rolle with DA Davidson. Just one question. You had talked about seeing increased promotional activity from the OEMs. Could you talk about what you're seeing in terms of how that's evolved from the beginning of the summer to where we're at right now and maybe from both a retail and wholesale incentive perspective, given what's going on in terms of dealer inventories?

Austin Singleton, CEO

Yes. I think they've all kind of come out with their traditional offerings. It starts with special rebates for boats, and to earn those you have to sell one and buy one. So, you get a discount, but it’s on the order boat. Initially, it begins with those offers but evolves into more desperate moves to push current inventory. Some manufacturers have implemented incentives to move product, and I expect that trend to ramp up as we approach the fall and winter seasons. Most manufacturers' orders are down right now, primarily connected to dealers looking at their floor plan interest statements and realizing the significant carrying costs. This concern pushes our production to find ways to reduce inventory quickly.

Brandon Rollé, Analyst

Okay, great. And just one follow-up: I know you have exposure to the pontoon industry but also the Ski/Wake category, which I know has been showing weaker metrics. Could you comment on what you think has been happening in that portion of the industry?

Austin Singleton, CEO

Yes. I believe the decline in that segment can be attributed partly to pricing pressures. Equipment costs have become high. Also, I think reverse drive options are influencing consumers. Buyers of expensive tow boats can opt for a Cobalt with a reverse drive, which can replicate many of the capabilities of traditional inboards at a lower price point and better performance. That competitive dynamic is influencing the segment, as we see different sales patterns.

Jack Ezzell, Chairman

I would also add on the pontoon segment that it has many units spanning various price points. Thus, we might not fully participate in lower-end sales, but our higher-end pontoon consumers show resilience, and we're performing better than broader SSI metrics suggest.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for participating, and you may now disconnect.