Smith & Wesson Brands - Q2 2024

Transcript

Operator (participant)

Good day, everyone, and welcome to Smith & Wesson Brands, Inc. Second Quarter Fiscal 2024 Financial Results Conference Call. This call is being recorded. At this time, I would like to turn the call over to Kevin Maxwell, Smith & Wesson's General Counsel, who will give us some information about today's call.

Kevin Maxwell (SVP, General Counsel, Chief Compliance Officer and Secretary)

Thank you, and good afternoon. Our comments today may contain forward-looking statements. Our use of the words anticipate, project, estimate, expect, intend, believe, and other similar expressions are intended to identify forward-looking statements. Forward-looking statements may also include statements on topics such as our product development, objectives, strategies, market share, demand, consumer preferences, inventory conditions for our products, growth opportunities and trends, and industry conditions in general.

Forward-looking statements represent our current judgment about the future and are subject to risks and uncertainties that could cause our actual results to differ materially from those expressed or implied by our statements today. These risks and uncertainties are described in our SEC filings, which are available on our website, along with a replay of today's call. We have no obligation to update forward-looking statements. We reference certain non-GAAP financial results.

Our non-GAAP financial results exclude costs related to the planned relocation of our headquarters and certain manufacturing and distribution operations to Tennessee, the spin-off of the outdoor products and accessories business in fiscal 2021, and other costs. Reconciliations of GAAP financial measures to non-GAAP financial measures can be found in our SEC filings and in today's earnings press release, each of which is available on our website.

Also, when we reference EPS, we are always referencing fully diluted EPS, and any reference to EBITDA is to adjusted EBITDA. Before I hand the call over to our speakers, I would like to remind you that when we discuss NICS results, we are referring to adjusted NICS, a metric published by the National Shooting Sports Foundation based on FBI NICS data. Adjusted NICS removes those background checks conducted for purposes other than firearms purchase.

Adjusted NICS is generally considered the best available proxy for consumer firearm demand at the retail counter. Because we transfer firearms only to law enforcement agencies and federally licensed distributors and retailers, and not to end consumers, NICS generally does not directly correlate to our shipments or market share in any given time period. We believe mostly due to inventory levels in the channel. Joining us on today's call are Mark Smith, our President and CEO, and Deana McPherson, our CFO. With that, I will turn the call over to Mark.

Mark Smith (President and CEO)

Thank you, Kevin, and thanks everyone for joining us today. We were very pleased with our second quarter results, which continued to reflect our innovative new product introductions and our consumers' enduring loyalty to the Smith & Wesson brand. Top-line revenue and unit shipments were both up just over 3% versus last year, while distributor inventories actually decreased slightly in the period by about 4,000 units during a time that traditionally sees channel inventory build in the preparation for the busy holiday season.

This robust sell-through, combined with our shipments outperforming NICS in the quarter by over 7%, underscores our belief that our strong performance was due to share gains at the retail counter. Our new product portfolio and reputation for quality continue to be key differentiators, and we are proud to have been the recipient of the 2023 Innovator of the Year awards from two major industry partners, Guns & Ammo Magazine and the NASGW, the trade association representing our distribution partners.

New products remain an important driver and accounted for 29% of our overall revenue mix in the quarter. Recently introduced products, including the M&P 5.7, the FPC, and the Response, have all been very well received by the market. In the first half of the fiscal year, new products accounted for 31% of our sales, and we expect this momentum to continue. We have some very exciting launches planned for SHOT Show next month, which I look forward to discussing in more detail very soon. Accordingly, ASPs remained strong in Q2 as we continued to maintain a healthy balance between new products and core products, up slightly versus last year and down mid-single digits sequentially.

All of this is consistent with what we shared with you on the Q1 call, where we noted that the return to normal seasonal trends and associated fall promotional activity would result in some moderation in our overall ASPs throughout fiscal 2024, but our strong product portfolio would offset most of those headwinds. Looking forward, as evidenced by strong NICS results in the last 60 days, the overall market has rebounded nicely from the summer slowdown and is following normal seasonal demand patterns. Promotional activity in the industry is expected to continue, but while we will be participating with targeted promotions, with the return to strong overall demand, we are confident that our pricing strategy, product mix, and award-winning innovation will continue to keep our ASPs healthy throughout the second half.

We are also very pleased with our core profitability metrics, although it is important to note that a couple of discrete one-time items negatively impacted our GAAP earnings in the quarter by more than $3 million and our adjusted EBITDA by more than $4 million, which Deana will cover in more detail in a moment. Absent these one-time items, our margins in the quarter were well within our expectations and should further improve in the second half as we move past the temporary impacts of unfavorable absorption from lower production rates as we reduced internal inventories throughout the first half of the year, and some dual costs associated with the current move to Tennessee.

The major components of the Tennessee move are either complete or scheduled to be complete within the next few weeks, and with demand increasing and inventories at healthy levels, we are currently in the process of ramping up several production lines in order to meet orders. Therefore, while we anticipate these headwinds will continue through Q3, they likely will have abated as we enter Q4. Turning now to our capital allocation strategy, we are pleased to announce that we made purchases under the recently authorized stock buyback program during our second quarter, and the board once again authorized payment of our quarterly dividend, underscoring our commitment to maximizing stockholder value through a balanced approach.

The strong balance sheet and significant reduction in CapEx on the horizon as we wind down the major investment in our new facility in Tennessee, we expect to be in a very strong position to drive returns for our stockholders throughout the second half and FY 25. I'll close with an update on the Tennessee relocation, which continues to progress as planned. The initial shipments from the facility commenced in August, and manufacturing activity has begun and is in the process of ramping. It is still early stages for the assembly and plastic injection molding, which will continue through the balance of our fiscal 2024, but we already have 300 employees working at the site, and our grand opening celebration and Fall Festival was a huge success, with over 5,000 attendees and great media coverage.

We also raised $170,000 for local charities at the event. I want to again thank our entire team of loyal, dedicated employees for their tireless efforts to ensure we consistently deliver on our commitment to excellence, upholding the legacy of the Smith & Wesson brand and driving value for our stockholders. With that, turn the call over to Deana to cover the financials.

Deana McPherson (EVP, CFO, Treasurer and Assistant Secretary)

Thanks, Mark. Net sales for our second quarter of $125 million were $3.9 million or 3.2% above the prior year comparable quarter. Inventory in the distribution channel remained steady, with weeks of inventory declining as sell-through has increased in line with our increased shipping levels. After a temporary spike in ASPs during our first quarter due to the favorable impact of new products, ASPs have returned to fiscal 2023 levels due to increased volume, which resulted in new products having a smaller impact on ASPs than in our first fiscal quarter. Gross margin of 25.4% was negatively impacted by a $3.2 million legal settlement accrual.

Excluding this one-time charge, gross margin would have been 28%, or 1.4% better than our first quarter and 4.4% lower than the comparable quarter last year. The decline from last year, which we continue to believe is temporary, was due almost entirely to a combination of unfavorable fixed cost absorption as a result of lower production levels, inflationary factors, and inventory reserve adjustments. Due to the persistence of these factors, we now expect margin to recover to more normalized levels later in fiscal 2024 than previously anticipated.

Operating expenses of $28 million for our second quarter were $1.3 million higher than the prior year comparable quarter, primarily due to the one-time costs associated with our grand opening event at our new Tennessee facility, combined with an increase in compensation-related expenses, partially offset by lower profit sharing accrual and a reclassification of sublease income from other income to operating expense. Cash used in operations for the second quarter was $2.9 million, $32.4 million better than last year.

This reflects a $7 million reduction in inventory during the current quarter versus a $14 million increase in the prior year quarter, partially offset by a seasonal increase in accounts receivable. With capital spending of $34.9 million, most of which was related to our relocation, we used $37.9 million in net free cash during the quarter. In September, our board authorized the repurchase of up to $50 million of our common stock. Accordingly, during the quarter, we repurchased nearly 646,000 shares at an average price of $12.70, utilizing $8.2 million of this authorization. We paid $5.5 million in dividends and ended the quarter with $44.2 million in cash and $65 million in borrowings on our line of credit.

We continue to expect to be in a position to repay our line of credit by the time our relocation is complete. Finally, our board has authorized our $0.12 quarterly dividend to be paid to stockholders of record on December twenty-first, with payment to be made on January fourth. Looking forward to our third quarter, as Mark noted earlier, demand has been good and channel inventory of our products is healthy, particularly when compared to last year, when it was much more elevated. From Q2 to Q3 last year, sales grew 6.6%, with inventory in the channel declining.

During our current Q3, we expect channel inventory to remain at low levels and demand to be more robust, and therefore sales to grow at a higher rate than last year in terms of both units and dollars. Please note that we do expect ASPs to drop by approximately 5% from Q2 levels, given an increase in promotions and a shift in handgun mix to lower priced products. While demand for our products is expected to be healthy, we do expect margins to continue to be pressured in the short term. Lower production volume as we continue to manage inventory levels, the impact of our holiday shutdown on production days, and targeted promotions will result in third quarter gross margins on a reported basis being roughly flat sequentially. We expect margin percentage to rebound into the low 30s in the fourth quarter due to an increase in production.

Operating expenses will likely be in the same range in Q3 as we experienced in Q2, with expenses related to the SHOT Show in January being offset by a grand opening event in Q2. Our effective tax rate is expected to be between 24% and 25%. Finally, with only about $25-$30 million left to spend on the relocation, capital investment for this project is expected to conclude within the next several months. With cash generation targets above $75 million annually and normal capital spending requirements of approximately $25 million, we expect to have a debt-free balance sheet by this time next year and be in a strong cash position. As a reminder, our capital allocation plan continues to be: invest in our business, remain debt-free, and return cash to our stockholders. With that, operator, can we please open the call questions from our analysts?

Operator (participant)

Thank you. Ladies and gentlemen, at this time, we'll conduct our question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue.

For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Mark Smith with Lake Street Capital. Please state your question.

Mark Smith (President and CEO)

Hi, guys. I guess first question, just looking for any additional insights, Mark, that you might have on the, the promotional environment today, and, and, you know, continued outlook into, into ASP, maybe excluding new items. Do you feel like it's gonna have to push lower in the promotional environment? Do you feel like everybody's kind of staying relatively sane out there today?

Mark Smith (President and CEO)

Yeah, Mark, I think, you know, it's—it's—there's definitely the promotional activity has definitely picked up. You know, the, you know, we're—the, the, as we said, in the prepared remarks, you know, the, the, the demand is good for sure, you know, and it's picked up nicely from the summertime and, you know, it was encouraging to see, and we expect that to kind of continue. If you look at NICS, you know, in the last couple of months, you know, the last 60 days, October, November, that kind of increase, we, you know, we don't see anything that's gonna, you know, that's gonna slow that down. So, you know, that's kind of what we're forecasting going forward.

Mark Smith (President and CEO)

That said, you know, that's it, you know, still a competitive marketplace out there. There's still a lot of promotions. We do anticipate that that promotional, you know, environment will continue, but it's not crazy. It's not, you know, it's not gonna go to, you know, maybe go back five, six years ago, you know, the really, really heavy promotion and a lot of dollars being spent there. We don't see that. It's kind of, we're kind of back into that normal cadence.

So, as Deana said, I think, you know, I, you know, we, we do anticipate a little bit of, you know, pressure on the, on the ASPs, but, you know, it's, it's, it's gonna be in the 5% range. It's not gonna be anything crazy.

Okay. And then you brought up the NICS and kind of the demand environment. You know, as you guys look at the demand out there, you know, did you see that kind of uptick in October, early October, around you know outbreak of conflict? You know, and then as we've seen NICS remain higher here through November, you know, do you feel like this is sustainable growth, or you know was November maybe getting some tailwinds from events in October?

Mark Smith (President and CEO)

Yeah, I mean, I think that it definitely turned a corner in October. You know, you gotta remember, it usually turns a corner in October. You know, that's kind of when the season kicked off. Kicked off a little bit later than, you know, than maybe has been in some previous, quote, unquote, "normal years." But it's remained pretty steady, and I'll tell you, as we, you know, as we kind of sit here today, it's still steady now. So, you know, we're kind of into the busy holiday season, which is, you know, traditionally, and, you know, if you look at NICS, the NICS stack chart, you know, this is our busy time and, you know, and it's holding up.

So, you know, we don't see anything that's, again, that's gonna, you know, that's gonna materially change that. And we're going into an election year next year, which usually tends for the firearms industry to be, you know, elevated demand. You see a lot of the rhetoric around, around the industry and around the firearms.

Mark Smith (President and CEO)

Okay. And, and then, you know, new products, you know, mixed, pretty solid here this quarter, but especially as we look at the long guns. You know, it sounds like you've got some things coming up here, you know, next month as we move into SHOT Show. Maybe any insights you can give us into, you know, your comfort level with your pipeline around new products? Do you feel like, you know, maybe we'll be stacked a little heavier around SHOT Show, or, you know, should we still see a, a pretty steady, flow of new products throughout the year?

Mark Smith (President and CEO)

Yeah, I'll answer that in two ways. Yeah, the long guns is definitely, you know, kind of the bigger increase in NICS. And, you know, we're participating very well in that, so that our, you know, the FPC particularly is doing extremely well for us. We believe we're, you know, taking a lot of share with that product, and we anticipate to continue that cadence of new product introductions.

I mean, as I mentioned in the prepared remarks, you know, I think we're, you know, we're definitely the undisputed leader out there in innovation over the last two years, and we're, you know, we're anticipating to continue that cadence and keep that pressure up. So SHOT Show will definitely have a couple of big launches. It's a great opportunity for us to, you know, to get everybody all in the same place and get a lot of coverage on our new products. So we got a couple of big ones coming up then, but, you know, but that's not gonna be it.

You know, we got more coming. You know, there's gonna be, you know, a cadence of new products coming out. You know, you can kind of look back to the last year, that cadence, we expect that to be repeated again this year.

Mark Smith (President and CEO)

... Okay. And I think the last one from me, just as we think about, you know, the balance sheet, you know, it sounds like you're saying that a year from now, you guys would expect to be debt-free. You know, over that period, you know, do you expect to have some excess cash flow to still be able to do some share repurchases? Maybe walk us through kind of your thought process around capital allocation.

Mark Smith (President and CEO)

Yeah, I mean, as Deana covered, you know, obviously, we're not, you know, if we see the right opportunity, we're not, you know, we're not against, you know, doing some share repurchases when, you know, when we still have, when we don't have a debt-free balance sheet. We've got, you know, we got $65 million out on the line right now, and we repurchased $8 million in the, in, in the last couple of months.

So but, you know, I will say that going forward, while we're, while we're kind of getting back out of the line and getting to debt free, we'll probably we'll continue to obviously be in the market and be opportunistic, but it's gonna be a little bit more of a cautious approach. You know, as we kind of move past the, you know, the move and, you know, towards, you know, the tail end of Q3 and then a little bit into Q4, you know, with all those, that major spending will largely be done, and we'll be in a position to really kind of start to generate. If you remember, you know, we've always kind of communicated, we want at least a minimum of $75 million in, in cash generated.

But, you know, I'll just point you to, you know, the cash generation in the first half of this year alone is $37 million, and those are our two, two lowest quarters usually. So, you know, this year, obviously, you know, we're on track for a nice, a nice beat on that target. And, you know, and again, next year, we're going into an election year. You know, I think the short answer to your question is, yeah, we should be in a position where we've got a healthy balance sheet to start looking at returning value to the stockholders.

Mark Smith (President and CEO)

Excellent. Thank you.

Mark Smith (President and CEO)

Thanks, Mark.

Deana McPherson (EVP, CFO, Treasurer and Assistant Secretary)

Thanks, Mark.

Operator (participant)

Our next question comes from Steve Dyer with Craig-Hallum Capital Group. Please state your question.

Ryan Sigdahl (Senior Research Analyst, Consumer)

Good afternoon, Ryan, on for Steve.

Mark Smith (President and CEO)

Hey, Ryan. How you doing?

Ryan Sigdahl (Senior Research Analyst, Consumer)

Good. Good. Maybe staying on that last topic, last quarter, you were targeting to be debt-free by year-end. Now, sounds like Q2 next year. Guess, what are the puts and takes to, to shift that out?

Deana McPherson (EVP, CFO, Treasurer and Assistant Secretary)

Yeah, you know, we said by year-end would be April, right? So, we're being cautious. We are planning to make sure that we're providing that information to you. Right now, it could be April, it could be December. We're being cautious, and, you know, we have done share repurchases.

We're looking at, you know, that authorization is still out there, and, you know, we're gonna play it by ear and make sure that we protect our balance sheet, but also make sure that we're doing right by our investors as well.

Mark Smith (President and CEO)

Yeah, I think, you know, there's obviously some range in there, Ryan. And so, you know, I mean, the it'll be some time. It, it's not materially changing, I guess, is where I'm trying to get to, you know? So we said before, it was gonna be April, which is the end of our fiscal year, you know, it'll be within a couple of months of that, if it's not April.

Ryan Sigdahl (Senior Research Analyst, Consumer)

So it sounds like it's more a reallocation of capital. Potentially, you bought some stock back, potentially leaning in there versus a change in the underlying business and cash generation of the business. Is that right?

Deana McPherson (EVP, CFO, Treasurer and Assistant Secretary)

Correct.

Mark Smith (President and CEO)

Yeah, it was a very good assumption, yes.

Ryan Sigdahl (Senior Research Analyst, Consumer)

Good. Then just switching over to gross margin. So getting back to the low 30% target for Q4, is that sustainable in the next fiscal year, given Q4, you have the greatest production days, which helps you from an operating leverage and absorption standpoint? So I guess, is that sustainable, or is that, how much of the benefit in Q4 is from the higher production versus other factors that are maybe sustainable into, next year?

Mark Smith (President and CEO)

Short answer is yes, it's sustainable into next year. The reason is that this year, you know, you got to remember, we built a lot of inventory as we kind of came towards the move, and, you know, the tail end of a surge always gets a little bit of natural inventory build internally. So our production rates have been, you know, kind of, you know, artificially suppressed this year while we brought that inventory down.

Next year, that production, those production rates, you know, will be back to normal. And, you know, and we do anticipate some also some efficiency gains from the new facility in Tennessee. So, you know, I'll tell you the Q4 numbers that we're looking at right now also include of just a little bit at the beginning, also of some continued dual costs. So, you know, you know, so there's still even that 30% has got some headwinds associated with. So the short answer to your question is that, that's sustainable? Absolutely.

Ryan Sigdahl (Senior Research Analyst, Consumer)

Great. Thanks, Mark, Deana.

Deana McPherson (EVP, CFO, Treasurer and Assistant Secretary)

All right. Thank you.

Ryan Sigdahl (Senior Research Analyst, Consumer)

That's it for us.

Mark Smith (President and CEO)

Thanks, Ryan.

Operator (participant)

Thank you. There are no further questions at this time. I'll hand the floor back to Mark Smith for closing remarks.

Mark Smith (President and CEO)

All right. Thank you. And, thank everyone for joining us today and your interest in Smith & Wesson. Hope everybody enjoys Merry Christmas. Have a safe and Happy New Year, and we look forward to speaking with all- you all again next quarter.

Operator (participant)

Thank you. This concludes today's conference. All parties may disconnect. Have a good evening.