Smith & Wesson Brands - Q4 2023

Transcript

Operator (participant)

Good day, everyone, and welcome to Smith & Wesson Brands, Inc. Q4 and Full fiscal 2023 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 of General Counsel and Chief Compliance Officer)

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 our outdoor products and accessories business in fiscal 2021, COVID-19 related expenses 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. When we reference EPS, we are always referencing fully diluted EPS, and any reference to EBITDAS is to adjusted EBITDAS. 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 purchases.

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. Thanks everyone for joining us today. Before we move into a discussion of our results, on behalf of the company, our board, and the entire Smith & Wesson family, I want to take a moment to acknowledge the significant contributions to Smith & Wesson of Mike Golden, who passed away unexpectedly earlier this month. Mike served as our President and CEO from 2004 to 2011, as a member of our board of directors since 2004. The impact of his leadership and dedication to our industry, our company, and most of all, our employees, cannot be understated. Mike had a long and very successful professional career across multiple industries. He will be remembered fondly for accomplishing so much with a management philosophy and style of kindness, generosity, and gentle guidance.

We are grateful for our memories of Mike and deeply appreciate his commitment to the success of Smith & Wesson. Our thoughts and prayers are with his family and friends. On to a review of our business. Fiscal 2023 ended with a very solid Q4 as the headwinds we faced from elevated channel inventory throughout the first half of the fiscal year abated. Focused consumer promotions in the second half were successful in driving retail and distributor inventories down significantly, and we are now at or below targeted levels with every major customer. Most importantly, our retail market share data indicates that we've maintained our leadership position at the sales counter with the firearm consumer. Combined with lower inventory levels, this points to continued success throughout fiscal 2024.

This is all thanks to our seasoned team, who navigated through an extremely busy and challenging year, never losing sight of our long-term focus. Our operations team leveraged our flexible manufacturing model, adjusting production rates to match normalizing demand patterns, while still delivering impressive profitability. Our sales and marketing teams worked to maintain a strong presence with our consumers and our channel partners, designing and executing strategic promotions to take advantage of opportunities as they arose to maintain our market share leadership. The impressive slate of new products launched throughout the year, thanks to our new product development team, have bolstered Smith & Wesson's position as an innovation leader. Last but not least, none of this would be possible without the tireless dedication of our back-office support functions of HR, finance, legal, compliance, and IT, without whom we simply could not run the business day to day.

All of this while simultaneously navigating the challenges associated with our move to Tennessee, which is fully on track, as I'll cover in a few moments. I could not be more proud of the team and humbled to lead such a tremendous organization. Moving on now to a discussion of market conditions. All factors continue to point towards stable demand and normal seasonality. NICS was down low single digits on a year-over-year basis during our Q4, modestly below trends in Q3, and within normal variability. May NICS results continued to support the view that overall consumer demand remains steady compared to a year ago. Therefore, we expect that NICS will continue this trend throughout FY 2024, largely following the same demand pattern at the retail counter as we experienced in FY 2023.

Taking into account the channel inventory declines I just covered, we expect that our results will compare favorably to last year. We are still seeing a somewhat bifurcated market at retail, with entry-level price points and fully featured premium products both remaining strong. In our view, this continues to reflect overall macroeconomic conditions, where the average consumer spending is being squeezed by inflation. Importantly, we continue to be in a strong position to succeed despite these headwinds, as evidenced by our solid Q4 results. In this competitive environment, in addition to constantly monitoring and adjusting key aspects of production, pricing, and promotion to ensure supply is aligned with demand, we remain very focused on innovation. We view new product introductions as a key point of competitive differentiation.

Our new product launches in the second half of FY 2023, the M&P FPC, the M&P 5.7, the M&P Metal, the Competitor, and the Equalizer, have all been top-selling products, not just for us, but are for our retailers as well. With a robust pipeline of upcoming releases, you can expect us to continue this cadence throughout FY 2024. Before I hand the call over to Deana, just a quick update on the move to Tennessee. As I mentioned in my earlier comments, the project continues on track, with construction nearing completion. We have begun hiring and training our operations workforce, and equipment installation and testing is well underway. We expect to begin operations in August with the distribution go live, and are planning to have the front office employees in place by the fall.

It's also worth noting that with our upcoming move to Tennessee at the end of Q1, inventory on the balance sheet will remain elevated compared to historical levels, consistent with our plan for mitigating any potential disruptions. With that, I'll hand the call over to Deana to cover the financials.

Deana McPherson (EVP and CFO)

Thanks, Mark. Net sales for our Q4 are $144.8 million, or $36.5 million, or 20.1% below the prior year comparable quarter, which was as expected, given the change in the competitive environment from last year. We were pleased that inventory in our distribution channel continued to decline from January, resulting in five consecutive quarters of inventory reduction. Gross margin of 29% was below the 39.8% realized in the prior year comparable quarter and reflects a combination of reduced sales volumes, unfavorable fixed cost absorption due to lower production volume, the impact of inflation on material and labor costs, and the impact of promotional programs that were run during the quarter.

Operating expenses of $24.1 million for our Q4 were $1.4 million lower than the prior year comparable quarter due to a reclassification of sublease income from other income to operating expense. Excluding this adjustment, operating expenses were slightly above the prior year due to increased employee costs, mostly stemming from relocation factors, along with higher depreciation. We also had higher consulting expense, but this was almost entirely offset by lower profit-related compensation expenses, lower marketing costs resulting from the launch of a brand anthem in the prior year, and lower co-op advertising. Net income of $12.8 million in the Q4, compared to $36.1 million in the prior year comparable quarter, was entirely due to lower net sales and gross margins.

GAAP earnings per share of $0.28 was down from $0.79, while non-GAAP earnings per share of $0.32 was down from $0.82 in Q4 fiscal 2022. Turning to cash flows. During the Q4, we generated $38 million in cash from operations and spent $25 million on capital projects, resulting in net free cash of $13 million. We paid $4.6 million in dividends and ended the quarter with $53.6 million in cash and $25 million in borrowings on our line of credit. During our full year, we generated $16.7 million in cash from operations and spent $89.8 million on capital projects, resulting in $73 million in net free cash used for the year.

This use of cash represented a replenishment of depleted inventory, combined with approximately $73.2 million in capital projects related to the relocation. As Mark noted, the timing of the relocation is on target, and we expect to begin distributing product from Tennessee in our second quarter. We will incur an additional investment of $85 million-$90 million during fiscal 2024 related to this important project. With the relocation nearing the final phase, our board has authorized a 20% increase in our quarterly dividend, raising it to $0.12, to be paid to stockholders of record on July 13th, with payment to be made on July 27th. Looking forward to fiscal 2024, we expect consumer demand in fiscal 2024 to resemble fiscal 2023.

That being said, we anticipate that our top-line revenue will grow at a higher rate given the significant decline in inventory in the distribution channel that we experienced during the last fiscal year. Given the recent competitiveness of the promotional environment, we expect ASPs to be down by 5%-10% in fiscal 2024. With regard to seasonality, we expect fiscal 2024 to follow a similar pattern to fiscal 2023, with a higher proportion of revenue in the Q1 than we realized in Q1 2023, again, due to channel inventory. We expect margins to continue to be pressured by promotions and higher costs due to inflation and rising interest rates. The opening of the Tennessee facility will include additional one-time costs related to startup, inventory movement, and continuing employee severance and relocation, resulting in margin pressure.

Operating expenses will also likely be higher due to increased profit-related compensation costs, inflation, and one-time transition costs. We currently expect a total of $10 million-$12 million in transition costs, spread primarily in cost of goods sold, marketing, and general and administrative expenses. Finally, our effective tax rate is expected to be approximately 24%. With that, operator, can we please open the call to questions from our analysts?

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Our first question comes from Mark Smith with Lake Street. You may proceed.

Mark Smith (President and CEO)

Hi, guys. First up, just wanted to ask about long guns. Good to see what the recovery there. Was this due purely to new products, or was there anything else that helped drive the demand there?

Mark Smith (President and CEO)

Sorry, Mark, you broke up.

Deana McPherson (EVP and CFO)

Long, long guns. Hey, Mark, the long gun increase, the improvement there? [crosstalk]

Mark Smith (President and CEO)

Yes, exactly. Yeah.

Mark Smith (President and CEO)

Yeah. Sorry, you broke up there at the beginning. This is Mark. That's driven by a new product. As you know, we launched the M&P FPC at in the March timeframe or the in the Q4 there, it's very successful. Continues to be very successful and you know, over a third of our, of that number.

Mark Smith (President and CEO)

Excellent. Then any more update on the competitive environment, you know, especially as we look at pricing? You know, maybe any thoughts on inventory, you know, throughout your competitors and throughout the industry, but really want to hear about pricing competition.

Mark Smith (President and CEO)

Yeah, I mean, for us, our pricing, we've been able to hold our pricing nicely, actually, so we're very pleased with that, as you can see with the ASPs in this quarter. I think Deana covered, you know, a little color on what we, what we expect them to be going forward. We expect to hold 90%-95% on our, you know, on the gains we've been able to achieve there. You know, in the marketplace overall, it definitely as I kind of talked about in my prepared comments, there's definitely a bifurcation. There's, you know, kind of that lower end is, you know, doing well and a lot of volume there.

Again, at the higher end, it's, you know, less price-sensitive consumer, probably, and, you know, that's doing well as well. We've been able to be successful. You know, as you know, we run the gamut on our product line between, you know, good, better, best, and, you know, we've got plenty of product offerings in both of those categories. You know, we continue to believe that, you know, we won't have to, you know, promote aggressively any more beyond than what we've been doing already. That said, you know, the inventory in the channel right now, we're experiencing a normal summer, just like we did last summer. For us, specifically, we're very pleased, as we talked about in the comments, with where our inventory in the channel is.

That promotion we ran, in the beginning of the calendar year, was very successful in kind of correcting, you know, the last few pockets of inventory out there in the channel, for us. We're very pleased with where our inventory sits coming into the summertime and into this new fiscal year. As far as the channel inventory, you know, for other competitors, you know, I think, you know, I'd have a hard time kind of commenting on that. I'd be, you know, I'd be kind of giving you some more opinion than fact on that. I'm, you know, I'm going to kind of leave that to you to do some channel checks.

Mark Smith (President and CEO)

No, that's fair. Thanks. The last one for me, just it sounds like the timing of the move here to Tennessee is going really well. Any comments kind of on budget? You know, you've still got a fair amount of CapEx here to spend. Any thoughts on kind of how the project has been moving relative to budget?

Mark Smith (President and CEO)

Yeah, we, as you know, I think we talked about in some previous calls, you know, we were definitely over our initial estimates when we came into the project, just given the inflationary environment. If you think about in the last. You know, we started this project two years ago, and think about what the inflation has done in that time frame. That said, though, it really has plateaued. You know, we don't anticipate that, you know, from our last estimate, which was in the $160 million-$170 million range in total, we still very much expect that it's going to come into that range. No further, you know, inflation creep on that project.

Mark Smith (President and CEO)

Excellent. Thank you.

Mark Smith (President and CEO)

Got it. Thanks, Mark.

Operator (participant)

Thank you. As a reminder, to ask a question, you will need to press star one one on your telephone. Our next question comes from Steve Dyer with Craig-Hallum Capital Group. You may proceed.

Steve Dyer (CEO and Senior Research Analyst)

Thank you. Good afternoon. Along those lines, it looks like, I think if I recall, you had guided $115-$120 on CapEx for fiscal 2023. $30 or $40 of that slipped to fiscal 2024. Is that right?

Deana McPherson (EVP and CFO)

Yeah, that's a lot of that is the way that you report in GAAP financials, is that anything that's in accounts payable that didn't get paid before the end of the year, doesn't sit in your cash flow statement. There's a chunk of it that slipped just because of, you know, timing of payables, and then the rest of it's just gonna fall into our first and second quarter, just based on construction timing and when the bills come in.

Steve Dyer (CEO and Senior Research Analyst)

Gotcha. I guess, why would payables go into CapEx on that statement?

Deana McPherson (EVP and CFO)

What happens is, you have to remove them out of both payables and out of capital, because it's a cash flow, and the way the GAAP requires you is, if you haven't paid it by April 30th, it's gotta come out of your capital spending.

Steve Dyer (CEO and Senior Research Analyst)

Gotcha, okay.

Deana McPherson (EVP and CFO)

There was a good chunk of it at the end of the year, where we had received bills, but just based on the timing of payment, it didn't go out the door, until the beginning of May, and so it comes out of that number.

Steve Dyer (CEO and Senior Research Analyst)

Gotcha. I guess I'm trying to think back to when you guys first decided to make the move, and it's been more expensive, it sounds like, than you expected, which I understand. Can you sort of refresh our memory as to the rationale at the time for the move? I mean, you guys are gonna be $200 million into this thing, and just kind of wondering what the payback looks like on that.

Mark Smith (President and CEO)

Yeah. I guess that's two questions. The primary driver of the move, and, you know, the beginning of the discussion was due to some, you know, unfavorable legislation that was being proposed in the state of Massachusetts that was gonna be extremely damaging to our business. You know, there was some proposals, essentially, that would prohibit us from being able to produce about 60% products that make up about 60% of our revenue. That was kind of the impetus to begin on the project. As far as the payback goes, you know, we've been operating, you know, I think, as you know, Steve, out of this facility, you know, here in Massachusetts for, you know, this specific facility since the 1940s.

You know, and it's and it's been very good to us, and we, you know, we're gonna continue operating out of this facility, quite frankly, on the manufacturing side, you know, indefinitely. As we, you know, as we move the assembly operations out, though, and plastic injection molding and align that with our distribution operations out of Missouri, and now are kind of looking at a big open box. It's, you know, if you wanna say it's a once-in-a-lifetime opportunity to look at efficiency improvements on the operational side. We anticipated those, at that time, to be in the, you know, $0.07-$0.10 EPS range. You know, we still believe that to be the case.

You know, when you think about that as a payback, you know, it's, you know, it's pretty significant and, you know, and still makes the investment worthwhile in the long term, aside from the, you know, existential risk to the business.

Steve Dyer (CEO and Senior Research Analyst)

Yep, that's helpful. Thank you. As you flip to fiscal 2024, it sounds like you sort of expect end consumer demand to be relatively healthy. Or, consistent, I guess, with this last year, steady. Would you expect any restocking, or do you feel like the channel's at a spot where it's gonna sort of stay, and you guys will sort of ship more towards end demand?

Mark Smith (President and CEO)

I think there is an opportunity for a little bit of restocking with us, as I said in some of the prepared remarks, you know, that we're below, we're at or below our targeted inventory levels, as we've talked about before, is 8 weeks of supply with our major distributors. There's an opportunity for a little bit of restocking with us. You know, that said, you know, we're not operating at two weeks, you know, I mean, we're in the seven-week range, you know, on average. Some of those distributors definitely will have an opportunity to restock. We are looking, though in answer to your question, in short, yes, we'll be a lot more tied to what's happening at the retail counter.

We do anticipate to continue that cadence of new product. Mark's question earlier about where the long gun increase came from, that was from a new product. We've got some new products coming, I'll just tell you, in the next, you know, one coming out in the next couple of weeks. That cadence continuing throughout the rest of our fiscal year, that are gonna be, you know, that type of, you know, product category. That type of product in that category. You know, we anticipate to be able to, you know, very much keep up with the market and, you know, and the goal, obviously, is to continue gaining market share. Yes, we'll be, you know, in line, but we, you know, we're working to make that consumer retail activity higher for us than others.

Steve Dyer (CEO and Senior Research Analyst)

Sure. Yep. Okay. Thanks very much. Appreciate the time.

Mark Smith (President and CEO)

Yep, yeah.

Deana McPherson (EVP and CFO)

Thanks, Steve.

Operator (participant)

Thank you. This concludes the Q&A session. I'd now like to turn it back over to Mark Smith for any closing remarks.

Mark Smith (President and CEO)

All right. Thank you, everybody, and thanks, everyone, for joining us today. We look forward to speaking with you next quarter.

Operator (participant)

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