Smith & Wesson Brands, Inc. (NASDAQ:SWBI) Q4 2023 Earnings Call Transcript

Smith & Wesson Brands, Inc. (NASDAQ:SWBI) Q4 2023 Earnings Call Transcript December 7, 2023

Operator: 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: 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 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: Thank you, Kevin, and thanks, everyone, for joining us today. We are 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 the 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 mixed 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 innovations, 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 EBITDAS 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 completed 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. A strong balance sheet and a 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 the local — 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, I’ll hand the call over to Deana to cover the financials.

Deana McPherson: Thanks, Mark. Net sales for our second quarter of $125 million was $3.9 million or 3.2% above the prior-year comparable quarter. Inventory in the distribution channel remained steady with the 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 volumes 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 absorptions 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 the 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. The 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 a $0.12 quarterly dividend to be paid to stockholders of record on December 21st, with payment to be made on January 4th. Looking forward to our third quarter, as Mark noted earlier, demand has been good and channel inventory of our products is healthy, particularly with 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. In 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 volumes 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-30%s 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 our grand opening event in Q2.

Our effective tax rate is expected to be between 24% and 25%. Finally, with only about $25 million to $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 for questions from our analysts?

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Q&A Session

Operator: Thank you. And ladies and gentlemen, at this time, we’ll conduct our question-and-answer session. [Operator Instructions] And our first question comes from Mark Smith with Lake Street Capital. Please state your question.

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

Mark Smith: Yes, Mark, I think it’s — there’s definitely the promotional activity definitely picked up, as we said in the prepared remarks the demand is good for sure. You know, and has picked up nicely from the summer time and it was encouraging to see and we expect that to kind of continue. If you look at NICS last couple of months last 60 days, October, November, that kind of increase, we don’t see anything that’s going to — that’s going to slow that down. So that’s kind of what we’re forecasting going forward. That said it’s still a competitive marketplace out there, still a lot of promotions. We do anticipate that that promotional environment will continue, but it’s not crazy. It’s not going to go to maybe go back five, six years ago really, really heavy promotion, we had a lot of dollars being spent that we don’t see that as kind of, we’re kind of back into that normal cadence.

So, as Deana said, I think we do anticipate a little bit of pressure on the ASPs, but it’s going to be in the 5% range, it’s not going to be anything crazy.

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

Mark Smith: Yes, I mean I think it definitely turned the corner in October you got to remember, it usually turns the corner in October that’s kind of when the season kicked off, kicked off a little bit later than maybe has been in some previous “normal years” but it’s remained pretty steady. And I’ll tell you, as we — as we kind of sit here today, it’s still steady now. So we’re kind of into the busy holiday season which is traditionally if you look at NICS — the NICS stack chart this is our busy time and it’s yes, it’s holding up. So we don’t see anything that’s, again that’s going to that’s going to materially change that and we’re going into an election year next year, which usually tends to the firearms industry to be elevated demand, you see a lot of rhetoric around the industry and around the firearms.

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

Mark Smith: Yes, I’ll answer that in two ways. Yes, the long guns is definitely, kind of, the bigger increase in NICS and we’re participating very well in that, so that the FPC particularly is doing extremely well for us. We believe we’re 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 I think we’re definitely the undisputed leader out there in innovation over the last two years and we’re anticipating to continue that cadence and keep that pressure up. So, SHOT Show, we’ll definitely have a couple of big launches. It’s a great opportunity for us to get everybody on the same place and get a lot of coverage on our new products.

So, we got a couple of big ones coming up them but that’s not going to be a — we got more coming out of this new cadence of new products coming out. You can kind of look back to last year, that cadence, we expect that to be repeated again this year.

Mark Smith: Okay. And I think the last one for me, just as we think about the balance sheet it sounds like you’re saying that a year from now, you guys would expect to be debt-free. Over that period, 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: Yes, I mean, as Deana covered obviously, we’re not if we see the right opportunity, we’re not against doing some share repurchases when we still have — when we don’t have a debt-free balance sheet, we’ve got — we got $65 million out on the line right now and we repurchased $8 million in the — in the last couple of months. So — but I will say that going forward, while we’re — while we’re kind of getting back out on the line and getting to debt-free, we’ll probably be — we’ll continue to obviously be in the market and be opportunistic, but it’s going to be a little bit more of a cautious approach. As we kind of move past the move and towards the tail end of Q3 and a little bit into Q4 with all those — that major spending will largely be done and we’ll be in a position to really kind of start to generate.

And if you remember we’ve always kind of communicated we want at least a minimum of $75 million in cash generated, but I’ll just point you to the cash generation in the first half of this year alone is $37 million and those are our two lowest quarters usually. So this year, obviously we’re on track for a nice — a nice beat on that target, and again next year, we’re going into election year, so I think the short answer to your question is, yes, we should be in a position where we’ve got a healthy balance sheet to start looking at returning share — returning value to the stockholders.

Mark Smith: Excellent. Thank you.

Mark Smith: Thanks, Mark.

Deana McPherson: Thanks, Mark.

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

Ryan Sigdahl: Good afternoon, Ryan on for Steve.

Mark Smith: Hey, Ryan. How you doing?