Smith & Wesson Brands, Inc. (NASDAQ:SWBI) Q2 2023 Earnings Call Transcript

Smith & Wesson Brands, Inc. (NASDAQ:SWBI) Q2 2023 Earnings Call Transcript December 6, 2022

Operator: Good day, everyone, and welcome to Smith & Wesson Brands, Inc. Second Quarter 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: 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 & 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. Also, when we reference EPS, we are always referencing fully diluted EPS.

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. Before I hand the call over to our speakers, I would like to remind you that any reference to EBITDA is to adjusted EBITDA.

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. With firearm demand continuing to normalize, our second quarter results once again demonstrated the significant progress we’ve made over the past several years in creating a highly adaptive and robust business model that consistently delivers strong profitability regardless of market conditions. A comparison back to our fiscal 2020, which was the last period of normal firearm demand provides a great illustration. While top line revenue increased by 6% in Q2 of this year versus FY ’20, EBITDA increased by nearly 90%, driven by higher ASPs and lower operating costs. Looking forward to the second half of our fiscal year, while we anticipate more normal demand levels, our seasoned team has effectively managed through these cycles before, and our business model is specifically designed for this, and we expect to continue delivering strong level of profitability even with the significant one-time expenses associated with our move to Tennessee.

All of this is thanks to the hard work of the Smith & Wesson team in remaining steadily focused on the long-term success of the business, no matter the conditions. And as always, our appreciation for their dedication cannot be overstated. Turning now to the market. Consumer demand for firearms as measured by NICS was largely consistent from our fiscal Q1 to Q2, tracking below the surge period. The trend worsened in the latter half of our second quarter, as evidenced by the accelerated year-over-year decline in monthly NICS, ending with October only nominally increasing sequentially and representing the lowest sequential increase over September on record. Not surprisingly, this deterioration coincided with the broader consumer slowdown, driven by persistently high inflation, the beginning of the winter heating season across the northern half of the country and rising interest rates.

But this said, the most recent data from November NICS released last week indicates a return to more normal demand patterns, and firearm demand does remain healthy when compared to historical levels and remains elevated when compared to our FY ’20, which again was the last pre-pandemic period. This indicates that the temporary headwinds are being offset by longer-term tailwinds. As you’ll recall, there were more than 10 million new consumers added to the firearms market over the past 18 to 24 months, many of whom are now returning for subsequent purchases. With these new entrants, previous studies indicating that firearms enthusiasts will own an average of seven to eight firearms and recent data showing that conceal carry is on the rise, we believe long-term demand trends remain very healthy.

However, with the uncertainty surrounding the current economy and its impact on firearm demand levels, many firearm retailers and distributors continue to take a cautious approach and continue to adjust inventory levels. This is creating a near-term headwind to our business, as we discussed on the last earnings call. Importantly, this is a normal and healthy process and consistent with how we have seen the market adjust in past periods following significant surges in demand. And we note that inventory levels for our products within our distributors and strategic retail accounts are down considerably sequentially and versus prior year, marking the third consecutive quarter of significant channel inventory declines and indicating therefore, a solid pull-through of our products at retail.

All of this means we remain in a highly competitive environment and winning profitable market share at the consumer level remains our core focus. With many consumers squeezed by inflation and record prices for household essentials, consumer price sensitivity on discretionary purchases has increased, predictably, leading to increased promotional activity within the firearm space. As we have mentioned before, we take a very strategic approach to pricing and are confident in the pricing actions we’ve taken to align our ASPs with the power of the Smith & Wesson brand and our long-standing reputation for quality and innovation. We believe we are now well positioned versus competing products across the full feature value spectrum. The resulting higher ASPs have driven strong profitability by helping us mitigate inflationary pressures and also partially offsetting lower volumes.

We expect our use of promotional activity in this competitive landscape to similarly remain aligned to ensure we do not erode those gains long term. However, we may increase promotional activity on certain of our core product lines in the second half of our fiscal year to address the realities of the current challenging economic conditions. Additionally, and now more than ever, innovation and new product introductions are critical to continuing our leadership position in the industry. Thanks to the hard work of the Smith & Wesson engineering and product management team throughout the pandemic, we are very well positioned to continue our steady cadence of product launches. Just in the past few months, we introduced our M&P metal, a full metal version of our iconic M&P full-size pistol, our equalizer, a 15-round concealed carry pistol, featuring our patented EV technology, which reduces slide racking force by over 35% and our competitor made by our Performance Center in collaboration with our legendary pro-shooting team of Jerry Miculek and Julie Golob, a full-featured metal frame pistol ready for competitive shooting straight out of the box.

These products have been very well received by the market and are exceeding our expectations. And stay tuned, we have several more exciting new products lined up for introduction throughout the second half of our fiscal year. In summary, we continue to manage the business for the long term, ensuring we consistently deliver high levels of profitability regardless of which direction demand is trending. Fiscal 2023 continues to be a year of recalibration an adjustment for our industry and Smith & Wesson. Interest in shooting sports remains strong and participation rates remain above pre-pandemic levels, which bodes well for the long term. Over the near term, the industry is facing the dual challenge of a cyclical downturn and more intense macroeconomic headwinds, pressuring consumer spending, particularly on discretionary items, such as firearms.

While this will likely to continue to impact our top line revenue over the balance of fiscal 2023, it is precisely the type of environment for which our flexible model was built, and we expect to remain highly profitable and continue delivering on our commitments to our customers, employees and stockholders well into the future. With that, I’ll hand the call over to Deana to cover the financials.

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Deana McPherson: Thanks Mark. Net sales for our second quarter of $121 million was $109.4 million or 47.5% below the prior year comparable quarter, but $7.3 million above the second quarter of fiscal 2020, the last pre-pandemic comparable second quarter. As we noted in our last earnings call, we expected our second quarter volumes to be roughly 20% to 25% of the full year, and we came in within that range. For the third consecutive quarter, inventory in our distribution channel has meaningfully declined. This ongoing inventory correction, combined with the impact of promotional activity by our competitors and the trading down by consumers to lower-priced products negatively affected our quarterly sales. On a positive note, however, the discipline that we’ve exhibited in promotions during the current quarter has improved our overall profitability when compared with pre-pandemic levels, reflecting ASPs that were approximately 45% above fiscal 2020.

Although gross margin in the second quarter of 32.4% was well below the 44.3% realized in the prior year comparable quarter, the increase in ASPs resulted in a 4% improvement over the second quarter of fiscal 2020. Relocation costs negatively impacted the current quarter gross margins by 1.5% in the comparable quarter last year by 0.5%. The decrease in margins from last year was also due to a combination of reduced sales volumes across nearly all product lines the impact of inflation on material and labor costs, unfavorable fixed cost absorption due to lower production volume and unfavorable product liability and inventory valuation adjustments partially offset by decreased compensation costs. Operating expenses of $26.7 million for our second quarter were $9.9 million lower than the prior year comparable quarter primarily due to a $3.1 million reduction in relocation costs, lower sales-related expenses, such as co-op advertising and freight and decreased compensation-related costs driven by temporarily unfilled positions, we believe, as a result of the relocation.

Net income of $9.6 million in the second quarter compared to $50.9 million in the prior year comparable quarter, reflecting lower net sales and gross margin slightly offset by reduced operating expenses. However, when compared to the second quarter of fiscal 2020, net income was $9.3 million higher this quarter due to higher ASPs and lower operating and interest expenses. GAAP earnings per share of $0.21 in the second quarter was down from $1.05 last year, but was $0.20 more than we reported in the second quarter of 2020. Non-GAAP earnings per share of $0.26 was down from $1.13 in Q2 fiscal 2022, but $0.24 higher than in fiscal 2020. EBITDA of $25.6 million represented 21.1% of sales. During the quarter, we used $35.3 million of cash from operations and spent $28 million for capital projects, resulting in net free cash used of $63.3 million.

This was consistent with our expectations, given our planned inventory build during the quarter, payment of profit sharing from fiscal 2022 and increased spending on the construction of our new facility in Tennessee. We remain focused on managing the business for long-term profitability, market share performance and capital return to our stockholders. To that end, our board has authorized our $0.10 quarterly dividend to be paid to stockholders of record on December 20, with payment to be made on January 3. Looking forward to the third quarter. Now that we are operating under a more normal seasonal demand model with distributor inventory at more comfortable level, our earlier estimate of 20% to 30% unit volume for the third quarter continues to appear reasonable.

We expect that margins will continue to be pressured by costs associated with relocations, inflation and lower volume than the prior two years. In addition, we’ve begun to increase promotional activities on select products and expect that to continue through most of the rest of this year, which will likely affect ASPs, margins and operating costs. And finally, as show season begins in January, both sales and marketing costs are likely to grow beyond our current quarterly run rate. We remain committed to our long-term financial targets and while the low end is still within reach for fiscal ’23, recent industry trends have created additional uncertainty as we are also being impacted by the one-time costs related to the construction of the Tennessee facility and equipping it with state-of-the-art machinery.

When you combine these one-time costs with the working capital needs of our business to meet cyclical consumer demand and costs associated with preparing for next summer’s move, we will likely continue to experience negative free cash flow during our third quarter even with inventory beginning to decline seasonally. 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.

Q&A Session

Operator: Our first question comes from the line of Mark Smith of Lake Street. Please go ahead.

Mark Smith: I just want to start out just talking big picture on kind of the promotional environment. It seems like it’s gain steam kind of around the holidays in Black Friday. It doesn’t seem like you guys have followed suit. Is that correct? And then, it sounds like you may be open a little bit more here in the second half to be a little more promotional, but it doesn’t sound like you’re going to follow what we’re seeing from some peers and get overly promotional here in the second half.

Mark Smith: Yes. That’s a good question, I think. So, so far, yes, the answer is we haven’t participated to the level of some of our competitors. I think we’re taking a little bit as we kind of — as I said in some of the prepared remarks, we’re kind of taking more of a longer-term approach. We don’t want to erode those ASPs that we’ve been able to gain over the last couple of years. We do feel like we’re in a good position versus the competition and what the brand should be able to command. With all that said, we’re — sorry, and one more thing. We’re also going to try and push a little bit more on new product and get a little bit rather than being totally reactive and just going in straight into promotions, there’s some things we can do with new products to kind of drive volume and maybe some bundling with some accessories, et cetera, so a little bit more creative things.

All that said, I think we all understand that the economic conditions are what they are, especially for discretionary items like firearms. So, we’re kind of going to have to play the hand we’re dealt as we kind of go forward here. And so, I think your question of are we going to participate in a more meaningful in promotions in second half, the answer is probably yes.

Mark Smith: Okay. And it looks like just as we look near term, and I know you don’t and haven’t given kind of quarterly guidance. But given we saw some handguns 9 millimeters being sold by peers at $200-or-so at retail, plus rebates, I would expect that you’re not expecting any significant volume growth here in the near term as peers are overly promotional?

Mark Smith: Yes. I think Deana kind of gave some comments — some color to that in her prepared remarks around the percentages of unit volume that we expect for the first half versus the second half. And so, I think we’re kind of holding to that. I think you can probably get to where you need to be based on some of the comments that Deana gave on the percentages first half versus second half on unit volume.

Deana McPherson: I mean, generally speaking, Mark, we don’t expect Q3 to be terribly different from where Q2 came. The seasonality may change. We’ll see how the Christmas season goes and reorders in January. But right now, we’re not forecasting it to be terribly different than Q2.

Mark Smith: And then your Q4, as you know, you’ve been around a while. Q4 is usually for us, our fiscal Q4 is usually kind of — you get that pickup in Q4. So kind of go back to historical and expect that same kind of pickup we’ve had historically pre-pandemic.

Mark Smith: Yes. And that’s just — I want to walk through just your new product launches and moving to more kind of historical norms and kind of timing of shipments. Within your inventory build at the end of the quarter, can you speak to maybe how much of that was new product as you had some new products that we’re launching kind of at the end of the quarter?

Mark Smith: Not a lot of it. Our new products, just the timing of it we usually load into the channel prior to the actual consumer launch that it’s available at retail once we start talking about it. So you’ll note that we launched the — those new products were right at the beginning of November. So, we had really loaded a lot of those in already and then middle of November. So, they were already starting to ship into the channel. So a lot of that inventory build was not associated with new products.

Mark Smith: Okay. And then as you just discussed Q4 the April quarter, maybe seeing a little bigger build in shipments, is that primarily due to continued new product launches and getting that product into distributors and retailers’ hands?

Mark Smith: Yes, yes. Our second half will continue. You saw the cadence kind of pick up, and we almost had kind of one new product launch every month since September — end of — right at the end of October, beginning of September, one then at the beginning of October and — sorry, end of October, beginning of November, and then one just most recently with the competitor that we do anticipate to kind of continue a pretty steady cadence probably not to that level, but throughout the second half. So, the second half does have a lot of new products included in.

Mark Smith: Okay. And it might be digging a little bit here just into your plans on launches, but a lot of your products that you have launched recently have been at mid- to higher end of maybe ASPs and price points. Should we expect that going forward? Or is there a chance that you come out with more lower and introductory type products going forward?