Clarus Corp Q2 FY2023 Earnings Call

Thank you. Before we begin, I'd like to remind everyone that during today's call, we will be making several forward-looking statements, and we make these statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act. These forward-looking statements reflect our best estimates and assumptions based on our understanding of information known to us today. These forward-looking statements are subject to potential risks and uncertainties that could cause the actual results of operations or financial condition of Clarus Corporation to differ materially from those expressed or implied by the forward-looking statements. More information on potential factors that could affect the company's operating and financial results is included from time to time in the company's public reports filed with the SEC. I'd like to remind everyone this call will be available for replay through August 7, 2024, starting at 7:00 p.m. Eastern Time tonight. A webcast replay will also be available via the link provided in today's press release as well as on the company's website at claruscorp.com. Now I'd like to turn the call over to Clarus' Executive Chairman, Warren Kanders. Warren?

Thank you, Cody. Good afternoon, and thank you all for joining Clarus' earnings call to review our results for the second quarter of 2023. I am joined by our Chief Operating Officer, Aaron Kuehne; and Chief Financial Officer, Mike Yates. I will start by addressing the overall business and corporate strategy. Aaron will provide an update on each of our segments, and Mike will walk through our financial performance for the quarter. Our second quarter results were negatively impacted by the continued challenging macroeconomic environment and related headwinds. We were seeing destocking take place, particularly in North America. The overall promotional environment, coupled with retailers tightening their inventory positions and open-to-buy dollars weighed on our performance. We took effective countermeasures during the quarter, generating free cash flow of $12.3 million versus $2.3 million during the same period last year. I am pleased that each segment was cash flow positive during the quarter as we right-sized the businesses to match expected demand for the year. Since the beginning of the year, we have undertaken a strategic review of all of our businesses, including our management structure. During last quarter's call, we highlighted the inflection point in our organizational evolution and the strategic shift to decentralize and focus on individual segment performance. As part of this strategy, we have made several significant changes to date, which we expect to contribute to long-term value creation. We continue to evaluate all of our businesses and their strategic initiatives to maximize value. We believe that the sum of the parts of our three segments exceeds today's market valuation. We continue to evaluate our corporate structure. And inclusive of the changes we have already made, we have a series of initiatives in place that we expect will reduce our normalized corporate overhead by $1.5 million compared to that of 2022. While we are experiencing a challenging retail landscape, the changes we have made through the first half of this year and the further cost-outs and savings initiatives we expect to make in the next six months are foundational to our growth strategies. Our management teams continue to seek to simplify their businesses and invest more dollars into commercializing new products and improving sales channel management. We have worked with our retail partners carefully to help drive sell-through, while working with our supply chain partners to dynamically manage the flow of inventory to seek to reduce inventory levels while ensuring on-time deliveries and higher levels of fulfillment. We are excited by the ongoing work of our three segment leaders. Specifically, on Outdoor and Adventure, we now have two new leaders who are laying the foundation for anticipated future growth and improved profitability. Our focus for the balance of the year will be on ensuring that the starting point for next year is optimized organizationally and clean from a balance sheet perspective. Later on in the year, we will be introducing our segment leadership team and their vision for long-range plans. Despite the headwinds outlined, we continued to see monthly sequential improvement during the quarter. In Outdoor, we saw increasing sales each month, driven by a strong push in direct-to-consumer, aiding our inventory work down. While we saw some margin degradation due to off-price and promotional activity, we still increased our outdoor gross margin by 440 basis points to 37.5%, achieving our plan to generate cash and further normalize inventory. I am pleased with the continued performance in our Adventure segment. During the second quarter, we saw continued stabilization in the market for our adventure products, resulting in improved gross margins of 370 basis points to 42.4% for the Adventure segment. We continue to see normalized levels in sales in Australia, which we expect to increase in the seasonally stronger second half as we introduce exciting new products. Adventure's U.S. business experienced strong growth month-over-month during the quarter, improving sales by 63% over the first quarter of 2023. Consistent with how others have reported in the channel, our Precision segment experienced sales declines of 27% while holding EBITDA margins at 26%. We have taken costs out to match our expected production and sales levels, which we believe will drive higher margin in the second half. Further, we took important strategic steps to stabilize our component supply chain, which we expect will enhance our ability to build programs for our partners going into 2024. To summarize, we believe that we have reached the trough in our Outdoor and Adventure segments, and the quick actions we have taken to right-size those segments should set us up for more profitable growth in future periods. While Precision has experienced a slowdown from market dynamics and the normal summer slump, we believe that the hunting season and the looming election cycle into 2024 should catalyze demand. With that, thank you for being with us today, and I will turn the call over to Aaron.

Thanks, Warren. I would like to dive into specific comments on our segment performance. First, let me address Outdoor. Our Outdoor segment was impacted by lower consumer demand, given the inflationary environment and continued lower open-to-buys as retail partners right-size their inventory. Additionally, our retail partners are acting conservatively in terms of building back inventory, specifically weeks of inventory on hand, where we are seeing key retailers behave conservatively and shorten up their weeks of supply. We believe this is due to bloated inventory levels industry-wide, specifically private label products, which impact overall working capital and open-to-buy dollars. However, as we head into Q3, we are starting to see retail purchasing habits normalize, but we do expect it will take until year-end before the market approaches equilibrium. Somewhat offsetting this weakness was a 28% increase in our direct-to-consumer business, which we believe shows the strength of the Black Diamond brand despite the broader retail environment. Looking ahead for the year, our top priority in Outdoor remains seeking to bring supply and demand into better alignment across our regions and channels, while reducing our outdoor inventory levels by 15% by the end of this year compared to the end of 2022. Also at the top of our priority list is the goal of rebuilding our go-to-market approach in North America, baselining our apparel initiative, and bolstering our digital presence. In our Precision segment, we experienced lower sales year-over-year as retail inventory came in line with historical levels. While Sierra and Barnes were each off approximately 27% over the prior year period, we think it is relevant to take a longer historical view where Barnes was up 5% over 2021 and over 100% during the same period in 2020. While Sierra was down 19% versus 2021, it was up 38% over the same period in 2020. The investments we have made in capacity and our continued partnership with OEM customers and retailers yielded meaningful share gains over the last three years. We continue to see a highly promotional environment for commodity ammunition as consumers look for value. We're also seeing open-to-buy dollars tighten as our retail partners remain conservative with weeks of inventory on hand. We are seeing positives, however, as reloaded component availability loosens up, which should help our consumers who purchase our green box and black box component bullets for reloading, especially as we head into the hunting season. Military and law enforcement opportunities are also coming into focus. As we head into the second half of the year, our partners continue to expect the hunting season to pull through for highly promotional activity to subside by year-end. As Warren mentioned, we are pleased with the progress we've made in short shell cases through a strategic supply agreement that covers us over the next 2.5 years, which will improve our ability to drive ammunition programs and better serve our retail and distribution partners going into 2024. Finally, our Adventure segment. We continued to experience sales improvement each month of the quarter, while substantially increasing our gross margin and EBITDA levels. In our brand's home market of Australia, inventory levels have improved with our retail partners. And in North America, we continue to right-size our sales channels and began to experience the early signs of recovery that we expected. For example, we have partnered with several of our strongest retail partners here in North America to support sell-through and increase the velocity of their destocking efforts. With one of our accounts, this has resulted in a year-over-year increase of 60% in Rhino-Rack branded products sold, while the category itself is down high single digits. These efforts are not only expanding Rhino-Rack's market share but also further reinforcing our strategic relationships, demonstrating our ease of doing business with, accelerating their destocking efforts and further positioning Rhino-Rack for growth. Just as important, our gross margins in Adventure for the quarter ended up at 42.2%, which represents the highest margin quarter since mid-2021. We have made strides to right-size direct labor, assembly, and overhead while reworking input costs in core products. For context, our gross margin for fiscal year 2022 was 35.4%, and our 2023 year-to-date gross margin was 41.6% on sales that were 37% lower than the same period. Our goal for the remainder of the year is to maintain our gross margins while driving inventories down, as we introduce next-generation products in Q4 in Australia and globally in 2024. The business has strong fundamentals in place, and we expect that as our growth initiatives take hold, we will see strong operating leverage from the organizational reshaping. While vehicle levels haven't fully rebounded, we are starting to see green shoots with regards to vehicle availability. We expect the supply and demand imbalance with new vehicles to persist through the fourth quarter, but we have important initiatives that we believe will accelerate our growth in the back half of the year for Adventure. Let me lay them out here. First, we will focus on transforming our product development and innovation process to seek to drive improvement in speed to market and product differentiation. We have a renewed focus on customer and consumer insights to drive overhauled product hierarchy. A key part of our go-to-market evolution will be how we create and launch products as part of a larger ecosystem of lifestyle demands. Next is customer service, with a renewed focus on our key account partnerships and key account programs, the goal to be the easiest partner to work with in the industry. Our people will be empowered to take action to drive performance and deliver on the challenge with an understanding that there are different business models for different customers. Next is digital transformation. We are planning to maximize our operational infrastructure to develop our e-commerce platforms to support both B2B and B2C opportunities. We aim to build our distribution strategy around the consumer in a way that will continuously strengthen our premium market positioning and drive the pricing power. And finally, we will be data-led in our decisions. We are developing a demand and data-driven operating model that plans, buys, and sells inventory closer to demand. Now, I'll pass the call to Mike to discuss our Q2 financial results in more detail.

Thank you, Aaron, and good afternoon. Jumping right into our performance in the second quarter. Sales were $83.7 million compared to $114.9 million in the prior year quarter. On a constant currency basis, total sales were down 26%, while reported sales were down 27%. Second quarter sales in our Outdoor segment were down 24% to $40.1 million versus $52.6 million in the second quarter of 2022. If you adjust for the foreign currency exchange headwind, Outdoor sales were down 23%. As Aaron mentioned, we are still constrained by lower open-to-buys from our key North American retail partners, due in part to their inventory destocking activities. Partially offsetting this decline was continued strong execution in our direct-to-consumer business at Black Diamond. Precision Sports sales were $25.8 million in the second quarter compared to $35.2 million in the second quarter of last year. In the quarter, we experienced broad-based discounting from our competitors and retail partners as the market continued to right-size inventory levels. Our ammunition business has been a significant headwind for the first half of the year on gross margin. However, we remain very optimistic that Precision Sports and the market will return to solid demand as we move to the second half of the year, supported by the upcoming hunting season. The Adventure segment contributed sales of $17.9 million versus $27.1 million in the prior year quarter. And on a constant currency basis, sales were down 31% and reported sales were down 34%. Despite these challenging market conditions, we believe we are starting to see stabilization in the market as sales were up on a sequential basis compared to the first quarter of 2023, and we expect to see sequential improvement in sales in both the third and fourth quarters of 2023. Rhino-Rack's U.S. business did well during their peak selling season here domestically, and some of the cost actions we've taken have shown up in improved profitability for our Rhino-Rack business in North America. During the first six months of 2023, we moved to a new headquarters and consolidated our three previous warehouses under one roof in Denver for our North American business. During this period, for the first six months of 2023, we incurred over $700,000 of moving costs that should not repeat. Just to be clear, the Rhino-Rack facility in Denver serves as an under-one-roof solution for the entire Adventure segment here in North America, housing our North American headquarters, sales and marketing, warehousing, and assembly. In Australia, sales were strong in April and May, but softened in the last few weeks of June as a result of Australians' observation of the end of their fiscal year. Importantly, sales picked back up in July. While the market environment in our Adventure segment is still challenging, we believe the worst is behind us, and we look forward to reporting a business that produces better than 12% adjusted EBITDA margins going forward. Moving on to consolidated gross margins. In the second quarter, gross margins declined to 36.7% compared to 38% in the year-ago period. We experienced a 140 basis point benefit from favorable variances in write-offs, but this was more than offset by unfavorable FX of 110 basis points and unfavorable product and channel sales mix of 160 basis points. From a segment perspective, gross margin at Outdoor was 37.5% in the quarter compared to 33.1% in the prior year quarter, reflecting a 440 basis point improvement. The primary driver here was the elimination of the high freight cost from 2022, not repeating this year. Gross margin at Adventure was 42.2% in the quarter compared to 38.5% in the prior year quarter, reflecting a 370 basis point improvement due to the operational improvement and cost actions taken in the second half of last year taking hold, as well as a more favorable FX environment. Gross margin at Precision Sports was 31.7% in the second quarter compared to 44.9% in the prior year quarter, reflecting a 1,320 basis point degradation. This decrease in gross margins at Precision Sports was due to the sale of ammunition at a lower margin profile due to the promotional pricing environment that the market is currently demanding. The ammo market has been very tough and has been a drag on gross margin. To put this in context, I want to share the following. During the first half of the year, we used internally produced bullets at Sierra and loaded Sierra ammunition, selling a total of $4.7 million of Sierra ammunition in the first half of 2023. We only realized $236,000 of gross profit on these sales. Have these bullets been sold through Sierra's OEM channel, we would have recognized an additional $550,000 of gross profit, which would have increased gross margins at Sierra by nearly 700 basis points during the first half of the year. Once the market stabilizes, we would expect margins to normalize for our ammo product. Until then, we will continue to realize decent margins on our component bullet business. Selling, general and administrative expenses in the second quarter decreased compared to $35.4 million in the year-ago quarter. The decline was driven by expense reduction initiatives in the Outdoor, Adventure, and Precision Sports segments, as well as lower sales commissions and lower noncash stock-based compensation expense for performance awards in corporate. Net loss in the second quarter was $2.1 million or a $0.06 loss per diluted share, compared to net income of $3.8 million or $0.09 of EPS in the prior year quarter. Adjusted EBITDA in the second quarter was $7.3 million or an adjusted EBITDA margin of 8.7% compared to $17.6 million or an adjusted EBITDA margin of 15.3% in the same year-ago quarter. The decline in adjusted EBITDA was driven by lower sales volumes, unfavorable product and channel mix and a $1.5 million consolidated foreign currency exchange headwind due to the strength of the U.S. dollar. These impacts were partially offset by the improvements in SG&A during the quarter that I just previously mentioned. Now, let me shift over to liquidity. At June 30, cash and cash equivalents were $11.3 million compared to $12.1 million at December 31, 2022. As Warren highlighted in his opening comments, free cash flow was outstanding. Free cash flow, defined as net cash provided by operating activities plus capital expenditures for the second quarter of 2023 was $12.3 million compared to $2.3 million of free cash flow in the same year-ago quarter. We used this free cash flow to pay down nearly $10 million of debt and ended the quarter with total debt of $127.2 million. This put us in a net debt position of $115.9 million, resulting in a net debt leverage ratio of 2.7 times on a trailing 12-month adjusted EBITDA basis. We expect to stay within our stated range of 2 times to 3 times leverage for the remainder of the year. Under our $300 million revolving credit facility, we have approximately $11.4 million outstanding and further borrowing capacity of approximately $32 million at June 30, while maintaining compliance with the required covenants under our credit agreement. Our inventories ticked up sequentially by $3.2 million to $149 million at June 30. As discussed in our prior call on May 1 of this year, this increase was expected. As of June 30, we've taken possession of key inventory, specifically at our Outdoor business for the prime fall/winter selling season. From a tax perspective, we have over $17 million of NOLs remaining, and we expect these NOLs to offset any federal cash taxes due in 2023. Now, let me move on to our 2023 outlook. We now expect sales to land within the range of $385 million to $400 million for the full year 2023 and adjusted EBITDA to be in the range of $42 million to $50 million, or an adjusted EBITDA margin of 11.7%, assuming the midpoint of the sales and adjusted EBITDA guidance. We also now expect full year capital expenditures to range between $6.5 million to $7.5 million, and free cash flow is now expected to range between $30 million and $35 million for the full year 2023. Finally, for the third quarter of 2023, we expect consolidated sales to be $100 million to $105 million, reflecting continued headwinds surrounding the unwinding of inventory at our key North American partners, both at our Outdoor and Rhino-Rack USA businesses, and the promotional environment within the Precision Sports segment. Let me pause here, hand the call back to the operator as we are now ready for the Q&A.

Thank you, sir. At this time we will conduct the question-and-answer session. Our first question comes from the line of Alex Perry with Bank of America.

Hi. Thanks for taking my questions here. I guess just first, what areas of your portfolio are you seeing sort of the heaviest destocking from your retailer partners? Is this mostly BD? And within BD, are you seeing it sort of across the board with both sporting goods retailers, as well as some of your independents? And what is sort of contemplated in the guidance in the second half regarding that? Thank you.

I'll go ahead and start with that. So from a guidance standpoint, we noted in our prepared remarks that we expect this tough destocking environment to continue. But through the remainder of the year, we think it will take until the end of the year to clear. But our guidance assumes that it does clear by the end of the year. What it also assumes is that our normal preseason fall/winter orders at Black Diamond, if they do flow through as the preseason orders. We've taken possession of that inventory, and we believe that our key retail partners are in a position to take that inventory come September, October, November of this year.

Hi, Mike. This is Aaron. I want to provide some additional commentary for you, Alex. As noted, the primary focus is within the Outdoor segment, which centers around the Black Diamond brand. If we consider our distribution in North America from a wholesale viewpoint, it can be divided into three main components: national accounts, which make up about 33% of our business, key accounts, another 33%, and then specialty retail. We have observed that particularly our national and key accounts, especially those with private label products, are experiencing the most substantial destocking. This situation primarily concerns about 66% of our North America wholesale distribution partners, and we are working with them to address their inventory levels. Additionally, as mentioned in our prepared remarks, many of these retail partners have been cautious in managing their inventory on hand. For context, before COVID, it was common for retail partners to maintain around 10 to 12 weeks of inventory. That number increased to 18 to 20 weeks during COVID, and now it has dropped to about six to seven weeks. This shift is transferring a lot of inventory risk to the brands and prompting us to reassess our demand planning process, which we are currently updating. We are focusing on managing our inventory and supply chains dynamically to ensure high fulfillment levels and ease of business while aiming for lower inventory levels. Our efforts will continue to emphasize those two segments of our North America wholesale channel, where we intend to enhance our digital presence and support our partners with various sell-through initiatives to expedite the destocking process and achieve a more normalized inventory level over the next six months.

That's really helpful. My follow-up is about the guidance. The Q3 guide suggests a sequential acceleration from Q2, but it's still down year-over-year, albeit improving. Is this primarily based on your pre-booking observations? Additionally, the implied guidance for Q4 looks even better. What aspects of the Q3 versus Q4 guidance give you confidence in this outlook? Thanks.

Yes. This is Aaron again. I'll give you a little bit of commentary, and then Mike can fill in the gaps. But as we look at the back half, especially for that of Outdoor, as a reminder, we do operate in two six-month seasons, a spring/summer season and a fall/winter season that are supported by preseason bookings and forward orders by the majority of our key retail partners. What we saw in the first half is that we were realizing about 65% to 70% of those forward orders. Now historically, we will traditionally realize about 85% to 90% of those forward orders. Through attrition, we'll offset the attrition rates with re-plans or ASAP orders that typically come in. So as we thought about planning for the back half, we are expecting to see improvements in the realization of our forward orders for our bookings. We are not expecting it to get back to historical levels of 85% to 90%. But we are expecting it to get back to levels of 80% to 85%, which is something that we started to see towards the end of June and something that's carried forward through July as well.

Yes. Our guidance suggests revenue between $204 million and $219 million for the second half of the year. We anticipate sequential improvement in both Q3 and Q4 for Adventure. Regarding Precision Sports, our performance will depend on how ammunition sales evolve. For the Black Diamond business, while we might not fully recover, we do have a strong order book for our fall and winter products, which makes up the inventory we've received. We expect this segment to recover to the $60 million to $65 million range in revenue.

Perfect. That's really helpful. Best of luck going forward.

One moment for our next question. Our next question comes from Anna Glaessgen with B. Riley. Your line is open.

Hi. Good afternoon. Thanks for taking my question. First, would it be possible to put in perspective what POS was in Black Diamond for the quarter, just to contextualize the difference between the sell-in, sell-through, and understand the impacts from the retailer destocking or caution with open-to-buys?

Yes. From a point-of-sale viewpoint, we are receiving feedback that the main categories within Black Diamond are performing well. They continue to do quite well at retail, and point-of-sale data indicates high single-digit growth rates. However, there will still be some stocking activities, along with adjustments to their inventory levels, which have affected their open-to-buy. Importantly, we are observing that Black Diamond's inventory levels are declining at a faster pace than what we see at the point of sale. This gives us confidence that the inventory management and destocking efforts are effective, which should lead to more normalized purchasing patterns as we approach Q3 and Q4.

Got it. Thanks. And then turning to Precision Sports, I think in the Q, I saw that international sales actually underperformed domestic, which is a bit of a shift from the recent trend. Anything to call out there? Are inventories normalizing internationally after being fairly depleted versus the domestic market?

A lot of this also comes down to just how we're able to prioritize the output and capacity. The team has done a tremendous job of really focusing on these three verticals that we've outlined before: that of ammunition, our OEM business, as well as the component side of things, which is green box for Sierra and black box for Barnes. Because of the demand that we've seen both domestically and internationally, in particular, on the component side, it does require us to think about how we manage capacity and just the sequencing of the fulfillment of orders. And so we have a very strong order book as we look into the next six months to nine months. And so it really just comes down to how we're able to prioritize and sequence the various fulfillment of those orders, and it actually causes a shift between domestic and international versus a wholesale change in terms of demand or just where the inventory levels are.

Got it. So would it be fair to say internationally, you're at a better place with inventory than maybe the last quarter or a couple of quarters ago?

Yes. So we are able to provide higher levels of fulfillment on the international side. And so the pent-up demand isn't as pronounced as it was previously. There was a lot of demand that we just weren't able to fill over the last two years because a lot of focus was going into building out the ammo initiatives across both of the brands, but also fulfilling that demand that was quite insatiable. But over the last several months and quarters, we've been very focused on shifting a lot of our production to the international side just to make sure that we don't lose market share, but also continue to be that great partner that we've been able to prove that we are and support those initiatives that then feed to additional programs and opportunities into the future.

One moment for our next question. Our next question comes from Randy Konik with Jefferies. Your line is open.

Thank you and good evening. Aaron, could you provide some insight on the shift to national accounts where there's an increased focus on private label, and how this is affecting destocking and the order book? Specifically, in your discussions, where do you think we stand in terms of finding an equilibrium with private label penetration that these accounts are emphasizing, which seems to be reducing orders? Are we at a point like the eighth inning or the fifth inning? How do you envision this evolving over the next four to eight quarters?

Yes. So I think because of what took place during the pandemic, it presented a lot of opportunities for some of these retail partners to evaluate that strategy further and to pursue it. There's a lot of opportunities to develop one's channels and also one's brands. But I think what it also highlighted is that things started to slow down and the dynamics associated with supply chains both elongated and then also shortened in a very quick period of time. What I've highlighted is that that's a different ball game. That's a different business model than what some are traditionally comfortable with or typical in operating under. And so what it's done is it has opened up the conversation for us to be able to have more holistic discussions around the positioning of our brands, but also the way that we continue to partner with them, whether it be the way that we merchandise products, our product offering, but also even doing shop-in-shops or different types of POP that really help drive awareness but also traffic to their locations while also helping to drive sell-through as well. And so the discussions have been really focused on just the underlying economics and how we can all partner together. But as a result, it also has created this overhang that they continue to work through from a working capital and just overall liquidity and availability perspective. That's something that started to rear its head in Q2, Q3 of last year and has continued to be a headwind for us over the last four quarters. Now one thing that we are starting to see is that those pressures are starting to subside. There are still certain categories that are a pretty massive overhang for folks that they anticipate will be an overhang over the next anywhere from a year to two years. Fortunately for us, those are not categories that we participate in, but it does naturally constrain how they think about open-to-buys and just the weeks of inventory on hand that they hold. And so as a result, for us, the discussion that we've also been having is just how we, as a collective group, manage these dynamics but also how we support them with making sure that we have inventory availability, but also helping to support them with sell-through, while also continuing to build our brand through our own channels and really bolstering up our own business through our own efforts. I feel like we're in a good position. But there are going to be some just natural overhangs that continue to persist throughout this year. And then I think as we get into 2024, it will be more normalized, recognizing that there will be certain categories that will just continue to be a problem child, but not something that should negatively impact overarching open-to-buys and also liquidity positions for these retail partners.

Could you provide some insights on how you plan to approach promotions by division and segment going forward? I'm interested in your perspective on whether things are expected to improve, stay the same, or possibly worsen. More detailed information on this would be very helpful.

You bet. So, on the Outdoor segment, we'll continue to see some promotional levels through the course of the year. We do anticipate that it will get sequentially better based off of the inventory levels in the channel and just what we're seeing is people are now transitioning to a different season and starting to annualize a lot of the noise that we've all experienced over the last four quarters. On the Adventure side of things, we're also seeing much healthier inventory levels both in Australia and here domestically. Our retail partners don't participate in private label, and so they came into the headwinds in a cleaner position. We have supported them in a pretty substantial way in moving that inventory through the system. As a result, there's a little bit of carryover that will still persist through Q3 and maybe into Q4. But we actually feel that we're in a pretty good position as it relates to just the promotional environment and how we'll participate in that. And I think that commentary is supported by what we saw also with our gross margin improvement both in the Outdoor space and also in Adventure. Despite these overhangs, we are seeing still margin improvement because of the different productivity and efficiency initiatives that we've been able to drive through. The one segment that could continue to see some overarching headwinds is that of Precision Sports. We are getting feedback from retail partners that they do expect that the hunting season will help recalibrate this and start to pull through inventory so that the promotional environment doesn't need to be as pronounced as it has been over the last two quarters in particular, but also as we head into the election cycle, that should also help normalize and bring to equilibrium the different dynamics associated with inventory. Overall, I would say that we should still expect to see a promotional environment for the rest of this year. But I think everyone is very focused on, similar to what we are and what we've already communicated as far as just coming into 2024 with a very clean balance sheet and just getting a lot of this gyration behind us that we've all been experiencing for the last four or so quarters.

Super helpful. Thanks, guys.

One moment for our next question. Our next question comes from Joe Altobello with Raymond James. Your line is open.

Thanks. Good afternoon, everyone. My first question is about the promotional environment, which seemed to escalate during the second quarter. Can you clarify when that began? It appears to have worsened as the quarter went on, and it doesn't seem like conditions have improved in July and August.

We began to notice a shift in the promotional environment, particularly in the Outdoor segment, toward the end of Q1. This trend accelerated significantly in Q2, especially in late May and throughout June, extending into early July. The motivation behind this increase stems from efforts to stabilize and maintain a healthy ecosystem, while also encouraging individuals to clean up their balance sheets and move past existing overhangs. As we transition out of the spring and summer season, the intensity of promotions has surged, which is to be expected since many are eager to put this behind them as they prepare for a new season. In the Precision Sports category, the focus of promotions has been on commodity calibers, particularly nine millimeter and 223, which have started to affect the availability of 300 Blackout ranges. As product availability has risen, we’ve witnessed increased competition in the promotional landscape, especially during May and June, and this trend is likely to persist through August and September as we approach the hunting season. In the Adventure segment, promotions have been ongoing since February or March, driven by factors from the previous season. The prolonged winter and wet conditions created pressure to begin promotions earlier than usual. The positive side is that these promotions are effective in speeding up destocking efforts. Overall, the promotional dynamics vary across segments. We expect this trend to continue over the next two quarters, with a collective aim of getting balance sheets in order and achieving normalization as we enter 2024.

Got it. And that's very helpful, Aaron. Thank you. And maybe just a follow-up on that. Is there a way to quantify how much destocking across the three segments is costing you in terms of sales this year? And maybe kind of to follow up on that, how confident are you that we're going to be clean by the end of this year?

Well, in a simple way of putting it, if you look at how we re-guided the business, I think that re-guide is directly attributable to the destocking activities and what it's cost us from a revenue standpoint. We came into the year applying the same approach in terms of how we think about the business, looking to realize a lot of our bookings but due to the destocking activities, that's had a negative impact on the first half of the year. And that's why we're optimistic as we head into the back half and really as we head into 2024. I think as it relates to just where we're at and the confidence level, it keeps on being reinforced by the bookings but also the conversations that we have with retail partners that everyone is very focused on having this cleaned up by the end of the year. Now there's a lot of variables that come into play there. But I think everyone is very focused on that. Everyone is taking a very disciplined approach, as are we. And the results are demonstrating that with our free cash flow generation that we highlighted or that we reported, but also just the way that we're planning for the business. Mainly, we're taking it a little bit more conservatively ourselves as we think about our demand plans and just the way we manage inventory levels because we want to get things normalized and rebalanced as fast as possible.

One moment for our next question. Our next question comes from Mark Smith with Lake Street. Your line is open.

Hi, everyone. I wanted to touch on the international business briefly, as it performed weaker than we had anticipated. Aaron, could you explain how much of this was influenced by supply versus demand? How much are we looking to ship internationally compared to what is driven by demand and the broader macro factors that are affecting international sales?

So, on the international piece, a lot of this is driven by programs that we have in place with key distributors, but also key partners that are underpinned or underwritten by law enforcement and military-type programs. And so when we look at our order book, which Mike can provide additional commentary on, we have a very strong order book, especially as it relates to that of Sierra that, in essence, covers us for the bulk of the rest of the year as we think about that business. And so the order book is intact. The order book is there. It's just that there are dynamics associated with the licensing side of things, but also just getting the logistics all lined up, but also how we continue to fulfill domestic demands and programs that we have desires and obligations to fulfill on as well. It really does come down to capacity, especially as we think about the component side of things and how many bullets we can produce on a given day, but also how that all ends up in terms of our ability to ship it out. The demand on the international side continues to be very strong, especially with our bread-and-butter type calibers, whether it be a 30 cal or 308 and the 335, et cetera. But those are programmatic calibers and programmatic orders that we have in place that once again are there, and it's just a matter of can we fill it and when.

And if we look at the outdoor business within international, can you just talk about the puts and takes there that was, perhaps, I think the lowest since before the pandemic? Talk about any pressures that you're seeing on international business within the Outdoor segment.

The outdoor segment internationally is primarily influenced by Europe, which has performed exceptionally well despite geopolitical risks and global economic challenges. Although this region had been outperforming both relatively and sequentially for a long time, we faced some setbacks in Q2. The order book remained stable, but we noticed a significant drop in our ASAP or replenishment orders. This was partly due to our strong fulfillment of preseason orders, which peaked in February and March. However, as we moved into May and June—periods reliant on ASP and replenishment rates—orders diminished. Discussions with our team and retail accounts in that region revealed they are experiencing challenges similar to those the U.S. market faced about a year ago, and they are actively working to resolve these issues. Fortunately, much of this is temporary as we approach the fall/winter season. Bookings are stable, and the feedback indicates a willingness to continue placing orders. Our focus now is to align our order book with available inventory since any delays in fulfilling open orders could impact our capability to achieve the full potential indicated by our order book. Ultimately, success hinges on execution and our ability to collaborate effectively with our retail partners.

Okay. And then back to Precision for one more question. Just it sounds like you guys feel better about where kind of you're locked in on components and some contracts there. Can you talk at all about pricing? Margins were squeezed here this quarter. How much of that's really coming from component costs? And as you sound like you feel better, what kind of price increases are you looking at on components going forward?

A lot of what we saw from a gross margin perspective was driven by the promotional environment and what Mike highlighted in the prepared remarks associated with the ammo that we moved. This is the ammo that we built in anticipation of being able to sell through it over the last four quarters, and it just got to a point where we wanted to be able to move it. The bulk of that was either nine mil or 223. And that's been a consistent story for us over the last three quarters. There has been some margin pressure as it relates to input costs, in particular, related to components, shell cases being a primary driver, as well as labor. We have been able to plan for that, though, over the last couple of quarters as it relates to the different price increases that we activated, in particular in 2022, that have carried over into 2023. The team has also been very focused on continuous improvement initiatives. They have done a great job in increasing capacity, becoming more efficient, more productive and finding ways to lower the overall overhead structure of both of the businesses. What we're also focused on is just the mix and making sure that we have a good balance of changeovers versus high runners, but also really focusing on the channels and the calibers or the types of products that we're known for but also actually come with higher levels of gross margin as well. And so that is where we have deemphasized some of our focus on some of the more commodity-based ammunition initiatives, in particular, within Sierra, but also really focusing on our OEM and on our component bullet businesses as well.

Okay. Great. Thank you.

One moment for our next question. Our next question comes from Jim Duffy with Stifel. Your line is open.

Thank you. Good afternoon, guys. I've got a couple of questions for you. First, Mike, can you give us some help on the inventory mix by category?

By segment or by raw material, finished goods?

No, by segment.

Yes. Well, we haven't provided that anywhere. So, we can talk about that. In BD, inventory is about $80 million. Precision Sports inventory is around $40 million. And the remainder is at Adventure, so that's about $30 million.

Okay. Helpful. Thank you. And then with respect to BD, I'm curious the mix of spring/summer that you may have to carryover versus fall/winter.

That's the inventory we're moving, right? We are taking a lot of inventory on for fall/winter. We're being aggressive in the promotional environment and moving the spring inventory, and that's what everyone is focused on over in the Outdoor space is to right-size that inventory. That's the whole process that we've been talking about. So maybe I don't understand your question.

Sorry, Mike, I would like to add some additional commentary. This is Aaron, Jim. The way we traditionally view this from an outdoor perspective is related to DM versus in-line type products. Throughout this entire process, we've managed to keep the DM levels relatively stable. We finished Q2 with around $4 million to $4.5 million in DM, which is somewhat higher than in the past but still manageable. Now, it’s essential for us to continue adjusting the highs and lows across different categories, and that’s where our goal of reducing inventory levels by 15% becomes important. We need to be very strategic as we transition from one season to the next. We will always have some discontinued merchandise, but the key is how we manage that process by proactively engaging in pre-DM promotions and collaborating with retail partners, as well as managing our own channels to move that inventory.

Okay. Aaron, you might have addressed this when discussing the lease inventory available at retail, which extends beyond just your own brands. A crucial aspect for meeting guidance in the latter half of the year is your confidence that retailers will accept the fall/winter products and won’t come back stating they are overwhelmed with bikes, paddle boards, and hiking shoes. What gives you the confidence that some of these other categories won't pose challenges for your business?

The primary driver of that is just where the weeks of inventory on hand for BD is within retail being at that six weeks to seven weeks. If we were at 10 weeks to 12 weeks, then there could be a little bit of exposure there, call it, anywhere from half month to a month's worth of inventory. But when you're at six weeks to seven weeks, there's just not enough flexibility or agility in the pipeline to be able to take that much lower. And so it really does come down to what's on the docket from an order book perspective and how do we support it with sell-through because at that point in time, you're really just getting into replenish-type activities, which these guys have open-to-buy dollars for because they just need to happen. We need to have the product on the shelf space around the pegs.

Okay. Thank you. And then just a broader question around Precision Sports. You've demonstrated the economic rationale for owning these businesses, certainly. That said, the message had been that you were a small player in a large market, and share gains could support the top line through the market cycles. I guess I'm trying to understand, is this simply a cyclical business from here forth? What was the miscalculation with respect to ammo? Why is the business proving more exposed to the cycle than you had initially thought?

Yes. The main issue is our inability to consistently provide a full range of ammunition products, which affects our ability to operate a programmatic business with various retail partners. Essentially, we are adjusting our offerings monthly based on when we receive components and can produce the products. Consequently, this creates an ASAP or opportunistic model rather than a structured program, which is what we really need, especially in a time when promotions are prevalent and product availability is strong. Our retail partners have consistently expressed their satisfaction with our position, particularly with the Barnes brand. The Barnes brand stands out as high-quality, well-positioned, and has strong sell-through rates. To succeed, we need to operate more consistently and be easier to do business with by ensuring regular availability, not in large quantities. This is why the supply agreement is crucial for us and gives us confidence that we will achieve a better run rate as we move into 2024, allowing us to develop and execute this program effectively.

Okay. That was very helpful. Thank you.

Thank you very much, everyone, for joining the call. We look forward to connecting with you as part of our Q3 earnings call in process.

Ladies and gentlemen, this does conclude today's teleconference. You may now disconnect your lines. Thank you for your participation.