Smith & Wesson Brands, Inc. Q2 FY2025 Earnings Call

Good day, everyone, and welcome to Smith & Wesson Brands' Second Quarter Fiscal 2025 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 some information about today's call.

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 relocation 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, 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.

Thank you, Kevin, and thanks, everyone, for joining us today. Second quarter results came in below our expectations as overall demand for firearms normalized late in the quarter. Despite these headwinds, we continue to outperform the market and believe we gained share, led by our best-in-class innovation with new products representing 44% of our sales in the period, which I'll cover in more detail in a few moments. From a profitability standpoint, as we've detailed many times before, our unique flexible manufacturing model is designed to quickly react to the volatility that is typical in the firearms industry. And as always, our team executed very well in response to the slowdown, enabling us to again deliver solid adjusted EBITDA. Looking at the overall firearms market as measured by FBI background checks for firearms purchases, adjusted NICS was up 1.1% for our second quarter but deteriorated significantly as the quarter progressed, including a 5% decline in October. Overall, for Smith & Wesson, our units shipped into the channel increased by 8.7% while distributor and strategic retail account inventories largely held flat with only a 2.7% increase, indicating strong share growth despite a challenging market. Breaking those numbers down by category. Handgun mix was flat in Q2 while long gun mix was up 3.6%. For Smith & Wesson, our handgun shipments were up 19.2%, significantly outperforming the market due mostly to very strong demand for our new products, led by the entry-level price Bodyguard 2.0. On long guns, our shipments were down 26.4%. However, I will note that this is largely due to timing associated with channel fill shipments and outperformance of new products in the comparable quarter last year. Removing these outliers, shipments of our core long gun line were down only 4.8%, which is typical this quarter, which is the strongest quarter for hunting products. And since we are just beginning to enter the hunting category with our lever-action rifles, the benefit was less impactful on our results. We believe that the primary driver of the demand pressure continues to be inflation. The consumer cautiousness with discretionary spend that we observed in recent quarters was more pronounced during Q2 than we anticipated. I will also note that this continued into November as evidenced by the recent NICS results. Lower or opening price point products are generally performing better, which is evidence of trade-down activity. We are well positioned to navigate this challenging demand environment as we have many times before. By remaining focused on executing against our flexible manufacturing model, we expect to preserve profitability and a strong balance sheet. Additionally, we expect to maintain and gain share through innovation. Highlighting this point, our new Bodyguard 2.0 chambered in 380 ACP, which we launched in July, has quickly become one of the most sought-after concealed carry pistols in the industry. And we are proud to have won Best New Handgun of 2024 from the National Association of Sporting Goods Wholesalers, which represents our largest channel customers, and also 2024 Handgun of the Year from Guns and Ammo Magazine, one of the most popular firearms consumer publications. Additionally, our 1854 lever-action rifle continues to perform well. And with our planned expansion of this popular line throughout the second half of FY '25, we expect this momentum to build even further as the year progresses. Smith & Wesson has proven to be a leader in innovation. With a very strong pipeline of new products, an award-winning engineering and design team and core value of operational excellence in quality and manufacturing efficiency, innovation will continue to be a strong driver of success. Moving now to average selling prices. Overall, ASPs were down 8% versus a year ago driven by mix factors as well as increased promotional activity. Handgun ASPs declined 11%, reflecting strong sales of the Bodyguard 2.0, which has a retail price of around $400, combined with lower sales in revolvers. In contrast, long gun ASPs increased 11% due to the increased sales of lever-action rifles relative to the remainder of the long gun line. Additionally, as expected, the market has become increasingly competitive with substantial promotional activity across the board. With our strong balance sheet, we're able to carefully evaluate our participation in promotions, and we'll continue to do so thoughtfully. But we do anticipate sustained pressure on ASPs throughout the remainder of the fiscal year from promotional spending. In summary, our disciplined approach to managing the business continues to deliver solid profitability and a strong balance sheet, no matter the market conditions. We remain committed to our capital allocation strategy of returning value to stockholders as evidenced by our very healthy quarterly dividend and our repurchase of 1.6 million shares since the beginning of this fiscal year with 754,000 of those shares purchased in Q2. Finally, and as always, I just want to thank our entire team of dedicated Smith & Wesson employees for tirelessly putting their skills to work every day to make us successful. With that, I'll turn the call over to Deana to cover the financials.

Thanks, Mark. Net sales for our second quarter of $129.7 million were $4.7 million or 3.8% above the prior year comparable quarter on the strength of our new Bodyguard 380 pistol and lever-action rifle. During the quarter, inventory in the distribution channel grew slightly in terms of actual units, but declined significantly in terms of weeks outstanding as expected due to increased volume. Handgun ASPs declined significantly from Q1 levels, reflecting volume growth in the Bodyguard combined with additional promotions. As expected, ASPs for long guns returned to Q4 levels. As a reminder, Q1 levels and ASPs were disproportionately high due to the mix of higher-priced products and lower overall volume. Gross margin of 26.6% was 1.2% above the comparable quarter last year due to a one-time accrual in the prior year quarter for a legal settlement. Excluding this one-time accrual, the prior year margin would have been 28% or 1.3% higher than the current year. The current year margin was negatively impacted by the lower average selling prices and higher labor and overhead costs. Operating expenses of $27.6 million for our second quarter were $400,000 lower than the prior year comparable quarter, with higher R&D costs and legal expenses being more than offset by the absence of costs associated with the Maryville grand opening event last year. The increased sales volume and related margin resulted in net income of $4.1 million or $0.09 per share. On a non-GAAP basis, income per share was $0.11. Cash used in operations for the second quarter was $7.4 million compared with $2.9 million in the prior year comparable quarter due to a larger increase in net working capital in the current quarter, partially offset by increased net income. We spent $3.3 million on capital projects this quarter compared with $34.9 million in the prior year comparable quarter, primarily due to lower investment in the current year related to the relocation. We expect our capital spending for the year to be between $25 million and $30 million. In September, our Board approved a new $50 million share repurchase authorization effective when the prior authorization expires. Also, during the quarter, we signed a new unsecured $175 million line of credit. This new line increased our total available borrowings by $75 million and extended the maturity to October 2029. This new unsecured line of credit has nearly identical terms as our prior line that was set to expire in August 2025 and shows the continued support that we have from our banking partners. During the quarter, we repurchased approximately 754,000 shares at an average price of $12.94 for a total of $9.8 million. We paid $5.8 million in dividends and ended the quarter with $39.1 million in cash and $100 million in borrowings on our line of credit, which we expect to pay down in the second half. Finally, our Board has authorized our $0.13 quarterly dividend to be paid to stockholders of record on December 19 with payments to be made on January 2. Looking forward to our third quarter, based on the softer demand trends we've seen across the industry in recent months, we have reduced our expectations for the second half of fiscal 2025 and now expect full year revenue to be 5% to 10% lower than fiscal 2024. Although, we're experiencing very strong support for our new products, we are also seeing a more visible impact from inflation on consumer behavior, including trading down to lower-priced products for many of our core products. In addition, promotional activity has increased significantly due to market dynamics, creating incremental margin pressure that we expect to result in our full year margin being in line or even slightly below fiscal 2024. Channel inventory is expected to remain stable, and we believe that the distribution channel remains cautious and will continue to manage their inventory carefully. For our third quarter, we expect our top line to be approximately 10% to 15% lower than fiscal 2024 with margins a few points lower than the prior year quarter due to increased promotions and lower ASP. We also expect to see operating expenses at 5% to 10% above the prior year comparable quarter due to investments in research and development, promotions, and marketing programs to drive volume-related market share. Our effective tax rate is expected to be approximately 25%. Due to the changes in the market and the share repurchases that we've already completed, we now expect to end the year with debt levels similar to or slightly above last year with roughly an equivalent amount of cash on hand. Although we expect that cash generation will be lower than our annual target of $75 million, our capital spending needs are also lower due to the completion of the relocation and our focus on internal projects. This will allow us to repay a large portion of our outstanding revolver while still investing in our business. 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 to questions from our analysts?

Thank you. We will now be conducting a question-and-answer session. Our first question is from Steve Dyer with Craig-Hallum. Please proceed with your question.

This is Matthew Raab on for Steve. Just one for me. On the puts and takes in the model, just on ASPs. It sounds like there's a little bit more pressure in the second half. Do you think you can kind of hold the Q2 levels? Or do you think it's going to come down a little bit more than that across both handguns and long guns?

Yes, good question. This is Mark, as I covered in the prepared remarks, we will be seeing some pressure from probably some increased promotional activity, just due to the competitive market. But we do believe that's going to be more than offset by NICS associated with some new products that we'll be launching here in the beginning of our third quarter. So overall, for the second half, I think you can kind of anticipate that Q3 will be largely flat on handguns, up a little bit on long guns and then overall for the second half, we'll actually be up slightly on ASP for both.

Okay. Got that. And then just on the channel, you covered it in the comments. But it seems to be mostly the finished goods. What's the confidence level of bringing down inventory in the second half in the backdrop of a probably cooling off gun market?

Yes. I mean obviously, the inventory rose a little bit more than anticipated, just simply related to the fact that the market was a little bit softer than we anticipated, specifically in the back half of September and into October. But we have a pretty robust sales and operations planning process that we go through on a monthly basis to make sure that our production is aligned with the sales volume. So, feel pretty comfortable with being able to bring that inventory back down. And again, I mean, strong balance sheet for the Company is a core focus of ours, and so no rush there. There's no need to kind of jerk the manufacturing plants around; we'll kind of ramp that down. We're all still very comfortable with the inventory reduction by the end of the year.

Our next question is from Rommel Dionisio with Aegis Capital. Please proceed with your question.

Regarding new product launches, this is the time of year when the industry tends to launch aggressively, as do you. Mark, could you provide an initial impression of how willing retailers and distributors are to take on inventory, considering the current challenging inflationary environment?

Sure, that’s a good question, Rommel. In this environment, the firearms market is not unique in facing challenges among consumer goods, but the key will be innovation. At Smith & Wesson, we have demonstrated over the past couple of years that we are the leaders in innovation within the marketplace, and this will remain a focus for us. Retailers and channel partners are eager to build their inventory with new products because that’s where the current volume is. During the second quarter, we saw two significant highlights: the Bodyguard 380, which we launched in July and quickly became the top concealed carry pistol in the market, and our lever action products that continue to perform well. As we maintain our pace of new product introductions in the second half of the year, we feel optimistic that these will deliver pleasant surprises.

Okay. Maybe just a quick follow-up, if I could. I noticed obviously the softening consumer demand, primarily site inflation there. Was weather a factor? It seemed like it was a really warm fall early start this hunting season in a lot of key markets in the country. So, was there any impact from that, would you say?

No, I wouldn't say so. Actually, Rommel, our August was very strong. August was strong, the beginning of September was strong, and it started to slow down in the second half of September into October. I really do think it's related to inflation and the pressure on discretionary spending in consumers' wallets, and that really is the primary driver there.

Our next question is from Mark Smith with Lake Street Capital Markets. Please proceed with your question.

Handful of questions for me today. First, just wanted to walk through the guidance, make sure that I kind of caught everything right here. Just for the year on revenue, you said down 5% to 10%, I believe, and in margins, similar to last year. Just correct me, if I'm wrong on either of those, but then I missed kind of your operating expense guidance for the year.

We didn't give operating expense guidance for the year. We only gave for the quarter. Quarter will be up 5% to 10%.

Thank you for clarifying that. Mark, I wanted to revisit the average selling price, especially regarding handguns, but also in relation to other products. Can you explain how much the average selling price may have been affected by the success of the Bodyguard and the trend towards lower-priced items? Additionally, can you share any insights on consumer behavior shifting towards budget-friendly brands and the impact of the used firearm market, particularly in light of the rising NICS checks, and how that might make NICS less relevant to our business? I believe it's likely a mix of factors regarding the average selling prices, including customers opting for lower-priced products and the success we're experiencing with the Bodyguard 380. As I mentioned earlier, we've gained market share specifically in handguns. I don't think the shift towards other brands really affected us; the main factor was definitely the success of the Bodyguard model, which is what we aim for. We want innovation to lead us, especially in this challenging environment. The company with the best new product will come out on top, and currently, that’s us. Regarding the used gun market, whenever the firearms market starts to weaken, the used gun market tends to rise slightly, which is happening now as expected. Okay. And then you talked about the promotional environment a little bit. Maybe give us any indication of how you feel about kind of the rebate programs that you guys ran, it seems like later in the quarter, but still some current ones out there. It feels like you're getting kind of the bang for your buck on those, how successful that's been kind of response from consumers? Yes, as I mentioned earlier, we approach this thoughtfully. Given our strong balance sheet, we don’t have to act impulsively, so we take our time to assess and ensure we will achieve a return on any money spent on rebates and promotions, whether directed at the channel or consumers. Currently, our two active promotions are performing very well and are either meeting or exceeding our expectations. This measured approach is working for us. Looking ahead, we will likely need to continue participating in this space because the environment is becoming more competitive. Okay. Looking broadly at the industry, you've talked a bit about your kind of inventory levels. Is there any fear or how do you feel about kind of industry inventory levels? Are you seeing kind of stockpiling by retailer distributors, things kind of backing up and inventory getting jammed higher than it should be within the industry? Or is the industry being thoughtful, I guess, around inventory? Yes, it's actually the opposite. They are being very considerate. They are not stockpiling at all. We are quite comfortable with the inventory levels we observe in the channel. As you know, we measure this very frequently. We monitor distributor inventory levels and ensure they are not exceeding their SKUs. They are not. The inventory levels in the market are very healthy, and we are confident about their current standing. Excellent. And I think the last one for me, maybe a couple ones to answer because you can’t really quantify it. But as we think about just big picture here and kind of outlook for shooting sports or the firearm industry here over the next year or two. Is there a reason to think that we're maybe past or beyond fear-based buying that we saw kind of in the past? We saw kind of a weaker demand into the election than we've seen in the past. Obviously, a lot of firearms purchased over the last four or five years here. But just given the mix of kind of government and courts, do you feel like maybe we're past that big spikes in demand just as people fear any increased regulations? Yes. I believe the main factor right now is that consumers are facing financial pressure due to the economy and inflation, which affects their discretionary spending on groceries and other essentials. This situation outweighs any regulatory concerns related to the election cycle. However, the ongoing trend towards personal protection remains significant, and we continue to monitor this. It's fair to say that the fear-driven purchasing related to potential regulations has decreased.

Thank you. There are no further questions at this time. I would like to hand the floor back over to Mark Smith for any closing comments.

Thank you, operator, and thanks, everyone, for joining us today and your interest in Smith & Wesson. We look forward to speaking with you all again next quarter.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.