Earnings Call Transcript - SWBI Q4 2023

Operator, Operator

Good day, everyone, and welcome to Smith & Wesson Brands, Inc. Fourth Quarter and Full Fiscal 2023 Financial Results Conference Call. This call is being recorded. At this time, I would like to turn the call over to Kevin Maxwell, Smith & Wesson's General Counsel, who will give us some information about today's call.

Kevin Maxwell, General Counsel

Thank you and good afternoon. Our comments today may contain forward-looking statements. Our use of the words anticipate, project, estimate, expect, intend, believe and other similar expressions are intended to identify forward-looking statements. Forward-looking statements may also include statements on topics such as our product development, objectives, strategies, market share, demand, consumer preferences, inventory conditions for our products, growth opportunities and trends and industry conditions in general. Forward-looking statements represent our current judgment about the future and are subject to risks and uncertainties that could cause our actual results to differ materially from those expressed or implied by our statements today. These risks and uncertainties are described in our SEC filings, which are available on our website, along with a replay of today's call. We have no obligation to update forward-looking statements. We reference certain non-GAAP financial results. Our non-GAAP financial results exclude costs related to the planned relocation of our headquarters and certain manufacturing and distribution operations to Tennessee, the spin-off of our Outdoor Products & 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, and any reference to EBITDAS is to adjusted EBITDAS. Before I hand the call over to our speakers, I would like to remind you that when we discuss mixed results, we are referring to adjusted NICS, a metric published by the National Shooting Sports Foundation based on FBI NICS data. Adjusted NICS removes those background checks conducted for purposes other than firearms purchases. Adjusted NICS is generally considered the best available proxy for consumer firearm demand at the retail counter. Because we transfer firearms only to law enforcement agencies and federally licensed distributors and retailers and not to end consumers, NICS generally does not directly correlate to our shipments or market share in any given time period, we believe, mostly due to inventory levels in the channel. Joining us on today's call are Mark Smith, our President and CEO; and Deana McPherson, our CFO. With that, I will turn the call over to Mark.

Mark Smith, President and CEO

Thank you, Kevin. And thanks, everyone, for joining us today. Before we move into a discussion of our results, on behalf of the company, our Board and the entire Smith & Wesson family, I want to take a moment to acknowledge the significant contributions to Smith & Wesson of Mike Golden, who passed away unexpectedly earlier this month. Mike served as our President and CEO from 2004 to 2011, and as a member of our Board of Directors since 2004. The impact of his leadership and dedication to our industry, our company and most of all, our employees, cannot be understated. Mike had a long and very successful professional career across multiple industries. And he will be remembered fondly for accomplishing so much with the management philosophy and style of kindness, generosity and gentle guidance. We are grateful for our memories of Mike and deeply appreciate his commitment to the success of Smith & Wesson. Our thoughts and prayers are with his family and friends. Now on to a review of our business. Fiscal 2023 ended with a very solid fourth quarter as the headwinds we faced from elevated channel inventory throughout the first half of the fiscal year abated. Focused consumer promotions in the second half were successful in driving retail and distributor inventories down significantly, and we are now at or below targeted levels with every major customer. And most importantly, our retail market share data indicates that we've maintained our leadership position at the sales counter with the firearm consumer. Combined with lower inventory levels, this points to continued success throughout fiscal 2024. This is all thanks to our seasoned team who navigated through an extremely busy and challenging year, never losing sight of our long-term focus. Our operations team leveraged our flexible manufacturing model, adjusting production rates to match normalizing demand patterns while still delivering impressive profitability. Our sales and marketing teams work to maintain a strong presence with our consumers and our channel partners designing and executing strategic promotions to take advantage of opportunities as they arose to maintain our market share leadership. And the impressive slate of new products launched throughout the year, thanks to our new product development team, have bolstered Smith & Wesson's position as an innovation leader. Last but not least, none of this would be possible without the tireless dedication of our back-office support functions of HR, finance, legal, compliance and IT, without whom we simply could not run the business day to day. And all of this, while simultaneously navigating the challenges associated with our move to Tennessee, which is fully on track, as I'll cover in a few moments, I could not be more proud of the team and humbled to lead such a tremendous organization. Moving on now to a discussion of market conditions. All factors continue to point towards stable demand and normal seasonality. NICS was down low single digits on a year-over-year basis during our fourth quarter, modestly below trends in Q3 and within normal variability. And May NICS results continue to support the view that overall consumer demand remained steady compared to a year ago. Therefore, we expect that NICS will continue this trend throughout FY '24, largely following the same demand pattern at the retail counter as we experienced in FY '23. Taking into account the channel inventory declines I just covered, we expect that our results will compare favorably to last year. We are still seeing a somewhat bifurcated market at retail with entry-level price points and fully featured premium products, both remaining strong. In our view, this continues to reflect overall macroeconomic conditions where the average consumer spending is being squeezed by inflation. Importantly, we continue to be in a strong position to succeed despite these headwinds, as evidenced by our solid Q4 results. In this competitive environment, in addition to constantly monitoring and adjusting key aspects of production, pricing and promotion to ensure supply is aligned with demand, we remain very focused on innovation. We view new product introductions as a key point of competitive differentiation. Our new product launches in the second half of FY '23, the M&P FPC, the M&P 5.7, the M&P Metal, the Competitor, and the Equalizer have all been top-selling products, not just for us but for our retailers as well. With a robust pipeline of upcoming releases, you can expect us to continue this cadence throughout FY '24. Before I hand the call over to Deana, just a quick update on the move to Tennessee. As I mentioned in my earlier comments, the project continues on track with construction nearing completion. We have begun hiring and training our operations workforce, and equipment installation and testing is well underway. We expect to begin operations in August with the distribution going live and are planning to have the front office employees in place by the fall. It's also worth noting that with our upcoming move to Tennessee at the end of Q1, inventory on the balance sheet will remain elevated compared to historical levels, consistent with our plan for mitigating any potential disruptions. And with that, I'll hand the call over to Deana to cover the financials.

Deana McPherson, CFO

Thanks, Mark. Net sales for our fourth quarter were $144.8 million, $36.5 million or 20.1% below the prior year comparable quarter, which was as expected given the change in the competitive environment from last year. We were pleased that inventory in our distribution channel continued to decline from January, resulting in 5 consecutive quarters of inventory reduction. Gross margin was 29% and was below the 39.8% realized in the prior year comparable quarter and reflects a combination of reduced sales volumes, unfavorable fixed cost absorption due to lower production volumes, the impact of inflation on material and labor costs, and the impact of promotional programs that were run during the quarter. Operating expenses of $24.1 million for our fourth quarter were $1.4 million lower than the prior year comparable quarter due to a reclassification of sublease income from other income to operating expense. Excluding this adjustment, operating expenses were slightly above the prior year due to increased employee costs, mostly stemming from relocation factors, along with higher depreciation. We also had higher consulting expenses, but this was almost entirely offset by lower profit-related compensation expenses, lower marketing costs resulting from the launch of a brand Anthem in the prior year, and lower co-op advertising. Net income of $12.8 million in the fourth quarter compared to $36.1 million in the prior year comparable quarter was entirely due to lower net sales and gross margin. GAAP earnings per share of $0.28 was down from $0.79 while non-GAAP earnings per share of $0.32 was down from $0.82 in Q4 fiscal 2022. Turning to cash flow. During the fourth quarter, we generated $38 million in cash from operations and spent $25 million on capital projects, resulting in net free cash of $13 million. We paid $4.6 million in dividends and ended the quarter with $53.6 million in cash and $25 million in borrowings on our line of credit. During our full year, we generated $16.7 million in cash from operations and spent $89.8 million on capital projects, resulting in $73 million in net free cash used for the year. This use of cash represented a replenishment of depleted inventory combined with approximately $73.2 million in capital projects related to the relocation. As Mark noted, the timing of the relocation is on target. And we expect to begin distributing products from Tennessee in our second quarter. We will incur an additional investment of $85 million to $90 million during fiscal 2024 related to this important project. With the relocation nearing the final phase, our Board has authorized a 20% increase in our quarterly dividend, raising it to $0.12 to be paid to stockholders of record on July 13 with payment to be made on July 27. Looking forward to fiscal 2024, we expect consumer demand in fiscal '24 to resemble fiscal '23. That being said, we anticipate that our top line revenue will grow at a higher rate given the significant decline in inventory in the distribution channel that we experienced during the last fiscal year. However, given the recent competitiveness of the promotional environment, we expect ASPs to be down by 5% to 10% in fiscal '24. With regard to seasonality, we expect fiscal '24 to follow a similar pattern to fiscal '23 with a higher proportion of revenue in the first quarter than we realized in Q1 '23, again, due to channel inventory. We expect margins to continue to be pressured by promotions and higher costs due to inflation and rising interest rates. In addition, the opening of the Tennessee facility will include additional onetime costs related to start-up inventory movement and continuing employee severance and relocation resulting in margin pressure. Operating expenses will also likely be higher due to increased profit-related compensation costs, inflation, and onetime transition costs. We currently expect a total of $10 million to $12 million in transition costs, spread primarily in cost of goods sold, marketing, and general and administrative expenses. Finally, our effective tax rate is expected to be approximately 24%.

Operator, Operator

Can you please open the call to questions from our analysts?

Mark Smith, Analyst

First off, I just wanted to ask about long guns. Good to see a recovery there. Was this purely the new products or was there anything else that helped drive the demand there? Sorry, you broke up.

Deana McPherson, CFO

Mark, are you asking about the improvement in long guns?

Mark Smith, Analyst

Yes, sorry. I broke up there at the beginning. This is Mark. The growth is driven by a new product. As you know, we launched the M&P FPC in March, and it has been very successful, continuing to perform well and accounting for over a third of that total. Excellent. And then any more update on the competitive environment, especially as we look at pricing? Maybe any thoughts on inventory throughout your competitors and throughout the industry, but really want to hear about pricing competition. Yes. I mean for us, our pricing, we've been able to hold our pricing nicely actually. So we're very pleased with that, as you can see with the ASPs in this quarter, and I think we covered a little color on what we expect them to be going forward. We expect to hold 90% to 95% of the gains we've been able to achieve there. In the marketplace overall, definitely, as I kind of talked about in my prepared comments, there's definitely a bifurcation. There's kind of the lower end is doing well and a lot of volume there. And again, at the higher end, the less price-sensitive consumer is doing well as well. We've been able to be successful. As you know, we run the gamut on our product line between good, better, best. And we've got plenty of product offerings in both of those categories. And we continue to believe that we won't have to promote aggressively any more beyond what we've been doing already. That said, the inventory in the channel right now, we're experiencing a normal summer just like we did last summer. For us specifically, we're very pleased, as we talked about in the comments, with where our inventory in the channel is. That promotion we ran in the beginning of the calendar year was very successful in correcting the last few pockets of inventory out there in the channel for us. And so we're very pleased with where our inventory sits coming into the summertime and into this new fiscal year. So as far as the channel inventory for other competitors, I think I'd have a hard time commenting on that; I'd be kind of giving you some more opinion than fact on that. So I'm going to kind of leave that to you to do some channel checks. No, that's fair. The last one for me. Just it sounds like the timing of the move here to Tennessee is going really well. Any comments on budget? You've still got a fair amount of CapEx here to spend. Any thoughts on how the project has been moving relative to budget? Yes. As we discussed in previous calls, we have definitely exceeded our initial estimates when we began the project due to the inflationary environment. When we started this project two years ago, the impact of inflation has been significant. However, it has now stabilized. We do not expect any further increase from our last estimate, which was in the range of $160 million to $170 million in total. We still firmly believe that the project will fall within that range, so there will be no additional inflation affecting it.

Operator, Operator

Our next question comes from Steve Dyer with Craig-Hallum Capital Group.

Steven Dyer, Analyst

Along those lines, it looks like, I think if I recall, you had guided $115 million to $120 million on CapEx for fiscal '23. It looks like $30 million or $40 million of that slipped to fiscal '24. Is that right?

Deana McPherson, CFO

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

Steven Dyer, Analyst

Got you. And then, I guess, why would payables go into CapEx on that statement?

Deana McPherson, CFO

So what happens is you have to remove them out of both, payables and capital, because it's a cash flow. And the way GAAP requires you is if you haven't paid it by April 30, it has to come out of your capital spending. So there was a good chunk of it at the end of the year where we had received bills. But just based on the timing of payments, it didn't go out the door until the beginning of May. And so it comes out of that number.

Steven Dyer, Analyst

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

Mark Smith, President and CEO

Yes. So I guess that's two questions. The primary driver of the move and the beginning of the discussion was due to some unfavorable legislation that was being proposed in the state of Massachusetts that was going to be extremely damaging to our business, some proposals essentially that would prohibit us from being able to produce about 50% of products that make up about 60% of our revenue. So that was kind of the impetus to begin on the project. As far as the payback goes, we've been operating, I think, as you know, Steve, out of this facility here in Massachusetts for the specific facility since the '40s. And it's been very good to us, and we're going to continue operating out of the facility, quite frankly, on the manufacturing side, indefinitely as we move assembly operations out though and plastic injection molding and align that with our distribution operations out of Missouri and now are kind of looking at a big open box. You want to say it's a once-in-a-lifetime opportunity to look at efficiency improvements on the operational side. So we anticipated those at that time to be in the $0.07 to $0.10 of EPS range. We still believe that to be the case. So when you think about that as a payback, it's pretty significant and still makes the investment worthwhile in the long term, aside from the existential risk to the business.

Steven Dyer, Analyst

Yes, that's helpful. As we approach fiscal '24, it seems you expect consumer demand to remain relatively strong. Do you anticipate any restocking, or do you believe the channel is stable, leading you to direct shipments more towards end demand?

Mark Smith, President and CEO

I think there is an opportunity for some restocking with us. As I mentioned earlier, we're at or below our targeted inventory levels, which are 8 weeks of supply with our major distributors. So there is a chance for some restocking. However, we are not operating at just 2 weeks; we are averaging around 7 weeks. This means some of those distributors will indeed have the opportunity to restock. In response to your question, yes, we will pay closer attention to what is happening at retail. We expect to maintain the pace of new product launches, and regarding the increase in long gun sales, that was driven by a new product. We have more new products coming out in the next couple of weeks, and this will continue throughout the rest of our fiscal year in that product category. We anticipate being able to keep pace with the market and our goal is to continue gaining market share. So, we aim to align our activities to drive higher consumer retail activity compared to our competitors.

Operator, Operator

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

Mark Smith, President and CEO

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

Operator, Operator

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