Q2 2023 Smith & Wesson Brands Inc Earnings Call
Good day, everyone and welcome to Smith, <unk> Wesson brands, Inc. Second quarter fiscal 'twenty to 'twenty three financial results Conference call.
This call is being recorded at this time I would like to turn the call over to Kevin Maxwell Smith, <unk> Wesson as General Counsel, who will give us some information about today's call.
Okay.
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 referenced 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.
Spin off of the outdoor products and accessories business in fiscal 2021.
COVID-19 related expenses and other costs.
Reconciliations of GAAP financial measures to non-GAAP financial measures can be found in our SEC filings and in today's earnings press release, each of which is available on our website.
Also when we reference EPS, we are always referencing fully diluted EPS.
When we discuss next results we are referring to adjusted mix a metric published by the National shooting Sports Foundation based on Spi next data.
Adjusted mix removes those background checks conducted for purposes other than firearms purchases.
Adjusted next 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 next generally does not directly correlate to our shipments or market share in any given time period, we believe mostly due to inventory levels in the channel.
Before I hand, the call over to our speakers I would like to remind you that any reference to ebitdas is to adjusted Ebitdas.
Joining us on today's call are Mark Smith, our president and CEO and Dana Macpherson, our CFO with that I will turn the call over to Mark.
Thank you, Kevin and thanks, everyone for joining us today.
The firearm demand continuing to normalize our second quarter results. Once again demonstrated the significant progress we've made over the past several years in creating a highly adaptive and robust business model that consistently delivers strong profitability regardless of market conditions.
A comparison back to our fiscal 2020, which was the last period of normal firearm demand provides a great illustration.
Top line revenue increased by 6% in Q2 of this year versus FY 'twenty EBIT.
EBITDA increased by nearly 90% driven by higher Asps and lower operating costs.
Looking forward to the second half of our fiscal year, while we anticipate more normal demand levels.
Our seasoned team has effectively managed through these cycles before and our business model is specifically designed for this and we expect to continue delivering strong levels of profitability, even with the significant one time expenses associated with our move to Tennessee.
All of this is thanks to the hard work of the Smith <unk> Wesson team and remaining steadily focused on our long term success of the business no matter the conditions.
And as always our appreciation for their dedication cannot be overstated.
Turning now to the market consumer demand for firearms as measured by next was largely consistent from our fiscal Q1 to Q2 tracking below the surge period.
The trend worsened in the latter half of our second quarter as evidenced by the accelerated year over year decline in monthly next ending with October only nominally increasing sequentially and representing the lowest sequential increase over September on record.
Not surprisingly this deterioration coincided with the broader consumer slowdown driven by persistently high inflation, the beginning of the winter heating season across the northern half of the country and rising interest rates.
But that said the most recent data from November Nick's released last week indicates a return to more normal demand patterns and firearm demand does remain healthy when compared to historical levels and remains elevated when compared to our FY 'twenty, which again was the last pre pandemic period.
This indicate that the temporary headwinds are being offset by longer term tailwind.
As Youll recall, there were more than 10 million new consumers added to the firearms market over the past 18 months to 24 months, many of whom are now returning for subsequent purchases.
With these new entrants previous studies, indicating that firearms enthusiasts will own an average of 7% to eight firearms and recent data showing that can feel carry is on the rise. We believe long term demand trends remain very healthy.
However, with the uncertainties surrounding the current economy and its impact on firearm demand levels, many firearm retailers and distributors continue to take a cautious approach and continue to adjust inventory levels.
Is creating near term headwind to our business as we discussed on our last earnings call.
Importantly, this is a normal and healthy process and consistent with how we have seen the market adjust in past periods following significant surges in demand.
And we note that inventory levels for our products within our distributors and strategic retail accounts are down considerably sequentially and versus prior year, marking the third consecutive quarter of significant channel inventory declines and indicating therefore solid pull through of our products at retail.
All of this means we remain in a highly competitive environment and winning profitable market share at the consumer level remains our core focus with many consumer squeezed by inflation and record prices for household essentials consumer price sensitivity on discretionary purchases has increased predictably leading to increased.
Activity within the firearm space.
As we have mentioned before we take a very strategic approach to pricing and are confident in the pricing actions, we've taken to align our asps with the power of the Smith, <unk> Wesson brand and our long standing reputation for quality and innovation.
We believe we are now well positioned.
Versus competing products across the full feature value spectrum.
The resulting higher asps have driven strong profitability by helping us mitigate inflationary pressures and also partially offsetting lower volumes.
We expect our use of promotional activity in this competitive landscape to similarly remain aligned to ensure we do not erode gains long term.
However, we may increase promotional activity on certain of our core product lines in the second half of our fiscal year to address the realities of the current challenging economic conditions.
Okay.
Additionally, and now more than ever innovation, and new product introductions are critical to continuing our leadership position in the industry.
Thanks to the hard work of the Smith, <unk> Wesson engineering and product management teams throughout the pandemic, we are very well positioned to continue our steady cadence of product launches.
Just in the past few months, we introduced our MMP metal Ah full metal version of our iconic MMP full sized pistol. Our equaliser 15 round concealed carry pistol, featuring our patented easy technology, which reduces slide racking forced by over 35%.
Our competitor made by our performance center in collaboration with our legendary pro shooting team of Jerry mentioned like in July .
Full featured metal frame pistol ready for competitive shooting straight out of the box.
These products have been very well received by the market and are exceeding our expectations and.
And stay tuned we have several more exciting new products lined up for introduction throughout the second half of our fiscal year.
In summary.
We continue to manage the business for the long term and sharing we consistently deliver high levels of profitability, regardless of which direction demand is trending.
Fiscal 2023 continues to be a year of recalibration and adjustment for our industry and Smith <unk> Wesson.
Interest in shooting sports remains strong and participation rates remain above pre pandemic levels, which bodes well for the long term.
Over the near term the industry is facing the dual challenge of a cyclical downturn and more intense macroeconomic headwinds pressuring consumer spending, particularly on discretionary items such as firearms.
While this will likely to continue to impact our top line revenue over the balance of fiscal 2023. It is precisely the type of environment for which our flexible model was built and we expect to remain highly profitable and continue delivering on our commitments to our customers employees and stockholders well into the future.
With that I'll hand, the call over to Diana to cover the financials.
Thanks Mark.
Net sales for our second quarter of $121 million plus.
It was $109 4 million or 47, 5% below the prior year comparable quarter, but seven 3 million above the second quarter of fiscal 2020, the last pre pandemic comparable second quarter.
As we noted in our last earnings call, we expected our second quarter volumes to be roughly 20% to 25% of the full year and we came in within that range.
Third consecutive quarter inventory in our distribution channel has meaningfully declined.
This ongoing inventory correction combined with the impact of promotional activity by our competitors and the trading down by consumers to lower priced products negatively affected our quarterly sales.
On a positive note. However, the discipline that we've exhibited in promotions during the current quarter has improved our overall profitability when compared with pre pandemic levels, reflecting asp's there were approximately 45% above fiscal 2020.
Although gross margin in the second quarter of 32, 4% well below the 44, 3% realized in the prior year comparable quarter. The increase in Asps resulted in a 4% improvement over the second quarter of fiscal 2020.
Relocation costs negatively impacted the current quarter gross margins by one 5% in the comparable quarter last year by half a percent.
The decrease in margin from last year. It was also due to a combination of reduced sales volumes across nearly all product lines.
Impact of inflation on material and labor costs.
Unfavorable fixed cost absorption due to lower production volume and unfavorable product liability and inventory valuation adjustments, partially offset by decreased compensation costs.
Operating expenses of $26 7 million for our second quarter were $9 9 million lower than the prior year comparable quarter, primarily due to a $3 $1 million reduction in relocation costs lower sales related expenses, such as co op advertising and freight.
And decreased compensation related costs, driven by temporarily unfilled positions.
Believe as a result of the relocation.
Net income of $9 6 million in the second quarter compared to $59 million in the prior year comparable quarter, reflecting lower net sales and gross margin slightly offset by reduced operating expenses.
However, when compared to the second quarter of fiscal 2020, net income was $9 $3 million higher this quarter due to higher asps and lower operating and interest expenses.
GAAP earnings per share of 21 in the second quarter was down from $1. Five last year that was 20 <unk> more than we reported in the second quarter of 2020.
non-GAAP earnings per share of 26% was down from $1 13 in Q2 fiscal 2022, 24 times higher than in fiscal 2020.
Ebitdas of $25 6 million represented 21, 1% of sale.
During the quarter, we used $35 $3 million of cash from operations and spent $20 million for capital projects, resulting in net free cash used of $63 3 million.
This was consistent with our expectations given our planned inventory build during the quarter payment of profit sharing from fiscal 2022 and increased spending on the construction of our new facility in Tennessee.
We remain focused on managing the business for long term profitability market share performance and capital return to our stockholders.
To that end our board has authorized our 10 cent quarterly dividend to be paid to stockholders of record on December 20th with payment to be made on January 3rd.
Looking forward to the third quarter now.
Now that we are operating under a more normal seasonal demand model with distributor inventory at more comfortable level.
Our earlier estimate of 20% to 30% unit volume for the third quarter continues to appear reasonable.
We expect that margins will continue to be pressured by cost associated with relocation inflation and lower volume than in the prior two years.
In addition, we have begun to increase promotional activities on select products and expect that to continue through most of the rest of this year, which will likely affect asps.
Margins and operating costs and.
And finally, a show season begins in January both sales and marketing costs are likely to grow beyond our current quarterly run rate.
We remain committed to our long term financial targets and while the low end is still within reach for fiscal 'twenty three.
Current industry trends have created additional uncertainty as we are also being impacted by the onetime costs related to the construction of the Tennessee facility and equipping it with state of the art machinery.
When you combine these onetime costs with the working capital needs of our business to meet cyclical consumer demand and cost associated with preparing for next summer's move we will likely continue to experience negative free cash flow during the third quarter, even with inventory beginning to decline seasonally.
Finally, our effective tax rate is expected to be approximately 24%.
With that operator can we please open the call to questions from our analysts.
As a reminder to ask a question you will need to press star one one on your telephone again Thats Star one one on your telephone to ask a question. Please standby, while we compile the Q&A roster.
Our first question comes from the line of Mark Smith with Lake Street. Please go ahead.
Hey, good afternoon, how are you guys, Hey, Mark hasn't gone as.
Good good Hey, I just wanted to start out just talking big picture on kind of the promotional environment. It seems like it's gained steam kind of around the holidays Black Friday.
It seemed like you guys have followed suit is that correct and then it sounds like Youre may be open a little bit more here in the second half to be a little more promotional but but it doesn't sound like you're going to follow what we're seeing from some peers and get overly promotional here in the second half.
Yes, that's a good question I think so so so far yes. The answer is we haven't.
We haven't participated to the level of some of our competitors I think we're taking a little bit as we kind of as I said from some of the prepared remarks.
Sure.
We're kind of taking more of a longer term approach, we don't want to erode those asps that we've been able to gain over the last couple of years, we do feel like we're in a good position versus the competition and what the brand should be able to command.
With all that said.
Sorry, one more thing, we're also going to try and.
Pushed a little bit more on new product and get a little bit rather than being totally reactive and just going into straight into promotions are there. Some things we can do with.
With new product.
Volume and maybe some bundling with some accessories et cetera.
A little bit more creative things all of that said.
I think we all understand that the economic conditions are what they are especially for discretionary items like firearm. So we're kind of going to have to.
Play the hand, we're dealt as we kind of go forward here and so I think your question of are we going to participate.
In a more meaningful way.
Promotion second half the answer is probably yes.
Okay and it looks like just as we look near term and I know you don't and haven't given kind of quarterly guidance, but.
Given we saw some handguns nine millimeters being sold by peers at $200 or so of retail.
Plus rebates I would expect it.
Youre not expecting any significant volume growth here.
In the near term as spares or overly promotional.
Promotional.
Yes, I think Dana kind of gave some comments some color to that in her prepared remarks around the percentages of unit volume that we expect for the first half versus the second half and so I think we're kind of holding to that I think you can probably get to get to where you would need to be based on some of the comments that geno gave on the percentages first half versus second half on unit volume right I mean in general.
Speaking, Marc we don't expect Q3 to be terribly different from where Q2 came.
That seasonality May change, we'll see how the Christmas season gather then reorders in January but right now we're not forecasting it to be terribly different than Q.
And then your Q4 is as you can as you know you've been around a while Q4 is usually for US our fiscal Q4 is usually kind of you get that.
Pickup in Q4, so you can kind of go back to historical and expect that same kind of pickup that we've had historically pre pandemic.
Yes, and that's just I wont walk through just your new product launches and moving to more kind of historical norms and kind of timing of shipments.
Within your inventory build at the end of the quarter can you speak to maybe how much of that was new product that you had some new products that we're launching kind of.
At the end of the quarter.
Not a lot of it are.
Our new products.
Just the timing of it we usually load into the channel prior to the actual consumer launch that it's available at retail once we start talking about it so you'll note that we launched.
Those new products were right at the beginning of November . So we had we had really loaded a lot of those already and then middle of November So they were already starting to ship into the channel. So.
So a lot of that inventory build was not was not associated with new products.
Okay.
And then as you just discussed Q for the April quarter, maybe seen a little bigger build in shipments is that primarily due to continued new product launches and getting that product into distributors and retailers.
Yes, yes.
Second half we will we will continue you saw the cadence kind of pickup in.
We almost had kind of one new product launching every month since September end of right at the end of October beginning of September one and then at the beginning of October and sorry end of October beginning of November and then one just most recently with the competitor.
We do anticipate to kind of continue a pretty steady cadence probably not to that level, but throughout the second half. So the second half does have a lot of a lot of new product and concluded.
Okay, and it might be digging a little bit here just into your plans on launches, but a lot of your products that you have lots of recently have been at.
Mid to higher end of maybe asp's and price points.
Should we expect that going forward or is there a chance that you've come out with more.
Lower and introductory type type products going forward.
Yes, I think Youre, you are digging a little bit there, but I can't.
Are you a little bit of color.
It's.
As I said earlier I mean, we're managing the business for the long term and we do believe that the Smith <unk> Wesson brand and our reputation does allow us to kind of play in that mid upper tier.
And so yes.
The new products, we're launching the intent with the new products that we're launching is that we can command full margin for a brand new product.
And we anticipate those products will come in kind of where our asps are sitting today and shouldn't materially impact the most hopefully help us to be able to maintain them.
But that said the new products the detail of it is youre going to youre going to span the spectrum between kind of our our lower end and all the way up into our high end products such as <unk>.
Not as much color as I can give you that they're not really going to materially impact our asps.
Okay.
One way or the other.
Okay.
One just kind of shifting a little bit can you just give any more update on relocation as far as timing and cost and anything is it still going according to plan, but have we seen anything shift.
No yes.
Appreciate the question everything is going very well and.
And yes. According to plan on a timing basis as we've talked about in previous calls, but the inflationary impacts across the economy.
It is a little bit towards the north end of our range of what we expected, but we are still within our contingencies and we still anticipate to be able to do it within our budget, although albeit towards the north end and from a timing perspective is going very well so.
The building is right on track.
Our.
Personnel out there we're actually we've got over 60 employees already working out of the area of them, mostly front office personnel working out of the out of the Tennessee temporary location. There. So that the move from a personnel perspective is going very well as well.
Okay, and then another kind of big picture question.
Cash the balance sheet has changed Paramount, we see the inventory come up cash position come down still debt free.
Just looking at expectation that Youll still have some negative free cash flow here. This next quarter.
Has anything changed as far as capital allocation, our plans of investment.
Let dean and get into the detail in a second but just generally from capital allocation nothing has changed in terms of our priorities I think we said right from the get go three years ago.
Great.
Talking about the spin that our capital allocation priorities would be reinvestment back in our business and then returns.
Excess cash back to the stockholders and that remains the priority. So.
Right now obviously, we're investing back in our business with the facility in Tennessee, which continues to be a fairly significant cash drain but was planned and anticipated and then once we're done with that.
Don't see anything major on the horizon in terms of the cash.
Cash expenses needed for the business and we'll be back into returning cash to the <unk>.
<unk>, yeah, and you'll see that our capital spending is.
Higher than it normally is just just in a quarter never mind for the full year.
Without that we would have been.
<unk> $30 million to $40 million higher than cash so.
We did plan for it we expect to spend the cash.
We went into this knowing that that was an excellent use of cash for the long term viability of the business and unfortunately that means I don't get to hold the cash that I want to.
Hold but.
Once we get back to the.
We opened the grand opening of the new facility.
That should cover everything that we need to do in the short term and we'll get back to looking at how can we make more investment to our investors.
Okay.
And then the last one for me just big picture again regulatory environment. We've seen the first kind of piece of legislation or change here in a long time.
Can you just give an update on where you guys stand and any recent legislation nationwide not state by state any change that that had on your business.
Yes.
As we always kind of answered this question Mark we make lawful products and we abide by all the laws and whether it's local state or federal and we will always continue to do that.
One of the things we pride ourselves on is compliance with regulations and running unethical business. So.
That said.
The state regulations, we have seen them kind of.
<unk> come and go ebb and flow and you know Theres a lot of I guess a lot of noise. If you want to call. It there.
The Oregon legislation, obviously is causing a temporary spike in that area for folks looking to exercise the second amendment rights, while they feel they still can.
We will continue.
To react to those as they come up in terms of the long term macro impact to the business. We've just seen.
Look at some of the states that have the most restrictive.
Yeah.
<unk>.
Restrictive laws on the second amendment there as some of our some of our top next states. So.
Those those consumers still willing to exercise their rights, even with the restricted list <unk> of losses to the impact to our business.
It's it's fairly minimal.
Okay, great. Thank you guys.
Yes.
Thank you once again to ask a question. Please press star one one on your telephone again Thats Star one one on your telephone to ask a question.
Our next question comes from the line of Rommel Dionisio of ages. Please go ahead.
Hi, good afternoon, Thanks for taking my question.
You guys launched the <unk> the shotgun about a year ago and about a year now that we're about a year into it Mark I Wonder if you could just go through your thoughts on the category.
Have a launch has gone a year into it.
And I'm guessing you didn't under this broad new category is just one model one SKU.
Not being a long term <unk>, which I would just love to hear your thoughts in terms of how that launch has gone and how you view the category and the response to your product and your plans going forward to the extent that you can disclose those thank you.
Sure. Thanks for the question Ralph.
Yes.
Long gun category in the.
And Jack guns in general yes.
Since some opportunity for us and white space for us in the company.
The MMP.
<unk> 12 that we launched was.
And is more of a one of the higher end ballpark shotguns and again as I said earlier, and we believe definitely commands that that higher end price due to the.
The quality and brand reputation that we have.
That is unfortunately.
The recent.
Downturns, when one of those categories, the higher and more tactical spec.
Specialty shotguns has been one of those categories, that's been kind of more hard hit.
Chuck on category still we anecdotally hear it's still moving very well, but it is at the low end.
And a lot of hunting shotguns pumps etcetera. So.
Long term is but that's as much color as I can give you is yes.
Some white space for us and continues to be an area, we look at and evaluate and.
And as I said earlier on new product development is one of those things one of those areas. It's a really great lever, we feel we can pull to keep those consumers interested in us and gain more than our fair share of the market as we go forward so hopefully.
It gives you.
Between line that gives you gives you information.
Sure Thanks for the color.
Thanks Ralph.
Yes.
Thank you again to ask a question. Please press star one on your telephone again Thats Star one on your telephone to ask a question.
And as there are no further questions in queue I'd like to turn the call back over to Mark Smith for closing remarks, Sir.
Thank you, Sir and I just want to thank everybody for joining US today, we will talk to you next quarter.
This concludes today's conference call. Thank you for participating you may now disconnect.
The conference will begin shortly.
To raise your hand during Q&A you can dial star one one.
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Yes.
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