Smith & Wesson Brands, Inc. (NASDAQ:SWBI) Q1 2023 Earnings Conference Call September 8, 2022 5:00 PM ET
Company Participants
Kevin Maxwell – General Counsel
Mark Smith – President & CEO
Deana McPherson – CFO
Conference Call Participants
Mark Smith – Lake Street Capital Markets
Steve Dyer – Craig-Hallum Capital Group
Operator
Thank you for standing by, and welcome to the First Quarter 2023 Smith & Wesson Brands Earnings Conference Call. [Operator Instructions] As a reminder, today’s program may be recorded.
And now I’d like to introduce your host for today’s program, Kevin Maxwell, Smith & Wesson’s General Counsel, who will give us some information about today’s call.
Kevin Maxwell
Thank you, and good afternoon. Our comments today may contain forward-looking statements. Our use of the words anticipate, project, estimate, expect, intend, believe and other similar expressions are intended to identify forward-looking statements.
Forward-looking statements may also include statements on topics such as our product development, objectives, strategies, market share, demand, consumer preferences, inventory conditions for our products, growth opportunities and trends and industry conditions in general.
Forward-looking statements represent our current judgment about the future and are subject to risks and uncertainties that could cause our actual results to differ materially from those expressed or implied by our statements today. These risks and uncertainties are described in our SEC filings, which are available on our website, along with a replay of today’s call.
We have no obligation to update forward-looking statements. We reference certain non-GAAP financial results. Our non-GAAP financial results exclude costs related to the planned relocation of our headquarters and certain manufacturing and distribution operations to Tennessee, the spin-off of the Outdoor Products & Accessories business in fiscal 2021, COVID-19-related expenses and other costs.
Reconciliations of GAAP financial measures to non-GAAP financial measures can be found in our SEC filings and in today’s earnings press release, each of which is available on our website. Also, when we reference EPS, we are always referencing fully diluted EPS. When we discuss NICS results, we are referring to adjusted NICS, a metric published by the National Shooting Sports Foundation based on FDI NICS data.
Adjusted mix removes those background checks conducted for purposes other than firearms purchases. Adjusted NICS is generally considered the best able proxy for consumer firearm demand at the retail counter. Because we transfer firearms only to law enforcement agencies in federally licensed distributors and retailers and not to end consumers, NICS generally does not directly correlate to our shipments or market share in any given time period. We believe, mostly due to inventory levels in the channel.
Before I hand the call over to our speakers, I would like to remind you that any reference to EBITDA is to adjusted EBITDA.
Joining us on today’s call are Mark Smith, our President and CEO; and Deana McPherson, our CFO.
With that, I will turn the call over to Mark.
Mark Smith
Thank you, Kevin. And thanks, everyone, for joining us today. Beginning with top line revenue, our first quarter results reflect a return to a more normal demand pattern at the retail counter for firearms, combined with temporary headwinds on from inventory corrections within the channel. The industry experienced our first normal summer slowdown in three years.
And in addition to the usual seasonal foot traffic decline throughout the period, our channel partners were also selling through existing inventories. And therefore, we believe manufacturer orders were artificially depressed as compared to retail pull-through. Encouragingly, even with this lower retail activity, unit inventory of Smith & Wesson products within our distribution and strategic retailer accounts dropped significantly throughout the quarter, and we believe are now largely within target ranges for this time of year.
Since the end of the first quarter, order rates have also rebounded indicating that the inventory correction should now largely be in the rearview mirror as we enter the typically busy fall and winter seasons. I think it’s important to note that this was fully within our expectations.
As you will recall, and as Deana will cover in some more detail shortly, we estimated that our unit volume in the first quarter would be lower than it has been historically during a normal year due to this inventory correction. We estimated that Q1 would be between 10% to 20% of our FY ’23 annual volume, and we believe our results for the quarter were indeed within this range, albeit certainly towards the bottom end.
Further, in spite of a challenging quarter from a top line perspective, impressive Q1 profitability numbers prove that once again our team can deliver on our no-matter-what motto. In comparison of Q1 of FY ’20, which was the last normal summer, although top line was down for the reasons we just covered, the team delivered impressive bottom line profits, which far exceeded this comparable quarter, not just in relative percentages but in absolute dollars. And we fully expect to continue that discipline in cost control and promotional spending, which combined with the pickup of order rates over the past few weeks, as I just mentioned, bodes well for continued strong profitability over the remainder of the year.
Given this, we remain confident in our ability to comfortably maintain our published full year targets for cash generation of $75 million, cash on hand of $100 million, gross margins of 32% to 42% and EBITDAS at 20% to 30% of revenue.
With that, just a few comments on the overall firearms market from our perspective. The incredible strength of the consumer demand for firearms over the past couple of years vastly overshadowed the inherent seasonality of the business as demand outstripped the industry’s ability to supply.
Now with demand normalizing and manufacturers’ added capacity, the industry is returning to the seasonal cadence that was typical throughout much of pre-pandemic history. This has led distributors and retailers to adjust inventory level targets to be more in line with the normalized demand as well as adjusting to the incremental capacity that most manufacturers added over the past couple of years. Throughout the past few months, the industry navigated through the inflection point from the largest surge in history.
So unsurprisingly, this dynamic became more pronounced. We believe this created a considerable disconnect over the summer between shipments from manufacturers and corresponding NICS data. Looking forward, however, as indicated by NICS data and our channel partner feedback, interest in the shooting sports remains healthy and elevated relative to pre-pandemic levels, reflecting millions of new participants as well as continued support from core enthusiasts.
As mentioned earlier, distributor inventory of our products is very comfortable and currently sits at 14.5 weeks of supply. Please remember that although this is higher than our average target of eight weeks, this time of year is typically higher as we calculate weeks of supply by looking back across the past 13 weeks of demand, which is the slowest seasonal period as we simultaneously head into the fall and winter, which are typically the busiest.
This, combined with the order rate jump we’ve seen in the most recent few weeks gives us confidence that our sales forecast and production plans are firmly aligned with the current market. And again, we believe that the inventory correction we experienced over the past few months is now behind us. With this said, the return to a more normalized environment has allowed inventory of competitive brands to largely return to pre-pandemic level availability.
This obviously drives a much more competitive market versus the surge when we believe Smith & Wesson significantly outpaced the rest of the industry in deliveries, thanks to our flexible operations. In this environment, we believe that we still maintain the advantage with the Smith & Wesson brand indexing extremely high across the entire customer spectrum, reflecting our 170-year history of consistently delivering high-quality innovative products.
Additionally, we have been hard at work throughout the surge preparing for the inevitable return to a more competitive marketplace. Our marketing team has just released our newest national branding campaign, which underscores the amazing employees who make up our iconic company and has been receiving very positive reviews. Our sales team has been working around the clock to ensure that our partners are maintaining a full assortment of Smith & Wesson products.
And as with any successful consumer goods company, product innovation is critical to maintaining and growing share in a competitive environment. We are very excited about our strong pipeline of innovation for 2023. Just within the last month, we launched the first production revolver in the popular new 350 Legend caliber and introduced the first ever full metal frame M&P, both of which are already exceeding expectations.
And we still have two exciting new products scheduled for launch by the end of the quarter and several more to come before SHOT Show in January. In conclusion, the firearms market fluctuations are exactly what our business model is designed for. We will capitalize on the demand surges while remaining nimble and efficient so that we are always profitable no matter what.
We focus on driving long-term profitability and strong returns for our stockholders. And so despite the firearms market in fiscal 2023, expected to be down versus last year and well below the fiscal 2021 peak, we still expect to deliver strong top line performance with profitability ratios and cash flow comfortably within our long-term targets, a testament to the efficacy of that flexible manufacturing model and the power of the Smith & Wesson brand.
Throughout the demand surge in 2020 and 2021, we consistently demonstrated our ability to clearly understand the market dynamics, stay ahead of the trend, adapt and execute to optimize performance and ultimately maximize returns for long-term stockholders.
With that, I’ll hand the call over to Deana to cover the financials.
Deana McPherson
Thanks, Mark. Net sales for our first quarter of $84.4 million was $190.2 million or 69.3% below the prior year comparable quarter and $11 million lower than the first quarter of fiscal 2020, the last pre-pandemic comparable first quarter. As we noted in last quarter’s earnings call, we expected our Q1 sales to be the lowest quarter of the year at roughly 10% to 20% of the full year total and we came in towards the lower end of that estimate. Total units shipped were below fiscal 2020 levels, mainly due to an inventory correction, as Mark covered earlier.
Additionally, discipline in promotions during the current quarter resulted in ASPs that were approximately 50% above fiscal 2020; and in handguns, even higher than fiscal 2022 levels. All of this led to gross margin in the first quarter of 37.3%, which was well below the 47.3% realized in the prior year comparable quarter, but equal to the first quarter of fiscal 2020 in spite of lower sales.
Excluding relocation costs, however, gross margin would have been 38.8%, 1.5 percentage points better than in 2020 with approximately 12% less revenue. The decrease in margin from last year’s high was due primarily to a combination of reduced sales volumes across nearly all product lines; unfavorable fixed cost absorption due to lower production volume and employee-related costs associated with the relocation, partially offset by decreased compensation costs due to vacancies and favorable inventory valuation adjustments.
Operating expenses of $27.6 million for our first quarter were $2.5 million lower than the prior year comparable quarter, primarily due to lower sales-related expenses, such as co-op advertising and freight as well as decreased compensation-related costs driven by temporarily unsold positions, we believe as a result of the relocation.
Offsetting these temporary cost reductions were increased legal and professional fees and employee costs associated with the relocation. Net income of $3.3 million in the first quarter compared to $76.9 million in the prior year comparable quarter, reflecting lower net sales and gross margin, slightly offset by reduced operating expenses. However, when compared to the first quarter of fiscal 2020, in spite of $11 million on lower sales, net income was $1.1 million higher this quarter due to lower operating expenses and interest offset by lower gross profit dollars.
GAAP earnings per share of $0.07 in the first quarter was down from $1.57 last year but was $0.03 more than we reported in the first quarter of 2020. Non-GAAP earnings per share of $0.11 was down from $1.57 in Q1 fiscal 2022, but $0.07 higher than in fiscal 2020. EBITDA of $15.7 million represented 18.5% of sales.
During the quarter, we generated $7.1 million in cash from operations and spent $11.6 million in capital spending, resulting in net free cash used of $4.4 million. This was consistent with our expectations, given our planned inventory replenishment and increased spending on the construction of our new facility in Tennessee. We expect negative free cash for at least the next quarter as we continue to invest in the relocation, but we’ll generate ample cash throughout the remainder of the year to meet our annual cash generation target of $75 million.
As a reminder, our capital allocation priorities are in order, maintain no debt, invest in our business, including new product development, repair and replacement, information technology systems and most recently and significantly, our relocation to Tennessee. And finally, return capital to our stockholders in the form of share repurchases and increasing dividends over time.
Given our current cash forecast, we expect that our fiscal 2023 cash activities will be focused primarily on investment in our business. Consistent with our capital allocation strategy, our Board has authorized our $0.10 quarterly dividend to be paid to stockholders of record on September 22, with payment to be made on October 6.
Looking forward to the second quarter, as Mark noted, the firearm market appears to have returned to a more normal seasonal demand model with an increase in August order rates. And we are pleased to see inventory units at distribution continue to decline, although it continues to hover at approximately 14.5 weeks due to lower distributor revenue in the past 13 weeks.
Of course, while our average target is eight weeks of inventory at distribution, our experience tells us that the number of weeks at any given time varies based on seasonality, mix and many other factors. We continue to believe that calendar 2019 provides a good framework for modeling demand and seasonality for our fiscal 2023.
As noted, we expect Q1 to have been our lowest volume quarter and expect Q2 to pick up nicely as the summer ends and consumers begin to think about heading back to the range. We expect that Q2 will grow at a faster rate than historically seen over Q1 so that it will still represent approximately 20% to 25% of our total year units shipped.
Given ongoing inflationary pressures and costs associated with recruitment and the relocation to Tennessee, we don’t expect a significant change in our gross margins from what we experienced in Q1. However, as we replenish our vacant positions and begin to relocate activities to Tennessee and as revenue increases, we expect our operating expenses to increase by 10% to 15% over Q1 levels. 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?
Question-and-Answer Session
Operator
Certainly. [Operator Instructions] And our first question comes from the line of Mark Smith from Lake Street Capital.
Mark Smith
You guys addressed a lot of this in the — in your commentary, but I just want to walk through a little bit more, just the inventory kind of out there in the channel. Obviously, pretty overbuilt early in the quarter. Can you just talk about maybe…
[Technical Difficulty]
Operator
Mark Smith, your line is open again.
Mark Smith
Sorry, Mark, well, technical issue.
Mark Smith
No problem. Can you guys hear me now?
Deana McPherson
We can.
Mark Smith
Excellent.
Mark Smith
Yes, let me just give you — answer your question. So the question was inventories in the channel, right, and some — a little more color there on what’s going on. So throughout the quarter, our inventory units, so probably looking at our weeks of supply, remained relatively flat, but our inventory units dropped fairly significantly. And we don’t go into — we don’t know anymore on to the exact details there.
But what I will tell you is that our inventory units in the channel today are about what they were this time in — in calendar 2019, our fiscal ’20. So we’re on par about with where we were then. However, our weeks of supply today is significantly lower than it was in ’20, which tells us, and again, as we’ve talked about before, is that the demand for our product was there. And we corrected that. We’re through that now. And the demand is higher today than it was, obviously, over the summer period, it’s higher now than it was in fiscal ’20 if that makes sense.
Mark Smith
No, that’s helpful. As we look at your inventory in the channel maybe versus peers, competitors, can you talk about the rest of the industry in inventory? Is it similar to what we saw for your products? Is it maybe overbuilt or less that’s out there? Any insight you can give there would be helpful.
Mark Smith
Yes. I can’t — I don’t really have that level of insight, obviously, into any kind of detail. I can talk directionally just based on our conversations with our channel partners that the competitive products were pretty bare at the retail level throughout the pandemic. And we were the only ones who are really kind of delivering in any kind of significant meaningful fashion with a couple of others. I’m not going to get into names, but we’re doing a fairly good job, but that we definitely were well out in front in terms of deliveries.
So that was good for us. Unfortunately, when that inventory inflection point comes, as it did in the late winter, spring and over to the last summer, you become a victim of your own success a little bit and that everybody else is now got inventory coming into the channel. And we ended up becoming a little bit overstocked. And I think it is a fair statement to say that we’re a little more overstocked than some of the competitive products. But again, that was a temporary headwind, and we seem to be through it now.
Mark Smith
Okay. And with that said, as we look into more historical seasonality and coming into a more important time of the year here, how do you guys feel about promotional pricing and maybe what we may see over the next 6 months, given the inventories built back up, do you expect us to get into a more promotional environment?
Mark Smith
I think versus the pandemic, for sure, but you’re right to compare it to pre-pandemic levels. I think it’s going to be — in my opinion and our position is it’s going to be a lot more muted. I think we can be a lot more thoughtful about how we drive sales rather than just kind of the knee jerk, let’s just put a buy X, get Y out there or do it a rebate card.
And that’s not to say we wouldn’t be doing anything like that, but I think we can get a lot more creative in doing bundles and providing the extra value adds to the consumer through providing whether accessories, whether it be holsters or range bags or other things like that. In terms of the competitive market, it’s — and what the competitors are doing, you can definitely see that there’s a lot more a lot more promotional activity going on, but everybody else kind of seems to be in that same mode of let’s try and get a little more creative and a little more thoughtful about how we’re trying to drive sales out there rather than just dropping price.
And that’s really the environment we want to see. And as you saw, that allows us to maintain those ASPs. And again, the old saying revenues for vanity, you look at our revenue in Q1. And although we were lower than we were at that time, the last time we were pre-pandemic profitability significantly better, right? So that’s the mode and the model we want to continue going forward.
Mark Smith
Okay. And then you talked about kind of new products that you’ve introduced and new ones potential to come in here very soon. Can you talk about the mix or quantify at all kind of sales in the quarter that skewed towards new products? And maybe how much that helped ASP?
Mark Smith
In our first quarter, there wouldn’t have been a whole lot of new product there. We did a couple of line extensions and a few special makeups, but — so that was kind of the — that was the core product line. As we look forward into the rest of this fiscal year, that is a focus for us. So in Q1, we would have had the — the newer products would have been things like the CSX and et cetera, things we launched kind of SHOT Show and maybe the 30 Super Carryies in those products as we look forward though, as we kind of come into the fall season now, that is going to be a much larger percentage of the revenue is going to be coming off of some of these exciting new products we got coming.
Deana McPherson
Yes. So the — as we design new products, anything launched in the last year, that impacted the quarter by 21.3%, and that’s pretty standard, not — it’s — I think it’s a great thing. But the newest products came out just recently.
Mark Smith
Okay. And then just as we think about longer term, if you can give any more update on kind of the relocation, it sounds like still cost, you’re still in but maybe an update on kind of where you’re at in the process and what still needs to happen over the coming months? And then also, I’m curious about as we think about flexible manufacturing, what your opportunities are as you move, do you continue to have this kind of flexibility in manufacturing?
Mark Smith
Sure. So first part of the question is the move is on, the building is on track. So walls are actually going up right now, the concrete pad for both the front office and the — and the manufacturing — and the distribution space is poured. So well on track, and we’re still within our contingency budgets there. So no significant changes to the cost either.
The longer-term plan as we expect by about this time next year to be starting to move the front office towards the beginning part of next summer will be — starting to ramp up the operations in earnest and start to be manufacturing and distributing product out of that location.
In terms of the flexible manufacturing, it shouldn’t really have any impact because let’s remember that all of the machining operations, which is really where that flexible manufacturing comes into play. All those machining operations are staying here in Springfield. So there really isn’t a whole lot of change there.
So in terms of the new facility and what that means for us in terms of flexibility, it will significantly enhance our efficiency and our nimbleness because our assembly operations will be right in line with our distribution operations. So that will be — and also our plastic injection molding operations. That will allow us to take a lot of steps, work in process inventory, et cetera, out of the system, which allows us to be more nimble and efficient, but from the flexible manufacturing side, that all is staying here in Springfield. So that structure we have and that relationship we have set up with that vendor base really — there really isn’t a whole lot of impact to it.
Operator
Our next question comes from the line of Steve Dyer from Craig Hallum.
Steve Dyer
Just a little bit broader, curious when you look at sort of personal protection versus shooting sports versus hunting, are there any particular pockets of strength or resilience that you’d call out versus the others?
Mark Smith
Yes. I think personal protection and the shooting sports is right now where we a lot of our time and effort from the marketing perspective. And I think that’s kind of one of those, if you want to call it, more resilient and kind of has that — always has that obviously to go through the surges as we all know, but has that really steady base. And then I would say the next one is probably hunting, right? I mean hunting, there’s — that tends to be a slower moving — slower moving trends as more people — and I think that is one of the things that’s encouraging a lot of people get into hunting throughout the COVID pandemic, as they add a lot of free time in their hands, a lot of folks who used to hunt when they were younger out in the field.
So that — we kind of see that category picking up, but that’s kind of more of what you would think of as a traditional consumer good where it moves slowly in the single digits growth or if it’s going to fall off, it falls out in the single digits. The personal protection and shooting sports is kind of the one where you see those huge surges, but things to remember is that if you think about surges to the sine wave the bottom of those sine waves is fairly consistent. And that is where kind of we — and that’s our whole idea to be on the flexible manufacturing. That’s where we watch that, the bottom of those sine waves to see as we go into a surge and now we’re coming out of it is the bottom of this sine wave higher than the last time, right? And the answer to that right now, frankly is what we’re seeing is the answer is yes. And so — and when you talk about resiliency there, we do see some resiliency there and some stickiness to that.
So — and one more thing to just point out is our revolvers. So for that, that’s kind of what we’re known for. That was the foundation of the company. We’re still sold out on revolvers. So from that perspective, we see a lot of strength there.
Steve Dyer
Got it. That’s helpful. Couple of modeling questions. You talked about OpEx increasing 10% to 15% above Q1 levels once you’re in the new facility, which won’t be for another nine to — nine-ish months yet. So is the level in Q1 from an OpEx perspective sort of the right level until then?
Deana McPherson
No. So I’m sorry that, that wasn’t clear. OpEx between Q1 and Q2 will go up 10% to 15%. We’ve been experiencing what you would think of as normal attrition when you announce that you’re relocating and closing a facility. So right now, our operating expenses are what I would say, lean. So going into Q2, they will increase 10% to 15% over Q1 levels because of adding back headcount that we’ve lost and also because we expect revenue to be higher.
So revenue-related items such as co-op advertising and freight will be higher relative to the increase in revenue.
Steve Dyer
Got it. Okay. And then when you talk about assumptions sort of similar to calendar ’19. Are you talking about units or revenue? Or are you sort of thinking about it as one and the same? I’m just trying to sort of solve for ASPs.
Mark Smith
We’re talking about it in units.
Steve Dyer
Got it. Okay. And then just one cash flow question. I’m trying to sort of reconcile. So you have about $110 million in cash on the balance sheet right now. You’ve talked about generating another $70 million, $75 million plus. And I’m thinking of that after CapEx is the way I’m sort of reading that. But then you talk about ending the year with $100 million on the balance sheet. So to my mind, it should be closer to $200 million, but maybe help me where I’m missing that?
Deana McPherson
Yes. No cash generation is actually cash from operations. So we’re going to use up cash during the year.
Steve Dyer
Okay. So that’s not a free cash flow number.
Deana McPherson
Yes, that’s a cash from operations, that’s cash generation.
Steve Dyer
Okay. And then can you remind me, what’s your guided CapEx for the year?
Deana McPherson
So $20 million to $25 million or so in normal CapEx and $90 million to $95 million in relocation CapEx.
Operator
Does that answer your questions?
Mark Smith
Steve, you’re still there?
Steve Dyer
Can you hear me?
Mark Smith
Yes, we can hear you.
Deana McPherson
Yes, we can now.
Steve Dyer
Yes. No, that answers my question. Thank you. I’ll hop back in queue.
Operator
This does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Mark Smith, President and CEO.
Mark Smith
All right. Thank you, operator, and thank you, everybody, for joining us today. We’ll talk to you next quarter.
Operator
Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.
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