Q3 2024 Smith & Wesson Brands Inc Earnings Call
Participants
Deana L. McPherson; Executive VP, CFO, Treasurer & Assistant Secretary; Smith & Wesson Brands, Inc.
Kevin Alden Maxwell; Senior VP, General Counsel, Chief Compliance Officer & Secretary; Smith & Wesson Brands, Inc.
Mark Peter Smith; President, CEO & Director; Smith & Wesson Brands, Inc.
Steven Lee Dyer; CEO & Senior Research Analyst; Craig-Hallum Capital Group LLC, Research Division
Unidentified Analyst
Presentation
Operator
Good day, everyone, and welcome to Smith & Wesson Brands, Inc. Third Quarter Fiscal 2024 Financial Results Conference Call. (Operator Instructions) This call is being recorded.
At this time, I will turn the call over to Kevin Maxwell, Smith & Wesson's General Counsel, who will give us information about the call.
Kevin Alden 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 move of our headquarters in certain of our operations to Tennessee 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 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 purchase. 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 Peter Smith
Thank you, Kevin, and thanks, everyone, for joining us today. Our team delivered another strong quarter on both the top and bottom line in Q3. We believe we gained market share as our shipments outpaced the overall firearms market, reflecting the continuing robust demand for our best-in-class innovative new products and sustained momentum in our core product portfolio.
On the bottom line, our persistent focus on cost discipline, combined with increasing production rates and solid operational execution against key initiatives, including our Tennessee move, drove better-than-expected EPS of $0.17. And consistent with our commitment to return value to our stockholders, we continued to buy back shares during the quarter and paid out $5.5 million in dividend.
Top line revenue was up just under 7% over last year, whereas shipments were up almost 11%. This reflected mix factors stemming from strong reception to the launch of second-generation entry-level pistol, the SD 2.0 and holiday promotional activity. By category, our long gun shipments doubled versus the year ago period, and our handgun shipments were largely flat, down less than 4%, while the overall market, as measured by NICS (inaudible) was up only 5% in long guns and down 4% in handguns. This highlights the power of our new products, which made up over 20% of our sales in the quarter, led by the FPC, which continues to be the top-selling product for many of our channel partners.
As we've covered many times before, an important factor in comparing our shipments to NICS is fluctuating inventory levels at retailers and distributors. Notably, our inventory levels during the quarter remained healthy with unit inventories at our distributor, [strategic] retail partners actually decreasing by about 12% throughout the quarter. This indicates strong consumer hand and pull-through at the retail counter for Smith & Wesson products and reinforces our belief that we gained market share in the quarter.
And in spite of the mix factors I mentioned earlier, ASPs also remained healthy during the quarter and continued to trend in line with our expectations. As expected and as Deana covered last quarter, handgun ASPs declined by about 6% versus a year ago, whereas long gun ASPs beat expectations by improving by about 7%. These strong ASPs, combined with excellent operational execution by our team in getting our new facility up and running led to better-than-anticipated profitability as we were able to ramp production in the quarter and improve manufacturing absorption. This drove gross margins of nearly 29% in spite of some continuing duplicate costs, which will abate as we enter FY '25.
Looking forward, with our internal inventory levels now at or below target in almost every category, we are continuing to increase production in Q4 to meet demand. As such, we fully expect our fourth quarter gross margins to further improve and return to levels consistent with long-term model of 32% to 42%. We also anticipate these levels to be sustained into FY '25 as the final remaining duplicate costs from the Tennessee moved are phased out and we begin to fully realize the efficiency benefits of our new state-of-the-art facility.
Finally, we attended SHOT Show in late January and used this industry event to announce a significant new product that I'd like to spend a few more minutes on. Our new 1854 lever-action rifle has the potentially a major contributor to growth for many years to come. We view it as a platform product for Smith & Wesson. And believe we are well positioned to execute on this vision based on the rich heritage of our brand, loyal consumer base and successful track record of building out other platform products such as our M&P line. Lever-action has been a part of Smith & Wesson's DNA since the beginning. We owned the original lever gun patent that was granted 170 years ago in 1854 that led to the development of the Volcanic, one of the first repeating firearms. This is why we named our lever-action rifle, the 1854.
As a category, we view lever-action today as very underserved and believe that our heritage and authenticity give us a lot of brand permission to look broadly at potential opportunities that intersect with lever-action, with new calibers, finishes, purpose-built extensions and an entry into the broader hunting category. The 1854 represents a significant white space opportunity for Smith & Wesson, and we're very excited to put our award-winning new product development team to work in expanding into this new area.
In summary, we are very pleased with our third quarter results and are looking forward to a strong finish to FY '24. We continue to expect the firearms market to experience healthy demand throughout the 2024 election cycle and with our deep pipeline of new products, leading brand, new state-of-the-art facility now operational, strong balance sheet and most importantly, world-class dedicated employees, we are excited to continue to delivering value for our stockholders.
With that, I'll turn the call over to Deana to cover the financials.
Deana L. McPherson
Thanks, Mark. Net sales for our third quarter of $137.5 million were $8.4 million or 6.5% above the prior year comparable quarter. During the quarter, inventory in the distribution channel declined from October in terms of actual units and weeks of inventory, indicating strong sell-through of our products at retail. As expected, ASPs declined from Q2 levels due to promotions and a shifting mix in handguns to lower-priced products, while ASPs in long guns increased due to new product introductions.
Gross margin of 28.7% was better than anticipated at 3.3% above Q2 and 3.7% lower than the comparable quarter last year. The decline from last year was due to the impact of operating the new Tennessee facility combined with inefficiencies associated with the start-up of that facility and inflationary factors in both material and labor, partially offset by higher sales volume, lower spend on the relocation and the January 1 price increase.
It should be noted that while the Tennessee facility is increasing costs at the margin level, some of this is due to geography on the P&L as we are no longer operating the Missouri facility, which was entirely recorded in operating expenses. In addition, the cost savings associated with operating with Tennessee facility have not yet been fully realized as we are ramping up our operations and have not begun some of the automation that will improve efficiencies. We also have yet to realize the savings associated with closing our Connecticut facility and the offsite Massachusetts 3PL location.
Operating expenses of $28.1 million for our third quarter were $438,000 higher than the prior year comparable quarter, primarily due to an increase in depreciation on the new facility and legal costs. Cash generated by operations for the third quarter was $25.4 million, $18.5 million better than last year, primarily due to receivables remaining relatively flat to last quarter, while inventory declined by $9.8 million. With capital spending of $18.2 million, most of which was related to our relocation, we generated $7.2 million in net free cash during the quarter.
We continue to opportunistically repurchase shares under our $50 million authorization. During the quarter, we repurchased approximately 71,000 shares at an average price of $12.88, for a total of $916,000. We paid $5.5 million in dividends and ended the quarter with $47.4 million in cash and $65 million in borrowings on our line of credit.
Subsequent to quarter end, we have already repaid $15 million on this line, and we continue to expect to be in a position to fully repay our line before the end of the calendar year. Finally, our Board has authorized our $0.12 quarterly dividend to be paid to stockholders of record on March 21, with payment to be made on April 4.
Looking forward to our fourth quarter. As Mark noted earlier, demand has been good and channel inventory for our products is healthy, particularly when compared to last year when it was about 50,000 units higher. As is typical, due to the seasonality in our industry, we expect our fiscal fourth quarter to be the highest quarter in terms of revenue. From Q3 to Q4 last year, sales grew 12.2% with inventory in the channel declining. During our current Q4, we expect channel inventory to remain at the current low levels and demand to be stable. Therefore, we expect Q4 sales to grow at a slightly higher rate sequentially than last year in terms of both units and dollars.
Please note that we do expect ASPs to increase slightly sequentially due to mix in handguns and new products in long guns. As noted last quarter, we expect margins to rebound in the fourth quarter with operating days increasing from 58 days in the third quarter to 64 days, and production levels increasing as the Tennessee facility begins to exit the startup phase of operations. This means that we expect margin percentage for our fourth quarter to enter the low 30s.
Operating expenses will likely be 5% to 7% higher than in Q3, with an increase in profit sharing driving the higher amount. As a reminder, our profit sharing paid to our employees each year represents the lower of 15% of total wages or 15% of operating profit. Because the fourth quarter is our highest profitability quarter, profit sharing will be higher than in any other quarters. Our effective tax rate is expected to be approximately 24%.
Finally, we continue to expect to have a debt-free balance sheet by the end of the calendar year, if not sooner. With less than $10 million left to spend on the relocation, capital investment for this project is winding down. Consistent with prior commentary, we expect to generate operating cash of at least $75 million annually and normal capital spending requirements are approximately $25 million per year, providing significant excess cash flow. 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, let me please open the call to questions from our analysts.
Question and Answer Session
Operator
(Operator Instructions) The first question comes from Mark Smith from Lake Street.
Unidentified Analyst
This is [Jason] on for Mark. I appreciate you taking our questions. I just want to start with the Tennessee facility transition. I know you talked a little bit about some efficiencies. But what are you seeing from a product innovation capability standpoint? And then if you could go into any early wins or challenges you've encountered since the move?
Mark Peter Smith
Sure. From the innovation side, the Tennessee facility is -- houses as we covered before, houses are assembly operations for more sporting rifles and pistols and as well as our logistics operation and our plastic injection molding. So the innovation and the design work still is based here out of the Springfield, Massachusetts facility, and that will continue. So in terms of any disruption to that, there shouldn't be any from the Tennessee move.
As far as the move itself, it's going very well, as I kind of covered in the prepared remarks, I think, frankly, we're kind of a little bit ahead of schedule, and now that led to some of the positive news on the margin line. So that said, though, we're still starting up a greenfield facility, and we're still going through some of the transitions there and some of the start-up inefficiencies from new staff, et cetera. And -- but we're very pleased with the first couple of months and should only get better here as we kind of start to settle down going into the second half of Q4 and into FY '25. So our costs -- our duplicate costs, we do have some that are kind of lingering and probably will -- some minor costs that lingers through the end of -- calendar, sorry, '24, but they'll be pretty de minimis as we kind of get into Q1 of FY '25.
Unidentified Analyst
Got it. That's helpful. And then looking at ASPs, I know you mentioned you expect them to be up sequentially here in Q4. How should we think about those trending beyond Q4?
Mark Peter Smith
Yes, good question, Jason. So the new product pipeline is kind of covered, and we've demonstrated over the last 2 to 3 years is that's really been a focus of ours. The new product pipeline remains robust going into FY '25. So right now, what we're anticipating is we'll definitely be increasing overall ASPs, mainly driven by long gun ASPs. So we're kind of anticipating largely flat handgun ASPs throughout FY '25, but those long guns should increase nicely with the launch of the lever-action rifle and some other new products we've got coming.
Unidentified Analyst
Okay. Perfect. And then just the last one for me, and I'll jump back into queue. Just curious your thoughts on demand levels with this year's election. Is it comparable to historical years? Or how are you thinking about that profile?
Mark Peter Smith
Yes. I mean, I don't think we'll be able to give you too much color on comparable to historical years, but just in general, look, I mean, the election year is always a healthy demand period for the firearms industry. I think you can kind of -- we expect the NICS results in the firearms market to remain healthy throughout the calendar year. And then after the election, we'll kind of have to see where it goes from there. But overall, for our -- generally in our FY '25, including the first couple of months of calendar '25, we expect it to be a good year. We expect to be healthy. So we're looking forward to it.
Operator
The next question comes from Steve Dyer from Craig-Hallum.
Steven Lee Dyer
Congratulations on the good execution. I appreciate all the color, by the way, on all the different sort of puts and takes in the business. You're obviously gaining a lot of share. Can you help us sort of to the degree you're willing to kind of give granularity as to where you feel that is long guns, handguns, and even to the product line level maybe where you're seeing some momentum?
Mark Peter Smith
Yes, sure. Yes. I mean that's been our goal, obviously, for the last couple of years since we kind of took over as a new management team is to really focus on firearms and focus on taking share within firearms. And I think you can kind of see it's really bearing fruit. The share gains in the -- on the long gun side, we're frankly nothing to do with lever-action. It was all a product that the main driver was product we introduced as I covered in the prepared remarks about this time last year the FPC that's performing extremely well for us out in the retail channel. And we'll be kind of phasing out now as we measure our new products as products introduced in the last 12 months.
Well, as I just said, it was introduced about this time last year. So that will be phasing out of the new product, but quickly replaced now with the lever-action rifle. So should continue to get a lot of momentum from that lever-action rifle. It is a platform product for us and completely new white space that we don't really play in today. So cannibalizing really nothing from our product line. So we're really excited about that as an opportunity for growth in the future. And on the handgun side, it's an area where we just feel it's our bread and butter, and we need to continue focusing on holding that leadership position there. So that's a lot of new products coming out in the handgun side in fiscal '25.
Steven Lee Dyer
Yes, that makes sense. With respect to the lever-action are you -- is that -- you said it's a platform product, so assuming sort of multiple calibers, et cetera?
Mark Peter Smith
Yes, you'll see a lot of new line extensions, et cetera, coming out on that over the next 12, 18, 24 months, and we really expect to build out that entire category into all of the calibers, all your typical calibers that you'd expect from a lever-action rifle and maybe even some that you wouldn't.
Steven Lee Dyer
Cool. And then going forward, it sounds like gross margins are certainly on the upswing. A lot of puts and takes on the operating expense line with sort of new costs, depreciation and so forth, along with some other stuff falling away. But -- on an absolute basis, I mean, can you talk a little bit about what you sort of expect or how we should think about operating expenses next year, maybe, I don't know, either as a percentage of sales or growth or et cetera?
Mark Peter Smith
Yes. I mean we don't expect our operating expenses to materially change next year. As we've talked about many times before, that's kind of one of the core tenets of our flexible model is that when we're profitable in any environment. And what that means is that we're in surge environment and even in an extreme surge environment, we found ourselves here during COVID, if you'll notice, we really didn't change our fixed cost base, right? So our fixed cost base largely stays the same. We don't get carried away. We lead with a steady hand understanding that the top line can be volatile in this industry. And so that doesn't change next year, right? So we expect that our fixed costs and our OpEx will be flat, will be very comparable to this year.
Steven Lee Dyer
Got it. And then last one for me, I guess, it sounds like pricing and promotional activity is pretty rational in the channel, competitors behaving fairly rationally, anything you're concerned about there? Do you feel like you're in a pretty good spot?
Mark Peter Smith
Yes. I mean we've -- obviously, as you can see, if you've been -- if you've done some challenge checks, you can see we've definitely been participating in promotions. But they -- as you -- that's a good word for it. They've been very rational. There hasn't been any kind of panic promoting by our competitors. We don't anticipate that changing. As I said, I think the demand is going to remain healthy through '24 -- calendar '24, which will obviously moderate that. That said, I think the promotional activity that you've seen from us is probably going to continue, probably won't get any less, but it won't get -- we won't get really good anymore either.
Operator
Ladies and gentlemen, we have reached the end of the question-and-answer session. I'd now like to hand the call over to Mark Smith for closing remarks. Thank you, sir.
Mark Peter Smith
Thank you, operator. And I just want to thank everybody for joining us today and your interest in the company, Smith & Wesson, and we look forward to speaking with you all again next quarter.
Operator
Ladies and gentlemen, that does conclude today's call. Thank you very much for joining us. You may now disconnect your lines.
