Smith & Wesson Brands Inc. (NASDAQ: SWBI) Q3 2022 earnings call dated Mar. 03, 2022
Corporate Participants:
Kevin A. Maxwell — Senior Vice President, General Counsel, Chief Compliance Officer and Secretary
Mark P. Smith — President, Chief Executive Officer
Deana L. McPherson — Executive Vice President, Chief Financial Officer, Treasurer, and Assistant Secretary
Analysts:
Mark Smith — Lake Street Capital Markets — Analyst
Presentation:
Operator
Good day, everyone, and welcome to Smith & Wesson Brands, Inc. Third Quarter Fiscal 2022 Financial Results Conference Call. [Operator Instructions] 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 A. Maxwell — Senior Vice President, General Counsel, Chief Compliance Officer and Secretary
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 the 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 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.
Finally, when we discuss NICS results, we are referring to adjusted NICS, a metric published by the National Shooting Sports Foundation based on FBI NICS data. Adjusted NICS removes those background checks conducted for purposes other than firearms purchases. Please remember that adjusted NICS background checks are 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.
Before I hand the call over to our speakers, I would like to remind you that any reference to income statement items refers to results from continuing operations unless otherwise indicated, and any reference to EBITDA is to adjusted EBITDAS. 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 P. Smith — President, Chief Executive Officer
Thank you, Kevin, and thanks everyone for joining us today. As you can see from the NICS data over the past three months, the firearms market although still elevated and healthy with new entrants has cooled significantly from the height of the pandemic surge returning to more normal levels throughout our entire Q3 and with recent results from February just released this week now seems to be following the pre-pandemic historical demand patterns. While this obviously has resulted in lower revenues from prior periods for Smith & Wesson and no one has ever pleased to report a quarter with significant revenue declines, this macro demand pattern is very familiar to us and is exactly what our business model is designed to accommodate.
I’m very proud of the team and the fact that once again they have demonstrated the ability to deliver meaningful profitability no matter the overall market conditions. Our ability to ramp production aggressively to meet surging demand over the past couple of years fueled significant market share gains for Smith & Wesson and provided a demonstrable proof point for our flexible manufacturing strategy. Our manufacturing team increased throughput by over 82% during the surge, which has enabled us to not only gain impressive market share, but also to set is a very solid business foundation for long-term success. Since the demand surge began in March of 2020, we have paid down $160 million of debt and are now debt free, bought back $200 million of stock, which reduced our outstanding shares by nearly 20%, paid nearly $20 million in dividends, invested nearly $40 million back into our business, and today have a strong and healthy balance sheet with over $107 million in cash.
As we’ve discussed previously, our long-term commitment is to continue returning value to stockholders through regular fixed dividends and share repurchases. And as a result of these accomplishments, we are well positioned to do so. Now, as demand trends normalize, the same factors that underpin this strategy are enabling us to deliver high levels of profitability despite a contraction in revenue. Just as we can ramp up, our model allows us to ramp back down. Strong gross margins in this quarter provided a great illustration of how we are able to react to lower market demand without over-burdening our fixed costs. When demand begins to return to more normal levels, we don’t encounter the typical under-utilization problem that many manufacturers would face in such a volatile market.
During the third quarter, our gross margin only declined 300 basis points despite a 31% decline in revenue, all while also facing global headwinds related to inflation and supply chain challenges. And I’ll also point out that gross margin and EBITDAS percentages for the quarter are at the very top end of our published financial guidance model and exceed the top end fiscal year to date. The firearms market has always been subject to cyclicality, which is why our focus as a company has been on managing our business for the long-term, sustainable growth, emphasizing safety, quality, new product innovation and operational excellence that will endure the test of time. Our solid foundation and strict adherence to our core strategic principles continue to position us for strong financial performance and industry leadership in any market condition.
Speaking now specifically to our third quarter results, slower consumer demand for firearms was the primary factor driving the year-over-year decline in revenue. As you’d expect, we experienced steeper declines in the long gun category than we did in handguns, but we also saw sharply lower volumes in polymer-frame pistols versus a year ago, partially offset by our revolvers which are still in high demand. With our top end capacity levels being much higher than many of our competitors, we were able to refill the channel very quickly during our second quarter as demand slowed. And since then, the inventory levels in the channel for our products have remained largely flat, indicating a strong sell-through of our shipments during the quarter, albeit at lower levels.
It is also important to note that despite lower volumes, our ASPs remain very strong. Throughout the surge we have been actively working to optimize our product line portfolio by rationalizing certain SKUs or occasionally entire product lines, introducing new products to replace them and evaluating pricing across the entire line. With higher ASPs from pricing and mix offsetting nearly a 22% of the volume related declines in the quarter, the results of those efforts are evident. While a more competitive market in the near-term will likely pressure those ASPs to some degree, we do anticipate that long-term the majority of those gains will be lasting. Additionally, we are focused on long-term market share factors with innovation and customer engagement being ever critical. Our product management and design engineering teams have an impressive pipeline of new products scheduled for launch over the next 12 months and I’m very proud of the work that they’ve done to position us for continued success.
Just in our third quarter, we launched our much anticipated MNP chambered in 10 millimeter, a brand new CSX a hammer fired full metal frame concealed carry pistol that has been very well received and is in strong demand, our Volunteer rifle series, the next generation of our popular M&P15 rifle line and we also partnered with Vista Outdoor to co-launch their brand new 30 Super Carry ammunition along with our very popular SHIELD EZ and SHIELD PLUS chambered for this exciting new round with ballistics comparable to the extremely popular 9 millimeter yet with dimensions which allow for increased around capacity in the same firearm footprint. And of course, stay tuned for many more exciting new products in the coming months.
Our marketing team also remains hard at work and the consumer engagement activity that we’ve covered on previous calls continues. The brand campaigns we developed around the 10 millimeter M&P reached over 3 million customers just on the first day and we had a similar response for the content we created for the CSX Volunteer and 30 Super Carry with each reaching over 3 million customers during the initial week. And all of this great work is also being recognized by our industry partners. We are proud to have been awarded Innovator of the Year Chairman’s Award to our VP of Sales, Sue Cupero, and Manufacturer of the Year by our distribution partner trade group, The National Association of Sporting Goods Wholesalers.
In summary, we remain well positioned for the long-term growth as the industry leader, leveraging innovation and technology coupled with an agile business model designed to quickly adapt to changes in the marketplace. I want to thank our loyal and dedicated employees for all their hard work, serving our customers and driving our vision for the future. Before I turn the call over to Deana to cover the financials in more detail, just a quick update on our relocation to Maryville, Tennessee. The project is continuing to progress well and we are still on track to be substantially complete by the third or fourth quarter of calendar 2023. Deana?
Deana L. McPherson — Executive Vice President, Chief Financial Officer, Treasurer, and Assistant Secretary
Thanks, Mark. Echoing Mark’s comments and consistent with our discussion last quarter, the historic demand for firearms that began in March of 2020 continues to return to a more normalized and seasonal pattern, which will make comparisons to the prior fiscal year difficult over the next several quarters. However, looking back to where we were during the same quarter in fiscal 2020, you can see how our response to the surge in demand over the last two years has strengthened our foundation, creating an agile business model that optimizes profitability to drive long-term value. Revenue for our third quarter grew from $127.4 million in fiscal 2020 to $257.6 million in fiscal 2021 or 202.6% increase and is now at $177.7 million in fiscal 2022. While this represents a 31% decrease from the historic levels recorded last year, it is truly remarkable that we were able to achieve a $50.3 million increase in revenue this quarter versus two years ago on nearly the same number of units shipped.
As Mark noted, the reduction in promotional programs combined with price and mix impacts help to significantly increase average selling prices. During our fiscal third quarter, mix declined 23.4% when compared to the same period last year, while our units shipped into the consumer channel declined 41.1% for the same period. But we believe the quarterly figures are not reflective of our true market position as our flexible manufacturing model allows us to quickly adjust capacity relative to changes in demand. The outsized share gains to capture as demand surge have largely endured as evidenced by viewing our results on a year-to-date basis relative to 2020 where are sporting good shipments are up 56.3% versus a 25.7% growth in mix.
Gross margin was 39.6% in the quarter, which was 300 basis points below the 42.6% realized in the prior-year comparable quarter, but is 1,160 basis points above the 28% in the third quarter of fiscal 2020. The decrease in revenue was the primary driver for the decrease in margin percentage, while impacts related to unfavorable absorption, inflation costs on certain labor and material, and payroll related accruals associated with our planned relocation to Tennessee were offset by the impacts of price increases and favorable mix shifts during the fiscal year. Operating expenses of $30.7 million for our third quarter were $1.4 million above the prior year comparable quarter, primarily due to $1.7 million of costs related to our planned relocation to Tennessee as well as increased marketing, trade show, travel and sales promotion costs, much of which is associated with a return to more normal business operations after pandemic restrictions began to ease. Partially offsetting these increases were reduced distribution, legal and compensation-related costs.
The decrease in revenue was the primary driver for a $31.7 million reduction in income. GAAP earnings per share of $0.65 was $0.47 lower than the $1.12 realized in the prior comparable quarter and non-GAAP earnings per share of $0.69 compared with $1.12 during the third quarter of last year. Finally, EBITDAS of $51.9 million was $37.9 million lower than the prior year and 29.2% of revenue. During the third quarter, we generated $6.9 million of cash from operations and spent $5 million on capital equipment, resulting in $1.9 million of free cash generated in the quarter. During the third quarter, we completed our $50 million share repurchase authorization, acquiring 2.8 million shares of our common stock on the open market. Since we completed the spin in August 2020, we have repurchased nearly 10.9 million shares and reduced our share count by nearly 20%.
We will not be able to repurchase any additional shares prior to the two-year anniversary of the spin in August 2022. We paid $3.7 million in dividends and ended the quarter with $107.3 million of cash and no bank debt. Our Board has authorized the payment of our $0.08 per share quarterly dividend to shareholders of record on March 17 with payment to be made on March 31. Looking forward into our fourth quarter of fiscal 2022, inventory in the channel remained relatively stable throughout our third quarter. As of today, our distributors have approximately 18 weeks of supply, representing a broad range of products. We believe current channel inventories are healthy, which ultimately drives positive consumer experiences by ensuring adequate supply to balance normal production levels and still meet short term fluctuations in demand.
The strong inventory levels in the channel and more normalized consumer demand as demonstrated by February NICS, we expect our fourth quarter financial performance to return to pre-pandemic levels, implying flat results sequentially. For these purposes, March 2020 represents the start of the pandemic. We expect to build internal inventory throughout the fourth quarter as we continue to restock after last year’s complete depletion of finished goods inventory. In spite of the expected reduction in sales and approximately $3 million in expense related to our Tennessee move, we will continue to meet or exceed the targeted gross margin, EBITDAS, and cash metrics that we shared last June during our Analyst Day.
As a reminder, at that time, we highlighted our goals of maintaining EBITDAS margins of 20% to 30%, gross margins of 32% to 42% and generating more than $75 million in cash annually. Our capital allocation strategy remains balanced approach, continuing to emphasize investments in our business to drive growth and productivity as well as returning value to stockholders in the form of our regular quarterly dividends and share repurchases. Finally, our effective tax rate will be approximately 23%.
With that, I’ll now turn the call over to the operator for questions.
Questions and Answers:
Operator
[Operator Instructions] Our first question comes from Mark Smith with Lake Street Capital.
Mark Smith — Lake Street Capital Markets — Analyst
Hi, guys. First, I wanted to just dig into pricing a little bit more in ASP. Can you guys quantify or discuss how much maybe you took in January?
Mark P. Smith — President, Chief Executive Officer
Hey, Mark. In January, we took a 3% on average across the board obviously was — mix was different on certain product lines, but on average is about 3%.
Mark Smith — Lake Street Capital Markets — Analyst
Okay. And as we look at new products, especially those that have come out in the last couple of months, are we seeing — it seems like typically higher pricing on these new products, right?
Mark P. Smith — President, Chief Executive Officer
Yeah. Yeah, I mean, that’s, as I said in the prepared remarks, that’s kind of the goal here is to kind of readjust, I guess, if you will, our pricing portfolio. We feel like the brand is definitely and I think it’s been proven over the last year and recent results the brand is definitely able to command that higher price point. So we’ve done a lot of work over the last 18, 24 months on kind of realigning the product portfolio and moving certain product lines completely out of the portfolio and replacing them with, as you can see, with a lot of new product and a lot of new product to come to kind of hold those ASPs and drive some lasting change there.
Mark Smith — Lake Street Capital Markets — Analyst
Perfect. And as we look at the promotional environment, you at retailer are you beginning to see some signs of promotion or do you feel like we’re still a little ways off there and in line with that? Do you guys feel like with inflationary pressures, there is still opportunities or that you can take future price increases?
Mark P. Smith — President, Chief Executive Officer
I definitely think that if the inflationary pressures continue that we will be able to pass those through through price increases, but obviously it’s — it depends on the market at the time and we’ll make that valuation when we come to it. If you remember last year we did one in the summer time in June and then another one in January. So we’ve been able to offset a lot of the inflationary pressures. To date, I expect that we’ll be able to continue doing that. As far as the promotional environment, I think we are definitely beginning to see the early signs of that — of the promotional environment starting to kind of kick in a little bit. Now, with that said, it’s not — it’s by no means any kind of a panic race to the bottom. It’s just people I think sort of trying to trim around the edges a little bit and so I think the market as you can see from the NICS is kind of returning back to normal historical levels. Although, as I said, still elevated, but it is kind of starting to get little more competitive out there and product is available at retail from multiple brands.
Mark Smith — Lake Street Capital Markets — Analyst
Okay. And then I think the last one from me, just can you guys dig in a little deeper on your flexible manufacturing and maybe talk about any pull back or shut down on some of the outsourcing that we’ve seen here recently.
Mark P. Smith — President, Chief Executive Officer
Yeah. As we talk about — talked about many times before that model is pretty unique for us and allows us I think to react a lot faster to some of the demand changes that we see in this volatile market. We can ramp up very quickly as we saw back in March and April and early part of the summer of 2020 and then we can, on the flip side, we can ramp that back down pretty rapidly as well and that allows us — our flexible manufacturing model is just in a nutshell. That ramp up is using outsourced capacity. So when we ramp back down, our facilities remain 100% utilized and helps us on fixed cost absorption and remaining profitable out of the market conditions. So, that’s, as you can see here in this quarter, that’s how we’re able to do that.
Deana L. McPherson — Executive Vice President, Chief Financial Officer, Treasurer, and Assistant Secretary
Some of, hey Mark it’s Deana, some of the pricing increase, sorry, some of the parts increases that you see in our balance sheet, if you look at inventory, that’s because we do ramp our suppliers down slower than we might ramp ourselves down in order to give them a soft landing. We don’t want to destroy the relationship we have with them. We have great partners. So we do ramp them slower because we know that our products are going to sell in the future. We’re willing to take that in. So, finished parts will grow a little bit during that period of time and then eventually finished parts will start coming back down as finished goods are made.
Mark Smith — Lake Street Capital Markets — Analyst
Okay, great. Thank you.
Mark P. Smith — President, Chief Executive Officer
Thanks, Mark.
Operator
[Operator Instructions] I’m showing no further questions in queue at this time. I’d like to turn the call back to Mark Smith for closing remarks.
Mark P. Smith — President, Chief Executive Officer
All right. Thank you, operator, and thanks everyone for joining us today. Just another thank you to all of our employees for yet another very profitable and successful quarter. Talk to you next time. [Operator Closing Remarks]