Smith & Wesson Brands, Inc.: Form 10-Q for the period ended Jan 31, 2024

Overview

Please refer to the Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Fiscal 2023 Annual Report and our unaudited condensed consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q. This section sets forth key objectives and performance indicators used by us as well as key industry data tracked by us.

Third Quarter Fiscal 2024 Highlights

Our operating results for the three months ended January 31, 2024 included the following:

• Net sales were $137.5 million, an increase of $8.4 million, or 6.5%, over the comparable quarter last year.
• Gross margin was 28.7% compared with gross margin of 32.4% for the comparable quarter last year.
• Net income was $7.9 million, or $0.17 per diluted share, compared with net income of $11.1 million, or $0.24 per diluted share, for the comparable quarter last year.

Our operating results for the nine months ended January 31, 2024 included the following:

• Net sales were $376.7 million, an increase of $42.2 million, or 12.6%, over the prior year comparable period.
• Gross margin was 27.0% compared with gross margin of 33.7% for the prior year comparable period.
• Net income was $13.5 million, or $0.29 per diluted share, compared with net income of $24.0 million, or $0.52 per diluted share, for the prior year comparable period.

During the nine months ended January 31, 2024, we purchased 716,869 shares of our common stock for $9.1 million, utilizing cash on hand.

Results of Operations

Net Sales and Gross Profit – For the Three Months Ended January 31, 2024

The following table sets forth certain information regarding net sales and gross profit for the three months ended January 31, 2024 and 2023 (dollars in thousands):

The following table sets forth certain information regarding firearm units shipped by trade channel for the three months ended January 31, 2024 and 2023 (units in thousands):

20

Sales of our handguns decreased $7.5 million, or 7.4%, from the comparable quarter last year, primarily due to lower demand for several of our older handgun products and certain products that were introduced in the prior year, partially offset by increased shipments of newly introduced products (defined as any new SKU not shipped in the comparable quarter last year), which represented 17.2% of handgun sales in the period, the impact of targeted promotions on certain polymer frame pistols, and a 2%-5% price increase on select products that became effective in the quarter. Handgun unit shipments into the sporting goods channel decreased by 3.9% from the comparable quarter last year while overall consumer handgun demand decreased 3.5% (as indicated by adjusted background checks reported in the National Instant Criminal Background Check System, or NICS).

Sales of our long guns increased $16.9 million, or 110.5%, over the comparable quarter last year, primarily due to increased shipments of newly introduced products, which represented 35.7% of long gun sales in the period, as well as a 3% price increase on select products that became effective in the quarter. Long gun unit shipments into our sporting goods channel increased 100.0% over the comparable quarter last year while overall consumer demand for long guns increased 4.8% (as indicated by NICS).

Other products and services revenue decreased $975,000, or 8.3%, from the comparable quarter last year, primarily because of decreased sales of component parts and decreased licensing revenue, partially offset by increased sales of handcuffs.

Newly introduced products represented 20.2% of sales for the three months ended January 31, 2024 and included one new pistol, two new long guns, and many new product line extensions.

Gross margin for the three months ended January 31, 2024 was 28.7% compared with 32.4% for the comparable quarter last year, primarily because of an increase in overhead relating to operating manufacturing facilities in both Massachusetts and Tennessee, inefficiencies related to the start-up of operations in Tennessee, the impact of inflation on raw materials and finished parts, which increased approximately 5.8% over the prior year comparable quarter, the impact of inflation on labor costs (particularly as it relates to entry level positions), partially offset by the impact of higher sales volume, decreased Relocation spend, and a price increase that became effective during the quarter.

Inventory balances decreased $23.6 million between April 30, 2023 and January 31, 2024. While inventory levels, both internally and in the distribution channel, in excess of demand may negatively impact future operating results, it is difficult to forecast the potential impact of distributor inventories on future revenue and income as demand is impacted by many factors, including seasonality, new product introductions, news events, political events, and consumer tastes. We expect our inventory levels will remain relatively flat during our fourth fiscal quarter.

Net Sales and Gross Profit – For the Nine Months Ended January 31, 2024

The following table sets forth certain information regarding net sales and gross profit for the nine months ended January 31, 2024 and 2023 (dollars in thousands):

21

The following table sets forth certain information regarding firearm units shipped by trade channel for the nine months ended January 31, 2024 and 2023 (units in thousands):

Sales of our handguns increased $14.5 million, or 5.7%, over the prior year comparable period. The increase in sales was primarily due to increased shipments of our revolvers, increased shipments of newly introduced products, which represented 22.7% of handgun sales in the period, the impact of targeted promotions on certain polymer frame pistols, a 5% price increase on select products that became effective in the second quarter of fiscal 2023, and a 2%-5% price increase on select products that became effective in January 2024. Handgun unit shipments into the sporting goods channel increased by 4.7% over the comparable period last year while overall consumer handgun demand decreased 8.1% (as indicated by NICS).

Sales of our long guns increased $32.7 million, or 70.5%, over the prior year comparable period, primarily due to increased shipments of newly introduced products, which represented 51.0% of long gun sales in the period, as well as a price increase on select products that became effective in January 2024. Long gun unit shipments into our sporting goods channel increased 78.0% over the comparable period last year while overall consumer demand for long guns decreased 2.1% (as indicated by NICS).

Other products and services revenue decreased $5.0 million, or 15.0%, from the prior year comparable period, primarily because of decreased sales of component parts, decreased business-to-business services, and decreased licensing revenue, partially offset by increased sales of handcuffs.

Newly introduced products represented 26.9% of sales for the nine months ended January 31, 2024 and included six new pistols, four new long guns, and many new product line extensions.

Gross margin for the nine months ended January 31, 2024 was 27.0% compared with 33.7% for the comparable period last year primarily because of a combination of unfavorable fixed-cost absorption (due to lower production volume), the impact of an accrued legal settlement for $3.2 million, the impact of inflation on raw materials and finished parts, which increased approximately 5.1% over the prior year comparable period, the impact of inflation on labor costs (particularly as it relates to entry level positions), and unfavorable inventory reserve adjustments, including capitalized variances, partially offset by the impact of decreased Relocation spend and favorable mix associated with newly introduced products.

Operating Expenses

The following table sets forth certain information regarding operating expenses for the three months ended January 31, 2024 and 2023 (dollars in thousands):

Research and development expenses decreased $164,000 from the prior year comparable quarter, primarily because of decreased sample and testing costs associated with new product development. Selling, marketing, and distribution expenses increased $112,000 over the prior year comparable quarter, primarily as a result of increased costs associated with the Relocation and increased depreciation expense, partially offset by decreased spend on targeted customer promotions and decreased advertising costs. General and administrative expenses increased $489,000 over the prior year comparable quarter, primarily because of increased legal-related expenses and depreciation expense, partially offset by decreased Relocation costs. Current year general and administrative expenses were also lower than the prior year comparable quarter due to a change in where the sublease-related income is recorded. During the three months ended January, 31, 2024, sublease-related income of $256,000 was recorded in general and administrative expenses whereas, in fiscal 2023 $579,000 was reported in other income/(expense).

The following table sets forth certain information regarding operating expenses for the nine months ended January 31, 2024 and 2023 (dollars in thousands):

Research and development expenses decreased $183,000 from the prior year comparable period, primarily because of decreased sample and testing costs associated with new product development. Selling, marketing, and distribution expenses increased $3.6 million over the prior year comparable period, primarily as a result of a $1.9 million impairment on distribution equipment related to the Relocation, one-time costs related to the grand opening event at our new Tennessee facility, increased compensation-related costs, and increased spend on targeted customer promotions, partially offset by decreased digital advertising costs and decreased sample costs. General and administrative expenses decreased $3.3 million from the prior year comparable period, primarily because of a $1.2 million decrease in compensation-related expenses and decreased Relocation costs. During the nine months ended January, 31, 2024, sublease-related income of $1.2 million was recorded in general and administrative expenses whereas, in fiscal 2023 $1.7 million was reported in other income/(expense).

Operating Income

The following table sets forth certain information regarding operating income for the three months ended January 31, 2024 and 2023 (dollars in thousands):

Operating income for the three months ended January 31, 2024 decreased $2.9 million from the comparable quarter last year, primarily because of the increase in overhead relating to operating manufacturing facilities in both Massachusetts and Tennessee, as well as inefficiencies related to the start-up of operations in Tennessee, increased legal-related costs, and increased depreciation expense, partially offset by decreased costs on targeted customer promotions and increased sales volumes.

The following table sets forth certain information regarding operating income for the nine months ended January 31, 2024 and 2023 (dollars in thousands):

Operating income for the nine months ended January 31, 2024 decreased $11.2 million from the prior year comparable period, primarily because of unfavorable fixed-cost absorption, unfavorable inventory reserve adjustments (including amortization of capitalized variances), the impact of an accrued legal settlement for $3.2 million, a $1.9 million impairment on distribution equipment related to the Relocation, increased costs on targeted customer promotions, and costs associated with the grand opening of the new Tennessee facility, partially offset by increased sales volumes, decreased Relocation spend and decreased digital advertising costs.

Income Taxes

The following table sets forth certain information regarding income tax expense for the three months ended January 31, 2024 and 2023 (dollars in thousands):

23

Income tax expense decreased $955,000 from the comparable quarter last year as a result of lower operating income.

The following table sets forth certain information regarding income tax expense for the nine months ended January 31, 2024 and 2023 (dollars in thousands):

Income tax expense decreased $2.9 million from the prior year comparable period as a result of lower operating income.

Net Income

The following table sets forth certain information regarding net income and the related per share data for the three months ended January 31, 2024 and 2023 (dollars in thousands, except per share data):

Net income for the three months ended January 31, 2024 was $7.9 million compared with $11.1 million for the comparable quarter last year for the reasons outlined above.

The following table sets forth certain information regarding net income and the related per share data for the nine months ended January 31, 2024 and 2023 (dollars in thousands, except per share data):

Net income for the nine months ended January 31, 2024 was $13.5 million compared with $24.0 million for the prior year comparable period for the reasons outlined above.

Liquidity and Capital Resources

Our principal cash requirements are to (1) finance the growth of our operations, including working capital and capital expenditures, (2) fund the Relocation, and (3) return capital to stockholders. Capital expenditures for the Relocation, new product development, and repair and replacement of equipment represent important cash needs.

The following table sets forth certain cash flow information for the nine months ended January 31, 2024 and 2023 (dollars in thousands):

24

Operating Activities

On an annual basis, operating activities generally represent the principal source of our cash flows. Cash provided by operating activities was $63.1 million for the nine months ended January 31, 2024 compared with $21.2 million of cash used for the nine months ended January 31, 2023. Cash provided by operating activities for the nine months ended January 31, 2024 was favorably impacted by a $23.6 million decrease in inventory versus a $56.8 million increase in inventory in the prior comparable period. Partially offsetting this was a $5.5 million increase in accounts receivable versus a $4.4 million decrease in accounts receivable in the prior comparable period due to increased sales volume.

Investing Activities

Cash used in investing activities increased $17.7 million for the nine months ended January 31, 2024 compared with the prior year comparable period. We paid $85.2 million for capital expenditures for the nine months ended January 31, 2024, $20.6 million higher than the prior year comparable period primarily due to payments related to the Relocation. Excluding payments related to the Relocation, we expect to spend between $20.0 million and $25.0 million on capital expenditures in fiscal 2024.

We expect to spend between $75.0 million and $80.0 million on capital expenditures in fiscal 2024, of which $50.0 million to $55.0 million related to the construction of the Tennessee facility, most of which has been capitalized.

Financing Activities

Cash provided by financing activities was $13.2 million for the nine months ended January 31, 2024 compared with $9.9 million for the nine months ended January 31, 2023. Cash provided by financing activities during the nine months ended January 31, 2024 was primarily the result of a net $40 million in borrowings under our revolving line of credit, partially offset by $16.6 million in dividend distributions and $9.1 million of share repurchases. For the nine months ended January 31, 2023, cash provided by financing activities was primarily the result of $25 million in borrowings under our revolving line of credit, partially offset by $13.7 million in dividend distributions.

Finance Lease – We are a party to a material finance lease, the Missouri Lease which is a $46.2 million lease for the Missouri Distribution Center that has an effective interest rate of approximately 5.0% and is payable in 240 monthly installments through fiscal 2039. The building is pledged to secure the amounts outstanding. During fiscal 2024, we paid approximately $559,000 in principal payments relating to the Missouri Lease. With the completion of the Separation, we entered into the Missouri Sublease. On July 16, 2022, we entered into an amendment to the Missouri Sublease, increasing the subleased space to 64.7% of the Missouri Distribution Center under the same terms as the Missouri Lease. On January 31, 2023, we entered into the Assignment and Assumption Agreement and the Amended and Restated Guaranty, which became effective January 1, 2024. We terminated the Missouri Sublease on January 1, 2024. Through the nine months ended January 31, 2024, we recorded $1.9 million of income related to the Missouri Sublease, of which $944,000 was recorded in general and administrative expenses and $924,000 was recorded in interest income in our condensed consolidated statements of income.

Credit Facilities — We maintain an unsecured revolving line of credit with TD Bank, N.A. and other lenders, or the Lenders, which includes availability up to $100.0 million at any one time, or the Revolving Line. The Revolving Line provides for availability for general corporate purposes, with borrowings to bear interest at either the Base Rate or SOFR rate, plus an applicable margin based on our consolidated leverage ratio, as of January 31, 2024. The credit agreement also provides a swingline facility in the maximum amount of $5.0 million at any one time (subject to availability under the Revolving Line). Each Swingline Loan bears interest at the Base Rate, plus an applicable margin based on our consolidated leverage ratio. In response to a Springing Lien Triggering Event (as defined in the credit agreement), we would be required to enter into certain documents that create in favor of TD Bank, N.A., as administrative agent, and the lenders party to such documents as legal, valid, and enforceable first priority lien on the collateral described therein. Subject to the satisfaction of certain terms and conditions described in the credit agreement, we have an option to increase the Revolving Line by an aggregate amount not exceeding $50.0 million. The Revolving Line matures on the earlier of August 24, 2025, or the date that is six months in advance of the earliest maturity of any permitted notes under the credit agreement. On April 28, 2023, we entered into an amendment to our existing credit agreement to, among other things, replace LIBOR with SOFR as the interest rate benchmark and amend the definition of “Consolidated Fixed Charge Coverage Ratio” to exclude unfinanced capital expenditures in connection with the Relocation.

As of January 31, 2024, we had $65.0 million of borrowings outstanding on the Revolving Line, bearing interest at an average rate of 7.20%, which was equal to the SOFR rate plus an applicable margin.

The credit agreement for our credit facility contains financial covenants relating to maintaining maximum leverage and minimum debt service coverage. We were in compliance with all debt covenants as of January 31, 2024.

Share Repurchase Programs — On September 19, 2023, our Board of Directors authorized the repurchase of up to $50.0 million of our common stock, subject to certain conditions, in the open market or in privately negotiated transactions through September 19, 2024. During the nine months ended January 31, 2024, we repurchased 716,869 shares of our common stock for $9.1 million under this authorization. There were no common stock purchases through the nine months ended January 31, 2023, nor were there any unfulfilled authorizations.

Dividends — In April 2023, our Board of Directors authorized a regular quarterly dividend for stockholders of $0.12 per share, subject to Audit Committee confirmation. The current dividend will be for stockholders of record as of market close on March 21, 2024 and will be payable on April 4, 2024.

Our future capital requirements will depend on many factors, including net sales, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity, and costs related to the Relocation. Further equity or debt financing may not be available to us on acceptable terms or at all. If sufficient funds are not available or are not available on acceptable terms, our ability to take advantage of unexpected business opportunities or to respond to competitive pressures could be limited or severely constrained.

As of January 31, 2024, we had $47.4 million in cash and cash equivalents on hand. Based upon our current working capital position, current operating plans, and expected business conditions, we believe that our existing capital resources and credit facilities will be adequate to fund our operations, including our finance leases and other commitments, for the next 12 months.

Other Matters

Critical Accounting Policies

The preparation of condensed consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Significant accounting policies are disclosed in Note 2 of the Notes to the Consolidated Financial Statements in our Fiscal 2023 Annual Report. The most significant areas involving our judgments and estimates are described in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Fiscal 2023 Annual Report, to which there have been no material changes. Actual results could differ from our estimates.

Recent Accounting Pronouncements

The nature and impact of recent accounting pronouncements, if any, is discussed in Note 2—Basis of Presentation to our condensed consolidated financial statements included elsewhere in this report, which is incorporated herein by reference.

During the period ended January 31, 2024, we did not enter into or transact any forward option contracts nor did we have any forward contracts outstanding.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of January 31, 2024, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act was recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There was no change in our internal control over financial reporting during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.