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

Overview

Please refer to the Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Fiscal 2024 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.

First Quarter Fiscal 2025 Highlights

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

• Net sales were $88.3 million, a decrease of $25.9 million, or 22.7%, from the comparable quarter last year.
• Gross margin was 27.4% compared with gross margin of 26.6% for the comparable quarter last year.
• Net loss was $2.1 million, or $0.05 per share, compared with net income of $3.1 million, or $0.07 per diluted share, for the comparable quarter last year.

During the three months ended July 31, 2024, we purchased 870,669 shares of our common stock for $12.9 million.

Results of Operations

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

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

Sales of our handguns decreased $32.8 million, or 38.1%, from the comparable quarter last year, primarily due to lower consumer demand within the industry, partially offset by increased shipments of newly introduced products (defined as any new SKU not shipped in the comparable quarter last year), which represented 36.1% of handgun sales in the period, and a 2%-5% price increase that became effective in the third quarter of fiscal 2024. Handgun unit shipments into the sporting goods channel decreased by 31.1% from the comparable quarter last year while overall consumer handgun demand decreased 5.0% (as indicated by adjusted background checks reported in the National Instant Criminal Background Check System, or NICS).

Sales of our long guns increased $5.9 million, or 31.6%, over the comparable quarter last year, primarily due to increased shipments of newly introduced products, which represented 70.0% of long gun sales in the period, as well as a 2%-5% price increase on select products that became effective in the third quarter of fiscal 2024. Long gun unit shipments into our sporting goods channel decreased 3.0% from the comparable quarter last year while overall consumer demand for long guns decreased 0.5% (as indicated by NICS).

Other products and services revenue increased $981,000, or 10.5%, from the comparable quarter last year, primarily because of increased suppressor and component parts sales, partially offset by lower business-to-business and handcuff sales.

Newly introduced products represented 41.4% of net sales for the three months ended July 31, 2024 and included six new pistols, four new long guns, and many new product line extensions.

Gross margin for the three months ended July 31, 2024 was 27.4% compared with 26.6% for the comparable quarter last year, primarily because of favorable fixed-cost absorption from higher production volume, lower inventory reserve adjustments, a price increase that became effective in the third quarter of fiscal 2024, and lower Relocation costs, partially offset by higher promotional costs.

Inventory balances increased $29.3 million between April 30, 2024 and July 31, 2024 due to a combination of the seasonal slowdown in demand combined with level loading of our manufacturing facilities to ensure our ability to satisfy anticipated future demand. 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 rise slightly during our second fiscal quarter before declining during the remainder of the fiscal year.

Operating Expenses

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

Research and development expenses increased $716,000 over the prior year comparable quarter because of higher materials and testing costs associated with new product development and higher compensation-related costs. Selling, marketing, and distribution expenses decreased $203,000 from the prior year comparable quarter primarily as a result of a $2.0 million impairment recognized in the prior year comparable quarter on distribution equipment related to the Relocation. Excluding the impact of the prior year impairment charge, selling, marketing, and distribution expenses increased $1.8 million due to higher spending on promotions, to stimulate demand, and the timing of certain industry events. General and administrative expenses decreased $511,000 from the prior year comparable quarter, primarily because of lower profit sharing expense and lower Relocation costs, partially offset by higher legal costs.

Operating (Loss)/Income

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

Operating (loss)/income for the three months ended July 31, 2024 decreased $6.2 million from the comparable quarter last year, primarily for the reasons outlined above.

Income Taxes

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

Income tax expense decreased $1.9 million from the comparable quarter last year primarily as a result of lower operating income. Before adjusting for discrete items related to stock-based compensation, the effective tax rate is 25.5% in the current quarter and 24.7% in the prior year comparable quarter. The increase in the effective tax rate was due to changes in state apportionment.

Interest (Expense)/Income, net

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

Interest expense increased by $885,000 over the comparable quarter last year as a result of higher average debt balances, lower capitalized interest, and lower average cash balances during the three months ended July 31, 2024 compared with the comparable quarter last year.

Net (Loss)/Income

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

Net loss for the three months ended July 31, 2024 was $2.1 million compared with net income of $3.1 million for the comparable quarter last year for the reasons outlined above.

Liquidity and Capital Resources

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

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

22

Operating Activities

Cash used in operating activities was $30.8 million for the three months ended July 31, 2024 compared with $40.6 million of cash provided for the three months ended July 31, 2023. Cash used in operating activities for the three months ended July 31, 2024 was unfavorably impacted by a $29.3 million increase in inventory compared with a $6.4 million decrease in inventory in the prior comparable period, an $11.3 million decrease in accounts receivable compared with a $27.0 million decrease in accounts receivable in the prior comparable period, an $11.7 million decrease in accounts payable compared with a $1.8 million decrease in accounts payable in the prior comparable period, and a $4.8 million decrease in accrued payroll and incentives compared with a $1.6 million increase in accrued payroll and incentives in the prior comparable period.

Investing Activities

Cash used in investing activities decreased $27.4 million for the three months ended July 31, 2024 compared with the prior year comparable period. We paid $4.7 million for capital expenditures for the three months ended July 31, 2024, $27.4 million lower than the prior year comparable period primarily due to payments related to the Relocation in the prior year period.

We currently expect to spend $25.0 million to $30.0 million on capital expenditures in fiscal 2025.

Financing Activities

Cash provided by financing activities was $10.2 million for the three months ended July 31, 2024 compared with $6.6 million of cash used in financing activities for the three months ended July 31, 2023. Cash provided by financing activities during the three months ended July 31, 2024 was primarily the result of $30 million in borrowings under our revolving line of credit, partially offset by $12.9 million of share repurchases and $5.9 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. With the completion of the Separation, we entered into the Missouri Sublease. In July 2022, we entered into an amendment to the Missouri Sublease, increasing the subleased space to 64.7% of the facility under the same terms as the Missouri Lease. As part of the Relocation, in January 2023, we entered into the Assignment and Assumption Agreement and the Amended and Restated Guaranty. We terminated the Missouri Sublease as of January 1, 2024. During the three months ended July 31, 2024, the finance lease liability relating to the Missouri Lease was reduced by $366,000 as a result of payments made by AOUT directly to the landlord. During the three months ended July 31, 2024, we recognized $878,000 of related income, of which $424,000 was recorded in general and administrative expenses and $454,000 was recorded in interest expense, net, in our condensed consolidated statements of operations.

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 July 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 amended 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 July 31, 2024, we had $70.0 million of borrowings outstanding on the Revolving Line, bearing interest at an average rate of 7.19%, 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 July 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 fiscal 2024, we purchased 793,551 shares of our common stock for $10.2 million under this authorization. During the three months ended July 31, 2024, we repurchased 870,669 shares of our common stock for $12.9 million under this authorization. There were no common stock purchases during the three months ended July 31, 2023, nor were there any unfulfilled authorizations. On September 5, 2024, 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 from September 20, 2024 through September 20, 2025.

Dividends — In June 2024, our Board of Directors authorized a regular quarterly dividend for stockholders of $0.13 per share. The current dividend will be for stockholders of record as of market close on September 19, 2024 and will be payable on October 3, 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 July 31, 2024, we had $35.5 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 for at least 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 2024 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 2024 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 July 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 Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of July 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.

Investors should carefully review and consider the information regarding certain factors that could materially affect our business, results of operations, financial condition, and cash flows as set forth under Part I, Item 1A “Risk Factors” of our 2024 Form 10-K. Additional risks and uncertainties not presently known to us or that we currently believe not to be material may also adversely impact our business, results of operations, financial position, and cash flows. We are aware of no material changes to the Risk Factors discussed in our 2024 Form 10-K.