Good day, ladies and gentlemen, and welcome to the American Outdoor Brands Second Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Ms. Liz Sharp, Vice President of Investor Relations. Ma'am, please go ahead.

Thank you and good afternoon. Our comments today may contain predictions, estimates and other forward-looking statements. Our use of words like anticipate, project, estimate, expect, intend, believe and other similar expressions is intended to identify those forward-looking statements. Forward-looking statements also include statements regarding: revenue; earnings per share; non-GAAP earnings per share; fully diluted share count and tax rate for future periods; our product development, focus, objectives, strategies and vision; our strategic evolution; our market share and market demand for our products; market and inventory conditions related to our products and in our industry in general; and growth opportunities and trends. Our forward-looking statements represent our current judgment about the future, and they are subject to various risks and uncertainties. Risk factors and other considerations that could cause our actual results to be materially different are described in our securities filings, including our Forms 8-K, 10-K and 10-Q. You can find those documents as well as a replay of this call on our website at aob.com. Today's call contains time-sensitive information that is accurate only as of this time, and we assume no obligation to update any forward-looking statements. Actual results could differ materially from our statements today. I have a few important items to note with regard to our comments on today's call. First, we reference certain non-GAAP financial measures on this call. Our non-GAAP results and guidance exclude acquisition-related costs, including amortization, onetime transition costs, a change in contingent consideration liability, fair value inventory step-up and the tax effects related to all those adjustments. The reconciliations of GAAP financial measures to non-GAAP financial measures, whether or not they are discussed on today's call, can be found in today's form 8-K filing as well as today's earnings press release, which are posted on our website. Also, when we reference EPS, we are always referencing fully diluted EPS. For detailed information on our results, please refer to our quarterly report on Form 10-Q for the period ended October 31, 2018, and our annual report on Form 10-K for the year ended April 30, 2018. I'll now turn the call over to James Debney, President and CEO of American Outdoor Brands.

Thank you, Liz. Good afternoon and thanks, everyone for joining us. With me on today's call is Jeff Buchanan, our Chief Financial Officer. Later in the call, Jeff will provide a recap of our financial performance as well as our updated guidance. We are pleased with our second quarter operational and financial results, which reflect year-over-year increases in revenue and profitability in both our Outdoor Products & Accessories segment and our Firearms segment. In addition to delivering a solid quarter, we also made good progress on several initiatives that support our strategic plan. I will elaborate on that as I take you through our results. But please bear with me as I provide you with a bit more detail than usual on today's call. With that, let's get started. Our Outdoor Products & Accessories segment, a strategically important market that we first entered just 4 years ago with our acquisition of Battenfeld Technologies, grew 10.2% year-over-year and generated gross margins of 45% or more than 30% of our total revenue in the quarter. Sales growth occurred in both our Hunting & Shooting product categories as well as our Cutlery & Tool product categories and came from a variety of retailers, particularly our online retailers. A result of good work by the team and partnering with key customers to focus on several of our growth brands and our strong product portfolio. In our Firearms segment, year-over-year growth in revenue of 10.2% and higher gross margins reflected a consumer preference for many of our products, including our very popular M&P Shield 380 EZ pistol, which we launched less than a year ago. This growth also reflects the success of 2 bundled promotions that we booked in Q1 and shipped in Q2. These bundled promotions demonstrate our unique ability to create packages featuring…

Thanks, James. Revenue for the quarter was $161.7 million, an increase of 8.9% from the prior year. Revenue from our Firearms segment was $111.8 million, an increase of 10.2%, and revenue from our Outdoor Products & Accessories segment was $56 million, also an increase of 10.2%. Intercompany eliminations were $6 million. In Q2, the total company gross margin was 34.9% compared to 34.2% in the prior year. The Firearm's gross margin was 29.8% and the Outdoor products gross margin was 46%. Those segments delivered slightly improved gross margins over the prior year. In the quarter, GAAP operating expenses were $45.1 million compared to $42.8 million in Q2 of last year. On a non-GAAP basis, operating expenses were $39.2 million as compared to $38.2 million in the prior year. Although we had cost savings in many areas, we registered a slight increase in OpEx primarily because we did not accrue for incentive compensation in the prior year. For the second quarter, EPS came in at $0.12 as compared with $0.06 last year. Our non-GAAP EPS, which excludes amortization related to prior acquisitions, was $0.20 as compared with $0.11 in the year-ago quarter. Adjusted EBITDA in the second quarter was $26.7 million or a 16.5% EBITDA margin improvement over the 15.5% margin for Q2 of last year. Now turning to the balance sheet. For the first 6 months of our fiscal year, we had positive cash flow from operations of $9.1 million. In Q2, operating cash outflow was $1.6 million and our net CapEx, including expenditures for our logistics facility in Missouri, was $11.5 million. Thus in Q2, our free cash outflow was about $13.1 million as compared with free cash outflow of $1.5 million in Q2 of the prior year. Free cash flow in this quarter is typically neutral to negative.…

Thank you, Jeff. With that, operator, please open up the call for questions from our analysts.

[Operator Instructions] Our first question comes from the line of Steve Dyer with Craig-Hallum.

When you guys started this fiscal year, I think you had said you anticipated, I think you called it flattish consumer demand. And it's been a decent amount, I think, softer than that. I think adjusted mix is down about 10%, give or take, throughout that time, yet you guys continue to perform really pretty well. So I'm just wondering what you sort of attribute that delta to if it's gaining share, if it's something else that we may not be thinking about.

Steve, I think it's really what, we covered in the prepared remarks, when you think about new products, the M&P Shield 380 EZ, has definitely been very successful and it's getting really good traction, it's got a good following, it's become a very popular firearm with the consumer, getting great feedback. I think the 2 bundled promotions that we did, they were very successful. And as we talked about on our last earnings call, they were really responsible for us increasing our guidance at that point. We booked significant orders in Q1 and we've been shipping those in Q2, and we still have a bit more to ship actually, going forward in -- as we go into Q3. So tremendously successful there. And I think then just leveraging the other brands and firearms, leveraging the strong brands and product portfolio in the Outdoor Products & Accessories segment. And as I said, we're very excited about a lot of the new products there that have been launched already, in particular Crimson Trace, and the ones that we're about to launch in the Outdoor Products & Accessories division. So I just think it's a great team effort and a challenging market environment for firearms, which obviously remains 2/3 of our revenue. So we're pretty well connected in terms of our performance to what that part of the market doing, and you're right, it has been a bit softer than we thought it would be, but we were prepared for that.

And I guess, just along those lines, long gun strength in the quarter, is that something similar? Just the right product at the right time? Or anything else you could point to there?

As we mentioned, one of the bundled promotions that was highly successful was a .22 rimfire rifle, the M&P 1522, and that was combined with the red/green dots -- red/green dot sight that was sourced by Crimson Trace, i.e. the Electro-Optics division and also had a rifle case from our Outdoor Products & Accessories division, that was tremendously successful. So that no doubt helped with our long gun sales and gave it a bit of momentum.

And then just lastly, for me I guess, you've talked about the bundle extensively. Is there any -- you would sort of quantify how much that's helped you, I guess, year-to-date so far?

Not really. We haven't really -- well, we haven't given any detail at all. And I'm looking at Jeff right now whose confirming that there's nothing.

Other than to say, I think it definitely has helped us offset the weakness that you mentioned in NICS, so. But we haven't really specified how much it's helped.

Our next question comes from James Hardiman with Wedbush.

A couple of questions for me. Along the same lines of the last question, we talk about how NICS has been somewhat softer than expected. But to the extent that you can see sort of your own retail trends, do you think demand for your products has been softer than expected? Or has it been generally in line with how you thought coming in the year?

Well, I think given that NICS has been lower than we expected, going back to our comments last year, and then we thought this year was going to be flattish, but really become sort of flat to down, more down than flat. So it comes back to, we've had to work very hard to offset that headwind, and I think the team's done a great job for all the reasons I've listed, whether it's new products, created promotions i.e. the bundles, working across divisions, the growth in the Outdoor Products & Accessories segment in particular. You have to remember now 1/3 of our revenue is non-firearms, it's a highly profitable segment for us now, and it's growing and it's growing fast. So yes, we'll see Firearms no doubt ebb and flow with the size of the market. But OP&A, Outdoor Products & Accessories segment, continues to grow very successfully. Great brands, great team, great new product development process, lots of exciting things ahead of us there.

Got it. And then as I try to cobble together some of the data points that you guys have given us, what seems like the most impressive sort of combination is the fact that your shipments were able to significantly outperform the NICS numbers, while at the same time, your inventories were down substantially year-over-year. So I guess, a, does that, I know it's hard from where we sit, to really drop too many conclusions because we don't actually have the numbers, we just have percentages. But I guess, a, does that point to market share gains and I guess, the real question is, as we move forward, do we think that relationship can persist? Can we continue to see, I guess, most notably handgun shipments, but really overall shipments outperform the NICS numbers as we move forward?

Again, we always take a step back and say everything is built into the guidance, and you heard what the guidance was from Jeff. But the teams are working and their respective segments are working extremely hard, particularly in the Firearms side. We do have a major product launch coming up at SHOT Show. So we do know that, that will generate revenue in this fiscal year and continue to ramp up as we enter into the next fiscal year as well. So we're very excited about that. Going back to what you said about inventory, yes, a significant reduction at distributor inventory year-on-year. No doubt that's helping, as I said in the prepared remarks that we've got a closer connection to the retailer, because when they're ordering up a 2-step distribution partner right now, that 2-step distribution partner is very likely to place a replenishment order on us, so that's great news. So rather than them selling out their inventory because they want to reduce that inventory over time. So I think we can definitely put that past us. And if you sort of do the math about that inventory reduction and look at what is NICS down versus last year, you can understand our relationship there in terms of -- as you look at our revenue this year versus last year as well as for the Firearms segment.

Got it. And then just maybe lastly, just a clarification for me. We had talked previously about the OpEx for the year being up about 10% on a non-GAAP basis, really good first half performance. Is that still how we should think about OpEx? Obviously that would suggest a pretty big uptick in the second half. And if that's still on the table, how should we think about 3Q versus 4Q?

The back half of the year -- right now, we think like Q3 and Q4 will be about the same, and that the Q3 will be a bit higher than Q2. So in Q3, you have SHOT Show, variable selling expenses with Outdoor products. And then by Q4, even though the SHOT Show and marketing expenses might go away, you have a ramp-up of our logistics. So I'm not sure if it's going to be up as much as we mentioned. I think you can kind of run the numbers and see what it's going to be, based on the info I just gave you.

Our next question comes from the line of Cai Von Rumohr with Cowen and Company.

This is actually Jeff Molinari on, in place of Cai. I had a question about the Missouri facility. So when will that facility be fully operational? Will that be fiscal year '20 or calendar year 2020? And for the testing process, how long should that last? And then third, if we start to see -- when should we start to see kind of a build in buffer inventory? And for how many quarters should that be expected?

Okay. I'll try and take it one piece at a time. So the timing of the new facility in Missouri going live, so when will that be fully complete? That's very likely going to be late in the next calendar -- next year, so about halfway through our fiscal '20. That's when we believe the Firearms division is going first, because that, because it has highly compliant products, so we need to be extremely vigilant and do a lot of testing to make sure our processes are working in that respect. It's also the core of our business, 2/3 of revenue. So we will want to get the Firearms transition out of the way first, and then we'll move on to the Outdoor Products & Accessories segment, pretty much as I described in the prepared remarks. And regards to the inventory build, it's really there already, we've had to think about -- long and hard about this, because we have to build inventory, because we know we're coming into the industry show season as well. So wholesalers and retailers alike are looking to build their inventory as well, it's the busy holiday season for consumer shopping. So we need to be prepared for that. So really, we will think we've largely got that inventory balanced where we need it and in place. As ever, nothing's quite perfect. But we think we're pretty much 95% of the way there. And then Jeff, I don't know you want to add...

How would you say on the inventory, just echo what James said, it's already, like mostly built. What you're going to see in the second half of the year is that inventory typically comes down for us in the second half of the year, as -- because that's the show season, and a lot of -- our highest of sales are typically in Q4. So you're not going to see an initial build, but you're not going go ahead and see the inventory like come down, as we're going these testing phases and we begin shipping from both facilities until the logistics facility is ready. Like fully ready, I should say.

And just on the testing, the test, we're updated on that obviously, weekly. We're deeply involved ourselves on that. It's probably one of the largest strategic initiatives the company has ever undertaken. The testing is going really well. So if we believe that we can accelerate the transition, we will. But at the same time, as I keep stressing, we have complete flexibility to slow it down. If we feel it may cause the slightest amount of disruption to the business, we don't want to risk our customer service levels at all, we don't want to risk it generating revenue either. So we're very, very focused on getting it right first time around. And as I said we've gained an incredible amount of experience over the years with SAP and other warehouse management systems. So there's a lot of work going on there as well as we interface these systems together.

Our next question comes from the line of Scott Stember with CL King.

Can we talk about, again, the logistics center? The fourth quarter, you're talking about a ramp-up of cost. And is this strictly just related to the testing and the human capital related to ramping up the facility? Or is it running, I guess, double -- obviously, when you're going through a transition like this, you have to run, I guess double logistics sometimes just to make sure that you have adequate inventory. Just maybe walk us through what that is. And then maybe also, just for the full year of this year, related to that project, how much is being expensed in total?

Scott, well, so yes, the expenses are mostly, like double expenses. I think we mentioned this last time that, until we really are finished moving UST in from Jacksonville, we're going to have this period of time where we have these double expenses. So that, I mean that's basically, as you hire people to run the warehouse in Missouri and security teams, et cetera, then you have to expense that. Again, and also a lot of the IT expenses are capitalized until it's a go. And then those people that are currently being capitalized switch to being expensed. And we're sort of forecasting that to happen in Q4, our guidance takes that into account. Our depreciation and amortization is also going to like go up as you turn things on in Q4, we have a 0.5-year convention on depreciation, for example, so that will probably move up to a little over $14 million, which is right now, it's a little over $12 million.

Okay. And just going back to the inventory in the channel, you talked about it being down dramatically, and that's great. But you also talked about it being above your 8 weeks of threshold. Maybe just tie that together and it doesn't sound like you're that far above it.

Yes, we don't give much color to that. We just -- we're pretty binary, we just say whether we're above or below. But yes, it's normal. You're really coming out of summer into fall. Consumer foot traffic definitely starts to increase. You see sales increase directly correlating with the increase in foot traffic. We're getting into that busy holiday season. So right now, we're just looking at results right up until the end of October. So you're really right in the middle of the pool there. So as we would anticipate, as we, history tells us, is that you'll see the inventory drop, it should get back, we believe, below 8 weeks. But again, to Jeff's point, we are artificially holding our inventory higher than we normally would just because we want to mitigate risk to our customers in terms of, first, protecting their service levels and making sure our product is available, so protecting our top line and our profitability going forward. So you won't see that dramatic inventory reduction that you normally see in Q4 until we're comfortable that the new logistics facility is up and firing on all cylinders.

All right. Just a last question I guess, on the pricing environment. It seems like, when you have this bundling program, obviously, there's an effect to that on gross margins, but maybe just talk about how long this platform runs. Does it run through the show season? Or does the show season replace all of those bundling programs? Or should there be a continuation of that throughout the year? And that's all I have.

I think our use of bundle promotions will continue into the future. I have no time line on it, to be perfectly honest. I mean, we'll do it as long as it provides value to the consumer. If it's not providing value to the consumer, it's not going to work. So we'd have to think of some other approach. But the advantage that we have, we're sourcing all these internally. We have a fantastic sourcing team in China, we're leveraging that. We have sight of very low costs that we can get from some of the product that we source from China. And we think that gives us a competitive advantage in the market going forward. So some of these bundles we put together, perhaps aren't as expensive as people think they are.

And show season is our typical type of promotions as James mentioned in the script, buy x, get 1 free. So that's the same thing that's done every year. And so the show season promotions are the same type of thing as we've done in the past.

Our next question comes from Ronald Bookbinder with IFS Securities.

Nice execution in a tough environment. You called out in the press release the strength of the Outdoor & Accessories at online retailers. How does the type and price point of product sales differ from what you ship to the brick-and-mortar channel?

It really doesn't, to be honest. I mean, there may be some small differences in marketing support, for example, but it really doesn't differ. I mean, that's one of the challenges, it always going to be is managing the conflict that can occur between bricks-and-mortar and online retailers. But what we're seeing is that more bricks-and-mortar retailers are becoming online retailers at the same time. So it's still evolving, it's still pretty fluid. I think there's obviously a long runway to go ahead of us in terms of what's happening with online retail sales as we can only believe they're going to increase. But bricks-and-mortar for us will always play an important part in our future, and we have many very, very strong bricks-and-mortar customers. And we have product that people want to go and actually handle in the store, look at and understand and talk to an educated sales associate about it as well. So I think both play -- both, and when I say both, I'm talking bricks-and-mortar and Internet retailers, are important to our future. And we understand that and we've built that into our strategic plans going forward.

Your own online store for Outdoor & Accessories, how is the revenue growth there? And how did the gross margins differ from the company as a whole?

Our own online store sales are really small, to be honest. We're more focused on working with online retailers and obviously, they're major customers to us. So not much news there, Ron, at all. Obviously, when we do sell online ourselves direct to a consumer, margins do expand fairly significantly. But I don't want anybody to get carried away with that statement, it's a tiny part of our business.

And you stated that you preferred to work with retailers. So is there an opportunity to team up with retailers, to let the consumer order firearms, like at your site, and then they pick up at a physical retailer, which you could drop ship to, especially on the higher-price specialty items that a retailer might not want to carry in stock or on hand?

Absolutely. That's an opportunity and how I describe it is, there is a retailer, no doubt bricks-and-mortar, who also has an online presence, and they have firearms online for sale. And that consumer can order that firearm from that retailer, decide which store for that retailer that they actually want to pick the product up from. And we can ship that product directly to that store.

Are you finding...

That will be -- sorry, Ron. That will be one of the advantage of the new logistics facility in Missouri. So we're not there yet, Ron, being able to offer that, but for sure in the future, that's in the playbook.

Okay, terrific. And would you find that, that would be higher priced, more specialty items, that sort of a larger mass merchant might not bother to carry in stock and then just let people online?

It could be, for sure. Because you're right, some retailers don't want to, and it, to be honest, it's not smart. You don't want to carry one of every SKU that we offer, for example. So the online presence that the retailer has, they can offer the full assortment of our product, for sure. And then as long as we're good at shipping it in a timely fashion and getting it to the store, so that the consumer can get it in their hands and actually pick it up, do the transfer and so on, then yes, that could very well work.

And the new distribution facility would enable you to really accomplish that?

Yes, for sure. And that goes back to what I was talking about in the prepared remarks, the technology and the systems that we're adopting here are truly are an evolutionary step for the company. They don't have anything like that right now. But we will with the new logistics facility in Missouri.

[Operator Instructions] We have a follow-up question from the line of Steve Dyer with Craig-Hallum.

Just a quick follow-up for me. So obviously, your diversification strategy of a few years ago is starting to bear fruit in Outdoor Products. Is that something you're looking to be more aggressive with going forward? And then, I guess secondly, are there any other opportunities, maybe in the core Firearms segment that look potentially interesting to you, just given some of the distress in capacity still in the industry?

Yes is the answer. We are looking to grow the Outdoor Products & Accessories segment as aggressively as we can. I mean, you've heard me just think about all the talent we've been hiring, for example. It's going to be about those brands, those products but most importantly, about the teams that we're putting together. So we need talented people in those teams. And we really have put great teams together. So again, I'm excited about that, I think we have a long runway for growth ahead of us. It's going to be a really exciting journey. Coming back to Firearms, absolutely, it's the core of our business, we'll always keep a close eye on what's going on in the marketplace. There does seem to be a lot of change going on, there's a lot of variability in financial performance of some of the businesses that operate in the firearms space. So we'll just keep a close eye on that. But I think what's important for us is to continue in the direction of diversifying our revenues. So simply put, firearms versus non-firearms, so non-serialized product versus serialized product. And our focus is going to be on that non-serialized product, but we will always reinvestment in the core of our business, and that's why you'll see us heavy in new product development. And we're calling out that we're excited about new product introductions at SHOT because they are real, revenue-generating opportunities. And you've heard us talk a lot about organic growth, whether it is the Firearm segment or it's the Outdoor Products & Accessories segment. But we're also, we'll keep a close eye on those M&A opportunities, should they rear their head at the appropriate time. But I would say again, what we'd really like are those smaller, low risk acquisitions, brands that may be a sleepy brands right now, that we think that we can reinvigorate and create value. Those are going to be our focus going forward. Buying something distressed, to use your word, it's not as attractive, because it always comes with a lot of baggage, you can never figure out what's in the bag before you buy it.

And our last question is our follow-up from Cai Von Rumohr with Cowen and Company.

It's Jeff Molinari again. Just one last question here on the general market outlook, coming into the year, you guys were thinking flat to down for NICS, and now it's looking more like down. But kind of looking out further, when do you kind of think things start to turn around? Or is the visibility still pretty poor? And does Democrats picking up majority in the House, or some governorships in some states, does that change anything?

Well, Jeff, that is the million-dollar question. And I don't know the answer. All I'll say is, looking at history, when we think about adjusted NICS, it seems to be fairly consistent, in terms of it's 10% down over the prior year. So as you think forward, what you can do is map that going forward as well, and that's what we'll build our plans around when it comes to the Firearms segment. And we just have to be prolific generators of great marketing content, reaching our consumers via social media, that's how they want to connect with us, and give them the right new products. And we have very talented new product development teams, great engineers here in Springfield, Massachusetts, that are working hard to do exactly that. So you can do, you got to excite that consumer. It is no doubt an uncertain market. All those macro influencers give the market a tailwind in the future, who knows.

And that concludes today's question-and-answer session. I would like to turn the call back to Mr. Debney for closing remarks.

Thank you, operator. I want to thank everyone across the American Outdoor Brands team for their commitment and dedication to excellence. We wish all of you a happy and healthy holiday season. Thanks again for joining us, and we look forward to speaking with you next quarter.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.