American Outdoor Brands, Inc. (AOUT) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with our consolidated and combined financial statements and the related notes thereto contained elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under Item 1A, “Risk Factors” and elsewhere in this report.

Set forth below is a comparison of the results of operations and changes in financial condition for the fiscal years ended April 30, 2023 and 2022. The comparison of, and changes between, the fiscal years ended April 30, 2022 and 2021 can be found within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Form 10-K for the fiscal year ended April 30, 2022 filed with the SEC on July 14, 2022.

Background

We operate as one reporting segment. We analyze revenue streams in various ways, including customer group, brands, categories, and customer channels. However, this information does not include a full set of discrete financial information.

The following discussion and analysis includes references to net sales of our products in shooting sports and outdoor lifestyle categories. Our shooting sports category includes net sales of shooting accessories and our products used for personal protection. Our outdoor lifestyle category includes net sales of our products used in hunting, fishing, camping, rugged outdoor activities, and outdoor cooking.

In March 2022, we acquired substantially all of the assets of Grilla Grills, or Grilla, (including its branded products) from Fahrenheit Technologies, Inc., or FTI, for a purchase price of $27 million, subject to certain adjustments. Grilla is a provider of high-quality, barbecue grills; Wi-Fi-enabled wood pellet grills; smokers; accessories; and modular outdoor kitchens. We fully integrated Grilla into our business during fiscal 2023. Results of operations for the fiscal year ended April 30, 2022 include activity for the period subsequent to the acquisition date of Grilla.

Fiscal 2023 Highlights

Our operating results for fiscal 2023 included the following:

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Net sales were $191.2 million, a decrease of $56.3 million, or 22.8%, from the prior fiscal year, reflecting a decrease in net sales for both our e-commerce channels and our traditional channels, partially offset by an increase in our own direct-to-consumer business.

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Gross margin was 46.1%, a decrease of 10 basis points from the prior fiscal year.

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Net loss was $12.0 million, or ($0.90) per diluted share, compared with a net loss of $64.9 million, or ($4.66) per diluted share, for the prior fiscal year. The net loss in the prior fiscal year included a $67.8 million non-cash goodwill impairment charge.

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Non-GAAP Adjusted EBITDAS was $12.8 million, compared with $35.0 million for the prior fiscal year. See non-GAAP financial measure disclosures below for our reconciliation of non-GAAP Adjusted EBITDAS.

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We repurchased 377,034 shares of our common stock, in the open market, for a total of $3.5 million during fiscal 2023 leaving $6.5 million available to be purchased under our authorized repurchase program.

Results of Operations

Net Sales and Gross Profit

The following table sets forth certain information regarding consolidated and combined net sales for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

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The following table sets forth certain information regarding trade channel net sales for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

Our e-commerce channels include net sales from customers that do not traditionally operate physical brick-and-mortar stores, but generate the majority of their revenue from consumer purchases from their retail websites. Our e-commerce channels also include our direct-to-consumer sales. Our traditional channels include customers that primarily operate out of physical brick-and-mortar stores and generate the large majority of revenue from consumer purchases in their brick-and-mortar locations.

We sell our products worldwide. The following table sets forth certain information regarding geographic makeup of net sales included in the above table for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

The following table sets forth certain information regarding net sales categories for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

Fiscal 2023 Net Sales Compared with Fiscal 2022

Total net sales decreased $56.3 million, or 22.8%, from the prior fiscal year.

Net sales in our e-commerce channel decreased $10.2 million, or 10.5%, from the prior fiscal year, primarily as a result of lower net sales to the world’s largest e-commerce retailer because of reduced demand primarily in our shooting sports category as well as their efforts to reduce their overall inventory. The lower net sales to our online retailers were partially offset by a 76.0% increase in our direct-to-consumer net sales over the prior year, primarily in our outdoor lifestyle products, which also include sales resulting from the acquisition of Grilla Grills. We believe the increase in our direct-to-consumer net sales represents the demand for our products in the market that are not typically hindered by retailer inventory management. Our brands that are only sold on our direct-to-consumer websites represented $24.4 million, or 28.0%, of fiscal 2023 total e-commerce channel net sales, which includes net sales from a business acquisition completed in the prior fiscal year.

Net sales in our traditional channels decreased $46.1 million, or 30.7%, from the prior fiscal year, primarily because of lower net sales for most of our products as a result of decreased orders from retailers, which we believe was caused by a combination of lower foot traffic because of less discretionary consumer spending and retailers’ efforts to reduce their overall inventory levels. In addition, lower net sales of our shooting sports products to our OEM customers resulted in lower traditional channel net sales from the prior fiscal year. We also believe the decrease in traditional channel net sales was a result of a build in traditional channel inventories of our products during the first fiscal quarter last year as certain customers accelerated their purchases to offset the possibility of delays caused by global supply chain disruptions. Our international net sales declined primarily because of reduced demand for our shooting sports products and timing of customer shipments.

New products, defined as any new SKU introduced over the prior two fiscal years, represented 25.5% of net sales for fiscal 2023 compared to 25.8% of net sales for fiscal 2022. We have a history of introducing over 200 new SKUs each year, the majority of which are introduced late in our third fiscal quarter.

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Our order backlog as of April 30, 2023 was $7.0 million, or $3.3 million higher than at the end of fiscal 2022. Although we generally fulfill the majority of our order backlog, we allow orders received that have not yet shipped to be cancelled, and therefore, our backlog may not be indicative of future sales.

Fiscal 2023 Cost of Sales and Gross Profit Compared with Fiscal 2022

Gross margin for fiscal 2023 decreased 10 basis points from the prior fiscal year, primarily because of lower sales volumes, product and customer mix, increased promotional product discounts that are consistent with pre-pandemic promotional discount levels, and increased expense related to provisions on inventory, partially offset by lower freight and tariff expenses from the planned reduction in inventory purchases and new product introductions that typically have higher gross margins.

Operating Expenses

The following table sets forth certain information regarding operating expenses for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

Fiscal 2023 Operating Expenses Compared with Fiscal 2022

Excluding the impact of our non-cash goodwill impairment charge recorded during fiscal 2022, operating expenses in fiscal 2023 decreased $2.1 million compared with the prior fiscal year. Research and development expenses increased $860,000, primarily from increased consulting expenses; higher depreciation expense from new product tooling; and increased compensation-related expenses from additional headcount. Selling, marketing, and distribution expenses decreased $4.4 million, primarily because of lower sales volume-related expenses, lower advertising expenses, and reduced facility-related costs as a result of consolidating the Crimson Trace and Grilla operations into our headquarters in Columbia, Missouri. General and administrative expenses increased $1.4 million compared with the prior fiscal year primarily because of $1.2 million of legal and advisory fees associated with the completed cooperation agreement with a stockholder and $461,000 of increased standalone expenses, such as our information technology infrastructure costs, subscription and software costs, and insurance premium costs, partially offset by lower employee compensation-related expenses.

Operating Loss

The following table sets forth certain information regarding operating loss for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

Fiscal 2023 Operating Income Compared with Fiscal 2022

Excluding our non-cash goodwill impairment charge in fiscal 2022, we had a decrease of $24.0 million in operating income from the prior fiscal year. Operating income decreased primarily because of lower sales volumes and gross profit mentioned above.

Interest Expense, Net

The following table sets forth certain information regarding interest expense, net for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

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Interest expense, net increased $437,000 from the prior fiscal year because of interest to service our borrowings on our revolving line of credit during fiscal 2023. We borrowed $25.0 million in March 2022 to help fund the acquisition of Grilla Grills in the prior fiscal year. We had $5.0 million of borrowings on our revolving line as of April 30, 2023.

Income Taxes

The following table sets forth certain information regarding income tax expense for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

We recorded an income tax benefit of $249,000 for fiscal 2023 because of lower operating profit compared to income tax expense of $9.3 million for fiscal 2022. Fiscal 2023 income tax benefit was primarily because of recording return to provision adjustments relating to the Federal and State tax returns filed for the prior fiscal year and the impact of refundable state tax credits. Fiscal 2022 income tax expense was primarily due to recording a full valuation allowance against our deferred tax assets. The effective tax rates were 2.0% and (16.8%) for fiscal 2023 and 2022, respectively. Excluding the impact of the non-cash goodwill impairment charges and establishing the full valuation allowance against our deferred taxes, our effective tax rate for the fiscal year ended April 30, 2022 was 19.6%.

Net Loss

The following table sets forth certain information regarding net loss and the related per share data for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands, except per share data):

Fiscal 2023 Net Loss Compared with Fiscal 2022

We had a net loss of $12.0 million, or ($0.90) per diluted share in fiscal 2023. Excluding our non-cash goodwill impairment charge and related income tax effect in fiscal 2022, we had net income of $9.9 million, or $0.71 per diluted share. The decrease in net income from the prior fiscal year was primarily because of lower sales volumes and gross profit.

Non-GAAP Financial Measure

We use GAAP net income as our primary financial measure. We use Adjusted EBITDAS, which is a non-GAAP financial metric, as a supplemental measure of our performance in order to provide investors with an improved understanding of underlying performance trends, and it should be considered in addition to, but not instead of, the financial statements prepared in accordance with GAAP. Adjusted EBITDAS is defined as GAAP net income/(loss) before interest, taxes, depreciation, amortization, and stock compensation expense. Our Adjusted EBITDAS calculation also excludes certain items we consider non-routine. We believe that Adjusted EBITDAS is useful to understanding our operating results and the ongoing performance of our underlying business, as Adjusted EBITDAS provides information on our ability to meet our capital expenditure and working capital requirements, and is also an indicator of profitability. We believe this reporting provides additional transparency and comparability to our operating results. We believe that the presentation of Adjusted EBITDAS is useful to investors because it is frequently used by analysts, investors, and other interested parties to evaluate companies in our industry. We use Adjusted EBITDAS to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions, and to neutralize our capitalization structure to compare our performance against that of other peer companies using similar measures, especially companies that are private. We also use Adjusted EBITDAS to supplement GAAP measures of performance to evaluate our performance in connection with compensation decisions. We believe it is useful to investors and analysts to evaluate this non-GAAP measure on the same basis as we use to evaluate our operating results.

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Adjusted EBITDAS is a non-GAAP measure and may not be comparable to similar measures reported by other companies. In addition, non-GAAP measures have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. We address the limitations of non-GAAP measures through the use of various GAAP measures. In the future, we may incur expenses or charges such as those added back to calculate Adjusted EBITDAS. Our presentation of Adjusted EBITDAS should not be construed as an inference that our future results will be unaffected by these items.

The following table sets forth our calculation of non-GAAP Adjusted EBITDAS for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

Liquidity and Capital Resources

Historically, we have generated strong annual cash flow from operating activities. We have generated $45.5 million of cash from operating activities since the Separation in fiscal 2021. Our ability to fund our operating needs depends on our future ability to continue to generate positive cash flow from operations and obtain financing on acceptable terms. Based upon our history of generating strong cash flows, we believe we will be able to meet our short-term liquidity needs. We also believe we will meet known or reasonably likely future cash requirements through the combination of cash flows from operating activities, available cash balances, and available borrowings through our existing $75.0 million credit facility. If these sources of liquidity need to be augmented, additional cash requirements would likely be financed through the issuance of debt or equity securities; however, there can be no assurances that we will be able to obtain additional debt or equity financing on acceptable terms in the future.

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 capital needed to operate as an independent publicly traded company, enhancements to our enterprise resource planning systems, and any acquisitions or strategic investments that we may determine to make. 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.

We had $22.0 million and $19.5 million of cash equivalents on hand as of April 30, 2023 and 2022, respectively.

We expect to continue to utilize our cash flows to invest in our business, including research and development for new product initiatives; hiring additional employees; funding growth strategies, including any potential acquisitions; repaying our $5.0 million of borrowings under our revolving line of credit and any indebtedness we may incur over time; and repurchasing our common stock under our existing authorized repurchase programs.

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The following table sets forth certain cash flow information for the fiscal years ended April 30, 2023 and 2022 (dollars in thousands):

Operating Activities

Operating activities represent the principal source of our cash flow.

Cash generated in operating activities was $30.7 million for fiscal 2023 compared with cash usage of $18.0 million for the prior fiscal year. Cash generated in operating activities for fiscal 2023 was primarily impacted by $21.9 million of reduced inventory as a result of a planned reduction of inventory purchases during fiscal 2023 and a decrease in accounts receivable of $2.0 million as a result of lower sales volumes and timing of customer shipments. The cash generated in fiscal 2023 was partially offset by $1.3 million of reduced accounts payable due to timing of inventory shipments and $2.0 million of lower accrued payroll, incentives, and profit sharing primarily because of lower management incentive accruals.

We expect our inventory balance to increase in our first quarter of fiscal 2024 because of increased inventory purchases to support the fall hunting and winter holiday shopping seasons as well as inventory for new products that we expect to launch later in the year. Despite the expected increase in our first quarter of fiscal 2024, we expect our overall inventory balance to decline by the end of fiscal 2024 as compared to our inventory balance as of April 30, 2023.

Investing Activities

Cash used in investing activities was $4.8 million for fiscal 2023 compared with cash usage of $33.6 million for the prior fiscal year. This decrease was primarily because of the $27.0 million used to acquire Grilla Grills during fiscal 2022. We have incurred capital expenditures in fiscal 2023 and 2022 related to the development and implementation of our independent information technology infrastructure, including our new enterprise resource planning system, D365. We recorded spending of $2.0 million and $3.9 million of capital expenditures for fiscal 2023 and 2022, respectively, related to our development and implementation of our independent information technology infrastructure.

Financing Activities

Cash used in financing activities was $23.5 million in fiscal 2023 compared with cash provided by financing activities of $10.3 million in the prior fiscal year. Cash used in financing activities in fiscal 2023 was because of $20.2 million of payments on our revolving line of credit and $3.5 million of payments to repurchase our common stock under our authorized stock repurchase program. Cash provided by financing activity in fiscal 2022 was primarily from $25.2 million borrowings on our revolving line of credit used to acquire Grilla Grills, offset by $15.0 million to repurchase our common stock under an authorized stock repurchase program.

Credit Facility

On August 24, 2020, we entered into a five-year financing arrangement consisting of a $50.0 million revolving line of credit secured by substantially all our assets, maturing five years from the start date, with available borrowings determined by a borrowing base calculation. The revolving line included an option to increase the credit commitment for an additional $15.0 million. The revolving line bore interest at a fluctuating rate equal to the Base Rate or LIBOR, as applicable, plus the applicable margin.

On March 25, 2022, we amended our secured loan and security agreement, or the Amended Loan and Security Agreement, increasing the revolving line of credit to $75.0 million, secured by substantially all our assets, maturing in March 2027, with available borrowings determined by a borrowing base calculation. The amendment also includes an option to increase the credit commitment for an additional $15 million. The amended revolving line bears interest at a fluctuating rate equal to the Base Rate or the Secured Overnight Financing Rate, or SOFR, as applicable, plus the applicable margin. The applicable margin can range from a minimum of 0.25% to a maximum of 1.75% based on certain conditions as defined in the Amended Loan and Security Agreement. The financing arrangement contains covenants relating to minimum debt service

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coverage. During fiscal 2022, we recorded $192,000 of additional debt issuance costs associated with entering into the Amended Loan and Security Agreement.

As of April 30, 2023, we had $5.0 million of borrowings outstanding on the revolving line of credit, which bore interest at 6.05%, equal to SOFR plus the applicable margin.

Inflation

We have been impacted by changes in prices of finished product inventory from our suppliers and logistics as well as other inflationary factors, such as increased interest rates and increased labor and overhead costs. We evaluate the need for price changes to offset these inflationary factors while taking into account the competitive landscape. Although we do not believe that inflation had a material impact on us during fiscal 2023, increased inflation in the future may have a negative effect on our ability to achieve certain expectations in gross margin and operating expenses. If we are unable to offset the negative impacts of inflation with increased prices, our future results from operations and cash flows would be materially impacted. Additionally, inflation may cause consumers to reduce discretionary spending, which could cause decreases in demand for our products.

Critical Accounting Estimates

Revenue Recognition

We recognize revenue for the sale of our products at the point in time when the control of ownership has transferred to the customer, which is generally upon shipment but could be delayed until the receipt of customer acceptance. The revenue recognized for the sale of our products reflect various sales adjustments for discounts, returns, allowances, and other customer incentives. These sales adjustments can vary based on market conditions, customer preferences, timing of customer payments, volume of products sold, and timing of new product launches. These adjustments require us to make reasonable estimates of the amount we expect to receive from the customer. We estimate sales adjustments by customer or by product category on the basis of our historical experience with similar contracts with customers, adjusted as necessary to reflect current facts and circumstances and our expectations for the future.

Valuation of Goodwill and Long-lived Intangible Assets

As of April 30, 2023 and 2022, we had no goodwill recorded on our consolidated balance sheet. In the instance we have recorded goodwill, we test goodwill for impairment on an annual basis on each February 1 and between annual tests if indicators of potential impairment exist.

During the annual impairment review process, we have the option to first perform a qualitative assessment, commonly referred to as “step zero”, over relative events and circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value or to perform a quantitative assessment where we estimate the fair value of each reporting unit using both an income and market approach.

If the qualitative step zero analysis indicates that its more likely than not that the fair value is less than the carrying value, we will perform a step one analysis. When we perform a step one analysis to assess the recoverability of our goodwill, we determine the estimated fair value of our reporting unit and compare it to the carrying value of the reporting unit, including goodwill. The impairment test compares the fair value of our operating unit to its carrying amounts to assess whether impairment is present. We estimate the fair value of our operating unit using an equal weighting of the fair values derived from the income approach and the market approach because we believe a market participant would equally weight both approaches when valuing the operating unit. The income approach is based on the projected cash flows that are discounted to their present value using discount rates that consider the timing and risk of the forecasted cash flows. Fair value is estimated using internally developed forecasts and assumptions. The discount rate used is the average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. Other significant assumptions include revenue growth rates, profitability projections, and terminal value growth rates. The market approach estimates fair values based on the determination of appropriate publicly traded market comparison companies and market multiples of revenue and earnings derived from those companies with similar operating and investment characteristics as the operating unit being valued. Finally, we compare and reconcile our overall fair value to our market capitalization in order to assess the reasonableness of the calculated fair values of our operating units. We recognize an impairment loss for goodwill if the implied fair value of goodwill is less than the carrying value.

We have reviewed the provisions of Accounting Standard Codification, or ASC, 350-20, with respect to the criteria necessary to evaluate the number of reporting units that exist. Based on our review of ASC 350-20, we have determined that we have one operating unit.

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We evaluate the recoverability of long-lived assets on an annual basis on February 1 or whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. When such evaluations indicate that the related future undiscounted cash flows are not sufficient to recover the carrying values of the assets, such carrying values are reduced to fair value and this adjusted carrying value becomes the asset’s new cost basis. We determine the initial fair value of our long-lived assets, primarily using future anticipated cash flows that are directly associated with and are expected to arise as a direct result of the use and eventual disposition of the asset, or asset group, discounted using an interest rate commensurate with the risk involved.

Inventories

We value inventories at the lower of cost, using the first-in, first-out, or FIFO, method, or net realizable value. We evaluate quantities that make up our current inventory against past and future demand and market conditions to determine excess or slow-moving inventory that may be sold below cost. For each product category, we estimate the market value of the inventory comprising that category based on current and projected selling prices. If the projected market value is less than cost, we will record a provision adjustment to reflect the lower value of the inventory. This methodology recognizes projected inventory losses at the time such losses are evident rather than at the time goods are actually sold. The projected market value of the inventory may decrease because of consumer preferences or loss of key contracts, among other events.

Income Tax Valuation Allowance

We periodically assess whether it is more likely than not that we will generate sufficient taxable income to realize our deferred income tax assets. The ultimate realization of net deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary differences become deductible. We establish valuation allowances if it is more likely than not that we will be unable to realize our deferred income tax assets.

In making this determination, we consider available positive and negative evidence and make certain assumptions. We consider, among other things, projected future taxable income, scheduled reversals of deferred tax liabilities, the overall business environment, our historical financial results, and tax planning strategies. Significant judgment is required in this analysis.

We determined in the prior fiscal period that it was more likely than not that the benefit from our net deferred tax assets will not be realized and accordingly we established a full valuation allowance recorded as an increase to income tax expense. In the current fiscal year, we continued to maintain a full valuation allowance based on the assessment that it is more likely than not that the benefit from our net deferred tax assets will not be realized. Our assessment involves estimates and assumptions about matters that are inherently uncertain, and unanticipated events or circumstances could cause actual results to differ from these estimates.

Estimates may change as new events occur, estimates of future taxable income may increase during the expected reversal period of our deferred tax assets, or additional information becomes available. Should we change our estimate of the amount of deferred tax assets that we would be able to realize, a full or partial reversal of the valuation allowance could occur resulting in a decrease to the provision for income taxes in the period such a change in estimate is made. We will continue to assess the adequacy of the valuation allowance on a quarterly basis.

Recent Accounting Pronouncements

The nature and impact of recent accounting pronouncements is discussed in Note 2 — Summary of Significant Accounting Policies to our consolidated and combined financial statements, which is incorporated herein by reference.

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Contractual Obligations and Commercial Commitments

The following table sets forth a summary of our material contractual obligations and commercial commitments as of April 30, 2023 (in thousands):

As of April 30, 2023, we had $5.0 million of borrowings outstanding on our revolving line of credit. We are required to make interest payments for the unused portion of our revolving line of credit in accordance with the financing arrangement. Future unused loan fee obligations are not included above, which could accumulate up to approximately $185,000 per year, under certain circumstances, until the maturity date in fiscal 2026.

Interest on debt is based on outstanding debt as of April 30, 2023, and includes debt issue costs to be amortized over the life of the financing arrangement. The interest rate used to calculate was 6.1% as of April 30, 2023. See Note 10, Debt, for additional information.

Operating lease obligations represent required minimum lease payments during the noncancelable lease term. Most real estate leases also require payments of related operating expenses such as taxes, insurance, utilities, and maintenance, which are not included above. See Note 4, Leases, for additional information.

Purchase obligations represent binding commitments to purchase raw materials, contract production, and finished products that are payable upon delivery of the inventory. This obligation excludes the amount included in accounts payable at April 30, 2023 related to inventory purchases. Other obligations represent other binding commitments for the expenditure of funds, including (i) amounts related to contracts not involving the purchase of inventories, such as the noncancelable portion of service or maintenance agreements for management information systems, (ii) capital spending, and (iii) advertising.