Vista Outdoor Inc (VSTO) 2017 Q4 法說會逐字稿

Good day, and welcome to the Vista Outdoor Q4 and Full Year Fiscal Year 2017 Earnings Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Michael Pici, Vice President, Investor Relations. Please go ahead, sir.

Thank you. Good morning, and thank you for joining us for our fourth quarter fiscal year -- and fiscal year 2017 earnings call. With me this morning are Mark DeYoung, Vista Outdoor Chairman and Chief Executive Officer; and Stephen Nolan, Senior Vice President and Chief Financial Officer.

Before we begin, I'd like to remind everyone that during today's call, we will be making several forward-looking statements, and we make these statements under the safe harbor provisions of the Private Securities Litigation Reform Act. These forward-looking statements reflect our best estimates and assumptions based on our understanding of the information known to us today. These forward-looking statements are subject to the risks and uncertainties that face Vista Outdoor and the industries in which we operate. We encourage you to review today's press release and Vista Outdoor's SEC filings for more information on these risk factors and uncertainties.

Please also note that we have posted presentation materials on our website at vistaoutdoor.com, which supplement our comments this morning and include a reconciliation of non-GAAP financial measures.

With that said, I'll turn the call over to you, Mark.

All right. Great, Mike. Thank you. Good morning, everyone. Thank you for joining us on our Vista Outdoor FY '17 Fourth Quarter and Full Year Earnings Call.

Just 2 years ago, we launched Vista Outdoor with a vision to create a world-leading provider of products for outdoor enthusiasts. Our company, the executive leadership, we remain excited about this vision, and we remain committed to our core goal of providing innovative and high-quality products to our customers, creating rewarding careers for our employees and generating growth and returns for our shareholders. We believe we've assembled a brand portfolio that's well positioned to achieve our vision and take advantage of growth in the outdoor recreation market. Although current retail challenges exist, we're seeing participation growth.

As most recently highlighted in Outdoor Foundation's top line report, Vista Outdoor has strong product offerings in 6 of the 10 outdoor recreation growth categories, including stand up paddle boarding, BMX cycling, cross-country skiing, adventure racing, trail running and hiking. These trends indicate the strength and potential of this industry over the long term and reaffirm our strategy to expand our Outdoor Products portfolio into other outdoor recreation categories.

Additionally, the majority of our hunt/shoot products offerings are consumables. These products support an install base of approximately 350 million firearms in the United States, and this base has continued to grow by approximately 60 million additional firearms over the last 4 years. The number of shooting sports participants has increased by 15 million since 2009.

To achieve our vision, we must consistently deliver innovative products, continuously improve our operational performance and build on strategic partnerships. This requires us to invest in our business even during periods of challenging market conditions. Today, e-commerce, through our own and our partners' presence, represents over 20% of Outdoor Products segment sales. We are continuing to expand our e-commerce presence to capitalize on the ongoing shift by consumers to online shopping.

We are leveraging the knowledge and experience of our acquired brands and have hired a new dedicated Corporate Vice President for e-Commerce to drive growth across direct-to-consumer, business to business, dot-com and drop ship channels.

We continue to invest in R&D and innovation across all of our product lines. In the fourth quarter, we launched more than 150 new products at trade shows for golf, winter and trail sports and the hunt/shoot markets. These new solutions have garnered cover stories and best of the best awards, with nominations from both industry publications and our consumers.

Vista Outdoor's goal is to have the right person in the right place at the right time. This R2 strategy, as we call it, is evolving along with our relatively young company, and I'm pleased to say that we're attracting high-caliber talent and strengthening our teams. We are also elevating and maximizing the capabilities of high-potential employees from our recently acquired businesses and our traditional businesses. The company has and we will continue to drive cost savings initiatives and improve efficiencies within our manufacturing, sourcing and distribution capabilities.

In the fourth quarter, we reduced our headcount to align with demand. Additionally, we are reducing working capital, primarily through inventory reductions in both segments. We believe these efforts will position us to deliver strong cash flow and achieve long-term organic growth. We recognize that we fell short in the fourth quarter and the full year. We anticipate channel inventories will stabilize by mid-FY '18, and we are determined to improve the performance in the second half of this fiscal year.

I'm pleased to announce that we finalized a new long-term supply agreement with Orbital ATK that extends through September of 2020. This agreement allows us to ensure an ongoing supply of ammunition products produced at the Lake City Army Ammunition Plant and supports our long-held market position as the leader in these ammunition categories. With the first phase of our long-term ammunition capital investment plan coming online in the second half of this fiscal year and given the current market conditions, we are suspending future capacity expansion phases at this time.

While the current period of market softness has impacted our business, the breadth of our portfolio has allowed us to benefit from strength in certain markets such as power sports and outdoor cooking. We are benefiting from growth in these areas through our acquisitions of Action Sports and Camp Chef. Over the short term, our primary focus will be on delivering improved performance within our current brands. We continue to evaluate the performance and capabilities of our portfolio to ensure we have the right products and brands to support our long-term strategy and that the various components of our portfolio are generating the returns that we expect.

We have issued FY '18 financial guidance, which reflects our focus on generating strong cash flows through cost management, efficiency improvements and operational excellence. We believe that our scale and diversity will continue to give us opportunities to capture market share by leveraging product innovation and distribution strengths across all of our brands. Stephen will provide more detail on our view for the full year, including the first quarter.

Much progress is being made across the company in functional and operational areas. We are confident that a continued focus on our long-term strategy and execution of our near-term initiatives will ensure that we achieve the vision we created just 2 years ago. We cannot change the market, but we are taking actions on those things that we can control to improve the performance of the company.

With that, I'll turn it over to Stephen to discuss financial results for the past quarter and full year. Stephen?

Thank you, Mark. Good morning, everyone, and thank you for joining our fourth quarter and full year fiscal '17 earnings call. We've disclosed both as reported and adjusted results in our press release to assist you in your understanding of the underlying numbers and to assist in comparison to prior periods. You will find a more detailed financial presentation of our fourth quarter and full year performance on our website. Today, I will discuss the adjusted results, first, for Vista Outdoor overall; and then I will provide a little more color on the drivers of the segments.

As we talk about the results from acquisitions, I'd note that we're referring to the operations of our acquired businesses only for periods in which they were not part of Vista Outdoor in the comparable prior year periods. For the fourth quarter, we recorded sales of $579 million, down 5% from the prior year quarter. The decrease was caused by lower sales in both segments, partially offset by $93 million of sales from the Action Sports and Camp Chef acquisitions. The company achieved full year sales of $2.55 billion, up 12% from the prior year. The increase was driven by $426 million of sales from acquisitions, partially offset by organic declines in both segments.

Our fourth quarter gross profit of $144 million was down 12% from the prior year period, including $24 million of gross profit from acquisitions, partially offset by declines in both segments. Full year gross profit was $670 million, up 8% from the prior year, including $122 million in gross profit from acquisitions partially offset by an organic decline in the Outdoor Products segment.

Our operating expenses for the fourth quarter were $129 million compared to $93 million from the prior year quarter. The increase reflects a $17 million write-off of receivables from Gander Mountain due to their recent bankruptcy as well as additional operating expenses incurred by the acquired businesses and increased new product development activities. Full year operating expenses were $455 million compared to $344 million from the prior year. The increase reflects additional operating expenses incurred by the acquired businesses; the $17 million write-off mentioned earlier; and the increased new product development activities, partially offset by a reduction in annual incentive expense as a result of current year performance.

Interest expense for the fourth quarter was $11 million, up 48% compared to the prior year period. For the full year, interest expense was $44 million, up $19 million from the prior year. The drivers of both the quarter and the full year reflect the increase in average debt balance, partially offset by a decrease in our average borrowing cost.

The tax rate for the quarter was 56.1% compared to 38.2% in the prior year quarter. The tax rate for the full year was 34.9% compared to 37.9% in the prior year. The increase to the quarter's tax rate reflects certain small tax adjustments, the impact of which was magnified by the low pretax book income. The decrease for the year was driven by a settlement of an IRS examination and the onetime true-up of deferred tax assets in the prior year, partially offset by a lower tax deduction for stock-based compensation.

EPS in the fourth quarter was $0.03, down 95% from the prior year quarter. EPS for the full year was $1.90, down 24% from the prior year. These decreases were due to the results just discussed, partially offset by share repurchase performed throughout the year. The EPS results also include an $0.18 impact from the write-off I mentioned earlier.

Free cash flow for the full year was $38 million compared to $163 million in the prior year. The decrease was primarily caused by increased capital expenditures, as previously communicated; decreased net income; and increased inventory levels due to the recent sudden change in market conditions. As previously indicated, the company repurchased approximately 780,000 shares for $24.5 million in the fourth quarter. In fiscal year '17 overall, we repurchased a total of approximately 3.9 million shares for $151 million.

Now turning to our business segments, where we report both sales and gross profit. For the fourth quarter, our Outdoor Products segment recorded sales of $270 million, a 17% increase from the prior year quarter, including approximately $93 million of sales from acquisitions. Organically, the segment was down 23% over the prior year quarter. This decline was caused by decreases across most product lines due to the challenging retail environment, which began to worsen in the third quarter, partially offset by growth in the eyewear and golf product lines. For the full year, sales of Outdoor Products were $1.2 billion, up 36% from the prior year, including $426 million of sales from acquisitions. Organically, sales in the segment were down 18 -- or 14% year-over-year caused by decreases across all product lines.

Outdoor Products gross profit for the fourth quarter was $57 million, a 17% decrease from the prior year quarter, including $24 million from acquisitions. Organically, gross profit decreased 52% compared to the prior year quarter. The decrease was caused by lower organic sales, unfavorable profit mix and inventory rationalization.

Gross profit for the full year in Outdoor Products was $293 million, an increase of 21% from the prior year, including $122 million from acquisitions. Organically, gross profit was down 30% due to a decrease in organic sales, unfavorable product mix, increased sales programs and inventory rationalization.

Now turning to our Shooting Sports segment. Fourth quarter sales of $309 million were down 19% from the prior year quarter. The decrease over the prior year quarter reflects lower demand across our product lines due to the challenging retail environment, which began towards the end of the third quarter, with the exception of rimfire ammunition. For the full year, Shooting Sports reported sales of $1.4 billion, down 2%, which was caused by decreased demand in centerfire and shotshell ammunition volume, partially offset by increases in rimfire ammunition volume. Fourth quarter gross profit was $87 million, down 8% from the prior year quarter. The decrease is due to the lower sales, partially offset by product mix and lower sales programs. Full year gross profit in Shooting Sports was flat compared to the prior year of $377 million.

As Mark mentioned, we've entered into a new long-term supply agreement with Orbital ATK for Lake City products as part of a long-term strategy to secure supply of .223/5.56 product. While this product remains important, it does represent the market area where we expect to see the largest year-over-year declines in fiscal '18. In addition, the terms of the agreement include some cost increases for those products in fiscal '19 and beyond.

Looking forward, we've established fiscal '18 guidance for our existing business. We expect fiscal '18 sales in the range of $2.36 to $2.42 billion. We expect overall gross margins and R&D investment in line with fiscal '17. We anticipate Shooting Sports margin to be in the mid-20s and Outdoor Products margin to be in the mid- to upper-20s. We expect EBITDA margins to be approximately 11%.

Our fiscal '18 guidance also reflects interest expense of approximately $50 million, including amortization of financing costs. The effective tax rate for the year is expected to be approximately 37%. We expect EPS in the range of $1.10 to $1.30 per share with improvement in the second half of the year. Our expected fiscal '18 capital expenditures are approximately $70 million, which includes the completion of the bulk of our investment in capacity expansion. We expect free cash flow in the range of $175 million to $200 million. During fiscal '18, we expect to monetize excess inventory that we accumulated in the third and fourth quarters of fiscal '17.

Looking to the near term, we see conditions in the first quarter similar to those we saw in the fourth quarter. We expect these conditions to be exacerbated by impacts from Gander Mountain inventory liquidations and the recent incident at Orbital ATK's Lake City Army Ammunition Plant, which will lead to constrained supply of certain products from that facility during the quarter. Therefore, we expect to generate approximately 22% to 24% of our full year revenue guidance and 10% of our full year EPS guidance during the first quarter.

We expect to be a strong cash generator in the coming fiscal year. We also expect to see continued pressure on our leverage ratio, driven mainly by the decline in year-over-year EBITDA, which was implied by our financial guidance. As a result, we do expect that our leverage ratio will, at times during the year, exceed the 3.5 level reflected in our existing credit agreement covenants. In fact, it is likely that we'll exceed 4.0 near the middle of the year, driven by the combination of the lower trailing 12-months EBITDA and the normal seasonal nature of our cash collection. To address this issue and to ensure an adequate cushion in our credit covenants, we've executed an amendment to our credit agreement. This amendment has relaxed the leverage ratio covenant to 4.75 for calendar year '17 and '18 to 4.25 for calendar year '19 and 4.0 thereafter. The pricing grid has also been adjusted to reflect 2 new pricing tiers. All of the current pricing tiers remain unchanged, while the interest rates at leverage ratios above 3.5 and above 4.25 increased by 25 basis points and 50 basis points, respectively.

Finally, the amendment includes the new senior secured leverage ratio covenant established initially at 3.5 with a step-down to 3.0 at the end of calendar '18. We believe that this amendment will give us improved financial flexibility that we need during this current period of market softness.

In closing, we've taken actions on the credit agreement, on the Lake City agreement, on our go-to-market approach and on our cost structure that we believe will position Vista Outdoor for long-term success.

With that, we'll open it up for questions.

(Operator Instructions) We'll take our first question from Scott Hamann with KeyBanc Capital.

Mark, could you kind of give us a little bit more detail as to what you're seeing in the channel just with respect to inventory level, the progress, what's still kind of heavy? And then where -- your commentary in the release was that you thought the downturn would last a little bit longer, and just curious what data points you have that might support that.

Okay, sure. Thank you, Scott. So on channel inventories, what we are seeing is that those channel inventories still remain fairly high, particularly in the wholesale categories. As we mentioned previously and as you've heard other companies mention, prior to the election, the wholesale distribution channel, in particular, stocked up on additional inventories in anticipation of a different outcome in that election, which would have driven heightened demand for a lot of Shooting Sports products. That inventory remains high with most of our functional wholesalers, and it's going to take some time to work that out. We had mentioned in the last call that we thought it would be mid of this fiscal year, which is around the September, early fall time frame, before those inventories begin to be rationalized. We still think that looks about right, that those inventors are going to have a couple more quarters before they get normalized and rationalized. Based on the lower demand, it'll take longer to clean up those inventory balances. So that's a key part of why we believe this market softness is going to -- or is likely to continue at least through the summer and into early fall. So that's one the challenges we face in terms of the inventory levels and channel. In terms of the downturn in general, traditionally, Scott, these downturns have lasted between 12 and 24 months in the Shooting Sports. The last downturn was around 18 to 24 months in Shooting Sports. This downturn, to us, is a little unique because it was precipitated by a national geopolitical event, primarily with the election results. And so it's a little bit harder to call based upon it's a unique environment that we're in now. But we anticipate, just based again on channel inventory and current POS data, which remains generally negative in terms of year-over-year POS. Both in 4-week, 15-week and 52-week across the majority of Shooting Sports categories, POS remains down. So it is a slow turn. And because it is a slow turn, we're anticipating a couple more quarters before we begin to see a real momentum return to the shooting sports market.

Okay. And then, Stephen, just a question on the guidance. Is there any chance you could give us a little bit of help on the sales kind of breakdown between the segments? And then on the margin side, what are you contemplating within, I guess, primarily Shooting Sports for some of the moving pieces there around input cost and volumes and things like that?

Sure, Scott. As you know we don't guide revenue by segment. And I don't think at this stage we'd provide additional color there. But on the margin side, I did mention in my script that we do expect Shooting Sports gross margins to be somewhat lower than they were this year, driven by a combination effect of some promotional activity, some mix shift and in addition, the potential impact of some increased commodity cost later in the year. As you know, we typically engage in forward purchases of commodity products to insulate ourselves against short-term shifts in those prices. However, when there is a sustained shift in pricing, eventually, it catches up with us. Copper, in particular, has seen an increased price over the last 6 months. Right now, we're projecting that those price increases will continue. And at some point, we will lap our forward purchases at lower pricing, and that will start to hit us. So we think Shooting Sports is going to be somewhere in the mid-20s for gross margins rather than the high 20s we had seen for much of fiscal '17. Outdoor Products, on the flip side, where it has been operating more in the low-20s, we expect to see that increase somewhat during the coming year, driven partially by mix driven significantly by cost reduction activity we have engaged in, in that segment, where we've taken out a lot of cost of goods sold based on both supplier renegotiations and also some nonproduct cost of goods sold cost that's embedded within that segment for everything from distribution to management of the supply chain.

Okay. On the positive side, can you quantify any of the cost reduction stuff that you have done within the segments? And how sticky is some of that stuff as we move forward?

Yes. So the impact of this is embedded in our cost. We've taken out significant cost in both segments. On the Outdoor Products side, given the sourced finished good nature of most of our sales there, a lot of that is hitting the bottom line, which is why you're seeing the increased gross margin in that segment. On the Shooting Sports side, while we've taken out significant costs, most of those costs are merely offsetting the loss of fixed cost absorption because of the lower production rate at those facilities based on our recent departure from our long-term trend of operating at 100% capacity. As we mentioned on our last call, we have reduced shifts, we've engaged in certain layoffs and staffing reductions at both of our ammunition facilities. So a lot of -- while those cost reductions are not immaterial, they are offset by those increased fixed costs.

And I think, Scott, based upon Stephen's answer, those are very sticky cost savings. We anticipate long-term savings. We anticipate those savings to be locked in going forward. The supply chain work we've done, the headcount reductions we've done, the efficiency improvement investments that we've done are all very sticky in terms of cost reduction.

We'll take our next question from Greg Konrad with Jefferies.

Just wanted to follow-up on kind of what you're seeing in terms of longer-term trends. It looks like you took down your organic revenue goal over the next 2 to 3 years, and I would think most of that has to do with your expectations around fiscal year '18. But if I kind of calculate that CAGR, it would imply, as you get into '19 and '20, a high single-digit growth. Am I looking at that the correct way?

I think what we're projecting -- what we're suggesting is the growth is from fiscal '18 forward. Not flat line -- not carrying it from fiscal '17 forward. So the climb from fiscal '17 to fiscal '18 is not embedded in our short-term guidance -- our outlook, I should say, that we've provided in our investor brief.

And then are there any limitations on share repurchases going forward? Or would you expect to continue buying back shares?

We don't have an open authorization right now from our board, and so I think that, that option in terms of how we manage capital deployment going forward is still on the table. We would just need to go back and work with our board for an authorization to execute that going forward.

As we mentioned before, Greg, there are limitations on restricted payments in our credit agreement. But right now, there's open capacity under that restricted payments basket. I think our near-term focus is on internal operational improvements and capturing market share in our existing markets and managing our debt balances. I mentioned, while we've increased our leverage ratio in the near term, there are several step-downs in that leverage ratio within our amended credit agreement. So I think our focus, certainly, in the near term will be on debt repayment.

And then just lastly in terms of your long-term financial goals. One that's missing is kind of how we should think about free cash flow conversion going forward. Obviously, you're calling for a very good number in '18. Some of that is working capital improvement that didn't work down in Q4. I mean, how should we think about free cash flow conversion going forward in a more normalized environment without the working capital?

Yes. This business traditionally has been a strong cash flow provider, and we believe that will continue in the long term. So we focus this year -- as you saw on our guidance, we focus on efficiency improvement, we focus on working capital improvement. As I mentioned earlier, we're very focused on inventory and getting the right products in inventory and reducing our inventory balances. So we'll work on that very hard this year. I'm very optimistic we'll be able to drive our inventory balances down and that we'll be able to generate the cash that we have given in our guidance. And then our anticipation is that the company will continue over the long term to be a strong cash generator as it's been in the past.

Yes. Greg, while we obviously don't provide guidance beyond fiscal '18, I would expect our cash conversion ratio to return to the levels we have traditionally seen, with the exception of fiscal '17.

We'll take our next question from Gautam Khanna with Cowen and Company.

This is Bill Ledley on for Gautam. I had a quick question for you on the new OA agreement. Could you perhaps quantify the inflation on the new agreement and how much more expensive the .223/5.56 gets in fiscal '19?

Yes. So let me just back up and clarify for everyone, and Stephen can jump in if he'd like to. So just to clarify for everyone, the long-term agreement will take us through September of 2020. So we're very pleased to have that locked down over the long term here. There really is no cost increase in this fiscal year, FY '18. As Stephen mentioned and as you reiterate, those cost changes come in beginning in FY '19 and beyond. The cost increases are, I think, fairly modest in terms of the agreement. How those cost increases will be feathered in over the longer term, that agreement, I think, provides for us an opportunity to retain a leadership position and selling the bulk of that ammunition in the commercial market, where we have a strong foothold and very strong brand presence and distribution already established for that product. So just to make sure people understand, there really is no financial impact from the renegotiated agreement this year. In terms of going forward, Stephen, is there anything you want to add there?

Yes. The one thing I would just add is, Bill, given that agreement in fiscal '19 and beyond is no longer an exclusive agreement and Orbital ATK has the right to sell certain amounts of ammunition to other providers, we are not going to be disclosing anything publicly about our pricing under that agreement given the competitive nature of that market.

Yes, got it. That's fair. Just trying to see if it's modest or if it's pretty big. And then just secondly, just talking about mix. You guys mentioned some better mix in Outdoor Products in fiscal '18, and you've highlighted your focus on e-commerce. Is e-commerce a lower margin business than the traditional retail environment? And how should we think about growth in e-commerce kind of impacting gross margin?

No, e-commerce is not typically a lower margin business. We do -- as we mentioned, about 20% of the Outdoor Products segment sales today are generated through online sale of our products, and that's through a variety of large and capable partners as well as our own direct-to-consumer websites and selling that we have for online purchases. The margins are very much in line with other margins in other channels of distribution. So we are focused on that. We completely understand and see the shift of the consumer to online purchases. We are focused on making sure that when they go online, that they see our products, that they're able to purchase our products. As we mentioned, we just hired a dedicated resource -- Vice President of e-Commerce -- to join us. This executive has extensive experience and talent in establishing and growing e-commerce business, so we're excited about that. So we're very focused on it. We believe that over the long run, consumers will continue to shift some of their purchasing habits, particularly for our Outdoor Products type accessories, to that online marketplace. And we want to ensure that we're the leader in our space in that area. So margins there are good. The opportunity for us to grow there is good. And we're very focused on it, and we'll be making investments both in personnel and in capability going forward.

I would just like to emphasize, we are in no way backing away from our traditional customers. Our brick-and-mortar customers are still, obviously, very important customers of ours. And this is merely the next evolution of our omnichannel strategy, which we have adopted -- which we adopted several years ago and continue to execute. As the market has shifted online, we are merely moving where the consumers are.

Okay. And then just a couple of cleanup questions. Is the accounts receivable write-off at Gander the entirety of the accounts receivable balance there? And is there any more risk around any other customers potentially needing write-offs? And then, Stephen, just what's your capacity for capital deployment under the credit agreement, either for M&A or for buyback?

Yes. So to answer your first question, in terms of Gander Mountain, the $17 million write-off is the entirety of the receivables balance from Gander Mountain. While that process -- that bankruptcy process is ongoing and there was a successful auction of a number of their assets there a couple weeks ago, the likelihood of recovery under that is -- of significant recovery is low, and we believe it was prudent to write off the entirety of that balance. In terms of other customers, we obviously monitor customers very closely. Unfortunately, some of these things are difficult to predict. By their nature, they often occur relatively suddenly. There are no other significant customers about whom we have any material concerns today. And certainly, none that we have on any significant credit watch or other type of treatment. In terms of our credit -- of our capacity and our liquidity, our liquidity, I can say, at the -- certainly, at the end of the quarter, we finished with liquidity of a couple hundred million dollars, and I'm not going to provide an update of where we are today. We've not updated our cash position at the middle of the year. But I would think, as we go forward, we would like to maintain some amount of liquidity in that couple of hundred million dollar range. I would not expect us to deploy a significant amount of that in the near term for M&A activity given the focus, as Mark indicated, on our organic business. But we are always very mindful of what assets are available out there. And we certainly keep a close watch when it comes up for sale to make sure there would be no particularly strategic asset we would miss out on. So we are going to take a look at everything that comes for sale. And if something strategic came along, our posture might change.

We'll go next to Jay Sole with Morgan Stanley.

Mark, I have a question. It seems like the NICS checks have been okay. Some of the industry data suggest that firearm sales, in general, have been okay. But it seems like ammo is a category that's performing worse than firearms, and firearm accessories continue to also be weaker than maybe the NICS checks would imply or even firearm sales. Why do you think that's the case? Normally, the different categories all seem to move together in terms of sales. What's happened now that's made that different?

Yes, Jay, it's a good question because it is unusual. So I would agree with you. It's been a bit unusual. This has been unusual for about 12 months, through most of our fiscal year '17. We saw accessories -- the kind of things that you talked about, accessories and optics and holsters, some of those categories seem to trail the firearm spending. When you look at NICS checks, in our view, NICS checks has been led primarily by handgun purchases and by MSRs. Right now, when you look at those markets, both in handguns and MSRs, where we really don't materially participate even though we launched our own Savage MSR line, it was not a strategy to become a big provider of MSRs. It was a great complement to our long gun line. So that's where most of those purchases are, Jay, is in handguns and MSRs, which leads you to believe it's still purchases in personal defense primarily. And there has been heavy, heavy discounting in the last couple of months by firearms manufacturers in both MSRs and handguns, prices that I haven't seen in many, many years for some of their premium kind of leading products. So I think that's driving some of the NICS checks, is there are very good pricing right now in handguns and MSRs being offered by some manufacturers and by some of the retailers. So I think that's propping up or supporting some of those purchases. And so there might be a little bit of a disconnect between what people are seeing as where to spend their discretionary money in shooting sports and taking advantage of some of the discounting that is going on in handguns and MSRs. I think that's part of it, for sure. I think the other part is most people have only a certain amount of disposable income, and they appear to be still prioritizing firearms instead of accessorizing the firearms they'd purchased or instead of buying accessories and other items to complement the firearms they'd purchased. They seem very much to be taking their discretionary income and still putting it into that hard good. I think that's part of why we have issued guidance for this year which says that this correction and some of the inventory liquidation that is going on and some of the discounting which is going is likely to continue. The signs we're seeing in point-of-sale data remain negative, as I mentioned earlier. And I think people -- even in this economy, I think there's a lot of uncertainty. The economy is still not strong, and people have just chosen, it appears, to take advantage of that discounting in firearms.

Also on the ammunition side, as we've discussed before, we do believe there was a certain amount of personal stockpiling that took place leading up to the election. And there are -- there's currently very little fear about future regulation or lack of availability of ammunition. So it is a purchase that consumers, I think, can feel they can readily delay right now while burning through certain amounts of those personal stockpiles.

Yes, got it. That's helpful. And then maybe just a follow-up. Do you have a theory on what it takes to kind of flip the sentiment up there amongst consumers and what gets them to come back to the store to accessorize their guns or to buy more ammo or to go to target shooting ranges?

Yes. I do think that the participation rates -- if you look at the participation rates, really in all of outdoor recreation -- I mentioned that briefly in my initial comments -- there is good growth in outdoor recreation across lots of outdoor categories. And we mentioned we have 6 of the top 10 growth categories in outdoor rec we participate in. And then if you look at participation in the shooting sports, you have 15 million new firearms purchasers that have entered the market. Range growth has been positive in terms of new ranges opening up, and participation in shooting at the ranges has been positive. So I think we're in a bit of just a lull. I don't have any real concerns about the long-term health and strength in outdoor recreation or shooting sports. I think we are going to see that return. I think right now, as Stephen mentioned, there was pent-up purchases, which occurred during the election year and prior to the election year, during the prior administration. And so there is, I think, a period that we're in of liquidation of personal inventories in addition to some of the inventories that are in the distribution channels. And so, Jay, I think we're just in a temporary lull in terms of consumption. And as people continue to shoot, which I believe they are, as they continue to consume those inventories Stephen referred to, I think you'll see them come back. I really have no doubt that shooting sports continues to be growth market. It's been running at about 7% CAGR for a long time. I think in the future, we'll return to that. But we're just in a period that we've got to work through it. And as we've said in our discussions previously, we think there's a good likelihood that you don't begin to see some of those indications of people flipping back to purchasing of accessories or additional amounts of ammunition until the fall of this year, the back half of this year.

Yes. Jay, we have seen no data that would suggest the current correction in any way reflects a change in underlying consumption of ammunition. While, as you know, there's no good hard data on that, we only have anecdotal data. But certainly, the anecdotal data we see and collect from talking to range operators and retailers suggests that ammunition consumption remains strong. It is merely that we are now 2 levels removed ourselves -- 2 levels removed from that consumption as we march through both the stockpile and the inventory or the channel and also the stockpiles in personal inventory.

Our next question comes from Dave King with Roth Capital.

I guess, first, on the guidance. It sounds like the shortfall there is the ammo downturn lasting longer. I guess, Mark, how are you thinking about the outdoor side of the business at this point? I guess, one, given the correlation to shooting sports but also changes at retail. And then how should we be thinking about anticipating a rebound there versus I think the 14% sort of organic drop we had in this year?

Yes. So the biggest issue I think we've been facing in terms of general outdoor, which is impacting our business, has been the ongoing shift in retail, the retail malaise and lack of consumer spending that's occurred there. I think we also had -- as you know, the bankruptcies last year impacted us in our Outdoor Products. Weather impacts that business as well depending on how the ski season or snow is, what happens to inventories there. So there's been a lot of moving parts in general outdoor rec, including the bankruptcies and shifts in the market, which have had some impacts. I feel much the same way about outdoor rec. If you look at the Outdoor Foundation's annual report they published in terms of participation growth, read that report and you will feel really positive about the long-term future of outdoor rec and the categories in which we have chosen to participate. If you look at the acquisitions we've done, whether it be in stand up paddle boards, whether it be in personal protection for cycling and motor sports or in outdoor cooking, for example, those are great growth areas which are seeing significant increases in participation. And I think our acquisitions have positioned us to be in markets which are going to continue to grow. So again, I think in this case, Dave, we're in some lulls here of uncertainty in the economy and uncertainty around consumer spending compounded by this retail malaise and some of the bankruptcies that have impacted that segment. So I think that's what we're seeing there. All the long-term indicators are a return to health, and we anticipate that. I also think we can do a better job in how we have managed some of our inventory and supply chain and some of the ways that we have gone to market with some of those outdoor products. As we've mentioned previously in the hydration side in CamelBak, there's been a fairly rapid shift to stainless steel solutions. We were a little bit behind that. So we're working hard. We've got several new offerings which will put us back in play on stainless steel. So I think that's something we are catching up on as we got a little bit behind with the CamelBak brand. The backpack business and the outdoor hydration business is doing great. But the shift to stainless steel, we need to catch up on that. So we are working on that very aggressively to make sure we have value offerings there. So that's one of the challenges we face. But I think with the exception of a few of those internal opportunities for improvement, I think this one is going to work its way out over time. And I have every confidence that, that is going to be a very good market for us. We've got the right brands. We need to just make sure we get the right inventory, the right products and catch up to that growth.

Okay, that's good color. And then, Stephen, in terms of the new credit agreement, where did you exit the quarter on leverage under those terms? And then you sort of touched on it in terms of how you're seeing that progress over the course of the year. But if I sort of plug in some of the first quarter guidance, it seems like you're going to be kind of in the low 4s exiting Q1. And then if the weakness persists into Q2, you could be maybe even hitting or surpassing that level. I guess how should we be thinking about that one?

Yes, sure, Dave. So we finished the year under the measurement used for the credits written. This year, it's about 3.3. I -- while we don't provide cash flow guidance by quarter, we do not expect to be above 4 at the end of the third quarter. And while we may be modestly above 4 at the end of the second quarter, we would expect to maintain a significant buffer below the 4.75. And so we don't, in any of our modeling, come anywhere close to approaching that level. We remain much, much closer to 4 at all points within our modeling.

Our next question is from Scott Stember with CL King.

Can you maybe talk about the optics business? I know that was a big part of the weakness that we saw in Outdoor Sports just last year and what led to the big write-down you had. Can you maybe just talk about the product there, R&D efforts to make it more competitive? And maybe just talk about the competitive landscape and how that fits into your guidance for 2018.

Yes, you bet. So on the optics, let me just refresh your memory. In the optics category, when we talk about sports optics, we participate with a couple of different brands there that allow us to have a good-better-best strategy and allow us to segment our product branding, both by price and by channel. So we have Bushnell, Simmons, Tasco and Weaver. Those are our primary optics lines. We have done, I think, an excellent job this year in repositioning our optics in terms of channel segmentation by brand, by feature and benefit and by price. So we have made great progress, I believe, this year. And I think the optics team in Kansas City has worked very, very hard and made significant progress in getting our optics brands in the right channels of distribution. We were not in all the right channels of distribution by brand previously, and it was putting pricing pressure on our optics, and it was causing us to lose revenue opportunity by not having the right product in the right outlet at the right time for consumers. So the team has worked very hard on that. We've made huge progress this year in getting that right. Also in terms of our investment in innovation and new products, we have revamped our entire optics team. We've brought in new talent from competitive optics companies as well as outside talent with great expertise in channel management and in R&D development. We have launched new lines of optics. We did a mid-year launch at the NRA Show of a new optic line under the Bushnell brand, which was very, very well received. As we go forward in the future, you'll see us cleaning up our branding and our product offering in optics. We are going to be launching an entire new line of Bushnell optics next year, which I think will be very exciting. We have previewed it to key accounts. They've all been very excited about taking that product line on. So I believe we're turning the quarter on optics. Now that said, the market for optics remains soft. If you look at POS on optics, it has been negative. So the market itself for optics is down. It has been soft. And it's very, very competitive. As I've said in the past, when it comes to optics, there are very few barriers to entry. Nearly all of the optics that are sold, whether they be riflescopes, binoculars, rangefinders, spying scopes, they're nearly all sourced in Asia. So the barriers to entry are not great. The key for us will be leveraging our brand equity and leveraging our distribution channel strategy, and those things are going very well. So although optics remains an area where we are very focused on it, and although it remains a soft market in optics, we lost a little market share in the riflescope segment, but really held our own in binocular, spying scopes and rangefinders there. So I'm becoming increasingly pleased with the performance and the progress we're making in optics and excited about the new offerings, the brand rationalization and the brand segmentation strategies we've put in place. So good progress there.

Got it. And maybe just talk a little bit about the new e-commerce -- or the heightened e-commerce shift that you're expecting. Can you maybe just talk about the timing of that? And just maybe give us a little bit more granularity about how -- will this be a company-wide process. Or will the individual brands be working on their own initiatives?

Sure. So we value -- as Stephen mentioned earlier, we value all of our distribution outlets, and our great partnerships with a bunch of wholesalers are important to us. Our partnerships and relationships with key retailers is very important to us. And we work very carefully with customers that currently offer online sales programs. And those sales have been growing significantly for us with our online partners. We felt it was time to add true expertise and focus inside the company to how we drive that strategy going forward to support the shift in the market where consumers are shopping more and purchasing more online. So this will be a company-wide focus. The executives that we have hired have extensive experience in building and creating online sales. When I say company-wide, of course, I think most of you understand, there are certain regulatory constraints and issues which impact ammunition and firearm sales. So although we'll be looking at strengthening our product placement for firearms and ammunition, I think you'll see the biggest benefit of this spoke as being in outdoor products and accessories. And that's where, I think, you'll see the real improvements. And we will be looking, as we said, in terms of our strategy for online sales. It includes direct-to-consumer. It'll include improving our business to business sales and replenishments with our partners. It will include dropship capabilities where we can work with partners, so when consumers are going to their websites and purchasing our product, we can get that product directly to consumers quicker and capture that order quicker. So we'll be focusing on the dropship capability as well as working with our dot-com partners. So I think it's a very fulsome approach that we're laying out. I would encourage you to think of it in terms of the biggest impact will be continuing to drive growth in our 20% of sales which is already created in Outdoor Products from online sales.

And just following up on that, do you have a targeted percent that you would like to get to over a specific...

No, we're not going to release that yet. We are working through this process right now in targeting that. We have actually done some work. We think we know what good looks like. We can look at competitors, whether it be in other outdoor product, online sales and competitors, for example, in the cook area or other products like that. So we know about what good companies who have great e-commerce capabilities are able to generate as a percentage of revenue from online sales. We're working our own targets right now of what we think that could look like. But I think it's a substantial increase in outside for us in the future.

Our next question is from Andrew Burns with D.A. Davidson.

I have a couple of questions on the Shooting Sports gross margin. First, on the 4Q improvement, I understand that -- the commentary on the lower year-end sales programs, but curious about the favorable mix that was highlighted and if there's anything sustainable to call out there.

Nothing in particular that -- as we've regularly discussed, the mix in our ammunition business was both positive and negative quarter-to-quarter. As you know, we have a full range of products, not only with the split between our premium and more value-oriented brand, but also even within those families across different brands and product categories, the margins differ within those bands -- not terribly wide-range band -- but the band will differ. But there's also the impact within shooting sports of firearms. A lot of the mix shift benefit we've discussed as we've gone through the year has been the growth of firearms as well as ammunition. And some of what you're seeing in Q4 is relative weakness in ammunition compared to our firearms business, where there's been a slight benefit there. But nothing terribly material that one would expect to continue on a sustained basis.

And as you look on a longer-term basis at that segment gross margin, as you look at FY '19, there's a new Lake City contract, there's capacity coming online which should be more efficient in a normal market, the commodity cost inflation, a lot of moving parts. But as you roll all that up and look at what margin performance could be in a normal market, is it structurally similar to that high 20s gross margin performance that we saw in '16, '17? Or has it potentially structurally changed in any way?

Well, obviously, we can't guide forward into '19 and properly answer your question. But I think we are focused on margin improvement. We're focused on cost reduction and efficiencies. You talk about the additional capacity coming online, our tranche one investment in CapEx. That capacity begins to come online later this year. We'll see some benefits in efficiency from those new machines, as you described, so we're excited about that. But I think it's just -- we can't call '19. I think what we can say is that we're very focused on cash generation, getting back to our traditional cash conversion rates, which were very good for this company. We fully believe we will do that. And we're focused on margin improvement not only through manufacturing efficiencies, but also through our sourcing and supply chain efficiencies with our suppliers. We're very focused on that. I can tell you, we've been over in Asia about 6 times this year already working with the supply chain and making sure that we have an efficient supply chain and we're taking cost out. We've had good success there in our Outdoor Products segment. So we are very focused on margin improvement and look forward to being able to discuss with you the results of that as we go forward. But it's just too early to talk about '19.

We'll go next to Rommel Dionisio with Wunderlich Securities.

Maybe a big picture question for you, Mark. Over the years, you've sort of highlighted this focus on your retail customers and having that sales force call. They had the relationship with the customer and you market a variety of different products, which some you gained through acquisition, to those customers. So as the market shifts to online does that, in some way, negate the kind of corporate strategy -- or the general strategy you pursued these past several years? How do you sort of adapt to that online marketing going forward?

Sure, no, that's a very good question. We think that this is synergistic with our relationships that we already have with online partners and retail partners at brick-and-mortar stores. So if you look at a lot of our brick-and-mortar partners, where we have -- I'll just say, we have fantastic relationships with them, which allows us to capture some real opportunities and have strategies that supplement and support their strategy. That is always going to be a strength for us. I think when people talk about whether the shift to online shopping is somehow going to degrade our distribution strategy that we have, I do not believe that at all. I think that a lot of these retailers that have an online capability, they value our brands, they value the trust that we have, and they value the profits that we create for them with our brands, both in their online stores and in their brick-and-mortar stores. So we are leveraging those relationships to have more of our offering in their online presence. So we'll continue to do that. At the same time, we're working very closely with wholesalers. We have a very loyal following, lots of dealers across the country. I just attended a conference of dealers in Kansas City. We have our top 12 dealers from across the country. The feedback was incredibly positive. The relationships were incredibly loyal. The brands that we have and the value we create on the dealer network is important to us. There's about 10,000 dealers, which are still servicing this country with our products, and we value those relationships as well. So our focus on moving to online sales, as I mentioned, we're doing it, we think, in a holistic way. We're going to focus on dot-com. We're going to focus on strengthening our offering with our partners. We're going to focus on dropship so that we can have more products delivered more quickly to consumers that are shopping online. And we're also going to focus on dot-com and our own capabilities. So it's a holistic approach, and I don't believe that it will impede our relationships with our partners. And in fact, I actually believe it will enhance them. So we're excited about it, and we believe that we can walk and chew gum at the same time, so to speak, in supporting both brick-and-mortar and online sales growth.

We'll go next to Jim Chartier with Monness, Crespi and Hardt.

I want to talk about the Outdoor products gross margin down significantly this year, I think, largely due to some promotional pressures. And in your guidance for this year, it seems like the improvement is mostly due to cost savings that you've negotiated with vendors. So I'm curious, what do you think has happened with kind of pricing in that category at retail? Is it structurally lower and more promotional? Or as inventory is better aligned with demand later this year or into next year, do you think that there's a more gross margin opportunity from better pricing there?

Yes. Stephen can jump in if he'd like, but let me just start with that question. I think it's a great question in terms of what's happening in the market. I would tell you that right now, when we look at the market for Outdoor Products, there is still a lot of promotional activity there. There will be -- I think as we go forward, particularly in the next few months, there will be some pressures, I think, in terms of pricing in the market. That's why we work so hard on our cost structure. That's why we work so hard in our supply chain and the cost side of this model and cost of goods sold side of this model. We are also going to be driving our inventory balances down, as we mentioned, as part of reducing our working capital and increasing our cash flow. And we will need to do some of that through promotional activity. We understand that. We think as we work our way through these inventory reductions and as we compete in the marketplace to protect our market share and garner additional shelf space, that we'll be able to fight through that even though it is a promotional activity and offset some of that promotion with our cost reduction. And that's basically what we factored in to our plan and to our strategy going forward in terms of Outdoor Product margin. Anything you want to add, Stephen?

Yes. I would just add, look, the cost reductions in Outdoor Products are much more than just reducing the cost or the pricing we get from our suppliers. While that's important, there is substantial cost involved with operating the distribution capability and the product development and product management within the Outdoor Products segment. And we certainly have taken significant cost out of those parts of the business. So it's much more than just asking our suppliers for cost reductions. Particularly, as Mark mentioned earlier, those cost reductions we take on our side of the ledger, which are with our own folks and our own direct costs, we can make sure that those cost reductions stick. This is not a short-term impact, where we've just got some great pricing from our suppliers, which may or may not last for years to come. We know that the cost reductions we take within our cost structure, we can sustain.

The only other thing I would mention when we're talking about cost management is we believe we're never done. So we don't want to talk about cost management just in the past tense. It's future tense for us. So we'll be monitoring our cost. We'll be monitoring margins and revenue and what's happening in the business throughout this year. We have a plan to continue to take out cost going forward and initiatives that are in place right now in both segments to drive further improvements in efficiencies and cost reduction. So this is always a work of continuous improvement for us. So we've done a lot of work in the third and fourth quarter after the market turned, and we'll be doing a lot of work going forward this year to continue to make sure we get that right.

Great. And then, Stephen, just quickly, what's your assumption for incentive comp this year? I know it was down last year. Do you assume that, that is up in FY '18? Or is that flat or down?

Our standard approach entering every year is to assume that payout will be at the target level of performance. Obviously, we fell well short of that last year, and the vast majority of, certainly, management received no bonus for fiscal '17 -- or will receive no bonus for fiscal '17. So with fiscal '18, we've assumed a whole level of target. So a significant increase over what was in our results in fiscal '17. That is one of the significant -- from an SG&A perspective headwinds in our guidance because all of that bonus gets reflected there in the SG&A line.

It appears we have no further questions. Now let me turn the floor to Mark DeYoung for any closing comments.

Well, thank you all very much for joining us on the call. We look forward to talking with you at end of the first quarter. And we are excited about our business. We're excited about the long term for our business and are confident we can work through the current market challenges we face. So we'll update you here in a quarter. Thank you very much.

And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.