Byrna Technologies, Inc.

Greetings and welcome to the Berna Technologies Fiscal Third Quarter 2022 Earnings Conference Call and Webcast. As a reminder, this conference call is being recorded and all participants are in a listen-only mode. Before turning the call over to Brian Ganz, Berna Technologies Chief Executive Officer, I will read the Safe Harbor Statement. Some discussions made today may include forward-looking statements. Actual results could differ materially from the statements made today. Please refer to Berna's most recent 10-K and 10-Q filings for a more complete description of risk factors that could affect these projections and assumptions. The company assumes no obligations to update forward-looking statements as a result of new information, future events, or otherwise. As this call will include references to non-GAAP results, please see the press release in the Investors Select investor section of our website, ir.berna.com, for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results. I'll now turn the call over to Mr. Brian Gant. Sir, please go ahead.

Thank you very much. Good morning, everyone, and thank you for joining us for BERNA's fiscal year 2022 third quarter earnings call. As usual, David North will be discussing our financial results, after which time I will provide some additional color on the quarter and discuss recent events. I'd like to start by turning the call over to David so he can discuss our third quarter financial performance. David and I will be taking questions at the conclusion of the presentation. David?

Thanks, Brian, and thanks, everyone, for joining us today. Let's start with a walk down the third quarter's income statements. Third quarter revenues came in at $12.4 million, an increase of 43% over revenues of 8.7 million in the third quarter of 2021. Revenues were also up 0.8 million from the second quarter of this year, making this the third consecutive quarter of revenue growth in 2022. We ended the quarter with $1.7 million of unshipped orders, all of which we expect to ship this quarter. Berna's gross profit margin was 55.4% after $0.2 million of charges for inventory reserves and another $0.2 million of unfavorable manufacturing variances. Our move of our manufacturing operations into our larger new greenfield facility in Fort Wayne, Indiana went well and we're back up running smoothly and experiencing higher levels of both efficiency and quality in this larger, more efficient facility. Nevertheless, some minor startup inefficiencies are inevitable in such a move, and the unfavorable manufacturing variances were a result of those. Gross margin was favorably affected by a variance of about $0.1 million as a result of receiving our first raw material shipments by ocean freight. And we anticipate further margin benefits as we transition more of our incoming shipments to ocean freight from the far more expensive air freight shipments that the company's been relying on for the past two years. The reason we're now in a position to transition to ocean freight is that we've built up adequate inventory levels so we can wait the 60 days or more that it takes to sail a container across the Pacific. The increase in levels of both finished goods and raw materials should significantly reduce the risk of any unforeseen supply chain disruptions. Operating expenses were $8.3 million in the third quarter, which is up from $6.7 million for the same period one year ago, but is relatively flat in comparison with the past three fiscal quarters. Our non-GAAP adjusted EBITDA measure, which we use as an estimate of cash flow from ongoing operations, was a positive $0.3 million in the third quarter compared to a loss of $0.8 million for the third quarter of fiscal 2021. Now let's take a look at the balance sheet. Despite our positive adjusted EBITDA, cash dropped $1.4 million from $25.9 million at the end of the second quarter to $24.5 million at the end of the third quarter of 2022. That's because inventory increased by $1.9 million from $13.5 million at the end of the second quarter to $15.4 million. As I've explained, we've built inventory during the third quarter to allow for less expensive but slower ocean freight We've also built inventory levels in anticipation of the traditionally very strong fourth quarter. We expect to see a reduction in inventory levels by year-end as a result of the expected surge in holiday sales during the fourth quarter. Total assets were up $1.2 million from the end of the second quarter to $58 million. At the same time, total liabilities were down $0.4 million with an increase in shareholders' equity of $1.6 million in comparison to the end of the previous quarter. The company continues to have no current or long-term debt. Now I'll hand it back over to Brian.

Thank you very much, David. Financial results for this third quarter demonstrate continuing improvement on both top and bottom lines. The company posted its third consecutive quarter of top-line growth. And excluding the second quarter of last year, which included $8 million of incremental sales from an unexpected endorsement from Sean Hannity, this quarter's sales of $12.4 million set a new record. Moreover, it marked an important inflection point for the company, as burnout was profitable on an adjusted EBITDA basis. The improving profitability is due to improving operating leverage. As David pointed out, sales grew by 43%, while OpEx grew by only 24%. Berna expects to see further improvements in the fourth quarter of this year. We've issued revenue guidance of 16 to 18 million for the quarter. This would be a new record for the company without any exception, and compared to the same period of last year, would represent 52% growth at the midpoint of the range. With operating expenses expected to be in line with the run rate of the last four quarters, We expect further improvement in all measures of profitability in the fourth quarter. We expect to see continued top line growth in 2023 as Berna continues to benefit from growing brand awareness. We can see evidence of increased consumer awareness in our web traffic numbers. For the first nine months of this year, 2022, Berna registered 5.7 million web sessions on Berna.com and another 2.3 million on Amazon.com for a total of 8 million web sessions. This compares to 4.2 million total web sessions during the same period of last year. In particular, in fiscal year 2023, we expect to see continued growth in Amazon sales as we're seeing momentum build in that channel. We also expect to see significant growth in sales of aerosol products under the Fox Labs and Burn a Bad Guy repellent labels, as we have only had these products for sale during the second half of 2022. Moreover, these price point products may prove to be particularly strong sellers during what we perceive to be more difficult economic times in 2023. Along the same lines, we expect sales of the launcher products acquired with the Mission Less Lethal Acquisition, specifically the TCR and the M4, to add to 2023 sales as they also were not available for the full year of 2022. Finally, we plan to introduce the 12-gauge ammunition and the Berna LE launcher within the next several months and and these products should have a material impact on 2023 sales. Despite our expectations for a strong fourth quarter and for continued growth through next year, the economy is clearly softening, and whether we experience a soft landing or a recession in 2023, we do expect that the headwinds will negatively impact the demand for discretionary consumer products such as the Berna SD Launcher. As a result, we do not expect to see continued 40% to 50% growth in 2023 as we have seen these last several quarters, and we have accordingly tempered our expectations. We are expecting more temperate growth in 2023 with revenues growing by 10% to 30% rather than the 40% to 50% year-over-year growth we've seen recently. Given our expectations of more difficult economic environments in 2023, Berna is in the process of trimming operating costs. Our goal is to reduce operating expenses by 5% year over year, excluding such variable expenses as credit card fees and so forth. And as part of this process, we will be deemphasizing less productive areas of the business. This past year, Berna embarked on a number of initiatives designed to drive growth. Some, like the Fox Labs acquisition and the Mission Less Lethal acquisition, have been extremely successful, resulting in annual sales that will be a multiple of the purchase price with little incremental overhead. Others, like the Ballista Packs acquisition, which formed the basis of our school safety program, have been less successful despite our best efforts and our sincere belief in the project, as high overhead costs associated with this program and slow sales have resulted in poor ROI. Accordingly, Burna will be shutting down its school safety initiative, although we will continue to offer the school safety products, specifically the Burna Shield and Burna Ballista Pack, online and through our dealer network. This should result in an annual savings of more than $600,000. In conjunction with other planned cuts, Burna intends to reduce its operating expense budget by more than $1.6 million in 2023. As we are now cash flow positive from the perspective of adjusted EBITDA, and we have no acquisitions planned, we should have more than adequate cash on hand to fund operations for the foreseeable future. We do not believe that the market is valuing Burna's stock appropriately, and accordingly, we plan to reinstitute our previously approved stock buyback program. In conclusion, we've made excellent progress so far this year in terms of both growing the top line and controlling expenses. We believe we've reached the point in terms of operating leverage that will allow us to consistently generate positive cash flow with strong year-over-year revenue growth. Now I'd like to turn it back to the operator, and we'll be happy to take questions from our analysts. Thank you.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for your questions. Our first questions come from the line of Jeff Van Sinderen with B. Reilly. Please proceed with your questions.

Good morning, everyone. Just wanted to start with a couple of things on the P&L. Maybe thoughts on expectations for gross margin for Q4. and maybe outlook there directionally for next year. And then just wanted to follow up also on SG&A. I realize you're, I think you said 1.6 million was what you were planning to reduce SG&A by for next year. But any other color you have in terms of how we should be modeling SG&A for Q4 next year?

Yeah, I'm going to discuss the margins and I'll turn it over to David for the SG&A part of your question. We expect margins to dip slightly in Q4 as a result of the holiday specials that we will be offering. We saw this last year, and we expect it to impact one or two margin points. We do expect there to be a continuing upward trend. As David pointed out, We benefited from a $100,000 favorable freight variance in Q3, and that was the result of a single shipment of components coming in from Malaysia by ocean freight rather than air freight. As we start to put more and more of the components and ammunition on the water, we expect that to have a continuing positive impact on margins. So next year we expect our average margin to be several percentage points higher than it is this year. David, can you address the SG&A issue? Would you repeat the exact question, please?

Yeah, sure. I'm just, you know, was just trying to get a sense of how you're thinking about operating expenses for Q4 next year. Realize that you're making some cuts and I think you pointed out 1.6 million or so for next year. Just trying to get a sense of, you know, how we should or how you're thinking about that 1.6 or whatever that total is for next year.

Sure. So, I mean, you know, a year ago, a little more than a year ago, we had a very successful public issue. And we had quite a lot of funding and we – said that we would invest a lot of that in working capital and in growing the business, and we did. And so we've gone through a phase of spending on seeing what would work here and there. Brian mentioned the school safety program and so on. And what we've done now is, as part of the annual budget preparation process, senior management has gone through very carefully, line by line, to look at what of these investments are performing and what aren't. Brian mentioned one example, as I said, was with school safety, but we've gone much more down into detail than that. Specifically, you know, one of the places where we really ramped up spending was marketing spend. And we have said that we would look at that and we would analyze return on advertising dollars to decide what was working and what wasn't. And so as part of this review, we've gone through in detail exactly where we're spending, and the result is that we've found this $1.6 million worth of detailed expenditures that we think can be eliminated because they aren't returning or because we can be more efficient. So it's really been that kind of a detailed review of the whole organization.

And I would add that I feel strongly that we've not cut into muscle or bone. We've identified, as David said, $1.6 million of expenses that we really felt we were not getting, you know, any significant return on investments. And we were able to remove those, I think, without having any negative impact on the growth prospects.

Yeah, I was just saying to Brian yesterday, a lot of my background is in – more mature industrial manufacturing, and I'm used to going through this process on a regular basis, but I'm used to it being a lot more difficult, I think, because in a more mature company, you've done it so many times that it's very difficult to find, you know, more marginal success in this sort of thing, but Berna's a very young company, so it's, you know, it was quite a productive exercise to go through and find these efficiencies.

Okay, fair enough. That's helpful. And then just as a follow-up to that, given that broadly speaking, let's say the more affluent consumer generally seems to be holding up better than the lower-end consumer, how are you thinking about that phenomenon as it relates to your product line? And then I guess thoughts on evolving marketing to go after maybe more that high-end consumer. I know you mentioned the aerosols as being perhaps more accessible.

Yeah, look, I think that... You're correct. We're seeing auto sales start to fall off except in the luxury segment of the market. It is clear that the high-end consumer is not being affected to the same extent as the average Joe. Our product is a relatively high-end product. We think our demographic is a relatively wealthy demographic. As we start planning our marketing push for next year, we will be focusing on demographics that are wealthier. So we're going to be targeting RV owners. We're going to be targeting boat owners. We're going to be targeting business owners, people that own liquor stores and convenience stores. So we're very cognizant of the fact that, in the infamous words of John Dillinger as to why he robs banks, because that's where the money is, we are going after the market where the money is, and that is the wealthier consumer.

Okay, thanks. And then if I could just squeeze one more in here and I'll turn it over. Just anything you could tell us about the response to the bad guy repellent launch in the dealer channel and then on Amazon and Walmart?

The bad guy repellent launch has been very well received. We started off with just the Fox Labs brand, and we are continuing to offer the Fox Labs brand today. because it's so well known in law enforcement, what we're beginning to see is sales of bad guy repellent are starting to eclipse sales of the Fox Labs spray. So we think we're just at the very, very early stages of this. These aerosol markets are very, very large markets, well in excess of $100 million domestically. And we think we can take a significant share of that market.

Okay. Thanks very much. I'll jump back in the queue.

Thank you. Our next question has come from the line of Jim Mappery with Dawson James. Please proceed with your questions.

Thank you. Good morning. Can you talk about what needs to be to be done in order to get the LE and the 12-gauge launch? What are the final steps on getting that to the market?

The LE is in testing right now. We've done our first engineering build. We're now in a pre-production build. As you can imagine, with products like the Burna, we have to – ensure the safety of our consumers and there's a lot of testing that goes into it. But we are extremely pleased with the Berna LE. We think that consumers and law enforcement will find it to be significantly improved from the SD in terms of both the speed of the rounds, the feel of the launcher, the trigger pull is significantly lighter. In terms of its operating range, it will be able to operate at very cold temperatures. But it does require a lot of testing. So we would expect this to go into serial production. I think we're scheduled for November 15th for it to go into serial production. And between now and then, we're just going to be doing a significant amount of testing of the products. The 12-gauge, we are... We were forced to pivot a little bit on the 12-gauge because of the inavailability of 12-gauge hulls. So we had originally designed the product to work in a standard hull, like a Fiocchi hull, and because of the shortage of ammunition, these hulls are not readily available. We've pivoted to producing this in a plastic injection molded hull. We think over the long run this is a much better solution for two reasons. One, it differentiates the product. It will not look like a normal 12-gauge round, so it will never be confused for a normal 12-gauge round. And I think one of the risks with a less lethal 12-gauge round is that people might think they're using less lethal and instead put a lethal round in their shotgun. So by going with a plastic injection molded hull, we will be able to get away from that risk. Secondly, we're able to control our own destiny. So right now, you know, this was a good wake-up call when we were unable to get, you know, the number of hulls we wanted. We were able to secure hulls in the tens of thousands when we need them in the hundreds of thousands or, frankly, millions of hulls. So by going with the plastic injection molded hull, we'll be able to control our own destiny. And we do have a lot of experience with plastic injection molded hulls, because if you remember, the genesis of this business was the 40 millimeter business, and we use a plastic injection molded hull for that. So that put us back a little bit, but we do expect to be in production later this quarter. We are going to have an official kickoff at SHOT Show in Las Vegas the week of January 20th. We'll be introducing the 12-gauge at range day. So we'll be able to allow people to fire these rounds. And I think, you know, we expect it to be extremely well received.

Great. Thank you. And then I was a little bit confused about your answer to the questions on COVID. gross margin in Q4. I was uncertain as to whether or not you were talking about the total gross margin being impacted by one or 200 basis points, or if there was just an aspect of gross margins that was getting impacted from incentives in Q4. Can you clarify that for me, please?

Yeah, we think the total gross margin will be negatively impacted by one or 200 basis points. Keep in mind that we will be offering large specials. We've got the second Amazon Prime Day coming up in a couple of days. And in order to participate in Amazon Prime Day, we need to give a 20% discount. We will be giving relatively significant discounts on our own website for our Black Friday sales and Cyber Monday sales. And of course, we also then have to give if not the exact same discount, somewhat commensurate discounts to our dealers when we drop below our MAP pricing and we create a MAP holiday. So for Q4, we do expect overall margins to decline by one or 200 basis points. That said, we expect to see sales volumes increase pretty substantially.

Right. And that decline is measured against Q3 or it's measured against the prior year? No, measured against Q3. Fantastic. All right. Thanks a lot, guys. That's all for me. Thanks, Jim.

Thank you. Our next questions come from the line of Jeff Van Sinderen with B. Reilly. Please proceed with your questions.

Thanks. Just a quick couple of follow-ups here. What were the inventory reserves taken in Q3? I think you mentioned inventory reserves.

Yeah, there were various things. About half of it was South Africa really went through all their inventories and did a cleanup so that we would avoid that kind of a thing in Q4 where it's happened in the past. We put a small reserve on inventory in transit to Amazon, where there are some things that we can't quite reconcile it, but that's maybe $40,000. We also put a reserve in for certain product that we intend to send to customers who have already purchased things. Some of the first shipments of our seven-round mag had some slight problems in them, so we sent out some merchandise to those customers, and that was part of it as well. So a bunch of small things.

Okay. And then I wanted to just turn to international for a moment if we could, if you could speak more about the opportunities you're seeing internationally.

The international opportunities are starting to really – take off over the last several quarters, as you've seen in our results. The international market for Burna is somewhat different than the domestic market. Domestically, we are very, very significantly focused on the consumer market. Internationally, law enforcement is a much bigger channel for us. We did have a sale in Q2 of over a million dollars that went to the Indonesia Federal Police. We are talking to a number of other large police agencies right now. We expect to see those sales go through in Q4. And as we've announced, we have a cooperation with one of the two gun companies in South America, Bursa. They think that because of the restrictions on owning firearms in Argentina and throughout South America, frankly, that the Burna will be a really attractive product. So we expect to see continued growth. The one caveat of continued growth internationally is that our margins are lower. So we project our margins for... sales into South Africa at only 40%, and our margins generally for international at 50%. So we expect to see a relatively rapid growth next year in international sales, albeit at somewhat lower margins.

Okay. Thanks for taking my questions, and best of luck. Thank you very much.

Thank you. Our next question has come from the line of Jim Apparee with Dawson James. Please proceed with your questions.

Thanks again. You talk about gross margins improving because of your shift to ocean freight, and there's been recent stories about significant declines in ocean freight costs. I'm wondering if the margin projections that you've talked about include that significant reduction in ocean freight recently, or if that could be an even larger improvement than what you're suggesting?

We are not building in the significant reduction in ocean freight costs because we are not currently shipping by ocean freight. So ocean freight, even at its peak, even with these crazy ocean freight rates, was a fraction of the air freight rate. And because we've sort of been operating behind the eight ball from the day we sold the first Berna, and we've been in short supply, we've been shipping everything into our factories by air freight, and we've been shipping everything out of our factories by air freight. So to give you a very quick example, our landed costs for a kinetic round is 700% higher than our FOB cost. So if you think about that for a second, we have the opportunity to save about 600% of our cost, our landed cost, by transitioning the shipment of these kinetic rounds to ocean freight. So we do see a significant improvement in bottom line. How much is somewhat difficult to quantify. I think the bigger issue for us is not what is the rate of ocean freight, but rather what is the availability of ocean freight. So as David spoke about in the earlier part of this discussion, he said that we built up inventory so that we could deal with a 60-day delay of containers coming across the water. But right now, a lot of what we're faced with is the inability to find containers. I think as the economy softens a little bit and containers free up, that will be more meaningful to us in terms of reducing our cost of freight than the actual ocean freight rates.

Yeah, so you asked how much is built into the estimates that we just discussed for the fourth quarter, and the answer is what's built in is what we expect to happen, but what we expect to happen is only a little bit of the potential that's still out there. In other words, we're starting to experience this, but getting everything on the water and getting all the potential that we can out of it, it's slow going.

Yeah, that's going to take most of next year to transition everything to ocean freight. And so we... So we expect next year to see improving margins quarter by quarter.

And so would it be fair to say that most of the shipments right now are air freight and most of the shipments by the end of next year will be ocean freight? And so we have – is a good estimate linear? So I said in this third quarter we saw –

the very beginnings of favorable impact from ocean freight. We got our first... One shipment. Yeah, our first one container shipment from the Far East in this quarter. And we haven't even really started working on ammo. We've just started measuring the potential for what that will be. And as Brian said, for getting all the stuff that is coming from the Far East, either resourced into the United States or securing containers and ships and getting them to leave China, that's going to take a long time. And then over the course of next year, we do expect to see improving margins, mainly because of this. But we also are seeing that that potential, that great potential for international sales is going to cause a slight shift in our sales mix to those lower margin international sales. So we'll be putting all of that together as we budget next year. The net of it, though, we have run through the budget numbers already at first pass. The net of it is that we expect moderately improving gross margin percentages.

All right. Very good. Thank you.

Thank you. There are no further questions at this time. I would now like to turn the call back over to Brian Gantz for any closing comments.

Thank you, Darrell. I just would like to thank everybody for joining us this morning. And as always, you know, we are open to speaking with the analysts whenever they'd like to set up a call. Thank you very much and have a good day.

This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.