Smith & Wesson Brands, Inc. — Q3 FY2021 Form 10-Q
Reporting period: Three and nine months ended January 31, 2021. Dollar amounts below are in millions unless noted. Results are unaudited. The outdoor products and accessories business was spun off on August 24, 2020 and is reported as discontinued operations; continuing-operations comparisons are the most relevant measure of the remaining firearms business.
Financial performance
| Metric | Three months ended Jan. 31, 2021 | Prior-year quarter | Nine months ended Jan. 31, 2021 | Prior-year period |
|---|---|---|---|---|
| Net sales | $257.6 | $127.4 | $736.2 | $336.6 |
| Gross profit / margin | $109.7 / 42.6% | $35.7 / 28.0% | $303.2 / 41.2% | $103.6 / 30.8% |
| Operating income / margin | $80.4 / 31.2% | $8.8 / 6.9% | $203.5 / 27.6% | $19.3 / 5.7% |
| Income from continuing operations | $62.3 | $4.2 | $154.7 | $6.8 |
| Diluted EPS from continuing operations | $1.12 | $0.08 | $2.75 | $0.12 |
- Quarterly sales increased 102.2%; nine-month sales increased 118.7%. Handgun and long-gun revenue rose sharply, with long-gun revenue up 149.8% in the quarter and 203.0% year to date.
- Management attributed growth to elevated consumer demand, increased capacity and shipments, price increases, reduced promotional activity, and, for long guns, increased outdoor participation. New products represented 16.4% of quarterly sales and 14.7% of nine-month sales.
- Margin expansion reflected richer product mix, lower promotional spending, favorable fixed-cost absorption, and pricing. Increased manufacturing spending and recall-related expenses partly offset these gains; nine-month results also included unfavorable inventory valuation adjustments.
- Interest expense fell to $0.6 million for the quarter and $3.4 million for nine months, mainly due to lower revolving-credit borrowings. Effective tax rates were 22.9% and 23.4%, respectively.
Cash flow, balance sheet, and capital allocation
- Nine-month operating cash flow was $196.3 million, versus cash used of $24.8 million a year earlier. Investing used $19.7 million, including $18.4 million of capital expenditures. Financing used $241.9 million, principally reflecting $160.0 million of net debt repayments, a $50.0 million share repurchase, and a $25.0 million distribution to the spun-off business.
- Cash was $59.7 million at January 31, 2021, down from $125.0 million at April 30, 2020. Current assets were $223.5 million and current liabilities $116.4 million. Comparisons with April are affected by the spin-off.
- No revolving-line borrowings or notes and loans payable were reported at quarter-end. The company had a $100 million revolving facility, with a potential $50 million increase subject to conditions, and reported compliance with debt covenants. Finance lease liabilities totaled $40.1 million, largely related to the logistics facility; the facility is pledged as security.
- During the period, the company completed a $50 million repurchase of 2.74 million shares. Subsequent to quarter-end, the board authorized a further repurchase program of up to $100 million through March 1, 2022, and a $0.05-per-share quarterly dividend payable March 31, 2021.
Outlook, risks, and other notable matters
- No revenue or earnings guidance is provided. Management expected firearm inventory to remain relatively flat in the next fiscal quarter and forecast fiscal 2021 capital expenditures of $25–$30 million, primarily to expand manufacturing capacity. Management believed cash and available credit would fund operations and commitments for the next 12 months.
- Management cited demand uncertainty, COVID-19 and consumer behavior, possible firearm regulation, raw-material and component availability and costs, competition, order cancellations, and litigation among factors that could cause actual results to differ from expectations.
- Litigation includes product-liability matters, a Canadian proposed class action, claims related to the Poway shooting, a Gemini acquisition dispute seeking $18.6 million, and two AcuSport-related claims totaling $5.7 million. The company said it could not reasonably estimate potential additional losses for material adverse judgments and had not accrued for such judgments. The Sixth Circuit affirmed dismissal of the Primus case on February 8, 2021; other proceedings remain pending.
- Management reported disclosure controls effective as of January 31, 2021, but also disclosed an unremediated material weakness in internal control over financial reporting involving goodwill impairment accounting, first identified in connection with the April 30, 2020 year-end. Remediation controls were being designed and evaluated and had not yet been tested for sustained effectiveness.
- The spin-off reduced the balance sheet substantially and removed the former outdoor business from continuing results. Nine-month continuing results also included $6.0 million of separation expenses; discontinued operations contributed $8.3 million of net income, including pre-separation results.
Investor verification priorities
- Assess whether unusually strong firearms demand and margins are sustainable, and review shipment trends, channel inventory, pricing, and manufacturing capacity.
- Reconcile cash generation with debt repayments, repurchases, dividends, and planned capital spending; monitor liquidity and covenant headroom.
- Review the status and potential exposure of product-liability, class-action, acquisition, and bankruptcy-related litigation, noting that a loss range was not estimable.
- Track remediation and testing of the goodwill-impairment control weakness, separately from management’s conclusion that disclosure controls were effective.
- Review the effects and ongoing obligations of the AOUT separation, including transition services and the logistics-facility sublease.