Smith & Wesson Holding Corporation — Form 10-Q Summary
Reporting period: Three months ended July 31, 2015, the first quarter of fiscal 2016. The company manufactures firearms and, following its 2014 BTI acquisition, also sells hunting and shooting accessories. Financial amounts below are in U.S. dollars.
Financial performance
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net sales | $147.8 million | $131.9 million | +12.1% |
| Gross profit / margin | $58.9 million / 39.8% | $49.1 million / 37.2% | Margin +2.6 percentage points |
| Operating income / margin | $29.8 million / 20.2% | $25.7 million / 19.5% | +16.1% |
| Net income | $14.4 million | $14.6 million | -1.0% |
| Diluted earnings per share | $0.26 | $0.26 | No change |
| Operating cash flow | $16.6 million | $10.8 million | +$5.8 million |
Firearms sales rose 1.9% to $134.4 million; accessories contributed $13.3 million, or 9.0% of sales, with no comparable prior-year segment sales because BTI was acquired in December 2014. Firearms long-gun revenue increased 27.9%, while handgun revenue declined 2.8%. Total operating expenses rose 23.9% to $29.1 million.
Gross-margin improvement reflected higher production and better fixed-cost absorption, lower manufacturing spending relative to revenue, and the accessories business; increased promotional discounts partly offset these benefits. BTI contributed 1.1 percentage points to company gross margin. Net income was held back by higher interest expense and BTI-related intangible amortization.
Cash, liquidity and debt
- Cash and cash equivalents were $55.4 million at July 31, 2015, up from $42.2 million at April 30, 2015.
- Operating cash flow was $16.6 million; investing cash outflow was $7.2 million, including $7.9 million of property and equipment purchases. Financing provided $3.7 million.
- Current assets were $223.2 million and current liabilities were $89.1 million. Inventory increased to $90.1 million from $76.9 million at April 30.
- Notes payable had a reported carrying amount of $177.0 million, including $6.3 million current and $170.7 million long-term. The company also had $55.4 million cash.
- A new June 2020 credit facility includes a $175 million revolving line, with no borrowings outstanding at quarter-end, and a $105 million term loan. The term loan was used to redeem $100 million of 5.875% notes. Separately, $75 million of 5.000% senior notes due 2018 remained outstanding.
- A swap covering the $105 million term loan effectively fixed its rate at 3.31% as of July 31, subject to changes in the leverage-based margin. Letters of credit totaled $1.0 million. The company reported compliance with all debt covenants.
Material changes and unusual items
- Interest expense increased to $7.3 million from $2.0 million. It included a $2.9 million call premium and a $1.7 million write-off of unamortized issuance costs from redeeming the 5.875% notes.
- The company recorded $2.0 million of BTI-related intangible amortization in the quarter. The bond premium, debt-cost write-off and additional amortization together reduced diluted EPS by $0.08, net of tax, according to management.
- A $1.8 million insurance recovery for previously incurred defense costs was recorded in the quarter; the company said it received the proceeds after July 31. Management reported a $0.02 favorable EPS effect, net of tax.
- The board authorized up to $50 million of share repurchases through June 23, 2017; no shares had been repurchased under this authorization by July 31.
- BTI purchase-price allocation remained subject to measurement-period adjustments. Goodwill increased by $631,000 during the quarter, primarily due to revised estimates for acquired intangible assets.
Outlook, risks and contingencies
- Management expects approximately $50 million of fiscal 2016 capital expenditures, compared with $28.2 million in fiscal 2015, primarily for manufacturing flexibility, product tooling and information technology.
- Management believes cash, working capital and available credit will fund operations, debt service and other commitments for the next 12 months, excluding major acquisitions. The filing provides no specific revenue or earnings guidance.
- Management cited promotional pricing, reduced professional-channel shipments, delayed law-enforcement contracts and export licenses, and product mix as factors affecting sales. The professional channel was down 31.7%; management attributed shipment declines to contract delays and delayed export licenses for Canada and Thailand.
- The company was defending seven product-liability cases and was aware of approximately eight additional claims, as well as a long-running lawsuit brought by the city of Gary, Indiana. It said it could not reasonably estimate the range of possible losses for material adverse judgments; it had accrued defense costs and stated that an estimate of additional losses could not be made.
- An environmental reserve of $675,000 was recorded. A $1.4 million portion of acquisition escrow remained available for potential remediation at the acquired Deep River site; the company said it believed costs exceeding the available escrow were remote. It also noted environmental obligations could change and may not be insured.
- Management identified business, legal, environmental, acquisition-integration, liquidity and market risks, and referred investors to the risk factors in its fiscal 2015 Form 10-K. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- How much of sales growth and improved margin is attributable to the BTI acquisition versus underlying organic performance.
- Whether firearms demand, promotional pricing and professional-channel delays persist, and how they affect average selling prices and margins.
- The ongoing earnings and cash-flow effects of the refinancing, remaining debt, interest-rate swap and debt covenants.
- Whether the planned $50 million of capital expenditures and rising inventory are supported by operating cash generation.
- Developments in product-liability matters, environmental remediation and the final valuation of acquired assets and goodwill.