Business context and reporting period
Smith & Wesson Holding Corporation, a firearms manufacturer, filed this unaudited Form 10-Q for the quarter and nine months ended January 31, 2012 (fiscal 2012 Q3; filed March 8, 2012). Results are presented for continuing operations unless noted. The security solutions division is classified as discontinued operations following the October 2011 decision to divest it.
Financial performance and position
Amounts below are in millions of dollars except per-share data. Comparisons are with the corresponding period ended January 31, 2011.
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $98.1, up 23.8% | $282.2, up 17.3% |
| Gross profit / margin | $30.0 / 30.6%, versus $19.4 / 24.5% | $81.1 / 28.8%, versus $73.4 / 30.5% |
| Operating income from continuing operations | $10.3, versus a $1.9 loss | $19.2, versus $9.8 |
| Income from continuing operations | $5.4, versus a $2.7 loss; diluted EPS $0.08 versus $(0.05) | $8.6 versus $3.7; diluted EPS $0.13 versus $0.06 |
| Net income/(loss), including discontinued operations | $4.4 versus a $52.8 loss | $3.6 versus an $83.9 loss |
| Operating cash flow | $8.3, versus $0.2 for the prior nine-month period | |
| Investing / financing cash flow | $(10.2) / $(30.6) for the nine months |
Quarterly sales growth was led by modern sporting rifles (+163.7%) and handguns (+16.8%); hunting firearms fell 42.0%. For the nine months, modern sporting rifles rose 108.4% and handguns 19.9%, while hunting firearms fell 38.1% and Walther sales fell 11.3%. Backlog was $198.5 million at quarter-end, $124.7 million above the prior-year quarter.
At January 31, 2012, cash and cash equivalents were $25.7 million, including $3.3 million restricted; current assets were $161.5 million and current liabilities $69.2 million. Total liabilities were $136.8 million and equity $101.0 million. The company had $50.0 million of senior notes outstanding, a $3.4 million capital lease obligation, no convertible notes outstanding, and no borrowings against its $60 million revolving facility. The senior notes bear 9.5% interest and mature in 2016. The company reported compliance with debt covenants.
Material changes, outlook and risks
- Quarterly margin improved partly because prior-year results included price-repositioning and promotional costs, and because hunting-operation relocation costs declined. Nine-month margin nevertheless fell, reflecting Venture rifle recall costs, relocation-related expense and inefficiencies, higher depreciation, and increased employee and maintenance costs.
- Management attributed sales gains to strong handgun and modern sporting rifle demand and increased production capacity. Hunting sales were constrained by the Venture rifle recall and the move of hunting operations from Rochester, New Hampshire, to Springfield, Massachusetts, completed in November 2011. Walther sales faced lower-priced competition and a production hold on a high-volume product.
- Management expected fiscal 2012 capital expenditures of $18–20 million, including $3.4 million financed through a capital lease, and stated that existing resources and credit facilities should fund operations and commitments for the next 12 months. It expected no further plant-consolidation expenses in the remainder of fiscal 2012.
- The Venture rifle recall covered rifles manufactured since the product’s 2009 introduction. The company had incurred $0.324 million through January 31 and estimated $1.8 million of remaining recall cost, included in accrued warranty. Nine-month warranty expense was $4.2 million, versus $2.1 million a year earlier.
- The company could not estimate the timing or total costs of the security-solutions divestiture. That division recorded a $5.0 million nine-month net loss on $21.9 million of sales; prior-year losses were dominated by impairment charges.
- Risk matters include product-liability and shareholder litigation, a continuing SEC inquiry, and environmental remediation. The filing says additional reasonably possible litigation losses cannot be estimated; claimed product-liability amounts exceed accruals and, where applicable, insurance. Environmental reserves were $2.0 million. The DOJ dismissed indictments against remaining defendants, including a former company executive, in February 2012; the company itself was not charged in those indictments. The SEC inquiry remained open, with its outcome and timing uncertain.
- Cash declined by $32.5 million over the nine months, primarily reflecting $30.0 million spent to repurchase the remaining convertible notes. Operating cash flow improved, but capital spending and debt service remain important cash requirements.
Important facts for investors to verify
- Whether strong handgun and modern sporting rifle demand and the $198.5 million backlog convert to shipments and cash flow, and whether growth is concentrated in particular products or channels.
- Actual remaining Venture recall costs, warranty claims, and any effect on production, hunting sales, and margins.
- Progress, timing, proceeds, and potential costs of the security-solutions divestiture.
- Liquidity after planned capital expenditures, debt interest and repayments, and the terms and availability of the undrawn revolving credit facility.
- Developments in the SEC inquiry, product-liability and derivative litigation, and environmental remediation obligations.