Business context and reporting period
Smith & Wesson Holding Corporation reported its unaudited first quarter of fiscal 2014, the three months ended July 31, 2013. The company manufactures and sells firearms and related products. Its former Security Solutions division is presented as discontinued operations.
Financial performance and liquidity
Amounts are in millions of dollars except per-share data. Comparisons are with the three months ended July 31, 2012; balance-sheet comparisons are with April 30, 2013.
| Metric | Current period | Prior period / change |
|---|---|---|
| Net sales | $171.0 | $136.0; up 25.8% |
| Gross profit / margin | $72.8 / 42.6% | $51.2 / 37.7% |
| Operating income / margin | $48.0 / 28.1% | $31.3 / 23.0% |
| Income from continuing operations | $26.5 | $18.9 |
| Net income | $26.5 | $17.8 |
| Diluted EPS, continuing operations / net income | $0.40 / $0.40 | $0.28 / $0.27 |
| Operating cash flow | $19.0 | $9.3 |
| Capital expenditures | $12.0 | $6.3 |
| Cash and cash equivalents | $146.5, including $3.3 restricted | $100.5 at April 30, 2013 |
| Total debt notes payable | $101.3, including $1.3 current | $43.6 at April 30, 2013 |
| Current assets / current liabilities | $287.2 / $83.9 | $229.6 / $82.6 at April 30, 2013 |
Interest expense was $6.7 million versus $2.0 million, including $4.3 million of expense associated with the senior-note exchange and $0.8 million of debt-issuance write-off costs. The effective tax rate was 36.0%, compared with 36.5%. Cash increased by $46.0 million, reflecting operating cash generation and financing proceeds, partly offset by investment and share repurchases.
Material changes versus the prior comparable period
- Sales rose $35.0 million. Handgun sales increased 43.0% and long-gun sales increased 30.1%; Walther sales fell $10.2 million after the exclusive U.S. distribution agreement ended. Excluding Walther, management reported sales growth of 36.4%.
- Gross margin increased 4.9 percentage points. Management cited higher volumes, improved fixed-cost absorption and manufacturing efficiencies, the exit from lower-margin Walther distribution, and a new pricing and discount structure. Inventory reserve adjustments and volume-related spending partly offset these benefits.
- Operating expenses increased 24.2%, led by higher general and administrative costs, including stock-based compensation, profit-sharing and incentive accruals, and ERP implementation training.
- Net income from discontinued operations was a loss of $0.05 million, compared with a $1.1 million loss in the prior-year quarter. The prior period also included a loss on disposal; SWSS was sold in July 2012.
- The company repurchased 1.42 million shares through a tender offer for $15.6 million (reported cash outflow including fees was approximately $16.0 million).
Outlook, management commentary, risks and unusual items
- Management expected fiscal 2014 capital expenditures of approximately $50 million, mainly for capacity, production efficiency, new-product tooling, ERP implementation and manufacturing upgrades. It expected the tax rate to remain stable for the rest of the fiscal year.
- Management said existing capital resources and credit facilities were expected to fund operations, debt and other commitments for the next 12 months, excluding major acquisitions. This assessment considered the authorized share-repurchase program.
- In June 2013, the company issued $100 million of 5.875% senior notes due 2017 through an exchange and cash offering, retiring the remaining 9.5% notes. The transaction increased indebtedness by $56.4 million and annual debt service requirements by $1.8 million. The company reported compliance with debt covenants at July 31, 2013 and no borrowings on its then-existing $60 million revolver.
- On August 15, 2013, after quarter-end, the company entered into a new unsecured $75 million revolving facility, expandable in certain circumstances to $175 million, replacing the prior facility and extending availability to December 2016.
- After quarter-end, the company reported repurchasing an additional 1.82 million shares for $20 million through September 4, 2013. It had $64.4 million remaining under its $100 million authorization at that date.
- A safety alert issued August 22, 2013 covered M&P Shield products manufactured before August 19; estimated cost was $0.37 million and was included in accrued warranty. The company also disclosed a June 2013 recall of Thompson/Center bolt-action rifles and estimated $3.6 million of remaining costs for the recalls recorded in warranty accruals.
- Risks include unresolved DOJ and SEC inquiries relating to possible FCPA and securities-law issues; stockholder derivative suits; product-liability claims and litigation; environmental remediation obligations; and reliance on a limited number of suppliers, often without long-term contracts. The company said it could not estimate a range of reasonably possible additional litigation losses. Environmental reserves were $0.58 million.
- Forward-looking statements are subject to risks described in the company’s latest Form 10-K. Management cautioned that quarterly results may not indicate full-year results. Disclosure controls were assessed as effective at a reasonable assurance level.
Important facts for investors to verify
- Whether elevated firearm demand and production capacity can be sustained, and how sales mix and Walther’s exit affect future growth and margins.
- Actual fiscal 2014 capital spending and the returns from capacity, efficiency and ERP investments.
- Final costs and customer response to the M&P Shield safety alert and Thompson/Center recalls.
- Progress and potential financial, legal or business consequences of the DOJ and SEC inquiries, litigation and environmental matters.
- Debt-service effects of the note refinancing, terms and availability under the new revolver, and the pace and funding of further share repurchases.