Smith & Wesson Holding Corporation — Form 10-Q
Reporting period: Quarter and six months ended October 31, 2012 (fiscal 2013). The filing presents the security solutions division as discontinued operations; continuing results principally reflect firearms and related products.
Financial performance
| Metric | Three months ended Oct. 31, 2012 | Six months ended Oct. 31, 2012 | Prior-year comparable |
|---|---|---|---|
| Net sales, continuing operations | $136.6 million | $272.6 million | $92.3 million and $184.0 million; increases of 48.0% and 48.1% |
| Gross profit / gross margin | $48.5 million / 35.5% | $99.8 million / 36.6% | $24.6 million / 26.7%; $51.1 million / 27.8% |
| Operating income / margin | $26.6 million / 19.5% | $57.9 million / 21.3% | $3.4 million / 3.7%; $9.0 million / 4.9% |
| Income from continuing operations | $16.4 million; diluted EPS $0.24 | $35.3 million; diluted EPS $0.53 | $0.9 million / $0.01; $3.2 million / $0.05 |
| Net income including discontinued operations | $21.2 million | $39.0 million | Net losses of $1.6 million and $0.8 million |
Reported net income included discontinued-operations income of $4.8 million for the quarter and $3.7 million for six months, primarily reflecting a tax benefit from the SWSS divestiture. Thus, net income was higher than continuing-operations income despite losses from discontinued operations before tax.
- Cash flow: Six-month operating cash flow was $13.8 million, versus $2.5 million used in the prior year. Investing used $8.3 million, including $15.8 million of property and equipment purchases and $7.5 million proceeds from the SWSS sale. Financing used $0.9 million. Cash increased $4.6 million to $61.3 million.
- Liquidity: Cash and cash equivalents were $61.3 million, including $3.3 million restricted. Current assets were $210.0 million and current liabilities $70.7 million. The company reported no borrowings on its $60.0 million revolving facility at October 31.
- Debt: $43.6 million of 9.5% Senior Notes remained outstanding after $6.4 million was repurchased during the six-month period. The company reported compliance with debt covenants. It also had capital-lease obligations with a $3.1 million present value.
Material changes and management commentary
- Sales growth was driven by higher demand and production for handguns—especially polymer pistols—and modern sporting rifles. Six-month modern sporting rifle sales rose 109.4%; handgun sales rose 37.2%. Hunting firearm sales also increased as output improved following relocation of production.
- Management attributed the gross-margin improvement to higher volumes and fixed-cost absorption, product mix, manufacturing efficiencies, favorable foreign-exchange price variances, and lower prior-year recall and plant-consolidation costs. Some current-period manufacturing variances were described as one-time benefits.
- Operating expenses were nearly flat for six months at $41.9 million, despite higher general and administrative costs, as selling and marketing and research and development spending declined. Lower legal and consulting expenses included reduced costs related to DOJ and SEC matters.
- The company completed the sale of its security solutions division to FutureNet on July 26, 2012 for a stated purchase price of $8.3 million, including a working-capital adjustment. It had received $7.5 million by October 31 and expected an additional $824,000 working-capital adjustment, subject to further adjustment.
- Backlog was $332.7 million at October 31, up $182.8 million year over year but down $59.7 million sequentially. Management cautioned that orders may be cancelled and backlog may not indicate future sales, particularly because demand exceeded manufacturing capacity.
Outlook, risks and unusual items
- Management expected fiscal 2013 capital expenditures of $35–$40 million, for capacity, production efficiency, tooling, manufacturing technology, and an ERP system scheduled for implementation in fiscal 2014. It believed cash and credit resources would fund operations and commitments for the next 12 months, assuming the planned stock repurchase and expected business conditions.
- In the third fiscal quarter, the board authorized repurchases of up to $20 million of common stock through June 30, 2013, subject to conditions.
- The company had an estimated $875,000 of remaining costs for the Thompson/Center Arms Venture rifle recall, included in accrued warranty. The filing warns that actual warranty claims and repair costs could exceed estimates.
- Risks include ongoing DOJ and SEC inquiries related to potential FCPA and securities-law matters; potential product-liability claims and litigation; environmental remediation obligations; and reliance on a limited number of suppliers for some components and materials. The company stated it was cooperating with authorities, but could not predict the investigations’ timing or outcomes.
- Environmental reserves were $2.1 million; the company noted remediation estimates and future regulatory costs remain uncertain. It also disclosed approximately 16 product-liability cases and about 10 other claims, while stating that it could not estimate a range of reasonably possible additional losses.
- Foreign-currency exposure remained under review. There were no forward contracts outstanding at October 31, 2012. The filing also identifies forward-looking statements as subject to risks and says actual results may differ materially.
Key facts for investors to verify
- Whether elevated firearm demand and backlog translated into shipped sales, and whether production capacity could keep pace without weakening margins.
- How much of the period’s margin gains came from recurring volume and efficiency improvements versus favorable currency effects, reduced prior-year costs, and one-time manufacturing benefits.
- Cash conversion and working-capital needs, particularly the buildup in inventory and receivables, alongside the planned $35–$40 million capital-spending program and up-to-$20 million buyback.
- Progress on the remaining SWSS sale proceeds and working-capital adjustment, and the financial effects of discontinued operations and the related tax benefit.
- Developments in DOJ/SEC inquiries, product-liability claims, environmental remediation, and the Venture rifle recall reserve.
- The filing reports six-month diluted EPS from continuing operations of $0.53 in its financial statements; MD&A separately states $0.52, an internal inconsistency to reconcile.