Smith & Wesson Holding Corporation — Q2 FY2014 Form 10-Q
Reporting period: Quarter and six months ended October 31, 2013. The quarter is the second quarter of fiscal 2014. Financial statements are unaudited. Unless noted otherwise, amounts below are in U.S. dollars.
Business context
The company manufactures firearms and related products, including handguns, long guns, handcuffs, and accessories. Its former security solutions division, SWSS, is reported as discontinued operations after its sale in July 2012.
Financial performance
| Metric | Three months ended Oct. 31, 2013 | Six months ended Oct. 31, 2013 | Comparable prior period |
|---|---|---|---|
| Net sales | $139.3 million | $310.3 million | $136.6 million / $272.6 million |
| Gross profit; gross margin | $57.9 million; 41.6% | $130.7 million; 42.1% | $48.5 million; 35.5% / $99.7 million; 36.6% |
| Operating income from continuing operations | $28.8 million; 20.7% of sales | $76.8 million; 24.7% of sales | $26.6 million; 19.5% / $57.9 million; 21.3% |
| Income from continuing operations | $17.1 million; diluted EPS $0.28 | $43.7 million; diluted EPS $0.69 | $16.4 million; $0.24 / $35.3 million; $0.53 |
| Net income, including discontinued operations | $17.0 million | $43.5 million | $21.2 million / $39.0 million |
| Operating cash flow | Not provided for the quarter alone | $24.0 million | $13.8 million for six months |
Quarterly sales grew 2.0%; six-month sales grew 13.9%. Excluding Walther sales, management reported increases of 9.2% and 22.7%, respectively. Handgun sales were a key contributor, rising 27.4% in the quarter and 34.7% for six months. Quarterly net income was below the prior-year quarter, which included a substantial tax benefit from discontinued operations; continuing-operations income increased.
For the six-month period, investing cash outflow was $26.1 million, principally reflecting $26.1 million of property and equipment purchases. Financing cash outflow was $45.4 million. Cash and cash equivalents declined from $100.5 million at April 30 to $52.9 million at October 31. Accounts receivable rose to $68.5 million from $46.1 million and inventory to $76.3 million from $63.0 million.
Debt, liquidity, and capital allocation
At October 31, notes payable were $100.8 million, including $100.0 million of 5.875% senior notes due 2017 and $0.8 million current portion. The company exchanged or retired its 9.5% notes during the period; the refinancing increased indebtedness by $56.4 million and annual debt service by $1.8 million. It recorded $4.3 million of interest expense and $795,000 of debt-issuance write-off costs related to the transaction. Interest expense for the six months was $8.7 million, versus $3.3 million in the prior-year period.
A $75 million unsecured revolving credit facility, expandable to $175 million subject to conditions and maturing in December 2016, had no borrowings outstanding. The company reported compliance with debt covenants. Management believed cash, credit facilities, and operating resources would fund operations and commitments for the next 12 months, excluding major acquisitions.
During the six months, the company spent approximately $100.0 million on share repurchases: $15.6 million through a tender offer and $84.4 million in open-market purchases. It had $15.0 million of authorization remaining. Management expected fiscal 2014 capital expenditures of approximately $60 million, compared with $41.4 million in fiscal 2013.
Material changes, outlook, and risks
- Margins and operating costs: Higher volume, favorable product mix, improved factory fixed-cost absorption, lower-margin Walther sales ending, and pricing changes supported gross-margin expansion. General and administrative expense increased 61.4% in the quarter, mainly due to ERP consulting and training, stock-based compensation, added staffing and incentives, and depreciation.
- Operational disruption and products: ERP implementation caused production losses and inefficiencies. Bolt-action rifle sales were constrained while the company addressed a Thompson/Center recall; ammunition constraints reduced sales of its rimfire M&P rifle. An August 2013 safety alert covered M&P Shield products manufactured before August 19, 2013. The company included estimated costs for the alert and rifle recalls in its warranty reserve.
- Outlook: Management cited strong consumer demand and planned capacity investment, but warned that results for the first six months may not indicate full-year results. The filing does not provide a specific full-year sales or earnings forecast. Management expected the effective tax rate to remain stable for the rest of fiscal 2014.
- Contingencies: The company disclosed ongoing DOJ and SEC inquiries related to possible FCPA and securities-law matters, derivative lawsuits, product-liability claims and litigation, and environmental remediation obligations. It stated that outcomes and potential additional losses could not be reliably predicted in certain matters. Supplier concentration and limited long-term supply contracts could disrupt production. Warranty and self-insurance estimates may prove inadequate.
- Other items: SWSS discontinued operations generated a $0.2 million loss for the six-month period; the prior-year period included a gain from a tax benefit. No impairment charges were recorded. Management reported disclosure controls effective at a reasonable assurance level and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether ERP-related production inefficiencies have been resolved and whether planned capacity spending converts into sustained shipments and margins.
- Progress, customer response, and final costs of the M&P Shield safety alert and Thompson/Center rifle recalls.
- Cash generation and working-capital trends, given the decline in cash and increases in receivables and inventory alongside substantial repurchases and capital spending.
- Debt-service capacity, covenant headroom, and the effect of the $100 million notes and remaining share-repurchase authorization.
- Developments in DOJ/SEC inquiries, litigation, and environmental matters, including any change in potential exposure or required reserves.