Smith & Wesson Holding Corporation — Q1 FY2015 Form 10-Q
Reporting period: Three months ended July 31, 2014; comparisons are with the three months ended July 31, 2013. The company manufactures firearms and related products. Financial amounts below are in U.S. dollars; millions unless stated otherwise.
Financial results
| Metric | Q1 FY2015 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $131.9 million | $171.0 million | Down 22.9% |
| Gross profit / margin | $49.1 million / 37.2% | $72.8 million / 42.6% | Profit down 32.5%; margin down 5.4 percentage points |
| Operating income / margin | $25.8 million / 19.5% | $48.0 million / 28.1% | Income down 46.3% |
| Income from continuing operations | $14.6 million | $26.5 million | Down 44.9% |
| Net income | $14.6 million | $26.5 million | Down 45.0% |
| Diluted EPS | $0.26 | $0.40 | Down $0.14 |
| Cash from operating activities | $10.8 million | $19.0 million | Down $8.2 million |
- Sales mix: Handguns were $103.1 million, down 3.2%; long guns were $16.7 million, down 67.2%, primarily reflecting weaker modern sporting rifle sales. Pricing contributed 0.5% to sales, while lower unit volumes reduced sales by 23.8%. New products accounted for 14.3% of sales.
- Margins and expenses: Lower sales of higher-margin modern sporting rifles, increased production spending and weaker fixed-cost absorption pressured gross margin. The company said these latter manufacturing factors reduced gross margin by 4.7 percentage points; three fewer production days reduced it by a further 1.5 points, partly offset by price increases and the TTPP acquisition. Operating expenses fell 5.7% to $23.3 million, largely due to lower incentive and profit-sharing costs.
- Cash and liquidity: Cash was $83.5 million at July 31, up from $68.9 million at April 30. Current assets were $263.3 million and current liabilities $85.6 million. Operating cash flow was lower year over year; inventory increased by $11.6 million during the quarter. Investing used $38.7 million, including the TTPP purchase and capital spending.
- Debt: Notes payable totaled $175.0 million at quarter-end. The company issued $75.0 million of 5.000% senior notes due 2018; it also had $100.0 million of 5.875% senior notes due 2017. The $75.0 million revolving facility had no borrowings outstanding. The company reported compliance with debt covenants and $1.1 million of outstanding letters of credit.
Material changes and significant events
- Management attributed the sales decline mainly to lower firearm-industry demand following the prior-year surge associated with consumer expectations of possible restrictive regulations. Long guns were most affected; concealed-carry pistols and revolvers continued to show demand, partly offset by weaker larger-frame polymer pistols.
- On May 5, 2014, the company acquired substantially all net assets of Tri Town Precision Plastics for $24.1 million. The acquisition was intended to bring key polymer-frame manufacturing capabilities in-house and increase supply-chain flexibility. The preliminary allocation included $14.0 million of goodwill and $990,000 of identifiable intangible assets.
- The company completed a $30.0 million share-repurchase program, buying approximately 2.1 million shares at an average $14.25 per share. Repurchases were funded with cash on hand.
- Interest expense fell to $2.0 million from $6.7 million, primarily because the prior-year quarter included bond-premium and debt-issuance write-off costs associated with retiring 9.5% senior notes.
Outlook, risks and contingencies
- The filing does not provide specific full-year sales or earnings guidance. Management expected approximately $35.0 million of FY2015 capital expenditures, compared with $53.3 million in FY2014, mainly for manufacturing flexibility, product tooling and information technology.
- Management believed existing capital resources and credit facilities would fund operations, debt and other commitments for the next 12 months, excluding major acquisitions. It cautioned that future financing might not be available on acceptable terms.
- On July 28, 2014, the company settled SEC civil FCPA charges without admitting or denying the allegations, agreed to pay $2.0 million, and accepted two years of SEC reporting obligations concerning FCPA compliance. The DOJ had previously closed its investigation without bringing FCPA charges.
- The company reported 10 product-liability cases and approximately eight additional claims, along with other litigation. It said it could not reasonably estimate possible losses from material adverse judgments and had not accrued for such judgments; defense-cost reserves were recorded. A derivative lawsuit was on appeal, with a decision not expected until 2015.
- An environmental reserve of $623,000 was recorded. TTPP’s former owner provided an indemnity, with $3.0 million placed in escrow, part of which may be used for remediation at the acquired site. The ultimate remediation costs and escrow use were not clear.
- Management identified lower firearm demand, manufacturing cost absorption, litigation, environmental obligations, and changing regulatory requirements as risks. The filing also states that quarterly results may not indicate full-year performance.
Important facts for investors to verify
- Whether firearm demand, particularly for modern sporting rifles and other long guns, stabilized or continued to weaken after the quarter.
- Whether gross margin recovered as production levels, product mix and fixed-cost absorption changed, and whether TTPP delivered the expected operating benefits.
- How the $175.0 million of senior notes, share repurchases and capital spending affected cash generation and covenant headroom.
- The eventual costs and outcomes of the SEC settlement, product-liability matters, derivative litigation and environmental remediation.
- Whether FY2015 capital expenditure expectations and management’s stated 12-month liquidity assessment remained achievable.