Business context and reporting period
Smith & Wesson Holding Corporation filed this unaudited Form 10-Q for the three and six months ended October 31, 2016 (fiscal 2017 second quarter and first half). The company sells firearms and outdoor products and accessories. Results include Taylor Brands and Crimson Trace only from their acquisitions in August 2016.
Financial performance and liquidity
| Metric | Three months ended October 31, 2016 | Six months ended October 31, 2016 |
|---|---|---|
| Net sales | $233.5 million, up 63.0% | $440.5 million, up 51.4% |
| Gross profit / margin | $97.6 million / 41.8%, versus 39.2% | $185.2 million / 42.0%, versus 39.5% |
| Operating income / margin | $52.2 million / 22.3%, versus 15.2% | $104.7 million / 23.8%, versus 17.7% |
| Net income | $32.5 million, versus $12.5 million | $67.7 million, versus $26.9 million |
| Diluted EPS | $0.57, versus $0.22 | $1.18, versus $0.48 |
| Operating cash flow | $61.4 million for the six months, versus $22.8 million |
- Firearms sales rose 57.5% for the quarter and 52.5% for the half year. Outdoor Products & Accessories sales rose 97.9% and 43.9%, respectively; the acquisitions contributed $18.6 million in revenue.
- Cash was $73.9 million at October 31, down from $191.3 million at April 30. Investing used $196.7 million, including $178.1 million for Taylor Brands and Crimson Trace; financing provided $17.9 million.
- Current assets were $273.7 million and current liabilities $120.8 million. Notes payable had $194.6 million carrying value; disclosed principal included a $97.1 million term loan, $25.0 million revolver borrowing, and $75.0 million of 5.000% senior notes due 2018.
- The amended revolving facility provides $350 million of commitments, with an option for an additional $150 million, and matures October 27, 2021. The term loan’s effective rate was 3.06%; the company reported compliance with debt covenants.
Material changes and notable items
- Higher firearm demand, unit shipments and production volumes drove revenue and improved firearms gross margin through better fixed-cost absorption. Management attributed demand to market-share gains, new products and promotions, as well as increased consumer interest.
- Wholesale firearm inventory increased as the company built stock ahead of the holiday season and distributor shows.
- Outdoor Products & Accessories quarterly gross margin was 40.5%, down from 49.9%; the acquired businesses’ inventory fair-value step-up and backlog expense weighed on margins. The inventory step-up contributed about $3.0 million of cost and reduced total-company gross margin by 1.6 percentage points in the quarter and 0.9 points for the half year.
- General and administrative expense rose, reflecting acquisition costs, acquired-intangible amortization, higher management incentives, professional fees and profit-sharing expense. Acquisition-related costs totaled $3.2 million for the six months. Management said the acquisitions reduced diluted EPS by $0.09 for the quarter and $0.11 for the half year.
- Six-month interest expense fell to $4.2 million from $9.5 million, largely because the prior-year period included refinancing-related charges.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided. Management expected fiscal 2017 capital expenditures of approximately $50 million, mainly for manufacturing flexibility, product tooling and information-technology projects.
- Management believed existing cash, operating resources and credit facilities would fund operations, debt service and commitments for the next 12 months, excluding major acquisitions. The filing identifies working capital, capital spending, debt service and potential acquisitions as cash needs.
- On November 18, 2016, the company acquired substantially all net assets of Ultimate Survival Technologies for $32.3 million, subject to adjustments, with up to $2.0 million of contingent consideration. Purchase-price allocation was not complete.
- Risks cited include changes in firearm demand and consumer spending, regulation, political and news-driven demand, competition, order cancellations, acquisition integration, and legal and environmental matters. The company faced seven product-liability cases and five other claims; it could not estimate reasonably possible additional losses. It recorded a $0.7 million environmental reserve and said future remediation or regulatory costs could be uncertain.
Important facts for investors to verify
- Whether demand and elevated wholesaler inventory levels are sustainable, and how they affect future orders and production.
- Acquisition integration and returns, including final purchase-price allocations, goodwill and intangible-asset amortization, and UST’s contingent payment.
- Cash use, working-capital needs, planned capital expenditures and debt capacity after the acquisitions.
- Developments in product-liability litigation and environmental remediation; the filing provides no estimable range for possible additional litigation losses.
- The effects of acquisition-related purchase-accounting charges and other elevated expenses on ongoing margins and earnings.