Sturm, Ruger & Company, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 29, 2018. The company designs, manufactures, and sells firearms, primarily in the United States; firearms accounted for about 99% of sales and exports about 4%.
Key financial results
| Metric | Three months 2018 | Three months 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $114.9 million | $104.8 million | $374.5 million | $404.0 million |
| Gross profit / margin | $28.1 million / 24.4% | $30.2 million / 28.8% | $100.5 million / 26.8% | $120.9 million / 29.9% |
| Operating income | $12.0 million | $13.3 million | $49.9 million | $62.5 million |
| Net income | $9.2 million | $9.4 million | $38.7 million | $41.8 million |
| Diluted EPS | $0.52 | $0.53 | $2.19 | $2.32 |
| EBITDA (non-GAAP) | $20.5 million | $20.8 million | $75.8 million | $89.4 million |
For the nine months, operating cash flow was $95.6 million, versus $59.0 million a year earlier. Capital expenditures were $4.9 million versus $13.2 million; cash dividends paid were $15.5 million. Cash at September 29 was $137.8 million, up from $63.5 million at year-end 2017. Working capital was $152.6 million after the LIFO reserve, and the current ratio was 3.5 to 1. The company had no debt and its $40 million revolving credit facility was unused.
Changes and operating drivers
- Q3 sales rose 9.7% year over year, while nine-month sales fell 7.3%. Firearms sales rose 9.8% in Q3 but declined 7.5% year to date; firearms unit shipments increased 17.4% in Q3 and decreased 3.4% for nine months.
- Despite higher Q3 sales, gross margin declined 4.4 percentage points year over year. The company cited ASC 606 accounting changes, higher product costs as a percentage of sales, and inventory overhead-rate adjustments. ASC 606 moved certain promotional costs from selling expense into cost of products sold, reducing reported gross margin by approximately 3 percentage points in Q3 and 2 points year to date.
- Q3 selling, general and administrative expenses were $16.1 million, down 4.5%; nine-month expenses were $50.6 million, down 13.4%. Management attributed the decreases primarily to lower firearms promotional expense, in part reflecting the accounting reclassification.
- The effective tax rate fell to 24.5% for Q3 and 24.4% year to date, from 30.3% and 34.0%, respectively, primarily due to the lower federal tax rate. The tax reduction increased 2018 EPS by approximately $0.04 in Q3 and $0.29 year to date.
- Estimated distributor-to-retailer sell-through increased 1% for the first nine months, while adjusted NICS background checks fell 5%. Management attributed the company’s relative performance to demand for newer products. New products represented $112.7 million, or 30%, of nine-month firearm sales.
Outlook, risks and notable items
- No specific revenue or earnings guidance was provided. Management expected 2018 capital expenditures of approximately $10 million, mainly for new-product tooling and manufacturing upgrades, funded from operations and cash. Actual spending could vary.
- The board authorized a $0.21-per-share dividend payable November 30, 2018. Future dividends depend on performance, available cash and funding needs.
- Inventory quantities declined during the first nine months. If the reduction persists through year-end, a LIFO inventory liquidation could materially affect results for the period; management said the financial-position effect would not be material.
- In October 2018, the company issued a safety bulletin for certain Ruger American 9mm pistols and recorded a $1.0 million Q3 expense, its estimate of the total retrofit cost. The filing also describes existing product-liability, consumer class-action and municipal litigation; management did not consider a material adverse effect on financial position probable, but said litigation could materially affect results or cash flows in a particular period.
- Management warned that material-price increases, including potential tariff effects, or shortages of raw materials could interrupt manufacturing or adversely affect results. The company also self-insures significant portions of certain liability and other insurance exposures.
- ASC 606 adoption reduced opening retained earnings by $2.2 million and left a $5.9 million contract liability at quarter-end, which the company estimated would be recognized in Q4 2018. The filing also notes that a year-over-year comparison is affected by this accounting change.
Important facts for investors to verify
- Whether demand and distributor sell-through remain resilient amid weaker adjusted NICS checks, and how distributor and company inventory levels evolve.
- Whether gross margins stabilize, separating underlying production costs from ASC 606 presentation changes and inventory adjustments.
- Whether the estimated LIFO liquidation occurs at year-end and its effect on earnings.
- Actual costs and customer response to the Ruger American pistol retrofit, and developments in pending litigation.
- Capital spending, cash generation and dividend decisions, including any changes to the unused credit facility or share-repurchase authorization.