Sturm, Ruger & Company, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended April 1, 2017; comparisons are with the three months ended April 2, 2016. The company designs, manufactures, and sells firearms, primarily to U.S. wholesale distributors. Firearms accounted for approximately 99% of sales; exports were approximately 5%.
Financial results and position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total net sales | $167.4 million | $173.1 million | Down 3.3% |
| Gross profit / margin | $55.8 million / 33.3% | $59.1 million / 34.1% | Margin down 0.8 percentage points |
| Operating income | $33.9 million | $36.2 million | Down 6.4% |
| Net income | $22.2 million | $23.3 million | Down 4.5% |
| Diluted EPS | $1.21 | $1.21 | Unchanged |
| Operating cash flow | $18.9 million | $29.4 million | Down $10.5 million |
| Capital expenditures | $7.2 million | $6.3 million | Up $0.9 million |
Firearms sales were $166.4 million, down 3.0%; shipments rose 1.0%. Castings sales were $1.0 million, down 37.7%. EBITDA, a company-reported non-GAAP measure, was $43.6 million, down 2.7%.
At April 1, 2017, cash was $35.1 million, working capital was $92.8 million after the LIFO reserve, and the current ratio was 2.2 to 1. The company reported no debt. Its unused $40 million revolving credit facility was scheduled to expire June 15, 2017. Stockholders’ equity was $225.0 million.
Material changes and operating trends
- Estimated distributor-to-retailer sell-through declined 7% year over year; adjusted NICS background checks declined 11%. Management attributed softer demand to unusually strong 2016 demand around the U.S. election and retailer inventory commitments made ahead of it.
- New products, including Mark IV and LCP II pistols and the Precision Rifle, generated $41.5 million, or 25% of firearm sales.
- Firearm production increased 6% year over year. Company finished-goods inventory rose by 8,800 units during the quarter, while distributor inventory declined by 12,900 units. Ending backlog fell to $163.8 million from $276.1 million a year earlier.
- Gross margin declined primarily because of unfavorable product mix and higher underlying product costs as a percentage of sales. Lower promotional spending contributed to a 4.5% decrease in selling, general and administrative expenses. Favorable product-liability experience produced $0.2 million of income in Q1 2017, compared with $0.8 million of expense in Q1 2016.
- Operating cash flow fell largely due to inventory and receivables movements and other working-capital changes. Cash declined by $52.0 million, primarily reflecting $53.5 million of share repurchases and $7.8 million of dividends, partly offset by operating cash flow.
Outlook, risks, and contingencies
- No earnings or sales guidance was provided. Management expected approximately $40 million of 2017 capital expenditures for new-product tooling and manufacturing upgrades, funded with operating cash and existing cash; actual spending may vary significantly.
- On May 5, 2017, the board declared a $0.48-per-share dividend, payable May 31, and expanded the share-repurchase authorization to $100 million. During Q1, the company repurchased 1,074,285 shares for $53.5 million at an average $49.73 per share; $5.5 million of authorization remained at quarter-end before the subsequent expansion.
- Inventory quantities declined during Q1. If the reduction persists through year-end, a LIFO liquidation could materially affect results for the period, though management did not expect a material effect on financial position.
- The company reported four lawsuits and other claims, including two product-liability cases, patent litigation, and the City of Gary municipal case. Management believed the claims were unfounded and litigation was unlikely to materially adversely affect financial position, but could materially affect results in a particular period. A patent infringement claim was partially dismissed in February 2017, with alternate theories proceeding to discovery.
- Management cited risks including firearm demand and sales, raw-material availability and prices, litigation, potential firearms-control and environmental legislation, and the need for financing. The company self-insures significant portions of product liability, workers’ compensation, medical, and other risks.
- Management stated that disclosure controls were effective and that no material changes to internal control over financial reporting occurred during the quarter. No material changes to the prior annual-report risk factors were reported.
Important facts for investors to verify
- Whether firearm demand and distributor inventories stabilize, and whether the declining backlog translates into lower future shipments.
- How product mix, cost absorption, and any year-end LIFO liquidation affect gross margin and earnings.
- Whether planned capital spending, dividends, and repurchases remain supportable by cash generation, particularly as cash fell to $35.1 million.
- The renewal or replacement of the $40 million credit facility due to expire in June 2017.
- Developments in the patent, product-liability, and municipal litigation, including potential exposures not clearly quantifiable in the filing.