Business context and reporting period
Smith & Wesson Holding Corporation’s Form 10-Q covers the third quarter and first nine months of fiscal 2015, ended January 31, 2015. The company manufactures firearms and related products and, following its December 11, 2014 acquisition of Battenfeld Technologies (BTI), shooting and hunting accessories. Figures below are in millions of dollars except per-share data.
Financial performance and liquidity
| Metric | Three months ended Jan. 31, 2015 | Prior year | Nine months ended Jan. 31, 2015 | Prior year |
|---|---|---|---|---|
| Net sales | $130.6 | $145.9 | $370.9 | $456.2 |
| Gross profit / margin | $43.8 / 33.6% | $58.7 / 40.2% | $127.8 / 34.5% | $189.4 / 41.5% |
| Operating income / margin | $15.7 / 12.0% | $31.1 / 21.3% | $52.3 / 14.1% | $107.9 / 23.7% |
| Income from continuing operations | $8.2 | $20.1 | $27.9 | $63.7 |
| Net income | $8.1 | $20.8 | $27.7 | $64.2 |
| Diluted EPS from continuing operations | $0.15 | $0.35 | $0.50 | $1.03 |
- For the nine months, operating cash flow was $29.9, down from $54.2. Investing cash use was $182.6, principally reflecting acquisitions and $24.2 of capital spending. Financing provided $142.9, including $100.0 of revolver borrowings and $75.0 from senior notes issuance. Cash fell $9.9 to $59.0.
- At January 31, cash was $59.0; current assets were $242.9 and current liabilities $59.2. Notes payable were $275.0, versus $100.0 at April 30, 2014; stockholders’ equity was $169.6.
- Debt included $100.0 drawn on the $125.0 unsecured revolving facility, $100.0 of 5.875% senior notes due 2017 and $75.0 of 5.000% senior notes due 2018. The revolver matures in December 2016. The company reported compliance with debt covenants; $1.1 of letters of credit was outstanding.
Material changes versus the prior comparable periods
- Third-quarter sales decreased 10.5%; nine-month sales decreased 18.7%. Firearm division sales declined 14.7% for the quarter and 20.0% year to date. Nine-month long-gun sales fell 54.4% and handgun sales fell 8.1%.
- Management attributed weaker firearm results to lower consumer demand, distributor and retailer inventory overhang, and the prior-year demand surge. For the quarter, firearm unit volumes reduced sales by 16.2%, partly offset by price increases.
- Gross margin contracted 6.6 percentage points in the quarter and 7.0 points year to date. Management cited product mix, promotions, higher spending relative to sales and unfavorable fixed-cost absorption.
- Operating income fell 49.6% in the quarter and 51.5% year to date. Nine-month interest expense declined to $8.1 from $10.5, mainly because prior-year expense included costs associated with retiring higher-rate debt; quarterly interest expense rose to $3.2 from $1.8 after new borrowing and note issuance.
Outlook, management commentary, risks and unusual items
- The company expected fiscal 2015 capital expenditures of approximately $34.0, down from $53.3 in fiscal 2014. Management said existing capital resources and credit facilities should fund operations, debt service and other commitments for the next 12 months, excluding major acquisitions. No earnings or revenue forecast is provided in the filing text.
- BTI was acquired for approximately $134.3, including a working-capital adjustment; Hooyman assets were acquired for $1.9. The preliminary BTI allocation included $73.6 of intangibles and $62.1 of goodwill and remained subject to measurement-period adjustments. BTI contributed $6.1 of reported sales after acquisition. Its segment reported a $2.0 operating loss, including inventory fair-value step-up and intangible amortization; corporate overhead was temporarily included in the firearm segment.
- BTI-related inventory step-up, acquisition costs and amortization reduced quarterly continuing-operations EPS by a combined $0.05, according to management. The nine-month impact was $0.06 per share. TTPP, acquired in May 2014 for $23.8, vertically integrated a key polymer-component supplier.
- The company completed a $30.0 share-repurchase program, buying 2.1 million shares. It reported an environmental reserve of $0.623 and product-liability defense reserves, but said it could not reasonably estimate possible material adverse judgments. A $3.0 TTPP escrow covers certain potential environmental obligations; the ultimate costs were not clear.
- The company reported eight product-liability cases and approximately eight additional claims. It settled SEC civil FCPA-related charges in July 2014 for $2.0, without admitting or denying the allegations, and agreed to two years of compliance reporting. The DOJ had closed its investigation without charges. A derivative lawsuit dismissal was upheld on appeal in February 2015.
- Key business risks include continued excess channel inventory and weak firearm demand, margin pressure, acquisition integration and valuation, litigation and environmental obligations, and access to financing. Management stated disclosure controls were effective as of January 31, 2015.
Important facts for investors to verify
- Whether firearm demand and distributor/retailer inventory levels improve, particularly for long guns and larger-frame M&P pistols.
- BTI’s contribution to future sales, margins and cash generation after temporary purchase-accounting charges, and whether its preliminary purchase-price allocation changes.
- Debt covenant headroom, refinancing needs and liquidity after the acquisition-related increase in debt.
- Actual fiscal 2015 capital spending versus the approximately $34.0 estimate and cash-flow performance relative to the lower year-to-date operating cash generation.
- Potential exposure from product-liability claims, environmental remediation and the SEC compliance-reporting commitments.