Smith & Wesson Brands, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended October 31, 2020 (fiscal 2021 second quarter). Unaudited results; amounts below are in U.S. dollars. Following the August 24, 2020 spin-off of American Outdoor Brands, Inc. (AOUT), the company’s continuing operations principally reflect firearms and related products. Prior periods are presented with the outdoor business classified as discontinued operations.
Financial performance
- Second-quarter sales: $248.7 million, up 118.7% from $113.7 million. Handgun revenue grew 97.8% to $161.0 million; long-gun revenue grew 217.3% to $76.0 million.
- Profit and margins: Gross profit was $101.1 million, with a 40.6% gross margin versus 28.4% a year earlier. Operating income from continuing operations was $64.4 million (25.9% operating margin), versus $3.6 million. Continuing-operations net income was $49.1 million, or $0.87 diluted EPS, versus $0.3 million, or $0.01 per diluted share. Net income including discontinued operations was $52.2 million.
- Six-month results: Sales were $478.6 million, up 128.8%; gross margin was 40.4%, versus 32.5%. Continuing-operations net income was $92.4 million, or $1.64 diluted EPS, compared with $2.5 million, or $0.05. Net income including discontinued operations was $100.6 million.
- Cash flow: For the six months, net cash from operating activities was $135.9 million, compared with cash used of $34.9 million a year earlier. Investing used $16.5 million, including $15.0 million of capital expenditures. Financing used $188.9 million, chiefly reflecting net debt repayments of $160.0 million and the $25.0 million cash distribution to AOUT. Cash declined $69.5 million from April 30 to $55.5 million.
- Liquidity and obligations: Current assets were $215.4 million and current liabilities $125.1 million. No borrowings were outstanding on the $100 million revolving credit line at quarter-end; the company reported compliance with debt covenants. Notes and loans payable were zero on the balance sheet, down from $159.2 million at April 30. Finance lease liabilities totaled $40.4 million. The company believes cash and available credit will fund operations and commitments for the next 12 months.
Material changes and drivers
- Management attributed sharp sales growth to heightened consumer firearm demand, which it associated with COVID-19 concerns, personal-protection concerns, and uncertainty about potential regulation after the election. Reduced promotions also supported average selling prices. Flexible manufacturing capacity helped increase shipments.
- Gross-margin expansion reflected lower promotional spending and favorable fixed-cost absorption, partly offset by increased manufacturing spending and recall costs; six-month results also included unfavorable inventory valuation adjustments.
- Operating expenses rose 27.7% in the quarter, including higher separation costs, profit-sharing expense, and freight. General and administrative expenses included $4.8 million of separation costs for the quarter and $8.4 million for the six months.
- The completed spin-off transferred net assets of $260.4 million, including $25.0 million in cash, to AOUT. AOUT’s historical results through August 23, 2020 are reported as discontinued operations. The company continues to provide and receive certain transition services under agreements lasting up to 24 months.
Outlook, risks and contingencies
- Management expects firearm inventory balances to remain relatively flat in the next fiscal quarter and forecasts fiscal 2021 capital expenditures of $30 million to $35 million, primarily to expand manufacturing capacity. No revenue or earnings guidance is provided in the supplied filing text.
- The company cited demand uncertainty, economic and consumer-spending conditions, potential regulation, supply and component availability and costs, competition, order cancellations, and litigation among factors that could cause actual results to differ from expectations.
- Product-liability and other litigation remains a risk. The company says it cannot reasonably estimate a range of possible additional losses from material adverse judgments and has not accrued for such judgments; it has accrued for defense costs and recorded insurance-reimbursement receivables. Several cases and claims remain pending, including the Gemini dispute and product-liability actions.
- A material weakness in internal controls over accounting for goodwill impairment was identified in the fiscal 2020 year-end assessment. Management was designing and evaluating remediation controls and had not yet established that they operated effectively. Management separately concluded that disclosure controls were effective as of October 31, 2020.
- After quarter-end, the board authorized a $0.05-per-share quarterly dividend, payable January 5, 2021 to holders of record December 17, 2020.
Important facts for investors to verify
- Whether elevated consumer demand and shipment growth persist, and how channel inventory and promotional activity develop.
- Execution and returns on planned capacity-related capital expenditures, alongside production, freight, and recall costs.
- Cash and liquidity after substantial debt repayment, spin-off-related payments, capital spending, and dividends; review the credit agreement’s covenants and springing-lien provisions.
- Progress in remediating the goodwill-impairment control weakness, and any resulting financial-statement or audit implications.
- Developments in litigation and whether potential losses can be estimated or require additional accruals or disclosure.
- The separation’s continuing costs and transition-service arrangements, and the basis for comparing current results with prior periods.