Business context and reporting period
American Outdoor Brands Corporation (the registrant named in this filing; the request identifies Smith & Wesson Brands, Inc.) filed this unaudited Form 10-Q for the quarter and nine months ended January 31, 2018. The company reports Firearms and Outdoor Products & Accessories segments. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Three months ended Jan. 31, 2018 | Prior-year quarter | Nine months ended Jan. 31, 2018 | Prior-year period |
|---|---|---|---|---|
| Net sales | $157.4 | $233.5 | $434.8 | $674.0 |
| Gross profit / margin | $46.9 / 29.8% | $99.3 / 42.5% | $138.3 / 31.8% | $284.5 / 42.2% |
| Operating income / margin | $5.8 / 3.7% | $50.2 / 21.5% | $10.6 / 2.4% | $154.9 / 23.0% |
| Net income | $11.4 | $32.5 | $12.5 | $100.2 |
| Diluted EPS | $0.21 | $0.57 | $0.23 | $1.75 |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $(4.5) | $109.5 |
- Quarter sales fell 32.6%; nine-month sales fell 35.5%. Firearms external revenue declined 40.7% in the quarter and 46.0% year to date. Outdoor Products & Accessories revenue increased 10.9% and 32.4%, respectively, with acquisitions contributing to growth.
- Nine-month operating cash flow turned negative, while investing activities used $37.5 million and financing activities provided $18.6 million. Cash declined $23.4 million to $38.2 million from April 30, 2017.
- At January 31, current assets were $291.4 million and current liabilities $93.2 million. Inventory was $162.3 million, up from $131.7 million at April 30, 2017; finished goods rose to $98.2 million.
- Notes and loans payable totaled approximately $238.0 million: $6.3 million current and $231.7 million long term. The balance included $75.0 million drawn on a revolving facility and $89.3 million outstanding on a term loan. The filing reports compliance with debt covenants.
Material changes and management commentary
- Management attributed weaker firearms sales to softer customer orders, high industry and distributor inventories, lower consumer demand, reduced political pressure around firearm regulation, and promotional activity in the prior year that may have pulled shipments forward. Adjusted NICS background checks fell 11.3% in the quarter and 12.5% for the nine-month comparison, as cited by management.
- Firearms gross margin was 23.4% for the quarter versus 41.3% a year earlier, and 26.5% for nine months versus 41.8%. Lower volume and resulting unfavorable fixed-cost absorption, promotions, and inventory valuation adjustments weighed on margins.
- Management expected company and distributor firearm inventory to continue declining in the fourth fiscal quarter, supported by lower production, product introductions, and orders from distributor and buying-group shows. It cautioned that excess channel inventory and demand drivers make future revenue and income difficult to forecast.
- The 2018 acquisitions of Gemtech and Bubba Blade cost $23.1 million in aggregate and did not materially affect reported-period results. The company also reported $63.5 million of nine-month revenue from its 2017 acquisitions. Acquisition-related purchase-price allocations remained subject to adjustment.
- Tax Reform produced an estimated $9.4 million tax benefit included in current-period results, primarily from remeasuring deferred tax balances; most of the benefit was non-cash. Excluding Tax Reform and other discrete items, the reported effective tax rates were 42.9% for the quarter and 41.5% for nine months.
- After quarter-end, the company issued $75.0 million of 5.0% senior notes due 2020 and said it intended to use the proceeds to redeem its $75.0 million 5.0% notes due July 2018. The reported January 31 debt balances precede that refinancing.
Outlook, risks and contingencies
- Management said cash, working capital, operating plans, and credit facilities were expected to fund operations, debt service, and commitments for the next 12 months. This is a forward-looking assessment, not a guarantee.
- A 632,000-square-foot distribution center was under construction under a 20-year lease expected to commence in the second half of fiscal 2019. Building cost was estimated at $45–$50 million, with a further $25–$30 million expected over two fiscal years for equipment, systems, and related projects. The company expected the lease to be classified as a capital lease.
- Gemini Technologies sued the company and Smith & Wesson Corp., seeking $18.6 million and declaratory relief over acquisition agreement and earn-out terms. The company disputed the claims and intended to defend itself. Product-liability matters included five lawsuits and six additional claims; management said it could not estimate a range of reasonably possible additional losses.
- Other disclosed risks include demand and channel inventory, firearm regulation and market conditions, competition, raw-material availability and cost, acquisition integration, product launches, litigation, and the distribution-center project. The company expected to adopt the new revenue recognition standard on May 1, 2018, but had not estimated its financial impact.
Important facts for investors to verify
- Whether firearm demand and distributor inventories continued to improve after January 31, 2018, and whether the expected fourth-quarter inventory reduction occurred.
- How much of the reported $11.4 million quarterly and $12.5 million nine-month net income depended on the $9.4 million non-cash Tax Reform benefit.
- Subsequent cash generation, inventory levels, and debt after the February 2018 notes issuance and planned redemption of the 2018 notes.
- Final acquisition valuations and earn-out exposure, including the Gemtech litigation and the contingent consideration estimates.
- Distribution-center construction costs, lease accounting, expected incentives, and the additional equipment and systems spending.