Smith & Wesson Holding Corporation — Form 10-Q
Reporting period: Fiscal third quarter ended January 31, 2014; results compare the three and nine months ended January 31, 2014 with the corresponding 2013 periods. Amounts are in U.S. dollars; financial statement amounts below are in millions unless noted.
Business context
The company manufactures firearms and related products, including handguns and long guns. Its former Security Solutions division was sold in July 2012 and is reported as discontinued operations. The filing is unaudited.
Key financial metrics
| Metric | Three months ended Jan. 31, 2014 | Three months ended Jan. 31, 2013 | Nine months ended Jan. 31, 2014 | Nine months ended Jan. 31, 2013 |
|---|---|---|---|---|
| Net sales | $145.9 | $136.2 | $456.2 | $408.8 |
| Gross profit / margin | $58.7 / 40.2% | $49.9 / 36.6% | $189.4 / 41.5% | $149.6 / 36.6% |
| Operating income from continuing operations / margin | $31.1 / 21.3% | $28.0 / 20.6% | $107.9 / 23.7% | $86.0 / 21.0% |
| Income from continuing operations | $20.1 | $17.5 | $63.7 | $52.8 |
| Net income | $20.8 | $14.6 | $64.2 | $53.5 |
| Diluted EPS from continuing operations | $0.35 | $0.26 | $1.03 | $0.79 |
| Interest expense | $1.8 | $1.2 | $10.5 | $4.6 |
- For the nine months, operating cash flow was $54.2 million, capital expenditures were $36.3 million, and net cash used in investing activities was $48.7 million. Financing activities used $60.7 million; cash declined $55.2 million to $45.3 million.
- At January 31, 2014, current assets were $212.2 million and current liabilities were $88.2 million. Total liabilities were $207.2 million and stockholders’ equity was $138.9 million.
- Notes payable totaled $100.3 million, including $100 million of 5.875% senior notes due 2017; no borrowings were outstanding under the $75 million revolving credit facility. The company reported compliance with debt covenants. Capital lease obligations had a $2.5 million present value.
Material changes and management commentary
- Third-quarter sales rose 7.1%; nine-month sales rose 11.6%. Excluding Walther, which was down $11.0 million in the quarter and $30.2 million year to date following termination of the U.S. distribution agreement, sales increased 16.7% and 20.7%, respectively.
- Handgun sales increased 29.9% in the quarter and 33.0% year to date, led by M&P polymer pistols. Long-gun sales fell 9.4% in the quarter, partly due to the Thompson/Center bolt-action rifle recall and ammunition constraints. Management cited capacity growth, product mix, and demand as drivers of results.
- Gross margin improved on stronger higher-margin product mix, production efficiency and fixed-cost absorption, and reduced promotional spending. Higher manufacturing and volume-related spending partly offset those benefits.
- Operating expenses rose 25.8% in the quarter and 28.0% year to date, primarily reflecting ERP implementation support and training, higher stock-based compensation, added staffing, and depreciation. Year-to-date interest expense included $4.3 million of bond premium and $795,000 of debt-issuance write-off costs related to retiring the 9.5% notes.
- The company repurchased $115 million of stock during the nine months, using $15.6 million for a tender offer and $99.4 million for open-market purchases. The repurchase program was completed.
Outlook, risks and unusual items
- Management expected approximately $60 million of fiscal 2014 capital expenditures, versus $41.4 million in fiscal 2013, mainly for capacity, production efficiency, tooling, and ERP-related projects. It said existing capital resources and credit facilities should fund operations and commitments for the next 12 months, excluding major acquisitions.
- The company disclosed an M&P Shield safety alert and Thompson/Center rifle recalls; estimated remaining costs of the recalls and alert were $3.4 million, recorded in accrued warranty. Warranty accruals depend on claims and repair-cost estimates.
- Material uncertainties include DOJ and SEC inquiries concerning possible FCPA and securities-law violations, product-liability cases and claims, environmental remediation, and potential supplier constraints. The company said it could not reasonably estimate possible losses for material adverse product-liability judgments; it had recorded $4.4 million of product and municipal litigation reserves, consisting of expected defense costs.
- Management noted that the new ERP system affected internal control over financial reporting during implementation, while disclosure controls were assessed as effective and no material change in internal control was reported for the quarter. It also cited ERP-related sales and production losses and inefficiencies.
- The filing provides no specific sales or earnings guidance. Management cautioned that nine-month results may not indicate full-year results; the effective tax rate, excluding discrete items, was expected to remain stable for the rest of the fiscal year.
Important facts for investors to verify
- Whether handgun demand and production capacity remain strong, and whether recall-related constraints or ammunition availability continue to affect long guns.
- Whether ERP costs, operational disruption, and capital spending develop as management expects.
- The cash, debt, interest burden, and covenant implications following the $115 million share repurchase and refinancing; the filing reports $45.3 million cash and $100 million of senior notes at period-end.
- Developments in the DOJ and SEC inquiries, litigation, product recalls, and environmental matters, including any change in estimated exposure.
- That reported net income includes discontinued-operation effects: third-quarter discontinued operations contributed $0.7 million after tax, while continuing operations provide the clearer measure of ongoing performance.