Business context and reporting period
Smith & Wesson Holding Corporation’s unaudited Form 10-Q covers the quarter and six months ended October 31, 2011 (fiscal 2012). The continuing business manufactures firearms and related products. The security solutions division is reported as discontinued operations after the company committed on October 5, 2011 to divest it.
Key financial metrics
Amounts are in millions of dollars, except per-share data. Prior-period figures are for the comparable periods ended October 31, 2010.
| Metric | Q2 FY2012 | Q2 FY2011 | Six months FY2012 | Six months FY2011 |
|---|---|---|---|---|
| Net sales, continuing operations | $92.3 | $83.6 | $184.0 | $161.3 |
| Gross profit / margin | $24.6 / 26.7% | $25.4 / 30.4% | $51.1 / 27.8% | $54.1 / 33.5% |
| Operating income / margin | $3.4 / 3.7% | $4.8 / 5.8% | $9.0 / 4.9% | $11.7 / 7.3% |
| Income from continuing operations | $0.9 | $2.6 | $3.2 | $6.4 |
| Net loss, including discontinued operations | $(1.6) | $(37.3) | $(0.8) | $(31.1) |
| Diluted continuing-operations EPS | $0.01 | $0.04 | $0.05 | $0.10 |
- Cash flow: For the six months, operating cash flow was $(2.1) million, investing cash flow $(6.6) million, and financing cash flow $(0.4) million. Cash declined $9.1 million to $49.2 million, including $5.8 million of restricted cash.
- Liquidity and debt: Current assets were $192.7 million and current liabilities $108.3 million at October 31. Notes payable were $80.5 million, including $30.5 million current and $50.0 million long-term. The company also recorded a $3.5 million capital lease obligation. Its revolving credit facility was reduced from $120 million to $60 million; there were no borrowings outstanding. The company reported compliance with debt covenants.
- Orders and investment: Backlog was $149.9 million, up $117.5 million year over year. Management expected fiscal 2012 capital expenditures of $21–$23 million.
Material changes versus prior comparable periods
- Sales growth reflected stronger handgun and modern sporting rifle demand: six-month handgun sales rose 21.6% and modern sporting rifle sales rose 82.1%. Six-month hunting firearm sales fell 36.9%; Walther sales fell 13.4%.
- Gross margin contracted 3.7 percentage points in Q2 and 5.7 points for the six-month period. Management cited the Venture rifle recall, lower average selling prices and product mix, and costs and inefficiencies from relocating hunting production.
- Continuing-operations income fell despite higher sales. Higher warranty, employee and relocation costs reduced operating income; increased interest expense also weighed on earnings. Six-month interest expense increased to $4.4 million from $2.2 million, reflecting 9.5% Senior Notes and a $563,000 write-off of debt issuance costs.
- Discontinued security solutions sales declined 55.4% in Q2 and 57.3% for six months. Its losses were much smaller than in 2010, when results included a $39.5 million impairment charge; excluding that charge and contingent-consideration gains, the division’s 2010 adjusted losses were $1.2 million for Q2 and $1.4 million for six months.
Outlook, commentary, risks and unusual items
- Debt maturity: Holders may require repurchase of the remaining $30 million of 4% convertible notes on December 15, 2011. The company anticipated a cash repurchase and intended to use cash on hand or credit-facility borrowings. Management believed available capital and facilities would cover operations, debt and commitments for the next 12 months.
- Recall and restructuring: A November 11, 2011 recall covered all Thompson/Center Arms Venture rifles made since the product’s mid-2009 introduction. Estimated recall cost was approximately $2.1 million, included in warranty accruals. The hunting-production consolidation was completed in November 2011; management expected a further $0.4 million of related costs in fiscal 2012.
- Divestiture uncertainty: The company could not estimate the security solutions divestiture’s timing or major costs, and its net assets did not qualify as held for sale because the timing was uncertain.
- Investigations and litigation: DOJ and SEC inquiries remained ongoing; the company was cooperating and disclosed potential fines, penalties, legal costs, contract restrictions and reputational harm. Product-liability and other litigation also remained, and the company could not estimate a range of reasonably possible additional losses. It reported $5.3 million of product and municipal litigation reserves, consisting of expected defense costs.
- Other exposures: Management identified reliance on a limited number of suppliers, environmental remediation obligations, and warranty and self-insurance estimates as risks. Environmental reserves were $2.1 million; timing of remediation was indeterminable.
- Other unusual items: The company recorded $988,000 of severance benefits for its former CEO in the quarter. No formal full-year sales or earnings guidance is provided in the filing; the stated outlook includes capital spending and management’s liquidity assessment.
Important facts for investors to verify
- Whether the $30 million convertible-note put was completed on December 15, 2011, and its effect on cash, borrowings and liquidity.
- Actual costs, claims and any further product actions associated with the Venture rifle recall, and the resulting warranty expense.
- Progress, timing, proceeds and costs of the security solutions divestiture.
- Whether hunting-production consolidation delivered the expected capacity and efficiency improvements, and whether planned capital expenditures remained within the $21–$23 million range.
- Developments in the DOJ and SEC inquiries, securities and derivative litigation, and environmental remediation that could affect results or cash needs.