Sturm, Ruger & Company, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 26, 2015. The company designs, manufactures, and sells firearms, primarily to U.S. wholesale distributors; castings sales were about 1% of sales and exports about 5%.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $120.9m | $98.3m | $398.7m | $421.9m |
| Gross profit | $34.0m | $23.7m | $123.9m | $135.2m |
| Gross margin | 28.1% | 24.1% | 31.1% | 32.1% |
| Operating income | $18.0m | $10.0m | $68.4m | $81.0m |
| Net income | $12.0m | $6.8m | $45.0m | $53.4m |
| Diluted EPS | $0.62 | $0.34 | $2.33 | $2.69 |
- Cash flow: Nine-month operating cash flow was $94.9m, versus $31.0m; capital expenditures were $24.5m, versus $28.7m. Cash at period-end was $60.3m, up from $8.9m at December 31, 2014.
- Liquidity and debt: Working capital was $95.3m after the LIFO reserve, with a 2.4-to-1 current ratio. The company reported no debt; its $40m revolving facility was unused and scheduled to expire June 15, 2016.
- Capital returns: The company paid $15.9m in dividends and repurchased 82,100 shares for $2.8m during the nine months. The board subsequently declared a $0.25-per-share dividend, payable November 30, 2015.
Material changes and operating trends
- Q3 sales rose 23.0% year over year; firearms sales increased 22.0%, and firearm unit shipments rose 24.5%. For the nine months, sales declined 5.5%, firearms sales declined 6.2%, and firearm shipments fell 9.5%.
- Management reported Q3 distributor-to-retailer sell-through up 28% year over year, while nine-month sell-through was unchanged. New products introduced in the prior two years contributed $81.1m, or 21%, of nine-month firearm sales.
- Q3 gross margin improved, with management citing higher volume, manufacturing overhead leverage, and improved productivity. Nine-month margin fell as sales declined and overhead and labor rate adjustments to inventory increased cost of products sold.
- Q3 selling and administrative expenses rose 16.5%, mainly due to increased promotions, including the “2 Million Gun Challenge to Benefit the NRA.” Nine-month expenses rose 2.3%.
- Ending order backlog fell to $80.5m from $242.9m a year earlier. Company and distributor inventories together were 485,700 units at Q3 end. Management cautions that distributor sell-through estimates are based on unverified distributor data and do not capture retailer inventory.
- The castings segment recorded a pretax loss of $1.9m in Q3 and $2.9m for the nine months, compared with pretax income in the respective 2014 periods.
Outlook, risks, and unusual items
- No specific revenue or earnings guidance is provided. Management expected approximately $30m of 2015 capital spending for new-product tooling and manufacturing upgrades, funded from operating cash and existing cash.
- Management said interim results may not indicate full-year results. Demand, distributor orders and inventories, raw-material availability and pricing, firearms legislation, and litigation are cited as factors that could affect results.
- Product-liability exposure is substantially self-insured; insurance generally applies to qualifying claims above $5m per claim, subject to a $10m annual aggregate, with certain municipal claims excluded. Management said litigation was unlikely to materially affect financial position but could materially affect results in a particular period; a reasonably possible loss range was not estimable.
- The filing discusses a product-liability suit, the long-running City of Gary municipal suit, and a Kelley case instituted during the quarter. The municipal case had renewed scheduling activity, although the plaintiff missed a filing deadline.
- Inventory uses LIFO; interim LIFO valuations rely on year-end estimates. Management said any 2015 LIFO liquidation, if it occurred, was not expected to have a material impact.
- Management expected no further pension-plan contributions after the plans were fully funded and terminated in 2014. Disclosure controls were assessed as effective, with no material changes in internal control reported during the quarter.
Important facts for investors to verify
- Whether the sharply lower backlog and rising company and distributor inventories signal weaker future shipments or a normal seasonal pattern.
- Whether Q3 margin improvement is sustainable, given lower nine-month margins and the effect of inventory overhead, labor, and LIFO adjustments.
- Progress and potential financial exposure from the product-liability and municipal litigation, including the Kelley case and applicable insurance exclusions.
- Whether planned capital spending, dividends, and repurchases remain supportable from cash generation, particularly as the credit facility approaches its June 2016 expiration.