Sturm, Ruger & Company, Inc. — Q3 2014 Form 10-Q
Business context and period: Firearms designer and manufacturer reporting the quarter and nine months ended September 27, 2014. Firearms generated approximately 99.6% of sales; exports were about 5%. The interim financial statements are unaudited.
Financial performance
Amounts below are in millions of dollars, except per-share data. Comparisons are with the corresponding 2013 period.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $98.3 | $170.9 | $421.9 | $506.4 |
| Gross profit / margin | $23.7 / 24.1% | $62.9 / 36.8% | $135.2 / 32.1% | $195.0 / 38.5% |
| Operating income | $10.0 | $44.8 | $81.0 | $132.7 |
| Net income | $6.8 | $28.7 | $53.4 | $84.7 |
| Diluted EPS | $0.34 | $1.44 | $2.69 | $4.25 |
| EBITDA (non-GAAP) | $19.6 | $49.9 | $109.0 | $147.7 |
- Quarterly sales fell 42.5%; nine-month sales fell 16.7%. Firearms shipments declined 42.7% and 14.7%, respectively. Castings sales also decreased sharply, following the company’s 2013 decision to prioritize internal casting needs and discontinue many outside customers.
- Gross margin contracted amid lower volume and fixed-cost deleverage, a shift away from higher-margin accessories, and higher depreciation. Selling, general and administrative expenses declined 24.1% in Q3 and 12.9% year to date, partly due to lower promotional costs and incentive compensation.
- Operating cash flow was $31.0 million for nine months, versus $83.7 million a year earlier. Capital expenditures were $28.7 million; dividends paid were $28.7 million. Cash fell to $28.1 million from $55.1 million at year-end 2013.
- At quarter-end, working capital was $82.5 million after the LIFO reserve; the current ratio was 2.7 to 1. The company reported no debt and an unused $40 million revolving credit facility, expiring June 15, 2015.
- Net inventory increased to $47.7 million from $23.3 million at year-end; finished-goods inventory rose materially. The company also recorded a $2.6 million slow-moving inventory valuation adjustment in the first nine months.
Material changes, outlook and risks
- Management said demand weakened sharply: Q3 estimated distributor-to-retailer sell-through fell 44% year over year, while adjusted NICS checks, used as a retail-demand proxy, declined 3%. Management cited high retail inventory, retailer destocking, competitor discounting, fewer significant new products and limited rimfire ammunition availability. The company did not match competitor discounting and said this likely cost market share.
- Net orders received in the first nine months declined 65%; backlog was 824,700 units at September 27, 2014, down from 1.9 million a year earlier. Management cautions that orders and backlog are not its primary production-planning measures; its sell-through estimates are also approximate and depend on distributor-provided data.
- Production decreased 36% in Q3 and 8% year to date. Management described actions to manage labor and reduce or defer capital spending. It nevertheless expected approximately $40 million of 2014 capital expenditures for new-product tooling and equipment modernization, funded from operations and cash.
- The AR-556 modern sporting rifle launched in late September; initial Q3 shipments were limited. New products accounted for $72.3 million, or 17%, of firearms sales in the first nine months.
- Management expected to settle and terminate frozen defined-benefit pension plans in Q4 2014. The expected cash payment was approximately $8 million and the expected income-statement expense approximately $40 million. This is a significant anticipated charge, not included in Q3 results.
- The board authorized a 14-cent-per-share dividend payable November 26, 2014. Future dividends remain dependent on performance, cash needs and other factors.
- Product-liability exposure includes approximately three lawsuits and other claims. Claimed amounts exceed accruals and applicable insurance coverage; management said a reasonably possible loss range could not be estimated. It considered a material adverse effect on financial position unlikely, but noted litigation could materially affect results in a particular period.
- Other stated risks include demand and pricing, raw-material availability and costs, pending litigation, and potential firearms-control or environmental legislation. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether demand, distributor and retail inventory levels, orders, and backlog continue to weaken or stabilize, and whether the AR-556 and other new products gain traction.
- The expected Q4 pension settlement expense and cash payment, and whether the plan termination is completed as anticipated.
- Inventory valuation and cash conversion as production, shipments, and demand adjust; also verify planned capital expenditures against the approximately $40 million estimate.
- Gross-margin recovery prospects given lower volume, product mix, depreciation and competitive pricing, alongside the company’s dividend and liquidity needs.
- Developments in product-liability and other litigation, including any material change in exposure, accruals or insurance coverage.