Business context and reporting period
Smith & Wesson Holding Corporation (now Smith & Wesson Brands, Inc.) filed this unaudited Form 10-Q for the fiscal third quarter and nine months ended January 31, 2016. The company manufactures firearms and related products and, following its 2014 BTI acquisition, shooting and hunting accessories. Comparisons are with the same periods of the prior year.
Key financial results
| Metric | Three months ended Jan. 31, 2016 | Nine months ended Jan. 31, 2016 |
|---|---|---|
| Net sales | $210.8 million, up 61.5% | $501.8 million, up 35.3% |
| Gross margin | 41.1%, versus 33.6% | 40.2%, versus 34.5% |
| Operating income | $50.1 million, versus $15.6 million | $101.7 million, versus $52.1 million |
| Net income | $31.4 million; diluted EPS $0.56 | $58.3 million; diluted EPS $1.05 |
| Operating cash flow | Not separately presented | $73.7 million, versus $29.9 million |
At January 31, 2016, cash was $105.2 million, current assets were $293.0 million and current liabilities were $100.9 million. Notes payable had a carrying value of $174.2 million, including $6.3 million current; contractual principal was approximately $176.9 million. The $175 million revolving facility had no borrowings outstanding, with $1.0 million in letters of credit. The company reported compliance with debt covenants.
Material changes versus prior comparable periods
- Quarterly firearm sales rose 56.4% to $194.7 million; handgun sales increased 56.5% and long-gun sales 85.4%. Management attributed demand partly to news events and the political environment, alongside continued consumer interest.
- Accessories sales increased to $16.1 million for the quarter and $47.8 million year to date. Comparisons are affected by the prior year including only six weeks of BTI revenue.
- Higher production volumes and improved fixed-cost absorption helped lift margins. Promotional discounts and higher manufacturing spending partly offset the benefit. BTI contributed 90 basis points to quarterly company gross margin and 1.2 percentage points year to date.
- Year-to-date interest expense increased 44.8% to $11.7 million, principally reflecting a $2.9 million call premium and a $1.7 million write-off of debt issuance costs associated with redeeming the 5.875% notes. The replacement term loan and interest-rate swap lowered quarterly interest expense versus the prior year quarter.
- Year-to-date operating cash flow improved, but accounts receivable used $34.5 million of cash, reflecting sales timing. Cash from operations also benefited from higher payables and accrued payroll and profit sharing.
Outlook, risks and unusual items
- Management expects fiscal 2016 capital expenditures of approximately $35–$40 million, primarily for manufacturing flexibility, product tooling and information technology. It believes cash and available credit will fund operations, debt and other commitments for the next 12 months, excluding major acquisitions.
- The company entered a five-year interest-rate swap covering $105 million of term debt; the effective term-loan rate was 3.06% at January 31, 2016. Management did not expect the swap to materially affect earnings in the following 12 months.
- Management described demand as influenced in part by news and the political environment. Demand variability, promotional activity, production capacity and export-license delays could affect sales and margins; law-enforcement and international shipments were lower year to date.
- Product-liability and other litigation is ongoing. The company said it could not reasonably estimate the range of possible additional losses from material adverse judgments; an unfavorable outcome or prolonged litigation could harm the business. It reported a $675,000 environmental reserve and remediation obligations.
- A $1.8 million insurance recovery for prior-period defense costs was recorded in the nine-month period. The board had authorized up to $50 million of share repurchases through June 23, 2017, but none had been made as of January 31, 2016.
- After quarter-end, on February 26, 2016, the company acquired substantially all of PowerTech, Inc.’s net assets for $1.2 million, with a possible additional $275,000 earnout.
Important facts for investors to verify
- Whether elevated firearm demand and production volumes persist, and how much sales growth reflects durable demand versus news or political events.
- How accessories growth compares on a full-period basis, given the BTI acquisition’s timing effect on prior-year results.
- Cash conversion and working-capital trends, particularly receivables, as sales change.
- Debt principal, covenant headroom, swap exposure and the effect of scheduled term-loan repayments.
- Potential litigation and environmental exposure beyond recorded reserves, and the terms and integration costs of the PowerTech acquisition.