Smith and Wesson Swings to Q2 Loss Despite 26.3% Gain in Hunting Sales

The company reported sales rose just 1.5% to to $96.3 million in the quarter ended Oct. 31, which it described as “a challenging environment.”

“As overall purchasing of firearms moderated during the quarter compared with the record levels a year ago, total sales came in slightly below our previously issued guidance,” said Michael F. Golden, Smith & Wesson Holding Corporation president and CEO.  “The environment has become increasingly challenging, leading us to the decision to lower our revenue outlook and to partially impair certain intangible assets related to our USR acquisition.”

Total company net sales of $96.3 million for the second quarter decreased $13.4 million, or 12.2%, from net sales of $109.7 million for the comparable quarter last year, a period that reflected significant strength in the firearm industry. 

During the second quarter, the company determined that the goodwill and certain long-lived intangible assets related to its acquisition of USR were partially impaired because of changing market conditions, including extended government and corporate purchasing cycles.  Based on this determination, the company recorded a non-cash impairment charge of $39.5 million, representing intangibles and approximately 50% of the net book value of goodwill associated with the acquisition of USR. 

The company incurred a net loss for the second quarter of fiscal 2011 of $37.3 million, or $0.62 per diluted share.  The company had net income for the second quarter of the prior fiscal year of $14.4 million, or $0.22 per diluted share.  Non-GAAP net income for the second quarter of fiscal 2011, which excludes the partial impairment of USR assets, DOJ and SEC investigation costs, and the effect of USR earnout adjustments, was $3.1 million, or $0.05 per diluted share, compared with non-GAAP net income of $7.2 million, or $0.12 per diluted share, for the second quarter of fiscal 2010.

Second quarter fiscal 2011 adjusted EBITDAS totaled $9.3 million compared with adjusted EBITDAS of $17.4 million for the comparable quarter last year.

Firearm Division
Firearm Division net sales for the second quarter of fiscal 2011 were $83.6 million, a decrease of $9.8 million, or 10.5%, from net sales of $93.4 million for the second quarter last year, a period that reflected significant strength in industry-wide firearm sales and corresponding strong sales for the company. 

Indications are that the consumer firearm market has moderated further following the significant increase that started in the company’s third quarter of fiscal 2009.  In the second fiscal quarter of this year, sales in all handgun and tactical rifle product lines, except premium products, were flat or lower than in the prior year quarter due to a more competitive environment and a trend towards more value-oriented products.  Hunting products were the exception and increased 26.3% over the prior year comparable quarter on improved sales of black powder products and the company’s new bolt-action rifles.

In late July, the company began shipping its innovative new BODYGUARD revolvers and pistols, designed for the concealed carry-market.  Market reception for these new products has been positive, and the company expanded its capacity to produce the BODYGUARD pistols.

In the third quarter, the company made the strategic decision to relocate its Thompson/Center Arms operations from Rochester, New Hampshire to the company’s Springfield, Massachusetts facility.  This relocation is designed to provide the company with increased operational efficiencies through the optimization of the company’s manufacturing footprint and increased synergies generated in fixed, marketing, and administrative costs. 

 

The bulk of the $9.0 million of estimated cash outlays associated with the relocation will occur in the second half of fiscal 2011, and those outlays are expected to be recovered in approximately 24 months.  The relocation is scheduled to commence in January 2011 and conclude by November 2011. 

Gross profit for the Firearm Division for the second quarter of $25.4 million was lower than gross profit of $31.7 million for the second quarter last year, primarily because of a decrease in sales and additional promotional spending.  As a result, gross profit as a percentage of revenue was 30.4%, a decrease from gross margin of 34.0% for the second quarter last year. 

Firearm order backlog was $32.4 million at the end of the second quarter of fiscal 2011, which was $63.4 million lower than backlog associated with the heightened level of industry sales at the end of the prior year comparable quarter.  A $42.4 million reduction versus the first quarter of fiscal 2011 reflects diminished end-market demand as well as distributors’ shift towards tighter inventory levels versus prior periods.

Perimeter Security Division
Perimeter Security Division net sales for the second quarter of fiscal 2011 were $12.8 million compared with net sales of $16.3 million for the comparable quarter a year ago.  The decline in sales resulted from lower beginning backlog than a year ago and delays or changes in funding for several customers.

Operational Overview
Total company gross profit as a percentage of net revenue was 29.4% for the second quarter compared with 33.1% for the second quarter last year. The decrease was attributable to lower production volume and increased promotions in the Firearm Division, and lower gross margins in the Perimeter Security Division related to outstanding projects that were bid prior to the improved estimating procedures.

Total company operating expenses, including the $39.5 million expense related to the non-cash USR asset impairment and the $3.3 million of expenses related to DOJ and SEC matters, totaled $65.1 million, or 67.6% of sales, for the second quarter of fiscal 2011 versus operating expenses of $23.4 million, or 21.4% of sales, for the comparable quarter last year.  In addition, Perimeter Security Division operating expenses increased approximately $2.1 million for the second quarter, versus the comparable quarter last year, driven by increases in sales and management support functions designed to improve the capabilities of the business.  Increased expenses in the Firearm Division related to legal and consulting expenses as well as costs associated with improving our international business processes.

At the end of the second quarter, the company had $43.6 million in cash and cash equivalents on hand, an increase of $16.9 million from the first quarter of fiscal 2011, and had no borrowings under its revolving line of credit.  As mentioned, after the close of the quarter, the company successfully expanded its revolving line of credit from $60.0 million to $120.0 million.

Accounts receivable decreased to $67.2 million at the end of the second quarter compared with $73.5 million at the end of the prior fiscal year, largely a result of seasonality in the hunting business. 
Inventory was $58.2 million at the end of the second quarter compared with $62.6 million in July and $50.7 million in April.  The $4.5 million sequential decline in inventory reflects seasonal hunting sales along with company’s successful efforts to reduce inventories through adjustments to production and product promotion activities during the quarter.

Business Outlook
The company currently anticipates total sales for full fiscal 2011 of between $405.0 million and $425.0 million. Full year Firearm Division sales are anticipated to be between $345.0 million and $355.0 million, with the company’s Perimeter Security Division contributing $60.0 million to $70.0 million.

 

The company now expects total gross profit margin for full fiscal 2011 to be between 30% and 31%, excluding costs incurred related to the Rochester, New Hampshire facility consolidation.  The company now expects fiscal 2011 operating expenses to be approximately 25% of sales, excluding the impairment charge taken in the second quarter, an increase versus prior guidance arising from the reduction in sales combined with increases in legal expenses and certain international business process reviews. 

 

Lastly, the company expects to incur $6.0 million of expense during the remainder of the fiscal year related to relocating the Thompson/Center Arms operations to Springfield, Massachusetts.

The company expects total sales for the third quarter of fiscal 2011, the period ending Jan. 31, 2011, to be between $94.0 million and $99.0 million.  Firearm Division sales are anticipated to be between $79.0 million and $84.0 million, with the Perimeter Security Division contributing the balance.

 

Total company gross profit margin is anticipated to be between 27% and 28%, excluding costs incurred related to the Rochester, New Hampshire facility consolidation, affected by an increasingly competitive environment in the firearm market and lower seasonal sales in hunting products.  Margins in the perimeter security business are expected to improve to prior year levels. 

 

Total company operating expense is expected to be between 27% and 28% of sales, reflecting ongoing legal and consulting expenses related to ongoing DOJ and SEC matters.  The company expects to incur $3.4 million of expenses during the third fiscal quarter to relocate the Thompson/Center Arms operations.

“We are continuing to operate under challenging industry conditions with reduced consumer spending and difficult year-to-year comparisons to prior year surge levels,” said Golden.  “As we enter the second half of our fiscal year, our new and expanded credit facility strengthens the resources available to enhance our business.  We are also taking steps that we believe will improve our operating performance.  The relocation of our Thompson/Center Arms operations from Rochester, New Hampshire to our Springfield, Massachusetts facility is designed to streamline our firearms manufacturing processes and improve our margins.  Sales of our BODYGUARD pistols are strong, and we are optimistic about initial feedback on our new product offerings in both the Firearm and the Perimeter Security Divisions.  Our new crash-rated GRAB-400 and EMB barriers are also generating interest among our existing and new customers.  The development of new and proprietary products serves as a cornerstone for our overall business, as we continue to foster our heritage of innovation.”