American Outdoor Brands (NASDAQ:AOBC) gave investors an early Christmas present by posting fiscal second-quarter revenues and earnings that beat analyst expectations while raising guidance for its third quarter.

It's been a welcome turn for the Smith & Wesson brand owner, which has been weighed down by the two-year industry slump that only now seems to be slowly lifting. Yet as good as American Outdoor's earnings were, they were only just that -- good, they weren't great -- and investors should employ caution now that the market has bid the gunmaker's shares higher.

Two boys hunting with a rifle

Image source: Getty Images.

On the hunt for growth

You can't deny American Outdoor's report was worthy of a high five or two. Sales were up 9% to $161.7 million, handily beating Wall Street's expectations of $154 million, while earnings crushed the forecast of $0.14 per share by coming in at $0.20 per share. Moreover, despite an 11% decline in adjusted background checks for individuals wanting to purchase long guns like rifles and shotguns, American Outdoor saw its sales rise over 14%.

Dicks Sporting Goods (NYSE:DKS) shot itself in the foot earlier this year by banning the sale of modern sporting rifles and raising the minimum age of persons to whom it would sell a gun. It acknowledged its stance in favor of stricter gun control backfired as it saw demand for hunting rifles and shotguns tumble during the quarter as gun buyers took their business elsewhere. While summer months are soft for gun sales, they typically pick back up in the fall with the start of the hunting season.

Handguns also came up short for American Outdoor as it experienced a 1.8% decline in sales, but that was a substantially better result than the 8.8% decline in background checks seen during the quarter. (Although background checks don't correlate precisely with gun sales, and American Outdoor sells firearms only to law enforcement and federally licensed dealers, not consumers, they are still seen as an industry proxy for customer demand.)

Financial gymnastics

FBI checks on gun buyers through the National Instant Criminal Background Check System are running 4.4% ahead of last year through November, but are down 12% when adjusted for checks on existing permit holders and other duplications in the background check process. It shows the firearms industry remains weak, but also why American Outdoor Brands' quarterly report was good.

But tempering the enthusiasm over the results is the fact that an accounting change adopted by the firearms leader earlier this year is once again responsible for the majority of the revenue growth American Outdoor achieved in the firearms segment.

In its fiscal first quarter, the accounting change represented virtually all the growth American Outdoor saw, while this quarter it was responsible for 8.6% of the 10.7% gain in firearms sales it recorded. Only 2.1% was due to higher demand.

Further, American Outdoor is being very promotional, for example offering a free M&P Shield pistol -- one of the gunmaker's more popular handguns -- with the purchase of five. While the discounting moves product, it also whittles away margins. For its guidance, the gunmaker said the midpoint of its forecast is similar to what it saw in the second quarter, but it is expecting margins to tighten due to the discounting.

Key investment takeaway

There's no question American Outdoor Brands is doing better now than it was a year ago, which is another factor in how much better its results looked. Firearms sales last year had plunged 49% from 2016, meaning the bar that it needed to step over this quarter was fairly low.

So while the gunslinger's results are good, they're not great, and it still has a ways to go before it finds itself on target for sustained growth.



Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.