Massachusetts-based gun maker Smith & Wesson (Nasdaq: SWHC) recently posted better-than-expected second-quarter results as demand for firearms increased during the period. However, the underperformance of its security service business weighed on profits.
Let's dip deeper.
The numbers
Revenue for the period increased to $99.2 million, a 4.5% increase from last year's second quarter. Despite that, net income saw a steep fall to $0.79 million, which is an 87% plunge over the year-ago quarter. This was primarily because of the bad performance of the security service division. Earnings per share were $0.01, just above break-even.
What paid and what pinched?
The firearm division, a major revenue earner for the company, recorded a good performance as its revenue -- $91.7 million -- grew by 18% because of increased demand for pistols and modern sporting rifles. Handgun sales also grew. Total consumer firearm unit sales were up by 44%.
The security service business, which provides 7.5% of total revenue, hurt quarterly income because of low government and corporate spending on security devices. Sales of this division fell to $7.5 million from $17.1 million last year.
Errant margins
Gross margin contracted by 5.6 percentage points to 28.4%. This is 2.5 percentage points lower than the five-year average, as noted by fellow Fool Seth Jayson. The company lags industry peers such as Sturm, Ruger (NYSE: RGR), Ceradyne (Nasdaq: CRDN), and Microsemi (Nasdaq: MSCC) in this area. Smith & Wesson needs to discipline its cost line to avoid profit "leakage."
The Foolish bottom line
S&W's management is looking at consolidating its operations and plans to add flexible manufacturing capacity in the hope of improving margins. In my view, security service will continue to hurt the bottom line, gross margins will continue its move southward, and guidance will fall short of analyst expectations.
Is the problem product or management? I'll examine that in my next take on the company.
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