Gun maker Smith & Wesson (SWHC +1.11%) reported earnings last night -- and the crowd went wild. But why?
After all, for its second quarter of fiscal 2014, the gunsmith reported several disturbing numbers. Starting at the top, quarterly sales increased a mere 2% in comparison to second-quarter 2013. That's a pretty far cry from the "30% annualized profits growth" that analysts have been telling investors to expect from S&W over the next five years. And the news didn't get much better from there:
- Net profits for the quarter declined 20% year over year, to $17 million.
- Profits per diluted share dropped 10% to $0.28 -- despite a 10% reduction in share count.
- Free cash flow turned negative, erasing last quarter's positive performance and pushing S&W $2.1 million into the red.
So what's to like about that? Why were investors bidding the shares up by more than 4% in midday trading?
Hope springs eternal
Well, there are at least a few reasons for optimism. For one thing, if Smith & Wesson's numbers were worse than what it reported last year, they did at least exceed expectations. Revenue edged out analyst estimates. Profits "beat estimates" by a good $0.07 per share.
And looking out across the next six months, S&W management stuck to its guns on full-year guidance. Sales are still expected to come in between $610 million and $620 million, right on target with analyst expectations. Profits per diluted share from continuing operations should still exceed $1.30.
Plus, things may not be as bad as they look on the sales front. One big reason Smith & Wesson was unable to grow sales much was because the company has ceased distributing guns for Walther. That alone probably cost it more than $40 million in sales. Add in the missing Walther sales and S&W says revenue would have been up more than 9% in the second quarter.
Handgun sales are showing strength despite the lack of a tailwind from threatened gun legislation to push buyers into stores. Management says pistol sales in particular were up 27%. Finally, no longer depressed by the low-margin Walther distribution agreement, gross margin on S&W's guns soared 610 basis points to 41.6%.
Foolish takeaway
Flush with cash, and trading for a P/E ratio of less than 10, Smith & Wesson continues to look attractive. If there's one thing holding me back from buying, though, it's that lack of positive free cash flow. If and when S&W manages to get that little detail repaired, it should be open season on the shares.
