On Friday, gunmaker Smith & Wesson (AMEX:SWB) -- a company with a sterling history but a questionable future -- reported its second-quarter earnings. At first glance, the company hit every earnings bullseye in sight, but when shooting for an increase in revenues, the company couldn't hit the broad side of a proverbial barn. S&W's quarterly earnings more than tripled year on year, to $0.07 per diluted share -- despite less than 1% increase in quarterly sales. Similarly, over the first half of fiscal 2004, earnings rose by a bit more than two-and-a-half times; revenues actually decreased year on year, down by 1.4%.
Over both periods, the company did best at, well, what it does best: making and selling firearms. When compared to its 2003 results, S&W's sales of firearms actually increased in the first half of 2004. Its entire first-half decline in revenue can be attributed to lackluster sales of handcuffs, and discontinuation of its optics and third-party machining businesses.
All of which is really beside the point. After all, the revenue decline through the first half and the revenue increase in Q2 were both minuscule in size. The difference in sales had essentially no effect on the company's profitability either way. In fact, almost the entire increase in profits since 2003 came from S&W's insurance company agreeing to reimburse S&W for some past litigation expenses (and to bear some future litigation costs).
Now, being relieved of the cost of some of its future legal fees should permit the company to retain as profits some revenue that would otherwise have gone to its lawyers. That suggests that the company may be able to maintain its new higher level of profitability (S&W projects between $0.16 and $0.19 per diluted share in profits for fiscal 2004.) So this is not just a "one-time benefit" for the company. It is, however, a one-time jump in profitability. It seems highly unlikely that S&W will repeat this 250% annual increase in profits any time soon.
What's more, the gunmaker remains highly unprofitable from the point of view that matters most: free cash flow. Although cash from operations nearly doubled year on year, capital expenditures nearly doubled as well. Net result: True cash outflow grew from $0.9 million in 1H 2003 to $1.9 million in 1H 2004.
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Fool contributor Rich Smith owns no interest in any of the companies mentioned in this article.
