Smith & Wesson Holding (NASDAQ:SWHC) wowed Wall Street last week, delivering fiscal first-quarter 2007 sales growth far exceeding expectations, better profits than predicted, and upping guidance for the rest of the new fiscal year (2007). Result: a one-day 8% pop in the share price.

Year over year, the company posted revenue growth of 50% on the strength of amazing pistol sales growth. Firearms revenue in general grew 54%, while Walther pistol sales rocketed 73% and S&W's own-brand sales grew 84%. Management executed brilliantly on its promise to grow sales of its new Military & Police (M&P) line of products, reporting that sales to law enforcement had doubled since this time last year, and that combined sales to law enforcement and the federal government (including U.S. Army purchases used to arm the Afghan military and police) more than tripled.

Although the company was not specific on this point, I suspect that the large increase in volume of sales also benefited S&W by delivering certain economies of scale. In a world of continued high energy and raw materials prices, it would otherwise be hard to explain the 530-basis point improvement in gross margins to 34.7%.

Mind you, the lower parts of the income statement didn't look nearly so good. Operating margins declined 270 basis points to 12.4%, and net margins fell 140 basis points to 7.1%. However, both of these numbers are deceiving; one year ago, earnings benefited from a one-time "environmental reserve reduction" that temporarily inflated operating and net margins, and that did not recur this quarter.

And speaking of recurring events, management seems pretty confident that last week's numbers were no flash in the pan. Looking farther out, it expects to repeat success and maintain gross margins in the 34% range. It also upped sales and earnings guidance by roughly 10%, and now predicts $200 million in revenue and $0.36 per share for the year.

Where's the cash?
So much for the world according to GAAP. But as pretty as the accounting profits picture appears, it seems my concerns about free cash flow, expressed in last week's Foolish Forecast, have proven correct. In predicting its cash flow for the rest of the year, S&W scaled back its operating cash flow estimate for the year to about $13 million, while adding $5 million in expansion capital expenditures (to fund its move into producing "long guns") to its already-stated objective of $8 million in maintenance capex. Result: Even as management upped its GAAP profits prediction to $15 million, its free cash flow now looks likely to approach zero.

Call me a cynic, but when I see non-existent free cash flow, contrasted with apparently superb GAAP results, and promises of more of the same in the near future -- and combined with a planned offering of 15 million shares -- I get the uneasy feeling that the business isn't as strong as the GAAP numbers imply.

S&W has a history of reporting higher accounting profits than it generates as free cash flow. See:

For timely guidance on managing your portfolio, why not try a free test-drive of one of our investing newsletters? You can look any of them over for 30 days, and there's no obligation to subscribe.

Fool contributor Rich Smith has no interest, short or long, in Smith & Wesson.