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Sturm Ruger & Company (RGR-N) Quote - Press Release

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10-Q: STURM RUGER & CO INC

Edgar Online - (EDG = 10Q, 10K) - Tue Oct 31, 4:05PM CDT

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Company Overview

Sturm, Ruger & Company, Inc. (the "Company") is principally engaged in the design, manufacture, and sale of firearms to domestic customers. Approximately 99% of sales are from firearms. Export sales represent approximately 5% of total sales. The Company's design and manufacturing operations are located in the United States and almost all product content is domestic. The Company's firearms are sold through a select number of independent wholesale distributors, principally to the commercial sporting market.

The Company also manufactures investment castings made from steel alloys and metal injection molding ("MIM") parts for internal use in its firearms and for sale to unaffiliated, third-party customers. Less than 1% of sales are from the castings segment.

Orders for many models of firearms from the independent distributors tend to be stronger in the first quarter of the year and weaker in the third quarter of the year. This is due in part to the timing of the distributor show season, which occurs during the first quarter.

Results of Operations

Demand

The estimated unit sell-through of the Company's products from the independent distributors to retailers decreased 25% and 16% in three and nine months ended September 30, 2017 from the comparable prior year periods. For the same periods, the National Instant Criminal Background Check System ("NICS") background checks (as adjusted by the National Shooting Sports Foundation ("NSSF")) decreased 16% and 10%. The decrease in estimated sell-through of the Company's products from the independent distributors to retailers is attributable to:

· Decreased overall consumer demand in 2017 due to stronger-than-normal demand during most of 2016, likely bolstered by the political campaigns for the November 2016 elections,

· Reduced purchasing by retailers in an effort to reduce their inventories and generate cash,

· Aggressive price discounting and lucrative consumer rebates offered by many of our competitors, and

· Increased industry manufacturing capacity, which exacerbated the above factors.

Sales of new products, including the Mark IV pistols, the LCP II pistol, and the Precision Rifle, represented $118.8 million or 30% of firearm sales in the first nine months of 2017. New product sales include only major new products that were introduced in the past two years.

Index

Estimated sell-through from the independent distributors to retailers and total adjusted NICS background checks for the trailing seven quarters follow:

2017                                             2016
                                                              Q3            Q2            Q1            Q4            Q3            Q2            Q1
Estimated Units Sold from Distributors to Retailers (1)     341,300       362,400       533,800       529,100       453,400       453,700       571,000
Total adjusted NICS Background Checks (thousands) (2)         2,948         3,116         3,694         4,861         3,519         3,199         4,148

(1) The estimates for each period were calculated by taking the beginning inventory at the distributors, plus shipments from the Company to distributors during the period, less the ending inventory at distributors. These estimates are only a proxy for actual market demand as they:

· Rely on data provided by independent distributors that are not verified by the Company,

· Do not consider potential timing issues within the distribution channel, including goods-in-transit, and

· Do not consider fluctuations in inventory at retail.

(2) NICS background checks are performed when the ownership of most firearms, either new or used, is transferred by a Federal Firearms Licensee. NICS background checks are also performed for permit applications, permit renewals, and other administrative reasons.

The adjusted NICS data presented above was derived by the NSSF by subtracting out NICS checks that are not directly related to the sale of a firearm, including checks used for concealed carry ("CCW") permit application checks as well as checks on active CCW permit databases.

Orders Received and Ending Backlog

The Company uses the estimated unit sell-through of our products from the independent distributors to retailers, along with inventory levels at the independent distributors and at the Company, as the key metrics for planning production levels. The Company generally does not use the orders received or ending backlog for planning production levels.

Index

The units ordered, value of orders received and ending backlog, net of excise tax, for the trailing seven quarters are as follows (dollars in millions, except average sales price):

(All amounts shown are net of Federal Excise Tax of 10% for handguns and 11% for long guns.)

2017                                             2016
                                                     Q3            Q2            Q1            Q4            Q3            Q2            Q1
Units Ordered                                      221,900       214,400       395,000       432,100       445,700       399,400       969,400
Orders Received                                  $    62.9     $    62.4     $   131.9     $   130.2     $   116.5     $   145.7     $   296.1
Average Sales Price of Units Ordered             $     283     $     291     $     334     $     301     $     261     $     365     $     305
Ending Backlog                                   $    56.6     $    95.0     $   163.8     $   195.0     $   219.1     $   257.6     $   276.1
Average Sales Price of Ending Unit Backlog (1)   $     332     $     342     $     331     $     314     $     306     $     331     $     313

(1) The average sales price of units in the third quarter of 2016 was reduced due to strong orders for the relatively lower priced LCP II pistol, and the cancellation of orders for the original version of relatively higher priced Precision rifle, which was discontinued due to the popularity of the new Enhanced Precision rifle.

Production

The Company reviews the estimated sell-through from the independent distributors to retailers, as well as inventory levels at the independent distributors and at the Company, semi-monthly to plan production levels. These reviews resulted in decreased total unit production of 38% and 17% for the three and nine months ended September 30, 2017, respectively, from the comparable prior year periods.

Summary Unit Data
Firearms unit data for the trailing seven quarters are as follows (dollar
amounts shown are net of Federal Excise Tax of 10% for handguns and 11% for long
guns):
                                                        2017                                             2016
                                           Q3            Q2            Q1            Q4            Q3            Q2            Q1
Units Ordered                            221,900       214,400       395,000       432,100       445,700       399,400       969,400
Units Produced                           327,300       432,900       529,900       566,200       527,600       529,600       502,100
Units Shipped                            329,100       432,000       521,000       527,300       507,500       504,000       516,700
Average Sales Price of Units Shipped   $     315     $     302     $     319     $     304     $     315     $     330     $     332
Ending Unit Backlog                      170,600       277,800       495,400       621,400       716,600       778,400       883,000

Index

Inventories

During the third quarter of 2017, the Company's finished goods inventory decreased by 1,800 units and distributor inventories of the Company's products decreased by 12,200 units.

Inventory data for the trailing seven quarters follows:

2017                                             2016
                                        Q3            Q2            Q1            Q4            Q3            Q2            Q1
Units - Company Inventory             165,400       167,200       166,200       157,400       118,500        98,500        72,800
Units - Distributor Inventory (1)     363,800       376,000       306,400       319,300       321,100       267,000       216,700
Total inventory (2)                   529,200       543,200       472,600       476,700       439,600       365,500       289,500

(1) Distributor ending inventory is provided by the Company's independent distributors. These numbers do not include goods-in-transit inventory that has been shipped from the Company but not yet received by the distributors.

(2) This total does not include inventory at retailers. The Company does not have access to data on retailer inventories of the Company's products.

Net Sales

Consolidated net sales were $104.8 million for the three months ended September 30, 2017, a decrease of 35.1% from $161.4 million in the comparable prior year period.

For the nine months ended September 30, 2017, consolidated net sales were $404.0 million, a decrease of 19.6% from $502.5 million in the comparable prior year period.

Firearms net sales were $103.7 million for the three months ended September 30, 2017, a decrease of 35.2% from $160.1 million in the comparable prior year period.

For the nine months ended September 30, 2017, firearms net sales were $400.5 million, a decrease of 19.6% from $497.9 million in the comparable prior year period.

Firearms unit shipments decreased 35.2% and 16.1% for the three and nine months ended September 30, 2017, respectively, from the comparable prior year periods.

Casting net sales were $1.2 million for the three months ended September 30, 2017, a decrease of 15.3% from $1.4 million in the comparable prior year period.

For the nine months ended September 30, 2017, castings net sales were $3.5 million, a decrease of 23.9% from $4.6 million in the comparable prior year period.

Index

Cost of Products Sold and Gross Profit

Consolidated cost of products sold was $74.6 million for the three months ended September 30, 2017, a decrease of 32.9% from $111.2 million in the comparable prior year period.

Consolidated cost of products sold was $283.1 million for the nine months ended September 30, 2017, a decrease of 15.8% from $336.4 million in the comparable prior year period.

Index

Gross margin was 28.8% and 29.9% for the three and nine months ended September 30, 2017, respectively, compared to 31.1% and 33.0% in the comparable prior year periods as illustrated below (in thousands):

Three Months Ended
                                               September 30, 2017            October 1, 2016
Net sales                                  $ 104,817         100.0 %    $ 161,427         100.0 %
Cost of products sold, before LIFO,
overhead and labor rate adjustments to
inventory, and product liability              76,097          72.6 %      109,302          67.7 %
LIFO expense                                     695           0.7 %          576           0.4 %
Overhead rate adjustments to inventory        (2,070 )        (2.0 )%         748           0.5 %
Labor rate adjustments to inventory             (284 )        (0.3 )%        (107 )        (0.1 )%
Product liability                                165           0.2 %          657           0.4 %
Total cost of products sold                   74,603          71.2 %      111,176          68.9 %
Gross profit                               $  30,214          28.8 %    $  50,251          31.1 %
                                                             Nine Months Ended
                                               September 30, 2017            October 1, 2016
Net sales                                  $ 404,026         100.0 %    $ 502,480         100.0 %
Cost of products sold, before LIFO,
overhead and labor rate adjustments to
inventory, product liability, and
product recall                               281,581          69.7 %      331,797          66.0 %
LIFO expense                                   2,175           0.6 %        1,775           0.4 %
Overhead rate adjustments to inventory        (3,291 )        (0.8 )%       1,239           0.3 %
Labor rate adjustments to inventory             (308 )        (0.1 )%         116             -
Product liability                                456           0.1 %        1,495           0.3 %
Product recall                                 2,500           0.6 %            -             -
Total cost of products sold                  283,113          70.1 %      336,422          67.0 %
Gross profit                               $ 120,913          29.9 %    $ 166,058          33.0 %

Index

Cost of products sold, before LIFO, overhead and labor rate adjustments to inventory, product liability, and product recall - During the three months ended September 30, 2017, cost of products sold, before LIFO, overhead and labor rate adjustments to inventory, product liability, and product recall increased as a percentage of sales by 4.9% compared with the corresponding 2016 period primarily due to the 35% decrease in sales which resulted in unfavorable de-leveraging of fixed manufacturing costs, including depreciation and indirect labor.

For the nine months ended September 30, 2017, cost of products sold, before LIFO, overhead and labor rate adjustments to inventory, product liability, and product recall increased as a percentage of sales by 3.7% compared with the corresponding 2016 period due to the 20% decrease in sales which resulted in unfavorable de-leveraging of fixed manufacturing costs, including depreciation and indirect labor.

LIFO - For the three months ended September 30, 2017 the Company recognized LIFO expense resulting in increased cost of products sold of $0.7 million. In the comparable 2016 period, the Company recognized LIFO expense resulting in increased cost of products sold of $0.6 million.

For the nine months ended September 30, 2017, the Company recognized LIFO expense resulting in increased cost of products sold of $2.2 million. In the comparable 2016 period, the Company recognized LIFO expense resulting in increased cost of products sold of $1.8 million.

Overhead Rate Adjustments - The Company uses actual overhead expenses incurred as a percentage of sales-value-of-production over a trailing six month period to absorb overhead expense into inventory. During the three and nine months ended September 30, 2017, the Company became less efficient in overhead spending and the overhead rates used to absorb overhead expenses into inventory increased, resulting in an increase in inventory values of $2.1 million and $3.3 million, respectively, and a corresponding decrease to cost of products sold.

During the three and nine months ended October 1, 2016, the Company became more efficient in overhead spending and the overhead rates used to absorb overhead expenses into inventory decreased, resulting in decreases in inventory values of $0.7 million and $1.2 million, respectively, and corresponding increases to cost of products sold.

Labor Rate Adjustments - The Company uses actual direct labor expense incurred as a percentage of sales-value-of-production over a trailing six month period to absorb direct labor expense into inventory. During the three and nine months ended September 30, 2017 the Company became less efficient in direct labor utilization and the labor rates used to absorb labor expenses into inventory increased, resulting in increases in inventory value of $0.3 million and corresponding decreases to cost of products sold in both periods.

During the three and nine months ended October 1, 2016, impact of the change in labor rates used to absorb incurred labor expenses into inventory was insignificant.

Product Liability - This expense includes the cost of outside legal fees, insurance, and other expenses incurred in the management and defense of product liability matters.

During the three and nine months ended September 30, 2017 product liability expense was $0.2 million and $0.5 million, respectively.

During the three and nine months ended October 1, 2016 product liability expense was $0.7 million and $1.5 million, respectively.

Index

Product Recall - In June 2017, the Company discovered that Mark IV pistols manufactured prior to June 1, 2017 had the potential to discharge unintentionally if the safety was not utilized correctly. The Company recalled all Mark IV pistols and recorded a $2.5 million expense in the second quarter, which is the expected total cost of the recall. No such expense was recorded in the prior year.

Gross Profit - As a result of the foregoing factors, for the three and nine months ended September 30, 2017, gross profit was $30.2 million and $120.9 million, respectively, a decrease of $20.1 million and $45.2 million from $50.3 million and $166.1 million in the comparable prior year periods.

Gross profit as a percentage of sales decreased to 28.8% and 29.9% in the three and nine months ended September 30, 2017, respectively, from 31.1% and 33.0% in the comparable prior year periods.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $17.0 million for the three months ended September 30, 2017, a decrease of $3.2 million or 16.3% from $20.2 million in the comparable prior year period. This decrease is primarily attributable to the absence of the "2.5 Million Gun Challenge" and the "$5 Million Matching Challenge", both of which were in effect in 2016. The decrease was partially offset by increased firearms promotional activities in 2017.

Selling, general and administrative expenses were $58.4 million for the nine months ended September 30, 2017, a decrease of $4.9 million or 7.7% from $63.3 million in the comparable prior year period. This decrease is primarily attributable to the absence of the "2.5 Million Gun Challenge" and the "$5 Million Matching Challenge", both of which were in effect in 2016. The decrease was partially offset by increased firearms promotional activities in 2017.

Other income, net

Other income, net was $0.1 million and $0.8 million in the three and nine months ended September 30, 2017, respectively, compared to $0.4 million and $0.8 in the three and nine months ended October 1, 2016, respectively.

Income Taxes and Net Income

The Company's effective income tax rate in the three and nine months ended September 30, 2017 was 30.3% and 34.0%, respectively. The Company's effective income tax rate in the three and nine months ended October 1, 2016 was 34.8% and 35.7%, respectively. The decrease in the effective tax rate in 2017 is attributable to the inclusion of the tax impact of 2017 equity-based compensation in income taxes, as required by newly issued Accounting Standards Update (ASU) 2016-09, "Improvements to Employee Share Based Payment Accounting." In the prior year, the tax impact of equity-based compensation was recorded directly into equity.

As a result of the foregoing factors, consolidated net income was $9.4 million and $41.8 million for the three and nine months ended September 30, 2017, respectively. This represents a decrease of 52.8% and 37.3% from $19.9 million and $66.6 million in the comparable prior year periods.

Index

Non-GAAP Financial Measure

In an effort to provide investors with additional information regarding its financial results, the Company refers to various United States generally accepted accounting principles ("GAAP") financial measures and one non-GAAP financial measure, EBITDA, which management believes provides useful information to investors. This non-GAAP financial measure may not be comparable to similarly titled financial measures being disclosed by other companies. In addition, the Company believes that the non-GAAP financial measure should be considered in addition to, and not in lieu of, GAAP financial measures. The Company believes that EBITDA is useful to understanding its operating results and the ongoing performance of its underlying business, as EBITDA provides information on the Company's ability to meet its capital expenditure and working capital requirements, and is also an indicator of profitability. The Company believes that this reporting provides better transparency and comparability to its operating results. The Company uses both GAAP and non-GAAP financial measures to evaluate the Company's financial performance.

EBITDA is defined as earnings before interest, taxes, and depreciation and amortization. The Company calculates its EBITDA by adding the amount of interest expense, income tax expense, and depreciation and amortization expenses that have been deducted from net income back into net income, and subtracting the amount of interest income that was included in net income from net income.

EBITDA was $20.8 million for the three months ended September 30, 2017, a decrease of 46.6% from $39.1 million in the comparable prior year period.

For the nine months ended September 30, 2017, EBITDA was $89.4 million, a decrease of 30.6% from $128.9 million in the comparable prior year period.

Non-GAAP Reconciliation - EBITDA
EBITDA
(Unaudited, dollars in thousands)
                                                 Three Months Ended                Nine Months Ended
                                            September 30,     October 1,      September 30,     October 1,
                                                2017             2016             2017             2016
Net income                                 $       9,370     $    19,850     $      41,793     $   66,642
Income tax expense                                 4,071          10,604            21,530         36,925
Depreciation and amortization expense              7,373           8,567            26,026         25,263
Interest expense, net                                 30              32                96            102
EBITDA                                     $      20,844     $    39,053     $      89,445     $  128,932

Index

Financial Condition

Liquidity

At the end of the third quarter of 2017, the Company's cash totaled $45.4 million. Pre-LIFO working capital of $143.7 million, less the LIFO reserve of $44.7 million, resulted in working capital of $98.9 million and a current ratio of 2.8 to 1.

Operations

Cash provided by operating activities was $59.0 million for the nine months ended September 30, 2017, compared to $85.4 million for the comparable prior year period. This decrease is primarily due to decreased earnings in 2017 and working capital fluctuations in both periods.

Third parties supply the Company with various raw materials for its firearms and castings, such as fabricated steel components, walnut, birch, beech, maple and laminated lumber for rifle stocks, wax, ceramic material, metal alloys, various synthetic products and other component parts. There is a limited supply of these materials in the marketplace at any given time, which can cause the purchase prices to vary based upon numerous market factors. The Company believes that it has adequate quantities of raw materials in inventory or on order to provide sufficient time to locate and obtain additional items at then-current market cost without interruption of its manufacturing operations. However, if market conditions result in a significant prolonged inflation of certain prices or if adequate quantities of raw materials cannot be obtained, the Company's manufacturing processes could be interrupted and the Company's financial condition or results of operations could be materially adversely affected.

Investing and Financing

Capital expenditures for the nine months ended September 30, 2017 totaled $13.2 million, a decrease from $23.0 million in the comparable prior year period. In 2017, the Company expects to spend approximately $30 million on capital expenditures to purchase tooling fixtures and equipment for new product introductions and to upgrade and modernize manufacturing equipment. Due to market conditions and business circumstances, actual capital expenditures could vary significantly from the projected amount. The Company finances, and intends to continue to finance, all of these activities with funds provided by operations and current cash.

Dividends of $20.2 million were paid during the nine months ended September 30, 2017.

On October 27, 2017, the Board of Directors authorized a dividend of 21¢ per share, for shareholders of record as of November 15, 2017, payable on November 30, 2017. The payment of future dividends depends on many factors, including internal estimates of future performance, then-current cash and short-term investments, and the Company's need for funds. The Company has financed its dividends with cash provided by operations and current cash.

During the nine months ended September 30, 2017, the Company repurchased 1.3 million shares of its common stock for $64.8 million in the open market. The average price per share purchased was $49.10. These purchases were funded with cash on hand. As of September 30, 2017, $88.6 million remained authorized for future stock repurchases. No shares were repurchased in the nine months ended October 1, 2016.

Index

Based on its unencumbered assets, the Company believes it has the ability to raise cash through the issuance of short-term or long-term debt. The Company's unsecured $40 million credit facility, which expires on June 15, 2018, remained unused at September 30, 2017 and the Company has no debt.

Other Operational Matters

In the normal course of its manufacturing operations, the Company is subject to occasional governmental proceedings and orders pertaining to workplace safety, firearms serial number tracking and control, waste disposal, air emissions and water discharges into the environment. The Company believes that it is generally in compliance with applicable Bureau of Alcohol, Tobacco, Firearms & Explosives, environmental, and safety regulations and the outcome of any proceedings or orders will not have a material adverse effect on the financial position or results of operations of the Company.

The Company self-insures a significant amount of its product liability, workers' compensation, medical, and other insurance. It also carries significant deductible amounts on various insurance policies.

The Company expects to realize its deferred tax assets through tax deductions against future taxable income.

Adjustments to Critical Accounting Policies

The Company has not made any adjustments to its critical accounting estimates and assumptions described in the Company's 2016 Annual Report on Form 10-K filed on February 22, 2017, or the judgments affecting the application of those estimates and assumptions.

Forward-Looking Statements and Projections

The Company may, from time to time, make forward-looking statements and projections concerning future expectations. Such statements are based on current expectations and are subject to certain qualifying risks and uncertainties, such as market demand, sales levels of firearms, anticipated castings sales and earnings, the need for external financing for operations or capital expenditures, the results of pending litigation against the Company, the impact . . .

Oct 31, 2017

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