Free Cash Flow vs. Operating Cash Flow

[JaxNovice]

I cannot believe this guy runs a public company.




Smith & Wesson's Self-Inflicted Wound
By Rich Smith December 11, 2007
4
Recommendations
All is not well at arms maker Smith & Wesson (Nasdaq: SWHC).

For the second time in as many months, management issued a warning on sales trends last week, joining a string of companies issuing similar dire forecasts that stretches from Palm (Nasdaq: PALM) toFedEx (NYSE: FDX) toCitigroup (NYSE: C) toLowe's (NYSE: LOW). Having already talked down sales expectations to $325 million back in October, in Thursday's earnings report, S&W predicted just $300 million, 32% gross margins, and about $0.40 per share in profit. That last number, by the way, is 25% lower than management's October estimate -- which was itself a 16% reduction from management's guess just three months ago. All told, fully 37% of this year's expected profits have gone poof!

Where'd they go?
In the preliminary release, CEO Michael Golden mentioned a certain "softness in the market for hunting rifles and shotguns, driven by lower than expected consumer demand, a buildup of pre-season retail inventories, and unseasonably warm autumn weather." That trend seems to have taken a larger toll than management feared as recently as six weeks ago. Golden says we're in the middle of an "industry-wide inventory buildup, accentuated by lower retail traffic."

With piles of guns lying around, and everyone competing to make a sale, S&W's rival gunsmiths are "offering significant discounts on both long guns and handguns. This caused increased price competition in the channel and served to exacerbate already inflated inventory levels" (emphasis added).

Which one is the shootin' end?
Huh? OK, I get that high inventories have caused gun makers to compete on price, hurting profits. But how do "significant discounts ... exacerbate already inflated inventory levels"? Seems to me, the opposite should happen. If everybody cuts prices, inventories should fall as customers snap up cheap guns. I have to admit -- the apparent logical disconnect here doesn't give me a whole lot of confidence that management knows what it's talking about.

The more so because these guys seem confused about a lot of things. In trying to provide clear guidance for the rest of the year, it appears that S&W obfuscated matters further by mixing up its definitions of free cash flow and operating cash flow. After retranslating the release back into English, though, it seems that S&W is projecting cash from ops will be $29 million this year; minus $16 million in capital spending, that will leave $13 million in free cash flow.

Foolish takeaway
If you can work your way through management's language issues, that leaves us with a firm valued at roughly 21 times this year's free cash flow, expected to grow at 25% per year over the next half decade. If you ask me, the resulting price-to-free cash flow-to-growth ratio of 0.84 should make this stock a candidate forDirt Cheap Dream Stocksstatus -- that is, if you still have any confidence at all that management knows what it's talking about.

What did we expect out of S&W last quarter, and what did we find? Read about it in:

 

[mordechaianiliewicz]

I still refuse to buy a Smith, and that has nothing to do with their treachery. It has to do with them not making very good weapons.

 

[jakemccoy]

mordechaianiliewicz, what brand do you think makes good weapons?

 

[tinygnat219]

It was trading at near 20 bucks a share a few months ago. It's now 4 bucks or so a share. Just picked up 100 shares myself for giggles.

 

[individual]

I would also be interested in what's wrong with S&W products. My two M&Ps have performed flawlessly.

+1 on S&W's management needing training-wheels. :banghead:

 

[Run&Shoot]

I am not going to bash S&W because I suspect many companies, including firearms manufacturers have been caught with a lot of excess iventory and evaporating margins.

The challenge of any business, and especially a public one, is to grow the bet profits, that is the return on investment to the owners/stock holders. A business can grow net profits by decreasing cost of materials and operations, by entering new markets (products or geographic regions), or finding a way to increase margins on the products it does sell (that is increasing the perceived value so that customers will pay a premium).

One thing I think gun companies could do is to invest more in making it easier for shooters to practice shooting. Shooting ranges are drying up almost everywhere. The majority of shooters will not keep purchasing if they do not have a convenient place to shoot. perhaps they could build and operate company ranges, or provide sponsorship to new ranges, or help with legal issues or ordinances that make it expensive to start and operate a range.

Or, a company like S&W could provide more shooting clinics and fun shoots using their firearms at existing clubs. I bet every clinic of 50 people using M&P pistol would result in at least a couple of new loyal fans and consumers of their products. personally, I would jump at a low cost clinic on combat rifle shooting using the M&P AR15, or any of their fine revolvers and pistols. What about revolver hunting clinics and practices, or even S&W revolver hunting trips? If you believe you have a superior product, then create opportunities for people to get extended exposure to them, make them believers through trial use, and make it easy for them to purchase right now. Liked that M&P carbine used on last weekend's prairie dog shoot, well heck you can purchase that exact rifle right now, pard!

 

[strat81]

S&W will also be facing class-action lawsuits regarding securities laws.

http://news.moneycentral.msn.com/ticker/article.aspx?symbol=US:SWHC&feed=MW&date=20080110&id=8022409
http://news.moneycentral.msn.com/ticker/article.aspx?symbol=US:SWHC&feed=MW&date=20080110&id=8022629

More specifically, the Complaint alleges that the Company failed to disclose and misrepresented the following material adverse facts which were known to defendants or recklessly disregarded by them: (1) that the Company's reported sales figures were in fact inventory stocking transactions, as opposed to true representations of growth; (2) that the Company's subsequent quarterly sales would decrease as customers worked through overstocked inventory levels; (3) that the Company had observed market saturation in various product lines, which would have the effect of customers postponing or reducing orders and purchases; (4) that the Company lacked adequate internal and financial controls; and (5) that, as a result of the foregoing, the Company's statements about its financial well-being and future business prospects were lacking in any reasonable basis when made.

On October 29, 2007, the Company shocked investors when it announced its preliminary second quarter financial results, indicating therein that gross margins for the quarter would be lower than previously projected. The Company stated that it had observed softness in certain product markets, low consumer demand, and "a buildup of pre-season retail inventories." The Company further announced that it expected sales of $325 million for fiscal 2008, lower than its previous projection of $330 million. Additionally, the Company significantly lowered its earnings guidance for fiscal 2008 to $23.5 million, or $0.53 per share, compared to its previous guidance of between $28.5 million, or $0.63 per share. On this news, the Company's shares fell $7.97 per share, or 39.6 percent, to close on October 29, 2007 at $12.12 per share, on unusually heavy trading volume.

Then on December 6, 2007, the Company further shocked investors when it announced its final second quarter financial and operational results, painting an even more dismal picture than was presented in its preliminary results for the quarter. The Company disclosed that its reduced retail sales activities were "compounded by the fact that inventory in the channel was at an extremely high level," which had the effect of impacting product pricing in order to clear out built-up inventory. Additionally, the Company further lowered its sales forecast for fiscal 2008, down to $300 million for the year against its previously reduced guidance of $325 million for the year. On this news, the Company's shares fell an additional $1.84 per share, or 20.6 percent, to close on December 7, 2007 at $7.08 per share, again on heavy trading volume.

Plaintiff seeks to recover damages on behalf of class members and is represented by the law firm of Schiffrin Barroway Topaz & Kessler which prosecutes class actions in both state and federal courts throughout the country. Schiffrin Barroway Topaz & Kessler is a driving force behind corporate governance reform, and has recovered billions of dollars on behalf of institutional and individual investors from the United States and around the world.

 

[Valkman]

CEO Michael Golden mentioned a certain "softness in the market for hunting rifles and shotguns

S&W makes rifles and shotguns? LOL

I have older pre-lock revolvers and a M41 but that's all I'm interested in buying.

 

[Standing Wolf]

S&W makes rifles and shotguns? LOL

It's tried again and again without a shred of success. Smith & Wesson doesn't even make pistols very well any more, so I can't imagine why it thought it ought to go into the long guns line of work.

 

[Winchester 73]

Michael Golden had never fired a gun in his life when he became CEO of S&W.
How much competitive firearms savvy can be expected from a man with absolutely no groundwork in an extremely difficult field in which to show a profit?
Love him or hate him Bill Ruger was versed in firearms from the time he was weaned.
S&W seems to be cursed and probably will fall by the wayside eventually.
And Standing Wolf is correct.The quality of just 15 or 20 years ago is no longer there.I've had to repair my 686P .357 Mag twice in the last 2 years for internal problems.Very costly.

 

[Soybomb]

Michael Golden had never fired a gun in his life when he became CEO of S&W.
How much competitive firearms savvy can be expected from a man with absolutely no groundwork in an extremely difficult field in which to show a profit?

I think I could be sold that its not that important and a strong skills set as an executive with strategy and planning expertise is more important that being a shooter. You can study up on the history of the gun industry, your competition, and where the market is moving easier I think. Ymmv.

I've had to repair my 686P .357 Mag twice in the last 2 years for internal problems.Very costly.

Why wouldn't s&w fix it under warranty?

Anyway I haven't really followed SWHC for about a year now, have sales in the firearms industry dropped that quickly? Last I looked sales seemed quite brisk.

 

[Winchester 73]

I've had to repair my 686P .357 Mag twice in the last 2 years for internal problems.Very costly.

Why wouldn't s&w fix it under warranty?

Soybomb,they probably would have done the work under warranty.But you are now forced to overnite the firearm by UPS to Springfield MA due to UPS rip off rules and right there you are out over $50.00.And in both cases(firing pin and trigger problems)I did not think the jobs would be as costly as they turned out.Perhaps I was ripped off by the gunsmith.Who knows?
So I can't blame S&W for that.It's not their fault you have to overnite handguns.
But the fact remains this is the only S&W I have had problems with and its less than 6 years old.My other 3 S&W revolvers and pistol are all over 12 years old and have only required routine maintenance.
But maybe this 686P is just a lemon.Its has a wonderful trigger however, like butter(when working), and I'll bear with it and the company.I just hope they survive.

 

[Soybomb]

Soybomb,they probably would have done the work under warranty.But you are now forced to overnite the firearm by UPS to Springfield MA due to UPS rip off rules and right there you are out over $50.00.And in both cases(firing pin and trigger problems)I did not think the jobs would be as costly as they turned out.Perhaps I was ripped off by the gunsmith.Who knows?
So I can't blame S&W for that.It's not their fault you have to overnite handguns.
But the fact remains this is the only S&W I have had problems with and its less than 6 years old.My other 3 S&W revolvers and pistol are all over 12 years old and have only required routine maintenance.
But maybe this 686P is just a lemon.Its has a wonderful trigger however, like butter(when working), and I'll bear with it and the company.I just hope they survive.

For what its worth if you have problems with them again call S&W before you talk to your gunsmith. S&W will send you a prepaid shipping label and you won't be out a dime for the repairs. Their service department is the standard by which I judge others

 

[Winchester 73]

For what its worth if you have problems with them again call S&W before you talk to your gunsmith. S&W will send you a prepaid shipping label and you won't be out a dime for the repairs. Their service department is the standard by which I judge others

Thank you very much!I'll remember that if "Arnold"(686P)ever fails again.

 

[no_problem]

<<If you can work your way through management's language issues, that leaves us with a firm valued at roughly 21 times this year's free cash flow, expected to grow at 25% per year over the next half decade. If you ask me, the resulting price-to-free cash flow-to-growth ratio of 0.84 should make this stock a candidate forDirt Cheap Dream Stocksstatus -- that is, if you still have any confidence at all that management knows what it's talking about.>>

S&W spent over 100 mil in the acquisition of TC. They also have over 200 mln in debt. A company that heavily laden in debt, in the market making non-essential consumer products, in a country that has the heaviest deficit and in a recession, and with their former clients (law enforcement) moving to other vendors for LE firearms...I think that if I were the CEO, I would get on the biggest soapbox I can and yell as loud as I can that earnings are down and things look bad.

It sounds like what accountants call, taking a "big bath".

In short, the short term outlook is being spun by the CEO as bad, which allows him to clean the financial house and better position himself in the industry. As the recession and low interest rates allow him borrow money cheaply and to make strategic acquisitions and strengthen his position in the industry, when the industry consolidates, He'll be in a better position to increase his market share amongst lesser competitors. ...he hopes.

As far as the stock market right now, stocks are worth less than a truckload of dead rabbits at a rubber chicken factory. Too much Violatility in this recession economy, systemic risk is too high and stocks do not provide enough of a risk premium to entice me to move my money from risk free instruments.

That's just my opinion. YMMV, I suggest that if you disagree, do your own CAPM calculations and come to your own conclusions.

 

[MAKster]

What's killing S&W is that their much hyped synergy with the pistols, ARs, new shotguns, and bolt action rifles has been a total flop. The shotguns are overpriced Turkish guns that no one wants. The x-bolt is overpriced and I believe is being discontinued. The ARs are equal to the dozen other companies selling ARs but more expensive. Revolvers are the one product where they are the clear leader and they are ruining that with the internal lock. I suspect we'll be reading about Cerberus buying S&W in the near future.

 

[strat81]

S&W spent over 100 mil in the acquisition of TC. They also have over 200 mln in debt. A company that heavily laden in debt, in the market making non-essential consumer products, in a country that has the heaviest deficit and in a recession, and with their former clients (law enforcement) moving to other vendors for LE firearms...I think that if I were the CEO, I would get on the biggest soapbox I can and yell as loud as I can that earnings are down and things look bad.

According to their most recent 10-Q, they have approximately $215 million in liabilities. Not all liabilities are debt. Long term debt is approx. $119 million. Much of the balance of their liabilities include product liabilities, warranty liabilities, accounts payable, worker's comp, payroll, etc. That is, liabilities that any healthy company would have.

They also have approx. $49 million in accounts receivable (net), $51 million in inventory, and net PP&E of $49 million.

S&W realizes that it cannot bank on the success of handguns, hence the purchase of TC. TC gives them access to the premium rifle and handgun markets as well as black powder. The rifle market will look on S&W bolt-actions with some doubt, but not with TC products. And, by most accounts, the M&P handguns and M&P rifles have been a success.

This is a buying opportunity for S&W stock. IMO, it was over valued at $20+, but they'll do well in the coming months.

 

[KBintheSLC]

I would stay away from consumer weapon stocks right now (including ammo manufacturers like Olin Corp.). As the cost of raw materials, and energy continues to rise, the margins will just keep on shrinking. On the other hand, SWHC appears to be pretty well bottomed out. Nowhere to go but up..??

 

[JaxNovice]

I like Strats take. I think buying now would not be a bad move as I think if they could reduce inventories things would look up. I think that they stumbled in the belief that the S&W brand alone would drive sales in the new markets they entered. This proved to be wishful thinking.

 

[30 cal slob]

micro cap stocks =

consumer discretionary sector =

i'm calling up investor relations to bust their balls about my crappy Walther P-22 that won't work anymore =

 

[Intrepid Dad]

On the other hand, SWHC appears to be pretty well bottomed out. Nowhere to go but up..??

That's what I said about Webvan.

 

[BozemanMT]

I own SWHC, have for some time. quadrupled my money, sold a 1/4, now the rest is just riding. I think S&W has done some great things. Name one other gun company trying to innovate. Coming out with new products. Sure, some fail, but some don't.

Anyway

SWHC is in the same boat as Harley. For most people a gun (esp a hunting gun) is a luxury. If you are hurting, you aren't buying a luxury. You aren't buying a new motorcyle, you aren't buying a new gun. Consumer led recession is coming (probably here we'll find out in a year or so). Everyone has too much debt and just too much stuff. Look at all the self-storage things, do people really need all that crap? And yes, 98% of it is crap. People are out of cheap debt to spend, wages aren't matching our imagininary inflation ("you are only imagining that prices are going up for day to day items" .gov)

I still have my shares, they aren't going anwhere, they are in a better position than others. The AR's aren't really for the retail market, they are for the gov market. (Look, we have an end to end solution for your pistols and rifles" every police agency wants that). I might even double up again. Might take a few years to sort out but the strategy makes sense to me.

 

[no_problem]

>> Intrepid Dad
Senior Member


Join Date: 11-28-06
Location: Colorado Springs, CO
Posts: 124

Quote:
On the other hand, SWHC appears to be pretty well bottomed out. Nowhere to go but up..??
That's what I said about Webvan. <<

Intrepid Dad, I feel your pain!!

I remember when Webvan was the hottest thing since sliced bread. They were so overhyped about their warehouse and distribution network, then when they dropped like a rock and never recovered. They just kept dropping.

Yet another lesson learned...gotta take the marketing with a grain of salt.