STURM RUGER & CO INC 10-Q

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 accounted for approximately 7% of total sales for the nine month periods ended September 30, 2023 and October 1, 2022. 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 8% in the first nine months of 2023 compared to the prior year period. For the same period, NICS background checks (as adjusted by the National Shooting Sports Foundation (“NSSF”)) decreased 7%. Estimated sell-through from the independent distributors to retailers and total adjusted NICS background checks for the trailing seven quarters follow: 2023 2022 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Estimated Units Sold from Distributors to Retailers (1) 307,400 323,000 391,500 397,800 343,500 354,300 411,200 Total adjusted NICS Background Checks (thousands) (2) 3,284 3,654 4,168 4,531 3,764 3,917 4,213 (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. 19 (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. The adjusted NICS checks represent less than half of the total NICS checks. Adjusted NICS data can be impacted by changes in state laws and regulations and any directives and interpretations issued by governmental agencies. Orders Received and Ending Backlog The Company uses the estimated unit sell-through of its 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. The units ordered, value of orders received, average sales price of units ordered, and ending backlog 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.) 2023 2022 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Units Ordered 176,300 258,100 408,000 156,000 295,600 250,600 381,600 Orders Received $ 58.8 $ 102.1 $ 156.2 $ 81.0 $ 124.3 $ 98.9 $ 147.0 Average Sales Price of Units Ordered $ 334 $ 396 $ 383 $ 519 $ 421 $ 395 $ 385 Ending Backlog $ 234.8 $ 293.7 $ 327.3 $ 314.4 $ 377.6 $ 389.6 $ 420.5 Average Sales Price of Ending Unit Backlog $ 510 $ 496 $ 488 $ 486 $ 427 $ 405 $ 384 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. Consequently, the Company’s overall production in the first nine months of 2023 decreased by 18% from the first nine months of 2022 . 20 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): 2023 2022 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Units Ordered 176,300 258,100 408,000 156,000 295,600 250,600 381,600 Units Produced 324,500 387,400 381,000 397,300 382,800 431,800 521,300 Units Shipped 308,400 336,400 384,900 393,100 373,800 382,600 491,500 Average Sales Price of Units Shipped $ 390 $ 422 $ 387 $ 378 $ 371 $ 366 $ 338 Ending Unit Backlog 460,000 592,100 670,400 647,300 884,400 962,600 1,094,600 Inventories During the third quarter of 2023, the Company’s finished goods inventory increased by 16,100 units and distributor inventories of the Company’s products increased by 1,000 units. Inventory unit data for the trailing seven quarters follows: 2023 2022 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Company Inventory 176,100 160,000 108,900 112,800 108,600 99,700 50,400 Distributor Inventory (1) 306,200 305,200 291,800 298,400 303,100 272,800 244,600 Total Inventory (2) 482,300 465,200 400,700 411,200 411,700 372,500 295,000 (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. 21 Net Sales, Cost of Products Sold, and Gross Profit Net sales, cost of products sold, and gross profit data for the three months ended (dollars in millions): September 30, 2023 October 1, 2022 Change % Change Net firearms sales $ 120.4 $ 138.8 $ (18.4 ) (13.3% ) Net castings sales 0.5 0.6 (0.1 ) (15.2% ) Total net sales 120.9 139.4 (18.5 ) (13.3% ) Cost of products sold 96.2 100.5 (4.3 ) (4.3% ) Gross profit $ 24.7 $ 38.9 $ (14.2 ) (36.4% ) Gross margin 20.5% 27.9% (7.4% ) (26.5% ) Sales of new products, including the LCP MAX pistol, Marlin lever-action rifles, LC Carbine, Small-Frame Autoloading Rifle, Super Wrangler revolver, and the Security-380 pistol, represented $27.2 million or 22.9% of firearm sales in the three months ended September 30, 2023. New product sales include only major new products that were introduced in the past two years. The decreased gross profit for the three months ended September 30, 2023 is attributable to the decrease in sales, unfavorable deleveraging of fixed costs resulting from decreased production, increased promotional costs, inflationary cost increases in materials, commodities, services, wages, energy, fuel and transportation, and a product mix shift toward products with relatively lower margins that remain in relatively stronger demand. The decrease in gross margin for the three months ended September 30, 2023 is attributable the aforementioned factors, partially offset by increased pricing. Net sales, cost of products sold, and gross profit data for the nine months ended (dollars in millions): September 30, 2023 October 1, 2022 Change % Change Net firearms sales $ 411.1 $ 444.6 $ (33.5 ) (7.5% ) Net castings sales 2.1 2.0 0.1 1.6% Total net sales 413.2 446.6 (33.4 ) (7.5% ) Cost of products sold 311.8 306.1 5.7 1.9% Gross profit $ 101.4 $ 140.5 $ (39.1 ) (27.9% ) Gross margin 24.5% 31.5% (7.0% ) (22.2% ) 22 The decrease in total consolidated net sales and net firearms sales for the three and nine months ended September 30, 2023 is attributable to decreased consumer demand for firearms, as evidenced by the adjusted NICS checks. Sales of new products, including the MAX-9 pistol (during the first quarter only), LCP MAX pistol, Marlin lever-action rifles, LC Carbine, Small-Frame Autoloading Rifle, Super Wrangler revolver, and the Security-380 pistol, represented $90.5 million or 22.7% of firearm sales in the first nine months of 2023. New product sales include only major new products that were introduced in the past two years. The decreased gross profit for the nine months ended September 30, 2023 is attributable to the decrease in sales, inflationary cost increases in materials, commodities, services, wages, energy, fuel and transportation, unfavorable deleveraging of fixed costs resulting from decreased production, a product mix shift toward products with relatively lower margins that remain in relatively stronger demand, and increased promotional costs. The decrease in gross margin for the nine months ended September 30, 2023 is attributable to the aforementioned factors, partially offset by increased pricing. Selling and General and Administrative Expenses Selling and general and administrative expenses data for the three months ended (dollars in millions): September 30, 2023 October 1, 2022 Change % Change Selling expenses $ 8.7 $ 8.8 $ (0.1 ) (1.1% ) General and administrative expenses 9.7 10.2 (0.5 ) (5.0% ) Total operating expenses $ 18.4 $ 19.0 $ (0.6 ) (3.2% ) The decrease in selling expenses for the three months ended September 30, 2023 was primarily attributable to the decreased shipping costs as a result of the decrease in sales for the period, partially offset by increased advertising and promotional activity. The decrease in general, and administrative expenses for the three months ended September 30, 2023 was primarily attributable to decreased professional service costs and decreased incentive compensation. 23 Selling and general and administrative expenses data for the nine months ended (dollars in millions): September 30, 2023 October 1, 2022 Change % Change Selling expenses $ 27.7 $ 25.8 $ 1.9 7.3% General and administrative expenses 31.9 30.9 1.0 3.1% Total operating expenses $ 59.6 $ 56.7 $ 2.9 5.0% The increase in selling expenses for the nine months ended September 30, 2023 was primarily attributable to the resumption of trade show participation costs, travel expenditures, and advertising, some of which had been deferred in 2022 due to COVID-19 restrictions, partially offset by decreased sales volume. The increase in general, and administrative expenses for the nine months ended September 30, 2023 was primarily attributable to increased professional service costs, partially offset by decreased incentive compensation. Other Income Other income data for the three months ended (dollars in millions): September 30, 2023 October 1, 2022 Change % Change Other income $ 1.8 $ 1.1 $ 0.7 55.7% The increase in other income for the three months ended September 30, 2023 was the result of increases in interest income, partially offset by decreased royalty and miscellaneous income. Other income data for the nine months ended (dollars in millions): September 30, 2023 October 1, 2022 Change % Change Other income $ 5.1 $ 2.8 $ 2.3 78.0% The increase in other income for the nine months ended September 30, 2023 was the result of increases in interest income, partially offset by decreased royalty and miscellaneous income. The Company's 2023 and 2022 effective tax rates differ from the statutory federal tax rate due principally to research and development tax credits, state income taxes and the nondeductibility of certain executive compensation. The Company’s effective income tax rate was 8.1% and 18.9% for the three and nine months ended September 30, 2023, respectively. The Company’s effective income tax rate was 12.4% and 19.9% for the three and nine months ended October 1, 2022, respectively. 24 Non-GAAP Financial Measures 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 two non-GAAP financial measures, EBITDA and EBITDA margin, which management believes provides useful information to investors. These non-GAAP financial measures may not be comparable to similarly titled financial measures being disclosed by other companies. In addition, the Company believes that the non-GAAP financial measures should be considered in addition to, and not in lieu of, GAAP financial measures. The Company believes that EBITDA and EBITDA margin are 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 this 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 to arrive at EBITDA. The Company calculates EBITDA margin by dividing EBITDA by total net sales. EBITDA was $13.3 million for the three months ended September 30, 2023, a decrease of 50.8% from $27.0 million in the comparable prior year period. For the nine months ended September 30, 2023 EBITDA was $62.4 million, a decrease of 41.1% from $106.0 million in the comparable prior year period. Non-GAAP Reconciliation – EBITDA EBITDA (Unaudited, dollars in thousands) Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 September 30, 2023 October 1, 2022 Net income $ 7,431 $ 18,389 $ 37,966 $ 69,378 Income tax expense 658 2,602 8,848 17,236 Depreciation and amortization expense 6,530 6,656 19,576 20,120 Interest income (1,454 ) (730 ) (4,147 ) (951 ) Interest expense 122 88 177 205 EBITDA $ 13,287 $ 27,005 $ 62,420 $ 105,988 EBITDA margin 11.0% 19.4% 15.1% 23.7% 25 Financial Condition Liquidity and Capital Resources At the end of the third quarter of 2023, the Company’s cash and short-term investments totaled $120.0 million. Pre-LIFO working capital of $277.8 million, less the LIFO reserve of $65.0 million, resulted in working capital of $212.8 million and a current ratio of 4.5 to 1. Operations Cash provided by operating activities was $17.3 million for the nine months ended September 30, 2023, compared to $50.3 million for the comparable prior year period. The decrease in cash provided in the nine months ended September 30, 2023 is primarily attributable to the decrease in net income and the increase in prepaid expenses and other assets in the nine months ended September 30, 2023, partially offset by the decrease in accounts receivable in the nine months ended September 30, 2023. Third parties supply the Company with various raw materials for its firearms and castings, such as steel, 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. A limited supply of these materials in the marketplace can result in increases to purchase prices and adversely affect production levels. 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, 2023 totaled $11.6 million, a decrease from $17.2 million in the comparable prior year period. In 2023, the Company expects capital expenditures related to new product introductions and upgrades to our manufacturing equipment and facilities to total approximately $20 million. 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 and cash equivalents. Dividends of $107.8 million were paid during the nine months ended September 30, 2023. This included $88.3 million paid in January 2023 for a $5.00 per share special dividend declared by the Board of Directors in November 2022. The Company has financed its dividends with cash provided by operations and current cash. The quarterly dividend varies every quarter because the Company pays a percentage of earnings rather than a fixed amount per share. The Company’s practice is to pay a dividend of approximately 40% of net income. On October 27, 2023, the Company’s Board of Directors authorized a dividend of 17¢ per share to shareholders of record on November 15, 2023, payable on November 29, 2023. 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. As of September 30, 2023, the Company had $88.1 million of United States Treasury instruments which mature within one year. The Company also invests available cash in a bank-managed money market fund that invests exclusively in United States Treasury instruments which mature within one year. At September 30, 2023, the Company’s investment in this money market fund totaled $18.4 million. 26 The Company did not purchase any shares of its common stock during the nine months ended September 30, 2023. As of September 30, 2023, $86.6 million remained authorized for future stock repurchases. 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 January 7, 2025, was unused at September 30, 2023. 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. If these regulations become more stringent in the future and the Company is not able to comply with them, such noncompliance could have a material adverse impact on the Company. The Company has 15 independent distributors that service the domestic commercial market. Additionally, the Company has 45 and 25 distributors servicing the export and law enforcement markets, respectively. 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. Impact of Covid-19 The global outbreak of the coronavirus disease 2019 (“COVID-19”) was declared a pandemic by the World Health Organization and a national emergency by the U.S. Government in March 2020. The Company has taken many proactive steps to maintain the health and safety of its employees and to mitigate the impact on its business. During the nine month period ended September 30, 2023, the Company did not experience a significant adverse impact on its business from COVID-19 or related government restrictions. The Company cannot predict the extent to which its business, results of operations, financial condition, or cash flows will ultimately be impacted by COVID-19. Adjustments to Critical Accounting Policies The Company has not made any adjustments to its critical accounting estimates and assumptions described in the Company’s 2022 Annual Report on Form 10-K filed on February 22, 2023, or the judgments affecting the application of those estimates and assumptions. 27 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 of future firearms control and environmental legislation, the impact of COVID-19, and accounting estimates, any one or more of which could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made. The Company undertakes no obligation to publish revised forward-looking statements to reflect events or circumstances after the date such forward-looking statements are made or to reflect the occurrence of subsequent unanticipated events.