CONDENSED BALANCE SHEETS

(Dollars in thousands)

Note:

See notes to condensed financial statements.

STURM, RUGER & COMPANY, INC.

CONDENSED BALANCE SHEETS (Continued)

(Dollars in thousands, except share data)

Note:

The balance sheet at December 31, 2013 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

See notes to condensed financial statements.

STURM, RUGER & COMPANY, INC.

CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)

(Dollars in thousands, except per share data)

See notes to condensed financial statements.

STURM, RUGER & COMPANY, INC.

CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(Dollars in thousands)

See notes to condensed financial statements.

STURM, RUGER & COMPANY, INC.

CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands)

See notes to condensed financial statements.

STURM, RUGER & COMPANY, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands, except per share)

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 99.6% of the Company’s total sales for the three and six months ended June 28, 2014 were firearms sales, and 0.4% were investment castings sales.  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 for internal use in its firearms and for sale to unaffiliated, third-party customers. 

Orders of 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

During the first half of 2014, there was a significant industry-wide reduction in firearms demand.  National Instant Criminal Background Check System (“NICS”) background checks (as adjusted by the National Shooting Sports Foundation (“NSSF”)) during the second quarter and first half of 2014 decreased 12% and 18%, respectively, from the comparable prior year periods. 

During the second quarter and first half of 2014, the estimated unit sell-through of our products from the independent distributors to retailers decreased 31% and 11%, respectively, from the comparable prior year periods.  The estimated sell-through of our products from distributors to retailers in the second quarter was adversely impacted by the following:

• the reduction in overall industry demand,
• the aggressive discounting of many of our competitors, and
• the absence of recent significant new product introductions from the Company. 

Nonetheless, the estimated sell-through of our products from the independent distributors to retailers for the six months ended June 28, 2014 was the second highest in the Company’s history, exceeding the estimated sell-through from the first half of 2012 by 83,100 units or 10%.

New products represented $57.1 million or 18% of firearm sales in the first half of 2014.

Estimated sell-through from the independent distributors to retailers and total NICS background checks for the trailing six quarters follows:

(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)        While NICS background checks are not a precise measure of retail activity, they are commonly used as a proxy for retail demand.  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.  While not a direct correlation to firearms sales, the NSSF-adjusted NICS data provides a more accurate picture of current market conditions than raw NICS data.  

Orders Received and Ending Backlog

Net orders received in the first half of 2014 decreased 66% from the comparable prior year period and our ending order backlog of 1.0 million units at June 28, 2014 decreased 1.0 million units from backlog of 2.0 million units at June 29, 2013.  This decrease is due to the reduction in demand discussed above and the unprecedented level of orders received in the first quarter of 2013. 

The units ordered, value of orders received and ending backlog, net of excise tax, for the trailing six 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.)

Production

Total unit production in the first half of 2014 increased 7% from the first half of 2013.  During the three months ended June 28, 2014, production rates were reduced in response to the decline in estimated sell-through of our products from the independent distributors to retailers. 

The Company reviews the estimated sell-through from the independent distributors to retailers semi-monthly in an effort to regulate production and mitigate increases in inventory.  As estimated sell-through began to slow, the Company managed its labor force by limiting the hiring of new employees, reducing overtime hours, and allowing attrition to reduce its total employee base.  The Company’s compensation structure, under which at least 25% of individual employee compensation was variable in 2013, allows for a more rapid reduction in labor cost.

Capital expenditures have been curtailed by the cancellation or delay of purchase orders and the redeployment of manufacturing equipment from mature production lines to new production lines for products in development.

           In 2013, the Company revised its estimate of the useful life of machinery and equipment from 10 to 7 years.  This change, which became effective December 31, 2013, resulted in increased depreciation expense of $2 million and $4 million for the three and six months ended June 28, 2014, respectively.  The Company estimates that this change will increase depreciation expense for the machinery and equipment on hand at December 31, 2013 by approximately $8 million in 2014.

Summary Unit Data

Firearms unit data for the trailing six quarters are as follows:

(3)       Net of Federal Excise Tax of 10% for handguns and 11% for long guns.

Inventories 

            The Company’s finished goods inventory increased by 75,400 units during the first half of 2014.  This is the first significant replenishment of finished goods inventory in several years.  Additional replenishment of finished goods inventory could increase the FIFO value of finished goods inventory by as much as $10 million.

           Distributor inventories of the Company’s products increased by 120,800 units during the first half of 2014 and approximate a reasonable level to support rapid fulfillment of retailer demand.  The Company reviews the estimated sell-through from the independent distributors to retailers semi-monthly in an effort to regulate production and mitigate further increases in distributor inventory.

             Inventory data for the trailing six quarters follows:

(4)         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.

(5)         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 $153.7 million for the three months ended June 28, 2014, a decrease of 14.4% from $179.5 million in the comparable prior year period.

For the six months ended June 28, 2014, consolidated net sales were $323.5 million, a decrease of 3.5% from $335.4 million in the comparable prior year period.

Firearms net sales were $153.0 million for the three months ended June 28, 2014, a decrease of 13.4% from $176.8 million in the comparable prior year period.

For the six months ended June 28, 2014, firearms net sales were $322.2 million, a decrease of 2.4% from $330.2 million in the comparable prior year period.

Firearms unit shipments decreased 11.0% for the three months ended June 28, 2014 but remained virtually unchanged for the six months ended June 28, 2014 from the comparable prior year periods.  The greater percentage decrease in firearms net sales compared to firearms unit shipments is attributable to decreased accessory sales in the three and six months ended June 28, 2014.

Casting net sales were $0.6 million for the three months ended June 28, 2014, a decrease of 76.6% from $2.7 million in the comparable prior year period.

For the six months ended June 28, 2014, castings net sales were $1.4 million, a decrease of 73.8% from $5.2 million in the comparable prior year period.

During 2013, the Company prioritized its internal casting needs and terminated many of its outside casting customers.  As a result net casting sales decreased.

Cost of Products Sold and Gross Profit

Consolidated cost of products sold was $103.3 million for the three months ended June 28, 2014, a decrease of 5.1% from $108.8 million in the comparable prior year period.

For the six months ended June 28, 2014, consolidated cost of products sold was $212.1 million, an increase of 4.3% from $203.4 million in the comparable prior year period.

              Gross margin was 32.8% and 34.5% for the three and six months ended June 28, 2014, respectively, compared to 39.4%  in the comparable prior year periods as illustrated below (in thousands):

Cost of products sold, before LIFO, overhead and labor rate adjustments to inventory, and product liability — During the three and six months ended June 28, 2014, cost of products sold, before LIFO, overhead and labor rate adjustments to inventory, and product liability increased as a percentage of sales by 7.2% and 5.3% compared with the comparable 2013 periods due principally to reduced sales volume, a product mix shift away from higher-margin firearms accessories, and increased depreciation expense due to the reduction in the estimated useful lives of the Company’s capital assets.

LIFO — For the three months ended June 28, 2014, gross inventories increased by $12.4 million and the Company recognized LIFO expense resulting in increased cost of products sold of $0.4 million.  In the comparable 2013 period, gross inventories increased by $1.9 million and the Company recognized LIFO expense resulting in increased cost of products sold of $0.4 million.

For the six months ended June 28, 2014, gross inventories increased by $18.8 million and the Company recognized LIFO expense resulting in increased cost of products sold of $0.8 million.  In the comparable 2013 period, gross inventories increased by $0.3 million and the Company recognized LIFO expense resulting in increased cost of products sold of $0.5 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 six months ended June 28, 2014, the Company was less efficient in overhead spending and the overhead rates used to absorb overhead expenses into inventory increased, resulting in increases in inventory value of $0.5 million and $0.6 million, respectively, and corresponding decreases to cost of products sold.

During the three and six months ended June 29, 2013, the Company was more efficient in overhead spending and the overhead rates used to absorb overhead expenses into inventory decreased, resulting in decreases in inventory value of $0.5 million and $0.9 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 six months ended June 28, 2014 and June 29, 2013, the impact of the labor rate adjustment was de minimis.

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. 

For the three and six months ended June 28, 2014 product liability costs totaled $0.3 million and $0.7 million, respectively.  For the three and six months ended June 29, 2013, product liability costs totaled $0.3 million and $0.7 million, respectively.  See Note 10 to the notes to the condensed financial statements “Contingent Liabilities” for further discussion of the Company’s product liability.

Gross Profit — As a result of the foregoing factors, for the three and six months ended June 28, 2014, gross profit was $50.4 million and $111.5 million, respectively, a decrease of $20.3 million and $20.5 from $70.7 million and $132.0 million in the comparable prior year periods.  Gross profit as a percentage of sales decreased to 32.8% and 34.5% in the three and six months ended June 28, 2014 from 39.4% in the comparable prior year periods.

Selling, General and Administrative, and Other Operating Expenses

Selling, general and administrative, and other operating expenses were $17.3 million and $40.5 million for the three and six months ended June 28, 2014, respectively, a decrease of $2.7 million and $3.6 million from the comparable prior year periods.  This decrease is attributable to decreased volume-driven promotional selling expenses.

Other income, net

Other income, net was $0.1 million and $0.4 million in the three and six months ended June 28, 2014, compared to $0.1 million and $0.3 million in the three and six months ended June 29, 2013, respectively.

Income Taxes and Net Income

The Company’s effective income tax rate in the three and six months ended June 28, 2014 was 32.8% and 34.8%, respectively.  The Company’s effective income tax rate in the three and six months ended June 29, 2013 was 36.5%.  The decrease in the effective income tax rate in 2014 is due to the recognition of an increase in the 2013 domestic production activities deduction.

As a result of the foregoing factors, consolidated net income was $22.3 million and $46.6 million for the three and six months ended June 28, 2014.  This represents a decrease of 31.0% and 16.8% from $32.3 million and $56.0 million in the comparable prior year periods.

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 EBITDA, a non-GAAP financial measure 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 this non-GAAP financial measure 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 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 decreased 25% and 9% for the three and six months ended June 28, 2014 compared to the prior year periods.

Non-GAAP Reconciliation – EBITDA

EBITDA

(Unaudited, dollars in thousands)

Financial Condition

Liquidity

At the end of the second quarter of 2014, the Company’s cash totaled $47.4 million.  Pre-LIFO working capital of $124.0 million, less the LIFO reserve of $39.3 million, resulted in working capital of $84.7 million and a current ratio of 2.3 to 1. 

Operations

Cash provided by operating activities was $35.6 million for the six months ended June 28, 2014 compared to $69.8 million for the comparable prior year period.  The decrease in cash provided by operations is primarily attributable to the increases in inventory and other assets during the six months ended June 28, 2014 and the decreases in accounts payable and employee compensation during such period.

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 six months ended June 28, 2014 totaled $22.8 million.  In 2014, the Company expects to spend approximately $40 million on capital expenditures to purchase tooling fixtures and equipment for new product introductions and to upgrade and modernize manufacturing equipment.  The Company finances, and intends to continue to finance, all of these activities with funds provided by operations and current cash. 

Dividends of $20.0 million were paid during the six months ended June 28, 2014. 

On July 29, 2014, the Board of Directors authorized a dividend of 45¢ per share, for shareholders of record as of August 15, 2014, payable on August 29, 2014.  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 six months ended June 28, 2014, the Company did not repurchase any shares of its common stock.  As of June 28, 2014, $25 million remained available for future stock repurchases.

On July 29, 2014, the Board of Directors expanded the Company’s authorization to repurchase shares of its common stock from $25 million to $100 million.

The Company has migrated its retirement benefits from defined-benefit pension plans to defined-contribution retirement plans, utilizing its current 401(k) plan.

The Company amended its hourly and salaried defined-benefit pension plans so that employees no longer accrued benefits under them effective December 31, 2007.  This action “froze” the benefits for all employees and prevented future hires from joining the plans.  Currently, the Company provides supplemental discretionary contributions to substantially all employees’ individual 401(k) accounts.

The Company contributed $3 million in both 2013 and 2012.  In future years, the Company may be required to make cash contributions to the two defined-benefit pension plans.  The annual contributions will be based on the amount of the unfunded plan liabilities derived from the frozen benefits and will not include liabilities for any future accrued benefits for any new or existing participants.  The total amount of these future cash contributions will depend on the investment returns generated by the plans’ assets and the then-applicable discount rates used to calculate the plans’ liabilities. 

         The Company expects to satisfy all of its obligations under the frozen pension plans when market conditions are favorable.  Late in the fourth quarter of 2013, 94% of the pension plans’ assets were allocated to money market funds to capture the investment returns in 2013.  This was an initial step to prepare to fully fund and terminate the plans in accordance with Internal Revenue Service and Pension Benefit Guaranty Corporation requirements, which, if successful, would not occur before late 2014 or early 2015. Plan participants will not be adversely affected by the plan terminations, but rather will have their benefits either converted into a lump sum cash payment or an annuity contract placed with an insurance carrier.

It is expected that the settlement of the frozen pension plans would have a material impact on the financial results of the period in which it occurs, and may have a material impact on the financial position of the Company.

          Based on its unencumbered assets, the Company believes it has the ability to raise cash through issuance of short-term or long-term debt.  The Company’s unsecured $40 million credit facility, which expires on June 15, 2015, remained unused at June 28, 2014 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 related 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 has transitioned to a new enterprise resource planning system and has converted all of its manufacturing facilities and its support functions during the past two years.

The valuation of the future defined-benefit pension obligations at December 31, 2013 and 2012 indicated that these plans were overfunded by $0.5 million and underfunded by $19.6 million, respectively, which resulted in a cumulative other comprehensive loss of $19.4 million and $29.6 million on the Company’s balance sheet at December 31, 2013 and 2012, respectively.

           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 2013 Annual Report on Form 10-K filed on February 25, 2014, 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 of future firearms control and environmental legislation, 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.

ITEM 3.              QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Historically, the Company has been exposed to changing interest rates on its investments, which consisted primarily of United States Treasury instruments with short-term (less than one year) maturities and cash.  The interest rate market risk implicit in the Company’s investments at any given time is typically low, as the investments mature within short periods and the Company does not have significant exposure to changing interest rates on invested cash.

ITEM 4.              CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (the “Disclosure Controls and Procedures”), as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of June 28, 2014.

Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of June 28, 2014, such Disclosure Controls and Procedures are effective to ensure that information required to be disclosed in the Company’s periodic reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer or persons performing similar functions, as appropriate, to allow timely decisions regarding disclosure. 

Additionally, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, there have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 28, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The effectiveness of any system of internal controls and procedures is subject to certain limitations, and, as a result, there can be no assurance that the Disclosure Controls and Procedures will detect all errors or fraud.  An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the internal control system will be attained.

PART II.            OTHER INFORMATION

ITEM 1.             LEGAL PROCEEDINGS

         The nature of the legal proceedings against the Company is discussed at Note 10 to the consolidated financial statements in this Form 10-Q report, which is incorporated herein by reference.

         The Company has reported all cases instituted against it through March 29, 2014, and the results of those cases, where terminated, to the S.E.C. on its previous Form 10-Q and 10-K reports, to which reference is hereby made.

         There were no lawsuits formally instituted against the Company during the three months ending June 28, 2014.

ITEM 1A.          RISK FACTORS

There have been no material changes in the Company’s risk factors from the information provided in Item 1A. Risk Factors included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

ITEM 2.             UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

                            Not applicable

ITEM 3.             DEFAULTS UPON SENIOR SECURITIES

                            Not applicable

ITEM 4.             MINING SAFETY DISCLOSURES             

                            Not applicable

ITEM 5.             OTHER INFORMATION

                            None

ITEM 6.              EXHIBITS

(a)          Exhibits:

10.1  Sixth Amendment to Credit Agreement dated June 9, 2014 between the Company and Bank of America, N.A. (1)

31.1  Certification Pursuant to Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2  Certification Pursuant to Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1  Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2  Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)     Incorporated by reference to the Company’s Form 8-K filed with the S.E.C. on June 16, 2014.

STURM, RUGER & COMPANY, INC.

FORM 10-Q FOR THE THREE MONTHS ENDED JUNE 28, 2014

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.