Firearms & Ammunition
Date August 2017
- Industry growth has cooled off as regulations are expected to stabilize
- Manufacturing revenue is expected to decline at an annualized rate of 1.0% to $13.3 billion for the five years ended 2017
- Demand is driven by government contracts, such as weapons upgrades by police departments and the Army’s recent $580 million contract with Sig Sauer, hunters, and gun enthusiasts
Sales and manufacturing down: After back-to-back sales increases in 2015 and 2016, demand has dropped as post-election fears of gun control subside. Reflecting lower demand for guns, Fortune notes that Sturm Ruger & Company reported revenue for the quarter ending on July 1, 2017 to be down 22 percent at $132 million. The company said the drop was due to unusually strong demand last year related to the November 2016 election. Per the company, during the second quarter of 2017, retailers bought fewer guns as they worked through existing inventory, and revenues also fell as other manufacturers offered rebates. Similarly, sporting goods retailer Cabela’s posted a 4.2 percent decrease in second quarter revenue. “Since the fall election, we have continued to see a slowdown in firearms and shooting related categories,” noted Cabela’s Chief Executive Tommy Millner. The 2016 U.S. presidential election may have exerted the greatest impact on the firearm and ammunition manufacturing industry. Donald Trump’s victory over Hillary Clinton eased concerns over sweeping gun reform, which is driving a forecasted 6.8 percent decline for firearm and ammunition manufacturing revenue in 2017.
Government contracts are important demand driver: Government contracts are key to many manufacturers in the industry, from large to small arms manufacturers. In January 2017, the U.S. Army awarded Sig Sauer a contract worth $580 million to make the next service pistol based on the company’s P320 handgun, which is intended to replace the 90s-era M9 pistol. Sig Sauer beat out Glock Inc., FN America, and Beretta USA, the maker of the current M9 9mm service pistol, in the competition for the Modular Handgun System, or MHS, program. The 10-year agreement calls for Sig Sauer to supply the Army with full-size and compact versions of the gun, and formally ends the Beretta’s 30-year hold on the Army’s sidearm market. The pistols can be outfitted with silencers and accommodate standard and extended capacity magazines. The firearms will be manufactured at the company’s facilities in New Hampshire. Furthermore, the contract has the potential to increase the popularity of the P320 handgun in the civilian market as other pistols have seen after being used by the Army.
Some companies rely heavily on government contracts, and it should be noted that this can pose a significant risk should contracts expire or not be renewed. Lenders should be aware to what extent government contracts comprise total sales and the expiration dates of these agreements.
Licensure and ownership considerations in liquidation: A Federal Firearms License (“FFL”) is required in the U.S. to manufacture and sell firearms. According to the Bureau of Alcohol, Tobacco, Firearms and Explosives (“ATF”), a successor of a company, including a trustee in bankruptcy, cannot commence a firearms business without a new FFL, or a transfer of the existing FFL which requires appropriate vetting. Therefore, in the event of a liquidation it is likely that the business entity must be maintained to facilitate the sale or liquidation of the inventory. This is contrary to a typical orderly liquidation where the secured lender has obtained ownership control of the assets and the company has been shut down. Considering this, as well as the overall complexity of the regulations involved, it would be recommended that an individual with an equity position in the firearms company be retained to help facilitate a liquidation of the inventory, should that become necessary. Management could, therefore, keep the business entity legally in place for license purposes as well as help to make sure that all applicable laws and regulations are met throughout the sale.
Also, according to the ATF, an auctioneer does not generally need a dealer’s license to help sell the inventory in liquidation, as long as the auctioneer does not take possession or ownership of the inventory. If an auctioneer or other entity with an interest in the inventory takes possession of the inventory, they are assumed to have control and, therefore, are generally required to have a dealer’s license to facilitate the sale. As would be expected, organizations such as the ATF have the authority to restrict a sale if the appropriate laws are not met. In addition to needing an FFL, when a manufacturer or dealer goes out of business, all records relating to the sale of firearms must be forwarded to the ATF’s Out-of-Business Records Center within 30 days.
While an FFL is needed for the sale of firearms, it should be noted that frames and lower receivers are the only components classified as firearms. For other component parts such as gas tubes, stocks, rails, sights, barrels, and other parts and accessories, an FFL is not required.
Excise tax: The first time firearms and ammunition are sold in the U.S., they are subject to an excise tax if they meet certain criteria. Depending on what is furnished by the manufacturer, liability for the tax may or may not be the manufacturers. This tax is typically passed along to the customer and then collected by the seller and passed through to the government. In a liquidation, excise taxes would need to continue to be collected and remitted.
Background checks: As of May 2017, only eight states, California, Colorado, Connecticut, Delaware, New York, Oregon, Rhode Island, and Washington, as well as the District of Columbia, required universal background checks at point-of-sale for all transfers of all classes of firearms, including purchases from unlicensed sellers.
Background checks are customarily performed via the NICS, or National Instant Criminal Background Check System. The NICS is a U.S. system mandated by Brady Handgun Violence Prevention Act of 1993 used to determine if prospective firearms or explosives buyers’ name and birth year match those of a person who is not eligible to buy. The NICS was instituted on November 30, 1998 by the FBI, and the most recent complete calendar year NICS data is available for is 2016, when 27,538,673 NICS background checks were completed. From January 2017 through the end of July 2017, approximately 14.3 million NICS background checks were completed. This is a decline from approximately 16.0 million NICS background checks from January 2016 to July 2016.
Although the NICS data does not represent a one-for-one correlation between background checks and firearm sales, it is a reasonable representation of demand in the industry, which is down year-to-date for 2017.
Regulatory environment can impact values: The firearm and ammunition industry is one of the most regulated in the U.S. In recent years, there have been changes in state-by-state restrictions and regulations. This poses risks for manufacturers as some states have banned certain firearms by name, which can have an adverse effect on the manufacturer. Massachusetts, for example, banned the Colt AR-15 along with other firearms by name. Propositions to enact stricter gun control measures are an ever-changing factor depending upon state and federal government leadership. Potential changes in regulations continually pose risks to firearm manufacturers. Typically, when more extreme gun control measures are mentioned on a national scale, or in the wake of domestic attacks, there are typically increases in gun sales as civilians purchase more firearms and ammunition before any proposed legislation can be passed.
Collateral monitoring points: There are several risk factors that lenders to this industry should consider monitoring to ensure that the inventory collateral is not significantly deteriorating in value. Firstly, when an industry begins to slow, there is a greater risk that manufacturers will begin to build up inventory, which may ultimately become slow moving and less valuable in an appraisal. Second, lenders should monitor commodity prices. Lead, copper, steel, brass, and zinc prices, which are key inputs in manufacturing firearms and ammunition, have historically experienced significant volatility primarily due to increased global demand and industry supply issues. Raw material prices can affect liquidation values, especially when raw material price increases cannot be passed on to the customer when selling finished goods. Third, lenders should look for any deterioration in gross margins. If manufacturers find themselves in an overstocked situation, they could begin to offer customers discounts to move product, as was seen at the end of 2014. This causes a deterioration in gross margins, which negatively affects the liquidation value.