Yesterday, the “other shoe dropped” in the matter of SportCo Holdings, the company that owns, among others, Ellett Brothers and United Sporting Co. After months of rumors concerning their overall fiscal health, the company filed for Chapter 11 bankruptcy, saying it planned to liquidate it’s holdings.

The company cited management’s impression that Hillary Clinton would win the White House in 2016 and it’s subsequent speculation into guns and ammunition based on that mistaken presumption as one major factor in their failure. Rather than booming sales and healthy margins, they were caught with inventory no one wanted.

Company CEO Bradley Johnson also cited other factors, including industry “disruption” caused by the Bass Pro Shop acquisition of Cabela’s, Gander Mountain’s bankruptcy and hurricanes that devastated much of the Southeast, including South Carolina.

But there’s more to this story than the long-term impact the failure will have on an already turgid business environment.

The top ten major unsecured creditors in the SportCo filing are (from #1 to #10) : Vista Outdoors ($3,299,326.61), Sturm Ruger ($3,196.842.10), Magpul Industries ($2,078,353.17), Savage Arms Rifles ($1,927,392.50), Bushnell Corp. ($1,879,795.66), Navico Company ($1,743,684.04), Henry RAC Holding Corp. ($1,467,618.00), Smith & Wesson Corp. ($1,386, 714.26), Garmin USA, Inc. ($1,150,579.41), and Fiocchi of America ($1,096, 632.70).

The filing’s listing of other unsecured creditors reads like a who’s who of the rest of the industry: FN America, Magtech, Remington Arms, Kel-Tec, Hornady, Leupold & Stevens, Heckler & Koch, Barrett Firearms, Browning Arms Company, Blaser USA, Armscor, Chiappa, Bond Arms, Truglo, and SCCY.

Keep in mind those are only the top 30 creditors. SportCo’s filing says there are anywhere from 200 to 999 companies and individuals.

With SportCo Holdings filing, the industry will be roiled for some time to come.

But another legal action, this time a civil suit filed in South Carolina nearly three weeks ago, by a New York financial group lays the groundwork for a story that will have even longer-lasting implications.

The first question will undoubtedly be whether the South Carolina suit puts the legality of the Delaware filing into question.

That’s because the two corporations listed as holding 10% or more of SportCo’s equity interest are Prospect Capital Corporation and Wellspring Capital Partners I.V. LP.

The opposing parties in the South Carolina suit.

Prospect Capital Corp., has filled their civil suit against “Wellspring Capital Management LLC; Wellspring Capital Partners IV, L.P.; WCM GenPar IV, L.P.; WCM GenPar IV GP, LLC; Alexander E. Carles; William F. Dawson, Jr.; John E. Morningstar; Bradley Johnson; F. Hewitt Grant; Charles E. Walker,Jr.; Todd Boehly; Bernard Ziomek; Andrew Kupchik; and John Does One through One Hundred.”

According to the filing, that listing of individuals, managers and entities were collectively loaned a total of $188,864,420.94, ostensible to build Ellett Brothers LLC and the various affiliated subsidiaries.

Instead, the suit alleges is the funds never used for their intended purpose. Instead the borrowers used them - along with proceeds of additional loans from other lenders- to enrich..themselves.

In fact, the lawsuit claims that $183,169,466.94 of more than $188-million went to Wellspring IV- the controlling and largest shareholder of the borrowers.

If that’s the case, this would unquestionably be the largest fraud case -ever- in the firearms industry.

The 32-page lawsuit paints a plain-language, less-than-flattering image of the group of investors Prospect Capital alleges took a company that as recently as 2015 was the fifth-largest privately held corporation in South Carolina and ran it into the ground. Along the way, they lined their own pockets with the loans and sales generated by the company.

Having read many lawsuits over the years, this plainly-worded filing pulls no punches, characterizing the intent of both the owners and managers of Ellett Brothers and its subsidiaries as less than honorable.

Citing record industry sales in 2016, the lawsuit notes that as Ellett’s sales increased, its profits decreased “lagging significantly behind its competitors.”

“Despite those recent periods of elevated sales, it continues, “the D&O defendants completely ruined Ellett, which is now on the brink of extinction. Ellett survived the Great Depression, serious recessions in the 1970s, 1990s, and 2000s, and legislation banning certain of its products. But Ellett could not survive the disastrous tenure of the D&O defendants, which caused Ellett to make the Fraudulent Conveyances and whose reckless and grossly negligent mismanagement of Ellett and bad faith dereliction of their duties led to the dissipation of substantially all of Ellett’s assets during some of the most historically profitable times for companies in the firearms industry.”

That is not typical legalese. One criminal attorney I asked to review the suit characterized it as “anything but a typical civil filing.” In fact, he said it reads like a “pre-charging document prepared by any decent prosecutor looking to go to a grand jury for an indictment.”

The suit is filed in South Carolina- Ellett’s HQ, and specifically references South Carolina’s “Statute of Elizabeth” - the litmus test for fraudulent conveyances.

Under that law, “every gift, grant alienation, bargain, transfer, and conveyance of lands… for any intent or purpose to delay, hinder, or defraud creditors and others of their just and lawful actions, suits, debts, accounts, damages, penalties, and forfeitures must be deemed and taken… to be clearly and utterly void…”

There are also these “badges of fraud”:

- insolvency or indebtedness of of transferor

- a lack of consideration for the conveyance

- a relationship between the transferor and transferee

- pending or threatened litigation

- secrecy of concealment

- departure from usual methods of business

- transfer or debtor’s entire estate

- reservation of benefit to the transferor

- retention by the debtor of possession of the property

In making the case for the actions of Ellett management meeting one-or several- of those “badges of fraud” the suit references transfers of millions of dollars received via loans to the trustees and the transfers of most -if not all- of those funds (and others) on the same day (my emphasis) to one or more of the parties listed as defendants in the suit.

This isn’t a simple case, and the filing by Prospect Capital certainly only represents one side in the story. But it clearly defines the battlefield across which a major industry story will be fought.

With nearly 190-million dollars in play, there will be some big guns involved in the civil suit. The implications for criminal actions also can’t be discounted.

Unfortunately, it seems things are tough worldwide for the firearms companies.

Late last week, I was forwarded a German business media report regarding Heckler & Koch.

It began with this (translated) headline: “The Gun Manufacturer Hecker & Koch Is Facing the End”.

It wasn’t a question; it was a straightforward, declarative sentence.

The story went on to report that H&K was losing a financial battle due to lagging sales, In fact, the report said, 2018’s losses were so significant that financial issues were only cushioned by “two bridging loans from an unnamed major shareholder.”

So severe was the situation that KPMG inserted a warning in their 2018 audit. The passage reads: “the lack of liquidity endangers the continued existence of Heckler & Koch. To ensure continued existence, significantly more revenue would have to be generated in the current year than the previous year.”

Indications are that the necessary revenue generation hasn’t happened yet. Last month, H & K’s German workers approved a wage waiver, agreed to increase weekly working hours from 37 to 37.5 hours with no overtime, and cancelled a planned one-time payment of 400 Euros per worker.

Earlier this year, H&K was forced to pay a multi-million fine over illegal arms exports to Mexico.

H&K, meanwhile, remains in the competition for the new assault rifle for the Bundeswehr - which currently carries the company’s G36.

But an issue outside rifle performance stipulated in the Ministry of Defense specs - is causing concern that H&K may be disqualified.

The issue? The overall fiscal health of companies being considered. H&K has asked for a change in the fiscal requirements, but the German report quotes politicians as saying any lessening of the fiscal requirements would be a very “political decision” -and not likely.

Currently H&K supplies the armies of France, Norway and Lithuania with combat rifles in addition to the German Bundeswehr.

Is H&K is “facing the end” or simply suffering the same lagging sales pressuring other manufacturers?

No one knows at this point, but I do know that U.S. manufactures are considering almost any option- from “rightsizing” production staff to outsourcing virtually everything except the actual manufacturing of product - to survive what has turned out to be a very long dry spell.

As always, we’ll keep you posted.

—Jim Shepherd