SMITH & WESSON BRANDS, INC. annual report, FY2013

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Business context and reporting period

This is Smith & Wesson Holding Corporation’s Form 10-K for the fiscal year ended April 30, 2013, filed June 25, 2013. The filing reports fiscal 2013 and comparative fiscal 2012 and 2011 results; it also provides fourth-quarter figures. This differs from the request metadata’s “2012 Q4” period. The company manufactures firearms and related products. Results below generally reflect continuing operations; its Security Solutions business was divested in July 2012 and is reported as discontinued operations.

Financial and operating highlights

  • Revenue: Fiscal 2013 net sales were $587.5 million, up 42.6% from $412.0 million. Handgun sales rose 36.1% to $324.6 million; long-gun sales rose 75.0% to $179.2 million.
  • Profit and margins: Gross profit was $218.4 million, with a 37.2% gross margin, versus $128.0 million and 31.1% in fiscal 2012. Operating income was $132.8 million (22.6% of sales), versus $44.9 million (10.9%). Continuing-operations income was $81.4 million, or $1.22 diluted per share, versus $26.4 million, or $0.40. Including discontinued operations, net income was $78.7 million, or $1.18 diluted per share, versus $16.1 million, or $0.25.
  • Fourth quarter: Fiscal Q4 net sales were $178.7 million, gross profit $68.5 million, continuing-operations income $28.6 million, and net income $25.2 million. Q4 gross profit included a $3.0 million charge for the Thompson/Center Arms bolt-action rifle recall.
  • Cash flow and investment: Cash provided by operating activities was $98.1 million, compared with $37.4 million. Capital expenditures were $41.4 million, versus $13.8 million; the simple difference between operating cash flow and capital expenditures was $56.7 million. Cash and cash equivalents at year-end were $100.5 million.
  • Liquidity and debt: Working capital was $147.0 million and the current ratio was 2.8, compared with $107.4 million and 2.3 a year earlier. Long-term notes payable were $43.6 million; no short-term debt or revolving-credit borrowings were outstanding at year-end. The company had a $60 million revolving credit facility and reported compliance with debt covenants.

Material changes versus the prior comparable period

  • Firearm production units increased 40.4%, but year-end order backlog more than doubled to $877.3 million from $421.0 million. Management said backlog exceeded annual manufacturing capacity and cautioned that orders could be cancelled or overstated by channel ordering.
  • Management attributed stronger results to higher volume, favorable product mix, improved manufacturing efficiency and fixed-cost absorption, and selected product price increases. Operating expenses rose only 3.0% despite the sales increase.
  • Fiscal 2013 capital spending increased substantially, primarily for production capacity, efficiency, new-product tooling, manufacturing technology, and a new ERP system.
  • The company repurchased $20.0 million of common stock during fiscal 2013. After year-end, it authorized a new repurchase program of up to $100 million.
  • After year-end, the company issued $100 million of 5.875% senior notes due 2017, exchanging approximately $42.8 million of 9.5% notes and selling additional notes for cash. The filing says this increased indebtedness by $57.1 million and annual debt service by $1.8 million.
  • Walther’s exclusive U.S. importer and distributor agreement ended at fiscal year-end; production of PPK and PPK/S handguns was expected to continue under existing rights through fiscal 2014.

Outlook, commentary, risks and unusual items

  • Management planned further fiscal 2014 product introductions and capacity increases through capital investment and outsourced components. It stated that existing resources, credit facilities, and the post-year-end notes were expected to fund operations and commitments for the next 12 months, apart from major acquisitions. No specific fiscal 2014 revenue or earnings guidance is provided in the supplied filing text.
  • Demand was associated in part with new-product acceptance and consumer concern about possible firearm legislation. Management noted that demand may change, that backlog may include excess distributor orders, and that capacity constraints could limit shipments or create excess capacity if demand falls.
  • On June 13, 2013, the company initiated a recall of Thompson/Center Arms bolt-action rifles manufactured since product introduction in 2007. It reported $3.6 million of recall costs incurred and estimated $3.8 million of remaining costs; fiscal 2013 warranty expense was $7.1 million.
  • The company disclosed continuing DOJ investigation into potential Foreign Corrupt Practices Act violations and an SEC fact-finding inquiry into potential federal securities-law violations. It was cooperating and could not predict outcomes. It also faced product-liability, municipal, shareholder derivative, and other litigation; outcomes and potential additional losses were uncertain.
  • Other cited risks include proposed firearm regulation, reliance on sporting-goods distribution, key suppliers, product-liability exposure, environmental remediation, and execution risks from the planned fiscal 2014 ERP implementation. The filing records a $577,000 environmental reserve and identifies two sites where it had received potentially responsible party notices.
  • SWSS contributed a $2.7 million after-tax discontinued-operations loss in fiscal 2013, including a $1.2 million loss on sale. The company reported that its independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting, and management concluded controls were effective as of April 30, 2013.

Important facts for investors to verify

  1. Whether the $877.3 million backlog converted to shipments and sales, given capacity limits, possible cancellations, and potential channel over-ordering.
  2. The final costs, claims experience, and any further product actions related to the Thompson/Center rifle recalls.
  3. Developments and financial consequences, if any, from the DOJ and SEC investigations and pending litigation.
  4. Post-year-end debt balances, the terms and use of proceeds from the 5.875% notes, and the effect of the $100 million share-repurchase authorization on liquidity and leverage.
  5. Progress and cost to complete the ERP implementation and capacity investments, including the stated $12.8 million remaining construction-in-progress spending estimate.