Smith and Wesson firearms: history and design

Smith & Wesson (S&W) is the nations' leading manufacturer of handguns, hunting accessories and safety equipment, and has one of the strongest brand names in this specific area of the firearms industry, with a 153-year-old legacy to build on. The company is publicly traded on the NASDAQ exchange under the symbol SWHC, and currently has a market capitalization of $518M with a P/E Ratio of 59.64. The turn-around strategy defined in this profile has been very successful, as their latest quarterly results attest with total revenue of $48M, gross profit of $16.6M, operating income of $5.8M and net income of $3.37M. With 854 employees producing their pistols, firearms, accessories and safety products in two manufacturing plants, Smith & Wesson is well positioned to move into entirely new segments of the firearms and weapons market. One manufacturing center is in Springfield, Massachusetts where revolvers and pistols are produced, and a second center in Houlton, Maine that manufactures handcuffs and pistols. The company has a series of impressive accomplishments including being the largest U.S. manufacturer of handguns, the largest U.S. exporter of handguns, the largest U.S. manufacturer of handcuffs. In addition Smith & Wesson's revolvers have the #1 market share position in the U.S., and this manufacturer also has the #3 U.S. Pistol Market share. Most significantly of all Smith & Wesson has 87% brand awareness with the general public. Smith & Wesson senior management's biggest challenge is turning this significant brand identity into greater growth in high-growths security markets.

A new leadership team has been brought in, and their immediate results have been impressive. This team was brought in during CY 2004. There has been a 20%+ growth in sales, primarily driven by an aggressive new marketing campaign, a greater focus on core markets, and more aggressive selling and distribution strategies in the fragmented handgun industry in the U.S. Smith & Wesson's financial performance, markets served, existing an planned new product lines, competitors, and key differentiators are provided in this company profile

Financial Performance

The strategy of bringing in a turn-around team of senior executives by the Smith & Wesson Board of Directors is working. Presented in Table 1, Smith & Wesson Holding Company Income Statement Comparisons, the impressive turnaround underway is quantified in both Total Revenues and a gain of $3.4M in Net Income between 2005 and 2006. The most recent 10-Q filed by Smith & Wesson on July 31, 2006 with the Securities and Exchange Commission on shows continue strength in sales, with a quarterly net product and services sales of $48M and a gross margin of 35% with a net income of $3,37M, Smith & Wesson's turn-around is in full force.

Table 1: Smith & Wesson Holding Co. Income Statement Comparisons

Total Revenues

Cost of Revenues

Selling, General & Administrative

Research & Development

Other Indirect Expenses

Total Indirect Expenses

Interest Income

Interest Expense

Realized Capital Gains (Losses)

Foreign Exchange Gain (Loss)

Income Taxes

Net Income

Average Shares (Basic)

Average Shares (Diluted)

Outstanding Shares

Earnings per share - Net Income (Basic)

Earnings per share - Net Income (Diluted)

The financial ratio analysis shown in Table 2, Smith & Wesson Holding Company Financial Ratio Analysis also shows the strength of the turn-around now in progress at the company. Return on Equity (ROE) continues to post very solid gains as the company moves into higher margin, and much more in-demand pistols and security products at the regional, national, and global level. Return on Assets (ROA) has also turned around, mainly as the result of more efficient processes being put into place within the key manufacturing centers the company owns in Massachusetts and Maine. Most significant results of the turnaround team is the dramatic turn-around on EBITA. This comes from rejuvenating the value of the brand, bringing in better cost controls and better distribution channel processes, and better management of the product mix as it relates to high-growth customer segments including state and local police departments, which has been a high growth area for Smith & Wesson.

Table 2 Smith & Wesson Holding Co Financial Ratio Analysis

Profitability Ratios

Return on Equity (%)

Return on Assets (%)

Return on Investment

Gross Margin

EBITDA of Revenue (%)

Operating Margin (%)

Pre-Tax Margin

Net Profit Margin (%)

Effective Tax Rate (%)

Liquidity Indicators

Quick Ratio

Current Ratio

Working Capital/Total Assets

Debt Management

Current Liabilities/Equity

Total Debt to Equity

Long-Term Debt to Assets

Asset Management

Revenues/Total Assets

Revenues/Working Capital

Interest Coverage

Markets Served

Smith & Wesson's revenue growth is attributable to 20% sales growth in sports, law, military & federal, and international markets, including new sales to the California Highway Patrol and Afghan Army. Here is a brief description of each of the core markets Smith & Wesson competes in:

Sporting Goods - The turn-around management team has abandoned an indirect sales force and moved to a direct sales force of 16 salespersons at last count to work with dealers to increase sales into high-margin segments. These segments include engraving, commemorative guns and performance centers. The launch of the S&W 460 and 500 revolvers assisted the growth of this segment.

Law Enforcement - S&W had nearly lost this market during the 1970s to Glock, who had created a polymer revolver that was very popular with law enforcement agencies throughout the U.S. In response to the drop in sales within this segment, S&W hired two sales reps away from Glock and increased sales staff by adding eight additional sales reps. With the introduction of the M&P pistol S&W is also getting more demonstration opportunities with police departments. At last count S&W had demonstrated the pistol at 150 departments and 33 law enforcement agencies.

Military/Federal - Through intensive lobbying and much work with Washington-based agencies stressing the fact the majority of U.S. government agencies were using foreign-manufactured pistols and firearms, S&W executives were successful in gaining four U.S. government contracts worth $20M to manufacture firearms for the Afghan Army. S&W executives also are working with U.S. government senior contacts to pursue the opportunity of selling weapons to the Iraqi Army and police forces.

International - After hiring a former executive from Colt who subsequently completely revamped the sales channels for Europe, Latin America, Asia and the Middle East, this segment declined during FDY2003 and 2004 yet has seen a significant rise during FY2006 attributed mostly to sales in Latin America.

Licensing - Previously unstaffed at the senior management level, the market and business development for Licensing is now managed by a senior executive with over 20 years of experience in this area. The result has been a $1.8M increase from licenses for hearing/eye protection, knives, safes, soft air guns, and branded merchandise.

Existing and New Products

At present the company is the market share leader in revolvers and pistols, yet does not participate in hunting rifles, tactical rifles, ammunition, and security systems. On November 16th S&W announced its move into the shotgun market, valued at $350M a year in sales and an integral part of the $1B per year long gun market. S&W will unveil their two models at the January SHOT show, and will produce the shotguns in a manufacturing center in Turkey. What is truly unique about their entrance into the shotgun market is the lifetime Heirloom Warranty on the two shotgun models.

Existing products include the S&W line of revolvers and pistols. The revolvers including the Scandium, Model 500 and Model 460XR. Pistols include the S&W 1911 Family and the M&P Pistol launched in 2005. The company is relying on the S&W 460 and S&W500 to further penetrate the sporting goods channel and segment as well.

S&W Key Differentiators Emerging during the turn-around the company is experiencing today are a series of key differentiators relative to competitors and market dynamics:

Regaining market share in the Law Enforcement segment through new product introductions better aligned with the needs of this segment relative to competitors.

Rejuvenated Sporting Goods segment through the combination of a more focused product strategy and more aggressive sales strategy.

Entrance into the long gun marketplace with the launch of two new shotgun models which will be formally introduced at the SHOT trade show in January.

Strengthening brand equity and very strong name awareness throughout the general public. This has translated into strength in Licensing Revenues and an increase of $1.8M in revenues overall for the latest fiscal year.

Emerging strength in the Military and Federal markets and strengthening relationships in Washington DC have yielded the company $20M in incremental revenue from four new contracts.

Assignment #2: Porter Five Forces Analysis

The five forces that comprise Dr. Porter's model are industry competitors, pressure for substitute products, bargaining power of suppliers, bargaining power of buyers, and the influence of potential entrants. Figure 1 shows the Porter Five Forces Model graphically. Each of these areas is now discussed in bullet form in the following series of sections.

Rivalry or Industry Competitors

Despite the fragmented nature of the handgun market, S&W faces strong competition from global competitors. This is true across all customer segments and most intense in the federal and military market. In this segment S&W competes with Beretta from Italy, Heckler & Koch from Germany and Fabrique Nationale from Belgium. The most dominant competitor in this segment is Glock of Austria, which sold 50,000 Glock Model 19 pistols to Iraqi Security Forces without the consent and approval of U.S.-based collation command or the U.S. Congress. Glock, in refusing to cooperate with the U.S. military, has opened up a significant opportunity for S&W in government markets based on the conflict Glock has created and the preference of Congressional members to buy from domestic suppliers.

Available Substitute Products

There is an abundance of substitute products as the handgun marketplace is fragmented with nine different manufacturers, each with between 5% to 14% market shares. Glock and their innovation in polymer pistols and firearms revolutionized the industry in the 1980s, yet S&W was able to regain their market share by working with distributors, dealers and key channel partners to understand unmet needs and design pistols that were more closely aligned with what buyers were looking for according to Smith & Wesson (2005).

Supplier Power

As of April 30th 2006, S&W had a backlog worth $42.1M in orders, the majority of which is for the M&P pistol orders from the Afghan Army. In addition the successful launch of the M&P15 rifle. This is a firm backlog based on purchase orders already received, and puts pressure on S&W to manage their key suppliers for inventory positions to fulfill these orders on time, as Glock is now considered by many the U.S. Government to be an unreliable supplier.

In the Form 8-K filed by S&W with the Securities and Exchange Commission on September 19, 2006 Michael Golden, President and CEO, and John Kelly, CFO discussed the implications of managing suppliers in light of the major turn-around in manufacturing process efficiencies. In the Form 8-K the impressive performance of manufacturing is discussed, with guns per day output going up 40% year over year, on-time delivery of orders increased from 60% of all orders to 85%, machine uptimes increased from 60% to 80% and inventory turns up 3 times over the previous fiscal year.

With production efficiencies being a major part of S&W's turnaround, there is the need to closely integrate all these activities with suppliers and build comprehensive supplier relationship management (SRM) strategies so manufacturing operations can have visibility multiple layers deep into the supply chain. Competitive pressures aren't simply on a given supply of raw materials it's on which manufacturers can get a specific level of supply chain visibility and be able to synchronize their production efforts with the incoming series of materials from suppliers according to Wainwright (2006). This integration between suppliers and manufacturers is defined by strategic partnerships between S&W and selected materials suppliers, and as a result S&W has been able to attain its production efficiency goals. Suppliers in the firearms marketplace are more integrated with manufacturers than many other industries, and as a result exert a much greater influence on profitability of manufacturers they choose to partner with. With many of the sales being made today based on project-by-product sales, both suppliers and manufacturers have realized that having a stable and integrated Supplier Relationship Management (SRM) strategy. As a result of all these factors, the balance of power is shifting to suppliers and their ability to provide visibility into their supply chains as well, making it possible for manufacturers to quote accurate delivery dates for large orders, as is the case with S&W today.

Buyer Power

S&W customers and the broader buyer population of rifle, revolver, and pistol purchasers across all served segments have a broad selection of manufacturers to choose from, including several dominant international brands. As the firearms market is very fragmented and there has been single-digit growth in terms of sales over the last three years as defined by Cowen & Company (2006), buyers are in the position to choose from multiple manufacturers. Cowen & Company (2006) also has estimated the total U.S. Gun Industry to have a market size of $2B in 2006, with no single manufacturer dominating all segments. While S&W does have a 40% share of revolvers and the market leadership position in pistols, their entrance into the rifle market, aimed primarily at the sporting goods channel, is one of the most competitive segments to participate in. The buyer exerts high levels of influence across all segments, and most notably in the sporting goods market where there are many competitors and alternatives. The difference for S&W has been their strong focus on building channels and markets instead of merely trying to participate in them. This is evident in the 19.4% revenue growth in the sporting goods channel and a 250% increase in the engraving and performance center and commemoratives market, where aggressive pull-oriented growth strategies including a NASCAR sponsorship, Shooting events in Hawaii, and an aggressive PR ad campaign all lead to buyers in this specific segment becoming much more aware of and considering S&W for their recreational and collecting firearm needs. The effort the company has made specifically in this segment has been world-class and exemplifies the level of effort required to gain new customers in a slow-growth market according to DataMonitor (2006). The bottom line is that the pressure buyers exert across all segments is very significant and given the brand loyalty to S&W the company has still had to work harder than every before to attract buyers in the sporting goods or retail segment. Awareness hasn't instantly translated into sales; buyers across all segments are being much more discerning and price-sensitive.

Threat of New Entry

S&W has over the last three years developed stronger barriers to entry in their core markets through relationships, lobbying and strong selling organizations developed by market segment served, in addition to greater production efficiencies and accuracy of manufacturing. The combination of stronger relationships in the government market, better sales teams in the sporting goods, law enforcement, military and federal, international and licensing market segments bring synchronization to S&W's marketing and selling efforts according to DataMonitor (2006). In many of their competitors, this is not the case. As S&W continues to gain market share and brand momentum, all these factors in addition to the dominance of their brand will become significant barriers to entry. Production efficiencies in the form of shorter order-to-ship, quote-to-order, and guns manufactured per day due to just-in-time inventory are also significant barriers to entry for any new entrant into the firearms market. Creating these levels of efficiency requires seeking out process re-engineering expertise and making the commitment internally to change production processes for greater efficiency, and that is a very difficult task for many firearms manufacturers to undertake.

Five Forces Analysis Competitive Summary

S&W faces different competitive dynamics in each of the key markets served, some requiring a predominately brand-centric response while others are more focused on product development and relationship-building, as is the case in the Military & Federal market. The aggressive product development plans and product introductions S&W has completed however have been the best competitive strategy the company could have undertaken to initiate a turn-around, in conjunction with bringing in key sales personnel with expertise in each segment.

This combination of selling expertise and unique and new pistols and revolvers gave the sporting goods market a major increase in sales throughout FY2006 to date, and has also significantly increased sales into the Law Enforcement market as well. The combination of relationship-building, lobbying and unique product designs that align with customers' unique needs has also come out in the Federal & Military market as well, where'd&W has won four contracts to date worth $20M. International sales have also been increased using the same strategy.

From a five forces perspective, the ability of S&W to generate and then capitalize on customer demand across all sectors has also influenced both supplier and buyer power, making both more manageable due to the voice of the customer defining the need for cooperation. In terms of threat of new entry and threat of substitution, the production efficiencies gained by S&W and their brand dominance will make it difficult for new competitors to enter their markets and for existing ones to replace them in larger accounts and with loyal sporting goods customers.

References for Assignment #2:

Cowen & Company (2006) - Smith & Wesson. Initiating to Outperform. May 26, 2006. Analyst Cai von Rumohr. Published in Boston, MA by Cowen and Company.

DataMonitor (2006) - Smith & Wesson Holding Corporation Company profile. Number 16191, June, 2006. London, England.

Form 8K, Securities & Exchange Commission (2006) - Filed by Smith & Wesson Holding Corporation on September 19, 2006 pursuant to Section 13 or 15(d) of the SEC Act of 1934. Accessed from www.freeedgar.comon November 23, 2006.

Smith & Wesson (2005) - Smith & Wesson Corporate Presentation accessed from the Internet on November 20, 2006 from http://media.corporate-ir.net/media_files/irol/90/90977/mfcosept2006.pdf

Wainwright (2006) - Initiate Smith & Wesson With Buy Rating: Plenty of Bang for the Buck. Michael Rindos, Analyst. July 20, 2006. Published by the firm in New York, NY.

Assignment #3: External Factor Evaluation Matrix

The following ten factors are chosen as the basis of creating an EFE Analysis of Smith & Wesson, and they are organized first by opportunity factors and second by threats:

Opportunities

Capitalize on unmet needs in the homeland security and law enforcement markets.

27% core business growth for Smith & Wesson has come from their Safety-Security-Protection-Sport (SSPS) strategy that has led to their continual growth in homeland security sales. This strategy is credited with winning $20M in new business in FY 2006, according to the Form 10-K (2006). Moving into this market is also accentuated by the company's strength of relationships in Washington DC and strong wins over Glock and other international competitors for U.S.-based global business.

Continue growing the long run product line with additional shot guns for the sporting goods channel or segment.

Fiscal year 2006 overall growth in the Sorting Good channel is 19.4%, with Q1, 2006 delivering 36.7% alone.

The company has recently added 30 additional sales persons specifically for the sporting goods channel. This has resulted in significant growth in the channel as sales productivity per employee dedicated to this segment has significantly increased.

New product support for this channel includes the SW460, M&P40, M&P9, M&P15 Tactical Rifle Series.

Smith & Wesson's core marketing efforts continue in this channel with NASCAR partnerships, strong public relations and article generation in industry publications, and shooting tournaments

Define strategies to dominate global law enforcement markets with the M&P Pistol line.

According to Form 10K (2006) Smith & Wesson achieved a 106.7% growth in revenue in the law enforcement segment and won 106 law enforcement departments to the M&P pistol since January, 2006.

The series of new product introductions specifically aimed at this market include the M&P40, M&P9 launched in May, 2006, M&P15 and M&P15T specifically designed for law enforcement SWAT teams, and the planning and initial production of the M&P Compacts and M&P45.

Look for new approaches to licensing brand and growing licensing revenue as a result (Harley-Davidson Strategy)

According to BusinessWeek (2005) the Harley Davidson brand ranks 46th in the world in value at $7.3B.

In the latest fiscal quarter Smith & Wesson reported $1.8M in license sales, and could effectively look at a multitude of co-branding initiatives, following the Harley-Davidson strategy and stressing the freedom of owning a gun in the United States. Harley-Davidson also capitalizes on the freedom message as is shown in License! Magazine (2005).

Expand leadership in the Revolver and Pistol markets, taking share in a fragmented market arena.

According to Bureau of Alcohol Tobacco and Firearms BATF (2005) studies, Smith & Wesson has $61M or 45% of the $136M U.S. Domestic Non-Military Revolver Market in 2006, and $52M or 11% of the $490M U.S. pistol market. This gives Smith & Wesson a powerful position to move into greater market growth from.

Threats

U.S. legislation favoring stricter gun controls takes effect, drastically impacting the sporting goods market.

In October 2005 the Lawful Commerce In Arms Act was signed into law, preventing gun makers from being sued for unlawful use of their products, alleviating the risk of liability suits, Wainright (2006). Despite the passing of this Act. with the presidential election in 2008 looming and the Democratic party appearing to have a strong chance at winning, it's important to realize that party's frontrunners for the nomination of their party as Presidential candidates both favor a national gun license program and also a national database or registry of all guns produced and sold. This is a major risk to the cost of doing business for Smith & Wesson, and will impose additional significant costs to the level the Sarbanes-Oxley Act (2002) did for all publicly traded companies in the U.S.

Acquisition by an unwelcome larger company looking to transform Smith & Wesson away from its core strengths.

S&W has previously been owned by Lear, a conglomerate in the aerospace and defense sector. Given the turnaround and the high P/E of 59 and the company's ability to generate cash and Return on Equity of 30.89% it could easily become an acquisition target. In addition, the stock has a relatively high level of institutional ownership at 38%, which makes it even more attractive for take-over according to Form 10K (2006).

Suppliers decide not to integrate scheduling systems and delivery systems due to cost.

Using Electronic Data Interchange (EDI) and private trading exchanges has gradually caught on with other supplier-manufacturer relationships. What's a major risk is the cost of these links proving to be too high for the suppliers to maintain. Private trading exchanges from suppliers are just becoming used and providing auction capability for example for more in-demand materials and assemblies.

Key External Factors Analysis for Smith & Wesson Holding Company

Opportunities

Weight

Rating

Weighted Score

Capitalize on unmet needs in the homeland security and law enforcement markets.

Continue growing the long run product line with additional shot guns for the sporting goods channel or segment.

Define strategies to dominate global law enforcement markets with the M&P Pistol line.

Look for new approaches to licensing brand and growing licensing revenue as a result (Harley-Davidson Strategy)

Expand leadership in the Revolver and Pistol markets, taking share in a fragmented market arena.

Threats

Weight

Rating

Weighted Score

U.S. legislation favoring stricter gun controls takes effect, drastically impacting the sporting goods market.

Acquisition by an unwelcome larger company looking to transform Smith & Wesson away from its core strengths.

Suppliers decide not to integrate scheduling systems and delivery systems due to cost.

References for Assignment #3:

Form 10-K (2006) - Smith & Wesson Form 10-K Filed with the Securities and Exchange Commission on July 14, 2006. Accessed from the Internet on November 13, 2006 at http://ir.smith-wesson.com/phoenix.zhtml?c=90977&p=irol-sec&control_selectgroup=Annual%20Filings

Bureau of Alcohol, Tobacco and Firearms BATF (2005) - Accessed from Research provided to the public from this agencies' website on November 14, 2006:

http://www.atf.treas.gov/firearms/stats/index.htm

BusinessWeek (2005) - Top 100 Global Brands Scorecard. BusinessWeek Online. Data Provided by Interbrand. Part of the Innovation Metrics Series. Accessed from the Internet on November 20, 2006 from http://bwnt.businessweek.com/brand/2005/

License! Magazine (2005) - Why and How Harley-Davidson Has Maintained its Customer Loyalty. License! Magazine. August, 2005. Accessed from the Internet on November 20, 2006: http://www.licensemag.com/licensemag/data/articlestandard/licensemag/332005/174785/article.pdf