Smith & Wesson Brands Inc (SWBI) 2007 Q1 法說會逐字稿

Good day ladies and gentlemen. Thank you for standing by and welcome to the Smith & Wesson Holding Corp. First Quarter 2007 Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn this presentation over to your host for today's conference, Ms. Liz Sharp, Vice President of Investor Relations. Please proceed, ma'am.

Thank you and good afternoon. Before we begin the formal part of our presentation, let me tell you that what we're about to say as well as any questions we may answer could contain predictions, estimates and other forward-looking statements. Our use of words like project, estimate, forecast, and other similar expressions is intended to identify those forward-looking statements. Any forward-looking statements that we might make represent our current judgment on what the future holds. As such, those statements are subject to a variety of risks and uncertainties. Important risk factors and other considerations that could cause our actual results to be materially different are described in our securities filings including our Forms S-3, 10-K and 10-Q. I encourage you to review those documents.

A replay of this call can be found on our website later today at www.smith-wesson.com. This conference contains time sensitive information that is accurate only as of the time hereof. If any portion of this presentation is rebroadcast, retransmitted, redistributed at a later date, we will not be reviewing or updating the material content herein. Our actual results could differ materially from these statements.

Our speakers on today's call are Mike Golden, President and CEO and John Kelly, Chief Financial Officer and with that I'll turn you over to Mike.

Thank you, Liz and hi everybody. Let me begin by giving you the agenda for today's call. First, John will review our financial results and then I will share my thoughts with you regarding our performance for the quarter as well as our strategy and outlook for the future. After that, I will open the call up for questions from our analysts.

Now, I'll turn the call over to John for a review of our financial performance. Please go ahead, John.

Thanks, Mike. Good afternoon. Net product sales for the quarter ended July 31, 2006 were $47.6 million, a $15.8 million or 49.5% increase over sales of $31.8 million for the quarter ended July 31, 2005.

Firearm sales, our core business, increased by $15.8 million or 54% over the comparable quarter for the previous year. Net income of $3.4 million or $0.08 per diluted share for the quarter ended July 31, 2006 was $682,000 or $0.01 per diluted share higher than the $2.7 million or $0.07 per diluted share for the quarter ended July 31, 2005. It should be noted, however, that the results for the first quarter last year included a $1.9 million or $0.05 per diluted share after tax benefit from the release of environmental reserves relating to the property sold by the company in 2003.

The increase in firearms sales in the quarter ended July 31, 2006 was driven by an 83% increase in pistol sales, a 73% increase in Walther sales, continued ramp up of our tactical rifle line and steady growth of our revolver line. The pistol sales were driven by the Federal Government sales for Afghanistan as well as the M&P pistol.

Our engraving business grew at a rate in excess of 130% with sales increasing to $2.4 million for the quarter ended July 31, 2006.

Gross margin for the quarter ended July 31, 2006 increased by approximately $7.1 million over the comparable quarter ended July 31, 2005. Gross margin as a percentage of sales and licensing was 34.7% compared with 29.4% for the quarter ended July 31, 2005. The increase in gross margin is attributable to the higher sales volume. In addition, we are realizing substantial benefits as we leverage our fixed costs. While net product sales increased by 49.5% for the quarter, fixed manufacturing costs only increased by 18.6%.

Costs of goods sold for the quarter ended July 31, 2006 included an additional $355,000 in depreciation expense due to the significant capital expenditures in the previous year. Utility costs for the quarter also increased by approximately $440,000.

Operating expenses for the quarter increased by $6 million. Operating expenses for the quarter ended July 31, 2005 included the $3.1 million favorable release of environmental reserves relative to a parcel of land that the company sold in February 2003.

Sales and marketing expenses for the quarter increased by $762,000 reflecting the additional staffing implemented in fiscal 2006 to support our sales initiatives.

General and administrative expenses increased by approximately $2 million driven by higher compensation expense. General and administrative expenses for the quarter ended July 31, 2006 also included $691,000 in stock option expense compared with $275,000 for the quarter ended July 31, 2005, a $416,000 increase. Profit sharing expense was $727,000 higher for the quarter as compared with the quarter ended July 31, 2005.

Capital expenditures in the quarter totaled $3.4 million, a $1.1 million increase when compared with capital expenditures for the first quarter of last year. Capital expenditures related to the expansion of our pistol production and new product tooling.

Net cash inflow for the quarter was $528,000 compared with a cash outflow of $2.8 million for the quarter ended July 31, 2005. We had $3 million in short-term borrowings as of July 31, 2006 compared to $2.5 million at July 31, 2005. At the present time, all of the $3 million in borrowings has been repaid.

Now let's talk about our outlook for the year. Please note that our guidance for the fiscal year ended April 30, 2007 is based upon the results from the existing business and does not include any additional revenue or profits from potential business ventures we may pursue.

Net core product sales for fiscal 2007 are now expected to increase to approximately $200 million, a 27% increase over fiscal 2006.

The first quarter performance has been encouraging. Sales in our sporting goods channel increased by 36.7% for the quarter as we continue to see the year-over-year benefit from the changes we made in our sales force structure in the fall of 2005. We expect to see a similar increase in the second quarter in terms of year-over-year comparables with the increases returning to a more modest level in the second half of the fiscal year.

Law enforcement sales more than doubled in the first quarter when compared to the comparable period last year. We expect to see continued strong improvement in this channel as sales in the M&P line continue to increase and additional variations are added. Federal government and international sales are expected to increase 15 to 20% year-over-year. Licensing revenue for fiscal 2007 is expected to be $1.7 million.

Net income for fiscal 2007 is now expected to increase to approximately $15 million or $0.36 per diluted share. The increase in our annual earnings projection from our previously announced guidance reflects the increased sales volume. Gross margin as a percentage of sales and licensing is still expected to be approximately 34% for the year. This increase will be driven by continued leveraging of fixed costs and improved efficiencies in manufacturing operations offset by increased depreciation expense related to new capital expenditures.

Operating expenses for fiscal 2007 are expected to be between 23% and 24% of sales and licensing. This compares favorably with fiscal 2006 results when the environmental reserve reduction is excluded from 2006 operating expense.

Capital expenditures of $13 million represents a $5 million increase from our previous estimates. We've added an additional $3 million to increased pistol production and have earmarked another $2 million for long gun products.

That concludes my financial discussion. So now, I'll turn the call back over to Mike.

Thanks, John. We have certainly started off the new fiscal year with some great results. We have now delivered two consecutive quarters of revenue growth in excess of 40% and more than doubled profits. In fact, we posted 300% growth in net income for the first quarter exclusive of the environmental reserve adjustment last year. This tremendous growth is being driven by a solid product portfolio, innovative new product launches, a direct domestic sales force, great execution on our commitment to law enforcement and government sales and continuing improvements in operational efficiencies in the factory.

And while we're clearly getting some tremendous results, we believe there is still much, much more progress to be made. We will to continue to execute in all these areas throughout the year in addition to growing our business by exploring new opportunities in businesses of safety, security, protection and sport. We are very excited about both our core business and those opportunities. Our success to date combined with our outlook for the future has led us to raise our expectations for both revenue and profit for 2007 as John has indicated.

Now, let me recap some of our efforts from the quarter and tell you what we have in store for the rest of the fiscal year.

Growth in the sporting goods channel was up 37%, following last quarter's 32% increase. This growth is a testament to our existing product portfolio enhanced with new products including our M&P series of pistols and tactical rifles as well as a direct sales force which was implemented in mid-fiscal 2006.

Channel has been very receptive to our new products and we believe that our consumer marketing efforts including Nascar sponsorship, editorial focus, advertising, and product promotions are all contributing to making Smith & Wesson the product of choice in the sporting good channel.

Law enforcement sales this quarter were up more than 100% year-over-year. This growth is largely due to sales of our M&P pistols and rifles. Yesterday, we announced two recent police department conversions to the M&P polymer pistol. The Dallas/Fort Worth Airport police and the Columbus, Ohio police. As you know, we don't announce every single department we win but rather choose to update you each quarter on our overall progress in law enforcement, a market where we once held a 98% share. Well, we intend to regain that leadership.

So now, I want to give you some very impressive numbers on how the M&P is doing. Please note that these numbers are departments that have completed their test and evaluation process and have chosen the M&P. These departments have purchased, approved for purchase or approved for on duty carry the M&P pistol. So far, we have won business with a total of 106 different law enforcement agencies. This is exceptional progress for a product that was launched less than 10 months ago.

And perhaps more impressive is the win rate we are experiencing. Of those departments that have completed their test and evaluation process, 80% have chosen to make the conversion to the M&P, 80%. We also have another 140 plus departments currently undergoing testing of the M&P. These numbers reflect what we continue to hear from so many law enforcement agencies and that is that the M&P outperforms competitors on all fronts.

We're equally pleased with our M&P Tactical Rifle which is also gaining traction in law enforcement. To date, we have had 28 departments make the choice to approve the M&P Tactical Rifle for use by their officers and that's just six months from the original launch date.

As you know, we are currently manufacturing pistols for the U.S. Military for shipment to Afghanistan and we're working hard to grow future sales to the Federal Government. There's been a great deal of media coverage recently about the upcoming military contracts reporting that it is expected to be for 650,000 pistols and valued somewhere between 300 and $500 million. We believe these figures are accurate.

Beyond this information, we still don't have many details. What we do know is this. We know the military wants to shift from a 9-millimeter to a 45-caliber for added stopping power and for a variety of other reasons.

While we have always thought that the new contract would be issued based on the expiration of the existing 9-millimeter contract, we know longer believe that that is an important event. Rather, we expect the trigger for the new contract will be the finalization of the requirement specification from the military. That spec has been under development for some time and we expect to see it completed sometime in calendar 2007.

As a separate issue, we have been expecting to see by the end of this calendar year 2006 ,an RFP from U.S. Special Operations Command for 50,000 45-caliber pistols to replace their current weapons. We expected this RFP to be the precursor to the larger 600,000 firearms required to replace the M-9 for the military. Just this morning, however, SOCOM notified the industry that it has postponed its plan and will not issue an RFP. While the military has yet to communicate their plans, we would still expect a new specification and RFP from the military for the larger requirement in calendar 2007. We have no reason to believe that the postponed SOCOM RFP will change the requirements of the Army and other military branches.

We are also pursuing opportunities with federal law enforcement agencies. For competitive purposes, we're not going to share a lot of the details. However, I'm very pleased to tell you that the M&P polymer pistol series is being tested by several federal law enforcement agencies and we have received some very positive initial feedback. Remember, that with the exception of the 73,000 unit contract we won for Afghanistan, any and all federal government business will represent new opportunities for Smith & Wesson.

This is a very exciting space right now and we expect to stay very active in it. And as we have stated, we expect nothing short of fair and open competitions and we intend to compete vigorously. We'll keep you posted as we have developments.

In the last year and a half, we have focused on diversifying our company by exploring new businesses within safety, security, protection and sports. In February, we launched our new M&P Tactical Rifle which represents our move into the long gun market. The tremendous response we have received demonstrate that the Smith & Wesson brand has earned a space in long guns and we believe that space can be very large for us. Therefore, we will continue to diversify by moving deeper into long guns, a market that is 60% larger than the hand gun market.

While I can't provide you with specific product information just yet, I can tell you that we plan to launch additional new long gun categories in the first half of calendar 2007 in time for the 2007 fall hunting season. I look forward to sharing more detail with you when we get a bit closer to the launch.

As we grow our core business and move into new categories, improvements in operational efficiency will remain our focus. These improvements continued in the first quarter and the rewards are evident in our gross margin of 34.7% for the quarter, up from our fiscal 2006 gross margin of 31%. Our employees in the factory continue to step up to the challenge of streamlining operations and incorporating new technology. We will support their efforts and our company's growth with ongoing capital expenditures through 2007. These investments will create further efficiencies to increase the pistol manufacturing and to facilitate our expansion into long guns.

As we diversify our company by adding new product categories, we continue to search for opportunities to expand into completely new businesses of safety, security, protection and sport. Our radar screen includes companies that represent not only firearms, but Homeland Security products and services, law enforcement products and defense.

To that end, we recently announced that we have filed Registration Statements on Forms S-3 and S-4 and that we have received approval from TD Banknorth for an acquisition line of credit. All three of these moves were undertaken to provide us maximum flexibility for financing options as we encounter opportunities related to acquisitions and alliances.

As we grow and diversify, licensing continues to provide us with a platform built on strong brand loyalty. As I said before, licensing is and will always be an important component of revenue growth and a key driver in building brand loyalty among existing and new customers. We are learning that licensing has an even more important role to play beyond revenue. That role supports our diversification helping to carve a space for us in new markets where the Smith & Wesson name resonates well.

As we strengthen our position in the professional market segments and begin to enter business related to law enforcement, Homeland Security, and defense, licensing with the Smith & Wesson name to companies within those spaces will help expand our legendary brand into these new territories. A great example is the licensing agreement we recently signed with the maker of explosive detection devices used by Homeland Security and defense specialists around the world. While this is one of just many niche markets we are looking at, it represents clearly the way in which we will establish the Smith & Wesson brand name with professionals in new spaces. And since we intend to grow in all segments of our business you can expect to see us focus our licensing efforts increasingly on these new markets rather than relying only on retail licensing as we have in the past.

And finally, I want to point out that delivering shareholder value remains our overriding commitment. We made the decision to move our stock to the NASDAQ market, an environment that we believe will provide increased liquidity and greater visibility for our shareholders. We began trading on NASDAQ on July 20th. We will celebrate that move by ringing the opening bell in New York this coming October 19th. I hope you'll all watch for us.

I'm also pleased to report that our company was recently added to the Russell 2000 and Russell 3000 Indexes, an achievement that helps to heighten visibility for our shareholders.

In conclusion, our results for the first quarter of this new fiscal year reflects our ongoing commitment to a strategy that we formulated last year and is just now in the initial stages of execution. That strategy calls for growth in our core firearms business coupled with expansion in new areas. Now, more than ever, we'll remain steadfastly focused on making Smith & Wesson name a major presence in safety, security, protection and sport. We believe that we have just scratched the surface.

With that, I'd like to open the call for questions.

[OPERATOR INSTRUCTIONS]

Sir, our first question is from the line of Eric Wold with Merriman Curhan Ford.

Hey, good afternoon, everybody.

Good afternoon, Eric.

Good. Couple of questions on the M&P on the 106 departments that have gone through the T&E on that. Can you give any kind of range as to what those 106 might represent in terms of revenues over the life of them being rolled out? Or the average number of officers per department?

I think we'd have to kind of figure that out, Eric. I can tell you that the department sizes range all the way up through I think the largest was the North Carolina Corrections -- I'm looking at John to make sure I'm saying right -- with 5,700 officers. We think there's about 15,000 officers total in the bucket that we have chosen the M&P, so we have to go and play a little bit with that. But there's still a lot of room to grow in law enforcement as far as the M&P and we're just kind of getting started with it.

I hear you. And those 106 that have approved it, are some portion are still waiting for funding?

Not a lot are waiting for funding. Some are generating the POs. They don't give you - some departments give you -- there's -- Cincinnati -- how many officers was that? Like 1,100 officers? It's like 1,100 officers and they gave us an order -- they're going to split their order out over I think it's a 100 a month for 11 months or whatever. North Carolina wanted their 5,700 pieces all at once. So they all have different ways as to how they do it.

Okay.

Okay.

And then you mentioned the 80% kind of win rate of these orders. Can you talk about what guns or what manufacturers were replaced in those ones and how many were prior Smith & Wesson customers?

Well the -- I don't know [right now] how many were prior Wesson customers. When the department does a T&E, everything's on the table. So everything kind of starts from a blank sheet of paper. I can tell you that across the competitors whether it's Glock or Beretta or SIG, they're all in this thing and we've won business from departments that really represent them all.

And then lastly on the tactical rifle, can you give the revenue for tactical rifles in the quarter and are you going to give any kind of look as to what that might be for the entire year?

Do you have the quarter number there?

Yes. I think Eric it's about - let me just check for a second here. About $2.1 million, 2.1 million in the quarter, Eric, and we're still ramping up production on that. I can tell you one of the pleasant problems that we're dealing with, if you will, is that demand far outweighs our ramp up of production. So we are working very hard to accelerate our production, to supplement the production we have on that. It's a, big hit. You talk sporting goods or you talk law enforcement it's a big hit.

Last question on that. You ended -- kind of on that production question --you ended Q4 something like eight and change and million in backlog on the rifle. I'm assuming that you probably got, hopefully, more orders in Q1 than you shipped and so the backlog probably went up a little bit. Are you getting to -- can you talk about the production level in Q2 now versus where it was in Q1 and could you get through that 8 and change or more million dollars in backlog over the next two, three quarters or will it take a little longer than that?

It's growing. We basically -- our backlog at the end of Q1 is $8.6 million. So the backlog is still there. It actually probably grew a little bit during the quarter even with us shipping 2.1 million. So we're ramping up in this process but given that backlog, I think we've got a substantial period before we fill that backlog because we're continuing to get orders.

And you know what's interesting on it, Eric, is we have people actively working on supplementing our production as quickly as we possibly can because we really haven't unleashed the sales force with that product yet.

Right.

So the demand we're seeing is, we think, the tip of the iceberg.

Thanks guys again. Appreciate it.

Okay, Eric. Thanks.

Thank you.

And sir our next question is from the line of Cai Von Rumohr with Cowen and Company.

Yes. I think you've certainly earned congratulations. Great quarter, guys.

Thanks.

Thanks. We appreciate it. Good to hear your voice.

Could you give us a little more color on, you gave us you're up 37% in the sports channel. You're up 2 times in the law enforcement. What are the hard numbers there that we can kind of start to model this by channel for this year and last year for those four categories?

The sporting channel was about 32 million, Cai.

Okay.

The law enforcement and federal --

You gave us the total but what was the law enforcement exclusive of the federal?

It's about an even split between the two. It's about $11 million.

So it's around 5.5 and that was up?

That's pretty close on it.

Okay and so then the international is about--

I'd say 3.5, 3.6 million and the rest is various retail and parts and things like that. Does that help?

Yes, that's very helpful.

Okay.

And then give us a little more color. You had this price hike that's effective August the 10th and you guys have said what, that it averages about 3% over the entire product line. Is that correct?

Probably on average. It wasn't an across the board hike. It was one that was specific lines.

Okay, and it was presumably on all the stuff going through the sports channel because you can't up it on the law enforcement. Is that correct?

It wasn't everything going through the sporting good channel Cai, it was on selected SKUs.

Selected SKUs, but again where you have bids out there obviously for law enforcement or international you can't change those pricing but anything new would go out at the new pricing.

Okay and I guess I'm a little confused. You have this margin of 34.7 in the first quarter and then so the 3% price hike basically hit then for most of this current quarter, so that's kind of like 3% and your costs potentially aren't up 3%. So why is this gross margin not going to be closer to 35, 36% for the year?

Well, what you have is again, as I said it's 2 to 3 and it's across the board but what you also have Cai, you have to take into account is the fact that in the second quarter we're shut down for the first two weeks of August. So you have some inefficiencies that happen within that period so your margins will decline in that quarter. We're shutdown for a week in the third quarter during the holiday period.

So you're going to have some periods there where you have unabsorbed fixed costs. So your margins aren't going to stay level across the quarters. So on average, we expect it to be 34 but you'll probably see it below that in the second quarter and probably in the third quarter as well because of the vacations and the holidays in there. So that's kind of why it doesn't --

So you still get some of that some of that hockey stick effect you had in the fourth quarter last year.

It's more like a horseshoe than a hockey stick, I think, would be the better analogy in the fact that the middle two quarters should be lower than the first and the fourth.

Okay. Is there any -- you mentioned 23% for your indirect. You were pretty high year-over-year on the G&A and also how should we model those as we go through the year? Are they going to be fairly level as we go through the year? Less than --the fourth quarter or any --?

The G&A will probably be fairly level. We'll probably get some seasonality as we get into some of the [shell] seasons in January. January, February time period and we do have a lot of shows at that point and expenses tend to spike during that time period on the selling but generally with the switchover to a factory sales force you kind of level that off a little bit. You won't see the spikes related to volume that you saw.

Okay. Then last point you made Mike about you're going to be ready for the '07 hunting season. Are we to take it that basically you're going to have a hunting rifle and/or a shotgun and when do you have to announce to be able to be ready? Does that make this a fiscal '07 event and therefore something that's not in your guidance?

The answer to your first question is it hunting rifles and/or shotguns is yes. It's hunting rifles and/or shotguns. The way that the season will work is the actual retail sales and sales the hunting season is in the fall so as you get in through the summer is when stores buy and all that. So we will be -- our intent is to be in the business to catch, we won't be up to full swing by then but we will be -- in have product in the marketplace for the fall hunting season and during the first half, you've got a number of major shows on the first half. You've got the shot show, the big industry shows and then you've got the NRA show which is in April I think, late April. So we have a number of times to be able to do our coming out deals here and catch the marketplace.

So presumably we should expect that one or both of those shows that we will see some sort of announcement?

That's a fair observation. Let me go back to make sure we're not talking past each other, Cai, you won't see volume and there's no volume in our forecast for new categories of long guns in our current guidance for fiscal 2007.

So it sounds like given your timetable, you're not likely to ship much in '07 because you're really planning for the end of the '07--?

Or fiscal '08 which is May, June, July of next year. Right, right, right.

That's a correct assumption.

Presumably, I guess, you'd mentioned this type of -- you would probably outsource production of these kind of these products and yet you have this shell and you mentioned kind of looking at other security products. What's your appetites for kind of doing the long gun, the traditional product essentially in your existing bailiwick as well as kind of doing a security product. Do you feel that's something you're interested and could handle or do you want to do one first and then the other second?

Well in the long guns, we've said all along that one, we used to make rifles in this factory so -- the receivers for rifles in this factory for Remington. So we know how to do this. It could be a combination of outsourcing, acquisitions if we found a company that brought something that, a core confidence that would help accelerate our growth there and -- or we could do it ourselves. And we have been looking at all those different options.

As we look at the integration -- if we were to purchase another firearms company, the integration process would be far different because we know the business and we know the marketplace and the manufacturing's not all that different from what we're doing today. That's far different than a business that's in Homeland Security products that's outside of firearms. I don't think you would see us do two at the same moment, but we don't think there has to be a three year hiatus in between either.

Excellent. Thank you very much.

Okay, thanks guys.

Sir, our next question is from the line of Chris Krueger with MJSK.

Hi, good afternoon.

Hey Chris, how you doing?

Good. Just to follow-up on that very last question about new products. I think you've indicated in the past your goal is for a 40% gross margin on new products. Would that still be the case with long guns or would that be a little bit different?

The 40% is the target that we have and we're operating by for new products in handguns because we understand the manufacturing process and that. Depending on how we do other products, whether it's an internal manufacturing or an outsourcing, there could be different bars that we set for long guns. The real number there, Chris, is the operating margin because if you stop and think about long guns we don't need a lot of SG&A to the -- we're not bad sales guys to sell long guns so our costs below the gross margin line are very minimal which would be reflected in the operating margin.

Right. You said you probably wouldn't really talk specifically about those until these shows early next year?

Yes, I only do that for competitive reasons. We've told the competitors we're coming and we did that for a strategic reason but we're not going to let them under the cover here.

Okay. Last question. You've had strong sales to the sporting goods channel really the last couple of quarters especially. Do you have a way to read the actual sales to the end customers? I guess what I'm getting at is historically is there any correlation to consumer confidence, GDP, interest rates, or any kind of macro figure that affects that or do you just simply go through it at this stage or what's your thoughts on that?

That's a good question Chris. We have a couple of ways we do it. One, having our own direct sales force, calling on the dealers is eyes and ears in the store which helps us. We have a promotion that is underway for the industry for dealers that we call shooting for Hawaii promotion that there's certain requirements and it gets the people in the store engaged in Smith & Wesson. But the stores that are participating are required to feed us back what they're selling through - what they buy of our product and what they're selling through. So we can get a barometer on is inventory building up or not building up.

And the third is that for example we just had in the last two or three weeks a group of, I think, there was a dozen dealers. We have a dealer council that comes in from around the country and to kind of give us feedback as to how our stuff is selling. You talk to our distributors, we also get a feel for the sell in and sell out of our products at the distributor level which is a pretty good indication of what's going on in retail and we're not seeing a build up at the distributor level at all.

So it's easily keeping up with that rate then to the end user?

Yes, yes.

Okay, good. That's all I've got. Thank you.

Thanks Chris.

And sir, our next question is from the line of Amit Dayal with Rodman & Renshaw.

Thank you. Excellent quarter guys. Congratulations.

Amit, thanks a lot.

Most of my questions have been asked. I just have to begin with are there any new models for this hunting season out there?

Out the -- I lost you there.

Are there any new models for the handguns side on the consumer sporting goods side for this hunting season? I know that last year the 460XVR did very well. Is that still going to be --?

Yes. There are a couple things variations that we have. We have two kits -- I guess that's the right word for them, kits. One is an emergency survival kit that has the 500 in it and the other is a same type of thing that has the 460 in it and it has like a -- it has a flare in it. There's stuff that you would have to keep in your tent or you keep in your boat or keep in your cabin for hunting and they've actually gotten a very good response from this.

Right.

The thing, it's actually kind of interesting because it's marketing. We're bringing consumer marketing to the industry and that's really kind of -- the guys took an idea that's used in a lot of other businesses - a kit and we put it into firearms and it's taken off very well.

Great. And last quarter you talked about compact business for the M&P line. Can we expect that to materialize anytime soon?

Yes. Between now and the end of the year we will begin to see compact M&Ps.

Right. Just one more question. Today morning I read an article stating that you have a new director of marketing. Could you elaborate on that a little and just provide some additional color on what the synchronization between branding and marketing has within Smith & Wesson?

We have already a new gentlemen just joined the company. He's got a terrific background from Timex and spent a number of years in marketing at Colt. So he understands the firearms industry and Timex is a pretty good marketing company. Very, very smart guy. We're always looking to strengthen our team. We believe a lot of the success that we've had here is because we've got a great product line and a great company and we've got people that are energized to grow this business. So we're always looking for talent to come in.

Quite honestly the people we've put in place Amit, almost to a person, there's probably somebody that's not, but the people that we've brought in have done bigger jobs, similar jobs in bigger companies or bigger jobs so this is not a training program. This is a hit the ground running and moving .Jan will be responsible for the channel marketing of our product line and certainly be very, very involved in working with Tom Taylor, our vice president of marketing on the branding and the brand work we do to continue to develop the brand, the events. All that stuff.

Commercialization is a big opportunity with new products in this channel because prior to the M&P it really didn't happen like you'd see it in other channels. Like I'm familiar with in the hardware industry and Leland's familiar or Tom Taylor's familiar with. So that's a big -- getting someone in that has a background in just kind of increases our thought power as we try to change the industry.

So is there anything new that's going to be undertaken on the marketing side this fiscal year?

Anything new -- say that again Amit.

Any new initiatives on the marketing side? I know we have the Nascar thing going but is there anything similarly exciting that you guys could probably undertake this year?

The first thing is that the Shooting for Hawaii promotion that we have for dealers is really the first of its kind that we're aware of and dealers have told us this that were in this industry which has gotten the sales people at the dealer level engaged and focused on Smith & Wesson because they can win awards and there's whole incentives built behind it.

You're going to see more consumer promotions like the survival kits I was telling you about with the 460 and 500 with other products. Taking what works in other channels and bringing it into the firearms sporting goods channel and a real focus on our part continuing with the dealer. We have a very strong sales organization out there in place today. You can see the results and we haven't really begun to feed them with terrific dealer focused consumer promotions. So that's a whole opportunity for us.

Right. Last question. In the last conference call, you talked about a 28,000 piece solicitation that is granted to Glock for Iraq but later rescinded?

Right.

Is there any update on that for us?

That solicitation was a new solicitation. That was pulled off the table by the military and that no longer exists.

Okay, so is there any opportunity --?

Actually, what ended up happening there is through an existing contract that existed with Glock for Iraq -- remember we got the contracts for Afghanistan off of an existing contractor. The one that was pulled off the table was a new contract which was great for us because then we had a chance to get in there. The requirements changed. That was pulled off the table and they did buy -- I don't know the exact number of pistols from Glock to -- off of their existing contract that's out there.

So that's no longer in play anymore?

That's no longer in play anymore but we haven't given up on Iraq.

Right, I understand.

I don't give up easily.

Thank you so much.

Okay thanks Amit.

And our next question is from the line of [Spencer Ferraro] with Cowen and Company.

Hey gentlemen, how you doing there and congratulations again.

Thank you, Spencer.

Thanks.

Quick question on tactical rifles. It seems like one of the big challenges that you're facing is in the switching costs. A lot of the police departments with whom I've spoken has indicated that while you know S&W or M&P15 may be a great weapon one of the problems is the repair parts and the training for the armor. Tacs take some time. So how are you dealing with that?

And secondly, on a related note, I was told that about two or three years ago I think the DEA or ATF did a test to certify rifles or tactical rifles for the law enforcement community and only Colt and Rock River were certified to be most spec. So for the M&P15, have you gone through a formal certification process to become most spec. If not, is that something that you have in the works?

There's a couple of things that have gone on with the M&P. As we said, we're ramping up and we're -- our problem with M&P now, the 15 I'm talking about the rifle, is working feverishly to expand our capacity because we really haven't aggressively pursued this as of this point because we can sell every one we have.

We have just brought on board a very qualified individual whose responsibility is going to be to do armors training because that is an issue with rifles that we need to get out in training armors on how to repair the product. Very, very important piece. Just brought the guy on. Very qualified gentleman about less than a month ago. So we're addressing that. So tactical training and armors training for law enforcement is a fairly big opportunity. We only have three SKUs that are in this category today so we have room to expand. I don't believe --- I'm not familiar with the certification that Colt and was it Rock River you said?

Yes.

I'm sure the guys are. I'm not familiar with that so I really can't speak to that but the guys could certainly answer that.

Okay. And are the parts for the M&P15 generally compatible with the Bushmaster or Colts of the world or are there unique characteristics which make them --?

We believe and the performance of our product kind of dictates that they're built to a tighter manufacturing tolerance but the parts are interchangeable yes.

Okay. Second question here. Going back actually to the first one regarding the 106 agencies plus another 140 to kind of approach it from a different angle, I understand your breakdown of the firms and how they've either been approved for use or acquisition but can you give us an indication about roughly what percentage of those agencies have had a non-Smith & Wesson handgun with a shelf life of 12 to 15 years? In other words, what percentage of the police departments are looking potentially at changing their entire stock rather than onesies and twosies here and there?

Trying to think about that, if I can --

You've got a combination of pieces in there, Spencer, and that's what --

Yes and most changes are for the whole department. They don't say we're going to give these three guys a different pistol. So when they do a T&E when they -- pick a department, North Carolina or Cincinnati or anyone of the departments -- they do a T&E. They typically bring all competitors that they're interested in. It's a formal process that they go through and then regardless of what they have in the past and they pick the product that they're going to go with and based on their criteria. And then it's an all -- it may take a little time to transition the department but it's just because of training needs and what have you or maybe it's funding. But it's typically not multiple choice. Now there are certain departments like New York that has a list of three pistols that the officers can choose from. It's the officer's choice but it's got to be one of those three.

Okay. I guess what I was getting at was where you're saying is that the majority of these departments that are currently evaluating the pistol are potentially subject to changing their entire inventory. It's not that they already have their contract with SIG or Glock or another company and they're just going to approve your gun for additional product purchase but it's for the whole department?

By in large that's right Spence, but I jut saw a note today that I want to say it's from Nevada State Police. That may not be correct, but they just approved the M&P for on duty carry by their officers. I just saw a quick email on that. They probably have two or three pistols that the department can choose from. That's kind of the exception but that does happen.

Okay and final question. I'm sorry, the DFW airport contract that just took place. Was that a switchover from another line or did they previously have a Smith & Wesson?

DFW was Beretta.

Beretta, okay. Right, because I know the Dallas/Fort Worth Police actually carry the SIG so that's great. Well thank you very much.

And sir we have another question from the line of Amit Dayal:

Okay, just one more question. There was news on the Canadian Border police to attempting to provide side arms for their officers. The order size seems to be pretty substantial. Probably over $100 million over a period of 10 years. Could you just provide us with some color on what relationships you have in Canada and what steps you guys can take in terms of winning this contract?

Good question. I saw that note about a week ago also. I can tell you that the RCMP use Smith & Wesson pistols and if you guys remember the first international order on M&P we got was with the Peel region police. Peel, they call regions, they're like counties. What we would call county. I use to live in Canada. Peel is right outside Toronto. I don't know if that's greater Toronto or not but it's a fairly large department. It was 1500 or 1800 officers. But we had a very good relationship with law enforcement in Canada and we're on that one.

Right, perfect.

I like to see little notes like that.

And sir, our next question is from the line of [Tony Lisa] with Crown Advisors.

Hi guys.

Hey Tony, how you doing?

Good. How are you?

Good.

Most of my questions have been answered by I was wondering if I could ask you a little bit about inventory.

Okay.

How does the composition of final inventory compare if you were to break it down portion by portion to what it did a year ago at this time because this is typically the quarter where you build inventory.

We built during the quarter like we did last year, Tony. The dollar level I think we had about a $4 million build. This year we have about 3, 4. If you take into account inflation, it's pretty much the same size and that's because we build -- we level load our plants over the course of the year. We will build inventory the first quarter and seasonally there's a little bit of a seasonality of the business that is stronger in the last quarter.

No, no. Yes, I understand that. I'm just kind of wondering does the composition of that inventory look a lot different in terms of final product?

You mean revolvers versus pistols?

Yes.

Obviously, some of the shifts in there but we're -- generally with the products we have we haven't had -- the new stuff that we're making in the polymer line is something that moves through very quickly.

Right.

Not as much manufacturing process. So you don't have a WIP number in there or something like that. So you're not getting a big issue and the fact that sales are so strong you don't have much in inventory.

Right. So if I do look at the sequential change. If I just go April to July of '05 versus April to July this time around, it is a good bit in terms of percentage growth higher and I guess you just said John that that's inflation. Is 100% of that inflation?

I think last year I think we're what about on the inventory side I think we're about 23 at the end of --

Last year you were at 22.7 --?

22.7 at the end of last year.

Yes.

And this year we're -- actually I think we're at 22.7 in July of last year. So it didn't move at the beginning of --

Well that's what I'm saying. You went from 19.9 to 22.7 and this time around you went from 19.1 to 23.1 so on a percentage basis that's a good bit more and I'm not questioning it as a problem. What I want to turn around and say is are you building for a stronger sales number than people seem to be expecting?

We're building to the plans that we have announced and that's been the plan. The inventory build is consistent with the guidance that we provided last year and the fact that we're buying additional capital is to support the additional increase that we announced today. We're building and it's going right out the door in terms of -- on the pistol side.

And so if I look at those two numbers the July number of last year versus this year how much of that change is actually the inflationary cost?

Just figure on average, Tony, about 3%. Okay?

Okay.

Hey Tony, one other piece that influences that. Last year in the fourth quarter we backed off on revolver production.

Okay.

So it was, I don't want to say artificial, but a lower number.

So this might be a little more normalized?

Yes.

Yes.

Okay.

What we're trying to do is to build an inventory base here that supports our distribution network and have a bit of a buffer there. It's a strategy that has worked in other industries and we're trying to implement that as we can within this process.

Right, right. The only other question that I have and Mike, I apologize, is very broad based, but we're right at the beginning of a political cycle. Things have been about as good as they can be for your industry and your company as a result of how much activity for lack of a better word is going on. Anything that worries you on that front?

Tony, really not with the business. I mean I guess I'm worried about the country but not for the business and I think that the moves that have been made by the current administration are -- they're etched into law. They're directional. The country is at war. Homeland Security is high on everybody's mind. The Lawful Commerce in Arms Act has been tested for constitutionality I think three times in the last seven or eight months and it's always passed. I think there are other fish to fry, and this is my own opinion, but we're not seeing anything abnormal from the political end that say that people are going to try to change the landscape here.

If there is a change of control in either the Senate or the House does that make any of the work that you've done I don't want to say waste. Obviously, it hasn't. You're raising your profile and that's great but have you been lobbying both sides of the aisle equally?

I would say equally because we have been talking to people on both sides building relationships. Because we -- certainly in Congress it's not a surprise.

Right.

So actually what we're talking to Congress about is U.S. jobs, products that support our military coming from a U.S. company. That's pretty hard to argue with regardless of the aisle you're on.

Right.

The other piece that's an important piece is as we diversify our company into long guns we really start to change the landscape of our company outside of just handguns. So we've said all along the big growth opportunities and it sounds a little bit bizarre because we're growing this sporting good channel by 37% but the big upside for our company long run is the law enforcement globally and federal government and international markets and they're all professional businesses.

Last question, Mike. On the 45 or the expected 45 if you will, is that something you're going to pursue the exact same way in terms of development that you did with the 40 in terms of bringing people in, creating a product that everybody wants that addresses the concerns of the existing products and if so how far along would you say you are in that process?

Yes, that's a good question Tony. The exact requirements while they're a bit of a mystery, certainly our guys are engaged talking to people so we have pretty good insight as to what they're looking for and we've spent a lot of time out of range with people in the military end to try to understand what they like and what they don't like. The M&P has been developed with this in mind.

Right.

So what we don't know is whenever this requirement comes to the table we think the way this will work is everybody trying to understand it so they build it into the product but then everybody's going to have probably a 60-day maybe 90-day we don't know period to submit whatever it is they exactly look for and we understand that and we think we have a pretty good insight into what they're looking for and our guys have been building that into our product. Certainly the 45 is not coming as a surprise to us. So I think we have as good an insight into it as anybody and we just don't know when they're going to tell us what they exactly want.

Right.

Could be little things that are different on it that are different than the way we've been going but none of it we believe is insurmountable for us.

So your lack of current participation is not ultimately a barrier to entry at least from the product side?

Oh no, not at all, that I don't --

In fact, may be a benefit.

I don't know that I'd say that it's a benefit. I think that the benefit is that we're a quality manufacturer with a 154 year history. We're an American company with jobs in the U.S. that have product that we believe is the best in the world. That's an advantage for us. I don't think the fact that they're buying Beretta today is a plus or minus for to be honest with you.

Thanks a lot.

Okay, nice talking to you.

And with that ladies and gentlemen that concludes the question and answer portion of today's presentation. I'd like to turn it back over to Mike for any closing comments.

Great thank you. Well thank you everyone for joining us today. I look forward to talking with you again next quarter. Until then, watch for us at the Merriman Conference coming up on September 19th in San Francisco and the ringing of the bell at NASDAQ on October 19th. Thanks again.

Ladies and gentlemen, thank you for participating in today's conference. This concludes your presentation and you may now disconnect.