Smith & Wesson Brands Inc (SWBI) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2007 Smith and Wesson Holding Corporation earnings conference call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the call over to 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 are 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. The conference contains time-sensitive information that is accurate only as of the time hereof. If any portion of this presentation is rebroadcast, retransmitted or 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. 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 up the call 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 three months ended October 31, 2006 were $50.8 million, a $15.2 million or 42.9% increase over sales of $35.5 million for the three months ended October 31, 2005. Firearm sales, our core business, increased by $14.6 million or 43.9% over the comparable three months of the previous year. Net income of $2.9 million or $0.07 per diluted share for the three months ended October 31, 2006, was $2.2 million or $0.05 per diluted share higher than the $692,000 or $0.02 per diluted share for the three months ended October 31, 2005.

The 43.9% increase in firearm sales in the three months ended October 31, 2006 reflects an 87.4% increase in pistol sales and a 44.5% increase in Walther sales. Revolvers grew at a steady rate of 11.7% year over year. Pistol growth was driven by sales to the federal government for shipment to Afghanistan and by the success of the M&P pistol. Gross profit of $16.1 million for the three months ended October 31, 2006 increased by approximately $5.5 million year over year.

Gross margin as a percentage of sales and licensing were 31.2% compared with 29.3% for the three months ended October 31, 2005. Sequential decrease in gross profit for the second quarter was expected and reflects the impact of our annual two-week plant shutdown in August, specifically unabsorbed fixed cost which occur as a result of that scheduled shutdown. Cost of goods sold for the three months ended October 31, 2006 were $35.3 million and included $382,000 in an additional depreciation expense related to significant capital expenditures in fiscal 2006 as well as $297,000 in higher utility expenses.

Operating expenses for the three months ended October 31, 2006 were $10.7 million, a 15.1% increase over expenses of $9.3 million for the comparable three months last year. The increase was driven by compensation expense for our expanded sales force as well as increased profit sharing expense as a result of the higher operating profits. Despite these increases, operating expenses as a percentage of sales and licensing decreased to 20.8% for the three months ended October 31, 2006 compared with 25.8% for the comparable three months of last year. Income from operations for the three months ended October 31, 2006 grew to $5.3 million or 10.4% of sales and licensing compared with $1.2 million or 3.4% of sales and licensing for the three months ended October 31, 2005.

Now, let's look at the six-month results. Net product sales for the six months ended October 31, 2006 were $98.4 million, $31 million or 46% increase over sales at $67.4 million for the comparable six months of last year. Firearm sales, our core business increased by $30.4 million or 48.6% over the comparable six-month period of the previous year. Net income of $6.2 million or $0.15 per diluted share, for the six months ended October 31, 2006 was $2.8 million or $0.06 per diluted share higher than the $3.4 million or $0.09 per diluted share for the comparable six months of last year.

Results for the six months ended October 31, 2005 included a $3.1 million favorable environmental reserve reduction, which represented $0.05 per diluted share on an after-tax basis. Without that reduction, earnings would have been $0.04 per diluted share for the six months ended October 31, 2005. Gross profit for the six months ended October 31, 2006 of $32.7 million increased by approximately $12.6 million year over year. Gross margin as a percentage of sales and licensing increased to 32.9% compared with 29.3% for the comparable six months last year.

The increase in gross margin percentage is attributable to the higher standard margins on new products and improved operating efficiency. We continue to realize substantial benefits from leveraging our fixed costs. While sales volume increased by 46% in the first half of fiscal 2007 on a year-over-year basis, fixed manufacturing costs increased by only 23.6%. This fixed cost increase was driven by higher utility costs and increased depreciation expenses were $1.5 million higher than the comparable six months of last year.

Operating expenses for the six months ended October 31. 2006 were $21.5 million, a 52.6% increase over expenses of $14.1 million for the comparable six months last year. Operating expenses for the six months ended October 31, 2005 were net of a $3.1 million favorable reduction in environmental reserves. Excluding this reserve adjustment, operating expenses for the six months ended October 31, 2006 increased by $4.3 million. This increase was driven by higher compensation expense relative to the expanded sales force, a $1.3 million increase in profit-sharing expense as a result of higher operating profits, net increase of $420,000 in additional stock-based compensation expense.

Operating expenses as a percentage of sales and licensing was 21.6% for the six months ended October 31, 2006 compared with 20.5% for the six months ended October 31, 2005. However, excluding the environmental reserve reductions, operating expenses for the six months ended October 31, 2005 were 25% of sales and licensing. Income from operations for the six months ended October 31, 2006 nearly doubled to $11.2 million or 11.3% of sales and licensing compared with $6.1 million or 8.8% of sales and licensing for the comparable six months last year. Again, of the $6.1 million in income from operations in 2005, $3.1 million of it was contributable to the favorable environmental reserve adjustments.

Capital expenditures for the six months ended October 31, 2006 totaled $5.9 million, a $111,000 decrease compared with capital expenditures for the six months ended October 31, 2005. Capital expenditures were related to the expansion of handgun production and new product sales. Net cash outflow for the six months ended October 31, 2006 was $77,000 compared with a cash outflow of $3.6 million for the six months ended October 31, 2005. We had $4.5 million in short-term borrowings as of October 31, 2006, which was unchanged on a year-over-year basis.

Now, for our outlook for fiscal 2007. Please note that our guidance for the fiscal year ended April 30, 2007 is based upon expected results from our existing business and exclude any additional revenue or profits from potential business ventures we may pursue. Our performance for the first six months of fiscal 2007 tracked to our forecast. Net product sales for the full year fiscal 2007 are still expected to be approximately $200 million, an increase of 27% over fiscal 2006. First shipments of our new shotguns line will take place in the fourth fiscal quarter, which ends April 30 and, due to ramp-up, will not significantly impact our sales projections for the current fiscal year.

We have now completed the first full year with our reorganized direct sales force and expect sales to grow at more modest rate in the mid-teens. Year-over-year increases in law enforcement sales have been strong and we expect that our introduction of additional variations of the M&P pistol will further improve our penetration in this segment. International sales have been adversely impacted by some delays in export licenses from Thailand, due to the political situation there, but we expect to see a significant improvement in the second half.

We have completed shipments of the most recent order for Afghanistan and expect federal government sales to be at more modest level in the second half. Net income for fiscal 2007 is still expected to increase to $15 million or $0.36 per diluted share. Gross margin as a percentage of sales and licensing is still expected to increase from 31% in fiscal 2006 to approximately 34% in fiscal 2007. We expect third quarter gross margins to be similar to second quarter levels due to the large number of holidays during the quarter. Fourth quarter gross margins are projected to be considerably stronger, bringing our gross margin percentage up to 34% for fiscal 2007. We now expect capital expenditures of $14.3 million for fiscal 2007, reflecting a $1.3 million increase from our previous projections to address additional spending for long gun products and capacity. Depreciation of $6 million for fiscal 2007 remains unchanged from previous projections.

Now, for our outlook for fiscal 2008, which begins May 1, 2007. We are projecting net sales of $250 million, which will reflect a 25% increase over our forecasted results for the current fiscal year. We expect to see continued penetration in all market segments supported by a full line of M&P pistol products available for the entire fiscal year. We expect the ramp-up of our shotgun line to continue through the first half of fiscal 2008 and the expansion of long gun products throughout fiscal 2008 should contribute to the strong top-line performance.

We are projecting net income of $22 million or $0.52 per diluted share for fiscal 2008. This represents a 46.7% increase in net income and a $0.16 or 44% increase in earnings per diluted share over our projected fiscal 2007 results. Gross margins are expected to be between 34% and 35% for fiscal 2008 and operating expenses are expected to be about 20% to 21% of sales and licensing. Capital expenditures are expected to be approximately $12 million to $15 million in fiscal 2008 and cash flow is expected to be approximately $18 million.

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

Thank you, John, and thank you, everyone, for joining us today. It recently occurred to me that this week marks the two-year anniversary of my arrival at Smith & Wesson. It's been a great two years. As I reflect on our accomplishments of the company over that time and as I speak to you today about our current performance results, I could not be more pleased with the tremendous progress we have made as a team.

Two years ago, we laid out an aggressive plan to grow our core handgun business and diversify the company into areas that would define Smith & Wesson as a company in the business of safety, security, protection and sport. This quarter, we continue to deliver on our growth objectives and we hit another major milestone on the road to diversification. Our results reflect that we continue to execute on a plan. Let me walk you through some of the details.

This marks the third consecutive quarter of revenue growth in excess of 40% as well as our highest level yet of net income growth, an impressive 312%. This growth in our core business is the result of many initiatives that were recently put into place. Key among those was our conversion to a direct sales force from the previous network of manufacturer reps a little over a year ago. Our sales results clearly show that this team, made up of direct Smith & Wesson employees is giving us traction at the deal level, making our name much more visible to consumers and driving growth in the sporting goods channels.

One of the more exciting elements of our business is that we will now begin to leverage this sales network as we broaden our product portfolio and give them some great new products to work with. I'll talk more about that in a minute. Our growth has also been supported by the launch of some exciting new products, namely the M&P series of pistols and tactical rifles. We've used these products to begin to recapture our rightful share of the law enforcement market. As many of you have heard me say, Smith & Wesson once owned 98% of this market. The M&P is fueling our progress in winning over a growing number of police agencies.

Let me give you an update on those numbers. Our traction in law enforcement grew this quarter. To date, our M&P has one business with 135 law enforcement agencies across the nation. This number includes departments that have completed their test and evaluation process and have either approved for purchase -- approved for duty carry the M&P -- or approved for duty carry the M&P pistol. Moreover, this number represents a win rate of over 77% for all agencies that have put the M&P to the test. Equally impressive, those 135 departments represent over 19,000 officers. With a total market size of about 17,000 police departments representing 800,000 officers, we have a lot of runway left in this space. I'll continue to update this -- update you on this as we make progress through the year.

The launch of our M&P tactical rifle also supported our growth and is making great progress in the marketplace. While our intent when we launched the new tactical rifle was to first penetrate the consumer market -- and we're doing that very successfully -- the response from law enforcement has been equally impressive. Demand for our tactical rifles continues to outpace our supply and we are very actively looking at ways that we can increase the capacity for this line.

To date, a total of 48 law enforcement agencies have put the M&P tactical rifle through their test and evaluation process. Of those, we have one business -- again, this number represents purchases, approvals for purchase or approval for duty carry -- we have one business with 46 of the 48. That's a staggering rate of nearly 96%. The M&P series in both pistols and tactical rifles continues to deliver new customers. To support our sales growth in the future, we will continue to add innovative new products to the M&P family.

Last quarter, we launched the first compact version of the M&P in nine millimeter. We developed a compact version in response to both law enforcement agencies as well as consumers seeking a high quality, concealable firearm for duty use or for personal protection. We knew they liked the features we had designed into the M&P and with concealed carry permits on the rise and our growing presence in law enforcement, the addition -- the new addition just made sense. A compact version of the M&P 40 will follow very shortly.

Today, we are announcing that we are further expanding the M&P line with a 45 caliber M&P, which will be unveiled at the industry's SHOT Show next month. In addition to expanding the M&P family with calibers that are attractive to consumers and police officers, our addition of the 45 also has strategic significance in the military market. Now, most of you are aware of a large potential contract for military pistols that we're hoping to see in the future. Estimates are that the order could represent as many as 650,000 pistols and somewhere between $300 million and $500 million in revenue over time.

While we don't have any definitive news just yet, we have seen some recent movement. The Air Force came out with an RFI about a month ago for 100,000 pistols. An RFI is a request for preliminary information and generally precedes an RFD. The RFI requests various information on both 40 and 45-caliber models, holsters, magazines and guns. We don't know for certain if this is a predecessor to the larger order, but at this point, we're pleased to see some kind of activity from the -- on the federal government front.

The request for information on two calibers reinforces what we've heard -- that the military wants to shift from a nine-millimeter pistol to a 45-caliber for more stopping power. And we know that the features we've designed into the M&P series are what professionals are looking for. So, our timing and the design features of our M&P 45 should fit nicely into what is hopefully a developing opportunity. We look forward to the launch of our M&P 45 at the SHOT Show and I assure you that we will be ready to compete when the military is ready to move.

Now, let me talk a bit about diversification, which is the second piece of our growth strategy. We recently achieved a major milestone when we announced that we will enter the market for shotguns. We plan to show our new shotguns at this year's SHOT Show in January. This is -- now, this move is exciting for a lot of reasons. The overall shotgun market represents about $350 million of the $1.1 billion long gun market. And that's domestic only. It's a highly fragmented market where we believe the Smith & Wesson brand name and our marketing resources can generate significant response.

Our initial entry into the space will be our elite series of over and under and side-by-side shotguns and our 1,000 series of semiautomatic shotguns. Those products, as a category, represent about one-third of that market or approximately $115 million. We will enter that market with shotgun in the mid-market price range and we will offer consumers a series of shotguns that deliver high quality, exceptional features and an heirloom warranty, which is the first of its kind in the business. All this comes in an affordable price range to our consumers. Based on early and extremely positive feedback from our dealers and distributors who have previewed the shotguns, we believe that the combination of our product quality and features along with our brand name and the existing sales channel will allow us to secure approximately 10% of that market in the first year of participation.

In addition to its size, the long gun market is attractive for another reason. We bring to it the added advantage of an existing sales force and distribution channel that can immediately incorporate those products. When we changed our sales organization last summer, moving from manufacture reps to direct employees, we did it to further develop our relationship with dealers and to support our handgun business. But we also did it because we knew at that time that we would eventually move into the long gun space. That move to direct sales people significantly strengthened our position in the sporting goods channel, as our results now clearly show. And that channel is now fully prepared to handle a bigger, broader and more diverse Smith & Wesson portfolio. In fact, we have our sales force in Springfield this week training on the new shotgun line.

When we hit the ground running at the SHOT Show, our sales staff will be fully up to speed on the product and ready to run. And we should mention that our sales in that channel last quarter were up 52%. We continue to look at additional diversification opportunities in the long gun market. To help you understand the significance of that market, note that its total size, including shotguns and rifles, is about $1.1 billion in the United States. That's more than 60% larger than the handgun market we serve today. Hunting rifles, which make up over half of the long gun market, is about $500 million a year, represents the third portion of the long gun market after the tactical rifles and shotguns and the only remaining part of the market where we do not play today. So, you can see why we're moving so aggressively into this space.

Now, I want to give you a brief licensing update before we wrap up. Hopefully, you all saw that we have signed a licensing agreement with Wilson's Leather for a line of Smith & Wesson branded products. I'm very happy to add Wilson's to our list of new licensees for a variety of reasons. They are a premier retailer of leather products in the United States with a strong distribution channel and 425 highly visible retail stores across the country. That's good for Smith & Wesson as we continue to focus on building our brand strength among consumers. Wilson will also help us achieve -- Wilson will help us achieve that objective.

But also, Wilson has agreed to develop a line of Smith & Wesson branded outerwear designed especially for law enforcement officials. This is equally important to us because it helps drive our brand visibility further into the professional law enforcement market, a key area for -- of growth for us. As we build our licensing portfolio, we will increasingly look for this type of model, where license agreements provide not only a revenue stream for Smith & Wesson, but provide strategic benefits for our brand.

As we move into the next half of our fiscal year and as we wrap up this calendar year, we will continue to focus on our long-term goals for growth and diversification. Our business is growing on all fronts and we're planning for a 25% increase for fiscal 2008, which begins in May, with profitability growing 44% over our expected fiscal 2007 levels to $0.52 per diluted share. I look forward to reporting on our progress throughout the balance of this current fiscal year.

And with that, I'd like to open the call up for questions.

[OPERATOR INSTRUCTIONS]

And your first question comes from the line of Amit Dayal from Rodman & Renshaw. Please proceed, sir.

Thank you. I guess I'd like to begin with the shotgun line. What level of commitments from distributors do you have currently for the new shotgun lines? I mean, is there any visibility into that?

I can tell you this, Amit. We recently had the -- there's a distributor convention that happened in -- I don't know -- a couple -- about two weeks ago. And our guys talked to all of our major distributors on the product line. And we got extremely bullish support. We -- which I would have expected. The real key is out in the retail level in that the dealers buy the product. And that's what we're training our sales guys on today or this week, while they're in town, so we get pull-through on the product. We won't -- I don't expect that we'll have any issue on a distributor level getting support and I don't expect a lot of issues on the dealer level because we have a great relationship and we've got terrific product coming. But that process is just starting to take hold. I can tell you this -- the response that we've seen from dealers and from distributors on the product line -- and they actually saw product -- was very, very positive.

That's great. And just, Mike, in terms of your financial commitments or Smith & Wesson's financial commitments, through this whole line of products that you're bringing in -- I mean, it is not very clear in the press release. I mean, if there's any color you can provide on that, it would be very helpful for us.

The -- if I understand your question right, Amit, the arrangement that we have with a partner is -- that is -- there is no capital involved from us. The manufacturing facility is 100% dedicated to Smith & Wesson. They manufacture to our specifications, to your design, to our forecast. So, there's not -- I mean, we've given them volume commitment, obviously, so they can plan the production over there. But that's kind of it. I mean it's a good -- really good relationship. Real -- we really like these guys.

And just one final question and I'll get back in the queue.

Sure.

In terms of your sales to the law enforcement agencies ...

Yes.

Do you have any color on how many [glocks] you've actually replaced so far?

I don't know that number, Amit.

Right.

I don't know that number. I mean, we're just early into this. Our sales to law enforcement last quarter were up 148% versus the year before. So, we're making progress. But remember, we're coming from a 10% share. They have 65%. So, we've got a lot of runway ahead of us.

All right. Great. Thank you so much.

Okay. Thanks.

Your next question comes from the line of Cai Von Rumohr. Please proceed, sir.

Yes, thank you, guys. Could you give us the breakdown of sales by the channels? You kind of gave us the percentage increases, but just so we can kind of triangulate this?

Are you talking for the quarter, Cai?

For the quarter. Correct.

As Mike mentioned, the sporting goods channel increased by about 52.8% for the quarter.

Yes, but -- so that's what -- the $36 million?

No, $36 million is the total sales for the year.

No, no, no, no, no.

No, no, no.

No, no, no, no, no.

No, I'm sorry.

For the quarter.

For the quarter, it's 52.8%.

You don't know what the number -- I mean, the reason I'm trying to get here is I'm trying to find out where was fed -- I have fed military at about five million. I had law enforcement at a little over 7.5 million. And by subtraction, international looks like it's like $2 million. Is that essentially correct?

International was a little stronger than that. It's about $3.5 million for international for the quarter. The sporting channel was about $35 million. And law enforcement about $6 million and federal about $5 million.

Five. Okay. And so, as we look at the second half, you talked of this delay. So, really, international was, in fact, down a bit. Could you talk a little bit about -- I think, at one point, you were looking for international to do 21. Is that still a feasible number?

For the year -- for the year, Cai, yes. Yes, some -- that's some tiny things like they had that coup in Thailand back in September. We're shipping net pieces of that order now, so that -- we're passed that. But it didn't hit in the quarter.

And basically, it reopens now and licenses are being granted.

But for the full year, nothing has changed.

Okay. So, really, in the second half, while the fed military, presumably, is going to be going down to a level of -- what are we talking about -- something like ...

We don't think, Cai, we don't think -- the Defense Department, what do they call their budget? Their supplemental budget is supposed to hit the floor in February, so we think it's going to be purchasing from Afghanistan, Iraq -- any of that stuffy is going to be kind of subdued. You guys saw the same report I saw last night on -- the Baker Report. And that could mean -- that could possibly mean more handguns going to Afghanistan and Iraq. But nothing is going to happen until that budget's approved we don't think.

Right. No, no, but I guess where I'm getting at is to do your number, fed military looks like it goes to very low level in the second half. But we should get a big pickup, sequentially, in year over year in international, if you're going to do 21.

Yes, I'm sorry, Cai, you're right.

Okay. Okay. So, these numbers, which look, I mean, given where you are in terms of law enforcement now, the law enforcement growth looks like it's pretty good. Could you talk a little bit about your backlog for tactical rifles and can law enforcement -- I mean, it looks like it's on a path to get to over $24 million. Is that correct?

Well, we've shipped -- of the departments that have approved the M&P, about half of them have -- a little less than half have already had some flow of shipments and they're all different sequences. Some are all, some are -- taken them some each month. The M&P, we are feverishly looking to supplement the production of the M&P 15 because our backlog level there is -- it's about $8 million, which -- it's been at that level. We're just trying to catch up so we can go and sell some of these. So, adding production is going to help us in that. So, we're beginning to try to -- we're beginning to get that in place and you'll start to see that help. But you'll also see that backlog -- I'm not saying the backlog are down because to be honest with you, our sales guys really haven't sold any because the orders are coming in so strong.

Okay. And could you talk to the issue that the gross margin was down from the first quarter? It looks like, year over year, that the increase in depreciation and utilities was about $600,000 in the second quarter and about $900,000 in the first. So, it was not as much a drag as in the first. Why was the gross margin down from the first quarter?

That was -- that was -- if you go back and look at what we announced last time, Cai, the -- that was not unexpected. We close our factory for the first two weeks in August every year. We do it -- and people take their vacations and -- so, we don't have any production. But we have vacation pay and what have you.

And yet, you didn't last year. Last year -- I know if you go back to years before then, but last year, as I looked at it, the gross product, gross margin was relatively level in the second quarter versus the first.

Well, we had the shutdown in the first two weeks of last year. I'm trying to think what happened in the first quarter, John. Do you remember?

No, off the top of my head, Cai, no. It may be a case of just timing on product that was built.

Could it have been mixed, the fact that you had less export and more law enforcement?

I don't think it contributed to that as much as -- it could have been timing on some of the federal government shipments there and there might have been more volume in that period. I'm not sure if we even -- did we run any production? I'm trying to remember now if we ran any production during that shutdown because of trying to handle some of these government contracts. So, I'd have to go back and look at it to see exactly what happened.

But Cai, on that note, and it's important that everybody understands, the way -- and we've laid out that our gross margin will go -- we were at 34.7, I believe it was for the first quarter. You'll see the dip in the second quarter. The third quarter, because between holidays -- between Thanksgiving and Christmas -- you have almost the same number of days off -- you'll see about the same. In the fourth quarter, we have -- we don't have any holidays, so you have all the workdays. So, you see it bounce back in the fourth quarter for an average for the year of 34%. Okay?

Got it. Just one last one and I'll let someone else go. Shotguns, you mentioned that -- I think you -- if I caught this right, that the markets you're addressing are -- is that $115 million, which would be a third of the $345 million market?

That's correct. At this point, Cai, as we're getting into it -- the first products we launched. That's right.

Okay. But -- so, you're really only in one-third of the market and you hope to get 10% share. What's the other two-thirds? Are you going to address either of those? And if so, when?

Yes, we will. We're not giving time. This is our first year of it. The second part of the thing -- other things are -- parts are like pump shotguns, Cai, are a big part of what's left in shotgun. You're -- I've said all along, long guns, to me, total long guns is a category that is ripe for a company like Smith & Wesson to come in and become a major player in. So, we're not doing it all at once and the -- you're exactly right. The $115 million or about a third of the shotgun market is what we're entering it in. But over year one, year two, year three, you'll see that grow.

Okay. Thank you.

Okay. Thanks, Cai.

Your next question comes from the line of Mike Rindos from H.C. Wainwright. Please proceed, sir.

Hey, Mike.

Hey, fellows. Can you hear me?

Yes, we can hear you.

Yes, two questions for you. The M&P 45 ...

Yes.

Do you have any orders teed up for that, based on the strength of the nine millimeter and the 40 -- situations where people have tested them and have said come back to us when you have the 45?

Not really. But we really haven't shown it yet, to be honest with you. I mean, we've shown it to -- let me back up on that. We've shown it to a few government agencies, but -- in distribution where we would expect to see initial volume. We'll show that next week at the shows. But in fact, this -- tonight is the first time we've announced it. So, I mean, it will flow right into our distribution. We have people asking for it. We've had people asking for it. But we're really not taking any orders on it right now until we get to the SHOT Show.

Okay.

They haven't asked for any, either, at this point.

Yes, yes. People have been asking for that.

Right. Now, is it typical in the industry where it would have to go through a whole new testing and evaluation process per caliber or might they accept the performance that they've seen on the other versions?

You mean like the -- with agency in federal government?

Right. There's been agencies ...

No, they'll all -- they'll test them again. They'll all test them.

They'll test them again.

Any -- to be honest with you, Mike, it's not necessarily just because it's a different caliber. It's a different gun.

Okay. On the shotguns, are you guys going to have a configuration for the spring turkey season? Perhaps a cam load version? It will an auto loader?

Yes, we will. Yes, we will.

Will that be out at retail?

We will be ramping up, okay? But, yes.

Like in front end stores by this spring?

We -- well, you should start to see them in stores in the first calendar quarter.

Great. Great. And on the ...

I take it you're a hunter, huh?

Yes, I'm looking forward to it. Are you guys going to be advertising and doing a lot of those promo shows like you see on Outdoor Life Network by the other manufacturers?

We're not, Mike, at this point, for competitive reasons, we're not giving out the details of what we're going to do, but what we've been able to prove in this industry in the last year and a half or so is when you bring marketing into the industry, you can see the results we're saying -- 52% sales growth in a channel. So, we're going to be behind long guns. This is an important category for us. So, you'll see world class marketing effort behind it coupled with our world class sales organization.

On the rifle category, on the shotguns, I know you came up with 29 configurations or so. How many configurations do you need for the rifle market, initially, do you think?

You talking about like bone action rifles?

Well, how many -- how many different versions or product SKUs might you have out there next year?

Well, we're not giving those details out, Mike, but I can tell you there are -- four calibers make up about 70% of the market. So, that's a big market for us. That's half the long gun market. So, we're not being idle on it, but we're not also giving any information out in it.

And you know -- and you know, Mike, how that thing kind of gets -- expands exponentially. Four calibers -- you then start talking different types of stocks and all that stuff.

Suffice it to say, guys, we're not looking to dabble in long guns. We're looking to be a major player.

And as far as your capacity with your partner in turkey, is there room there for the production of the rifles, as well?

That's not our plan.

Okay. Let me just hit you with one other. When will the shotguns be in the hands of some of the reviewers of the industry?

Actually, that's already happening.

Okay.

We're -- Mike, the SHOT Show is -- it's only three weeks away. So, we're -- we've done our prep work.

You should see some magazine covers shortly.

We're not going to give you any details because we want you to buy them all, Mike.

Separately on -- we've talked in the past about the pursuit of sort of recurring revenue businesses. Have you pursued that path to any great degree lately?

Pursuit of recurring -- well, our retail business, in my mind -- I've been doing this for 30 years -- is a recurring business. It's a demand business like any retail business. I also personally don't buy that law enforcement is not recurring because there's 800,000 cops out there. And you're not going to get them all at once. So, there's a continuous turnover of that business. But I kind of look at -- some of the military stuff, like the Afghanistan orders, are -- you can't count on when they'll recur or how that will happen, but I look -- I've had a couple of people ask me about that and I really believe 85%, 90% of our business is what I would call recurring business.

Okay. All right, guys. I'll get back in the queue.

Thanks, Mike.

Thanks, Mike.

[OPERATOR INSTRUCTIONS]

Your next question comes from the line of [Spencer Ferraro] from Cowen and Company. Please proceed.

Hey, gentlemen. How are you doing there?

Hey, Spencer. How are you, buddy?

Hi, Spencer.

Good [work]. Quick question back on the shotguns. For modeling, can you give a sense of the breakdown between auto load versus over and under? And kind of a follow-on to that, for the side by side, from just the research I've done and the folks I've talked to, that really doesn't seem to be a big player in the shotgun market. The big players, obviously are pump action, which I know you're not delving into, auto loading and then also over and under. So, what was the kind of rationale for developing a side by side?

Here's what we think our breakout will be and you're right. We -- our research shows that in the shotguns, pump shotguns are about half that business. Okay? Ballpark. The -- when we look at our business, our revenue this year -- and you got to remember, we're ramping up, okay? So, in -- we're just getting started this year, but as we get in through this current hunting season, we're still on a ramp. So, we'll be looking -- I'm sure we could sell more product than we'll be able to get our hands on. But we believe that our mix -- our mix will be about, in dollars, about 60% fixed faction and 40% semiautomatics.

Okay.

Okay? So, about 60-40.

Great. Another follow-up here.

The semiautomatic -- you're asking information -- you're knowledge is right, though, Spencer, because, as time goes on, the semiautomatic piece will become bigger and it will become bigger faster.

Okay.

Okay?

Great. A follow-up also on shotguns, regarding markups. According to the National Sporting Good Association, the retail value of shotguns in the market is about $670 million. And given that the revenue or expected revenue at your level or at the company level would be about $350 million and plus about a 91% markup, that's pretty high. But, I mean, is that actually kind of a ballpark range within the shotgun market and how do you break down, again, for modeling, kind of the markups one could expect through the distributor and up to the dealer level by type? So, for example, by auto loading, over and under, are there market differences? And also, with foreign weapons like Benelli, Beretta, I mean, what's kind of the thought there in terms of distributor-dealer markups?

I don't know that we're going to see differences in distributor margins between the different categories. And it's a category, also, where it's a -- the ammo is where some of the margin is. But by and large, distributors will be in the 7% to 10% range and retail will be in the, I don't know, 15% to 20% range.

Okay.

Don't forget to factor in, too, is your FET there as you're looking at that. The excise tax on those is about 11%.

Okay. Great. Final question. Regarding the federal law enforcement market, i.e. DHS, FBI, DEA and so forth, it looks like the last big contracts were in '04 with -- DEA had two -- I'm sorry, DHS had two separate contracts for about $47 million. Last couple years have been pretty tepid. I haven't really seen a lot of activity there. And as you yourself said, every few years you have recurring business that pops up. So, have you kind of gotten any sense of if FBI or DEA or any of the other fed law enforcement agencies have any requirements of magnitude coming up in '07?

Here's what I'll tell you on that, Spence, is that -- and we're not giving agencies out. One, because it's not public information and, second, I don't want to tell our competitors. But there are a number of agency -- federal agencies -- that are looking at or have test units of the M&P.

Okay.

But, to be honest with you, the statistic you said, I kind of like, and that's that there haven't been any major new contracts and so forth. That's a good thing.

Right. All right. Well, thanks very much. I appreciate it.

Appreciate it, bud.

Your next question comes from the line of [Michael Murray] from UBS. Please proceed, sir.

Hey, guys, great quarter.

Hey, Mike. Thanks, buddy.

Listen, I wanted to -- I wonder if you could address the higher margins that you have in handguns with the performance center and custom engraving as they relate to shotguns -- number one. And then, number two, you mentioned the heirloom warranty and I was just wondering if you could go through that.

Yes, that's a great question, Mike. The -- our guys in engraving are chomping at the bit on long guns, I can tell you that. Because I've said it before, that the engraving business is a wonderful business. We like the margins on it. It's just a neat business for us that -- long -- think about long guns. There's more space on there to engrave. It's probably the easy -- it's -- our guys look at it as a canvas. And so, there's a huge -- I shouldn't say huge. I mean, it's not a billion dollars. But there certainly is an opportunity for us in engraving long guns that we fully expect to take advantage of. And in the performance center -- the same thing in performance center. The guys have been looking for this for awhile. So, just as our performance center addresses handgun opportunities, that same market opportunity exists, certainly, when you get into rifles.

And what kind of difference in margins are we talking about there?

Well, we don't give out the difference in margins, but I like them.

Okay.

But then, you had a second question, Mike that was ...

The heirloom warranty.

Yes, the heirloom warranty. I thought our guys came up with a terrific idea. And what the heirloom warranty says is if you buy a Smith & Wesson -- this is the elite -- shotguns, that you can -- your warranty -- it's a lifetime warranty -- and your warranty can be passed down to an heir of your choice. And that is -- it's going to be marketed in a terrific fashion. Tom Taylor and the guys have done a neat job with the certificate that comes with it that firearms collectors certainly cherish. And they can -- these are collector's items.

Yes.

These are things that are passed down. And a number of times I talk to people and they tell me about a Smith & Wesson that's been -- a handgun that's passed down from their great-grandfather to their father, all the way through. That there's a certificate that goes with it and there -- it comes in a nice leather pouch. It's all marketed properly. But that the warranty is in effect through -- with your heir -- you're -- we think it will have a nice touch. And the response we've heard from dealers and distributors to that has been like, "Wow, what a great idea. I wonder why no one thought of this before." So, we're -- we think it will help to the marketing sizzle, but it will be behind some terrific, terrific products.

Great. Thanks, guys.

Hey, Mike. Thanks.

Ladies and gentlemen, at this time we have exhausted the time set aside for Q&A. I would now like to turn the call back over to Mr. Mike Golden for closing remarks. Please proceed, sir.

Thank you. And thank you, everyone, for joining us today. I want to take a quick moment and thank the entire team at Smith & Wesson for another great quarter. And thanks to your support throughout calendar 2006 to the entire team. Please look for us if you'll be attending the SHOT Show, which is January 11 to the 14, down in Orlando, Florida. We've got a lot going on. And we'll also be attending the Cowen and Company 2007 Aerospace and Defense Conference, which is February 6 and 7 in New York. And for everyone, please have a happy holiday and we'll look forward to talking to you again next quarter. Thank you very much.

Thanks for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.