Smith & Wesson Brands Inc (SWBI) 2008 Q3 法說會逐字稿

Good evening, ladies and gentlemen, welcome to the Smith & Wesson Holding Corp. conference call. I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We'll facilitate a question-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call, Ms. Liz Sharp, Vice President of Investor Relations.

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 judgement 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 would encourage you to read 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, 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 or Mike Golden, President and CEO, and John Kelly, Chief Financial Officer. And with that I'll turn out over to Mike.

Thank you, Liz. Hi, everyone, and thanks for joining us. Let me give you the agenda for today's call. First, John will review our financial results. 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, we will open up the call for questions from our analysts. Go ahead, John.

Thanks, Mike. Sales for the three months ended January 31, 2008, were $66.1 million, a $12.2 million or 22.6% increase over sales of $53.9 million for the three months ended January 31, 2007. Firearm sales, our core business increased by $10.8 million or 21.3% over the comparable three months ended for the previous year. Net loss was $1.8 million, or $0.04 per diluted share for the three months ended January 31, 2008, compared with net income of $1.6 million, or $0.04 per diluted share, for the three months ended January 31, 2007.

The increase in firearms sales in the three months ended January 31, 2008, was entirely attributable to the addition of Thompson Center Arms, which we acquired in January 2007. Pistol sales for the three months ended January 31, 2008, were $1.5 million below the comparable period last year. The decrease is attributable to $2.2 million in shipments to the California Highway Patrol in the third quarter of fiscal 2007, which did not recur this year. Sales of the M&P pistol grew at rate of 42.7% for the three month period, reflecting strong sales in the law enforcement channel. In fact, excluding shipments to the California Highway Patrol in the comparable quarter, law enforcement sales in the third quarter of the current period grew more than 40%. Revolver sales increased 2.1% for the three-month period reflecting the soft domestic consumer market.

In the long gun category sales of both shotguns and I-bolt rifles were below our expectations. Shipments to these products commenced as the market conditions were deteriorating, and distributors were reluctant to take on these products. Our Elite Silver over and under shotguns have been adversely affected by production start-ups. The Elite Silver, and the Elite Gold series are both being well received, but suffering from the current market environment. Our 1000 series semiautomatic shotguns have been adversely affected by the significant price discounting by competitors in this category. Our I-bolt rifles have been affected by a number of new entrants to the bolt action rifle category including new products from Browning and Marlin, which are established competitors in this space. Our sales and marketing personnel are currently evaluating the product positioning of our 1000 Series and I-bolt rifles given this environment. Total shotgun sales for the quarter were $200,000.

Tactical rifle sales increased by about 67% to 4.2 million in the quarter, driven by an attractive retail promotion and continued penetration in the law enforcement channel. Walther products also enjoyed another strong quarter with sales up 16.7% over the comparable period last year, based upon the introduction of the company's PPS subcompact pistol.

Gross margin for the three-month ended January 31, 2008, decreased by approximately $376,000 over the three months ended January 31, 2007, despite the higher sales volume. Gross margin as a percentage of sales and licensing was 25%, compared with 31.3% for the three months ended January 31, 2007. The decline in gross margin is attributable to $4.7 million in promotion costs, as well as the unabsorbed fixed costs as a result of the three week Springfield factory shut down that took place during the quarter. Cost of goods sold for the three months ended January 31, 2008, also included an additional $325,000 in depreciation expense due to the significant capital expenditures in the previous year.

Operating expenses for the three months end January 31, 2008, were $16.3 million, a 21.9% increase over expenses of $13.4 million for the three months ended January 31, 2007. The increase in operating expenses includes $3.4 million in operating expenses for Thompson Center Arms, which was acquired in January, 2007. Operating expenses, excluding the Thompson Center Arms impact, decreased by approximately $492,000. The decrease was the result of lower profit sharing, partially offset by higher professional fees. Operating expenses as a percentage of sales and licensing was 24.5% for the three months end January 31, 2008, compared with 24.6% for the three months earned January 31, 2007.

Operating income for the three months ended January 31, 2008, was $310,000, or 0.5% of sales and licensing, compared with $3.6 million, or 6.7% of sales and licensing for the three months ended January 31, 2007.

Now let's look at the nine months results.

Sales for the nine months ended January 31, 2008, were $211.3 million, a $59 million, or 38.7% increase over sales of $152.3 million for the nine months ended January 31, 2007. Firearm sales, our core business increased by $53.8 million, 37.4% over the comparable nine months ended for the previous year. Net income of $5.8 million, or $0.14 per diluted share for the nine months ended January 31, 2008, was $2 million, or $0.05 per diluted share lower than the $7.8 million or $0.19 per diluted share for the nine months ended January 31, 2007.

Of the $53.8 million in increased firearm sales, Thompson Center Arms accounted for $51.7 million. Revolver sales increased by 6% over the comparable period last year, representing solid performance over full year fiscal 2007 growth of 4.3%. Overall pistol sales decreased by 11.4% from the comparable nine month period last year. While we won business with several new law enforcement agencies during the nine month period ended January 31, 2008, last year's pistol sales for the comparable period included $13.1 million in sales to the Afghanistan National Police, and the California Highway Patrol, which were not replicated in the current period. Consumer pistol sales for the nine month period grew by approximately 14%. In addition, Walther pistol sales grew 10.1% for the period, bolstered in part by a new subcompact pistol launched in July of 2007.

Our tactical rifles continue to be very successful and grew at a rate of 49.9% for the nine month period ending January 31, 2008. This growth has been driven by a combination of solid and continuing penetration of the law enforcement market and a significant consumer promotion.

Engraving sales for the period were down 35.2% for the nine month period ending January 31, 2008. Last year's nine month results were heavily impacted by the very successful 50th anniversary commemorative of our famous Model 29, 44-caliber magnum revolver and a full line of Classic revolvers launched in calendar 2006.

Shotgun sales were $2.1 million for the nine month period.

Gross margin for the nine months ended January 31, 2008, of $66.9 million increased by approximately $17.2 million over the nine months end January 31, 2007. Gross margin as a percentage of sales and licensing was 31.4%, compared with 32.3% for the nine months ended January 31, 2007. The decrease in gross margin percentage was the result of increased promotion costs, and the unabsorbed fixed costs that occurred due to the extended Springfield factory shut down in the third quarter. Depreciation expense in the first nine months of fiscal 2008 was $879,000 higher than the comparable period last year.

Operating expenses for the nine months ended January 31, 2008, were $50.3 million, a $15.4 million, or 44.1% increase over expenses of $34.9 million for the nine months ended January 31, 2007. The increase in operating expenses includes $13.5 million in operating expenses for Thompson Center Arms. The remaining increase is attributable to $1.7 million in higher stock based compensation expense. Operating expenses as a percentage of sales and licensing was 23.6% for the nine months ended January 31, 2008, compared with 22.7% for the comparable period last year.

Operating income for the nine months ended January 31, 2008, was $16.5 million, or 7.8% of sales and licensing, compared with $14.8 million, or 9.7% of sales and licensing for the first nine months of last year. Capital expenditures for the nine months ended January 31, 2008, totaled $10.8 million. A $1.7 million increase when compared with capital expenditures for the comparable nine months of last year. Capital expenditures in the current period were related to the expansion of firearms production and new product tooling. There was $19.1 million in short term borrowings as of January 31, 2008, compared with zero at January 31, 2007. Free cash outflow for the nine month period ending January 31, 2008, was approximately $21 million, versus $400,000 for the comparable period last year. Free cash flow for the current nine month period and the corresponding increase in short term borrowings were primarily driven by inventory build. Inventories peaked at $56.5 million in November, but declined by $5.1 million in December and January. Inventories are expected to continue to decline through without the fourth quarter.

From a financial perspective we have take a number of steps over the last 4.5 months as the market situation has changed. Those steps have included a reduction in spending, including elimination of temporary labor in our manufacturing operations, and a reduction in force at our Springfield facility in November. We have maintained an extreme focus on our inventory level. We executed a three-week shut down over the holidays at our Springfield facility, which was an expansion of our typical one week shut down. That action was intended specifically to reduce inventory. We also implemented a series of aggressive retail focused promotions designed to stimulate demand at the consumer level and pull products through the channel. We have adjusted production levels primarily in our Springfield facility in light of current market conditions and inventory levels and we will continue to monitor and adjust those levels as needed. Our goal is to drive continuing decreases in inventory levels.

As you know, in January we suspended giving financial guidance through the end of our fiscal year, which ends in April. As Mike will discuss, we believe circumstances are beginning to gradually improve. However, given the uncertainty we continue to experience, and the unknown impact of existing inventories on future orders, we are not providing financial guidance today. Until we resume providing financial guidance in the future, there is only a limited amount of information we will be able to provide. What we can tell you at this point is that our future spending will generally be conservative, as will be our planned capital expenditures. We think that our distributors and direct customers will be cautious in their ordering practices, given factors in the economy, and the industry inventory build up that occurred in late calendar 2007.

Looking ahead, we are entering the seasonal period when Thompson Center Arms builds products for the fall hunting season, and ships products to distributors on extended payment terms, a standard practice in the hunting industry. Because of this, results from our efforts to increase cash flow and reduce borrowing may be masked by the seasonable order and payment cycle.

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

Thanks, John. While a tough consumer channel and worsening economic environment in the third fiscal quarter dealt us a difficult hand, the quarter was not without its bright spots. Before I talk about those, let me recap for those who may be new to our story, those factors we believe that led to the challenging environment we have experienced in the middle and second half of fiscal 2008.

The domestic consumer firearms markets experienced a decline in demand during the third fiscal quarter as a result of lower retail traffic. The period was marked by an escalation of the subprime loan crisis, a tightening of the credit markets, the continued worsening of the housing market, increasing fuel prices, less than robust employment growth, and generally weak economic conditions. Those factors contributed to a general slowdown of consumer spending across a wide variety of industries and product lines. Against this environment unseasonably warm weather throughout most of the United States adversely affected the retail traffic in the sporting goods channel. At the same time, significant distribution channel purchases in anticipation of a strong hunting season resulted in excess inventory levels which limited the ability of the distribution channel to purchase additional products.

Now, there are two data points we tend to go to the firearms industry as a barometer for activity. First, federal excise taxes give us a general indication of what manufacturers are building and putting into the distribution channel. Second is NICS data. NICS data gives us the number of federal background checks that are concluded over a period -- conducted over a period and this data point gives us a general idea of the trends in consumer purchases. A couple of notes. First, FET data is not immediately available to us. These quarterly reports are generally published about 120 days after the end of the quarter. The NICS data is generated monthly, and we can access information shortly after the end of each month. Very importantly, we also look at our major distributor's POS, or their sales to dealers.

So let's go back to how we attempt to interpret this data, and what it can tell us about what was occurring in the autumn of 2007. Federal excise tax data for the third quarter of calendar 2007, which has only recently become available, indicates that sales of long guns from manufacturers to distributors, were up 26.3% for the first nine months of calendar 2007, compared to 2006. When we compare this number with the NICS data which showed a reduced retail activity beginning in the fall, it confirms our assessment, originally provided in late October, of channel inventory build up. From that point forward, distributors began to work their inventories down by reducing their purchases from manufacturers, including Smith & Wesson. The inventory adjustment was not only on long guns, but handguns as well.

So let's move to where we are today. In short, we are not completely out of the woods yet, but we are seeing signs that things are beginning to improve. The adjustment for Smith & Wesson handguns appears to be running its course fairly quickly. Feedback from our distributors on their sales to dealers and POS feedback that we are gathering appear to indicate that we continue to take market share. Data that we have gathered over the course of January and February, from our seasonal distributor shows and direct buying group shows, reflects that the inventory situation is beginning to improve. While this is very encouraging, we also know from our discussions with several of our key distributors, that there are blocks of inventory out there in the channel from various manufacturers that still need to be cleared out.

Feedback from the field also leads us to believe that there are several key competitors with large supplies of inventories in their warehouses. Our sources also tell us that long gun inventories still remain high. As a result, we intend to keep in place, through the end of our fiscal year, promotional programs that we have launched over the past several months. At that time, we will be better able to assess how inventories in each of these channels are moving out and will adjust our marketing programs accordingly.

Now I would like to spend the balance of my time sharing with you some of the progress we are making on our strategy. Unfortunately the challenging conditions that we have been experiencing in the short term take center stage stage over discussions about our strategy. Yet this is a critical part of the Smith & Wesson story, because that strategy provides a foundation of growth over time in our core handgun and long gun channel of sporting goods, law enforcement, federal government, and the international market. It also provides us with a path over time to diversify our business into new professional non-consumer areas that capitalize on our foundation of safety and security.

In terms of growing our core business, nothing shows our commitment and progress in the sporting goods and law enforcement markets like our new product activity at the firearms industry's largest trade show, the Shot Show, which was held in February. At this year's Shot Show, we introduced 71 new products or product line extensions. That's not an unusually high number for us. We are known as one of the most innovative companies in the business. This list is obviously too long to detail, but I want to mention a couple of the key products.

This year's show featured the addition of a compact and a mid-sized version of our M&P45 polymer pistol, as well as several line extensions of our M&P15 tactical rifle. Both of these very successful products have been designed to cross multiple markets, including military, law enforcement, and consumers. We launched a classic version of our popular Thompson Center Arms Icon rifle, as well as additional calibers of the existing Icon. We also launched a new series of Night Guard revolvers. The Night Guard series is pretty exciting. It's the first new mid-frame size revolver series that we've launched in many years, and is based on a frame size that was originally very popular with law enforcement. The line is a modernized approach to the mid-frame and has been designed specifically for personal protection.

There were many more products, as well, but the key concept here is that we continue to innovate and deliver new products each year to address the demand of our customers in each of our key markets. We believe it is that innovation in both the Smith and Wesson and the Thompson Center brands, which led us to become the recipient of a number of awards this quarter. As our release mentioned, we were awarded the NRA Golden Bull's-Eye award for three of our products. The Thompson Center Icon rifle was named rifle of the year. Our Smith & Wesson Elite Gold shotgun was named shotgun of the year, and our M&P45 polymer pistol was named handgun of the year. For one company to be awarded three Golden Bulls-Eye awards is unprecedented. We are very proud of these industry acknowledgments, and I want to personally thank our Smith & Wesson and Thompson Center employees for their hard work, which is what earned us these tremendous awards.

But being proud is not the only benefit. Winning awards like this from publications and panels within our own industry, made up of our peers and customers has a tremendous marketing value to us. This recognition appears across several industry media outlets, and that means literally millions of firearm enthusiasts see the news and hear about our new products. That means great exposure for the Smith & Wesson and Thompson Center brand names and our products.

Another particularly positive spot on the third quarter was our ongoing progress in the law enforcement channel. The M&P series of pistols and tactical rifles continues to get great reviews from consumers, but equally important continues to win over law enforcement agencies across America. So far the M&P pistol has been chosen by 309 law enforcement agencies. That translates to a win rate of over 80% of all the contests in which it has competed. The Smith & Wesson M&P tactical rifle is posting equally impressive numbers, winning 128 law enforcement agencies, or over 90% of all contests that it enters. The law enforcement channel provides a significant opportunity for us to continue to diversify by growing in the professional markets. Remember, we used to have 98% of that business.

The military represents a similar future order on two separate fronts, a similar opportunity on two separate fronts. First, there has been some good progress since we last spoke in early December in terms of future business opportunities with the federal government. In January this year, the President signed the Fiscal Year 2008 Defense Authorization Bill. This year's bill was especially important for us because it contained a provision requiring the Defense Department to allow domestic manufacturers to compete for DOD small arms contracts. Believe it or not, this has not been the requirement in the past. This law requires competition for future defense contracts, and requires that American Companies have an opportunity to compete. This is an important change for our Company.

There's a second future area of potential business with the federal government, which remains a big focal point for us, and that is the military's consideration of switching from their nine millimeter to a new pistol, likely a 45-caliber. Let me tell you what we know so far. Last month, the Chief of Staff of the Air Force sent Congress a list of unfunded requirements. One item requested is $116.4 million for about 100,000 pistols. Now, the requirement is currently unfunded, but importantly, the request prioritizes and documents the requirement for a new pistol, so this is an important first step in the in the military's process of moving to a new handgun. We will be working to support the requirement and getting it funded.

Finally, as we maintain our intense focus on growing our core business in our established markets, both consumer and professional we remain equally focused on seeking out diversification opportunities. Thompson Center Arms represented our first step down that path, and that very successful acquisition continues to deliver the positive result we have planned. We continue to drive our diversification efforts forward, because expanding into new non-firearm businesses that tap into our brand strength in safety, security, protection, and sport, will provide us with a diversified foundation for our future growth and success.

With that, operator, I would like to open the call for questions from our analysts.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Mr. Paul Swinand with Stephens. Please proceed.

Hello, can you hear me?

Hey, Paul.

Good evening to you. My first question was on some of the way the weather patterns played out. Did you see any strength from Thompson Center? Because it didn't get very cold in December despite how warm it was earlier in the year, and obviously some of their seasons are later, and so it's just a question of, given their established trend in the market, did they see a pick-up or a strong December as the weather got colder?

You're exactly right, Paul. In many places, the black powder hunting season is later in the season, and they did actually see a pick up in their business, and we saw a difference in that versus what we were seeing in the rest of the industry.

So they were sort of comparatively soft earlier in the year when it was unseasonably warm, but then they outpaced in December, January would that be fair?

They were seeing the same things the rest of the industry saw, but they did have a fairly decent third quarter.

Okay. And given that Greg Ritz is head of that division now, or of hunting, Smith & Wesson hunting, I notice at the Shot Show you're make something tweaks here and there, but what do you think you're going to do differently in the hunting category in general for fiscal 2009?

Well let me start off, Paul, by saying the acquisition of Thompson Center as I said in the prepared remarks, we're very pleased with. The -- we really are just getting into the long gun business. We got our first year of it, and our sales in the first year will equal about 10% of that market. The -- as we -- you saw at the Shot Show, we have expanded the lines of bolt action with, the Icon classic, and a number of new SKUs that are in there. We have -- the I-bolt had some new SKUs at the Shot Show. We did not really do any promoting of the Smith & Wesson hunting products this year, because we were late coming into the season. So this is really our first full season, calendar year 2008, of really being in the long gun business.

And I guess one final question. As you -- as you're more stabilized in the acquisition, in calendar 2008, are there any specific savings now that you're making all of your long barrels yourself, and as you see opportunities in the factory in New Hampshire?

There are, as we've said all along, Paul, there are -- we knew there were a number of synergies we would pick up. Barrels are one of them, castings. We outsource castings at Springfield, and we can do them up at Thompson. We outsource heat tree from Thompson, and somewhere a heat tree operation here in Springfield. So there's a number of synergies that we expected and are seeing the barrel. You're right, the barrel coming to the M&P rifle. The barrel for the -- for the I-bolt rifle. So there's a number of synergies. We're not talking about ones we're still working on because we have relationships, and we have to see how they all play out, but there have been a number of things, which we expected, in the acquisition.

Okay. Thank you.

Okay. Thanks, Paul.

Your next question comes from the line of Shaun Smolarz with Sidoti and Company. Please provide.

My first question is, are you more or less confident in the near term business outlook today versus mid-January when guidance was suspended?

I'm sorry, I didn't hair the beginning of the question, Shaun.

Are you more or less confident in the near term business outlook today versus mid-January when the guidance was suspended?

Well, we're not giving guidance at this point in time, as, you know, but, as I said in my prepared remarks, we're seeing signs that are encouraging, from dealers and from our (was there anything here?)

And in terms of seeing signs that the situation is improving, I recall that back in December on the last conference call, that you also mentioned that there were some initial signs that things were improving, so how is, like, your thoughts in terms of industry improving different today versus back in December when you thought things were improving?

Well, we only had, I forget what it was, five days of data under our belt back in December. Okay? And if you look through we said -- I think one John may have been the one who said it at the time, that it appeared to us that when there's an inventory back build up, it takes about a quarter or so for handguns to work it's way through, and about six months on long guns. And that's about what we're seeing. There is still long gun inventory out in channel.

And the next question would be, could you elaborate on the comments in the press release on stating that and the Company expects once inventory levels correct that distributor buying patterns would be much more conservative compared to last year? Does that mean as we consider our financial models that you're expecting sales to be down in the fourth quarter and first quarter of '09?

I'm not going to comment on specific quarters, but what we mean by that is, you know, there are a number of factors that affect the industry and caused this inventory build out. Certainly weather was one of them, certainly the economy. You guys know better than I do all of the things going on out there. The -- we believe that distributors buying practices will take into consideration the uncertainty in the marketplace, and they will simply buy more conservatively.

What they went through is pretty fresh in their minds at this point so it's going to color them particularly with the economy in the way it is right now. You can expect them to be cautious.

Okay. And then my last question is on the -- on possible acquisitions front. Does the current industry weakness and also on the balance sheet being fairly leveraged, does that make it less likely that an acquisition would occur?

We're continuing to look at the -- at opportunities out there for us. The -- I mean, there's a number of ways that we could go back and support an acquisition. We've got a number of relationships with a number of banks. So it really doesn't change our strategy. We're not going to rush into anything. And we didn't rush into Thompson. We looked for awhile until we found something that really was in our wheel zone, so, but I don't want anybody to think that our strategy is going to change, because it's not.

Maybe this question more for John. In terms of the balance sheet, like leverage, about a 60% debt to total capital ratio, are you comfortable with that level?

The debt level is something we're comfortable with. We've played it out. Some of it fluctuates obviously with the season patterns, with the hunting season and as work through this inventory situation, that's a factor in that, but, we're comfortable as we work this inventory down of where we are in our financial model. We have adequate space on our lines of credit, so we're comfortable in our position, and our ability to move forward and do additional things if we need to.

Okay. All right. Thank you very much, guys.

Okay. Thanks, Shaun.

Your next question comes from the line with Cai von Rumohr with Cowen and Company. Please provide.

Hey, good job on starting to get that inventory to come down.

Thanks, appreciate it.

A couple of technical questions, can you give us, what was the backlog at the end of the quarter, and what were the international export sales in the quarter?

Hold on for second, Cai. John is looking in the queue for that. Our international export sales were down for the quarter, and that was driven by a licensing, from the State Department that we thought was going to come in this quarter and actually going to fall into this quarter. They're still up for the year though, the first nine months they are up, though, I want to say 30%, Cai.

Right, so if they were down this quarter -- let me just try to get to my numbers -- so they might have been -- so they were under 5 million probably in this quarter, so do you--?

A little bit more than 5 million, Cai?

Excuse me?

A little more than 5 million, like 5.2.

Okay. Okay great. And then do you expect them -- I mean I assume you said that you had something was delayed. Do you expect that -- should that be petter in the final quarter?

Yes, that will come into this quarter. We'll end up -- I think we're up about 30% in international, and, we'll -- we'll continue to be up for the year.

How big was that license, out of curiosity, approximately?

About $1 million. That's what triggers the congressional approval process versus just the State Department.

How big was it again?

About $1 million.

$1 million. Okay. And then do you have the backlog number?

Cai, rather than go into all the details of the specific backlog, I can tell you that the backlog has improved in the same trends as it improved last year. It's a little lower -- improved last year. It's a little lower than it was in the previous year, which is factored in somewhat because we had the CHP order in there last year, but the trend is mirroring what we saw last year as the backlog builds because of all the buying group shows and distributor shows that happened in the first part of the year. So we're having the normal seasonal build in the backlog at this point.

It's still lower than the 15 million you had last year at this time?.

And last year at this time, I think if I remember right, Shot Show was in January of last year, and we had all of the orders for Thompson Centers introduction to the Icon, plus the CHC which really, and the triumph muzzle loader, so it was an anomaly for Thompson there to have such a huge backlog in January, and this year Shot Show was in February, so it kind of distorted some of the numbers there from year over year.

Can you give us any color -- I guess normally at Shot Show, the dealers places their initial orders for the upcoming season. Any color on that? I assume the Icon is doing relatively well, although you have issues with the I-bolt and the 1,000.

Well, first let's back up, Cai. People don't place orders at the Shot Show with manufacturers. They begin to look at the array of products and start to wrap their minds around what they're going to do in that calendar year. So it's not an order writing show. Okay? The -- what we're seeing on the, probably the best barometer is Thompson, because they've been in the hunting business, and the booking orders are coming in around flat for last year, which is what we would expect, and what we think is going to happen, is if the business season is a good season, there will be more in season buying from distributors versus the way, just places the booking order, and that works favorable for us because of our flexibility in manufacturing. The -- what was the second part of your question?

That was -- that was -- that was the major part of it.

Okay.

I guess the one substantive one is you mentioned problems with the I-bolt, the competitive problem, and then the 1000, had the start-up problems. Do you feel you need to redesign either of those products, and are there any quality issue with the I-bolt that need to be freshened up?

Let me tell you how we see this. Okay? One, as you guys know, we are very excited about the long gun business. This is a big opportunity for our Company. We got a late start on the Smith & Wesson side, Thompson, we continue to be very pleased with. On the Smith & Wesson side we got a late start, so we didn't get much product out there, it's just that simple. Bust what has happened is the -- at the recent Shot Show, there were a number of manufacturers that launched new bolt action rifles that are at relatively -- not relatively, very low price points, and we're trying to understand, what kind of costs can be taken out of the I -bolt from manufacturing, not taking features out, but other things we can do to be competitive in that with this new lower price point that's out there. On shotguns, our -- Elite Gold and Elite Silver are positioned very well. In fact, Elite Gold won shotgun of the year. So we're very pleased with where they are. What we're finding on the semi-auto is that they -- the price points -- because of the market for shotguns, which was a very soft market last year, competitors did a lot of very severe price discounting on shotguns that really make our semi-auto not competitive at the price point it's in. So what we're trying to think that all the way through and understand how do we address this and what have you. We love the business. We love what we're seeing with the Gold and Silver Elite. We love the Thompson Center business and the icon business, but thrice a couple of areas that the guys are working on and rethinking.

Okay. And the last one, you had mentioned that you're aware of some of your competitors not really with respect to distributors, are you seeing increased price discounting to try to move that inventory over the last couple of months or is price discounting abating?

This is John. The price discounting, we're seeing that, there were some people at the show that were advertising substantial discounts. What we have seen is more of the push to get stuff into distributors, rather than the retail promotions, and the retail promotions, while expensive, are really the way we've been pursuing it, because they pull the inventory through the channel, and I think part of the rope why we've seen the recovery we have is because of those promos, in terms of getting that out of there, and I don't think some of the other players, some of the feedback we've had, have been able to do that. We've gotten feedback from distributors of high inventory levels of certain competitor product lines, as well as, looking at some other sources of data that the inventory -- their own inventory levels are probably high, so they've got to figure out what do with that, and that's part of this uncertainty that we're still dealing with, and how -- why we're considering with the promos into the fourth quarter.

Okay. Great. Thank you very much.

Okay, Cai, thanks a lot.

Your next question comes from the line of [Spencer Farrah] with Cowen and Company. Please pride.

Hey, folks, just doing our job to monopolize the questions here with Cowen. I actually got cut out, so I hope I'm not repeating anything. First question, Mike, is directed toward you, if you can kind of give your take on some of the legislative trends going on and in the gun industry right now. Specifically, I believe it was in the January '08 edition of American Rifleman, published courtesy of the NRA, there's an article that says a Congressman from New Jersey is introducing a resolution to mirror the microstamping law that took place in California a few months earlier. Just wanted kind of your take once again about this law in particular, or this proposal, and sort of the apparent shifting of sentiment from Congress toward more restrictive measures. How do you think this is going to impact the gun market in the next administration, or in the near term, and what other legislative issues are you addressing currently in Washington in your lobbying efforts there right now?

Okay. Let me take this one at a time, Spencer, because there's a number of things in there. On the microstamping, so everybody understands what that is, there was a bill passed in California that requires effective January of 2010, that any new pistol SKUs, in other words, new products that were issued and sold in California must have what they're calling microstamping. What microstamping does is when the gun is fired, it stamps the serial number onto the shell of the ammo, the bullet, and if you know with a pistol it is on the ground and they could figure out whose the pistols was. The industries point of view on that is we are not necessarily as an industry against microstamping, this doesn't work. The reason it doesn't work is, one, it very easy to, with a nail file, someone could rub out the serial number that would be on the striking pin. So it's very easy to defeat. Second, it doesn't apply to products that are already being sold in California. So like the M&P, it doesn't apply to products like that. And third it doesn't apply to revolvers because the shell doesn't eject.

There are two studies, one from the University of Southern California, that very clearly say that this is a flawed technology and doesn't work. It's being pushed by the manufacturer of the technology, who is the sole proprietor of the technology. So the industry is trying to take a stand to try to get that undone. If it does not get undone, then we will have to find way to be compliant with it. A lot of it is a logistics issue in the factory, because we typically put the serial number on the gun at the end the line, and if you have to match the serial number on the striking pin with the gun it gets complicated so that's the position we're taking on that. If it's something we have to adhere to, we'll have to, there will be a cost to that, and we'll just add that to the cost of the product, know, it doesn't, to me, sound like it's an extraordinary cost, but I'm not sure of that. What are we working on in Washington? was that the second one?

Yes, just kind of generally could you qualitatively describe what's going on right now?

Yes, the -- this move to get the -- where the Air Force sent in this request for 100,000 pistols, I really look at it as really a positive thing. If I'm in Washington now, my focus won't be so much on we need to get a new pistol -- we need to get, someone to put that forward, it's we need to get this funded. And, that's a totally different tactic we'll take down there. I really salute the Air Force for taking this lead, and they are very determined to make sure this happens. So we'll kind of see how that all works. The other issue that everyone, I think, is aware of, is the Supreme Court, and the Supreme Court is hearing a case on the second amendment, or hearing a Washington D.C. they're ruling on the constitutionality of the Washington D.C. gun ban. The hearing is in March. They expect the decision to come out in April. I just came back from an industry Board meeting and I haven't found anybody that thinks that the Supreme Court is going to rule that the second amendment is not an individual right, so we'll just have to wait and see how they rule on that, because I think that is the main things. Did I missing anything, Spence?

I think you covered it. Final thing is on shotguns.

One other thing I think is important, sorry, Spence. What I said about the Defense Authorization Bill. We were fortunate enough Senator Collins and Senator Lieberman really led that charge for us. The orders that the federal government, Defense Department have been buying handguns for Iraq, you guys know we got the last four pistol contracts from Afghanistan. For Iraq, the Defense Department was not completing the contract. They were simply placing out solicitations for orders of Glocks. Now that is against the law so we think that's a big deal, we very appreciate the two senators for helping us out with that. And the fact they have to do competition and U.S. companies cannot be excluded is a big deal. What was your other question?

Sure. On shotguns, I believe you said it was about 200,000 for the quarter for shotguns, was that correct?

Right.

Which I believe even by your standards is somewhat paltry. So at what point do you have to decide if you need to change strategy about shotguns? Do you have a branch plan, i.e. developing pump action guns or some other strategy in mind here? It seems like you've been engaged now in shotgun market for a year and granted their are these exogenous activities taking place but at what point do you decide is enough and you need to take a different approach?

You probably missed with because Cai asked the same question.

Well, in that case, I'll refer to the notes.

Let me just quickly say, we like the shotgun business, our fixed action, the Gold Elite won the NRA shotgun of the year. We think they are positioned well. We got into the season very late. In fact, the Silver, we just started shipping them recently, so just now. So we really only had very, very small tip toe in the water. We're rethinking the semi-autos, because obviously that market has changed. There are some very severely lower prices have come into the market on that that make it difficult for that piece to be profitable. And we don't need to be in businesses we can't make money at, so we are rethinking that.

Okay. Thanks very much.

Okay thanks, Spence.

Your next question controls from the line of Reed Anderson with D.A. Davidson.

In terms of margins, I'm not sure if this is Mike or John, but given what we've known you've been doing for promotion to kind of clean up the channel what's out there in retail, and what we saw in the third quarter, I mean, does it make sense that that's kind of the level, at least from a gross margin standpoint, that we might see over the near term, or could its get a lot worse?

Well, we're not going to give guidance on that, Reed, but as we said, we are continually promoting through this quarter, and we had the three-week shut down in the third quarter, in the factory, which obviously has a negative effect on gross margin. That is not planned to be duplicated in the fourth quarter in Springfield.

Reed, this is John. The shut down adversely impacted gross margin for about $2.25 million.

Okay.

That's about close to 3 points in itself on the margins.

Okay. That's helpful. Good. And then continuing down just kind of looking at the expense side, because most of my other questions have been answered, but if you look at G&A, for example, it's more or less flat with where you were in 2Q, but it is certainly up relatively to sales. What component of that is more or less steady state fixed and what makes sense as we look at that number going forward?

Reed, again, John. The -- from a -- from an SG&A standpoint, generally it's fairly fixed as group, as a category. The only thing that really would vary in the -- significantly in SG&A is you probably have the Shot Show, which kind of flipped from last year the expenses for that were in January last year. They're going to be in -- they're in February this year, and that's probably somewhere between 750 and $1 million in total expenses for the show. And that's the big fluctuation in the selling side and then the only other thing in the G&A side would be profit sharing, which will fluctuate with the operating profit. Otherwise, it's pretty much fixed.

Back to you, Mike, and just finishing off the last couple of questions, or groups of questions, but as you look at what you've done in long guns, I mean, clearly Thompson Center has been a terrific acquisition virtually any way you look at it, but what you've done on your own organically has really been very challenged, particularly in the long gun sight, and some of that is timing but as you look at it do you now sit here and think that maybe it's going to be hard to extend your great brand in handguns to long guns or is it too early to make that judgment?

Well, I think there's a couple of things. Well our M&P 15 is a long gun, and that's doing very well, was you have 67% last quarter.

True.

And that's a Smith & Wesson product. The Thompson brand -- we didn't buy Thompson for the brand but I got to tell you, the Thompson brand is a very strong brand with hunters, well, you know, you're a hunter, and we're trying to decide as we go forward, we're going to be in this business, our intent hasn't changed from where it was when I first said we were getting in the long gun business, and we expect to be a major player and have a share similar to our share in handguns. We have two brands in Smith & Wesson and in Thompson that both are terrific brands. So how we utilize them as we go forward will be an item by item decision that by make, but, I mean I -- I'm just totally pleased when I listen, when I stand in the booth and I see consumers come in, and -- or dealers at these distributor shows, and, the way they just fondle the Thompson product.

Yes. I agree. Thank you.

Okay thanks, reed.

Your next question comes from Chris Krueger with Northland Securities. Please proceed.

Good afternoon, guys. Most of my questions have been answered, but just, can you just walk us through a little bit more on what you're hearing and seeing really at the retail consumer type level, whether it's, more affluent neighborhoods or markets versus the less affluent ones, or value priced products, those selling more, and maybe the impact of ammunition pricing on the market? That it all I've got, thanks.

Hey, Chris. The -- certainly the economy is playing -- doing number on all retail businesses. I mean you just have to read the paper, and you can see that. Our promotions appear to be doing very well, and we've heard that all along. So -- but you are seeing, as I was saying, on things like shotguns, you are seeing manufacturers come in and take huge discounts in price to get themselves priced lower. I'm sure that's so they can sell some stuff through.

So the retail environment continues to be unsettled, and the -- the good news that we're seeing is the inventories that were really the roadblock are coming down, as we said, we think on -- certainly on our handgun side, we're about through that adjustment, but we're not seeing -- we continue to take market share. We have pretty good numbers to show us that, but we're not seeing the level of retail activity that we were seeing at let's say this time last year.

And any thoughts on ammunition pricing?

Ammo pricing has been going up for the last -- gee, I'm going to say it's been going up the last year and a half to two years. we are starting to hear that like 556 and 223 ammo may be coming down in prices, kind of the word we're hearing in the industry, so I don't want to start any rumors on that, but, certainly just a number of factors here that are doing some adjustment on the industry.

All right. Thanks.

Thanks Chris.

Your next question comes from Eric Wold with Merriman Curhan Ford. Please proceed.

Good afternoon. On just a general question on the industry. I mean, do you get the sense that the weakness of the industry in terms of sales the build up of inventory with specific guys out there, has it been bad enough that you're going to see some of these smaller exert get shaken out and either go out of business or get absorbed by somebody else? Has it been that bad in your opinion, or is it more of a hiccup?

I think it's more of a hiccup, Eric.

Most of these are mom and pop operations, a lot of these places private owned, and they kind of -- these things have happened in the past, and they've worked their way through them. So -- it's a situation where they kind of expect it, and they'll battle through it, and they look at it, I talked to one privately owned company, and they had a good year last year, and they just expect this year to be softer, because, the economy and that, so it's not a case where they're -- they're in any situation. There may be some real small guys that have trouble, but by and large, I think most of the players are relatively healthy.

And then going to gross margin, I'm not trying to get too specific on -- not trying to get guidance out of this in any way, but in Q3, I know you said about 3 points of that decline was the shut down, or the shut down caused about 3 points impact on the margin. If I think about going forward, if sales -- because obviously 25% margin versus the 32, 36 you had in first half of the year. Going forward, if you get sales back to where it was in the first half of the year on a quarterly basis, is there anything now that would keep you from getting back to that same margin?

When the market gets back to normal is what you're saying, right?

Yes, like in the first half of the year, you were doing 70, 75 million a quarter.

I've got you. Here is how I think about this, Eric, is think our business. There's been an issue in the retail market that we've had to address, and we believe it's temporary and we've gone through ad nauseum all of the factors involved, but we have no new competitors we have not lost any customers, nothing has fundamentally changed, other than the retail environment that we're working our way through. That's how I would think about it.

So how much of the discounting or promotions or kind of promotions you guys do goes through the gross margin line versus the sales and marketing line?

All of the $4.7 million we talked to is gross margin.

Okay.

Okay?

And then lastly, on the -- on the inventory side, I don't want to get too granular, but can you give a general sense of the inventory you've got, kind of, I guess, handgun versus long gun, if you want to just do it broadly?

The inventory is pretty well distributed. I don't think there's any -- any particular category that would be any cause for concern. There's no SKUs where we have tremendous quantities. It's very well distributed. Some of the inventory we have a significant increase there, we're working that down, but some of that was relative to our start up of the long gun operations, both the I-bolt, the Triumph, the I-cons, and really getting the production on the M&P 15 in house, and sort of those pieces. So we anticipated somewhat of a build, maybe in the 3, 3 million to $4 million range of that when we're looking at inventory over the course of the year. So we've still got some issues that we need to address. We've got plans in place that we're continuing to monitor and work on the operations guys are working on things, and the parts areas, and we're looking at production as relates to market situation and adjusting accordingly.

Perfect. Well, thank you guys, I appreciate it.

Thanks a lot.

We have a follow-up question from the line of Shaun Smolarz with Sidoti & Company.

My follow-up was answered already.

Thank you.

Thanks, Shaun.

And your next question comes from the line of [Matt Hacker] with [Baker Partners]. Please pride.

Could you guys give us in the detail on the finished goods portion of the inventories?

That is John Kelly. The finished goods is pretty well distributed throughout the -- throughout the area. I mean the promotions have balanced off the inventories. They've had their desired effect there from -- our finished goods are down about $5 million from where they were in November. So we balance things off with a shutdown. We're able to do that as well. So this quarter has been one where we've been able to balance the inventories off.

But I just wanted to, I guess, focus on that one number. I think the finished goods balance in October was 20.2 million, and I think you just mentioned roughly 15 today? I'm sorry. 15 by the end of the reporting period. I'm trying to get a sense of how much of that total inventory balance is finished goods, versus parts and work in progress?

It's about 16 million.

Okay. Thanks, guys.

Thanks.

And you have no further questions at this time.

Okay. Want to thank everyone for calling in, and the support, and we'll look forward to talking to you again next quarter.

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