Smith & Wesson Brands Inc (SWBI) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Smith & Wesson holding Corporation First Quarter 2009 earnings Conference Call. My name is Maria, and I will be your audio coordinator for today. (OPERATOR INSTRUCTIONS) At this time, I will now turn the presentation over to miss Liz Sharp, Vice President of Investor Relations. Please proceed.

Thank you, and good afternoon. Before we begin the formal part of our presentation, let me tell you what we're about to say as well as any questions we may answer could contain predictions, estimates and other forward-looking statements. Our use of words like project, estimate, forecast, and other similar expressions is intended to identify those forward-looking statements. Any forward-looking statements that we might make represent our current judgment on what the future holds. As such, those statements are subject to a variety of risks and uncertainties.

Important Risk Factors and other considerations that could cause our actual results to be materially different are described in our securities filings including our Forms 10-K and 10-Q. I encourage you to review those documents. A replay of this call can be found on our website later today at www.Smith-wesson.Com.

This conference contains time sensitive information that is accurate only as of the time hereof. If any portion of this presentation is rebroadcast, re transmitted or redistributed at a later date we will not be reviewing or updating the material content here in. Our actual results could differ materially from these statements. Speakers on today's call are Mike Golden, President and CEO, and Bill Spangler, Executive Vice President and Chief Financial Officer and with that I'll turn you over to Mike.

Thank you, Liz. And thanks everyone for joining us. Before we begin, I want to introduce Bill Spengler. Bill joined our Company two months ago as Executive Vice President and Chief Financial Officer, so this will be his first earnings call with us. While he is very new to Smith & Wesson, I worked with Bill several years ago at Black & Decker. I have a great deal of respect for his experience in finance , operations, strategy, and M & A from a number of public and private companies, and I am pleased that he has decided to join our team.

With that let me give you the agenda for today's call. First, I will share my thoughts with you regarding our performance for the quarter, as well as our strategy and outlook for the future. Then, Bill will review our financial results, after which we will open up the call for questions from our analysts. So let's get started. The First Quarter was certainly challenging, but we also met with success in some key areas. Despite continuing economic pressure, and the obvious impact it had on our rifle and shotgun product sales, we delivered solid results in our handgun product categories throughout all of our channels. These results reinforced our committment to a strategy that has delivered robust growth and profitability in prior years and will continue to do so when strength returns to the overall economy and the hunting industry. With that let me get into a few details.

Because they are consumer discretionary items, our long gun products, specifically our hunting products, felt the brunt of the weakness in the economy and its impact on retail sales. We believe this category is also suffering the aftereffects of an industry wide inventory build up which began in late 2007 when distributors and dealers already fully stocked with hunting products were impacted by both an economic downturn and unfavorable weather in the Fall hunting season. As a result it appears our distributors are now taking a shorter position in their hunting products inventory and relying on our ability to ship them quickly in the event of retail sales suddenly step up.

Although this creates an issue for the moment in revenue this may eventually prove advantageous to us as our pill rates are well above industry norms. As we indicated last quarter, and we shared with you, we're seeing slowing sales of hunting products at the retail level and cautious buying on part of distributors and dealers. While we cannot predict, nor can anyone, how long this weakness will persist there are steps we took last quarter to lower costs such as an unscheduled Rochester factory shut down and there are additional steps we can take during this period of uncertainty. We must work to control costs while maintaining enough flexibility so that we can respond quickly when circumstances change.

While lower production takes a temporary toll on gross margins, we believe that conservative planning is the most prudent approach for us until this market returns. Now let me address some other areas and point out some great progress.

On a product level our revolver sales increased by 3% and pistol sales increased by 18%. In fact, our M&P pistols continue to be very successful delivering 27% growth versus the same quarter a year ago. Walther products were strong as well delivering 19% growth. Growth in tactical rifle sales was also strong and the backlog for our tactical rifles was at its highest point in the last two years. It is evident that the M&P product line continues to win new customers for us in multiple channels including consumer, law enforcement and international. In fact law enforcement sales grew by 3% and international sales grew by 74% over a year ago quarter. Let me address the performance in each of our major channels.

We are pleased that in this challenging consumer environment our consumer sales channel delivered growth of about 9% in handguns this quarter compared to last year. We continue to monitor the next data on retail background checks and while that data indicates that the broad general trend is moving up, it also indicates a great deal of volatility still remains month to month. The continuing strength we saw in law enforcement sales is reflected in actual shipments growing by 3%, paired with a sharp increase in law enforcement orders which were up 34% in the quarter. Our M&P pistols now have been chosen by 402 law enforcement agencies and are continuing to win over 80% of the contests in which they compete. Our M&P tactic call rifle also continues to win in the law enforcement channel. They have now been chosen by 185 law enforcement agencies and are winning at a rate of over 90% of the contests in which they are competing.

We include with our law enforcement channel those companies that provide private security and a tactical rifle is winning there as well. Within the last two quarters, we have shipped over 1,000 of our M&P tactical rifles to a new customer, that is the Department of Defense subcontractor providing security services in Iraq.

Now, to the Federal Government and military channel. I'm especially pleased to report that we were able to register growth in this channel during the First Quarter. We have shipped an order for 550 M&P pistols to a key Department of Defense agency that we have been asked not to identify. The most important take away here is not the size of the order but the fact that this is the first major federal agency where we have won with the M&P. This is a solid indication that we can and will continue to make in-roads in the Federal Government and military channel. We intend to maintain our presence in Washington, making sure that we are aware of and included in any opportunities that arise.

Within this channel, the US military has the ability to provide several significant opportunities for us. Among them is their consideration to switch from a 9 millimeter to a .45 caliber pistol. As I mentioned last quarter, the Air Force has submitted an unfunded budget requirement for new pistols. We continue to monitor the dialogue that is taking place on this potential order and we stand ready to respond when the military takes its next steps.

In the international channel, again we see continued penetration and very strong growth of 74%. The vast majority of it is supported by M&P pistol products. Recent wins on the international front include the Halton PD in Ontario, Canada, Brinks Security in Canada, the Trinidad National Police Service and the Sen Provincial Police in Pakistan. The latter two were just announced last week. These four agencies alone are just a sample yet they account for thousands of M&P pistols and several of them represent our first orders from new customers with sizeable potential in the future.

On the legislative front, the first quarter was a historic one for the firearms industry. In June, the Supreme Court reinforced the second amendment as an individual right to bear arms. We applaud this decision. It firmly underscores our own belief that the second amendment is deeply woven into the fabric of our nation.

On the diversification front we continue to look at opportunities to expand both in firearms and in non-firearms businesses, that tap into our brand strength in safety, security, protection, and sport. In the firearms category, we are looking at opportunities to provide new products for our portfolio and greater market share. In non-firearms categories we are especially looking at companies with products that surround the police officer and the war fighter. While expansion is a key part of our future growth, we're also being selective to insure the best possible strategic fit and optimal financial outcome for our stockholders.

Now let me turn you over to Bill for his comments on our financial performance. When he's finished, I'll wrap up our call with a few final thoughts.

Thanks, Mike. First let me begin by just saying that I'm glad to be here. I joined Smith & Wesson in July because I believe the company is well positioned for an exciting future. As I look at the accomplishments of the past few years, in building the management team, brand strength, increasing market share, and diversification into new markets, I saw that much of the ground work had been laid for future revenue growth and profitability. I'm pleased to have joined and I look forward to contributing to this future.

With that let me address our financial results for the first fiscal quarter. Sales for the first quarter were $78 million, a $3.6 million or a 4.9% increase over the three months ended July 31, 2007. Within that, sales of firearms totaled $73.1 million, an increase of $3 million or 4.2% over the First Quarter of last years. The balance of our revenue, largely handcuffs and non-firearms accessories, totaled $4.9 million and grew by $600,000, or about 15%.

As I'll discuss in a bit more detail, results in our sales and firearms were mixed. We experience continuing weakness in the consumer market for long guns, specifically hunting rifles, shotguns, and related accessories, where revenue was lower than in the prior year. However excluding those categories, essentially just looking at handguns and our tactical rifles, firearms revenue in the quarter increased by 12.3% or $6.3 million over the comparable quarter last year.

Focusing initially on results within the handgun category , pistol sales grew 18.4%, driven by continued consumer market demand and law enforcement adoption of the M&P polymer pistol line. Walther products grew to 19% rate, based largely on the performance of the PPS subcompact pistol which was launched part way through last year. Revolver sales grew by 3.4% over the comparable quarter last year. More in keeping with the moderate historical growth rates generally experienced in the revolver marketplace.

This current quarter results should, however, be placed into context with the results from the first quarter of last year in which we added capacity to address a large backlog and deliver revolver sales growth of 39% over the proceeding year. Prior to talking about the hunting category, I would also note that tactical rifle sales grew by 11% in the first quarter as Mike indicated and demand for this product remains strong in both the consumer and law enforcement Markets.

Turning now to the hunting category, we believe a distributer inventory correction that began in mid fiscal 08 continued to influence our revenue in the first quarter of fiscal 09. As Mike also explained, we believe a number of our customers are being more cautious in their buying than they historically have been, relying on us to respond quickly should demand pick up during the upcoming season. Hunting product sales of $14.6 million therefore represented a decline of $3.3 million, or 18% versus the same period last year and here I'm referring to both hunting rifles and shotguns. Although all hunting rifle revenues declined in the quarter, our black powder revenues were especially hard hit.

In addition, the shotgun market was extremely weak during the Fall of 2007 hunting season. Particularly in the fixed action and semi-automatic categories that we entered at that time. Since then, the market for semi-automatic shotguns used for hunting has become increasingly difficult and manufacturers have dramatically lowered their pricing. In short, we continue to evaluate wether our semi-automatic shotgun is positioned correctly. While we are pleased with the status of our fixed action shotguns, these address just a small portion of the shotgun market and overall our shotgun sales, which are not particularly material to the total, declined by 89.2% in the first quarter versus a year ago. Our results in hunting rifles and shotgun revenue were only partially offset by shipments of our first bolt-action rifles which commenced late last year.

Turning now to our margins. Gross profit of $25.4 million in the first fiscal quarter was $1.8 million or 6.7% less in dollars than the prior year. On a percentage basis, our gross profit margin moved from 36.4% to 32.3% representing a 4.1 percentage point decline versus the same quarter last year. It should be noted, however, that we did see sequential improvement in our gross profit margins this quarter versus the immediately preceding quarter.

The deterioration in gross profit margin versus the First Quarter of 08 could be classified into two categories. The decline in hunting product margins accounts for about three quarters of the overall 4.1 percentage point deterioration, and is due to product mix and the negative impact of lower production levels on plant efficiencies. Hunting related product mix alone accounted for about half of our total gross profit margin erosion, caused by a shift toward lower margin hunting rifles. On a relative basis, much of this was due to a lower volume of encore, or black powder revenue this quarter, which carried a higher margin than the products where a higher portion of our revenue was actually obtained, specifically in the Icon bolt-action product line.

At the manufacturing cost level, our production of long guns has also been impacted by conditions in the category. Our Rochester, New Hampshire long gun facility was improved through capital investment last year and stamped under the assumption of flat or limited growth in the long gun market. However, revenue actually declined year on year and we sought the lower production in response as Mike indicated. The combined impact of overhead increases from last year and lower than anticipated production levels in long gun manufacturing in the current quarter accounted for about one quarter of our gross profit margin erosion. We believe this level of impact on our corporate margins related to the hunting business is transitory, as we expect an eventual turnaround in the hunting market. Until that occurs, we are seeking to address this to include taking near term action and controlling our costs, but doing so without negatively impacting our ability to launch new products or respond when the market for hunting products rebounds.

The final significant contributor to margin erosion versus 08 was consumer and to a lesser extent distributer promotions, which together represented a $900,000 spend in the handgun category. Having said that, we dramatically reduced our promotion spending in the First Quarter when it's compared to the $4.2 million of promotion expense in the preceding Fourth Quarter of last year. We promoted in the First Quarter in response to market conditions, with particular emphasis on consumer poll promotions and support of ongoing revenue growth and market share penetration. In light of this promotional activity, margins obtained were less than those in the prior year but again showed improvement over the preceding quarter.

Operating expenses were $19.1 million or 24.4% of revenue , versus $17.4 million or 23.2% of revenue in the prior year representing a $1.7 million increase. Over half or about $900,000 of this increase was due to higher advertising expenses. Much of this relates to increased advertising expense as we again sought to sustained growth. The remainder was due to the timing of the NRA show occurring in the first fiscal quarter of 09. Although there are a number of puts and takes the remaining increase in operating expenses can largely be explained by higher Research and Development costs supporting new Product Development, and incremental FAS 123 R or stock based compensation expense. As a result, income from Operations was $6.2 million for the First Quarter in Fiscal 09, a $3.6 million or 36% decline versus operating income in the same quarter last year.

Looking further down the P & L. Other expenses increased by $600,000 year-over-year which is the result of unfavorable foreign exchange expense associated with our Walther purchases. Of that a small portion is due to mark-to-market on existing contracts. The majority of it relates to actual settlement rates being worse than anticipated when our standard cross rates were established. Interest expense declined by $200,000, however, this was net of a one-time non-cash write-off of $485,000 worth of debt acquisition costs. The year on year savings is attributable to the lower rates, retirement of the acquisition line, and repayment of a $5 million note.

Income tax expense declined by $1.5 million, the effective rate in the First Quarter of Fiscal 08 improved slightly from 37.04% in the prior year to 36.77%. The bulk of the decline being due to lower pre-tax earnings. Net income therefore declined by 52% or $2.4 million, $2.3 million providing fully diluted earnings per share of $0.05. EPS results were also influenced by an increase of 4.7 million in the weighted average number of shares. The result of our issuance of approximately 6.25 million shares for the purpose of retiring the acquisition line.

Now let me turn briefly to the Balance Sheet. Accounts Receivable increased to $60.9 million in the First Quarter compared to $54.2 million at the end of the preceding quarter. This increase was largely expected and is entirely due to the industry-wide practice of providing hunting gun, long gun distributors with early year extended terms, eventual payment being anticipated during the Fall hunting season. In fact collections on some of these extended term orders have begun to occur in August. Inventories grew by $5.4 million over the most recent quarter, a trend that we will seek to remedy.

The bulk of the inventory growth was in handguns and it is attributed to the ongoing level loading of production for sales that are either committed or anticipated in the coming periods. In addition, there was an increase in long gun inventories as production restraints failed to offset revenue shortfalls. Again, inventory planning will become an increasing focus of the Smith & Wesson Management team as we move forward.

Turning briefly to cash flow, historically operating activities have represented the principal source of our cash flow on an annual basis. This quarters performance in the long gun business concludes the effects of anticipated extension of payment terms to distributors required incremental short-term borrowings to fully fund operating activities in the First Quarter. In the first three months of Fiscal 09, we used $4.8 million more in cash from operating activities than when compared to last year.

Capital Expenditures in the First Quarter were $1.1 million compared to $6.1 million last year. We expect to spend approximately $8 million on CapEx in Fiscal 09 versus the $14 million spent in Fiscal 08. Major Capital Expenditures in Fiscal 09 will focus on improving production efficiencies, new product offerings, and various projects to selectively increase capacity and upgrade manufacturing technology.

Including on the Balance Sheet as I mentioned earlier, we completed an offering of 6.25 million shares of Common Stock in May which yielded proceeds of $32 million and allowed us to repay $28 million in debt that had been incurred to finance a portion of the Thompson Center Arms acquisition. Short-term bank borrowings totaled $17.8 million at July 31, 2008 compared with $9.1 million at July 31, 2007, an increase attributable to higher working capital requirements and lower cash from Operations as we've discussed. During the First Quarter we also repaid $5 million of our long term notes payable.

On a final note, we would like to begin going forward to augment our financial discussion with the new metric, EBITDAS. As you know, this is earnings before interest, taxes, depreciation, amortization and as most of us in finance fondly refer to it, FAS 123 R or stock option expense. Again, this will not replace our discussion of GAAP and we will provide reconciliation between GAAP earnings and EBITDAS. We think though this will provide an additional understanding of the cash flow and thereby increase insight into our capacity to finance the Company. It also is relevant as we are capital intensive business.

In addition, our historical and ideally our future GAAP earnings will be subject to variation due to the effects of things such as the amortization of purchase accounting entries which this measure will remove. As we go forward together, we'll spend a portion of our time looking at EBITDAS and then combine that with a review of our Balance Sheet particularly working capital requirements. That concludes my comments and I'll turn the call back over to

Thanks, Bill. Q1 was certainly driven by challenging economic conditions which impacted results in our long gun business. We are, however, encouraged by continuing positive results in our handgun business. In conclusion, there are a few thoughts I want to leave you with today.

First, we have built a profitable Company that is capable of driving growth in every channel, consumer, law enforcement, Federal Government, and military, and international. Second, we have very sizeable opportunities that we believe lie ahead, among them, the military's possible switch to a .45 caliber weapon and the growth opportunity in the law enforcement market, the majority of which represents new territory for us, and we are winning 80% of the time.

And third, the consumer long gun market will return. It is not a function of if, it is a function of when, and that represents a $1.1 billion market for our products. The bottom line is that despite the current challenging economic environment we continue to deliver results on several levels and we remain very excited about our Company and its future. With that, operator, I'd like to open the call for questions from our analysts.

Ladies and Gentlemen, [OPERATOR INSTRUCTIONS]. Your first question comes from the line offer Paul Swinand with Stephens, Inc. Please proceed.

Good afternoon. Can you hear me?

Hi, Paul, yes, how you doing?

Good. How about yourself I? I guess I do have to say congratulations in this environment.

Thank you very much, Paul. It's tough out there.

Yes. My first question is actually on the long guns and you said there's slowness in black powder. Could you break that down or give us a little more color? I guess some were saying the market was tough, but it's a little slower than I expected and I must have just been hearing that the accessories are still holding up, so just trying to get a little more color on what's going on there.

We're hearing a lot of the same things you're hearing, Paul. Black powder, we believe is even a little more of a discretionary purchase than a bolt-action or a regular shotgun. It's a limited season and so we think that's having an impact on it on top of the economic environment that's certainly out there. We saw more of a hit on black powder than the overall business. As Bill said, products like the Icon helped to attack some of the negativeness that we saw in the category itself. The black powder -- we are seeing that there's inventory out there. There's been no recent legislation or new states adding black powder seasons that has an affect on that, and we are seeing a little bit of growth in Wal-Mart on accessories but it's early in the season. It's only, we're talking a couple thousand dollars because the season is just getting started so the delta that we're seeing at a place like Wal-Mart on accessories versus the guns themselves, it is a little better on accessories but they are real small numbers this early in the season, Paul.

Okay, understood. And then to understand the Icon there, is that new calibers and new product that you're shipping in or are the existing calibers and bolt-action products also comping up or both?

It's a little bit of both. At this time last year we were not shipping Icons, so it's indexing against a hunting rifle market that did not have Icons in it. But we're shipping some new calibers and some units with the new weather shield finish. Some of the stuff we show that you saw in January.

Okay, but you're not totally filled out in calibers there so you still have some more?

Oh, yes. You're going to see us as we go forward. Shot shows coming up in I think it's January this year and you'll see us continuing to expand on that range of product, yes.

Okay and then on tactical rifles up 11%, and I realize you've been having increases year-over-year so it's a tough compare but I was actually expecting a little stronger number. Could you break that down between between the pro and the sporting markets?

Yes. There's a couple pieces on the tactical rifle market. One, it was up 11% over a good quarter last year, second is we've got about an $8 million backlog on tactical rifles, so we've got a pretty healthy backlog. The mix ballpark between consumer and law enforcement is just under 20% or so of law enforcement and that percent is growing and the balance is on the consumer side.

Okay so both are still strong.

Yes.

I know you've introduced some new models there and some new ways to accessorize. Are you seeing strengthen the new or are both the old and the new models comping up?

It's kind of all of the above. We're seeing strong growth as I said on the consumer side but our law enforcement orders on tactical rifles were up 61% versus last year and you heard the number up to 185 departments so we're continuing to see that as a strong category.

Okay, thank you all. I'll let somebody else jump in.

Paul the other thing on that, in the international market, we're seeing some success with the tactical rifles so we talked about -- I said international, I meant government -- where we're going to security agencies so there's over a thousand of our rifles over in Iraq.

Okay, thank you.

Your next question comes from the line of Cai von Rumohr with Cowen & Co. Please proceed.

Yes, thank you and Bill, nice review.

Thanks, Cai. How you doing?

Very well. You'd mentioned the strong inventories and you gave us the number for tactical rifles. Could you give us some of the other color like where were the pistols which you said were up and where were the totals and the hunting rifles?

What is it? Say the question again. I'm not sure I follow.

Oh, the question is backlog. You'd mentioned that the backlog was up nicely in pistols. You gave us the backlog number for tactical rifles. What was it in hunting rifles, what was it in pistols because you said qualitatively [Inaudible].

Cai, the backlog is about $11.5 million.

Okay, so it's basically down $6 million from year-end?

I don't have the year-end numbers in front of me, but remember our pistol business was up in the quarter by what was it, Bill? Up 18%?

Right.

So it was down, in the hunting rifles?

Sorry, Cai. Say that again?

The hunting rifles?

That's down, the backlog is down in hunting rifles it's just under $7 million. That's reflective of what we're seeing.

Okay, and then given the build in the inventories can you talk a little bit about what, you'd mentioned, Bill, kind of concern for inventory, what's your planning? Are we going to have kind of another kind of shut down so we can kind of clean the inventories down or are you going to build it so you can kind of respond if demand is there? How are you approaching that?

Cai, we're looking at it in a number of ways. We aren't going to build inventory blindly and hope for the season, just hoping for the season to get better. We're going to watch it very very carefully. In fact we're watching it every day but we're going to take steps accordingly. We are sitting on inventory today, and we'll adjust our production schedule as we go forward, based on as we see the demand and production schedules will dictate what we do as far as what type of action steps we take, but we are going to watch it very carefully and not let it get out of hand but it's a tough balance to be able to respond as you get into the season.

Okay, and Bill, could you give us the number for FAS 123?

Hold on for a minute, Cai.

Okay.

We're going to look it up.

While Bill is looking that up --

Yes, I do have another, on the positive side, it looks like you may be starting to get more traction on the military front. Could you kind of walk us through some of the opportunities there of the .45 and any potential sales?

Yes, we're continuing to be very optimistic with the Defense Department. There's a couple things going on. You're exactly right. [Inaudible] That was an unfunded requirement that was put in earlier this year. It has not been funded yet. We're hearing that the Air Force, if it does not get funded this year and we'll see what happens. There's not a whole lot happening in Washington right now. They're serious about this and are looking at their future budgets not as an unfunded requirement but possibly a budgeted requirement. There's a lot of talk on rifles, military rifles and what's going to happen when the exclusivity on the M4 expires which is next June, so there's a lot of things potentially happening in Washington and we're keeping our ear to the ground and positioning ourselves to be able to take advantage of the opportunities if they make financial sense to us.

Okay.

Sure, Cai. Depreciation amortization first, $4 million - $4.0.

4.0, and FAS 123?

Yes, stock based comp is 1.1 million.

1.1, so that was really up quite a lot, so where would you expect that to be for the year?

Cai, we don't have that right now.

Okay.

I don't have the forecast of this year. I assume it will come up a bit during the year but I couldn't give you a real number on it. That's off of 857.

Got it.

Last quarter. So it's up whatever that is, 250 or so.

Got it and the last question is you kind of alluded to the difficulty in shotguns. Is there any chance you would exit that market and if you did make that decision, can you give us some color on terms of what are the costs in terms of the inventory and maybe any purchase commitments you might have outstanding?

Well, we continue to look at that category trying to understand it. It's a category that was very hard hit last year in the industry, it was down we've heard numbers 20-30% versus the year before. The first half of this year we're hearing similar types of decreases so it's a tough market out there driven in large extent by some of the economic conditions that are going on. And that, we as timing when we launched the product was right when the market was falling out and we saw competitors take price action to move their inventory through. We got into that the shotgun business with zero capital, as I'm sure you know, so we're looking to try to see what makes sense. We are happy with the fixed action shotguns, the side by side over and under, we've won several awards and we're trying to see how do we profitably participate in the semi- automatic and the pump shotgun which is a big piece of shotguns we've never been in that, we're trying to understand how we get into that, so it's not something that we invested a lot into, and we're trying to understand it because it's a part of the long gun business which we think we can certainly have a role in.

Terrific, thank you very much.

Thanks a lot, Cai.

Your next questions comes from the line of Eric Wold with Merriman Curhan Ford. Please proceed.

Thank you. Good afternoon, guys

Hey Eric - how are you doing?

Good. A couple of follow up questions on the ones that have already gone out. On the promotional activity that came down in Q1, can you characterize how you think it's trending so far in Q2 and when that should taper off, and the question is, if you do pull back the throttle on promotional activity, how much of a factor are promotions driving revenues so that if you really pull back, how much of an impact will that have on the consumer?

You're right. If you remember, in Q3 and Q4 of last fiscal year, so up through April, each quarter we spent approximately $4.5 million on promotions and that was part of our plans. We announced that back towards the end of last year. This year we've spent about $900,00 so we've spent significantly less. You're going to see a lot of focus as we go into the hunting season on hunting products in season to pull that through. But we're going to continue to promote at a fairly high level until we start to see some signs of life in the economy. You look at our handgun business, with all the economic stuff that we're all tired of hearing about, our handgun business was up 12%, so some of the things we've put in place have worked. It's kind of a watch and see as to how we're going to continue spending but as we committed to you guys we significantly reduced that from the 3rd and 4th quarter.

So the $900,000 that you spent in Q1, should that up take in Q2 and during the season or is that going to stay at that level?

In Q2 it's going to be about flat to that - you're going to see it up take a little bit in Q3 as we have certain promotions that we're planning that far out. And going into the holiday season, we're going to try to take advantage of holiday purchases.

Got it. And then on the consumer side, are there any trends you're seeing - I know one of your competitors says that we're buying pistols and revolvers, we're trading down for the price point. Have you seen any impact there?

Well, not really. Our pistol sales are up 18%. M&P, which is not a low priced pistol, is up 27%. We continue to see trends. Dealers tell us that you're seeing more females looking for concealed carry, small frame revolvers, and thing like that, but we're not seeing any real difference than in the past.

Okay. Lastly, on the inventory, can you break down the inventory between long gun, hunting and hand guns?

I don't have that here.

We don't have that Eric.

Your next question comes from the line of Reed Anderson with D A Davidson. Please proceed.

Good afternoon.

Hi, Reed. How are you doing?

Good. A couple follow-ups. Closing on that promotion commentary, most of your promotion is taking the form of $50 or $75 rebate - are you comfortable, Mike, that that's the right way to approach the promotion are you thinking about some other things as you head into the holiday season?

Some of the stuff that we like using are the free accessories. That not as expected as the rebates are, people seem to like the free magazines - that's always been pretty successful. for us. But we have found that rebates are working for us.

And we shouldn't be thinking of anything radically different that we've seen already, where it's rebates, accessories, or whatever?

Not radically different, no. We're going to try to be creative, but not radically different.

Then, thinking about the long gun business and you've made a variety of comments. Mike, are you comfortable that you've got enough distribution of that product at retail because if you were a little late to market with it and then you got hit with bad weather and the market turned, and I'm just wondering if we're still sitting here today, whether some major chains or independents, whatever, you still don't have adequate distribution - that's still something that's on the come.

You're exactly right, Reed. Our distribution is not where we want it to be. We're new in this business so we are looking to expand distribution we are finding that there's resistance in many places. Some retailers just want to see what they've got. They're getting beat up like everybody else is trying to keep their head above water. Certainly continuing to have our sales force, with our own people, expand distribution on our product line and every call they go in, there's a key focus.

But would it be fair to say or infer that it's not that they're opposed to your entry into that product or anything relative to that, it's more just that in this environment they're very conservative relative to that category and they're just not going to take a chance on something new. Is that fair?

I think the conservativeness on the category at this point because of what occurred last season and what's happening so far this year is correct. We know that Smith & Wesson is a firearms company with 156 years of legacy and people associate us with firearms. We also know it's not an established hunting brand - with Thompson it's a terrific hunting brand. So we're trying to understand what our brand mix is and what products carry which brand and what have you, But I think there's a fair amount of conservativeness at retail today. If you or I were running a store, we'd probably be pretty conservative too.

In relation to inventory, it sounded like the answer to the question, but I'll ask it directly - is there any amount of speculative inventory in that number we see at the end of July or is that just purely 'we're just a little bit higher that we want to be'?

There is - we're level loading the facility. We're operating the facility at capacity. And we're expecting an ongoing uptick in the revenues, so sure, not every dollar of inventory is a confirmed order, it's planned to forecast in portions of it.

We have, Reed, several major promotions planned with some of our retailers that if we waited for the month before to make them, we'd be out of capacity just because the seasonality of these promotions so what Ken has done is level loading the plant so we can make the stuff so we can sell it and hopefully sell more because we'll have capacity in the month before these big promotions. So a lot of it's tied to promotions that are planned.

I understand the speculative nature, but it's tied to a promotion you've planned, it's not tied to an expected turn in the market anytime soon. It's promotion driven.

It's forecast driven and promotions are in that forecast. Some of the promotions are locked in - we know people are going to buy X number of Sigmas or whatever, they've already committed to that.

Got it. A couple more. Bill, you'd said that there was about $485,000 related to something and I didn't pick that up, so it really would have been that much less on a normalized basis - is that correct?

That's exactly right. What I said was $485,000. What that was is the unamortized piece of dead acquisition costs on the line that we retire. We take a one-time, non-cash hit so if we're down $200,000 period on period, we're actually down $685.000.

Okay, that makes sense. So despite having to borrow a little bit more that maybe we would have thought, maybe a little bit more inventory, actually the interest expense piece is coming down a little bit.

Exactly, and part of that is replacing the debt that we spoke to, and part of that is a lower rate.

And then lastly, are there things that you can go to manage that FX exposure a little bit better? Were there things in there that were just kind of out of wack that we can fix going forward?

Yes, I think we can take a look at that and maybe put some for work against it, so yes, we're a little bit naked there right now.

Okay, that's it for me. Thank you, guys.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Spencer Farrar with Cohen & Co.

Hey Mike and Bill, most of my questions have been asked, just two others. First one is regarding a protest that allegedly was filed on the 19th of August according to the GAO, just wondering what the status is of that and if you could give a little more background about why you filed the protest and what's the potential dollar amount and so forth.

Absolutely. First, Hi Spence, how are you doing. We filed a protest I think in February of this year President Bush signed into law the Defense Authorization Act. We talked about that on one of these calls. The Defense Authorization Act had an amendment in it that said specifically when the defense department is buying small arms for Iraq or Afghanistan, they are required to compete the contracts and they are required to include US companies. There was a requirement that came out for pistols, one for Iraq and one for Afghanistan, and the contracts came out as sole-source contracts, not open to competition, one for each of our two competitors. Our view is that's against the law. We worked hard to get that amendment in and they were not following the policy in our view so we filed a protest and we're waiting for a response on the protest.

And you still expect that to be, according to a GAO on the 20th of November, so you're still on track for a decision by that time?

Actually we're expecting September.

The information that I have says the 20th of November.

I think it's around the 20th of September.

It says here the filing date was the 19th of August and the due date is the 28th.

We're on top of it and we worked hard for that so we're going to stand up for our rights. When you compete the contracts, the last couple they've competed, we won. So we like it when we have competition.

Okay, and the second question, just maybe some atmospherics on the pre-election buildup, I've talked to distributors and they say like we've all talked about before, that historically before a change of administration there tends to be a spike or pick up. Have you got any feel for what that is and what categories and what growth potential you're looking at here?

We're hearing some pretty strong growth in handguns and certainly anecdotally at least we're hearing that some of the growth in tactical rifles is pre-election buying that is happening out there. You talk to some guys that have been in the industry for awhile and they think it's only going to continue to increase as we get closer to November, depending on how things are looking. It's kind of hard to say, but what you're hearing is the same thing we're hearing, and our numbers in the past show a little bump and we do believe that part of on the consumer side the tactical rifle strength is driven by that.

Okay, thank you very much.

At this time there are no further question in cue, and I will now turn the call to Mike Golden for final remarks.

Thank you, operator. I want to point out a few upcoming events to you. On September 15th, we will hold our annual stock holders meeting, and we also will be attending the Merriman, Curhan & Ford conference in San Francisco on Tuesday, September 16th. I hope to see some of you there. Thanks everybody for joining us and we'll talk to you next quarter.

Thank you for your participation in today's conference, ladies and gentleman. All parties may now disconnect. Enjoy your day.