Smith & Wesson Brands Inc (SWBI) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2009 Smith & Wesson Holding Corporation earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session at the end of this conference. (Operator Instructions). As a reminder, today's call is being recorded for replay purposes. I would like to turn the call over to Ms. 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 that what we are about to say, as well as any questions we may answer could contain predictions, estimates and other forward-looking statements. Our use of words like project, estimate, forecast and other similar expressions is intended to identify these forward-looking statements. Any forward-looking statements that we might make represent our current judgment on what the future holds. As such those statements are subject to a variety of risks and uncertainties. Important risk factors and other considerations that could cause our actual results to be materially different are described in our securities filings including our forms S-3, 10-K and 10-Q. I encourage to you review those documents. A replay of this call can be found on our website today at www.smith-wesson.com.

This conference call contains time sensitive information that is accurate only as of the time hereof. If any portion of this presentation is rebroadcast, retransmitted or redistributed at a later date, we will not be reviewing or updating the material content herein. Our actual results could differ materially from these statements.

Our speakers on today's call are Mike Golden, President and CEO, Bill Spengler, Executive Vice President and Chief Financial Officer. With that, I now turn it over to Mike.

Thank you, Liz. Thanks everyone for joining us. Second quarter delivered mixed results, some very exciting and some obviously very disappointing. It was a stark contrast between strong, solid performance in parts of our handgun and tactical rifle products, offset by very tough, ongoing challenges in the hunting business. Today, Bill will provide a detailed financial analysis of the quarter. But first, I'll address each part of our business. I'll review our performance in key areas, what we are doing to address current challenges, and why we believe that despite the challenges that we and all businesses face today, our strategy and our structure position us well for the future. With that let's begin.

Our handgun and tactical rifle categories continue to deliver positive results in the second quarter. It is especially important to realize that these product lines have delivered positive results consistently over the past several quarters, despite the fact that we now appear to have been in a recession for nearly a year. Pistol sales of $18.5 million reflected growth in the quarter of over 40% versus the prior year. Within that category, sales of our Sigma pistol line grew by 77% in the second quarter versus a year ago. Sigma is a well-positioned product that is performing well in the consumer marketplace, both for sport shooting and for self defense.

Sales of our M&P pistols grew nearly 45% year over year. And here I want to make a couple of important points. First, those M&P results contain our first shipments into Iraq for distribution to the Iraqi military and security forces. We believe that order indicates that we continue to maintain a high degree of positive visibility with the Defense Department, boding well for future orders. Second, our 45% growth also reflects our ongoing success in selling M&P polymer pistols into law enforcement agencies. The M&P continues to win at at rate of over 80% in agencies where we compete. In that total are some recent notable departments that have converted to the M&P pistol. Such as Columbus, Georgia, Police Department, and the Texas Department of Criminal Justice. In addition to the traction we've been getting in law enforcement, retail sales of our M&P pistols for the second quarter were up 17%.

Revolvers also continue to show positive signs. Although revolver revenue of $13.7 million was slightly lower than revolver revenue from the second quarter a year ago. Last year's numbers included a $1.6 million order for the Japanese police. In fact, domestic revolver sales in the quarter actually grew by 13%.

Tactical rifle sales of $8.7 million in the second quarter were even more remarkable, showing a 308% growth versus the same quarter a year ago. We believe that our success in tactical rifles is based on a number of factors, not the least of these is the quality and accuracy that this rifle achieves by virtue of our rifle barrels, built using the technology that we acquired with the purchase of Thompson Center Arms.

While this growth was largely driven by strong adoption in the consumer market, we continue to drive growth from law enforcement market as well. We continue to penetrate law enforcement agencies in both the municipal and state level. So far there are 204 agencies that have selected our M&P15, and it is winning at an impressive rate of over 90% in departments where it competes. With regard to our tactical rifle and pistol results, bear in mind that we are only reporting the quarter that ended October 31st. So our second quarter sales don't reflect the bulk of the surge in retail sales volume that began in early November and we have all read about in the media. But more about that later.

It's clear that the high points of our second quarter relate to the solid traction that we have maintained in the handgun and tactical rifle markets and the strong growth these categories have consistently delivered despite the economic environment. Unfortunately, that environment, combined with a number of other factors, did take a severe toll on our hunting business and as a consequence, our results in this category were very disappointing.

Hunting rifle sales of $11.5 million in the second quarter showed a 41% decline from the same quarter one year ago. This category continues to be affected by its inclusion in the consumer discretionary marketplace and a distribution channel that is buying cautiously and still suffering the extended effects of an inventory correction. The reduced revenue in our hunting category in the second quarter negatively impacted gross margins in that business and negatively impacted our overall corporate results. Because of those results and based upon a detailed analysis we conducted in cooperation with outside evaluation experts and our auditors, we have taken a non-cash charge in the second quarter to reflect the impairment of goodwill and intangible assets of Thompson Center Arms. As Bill takes you through the detail of that charge and our second quarter results, it will be very clear that the hunting business has a significantly negative impact on the otherwise positive results we delivered in the remainder of the business.

Because of the magnitude of that impact, I want to explain clearly how we think about Thompson Center Arms and our plans for its future. As we conducted our recent review of Thompson Center, we realized the economy and therefore the hunting rifle market remains uncertain for the foreseeable future. In addition, we knowledge that the burden this business places on the balance of our company is sizeable and if left unaddressed, would continue.

As a result, we took a hard look at all of our options. These options range from reducing costs in our Thompson Center Rochester facility, to various forms of consolidating Thompson Center support functions and/or production into our other facilities. We also considered relocating only the most profitable and best performing SKUs to Springfield. And finally, we considered a liquidation or sale of Thompson Center business unit. That analysis ultimately led us to the conclusion that maintaining the Thompson Center facility while reducing costs and also consolidating some of the support functions is the optimal choice for the business at this time. Let me explain why.

First, we attribute a portion of the success we are experiencing in tactical rifles to the quality and accuracy of our barrels. And those barrels are a direct result of acquiring the Thompson Center barrel manufacturing expertise. Second, by possessing internal, high quality barrel manufacturing as a core competence, Smith & Wesson is a recognized rifle maker in the eyes of consumers, law enforcement and particularly in Washington and with the US military. This is very important, because we know that the sole source contract for the M4 rifle currently used by the military expires in 2009. We think that our ability to manufacture entirely in the United States a state-of-the-art high performance tactical rifle will position us well as the military weighs its options next year. Disrupting barrel manufacturing operations in the near term, therefore, did not seem to be a reasonable choice.

Lastly, recall that the market for hunting rifles in a healthy economy, similar to that which existed when we purchased Thompson Center Arms, is relatively large. At that time, Thompson Center was profitable, taking market share in black powder rifles and enjoying a reputation as one of the most highly respected, high-end hunting rifle producers in the marketplace. It continues to enjoy that same reputation but, in fact, is precisely the high price point, niche market, black powder products that position Thompson Center as one of the most discretionary product lines in what is already a generally discretionary category. We believe it is this position that has caused our revenues to be more impacted than others in the hunting category. However, we also believe that we can expand Thompson Center's addressable market with new, lower price point yet profitable products that we will begin to introduce in 2009. So we will continue to take cost out of Thompson Center while we expand the addressable market for our hunting products.

As we move into the future we will continue to revisit our analysis, assessing the recovery in the markets, traction of the new hunting rifle products, ongoing performance of our tactical rifles, developments with the M4 military opportunity, and health of the balance of our business. Should these elements change, we reserve the right to change our plans accordingly and immediately.

With that, I want to turn the call over to Bill for a more detailed financial discussion. When he's finished, I'll return with some comments and we will go to questions from our Analysts. Bill?

Thank you, Mike. Total company sales for the second quarter were $72.7 million, a $2 million or 2.8% increase over the three months ended October 31, 2007. Within that, sales of all firearms totaled $67.5 million, an increase of $1.7 million or 2.6%, over the second quarter of last year. The balance of revenue largely handcuffs and nonfirearm accessories, totaled $5.2 million grew by $225,000 or 4.5%. As Mike commented, results in our sales of firearms were mixed with strength in some categories and continued weakness in others, specifically those related to hunting. Hands gun sales totaled $43.6 million, an increase of 11.6% over the year ago quarter. Tactical rifle sales of $8.7 million represented an increase of 308% year over year and hunting rifle revenue totaled $11.5 million , a decrease of 41% on a year over year basis.

Gross profit for the second quarter of fiscal '09 was $20 million or 27.3% of revenue as compared with $23.1 million or 32.3% of revenue for the second quarter of fiscal '08. This represents a deterioration of 5% in terms of gross margin percentage from the year ago quarter. Approximately 60% of this gross margin erosion was caused by continued weakness in the hunting market, where lower sales volume led to reduction in production levels, resulting in lower fixed overhead absorption at our Thompson Center facility.

In the face of weak demand we implemented a series of consumer promotions on our hunting guns which further eroded gross margins. Finally, we did experience a shift in sales from high-end hunting rifles to lower priced hunting rifles, resulting in further margin erosion. The other significant contributor to our margin erosion versus the prior year continues to be our consumer and to a lesser extent distributor promotions in the handgun and tactical rifle categories. These promotions totaled approximately $1.4 million for the quarter versus essentially nothing in the same period during fiscal 2008. As you may recall our promotional activity really began to increase during the third fiscal quarter of last year. Promotional spending on handguns eroded the overall company gross margin by approximately 1.8 points, therefore accounting for most of the remaining 40% of the erosion.

I'll now move to operating expense and income. I want to point out that, for the moment, I'm going to discuss these items excluding the non-cash impairment charge, allowing us compare year over year performance more clearly. I will then separately address the impairment impact.

Total operating expense increased over the prior year by $708,000 or 4.3% in the second quarter of fiscal '09. This increase was driven by a combination of factors, including increased compensation expense, partly driven by inflation, the filling of some operating positions, higher net stock option expense along with some increase in our bad debt provision, and higher professional fees. As a result and largely due to the gross profit results, operating income was $2.7 million in the second quarter, a 58.5% decline from the same quarter a year ago.

Other expense totaled $927,000 in the second quarter, compared to other income of $213,000 last year. This expense is comprised almost entirely of an unfavorable, non-cash mark-to-market adjustment related to Euro foreign exchange contracts, used to protect our purchases of inventory from Walther. Interest expense of $1.4 million decreased by $669,000, compared with the year ago quarter. The pay off and retirement of our acquisition line of credit in the first quarter is now fully reading through in reduced interest expense as the main debt origination fees were written off last quarter.

Net income, excluding the impairment for the second quarter of fiscal '09, was $245,000 or $0.01 per fully diluted share compared with net income of $2.9 million or $0.07 cents per fully diluted share in the prior year. This result versus the prior year is largely attributable to the performance of our hunting business which I would like to clarify. Thompson Center is not a separate, reportable business segment in the context of SFAS 131. We have, however, separately analyzed the Thompson Center business unit, a process which involves some degree of operating expense and inter-company profit allocation so to develop visibility into performance.

In summary, the Thompson Center revenue in total, and here I'm including all Thompson Center activities, such as accessory revenue and revenue generated by the foundry, declined by 32% versus last year. From $25.3 million in fiscal '08 to $17.2 million in fiscal '09. Thompson Center gross profit declined even more dramatically from $9.1 million last year to $4.2 million in the current quarter, a 54% reduction driven by mix, promotional expense, and most importantly, the lack of overhead absorption.

Although we implemented an 80 person reduction in force during the second quarter in Rochester, this only occurred in late September and, therefore, did not significantly impact on our second quarter results. The 80 person reduction in force follows a 56 person reduction enacted during the first quarter. Operating expenses at Thompson essentially remained flat at $5.3 million. Estimated operating income for Thompson Center under this analysis was therefore a loss of $1.1 million versus income of $3.9 million in the prior year, a $5 million swing. It is clear that a separate Thompson Center business unit analysis revealed a significantly unfavorable impact on the total company operating income. The improvement in operating income of our nonhunting business which makes up the majority of our business was, therefore, matched by the impact of the hunting business resulting in a 58% decline in total company performance. This same dampening effect obviously occurred at the revenue and gross profit lines.

Turning now to the impairment charge. Intangible asset valuations are generally reviewed on an annual basis, unless there is a reason to believe that evaluation is required in an interim period. Accounting standards, specifically SFAS 142, outline several reasons that would lead a company to perform an interim evaluation. One such reason is a significant change in the performance of a business unit or the environment in which a business unit is operating. And here I am paraphrasing. For the reasons I've explained, in the second quarter it became appropriate for to us review our book value of assets originating from the purchase of Thompson Center Arms. As such we were required to review the fair value of our intangible assets related to this purchase under SFAS 144 and SFAS 142 accounting standards. We engaged outside valuation experts and we also worked together with our auditors in making this assessment. The result of this exercise is a non-cash net impairment charge of $76.5 million in the current quarter. This action reduces goodwill to a value of zero and other intangibles to a new value of $5.7 million from $62.8 million.

It should be noted that there was no obvious market based benchmark, such as any sort of comparable transaction available to us in determining this valuation. Therefore, we relied on cash flow forecasting for the hunting related business based upon the best assumptions available to us at this time. The effects of this impairment analysis are recorded in two locations in our income statement. A total amount of $98.2 million is showed in the operating expense category as its own line item. And this is the full effect of writing down goodwill and the other intangibles. There is also an offsetting tax effect, adjusting deferred tax provision in the amount of $21.8 million which appears on the income tax benefit line. As a result of the non-cash impairment charge,, positive second quarter earnings of a $0.01 per fully diluted share were reduced to a loss per fully diluted share of $1.62 under US GAAP. Going forward, the amortization of intangible assets related to the TCA purchase will now decline from $4.3 million to approximately $600,000 annually, a net expense reduction of $3.7 million annualized for a $2.3 million annual favorable effect on our after tax earnings.

Now let me turn to the balance sheet. Accounts receivable decreased to $51 million versus $54 million at year end, and versus $61 million in the last sequential quarter. As anticipated, we collected a large amount of the remaining receivables that had resulted from the dating terms typically provided in the hunting business earlier in the year. Inventories were $53.9 million at the end of the second quarter, a $6.8 million increase over last fiscal year end and a $1.3 million increase over the first quarter of this fiscal year. Actions have been and will be further implemented in the third and fourth quarters to reduce this carrying value. And I will discuss these in a moment when I comment on the third quarter.

Year-to-date capital expenditures were $3 million compared to $8.7 million last year. We expect to spend approximately $8 million on capital expenditures in fiscal '09 versus $14 million in fiscal '08. Major CapEx in fiscal '09 will focus on improving production efficiencies, new product offerings and various projects to selectively increase capacity and upgrade manufacturing technology.

Now to conclude on the current quarter with a look at cash flow and liquidity. As I discussed last quarter, we have begun to augment our financial discussion with a new metric, adjusted EBITDAS or earnings before interest, taxes, depreciation, amortization and stock based compensation expense. This measure will also eliminate non-cash one time charges, such as the impairment or the mark-to-market adjustments on foreign exchange and forward contracts that we've discussed today. Moreover, it will provide you with a basis on which to continue to evaluate the cash generating capacity and general liquidity of our business in the context of our bank covenants. Although I will not be providing you each quarter with specific results relative to each of the covenant terms under various debt instruments, the EBITDAS metric provide you with much improved visibility into where we stand.

Adjusted EBITDAS in the second quarter was $6.6 million compared to $11.4 million in the second quarter of fiscal '08. On a year-to-date basis, adjusted EBITDAS was $16.8 million versus $24.8 million in the first six months of fiscal '08. The presentation that is included in our earnings release clearly shows how this information has been derived. Next. In November we obtained a modification in the required leverage ratio from 3.0 to 3.25 for the second and third quarter from our revolving line of credit lender, TD Bank. We undertook this due to what we viewed as a remote but possible near term exposure, given the original three times EBITDAS covenant leverage ratio and the near term performance of our hunting product lines. I'm pleased to report that our business actually performed below the original 3.0 benchmark and we therefore would have more than met the original loan terms. In the end, this modification was prudent, but ultimately unnecessary in the quarter, and I personally appreciate the responsiveness of our bank. Lastly on liquidity, I would note that our draw on the revolving line of credit reduced from $7 million at the end of the last fiscal quarter to only $1.3 million at the end of the second fiscal quarter.

Now let me conclude by spending a few moments on our near term strategy, particularly as it would relate to the third quarter. As is clear from the discussions so far, our hunting business unit has recently proven to be a drain on total Smith & Wesson Company results. Although we appropriately do not report this as a separate business segment, we are internally focused on the earnings and the cash flow effect that it has on Smith & Wesson overall. As a result we have been reviewing the cost structure of both the manufacturing and the operating expense level. We eliminated 136 positions at our Thompson Center facility during the first half of the fiscal year and we have held year on year operating expenses in check.

However, we are taking further action to reduce costs and to reduce the inventory base at Thompson Center and in the company as a whole. We have just concluded a one-week closure of our Rochester, new Hampshire plant over Thanksgiving and we have added three incremental days to the Christmas shutdown for all of our manufacturing facilities so those holiday closures will now span two full weeks. We also plan further cost reductions in the third and fourth quarter. These actions will prove important to cash flow as they will allow us to control inventory levels in a manner that is most cash conserving.

We anticipate between a $4 million and $8 million inventory reduction for the total company in the third quarter results versus those in the second quarter. Interim planned closures such as those during the third quarter will, at the same time, heighten absorption issues, particularly at Thompson center such as those I've discussed throughout my review of the second quarter. Such actions, should they prove necessary in the fourth quarter, will do the same. This represents appropriate cash and business management but does not help EPS in the near term. My point here is cautionary. Our third quarter will indeed be aided by the strong handgun and tactical rifle trend in the quarter. Translation of these trends into EPS results, however, will be greatly reduced in the third quarter by the actions that I've outlined above.

Without providing a specific time frame, once we have lowered cost in our hunting business and inventory has appropriately been brought lower than current levels, we believe that the strength in both EPS performance and cash flow generation that is being exhibited by the majority of Smith & Wesson's business, will begin to read through the numbers with clarity. Our strategy is to lower the cost base of Thompson Center, minimize it's negative impact in terms of EPS and cash, and in turn limit the amount of borrowings we require. Again, the actions we take in this regard will unfavorably impact third and potentially fourth quarter earnings, offsetting gains in our handgun and tactical rifle business.

Throughout the coming months, we will continue to evaluate the performance of our Thompson Center Arms business in light of the very strategic options that Mike has outlined. It will be important that we make each decision not vis-a-vis Thompson Center alone but, as Mike indicated, within the context of the entire Smith & Wesson organization and it's future opportunities. That concludes my comments, so I will turn the call back over

Thanks, Bill. Before I close, I'd like to make just a few more comments. With regard to military opportunities, at this point in time we do not have any new information to share with you on the US Air Force solicitation to replace their M9 pistol with a new modern 45 caliber pistol. From what we know, this initiative is still listed as an unfunded requirement within their budget. On the rifle side, efforts to review the military rifle seem to be gaining traction as the Army is moving forward to review the M4 rifle and determine if there is a need to pursue an upgrade. In fact, we were invited and attended an industry day with the Army last month where we shared our design ideas and how to enhance and improve the current M4 carbine platform. We expect the Army to issue a request for information to the industry next spring that could lead to a rifle solicitation later next year.

On the consumer side, many of you have seen the media reports on the surge in gun sales, as indicated by the NICs background check data. For those of you who don't know, those background checks were up 45% in the month of November, a historical record. At Smith & Wesson we certainly are seeing the benefit. It is important to note that the bulk of the surge did not begin until just after the election and is largely not reflected in the revenue gains for the quarter we are reporting. From our perspective, the surge is affecting handguns and tactical rifles and our weekly read on distributor inventories indicate that these shipments are flowing immediately through to retailers. I want to point out that there's no way to know how long this surge will last, but for at least the short term this growth in orders and shipments will help offset some of the costs we will incur as we take the proper steps to lower our inventories and cost.

In closing, I want to make sure I've led you with a couple of key points today. First, we have a strong, robust business in handguns and tactical rifles. Not only is that business delivering growth results today but it has been doing so consistently throughout the last several quarters. Second, we currently face significant challenges in our hunting business. Despite this and the large impairment we took in the second quarter, we believe for a number of strategic reasons that keeping the Thompson Center business unit in our company is the right thing to do at this time. We will continue to revisit that decision and we reserve the right to make any changes in our strategy as circumstances evolve. With that, operator, I would like to open the call now for questions from our Analysts.

Yes, sir. (Operator Instructions). Our first question comes from the line of Reed Anderson with D.A. Davidson. Go ahead.

Thank you for taking my call. Good afternoon. Mike, -- first of all, nice job on the sales and particularly in the M&P and tactical. Curious on the promotional -- obviously you were promotional but it seems like the demand is there right now. To what extent does your outlook today continue to bake in assumptions that promotional activity is going to be here for the next couple of quarters?

That's a good question, Reed and just to kind of refresh everyone, last year in the third quarter was when we began the aggressive consumer promotions to help stimulate the business and move product through the channel. So we are just really anniversaring in the current quarter those changes. We have some rebate promotions in place that go through the end of December. They were put in place earlier this summer based on what we were seeing in the business. So they were in place prior to what we are calling this retail surge that we are seeing. At this point in time, we are not expecting to continue the rebates after December 31st of this year. We will see where things go and react off the market but certainly with the retail environment that we are seeing today, if it continues through the first half of next year, we don't see that as necessary.

And then on a related note that you also had commented in your prepared remarks that Sigma was very strong, you said 77% or something.

Yes, yes.

Should we read that to mean that, because that's a little bit lower price points, is that part of a trade down do you think or do you think that's a function of the promotions you are running? How would you read that?

The Sigma product has kind of a unique position. It's a very good product, it's a lower price point product that's out there. And certainly the economic environment is driving people to certainly look at how they are spending money and what they are spending it on. Don't forget the M&P did well too, even prior to this surge. But certainly the price point is affecting the Sigma sales.

Bill, a couple for you. On the gross margin piece, obviously from my expectations it's a little disappointing in this quarter given particularly how sales were. So, your comments at least the third and possibly the fourth quarter you are going to have this absorption issue, do you think it will get even worse than the sequential trend we saw from Q1 to Q2, just thoughts on, some color on --.

Yes, without getting too down the path on guidance, one way to look at it is Q2 still has hunting season effects in it for Thompson, and Q3 then we are out of season. As you have lower revenue you have worse absorption irrespective of the actions that were taken. So, yes, it was --

Still a factor but it's not the meat and potatoes of the hunting business, is that what you're saying?

That's true.

Another question I just want to do clarify. You'd said that the savings you'll pick up, because you basically have gotten rid of the intangible piece that you're amortizing off -- that amounts to on an after tax basis, $2.3 million per year?

Annually, yes.

That's it for me for now.

Okay, Reed, thanks a lot.

Our next question comes from the line of Chris Krueger with Northland Securities. Go ahead.

A couple of my questions answered already. Based on your own Smith & Wesson records and your own work that you've done with your customers going back to the '90s and back to the early monster quarters of the Clinton administration, can you give us any kind of history lesson there, what happened -- I know there wasn't nix data back then but I'm sure you've done some work on how that went at that time from sales at the retail level.

I certainly will and we have done our research on this and these are industry numbers, Chris, on handguns. And back in the mid '90s there was a surge in firearm sales, I think that's what you're talking about and it's pretty interesting phenomena. The surge lasted about ballpark 18 months. And after the surge, the years after the surge, there was a little bit of a dip but not much. It kind of came back down to the trend line and started back on the GDP growth level. So it's very interesting. Now circumstances, are they different today, we have a pretty severe recession going on, that's hard to guess. That's kind of what history would say is that the surge lasted for awhile and you did not see -- you saw a little bit of a dip as you went back and it kind of stayed at a little bit of a lower level but not significant.

Okay. Your tactical rifles, obviously, had another great quarter there. I think doing the math you did about $8.6 million in sales.

That sounds about right.

As far as capacity and all that goes if you sell them as quick as you can make them, is that a level -- kind of a maximum level, $8 million to $9 million range or what would you say there in the quarter?

We don't give capacity numbers out, Chris, but certainly the current surge is impacting tactical rifles -- because we manufactured internally we have some control, some parts come from the outside that we are working with suppliers to try to increase the production of. But the real surge, as I said, really did not have a significant impact on Q2. It really started hitting the full impact in Q3.

That included tactical as well?

Yes, yes.

All right. That's all I've got. Thanks.

Thanks, Chris.

(Operator Instructions). Our next question come from the line of Cai von Rumohr, of Cowen and Company. Go ahead.

Yes, gentlemen, good work on the cash flow.

How are you?

Good, good. Cow give us a little more color on sort of buy market channel approximately sales compares law enforcement, set military and international year over year?

How we did year over year in the quarter?

Yes.

Yes, the consumer channel for Smith & Wesson product was up in the quarter about 35%. Law enforcement was up about 20%. Our international business was actually down a little bit. As I mentioned to you, we had that Japan order that was in there last year.

And then, let's see, okay. And fed military?

Federal Government was down 9% but in small numbers.

Okay. Okay. And so where do you think you are in terms of the channel, in terms of inventory -- that was a problem going into the hunting season? I mean do you feel that's been pretty well cleared out or is that still an issue?

We, as I think you guys know, we work closely with our distributors and we do look at their inventory on a weekly basis. Certainly this retail surge has had a pretty significant impact on distributor's inventory. To say it's not an issue any more is probably an understatement. There still is some hunting product out there. In fact this focus on tactical rifles at retail and handguns has really had corresponding effect on people spending money on hunting products because the surge is on handguns and tactical rifles, as I said. But distributors inventories -- the product is selling, as I think I said, the product is selling right through distributors, right out to retailers as quick as they get it.

So that's clearly -- I mean in the handguns and the tactical rifles -- but on the consumer, on the hunting product, is that pretty well skinnied back or is that still an overhang?

It certainly has come down since last year. It's certainly not the problem that it was but there's still some pockets it's working through, Cai.

Okay. You're talking a pretty impressive decline in the inventories in the third quarter. Should that really take care of --because last year, as I recall, the inventories were just flattish. So, if in fact you've come down, refresh my memory, $4 million to $8 million?

We said $4 million to $8 million off of the balance at the end of Q2.

Okay. So if we come down to 49, we are going to be a little under 17% of sales or maybe even less depending where those sales are -- what's the right number? Should we expect, hopefully then, that inventories go down again in the fourth quarter which is a good quarter for handguns or what should we look for?

I mean, without putting the same kind of clarity on it we did with Q3, we will again take actions in the fourth quarter to bring the inventory down again from the level we ends up at Q3 with;

Okay. And any help in terms of with these kinds of numbers, where the net debt can be? Is there a target for where would you like to have the net debt at the end of the third quarter?

Sure, hopefully we can pay down a little bit more on some of the smaller loans but what we are really down now is not having a particularly large draw on the revolver. We are sticking with at this point the $80 million in the convert and then we'll bounce around with some level of draw on the revolver based on working capital needs at the time, but that will be a narrow range. So that is, I don't want to forecast it but start with $80 million and you shouldn't be able to get over $100 million.

Okay. And then in this tougher time, are you having any issues with receivables, folks paying, paying you late or anything like that? Is that a problem?

Infrequent, not really but what we did do, maybe you've seen this, we bumped up our reserve because of the general economic conditions that our trade or segments of our trade are operating in.

But how big, how large was that, that increase in the reserve, approximately?

For the quarter I think we, it's around $300,000, a little over $300,000. I don't have the exact number in front of me. It's about, if I recall it's about $340,000, Cai.

Hey, Cai, keep in mind that our -- we by and large bill distributors. And their experience in the surge in retail which is bringing cash into them too, so --

The other thing I'm going to add is that's a bad debt accrual or that's a bad debt provision. We really don't have write off experiences.

Okay, let's see, so kind of with what you are talking, should the -- the receivables in last year held relatively level in the January quarter and then they go up a little bit in the fourth as the inventory comes down. Should we expect that kind of a pattern, which would suggest that hopefully the working capital comes down both in the third and fourth quarter --

I think that pattern is not bad. Depending on where the revenue comes out in Q3, you could have some growth in receivables. Particularly driven by the other than hunting business segment. But it will be offset by a decline because we will be in a lower revenue period, really ,on the hunting business. We are also not altering, we are not varying from normal terms. (Inaudible - multiple speakers) part of our promotional activity. It ought to follow that trend and the inventory should follow the trend we were discussing before.

How should we think as we do our modeling on your handgun and tactical rifle business with converting NICs data into sales? I mean, we are up over 40% in November. I mean, on average -- and I think it's a fair question because we don't know what December is going to be or January is going to be but if it continues up 40% should we expect your sales to be up 40% or 20% to 30% or what's the rough?

Keep in mind, Cai, I think that's a little tricky. We use a number of factors to try to understand and forecast our business. NICs is only one of the factors that we look at. And remember, NICs is one number. They don't break it between handguns or long guns and used guns are in that number also. We selling into distributors so there's an inventory buff that's out there. NICs is reflecting retail sales. We use it as one of the indicators of the trend -- are people buying firearms, is what that basically tells us. Certainly when you go from September, from memory, I'll say the business was up [8/10ths] of 1% -- the NIC data. October was up 15% and then November up 45% -- is an indication that people are out buying guns, but there are a lot of factors that go into the NICs data. So it's one factor we use. Certainly an overall indicator, but it's not -- you can't draw a direct line.

Hey, thank you very much. I'll let someone else go.

Okay, Cai ,

(Operator Instructions). Our next question comes from the line of Eric Wold, with Merriman Curhan.

Hi, I apologize, I'm at the airport waiting to hop on a flight so I will ask a question, two parts so I can go back on mute. Number one, Cai asked the question about distributors -- distributors are already selling the stuff through and as fast as they can get it. Taking that a step further, what are you seeing from distributors in terms of their propensity to order, are they being cautious to order, are they ordering smaller amounts than they normally would given the headaches of last year so it's easier to sell thing, through? How long before they kind of take a little more risk and maybe order more -- is going to get more come through their doors and maybe in a real time basis, maybe less real time, more taking some chances on future trends? And two, if we do get the surge continuing for some amount of time in the coming months and quarters, how would you say Smith & Wesson is positioned to handle that surge relative to other manufacturers that they may not have the right products, they may not have the manufacturing capacity, may not have the capital, however you want to position it.

I am trying to answer all those questions, Eric. Right now on distributors, and you guys talk to retailers and you hear the same thing that we hear and see from retailers is that as quick as the product is hitting the retail store it's going out the door, on handgun and tactical rifles, not on hunting products and services. So distributors are ordering, by my view, aggressively. But they have experience, many of them have been around for a long time and they have experience of dealing with these surges. So they are monitoring it as we are monitoring it. But they are ordering aggressively as the product comes in and comes through. No one knows how long surge is going to last. We are not putting capital expenditures in place to increase capacity simply because of the surge. That would be mistaken in our view.

So we think that we are in a position to respond. Our manufacturing guys have built a fair amount of flexibility into our facility, even in the facility. So it gives us an advantage to be able to shift the mix. And the other is still our foreign competitors have a longer supply line back to the factories outside the United States than we have. And we try, our guys are look at it on a daily basis to make sure that we are adjusting our mix to meet with what the distributors are ordering. But I would say by and large, through the channel from the retail end and the distributor end, they are taking a fairly aggressive stance on the categories that I mentioned where the product is selling through very well.

Thank you guys, appreciate it.

Thanks, Eric.

Ladies and gentlemen, I show no further questions at this time. I would like to turn it back over to Mr. Golden for closing remarks. Please proceed.

Thank you, operator. I want to thank each of our employees at Smith & Wesson and Thompson Center for the hard work they've done this year. It's obviously been a difficult year. Together we want to wish all of you very happy holidays and a prosperous new year. Thanks everybody for joining us and we'll see you again next quarter. Thanks.

Ladies and gentlemen, thank you for your participation in today's conversation. This does conclude today's presentation. You may disconnect. Have a wonderful day.