Vista Outdoor Inc (VSTO) 2017 Q3 法說會逐字稿

Good day and welcome to the Vista Outdoor Q3 FY17 earnings conference call.

(Operator Instructions)

At this time I'd like to turn the conference over to Mr. Michael Pici Vice President of Investor Relations. Please go ahead sir.

Thank you. Good morning and thank you for joining us for our third-quarter FY17 2017 earnings call.

With me this morning are Mark DeYoung, Vista Outdoor Chairman and Chief Executive Officer, and Stephen Nolan, Senior Vice President and Chief Financial Officer.

Before we begin I'd like to remind everyone that during today's call we will be making several forward-looking statements and we make these statements under the Safe Harbor Provisions of the Private Securities Litigation Reform Act. These forward-looking statements reflect our best estimates and assumptions based on our understanding of the information known to us today.

These forward-looking statements are subject to the risks and uncertainties that face Vista Outdoor and the industries in which we operate. We encourage you to review today's press release and Vista Outdoor's SEC filings for more information on these risk factors and uncertainties.

Please also note that we have posted presentation materials on our website at www.vistaoutdoor.com which supplement our comments this morning and include a reconciliation of non-GAAP financial measures. With that said I'll turn the call over to you Mark.

Okay Mike. Thank you very much. Thank you all for joining us this morning we appreciate it.

Today we report third-quarter results as Michael mentioned which included a 10% year-over-year increase in sales, and gross profit being flat compared to the prior period. During the third quarter we experience the downward shift in point-of-sale data as we entered the holidays. In the past quarter we faced a very challenging retail environment with late holiday shopping, weak hunting season due to weather conditions, reduced indoor in-store retail traffic, expanding channel inventories, and all of this being compounded by continued share of wallet going to MSRs and handguns that we do not offer.

These sluggish market conditions resulting in increased competitive pressures that drove deep discounting. In order to maintain market share and shelf space and sustain revenues we engaged in promotional activity that pressured margins and impact at our near term cash flow.

Part of these negative trends can be directly tied to the outcome of the 2016 presidential election. The shooting sports market softened significantly following the election, as consumer demand was reduced due to a more circular regulatory environment for gun owners under the current administration. We are currently experiencing volatility in the ammunition market in terms of our daily and weekly order flow and weaker point-of-sale trends. This post election decline in demand for shooting sports product is continuing into our fourth-quarter and we believe will continue into our next fiscal year.

Therefore the company is actively engaged in initiatives designed to reduce working capital, our overheads and product costs. We are also continuing to invest in capital for improved efficiencies in our operations. In addition I'll note that we are actively engaged in pursuing long-term supply of products from Lake City Army Ammunition Plant.

As a result of these dynamics in hunt shoot market the company recorded a pretax non-cash impairment charge of approximately $450 million related to our Hunting and Shooting Accessories reporting unit. Although we are clearly disappointed with this impairment of tangibles, Vista Outdoor remains committed to delivering long-term value to the execution of our strategy, a focus on operational efficiencies and execution excellence, increasing our market share, and improving our competitive position.

We have been executing a capital deployment strategy which includes share repurchases, internal capital investments and strategic acquisitions. On January 23 the company fully completed a 100 million share repurchase plan. Such the creation of Vista Outdoor in early 2015, we've repurchased approximately seven million shares.

We also continue to carefully execute and manage our capital expenditure plans, including our previously announced efficiency improvement and capacity expansion program. In this program we are focused on safety, efficiency, product costs and quality within our manufacturing sites but also looking into our supply chain. The execution of the first tranche of a multi year capital investment program to reduce costs and increase capacity in specific bottleneck operations is on track.

We continue to evaluate and target opportunities where demand outpaces supply or more significant cost savings opportunities exist. We currently see organic growth, cash generation, and margin improvement as our best near-term opportunities for value creation. But we will continue to judiciously adhere to our disciplined M&A process and we will continue to explore the most fitting and highest-value-creating opportunities.

On this note I'm pleased to report the integration and performance of Camp Chef brand is on track and the business results are exceeding our expectations. We continue to drive improvements in innovation and new product development across the portfolio and the company launched more than 150 new products during the winter trade show season at the Archery Trade Association show, the Outdoor Retailer Winter Market, the SHOT Show, and the PGA Show. We have created market leading positions in numerous outdoor product categories and will continue to pursue leadership and growth with our leading portfolio top outdoor brands.

Helping to further enhance our focus on innovation and execution we have announced new roles for Dave Allen and Jason Vanderbrink. I've asked Dave to lead the outdoor products segment as part of the leadership change designed to drive growth in our sales and margins, address increasing market pressures, and further accelerate our innovation engine. I've asked Jason to lead our worldwide sales organization and he will be instrumental in helping us capture additional market share and leverage our portfolio capabilities and our strong relationships within the global sales and distribution network.

I would note that we have accomplished a lot the past quarter and this past fiscal year to enhance our company's talent base, deliver execution excellence in our operations, strengthen our brand positions, and deliver innovative solutions to consumers. Although we face market challenges we are remaining disciplined in implementing our strategy, and steadfast and upbeat in pursuing our objectives. As we have done many times over the years in many different business cycles we will focus on capturing market share, ensuring our role as a premier provider of outdoor product solutions for our customers, and on delivering strong cash flow.

Our overarching goal in being one of the world's top outdoor products companies is to deliver long-term growth and shareholder value. That has not changed. We are motivated, energized, focused on a bright future we know is ahead of us. Given the on unprecedented acceleration of market pressures during the third quarter, the company has updated his FY17 financial guidance.

Stephen will now provide more detail on our updated view of the current fiscal year and provide additional insights into the financial results for the past quarter. Stephen?

Thank you Mark. Good morning everyone. Thank you for joining our third-quarter earnings call.

We have disclosed both as reported and adjusted results in our press release to assist you in your understanding of the underlying numbers and to assist in comparison to prior periods. You will also find a more detailed financial presentation of our third quarter FY17 performance on our website.

Before I share information on the overall financial results, I'd like to give you an update on a previously announced expectation of an impairment charge. As Mark indicated, the company reported a pretax non-cash $449 million impairment charge related to our Hunting and Shooting Accessories reporting unit in third quarter. After-tax the charge was $414 million.

Breaking it down pretax $354 million was recorded as an impairment to goodwill and $95 million was recorded as an impairment to identifiable intangible assets. The impairment was primarily related to assets acquired as part of the Bushnell and Blackhawk transactions. We will share more detail in the impairment in our 10-Q.

I will now discuss our adjusted results, first for Vista Outdoor Global and then for the segments. The company achieved third quarter sales of $654 million, up 10% from the prior-year quarter. The year-over-year increase was driven by $92 million of sales from acquisition and slight organic growth in the shooting sports segment, partially offset by a decrease in organic sales for the outdoor products segments.

Third-quarter gross profit was $169 million, which is relatively flat compared to $168 million in the prior-year quarter. The third quarter results include $24 million of gross profits from our acquisition offset by a decline in organic gross profit in both segments.

Our operating expenses for the third quarter were $103 million compared to $92 million in the prior-year quarter. The increase reflects operating expenses generated by the acquired businesses, partially offset by a reduction in annual incentive accruals as a result of our current year performance and also by cost cutting initiatives. We reported operating profit of $65 million in the third quarter, a decrease of approximately 14% from the prior-year quarter. The decrease was caused by the increased operating costs I just mentioned.

Interest expense for the quarter was $11 million, an increase of $3 million over the prior-year quarter, caused by an increase in the average debt balance due to acquisitions as well as higher average interest rates. The tax rate for the quarter was 33.6% compared to 36% in the prior-year quarter. The lower tax rate was driven by a more favorable true up of the prior-year return and a higher domestic manufacturing deduction. For the third quarter we reported net income of $36 million, down 17% from $44 million in the prior-year quarter, resulting in EPS of $0.62 compared to $0.70 in the prior quarter.

Year-to-date free cash flow use was $18 million, compared to free cash flow generation of $51 million in the prior-year period. The year-over-year decrease in free cash flow was caused by the reduction in net income, an increase in working capital, and increased capital expenditures. The primary driver for the increase in working capital is higher inventory levels, caused by the decrease organic sales noted earlier. The company is taking appropriate actions to lower inventory by reducing certain purchases of source products and output of certain manufactured products across both operating segments.

As part of our long-term capital deployment strategy the company repurchased approximately 1.56 million shares for $60 million in the third quarter. Since the end of the third quarter we repurchased approximately 780,000 shares for $24.5 million. As Mark mentioned, we have completed the $100 million share repurchase program in the fourth quarter. Since the inception of the program we've repurchased approximately 2.7 million shares.

Now turning toward our business segments, where we report sales and gross profits, third-quarter sales in outdoor products were $293 million, up 24% from $236 million in the prior-year quarter, including approximately $92 million of sales from acquisitions. Organically the segment was down approximately 15% from the prior-year quarter. The organic decrease was caused by lower sales across all product claims, including the impact of increased promotional activities across the segment.

Gross profits in the third quarter for [actual] products was $71 million, an increase of 11% from $64 million in the prior-year quarter. The recent acquisitions contributed $24 million of gross profit, while organic gross profit in the segment was down 26% as a result of the decreased sales and increased promotional activity.

Shooting sports reported third-quarter sales of $361 million, up 1% from $356 million in the prior-year quarter. Sales of Centerfire and rimfire ammunition increased, partially offset by decreases in shock shell ammunition and firearms, and increased rebate of promotional costs. Third-quarter gross profit in shooting sports was $98 million, down 6% from $104 million in the prior-year quarter. The year-over-year decrease was a result of products mix and increased rebate in promotional costs.

Turning back to the company level we have updated our FY17 guidance, which takes into account continuing market challenges and increased promotional activities through the fourth quarter. We now expect sales in the range of $2.5 billion to $2.54 billion, interest expense of approximately $45 million, and adjusted tax rate of approximately 35%, adjusted EPS in the range of $1.95 to $2.10, capital expenditures of approximately $90 million, and free cash flow in a range of $25 million to $40 million. Additionally for the full year we expect gross margins roughly in line with our third-quarter results. Our preliminary review for FY18 is for a continuation of the current revenue and margin challenges.

As per our usual practice, we will provide additional insight on our expectations for FY18 during our fourth-quarter earnings call in May. Despite the pressures this year and next the company is committed to it's capital employment strategy, long term sales growth and margin improvement, and delivering long-term value to our shareholders.

I'm now happy to open it up for questions.

(Operator Instructions)

Greg Konrad, Jefferies

Good morning.

Just when we look at the 2017 guide, I know you don't give quarterly guidance so we can imply what your expectations are for Q4, and you mentioned that a lot of those trends kind of continue into 2018. Is Q4 a good guide for what you expect for margins and sales as we start heading towards 2018?

Greg, I don't think you can necessarily annualize Q4, and clearly as Mark indicated in the script, the challenges we face accelerated in the back half of our Q3 and into Q4 and really gave us insufficient time to react to those changes from a cost management perspective and from an inventory management perspective. I think Q4 should not be viewed as a normal quarter in this new environment. It's a quarter where we were unable to take the actions necessary within the quarter to adjust revenue and margin. But as I mentioned, it would be premature right now for me to give any sort of putative guidance for FY18.

We do expect continued revenue pressures. Continued promotional management pressures, but as Mark mentioned in the script, we are engaging in a series of activities around cost management, both overhead and product cost, and inventory, and other working capital management to improve cash flow.

Yes. I agree with Stephen, Greg. I think it would be a mistake to straight-line Q4 and annualize it. We will come out and react to these markets. We have a long history of up and down cycles taking share in all those cycles we have a very capable organization in terms of cost management. There's a lot of work we will be doing to improve as we go forward.

Thank you.

And to follow up around cash flow. Just looking at the stock price performance as of late, why not focus more on share repurchases over acquisitions? Then just a second part of that, any issues just related to the covenants with either share repurchases or just the decline in EBITDA?

On share repurchase that has been an important part of our strategy going forward. As we look at the intrinsic value of the company and as we look at the portfolio we have built and the opportunities we see ahead of us in this market to be able to continue to grow and take share and drive organic growth and improvement going forward over the longer term. I agree with you that, as I mentioned earlier, that we are going to be focused internally on our organic performance much more than any other strategy that we've been executing.

In terms of share repurchase that's been also part of the strategy we have been executing obviously as we have gone forward. We will be talking to the board about that and working through what that outcome might be as we look at entering our next fiscal year.

In terms of our credit agreement and our notes, Greg, our agreements have obviously, been publicly filed. You are welcome to look at them. We certainly do not have any current issues with respect to the covenants within those agreements, and as I think is clear if you read through them, there certainly are restrictions in those agreements about restricted payments and the level of cash flow we can direct towards share repurchase or other similar activity. We are certainly not unlimited in how much of that sort of activity we can do, even above and beyond as Mark mentioned, any [more] authorization. But I welcome to -- sir, you are welcome to look at those publicly filed documents.

Thank you.

Thank you.

Dave King, ROTH Capital Partners

Thanks, morning guys.

Thinking about the guidance a little bit, even a little bit more color there, can you talk about how you are thinking about the shooting sports business versus the outdoor side? Shooting sports I think was still up 1% or so in the quarter. As we think about the guidance for next quarter, it looks to me like it's implying a 25% organic decline overall. How much of that is driven on the outdoor side versus the shooting sports side? Any color there would be helpful.

Dave, as you know we do not provide guidance by segment. So I can not give you a quantitative sense, but obviously with the size of the organic decline we are talking about with our Q4 guidance it is clear that we see weakness across both segments in line with Mark's description of the overall market conditions. We clearly will see challenges in shooting sports, but I can not break apart the size of that organic decline between the two segments at this point in time.

Okay. It is fair to say then, it is declined in both businesses as we think about the fourth quarter and then maybe even next year, both businesses having weakness. Correct?

Well I think particularly, Dave, in the fourth quarter, which we are in the middle of right now which gives us a lot more clarity, we are seeing challenges in general in retail. We are seeing challenges in general across our distribution network as consumers have pulled back. We are seeing some of those pressures in both areas, primarily again in the hunt shoot, you remember the outdoor product segment there is a significant portion of that business which is associated with the shooting sports, although it is not guns and ammo. Those are being impacted by some of the same trends. If you are not buying a new rifle, you are not buying a new scope. If guns decline and you are not buying firearms, you are not buying accessories. There are some links there that prevail and impact the outdoor products segment.

That is the trends that we are most concerned about is what's happening post the election in the shooting sports market, which has been a very quick pullback in terms of demand and sell through, which has then caused inventories to build in wholesale and retail channels, and we are just concerned it's going to take awhile to work those inventories out and get back to where we are pursuing replenishments. Then during those kinds of times we focus heavily on taking market share. There are several companies that have entered this space over the last eight years of plenty under the prior democratic administration this has been a boom for this industry for eight years. A lot of small companies and other companies have come in with products because they could as demand outpaces supply.

As we have consistently said and as we have consistently demonstrated over the last thirty years, that as these markets go through these cycles we have demonstrated an ability to take that share back from importers or smaller suppliers because of our relationships in the channel and in distribution as a key strategic partner across a broad portfolio. We definitely would be pursuing those strategies that we have used successfully in the past. I can not speak exactly to what is going to happen in FY18, but in the fourth quarter it is really shooting sports is our largest concern and those products associated with shooting sports that are in the outdoor products segment.

Okay. That's good color. Thank you, Mark.

Then, as you think about the outdoor side of the business, how do you think about that these days in terms of the problems and issues that have arisen there? To what extent do you think those are self-inflicted versus end market driven? Then, as you think about the opportunities to capture share there, do you have the same ability to do what you've done over the last thirty years on the shooting sports side, to try to be able to get some additional business, given the retail challenges that are happening in outdoor?

That's a great question too. I appreciate that question. It is one that we are working through ensure that we get the proper answer and that we prevail through the challenges that we face.

I think your question in terms of self-inflicted versus market driven, as we look at this and we look at the magnitude of the issues and we look at materiality, any time you have a portfolio like ours, which is broad an complex, you have various areas of improvement organically. But the majority of the issues that we face, I don't see them necessarily as internal self-inflicted wounds. A mass majority of the issues we have been facing are market dynamics and are being market driven by consolidations in the retail space, for example in golf. The declines we saw in the golf market as some of our key customers exited that market through bankruptcies or through consolidations.

Some of the challenges we saw, we mentioned earlier in the year with retail consolidation with Sport Chalet and Sports Authority impacted some of our CamelBak business and Bell Helmet business and those kind of brands a little bit.

We don't -- when we look at our balance score card, when we look at our performance and hold ourselves accountable, the real material impacts that the company are seeing are not organic self-inflicted wounds or unforced errors. We really are facing market dynamics which are giving us the majority of our challenges.

I think those market dynamics in time, we will be able to respond to them and they will begin to stabilize, particularly as post election impact in the shooting sports. We will soon, I believe, find out what the new normal is. For several years the question has been asked "what does the new normal look like?" I think we will discover that new normal in our next fiscal year. We will capitalize on every opportunity we have as we get to that new normal.

Okay. That's great color.

Then, one last clarification. Stephen, on the impairment it sounded like it was primarily related to Bushnell and Blackhawk. Any other impairments in there related to CamelBak, Jimmy Styks, BRG, anything else?

The impairment that we recognize was truly within our Hunting and Shooting reporting unit.

Within our outdoor product segment are three reporting units. There is Outdoor Recreation, which includes the assets acquired as part of CamelBak, Jimmy Styks and Camp Chef transactions. There is our Sports Protective reporting unit, which is primarily comprised of the Action Sports and BRG transaction plus some of the Bushnell acquisitions we acquired at [rounds] such as Bolle, [Saben], and Serengeti. Then our Hunt Shoot acquisition, or our reporting unit, which includes some assets which were acquired as part of the Bond transaction back in 2001 plus the Blackhawk transaction plus the majority of the Bushnell assets.

The apparent with Bolle within the last reporting unit, it is difficult to break apart as you know the goodwill -- which acquisition and the goodwill impairment is related to because goodwill is treated monolithically within the reporting unit. But we do know that the bulk of the goodwill in that reporting unit came from the Blackhawk and Bushnell transactions, so we can certainly call those out. But there was no impairment recognized in the quarter to either of the two other reporting units.

Okay. That's again good color. Thanks for taking my question guys, and good luck in getting through the current environment.

Thank you.

Scott Stember, C. L. King

Good morning.

Good morning.

Just following up on that last question about impairment charges and potentially some of the other two segments, particularly your Outdoor Recreation, I know that there was nothing related to those subsegments in this quarter, but given the sales trend that you see right now, are you relatively confident that we will not see any other impairment charges, just given some of the large acquisitions that you made in those two subsegments?

Sure. It's difficult to give forward guidance on the impairment, or the lack thereof. If we believed there was a need for an impairment charge in those segments -- in those reporting units we would have taken it already. Certainly during the quarter, as we mentioned in our release about the impairment four weeks ago, we declared a triggering event for the whole of the outdoor products segment, which calls us to evaluate all three reporting units within the segment for impairment.

All three went through what is called a step one test under [the route] and accounting code [ASP] 350. There was only an indication of impairment in one of the three, and that is hunt shoot, which then went into a step two analysis which resulted in $449 million charge we have announced today. Th other two reporting units were tested and no impairment was identified. Obviously, going forward it is difficult for me to give a level of confidence around that impairment, or lack thereof, since we do not guide by segments. Since I can't predict when we go through an impairment test next.

But all of the variables that applied within the impairment test will be. But certainly there is no indication during the quarter, as you will see when we file our Q -- there was a positive cushion which is an excess of fair value over the carrying value on the books in both of those segments. So it's not as if they were at a position where carrying value equaled fair value, there was a cushion, an excess in those segments, which certainly indicates that we are not fitting right on the edge of impairment, but that is probably all the guidance I can give looking forward.

The only other thing I mention on impairments is, as you may recall, we took an impairment against Savage a year or more ago based upon market conditions again. These six months later Savage is a home run and the business was not impaired at all. I think our goal here is to ensure that these impairments of goodwills and intangibles does not impair the future ability of those businesses to deliver great products, grow, and increase their margins. We are very much focused on that, much like we were with Savage.

Got it.

Just one last follow up on optics. I know that in prior calls you guys have talked about increased competition and having to upgrade or affect some of the product offerings that you had. Obviously with the market the way it is right now I imagine that has accelerated that effort. Can you maybe just talk about what you are doing on that front from a product standpoint to (inaudible) market.

Yes, absolutely happy to do that. In fact, I'm pretty excited about this. We have completely restructured our optics capabilities within the company over the last year or so since we began to talk about the challenges we were seeing in terms of market share in optics. We have rebuilt the team. As you recall that optics business is about $150 million of our revenue; that's the size of it when we talk about optics, it's about $150 million.

We have completely rebuilt that team. We hired really capable engineers and we brought in additional equipment to support those engineers. We've hired great designers to be able to allow us to manage our own destiny through designing our products with features and benefits that we believe the consumer will look for. I'm very excited about that team. I'm excited about the talent that we've brought on board and the quick progress they are making.

We are talking through some of those strategies this week, as a matter of fact, with our Vice President over the hunt shoot segment, focused particularly on optics conversations. I was very heartened by the progress we are making. You are going to see us introducing new lines, new capabilities, you are going to see significant improvements in our products that will be launched this year. We are making terrific progress coming back in that very competitive market. I am quite bullish that we have turned the corner on that and that over the course of the next year we will be taking market share back and we will be introducing new and more exciting products which will appeal to our customers and to consumers.

Got it. That's all I have. Thank you.

Thank you.

Jay Sole, Morgan Stanley.

Great. Thank you.

The question is on the sales guidance for Q4. How much would you say the sales guidance is because of what you are seeing from the point of sales trends, or how much of it is just destocking that retailers are having too much inventory right now? Or they are cutting back their orders far more than the few trends would suggest just as a precautionary type of measure.

That's a good question, Jay. I think that's a critical element for us to understand as we go forward. What has really happened over the last eight weeks and is it really demand coming through the shelves or is it just clearing of inventory and lack of reordering?

Initially following the election, as you'll recall, even in the couple weeks following the election that the time that we had the investors conference in New York City, for example, point of sale trends were still positive. We were seeing point of sales trends positive a couple weeks after the election. About the time we were entering the holiday season, beginning about the Thanksgiving week, those point of sales trends began to flip negative.

Then we began to see this accelerating point of sales declines that continued through the holiday season in December and January. It really is a combination of both, and it's complicated trying to break that out. I'm not going to be able to break it out in terms of point of sales versus inventory and destocking because we have so many product lines and product categories where the numbers will be different. But in general it's been both.

We've seen both the decline in point of sale in terms of consumption, but we also know that inventories are high. We know they are high in retail and we know they are high in wholesale, which feeds our dealer network of thousands of dealers. We do believe that one of the key contributing factors is that people build up inventories in advance of the election season in anticipation of a democratic administration. When that didn't happen we know that many of our costumers had inventory levels which were too high and as point of sales trends began to decline it compounded the problem with their accelerated inventory build they had done pre election.

It truly is both of those and we will be working through this next quarter and into our next year to ensure that as those inventories realign with demand that we are taking market share, taking shelf space, and getting those replenishments.

Got it. Thanks Mark.

Let me just ask about SG&A and R&D for next year. Obviously you are not giving guidance, but the track record of the company over a long time, excellent ability to control SG&A. Can you give us a high level what your ability is to bring SG&A down to a level in terms of dollars and R&D, how we might think about that year? How much is fixed, how much is [built] in your ability to adjust based on the environment that you are seeing.

Yes, we have a long history of success in terms of cost management and managing variable and semi-variable costs both in our factories and in our SG&A side. We are very focused on that. This is not our first rodeo in terms of these cycles, up and down cycles over the last thirty years. We've seen this many times, maybe not with the velocity we've seen in the last eight weeks, but we've seen these trends go up and down.

We are working right now with Stephen and the financial team, our presidents, and our segments, and with those in our global product lanes to look at truly critical investments and truly critical expenses versus those that might be variable. I'm confident that we will continue to find ways to streamline and slim down the organization if we need to, to align with the challenges we'll face in the near term as we go through another one of these cycles, now particularly in the shooting sports where we have seen these before as well. We are very much focused on that.

We are also focused on product cost. A lot of the capital that we are investing in, our capital investment plan is focused on efficiency improvement and bringing state of the art modern capabilities into our manufacturing facilities to reduce our unit cost of production and allow us to continue and pursue being a low cost leader in the segments that we serve. That is going to be an important element for us as well beyond just the overhead element and SG&A is driving our direct cost in line with these investments we are making.

We are also working our supply chain. We've engaged in intense negotiations with suppliers to ensure that we are getting the best possible price out of our suppliers on products that we source. My answer on that, Jay, is yes we are very focused on the overhead and the SG&A, but we are also very focused on direct and semi-variable costs.

In terms of the other part of your question on R&D, when we look at our R&D investments, as you'll recall, we've increased our R&D investments over the last year and even at that level when we look at our R&D investments we are still quite slim and we are very efficient in what we are able to generate from our R&D investments. We will be very mindful not to cut off our nose to spite our face while we are in a cycle like this. We want to be able to maintain our engineering capabilities, we want to be able to maintain our innovation engine, we want to be able to take market share by having great products. It will be a balancing act, we have done that before very successfully and we are prepared to do it again.

Okay. Thanks, Mark. That's helpful.

You bet. Thank you.

Andrew Burns, D. A. Davidson

Thanks for taking my question.

It appears we're entering a short term ammunition correction which has occurred several times in the past and typically lasted any where from 12 to 22 months in duration. As we enter what looks to be this correction, do you think the profile is similar to historical patterns? Or anything to call out in terms of inventory pricing, consumer pricing behavior, that would make it different this time around? Thank you.

I appreciate your recognition of the fact that we've seen this movie before and we've weathered these storms before, you're right about that.

In terms of the duration, I think it is interesting. I saw their numbers mentioned previously in some write ups that were published. This one I think is too early to call, I think it is too early to call the duration. But we have seen durations in that 12 to 18 months as we've gone through these cycles and established whatever new norms are and figure where the bottom of the trough is. This one we're into at about eight weeks now, following the election primarily, so we'll work our way through that. And we'll be able to at some point in time, I think, do a better job for you in being able to call the trough and figure out exactly where the bottom is and identify what that new normal is.

This one is a little bit different, maybe just for a couple of reasons. I think the pre-election inventory build compounds the problem. This big inventory build that occurred in retail and wholesale in advance of the election compounds the problem at least in the near term as we need to work through those inventories. There is a little bit of a difference there in that, that was a fairly significant shift prior to what has been a fairly rapid decline. That may compound it at least in the near term for a little while. The other thing I think that is interesting is that some of the cycles we have had -- we're coming off of what I call, the eight years of plenty under the Obama administration. Being able to gauge exactly where that correction will be following a strong bull market in shooting sports for eight years is a little bit unique. So it causes just a little more uncertainty in exactly being able to identify what the new normal is.

That said there is a lot of new shooters in the market. There is a lot of new people that have come into the shooting sports and purchase firearms for the first time, or the second, or the third, or the fourth. We know there is a larger installed base of people that consume our products which I think bodes well in the long term. We know the demographics of new shooters is favorable, 18-34 age group has been where a lot of the growth has come and they are actively engaged in the sport, so I think that bodes well for us. The demographics shifting most recently to 50% women participants, I think is a great demographic for the long term health of the shooting sports.

I think all of those things are variables, some challenges to think it could be more challenging, others frankly comfort us, but we think it might be a little less challenging. I guess at the end of the day it's a little too early to tell. We expect to be able to have more information as we get through our fourth quarter. As we get into next year and we'll be trying to factor all of that obviously into the guidance which will give for FY18 when we have our standard May call.

Thanks for the color. That is helpful.

On part of the call, Mark, you mentioned a list of industry and retail headwinds that you as well as your competitors are facing. I was wondering if you could discuss what, if any, impact those retail headwinds are having on the non-hunting, non-shooting elements of the business like CamelBak, Bell Giro which just worked through the retail bankruptcies. What is the state of the union as you start 2017 for that area of the business?

That's a good question.

Obviously the retail sector in outdoor recreation supports the $63 billion industry that we have talked about and we have discussed in terms of this highly fragmented $63 billion market that we are operating in. Obviously retail really impact that item and sell through those items as well. We will not be immune to challenges from the retail market impacting all of our brands.

However what we have seen today with the exception really of golf, where we saw the golf consolidations and we saw some of our large golf customers either go bankrupt or consolidate. That was unique to golf and causes some real challenges right around the end of the golf season in that July, August, September, October time frame toward the fall. That was a specific and unique impact that has settled down a little bit now in terms of the impact of that.

The Sports Authority bankruptcy and the consolidation that occurred there did impact Camelbak, it did impact the Bell Giro business a little bit as those stores carried both cycle, snow, and hydration solutions in backpacks and bottles. There was some impact we saw clearly from those retail consolidations. But I haven't seen anything in general in retail which is heightening our exposure to those other outdoor product brands like we were seeing in the shooting sports side.

The only other trend, Andrew, we have seen in certain categories, strictly in winter sports gear, there was a bit of an inventory overhang from the last season where retailers came into this snow season with more inventory on hand. This is proving to be actually quite a good snow season and so we've certainly have seen improvement. Replenishment did lag POS data in the winter market as we -- as the retail channel of our existing inventory. There are also a few inventory overhang issues in the independent bike dealer channel. All of those added together while they are not insignificant pressures but certainly lower pressures than we face in the hunt shoot market today.

The other thing we're very much focused on, I would just add one last common on the retail environment, we are not necessarily completely tied to brick-and-mortar and in fact our strategy is to continuing to allow us to have other outlets for our products through online distribution and online retailers. As we see that shift from brick-and-mortar to online, we are very much engaged in taking advantage of participating in that shift. We're working that [tech] strategy every day and working the sales every day to grow our ability to go direct to these consumer and to grow our ability to be able to go online to these consumers. Some of our products, it's easier to do that than others. But frankly, you can sell firearms and ammunition through numerous online outlets. Traditionally that has not been the case, but that has grown significantly. We are supporting our brick-and-mortar retailers, they are very important to us and we're working closely with them. But at the same time we are working to ensure we have a balanced distribution network which allows online markets to become increasingly important for us as well.

Thanks. Good luck.

Thank you.

Bill Ledley, Cowen and Company.

Hi, guys. Good morning. This is Bill on for Tom this morning.

I just wanted to get your sense on the inventory that stuck in the channel. I think at Winchester mentioned take at least until the summer to work through. Would you just go through how you do that and how long you think it takes to destock that channel before you start getting restock purchases?

Yes, we are very much aware of all the Winchester's earnings call and their anticipation that it takes a couple of quarters. I'm not sure, and I don't think they are sure, and I'm not sure anyone is sure exactly how this is going to settle out because point-of-sale is also shifting on us. But we suspect it will take us into the back half probably of next year to be able to be confident that inventory resets have occurred and that we got to where the new demand is balanced to a supply and inventories are being cleaned up. I think as other companies report going forward that are in the shooting sports space, and you've got a couple more that are going to report here over the next few weeks, I think there will be a common theme around this inventory issue and clearing out that inventory and people trying to assess how long that might take. We're in such a state of flux now it's difficult but we think the back half of FY18 will begin to work our way through this.

Okay. Thanks that's helpful.

And then going back to the free cash flow guidance reduction. Can you talk about the major pieces of that and how you see that going into 2018. I know you are not giving guidance. How long do you think it takes for you to balance your own working capital?

Sure. The primary driver of the free cash flow guidance of the year of reduction. It was not unlike, as you listen to my comments on our third-quarter cash flow year to date, where there was a significant working capital impact, particularly in inventory build in third quarter compared to the prior year. As Mark mentioned, this really accelerated from Thanksgiving on. At that point in time we had a fair amount of product on order or in manufacture at our own plants. And we can turn on a dime on that output. Therefore we had not had time to react to our level of inventory.

Adding to that, obviously, we need to collect cash in the quarter so only through the sales of the first half of Q4 even generate meaningful cash flow during the quarter and during the full fiscal year. We would expect as we head into FY18, while we're not currently providing guidance, we would expect to be able to address a number of those issues. In particular as I mentioned during my remarks, we have reduced our orders of finished goods and for those finished goods we sell. We are also reducing the output of our own manufactured products across both segments to address the inventory balance. We would expect that to work it's -- while Mark mentioned the inventory retail channels would be the back half of the year before we could work that out. A lot of our own inventory challenges we would expect to fix certainly by the end of the first half of FY18.

Okay. Thanks.

And just given the environment are you guys still looking for M&A or do you put that on the back burner for now?

Yes. I would say that M&A is not our priority now. Our priority is focused internally on margin improvement, cash generation improvement, driving innovation so it can drive revenue, and doing the kind of things we know how to do to take market share in down markets or up markets. Our priority is going to be looking internally to drive execution improvement and improve our financials, including the cash flows discussions Stephen just had with you about managing our facilities and our supply chain, and ensuring next year we have good solid cash generation here; we feel good about that. We can't guide to that yet but we will when we can. We're going to be working heavily on those things. We will not turn a blind eye to M&A opportunities but I will tell you it's not our priority.

Okay. Thanks.

Just a last couple ones. Any incremental cost to enact those margin enhancements and if you could update us on the discussion with Orbital Lake City? Thanks so much.

Let me take the first one and Stephen can take the update on Orbital Lake City.

In terms of costs associated with our own internal inventory reductions, largely this will be really pulling back our order quantities in the supply chain and reducing order quantities which we are giving to our vendors on a lot of source product so there's no additional cost here.

Working through our factories, we have been working overtime in many of our factories. We obviously will be pulling back off the overtime as we go forward, it will not longer be necessary; that's cost savings actually by not having to pay time and a half in overtime. As we work through our overhead, as we work through other things there may be some additional costs here and there but it is not going to be a material driver. We will be able to do this very efficiently.

Stephen do you want to talk about OA?

Sure in terms -- as we mentioned before we are actively engaged in the discussion with Orbital ATK about future of long terms flag agreement. Those discussion are ongoing. Under that agreement there is a couple month negotiation period spelled out in that agreement. We are in the middle of that agreement. There is nothing to report at this stage, when and if there is we will certainly announce it.

Jim Chartier, Monness, Crespi, Hardt, & Co

Good morning. Thanks for taking my questions.

First can you talk about raw material costs for the ammunition business? How are they trending for you and then with overall kind of prices or cost going up what is your ability to raise prices in an environment where demand is a little softer than it has been historically?

Sure. That is something that we have managed successfully for many years. As we've told in the past, how we go about this is we exercise a process of looking at our manufacturing schedules and what our demand planning for our factories is going to be for consumption of raw materials, which are generally for us, heavily focused on lead and zinc. Those are the elements of brass and lead in bullets. Copper, zinc, and lead our three primary metals which drive our commodities as we buy those for brass and as we buy those for lead cores in our projectiles.

Our process is we are always buying well ahead of demand based on percentage of demand. Based upon what we believe the market is going. We have been locking in favorable pricing on materials and we've been locking that in for various periods of time. Out ahead of us depending on whether it is zinc, copper, or lead. And then going forward, of course, we as we do with the market we have been one of the leaders in using recycled metals and materials. We began the process of using recycled lead in our projectile manufacturing many years ago. And we led the market and we led the industry in thinking about recycled lead at a much lower cost. We've been pretty good at this over the years and we will stay very focused on this, Jim, as we go forward.

Of course if the commodity markets all continue to rise you cannot beat the market forever but we have demonstrated in the past the ability to get certain segments of our ammunition capability even in flat markets where some pricing opportunities there. We are going to be very focused on not dropping price, as we've said many times. We are not the low price leader, we want to be the low cost leader. You will not see us chasing price down or significantly reducing price. We have lots of other levers we can pull to make our products more attractive in the retail environment. But we are cautious about this. We are watching that market and commodities very closely.

Great.

Then, you talked about the impact of some larger retail bankruptcies over the last year. With the market for guns and ammo looking soft going forward, what is your outlook for the smaller independent gun shops that have popped up over the last few years? How would bankruptcies or closings there impact your business?

This will occur largely as you described, if you are looking at the dealer network, I think there will be some challenges potentially for small dealers. Whenever you have a period of time like we've experienced where you have eight years plenty and demand is outpacing supply and you have hot category firearms which have been very interesting to consumers like the AR platforms and concealed carry handguns; that has allowed not only retailers and dealers, it has allowed manufacturers to come into this market. Many small mom/pop manufacturers that have entered this market as well as small mom/pop dealers which have entered this market to take advantage of the favorable market conditions for almost a decade.

My experience has been that they will be -- they will find themselves under significant pressure, and many of them will not have the balance sheets and the cash flow and the wherewithal to remain in business. I think not only on the dealer side, small dealers, but also small manufactures if, depending on the length of this correction that we are in and depending on where the bottom of the trough is and where it settles out, my personal expectation is it will heavily pressure small manufacturers, both of ammunition and of firearms, and some of the newer smaller dealers. We will be working through that process to try and ensure that our dealer network is healthy, we have great relationships with functional wholesalers and with bigroups who service these independent dealers. We had very good meetings with those suppliers of independent dealers at the SHOT Show.

We believe we are a premier supplier of choice and I think as we have said in the past, what you will see typically in a market like this is you'll see import products on the ammunition side begin to decline first, then you'll see the small mom and pop domestic manufacturers supply to the market begin to decline; and our goal will be to pick up all that market share and get a larger piece of what could be a smaller pie. I don't know of anything right now which would cause material impact from the company from the scenario you laid out and in some cases we may benefit from smaller manufacturers which actually have to exit and we will pursue and take that shelf space.

Grant Jordan, Wells Fargo

Great. Thanks for taking my question.

Most of mine have been answered, but just thinking about cash flow and use of cash over the next year. How are you thinking about your balance sheet? Do you want to keep that leverage in the 3 to 3.5 times ratio you've talked about in the past?

Sure. Certainly our objective as we've talked before, our goal was during good times and to keep that leverage ratio under three and recognizing that we are in a consumer profits market, which is by it's nature cyclical, as we know there is always the opportunity for cycles to recur and we're currently in one of those cycles, we certainly will be very judicious in our use of cash over the next twelve months. We will be very careful, as Mark mentioned, our priorities for cash flow deployment and value accretion over the next twelve months. A lot of it is focused on actions we can take internally. We will work to reduce working capital, we will work to improve efficiency and gain market shares, markets that -- it's difficult to guide to an exact leverage basis when I have not given a cash flow guidance for next year, but we certainly do not intend to let our leverage ratio to grow excessively.

Okay. Thank you very much.

You're welcome.

Greg Konrad, Jefferies

Just one quick follow up, in terms of ammunition capacity expansion, when is the first off ramp decision and where do you stand in that investment program today?

That's a great question, Greg. In fact I'm actually glad you came back around and asked that, I think that's an important question for our investors and for the analysts here today. Let me just back up a minute here and lay the foundation of this question a little bit.

We announced that we were going to pursue a CapEx investment of up to roughly $100 million over the next several years to address bottlenecks in production, where we knew that if we could address those bottlenecks we actually would have additional capacity we could sell, and that also a large portion of this capital was ensuring that we could be a low cost leader across our categories of ammunition from shot shell, to pistol, to rifle. We are very much still focused on that. We are only in tranche one.

The off ramp in terms of what we might do in tranche two is right now, we are looking at those decisions right now of what we may do with tranche two. The other thing I would tell you is the reconfiguring of capital is an ongoing analysis for us or where we should be investing to reduce bottlenecks and reduce costs and improve our ability to compete and win. So this is not a -- even though we did this in tranches which allowed us to ensure we were not committing to the full $100 million of CapEx and that those tranches have windows, meaning that we are getting into the second tranche window right now for that decision, we also have a lot of flexibility in terms of how we applied this CapEx across our manufacturing facilities across the various components of our ammunition basis.

We are doing this very deliberately and very consciously and we will be making decisions in terms of CapEx spending which we will share with you when we do guidance. We will talk more about the cash flow and what we will be doing on CapEx next year, but we are in the throes of those decisions now. We believe very strongly that what we have done already in tranche one is critical and necessary for the long term competitive position of the business and to drive our cost down and to drive these positions of being able to be low cost leader.

We're very happy with how tranche one has progressed. The team has one a great job executing tranche one so far. We will be reviewing tranche two and then we will talk to you more about CapEx in general.

Greg, I would like to add that you should review the tranches as being synonymous with the years, and tranche one -- there are certain expenditures of the tranche one, which are in year two of the plan. But also, you should be aware that tranche one, as we mentioned this several quarters ago, tranche one is really focused on a couple of types of ammunition which are still fairing strongly even today. We do still do see some opportunity from tranche one, and as Mark mentioned, is also very flexible capacity. If that demand were to change from that, we can certainly reconfigure those lines, but also they won't reduce our average cost for those calibers and types of ammunition.

We'll be receiving our first benefits from tranche one investments in the back half of FY18. Those begin to materialize and will allow us to have the ability to capture additional revenue and market share.

Thank you.

You bet.

[Bill Ledley], Cowen and Company

Thanks, guys for getting me in for a second question.

I wanted to follow up on that question. Do you guys believe you can make the same rounds yourself that you source from Orbit ATK if you were to invest in a second tranche of CapEx?

Well the rounds that are manufactured by Orbital ATK are very well understood. Those same rounds are manufactured by Florida Induce who make a mill speck product and can be manufactured by us as well. There is nothing unique necessarily about the configurations of the ammunition manufactured by Lake City but we've had a very productive relationship with them over the years. They have access capacity which we have helped them get onto the commercial market in a win-win situation. It seems like it's a good opportunity for both companies going forward. In the event we couldn't get that supply from Lake City, certainly we could make those products and we would have to make certain investments to do that. But there is nothing unique about the rounds we purchased from Lake City in terms of an inability to make those elsewhere.

You think they just have a cost advantage then?

Yes, I don't think we can get into that. I think those are questions you would have to ask [away] about their own cost over whether they are think they're competitive in the market or not. The fact that we've been able to have a productive relationship with them is what we are really focused on just seeing if that relationship can continue to be a win-win for both companies. I wouldn't want to talk about their structures or where they are in terms of being cost competitive or not.

Okay. No problem. Thanks, guys.

Thank you. We thank you all for joining us. I think that was our last question. We look forward to talking to you again as we wrap up this fiscal year and will be able to give you guidance on FY18 when we do our next earnings call. Thank you very much.

Ladies and gentlemen that does conclude today's conference. Thank you all for your participation. You may now disconnect.