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Smith & Wesson Holding Corporation (NASDAQ:SWHC)

Q3 2009 Earnings Call

March 12, 2009 5:00 pm ET

Executives

Elizabeth Sharp – Vice President, Investor Relations

Michael Golden – President, Chief Executive Officer

William Spengler – Executive Vice President, Chief Financial Officer

Analysts

Eric Wold – Merriman, Curran Ford

Reed Anderson – D.A. Davidson

Chris Krueger – Northland Securities

Grant Govertsen – Deutsche Bank

Rommel Dionisio – Wedbush Morgan

Mark for Cai von Rumohr – Cowan & Company

Operator

Welcome to the third quarter 2009 Smith & Wesson Holding Corporation earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Miss Liz Sharp, Vice President of Investor Relations.

Elizabeth Sharp

Good afternoon. Before we begin the formal part of our presentation, let me tell you that what we're about to say as well as any questions we may answer could contain predictions, estimates and other forward-looking statements. Our use of words like project, estimate, forecast and other similar expressions is intended to identify those forward-looking statements.

Any forward-looking statements that we might make represent our current judgment on what the future holds. As such, such 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 F-3, 10-K and 10-Q. I encourage you to review those documents.

A replay of this call can be found on our website later today at www.smith-wesson.com. This conference contains time sensitive information that is accurate only as of the time hereof. If any portion of this presentation is rebroadcast, retransmitted or redistributed at a later date, we will not be reviewing or updating the material content herein. Our actual results could differ materially from these statements.

The speakers on today's call are Mike Golden, President and CEO and Bill Spengler, Executive Vice President and Chief Financial Officer. And with that, I'll turn it over to Mike.

Michael Golden

Thanks everyone for joining us. Today I am pleased to report very positive results for our third fiscal quarter. Despite ongoing weaknesses in the overall economy, we maintained solid focus on our strategy to grow our business in the sporting goods and professional channels, and we launched some significant new products.

At the same time, we capitalized on recent very strong demand for our pistols, revolvers and tactical rifles. We delivered solid profits and we made significant progress toward bolstering our balance sheet while reducing our inventories and strengthening our cash position.

There's a lot to cover so let me take you through some of the details of our progress. Our hand gun and tactical rifle categories continued to deliver increasingly positive results across the board in the third quarter. We are benefiting from the current increased demand for these products in the sporting good marketplace.

But I also want to point out that even without the recent demand strength, these product lines have in fact been delivering growth consistently over the past several quarters. Overall, hand gun sales increased 45% on a year over year basis. That growth reflects not just the recent hike in demand we are seeing in the sporting good market, but it also reflects continued demand for M&P pistols in the law enforcement sales channel.

Let's talk about each of those for a minute. In law enforcement, the M&P continues to win at a rate of over 80% in agencies where we compete. To date, our M&P pistols have been selected or approved for carry by 489 law enforcement agencies. Among wins in this category during the third quarter was the Raleigh, North Carolina Police Department which selected the M&P and placed an order for over 900 pistols.

And important point I want to make here is that wins in law enforcement are valuable not only in their own right, but they are also strategically important. This is because the sporting goods market often follows the law enforcement market and wins in law enforcement enhance our credibility with the Defense Department.

With that, let me address the sporting good market. As I explained before, background check data or mixed data from the FBI is one of the data points that we monitor each month to track consumer purchasing trends. The reported number of background checks remained strong throughout our third quarter, and January background checks showed 32% growth year over year.

In addition, I know you've all seen the numerous media reports over the past several weeks that highlight the exceptionally strong purchases of hand guns and tactical rifles that retailers are experiencing. This trend in consumer purchases certainly fueled our strong performance in the quarter.

Smith & Wesson branded pistols were up 47% led by sales of M&P pistols which were up 77% in the quarter. In addition, Walther pistols grew nearly 50%, revolvers were up 45% and tactical rifles grew over 111%.

Moreover, our backlog increased dramatically by the end of the third quarter. In fact, our total backlog reached $123 million by the end of the quarter which is $95 million higher than the same quarter a year ago.

I'd like to point out this extraordinary increase in backlog is directly related to the increase in consumer demand that we have experienced in the past several months. Our backlog numbers always represent product that has been ordered but not yet shipped, so those orders can still be cancelled. Therefore, it is possible that portions of the $123 million in backlog could be cancelled if demand should suddenly drop.

This is an especially important point to make give the very recent stress in the consumer demand that we are seeing. As I indicated, favorable sales results in the third quarter were not confined to pistols and revolver. It also occurred in the tactical rifle category.

Our M&P tactical rifles continue to gain popularity both with law enforcement and with consumers. To date, over 213 domestic law enforcement agencies have either selected or approved for duty our M&P 15 tactical rifles. Consumer demand remains extremely strong and that demand fueled the bulk of our sales growth in tactical rifles during the quarter.

In addition, we received a very favorable response to the launch of our new M&P 15-22 semi automatic sport rifle at the January Shot show. This new product has been designed along the exacting lines of our standard M&P 15 and offers all the preferred features M&P 15 family, but it uses a much more economical 22 caliber ammunition.

Distributors and retailers at the Shot show were very enthusiastic and we believe consumer will find this to be a much more affordable option for the shooting sports. We also received positive feedback on this product from law enforcement personnel who indicated that they will use it for training, again, because of the lower cost of ammunition. The M&P 15-22 is shipping later this year.

Also at Shot we introduced our M&P 4. This is our first fully automatic capable tactical rifle and has been designed exclusively for purchases by law enforcement and military organizations. In addition to its availability for law enforcement this summer, the M&P 4 serves as a platform we will use to address future military rifle opportunities.

Now let me switch gears and move to the hunting side of our business. When we talk about hunting products, I am addressing primarily the hunting rifles that are made in our Rochester facility along with sales of hunting related accessories.

This portion of our business consists largely of what we consider to be high end discretionary products, and it therefore continues to suffer in the current economic environment. Sales of hunting firearms were down nearly 46% in the third quarter year over year. Despite the situation, we believe the hunting rifle business holds exciting potential, and we took steps this quarter designed to bolster both our short and long term position in that market.

First, we continue to focus on removing costs from this side of our business including a work force reduction and a furlough in the quarter. Second, in January, we introduced the Thompson Center Venture bolt action rifle. This is a new hunting rifle that carries the well regarded Thompson Center brand name and product quality, but it does so at a lower price point that will reach an entirely new, higher volume portion of the hunting rifle market compared to the traditional Thompson Center rifles.

Our success with the i-Con rifle demonstrated that the Thompson Center brand is uniquely positioned to deliver a broader portfolio of high quality hunting products at various price points.

New product introductions like the Venture will effectively expand our addressable market. Moreover, we believe that we can perform with acceptable profit margins in each of these categories. We are excited about the Thompson Center Venture and I'm sure you'll be reading more about it in the months to come.

As I outlined for you last quarter, our decision to maintain the Rochester, New Hampshire facility was important for several reasons. First, despite short term economic concerns, the market for hunting rifles in a healthy economy is a sizable one. We are well positioned to address this.

Second, our Rochester facility produces barrels for our tactical rifles which are clearly in very high consumer and law enforcement demand right now. Lastly, our Rochester facility provides expertise that helps to define Smith & Wesson as a firearms manufacturer with a full portfolio of products and capabilities.

That is an important distinction as we compete for future potential business with the U.S. military and the Federal Government.

Now, lastly, let me give you a brief update on opportunities with the U.S. military. On the small arms, the U.S. Army contracts for the M4 Carbine which they currently purchase exclusively from Colt, expires in June of 2009. We have been told that the Army has decided to update the requirements for that rifle and at some point in the future they plan to pursue an open competition.

We were one of several companies invited to attend the Army Industry Day in November of 2008, an event held to ensure the new requirement takes into account state of the art carbine technology. We demonstrated a prototype of our M&P 4 and we were pleased with the level of interest and responses received.

Note that the Army can continue to purchase their existing M4 from Colt beyond the expiration of exclusivity in June. While we expect the competition to begin later this calendar year, this is only our estimate. We are fully prepared no matter what the timing to submit our M&P 4 platform in the competition when it arrives.

With that, I'll turn the call over to Bill Spengler who will provide a financial overview for the quarter.

William Spengler

Total company sales for the third quarter were $83.2 million, a $17.1 million or approximately 27% increase over the three months ended January 31, 2008. Within that, sales of all firearms totaled $78.5 million an increase of $16.9 million or approximately 28% over the third quarter of last year. The balance of revenue, largely hand cuffs, and non firearms accessories totaled $4.7 million and grew by $182,000 or about 4%.

The results in the sales of our firearms reflected significant strength in our pistol, revolver and tactical rifle categories, offset by continued weakness in our hunting related categories. Hand gun sales totaled $61.9 million, an increase of 45% over the year ago quarter. Tactical rifle sales of $8.8 million represented an increase of 111% year over year, while hunting firearm revenue totaled $6.7 million a decrease of 46% on a year over year basis as Mike indicated.

One way to break down our performance in firearms is to look at sales of hunting related products as a single and separate category. In Q3, sales of all hunting related products which represented only 9.9% of our total firearms revenue in the quarter were $7.8 million, a decline of $6.8 million or 47% versus Q3 in fiscal year '08.

Sales of all other firearms, specifically handguns and tactical rifles were $70.7 million, a $23.8 million or 51% increase over the same quarter last fiscal year.

Gross profit for the third quarter was $21.6 million or 25.8% of revenue as compared with $16.6 million or 25% of revenue for the third quarter of fiscal '08. This represents an improvement of .8% in gross margin percentage from the year ago quarter and there were a number of different factors contributing to this net improvement.

Gross profit on our non hunting firearms was up approximately $10.9 million and corresponding margins on those products improved significantly providing approximately a 6% lift to the gross margin percentage for the total company.

Offsetting these gains in gross margin percentage was the $2 million charge for the PPK recall which erodes total company gross margin by approximately 2.5%. In addition, lower sales demand in the hunting market led to significantly lower production levels and caused lower fixed overhead absorption at our Rochester facility.

This reduced total company gross margin year on year by approximately $4.3 million and eroded the total company gross margin percentage by close to 3%.

I'll now move on to operating expense. Total operating expenses increased over the prior year by $699,000 or 4.3% in this third quarter. Over 60% of this net increase was related to costs associated with the Shot show, an event which occurred during the third fiscal quarter this year versus the fourth fiscal quarter last year. The remainder of the increase was driven by a combination of factors to include an increased profit sharing position, a broad based program deployed throughout most of the organization.

Growth in these portions of our operating expense base was offset by lower profession fees as well as the lower level of intangible amortization that resulted from the impairment charge which we took in October 2008.

As a result of the many elements discussed above, operating income was $4.6 million for the third quarter, and increase of $4.3 million over the essentially break even point of one year ago.

Other income totaled $308,000 in the third quarter as opposed to other expense of $729,000 last year. This current year amount is comprised almost entirely of a favorable non cash mark to market adjustment related to Euro foreign exchange contracts which we use to protect our purchases of inventory from Walther. It represents a reversal of a portion of the loss in other income that we recorded related to the same contracts in the second quarter.

Interest expense of $1.2 million decreased by $1.1 million compared with the year ago quarter. The pay off and retirement of our acquisition line of credit in the first quarter of fiscal '09 is now fully reading through in reduced interest expense.

In addition, cash flow from operating activities has enabled us to pay down our short term revolving line of credit during the quarter. At the same time, the interest rate on our revolver decreased by 275 basis points versus the comparable period last year. Total debt outstanding at the end of the third quarter was $87.6 million compared to $141.3 million in the same quarter a year ago. For reference, both of these numbers incorporate our $80 million worth of convertible debt.

Tax expense in the third quarter increased $2.3 million over the income tax benefit of $952,000 in the year ago quarter. This is due to the increase in operating profit in the current period and the fact that during the prior year we incurred a loss.

Net income for the third quarter of fiscal '09 was $2.4 million or $0.05 per fully diluted share compared with a net loss of $1.8 million or a loss of $0.04 per share in the prior year.

Now let me turn to the balance sheet. Accounts receivable decreased to $42 million versus $54 million at year end of fiscal '08 and versus $51 million in the preceding sequential quarter. This occurred despite the increase we discussed in revenue and results largely from a reduced need to provide dating terms, particularly in our hunting business.

Inventories were $46 million at the end of the third quarter, a $1.1 million improvement over last fiscal year end and a $7.8 million improvement over the second quarter of this fiscal year. This was clearly aided by the increased level of demand, but it was also helped by temporary shut downs at Rochester during the quarter and better inventory management in general.

Year to date capital expenditures at the end of the third quarter were $4.3 million compared to $10.8 million at the same point last year. We continue to anticipate spending a total of approximately $8 million on capital expenditures in fiscal '09 versus the $14 million spent in fiscal '08.

Major CapEx in this fiscal year remains focused on improving production facilities, new product offerings and various projects to selectively increase capacity and upgrade manufacturing technology.

Now turning to a look at cash flow and liquidity. One of the metrics that we now track is adjusted EBITDA or earning before interest, taxes, depreciation, amortization and stock based compensation expense.

This measure eliminates non cash and selected one time charges such as impairment or mark to market adjustments on currency. It also provides a basis for evaluating our cash generating capacity and the general liquidity or borrowing capacity of our business in the context of our bank covenants.

That said, adjusted EBITDA from the third quarter was $9.2 million compared to $3.7 million in the third quarter of fiscal '08. On a year to date basis, adjusted EBITDA was $26 million versus $28.5 million in the first nine months of the prior year. The presentation we have included in our earnings release shows in detail how this information has been developed.

We ended the third quarter with approximately $21 million of cash on our balance sheet without accessing our revolving line of credit. In addition, we recently obtained from TD Bank, an amendment to the revolver that expands the leverage ratio covenant from three to 3.5 beginning April 30, 2009 and throughout 2010 fiscal year with an addendum to the leverage ratio from 3.0 to 3.25 for fiscal 2011.

Again, we did not draw on this line in the third quarter, but the important affect of the amendment is to provide us with incremental borrowing capacity in the future if we should choose to access it.

Now let me conclude by spending a few moments on our near term outlook. As you know, our fiscal year ends on April 30 and we're about six weeks away from the conclusion of our fiscal 2009. At this point we feel confident that for fiscal '09 we will deliver full year revenue growth of between 9% and 10% on a total company basis.

In the non hunting portion of our business, we expect to continue to produce and ship at our full capacity throughout the balance of the fiscal year. Conversely, we are not experiencing any improvement in the weak demand for our hunting products.

As the economy continues to struggle, the discretionary dollars typically spent by consumers in this category tend to be spent on more essential items, and in addition, much of our Thompson Center business is focused on black powder rifles, a particularly discretionary spending category.

Looking forward at our gross profit margin percentage, we expect the final quarter of our fiscal year in the non hunting majority of our business will look pretty similar to the third quarter information just discussed absent the cost of the PPK recall. Looking at the hunting portion of our company, although there have been significant head count reductions in Rochester, this facility remains in transition and therefore the full benefit of actions taken will not read true until fiscal 2010 as we indicated to you on our last call.

Operating expenses should not vary materially through the end of this fiscal year, although there will be some growth in the profit sharing account.

Finally as it relates to cash flow, we will continue our focus to ensure that any draw on our revolving line of credit is minimal.

Last, let me move to a slight change in the way we will be reporting our backlog to you. Traditionally we have reported our backlog balance on both a total basis and then broken down for each of the major product categories. Effective with today's filing of the Q, we will continue reporting a total backlog for the company, but we will no longer report backlog levels for the individual product categories.

Backlog numbers for individual categories may well contain duplicated orders for distributors who may cancel those orders once any manufacturer fills their need, a potentiality which may be particularly true under our current market conditions.

In addition, we believe that our disclosure of this information may also put us at a disadvantage as we compete with privately held companies. That concludes my comments so I will now turn the call back over to Mike.

Michael Golden

Before I wrap up, I want to leave you with a few key points. This was a very exciting and dynamic time for the firearms industry. The sporting good market is generating a demand level that is remarkable, and that has allowed us to achieve very positive results. We will continue to serve this market and capitalize on those opportunities as they arise.

At the same time, we will do so with the realization that the sharp upswing in consumer demand has an unpredictable duration. We intend to make every effort to address that demand to the fullest extent possible. As we do so, we will remain focused on executing our long term strategy, one that has continued to deliver consistent, profitable growth over the years, and the one that will carry us successfully into the future.

We will plan our investments carefully, balancing near term opportunities with the need to build an infrastructure that is sustainable far beyond any short term movement in our served markets. We have a robust portfolio of products that addresses all of our key sales categories; sporting goods, law enforcement, federal government, military and international, and we continue to expand that portfolio to address broader portions of the markets we serve.

At the same time, we continue to seek out opportunities to diversify the company in both firearms and non firearms categories, and in all our efforts, we plan to continue to grow in the markets of safety, security, protection and sport.

I want to thank our employees for their contributions towards a great quarter. With that, I'd like to open up the call for questions from our analysts.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Wold – Merriman, Curran Ford.

Eric Wold – Merriman, Curran Ford

On the inventory, can you give a sense of the inventory you've got in hand now relative to where you're seeing the strength coming from either retail channel, distributor, what consumers are buying and where the demand is, what you've still stocked in inventory or are they totally different?

Michael Golden

It kind of varies by category. Certainly tactical rifles, all the way through the channel to hand them out. Us manufacturing, sell to distributors, and they're selling right out to retailers. I'm sure you see that when you do your channel checks.

Similar position on some categories within revolver, we're not giving specifics but in revolvers and within pistols.

Eric Wold – Merriman, Curran Ford

Your conversations with distributors and dealers out there, how much more visibility are you getting in terms of demand? I know they're kind of ordering as fast as they can as things sell through. Are they trying to order further out? Are they kind of trying to predict further out and maybe get a larger amount of orders? I guess you have to get around the backlog number, a huge increase versus last year and sequentially. Do you think a lot of that, how much of that do you think is demand versus maybe ordering kind of further in advance to get themselves in line.

Michael Golden

We get from our comp 10 distributors on a weekly basis, statistic by SKU on what their inventory is and what they've sold the previous week. Actually it comes in on a Monday and we get it for the week before. So we can see what they're sitting on as far as inventory and we also can see what's selling. So we can keep a pulse on the volume that's moving through the distributors out to retailers.

And you know, you've been in the same or similar stores as I have, it's gone right out the door. So we can keep a pretty close pulse on what is happening in retail sales through this weekly data that we get, and again, it's by SKU. I'm not sure if I answered your question.

Operator

Your next question comes from Reed Anderson – D.A. Davidson.

Reed Anderson – D.A. Davidson

Just kind of drilling through things looking at the product category, of the various products, revolvers is one of those things that sort of surprises us each time regardless of which direction. Why would that be up so much in the third quarter? Was there something going on? Was there something related to timing? Just any color on that category.

Michael Golden

I just read an article somewhere yesterday that people are buying firearms in many cases for personal protection. Crime is on the increase. The economy certainly has affect, you know people losing their jobs. So a lot of it I think, and this is Mike Golden's speculation on it, but I think it's tied to the overall quite honestly, global situation of terrorism and the economy. Small frame revolvers are hot, and it's for personal protection.

Reed Anderson – D.A. Davidson

So it's not really any timing of products of anything different you did, you've just seen really good demand across the board.

Michael Golden

Right. Another piece on that, in fact I talked to a dealer today, and this was anecdotal, but there's a feel that there's a fair amount of first time gun purchasers that are coming in again tied to concerns about the overall personal protection and the economy.

Reed Anderson – D.A. Davidson

In terms of tactical, I was curious about there. Again, great year over year growth, but it kind of looked like dollar wise what you did in 2Q and I'm just wondering, you talked about your capacity. I mean, are we at our capacity with tactical? Is that an issue why we don't see that number jump even more because the demand has been just insatiable for that product, or is that something that can go a lot higher, it just didn't in this quarter?

Michael Golden

It's capacity constrained. We're making some prudent investments to increase our capacity as quick as we can because quite honestly, I think the entire industry is in the same position on tactical rifles.

Reed Anderson – D.A. Davidson

But the implementation of those, we're going to be at this sort of level I would think for at least the next few quarters, does that make sense, or can you do it quicker than that?

Michael Golden

It's going to take a little bit of time.

Reed Anderson – D.A. Davidson

Gross margins, basically if you stripped out the recall piece, the $2 million, basically you had a gross margin north of 28% more or less.

William Spengler

That's exactly right.

Reed Anderson – D.A. Davidson

So as we think about that going forward, particularly the quarter we're in now, is that a reasonable level relative to where your business might be in the fourth quarter or is there something else in there? It sounded in your comments, not a lot is going to change so if we strip that out, we're kind of in the neighborhood in the near term for gross margins. Does that make sense?

William Spengler

That's almost verbatim what I was going to say. I talked a little bit about Rochester still being in transition and not reading through some of the head count because we're switching people's roles around and that kind of stuff so that reads through at 2010 not fourth quarter. But that's essentially, you can pretty much look at it absent the PPK recall cost.

Reed Anderson – D.A. Davidson

What was the dollar benefit you got by not having the intangible amortization because of the write down? What was that in the third quarter?

William Spengler

It's exactly $850,000 in the quarter.

Reed Anderson – D.A. Davidson

Thinking about you've got the Thompson Center Venture coming out, you've got obviously the tactical rifle too, but thinking bout the Thompson Center, that piece as it pertains to hunting, when I think back to when there were some difficulties in the last couple as it revolved around bringing out new hunting product, some of that was just timing. You had a lot of new products in the pipeline, didn't quite get out in front of maybe the season, etc. and so to the extent that you believe that's true, what are you doing as you roll out a new Thompson Center more hunting oriented product to make sure you're in front with that and make sure that these key retailers stock the product as opposed to last time when they maybe did or didn't?

Michael Golden

Actually, certain products did fairly well for us. One that I know, you helped us by buying one of your own, was an i-Con. In the first year, in the segment that it competes which is a fairly narrow segment, a $900.00 bolt action rifle, we believe we picked up about 11% market share in the first year.

The Venture for example will sell just under $600.00 we believe and it's off the same platform as the i-Con but it appeals to a very broad, more high volume, higher volume segment of the market place. It just makes the market bigger for us.

Reed Anderson – D.A. Davidson

Can you make a similar margin at that $500.00 to $600.00 price point?

Michael Golden

Comfortable margins on the product, and one thing, you'll relate to this because you're a hunter is that it has a guaranteed MOA and I believe I'm right when I say there's not another rifle that could claim that retail in that $500.00 range.

Operator

Your next question comes from Chris Krueger – Northland Securities.

Chris Krueger – Northland Securities

Can you repeat the backlog figures. I understand that those things can change depending on cancellations, but what was the total backlog at the end of the quarter?

William Spengler

The backlog was $123 million.

Chris Krueger – Northland Securities

And sequentially what was the most recent quarter?

William Spengler

About $22 million, something like that. Same last quarter last year was right around $22 million I think.

Chris Krueger – Northland Securities

You mentioned the military M4, what your outlook is there at the moment? Anything to talk about on the new pistol potential for a pistol change?

Michael Golden

Nothing really new. There's an awful lot of talk in the Pentagon on small arms, small arms in total, handguns and rifles. But the situation, we're still working that, and there still appears to be a fairly strong desire to shift from a nine to a 45. The rifle, because of the exclusivity expiring on the M4 kind of moved that to the forefront which is an interesting opportunity. We're pretty interested in it.

Chris Krueger – Northland Securities

All the new products you introduced at Shot show, you talked about on the call, the bone collector, the economy, the price economy tactical rifle and the others, have any of this hit stores yet or is that yet to come in the next couple of months?

Michael Golden

Some of them like the MP 1522, the 22 caliber I spoke of in the prepared remarks, they're not shipped. That's going to ship a little later in the year. The bone collector is shipping now. Venture will start to ship in April/May. So they're kind of spread through the year.

I think it's fair to say that none of the products that we showed at the end of January at the Shot show had an affect on this quarter that we're reporting.

Operator

Your next question comes from Grant Govertsen – Deutsche Bank.

Grant Govertsen – Deutsche Bank

Going back to the Venture here for a minutes, obviously we're two months post Shot show, and about a month or so before your releases to the public, can you share with us some of the color you've received from your customers on this? In other words, are you feeling even better about this than you were when we last spoke?

Michael Golden

I think the last time we spoke was when we shared with you at the Shot show and I was feeling pretty good about it then. What we've seen with our customers, meaning dealers, and when we saw that at the dealer shows and with consumers that the fact that it's a Thompson Center product that will retail in that price range and that has a guaranteed MOA has really caught people's attention.

So we're just starting to see orders roll in. People are starting to wrap their mind around the fall hunting season, but we're going to have a marketing plan behind it, some advertising behind it. We're optimistic on that product.

Grant Govertsen – Deutsche Bank

On your comments on OpEx looking, it sounded like sequentially during the fourth quarter, were you talking about an absolute basis or more of a percentage of revenue. Obviously we saw a little over 20% of revenues for OpEx this quarter which is the lowest we've seen in a couple of year. Is that kind of how you're looking going forward or more?

William Spengler

I was in that case not talking about a percent of revenue basis. I was talking about an absolute basis. I essentially outlined relatively flat, but I pointed to we have a very broadly based profit sharing provision that touches essentially every employee, or most all employees, and that will go up because of the improving profitability, but otherwise we don't see major variation quarter on quarter and that's on a dollar basis.

Operator

Your next question comes from Rommel Dionisio – Wedbush Morgan.

Rommel Dionisio – Wedbush Morgan

I have a question on long term gross margins. I remember about a year and a half ago your guidance for gross margins used to be in the 35% to 36% and now, granted hunting is not as profitable given the economic environment, but when you're talking about 32% gross margins on the rest of the core business, is that as hypothetically as good as it's ever going to get. Industry conditions are obviously very solid for those categories. Is there more that can be done longer term to get that number up closer to the 34% to 35% level?

Michael Golden

I think what we did in our investor pitch was something that I would reference, and we were really trying to look there at the longer term. As we think about our margins and we think about productivity gains we see out there for us and we think about the new product launches that are in our future, we did indicate in that pitch that we think our gross profit margin ought to reach in the outer years about a 35% level.

Rommel Dionisio – Wedbush Morgan

How do you get there, higher margin, new products? Because it seems like the industry environment is pretty solid and so is that the case then? Is there more that you can take out of the cost structure or better cost absorption as the sales grows or a combination of all of that?

Michael Golden

I think one of the things we've spoken about on the last two calls, is the drag that we've experienced on an interim basis in our hunting business, and as we indicated here, we've made some significant reduction in the head count at that facility. We've indicated that it hasn't read through yet in its entirety and won't, but we see that beginning to have a real effect in 2010.

I think that, and I do point to the new products and I would point to the fact that we have some very, very strong people in the manufacturing part of our organization with a lot of experience in taking costs out of facilities and bringing in a higher degree of efficiency in the way we operate the plants.

Operator

Your next question comes from Mark for Cai von Rumohr – Cowan & Company.

Mark for Cai von Rumohr – Cowan & Company

Just to circle back on capacity a little bit, can you talk about some of the other product lines pistols and revolvers, pretty impressive numbers in the quarter. Where do you see not specific guidance, but are those business lines, are they at capacity right now? Are those the number we're going to see going forward?

Michael Golden

In some cases, yes they are.

Mark for Cai von Rumohr – Cowan & Company

And what about with suppliers? Are suppliers are constraint in this market right now with the demand you've seen?

Michael Golden

Yes they are, specifically on tactical rifles. They're seeing the same demand as we're seeing so it does put a strain on the system.

Mark for Cai von Rumohr – Cowan & Company

For some more color on the market, can you break out international military, how it was year over year and also federal government?

Michael Golden

That's all in the Q that went out this afternoon. It's all broken out by channel.

Mark for Cai von Rumohr – Cowan & Company

How has credit impacted your distributors? Are they still running pretty lean inventories or has this market growth allowed them to get a little bit more credit and built up their inventories? What's your visibility on what they're holding?

Michael Golden

They're running pretty lean inventories on hand guns and tactical rifles because of the momentum in the market place so it's not a conscious decision on their part to slim down their inventories. It's selling through.

Mark for Cai von Rumohr – Cowan & Company

So credit hasn't been any kind of restraint at all.

Michael Golden

Think about it this way. You're a dealer. Your business is pretty good so you've got that. You're buying from distributors so you've got the cash to pay them so it's kind of flowing right through the system.

Operator

Your next question comes from Eric Wold – Merriman, Curran Ford.

Eric Wold – Merriman, Curran Ford

Thinking forward two things, one on the Obama stimulus plan, where do you think you are positioned to benefit from that in terms of either monies going toward the hiring, I know there's a billion dollars there as well as the $2.8 billion for other items, and if those funds start coming through for firearms versus for law enforcement and the demand, the funds have to be spent in a very short amount of time, would you have the capacity to fill those orders, or could it take away possible orders going into the consumer channel?

Michael Golden

I think there's a couple of things going on in the stimulus package. Certainly knowing there's several billion dollars that are put right to LE, which will keep jobs. It will give department's money to spend on equipment, keep jobs for law enforcement and in many cases add law enforcement officers to the street. All that means opportunities for business for us.

The other side of that is if the stimulus package does what it's supposed to do, it's going to create several million jobs and that puts income back to people's pockets which is good for our business certainly, but probably all consumer businesses. That's the whole idea of it.

So it's Mike Golden's opinion on it but I think that there are a couple of angles here that could impact our business.

Eric Wold – Merriman, Curran Ford

Any degree to where you think you would not have the capacity? Do you think you've got enough capacity going into next year I guess assuming optimistically you get a fair amount of that.

Michael Golden

We have to see what happens with it is what it really comes down to and we'd react accordingly.

Operator

Your next question comes from Reed Anderson – D.A. Davidson.

Reed Anderson – D.A. Davidson

I'm going to guess the answer is no to both of these, but is there any planned reductions in hours or people over the near term that would hit your capacity utilization and similarly any planned promotions out there. I'm suspecting both the answers are no but if you could just elaborate on that please.

Michael Golden

In the Smith & Wesson side, you can see what our backlog looks like so that probably gives you the answer to the first question. On the promotion side, we always do promotions. We heavied them up in the last couple of quarters ago, because of some of the inventory that was built up in the channel, but you'll see us promoting our product.

You'll see different types of things similar to what we were doing two years ago, and we'll also be promoting hunting products as we go into the hunting season.

Reed Anderson – D.A. Davidson

It sounds like in the hunting space even though the demand isn't there, the channel inventory you feel very comfortable with where those are today.

Michael Golden

I didn't say I feel very comfortable. What I will say is they're in much better shape that they were last year.

Thank you operator and thanks to all of you for joining us today. We'll see you and talk to you next quarter.

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Source: Smith & Wesson Holding Corporation Q3 2009 Earnings Call Transcript
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