Smith & Wesson Holding's CEO Discusses Q3 2014 Results - Earnings Call Transcript

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Smith & Wesson Holding Corp (NASDAQ:SWHC)

Q3 2014 Earnings Conference Call

March 04, 2014 05:00 PM ET

Executives

Liz Sharp - VP of IR

James Debney - President and CEO

Jeff Buchanan - CFO

Analyst

Cai Von Rumohr - Cowen & Company

Scott Stember - Sidoti & Company, LLC

Brian Ruttenbur - CRT Capital Group LLC

Ronald Bookbinder - The Benchmark Company

Chris Krueger - Lake Street Capital Markets

Rob Bennett - Dougherty & Company

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2014 Smith & Wesson Holding Earnings Conference Call. My name is Philip, and I will be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Liz Sharp, Vice President of Investor Relations. Please proceed.

Liz Sharp

Thank you, and good afternoon. Our comments today may contain predictions, estimates and other forward-looking statements. Our use of words like anticipate, project, estimate, expect, intend, believe and other similar expressions is intended to identify those forward-looking statements. Forward-looking statements also include statements regarding capital spending, revenue, earnings per share, growth rate, and fully diluted weighted-average share count for future periods, our product development initiatives, objectives and strategies; market demand for our products and growth opportunities and trends.

Our forward-looking statements represent our current judgment about the future, and they are subject to various risks and uncertainties. Risk factors and other considerations that could cause our actual results to be materially different are described in our securities filings, including our Forms 8-K, 10-K and 10-Q. You can find those documents, as well as a replay of this call, on our website at smith-wesson.com. Today’s call contains time-sensitive information that is accurate only as of this time, and we assume no obligation to update any forward-looking statements contained herein. Our actual results could differ materially from our statements today.

A few important items to note with regard to our comments on today’s call. First, we reference non-GAAP free cash flow and adjusted EBITDAS on this call. Note that the reconciliations of free cash flow and estimated GAAP income from continuing operations to estimated non-GAAP adjusted EBITDAS can be found in today’s 8-K filing, as well as today’s earnings press release, which are posted to our website. Also, when we reference EPS, we are always referencing diluted EPS.

Finally, please note that this call references only our continuing operations. For the results of our discontinued operations, please refer to our 10-Q for the period ended January 31, 2014, which files this afternoon.

I will now turn the call over to James Debney, our President and CEO.

James Debney

Thank you, Liz. Good afternoon, and thanks for joining us. With me on today’s call is Jeff Buchanan, our Chief Financial Officer. Later in the call, Jeff will provide a recap of our financial performance, as well as our fourth quarter outlook.

Our performance for the third quarter of fiscal 2014 reflected the ongoing successful execution of our growth strategy which is to take market share with our MMP polymer pistols. We maintained our focus on that strategy in the quarter and thereby delivered handgun revenue growth of nearly 30%. This was a very favorable result when we consider the year ago period included a peak in consumer demand. Our financial results were highlighted by our delivery of double-digit growth in net income and the ongoing expansion of our gross margins, all while we continued to drive a number of initiatives designed to strengthen our business and return increased value to our stockholders.

Now, let me provide some of the highlights from the third quarter. Overall, our sales grew 7.1% versus the year ago quarter with our Walther products our sales grew 16.7%. We delivered gross margin of 40.2% more than 3.5 point higher than last year, robust gross margin helped us to exceed the high end of our third quarter EPS guidance by helped second incremental operational expense. We continued to see channel inventory remain low for our M&P SHIELD, our M&P15 sport rifles, our SDVE polymer pistols, our 1911 and all above revolvers. We continued working throughout the quarter to build channel inventory of these popular products. We attended multiple distributor shows as well as the SHOT Show, our industry’s largest tradeshow where we announced the number of new products. These included several revolvers under our Performance Center brand as well as pistols and revolvers under our M&P and Smith & Wesson brands. All were very well received and generated orders at the distributor shows in January.

We remained on track with the conversion of our Houlton operation to a precision machining center. An initiative we announced last quarter that reflects our focus on advanced efficiencies. We continue to invest in our new ERP system, which also remains on track and will allow us to more effectively scale our business in the future and advance our performance. We are clearly past the largest hurdles of this important project and are beginning to experience its significant benefits. Lastly, we continue to focus on returning value to our stockholders with the purchase of 1.1 million shares of our stock.

With that, I’ll ask Jeff to review the financial results.

Jeff Buchanan

James, thank you. Revenue for the third quarter was $145.9 million, which was up 7.1% over the prior year. Excluding Walther, revenue in the quarter grew by 16.7% and handgun revenue grew by 29.9%. We are pleased that gross margins continue to expand and meet/exceed our long term targets. In fact this is our third quarter in a row with gross margins in excess of 40% and gross margins for the first nine months were 41.5%. The gross margin improvements have primarily resulted from a favorable product mix, reduced promotions and the end of the Walther agreement.

In the quarter operating expenses were $27.5 million or 18.9% of revenue versus last year’s $21.9 million or 16.1% of revenue. This increase is largely attributable to cost relating to our ERP conversion. Operating margin in the third quarter was 21.3% compared to 20.6% in the prior year. Net income in Q3 was $20.1 million or an EPS of $0.35. This compares with EPS in the year ago quarter of $0.26 or a 34.6% increase.

Non-GAAP adjusted EBITDAS in Q3 was $37.5 million compared with $33.3 million in the year-ago period. Non-GAAP adjusted EBITDAS for the first nine months was $129.5 million, an increase of $28 million over the prior year. In the third quarter, operating cash flow was $29.6 million. Capital spending was $10.2 million, and deposits on machinery and equipment were $11.7 million, resulting in free cash flow of $7.6 million. As noted before we continue to extend capital at a higher than normal rate in fiscal ’14 for the capacity increases and infrastructure improvements. And we estimate that total capital spending in fiscal ’14 will approximate $60 million.

Now turning to the balance sheet, we ended the quarter with $45.3 million in cash, no borrowings on our line and $100 million of outstanding senior notes. Our inventory increased by $17.6 million as compared with the prior year, primarily in finished goods and finished parts. As a reminder, last year was a peak period in demand and inventories were exhausted across the supply chain. Since then inventories have been mostly replenished and we’ve been working to further build inventory levels so the portion of our sales are directed big box retailers and buying groups we also need to maintain finished goods inventory over and to be able to be flexible and responsive to those retail customers.

During the third quarter, we bought back 1.1 million shares of our common stock for $15 million. We’re completing the latest stock buyback authorization. Since December 2012, we have repurchased 12.2 million shares of our common stock at an average share price of approximately $11 or a total stock buyback of $135 million and a reduction in float of nearly 19%. As a side note, our senior notes restrict us from repurchasing any more of our shares until our next fiscal year.

With that, I will turn the call back over to James for discussion of our operational results.

James Debney

Thank you, Jeff. As I’ve stated earlier, firearm sales break with positive and excluding Walther, our total firearm unit sales into the domestic consumer channel increased nearly 16% for the third quarter. This compares favorably to adjusted NICS for the same period, which decreased by 32%, that’s we’ll all know. Lastly year’s NICS numbers were extraordinarily high, the negative year-over-year comps to be expected and we expect further negative comps until April or May of this year. Despite the decline, we believe it is clear that over the longer term the market continues to expand.

In terms of dollars, total sales into our domestic consumer channel in the third quarter grew about 20% while sales into our professional channel declined about 6%. We implemented several targeted price increases in the month of January, a notable action given that we’re no longer operating in a surge environment and a testament to the strength of both our brand and our product portfolio. We attended a number of annual distributor show in January with very favorable results in terms of orders quality and quality. Total order placed by independent dealers and distributors was not as high as last year showed a significant a increase over 2012. We continue to work closely with our distributors to make their orders are in accurate reflection of their needs. In fact, we regularly encourage our distributors to review those orders and to cancel them where they do not see demand. We believe our distributors done an excellent job working with this to achieve our objective.

With regard to channel inventories, we have a maximum threshold but we don’t like to exceed in terms of weeks of cover. We analyze six weeks of lagging distributor sales and inventory data in order to calculate that number. And ideally we prefer to have no more than eight weeks of cover in the channel. Our analysis at the end of the quarter three indicated that overall we were below that eight weeks threshold, so during the fourth quarter we will focus on better balancing products categories in the channel.

Turning now to new products, new SHIELD has remained strong driver of the market growth. We keep this in mind along with the current trends of personal protection of any kind. As we continue to populate our robust new product pipeline, we look forward to launching some notable new products in the coming year with the particular on the extending and strengthening our successful M&P brand. That said I’ll talk about now about our most recent new product launches. As I’ve mentioned earlier, we attended SHOT show in January. We will launch the number of exciting products and notable line extensions among them we’re number of high end performance center we’ve always.

We have observed an increase in orders for all our revolvers and our nearly introduced models were extremely well received. In fact, you will find them featured in a very detailed cover editorial in this month’s Guns & Ammo magazine which has a print circulation of over 400,000. That article also reviewed on new M&P BODYGUARD 380, a subcompact pistol enhanced with M&P style features. At the SHOT show, we also unveil several new finishes for our popular M&P15-22 rifles old/new camouflage design that’s refresh the offering what believe is the number selling rimfire modern sporting rifle in the United Sates.

All of these editions to the M&P platform served to further raise brand awareness and excite the consumer. We also announced at SHOT that in the near future, we will begin shipping California-complaint version of our M&P SHIELD and SDVE polymer pistols. This is significant because these firearms were proved in California just prior to the effected date of the micro-stamping requirement. As a result, they will be grant further and available for sale as long as we make no changes to those versions.

In contrast, most other pistols are some of those manufactures as well will fall off the California Roster overtime and will no longer be legal for sale by independent firearm dealer. We believe this creates a long-term opportunity for M&P SHIELD and SDVE polymer pistols in fact we expect sales revenues from these products will outweigh any lost revenue from our other pistols that will fall off the California Roster. It is also important to remember that neither revolvers nor rifles are subject to micro-stamping and to be clear we will not adopt the micro-stamping process in the manufacturing of our pistol products.

We continue to spur our product offering and retail with targeted promotion design to create pull from the consumer. This is especially the case of products that are facing interim headwinds for example because 22 ammo can be hard to consumers to find, we recently came up with CCI started ATK Security and Sporting Group to provide the consumer with 300 rounds of rimfire ammo, three with each new M&P15-22 they purchase.

While the ever expanding M&P polymer pistol family remains our strategic focus to growth and we believe we continue to take share with those products. Our investment in tooling in provide significant manufacturing flexibility that’s allowed us to leverage our existing and strong product portfolio for sale unmet needs in the market. As a result, we have grown by adding flexible capacity which allows us to quickly adapt our business to deliver what the market is demanding. One example of this can be seen in our M&P15 Sport rifle. When we observe the consumers were migrating towards lower price modern sporting rifles in retail, we were able to respond quickly by ramping up our production of the Sport. Today, we believe the Sport is the number one selling modern sporting rifle in the marketplace. In fact, we believe this single skew in our portfolio is larger than several other meaningful brand combined in terms of units. This flexible manufacturing has allowed us to respond the same in other major product categories.

For example, we have recently tuned our production to increase our volumes of M&P SHIELD pistols. M&P Bodyguard 380s, and most notably small frame revolvers, which have recently been in significant demand. We applied this flexible approach to our investments in base manufacturing capacity as well. As reflected in the deposit for machinery that Jeff referenced earlier. Basically, we have placed deposits with our equipment vendors on very long lead time equipment. This allows us to more effectively plan new product launches and respond quickly should consumer demand suddenly shift in a new market opportunity arise.

As you know, last quarter we announced the conversion of our Houlton manufacturing facility to a state-of-the-art precision machining center. The operations team has done an excellent job, and we have so far successfully moved all the Houlton’s assembly operations into the Springfield facility. We are on track to complete the project this fall. This action is designed to support our future growth while enhancing efficiencies, reducing manufacturing cost and lowering overall operational risk.

The reconfiguration of Houlton is one example of our plan to preserve and enhance gross margins. We believe that other opportunities exist as well, particularly in the area of vertical integration. And here I am referencing opportunities to further integration or acquire technologies and/or prices that we currently purchase externally, which would be core to our firearm business and of course accretive to our earnings.

In conclusions we continue to believe that our industry is in the midst of an underlying long-term growth trend, and our objective is to grow faster than the market. We will do this by continuing to; invest in marketing initiatives that communicate directly with the consumer and raise product and brand awareness; bring to market innovative new products that meet the needs, wants and desires of a growing and diverse base of responsible firearm users; add flexible capacity both internally and externally, particularly seeking vertical integration opportunities to maintain or improve gross margins; and improve the processes we use to operate our business and distribute our products in the marketplace. All of these initiatives are designed to support our primary goal of taking market share from our competitors with the M&P polymer pistol family while still leveraging our high value product portfolio, especially revolvers, the historic roots of the Smith & Wesson brand.

And with that I will ask Jeff to provide our financial outlook.

Jeff Buchanan

Thanks James. We estimate that our fourth quarter revenue will be between $159 million and $164 million, and we anticipate fourth quarter EPS of between $0.37 and $0.40. For the full year we are raising our fiscal ’14 guidance. We now estimate that revenues will be between $615 million and $620 million and EPS will be between $1.39 and $1.42. Excluding Walther revenue in fiscal ’13, achieving the midpoint of this guidance, we view that annual growth rate of over 12%.

The Q4 estimate is based on our current fully diluted share count of 56.5 million shares, and for the year it is based on a fully diluted weighted average share count of 60.9 million shares. Our tax rate is stable at 36%. James?

James Debney

Thanks Jeff. Operator, I’d like to open up the call for questions from our analysts please.

Question-and-Answer Session

Operator

Of course (Operator Instructions) And your first question comes from the line of Reed Anderson from Northland Capital Markets. Please proceed.

Unidentified Analyst

Hi guys its Stan on for Reed. Good quarter.

James Debney

Thank you.

Unidentified Analyst

Should we expect any changes to your product cast going forward this year and do you expect to sustain margins around these levels going forward?

James Debney

Sorry, I missed the first part of your question. Could you repeat the whole thing?

Unidentified Analyst

Yes. Just wondering if we should expect any changes to your product cast going forward this year and if you expect to sustain margins around these levels.

James Debney

I mean obviously we don’t really comment and necessary that level of detail we’ve built everything into guidance. Jeff, I’ll let you.

Jeff Buchanan

Right. I’m sorry I’m going to ask you one more time to second word. you are asking about our future products path do you think.

Unidentified Analyst

Just cost and margin.

Jeff Buchanan

Cost, product cost, okay. No, again we don’t comment specifically on our margins going forward. We give a top-line and bottom-line and some OpEx like color and let you basically fill in the dots.

Unidentified Analyst

Okay, thanks. And then also wondering when you expect to see ammo shortages and rimfire rifle begin to alleviate and if you are seeing any impact from other types of ammo?

Jeff Buchanan

That’s a great question which you nearly answered to that I mean obviously overall ammo is still pretty much in tight supply though some calibers have fright up, some other such as 22 rimfire, as I referenced earlier in the prepared remarks have not and that have caused some headwinds in the business which is the same way we felt plant to address. So, very difficult to tell and speculation on when ammo supply may improve. The good thing is we know there are many more new shooters who are enjoying the sport and therefore there are many more ranges as well and therefore there is much more ammo being shot than ever before. So, certainly a nice problem to have for the ammo manufacturers as they try and deal with this increased demand that can cause a few headwinds to us but none that we are really too concerned about.

Unidentified Analyst

Okay, thank you very much. And then one quick question, any updates on military or law enforcement orders that might be meaningful or were meaningful in the quarter?

Jeff Buchanan

On the military side, we were pleased and excited to attend the first industry day that went well but it’s a long process, so we have to be cautious there. We await the scheduling of the second industry day, so finally seems to be some movement which is good but of course it will depend on budgets and funding in the future. So, again it’s speculation but very well positioned with the M&P polymer pistol. It gets a lot of traction in the military in terms of people talking about it. It’s certainly highly regarded, tested and proven as we can demonstrate in law enforcement, some great wins there with the Los Angeles Sheriff Department. And we will always have more news in the future about major wins when it comes to law enforcement,

But coming back to the military, again it’s just a question of timing but we have an eye on it in excess of 400,000 units quite easily. And it would be obviously an honor and privilege for Smith & Wesson to serve the military with a side arm and it was our great marketing talk for us when it comes to the consumer.

Operator

Your next question comes from the line of Cai Von Rumohr from Cowen & Company. Please proceed.

Cai Von Rumohr - Cowen & Company

So, James, on the third quarter call you mentioned modern sporting rifles were being impacted by shortage of ammo as well as some softness in the market. Could you give us some color on kind of the tone of demand right now for MSRs?

James Debney

Talking obviously within the quarter, what we were saying and we will break it into centerfire and rimfire, so in terms of centerfire with regard to ammo 223/556 supply is pretty good to be honest. We don’t really see a headwind there. What you are saying is what we described that migration to lower price points. So, as you think back to the period a year ago which we referred to as a surge whenever I speak consumer demand. Modern sporting rifle sale extremely well in that market environment and you can set me so, up and down your price hierarchy of products from the most expensive to the lowest priced. What you see in this environment that we are in now is a more normal environment and there’s definitely been a migration down that pricing hierarchy and that’s why the M&P15 Sport which is ideally positioned us so well here.

It is really one of the rifles at the lowest retail price and it’s a high quality baron, little if no compromise it, certainly in quality there is no compromises, each of them benefit mostly compared to other rifles. So, that’s why I made those comments earlier on. Switching to rimfire, very different situation when it comes to ammo, extremely short supplied. We heard stories from dealers once they get a batch of 22 ammo, they can immediately start selling the M&P 15/22 again because it’s the number one we believe and it’s the number one in terms if share. It’s the most popular one out there with the consumer. But when that ammo supply dries up that product becomes tough to sale again and hence why we did our promotion in terms of the free 22 ammo really, really trying to support those independent firearms retailer and really, really trying to get the attention of the consumer because it’s a pretty good value package.

Cai Von Rumohr - Cowen & Company

About what percent of your MSR sales of rimfire approximately?

James Debney

Never broken out I know it’s unhelpful but we have never broken it out, so we can’t really give any color.

Cai Von Rumohr - Cowen & Company

Okay, and then you know your competitor Wilbur have their distributor inventories more than doubled in their fourth quarter and still were about 7.5 tons. Could you comment how much of your sales in this quarter were sales that ended up in increase in distributor inventories roughly?

James Debney

Again, I mean we don’t give any details there, other than what I said in the prepared remarks, you know we probably said we look at distributor inventory very-very closely, because last time when you see this inflated inventories out there that as we described today we have an eight-week threshold, that we don’t want to achieve and that’s eight weeks of cover, we calculated using writing sales data and average inventory and sell-on for a period of six weeks. So it is constantly revolving and we recalculate in every week. And so that means we are always looking to fine tune our inventory keeping a very close eye on it because we don’t want a huge amount of inventory between us and the consumer. That’s not healthy for anybody. So that’s why we maintain such a strict focus on that.

Cai Von Rumohr - Cowen & Company

And then this is a housekeeping issue, Jeff if you could tell us, fourth-quarter approximately what should the tax rate be, and what you look forward for at trends for your operating expenses, I know you’d indicated the ERP expenses likely would be down but sort of where do we look for tax rate and the other Op expenses?

Jeff Buchanan

On the tax rate, in the fourth quarter will be 36%. The operating expenses will be roughly in the same neighborhood as they were in this quarter. We continue to spend like money on our ERP conversion. Once you put in the base then there are additional things that you want to add. So we’re going to be at this higher run rate for a while at OpEx.

Cai Von Rumohr - Cowen & Company

Okay, I guess I’m a little confused because normally, I doubt your market sales and marketing expenses come down in the fourth quarter and even if the SAP expenses are flat with the third, unless the G&A goes up I would think the only way -- because normally your gross margin should be better in the fourth quarter. So I guess I don’t see if you get a flat while the earnings didn’t --

Jeff Buchanan

Actually the NRA show this year is in the fourth quarter. These shows kind of move around and also in the fourth quarter we have a half year convention on depreciation, so like depreciation jumps up in the fourth quarter.

Operator

Your next question comes from the line of Scott Stember with Sidoti & Company; please proceed.

Scott Stember - Sidoti & Company, LLC

Could you guys just talk about, in the quarter you really did a great job of outperforming the niche data which you said was down 32% in the quarter. Can you talk about how you did, we know how you did in the 30% increase in adjusted handgun sales, how did long gun sales to in the quarter?

James Debney

Long gun sales overall in the quarter was down about, just over 9%, Jeff?

Jeff Buchanan

Yes, it went from, I presume we’re talking sequentially or?

Scott Stember - Sidoti & Company, LLC

Year-over-year?

Jeff Buchanan

Year-over-year, yes, it was down about $5 million from $37.4 million down to $33.9 million. That’s down a little over 9%.

Scott Stember - Sidoti & Company, LLC

And just to help us frame out, this really eye-propping outperformance in the quarter versus the industry? Where there any new products that shipped ahead of the shot show on the handgun side for it was just market share gains across the board, in all your products?

Jeff Buchanan

No. No new products that we are shipping ahead of the shows because the only two ways to utilize the show is that the way to effectively launch those types of products because that’s media attention, you can be possibly get that to use your marketing dollars for show. So and then really comes down to a growth in handguns, you know and so on obviously we’ve said and we’ve been clear about it. You know there has been some product categories where inventory is being replenished but we’re also signed, we look at inventory very closely over time, and we are looking to find G&A and make sure it stays in balance.

Scott Stember - Sidoti & Company, LLC

And just looking at capacity, I think last quarter you guys had said that you were close to capacity on handguns and not so much so on long guns. Is that still the case in this quarter?

James Debney

Well, what we called out we said we use modern sporting rifles as an example saying that we were no longer add capacity i.e. we were not capacity constrained in that product category. Okay. But as we said repeatedly really the last two earnings calls is M&P SHIELD, Bodyguard 380, 1911s revolvers various very low inventory in the channel. So that’s why we’ve got to work hard to address the balance. Particularly small frame revolvers at the moment are in high demand, really alongside SHIELD.

Scott Stember - Sidoti & Company, LLC

Got you, and then on the inventory front. That eight-week threshold are we pretty much is it relatively even across the board and most of your categories or are there some areas that I think you said in the call that some of your new models some of the M&Ps are still at high demand and short supply?

James Debney

Yes, it’s the balance, right, in terms of across all the product categories now so to be clear we had some that we think are slightly too high so we’re looking to address those and that’s why I say we’re looking to rebalance so there is some that we know are slightly too high so we got to bring those back under the eight week threshold with some that so far away from the eight week threshold we worry that we’re just not getting distribution of retail and the M&P SHIELD and the small frame revolver are just great examples or that.

If we don’t get the inventory up we cost service to customer, we can’t get the product license and accounts to our retail and when the consumer comes into a store to buy our firearm they’re frustrated because they can’t find it but they end up waiting we hope but there is always a risk they’ll buy somebody else’s brand. So that’s why we got to focus on increasing the inventory in those real high demand product categories.

Scott Stember - Sidoti & Company, LLC

Got you. And just last questions the ERP system I think last quarter third quarter or in the second quarter there was still some disruptions to sales. Were there any in the third quarter and could you just disclose with the amount of SG&A dollars was for the ERP system?

James Debney

Yes. No, there was no disruption to add all I don’t think we called out the SAP cost basically what we said is most of the or a large portion of the increase over the comparable quarter of a year ago kind of related to SAP.

Operator

And your next question comes from the line of Brian Ruttenbur from CRT Capital. Please proceed.

Brian Ruttenbur - CRT Capital Group LLC

Okay. So a couple of quick questions on plans for expansion first of all. Can you talk about since you’re talking about the M&P, the small frame revolver everything couple of things, excuse me, are in very high demand. Are you going to have to build new factory space, add additional equipment, what are your plans going forward?

James Debney

It’s really the same as we’ve been demonstrating for 10 quarters now. M&P pistol family remains core to our growth strategy that’s our focus that’s really where we’ve been looking to add incremental capacity but at the same time we’re not ignoring the rest of the product portfolio which weighs to higher value and too important. So how we go about not ignoring it is to buy more tooling than we have equipment, okay that allows us to be extremely flexible.

So using small frame revolvers as an example so when we see demand continue demand increasing for that product we can flex our capacity to meet that demand. And obviously there is a lot of analysis by our marketing team about whether that’s the right thing to do and a lot of financial analysis about what will the impact be on our financial fulfillments before we make those decisions. So we’re very strategic about how we flex our capacity.

Brian Ruttenbur - CRT Capital Group LLC

Very good, plans another just two housekeeping questions I have one more question, plans for share repurchases in the fourth quarter it sounds like there is not much but I just want to make sure.

James Debney

Yes. Actually we’re not, our bonds and covenants we’ve maxed out for this fiscal year so we wouldn’t start again until May.

Brian Ruttenbur - CRT Capital Group LLC

Okay. And then ERP expenses in the fourth quarter, approximately, do you have any additional ongoing ERP?

James Debney

Yes, we haven’t specified but I said earlier we’re going to be at the same run rate in Q4 at the OpEx level as we are in Q3 and the significant portion of that is related to SAP.

Brian Ruttenbur - CRT Capital Group LLC

And does it end in Q4 are we going to carry over to next fiscal year?

James Debney

We haven’t given a forecast for next year but I am not category -- we're not by categorizing these as one-time expenses, I do believe that the expenses in SAP will come down but there is a lot going on when you want to add -- we’re beginning to see the benefit of SAP a lot, and there is a lot more things we can add and we want to add those additional things, and so we’re going to in doing these additions it is isn’t an implementation that causes all kinds of problems, it’s just now adding this module with that module.

So overall I think we’ll give view next quarter obviously of fiscal on ‘15, but we’re sort of at this run-rate right now.

Brian Ruttenbur - CRT Capital Group LLC

Thank you. Last question, you talked about what is your leading product and that’s the M&P the small frame revolvers. The lagers I assume are your MSRs or there is something else on the long gun side, there’s got to be something on the long gun side given that’s where your weakness is? Can you point out what that is?

James Debney

Yeah I mean, if it’s all back to as Jeff said I think it was the earnings call before this when I said we’re not capacity constrained in modern sporting rifles anymore. As I said it’s one of product that’s generally in very, very demand in a surge environment, longer in a surge environment. We’ve also had as you think about our hunting businesses incredibly small as well. As we look at both of those, make up the long gun category we see significant opportunities going forward.

Operator

And your next question comes from the line of Ronald Bookbinder with Benchmark Company. Please proceed.

Ronald Bookbinder - The Benchmark Company

Good evening and congratulations also. The shift to revolvers, are you taking market share in revolvers or is it a new sort of growing segment of the market, and what are the drivers behind the growth?

James Debney

That’s a very good question. And though we have somewhat struggled internally with as well, it appears that many more first time buyers in the marketplace, when I say buying obviously buying their first fire arm, and there is no doubt an attraction as we said before to buy a pistol over a revolver, we’ll go through that in some detail in our investor presentation, about some of the considerations that a consumer will make as they go through the purchasing prices.

It appears that after they gain some experience and this is a belief of ours and somewhat speculating as well. After they have made their first purchase enjoyed the pistol in shooting that, they then have the tendency to migrate towards looking at a revolver for the first time, even though they discounted at the beginning. And as we know from research people buying multiple fire arms, and I have been said before survey by National Shooting Sports Foundation 10,500 respondent all handgun owners are 10% probably first time buyers very likely, 90% the balance that are just under nine pretty impressive numbers.

So we know that people go and consider buying strongly consider buying multiple fire arms, and it appears that the revolver is getting much stronger consideration than ever before. For us that’s great, I mean Smith & Wesson the essence of our brand is a revolver, so we’re ideally placed to leverage our existing product portfolio add to it, as we did in new product launches. So the revolvers that we launched pretty spectacular and I’d recommend everybody grab a copy of Guns & Ammo and read that article, you will be impressed.

Ronald Bookbinder - The Benchmark Company

So you mentioned about the first time fire arm buyer that this could be the second item that they pick up. Does that study give any sort of timeframe as to how long it typically takes a person to pick up that second, third fourth items?

James Debney

No it doesn’t sadly, but I think it’s closely related to the disposable income. As we know these are not in a significant dollar purchases. But we know that the consumer can considers carefully before making such a purchase in a normal environment. So we don’t have any more tell on that that we can talk about. I am just referencing publicly available research such as National Shooting Sports Foundation. We obviously do our own research but again we’re helpful and we don’t disclose.

Ronald Bookbinder - The Benchmark Company

You mentioned earlier that people moving down in price points, are you seeing any increase in the promotional environment from your competitors, obviously you’re not promoting you’re actually raising price you said. But are you seeing any sort of increase in the promotional environment?

James Debney

Just to be clear on the price increases, we have targeted certain product categories, so it wasn’t across the whole product portfolio. Going back to your comment about promotional activity, you have heard a flavor of one of our on the M&P 1522, certainly we’re seeing I would say more consumer rebate out there that some of the other manufacturers are struggling and lagging with their sales we believe, so that’s for us in a way we like to see that because that’s how the consumer rebate activity that’s how the promotional activity only droves them to retail, get them through the doors, get them through the counter. And as you know, we spent a significant amount of timing communicating with both, the consumer and the sale associate so we get both sides of the counter. And we know the lot of sale purchases we trend on lot of our firearms will also have connect where we have rewards programs so a lot of now are enrolled and participating and connect as well, so we’re getting in the forefront of the mind of both the consumer and the sales associate and we think that’s the winning formula.

Ronald Bookbinder - The Benchmark Company

Okay and on the gross margin albeit approximate 350 basis points increase overall last year, can you breakout or at least give us color as to how much was it just been ex-Walther and how much was driven by mix shift towards polymer pistols?

James Debney

Actually, we lay that out specifically and the cue that we just filed, I can read it, 2.6 on percentage points out of the 3.06 was improved mix basically because we’re selling more polymer pistols and that offsets the lower margin products such as Walther. We also increased 1.6 percentage point basically the balance because of improved manufacturing efficiency and absorption.

Ronald Bookbinder - The Benchmark Company

Okay. And days of manufacturing I think you had your full 57 days in Q3 and we still expect 63 in Q4 and should we back to 238 days for 2015?

James Debney

Yes. Again, I want to emphasize what I’ve mentioned last quarter which is the days of the manufacturing are not as important now that’s some of our products are not out to on capacity, but you’re exactly right on the days 57 we had in Q3 and 64 in Q4 and we artificially had on seven days basically six or seven days taken out of Q2. So, yes, we’re back up to 239 I think in ’15.

Ronald Bookbinder - The Benchmark Company

And lastly, is there any manufacturer by you were pretty emphatic that you’re not working with adopting micro-stamping in California? Is there any manufacturer that’s working with California on this?

James Debney

We don’t believe that. We strongly hope not. That is not something that the consumer wants. And I would also say that not only are they - it’s almost impossible to do because the technology doesn’t work, so even if somebody wanted to which we think nobody wants to, it would be hard it’s not impossible to do. It doesn’t work.

Jeff Buchanan

Plus it’s easily defeated as well.

Operator

Your next question comes from the line of Rob Bennett from Dougherty & Company. Please proceed.

Rob Bennett - Dougherty & Company

Just a couple of questions. First of all, obviously, the industry is going through some difficult contrary now just curious to know what do you think the top line growth is possible in FY15?

James Debney

We come back to what we’ve said before and we’re not interesting in growing or shrinking with the size of the market we’re about taking shares and that’s our focus. As you know, M&P polymer in the pistol family has demonstrated quite obviously that it’s capable of taking share lot of hard work by great marketing, sales and operation teams to make that happen. And just continued with the plan, I mean that’s just capital execution of our great strategy. I believe that we can continue to take that share and also believe in other categories as well. The M&P polymer pistol family will remain our focus. Why? It’s by far the biggest addressable market and we still have eyes on pretty serious and large competitors that we believe we can take share from.

Rob Bennett - Dougherty & Company

Great thanks. And then in January, Illinois became the law changer where you can conceal carry (Ph). Curious if you had any uptick in the state?

James Debney

That’s a little early because I know a lot of permit applications are being processed at the momentum. I think those are little of bottleneck. I think they’re experiencing somewhat what Wisconsin experienced. But in a matter of months, you can expect that to free up and then for sure there will be a consumer pull from that state.

Operator

(Operator Instructions) And your next question comes from the line of Chris Krueger from Lake Street Capital markets, please proceed.

Chris Krueger - Lake Street Capital Markets

One just quick question following up the last couple of guys, you’ve been pretty clear on what’s going on in California and how you’re dealing with that. Are there any other lingering states out there with similar types of laws or things about to take effect or anything we need to be aware of, might concern you right now.

James Debney

Actually Maryland has a kind of springing smart gun law that it passed back in 2002 that says if smart guns are available that’s the only thing that you can…

Jeff Buchanan

New Jersey the other.

James Debney

There’s New Jersey, but of course in the states that have issues are the lowest nick (Ph) states and we don’t like sell a lot into Maryland and New Jersey and the states that like New York, if anything there’s a continued like movement to try to take back some of what they’ve done. So basically right now the California micro stamping is the only thing that is really out there.

Jeff Buchanan

And again these are the same states that have always been restricted, you know they’ve, there’s nothing new in terms of having other firearms manufacturer having to navigate whatever changes in legislation there are, you know, and so we will always follow the letter of the law, there’s no doubt about that and we’ll always be very closely on a state by state basis what is happening. And I think you know as you say we clearly explained on California, there could be other changes in the future we monitor very closely.

Chris Krueger - Lake Street Capital Markets

Okay, one more question, with the flexible production capacity, can we assume that all the new products you announced at SHOT Show immediately available.

Jeff Buchanan

Yes, absolutely.

James Debney

Its launch criteria, the inventory is available, depending on the magnitude of the launch.

Operator

And we have a follow up question from Cai Von Rumohr from Cowen and Company, please proceed.

Cai Von Rumohr - Cowen & Company

Yes, so thanks so much. So looking at the fourth quarter, if your op expenses are flat with the third, the only way you do $0.40 or less is if the gross margin doesn’t really improve that much and historically, actually if it’s down versus the third quarter and historically it’s always been better, you’re projecting is it $13 million, $14 million sequential increase in sales so you even if the gross margin is close to the third you’re going to do more than $0.40 if your op expenses are flat, so what am I missing here. Is there a concern about the gross margin or is that a number that offers some upside.

Jeff Buchanan

I don’t think there’s any concern about the gross margin, I mean we have said in the past that we expect the gross margin for the full year to be above 40%, the gross margin can change from quarter to quarter based on mix issues, James did state that the customers are moving to a lower price point on products which you can, sort of assume, I generally have lower gross margins but I’ll let you make all the calculations but I don’t think we have any concerns on gross margins.

Cai Von Rumohr - Cowen & Company

Okay, and then do you know, in the quarter your consignment deposits increased $14 million, what is that for and what kind of obligations does that place on the person making the deposit.

Jeff Buchanan

Well, most of it relates to those pool machines that James had referenced. So we, a lot of these, I’m…James you want to talk about that?

James Debney

Yes, sure, happens to everybody, I mean, Cai it’s really about you know just getting ahead of the curve, not having to experience these long lead times for this type of technology which is basically the CNC metal cutting machines. So that as we launch a new product we know the equipment’s in the pipeline, you know, we see the market expand you know the equipment’s in the pipeline, readily available to us that in essence is there. So that we’re not, we’re not hung up waiting for an asset to be deployed in the plant or one of the plants to be then producing products for us.

Jeff Buchanan

And Cai with respect to your question regarding the long term obligation these products are in high demand like everywhere in the United States, so if we decide that we don’t want to use one of these, these products it’s unused, it's a new product and it's easy to sell that product elsewhere.

James Debney

Yes, Jeff makes a great point, these assets roll in high demand in other industries. Obviously cutting metal is pretty popular in lots of industries, lots of peoples manufacturing processes. So there's no obligation even for us to take the equipment.

Operator

Ladies and gentlemen, that concludes the question and answer portion of today's call. I would now like to turn the call back over to James Debney for closing remarks.

James Debney

Thank you. And I want to thank the entire Smith & Wesson team for doing a great job and maintaining their focus on delivering results. Before we close, we have just a few events to mention. We were pleased to participate in the U.S. Army's industry day for the Modular Handgun System in December and we look forward to the second industry day, which as I said earlier has not been scheduled. On the investor front we will be at the Deutsche Bank 2014 Consumer Day Conference in Boston tomorrow and the Northland Capital Markets 2014 Growth Conference in New York on March 12th. Hopefully we'll see some of you there at these events. Thanks again for joining us and we look forward to speaking with you next quarter. Thank you operator.

Operator

You're very welcome. Ladies and gentlemen, that concludes today's conference. Thank you all for your participation and you may all now disconnect. Have a wonderful day.

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