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Smith & Wesson Holding Corporation (NASDAQ:SWHC)

F2Q08 (Qtr End 10/31/07) Earnings Call

December 06, 2007 5:00 am ET

Executives

Liz Sharp - VP of IR

Mike Golden - President and CEO

John Kelly - CFO and Treasurer

Analysts

Eric Wold - Merriman Curhan Ford & Company

Rommel Dionisio - Wedbush Morgan Securities

Chris Krueger - Northland Securities

Reed Anderson - DA Davidson

Amit Dayal - Rodman & Renshaw

James Maher - ThinkEquity Partners

Operator

Good day, ladies and gentlemen, and welcome to the secondquarter 2008 Smith & Wesson Holdings Corporation Earnings Call. (OperatorInstructions)

I would now like to turn the presentation over to your hostfor today's call, Ms. Liz Sharp, Vice President of Investor Relations. Pleaseproceed.

Liz Sharp

Thank you and good afternoon.

Before we begin the formal part of our presentation, let metell 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. Ouruse of words like project, estimate, forecast and other similar expressions isintended to identify those forward-looking statements. Any forward-lookingstatements that we might make represent our current judgment on what the futureholds. As such, such statements are subject to a variety of risks anduncertainties. Important risk factors and other considerations that could causeour actual results to be materially different are described in our securitiesfilings, including our Forms F-3, 10-K, and 10-Q. I encourage you to reviewthose documents.

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

Our speakers on today's call are Mike Golden, President andCEO; and John Kelly, Chief Financial Officer. With that, I'll turn it over toMike.

Mike Golden

Thank you, Liz, and thanks everyone for joining us.

Let me give you the agenda for today's call. First, I willshare my thoughts with you regarding our performance in the quarter, as well asour strategy and outlook for the future. Then, John will review our financialresults in more detail. After that, we will open up the call for questions fromour analysts. This is a change from our standard agenda. But, given the changesthat occur within our second quarter, I think it's appropriate.

Today's press release clearly laid out the issues thatimpacted our results in the consumer channel during the second quarter, and howthose issues are closing us to revise both our net sales and our earningsguidance for the balance of the year.

In summary, our environment changed abruptly late in aquarter, due to a number of factors. We responded immediately in October, byimplementing new consumer focus promotional programs, reducing our costs,adjusting our expectations for the fiscal year, and communicating with you, ourshareholders.

While these promotional programs are meeting with somesuccess, the environment has not improved to the degree that we had originallyexpected. In addition, recently released market data, which I will cover in a moment,has indicated that the industry-wide inventory overstock situation is much moreextreme than we estimated three weeks ago.

Today, we are providing you with our updated expectationsfor the current fiscal year. We will continue to respond as needed, until boththe consumer environment, and the industry-wide inventory overstock situation,have corrected. We believe that the current situation will not extend beyond ourcurrent fiscal year, which ends April 30th, 2008. Let me say upfront, that theinventory overstock issue is an industry situation, and we believe theinventory correction for Smith & Wesson is near its end.

What I'll like to do now, is walk you through our key saleschannels, and share with you some of the outstanding progress that has beenovershadowed by events in the consumer channel during the second quarter. I'llalso review with you our strategy for Smith & Wesson, and the reasons webelieve this strategy is solidly on track. We intend to continue to executethat strategy. In doing so, we will further diversify the revenue base of Smith& Wesson, globally, across multiple channels, within safety, security,protection and sport.

Let's begin with our consumer, or sporting good, channel.The second quarter was challenging for many companies in the consumer space, includingour own. Our challenges were compounded, however, with a strong pre-season,industry-wide inventory buildup in the consumer sales channel, coupled with anunusually warm hunting season, which serve to reduce hunting-related good trafficat the consumer level. That, in turn, intensifies the industry-wide inventoryoverstock situation.

As you might expect, our team has spent a lot of time overthe past few weeks analyzing the current situation. There are two key datapoints that best illustrate the firearms inventory buildup that occurred in themiddle of this year. Let me explain each one.

The first is the Federal Excise Tax data--or FET data. Thisinformation is issued quarterly by the Bureau of Alcohol, Tobacco and Firearms.And in mid-November, the numbers for the second calendar quarter of 2007 becameavailable to us. The FET number reflects the taxes charged on firearm salesinto distribution, and therefore, serve as an indicator of channel firearm purchases.

The second data is the Mix data, or the federal backgroundcheck data. Each time a consumer purchases a firearm, a federal background checkis run. The Mix data captures each of those background checks, and the numberis published by the National Shooting Sports Foundation. Mix data serves as anindicator of consumer firearms purchases.

Now, for calendar 2006--that's last year--the FET and theMix data points reveal that the both the sell-in to distribution, as well asthe sell-through at the consumer level, were about even. This is an industrythat historically grows at about GDP levels. Last year was a year in whichthere was no great disconnect between channel inventory levels and consumersales.

However, as we review the data for the first six months of2007, a vastly different picture emerges. Federal Excise Tax data shows ayear-over-year increase in sell-in by manufacturers to distribution of about26.4%, while Mix data indicate that sell-through at the consumer level for thesame six months period grew only about 5.2%.

Clearly, the industry was planning a robust year, whileconsumers were behaving otherwise. Again, we just received the April throughJune FET data in November. And now, we are able to fully analyze the market.That information and analysis demonstrated to us that there is a significantbuild-up in the channel. That explains how the current environment developed.

So, how do we respond? We have put plans in place to helptry greater demand at the consumer level, and pull some of the excess inventorythrough the channel. This whole method of stimulating demand is an approach webegan to use three years ago, to successfully drive sales of Smith & Wessonproducts.

It is a more beneficial approach to addressing the currentmarket environment, as opposed to simply discounting products to distributors,which only drives more products into an already crowded channel, and impactsfuture sales.

We have created 15 consumer-level programs, and multipledealer and distributor programs, that span Q3 and Q4. These programs provideeither mail-in rebates, or merchandized incentives, across a variety of therevolvers, pistols, rifles and shotguns.

We believe that creating demand at the consumer level willhelp reduce distributor and dealer inventories, while creating demand at thedistributor and dealer level will in return help reduce Smith & Wessoninventories.

We are not quite halfway through the third period yet. Whilethe initial feedback is positive, particularly with regard to handguns, it isalso clear the total industry-wide build-up in this channel over the course ofthe year has been substantial, and will take some time to clear out.

Our estimates for fiscal 2008 revenues and earnings that weprovided today, incorporate our estimation that the industry-wide overstocksituation will be corrected over the next few months. As John will explain in afew minutes, we expect our recovery to occur more quickly than that.

As you know, the acquisition of Thompson/Center Arms, inJanuary of 2007, was a key piece of our long-gun strategy. We continue to bevery pleased with the overall performance of Thompson/Center, which exceededour expectations during the second quarter.

Because of Thompson/Center, the ICON bolt-action rifle wasinitially launched at the SHOT show in early calendar 2007, that product wasavailable to dealers during the pre-season order cycle, and was, therefore,less impacted by the overstock situation.

Moreover, dealer and consumer feedback on the new ICON and Triumphmuzzleloader have been extremely positive. These products clearly live up tothe Thompson/Center reputation for quality in hunting firearms, and we believethey will play a role in our ability to gain market share in the future.

Our new Smith & Wesson long-gun--the i-Bolt bolt-actionrifle--and the 1000 series, and Elite Gold series of shotguns, began to arrivein the channel during our second quarter. While scheduled for a mid-season launch,the timing on these entries coincided with the unfavorable industry environmentthat evolved late in the quarter. As a result, dealers and distributors werereluctant to add to the already bloated firearms inventory, even with anexciting new product launch.

This situation, combined with the fact that these lines arestill ramping up, means that these products are not yet out in the marketplacein volume. As a result, it is still too early to report any substantialfeedback. As the industry works through existing inventories, shelf spacebecomes available and the 2008 hunting season approaches, we will update you onour progress.

But as I stated earlier, our strategy has not changed. Ourgoal is to become a significant player in this $1.1 billion market.

Now, let me take a minute and talk to you about ouraccomplishments in the law enforcement channel, where our military and policeline of tactical rifles and pistols continues to hit the mark.

Last year's second quarter results contained a particularlylarge order from the California Highway Patrol. Excluding that single order,law enforcement sales in the second quarter this year were up 28% on ayear-over-year basis.

During the quarter, we continued to win sizable agencies,such as the New Mexico State Police, the Charlotte,North Carolina Police; and the Syracuse, New York Police Department. Among law enforcementagencies where the M&P is considered for selection, we're continuing thewin T&Es at a win rate of over 80%.

This is happening because we have designed the M&P lineof products specifically for law enforcement and military professionals. Thenumber of law enforcement agencies that have purchased, or approved for carry, ourM&P pistol has now grown to 264. We will continue to expand on our M&Pline at the upcoming SHOT Show, and look forward to sharing some exciting neweditions with you, then.

On the federal government front, we continue to closelymonitor the landscape for signs of any RFP related to the military's stateddesire to shift from a 9 millimeter pistol to a 40-caliber or a 45-caliberpistol, for added stopping power.

Recent information indicates that we will see a new RFIearly in calendar 2008, followed by an RFP and evaluation process, later in2008. We will continue to monitor this situation and respond accordingly, butas we have stated, we intend to vigorously compete for any federal governmentopportunity that may arrive.

One extremely bright spot in the quarter, was ourperformance on the international front, with sales growth of 122%. Theinternational market is significant for several reasons; among them, the factthat most of our customers in this channel are military and law enforcementagencies.

In addition to extending the Smith & Wesson brand reachinto foreign countries, our international sales results deliver ongoing growthinto the professional ranks, a reflection of our overall growth strategy forthe future.

We are seeing M&P test evaluations get completed, andbusiness developing most recently in places like Mexico,Canada and Thailand. TheM&P pistol is now carried on duty by over 5,000 law enforcement personnel,in 13 countries outside the United States.

So that covers our major sales channel, and clearly, we'vegot a lot going on in each. While international law enforcement and federalchannels are either meeting, or exceeding all of our expectations, there is noovershadowing the astronomical growth, both organic and through acquisition,that we have consistently delivered over the past three years in our sportinggood channel. It is precisely this situation that fuels our growth strategy,and that strategy is to continue to expand our business in the new areas ofsafely, security, protection and sport.

The impact of the consumer channel during the second quartersimply underscores the fact that we must continue to seek out acquisitionopportunities that deliver global growth and diversification for Smith &Wesson into new non-consumer categories and the professional law enforcementsecurity and defense arenas.

Today, we filed an 8-K related to the expansion of ourcredit facility. Our cash flow forecast remains strong and the credit line isintended to serve as a resource that will allow our growth and diversificationto occur when opportunities arrive. Our acquisition selection process will berigorous, and as always, profitable growth and building shareholder value willbe our key objectives.

With that, I'll turn the call over to John to discuss thedetails of our financial results.

John Kelly

Thanks, Mike. Sales for the three months ended October 31,2007 were $70.8 million, a $20 million, or 39.4% increase, over sales of $50.8million for the three months ended October 31, 2006. Firearm sales, our corebusiness, increased by $18 million, or 37.8% over the comparable three monthsperiod in the prior year.

Net income of $2.9 million, or $0.07 per diluted share, forthe three months ended October 31, 2007 was equal to net income and dilutedearnings per share for the comparable period last year. Net income for thesecond quarter of fiscal 2008 reflects a 54.5% year-over-year increase inoperating expenses, combined with $1.7 million increase in interest expense,both attributable to the acquisition of Thompson/Center Arms in January 2007.

The increase in firearm sales in the quarter wasattributable to the addition of Thompson/Center Arms, which we acquired inJanuary 2007. Smith & Wesson firearmsales were down 10% for the second quarter of fiscal 2008.

Pistol sales for the three months ended October 31, 2007were $4.9 million lower to the comparable period in the prior year. Thedecrease is attributable to $6.2 million in shipments to Afghanistan and the California HighwayPatrol in the second quarter of last year, which did not recur in the second quarterof fiscal 2008. Sales in the M&P pistol grew at a rate of 54.2% for thesecond quarter of fiscal 2008, while revolver sales declined by approximately18% for the same period, reflecting the soft domestic consumer market.

Sales of short guns and i-Bolts were below expectations,largely because shipments of these products commenced in late September, whenmarket conditions were deteriorating and because distributors were reluctant totake on new products given their already inflated inventory levels.

Thompson/Center Arms product sales exceeded our expectations,primarily due to the preseason launch of the ICON and Triumph rifles, and thebenefit of a full season order cycle for those products, while the pistolproducts also enjoyed a strong quarter, with sales increasing 13% over the sameperiod last year.

Gross profit for the three months ended October 31 2007increased by approximately $7 million over the comparable period last year.Gross margin, as a percentage of sales and licensing, was 32.3%, compared with31.2% for the three months ended October 31, 2006. We experienced a typicalsequential decline in gross margin in the second quarter of fiscal 2008, due tothe impact of our annual two-week shutdown in August, and the resultingunabsorbed fixed costs.

Cost of goods sold for the three months ended October 31,2007 included $394,000 in costs for promotional programs launched in thequarter, as well as $302,000 in depreciation expense related to the significantcapital expenditures we incurred in fiscal 2007.

Operating expenses for the three months ended October 31,2007 were $16.5 million, a 54.5% increase over expenses of $10.7 million forthe comparable period last year. The increase in operating expenses includes$5.2 million for Thompson/Center Arms, which was acquired in January 2007. Theremaining increase is attributable to higher stock-based compensation expense,partially offset by a reduction in compensation and profit sharing expense.

Operating expenses as a percentage of sales and licensingwas 23.2% for the three months ended October 31 2007, compared with 20.8% forthe comparable period last year. Operating income for the quarter was $6.5million, or 9.2% of sales and licensing, compared with $5.3 million, or 10.4%of sales and licensing, for the comparable period last year.

Now, let's look at the six months results. Sales for the sixmonths ended October 31, 2007, were $145.2 million, a $46.8 million, or 47.6%,increase over sales of $98.4 million for the comparable period last year.Firearm sales, our core business, increased by $43 million, or 46.2%, over thecomparable six months ended in the previous year.

Net income of $7.6 million or $0.18 per diluted share, forthe six months ended October 31, 2007, was $1.4 million, or $0.03 per dilutedshare, higher than the $6.2 million, or $0.15 per diluted share, for the sixmonths ended October 31, 2006.

Gross profit for the six months ended October 31, 2007, of$50.3 million, increased by approximately $17.6 million over the six monthsended October 31, 2006. Gross margin as a percentage of sales and licensing was34.4%, compared with 32.9% for the six months ended October 31, 2006.

The increase in gross margin percentage is attributable tohigher standard margins on new products, and improved operating efficiency.Depreciation expense in the first half of fiscal 2008 was $554,000 higher thandepreciation expense for the comparable six months period last year.

Operating expenses for the six months ended October 31,2007, were $33.9 million, a $12.4 million, or 57.8%, increase over expenses of$21.5 million for the six months ended October 31, 2006. The increase inoperating expenses includes $10.1 million in operating expenses for Thompson/CenterArms, which we acquired in January 2007.

The remaining operating expenses is attributable to $1.7million in higher stock-based compensation expense, and $642,000 of higheradvertising and promotion expense.

Operating expenses as a percentage of sales and licensingwas 23.2% for the six months ended October 31, 2007, compared with 21.6% forthe comparable six-month period last year.

Operating income for the six months ended October 31, 2007,was $16.3 million, or 11.2%, of sales and licensing ,compared with $11.2million or 11.3%, of sales and licensing for the six months ended October 31,2006.

Capital expenditures for the six months ended October 31,2007, totaled $8.7 million, a $2.8 million increase, when compared with capitalexpenditure for the comparable six-month period last year. Capital expenditureswere related to the expansion of firearms production, and new product tooling.

Net cash outflow for the six months ended October 31, 2007,was approximately $15 million, compared with a cash outflow of $4.5 million inthe six months ended October 31, 2006. There was $11.5 million of short-termborrowings as of October 31, 2007, compared with $4.5 million at October 31.2006. Our current borrowings reflect the higher inventory level.

Now, for our outlook for fiscal 2008. Please note that ourguidance is based upon the results form the existing business. It does notinclude any additional revenue or profits from potential business ventures wemay pursue.

Net product sales for fiscal 2008 are now expected to beapproximately $300 million, an increase of 28% over fiscal 2007. Based upon onMix data, we believe that the firearms market will grow at approximately 5%rate in calendar 2007and 2008, in line with historical trends.

We have seen in the FET data that firearms shipments intothe channel in the first half of calendar 2007 were 26% higher than theprevious year. We believe that an approximate 20% inventory correction beganlate in the third quarter of calendar 2007, and will start to bringindustry-wide inventory levels back into line with market demand.

Smith & Wesson handgun ordershave improved, and retail point-of-sale information leads us to believe thatthe correction for Smith & Wesson is nearing its end.

Net income for the year endedApril 30, 2008 is now expected to be approximately $17 million, or $0.40 perdiluted share, a 33% increase in net income over fiscal 2007. This is adecrease of approximately $6.5 million or $0.13 per diluted share, frompervious forecast, reflecting our expected lower sales volume, as well as the costassociated with a three-week manufacturing shutdown we have scheduled for our Springfield facility thismonth.

Planned capital expenditure of$15.9 million represents a $1.8 million decrease from our previous projections,and reflects adjustments to spending based on our current profit projection.None of the delayed projects will impact fiscal 2009 volumes.

Depreciation and amortization expense is expected to beapproximately $12.5 million. Net cash flow is expected to be approximately $13million. We expect net sales for the third quarter of fiscal 2008 to increaseby approximately 5%-10% over net sales for the third quarter of fiscal 2007.

We anticipate the gross margin as a percentage of sales inlicensing in the third quarter fiscal 2008 to be approximately 26%, due tocosts associated with the three-week production shutdown at our Springfield facility inDecember, as well as increased cost for consumer-focused promotions, as well asreductions in operating production levels.

We have scheduled a full three-week production shutdown thismonth, rather than our typical one-week holiday shutdown, in order to help usbring inventory in line with desired levels. As a result, we anticipate netincome for the third quarter of fiscal 2008 to be breakeven.

We expect the industry-wide inventory overstock situation toprove in the fourth quarter of fiscal 2008, and therefore, expect net sales forthe quarter of 10%-15% over net sales of the fourth quarter of fiscal 2007. Weanticipate the gross margin as a percentage of sales and licensing in thefourth quarter of fiscal 2008 to improve to approximately 33%. We expect netincome for the fourth quarter of fiscal 2008 of approximately of $10 million,or $0.22 per diluted share

That concludes my financial discussions. I'll turn the callback over to Mike.

Mike Golden

Thank you, John. While the current environment has presentedus with some short-term challenges, I want to emphasize, today, that this in noway changes our long-term strategy. We will continue to respond aggressively tocreate demand at every level, and reduce costs in every corner, until theconsumer market is a healthier environment for us. And we will continue to stayfocused on the diversification and growth efforts that will grow our presencein safety, security, protection and sport.

With that operator, I would like to open up the call forquestions from our analysts.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Eric Wold. Pleaseproceed.

Eric Wold - MerrimanCurhan Ford & Company

Hi, good afternoon.

Mike Golden

Hi, Eric. How are you doing?

Eric Wold - MerrimanCurhan Ford & Company

Good. A couple of questions. I know you talked about how youare starting to see some improvements in your trends and you are optimisticthat you'll kind of get through this before the end of the fiscal year or bythe end of fiscal year, and so kind of will linger to next year.

Talk a little bit about what you're hearing from thedistributors and retailers during the situation in terms of what their thinkingis for next year. I mean, obviously, everyone is having issues right now. Butif the other manufactures are having more issues maybe don't come out asunscathed as you do, does this put you in a better situation going into nextyear with the distributor if they don't want to kind of repeat the samemistakes that happened this year?

Mike Golden

Well, let me try to answer in a couple of ways, Eric. Whatwe're hearing is that our promotions, specifically our handgun promotions areworking fairly well. And we have some experience of that, which is helping totake inventory down because there was a lot of Smith & Wesson inventory outthere at the beginning of the second half also.

And we're also seeing from a number of our distributorsdouble-digit increases out the door year-on-year of Smith & Wessonproducts, so dealers are pulling product out, which is another good indicationthat things are coming down. And the third thing is what John said is we'reseeing that reflected in our order rates in the first eight days of this month.This fiscal month has been significantly better than the last couple of months.So, many encouraging signs that we're seeing out there.

We don't believe that the inventory that is out in thechannel will carry on. A whole lot of that will carry into next season becauseof just the nature of the dealer base and the distribution base that we haveout there. We think that there will be some promoting of the product to move theproduct out. It probably won't all go away, but they're clearly gone into nextyear.

What we're hearing though from our all of our customers isthe promotions that were put in place that Smith & Wesson is reallycertainly on the forefront and the only manufacturer that is reacting to thesituation, which certainly will put us in good stead as we go into next year.We're selling programs into next year, the entire hunting program, but also onregular handguns. So we think the signs are looking pretty good.

John Kelly

Eric, just to give a little more color on that, the networkof dealers and distributors is not heavily capitalized and has liquidityconcerns. They can't afford to carry inventory for too long a period. Thedistributors were typically in a margin of 5% to 7%. So, carrying costs ofinventory become pretty critical on their profitability.

So I think you're going to see that come out, and I thinkit's going to be a situation where it's more been in the buying patterns. Welook at our top two distributors in the out of the door. For example, inOctober with them it was in the double-digits, and then our side, we're downsubstantially, one was down 44% in October in terms of year-over-year purchasesand the other was down 61%. If they're out of the door we're up 37% and 18%.

So they are correcting their inventories as we go here. Andso, it's going to be a situation where it doesn't necessarily whole have to bediscounted. It's going to be reduced purchases, which is what we saw in Octoberand significantly in November too.

Mike Golden

One other thing on that, Eric, it's a really good question,is the SHOT Show is the first weekend of February this year. At the SHOT Show,Smith & Wesson will launch 62 new items into the world, expanding our lineof hunting rifles and shotguns, handguns, Thompson product, I mean there is alot of stuff going on that's going a fuel the calendar year 2008.

Eric Wold - MerrimanCurhan Ford & Company

Okay. And then just last question then. You kind of playeddevil's advocate a little bit. If some of these other manufacturers are, aseveryone knows, kind of have a little capital constraint, not in the bestfinancial situation relative to Smith & Wesson, is there a chance that theykind of get spooked and really need to move inventory and generate any cashthey can and start discounting even heavier in the months to come and thesituation maybe gets a little bit worse or gets better?

Mike Golden

Well, if you take a look, as we said, we've already soldsome of that stuff going on. And we have taken that into account as we buildour estimate going forward. We think that we are close to the end of ouradjustment, but we are not reflecting that over the next couple of months. Youare going to see growth levels like we had been seeing prior to that until thestuff gets through the channel.

Eric Wold - MerrimanCurhan Ford & Company

I apologize, Mike. I mean less so on your side, more sort ofother manufacturers start giving even more aggressive rebates happening inchannels such that they attract consumers away from your products near term,because they are discounting it even more heavily?

John Kelly

Eric, we've kind of anticipated that into our forecast. Andthat is, I think Mike alluded to, we've scheduled promotions well into thisfourth quarter as well. So, we are not just building promotions or have notbuilt into our forecast promotions to move the inventory where we have doweledin some promotions along the lines that there is going to be some competitiveactivity that we need to respond to.

Eric Wold - MerrimanCurhan Ford & Company

Okay. That's perfect. Thank you, guys.

Mike Golden

Thanks, Eric.

Operator

Your next question comes from the line of Rommel Dionisio.Please proceed.

Rommel Dionisio -Wedbush Morgan Securities

Yes, good morning. Good afternoon, sir. Hi. I just want tospend a little time talking about the inventory, how big up was in the firstplace. As I look across categories, whether it's sporting goods or fitnessequipment or recreational vehicles, retails have been pretty conservative allyear long.

Did you get the sense if there was channel stocking on thepart of some competitors? It just is tough to believe that retails were thataggressive in thinking this would be phenomenal holiday season or huntingseason?

Mike Golden

I think 2006 for the industry was a good year. They enjoyedstrong levels. And I think going into the year, people anticipated 2007 wasgoing to be another good year for them. Extended handguns had a very good yearlast year and the sales into the channel were up 38% in the first half of thisyear, and long-guns were up 20%.

And I think what happened is when you look at the mix dataand you look at what happened in the third calendar quarter, there was anuptick in retail activity, where we started approaching the high single digits,low double digits in terms of increases in retail activity.

And I think that kind of encouraged them that they weregoing to see this kind of year. And then when they ran up against the softhunting season, it kind of started to come apart.

Rommel Dionisio -Wedbush Morgan Securities

Okay. Thanks very much.

Mike Golden

Thanks, Rommel.

Operator

Your next question comes from the line of Chris Krueger.Please proceed.

Chris Krueger - NorthlandSecurities

Hi. Good afternoon, guys.

Mike Golden

Hi, Chris, how are you doing?

Chris Krueger -Northland Securities

Good. Just a couple of quick questions. You indicated moresuccess on your efforts with domestic law enforcement continuing well over 80%of the T&Es that are out there. Can you remind us again just what the sizeof this market is as in number of departments that are out there?

Mike Golden

Yes, Chris. In United States,there are 17,000 police departments in United States, law enforcement agency in United States. A lot of them aresmall, but we have a long way to go, things like the state police like we justsaid the New Mexico State Police, the New Hampshire State Police that weannounced just recently.

State police, we think are a big deal, because a lot of tinydepartments in a state will do whatever the state police do. So they'll buywhatever the state will follow their lead. So that is when we win a statepolice department, we are pretty excited about that, and also other big citieslike Hartford, like Charlotte, like Syracuse.

But there are about 800,000 law enforcement officers in the United States.And we believe that all these officers that are part of these 246 departments,it's somewhere around 50,000 police officers. So a long runway in front of usthere.

Chris Krueger -Northland Securities

Okay. Further state department wins, how many of those haveyou had, just the New Mexicoso far or is it more than that?

Mike Golden

New Hampshire, that was abig one for us because there was a competitor up there and they manufacturedcompetitors' guns in New Hampshire.

Chris Krueger -Northland Securities

Okay.

Mike Golden

Iowa State Police that comes to mind right now

Chris Krueger-Northland Securities

Okay. Other question. Your M&P pistols have been growingnicely. I can't remember if you've provided this, but do you provide a percentof what the M&P product line up is as a percent of your total sales?

Mike Golden

No we don’t provide that.

Chris Krueger -Northland Securities

It’s okay.

Mike Golden

It's obviously a growing part of our sales, though.

Chris Krueger -Northland Securities

Right. All right. That’s all I've got. Thank you.

Mike Golden

Okay. Thanks, Chris.

Operator

Your next question comes from the line of Reed Anderson.Please proceed.

Reed Anderson - DADavidson

Good afternoon.

Mike Golden

Hi, Reed.

Reed Anderson - DADavidson

Hi. I guess, Mike, we all get the why kind of (inaudible)inventory and what’s happening. And I think that's understandable. But what Ithink is a struggle, at least for me and I think other people would share this,is the timing of it. I mean you reported your first quarter in early September,and then all of sudden, a couple of weeks later, it seems like the wheels havestarted coming off.

And I guess my question is can you just remind us or talk tous about kind of the timing of your orders, et cetera? Because what myrecollection is you have a handful of distributors that are may be upwards of30% in revenue. So, it's hard for me to understand how wouldn't know soonerfrom them until the end of October, say, that things were slowing. Can you helpus connect those dots a little bit?

Mike Golden

Yeah. The formal data, the FET data doesn't come out until-- we got it just a short time ago, mid-November, which kind of told us whatwas going on, okay. As we were going through, we had an event. The sales guyshad a promotion last year for our distributors and dealers where the winner,you know, you had to sell so much in one of those things, but the award was atrip to Hawaii. And that was in the middle of September.

Reed Anderson - DADavidson

Of this year, September '07?

Mike Golden

Yeah, just passed. And our guys came back from that witharguably 50 of our largest and most growing combination dealers anddistributors, and there was no indication that the slowdown at retail was beingfelt. People kind of just thought it was a little bit of a blip. So, it wasn'tuntil when we started to see it reflected in our order level, it was really inOctober. As we got into it, it was like, whoa, we got a lot of stuff here.

So, it really was not something that the industry recognizedat the dealer level back through the distributors, and that was kind of part ofthe problem. Our sporting good sales in September we're up 29% versus the yearbefore. So, really that's how it kind of caught us a little bit off guard andthat's why we reacted quickly to it.

Reed Anderson - DADavidson

Okay. And then in terms of the retailers that sort of thing,I mean at what point are we going to start to see a much more prominence inassortment or representation of your newer product, particular on the long gunside. In some of these larger category killer names like a Cabela's or a GanderMountain or somebody like that, when should we think that we're going to walkinto there and see a much better more jump off the page service assortment ofthose new products?

Mike Golden

A couple of things. The short answer is as we get into nextyear's hunting season. And this year, as we explained, we kind of caught it, welaunched it at a time that was unfortunate. But also the offering that we haveat this stage of the game under the Smith & Wesson brand is fairly limited.You're going to see more SKUs added to that to broaden that line at the SHOTShow, which will start to give it more of a presence, plus we're going to catchthe full season.

Reed Anderson - DADavidson

Okay. And then, I guess last question, in terms of SHOT Show,I mean give us a sense of what kind of order writing or order indication youtypically get there and how we might think about that as we look at your backlogcoming out of April?

Mike Golden

Yeah. You won't see people writing orders at the show. Imean they just don't do that. But after the SHOT Show, we try to have productsshown at the SHOT Show that we will begin to shift this fiscal year, in otherwords, not outside that window. So, you'll start to see orders graded after wecome out of the SHOT Show. So that's a February, March, April timeframe you'llstart to see that.

Reed Anderson - DADavidson

Okay.

Mike Golden

The other point to the big boxes just explain why youhaven't seen the presence of Smith & Wesson stuff, is we did not have theproducts available at the beginning of the year when they placed their orderswith the manufacturers. In other words, everybody goes before the big boxes, makesthe presentation of what they have, and they decide what they're going to carryfor the year. We then introduce our rifle until April or May at the NRA Show. Sothat effectively took us out of that game with all the big boxes.

Reed Anderson - DADavidson

That makes sense. I just wanted to make sure I'm clear. Andthen, lastly, I guess, John, is it possible for you to give the revenuebreakdown by product that you typically do in your Q at this point?

John Kelly

What are you looking for exactly, Reed?

Reed Anderson - DADavidson

Well, I'd just like to get the detail. I mean, we'llobviously get it out of the Q when that comes out in other week and a half, butit's always nice to get the detail by product categories, if you're willing todo it.

John Kelly

Well, the Q is going to come outon Monday, Reed.

Reed Anderson - DADavidson

Okay.

John Kelly

But let me also add to what John was saying to really answeryour question. Many of our distributors have their shows where dealers come tothem where they do write orders in the month of January and the month ofFebruary. And the timing of that and the SHOT show and the launching of our newproducts is really actually pretty good to kind of get this whole thing kickedoff.

Reed Anderson - DADavidson

Okay. But is it still the case though that, I mean, if welook at your backlog, which I know isn't a great indicator all the time, but itshould be something that coming into a new fiscal year that's essentially whereit peaks, and then it runs off from there throughout the year. Is that correct?

John Kelly

That will be probably the case there because the longerbooking orders happen in February, March, April time period. So you're right,Reed. There is a backlog. If I had to tell you when the peak period is, it'sprobably the end of the fiscal year.

Reed Anderson - DADavidson

Okay. All right. Thanks.

Mike Golden

Okay. Thanks, Reed.

Operator

(Operator Instructions)

Your next question comes from the line of Amit Dayal. Pleaseproceed.

Amit Dayal - Rodman& Renshaw

Thank you.

John Kelly

Hi, Amit.

Amit Dayal - Rodman& Renshaw

Hi, guys. How are you?

John Kelly

Good. Very good.

Amit Dayal - Rodman& Renshaw

Thanks. Just one question in terms of the guidance forfiscal third quarter.

Mike Golden

Yes.

Amit Dayal - Rodman& Renshaw

Does it come, I hope I'm reading it correctly, but it wouldcome to roughly $57 million to $60 million in terms of what's given in yourpress release?

John Kelly

You're talking about topline?

Amit Dayal - Rodman& Renshaw

Yes.

John Kelly

For the third quarter?

Amit Dayal - Rodman& Renshaw

Yes.

John Kelly

Approximately?

Amit Dayal - Rodman& Renshaw

Yeah. Like in that range, right.

John Kelly

Yes, approximately in $60 million.

Amit Dayal - Rodman& Renshaw

Right.

John Kelly

$57 million to $60 million, yes.

Amit Dayal - Rodman& Renshaw

Right. So my question to that is, I mean, given that thefourth quarter is usually the slowest for you guys…

John Kelly

No. It's usually the strongest, Amit.

Amit Dayal - Rodman& Renshaw

Right, sorry. So we are still confident about making that 85to 95 range in the fourth quarter?

Mike Golden

Yes.

Amit Dayal - Rodman& Renshaw

Right. Perfect.

Mike Golden

Yes. I mean it's basically, Amit, just to take you throughit, what we said is that what's happening as we expect our projections for theinternational law enforcement market, either they are going to grow strongly inthat fourth quarter based on information we have on contracts and thingssomething out. And what we did was we said we are just going to grow at themixed rate, which is about 5%.

Amit Dayal - Rodman& Renshaw

Right

Mike Golden

We're forecasting we're growing at the market in the fourthquarter. And then there is going to be some good growth in the internationalwhat we see is on the horizon or is in-house for international for Q4.

Amit Dayal - Rodman& Renshaw

Right. So the international growth, is it coming frompistols, revolvers, could you just --?

Mike Golden

Yes, pistols.

John Kelly

Primarily, the --.

Mike Golden

M&P.

John Kelly

The M&P has really provided us with a significant boostto our international business. Prior to the M&P, we did not have pistolthat could compete in the law enforcement or military market worldwide.

And now that we have that, the numbers are shown, as Mikehad said, by over 5,000 officers around the world. And basically that's in alittle over year, because that's primarily 9 millimeter caliber. In about 15months time, that's a pretty strong performance.

Amit Dayal - Rodman& Renshaw

You haven't provided this in your press release, and I don'tknow if you can give it to us or not, the EBITDA range that you expect forfiscal 2008 or if you could give us depreciation numbers for the next quarter--?

John Kelly

We gave you the depreciation and amortization. I think itwas 12.5.

Amit Dayal - Rodman& Renshaw

Okay

John Kelly

Let me just think for a second, Amit?

Amit Dayal - Rodman& Renshaw

Right.

John Kelly

Probably about 50 to 55 range, Amit.

Amit Dayal - Rodman& Renshaw

Okay. Thank you so much. And just one final question. I mayhave asked you this earlier as well when I spoke to you a couple of weeks ago.But are distributors and dealers allowed to send unsold stock back to thefactory? How does that work for you guys?

Mike Golden

No, they are not allow to.

Amit Dayal - Rodman& Renshaw

Okay. So it's their responsibility once it's shipped out ofyour factories?

John Kelly

Right.

Mike Golden

And as we said, our product is moving through the channelvery nicely, so that's not even a concern.

John Kelly

The issue doesn't appear to be on a dealer level as much asthe distributors' really. I mean from what we are seeing on the feedback fromour distributors is, their out the door is up significantly for Smith &Wesson.

Amit Dayal - Rodman& Renshaw

Right.

John Kelly

The October date is the last we have, and our two largestguys were showing up 37% and up 18% out the door. What they are doing is theyhave reduced their inventories. As I said before, they were 44% and 61% lowerwhen they purchased from us. So that's how the inventory correction is taking placereally at this point for us.

Amit Dayal - Rodman& Renshaw

Can you give us a sense of what the inventory mix is likefor you right now? Is it more pistols, more rifles?

John Kelly

Given the nature of what happens in the marketplace, it'sacross the board. We are comfortable that it isn't in any one particular area.It's pretty broad based. So as the business picks up, we don't anticipate anyproblems in any particular category where we are more severe than others.

Amit Dayal - Rodman& Renshaw

Right. That's all I have guys. Thank you so much.

John Kelly

Thanks, Amit.

Mike Golden

Thanks, Amit.

Operator

Your next question comes from the line of James Maher.Please proceed.

James Maher -ThinkEquity Partners

Good afternoon, guys.

Mike Golden

Hi, James.

John Kelly

Hi, Jim.

James Maher -ThinkEquity Partners

Most of my questions have already been addressed, althoughlet me ask just a couple of housekeeping items then. In terms of the sharecount, given the convertible, should we still be anticipating $48 million forthe next several quarters?

John Kelly

That's the way it's still calculated, James. It's based onthe if-converted, and the more dilutive impact is to add back the interest coston that of approximately $2 million to the net income number and divide it byapproximately 48.5 million shares. And it doesn’t carry in effect whether thestrike price is in the money or not.

James Maher -ThinkEquity Partners

Okay.

John Kelly

Okay.

James Maher -ThinkEquity Partners

Okay. And then secondly, I wasn’t doing my math incorrectlyhere. It looks like about $2.94 million net income over 48 million shares, I amgetting $0.06, not $0.07. Am I just not able to do math today or is --?

John Kelly

What you have to do there is to add back approximately $0.5million after-tax impact of the interest on the convert.

James Maher -ThinkEquity Partners

Okay. That's the interest again. Okay.

John Kelly

Yes.

James Maher -ThinkEquity Partners

Okay. Again, I think most of my other questions have beenaddressed. So thank you.

Mike Golden

Okay. Thank you.

John Kelly

Great. Thanks, James.

Operator

Ladies and gentlemen, this will conclude the Q&Asession. I’d like to turn the call back over to Mr. Golden for closing remarks.

Mike Golden

Thank you, operator. I want to let you all know that we willbe presenting at the Wedbush Morgan Investor Conference next week on December12 in Los Angles. I look forward to seeing some of you there.

Thank you everyone for joining us. Happy holidays to all ofyou, and I look forward to speaking with you again in the New Year.

Operator

Thank you for your participation in today's conference. Thisconcludes the presentation. You may now disconnect. Good day.

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