Smith & Wesson Brands, Inc. (SWBI) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3, 2018 American Outdoor Brands Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer-session and instructions will follow at that time. [Operator Instructions] And as a reminder, this conference call is being recorded. And I would now like to introduce your host for today's conference, Ms. Liz Sharp, Vice President of Investor Relations. Ma'am, you may begin.

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 revenue, earnings per share, non-GAAP earnings per share, net debt to adjusted EBITDA ratio; fully diluted share count and tax rate for future periods; our product development, focus, objectives, strategies and vision; our strategic evolution and organizational development; our market share and market demand for our product; market and inventory conditions related to our products and in our industry in general; 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 filing, including our Forms 8-K, 10-K and 10-Q. Excuse me -- you can find those documents as well as a replay of this call on our website at aob.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. Our actual results could differ materially from our statements today. I have a few items to note with regard to our comments on today's call. First, we referenced certain non-GAAP financial measures on this call. Our non-GAAP results and guidance exclude acquisition-related costs including amortization, onetime transition costs, a change in contingent consideration liability, fair value inventory step up and backlog expenses, discontinued operations and the tax effect related to all of those adjustments. The reconciliations of GAAP financial measures to non-GAAP financial measures, whether or not they are discussed on today's call, can be found in today's Form 8-K filing, as well as today's earnings press release, which are posted on our website or will be discussed on this call. Also, when we reference EPS, we are always referencing diluted EPS. For detailed information on our results, please refer to our quarterly report on Form 10-Q for the quarter ended January 31, 2018. And with that, I'll now turn the call over to James Debney, President and CEO of American Outdoor Brands.

Thank you, Liz. Good afternoon and thanks everyone 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 guidance for the fourth quarter and fiscal year. Our results for the third quarter reflected the continuation of challenging conditions in the consumer market for Firearms. Lower shipments in our Firearms business were driven by a reduction in wholesaler and retailer orders versus the prior year and were partially offset by double digit revenue growth within our Outdoor Products & Accessories segment. In Firearms, we believe that orders were negatively impacted by weaker consumer demand in general as reflected by decline in NICS background checks, coupled with ongoing heighten channel inventory of firearms at retail. Despite these elements, our focus on reducing internal production outputs and outsourced capacity during the quarter helped to lower our Firearm inventory both internally and at distributor locations. Overall, our long term strategy remains focused on being the leading provider of quality product for the shooting, hunting and rugged outdoor enthusiast. Continued growth in our Outdoor Products & Accessories business were helped us better balance our overall revenue by mitigating the volatility we have experienced with our Firearms business. With that introduction, let me provide some details. Many in the firearms industry follow the monthly adjusted NICS results which measured at the background checks conducted by licensed Firearm dealers when a consumer purchases a Firearm. The adjusted mixed number is generally considered the best available proxy for consumer demand. We follow this metric for the same reason. Please now also important to note that we do not sale directly to consumers, we sale only to law enforcement agencies and federally licensed Firearm wholesalers and retailers. With that being said, adjusted NICS results for our third quarter and particularly for the month of January were lower than we had anticipated far lower than it can be attributed to seasonality. In fact, it was the lowest January adjusted NICS results in the last 6 years. In our Q3, background checks for handguns declined 8.8% while our unit shipped into distributors and retailers declined 38.3%. Despite that decline, we believe we maintained our share leadership position in the consumer handgun market largely because retailers fulfill consumer demand for our firearms using their existing inventory of our products. For this reason, we also believe our unit sales relative to NICS results indicated channel inventory reduction efforts by wholesalers and retailers were successful in the quarter. Gross margins in our Firearm segment in Q3 were 23.4%, impacted by lower production volumes, which resulted in lower absorption of fixed overhead cost per unit. Those gross margins were also impacted by our cost participation in the promotional environment to consumer firearms that has persisted for the last several quarters. Successful promotions in our M&P and Thompson/Center product lines were designed to defend the market share during this period of market adjustment. We are pleased that distributed inventory of our firearms actually decreased to a total of 175,000 units at the end of Q3 versus 213,000 units at the end of Q2. Since the end of Q3 this favorable trend has continued and our current weeks of sales at distribution are now at our eight week threshold. Please note that achieving this lower level of inventory of our firearms and distributed is important to us because it restores a healthy level of tension back into the ordering system. With that tension in place, distributor orders placed on us tend to be more accurately reflective of consumer purchasing activity at the retailer level. While we believe firearms retailers still had inventories higher than they required levels in the quarter, we also believe that Firearm inventory conditions at the retail level have improved as well. This is based on intimation from one of our large distributors that had surveyed the same 200 retail locations for the past several years. Recent data from that distributor reflects current retail firearm inventory levels that are comparable to two years ago. As expected, our internal firearm inventory declined sequentially from the peak last quarter, as we ramped down internal and outsource production and benefited from the full hunting and holiday sales upswing, offset by inventory builds to support multiple new product introductions. During the period, we also significantly reduced our Outdoor Products & Accessories inventory, which typically runs between 20% and 30% of our total inventory. We have recently launched an exciting new personal protection concealed carry pistol, the M&P380 SHIELD EZ. Several years ago, we have recognized the existence for the large group of firearm owner that had difficulty racking the slide and loading the magazine on a semi-automatic pistol. When our engineer set out to define the M&P 380 SHIELD EZ, our goal was to develop an easy to use personal protection pistol, but these customers would be able to confidently operate practice without the range and carry concealed the personal protection. Throughout the development process, we focused on key areas that customer told us were important and we incorporated these features into this revolutionary new pistol allowing consumers of all statures and strength, the opportunity to own, carry and respectively utilize this personal protection pistol. The M&P 380 SHIELD EZ platform will be the basis for future models in several calibers and configurations that will be based on the ease-of-use concept. Now turning to our Outdoor Products & Accessories segment, which includes our electro-optics business, revenue grew 10.9% year-over-year, a combination of inorganic and organic growth. Gross margins in Outdoor Products & Accessories of 48.2% in Q3 validate our strategy to aggressively grow this segment and continue to diversify our business. As within firearms, our growth strategy in this segment is to innovate for the consumer, with the objective of meeting their unmet needs, wants and desires. This is a clear focus for our creative product development and engineering teams through our enthusiasts themselves. Our ideation development process in execution in this segment was clearly on display of SHOT Show in January where we launch nearly 150 new products to cross shooting, accessories, cutlery, tools and survival products. Some of these products provided our entry into completely new product categories. Let me provide a few examples, since acquiring Bubba Blade in August, which provided us entry into the very large fishing and hunting tool space. We have leveraged in-house product development and outsourcing capability, to launch 10 new skews. These IP protected products include a tapered flex fillet knife, pistol grip players, split ring players, and the ultimate fillet glove. For the 32 million Americans that participate in targets shooting at the range each year, our precision shooting accessories brand hold well, release three new pattern pending products geared for maximizing enjoyment at the range, including the markets lightest, most portable and stable shooting table at just 25 pounds in weight. We also expanded our M&P branded flashlight line with the introduction of 17 new LED powered lights, positioning us against the competition with more valued per lumens and arguably the most attractive and feature rich tactical designs on the market. This includes the most compact 12,000 lumen handheld flash light on the market that has seven different light settings, a rechargeable battery and integral battery light meter and is tripod mountable. As part of our electro-optics division expansion, Crimson Trace, the leading laser sight manufacturer in the firearms market also enter the large and diverse flashlight category. The Company launched all new dual purpose flashlights which can be interchange between handheld and rail-mounted configurations. In addition, Crimson Trace introduced several new laser and light products at SHOT Show, including red and green laser sights for Glock and HK pistols as well a universal rail-mounted light. And beyond all of these exciting new products, our development pipeline remains very robust. I look forward to sharing more details as they come to market. Lastly, we made significant progress in the quarter towards developing our new distribution center in Missouri, a long term objective that is well underway and will allow us to better serve our wholesale and retail customers. The precast walls have been installed. The steel roof installation is underway and most of the underground utilities and mechanicals are complete. The original construction timeline remains intact, and we're planning to startup in early December. The integration of various operations into the new facility will take place throughout calendar 2019. This is an important initiative will provide the framework for our future organic and inorganic growth and cost savings. I look forward to reporting on our progress in the coming quarters. Now turning to the current environment, we have completed nearly all of our wholesaler and buying groups selling shows, where retailers place orders for the coming year. Those shows take place early in the calendar year and they ramp well. While our new product development pipeline is robust and channel inventory levels appeared to be improving, we believe that the new lower levels of consumer demand we saw reflected in the January adjusted NICS results may persist with some time. During Q3, we effectively eliminated our containment outsourcing and reduced our headcount by 200 plus individuals which represents the 13% reduction in total manufacturing personnel. In fact, over the past 12 months, we have reduced our total manufacturing personnel by about 25%. Going forward, we will operate our business under the assumption that the next 12 to 18 months could deliver flattish revenues in firearms. Should market conditions changed our flexible manufacturing model allows us to quickly ramp production. In the meantime, we will focus on optimizing our manufacturing resources to align capacity with demand while preparing for a number of meaningful new product launches, reducing cost across the entire organization and generating cash, growing our business and particularly our outdoor products business organically through the development of new products across our well known and respected consumer brands. Developing new products, a large components of our organic growth strategy is focused on continues product innovation and we are excited about the pipeline of new offerings and development with the wide range of additional products planned for rollout in fiscal 2019. We believe the firearms market will eventually return to long term growth. Lower to slower pace than experienced in the last 10 years, as we navigate the current challenging market conditions in firearms, we anticipate the most of our organic growth will come from the Outdoor Products & Accessories segment, which now makes up of approximately 25% of our net sales and 40% of our gross profit. For this reason, we will continue to aggressively work to expand our product offering across this segment of our business. At the same time, we will continue to invest in our new distribution center and important strategic initiative design to lower overall cost structure and harvest energies from acquisitions. With that, I'll ask Jeff to provide more detail on our financial results and our guidance. Jeff?

Thanks, James. Revenue for the quarter was $157.4 million, a decrease of 32.6% from the prior year. Revenue from our Firearms segment was $117.6 million, a decrease of 40.6% and revenue from Outdoor Products & Accessories was $44.7 million, an increase of 13.4%. Within those total revenue numbers, intercompany sales eliminations were approximately $5 million. Total company gross margin for the quarter was 29.8% compared to 42.5% in the prior year. The firearms gross margin was 23.4% and the outdoor products gross margin was 48.2%. The total company gross margin decreased was mainly driven by the firearm segment, which had lower production volumes, increased manufacturing, spending percentages, and heightened promotional costs. GAAP operating expenses in the quarter were $41.1 million as compared to $49.1 million in the prior year. On a non-GAAP basis which excludes acquisition related amortization, operating expenses were at $35.6 million as compared to $42.2 million in the prior year. Significant reductions in incurred incentive compensation and profit sharing, as a result of our revised forecast contributed to lower operating expenses. EPS for the third quarter came in at $0.21, as compared with $0.57 in the prior year, although it should be noted at $0.17 of that EPS was a one-time $9.4 million tax take back resulting from tax reform. Our non-GAAP EPS which excludes acquisition related cost and the tax take back was $0.09 as compared with $0.66 last year. As results of cost saving efforts to $0.09 non-GAAP EPS was in line with our guidance despite lower than expected revenue. You'll note that our tax rate in Q3 excluding one-time adjustments and discrete items was 41.5%, which is higher than previous quarters, although the tax reform act will eventually provide us with a lower tax rate. The change in our forecast combined with some of the vagaries of the new law as well as state tax impacts drove our tax rate in Q3. Those items will have a similar effect in Q4. Adjusted EBITDA in Q3 was $20millionor or 12.7% EBITDAs margin compared to $67.6 million, a 28.9% margin in the prior year. So turning to the balance sheet, operating cash flow was a positive $26.1 million and capital spending was $4.1 million. Excluding our distribution center under construction, we have reduced our capital spending this fiscal year down to approximately $14 million, primarily related to IT and new product development. And as I have noted before, the distribution center will be financed primarily through capital lease construction although we will have cash outlays for IT and equipment. We also reduced inventory levels during the quarter. Our finished goods inventory of Firearm units decreased during the quarter by over 25%, helping to contribute to our positive cash flow, while distributor inventory units decreased by nearly 18%. As a reminder in addition to selling to wholesalers, a significant portion of our firearm sales are direct to strategic retailers and retail buying groups. Thus unlike companies that sell only to wholesalers, we must maintain inventory to support retailers. Also while we expect continued inventory reductions in Q4, I would note that as we transition to our new distribution center 8 to 10 months, we will need to maintain extra inventory as safety and buffer stock during that time. Safety stock will mitigate the transition risk and buffer stock will protect service levels that might be impacted by market volatility. The end of Q3, our balance sheet remains strong with approximately $38.2 million of cash and $200 million of total net debt. I would note that we pay down $50 million on our line of credit in Q3. And since the end of the quarter, we have paid down an additional $25 million on that line of credit. In addition, we just announced that we have effectively extended the maturity on our $75 million senior notes by two years to August 2020 on substantially the same terms. That means as of today, we currently have no short term debt maturities, and we have outstanding balances on our long term debt as follows: $50 million on our line of credit; $75 million on our outstanding senior notes; and $80 million on our bank term loan A. We currently pay a blended interest rate of approximately 4% on our long term debt. In Q4, we expect another strong quarter of strong positive cash flow, which will likely allow us to further reduce the outstanding balance sheet on our line of credits. So now turning to guidance, based upon the market conditions in Q3, we are updating our full year fiscal '18 revenue estimate up to a range of $597 million to $601 million. At that revenue range, we expect full year GAAP EPS of between $0.24 and $0.26 which includes the tax reform benefit. Excluding that tax benefit as well as amortization costs associated with acquisitions, our estimate for non-GAAP EPS is between $0.31 and $0.33. For the fourth quarter, we expect revenue of between $162 million and $166 million. We expect GAAP EPS of between $0.01 and $0.03 and non-GAAP EPS of between $0.09 and $0.11. And both our fourth quarter and full fiscal year numbers our non-GAAP EPS excludes amortization and cost related to our acquisitions. All these estimates are based on our current fully diluted share count of 55 million shares and a tax rate for Q4 of approximately 40%. Due to the various give and takes under the tax reform act, we won't see a benefit on our new tax rate until fiscal '19. For those of you modeling in our'19 numbers, we currently estimate the tax rate in that fiscal year will be around 27% to 29%. Back to James.

Thanks Jeff. Before we open the call for questions, I want to conclude our remarks by commenting on the horrific tragedy in Parkland Florida. We share the nation's grief over this incomprehensible and senseless loss of lives, and we share the desire to make our community safer. Through our membership and work with the National Shooting Sports Foundation, we will continue to support the development of effective solutions that accomplished that objective while protecting the rights of the law-abiding firearm owner. With that, operator, please open up the call for questions from our analysts.

[Operator instructions] Our first question comes from the line of Cai von Rumohr with Cowen & Company. Your line is now open.

So, first the housekeeping issue, your 10-Q normally is out before the call. Is that's going to be out this evening?

Yes, it's coming out, there were some like glitch filing with the SEC and I believe it just dropped. It was a technical difficulty, not a financial difficulty.

Okay. And can you give us some help in terms of what percent of your sales are to the large big box chains who have decided not to sell assault rifles, was that factored into your guidance? And what kind of impact do you expect that decision that they've made would have on your business?

Hi, Cai. Yes, so far and this is all we know is the -- the statement made by Dick's that they will not be selling modern sporting rifles, immediately. So, we looked at what percentage of our sales overall for the Company, were as a result of MSR sales to Dick's and it's extremely small, it's actually one-tenth of one percentage points of our total sales. So, there isn't really any impact and of course anything like this is obviously built into our guidance going forward.

But I would assume, given what's happened we may get more companies doing this and presumably there's going to be some kind of impact that if they're not selling MSRs. There may be lower sales of other -- of other items. What's your -- just your gut feel in terms of what that would do to the, to the market?

Well, really, that would just be pure speculation right now. I'm not aware of any other statements made by the big boxes, we call them strategic retailers that we sell direct and that is obviously the Bass Pro, who now owns Cabela's as we all know and Academy and Sportsman's Warehouse. So again, I don't want to speculate and its all speak on that half.

So inventories where should we expect them to be a year end roughly?

I think we're going to continue to see inventories drop over the course of the next quarter. So we had a 25% unit inventory drop in Firearms. We think Outdoor products will say, approximately like the same. So, on a dollar basis, it could go down by another $10 million to $20 million.

And then lastly, your, when you said you expect firearm sales to be flattish from here, but January tends to be seasonally a little bit better than July. Can you give us any rough color in terms of what that might imply? If your assumption is correct for fiscal '19 sales for Firearms?

What we don't want to get into now, we're not giving guidance where we were just really giving color on where we thought the next 12 to 18 months goes. Obviously, we'll do a much better job on that when we have our call in June and we'll give guidance for fiscal '19. And Cai, I just looked up some information that was relevant to your last question, where you were just asking about sales to the big boxes in general. If we just look at modern sporting rifle sales and total really trailing 12 months, so I can give you a percentage for both centerfire where they actually include rimfire 22 ammo as well that slightly less, and this is the aggregate for all of what we called strategic retailers. You're requesting those big boxes slightly less than 3% of our total sales.

Thank you. And our next question comes from the line of Scott Stember with C.L. King & Associates. Your line is now open.

Maybe just talking about the margins and the discounting environment, it seems, again, you're not giving guidance, but you kind of pointed to foreseeable future or once we get through the next few months, that NICS will be flattish and firearm sale will be flattish. But what is that due to your margin profile? How do you see, with inventories coming back, someone into line? What are you looking for with regards to promotional environment? Are you looking for to get better? Or are you just looking in this new normal that we're in right now that these heavy incentives here are stay?

Scott, so I really won't talk about gross margin because again, I don't want to get into giving guidance accidentally for the next fiscal year, but I can't talk about their promotional environment and some of the thoughts that we have there. Right now, as we said, we've been going through a wholesaler and buying group selling shows, where the independent retailers coming and place orders for the coming year. There is always every year promotional activity associated with that. So that's perfectly normal. We will conclude that in by the end of this fiscal year. And then going forward, now I feel that we're in a much better position in terms of inventory and the channel, our own inventory given all the transitions we have to due to the new DC for the firearms business as well, retailer inventory getting back to levels comparable with two years ago. For us, I see much less of need to do consumer rebates, which were obviously very costly and compressed our margins. So I think you’ll see a normal level for us and what I know now of that promotional activity going forward.

Is that inclusive of the quarter that we're right now?

I would say so, if you were go to the retail counter right now, you would find pretty much only one consumer rebate that we have an offer right now and that for RTC hunting brand. And that’s for a selection of rifles, both action and molded loaders with a variety of offers. So that one for us, it’s not very costly, it’s a much more part of our business strategically important to us. Because it’s a part that we believe, we can really grow in the future over the coming years. As you know, we have a pretty weak presence in the hunting market. So a lot of runway for growth particular with both action rifles to start with.

And going back to the long gun side of the business, I know that -- can you just remind us MSR as a percentage of your overall business and of your long gun business, just so we can frame things out as the discussion about MSRs and any legalities or any changes in laws takes place?

Yes, MSRs as a percentage of our total revenue and if I look at last 9 months trailing 12 months, it’s about, it’s anywhere between 10% to 12%.

And next question for now. Could you just -- what is your expectation for free cash flow for the full year operating cash flow in the CapEx for the full year again?

40 million on CapEx, not including what we’re doing, but if the distribution center. We should probably have maybe 3 million to 5 million more in the quarter on the distribution center. We in fact actually pretty strong on free cash flow in Q4. We’re just about breakeven right now and we expect overall strong positive of free cash flow and for the whole year.

And just one last question maybe just going back to the, again, I haven't seen queue come out of yet. But just maybe give us some flavor on the sales rates on hand guns versus long guns maybe just talk about the next performance versus long guns? And that‘s why I have.

Okay. So hand guns, hang on a second, we typically have this in the queue. So I have to find it. The hand guns was in Q3 was 55% long guns were 15%, other was 5% and outdoor and product was 25.7%.

And our next question comes from the line of James Hardiman with Wedbush Securities. Your line is now open.

So I guess my first question. I just want to understand that this flattish revenue's comment for the next 12 to 18 months. Obviously, if we look at your revenues versus NICS and certainly the inventory commentary, it would appear that you have significantly under ship the channel over the last couple of quarters. So I guess help me understand when you say flat, do you think that demand is going to be flat and that, that would almost imply that you are going to continue to under ship or do you think that demand continues to decline from here and that you would ship more in line with the manager? It just seems like there's sort of a disconnect given what's happened over the last couple of quarters.

I’ll start and let James finished, but just first of all the main thing we use the term flattish versus flat is because it was intended to not be guidance for next year. It was tended to be sort of a directional indication, okay. So what's going to happen in 12 months or 6 months is a little hard to speculate right now since the environment overall right now politically and otherwise is pretty, is pretty volatile. So that was just intended to be sort of a directional indicator. I can’t say however that it was not intended to be some kind of indication that we think we're going to lose market share. We think that as James mentioned a few minutes ago, that we do not have to do anything extraordinary going forward and that is going to revert to a more typical a promotional environment. And when you think we have a lot of new products including the SHIELD EZ that are going to be very much in demand. So our statement was more about the entire industry and not necessarily guidance for next year.

Okay, that’s fair. Let me ask this question, which I guess is, is somewhat related, but I think a little bit different type of a question. So probably the most positive thing that I took from the prepared remarks, you know, in addition to sort of the absolute number in terms of distributor inventory as well as sort of a commentary from, from the retailers, which I know was a point of focus for you guys on the last call was just the eight weeks that you had sort of achieved that eight week number with respect to a weeks of sales at among your distributor channel. So I guess first since there's an inventory and a sales component to that week's metric, obviously the inventory has come down. Has demand picked up in any way within those distributors? That's the first question then. And then I guess again, as we look forward. Are you comfortable enough with that number that we should think about shipping more in line with demand is as we move forward?

So on distributors, yes, definitely the sales had picked up, as we move through the show season. So as I mentioned, wholesalers, are being running that promotional events where the incentivizing without the pull, retailers to place orders for the coming year. So suddenly that historically has already -- always, sorry I should say, driven Q4 to be our largest quarter in terms of revenue, if you look back at history. And that's been -- those shows have been a primary driver of that revenue. So yes, velocity is definitely picked up. And as we've always said, seasonalities in play before we know that will be into May to June, we're seeing a slowdown as we were into summer that seasonally happens and that eight weeks we'll probably uptick to back into double digit. But then we're through summer into fall hunting and the holiday season. That's that pattern you know well. We are happy though and very encouraged with that inventory result with our two two-step distribution partners. And we think that's the stability and levels of inventory with retailers as well now, both our strategic retailers and independent retailers that we have surveyed by one of our distribution partners.

And then to the second question, how should we think about selling to the distribution channel or the distributor channel versus sell through? Is it going to be more in line or are you going to continue to under ship here going forward?

No, it's going to be more in line. I mean that's why we made the point in the prepared remarks about its good to be getting attention back in the system. So we've always talked a lot about the consumer. And for us consumer poll and so we connected to that poll, and by poll I mean the consumer actually transacting at the counter and buying one of our products. To feel that poll, they translate into retailer placing an order either directly on our zone, one of our two step distribution partners. And if it's our two step distribution partner then they're placing an order on us well. But consumer sale is not been failed out of existing inventory in the channel. So I think we'll be much more in line with demand. And with our share in tact we're very confident about holding our share as a minimum as well. And I think if you just another thing to think about, as we think about the next 12 to 18 months, as you know I'm sure we're not alone, as people think about dialing down the consumer promotional activities is that there is no doubt. As you look back at the last 12 months, the NICS probably very likely, let's say we're somewhat elevated due to that intense promotional activity. And we know the, as we look back at all the tail end of all fourth quarter and the last fiscal year and the very beginning, first couple of months of this fiscal year that we're currently in. That promotion that we had on the SHIELD, where we did a consumer rebate $75 was particularly powerful. And that elevated NICS during that period significantly. And there will not be an anniversary of that event, because there is no need to do it. That was to really bring inventory down of the first generation SHIELD as we made way for the introduction of the next generation SHIELD. The SHIELD 2.0, which as you know, comes in a laser and a long laser version.

And then last question for me. I mean you've talked about obviously the new distribution center, which would help on costs and then the significant personnel reductions. Anyway to quantify any of that or order of magnitude, how we think about just how much cost has been taken out of the business here?

I think taking the cost out is more of an ongoing issue versus like we haven’t reached equilibrium. The -- we’re focusing on the budgeting like for next year and looking at the cost to try and match the manufacturing costs and the operating costs with our expected run rates. So I don’t think I can really give anything more beyond that. James, did you have…

The any other color I'd add is, there is obviously as we’re going through transition, there's some duplication of cost to start off before -- before you get to hardest the benefit. So, there is an expectation. There will be a period of time where that happens. We’re obviously have a great team in place that we’re looking to minimize that as much as possible and move past to harvesting synergies not any from our current firearms business and the way that we run logistics and the supply chain to our customers, but also to acquisition that we’ve made in the past where we yet to harvest that synergy.

And what's the timing?

I was going to say that, the distribution that I'm centered of center. First, basically I'll have to move all the various sales operations and shipping operations into that distribution of center and that’s going to take at least a year period starting in December. So the fully realized, a benefit of that is out there a year and half to two years. And as James said like there will be a little duplication costs as we roll that out. But we do think that it’s a fairly incurred at the end of this get by time that we get out there in a couple of years savings in state tax costs, in logistics, in the ability to acquire companies and receive immediate synergistic benefits. So we think that’s a very important project for the Company.

Just one more comment on the DC James, so sorry for this clearance, but just ramping it up will take probably a year. But it’s done and four distinct phases and each phase, the conclusion of each phase which can last, let's say last three months. Then we'll be harvesting the benefit from that phase and then we'll move onto the next phase. I just didn't want you to think it was massive duplications for an extended period of time.

And our next question comes from the line of Steven Dyer with Craig-Hallum. Your line is now open.

We’ve touched on I guess the promotional environment et cetera. The channel seems healthier than it has in some times. So I guess going forward given that still probably too much supply in capacity. It’s a promotional environment sort of stays elevated. It is the game plan on the strategy still going to be there to play along and defense share going forward or something different this time?

Our focus is going to be on the continue activation of the new product, meaningful new product launches that we made in the last four or five months, and really there I’m talking about the M&P SHIELD 2.0, as I mentioned earlier non-laser and now a laser version under the Crimson Trace brand and M&P Compact Series 2.0. So both of those products designed for concealed carry therefore personal protection, so continued activation of those, there's good space in the market for those products. And obviously, we've been very successful over the last five or so years with the SHIELD and we intend to continue to do so. So, and then moving apart of those, we have multiple meaningful new product launches coming across the whole of AOB, particularly in firearms as well, which are meaningful. And that for our expectation is that we'll be growing via those new product introductions that really do not require promotional activity. So there's a change just in the way we're looking forward. I understand what you are your saying, hey, if competitors continue at a high level of promotions, what are you going to do, I just don’t say as sustainable, strategically, lot of time we are doing it strategically, we keep over doing opportunistically to fill that excess capacity that they have. You know, the capacity has been dialed down, or we’re the classic example of that we've dialed down completely our outsource capacity.

Question on guidance, I guess whether it's the specific guidance for this quarter or just generally directionally, how you're thinking about next year even. Does that include sort of any changes in demand, et cetera that you maybe have seen on a POS standpoint in the last week or two?

Basically, we calculate our guidance this morning, so we just take all the information we have up until the time we issue like the press release, like try not to get influenced by short swing events and focus more on, like you say the direction of how, how things are going.

Okay, question as it relates to capital allocation, it seems country or remark and what you've been that it's preferable to pay down the revolver right now, but with the stacks are trading off, pretty sharply here after hours. Does that change the calculus in your mind as to capital allocation choices?

Obviously, we don't give any advanced indication of what we're going to do. I would say that we still like a paying down the depth. We reduced our line of credit by $75 million during the last couple of months. Because -- because getting that back down to zero gives us, the necessary tools if a good inorganic opportunity that comes along, obviously we're focused right now on the distribution center. So we basically, you know, as we said in the past is the continual, it's a continual analysis of what's best for the Company, whether it's investing in the DC, paying down loans or investing in the sock.

Okay and then I guess just a couple of quick modeling questions, since the queue hasn’t dropped yet. Free cash flow for the year I think through three quarters you're running a sort of a negative 27 million. Would you anticipate you can swing that positive base from the free cash flow generation in Q4?

Yes, we do believe that's going to be on positive for the whole year.

And then I guess lastly for me and I'll hop back in. The organic growth from the Outdoor segment you talked about growth for both getting organically and inorganically. Do you have organic number on that side of the business?

About 7.5%.

Thank you. And we do have a follow-up question from the line of Cai von Rumohr with Cowen & Company. Your line is now open.

So following prior tragedies, we've tended to get a surge in buying demand as gun users are concerned, but legislation maybe passed that would not allow them to buy guns in the future. Have you seen any signs since the tragedy that that might occur? I know it's a, it's a politically confused environment, but have you seen any signs that you might see that or the reverse?

The only report that we've heard are of some increased foot traffic in firearms resellers and that is translating into some level of increased sales, but beyond that, no. You still there Cai?

Yes.

I apologize. The line was dropped. We can move on to the next question while I get that refigured out. Our next question comes from the line of Ronald Bookbinder with IFS Securities. Your line is now open.

Not to harp on the inventory and the gross margin, but I'm just having problems reconciling that you talked about getting back to a normal gross margin and being in a less promotional environment. But yes, your inventory dropped a decent percent sequentially but you're still up 27% year-over-year, while payable payables are done 37% showing that, that inventories aged. So I know you're focused on the new products and not promoting them and having them get pulled through but I guess, what is aged in the inventory? Is it firearms, or do we have some excess outdoor segment? And why wouldn't you promote that to turn that into cash?

There no doubt some of that is on the older side and it will be in firearms for sure. But remember, it's not a perishable. It's a consumer durable. So we are not concerned about the inventory or the mix of inventory that we have. Jeff made a number of points throughout the call, one is we have a large transition coming up to the DC. So that's moving our entire warehousing footprint for firearms to that DC and Missouri from Springfield, Massachusetts. And also we serve a large number of retailers direct whether they're members of the buy group. So they're independent retailers of which of the cost of free buy groups that we have now. I cannot remember the exact total, but it will be anywhere between 700 and 800 independent retailers. And then of course the large strategic retailers Bass Pro, who now owns Cabela's and Academy and Sportsman's Warehouse and Dick’s where we serve direct. So, obviously its preserved service levels to those retailers, we hold the inventory. Now, if you look back and do comparisons over years. Yes, taken as a long time to get to this loan with inventory, I don’t know staying a level of inventories exactly right now. We think there is room for improvement, but again we've got transition to go through. But it's taken as a long time to get to the level of inventory, we think really help us get achieve a much higher level of on-time deliveries going forward to those customers as well as our wholesaler partner.

And I just couple of things I would add is. I don’t think we ever like indicated that the lack of promotional activity would get us back to like what you -- a normal as on gross margin, which is the term you've used. I mean, I think our goal is to move our gross margins back up into a range that where they have historically on been. Outdoor Products does a good job of point that up, but Firearms margin is going to take from sometime and we’re going to work on that, the costing and the manufacturing expenses, like next year to try and pull that backup. So I don’t think we’re comment on it. But we didn’t say, it would -- they would be like normal next year. And then also on the inventory I would point out that units like drop as a percentage a lot on our own inventory and a lot higher of a percentage than the actual dollars did indicating that a lot of lower product, lower price of products or what move. And so exactly that some of the order inventory is the higher price inventory off in the higher price inventory has better margins. And so when I moves that could have a positive impact on the gross margin even if discounts are given.

And you talk about the eight weeks of supply threshold. What makes you think that retailers or the channel wouldn’t be happy or given a weakened environment of casing inventory rather than the eight week supply?

Sorry, Ron, you’re saying why wouldn’t there be…

Why couldn’t he go down to a six week supplies in the channels and retailers would takes inventory as pretty much every manufacture out there would be able to get a delivery fairly quickly to them?

Sure, I mean that could be something that we do observe going forward pretty standard for some years as you know. When you think about wholesale inventory has been around the 60-day mark where most people are comfortable, but in this in a different environment, Ron you’re right. Things may change and we'll be ready to adapt it up.

And then you talk about this couple of times in the past, but we haven't seen anything on it yet. The excess capacity in the factory you would talk to about sort of outsourcing it to the aerospace industry or other industries that, that you could cut metal for. Is there any update there, any progress or, or anything that that's on the gum?

The progress, but nothing material, Ron, nothing to discuss.

Okay. But it's still a plan and part of the….

Yes, absolutely. We don’t have, you know, as you think about the different processes, manufacturing services division performance. We don't have a ton of capacity to be perfectly honest. We have some capacity when it comes to plastic injection molding. We have some capacity when it comes to forging. But everything else is fairly well utilized.

Okay. And lastly, on the Outdoor segment, you’ve made some acquisitions and it grew like 7.5% organically this past quarter. But you took some, some contingent considerations in the beginning of the year. Are the acquisitions living up to your expectations or would you take a breather on, on doing any more acquisitions until you get these totally folded in and, and moved into the new distribution center?

Yes, actually the acquisitions for the most part are living up to our expectations. Crimson Trace has this more of a similar sales cycle as Firearms. And so I would say that is probably a bit of an unexpected like downdraft. On the other hand, we're focusing on Crimson Trace, which has a fabulous brand on doing new kinds of products in different areas like James mentioned, like in lighting. So overall, you know, I would just say in general, we think our acquisitions are doing great. As I mentioned earlier on going, going forward, we are taking a breather right now for a couple of reasons. One, is the prices have been like really high in the last six months. We really can't find anything that is affordable. But more importantly, we are spending the lot of time in dollars on our distribution center. Once we get that finish, there's a lot of synergistic things we can do with the companies that we've already acquired and we think it's important to make sure the distribution I'm saying or gets the full of attention of everybody in the Company so that is ready to go, which will set us up better for acquisitions in the future and will also allow us to actually perhaps spend more on acquisitions because we'll have more synergies to take out faster.

Okay, and so that the new DC we'll have plenty of extra capacity to take on that.

Absolutely, absolutely, it's like not is it being built with enough storage to handle additional -- big enough warehouse to handle additional companies, there was an ability to expand on the footprint that we have.

Okay. Thank you very much. And good luck in the new quarter.

And actually like before we take any other calls, I just wanted to say that our 10-Q still hasn't filed, I guess it just so happens that this is the 60-day deadline for year-end filers. And so, there is a huge rush right now at the SEC and they overwhelmed. And so our 10-Q has been sent to them, but it just hasn't been published. With that, I'll turn it back to the operator.

Thank you. And our final question is a follow-up from the line of James Hardiman with Wedbush Securities. Your line is now open.

Hey, thanks for taking my follow up in it. And it does look like the 10-Q has hit at this point. So thanks for that. I guess I just wanted to understand, that you had really encouraging inventory stats and encouraging comments on promotions and pricing. The demand picture is obviously pretty foggy right now given what's going on, going on in the last month. I guess why now with respect to the longer term comments. I don't think any of us were anticipating, you give us a longer term vision of what the next year and a half is going to look like. I guess I'm curious why you chose to sort of, I want to say lower expectations but, sort of extrapolate I guess January to the next year and a half just given some pieces that are getting better and demand environment that seems pretty unpredictable.

Yes, it's combination of two things. One is obviously what happened in December and January was disappointing and largely was the reason that we missed our guidance and Q3. And the more we've learned since we've been adjusting in this challenging market environment and obviously working really hard internally to get aligned with this market demand. What we didn't want to do was way pull the way through into June before we could really communicate. Just thinking about what were they think our current forward thinking on in terms of where we see all firearms business going. So that was really the basis of it, James. Nothing more than that. I'll Jeff comment.

Again, as I said earlier, we just wanted to give sort of a directional impact. And then let everybody know that that view of that sort of direction is how we are operating the Company. So we're working hard on reducing costs everywhere across the Company and taking efforts to increase the profitability of the Company going forward.

All the flexibility we've demonstrated in our manufacturing footprint over the last few years, well more than a few years six to seven years remains in place. And an outsource partners, we still have relationships. And it takes time to dial some of them back up, but some could be dialed up fairly quickly as well. So we remain nimble in that respect. So we wanted to really communicate that as well even Jeff says as we think about Firearms in that flattish way.

And then I guess last question for me. Are you seeing any more cracks in the supply chain? I guess A from a retailer perspective, we saw retailer exit the market that never helps? Or B from a supplier perspective, I think you’ve been pretty outspoken that, that probably would help and that probably needs to happen? So just touch on quickly those two points.

Nothing, as far as we’re aware in terms of the supply base, and as you look at retail and wholesale, I mean that’s always going to be a pretty fluid environment for sure. I would say, as you think about wholesale, there are some weaker wholesalers and there is some very strong wholesalers who really strong balance sheet. So, can they take market share overtime? I don’t know, okay. So -- but I think more will become apparent over the next six to nine months when it comes to the help of retail and certain wholesalers.

And that does conclude today’s Q&A session. And I’d like to return the call to Mr. James Debney, CEO for any closing remarks.

Thank you, operator. I want to thank everyone across the American Outdoor Brands team for their commitment and dedication to excellence. Thank you for joining us and we look forward to speaking with you next quarter.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.