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How Smith & Wesson Managed to Lose Money During a Gun-Buying Binge

.44 with a bullet.
Smith & Wesson (SWHC) has done the seemingly impossible: It's managed to lose money selling firearms to a nation with the highest rate of gun ownership in the world. Not only that, but S&W did it during a time of record gun purchases. That's like Exxon (XOM) going broke selling gas in Los Angeles during rush hour.

How did the makers of Dirty Harry's favorite six shooter do this? Through a number of usual and unusual ways: Bad acquisitions, bad weather and some alleged executive malfeasance.

From 2007 to 2011, the FBI has run approximately 52 million background checks on people wanting to buy some sort of personal firearm. (While not a definitive indicator of weapon sales, this is the statistic the firearms industry press uses.) That's an increase of 6 million over the four years before that. At the same time, S&W's stock has gone from $20 to less than $4. Ruger (RGR), S&W's only publicly traded competitor, has seen its stock nearly double in price over the same period.

As with many companies, S&W blamed its 2007 fall in profitability on the implosion of the subprime mortgage market. And on the weather. From its 2008 annual report:

Against this environment, unseasonably warm weather throughout most of the United States adversely affected the retail traffic in the sporting goods channel. At the same time, significant distribution channel purchases in anticipation of a strong hunting season resulted in unexpectedly high inventory levels, which limited the ability of the distribution channel to purchase additional products.
Translation: When it's sunny out people don't go to gun stores and besides the gun stores had already bought a lot of guns so they couldn't buy more guns. Oddly, Ruger's annual report makes no mention of the impact of clement weather.

This overly warm time is when S&W decided to go on its own buying spree. In 2007 the company bought another firearms maker -- Thomson Center Arms. This was followed two years later by the purchase of Universal Safety Response, a company which made high-tech walls and gates for protecting the perimeter of buildings.

As SeekingAlpha's Terrence Kennely put it: "The acquisition of Thompson Center Arms has not gone according to plan with consolidations putting a strain on operating income [and] SWHC's foray into the perimeter security business has been a large scale failure and the single largest contributor to SWHC's worst quarterly performance in years." (Motley Fool has a deeper dive into S&W's abysmal numbers.)

As if all this wasn't enough, last year one of the company's top sales execs was arrested at the industry's biggest trade show for engaging in schemes to bribe foreign officials. This, in turn, has spurred an SEC investigation concerning the Foreign Corrupt Practices Act. Add to that this statement from the company's recent 10-Q statement -- "Pistol sales decreased 25.3%, driven by the reduction in consumer demand as well as reduced international shipments related to our investigation" -- and it becomes clear that S&W cannot sell firearms abroad, either.

Hey, investors -- do you feel lucky?
S&W declined to comment because of the quiet period prior to the release of its annual report. So it is impossible to say how the company expects to extricate itself from this mess. But when it comes to the iconic, 150-year-old brand, investors have to ask themselves a question posed by Det. "Dirty" Harry Callahan: "Do I feel lucky? Well do ya, punk?"

That quote comes from perhaps the greatest product placement/endorsement in movie history.

"I know what you're thinking: 'Did he fire six shots, or only five?' Well, to tell you the truth, in all this excitement, I've kinda lost track myself. But being this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question: 'Do I feel lucky?' Well do ya, punk?"
The .44 in question was S&W's Model 29 and forty years later it is still selling the weapon to people who will never, ever encounter anything more dangerous than an rabbit.
The company's best hope may be for another Clint Eastwood movie. Or perhaps he'd like to be CEO.


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