Shares of SAF-T-LOK INC. (Nasdaq SmallCap: LOCKC), a manufacturer of handgun safety devices, shot up as much as 1200% in just two days last week, rising from Wednesday's price of $7/16 to a high Friday of $5 3/4. The stock closed Friday at $4 9/16 per share, up $1 9/16 on extraordinary volume of 18.4 million shares. This astonishing two-day gain followed Wednesday's announcement by the Clinton Administration that eight of the nation's leading gun manufacturers, responsible for 80% of all handguns sold in the U.S. each year, will soon include a child-safety lock with each new handgun sold.
News of the agreement seems to have come at just the right time for Saf-T-Lok, whose stock had dropped 96% since last fall as the company struggled to get its lock to market and, then, to stay afloat. Even now, the company is at risk of being delisted from the Nasdaq SmallCap market on October 15 unless its officials can convince Nasdaq to reconsider. Partly for that reason, the stock's rally has also brought out naysayers such as Texas-based Key West Securities, which initiated coverage of the firm on Thursday with a "sell" recommendation.
Despite the recent outpouring of investor enthusiasm, the skeptics appear to have a good case. In a phone interview Friday afternoon, Saf-T-Lok President John Gardner admitted that the company is not likely to benefit directly, at least in the near term, from the gun manufacturers' new agreement. The main reason is price. The company's grip lock product retails for $89.95. A new magazine lock, appropriate for law enforcement officials who use a Glock or other semi-automatic weapon, will go into production around mid-November. It will retail for about $95. By contrast, FORTUNE BRANDS (NYSE: FO) dominates the gun lock market with its MasterLock child-safety trigger lock, a clam-shell device that literally covers a gun's trigger and sells for $10 to $15.
The gun manufacturers that agreed to the deal include Smith & Wesson, Glock, Baretta, Taurus Firearms, Heckler & Koch, H & R 1871, SigArms, and O.F.Mossberg & Sons. Another major gun manufacturer, Sturm, Ruger & Co., began shipping trigger locks on its guns last spring. At this point, Saf-T-Lok doesn't have a purchase agreement with these or any other gun manufacturer, and Gardner conceded that these manufacturers are unlikely to opt for Saf-T-Lok's more expensive locks if they can get away with selling less expensive ones instead. Indeed, he suggested that the gun manufacturers might have consented to the voluntary deal with President Clinton in order to head off possible action from Congress that might have put more stringent and costly guidelines in place.
Other reports seem to confirm that the gun manufacturers have no immediate interest in Saf-T-Lok's products. "We estimate that an effective lock shouldn't cost more than $10 or $20 per weapon," Jeff Reh, general counsel for Baretta U.S.A., Inc. told Bloomberg News in an article that appeared late Thursday night. "We're not certain they [Saf-T-Lok] offer a lot more than other less-expensive locks."
Similarly, Smith & Wesson, which has already begun shipping handguns with trigger locks, reviewed Saf-T-Lok's grip lock last year but declined to enter a licensing agreement with the company. Kevin Foley, Smith & Wesson's vice president of product development, also told Bloomberg that Saf-T-Lok's claims are "overstated." In a July 1997 evaluation made at Saf-T-Lok's request, Foley said that the firm's lock "cannot be relied upon to prevent unauthorized use of [a] firearm," though it can serve as a deterrent.
Nonetheless, Gardner said that his company's locks offer good value when compared to the competition. "We believe that time will show that we actually have the right solution.... As people come to understand the limitations of trigger locks, which is what these manufacturers are saying is now an adequate approach to handgun safety, it's going to be difficult for them to stay in that stance because trigger locks are not an effective way to ensure handgun safety, and most everybody knows it."
Gardner said that trigger locks typically require a key to open the lock, so that a misplaced key can make the gun useless. Also, trigger locks are unsafe for use with a loaded weapon since the very act of putting on and taking off the lock could lead to an accidental discharge. After finding the key and unlocking the gun, then, an owner would need to load it with ammunition.
By contrast, Saf-T-Lok's devices can be used on a loaded weapon since the lock remains a permanent part of the gun's grip or magazine. Each product works on a three or four number combination system allowing the gun owner to unlock the gun in just a few seconds by quickly clicking little switches on the grip or magazine, plugging in the gun's specific combination of numbers. Because you can hear the clicking, it's easy to count off the combination even in the dark, Gardner said. "You can do it by touch and sound. So you don't actually have to see it." He added that the company has very strong patent protection, with nine patents on its grip lock and three pending patents on its magazine lock. He said no company offers a similar product and that the patents would present a substantial obstacle to any company that tried to do so.
Some critics, however, question the usefulness of the firm's locks. Key West Securities' chief analyst Tony Elgindy, who last January attacked highflying QUIGLEY CORP. (Nasdaq SmallCap: QGLY), issued two press releases claiming that the Saf-T-Lok's devices can be easily opened since the combination can be found simply by going through the possible variations of numbers. He said this could be done in as little as 46 minutes, suggesting that a child with some free time and enough determination could readily unlock this safety device while his or her parents were out of the house. Elgindy's suggestion is that such accessibility would defeat the purpose of the recent agreement, which was designed to help cut down on the estimated 1,500 children age 14 or younger who end up hospitalized each year due to unintentional firearms injuries.
So far, the company has clearly had its troubles. For the first six months of the year, Saf-T-Lok had just $33,521 in sales, good for a loss of $637,131, or $0.12 per share. Only 2,000 grip locks have been sold since they were introduced last year. Nonetheless, Gardner said he thinks the recent gun manufacturers' agreement plus the upcoming rollout of the firm's magazine lock will raise the company's profile and spark broader interest in Saf-T-Lok's products. Nick Navarro, a former president of the American Sheriff's Association, recently called the Saf-T-Lok "the greatest firearm safety advance of the century."
Such comments reflect the "enthusiastic response" the company has received from the law enforcement community, Gardner said. About 50 sheriff's departments have already expressed interest in the new lock. He put the total U.S. law enforcement market at about 2 million, with about 750,000 weapon-carrying police officers plus another 1.25 million private security officers. Police officers represent a viable market because 25% of officers shot in the line of duty are shot with their own weapons. Unlike the trigger lock, the Saf-T-Lok allows an officer to preset part of the combination when entering a high-risk situation, keeping the gun close to a ready condition but still secure. While the Saf-T-Lok devices are inherently more expensive than the trigger locks, Gardner said that in mass production the average retail price could drop as low as $45 to $50 apiece.
For months, though, the company has been struggling just to survive. On June 27, Nasdaq told Saf-T-Lok that its first quarter earnings report put it in violation of the SmallCap market's minimum listing requirements. The company spent only a few weeks actually below the requirements because it moved aggressively to raise cash by selling shares and issuing convertible debt in private placements under the controversial Regulation S clause of the securities code. Gardner said the company now meets the listing requirements, but that Nasdaq still has the authority to delist the company. If that happened, the stock would trade on the OTC Bulletin Board. Nonetheless, Gardner said he spoke with Nasdaq officials Friday afternoon and that, contrary to the earlier Bloomberg News report, he remained hopeful that Saf-T-Lok will be able to reach an agreement with Nasdaq and avoid being delisted.
Still, the cash crunch has already led to significant share dilution. As of August 7, Saf-T-Lok reported about 6.2 million shares outstanding, not including one million shares issuable to Chair Franklin L. Brooks and 600,000 shares issuable to former CEO Robert L. Gilbert, based on options exercisable at $2 a share. (Gardner confirmed the Bloomberg report that Brooks sold 68,000 shares on Thursday, about 4% of his total holdings including options. He said he knew of no other company official who had sold shares last week).
In the past few months, the company has issued $750,000 worth of 8% debt that converts into equity at a 30% discount to the average market price of the stock during the five days prior to conversion. Gardner didn't have exact numbers, but he said about half of this debt has now been converted into stock at about $0.70 a share, which would amount to another 500,000 shares. That effectively brings the share count up to at least 8.5 million, giving the company a current market cap of $38.8 million, or about 579 times annualized six-month sales.
While the recent agreement between the Clinton Administration and the leading gun manufacturers seems likely to have some positive though secondary effect on Saf-T-Lok, evaluating the possible impact is really a guessing game without many clues. Moreover, the company still needs to shore up its financial position. Gardner would not go into details, but he said the company is putting together a two-step financing deal. The stock's recent rally suggests there may never have been a better time for Saf-T-Lok to seek financing. Nonetheless, until the company can deliver solid sales and, eventually, perhaps even earnings, investors speculating in these shares seem likely to be shooting in the dark. And that's hardly a safe way to go about investing.