DAC’s products can be categorized in four broad groups: gun safety, gun maintenance, personal security, and non-security products. In the gun safety segment, the company markets and sells twelve different gun safety locks as well as five security and specialty safes. In the gun maintenance segment, the company markets over thirty-two different gun cleaning kits and rod sets. The personal security segment markets four different electronic security devices: Body Alarm, Key Alert, Glass Window Alert, and Patient Alarm. The company’s non-security segment markets the Clampit Cupholder and Plateholder as well as the Sportsman Lighter, three meat processors, and a portable light for ATV’s.
As you have probably already gathered, this isn’t a very exciting business. In fact, I’d argue it’s a pretty boring one. However, the valuation and operating momentum makes the situation a lot more exciting. The company maintains a solid balance sheet and rather consistently grows operating figures. According to the most recent 10Q, the company’s current assets easily cover the current liabilities and the company holds a solid cash position and no official debt.
For the first six months of the year, DAC recorded $5.48 million in sales, $1.94 million in gross profits and $770,500 in operating income. This compares to $4.53 million in sales, $1.62 million in gross profits, and $655,000 in operating income for the comparable period in 2005, respectively. This represents a 21% increase in sales during comparable periods with remarkable consistency in operating and gross margins.
During full year 2005 (10K) the company achieved positive operating cash flow of $102,000. While this might seem like a small figure (and it is) it is rather significant considering the company lost $400,000 in operating cash flows during 2004. Much more importantly, the company earned $372,000 in operating cash flows during the first six months of this year compared to only $125,000 during the same period last year. In addition, the company added (retained) $225,000 in cash during the first six months of 2006 versus just $45,000 for the comparable period in 2005. Most amazingly, though is the fact that operating cash flow for the second quarter of 2006 increased operating cash flow to $440,000, up more than tenfold from $43,600.
During the last twelve months the company has done $14.3 million in sales (vs. $10.9 million in the year prior same twelve months), $5.05 million in gross profits (up from $3.95 million), and $2.3 million in operating income (vs. $1.85 million). In addition, the company has increased EBITDA to $2.38 million from $1.93 million.
That’s some serious operating momentum. But that must come at a price, right? Wrong! The company’s current enterprise value is $13 million. Therefore, you are getting this incredible operating momentum for 5.5x EBITDA, 5.65x operating income, and less than 1x sales. While this is cheap, it becomes even cheaper when considering some of the company’s competitors. It is hard to find a peer, so I’ll be the first to admit these are certainly not perfect apples-to-apples comparisons (these companies are much larger and only operate against DAAT.OB in one or two of their segments), but they are still useful to put things into some context. Smith and Wesson (SWHC) currently fetches 24x EBITDA and 3.5x sales and Alliant Technology (ATK) fetches 9.5x EBITDA and 1.2x sales, despite the fact that the company has a more levered balance sheet and slower operating momentum.
As mentioned in the introduction of this post, I hold two key concerns about this stock: related party transactions and revenue concentration. All of the issues regarding related party transactions that I will speak of relate to the company’s current CEO, David Collins, and can be found in various parts of the 10K. When applicable, I’ll try to source my comments with a page from the 10K.
First, the company maintains an executive office in the CEO’s private home. While this isn’t a concern in itself, it is concerning that the company needs to lease this “office space” for $5,500 per month (P. 14) when, in reality, it probably serves as his personal office. In addition, the company has loaned Mr. Collins money no interest. According to page 26 of the 10K, the company has loaned about $100,000 to Mr. Collins directly as well as $72,500 to his (wholly owned) consulting firm, DAC Investment and consulting. Lastly, the CEO seems to be charging the company $60,000 per year for his consulting services, according to page 16 of the footnotes in the 10K.
It’s pretty scary when you find the CEO leasing his home office to the company, when the CEO has extended non-interest loans totaling more than 1% of his company’s market capitalization, and even more scary when the CEO is getting paid $60,000 extra via his consulting firm to run the company. This is all on top of his 2005 salary of $120,000 and bonus of $391,000.
When I tried to contact investor relations Thursday night the office was closed and on Friday the Investor Relations person was not in the office. If I had been able to reach an IR person I’d be able to quote the company’s reasoning for these issues.
A last concern is the company’s concentration of revenue received from Wal-Mart and Kmart. According to page 6 of the 10K, these two brands represented 57% of DAC’s sales in 2005. Therefore, a loss of either client would obviously be devastating for the company.
It’s quite obvious DAC is cheap, but is it cheap enough to justify the governance and concentrated revenue issues?