Paragon Technologies, Inc. Q4 2007 Earnings Call Transcript

| About: Paragon Technologies, (PTG)

Paragon Technologies, Inc. (PTG) Q4 2007 Earnings Call March 18, 2008 11:00 AM ET

Executives

Leonard Yurkovic – Acting CEO

Analysts

Chris Fox

John Sabo – Point Rich Capital

Ryan Lamberson

Jim Lewie

Dave Kova

Pat Hansel

Operator

Good morning. My name is Kerri, and I will be your conference operator today. At this time, I would like to welcome everyone to the Paragon Technologies Reports Fourth Quarter and Year-End Results for 2007 Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions) Mr. Yukovic, you may begin your conference.

Leonard Yurkovic

Thank you, Kerri. Good morning, everyone, and welcome to the teleconference. As usual today, I’ll be making some forward-looking statements within the context of the relevant security laws. Actual future results may vary significantly from those projected or implied for numerous reasons, including those cited in the Company’s reports on forms 10-K and 10-Q; and of course, the Company assumes no duty to update these comments made today in the event of changes in the business outlook or expectations.

I’m going to open with the comments on the financial side included with the news release issued earlier today. Since the upfront there was the balance sheet and of course our balance sheet is very strong with no debt, about $12 million in cash, about $12 million in working capital, and about $12 million stockholders’ equity, current ratio of 3.08.

On the P&L fourth quarter and 12 months, our expectations were for higher volume. We’re disappointed in the results, and I’ll speak to both of those particular periods.

The net sales in the fourth quarter of $4.5 million were up 28% from a year ago; however, they fell below our expectations. We had some slippage specifically one for the army MR fees that, MR Wraps as they call, M Wraps. They did a delay or stoppage on activity they’re involved with, cut their production in half, so the bigger part of the fourth quarter was the loss of the revenue. We were expecting it much higher. At $4.5 million, if you annualize that, that’s something just about an $18 million pace. You can see for the year that we operated about a $21.5 million pace.

For the year, the $21.5 million was about 21% over the prior year. Again, that fell below our expectations and mostly because we got hurt in the fourth quarter with the job involved with the orders. Some projects that were in process have flipped over and I guess the good news and the bad news situation is that that has increased our backlog along with buying from the previous period when we were $5.9 million backlog at the end of ’06. The backlog at the end of December is $7.9 million, and that implies a fairly good run starting the year in our first quarter with a higher backlog beginning.

The net income was flat in the fourth quarter and the profits were $340,000 of net income. In the news release we pointed out that significantly the business did not do as well operationally but we had a significant impact on the tax statute that expired from several years ago and has been returned and been put forth into a net income environment.

Noteworthy in our operations in sales and I’ll make some points in a few areas that international sales were quite high compared to prior years. We had about 30% of international sales involved in our revenue. In our past years, that has averaged maybe 5% or 6% in the two pervious years. We had operations in sales associated with Finland as well as in England and in Mexico. I think that the difference also is there’s been a swing and it’s unusual one and it’s best understood by defining the production assembly groups and the auto fulfillment groups.

We are the largest supplier in the production assembly groups with our LO-TOW product. We are the leader. But essentially that business was flat between ’06 and ’07. What was encouraging is this is that our order fulfillment business really doubled from the prior year and was double the, in the current year was also doubled, the LO-TOW business or PAS.

We have… That marketplace is the high growth market and I have to say this is most unusual as the first time it exceeded that other business units profitability as long as I can remember. That business has the systems integration, has a lot of resale contents that tends to a lot more volume to generate profits. We’ve put in significant software development effort. As mentioned in a previous meeting, we have added salesman in that group, are doing promotions, attending more shows.


We have gone forward with joint venture partners in voice activated voice recognition. We have put money into the DC Accelerator which is software slotting for order fulfillment, and we have engaged and accomplished a fair amount of customer response or development. So a lot of activity in that high growth marketplace, but we have it profitable as a standalone business unit but not obtaining the profits that we would like to see.

I won’t go through specific customer names, many of them you’re familiar with. The one in Finland was BRP is in the order phase during this quarter. Vistakon and the contact lenses has been strong. General Motors has done work out in Mexico. Maybelline, John Hopkins is a player looking for their next installations coming up here in the first half. But typical ones: Caterpillar, Walgreen, BMG, Sony, Goodyear, Wal-Mart, Harley, Office Depot are all intertwined at various stages, and I won’t go into great detail about the orders except to say that the backlog is strong.

I can’t see anything today that from the quote rates, they remain high. There’s 700 million out there in the firm category and the firm and closed budget category. We generally classify quotes in a lot of different ways. One is ballpark budget. But I cannot see a change in the pipeline. In fact, I’m encouraged by the pipeline that’s increasing. There is hesitation out in the marketplace and I could see that there’s second looks at jobs and I think that we have to plow our way through because everybody’s aware. There’s some economic situations, and the capacity utilization put out by the Federal Reserve has moved into a flat category. We’ve watched that fairly closely.

But I can say today that I don’t see activity that would preclude are having a profitable first quarter, especially starting with a $7.9 million backlog. As things are shaping up and looking like I cannot determine totally the second quarter in the second half, but have to remind folks about the fluctuations in the business. In ’07, we had a $3.6 million first quarter, in revenues now, $3.6 million the first quarter, $6 million the second quarter, $7.2 million the third quarter, and $4.5 million in the fourth. I constantly have to remind, of course, newcomers to our stock and our business that we have wide fluctuations. This is a cyclical business, and quarter-to-quarter does cause a fair amount of angst, and that’s understandable. When we look at our strategic aspects of it, we continue to try to seek aspects to mitigate some of the capital good cyclicality that is involved with our business.

The quarter, during the quarter, well market (inaudible), I’ll just explain that. We continue to see the strength in the health and beauty aides. They tend to not be too affected by the entertainment business but somewhat. The entertainment business and the… I said that wrong, affected by the economy. The entertainment business the same way. Over in the small vehicle assembly, the job in Finland that I spoke about is for snowmobile, so we have small vehicle assembly continues to be a good marketplace. Some questions in the automotive and appliance, as always, I think they are running very close and very tight, so I think those activities probably will be less viable as we go forward in the year.

During the quarter, on the stock repurchases, we purchased no stock in the fourth quarter. During the year last year, we bought about 100,000 shares at about 5.68 a share. Must of this isn’t going to be in the 10-Q released shortly and you can get into (inaudible) along those lines.

Strategically we have exchanged and been engaged and then heavily engaged with numerous firms as we have explored companies that are both synergistic and accretive.

We have tempted to look, we have not been overly aggressive acquisition mode, but we have looked at companies that were similar to our businesses and profitable. In a way what we found out is that with synergistic companies, it was not, they were not accretive and I didn’t think it was appropriate for us and our Board to not think so to aggressively go after activities that would not add to our income.

We have done due diligence on companies during the year, and they on us; we on them. They continue… Financial firms continue to show strong interest in the Company, especially from our technology-base and our financial strength on the balance sheet.

We continue to proceed on an organic growth posture commensurate with our financial strength. But it is inevitable that the Company will eventually have a restructured equity to take advantage of its technologies. We have difficulty in doing all we think we could do, should be doing and of course trying everything we can to maintain and control our expenses to provide sufficient profitability.

The Company’s looking at reverse mortgages and looking, reverse mortgages are qualified, reverse mergers and attempting to mitigate any of its public cost. I have had questions over the course of time in valuing the Company and the like and as most people know, the question comes up constantly about the fact that we maintain about $12 million in cash. Well most of the people who are valuing the company or looking at are basically starting with an EBITDA and a multiple and then adding the cash. Of course our cash is currently, as we speak today, worth about $4.38 a share; and the stock at the moment is not selling a whole lot of above that, which implies that all this activity and customers and (inaudible) is worth much more than the dollar share as it’s being traded in that marketplace.

I think that overall just conclude, and I’ll give you an advance to you that for questions to let you warm up to them, but I will say this is that from a vision standpoint and strategy standpoint, we can, we are redirecting to a strategy driven operation as opposed to customer driven. For many years we were strictly reacting to customers and their needs. We are reorienting all of our software, reorienting activity to the strategy which is to penetrate a marketplace that is very large. Addressable market is about $68 billion. We actually only have about 3% of that, so there’s a lot of marketplace for the Company that will never saturated by what we can do.

We have enhanced our development team efforts and will continue to do that through partnerships, joint ventures. We have had very successful ones in the past and of course organically and we will focus on next generation software. The base is, the software base, in March previous technology base is we really have to bring them up to speed to modernization. We’re getting wide and good acceptance in the software area, so I think we have to continue to put money on, at the same time maintaining good profitability which is of course a challenge. But I had mentioned earlier, the same goes with mitigating the capital goods cyclicality. This is very, very difficult because of the quarterly reporting but I think we will have the same kind of fluctuation in the four quarters coming up, a strong first, potentially could be a strong second, I’m not certain, but the pipeline is not been diminished. I might point out that from the foundation standpoint that the company has committed long-term employee has a lot of solid customer relationships. Many of them repeat for many years.

Our repair business is up significantly. Our service business, and it’s really in the software area where we continue to take contracts which will provide software support 24/7. We have a deep market analogy in the Company. We are highly respected with the name, and we have a tremendous amount of expertise. So really along those lines, I think our goal in here is to continue to work the growth potential, attempt to solve the neutralizer cyclicality issue and maintain our financial strength so that we can go forward.

Let me open up the floor now and ask Kerri to come back on to start taking questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Chris Fox.

Chris Fox

Hi Len, how are you?

Leonard Yurkovic

Good.

Chris Fox

Just a couple of small items first. I just wanted to be clear, so you bought no stock in the fourth quarter, so the shares outstanding now are the same as they were as the end of third quarter.

Leonard Yurkovic

Yeah, I think the shares outstanding at the moment are 2,740,000.

Chris Fox

Okay, 2,740,000. Then I had an operational question which is: In terms of the projects where there’s been slippage, I was just curious what categories were those in, perhaps maybe auto.

Leonard Yurkovic

Automotive. The Army project, they’re making the vehicles for marines over there and they start and go. As always with the government, they can do things. I think that most unit production assembly, no stoppage at all that we see in the auto fulfillment business and the distribution warehouse and distribution and that all whole area. Almost of the slowness appears to be in the production assembly areas and that’s with the large aspects like General Motors that has done some slippage here too we see.

Chris Fox

Right, but you’re confident that…

Leonard Yurkovic

But I might mention, I might comment, Chris, that when we see some slowing, it really means that they’re pushing the production along. We operate on percent completion but it does affect our revenue in the fourth quarter when they start sliding some things into the first.

Chris Fox

Right, and I was just going to say, you’re confident that slippage is not going to be cancellation.

Leonard Yurkovic

That’s right. I think that what we may have seen is a drop in the size of the order in the case of the Marines, but in the case of some of the others that have affected their revenue which I said we were disappointed on, we saw some slippage of projects that moved onto the first quarter from the fourth.

Chris Fox

Got it.

Leonard Yurkovic

You do a lot of projects. I mean you’re doing not only the making the product made, but then you’re out there with installers and there can be slow ups on that till they really want these things running. So I think there’s just a general caution period that we’re starting to sense.

Chris Fox

Yeah, well, I guess it’s not surprising given what’s going on everywhere, right?

Leonard Yurkovic

Yes.

Chris Fox

I wanted to talk to you about the strategic thrust that the company, and I was happy to hear that as you looked acquisitions and you saw that they did, the ones you looked at were non-accretive that you’re not going to forward in that, I applaud you for that. As far as you guys possibly being acquired, I was just curious where we kind of stood on that. I think in the last conference call you said kind of similar comments to what you just said a few minutes ago about how there’s definitely active interest from financial firms among others. So I was just curious if I could give us a little bit more of sense…

Leonard Yurkovic

Yeah, there are certain things that of course I’m under non-disclosure agreements and the like. But I have to say that during the course of year, things moved into, you know these things move into expressions of interest, even letters of intent. They don’t become binding until you get a price locked up and do releasing. So without going into that whole bit, I think that clearly attraction from the companies I see is our strong balance sheet, our cash position because many of them do not have strong balance sheets and cash positions and our technology base and whatever so that there are various ways that I said several times that it’s very, very difficult for us to maintain our level of equity, our structure here as a public company and that there’s nothing wrong with a public company but we need to get some size in one form or the other. We are active with the firms and when we say strategic firms, of course, these are companies that can have a one-plus-one equals three because we make sure salesman marketplaces (inaudible), and I have to say that we’ve had those in of course the past year and more recently came very close with one. As far as the financial investors, there continue to be a fair amount of financial firms that are interested in looking at the Company again from its strength and our technology base, and time is (inaudible)… because you don’t get the multiples with financial firms that you do with strategic buyers. But to point out that we’re very open to the (inaudible) in the business.

Chris Fox

The one that you came close with the strategic firm, what was, again, without knowing the name or any…

Leonard Yurkovic

Well I can’t share those numbers on that because…

Chris Fox

No, I don’t mean numbers, I’m just saying but was kind of like the general problem or issue, was it a financial numbers kind of issue or something else or…

Leonard Yurkovic

Well I think it was a due diligence issue and one in a like in that they… We also have to do diligence on the firm that is engaging, so we’re both doing due diligence in the process and as a result of that, I think we just couldn’t come to terms. Many times these resurface at a later time. I’ve seen that happen time and time again. I guess my only point in here, Chris, is there we are not sitting idle without looking at activity such as that. But I think that some time it’s one where people may view the stock price as being, let’s face it, the stock is selling at this moment at $5.23 and we have $4.48 or something close to that number in cash. Well we’re aren’t doing the shareholder any favor by selling the stocks somewhere down around the level, so any expectation down at that level to do a deal are just out the window.

Chris Fox

Good. I mean that would be crazy. Right here you’re doing…

Leonard Yurkovic

That’s for sure.

Chris Fox

…in sales and you’re enterprise value is $1.8 million or thereabouts. So any thought to possibly buying stock if the stocks…

Leonard Yurkovic

Yes, I think there’s a point in here, we go into dark periods, which we’ve been in. When we get close to a period before a news release such as today, we’re not allowed to purchase stock, also if we’re into a closeness on an activity level that will cross the point where counsel will say we cannot trade stock. But at the same time, we are not stopping the idea of purchasing back stock. We believe it’s a good buy for the shareholders, we’ll be purchasing stock.

Chris Fox

Are you working with an investment banker?

Leonard Yurkovic

Well we are engaged and looking at three, but we have already had input from investment bankers and probably will go forward with one. But I think that we have… If we engaged fully, that would require public announcement, and we haven’t reached that point.

Chris Fox

Why not? In other words, it would seem to me that you’re far along in your thinking that if I may be so bold as to say, “You should be.” In other words, you said to recognize that a $1.8 million enterprise value for a company doesn’t make any sense and that even acquiring another company half again your size is still not going to take care of the problems that you’ve outlined in terms of all the public company costs. I mean if public costs are a million dollars for you guys, that’s a $0.40 a share. Right? I mean it’s a huge number based on…

Leonard Yurkovic

Yeah, I shouldn’t leave you with the impression that we’re not engaging an investment banker. We are selecting and looking at that as the next methodology. One of the difficulties of course is that when we have earnings such as the fourth quarter, the timing of what we do, we see that (inaudible)…

Chris Fox

Len, I didn’t hear that; I heard a bunch of clicks. I didn’t hear your…

Leonard Yurkovic

Is somebody on the line? Kerri, can you pick up there?

Operator

Yes sir. I believe the clicking is coming from your line, from Mr. Yurkovic’s.

Leonard Yurkovic

Are we okay now?

Operator

You’re okay. It happens periodically.

Leonard Yurkovic

Go ahead back on, Chris.

Chris Fox

Yeah, and I’m sorry, Len, I didn’t hear your last response about the idea…

Leonard Yurkovic

I didn’t want to leave the impression that we are not engaging and looking at the investment bankers as a possibility of next step. We had some difficulty in saying when the earnings are down pretty far, it takes, people tend to get engaged who want to get engaged at the level and we think that might be a little too early timing.

Chris Fox

I see. Well I’m hearing the right things from my perspective when in terms of your orientation and how you’re kind of looking at things, and I also hear what you’re saying about engaging right at the moment maybe a perceived weakness. But what I’ve seen in my years of experience is sometimes these things can kind of drag on for a long, long time and it probably doesn’t serve anyone’s interest that much to do so over some long period of time.

Leonard Yurkovic

Your comments are appropriate and we’ll certainly talk at the Board level. I tend to fell the same. I think this is the year we have to reengage. I use the term restructure our equity.

Chris Fox

Right. Just one more and then I’ll get off. You said looking at reverse mergers. When you said that, I’m assuming you mean a sale of a Company.

Leonard Yurkovic

Well that would happen in the process, it would be a company probably larger than we are. It doesn’t say it wouldn’t be a public company; it merely says that they may be of more size and it can go several ways as you know.

Chris Fox

Well thank you so much for your time, Len.

Operator

Your next question comes from John Sabo.

John Sabo – Point Rich Capital

Hi, it’s John Sabo from Point Rich Capital. Thanks for taking the question. I wanted to explore this comment that you made about the international being a bigger component of, did you say it was the sales or the orders?

Leonard Yurkovic

Well both in a way, but it was the sales. I had looked at the numbers for the international sales for the year ending 2007 and they were 30% of our sales, for the year ending ’06 they were 5%. So there were a significant amount of sales for us that we haven’t seen in a long. Of course the dollar value versus the strength of the euro and others is affecting that for sure.

John Sabo – Point Rich Capital

Right. I guess I was a little surprised to hear that because I think maybe a few quarters ago I had asked you this question and you indicated, I believe, that this was primarily a domestic market and that there was some structural differences in the market in Europe, for example, that would make it less attractive for a U.S. partner and a U.S. partner to kind of attack the market together. Is that still the case and you would sort of view this as a big of a one-off or…

Leonard Yurkovic

Let me help you out with that. I think that comments I made at that point would be associated with attacking the market for fresh customers. I might point out that a lot of our international businesses because the companies we deal with such as BRP, have been proven customers here who tell their international operations, “You need to get this.” So we are selling… General Motors we dealt with for years, Vistakon contact lenses we put up millions of dollars in their European operations, so a lot of our affiliates of U.S. companies who want their international operations to do the same thing. We do not go directly into the marketplace with direct selling or cold calling, and I think that, John, that the comments I made before were to engage in marketplaces where the competition is pretty stiff and you would have to crank up your whole marketing advertising sales promotion effort and whatever. These sales are coming from affiliates and relationships or closeness to American, our customers here are a wide base, very large base so they’re really directing their international operations.

John Sabo – Point Rich Capital

I think the question that I was asking at that time was maybe related to the strategic question that you’ve talked about at length today and in the past and that is: Is there an international partner that would make sense for you strategically where you could leverage some of that engineering expertise or you could get the benefit of another company’s marketing expertise? I mean as you grow these strategic options, is there an international component to it?

Leonard Yurkovic

Yes, very much so. In fact, we were engaged with one in the past year and that was some company that would be in the industry with presence of stock capability. So we get engaged and are looking for those because those are very good relationships. We run a operation here and they run a operation there represent potential opportunity. So we tend to want to look at those very closely because they represent a good opportunity for us.

John Sabo – Point Rich Capital

On the share repurchase, did you elect not to purchase in the fourth quarter because you were blacked out due to some of these conversations?

Leonard Yurkovic

We were in a blackout period at that point.

John Sabo – Point Rich Capital

Maybe just to build a little bit more on Chris’ questions, I think about this time last year you said you would be surprised if the company still existed in its current form. Here we are a year later and you’re still sort of exploring these strategic opportunities. Again, I would applaud you as well if you’re looking at things that done make sense from an accretive standpoint that certainly makes some sense. But over the course of the year, the economy has worsened and the availability of financing has probably worsened. The delay put us at a point where maybe you’re not in as strong of a position as you were a year ago. How do you think about that and would you agree with that characterization or just sort of how would you put that in context of where you’re likely to go in 2008?

Leonard Yurkovic

Yeah, I would put that in context that if the operations that we looked at and looked at us were in a good fit, that would be the principal issue. I really would be very reluctant to just seek a company, especially one that would be shoring up on an acquisition basis during a period when we’re heading into a questionable economic one; therefore, let’s call at caution. But I think that we were probably held back and slowed down by the basis that it had to be a good fit when we said both synergistically and accretive. We’ve opened that valve of synergistically, but certainly still feel that accretive. Many companies that we looked at effectively had negative net worth. I mean they had technologies that were interested and there we sat with the both end as well as a lot of cash. So if they have a good technology, we would work that; but if it was such a drain on earnings as a public company, that causes us some difficulty of course.

John Sabo – Point Rich Capital

I guess you could make the argument that the Company’s performance fundamentally improved during the year so that puts you in a better sport. But would you say that a sale of the Company as opposed to an acquisition of another company would be the more likely outcome at this point?

Leonard Yurkovic

Yeah, it would be hard for me to comment on that because of course we have a Board that would have different views and would have to work that very hard. But I say this is that we’ll have an active period for sure. If in fact there’s a deal that is appropriate for our shareholders, we would recommend it and move forward on it in either case. I think that we have to take the position that our directors are very committed to enhancing shareholder value and it sounds like motherhood in the Marine Corp but I think the reality is that we aren’t in such dire straits that we need to work on a deal that is going to be effective for the shareholders.

John Sabo – Point Rich Capital

Then could you just help me out with an approximation of what the public company costs were for 2007, just sort of ballpark?

Leonard Yurkovic

Yeah, I can give you some approximation. This is a little difficult in the… The difficulty occurs after so many phases and numbers that are associated with it. But I can tell you this is that the public costs kind of approach post a million dollars, but I think that some people say, “Well is that your Board of Directors?” and the answer is no. Of course you have a Board of Directors, we maintain that down at five and try to keep that at a minimum. But I think we also run into the Sarbanes-Oxley cost and they’re significant. Directors and Officers and liabilities have changed so they’re very significant number. In fact, our directors’ cost, that is the expense of our directors, and of course I’m one, but I’m not a paid director in the Company, so we’re really only have four paid directors. So our directors’ cost is not the biggest one. The biggest play in here is of the aspect that of course if you’re looking at projects, you’re going to have legal costs; you’re going to have accountants’ costs. As you know, we’re required to have an outfit called Control Systems out of the auditor so it really is accounting cost and a lot of those areas that have impacted us. So many people that are looking at the Company, if it were private, effectively you can approach $1 million and to multiply that by a good multiply and add to that cash and you got a different valuation excluding any earnings.

John Sabo – Point Rich Capital

Right. Then would that million include costs that you may have incurred to evaluate some of these strategic…

Leonard Yurkovic

Absolutely. There’s legal costs on that. There’s no disclosures that have to be cleared. You reach a point there you’ might even approach a deal. You’ve got to engage to be sure. So yeah there’s no question about it, so a lot of those costs are associated with the strategic alternatives, yes. The reality of the businesses is that the business units themselves, the order fulfillment and the production assembly are profitable businesses. Both of those had a good profit last year and I think what we do struggle with is to get a boarder base in the business and get more muscle on the bone.

John Sabo – Point Rich Capital

Right. I mean just from my standpoint, it appears that you have a nice business albeit a bit of a niche business but one that has some potential, that is probably not going to get maximized given the current sort of size of the Company.

Leonard Yurkovic

That’s a correct assessment.

John Sabo – Point Rich Capital

You have a very nice balance sheet. You’re well capitalized, but again just the overall size, it’s going to be difficult for you to completely capitalize on your opportunities. So would you still say that you think, is it unlikely that we’re going to have the same conversation a year from now?

Leonard Yurkovic

It’s not likely that we’re going to have the same conversation a year from now, let me say it that way, and I maybe make it in stronger terms. We are not going to have the same conversation a year from now that we’re having now. First of all, I love (inaudible) if our earnings are up about triple or whatever but separately regarding strategic aspects, I don’t think so. I think that we need to redirect. Restructure the equity is a term I use because I think that’s what it means.

John Sabo – Point Rich Capital

Then just one last question and I’ll get off. We talked a little bit about this international opportunity and you mentioned a little bit of hesitation among some of your clients given what’s going on with the economy, given what’s happen to the dollar and potentially what that may mean for the competitiveness of the United States’ manufacturing base, do you think this may lead to actually more market opportunities down the road to the extent that maybe manufacturing starts to make a bit of a comeback or is that maybe just too long of a lead time for you to have any…

Leonard Yurkovic

No, I think this that we are, as I mentioned, in the production assembly business, we are dominant. We are the leader and that has relatively been flat last year, but I think that we move that technology into small vehicle assemblies – golf carts, snowmobiles – areas that we were not dominant many years ago and away from automotive and that aspect. So that I would say that given the level of things, we really should… It would suggest that product made here and being appropriate for movement outside the country is attractive because of the low dollar, of course.

John Sabo – Point Rich Capital

Right, but are we exporting many of those snowmobiles or is that…

Leonard Yurkovic

No, what we’re doing is that we’re providing certain amount of that, but we may use assistance for installing. But yes, we’re building him here in the United States and sending them out. That was true for Mexico too and it was true for England. We are basically building the product here and shipping it. However, there’s installers; there’s a whole bunch of things that go into the cost of sales that are not, they just appear manufactured pieces.

John Sabo – Point Rich Capital

Thanks, and good luck. I’ll look forward…

Leonard Yurkovic

Well thank you very much.

John Sabo – Point Rich Capital

Yeah, I look forward to hearing about your progress this year. Thanks.

Leonard Yurkovic

Good enough.

Operator

Your next question comes from Ryan Lamberson.

Ryan Lamberson

Hey Len.

Leonard Yurkovic

Hi Ryan.

Ryan Lamberson

Most of my questions, really all of my questions have been answered and most of the points that I would’ve made have been made. I really just want to reiterate that you need to move this strategic alternatives process along in a timely fashion. I mean it’s just dragged for so long and it really needs to be resolved in short order.

Leonard Yurkovic

I agree with you.

Ryan Lamberson

Thank you.

Operator

Your next question comes from Jim Lewie.

Jim Lewie

Hello Len. How are you?

Leonard Yurkovic

Good.

Jim Lewie

Len, the only thing I have to stay in addition to what already has been said is just simply that, again, as far as the interest of the Board versus the interest of the investors in that the Board, my understanding at least, many on the Board, or particular people in the Company aren’t big stock owners. They can continue to in this fashion without getting hurt because they’re getting paychecks; they’re getting salary. The concern it seems is not as much towards the shareholder as it towards their ongoing business and their continued employment. I’m just wondering if you have a comment on that. What is the ownership of the employee and the leadership other than the Board?

Leonard Yurkovic

Well the ownership overall in the Company is… I’m not sure I have a detail on here, but…

Jim Lewie

But the leadership, people who are currently the president.

Leonard Yurkovic

Yeah, it’s not a high level of ownership.

Jim Lewie

It’s not a high level of ownership, and that I think is a critical aspect of this thing. Let’s get the… If they believe their value is significantly higher than where they currently are sitting, then they should take ownership in the Company and send example to the rest of the shareholders that they have a strong interest in seeing, one, that it’s a great investment at this level, and if they have a strong interest. I mean I’m sure people (inaudible) if they’re doing a great job have the discretionary funds to go and buy some stock, especially if it’s this cheap, and I’m not seeing it. There is a real difference in what I’m hearing and what I’m seeing and that could be the critical difference.

Leonard Yurkovic

I understand your points.

Jim Lewie

But is there any comment on any move towards…

Leonard Yurkovic

The Company itself, typically internal people as a result of stock options and the like accumulate positions which they hold, which I did over many years and still maintain a position of significance. But I think that we did not approve last year at the shareholders meeting a stock ownership plan or stock plan. Last year because we didn’t make money, there were no bonuses. There were no salary increased in those types so… I’ve been running that type. The way internal people acquire, because they’re usually working people with families is through stock options and the like. We don’t have any significance out there. I think that, the other aspect of Board members and the like, we have requirements that Board members, especially newer ones, accumulate stock over a period of time and we are encouraging that at the Board level so that there is more participation. But I’m well aware of the issue and make it every time when we discuss it at the Board level.

Jim Lewie

I just think that would certainly give us and its shareholders greater confidence than the direction that you’re following as opposed to the status quo as the status quo seems to be… I mean you’re staying in business. You’re an ongoing concern and people are getting the salaries. As much as I appreciate people getting paid, investors need to get paid or they’re losing interest and that’s why you’re seeing stock trading $1.30 or $1.00 over cash.

Leonard Yurkovic

Your points are well taken.

Jim Lewie

Thank you, Len. I’m done.

Operator

(Operator Instructions) Your next question comes from Dave Kova.

Dave Kova

Hey guys, just had a quick question for you. I understand obviously there’s quarter-to-quarter volatility in your numbers. You did make some comments that because some of slippage, some in the Q1. Should we expect to see revenues up from this fourth quarter level?

Leonard Yurkovic

I think so. I guess even drop the I think so. I can’t imagine there would be slippage from the first to second because we’re running into delivery dates and we monitor this very carefully so that…I think that without first one here is that I have to say that we will be above the sales revenue because I think that backlog has to play up. There’s $7.9 million of backlog in there and a great majority of that has to work its way in the first quarter because some god delayed in the fourth and that’s by customers doing it. So I suspect that we’re going to be have a higher revenue quarter, and I don’t see some of the difficulties that we had in cost so I’m (inaudible) so far as to venture I can’t see why we wouldn’t have a good profitable quarter.

Dave Kova

Great. Thanks.

Operator

Your next question comes from Pat Hansel.

Pat Hansel

Leonard, yeah, my first time on the call. I had a couple of questions. I think I guess with Mr. Lewie’s comment about the shareholder, I agree with him but at the same token I think the Company’s making an concerted effort there to address them by having the Company buy back stock which I think is as good as you can get at this point. But on the sales mix, what about the software versus systems? How do you see that going forward?

Leonard Yurkovic

That’s the strongest area of growth. In fact, the one I’d mention at the (inaudible) business has doubled and that we’ve never seen that and for the first time as long as I can remember that business, and I’ll call it business unit has been more profitable in the production assembly business. The software is a big part of what we do. We have… In fact, it’s been an attraction from strategic buyers that are looking at us because of that piece. The good part is that we’ve accumulated an enormous body of software and we’re incorporating and upgrading that to the latest technologies and we’re in that process and we’re doing some of that in their development; we do some of that in their customer’s project development.

Software is a big part of what we do. We are moving to a product called the DC Accelerator. This allows companies, other companies than the traditional big ones, and I mean like Walgreens, CVS, BMG Music, Sony, and those who are very sophisticated companies and have been using our software. But we’re trying to do is to enhance and move that software to a broader base by slotting that, even do web slotting under security. The DC Accelerator, which we call is a product that’s been in development should be concluded here in the first quarter and we’ve gotten several out there. We have a lot of modules out there. We have probably 150 sites that have our technology, our software technology is called the SINTHESIS. So I do want to leave you with the impression that the growth in the business, and it surely showed up in the revenues this year where they doubled from, their doubling effect of the production assembly. As I said, that’s never happened I don’t believe. So I think that our direction is in that atmosphere and we really don’t want to slow down, even though it’s painful on the P&L and of the activity that is getting us into the arena because we have the sales people. We have the organization; we have the structure; we have the technology people and this is the piece that has the highest growth potential in the sophisticated material handling business.

Pat Hansel

What are the margins like in software?

Leonard Yurkovic

Well they tend to be about 50% plus. But when we look at an order, we may have, I’ll give an example. If you want to a Walgreen or a CVS warehouse or an Office Depot, a lot of our products certainly in the distribution of CD from BMG Music, so there’s a lot of resale product in there. Some of that resale product might be in our gross profits at 20% and 15% because all we’re doing is taking their product and putting it in with ours. We’re doing all this software to control everything in the business. But at our picking machines and the software itself, we sell that, put that in a margin and get over 50%. So that’s why we’re putting so much concentration on that piece of the business. That is the growth area for the Company, clearly.

Pat Hansel

Your sales people, is there, do they need to be trained to sell the software as opposed to what they’ve been traditionally selling as hardware if you will?

Leonard Yurkovic

Good question, and what we have done is that we’ve put on two salesmen in the past 12/14 months. The difference now is and I had to say it as opposed to our older salesman, is that these are folks that come in and can do layouts at the customer site by computer and then looking at his slotting and say, “How much Maybelline perfume is here, here, here and where’s it going?” kind of thing.

As a result of that, our people that we brought in are sophisticated to carry this forward. Now they’re already a year under the learning curve, that is learning our product. As a result, the calling on customers and analyzing their ability to use the technology is a very, very important part of what we have added people despite the fact that we saw soft year coming up because we believe that the growth in that area we should not stop effort, and we have been oriented to it.

We’re also attending shows where the software is emphasized with computer screens and the like. Here pending shortly is the North American Material Handling Show which we’ll be showing mostly software. So the product orientation is a thing of the past. We have, our products can be made outside even and we shut down our manufacturing here in case you’re weren’t aware of that and actually have it subcontracted because we have more orientation to the software and the high technology end of the business.

Pat Hansel

So I mean going forward, as your saying, your emphasis is going to be on software, I guess therefore the mix of your business is going to be going forward, it’s going to reflect more software sales than let’s hardware sales?

Leonard Yurkovic

We’re already doing that, yeah. We already have crossed that line, I think, and we don’t isolate the software itself because it sometimes communicating with programmable controllers in there and it’s very difficult to do. We can separate it when we have an order that’s nothing for software. We have many people like Walgreen and others where (inaudible) distribution centers and now we’re adding software to upgrade them to modernize their operation, so then we can identify the software as the sale. But other times it’s embedded in a $1 or $2 million contractor, so it’s pretty difficult to isolate. But it clearly is a seller. It’s an attraction and we have a lead position in our technology because we have very, very good software.

Pat Hansel

Would you characterize your software as an open platform or is this a platform that can, would only be used with your systems per se?

Leonard Yurkovic

I think this is that it can be an open platform. When I mention the use of the term DC Accelerator and that’s where you’re able to slot product, that can even go into a mom and pop operation. Now our history is with the big guys. I mean we have bid at a lot of players and we’ve done contact lenses of Johnson & Johnson which are in the millions, so that software has slotting which means you have to know where every product is and where it’s going. The slotting that we’re doing is to downsize it so that it can be taken and actually used on the websites for spotting any size operation and that will require coverage promotion and we’re getting into those phases, as we can afford it. So that’s where we’re headed.

Pat Hansel

. .

There’s a lot of scalability here is what you’re saying.

Leonard Yurkovic

Yes, there is, very much so.

Pat Hansel

Again, focusing on the sales, as you downplay the hardware end of it or you have that manufacturing done for you, therefore materials commodity, increases in cost are being passed through. I mean you’re not dealing with that necessarily.

Leonard Yurkovic

We’re dealing with that, but you can’t take a big margin on it. I mean what I’m saying is you might go into a plant and there’s carousels in there and certainly a lot of people make carousels. There’s also a conveyor in there and a lot of people make conveyors. We’ve got our own conveyor company which we sold, Ermanco, because it’s what we call a me-too product. We are less interested in that as far as… We’re more interested in doing the systems integration because that’s where the growth is and that’s where the money is and that’s where the software is. So when we have… We have our own products of course.

We have our A-Frame technologies and that and we sell those and we make a good margin on those. But even that product has direct competition and as a result but the competition can’t do the software that we do and that’s how we can differentiate ourself and that’s why we’re driving so hard to get the lead in that environment so that we can actually use a competitors’ piece of hardware and our software will run it.

Pat Hansel

So then we should see in ’08 at least if you were to have no growth in revenue, let’s see if you will, the mix of the business alone should show a better margins going forward.

Leonard Yurkovic

I think this but not a quarter-to-quarter basis. As you know, these things go up and down. But if you look year-over-year, I would expect to see a significant increase as we did this year which is almost a 50% increase in the order fulfillment business.

Pat Hansel

Right, and then on the competition here in the U.S., I mean is there anybody, any one company or a group of companies that you would say is your competition or is that primarily coming from overseas?

Leonard Yurkovic

The main competitor is from overseas, from Austria, and that is in the order fulfillment in our (inaudible) area. Our strength is that they can’t do the software we can. Their strength is that they have a nice machine. As a result, we actually could go in and use their machine and do the systems integration and tie the rest of the building together, and that’s the kind of potential that the Company’s looking at.

Pat Hansel

I mean to take that comment further, clearly if they’re looking for a beachhead if you will in the U.S., I mean I would think you’re jumping up and down waving your arms here we are.

Leonard Yurkovic

Well that’s right. I think that the attraction to the Company is actually in the software at many cases. We have very good hardware. We’ve made it for years and we were more of a product company. But our orientation moves away from about being a product company, a little bit, much more, especially in order fulfillment. You have to remember that in production assembly, we’re building a $1 billion plant that we’re going to be a subcontractor to somebody and there’s going to be less software. But what where we’re doing a distribution center, we’re the leader. We’re the guy they want because we’re systems integrating our stuff as long with others with our software.

Pat Hansel

So I mean if you had… If you looked at it from a feet, salesman covering the United States, you’ve got X amount now, what could really… If you added a number to that, what would really sort of ramp up sales without, by just adding salesman here?

Leonard Yurkovic

Well adding salesman, there’s more… There are various shows that people that are going to operate them and they’re new warehouses, they’re new people in the businesses. There’s a big marketplace and we constantly struggle with finding ways to address. We do a lot of (inaudible) shots that’s under the appropriate magazines that are read by the people that do this DC Velocity and other ones, so we have advertising pages in those. We have shows we attend. We put equipment there. We put software there. We have direct people calling. We have website that they can access and we’ve got a lot of follow-up by our sales people to the web access call. So I suspect that having been a little bit in this area, not a little bit, been in this area that I think that we’re covering the basis as to how to get the technology out there. What you have this particular year, certainly (inaudible) some hesitation and this always happens whenever there’s some slowdown, but I think that the bigger players do 10-year plans. They’re not worried about this year as much as they are going on their long-term plans to upgrade their operations.

Pat Hansel

I guess where I was driving with that is I mean the leverage here in your Company could be significant for the right company.

Leonard Yurkovic

Yes, I think that’s a fair statement. That’s a fair statement. I think the Company has…

Pat Hansel


I mean whether you require that company or whether you make an acquisition that’s strategic in that sense or it’s someone else that is looking to either gain more market share in the U.S., elsewhere in the Americas or what have you, right?

Leonard Yurkovic

Yes, that’s right, and I think we had activity in this past year along that line.

Pat Hansel

Thank you.

Operator

You have a follow-up question from John Sabo. Mr. Sabo, please go ahead.

John Sabo – Point Rich Capital

Sorry. Just a question about that Austrian company you mentioned as your competitor, what is the name of it?

Leonard Yurkovic

KNAP, K-N-A-P, K-N-A-P-P.

John Sabo – Point Rich Capital

Are they roughly the same size or…

Leonard Yurkovic


I think they’re bigger than us. They’re stronger, very strong in Europe.

John Sabo – Point Rich Capital

As I look at your income statement, I recognize this may be a difficult question but do you have an idea of roughly what it cost you to assemble the equipment? In other words, what percentage of your cost of goods sold would relate to assembly cost?

Leonard Yurkovic

I’d have to turn you over to my chief financial officer on that one. But I think that 75% of the product is in cost, 25% gross margins average let’s say, and I say that you got a lot of resale in there but of the manufactured product there’s… Software is a high percentage but I really don’t have those numbers at the top of my head except to say that we used to manufacture all our product, but with these wide waves we would find huge capacity issues so we basically have subcontracted to multiple subcontractors to manufacture of products. So we really operate with a high purchase part and very, very low inventories you’ll see form the balance sheet in the news release. We operate with… When we’re purchasing something for inventory, it’s going to a customer so we carry very little inventory and as a result that is entirely material cost. We have no direct labor content in the material side. We have a lot of direct labor content in the engineering side and in the installation side because our people doing direct work. But on the manufacturer side, we’re entirely having the product effectively drop ship. We’re going to the sites that are being made and having it cleared on the ISO 9000 rules to be sure it’s the right stuff and then it’s sent to the site and it’s assembled there by our people.

John Sabo – Point Rich Capital

When you say that you’re competitor has strengths in the actual machine and you have your strength in say software, the leverage if the two companies were to be put together would be that what, that you could save on the outsourcing of the machines that you’re doing now? But it sounds to me that you’d still need the labor component to assemble the machines at the customer site.

Leonard Yurkovic

That’s right. We still have a significant… Our installers will be able to put together all the pieces coming to a site. We have a significant installation and support operation.

John Sabo – Point Rich Capital

Is that SG&A or is it in…

Leonard Yurkovic

Cost of sales.

John Sabo – Point Rich Capital

Is it in cost of sales?

Leonard Yurkovic

Those people are only cost of sales, yeah.

John Sabo – Point Rich Capital

Maybe I’ll look through the K a little bit more.

Leonard Yurkovic

I think that the 10-K will be out fairly shortly. You could probably get a reaffirmation of some of the things we’re discussing here in certainly more detail.

John Sabo – Point Rich Capital

Great. Thanks again.

Operator

At this time, there are no further questions.

Leonard Yurkovic

Well let me thank you all for tuning in today and I’m expecting that the next time we get into a session that the numbers will look better. We certainly satisfied with these, but I think that I don’t think there’s any particular cause for concern and thank you very much for checking with us. Bye now.

Operator

This concludes today’s conference. You may now disconnect.

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