Tri-S Security Corporation Q2 2008 Earnings Call Transcript

Tri-S Security Corporation (TRIS)

Q2 2008 Earnings Call Transcript

August 13, 2008 10:00 am ET

Executives

Nicholas Chater – CFO

Ronald Farrell – CEO

Analysts

George Berman [ph] – GunnAllen [ph]

Mike Breard – Hodges Capital

John Goodwin [ph] – Goodwin Brothers [ph]

Benit Mustang [ph]

Presentation

Operator

Good day, and welcome to the Tri-S Security second quarter 2008 financial results conference. Today’s call is being recorded. Also today’s conference includes forward-looking statements within the meaning of Federal securities laws.

And now I would like to turn the conference over to Mr. Nicholas Chater. Please go ahead.

Nicholas Chater

Forward-looking statements are commonly identified by such terms and phrases as ‘should’, ‘expects’, ‘plans’, ‘anticipates’, ‘believes’, ‘estimates’, ‘projects’ and other terms with similar meanings, including potential impact on our business. Although we believe that the assumptions upon which such forward-looking statements are based are reasonable, we can give no assurances that these assumptions will prove to be correct. Important factors that could cause actual results to differ materially from our projections and expectations are disclosed in our filings with the Securities and Exchange Commission, including the ‘Risk Factors’ section set forth in our Annual Report on the Form 10-K for the year ended December 31, 2007. All forward-looking statements in this conference call are expressly qualified by such cautionary statements and by reference to their underlying assumptions. We do not undertake to publicly update the forward-looking statements contained herein to conform to actual results or changes in our expectations, whether as a result of new information, future events or otherwise. You may obtain and review our filings with the Securities and Exchange Commission by visiting http://www.sec.gov.

During this call, we may use non-GAAP financial measures, including EBITDA as adjusted. EBITDA as adjusted is calculated as earnings before interest, taxes, depreciation, amortization, non-cash stock based compensation, start-up costs on new contacts, and other income expense. We have reconciled EBITDA as adjusted to net loss in our earnings press release, which may be found on our Web site.

At this time, I would like to turn the conference over to Mr. Ronald Farrell, Tri-S Security’s President.

Ronald Farrell

Thank you Nicholas, and thank you everyone for joining us this morning for our second quarter conference call. Tri-S has made and continues to make significant progress on our objectives for 2008, and I remain more than pleased with our outlook going forward.

I will first summarize our highlights for the second quarter and the recent developments of our operating businesses, Cornwall and Paragon. Nicholas will then review our financial results for the quarter in more detail.

Let me begin with some highlights from the quarter in our business. Our revenue has increased by $16.9 million or 79% to $38.3 million for the second quarter numbers compared to the second quarter numbers of last year. This is all internal growth primarily related to 10 new contracts initiated at Paragon during the second half of last year and the first quarter of this year. As a result, we were able to continue the favorable trend in the first quarter 2008 positive EBITDA as adjusted.

For the second quarter 2008, EBITDA as adjusted was a positive $752,000, a significant improvement from a negative $771,000 a year ago. This is approximately $1.5 million positive swing. Our operating loss was reduced significantly to $60,000 for the quarter, down from

$1.9 million in the second quarter of last year, again a $1.8 million positive swing. I would like to point out that during the second quarter we incurred very few start-up costs on new contracts, since the majority of those costs relating to new contacts were incurred in the first quarter of ’08.

Overall, I am more than pleased with the momentum in our business as illustrated by the contracts we have been awarded since the beginning of the year worth approximately $372 million and the continuing improvements in our revenue and EBITDA as adjusted. We now employ approximately 3760 people in 13 states plus the District of Columbia. As of today, our headcount has increased by 45% since the beginning of the year.

Paragon continues to maintain its excellent reputation with the federal government and its momentum is still growing. Its pipeline of submitted bids plus anticipated bids for which we have been invited to submit proposals currently stands at approximately $612 million. In addition, we have now won at least one contract in each of the last 11 quarters, almost three years. I believe our success at winning new business continues to be a testament to the quality of our organization and the strong reputation that we have established with numerous agencies of the federal government.

Cornwall also continues to gain momentum as evidenced by its recent award of $8.7 million contract with the State of Florida. This is their first statewide contract. We believe Cornwall will continue to produce strong cash flows, and profitability will continue to grow with our increased focus on sales and marketing.

Our long-term goal has not changed, and is now really beginning to be realized. We remain focused on growing Tri-S organically and through acquisitions. And we are now within side of our long-term goal of building a $200 million plus company. We are currently evaluating opportunities available to us for possible private equity, our debt financing, recapitalization of our existing debt, and possible strategic acquisitions. We are committed to increase and enhance shareholder value.

To this end, we intent to offer to exchange our 10% convertible promissory notes due 2008 for shares of our common stock or new convertible promissory notes due in 2011, plus in each case warrants to purchase our common stock. We expect to commence the offer as soon as practical.

The offer will be made only to our existing noteholders and will be subject to terms and conditions to be described in appropriate documents, which we will file with the Securities and Exchange Commission on the date the offer is commenced. We expect to file within the next few days.

Today’s Tri-S [ph] ensure a strong security market for the long term and we continue to believe there are good opportunities through acquisitions as the market remains very fragmented. I am very pleased with our results for the quarter. And I can reconfirm our guidance for revenue for the full-year 2008 of $140 million to $150 million. This represents a significant increase of 57% to 68% over the 2007 results.

Let me now turn over the call to Nicholas, our CFO to discuss our second quarter financial results. Nicholas?

Nicholas Chater

Thank you Ron, and good morning everyone. Let me begin with a review of our second quarter financial results as compared to a year ago. Our revenue increased by $16.9 million or 79% from the second quarter last year. Our second quarter revenue was $38.3 million versus $21.4 million a year ago. The year over year growth is the result of contracts awarded during the past 12 months at both Paragon and Cornwall.

Paragon’s revenues grew 147% from the second quarter of 2007 and now represent 73% of total revenue for the three months ended June 30, 2008 and 69% for the six months ended on the same date. This level of growth continues to validate the opportunities that we’ve seen in the government sector and demonstrates the value of the contracts that we’ve been awarded.

Gross margin in the second quarter was 8.5% compared to 6.0% a year ago. During the second quarter we incurred very few start-up costs on new contracts, one since the beginning of the year, since the majority of those costs were incurred in the first quarter of 2008. The difference in the gross margin between 2007 and 2008 is primarily attributable to the improvement in contract profitability at Paragon.

General and administrative costs were $3.1 million for the first quarter of 2008 compared to $2.9 million in the second quarter of 2007. At the same time, revenue grew 79%. This increase was related to a non-cash expense for stock based compensation. These G&A costs represented 8% of revenue for the second quarter of 2008 down from 14% of revenue in the same quarter for 2007.

We continue to focus on reducing our G&A wherever possible to improve the profitability of the business. The operating loss for the second quarter of 2008 was significantly reduced to $60,000 compared to an operating loss of $1.9 million for the second quarter of 2007. Also as a reminder, included in our operating loss is a non-cash cost of approximately $800,000 in both the second quarter of 2008 and 2007. These costs relate to acquisition related intangible amortization, depreciation, and non-cash stock option expenses.

As Ron has indicated, I am pleased to reiterate that EBITDA as adjusted continues its positive trend and shows a positive $752,000 for the second quarter of 2008 as compared to a negative $771,000 for the second quarter of 2007.

Interest expense, net, increased to $1.5 million in the second quarter of 2008 compared to $500,000 in the second quarter of 2007. This increase is primarily attributable to a higher borrowing base due to the increased revenue from the new contracts, overadvance interest on our borrowing facility, and interest on our $2.5 million term loan issued in March 2007. As a result, the loss before income tax was $1.5 million in the second quarter of 2008 compared to $2.4 million in the comparable period last year, a 35% improvement.

A tax benefit of $55,000 was recorded for the quarter ended June 30, 2008 compared to a tax benefit of $792,000 for the quarter ended June 30, 2007 due to management's decision to record a valuation allowance of $497,000 against deferred tax assets in the second quarter of 2008. Net loss for the second quarter of 2008 was $1.5 million, or $0.35 a share, compared to a net loss of $1.6 million, or $0.45 a share, in the second quarter of 2007.

As Ron has discussed, the businesses continued in the second quarter the substantial momentum begun during the first quarter of 2008 and new business opportunities continue to materialize as shown by the new contracts that we’ve been awarded. We continue to be pleased with the current trends in the business, notably with respect to improvements in both margin and EBITDA as adjusted.

I would like to remind you that you can find our second quarter earnings release on our Web site, which is www.trissecurity.com. In the release, we have provided a reconciliation of EBITDA as adjusted to net loss.

Audrey, I’d like to open the line for questions please.

Question-and-Answer Session

Operator

(Operator instructions) And our first question will come from George Berman [ph] with GunnAllen [ph].

George Berman – GunnAllen

Good morning gentlemen.

Ronald Farrell

George, how are you?

George Berman – GunnAllen

Very good. It looks like we are almost there.

Ronald Farrell

I believe you are right.

George Berman – GunnAllen

You went on the numbers very nicely, if I take out the depreciation, amortization in the first quarter 4,500 [ph] to 170,000 were actually upwarding income positive. I have a quick question. There was an acquisition made in your industry about a week, 10 days ago by the Blackstone Group. They acquired, I believe, a larger competitor of yours for a pretty decent chunk of money. We’ve done some internal evaluations here and it looks to me like prices paid etcetera on cash flow EBITDA basis, revenues would give your company today a valuation of between $4 a share and $6 a share. The upcoming restructuring recapitalization, how do you feel that will affect your capital base and your debt repayments? Do you see people you mentioned, they are going to convert to new convertible debentures or straight common stock. What kind of illusion do you foresee?

Ronald Farrell

George, at this time, mainly because we have not filed our documents with the SEC yet, but we will be filing of course within the next few days, been advised not to dip into the structure of that transaction, but it will be available to everyone to see probably by the end of the week here. But we’ve been advised because we have not issued the offer to the noteholders yet, that we need to file these papers first. I apologize I can’t get into detail, but I will be making a little bit of a statement after the Q&A that, maybe, can shed a little light on we conceived to be value and maybe that will answer your question at that time.

George Berman – GunnAllen

Okay. A quick follow-up. What is your future contract opportunities look like at this point in time and how would you finance those?

Ronald Farrell

Well, right now, as I had said earlier, our pipeline of either actual bids that have been submitted or bids that are being prepared to submit stands at a little over $600 million. At the same time, looking forward into second half, we expect there to be the opportunity of perhaps somewhere around another $250 million to $300 million of additional bids that should come into play during the second half, and so far has ability to finance that potential growth. Obviously we have a very good relationship and understanding with our senior lender, LSQ, and have been given assurance that provided the growth is there and that the quality of the contract is what is has been in the past that we should have no problem in financing growth certainly through the second half.

George Berman – GunnAllen

And numbers that you were referring to they are multi-year contract or there would be multi-year contracts, right?

Ronald Farrell

Yes. Anytime $600 million divide that by 5 and that would give you an annual value.

George Berman – GunnAllen

So, it is possible that towards the end of the year we might be looking at a run rate of not $140 million, $150 million, but close to $200 million if we get the fair share of those contracts?

Ronald Farrell

I would say that’s very, very possible, and a very good estimate.

George Berman – GunnAllen

Okay. Thank you very much. We look forward to the next few days and weeks and hope to grow with your company into the future.

Ronald Farrell

I appreciate it. Thank you. Next question please.

Operator

And next question will come from Mike Breard with Hodges Capital.

Mike Breard – Hodges Capital

Yes. These contracts you are bidding on have generally become more efficient, in other words, how long has it taken to actually award a contract now? Is there any sort of average number you can give and is that shorter than it has been in the past?

Ronald Farrell

If we look at past, especially if we go back, say, to 2005 – from 2005 almost to the middle of ’06, I believe, there were no contacts awarded neither to us or to anyone else for that matter. And we have seen a steady progression and improvement on the government’s part insofar as shortening the time between when a bid is submitted and when an actual award is made. So, that’s one reason our volume has increased because the award process has become much efficient on their part and with the $600 million we have in bits out there, call it, and the potential of maybe even up to another $300 million, we are talking almost $900 million to $1 billion of potential work that could be out there and awarded by the end of the year. I mean the numbers are starting to get almost staggering.

Mike Breard – Hodges Capital

Okay. One other question, what percentage of these bids are you winning, is it a quarter, a third, or –

Ronald Farrell

We are at somewhere around a 40% number. It could be a little better, it could be a little worse. But I think 40% would be a good benchmark.

Mike Breard – Hodges Capital

Okay, that’s excellent. Okay, thank you.

Ronald Farrell

You’re welcome. Thank you.

Operator

And next we will hear from John Goodwin [ph] with Goodwin Brothers.

John Goodwin – Goodwin Brothers

Hey Ron.

Ronald Farrell

John, how are you?

John Goodwin – Goodwin Brothers

I am doing good. A question, I noticed in an SEC filing that you were arranging to pay some stocks to LSQ, I guess, when you max out the term loan. If we get new contracts, doesn’t that press up against that and actually end up costing some shares?

Nicholas Chater

Probably not, in that we will have increased collateral from the contracts upon which we can borrow. So, we do not see in the lights of winning new contracts that overadvance actually increases into a substantial figure.

John Goodwin – Goodwin Brothers

And I presume, as the start-up costs go away, that short-term note should get knocked down at some fairly rapid pace, is that right?

Nicholas Chater

That is a fair assessment.

John Goodwin – Goodwin Brothers

Okay, and that’s currently at like 25 million, 27 million?

Nicholas Chater

That is the estimate at this stage of the game. That’s absolutely right.

John Goodwin – Goodwin Brothers

Okay. And is the thought that in 12 to 18 months that would be cut in half or gone completely?

Nicholas Chater

At this point, don’t believe that would have gone completely. But I would hope that that will be certainly reduced over the period that you mentioned. Over the next 18 months, very much so.

John Goodwin – Goodwin Brothers

Okay. And then the next question is, I know you guys have done – there is a research outfit that has a report out on your stock. I know, Ron has probably made some visits with different people. Yet the stock price continues to struggle. Do you have any plans in terms of getting the story out to the investment community beyond what you’ve done so far?

Ronald Farrell

Right now – now that we’re getting this investor call and our Q filed here either today or tomorrow. That will enable us now to go back on the road again and talk to people. It was the opinion that, especially a month before the numbers came out, that the first question everyone would ask would be what is – how did you numbers look and without having them in the public domain, we couldn’t really give much in the way of guidance insofar as what the quarter would have looked like. But to answer your question, we will be getting back on the road and talking to various groups to make them aware of Tri-S and its recent turn around here. And hopefully that will have some impact on the stock value. We all feel very much that the true value of the company is not $1.80 a share, which is I believe we are kept today.

John Goodwin – Goodwin Brothers

And the nature of the contracts are such, I mean, that’s such – these are things or at least the Paragon contracts, I think it’s a 5-year contract, so those revenues are very predictable. Your costs are fairly predictable and would seem to me and certainly you’ve kept those down nicely with all those huge growth you’ve had that would seem that the ability to show what the company will do financially is much easier now as these contracts are lined up, isn’t that true?

Ronald Farrell

Insofar as the current business, I agree with you George that it’s, or John that it’s somewhat predictable. What we find is because of the amount of contracts that we are currently bidding on and that we feel that we might have a good chance of winning, our numbers could possibly change pretty dramatically, very quickly, as they did in the first quarter.

John Goodwin – Goodwin Brothers

In a sense that if you win another rush of contracts you would have another rush of start-up costs, is that what you’re saying?

Ronald Farrell

Exactly, and I mean our revenue would obviously spike, but so do the start-up costs. This current quarter, without any start-up costs, I am talking here at the third quarter, our number should look very good.

John Goodwin – Goodwin Brothers

Has there been any strategizing of pacing the contracts or the bid process so that you can smooth out the financial performance and maybe enhance the comfort of new shareholders as opposed to just rapidly putting as many contracts on as you can?

Ronald Farrell

I don’t think we have got much control over that one. The government of course puts out the RFPs and as for bids within a certain period of time. And obviously it’s entirely up to them as to when they award contracts.

John Goodwin – Goodwin Brothers

So, we have the choice to not always bid. So, in fact at some point would it make sense to not be bidding on as many on the theory that we wouldn’t win as many, but our financial performance wouldn’t be enhanced nicely by having somewhat slower growth?

Ronald Farrell

I don’t know if I am in favor or against that theory. I did enjoy announcing $360 million for the new business in the first quarter. And I’d certainly love to be able to say something like that again in the third or fourth quarter.

John Goodwin – Goodwin Brothers

And I guess I agree with you, except that if the stock price goes down 40% when we win another $300 million of business, then it seems to me maybe we have to think differently about how to maximize the return to the shareholders.

Ronald Farrell

I’m afraid that if we started passing on bids the government might look at us differently. We have worked so hard to get on everybody’s preferred list. I would honestly be reluctant to cut back on the bid process. But one thing, and I think Nicholas could explain it a little better than I could, with regard to start-up costs as our revenue base grows, those start-up costs are spread out over a much larger number and therefore the impact is not quite as great as they looked in the past. If all of the sudden I saw a contract that valued itself at $30 million a year come in in the next quarter or so, I don’t think I could resist not taking it. In fact I don’t think we will ever even consider such an idea.

Nicholas Chater

John, just a word on the start-up costs. Your point is well taken about those hitting a certain quarter. That’s absolutely true, but we do amortize first of all, all our equipments over those periods and secondly we will be actually taking into operating results as start-up costs it’s essentially the training and that varies anywhere from 40 hours to 120 hours per guard [ph] on the contract. But those can’t be smooth, they are much smooth over the quarter, but they are incurred in the quarter that they are charged. But the guns and the uniforms are amortized over a much longer period in order to Ron’s point to try and smooth some of these start-up costs over greater period of time.

John Goodwin – Goodwin Brothers

In which case then the cash flow actually gets better in future months and quarters?

Nicholas Chater

Depending when those start-up costs hit, yes.

John Goodwin – Goodwin Brothers

Just looking for some way to get better visibility to the financial performance, which would hopefully, eventually attract new investors into the company.

Nicholas Chater

I understand your point.

John Goodwin – Goodwin Brothers

That’s all I have. Thanks.

Ronald Farrell

You’re welcome. Thanks John. Any other questions?

Operator

And next we will hear from Benit Mustang [ph].

Benit Mustang

Hello.

Ronald Farrell

Benit, yes.

Benit Mustang

Yes, a question. I have some questions. You said before you had $200 million in bids most likely would hit in the second half. So, your estimate for $140 million to $150 million in revenue for ’08 doesn’t seem right, if that’s the case. That’s first question. You want to deal with that first and then I will –

Ronald Farrell

I’m not sure I understand –

Benit Mustang

You said before you had $200 million – you would expect about $200 million in contracts in the second half.

Ronald Farrell

No, no, I didn’t say that. I think you misunderstood it.

Benit Mustang

Okay, then I misunderstood it. Okay.

Ronald Farrell

I can give it to you again. What I had said was earlier in the year, I had given about $140 million to $150 million of revenue for the 2008 calendar year. And what I said was that I continue, especially now, to believe that the $140 million, $150 million margin for 2008 is still a very good solid number. And that based upon the number of contracts and bids that we are currently bidding on, which is, like I had said, roughly $600 million that if in fact we were fortunate enough to continue to win at the same percentage rate that in our 2009, call it, calendar year, a $200 million run rate is very much attainable.

Benit Mustang

Okay. Second question was about the notes. What is it, about $7.5 million outstanding, roughly?

Ronald Farrell

Yes, that’s right.

Benit Mustang

Well, if the noteholders decide they just want their money, what happens?

Ronald Farrell

Well, like I had said earlier, we are in the process of getting ready to file with the SEC.

Benit Mustang

No, I understood, that’s an offering. But I mean, let’s say, the note offer [ph] say, “Listen, we want our money back,” (inaudible) what happens?

Ronald Farrell

I can’t really comment on what we would do or how we would do it mainly because the filing is going to come out in the next two, three days. And lawyers because of SEC rules and so forth made it very clear to me, especially on that subject, not to project any ideas or thoughts as to what the company either can or will do until these filings are made and they are in the hands of the noteholders. I mean, I know one of which is yourself. Give me the benefit of those – the next two, three days and I think your question will be more than answered.

Benit Mustang

All right, (inaudible) will it be a conference call before the next quarter for the noteholders or something like that so we can – once we see whatever this offer, what this offer is?

Ronald Farrell

Believe or not, no one has suggested or thought about that. But I will certainly take that into consideration and it’s not a bad idea. I think can also say, we haven’t thought of that idea. But I will give it some very serious thought.

Benit Mustang

Okay. That’s all I have.

Ronald Farrell

Okay, thank you Benit. Any other questions?

Operator

And we will take a follow-up question from George Bermin.

Ronald Farrell

Okay.

George Berman – GunnAllen

Sorry. The caller pervious to the pervious caller mentioned of the 8-K you filed a couple of days ago with respect to your lender. The way I read it, maybe you can confirm it, is that you save $60,000 a month in cash and instead issue the lender warrants excitable at $3, which in essence becomes a self-funding prophecy. Is that right or am I not being there correct?

Nicholas Chater

You have a partial view of the story. What has also happened is that the flow for the borrowing rate has gone to 11% on billed and 12% on unbilled.

George Berman – GunnAllen

So, you have more advanced possibility there too?

Nicholas Chater

We don’t have more advanced possibilities. We’ve always had billed and unbilled. We have it at a very favorable rate at this point in time. The rate upon which we borrow has been increased. So, that is part of the story. But you are absolutely right that in order to offset that, the interest or the fees on the overadvance has been reduced by $60,000 a month, which is a reduction.

George Berman – GunnAllen

And that’s cash?

Nicholas Chater

That’s cash, and at the same time we are offering these $30,000 warrants every time there is an overadvance during the month.

George Berman – GunnAllen

And they would be exercisable at $3?

Nicholas Chater

That is correct.

George Berman – GunnAllen

Okay. So, theoretically in 12 months, they would have $3,600 warrants, exercise those warrants at $3, and the company would receive about a million some, 980,000 of cash, $1.08 million in cash?

Nicholas Chater

That is correct.

George Berman – GunnAllen

Brilliant. Well, we look forward to this restructuring and thanks for your time.

Ronald Farrell

You are welcome. Thank you. George. Any other questions?

Operator

(Operator instructions) And there appear to be no further questions.

Ronald Farrell

Audrey, I would like to make just a closing statement or at least give one last bit of a thought on our stock. And that is, I know we are all disappointed in the value of the stock currently. Especially, in light of the performance of Tri-S in Q2 in the first half of 2008. Therefore in closing, I would like to give everyone something to think about. And George Berman hit upon it in one of his questions. Based up on a recent pending sales of a security company very similar to Tri-S, a larger company but very similar insofar as its services, our enterprise value based on their calculation could be calculated at approximately $70 million. And on a fully diluted basis, the stock would be valued at approximately $6 per share. This calculation is of course purely hypothetical and not to be looked at as anything more than an exercise of numbers. But I felt it was something that everyone should be aware of.

I look forward to our next investor call in November, and I want to thank everyone for participating. Thank you.

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