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Executives

Dennis R. Raefield - President, Chief Executive Officer, Director

Gregory M. Krzemien - Chief Financial Officer, Treasurer

Robert M. Kramer - Executive Vice President, General Counsel, Secretary

Gerald T. LaFlamme - Director

[Eduardo Nieves] - Vice President, Investor Relations

Analysts

[Thurman Willis] - Private Investor

[Andrew Shapiro - Longbelt Capital Management]

[Eric Vonderboard - Leeward Investments]

[Bob Cathlinger - Cathlinger Partners]

Mace Security International, Inc. (OTCPK:MACE) Q2 2008 Earnings Call August 20, 2008 11:30 AM ET

Operator

Welcome to the second quarter 2008 financial results for Mace Security International. (Operator Instructions) At this time I would like to turn the event over to Mr. Eduardo Nieves.

Eduardo Nieves

Welcome to Mace Security International’s second quarter 2008 financial results. My name is Eduardo Nieves. I am Mace’s Vice President of Investor Relations. At the end of this call through September 3 I would like to give everyone a phone number if they want to hear a playback of the call. It’s 1-800-642-1687 and then please just dial in the conference ID of 59753085. You can also hear a playback on our website www.mace.com.

Also on today’s call are the following individuals: Dennis Raefield, Mace’s new Chief Executive Officer, Jerry LaFlamme who was the Interim CEO through August 18, 2008 and is now an independent Board member, Gregory Krzemien, Mace’s Chief Financial Officer, and Robert Kramer, Mace’s General Counsel and Executive Vice President. During the call Greg will discuss financial results for the second quarter and Jerry and Dennis will discuss the status of the business.

Before I turn the call over to Greg, there are some housekeeping matters that I must address. Please bear with me during this segment. Certain statements and information made during this call will constitute forward-looking statements within the meaning of the federal Private Securities Litigation Reform Act of 1995. When used during the conference call, the words or phrases will likely result, are expected to, will continue, is anticipated, estimate, projected, intend to, or similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks, known and unknown, and uncertainties including but not limited to economic conditions, limited capital resources, and the ability of management to effectively manage the business and integrate acquired businesses. Such factors could materially adversely affect Mace’s financial performance and could cause Mace’s actual results for future periods to differ materially from any opinions or statements expressed during this conference call. Additional discussions of factors that could cause actual results to differ materially from management’s projects, forecasts, estimates and expectations are contained under the heading “Risk Factors” in Mace’s SEC filings including its registration statements and its periodic reports on Form 10K and Form 10Q. All statements made during the conference call should also be considered in conjunction with the financial statements and notes contained in Mace’s annual reports on Form 10K and quarterly reports on Form 10Q.

With that I would now like to turn the call over to our Chief Financial Officer, Greg Krzemien.

Gregory M. Krzemien

Thanks again for joining us today on Mace’s second quarter and six months ending June 30, 2008 results conference call. I know many of you have been on our calls before but for those who may be new, I just wanted to go over our main lines of business. We operate currently in three segments: Our recently acquired July of 07 online digital media e-commerce business known as Linkstar.

And then we have our security products segment which has three operating divisions: Our original and world famous Mace personal defense operation, our personal security equipment operations in Fort Lauderdale, Florida which deals with professional level equipment, and our consumer oriented security equipment operation in the Dallas, Texas area.

Our third segment is the car wash segment which again most of you know we made a decision several years ago to exit that business. We made that decision we had approximately 50 car washes and truck washes in total. Again as a cumulative update we’ve now sold approximately 34 sites and five truck washes for a total of 39 properties. We generated a net cash amount of $33.7 million, again that’s net of paying off about $15 million worth of mortgage debt and defeasance costs. And we currently have about 15 car washes that we’re currently still operating.

Obviously the sale of these car washes and generation of cash have really given us the ability to build our cash balances and reduce our debt. Our debt was at about $23.9 million at the end of 2006 and at the end of 2007 it was down to $13.6 million and today we’re down to about $8.1 million or $8.2 million. So we really brought our leverage down quite a bit so our predicted interest expense is now based on this current debt at about $430,000 on an annual basis. So again a nice reduction in that carry.

We disclosed in our recent 10K that we also have four sites currently under agreement. They are subject to some final due diligence and some financial contingencies that the potential acquirers are working through. These four sites in Texas have a total sale price of about $9 million and they carry about $3.3 million in mortgage debt. So those sites we’re looking forward to hopefully closing on those between now and the end of the year.

Just in way of the financial statements to refresh everybody, we’ve gotten rid of our car washes in Arizona, all our car washes in Florida, our car washes in the Northeast region of the country, and we have substantially the agreements in Lubbock, Texas under agreement. All of those operations are reported as discontinued operations on our financial statements and accordingly the revenues and the expenses are all netted out and reported as results of discontinued operations in the six month and three month income statement that is contained in the 10Q. So the only car wash operations still in the continuing operation numbers are Dallas, Austin and San Antonio sites.

I’m going to go over the results a little bit here and give some highlights on the income statements first. For the second quarter ending June of 08 we reported a net loss of $3.9 million or $0.24 a share versus a loss of $1.3 million or $0.08 in the second quarter of last year. From a cash flow standpoint this would be cash flow of about $900 to $1,000 and that is net of a couple of fairly significant notable items. One is legal fees related to the immigration investigation settlement of about $157,000; we had about another $65,000 of costs to wrap up the Vermont EPA matter; and we also paid a charge of $39,000 for the termination of a lease in the Fort Lauderdale area where we’re going to consolidate some office space. The net loss of $3.9 million also included about $2.6 million of non-cash asset impairment charges as we do on a regular basis on a quarterly basis we look at all our assets from a carrying value and record an impairment charge of $1.4 million regarding our digital media business in writing off the book value of certain customer relationships.

Management had made a decision in June of this year to discontinue marketing efforts at this time of PromoPath our digital advertiser to outside customers. We found that profit margins were getting tighter and more difficult to maintain and we decided to use their efforts for promoting our Linkstar e-commerce business and also supporting our security properties websites. And with that we needed to look at the value of customer relationships and write that asset off, again worth about $1.4 million, as allocated at the original purchase date. We also wrote down car washes in Texas by about $1.2 million, again based on an evaluation of several sites that continue to not turnaround and have strong enough cash flow to support the carrying values of those sites. So again the results have those non-cash charges included.

Also I mentioned the immigration investigation. We also settled that matter as we disclosed in the 10Q and in our results for the six months ending June we paid a $100,000 fine and a $500,000 forfeiture of proceeds from the sale of those car washes. That’s an item that is noted in our six month cumulative numbers.

Speaking about those numbers we had a net profit for the six months of $44,000. This was based on revenues of $28.9 million. Again the unusual items in that number included a positive net of $5.3 million; a positive $6.9 million is in those numbers from the gain on the sale of our Florida sites; and then we had some large expenses going the other way: The $600,000 fines I just mentioned on the immigration settlement; we have non-cash stock option charges of $293,000; $204,000 of legal fees to wrap up the immigration investigation; and that lease termination fee payment of about $38,000.

From a revenue perspective, our revenues for the second quarter were about $15.1 million compared to $9 million last year in the second quarter. This increase was largely due to the addition of our digital media marketing segment which contributed about $5.5 million of revenues this quarter. This was offset by a slight decrease in our security equipment and total security segment of about $70,000 and we also saw an increase of $200,000 in our car wash revenues largely because of our fuel revenue going up with the fuel prices going up as well as some increases in our car wash and detail volumes.

I want to just mention that our revenues in the Linkstar PromoPath or digital media operations were a big part of our growth in the quarter and the six month numbers. From a six month standpoint our revenues went from $18.1 million last year to $28.9 million and $10.9 million of that was related to our digital media segment. For some kind of comparison I have a couple of numbers here comparing it to the first six months we owned them, almost six months ending December 31. Again we acquired it about the middle of July of 07 but our revenues in the December quarter were about $7 million versus $10.9 million. So that was a pretty nice increase of about $3.3 million or 43% and our gross profit increased about $2.5 million in that same period.

Our staff at Linkstar have done an excellent job of continuing to promote our products including the Purity cosmetic line that we introduced in late 07 that has shown significant growth in the first half of 08 and we introduced our Eternal Mineral products in early 08 and that’s showing nice month-to-month growth. So we’re very pleased with that operations performance so far this year.

From a gross profit perspective, our gross profit in the second quarter of this year was 30% versus 22.1% last year. Again the large contributor to that improvement is in the digital media marketing segment so we’re very pleased again that was able to help us out. That generated about a 39.1% profit margin; our security about 29.3%; and our car washes about 18.8%. We’re very pleased with the addition to help our gross profits.

From an SG&A standpoint for the three months ending June, we had SG&A of $5.5 million compared to $3.8 million last year in the second quarter. The increase in SG&A is largely due to the addition of Linkstar which added about $1.7 million of SG&A costs. I would like to note that a big part of their SG&A cost is related to fulfillment of the e-commerce orders, about $366,000 of freight expense, and about $200,000 of credit card fees. So almost $600,000 of costs in the SG&A relates to fulfillment. On a six month basis our SG&A was $11.2 million versus $7.7 million last year. Again Linkstar is the main reason for that increase. They contributed about $3.4 million in SG&A costs and again between credit card fees and shipping costs about $1.3 million are included in that $3.4 million for those costs. The SG&A costs also include the several notable items I mentioned regarding the legal fees on wrapping up the immigration; it also included a total of $445,000 of costs for the Vermont EPA item that we worked on the first half of this year.

From an interest expense standpoint I mentioned that is well down from the past. Our interest expense including discontinued operations for 2008 is about $248,000 versus $879,000 last year for this inner period. Again this is largely due to the significant reduction in debt. We were at $24 million at the end of 06 and currently as I mentioned we’re at $8.2 million so we’re very pleased to bring down that interest amount.

From an earnings perspective on investments we generated about $379,000 in the first half of the year so again we’re happy to be able to generate some additional earnings from our cash balances.

I’ll just mention a couple things on the balance sheet and I’ll wrap up here. Our balance sheet remains very strong. We have a very low leverage ratio of about 13.3 to 1. This is again on the $8.2 million debt balance and $53.8 million equity balance. We have a good cash balance of about $15.2 million at the end of June largely because of our car wash sales I previously mentioned. From a cash flow standpoint we used approximately $3.7 million of cash flow in operating activities in the first half of the year including the notable expense items that we needed to take care of. From an investing activity standpoint we generated about $7.6 million in cash largely from the sales of the car washes and from a financing standpoint we paid down total debt of about $1.1 million in the first half of the year. So that gives you an overview.

With that I’m going to wrap up. At this point I’d like to again thank everyone for joining us and supporting us. I’m going to turn the call now over to Jerry LaFlamme our Interim CEO who will now go back to independent Board status. Before I turn it over to Jerry, again I want to acknowledge and thank Jerry for his leadership role in the last couple of months. I appreciate it and I just wanted to thank him for that.

Gerald T. LaFlamme

I will make a few brief comments and then turn it over to Dennis Raefield who is our new incoming CEO as of August 18. As you know during May of this year the Board terminated Lou Paolino as Chief Executive Officer and I became the Interim CEO at that point and served in that capacity until August 18 when Dennis Raefield took over.

One of the first things I did was to go to every operating location of the company and meet with each of our key people and tour the facilities and to get a really good understanding of what the operations were all about. Following that and in fact in some of these cases I actually went there more than one time. And then began several cost-cutting initiatives. These cost-cutting initiatives the Board and I agreed were necessary and we think they will start to have an impact commencing with the third and fourth quarters this year and on into 2009.

These initiatives included terminating our lease on [Los Solas] in Fort Lauderdale and that will be effective at the end of the year, December 31, 2008. In addition Greg mentioned earlier that we exited the PromoPath digital media marketing segment and combined that operation with the Linkstar operation. And as a result we took a $1.4 million write-down on the impaired customer relationships but also as a result of that we did reduce our ongoing overhead. And so going forward we will have a reduction in overhead as a result of that combination. In addition we eliminated several positions during this period of time, the last 90 days. And we took several other initiatives which we haven’t yet announced within the company so I can’t really discuss them on this call but we will be able to talk about those at our next quarterly call. I can tell you that our expected cost savings on an annual basis at this point based on what we’ve done to date is about $1 million to $2 million a year. Dennis Raefield will continue to evaluate additional cost-cutting initiatives that we can take during the balance of this 2008 year.

With that I’m going to turn this over to Dennis Raefield and after Dennis finishes we’ll open it up to questions.

Dennis R. Raefield

I’m glad to be on board and the first thing I’m going to do is really send my deepest thanks to Jerry who is on the West Coast today. He has done a fantastic job in stepping up into a very tough, tough job and he’s made significant cost improvements in the company, about half of which are showing and the other half that have yet to reveal themselves on the P&L. I am really even more excited now that he has been able to see all the departments of the company to have him back on the Board to be able to know exactly what we’re talking about when we bring up issues and problems and personnel because he’s seen them firsthand. So I want to thank him. It was a fairly selfless act that he did. He worked very, very hard and lived on a plane and Jerry I’m deeply indebted to you for what you’ve done for the company.

Gerald T. LaFlamme

Thank you very much Dennis.

Dennis R. Raefield

I’m really excited to be on board as the CEO of the company. I think it’s the right time for the set of skills that we’re bringing here and hoping to exert some change. Mace is a great company and it needs a lot of help and I am totally committed to improving operations and increasing shareholder value. That’s why I was asked to be on the Board originated by one of the shareholders and I will continue in that role to do it. I anticipate it will be a multi-step operation and the company cannot be turned overnight but Jerry has already started the turn and I plan to continue that rudder that will get it in the right places.

I started on Monday so I’m somewhat of an innocent virgin but I’ve already visited the Linkstar facilities and I’m at the Horsham headquarters today and tomorrow I spend the rest of the week in Florida. The week after I will be in other sites and the week after that I will be in Texas and before the snow hits I will be in Vermont to see that facility and look at it.

Very simply, since there’s not much for me to talk about in the previous quarter I will tell you that my four goals are: Obviously continued cost reduction. Our costs do not match the industry norms or they’re out of connection with reality but many of them are going to be tough work to do it. We can’t do it with just cutting off arms and legs. We have to figure out how to do it in a way that keeps the company growing.

Number two, I think because of the recent events with the EPA and the INS and previous embezzlement, even though we now have compliance in place I am going to re-review all of those compliances and monitor them. I want to make sure that we don’t have any more or minimize any future one-off surprises like we’ve had that have bled cash from the company. I think it’s a serious drain on our already beleaguered assets so I plan to re-review those even though I know that there are strong systems put in place by Greg and Robert. I want to look at them again and not take anything for granted.

Number three, I’m going to build a Mace brand. I think this is one of our assets. Besides the cash that we have in the bank we have a fantastic name that’s been underutilized and I plan to help increase that brand awareness significantly.

Number four, the most important, I believe the way out is to increase top line revenue. We cannot shrink our way to greatness and bring shareholder value just by cost cutting. We must increase the top line and I will be focused on that. I am a sales leader by nature as well as a technical engineer and a business man, so I will be using those sales leadership skills.

So that’s really all I have to say. I am excited; I am on board; and I will be in the face of every manager and every division and every employee to find out the ways to turn this. I look forward to success and I believe that we will be successful and it will take us some time.

So I’m ready to move to questions in queue and we’ll answer them as a team as best we can.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from [Thurman Willis] - Private Investor.

[Thurman Willis] - Private Investor

I appreciate the debt being reduced to $8.1 million. You gentlemen mentioned that in selling off the car washes that would generate $9 million of which $3.3 million was related. But I’m looking at a cash position after the car washes are sold and I’m’ going to wipe that out. So it’s my understanding we have 11 car washes remaining and I would ask, of those 11 remaining we of course will have no debt. We have roughly a dollar a share in cash now and I would take it that these 11 car washes, can you give me some sense as to did we sell the best car washes, do we still have some good car washes out of these 11 that are left, and from previous calculations these 11 ought to produce enough monies when sold for us to have over $2.00 a share in cash considering there’s no bleed. Could you respond to that please?

Gregory M. Krzemien

The 11 that we have left, they are a mixture of a lot of good sites. In fact some of our best sites are still in that 11. There are some sites in there that we have written down in the past and again we adjusted a few of them as I mentioned previously. So they’re not all dogs by any means left. I don’t know exactly what we’ll get for those last 11. It could be somewhere in the range of $14 million to $17 million, somewhere in that range depending on how anxious we get to get rid of them. We do have about $4 million worth of debt on those last 11 so that could net us somewhere in the neighborhood of $10+ million cash on those last few in addition to the ones, the four that we have under agreement. So just kind of a little update there.

[Thurman Willis] - Private Investor

That matches my calculation that after that considering that we have no burn that basically would give us about $2.00 a share in cash. So my second question is, considering the fact and I know that it’ll take some time to sell these washes but of course our stock trades at about $1.56, looking at this even on a cash basis we’re under water from shareholder value of about $0.50 so that gives no valuation to Mace. It gives no valuation to Linkstar. A two-part question. When do you think we can become cash flow positive? Congratulations again for cutting the expenses. When do you think we can become cash flow positive? And we’re just a company out there that’s not been recognized for quite some time. What do we plan to do to help shareholders where the stock doesn’t trade at 50% of book which a lot of is cash and a good name brand company?

Dennis R. Raefield

I’ll address the part about I think we’re an invisible company. It’s kind of sad a little bit. We’re actually invisible in the security industry as well. We have a good consumer representation but even the security industry some of them didn’t know where I was going when I said Mace. So we’ve got to increase that. I am a publicly focused guy in the security industry. I will push that end of it because I believe that will help us increase shareholder value by becoming a player in the security industry. And I think that was one of the Board’s decisions why I went to the restroom and came back and I was the CEO. But I’m actually looking forward to making us more public.

As far as cash flow positive, I can’t answer that today because I’ve been on one day. But I understand that this ship has to right. We are not here to bleed the remaining cash down. I’m committed to it but I don’t have any dates. I will certainly have many more answers for you at the next quarterly call.

[Thurman Willis] - Private Investor

And following up we have a good IR person on board, we’ve held his hands tied for quite some time. When are we going to allow him to get out again going to conferences and to just update the street, because there are 6,000 companies out there and if we don’t get out and talk about what we are, when do we plan to really present ourselves to the street through IR?

Dennis R. Raefield

I will say that I’m meeting with Eduardo tomorrow in Florida and I know we have had his hands tied and I think that will be the second arm of our public refocus. So I will talk with Eduardo and I will try and respond to you at the next call or sooner with some kind of a release.

[Thurman Willis] - Private Investor

I made the same comment at the annual meeting. I think he’ll do a good job if we let him just get out and share our stories so I would encourage us to do that.

Operator

Our next question comes from [Andrew Shapiro - Longbelt Capital Management].

[Andrew Shapiro - Longbelt Capital Management]

What amount of this quarter’s loss adds to Mace’s existing tax NOL and what is our tax net operating loss carried forward up to now?

Gregory M. Krzemien

It’s about $27 million or $28 million, somewhere in that range. So we have quite a large NOL built up.

[Andrew Shapiro - Longbelt Capital Management]

How much cost cutting was reflected in this most recently reported Q2? If you took over really in June and were flying the country all through June, I just want to confirm this quarter that what we’re reporting does not have any reduced SG&A from cost cuts that you’ve implemented. Is that correct?

Gerald T. LaFlamme

There’s probably some Andrew but not very much. Most of it will be in the balance of this year and into next year.

[Andrew Shapiro - Longbelt Capital Management]

When you talked about the cuts that are made so far being in an annualized range of $1 million to $2 million a year and you identified certain cuts but then also said there are other undisclosed cuts to be announced internally and then implemented. Are those undisclosed cuts to be announced and then implemented part of the $1 million to $2 million or would they be incremental?

Gerald T. LaFlamme

They’re part of it. Incremental cuts would be any future cuts that Dennis Raefield would come up with as he goes forward as the new CEO.

[Andrew Shapiro - Longbelt Capital Management]

And segueing then to Dennis, can you give some insight in that your observation is that our costs are out of line for the scope and size of the business today? What other types of cost savings do you think might be taken or is the only way solely out of revenue growth from this in point in time from Jerry’s cuts?

Dennis R. Raefield

The Board had requested cuts as you know from the prior CEO and we couldn’t seem to get them so we got together as a Board and came up with some. Some are more complicated to implement and so I can’t really talk about them. I won’t call them the easy ones but there were some that were not connected to inter-departmentally or inter-divisionally so Jerry was able to implement those immediately when he came and the rest of them are more complex and require reorganization. There are continued cuts that we can do in addition to top line but because we’re a public company, a lot of the overhead is a fixed overhead and requires raising top line to be public. And as long as we’re a public company I cannot eliminate a lot of those. So I have to do a combination of both. I cannot do it just with a hacksaw. I have to do it with the growth because I will get to a point where I cannot deliver the proper services that are required by Sarbanes-Oxley and by being a public company that I cannot get rid of. So it’ll be a combination of both but I’m looking at it as a zero based budget and everything has to be justified and we’re working on it. There are places to do things and then there are tough calls that have to be made as well.

[Andrew Shapiro - Longbelt Capital Management]

On the corporate SG&A side your 10Q describes you’re getting out of the [Paolino Los Allis] headquarters and we took a lease termination fee. What’s the annual cost of the lease and that annualized cost reduction doesn’t start until January, is that right?

Gregory M. Krzemien

The annualized cost is about $160,000 and that is correct. January 1 of next year we will be able to stop making the lease payments.

[Andrew Shapiro - Longbelt Capital Management]

I noticed that Mace in the 10Q has disclosed they made counterclaims against Mr. Paolino seeking $1 million in restitution. Are these claims public and thus can you share for what acts or circumstances Mace is seeking payment? Is it paying back the car wash sales proceeds to pay the immigrant employee thing or recoupment of the Vermont EPA clean-up costs or the lost inventory monies or other things?

Robert M. Kramer

At this time the arbitration/litigation just is starting. We really aren’t at real liberty to say. Also Mr. Paolino in his arbitration as reflected in our filings has a defamation claim under which he’s claiming $6 million. So probably discretion here is the better route.

[Andrew Shapiro - Longbelt Capital Management]

Yes, we wouldn’t want to add to any of that nonsense. With many current and former Mace employees on this call Dennis, Jerry or Robert, can you tell us or them who they should contact and what if any particular information you might seek that might further strengthen Mace’s case that Mr. Paolino’s firing was for just cause and that he ought to pay substantial monies back to Mace? Who should they contact?

Robert M. Kramer

We have an ethics hotline that goes right to the Audit Chair and bypasses all management and that’s in our employee manual. So that’s always the case. In addition all employees are always encouraged and know of the ethics hotline, any wrongdoing by Mr. Paolino or by anyone else. And in terms of the litigation, the company is retaining an outside counsel and Mr. Mallon the Chairman of the Board is in direct supervision of that outside counsel and I’m aiding the matter. So everything is being thoroughly investigated.

[Andrew Shapiro - Longbelt Capital Management]

We just want to make sure people know where to turn state’s evidence because there seem to be a lot of people that come out of the woodwork in this particular company.

Dennis, having been in the industry for many, many years could you describe the opportunities you believe exist for Mace in terms of both the revenues side and the cost structure and in the segment already has good gross margins. Is the likely trend that you can keep those gross margins, increase them further, or as you grow it that the margins may come down a bit on a gross margin side?

Dennis R. Raefield

The gross margins in the security segments are decent already. They actually are a little higher than some of our competitors because we buy well from our sources and we have enough volume. So I don’t see them going up. I don’t also see them changing much. We have different margins depending on the business. Obviously we have the most margins in our retail catalog sales to end users because we are selling direct and those will hold. The professional line has lower margins. But we have good gross margins to work with and I feel that they’re not under pressure. There is pressure in the market place because of construction slowing and the general market slowing. We’re seeing now the trickle-down effect but we’re actually holding because we’re getting more aggressive to hold and gain market share. So I don’t see a change there.

I do see a continued use of Linkstar and we met yesterday to talk about expanding the Mace brand. I’m not ready to reveal it yet but it is going to go in the direction of Mace as a protection company and protecting people, places and things and to get some kind of a focus as Thurman was asking for in a previous question, get some focus on this brand because it’s difficult to explain a car wash/digital media/security company. But actually we’re going to come up with a way to do that and get an umbrella that I think will help the top line.

And I see us in other security services, other security related things that fit on the web. There are a lot of ways to do DIY now with the explosion of the Internet not just in marketing but actually Internet connected devices allowing people to take care of their homes and their cars and their children and keep track of their assets will allow us to sell directly. And we will use the resources of Linkstar to help us with that because they do know how to make sales on the Internet.

So I see us actually growing a broad connected message that will be across the board and the margins I think are not going to be the issue.

Operator

Our next question comes from [Eric Vonderboard - Leeward Investments].

[Eric Vonderboard - Leeward Investments]

On the arbitration with Lou Paolino, can you give us any guidance or thoughts on how long that process might take? Obviously it would be good to get it behind us.

Robert M. Kramer

I think our filing reflects it’s expected to be at least a year and maybe longer. Again it’s hard to say because there are two sides to an arbitration and while we can predict what we will do and how we will handle it, we can’t predict how Mr. Paolino will handle it. But the discovery will take place and will be allowed and that of course can prolong the proceeding. At this early stage it’s really hard to say beyond what we’ve said in our filing.

[Eric Vonderboard - Leeward Investments]

It’s a delight to have the new management team on board here. Can you tell us either for the car washes that are in contract and total the $9 million or the remaining car washes in total, what’s your net book value or the book value of the assets of the remaining washes?

Gregory M. Krzemien

I don’t have the number exactly with me but it’s somewhere in the range of $23 million to $25 million.

Operator

Our next question comes from [Bob Cathlinger - Cathlinger Partners].

[Bob Cathlinger - Cathlinger Partners]

Regarding the Linkstar, when that acquisition was announced the Board at that time or Mr. Paolino at that time said that he got an outside appraised value of $20 some million for what he paid $10 million for. We’ve already taken a $1.4 million impairment charge. The sentiment I think among outside shareholders when Linkstar was announced was that if we wanted to advertise on the Internet we could contract with an Internet providing advertising company and pay them a fee to put our ads on the Internet and we didn’t need to buy a company to do that and there were no real synergies. I still feel that way. Do you have any thought to disposing of Linkstar and what might you think it would be worth?

Dennis R. Raefield

I will tell you that I took my first visit to Linkstar yesterday and I was refreshingly surprised. I actually anticipate that we’re going to make something out of this and we are going to connect it to our industry more, not necessarily selling things that are one-off sales like teargas. I don’t think that synergy ever existing. We are selling it but their methodology doesn’t work but there are other things. They’re making money and they’re growing. Linkstar was making money.

The PromoPath was not making money and the Board agreed to shut it down and take the hit from it because it was bleeding us on a daily basis. And I think the returns on the Linkstar would have been stronger had we not had the PromoPath losses. So by closing that down I think things changed in that market place. Whether we should have been in it or not in the first place I won’t comment, but certainly it was no longer a time to be doing what we were doing there.

Linkstar itself is making money and growing and solid and as you know we just announced the departure of the president of Linkstar. I went there immediately as the first stop to see what that meant and I will say one thing about his departure or his leaving is he put a strong team in place. And I was very comfortable to not make any changes in his transition plan and I feel very comfortable that we’ve got a good solid team in place that knows what they’re doing. And the direction they’re going I’m going to continue to support. I think it’s not as much smoke and mirrors as I thought. It does have issues and we’ve corrected the issues and I’m going to push that we’re a strong high ethics company which means we give excellent customer service, but under Jerry’s leadership that was already corrected and we have great operations people in place who are giving us good customer service. So I anticipate that I’m going to make it into something or we will then again look at it for divestiture. But at this moment it’s generating all the things that we want it to generate. It’s been turned into something that is workable and I thank Jerry for some of that and I thank that team at Linkstar for that.

[Bob Cathlinger - Cathlinger Partners]

With the departing head of Linkstar, when we bought it I think what was regarded as one of the great assets was the founders and the management team that Linkstar had at the time. Do we have a non-compete or is he going to go out and hurt us? What were the circumstances under which he left?

Robert M. Kramer

There is a non-compete agreement in place. It’s a two-year non-compete agreement and it’s very broad. He can’t engage in anything that the company operates in for two years after he leaves.

[Bob Cathlinger - Cathlinger Partners]

I know you gentlemen are all relatively new and you have a lot on your plate, but there was a lot of discussion and a lot of favorite thoughts among shareholders of a stock buyback. Is that something that you’re considering at this time? And then I have one more question about the litigation with Mr. Paolino. I didn’t know that it would stretch for a year. I think there’s liability on his part certainly. Are there settlement talks underway? Do you think it can be settled or do you think it’ll probably go all the way and is the arbitration binding?

Robert M. Kramer

The arbitration is binding. Mr. Paolino employment agreement which is available on the EDGAR site and also I believe has been filed in 8Ks provides that the arbitration by the American Arbitration Association and the award entered by them can then be entered as a judgment of the court. There are very little appeal rights on that kind of judgment. So that part of your question is pretty easy to answer. In terms of settlement conversations, it’s early days. I understand it’s hard to have patience with litigation but again it’s a very defined issue. It’s not whether the corporation exercised the business judgment and the Board exercised the business judgment of terminating Mr. Paolino. That’s not the issue. The issue is that under specific clauses of Mr. Paolino’s agreement do we have to pay him a severance to terminate him. And that’s really what’s being arbitrated in addition to Mr. Paolino’s defamation claims and the other claims he’s made as outlined. So it’s hard to say if settlement talks at some time will be initiated. A lot of litigation is ultimately settled and we’ll just have to really leave it at that in this early stage.

[Bob Cathlinger - Cathlinger Partners]

This is a question out of ignorance I guess but arbitration is meant to short-circuit a lot of the motions before the court and so forth. It’s an attempt to speed things up. Is a year standard for this kind of a procedure? And then I want to get an answer from you about the stock buyback please.

Robert M. Kramer

In terms of a year, I think that most people would say that’s pretty short for litigation involving millions of dollars. So I can understand; I can sympathize that a year or more sounds long but cases can go on for four or five years easily. And again you pick your arbitrator, your panel, arbitration dates, parties get discovery, the length of time is often governed by how lengthy the discovery each party wants to do. So again it’s just early days and I’m sure no one would want me to reveal the corporation’s strategy in its arbitration on this conference call. So again I have to be circumspect in what I say.

Gregory M. Krzemien

In terms of the stock buyback I could say that the Board has considered this from time to time. The Board hasn’t chosen to do any buyback program as yet. You have a new CEO in place and it’s hard for him in his first week of work to ask him where he stands on a buyback program.

Operator

Our next question comes from [Andrew Shapiro - Longbelt Capital Management].

[Andrew Shapiro - Longbelt Capital Management]

I’m not sure I’m going to be as so softball about it on the buyback thing. I’m sorry. But I’d like to get a better clarification from Dennis. You were a Board member for several months now. Yes you’re CEO for just a week. The issue of buying back stock is not a new one. I’ve been very impressed with what I think is a credible plan to cut costs. I think you are someone who can really drive the revenues and the gross profits and we should have a point where we’re going to see light at the end of the tunnel and the burn rate not only cut but eliminated. And with so much cash here on the company’s balance sheet especially net of the proceeds from the car wash sales tallying up to be an amount far greater than the current stock price which prices are shares with an expectation of perpetual deterioration. I’d like to get a little bit better feel about the timing, milestones upon which the Board will re-review and move forward on buying and retiring shares especially at these dirt cheap prices?

Dennis R. Raefield

I was expecting this call from you anyway. It comes on the quarterly call and I understand why you as a shareholder ask it. I’m going to be presenting my strategic plan to the Board at a Board meeting in probably 30-40 days and at that time I’m going to lay out what I’m planning to need for acquisitions which is only one piece of the needs of the money, but I also plan at that time to ask again to settle the issue of the request of whether or not we should do a stock buyback. I think it would be inappropriate for me to be proposing it today when I’ve got to raise the top line. I told you that that is the way out. And some of the top line will be organic growth and some of the top line will be well placed and coordinated acquisitions; not a quick and dirty but ones that are accretive and add value. And that will use some cash I’m assuming. So until I lay out the strategic plan I think it’s inappropriate for me to support a buyback. Secondly, I really need to be sold by our advisors that buybacks work in the market place. I understand the value that they bring to shareholders but does it really raise the stock price and does it extend? And I’m not an expert on that. I’m an operating guy who runs businesses.

[Andrew Shapiro - Longbelt Capital Management]

I’m not talking about a buyback to give some kind of support to the stock price or help us save us from this price level. The stock is trading below the company’s liquidation value. It’s trading below the company’s net cash values valuing the Mace brand, the security business, and the Linkstar business at negative values. And as such, buying and deploying the cash and retiring shares is an accretive deployment of shareholders’ monies just as it would be to acquire another security products industry business. You’re looking for a rate of return.

Gerald T. LaFlamme

But it doesn’t generate any additional revenue.

[Andrew Shapiro - Longbelt Capital Management]

No, it doesn’t generate revenues but it does take the existing revenues and cash flow per share that the company generates and the liquidation value of the company per share and raises that. So it has got to be viewed in the same decision tree as an acquisition proposal would be viewed.

Gregory M. Krzemien

I agree with you Andrew. You have to remember that in the past we did not know what the settlements of the INS and the EPA and all of these things were.

[Andrew Shapiro - Longbelt Capital Management]

I understand that. I paraphrased this with that with light at the end of the tunnel, a cut in the burn rate, you’re going to have some vision here as to it slowing down the burn rate, eventually the elimination of the burn rate and there’s going to be a certain pot of cash there at the end. Yes, there are some acquisition monies, etc. but if your stock price is at too cheap of a price, the purchase and retirement of shares will provide higher value for shareholders than certain acquisitions would.

Robert M. Kramer

I’ll make one comment. It’s rare for companies with a burn rate to do buybacks.

[Andrew Shapiro - Longbelt Capital Management]

I wholeheartedly understand and agree with that except we do have an enormous amount of net cash and we have a plan and a process.

Robert M. Kramer

Sure. And your comments are very much appreciated and I’m sure the Board’s going to take them to heart and if you have any additional point you’d like to elaborate on I’m sure we would be happy to hear it.

Dennis R. Raefield

Andrew, the message is well received; I’ve got your message; and I understand your desires so I will make sure that that gets raised at a Board meeting again at the next one and discussed thoroughly again. And you have my commitment that it will be discussed and won’t be just pushed aside.

[Andrew Shapiro - Longbelt Capital Management]

What’s the status of Mace’s investment in Paolino’s little hedge fund foray? What is the lock-up on this money and your intentions on monetizing that?

Robert M. Kramer

It’s not in our filings but this is a public call. It was basically one hedge fund investment. Mr. LaFlamme and the Board directed that we ask for redemption in that hedge fund and I believe it comes in at the end of September.

[Andrew Shapiro - Longbelt Capital Management]

Right. And here’s an example. Wouldn’t the Mace stock be a better bargain at present prices than the hedge fund investment? There’s a pocket of cash being monetized and your stock is sitting here at $1.50 a share.

Back to the divisional questions. Am I correct to understand that PromoPath had declined to around $1 million of outside sales during Q2 based on your 10Q disclosure and what’s happening is is that PromoPath has discontinued all outside sales activity?

Dennis R. Raefield

It is correct that they’ve discontinued all outside sales activity. I can’t validate the numbers.

Robert M. Kramer

Greg will jump in but the write-off was due to when the acquisition was done. The value of the PromoPath goodwill and customer contacts were valued so when it was decided by the Board to discontinue that outside business, you had to write off that number.

[Andrew Shapiro - Longbelt Capital Management]

No, I’m talking about PromoPath sales. It looked like from your disclosures that PromoPath in Q2 accounted for about $1 million of outside sales.

Gregory M. Krzemien

That is correct Andrew.

[Andrew Shapiro - Longbelt Capital Management]

How profitable was this revenue? In other words what kind of cash flow generation did those sales in Q2 that are now not going to be in Q3 generate, if any?

Gregory M. Krzemien

It was very minimal and that’s why we made the decision.

[Andrew Shapiro - Longbelt Capital Management]

So it won’t be a cash pocket?

Gregory M. Krzemien

No, it’ll be actually a non-event to probably a slight positive.

[Andrew Shapiro - Longbelt Capital Management]

Can you more fully describe PromoPath’s new focus and is it even a separate segment anymore or it’s just basically part of Linkstar’s overhead now?

Gregory M. Krzemien

I’ll let Dennis answer but just to clarify, it never was a separate segment. Our digital media marketing segment had two divisions: E-commerce and PromoPath so that division still exists. It had two customers in the past; it had outside customers; and it had the biggest exclusive customer being Linkstar and it will continue its effort in supporting its largest continuing customer being Linkstar. And again management is looking to do more possible exclusive relationships in the future should something look appetizing and we’re going to focus on that with another possible outside party to also be an exclusive marketer. But for now they’re going to be the exclusive marketer for Linkstar. Dennis, do you want to add anything to that?

Dennis R. Raefield

With two days on the job I would only make a mistake.

[Andrew Shapiro - Longbelt Capital Management]

With the write off of $1.4 million on the customer lists, these were customer list values that were being amortized and expensed at a quarterly pace. Was the write off of $1.4 million net of this quarterly amortization rate being charged into the Q2 SG&A expense? Was there some double accounting and what kind of quarterly rate did that amortize at?

Gregory M. Krzemien

The $1.4 million write off was actually a write off as of June 30 after we had been amortizing that asset down to that point in time. So we will have amortization expense reductions going forward. If you have another question, it’ll take me about 30 seconds but I could actually tell you what that reduction -

[Andrew Shapiro - Longbelt Capital Management]

I have other questions but what was the quarterly hit on amortization in addition?

Robert M. Kramer

Greg will look that up and will come right back to you if you want to ask your next question.

[Andrew Shapiro - Longbelt Capital Management]

Exactly. I will. Maury’s leaving at the end of August here as mentioned in the 10Q and with PromoPath’s pretty much closure or being brought in-house only, are there plans or a need to replace his salary expense and his leadership position?

Dennis R. Raefield

I met yesterday and looked at the transition path and of course I’m in the cost reduction mode so I’m not eager to replace it. I have two strong people in place under Maury and I have not yet made a decision whether I will take them as a direct report and eliminate Maury’s position or replace it. I took three or four different proposals in hand and I’m looking at them. So obviously the timing helps our cost control but it’s also important that that business is doing well and that it continues to do well. We have to recover our investment in that company so I will make the right decision and I’m not ready to make it yet whether or not I need to replace Maury. I don’t need to replace him in the short term. He did do a good job of handing most of his day to day duties over the last three or four months and the team he’s put in place has a lot of my support.

Gregory M. Krzemien

And Andrew that number will reduce amortization expense by about $43,000 a quarter.

[Andrew Shapiro - Longbelt Capital Management]

On the car washes, do you intend to seek the sale of all the remaining washes or are there some good cash flowing washes that we may not necessarily rushing to exit while we have a burn rate to feed?

Dennis R. Raefield

Our goal is obviously to keep the ones that are generating profit to the very end and get rid of the less performing ones first. And that has actually been in general going down. We’ve got some of each in both places. So I’m not eager to sell the ones. I do want to get completely out of the business as soon as possible but I’m not going to give away the assets of the company for a well operating and contributing car wash and sell it at any kind of a loss. Nor has anybody asked us to. The market place doesn’t know which are the good ones and which ones are not so they don’t try and steal the good ones from us.

[Andrew Shapiro - Longbelt Capital Management]

It appears that the Arlington wash that is under contract was the one that was written down to its sales price this quarter. Is this the case or is there another Arlington wash and what are the book values of the other washes in the announced sales agreements?

Robert M. Kramer

There are several Arlington washes. Do you mean the Arlington one that’s in the Q as just having been put under the contract?

[Andrew Shapiro - Longbelt Capital Management]

There’s an Arlington one in the Q just put under contract and there’s a reference to I thought an Arlington wash singular for the write down or is it plural?

Gregory M. Krzemien

I think the wash that is under contract is not the one I had written down. The ones I had written down were two sites - one in San Antonio and one in Arlington. Then again we continue to work hard to try and turn around and make more cash flow positive. We’re still struggling with these two sites in particular and we wanted to make sure that the net book value represented what we think the ultimate cash flow from sale will be.

[Andrew Shapiro - Longbelt Capital Management]

So the write down reflected more than just one wash and not just Arlington, which I got that impression.

Gregory M. Krzemien

That’s right. It was a wash in San Antonio and a wash in Arlington.

[Andrew Shapiro - Longbelt Capital Management]

From the filing I got the impression it was just one wash. So is it just those two washes?

Gregory M. Krzemien

I apologize. It was a site in Arlington and a site in Dallas. Two sites in the Dallas/Fort Worth market area.

[Andrew Shapiro - Longbelt Capital Management]

The Arlington and Dallas financing contingencies, those were two of the four that are under semi-contract for sale. They have financing contingency dates that expire within the next two weeks. Have any extensions been requested or are these sales still looking to close in the current quarter?

Robert M. Kramer

No extension has been requested. Oftentimes you get the best price from single operators, an operator with maybe one other wash. And it’s very hard for me to predict with certainty whether they’re going to get their financing. It’s fair to say that they’re at this point both buyers, two different buyers, are proceeding. I don’t know any reason why they haven’t indicated that they’re having a problem getting their financing but I can’t in good conscious tell you they will get their financing.

[Andrew Shapiro - Longbelt Capital Management]

Can you just clarify which car washes are in the assets held for sale and the discontinued ops and what determines inclusion in these categories and what kept or keeps let’s say Arlington and the Dallas washes for example out of them in Q2?

Gregory M. Krzemien

Basically we’ve set criteria in-house based on our interpretation of the accounting principles and working with our outside accountants, but we feel we will put assets in assets held for sale which in my mind is a non-conservative measure because if we move assets there we’re creating working capital and we want to be pretty sure that it’s highly probable that the sites will sell in a reasonable period at the values that we’ve claimed. So basically it’s sites that are under contract as of the balance sheet date.

[Andrew Shapiro - Longbelt Capital Management]

Then that’s what generates discontinued ops classification as well?

Gregory M. Krzemien

That is generally the same. The only difference is is that discontinued operations would be that and we kind of make a call on putting a discontinued operations when we believe a segment or substantially all the revenue in an operating segment is under contract or sold. Again, Arizona’s complete sold as you know; Northeast is completely sold as you know; and Florida likewise and the region that we feel the substantial amount of the revenues are under contract; and moving out would be Lubbock at this point. That’s kind of the judgment call of the classification on that.

[Andrew Shapiro - Longbelt Capital Management]

Can we just do a real quick rundown to get a feel for the status and whether the costs are now behind us on basically the rogue’s list of all the various things under Mr. Paolino’s watch as to what’s maybe coming back in as payments and what might still have to go out? Regarding the car wash immigration employment issue, there were some expenses this quarter and the payment of what you already accrued as your penalty and fines, etc. with the federal authorities. Are there incremental expenses that you anticipate or expect here in Q3 or going forward, or do we have that matter behind us?

Gregory M. Krzemien

Yes, that is pretty much behind us. We probably will have a little bit of clean-up legal fees. I don’t expect it to be substantial. We have been paying for the fees of the terminated managers also and there was some clean-up on their plea agreements and so on in the September quarter. So there’s probably going to be a little bit of costs in the September quarter but it’s going to be substantially less than we’ve seen.

[Andrew Shapiro - Longbelt Capital Management]

Less than even Q2’s number?

Gregory M. Krzemien

Yes.

[Andrew Shapiro - Longbelt Capital Management]

The EPA matter in Vermont, it was an accrual, there was a clean-up, there was a small incremental accrual that you have here in Q2 and reference in your 10Q that everything is to be done by August 31. Is that still the case and does that mean there are still some expense unaccrued for here in Q3 we may see?

Robert M. Kramer

We think the accrual is accurate. The estimate in that accrual is that a number of the waste drums have to be taken to landfills and disposed of. The delay has been caused by the various agencies wanting a little more detail and then finally the dump site wanting a little more detail. The exact cost of that disposal is going to be done by weight and it’s not going to be weighted until it’s taken to the disposal site. So we had to estimate the weight to that. So it could change slightly but we don’t think it will change greatly. But again it’s an estimate and we think the estimate’s accurate.

[Andrew Shapiro - Longbelt Capital Management]

If the weights came in and everything came in as expected, you have accrued in Q2 this current quarter the costs that you think would be associated with that, is that right?

Robert M. Kramer

That’s correct. Now the one addition to that would be that as noted in our filings it was a subpoena issued by the US District of Vermont inquiring about basically the background of why this waste was on site. So we’re not able to predict if that investigation will be active or will be inactive and costs may result out of that investigation if it becomes active.

[Andrew Shapiro - Longbelt Capital Management]

And will they let you know that it’s inactive?

Robert M. Kramer

No, they don’t do that typically [inaudible].

[Andrew Shapiro - Longbelt Capital Management]

So how long would you generally keep your disclosure on the Securities filings before you make the determination it comes off?

Robert M. Kramer

On this EPA issue?

[Andrew Shapiro - Longbelt Capital Management]

Yes. Or these matters for these federal investigations. They saw your data; you don’t know if they’d ever come back and do something. You certainly institutionally have taken care of this in a credible and timely manner.

Robert M. Kramer

It’s as much art and science as something on that. Probably if nothing happens by the next K, it would probably come out from the K.

[Andrew Shapiro - Longbelt Capital Management]

On the embezzlement and inventory issues in Florida, I don’t think there are any more costs. Your investigation’s done but you had a tentative settlement where there was going to be some form of restitution and then I thought I read in some disclosures that there is still some outstanding issues. Where does that stand and the amount of restitution and timing of it?

Robert M. Kramer

I can provide some more detail on that. The settlement has been reduced to a judgment of using round numbers we have a $700,000 judgment against Mr. Sanders. I think the exact number is $720,000 something but again for round numbers. Getting the order allows us to get a recovery of some funds we found in the brokerage account. That’s again using round numbers approximately $65,000. We should be getting that money in a matter of a week or so. We then now face the decision to how much investigation are we going to try to find any hidden assets and we will be doing some investigation. I think that answers your question.

[Andrew Shapiro - Longbelt Capital Management]

So there’s no longer an attachment to a life insurance policy or any of that? That all went by the wayside?

Robert M. Kramer

Yes, I’m sorry. Again it’s a term life policy as part of the settlement. We did get the term life policy and of course we have to keep it current and we will only get proceeds from that if Mr. Sanders dies.

[Andrew Shapiro - Longbelt Capital Management]

What’s the value of the policy?

Robert M. Kramer

Off the top of my head I don’t remember. Greg, do you remember off the top of your head?

Gregory M. Krzemien

I really don’t, Bob.

Robert M. Kramer

I think it’s in the hundreds of thousands; it’s not in the two hundreds of thousands.

[Andrew Shapiro - Longbelt Capital Management]

And then there was a reference in the exhibits to Mr. Paolino’s publicized arbitration claims that the Board retained counsel to investigate inventory issues in Texas which was kind of new news. What is the issue there or the scope of that?

Robert M. Kramer

We have a filing that says that?

[Andrew Shapiro - Longbelt Capital Management]

No. It was in Mr. Paolino’s 8K filing. He made reference that he wanted to know why the Audit Committee retained counsel regarding issues in Texas. He may have been mistaken in this letter he wrote to the Board.

Robert M. Kramer

Andrew I hope you understand that I’m really reluctant and I think you mean the 13D filing and I think you can understand my reluctance to comment.

[Andrew Shapiro - Longbelt Capital Management]

If you can’t’ discuss that, then that’s fine. I’m thinking we might have covered most of the rogue’s gallery here. So no further questions on that.

Operator

At this time there are no further questions.

Eduardo Nieves

I just want to end the call by telling everyone that my phone number for follow up questions is 954-449-1313 and my email address is ed@mace.com. That will conclude our call for today. Thank you for participating.

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Source: Mace Security International, Inc. Q2 2008 Earnings Call Transcript
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