Yesterday’s article on George Risk Industries generated quite a bit of reader interest but due to the recent removal of the comment and forum features, the questions were not posted directly. This article consolidates the reader questions on George Risk and highlights a few additional points of interest.
Related Party Transactions
Question: There seem to be a number of related party transactions documented in the 10-K including the lease of an airplane that is co-owned by CEO Ken Risk. Is this a warning sign that the family is trying to extract value from the company at the expense of other shareholders?
Answer: There are in fact a number of related party transactions including the lease of the airplane at a cost of $27,000 per year. The plane is co-owned by the company and by Ken Risk and the company pays the cost of the lease for its portion of the plane to Ken Risk. While it is not clear why a small Nebraska manufacturer with two locations that are less than fifty miles apart requires a private plane, the cost does not appear to be material to the investment thesis.
The company also leased a duplex from Eileen Risk, the CEO’s mother, until the end of 2008. The lease required total payments of $7,000 per year. In December 2008, the company purchased the building from Eileen Risk for $15,000.
The company also leases a building from the CEO requiring a $1,535 monthly payment.
While the presence of related party transactions is a legitimate concern, such transactions are common in companies that are majority controlled by the founding family. In the case of George Risk, the transactions do not appear material to the investment thesis.
Marketable Securities
Question: The company has delegated responsibility for investment of the marketable securities portfolio to a “money manager” firm that has the permission to buy and sell stocks at will. The company pays a quarterly service fee based on the value of the investments. We know very little regarding the amount of the fee or the nature of the investments.
Answer: This is a legitimate concern given the amount of intrinsic value locked up the securities and prior results of the money manager which seem to be less than inspiring. The company does disclose more regarding the allocation of assets within broad categories such as municipal bonds, corporate bonds, and equity securities. As of October 31, 2009, 49.9 percent of the $19.1 million was invested in municipal bonds, 31.4 percent in equity securities, and 16.9 percent in money markets and CDs with the small remainder in corporate bonds and Federal agency securities.
While the most shareholder friendly move would be to distribute the excess capital to shareholders, this appears to be unlikely given management’s majority ownership of the company. One of the main risks to the investment thesis is that the funds may be diminished by poor investment decisions or the company may choose to liquidate securities and pursue an acquisition that destroys shareholder value.
Preferred Stock
Question: Please comment on the preferred stock.
Answer: The company has 4,100 shares of preferred stock outstanding. Each share of preferred stock is convertible into five shares of common stock. The analysis has assumed the conversion of the preferred stock and this has been assumed as well by the company in the calculation of diluted earnings per share. The amount of preferred stock does not seem material to the investment thesis.
Customer Base Concentration
Question: How does revenue break down across the company’s client base?
Answer: The security segment accounts for the vast majority of revenues as discussed in the article yesterday. Most of the customers are distributors who sell to the end customer. One distributor in the security segment accounted for approximately 42 percent of sales. Loss of the distributor would have a material impact on the company. However, management notes that the customer has purchased from the company for many years and is expected to continue.
Disclosure: No position in George Risk Industries.