Executives
Erika Kay – IR, KCSA Strategic Communications
Jim Henry – Chairman, CEO and Founder
John Hopkins – CFO
Brian Reach – President and COO
Analysts
Ken Liddy – Wachovia Securities
Henry Bros. Electronics, Inc. (HBE) Q3 2008 Earnings Call Transcript November 13, 2008 11:00 AM ET
Operator
Good morning, ladies and gentlemen, and welcome to the Henry Bros. third quarter 2008 conference call. At this time, all participants have been placed on a listen-only mode. The floor will be open for questions following today's presentation.
It is now my pleasure to introduce your host for today’s call Ms. Erika Kay of KCSA Strategic Communications. Ms. Kay, you may begin.
Erika Kay
Thank you. Again, welcome to Henry Bros. Electronics third quarter 2008 conference call. Representing the Company today are Jim Henry, Chief Executive Officer; John Hopkins, Chief Financial Officer; and Brian Reach, President and Chief Operating Officer.
Before I turn the call over to Jim for opening remarks, I would like to read the following Safe Harbor statement. Certain statements in this conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements.
Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained under the heading of Risk Factors listed in the Company's filings with the US Securities and Exchange Commission. Henry Bros. Electronics does not assume any obligation to update the forward-looking information.
With that, I would like to now turn the call over to Jim Henry, the Company's Chief Executive Officer. Jim, the floor is yours.
Jim Henry
Thank you, Erika and I'd like to welcome everyone to our third quarter 2008 conference call and thank you all for joining us today.
I would like to start with our view on what is clearly a challenging market place followed by comments on the quarterly and year-to-date results and our ability to operate in this environment. I would like to turn the call over to John Hopkins who will provide us with a detailed review of our financial results.
As you all are aware financial markets have been extremely volatile and many companies have seen their access to credit become severely limited crippling their ability to grow. At Henry Bros. we continue to have sufficient access to working capital and remain disciplined in our cost management.
We should also note that except for certain customers in our banking vertical market representing less than 2% of consolidated revenue, we have no exposure to any of the financial instruments or institutions that have been plagued by this historic global economic crisis.
The contingent positives of our business model driven by the improvements we continue to make in our business practices and our profitability has allowed us to double our credit line during this past quarter. With a backdrop of a most significant credit crisis ever, we amended our revolving credit agreement with TD Bank and increased our line of credit from $4 million to $8 million while extending the term of the agreement to June 30, 2010. The original line of credit afforded to us by TD Bank, N.A., provides us with great liquidity and working capital to finance our growth.
However, we acknowledge that all ships dip with a lower tide and have taken strategic steps to continue our growth in a difficult market. In the third quarter we initiated an expansion of our sales force across all regions as both an offensive and defensive move given the current market conditions. Although we expect to see demand softening in the new business construction and regional banking vertical markets the government’s desire to stimulate the economy with infrastructure projects may in fact lead to new opportunities.
While we also anticipate the market to become more competitive in a weakening economy, we will continue with our process improvement and measures to challenge sector [ph] competition.
Finally, the diversity and size of projects we are working on that are fully included in our backlog at present such as the Tactical Video Capture System or TVCS project gives a basis for enthusiastic view of the future.
The third quarter of 2008 saw a 23% decrease in our revenues compared to 2007 and while obviously disappointing I don’t believe that these results speaks to the progress that we continue to make in the quality of the revenue. Our project estimating process improvement, which commenced earlier in 2007, continue to improve the actual versus estimated results. It is important to note that our revenue shortfall during the quarter primarily resided in our New Jersey region and is a result of job bookings being delayed at the time that other larger projects were winding down. This point is supported by the backlog increase in New Jersey exceeding the revenue decrease in the quarter.
As I stated on previous call, because of the nature of our business can be somewhat lumpy in projects can occasionally slip into future periods both on the booking and implementation side of the business. It would be prudent for our investors to view our business on a year-to-date or annualized basis and not just on a quarterly basis.
While we did not see continued growth in our top line during the quarter, we are witnessing a continued increase in our gross profit margin. In the third quarter, our gross profit margins were 28.5%, an increase of 30% from the gross profit margin of 21.9% in the third quarter of 2007. As mentioned earlier the estimated process improvements initiated last year have contributed to this margin improvement. However, moves of this magnitude can only be made – can only be the result of our ability to manage projects and close them out in more favorably then originally planned.
Thus the current quarter’s gross profit margin is at the higher end of the range that we normally expect to see. In addition to improving our gross profit margin we are also building our backlog, which is now a historic $23.7 million. But despite the current financial crisis, we are on track to meet our growth objectives and believe our number of accomplishments we made in the quarter have further enhanced our market position.
On October 2nd, we moved to the NASDAQ making a major milestone for the company. Like our move to the Russell Microcap Index earlier this year our move to NASDAQ built upon our efforts to reach a wider audience of institutional investors. We believe that the electronic multiple market maker structure will not only augment our exposure to a new broader class of investors but will also enhance our liquidity and improve execution speed at a lower cost per trade.
As our company has grown so have the expectations of our shareholders and it is a priority for us to ensure that we are positioned to deliver the most value to them as possible. We continue to make progress in one of our largest projects to date the Praetorian L-3 next-generation, open-architecture 3D video observation system. As the lead subcontractor in a team of 8 contractors, HBE is playing a role – a key role in implementing the tactical video capture system in military training sites in the US and overseas. Through the first quarter, we continue to execute on the mobilization efforts and have hired have hired 20 full-time installation technicians, project managers and engineers to support this project for which we have commenced installation on by October 31st.
We had already received purchase orders in the amount of $2.7 million and expect to receive an additional purchase orders of approximately $4.1 million in the coming quarter. In addition to the continued opportunities that we serve on this expensive project we believe we will see similar opportunities to implement these surveillance systems under new contracts in the future.
Finally, before turning the call over to John to discuss the financials in further detail, I would like to once again highlight our ability to attract and retain key talent in important areas of our business. In September, we appointed John Noble as Vice President and General Manager of the Texas division. John brings almost 3 decades of sales and management experience and has a proven track record of driving aggressive revenue growth in selling security solutions and effective sales management.
I would like to now turn the call over to John for his review of our financial results. John.
John Hopkins
Thank you, Jim. I would now like to review our financial results for the third quarter of 2008.
Revenue for the three months ended September 30, 2008 was $12.3 million compared to revenue of $15.9 million for the three months ended September 30, 2007. Revenue for the New Jersey division increased significantly in the third quarter as a result of winding down of work completed on contracts for several large public agencies in the New York metropolitan area as well as a decline in revenue from our California integration operations. However, this decline was partially offset by an increase in revenue from our Virginia operation and revenue recorded under the upgrade projects at TVCS.
Revenue for the nine months ended September 30, 2008 was $43.3 million, representing an increase 7.5% over revenue of $40.3 million for the nine months ended September 30, 2007. New Jersey revenues increased significantly over the nine-month period, as much of the work of these large public agencies within the New York Metropolitan area was completion. In addition revenues improved within our Arizona, Colorado, and Virginia operations (inaudible).
We recorded net income of $210,782 or $0.04 per diluted share for the three months ended September 30, 2008, compared to net income of $328,040 or $0.05 per diluted share for the comparable period in 2007.
Our SG&A for the third quarter increased by $292,103 when compared to the previous quarter. This is primarily due to a combination of fuel increases and a net increase in the level of bad debt as the prior year’s third quarter reflects a reduction in interest expense.
We recorded net income of $832,000 or $0.14 per diluted share for the nine months ended September 30, 2008 compared to a net loss of $342,331 or $0.06 per diluted share for the nine months ended September 30, 2007.
The gross profit margin for the three months ended September 30, 2008, increased to 28.5% compared to 21.9% in the prior period, and there continues to be a shift towards higher margin jobs through tighter controls and improved labor utilization. However, as Jim previously mentioned the current quarter’s gross profit margin is at the higher end of the range that you would normally expect to see.
Backlog as of September 30, 2008 was $23.7 million compared to $17.6 million reported at June 30, 2008.
Booked orders increased by 33.2% to $18.4 million in the third quarter of 2008 compared to $13.8 million booked in the third quarter of 2007. However, booked orders decreased 5.2% to $40.5 million in the 2008 nine-month period as compared to $42.7 million in the similar period of the prior year. This decline is due to the booking of several large public agency jobs by the New Jersey operation in 2007 that we not due to be paid until 2008.
As of September 30, 2008, we had cash and cash equivalents of $2.1 million. Cash used in operating activities was $0.3 million during the nine months ended September 30, 2008. Total debt as of September 30, 2008 was $4.5 million, down slightly compared to June 30’08 count of $4.6 million.
We have updated our guidance for the 2008 fiscal year to operating margin to 4% to 5% from revenue of $65 million versus 4% of $65 million revenue, which was previously provided. The updated guidance is now inclusive of the $5 million revenue from the TVCS project. These results compare to an essentially break-even operating margin in 2007 from $57.8 million of revenue.
I would now like to turn the call back to Jim for his concluding remarks.
Jim Henry
Thanks, John. As John mentioned we continue to see our New Jersey operations performing well with revenues increasing significantly as we work to our contracts for several of our key customers in the New York Metropolitan area. These large public agencies remain the bread and butter of our company and we have (inaudible) security providers with a national footprint and a highly skilled workforce. This demand will be driven by the constant need for new technology, risk management, and the desire to fit properties [ph] and employees in an ever-changing world.
On behalf of our Board and our employees, I would like to thank you all for the continued support and would like to now turn the call over to questions.
Question-and-Answer Session
Operator
(Operator instructions) Your first question comes from the line of Ken Liddy with Wachovia Securities.
Ken Liddy – Wachovia Securities
Good morning.
Jim Henry
Hi, Ken. How are you?
Ken Liddy – Wachovia Securities
Congratulations on another profitable quarter and good bookings.
Jim Henry
Thank you.
Ken Liddy – Wachovia Securities
As far as this TVCS project (inaudible), when do you expect the project to really get off the ground and in what point of 2009 would we start seeing a steady flow of revenue?
Jim Henry
Actually as I mentioned in the call a little bit earlier a milestone was the kick off of installation construction at the first site, which was on October 31. So, the build up of designing the processes, the assessments going back to court with the government in L-3 and what not, you know, probably it has pushed the time line out in the area of 60 to 90 days further and what we thought was going to be but we have now crossed that feud [ph] and have commenced construction work at the first site and should be moving into additional sties come January, February. So, you can see revenue contributions here in the fourth quarter as John has referenced going on into 2009.
Ken Liddy – Wachovia Securities
Can we expect – I mean are you comfortable in saying between $5 billion and $10 billion a quarter in the first half of the year?
Jim Henry
It is premature at this point to isolate down by month-to-month or even a quarter. As we get into ’09, until we are able to see what the government construct, the range scheduled to get access to the ranges is an issue as well and you know, obviously you know we are out there on active ranges that the government is using for training. So, as much as you might forecast right now where our windows of opportunity are here to do construction which drives revenue recognition. Obviously, international events can occur that could change training schedules out there and impact our construction schedules. So, it is – it is entirely safe to say as we are going to be active throughout the entire 2009 at multiple sites exactly what is going to push through in the first quarter you know, even though we made a (inaudible) I hesitate to hang my hat on that because as I said earlier who knows what is going to happen between now and the first of the year on an international basis and they certainly can very quickly change our action (inaudible).
Ken Liddy – Wachovia Securities
(inaudible). And the operating margins on this particular project would you say that are in the 45% range or higher, lower?
Brian Reach
The operating range should be higher; because what we are doing is we are leveraging a lot of the corporate expense dollars [ph] managing this project. So, that was one of the benefits. It is a very large project .So, the gross margins will be reflective of obviously size but you know, the incremental overhead associated with this is already in place that has been our plan to now get more leverage off of the people of the systems and the processes that we have been constantly changing for the past year and a half.
Ken Liddy – Wachovia Securities
Is there much risk to having start up costs ahead of recognizing of revenue?
Brian Reach
No, we are very cognizant of that and we would expect that by the end of the fourth quarter that we are going to (inaudible) the startup costs, we are going through with – even though some of the startup costs may have – may benefit future periods, you know, our accounting which we are finalizing with our auditors now till year end seems to suggest that we will push everything through. Completion of the first site and it will start all over because you know, as Jim pointed out, we are actually – we are working on live ranges and from time to time depending upon deployment there is open windows and closed windows. So, basically we are going to defer cost on a range or on a site-by-site basis. So, by the time we finish the first site, which are expected to start October 31st. I mean this is a around the clock job and we out to be there [ph] December 21st to (inaudible) plan. You know, as John mentioned that is $5 million of revenue in that period of time. And all cost to pay will be flushed through the – as you know we have indicated that our Q1 operating margin has expanded from 4% to 5%. So, you know you can take from that the incremental contribution of that additional $5 million of revenue is contributing more to the bottom line.
John Hopkins
And just as a – and we will continue to anticipate and possibly from (inaudible) mobilization and recognition of revenue (inaudible) what not, the reason that we were focused on getting our line expanded with the banks to make sure that we did not have any impairment to our ability to move forward and it is possible to maximize our efficiency.
Jim Henry
(inaudible) deferred cost I think it is in the 10-Q, it is
John Hopkins
600,000 through September.
Jim Henry
600,000 through September. So, we expect that to be gone by the end of December and (inaudible).
Ken Liddy – Wachovia Securities
Have you had any type of a cost at all in previous quarters, or in the past quarter that you recognized?
Jim Henry
Well, we basically start incurring costs in the second quarter, maybe it was $100, 000. In the third quarter it went to $500,000 in the third quarter, of course, but in the third quarter we had 20 plus staff working on this, a large majority of them in the planning and the drawings in the site et cetera, et cetera. So, you want to match those costs against the revenue that it is going to generate.
Ken Liddy – Wachovia Securities
In 2009 in the third quarter you are expecting to start 2 new sites, (inaudible) is that correct.
Jim Henry
That is correct. Yes. And I have been looking some schedule of like to 60 to 90 days per site.
John Hopkins
As the field execution schedule is on that order, but as we have seen here there is a lot of – there is many more months of planning and coordination and mobilization and there is actually onsite mostly – particular intention of doing it that way is to minimize the on-site activities and limit the conflict that we have with (inaudible) operation.
Ken Liddy – Wachovia Securities
In what seem to have a first site, how would you compare that to the second, third as far as the size of the project, is it larger, smaller, or about the same?
Jim Henry
Yes, the first one is probably the middle of the road size. Those larger ones are yet to come and the smaller ones are yet to come.
John Hopkins
We will be breaking it out – when we give guidance for 2009. You know, what we think the range of attribution will be related to this project.
Ken Liddy – Wachovia Securities
(inaudible)
John Hopkins
(inaudible)
Ken Liddy – Wachovia Securities
(inaudible)
John Hopkins
We are looking at this as a very, very large project. So, it is something that, you know, we look, as we get more information that we can feel highly confident of course, we will disclose that.
Ken Liddy – Wachovia Securities
How many sites are there in all?
John Hopkins
As of the contract there are 15 potential sites and you have to keep in mind that this is a firm fixed price contract without a committed coupon. So, you know, it is not included in our backlog until we get a purchase order. So, there is no commitment that they are going to do these. Of course, it goes from now until 2011. But it is – so, as we go through the planning process, which starts with a site visit to determine what the exact needs are from that you come up with a design and you did the pricing. Of course to those what was agreed to on a unit pricing in the contract. So, you know, that is why it is easier said than done to give guidance on this. We have a pretty clear idea after the first one on how the designs have worked and how the size, you know, having more scale size-wise at some of these other locations, because we didn’t have – they are locations within locations and it is really for us it is timing to get. It is not on our time schedule. Really a lot of these branches are used for 265 days a year and you don’t want to be there when they are using it.
Ken Liddy – Wachovia Securities
Yes, understandable. And you mentioned that there is some talk that infrastructure projects by the new government. Could you talk about what the type of opportunities might be?
Jim Henry
Well, l will say, I will take the politically safe position of repeating (inaudible) rather than just my own opinion, because even though my opinion matches that of the consensus. I was (inaudible) new ground the last couple of days, the Investor Conference in New York City and obviously the economy of the future was on everybody’s mind. There seemed to be consensus there that the recession that we are in is going to shaped more like a U than a V and that the duration of that could be anywhere from couple of quarters to more quarters. But within that and even though the general feel on the – or general profiling on the security industry is pretty recession proof. It doesn’t mean that certain markets within it are totally recession proof. So, the – the consensus was that we will see obviously a death in the banking vertical and in retail, no surprise there, and plus they were bullish on other vertical markets.
Not only infrastructure, schools, transportation, and what not, healthcare, pharmaceuticals, you know those were the markets that were looked at as having favorable roles in 2009 to be offset by drops in the other areas. The net-net is you are not going to see – they don’t think if you ran that road the industry (inaudible) it is all going to be – still going to be down. So, it is reassuring for me. I mean I think we have done and as a guidance for the – that they have given for people in the industry. (inaudible) it to be focused on multiple vertical markets and also to have some geographic diversity as well as looking at some international opportunities and that is exactly what they are doing.
The mix that we have between public sector and private sector is a very, very good time and you know, as we look into how the government is going to try and not only address the banking infrastructure that they think was left unmaintained you know, over the past few administrations finding of course our mechanism is use to try and send their way, send the economy back into a positive stint. So, with our incumbency in transportation or what not we think we are well positioned for that. So, you know, it was reassuring to hear that and I can say it, it is kind of validated the course that we are on and we are sticking to it.
John Hopkins
Even saying that we are taking steps to substantially expand our work force on the sales side, both first offensively and second should the market not being there to go with theories that have happened in the past and take share from somebody else. So, that is a initiative that we started this quarter in anticipation of 2009 and that is complemented again the, it is not an insignificant achievement to double our line of credit with our bank and so if you are agile and be able to take advantages of some of these opportunities that maybe in the past competition would be able to go out to put maybe the size of it is such that such that can’t get the financial support for it. So, within every event, there is always ways to look at how to take advantage of what new opportunities that are going to be created by us even though overall it may not be a desirable market condition and I think that again our diversified positioning there, our good liquidity, and our access to capital right now and our positioning in the market in multiple geographies where we are aware – everybody, (inaudible) in that conference would like to be with regards to having some options and we will focus our energies going into ’09.
Ken Liddy – Wachovia Securities
Can you quantify how large I mean your pipeline of business opportunities might be?
John Hopkins
Well large, if you look in the past you can see the kind of mix of projects we have had and we continue to go after projects that have had magnitude up to $20 million in size for an individual project. The sweet spot as the jobs get to the opportunities are extended into the multi 100 million dollar contracts. So, we are not pursuing those at that time. That is the sweet spot of the big DoDs. As we are a sub (inaudible) on various other adventures, we are seeing to develop those relationships on those big projects should they be coming forward. We think we are well positioned to be an asset and a resource to participate on those projects. So, again at $20 million and under that is really a sweet spot for us. We have been there and done that before and we think we are pretty good at it and we have also gotten some traction and some experience now in dealing with some of the big guys on the real big infrastructure projects.
Ken Liddy – Wachovia Securities
Aside from this TVCS project, how is your pipeline along with the backlog compared to last year?
Jim Henry
As Brian had mentioned a lot of – most of our backlog here is reflective of business outside the TVCS because we only illustrate in our backlog those very near term releases that we have on the projects we are engaged in now. So, irrespective of what the overall of TVCS maybe confirmed. What we are reporting as backlog is the vast percentage of it is core business.
Brian Reach
But you know our bookings are – as John pointed out reached in his speech there, we had a big looking quarter where within 5% of the bookings for what we did last year. That kind of bookings. So, that business has locked in. We are expanding the sales work force to capture more growth of the base business. An overriding proposals going out the door we have been up. So, it is not like people have stopped spending. I can’t really forecast right now, you know, what that will look like come March of next year, but you know, in terms of the paper that we have to put out in the street and the percentage we get from that you know, those all are still unchanged despite everybody saying it is satisfying. No it is going to be catch up. I don’t think we will know we will start seeing that, probably – because most of these are capital projects and I would think that it is a longer planning cycle.
John Hopkins
But as a complement a thrust, a focus of the new sales team will be to increase the percentage of our business of service revenue, you know, RMR as the catch phrase in the industry here and RMR was a big discussion at the Securing New Ground conference as well and a realization that repeat business with the same customers and maintenance contract revenue you know is RMR is just as the allied industries very narrow definition of it being amongst the openings and closings, and we have made a big investment here in a pretty sophisticated computerized maintenance monitoring systems we call CMMS, which provides very accurate up-to-date utilized monitoring of not only the system’s conditions but also that of the service calls and response and what have you, which we think is a real value for the customers, who will further differentiate ourselves. But you know, as customers are looking to maybe get a few more months or years out of the existing infrastructure, they are delaying capital projects, then focusing on our service expertise, our service lineage and those kinds of value added tools for servicing accounts, not only will bring us new customers, but it will increase that as precious definition of RMR that is coming independent of capital expenditures.
Ken Liddy – Wachovia Securities
When you look at your projects going forward, do you see larger growth as the subcontractor to some of these big defense contractors for instance?
Jim Henry
I think that is going to be a function of what amount of money Congress put out there into place to try and revive the economy. I mean if there employments of billions of dollars for infrastructure then one could expect that within that there is going to be probably a lot of multi 100 million dollar contracts. Initially, we saw a bubble of those multi 100 million dollar contracts within a couple of years of 9/11. We have actually seen that going down. We won a number of contracts here with transportation agencies here locally that we thought initially we are going to (inaudible) into data procurements where we would be sub and we ended up bringing those smaller a la carte contracts. It maybe because the bureaucracy and the challenges that come along with putting out those mega procurements you know, are considered more trouble then they are worth and they prefer to keep the spending a little bit more finalized and disseminated. Not quite sure, but like I say, still a bubble of them. And now we are seeing some contracts that we won directly that if you have asked me 4 or 5 years ago, (inaudible) rolled up into one major procurement. So that may swing back another way then again if there is billions of dollars that are thrown out into the economy by the Feds.
Ken Liddy – Wachovia Securities
Do you see repeat business from the MTA [ph]?
John Hopkins
Sure, that repeat business from the MTA is (inaudible).
Jim Henry
They aren’t going anywhere. There maybe a little financial trouble right now as they have been asking the Feds for some help or what not, but whether they get the help from the government and when the shares go up, one way or the other people are riding trains. Even if gas goes to a buck a gallon, believe me, people are going to ride trains and –
Brian Reach
There maybe delays but you know as I said the planning cycles for some of these projects you know are a year or two in advance. I listen to the – we all listen to the (inaudible). Here, the NPA tomorrow that the sky is going to fall down. What I ask just walking down the hall is we are putting out this. So you say well where a lot of this stuff gets funded way upfront. So, I think those we are seeing visibility on that direction probably not until middle of next year and you know that all depends on the conditions between now and then in the market in terms of their plan. But as Jim says the trains will continue to move. I mean that is only way to get around.
Ken Liddy – Wachovia Securities
Okay, I almost don’t want to ask this next question, but I will, any news on the World Trade Center?
Jim Henry
Why don’t you read the paper every day. You got news everyday. It is someday I expect to see shadows of buildings there, we all hope to, but you know, it is – I think the absorption of what has happened here in the last 5 or 6 weeks regards to financial markets and jobs down of Wall Street or what not, much of these plans have been in place here for these buildings for a long time. At the end of the day, you know, they are commercial buildings and the developers who (inaudible) for these space. I am sure that their outlook for when they are going to able to fill up all the 10 million square foot of office space is (inaudible) and what we see to the schedules. We see come (inaudible) but my crystal ball is no clearer than anybody else is as to when actually we will see all those buildings up.
Ken Liddy – Wachovia Securities
One last question. When you look at 2009, can you give us any hint as far as what your minimum amount of revenue or operating margins. Do you think those operating margins will be in the 5 to 6 range?
John Hopkins
We haven’t finished our planning on that. I think the only thing I can say for that at this point is our plan is to continue the growth of the business. So, I mean going backwards is not really an option for us. And we as I said, we are increasing our sales force. So, I mean at this point, that is the best I can give you. But we will be more definitive on that before the next call.
Operator
Thank you. There are no further questions at this time. I will turn the floor back over to Jim Henry for closing remarks.
Jim Henry
Again, I'd like to thank everyone for joining us on today’s call and in particular for the (inaudible) of very good questions and we look forward to talking to you on the next call.
Operator
Thank you for participating on today's Henry Bros. third quarter 2008 conference call. You may now disconnect.
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