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Herley Industries Inc. (NASDAQ:HRLY)

F4Q09 Earnings Call

October 16, 2009 9:00 am ET

Executives

David H. Lieberman - Chairman

Richard F. Poirier - Chief Executive Officer and President

Anello C. Garefino - Chief Financial Officer

Peg Guzzetti - Investor Relations

Analysts

Eric Hugel - Stephens Inc.

James Foung - Gabelli & Co.

Joseph Garner - Emerald Advisers

Operator

Good morning. My name is Sarah and I will be your conference operator today. At this time I would like to welcome everyone to the Herley Industries fiscal 2009 year end conference call. (Operator Instructions)

Ms. Guzzetti, you may begin your conference.

Peg Guzzetti

Good morning and thank you for your interest in Herley Industries. Your host for today’s call will be David Lieberman our Chairman of the Board; Richard Poirier, President and Chief Executive Officer; and Anello Garefino, Chief Financial Officer.

Let me begin by reading our Safe Harbor Statement. Except for the historical information contained herein, this release and conference may contain forward-looking statements. Such statements are inherently subject to risks and uncertainties. Forward-looking statements involve various important assumptions, risks, uncertainties, and other factors which could cause our actual results to differ materially from those expressed in such forward-looking statements.

Forward-looking statements in this discussion can be identified by words such as anticipate, believe, could, estimate, expect, plan, intend, may, should or the negative of these terms or similar expressions. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievement.

Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including but not limited to competitive factors and pricing pressures, changes in legal or regulatory requirements, cancellation or deferral of customer orders, technological changes or difficulties, difficulties in the timely development of new products, difficulties in manufacturing, products or in the manufacture of such products, commercialization and trade difficulties, and current economic conditions including the potential for significant changes in the US Defense spending under the new administration which could affect future funding of programs and allocations within the budget to various programs as well as the factors set forth in this report and our other public filings with the Securities and Exchange Commission.

Mr. Garefino will now present the company’s financial results followed by comments from Mr. Poirier and then we will take your questions.

Anello C. Garefino

Good morning everyone, and now I’d like to review the financial results for our fourth quarter and fiscal 2009 which were released last night.

Net sales for the fourth quarter of fiscal 2009 were approximately $43 million compared to $37.9 million in the fourth quarter of fiscal 2008. In the fourth quarter of fiscal 2009, we recorded several significant charges which I will detail in a moment. Aggregating approximately $66.9 million including a non-cash goodwill and other intangible assets impairment charge of approximately $44.2 million. As a result, the loss from continuing operations for the quarter was approximately $44.4 million or $3.26 per diluted share compared to a loss from continuing operations of $1.5 million or $0.11 per diluted share last year.

Income from discontinued operations related to the sale of ICI in November 2008 was $1.2 million or $0.09 per diluted share in the fourth quarter of fiscal 2008. Net loss for the quarter was $44.4 million or $3.26 per diluted share compared to a loss of $0.3 million or $0.02 per diluted share last year.

In the fourth quarter of fiscal 2009, we reported an increase in net sales of $5.1 million compared to last year, which primarily resulted from the inclusion of revenues from Eyal which we acquired early in fiscal 2009.

Operating results for the fourth quarter of fiscal 2009 were impacted by several unfavorable charges including the following. Approximately $44.2 million related to the impairment of goodwill and other intangible assets, approximately $10.6 million related to employment agreement settlements with two formal officers of the company, approximately $4.3 million to cost of products sold related to the settlement of litigation with an important customer to our company, an adjustment to net sales of approximately $2.8 million and $0.3 million to cost of products sold related to the settlement of a claim for equitable adjustment for unpriced change orders, approximately $3.1 million to cost of products sold related to the transition of the Farmingdale, New York Manufacturing Operation including contract losses of approximately $1.1 million and inventory write-offs of approximately $2 million, approximately $1.3 million to cost of products sold for additional inventory adjustment and obsolescence reserves, and finally approximately $0.3 million to selling and administrative expenses related to the abandonment of fixed assets.

The non-cash impairment of goodwill and other intangible assets I’d like to point out does not affect the company’s cash position, cash flow from operating activities, our credit availability or liquidity, and none of these charges will have an adverse effect on our future operations.

Of further significance, in July 2009, the company’s Board of Directors appointed new senior management who were successful in resolving two litigations in claim matters resulting in a net cash outflow of approximately $0.5 million, and more importantly, restoring a favorable relationship with these customers.

And now, I’d like to turn it over to a member of the new senior management team, Richard Poirier, our CEO and President of the company.

Richard F. Poirier

Good morning. As you know, fiscal year 2009 had some significant events beginning with the acquisition in August 2008 of Eyal Microwave. Eyal has been successfully integrated into our Herley General Microwave business and has allowed us to expand into new markets.

In July of this year, the Board of Directors named David Lieberman as Herley’s new Chairman of the board and me as chief executive officer and president. Since then, we have reached out to our customers and investors, and with the support of the Board of Directors, we have taken some significant steps that we feel are best for Herley’s future.

In September, the company settled a claim for equitable adjustment under a contract with a major customer of ours, ending a long period of negotiations and a drain on management time. In October, we settled a law suit with another customer which resulted among other favorable benefits and agreed upon modification of the termination to a termination for convenience. We believe the resolution of these matters has created a more favorable relationship with both customers and will provide the company with additional future opportunities.

We are also taking steps to strengthen our management team. On October 5th, Howard Eckstein was chosen to manage Herley Lancaster, and with his abilities and prior experience we are confident that he will provide the kind of leadership that is essential at this important facility. We anticipate announcing additional management changes in the near future.

On a sad note, we moan the passing of one of our directors, Rear Admiral Robert Moore who died unexpectedly approximately 2 weeks ago. Admiral Moore was a vibrant loud-spoken member of the Board of Directors, and he will be missed. We offer our condolences to his family.

In summary, Herley has a strong foundation, a solid business, and a substantial backlog. Our new leadership team has set new and aggressive goals for the company, and we will be continually monitoring our performance at all levels. With these one-time charges behind us, we begin a new fiscal year with a fresh start and we are optimistic about future results.

Thank you, and we will open the call lines to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Eric Hugel - Stephens Inc.

Eric Hugel - Stephens Inc.

Your last comment you talked about setting your aggressive targets for the management team to grow the company, can you sort of delve a little into that and give some color as to sort of the magnitude of those targets, what they are, so that we can get our arms around that?

Richard F. Poirier

We don’t give forecast information, but I’ll talk a little bit about it.

Eric Hugel - Stephens Inc.

I understand you don’t want to give sort of guidance and stuff like that, but what management is focusing on and how compensation is related to that?

Richard F. Poirier

What we’ve done is, we’ve set targets at each of the individual divisions for the management teams based on budgets for the upcoming year that we’re very optimistic about, but their performance-based goals based on outcomes within the individual divisions as well as the overall corporate targets. So, we put those in place at each one of the divisions, we feel very good about that, having everybody tied into mutual goals for the corporation.

Eric Hugel - Stephens Inc.

You can’t give sort of even directionally, broad strokes kind of growth?

David H. Lieberman

The targets are that we provide it based on certain metrics including revenue, free cash flow, backlog, we can tell you that there have been specific targets set and we can also say at this time and we’ll volunteer this although we’re not giving guidance that we do expect the first quarter of this year to be better in revenue than the fourth quarter of last year.

Operator

Your next question comes from James Foung - Gabelli & Co.

James Foung - Gabelli & Co.

Could you just talk about your litigation expenses, what’s remaining, in your release you said over two litigation matters; I was wondering if you could talk about where you are in regards to more specifically the class action law suit as well as the derivative law suit?

David H. Lieberman

We have settled the dispute with Lockheed as you are well aware and we also have settled the cases with ITTE though; that settlement favorable to the company we believe is going to result in the savings of substantial additional legal expenses going forward among other things. With respect to the class action, the status of the class action is that discovery had been extended and it is now near completion, we expect it to be completed very very shortly, at which time, we intend to move the summary judgment. It has been a very expensive litigation which has directly affected our bottom-line. The expenses in that litigation are nearing an end but for trial while obviously we don’t anticipate or want to go to trial, it takes two parties to settle, and at this point, while we are attempting to settle, we can’t predict what the outcome is going to be, but expect for a possible case which we will obviously try to avoid, we think that the litigation cost, the legal cost in that case are going to be much much less in the coming year.

James Foung - Gabelli & Co.

Is there a date for the trial at the moment?

David H. Lieberman

No, there is not.

James Foung - Gabelli & Co.

When do you plan to move to summary judgment?

David H. Lieberman

We plan to move to summary judgment in the next few weeks.

James Foung - Gabelli & Co.

Can you comment on the insurance litigation too, would you attempt to recover the insurance proceeds from Federal Insurance?

Richard F. Poirier

Yes, as was specified in the last K, we have insurance; the Chalba Carrier denied coverage for certain individuals. A motion for summary judgment was made by both parties. The court determined in that motion that coverage will not be afforded for the company nor Lee Blatt, the other parties, however, are covered; so we do have a coverage in that case, and at this time, we are talking to the insurance company, they have made certain settlement offers which I can’t disclose at this time, but we are covered for all the other defendants.

James Foung - Gabelli & Co.

Except for the stated company and Lee Blatt?

Richard F. Poirier

Yes. We are incidentally appealing that decision. We think it was an erroneous decision and an appeal has been filed.

James Foung - Gabelli & Co.

Okay, great, thanks for the update.

Operator

Your next question comes from Eric Hugel - Stephens Inc.

Eric Hugel - Stephens Inc.

To follow up on the litigation; I was a little confused. There were a couple of litigation items in the litany of charges and then you talked about on the call, but then you said there were two settlements; are those the same things or are those additional?

Anello C. Garefino

The settlements that we spoke to relate to the settlement of the claim with Lockheed and the legal issues related to the ITTE, there was a settlement, those same issues.

Richard F. Poirier

There were four things going on instead of just two and both of those were resolved with good relationships.

Anello C. Garefino

Those two instances and the only other litigation is the class action.

David H. Lieberman

The only open issues are the class action and the derivative action, and we are sensitive to the needs to try to dispose off both cases.

Eric Hugel - Stephens Inc.

I just wanted to make sure given the size of that $4.3 million settlement that there wasn’t any negative ramification in regard to this to the customer in terms of your relationship.

Anello C. Garefino

Actually it was a very positive thing for us. There had been straining the relationships while you are in dispute with your customer and that is what this new management team does not want to do, and actually, outgrowth of these settlements has given us favorable relationships. We have critical meetings set up with these customers for future opportunities. So we take it as a very positive step.

Richard F. Poirier

As you know Lockheed is one of our two major customers and we have a long-term relationship with them and in settling the case it was a business decision. We looked long term rather than short term and decided it was in the best interest of the company to settle that case.

Eric Hugel - Stephens Inc.

With regard to all these charges, does this effectively clear the decks? Should we be thinking as we go forward or shouldn’t we, at least as you know of now, there shouldn’t be anymore of these major charges as we move forward into next year?

Anello C. Garefino

We don’t anticipate at this time anymore major charges.

Eric Hugel - Stephens Inc.

In terms of your backlog, the comments that you guys had made previously, at least led us to believe or we were thinking that we were going to see additional backlog expansion going forward; can you talk about it, and I know it wasn’t a huge number, but given the comments coming out, we were thinking that the backlog will continue to grow sequentially and it was down a bit; can you address that, were there any de-bookings or anything like that in the quarter that might skew that number?

Richard F. Poirier

No, I think actually our backlog was near record levels; it was over $180 million…

Eric Hugel - Stephens Inc.

Over 186 million as of the end of the last quarter; is that number not right?

Richard F. Poirier

No, the $186 million was an overstatement. In the fourth quarter our book to bill I think was approximately 1.2 and our forecast for the year, we believe that to continue, but it will be in excess of 1:1.

David H. Lieberman

The bookings forecast look strong.

Eric Hugel - Stephens Inc.

Fair enough. I will go back in and check my number; I just wanted to make sure that the backlogs were dropping.

David H. Lieberman

I think there might have been an approximation given in the last call.

Anello C. Garefino

We’re looking at the actual backlog at the close of the quarter versus at the date at the conference call took place and there was an estimate at that time that we probably may have been around $185 million.

Eric Hugel - Stephens Inc.

Okay, but what was it at as of the end of Q3?

Anello C. Garefino

In a second.

Eric Hugel - Stephens Inc.

While you’re looking for that number, just one question in terms of looking forward, tax rates; where should we be thinking?

Anello C. Garefino

Our current estimate for our tax rate is approximately 27% to 28% for 2010.

Richard F. Poirier

But do understand based upon the events that have transpired we will undoubtedly not have any or substantial taxes next year to be paid. The effective tax rate that we’re projecting is around 27% or 28% but due to the losses sustained in the year, we don’t anticipate paying taxes in the near future which obviously will add to our free cash flow.

Eric Hugel - Stephens Inc.

Did you find that backlog number? Is it in the Q; I can just look it up if it is in the Q.

Richard F. Poirier

Yes it is. Unfortunately I do not have the third quarter data here with me on the backlog.

Eric Hugel - Stephens Inc.

That’s fine. I’ll just look it up.

Anello C. Garefino

The bottom line is that the backlog is at new record levels and is continuing to grow.

Operator

Your next question comes from Joseph Garner - Emerald Advisers.

Joseph Garner - Emerald Advisers

Given all the various restructurings and write-downs and cleaning up some of the matters that were out there, there has been talk for some time going back to the prior management team about consistently improving the level of profitability of the company. I am wondering if you can talk about how feasible you see in the foreseeable future in getting back to some of the levels of profitability that the company enjoyed in the past and what you may have to do to get to those levels.

Richard F. Poirier

A couple of things. Our profitability is a result of a numerous things including backlog, mix, etc. We feel going forward our profitability will increase; we’re looking well, our backlog is real strong, strong margins, and so we look good. We’re also looking within the individual divisions and overall improving efficiencies at all the division levels. Between the solid mix from our backlog, a profitable business, and actions being taken at the division levels for improved efficiencies, we expect our profitability to improve throughout the year.

Joseph Garner - Emerald Advisers

Should we start to see some of the benefits from some of these recent activities early in the fiscal year or is this something that is going to require more patience?

Richard F. Poirier

I think it’s going to grow gradually throughout the year and the second half definitely looks stronger than the first half.

Joseph Garner - Emerald Advisers

The plans to relocate the corporate offices and such; has that been completed at this point? Should we begin to see the cost benefits related to that?

Anello C. Garefino

The present plan is to relocate the corporate office sometime around the end of this month at which time we will start seeing some of those benefits. We have as previously announced made certain major cost reductions which we estimate at this time could be as much as $2.5 million on an annual basis.

Operator

Your next question comes from James Foung - Gabelli & Co.

James Foung - Gabelli & Co.

In terms of your revenues, if you exclude the acquisition of Eyal’s contribution, it seems like it was flat year over year, and then I guess the stated revenues of $42 million were somewhat flat with the third quarter. I guess I was expecting sequential growth and year-over-year growth; could you just comment in terms of what would happen in terms of the top line?

Anello C. Garefino

The one item that did have an impact on the revenue in the fourth quarter was the settlement with Lockheed which did reduce our reported net sales by approximately $3 million. So, we would have reported on a pro forma basis approximately $46 million in revenue versus $42 million in the third quarter.

James Foung - Gabelli & Co.

So that settlement took away $3 million of sales from you then basically?

Anello C. Garefino

That’s correct.

James Foung - Gabelli & Co.

In your prepared remarks you talked about possibly realizing some additional opportunities with the settlement with the two customers; could you just expand on what the additional opportunities might be and where we might be able to see them?

Richard F. Poirier

Just with your customers doesn’t necessarily open the doors for new opportunities with these customers; Lockheed and Nido are critical customers in our industry and I can say that we have future meetings planned to make sure of both our technology roadmaps, looking at their future requirements and our future requirements are in line so that we can get on new businesses. So, to me it’s just a huge opportunity as opposed to an impediment in future opportunities that we have this good relationship now and we can team up with our customers going forward.

James Foung - Gabelli & Co.

Lastly, when you get to revenues of about $50 million a quarter, is that the time when we could see gross margins hit 30% or you think you can achieve that type of margin much sooner than that?

Anello C. Garefino

I think we will see, as Rich pointed out, a continuous improvement in the gross margin as we go forward, both attributable to the higher sales volume which in part gives us the benefit of additional absorption of overheads, but also from the initiatives that are being put in place on a go-forward basis for additional cost improvements. So I think we’re going to see a gradual ramp up of that profit margin as we go into the third and fourth quarter.

James Foung - Gabelli & Co.

Where do you think you might exit the year, this fiscal year, in terms of gross margins?

Anello C. Garefino

I think you know that we can’t give you that number at this time.

James Foung - Gabelli & Co.

In terms of the charges you took in the quarter, that $67 million, was that all non-recurring or was some of this going to be somewhat recurring?

Anello C. Garefino

These are non-recurring charges. The SEC frowns upon the use of the word non-recurring. So we didn’t put that word in our document, but essentially they are all non-recurring.

Operator

Your next question comes from Eric Hugel - Stephens Inc.

Eric Hugel - Stephens Inc.

Rich, you’ve been at the helm now for a couple of months doing your reviews, going through all the set, going through all the business units; can you maybe give us a briefing as to where you are in terms of what kind of opportunities you have in front of you and what the things which are better or worse than you would expect it, and just sort of give us a briefing as to where you are now versus where you were when you first took over and how quickly do you think you can get this task in front of you completed to do what you need to do?

Richard F. Poirier

I think the company is in great shape, very strong. We’ve done a few things that I’ll comment on. One, is customer relationships. We’ve done a lot of work since we’ve taken the helm to revitalize our customer relationships. In our industry relationships with our customer is key. We settled a couple of big litigation issues with two big customers of ours. So, I think that’s a great move forward. That’s what this new management team wants to do, it’s critical for us. Secondly, our technology. I think we have some great technology that we can expand and enter into some niche markets. For example, our Israeli operations with some solid state power amplifiers has great potential. They are already pretty strong in the international markets, but I think it has some great applications domestically to the US domestic markets. Likewise, UAV market we would like to penetrate. It is a natural fit for command and control operations at MSI, to go into that arena, as well as our other divisions with the various sensors that they are putting on the UAVs. So, we’re concentrating on that. Those are a couple of things. I think the company is doing great. We’re very happy with our management team, but we’re always looking to improve personnel and cut costs where we can. I am very encouraged looking forward.

Operator

There are no further questions at this time.

Anello C. Garefino

On behalf of everyone here in the whole Herley management team we want to thank everybody participating today and we look forward, we eagerly look forward to our next call.

Operator

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

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Source: Herley Industries Inc., F4Q09 (Qtr End 08/02/09) Earnings Call Transcript
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