On June 30, 2009, we coded Halifax (HX) as a special situation opportunity. Since 2005 the company has been taking the necessary steps to transform itself from a stagnant operating entity to a viable growth company.
Halifax is a 42 year old company that currently participates in the supply chain management industry. For the past several years Halifax had been operating as a company with sluggish revenues and inconsistent profitability.
In fact, past SEC filings show that from 1997 to 2008 the company had only three years where it posted an operating profit.
Coupling this with an embezzlement incident, discovered in 1999, involving a former controller of one of the company's subsidiaries, initially makes the Halifax story appear unappealing.
However, the future is looking brighter. With new management, the embezzlement incident is behind them and the company has been taking the necessary steps to transform itself into a consistent growth company.
The first task at hand was to pay down debt that arose from the fraudulent activities. This was resolved in 2005 when the company sold its federal services division responsible for designing and installing specified communication systems for governments. The company was able to pay off a significant portion of its debt with the proceeds.
The second task was to formulate and execute a plan that would set the groundwork for sustained profitability and increasing revenues.
It appears that the company's efforts are paying off as it has just reported its first annual profit in several years. The company's optimism is evident in its press releases and conference calls, reasons in part why we feel that Halifax is a special situation opportunity.
Understanding Halifax
Halifax operates in the supply chain management industry. In simple terms, supply chain management is the management of a portfolio of assets spanning different locations and can consist of human assets, equipment and components. There are several aspects involved with the process including computer network setup, movement of parts, product tracking, product returns, office relocation and the maintenance and repair of equipment. The ultimate goal of supply chain management is to enable companies to manage their business more efficiently. Many firms choose to outsource parts of or the entire process.
Halifax's Two Major Divisions
- Enterprise Maintenance Solutions, or EMS. The EMS provides maintenance services on a nationwide basis to major original equipment manufacturers, or OEM. Basically, this division only addresses a specific aspect of the supply chain management process and targets larger OEM firms. Through its more than 30,000 locations and over 400,000 units of equipment, Halifax is able to quickly address the maintenance, repair and tracking needs of its Global OEM Partner Customers, one of which is the technology and consulting giant IBM. In addition, Halifax is also contracted to perform EMS work for its Partners' customers.
Technology Deployment and Integration activities are also part of the EMS division and deal with the movement, installation and support of whole desktop environments.
The EMS division accounts for 85% of Halifax's revenues.
EMS was what was left of the company after the sale of the government service division in 2005. Although the EMS division offers the company a stable revenue stream, the growth opportunities and margins are particularly unattractive. This led to the creation of the Enterprise Logistics Solution, or ELS Division.
- Enterprise Logistics Solutions, or ELS. Through its R&D process, the company discovered that the middle-sized markets were being underserved when it came to supply chain management. Furthermore, if these smaller companies wanted to embark on such activities in-house, it became a costly and time-consuming endeavor. Thus, Halifax embarked on a mission to fine tune its process by offering a more complete supply chain solution as opposed to just maintenance targeted towards the middle markets. The culmination of this initiative occurred in 2008 when Halifax created the Enterprise Logistics Solutions division that offered logistics and supply chain solutions across the entire supply chain framework.
Halifax states, "We deliver comprehensive, fully integrated services including end-to-end customer support and fulfillment, critical inventory optimization and management, web-based customized reporting, onsite repair services, as well as depot repair and warranty management."
This division already accounts for 15% of revenues and has much higher margins compared to the EMS business.
Halifax's Strategy Going Forward
The company's growth strategy is simple-to maintain its stable EMS business and develop the ELS division which has opened a whole new avenue of growth prospects.
- New markets.
- Prior to the establishment of the ELS division, Halifax's business was mainly suited for the IT industry. Now that the company can accommodate the entire supply chain network, it can satisfy the needs of a wider variety of customer markets.
- The ELS division will also allow it to expand its reach through the company's partner relationships.
- As a result of having access to a much broader customer base, the company may be able to jump start its revenue growth.
- Growth in margins should occur.
- As the ELS division begins to account for more of the company's revenues, gross margins should improve.
- The company has a high degree of fixed leverage as SG&A expense can remain relatively stable when revenues increase.
- The company has been reducing fixed contract arrangements and will not enter contracts with substantial inventory requirements.
- The company is virtually debt free which gives it the flexibility to pursue synergistic acquisitions.
- The company's international sales account for less than 5% of its revenue stream.
We are also attracted to the annuity-like stream of revenues from the Halifax model as well as the notion that businesses, in a quest to become leaner in tough economic times, may utilize supply chain services.
The market has finally taken some notice of the Halifax story. After meandering well under $1.00 for several months , despite three consecutive quarterly profits, the stock finally responded on June 30, 2009 when it reported a profit for its 2009 fourth quarter and full year.
Although we are upset that it did not take a position in the stock while it was under $1.00, we are inclined to believe that if the company can execute its restructuring plan, more upside is available.
We are particularly impressed that the company is maintaining profits despite declining revenues and a weakened economy. This tells us that the company's plan to increase its higher margin ELS business is working, albeit at the sacrifice of its larger revenue and lower margin EMS business.
While maintaining current profitability, the company is optimistic that the substantial EPS and revenue growth needed to achieve P/E expansion will start to occur in its 2010 third quarter ending in December.
After reviewing the company's conference call transcripts it is evident that the maximization of shareholder value is one of Halifax's primary goals. We will continue to track the Halifax story. For more insight into the company, please see HX potential valuation scenarios at GeoInvesting.com .
