LoJack Corp. Q2 2009 Earnings Call Transcript

Executives

Paul McMahon – Senior Director, Corporate Communications

Ron Waters – President and Chief Executive Officer

Rich Riley – Chairman

Tim O'Connor – Senior Vice President and Chief Financial Officer

Analysts

Paul Coster – JP Morgan

Bill Dezellem – Tieton Capital Management

LoJack Corp. (LOJN) Q2 2009 Earnings Call August 5, 2009 9:00 AM ET

Operator

Welcome to the LoJack Corporation second quarter results 2009 conference call. (Operator Instructions) It is my pleasure to turn today's conference over to Paul McMahon.

Paul McMahon

Our moderator is Ron Waters, President and Chief Executive Officer. He will be joined in the call by Rich Riley, Executive Chairman of the Board, and Tim O'Connor, Senior Vice President and Chief Financial Officer. An archive of the Web cast will be available through lojack.com in the Investor Relations section.

Any of our statements, during this call that are not statements of historical fact, are forward-looking statements. These forward-looking statements are based on a number of assumptions and involve a number of risks and uncertainties and accordingly actual results could differ materially. For further information regarding the forward-looking statements and the factors that may cause such differences, please see the warning regarding forward-looking statements in Item 7 of our Form 10-K for the year ended December 31, 2008.

I'll now turn the call over to Rich Riley.

Rich Riley

I thought I would start with an overview of the broader economic factors affecting our business in order to provide some context for the comment of Tom and Ron that will follow. Tim will then cover the details of our financial performance for the quarter and Ron will provide a more thorough operational view of the business. After our formal comments, we will take your questions.

Economists confirm that the current recession in the U.S. has been more severe than originally forecasted and has now officially completed its sixth full quarter. While there are some signs that it may finally be stabilizing, there is still a great deal of uncertainty in many areas of the economy.

Domestic auto industry has been particularly hard hit, as widespread credit problems have combined with general economic issues to create unprecedented challenges for the last 22 months. Based on moderate improvements in sequential volume in the second quarter, however, we are now cautiously optimistic that the auto industry has bottomed out and will show moderate improvement over the second half of 2009.

We continue to navigate this difficult environment through careful and strategic management of our business. We are confident that we've responded appropriately to fundamental chances in how we do business by reducing our cost structure and remain committed to our strategic plan to diversify the business and ensure long-term growth.

We remain in a strong financial position with $53.4 million in cash at the end of the second quarter. Despite the problems in the auto industry, which were magnified by unprecedented government involvement during the second quarter, we delivered $5.5 million in operating cash flow and pro forma earnings of $0.09 per share for the quarter.

LoJack is positioned well as the global economy begins to emerge from recession. The domestic auto business finally appears to be stabilizing. Our cost structure is in line with the new anticipated domestic volume. Our international business is improving. As I mentioned we have a solid balance sheet and a strong cash position.

We hold a strong position in our core auto market with a clear value proposition for our dealers and consumers. We've added new markets such as tracking and rescuing those at risk where early demand seems to be strong. Finally, we have a very well-known brand that represents the gold standard for tracking and recovery.

With that as background, I will now turn it over to Tim for a more detailed review of our financial results for the quarter.

Tim O'Connor

Before I review the specific financial results, I would like to review the expected goodwill charge for the quarter. Under normal circumstances the company would perform goodwill impairment testing on an annual basis. For Boomerang Tracking, this annual test would take place at October 31 each year. In addition, management reviews detailed business results on a quarterly basis to insure a triggering event has not occurred.

As a result of the current volatile economic environment and the decision by management to integrate Boomerang's operations into the U.S. operating structure, we have determined that a triggering event has occurred in the second quarter. As a result, management is undertaking an interim impairment test of goodwill and intangibles related to Boomerang Tracking.

Management's best estimate of the impact is a non-cash charge of $13 million or $0.76 per share. The value of this charge is subject to change according to the final results of our impairment testing. The final non-cash GAAP charges affecting goodwill and intangible assets will be reflected in the company's 10-Q for the second quarter. This is the only potential change to our results.

Moving on to the specific financial results, second quarter consolidated revenue declined 31% from the prior year levels to $35.4 million. Domestic revenue in the quarter declined 32% from the prior year to $22.2 million. Revenue in our international business in the quarter declined 25% from the prior year to $10 million. Boomerang Tracking had revenue of $3.2 million dollars in the second quarter compared to $5.5 million in the second quarter of 2008. The devaluation of the Canadian dollar accounted for approximately $500,000 of the Boomerang decline.

Unit sales in our domestic and international businesses for the second quarter declined 34% year-over-year. Domestic unit volume for the quarter declined 44% versus the prior year, while international unit volume in the quarter decline 26% versus the prior year. For the second quarter, our consolidated gross margin dollars declined 32% from prior year levels to $18.6 million. Our gross margin as a percentage of revenue was 52.5% compared to 53.1% for the same period in 2008.

The workforce reductions in our operations organization implemented in the fourth quarter of 2008 and the first quarter of the current year sufficiently aligned our installation expenses with current sales volume levels. The total savings reflected in our quarter two gross margin is $2.7 million. I will discuss the additional savings reflected in operating expenses later in my comments.

For the quarter, our domestic gross margin dollars declined 34% and gross margin as a percentage of revenue declined to 53.2% compared to 54.7% for the second quarter of 2008. The favorable impact of our quarter four 2008 and first quarter 2009 operations workforce reductions helped to offset the impact of significant volume declines in the domestic auto business.

International gross margin dollars for this quarter declined 28% and gross margin as a percentage of revenue was 51.2% compared to 53.4% one year ago. The impact of the significant drop in unit volume could not be fully offset by fixed operational cost reductions in the quarter.

Boomerang gross margin dollars for the quarter were $1.6 million, which represents a 32% decrease over the second quarter of last year. The devaluation of the Canadian dollar accounts for approximately half of this decline. Gross margin as a percentage of revenue for Boomerang was 51% compared to 43% in the second quarter of 2008. The majority of this improvement is driven by savings related to Boomerang's analog to digital conversion and the benefits realized from our quarter four 2008 and first quarter 2009 workforce reductions.

Excluding the impact of the impairment charge noted previously, operating expenses for the quarter declined 18% versus quarter two 2008, $20.6 million. This decline reflects a $1.5 million savings related to our previous workforce and benefits reductions. This $1.5 million savings is in addition to the $2.7 million savings I noted in my comments related to gross margin.

Operating expenses for the quarter also reflect a reduction of approximately $3 million in media and advertising spending offset by $1.2 million of legal expenses related to our arbitration with our former licensee in China. It is important to note our quarter two operating expenses also reflect $800,000 of costs related to our supply chain integrity business, which were not included in our quarter two 2008 results.

On a GAAP basis, the preliminary operating loss for the second quarter was $15 million compared to operating income of $2.2 million for the same quarter of 2008. Excluding the impact of the impairment charge, the pro forma net operating loss for the quarter was $2 million.

On a GAAP basis, the preliminary net loss for the quarter was $11.5 million or $0.67 per share down from net income of $1 million or $0.06 per share in the same period of the prior year. Reflected in this loss is an estimated non-cash charge of approximately $13 million or $0.76 per share related to the impairment of goodwill and intangibles of our Boomerang Tracking business.

Management is continuing to review the amount of this charge and expects to conclude in conjunction with the filing of our second quarter 10-Q. Excluding the impact of the impairment charge, pro forma net income for the quarter was $1.5 million or $0.09 per share, including a $1.9 million net tax benefit in the quarter.

Pro forma net income also reflects approximately $600,000 of interest and dividends from investments and uncertain licensees, a gain of approximately $300,000 on our investment in Absolute Software, and foreign exchange gains of approximately $600,000.

The company generated approximately $5.5 million of positive operating cash flow in the second quarter. Working capital improvements, including lowered inventories and prepaid expenses, higher accounts payables and advanced payments from certain licensees drove the improvement. Accounts receivable grew $2.7 million in the quarter driven by higher sales to international licensees.

Our domestic accounts receivable remained essentially even with the prior quarter and have not extent any significant write-offs. The company's cash balance on June 30, 2009 was $53.4 million compared to $56.4 million on March 31, 2009. Capital spending in the quarter was $1.9 million in line with historical rates. The company reduced debt at Boomerang in the quarter by approximately $7.4 million to $18.4 million as of June 30, 2009.

Excluding the impairment adjustment, our depreciation and amortization for the quarter was $2 million. During the second quarter of 2009, we did not repurchase any shares. As of December 31, 2008, we have outstanding repurchase authority to repurchase approximately 1.7 million shares.

I will now turn the call over to Ron.

Ron Waters

Though our performance this quarter reflects the continued impact of the global recession, our domestic and international businesses did demonstrate sequential growth over the first quarter of this year and provides some constructive momentum going into the second half of 2009. The general economic climate in the marketplaces where we do business is showing signs of improvement, and we believe that the worst may be over for the domestic auto industry.

Our domestic auto business appears to have stabilized along with the trends in the broader auto industry. We have maintained a national penetration rate of approximately 6% of new vehicles sold in our markets. Though down from the year prior, our unit volume in the second quarter improved over the first quarter of this year.

Our relationships with dealers remains strong and we are experiencing no discernable erosion due to technology-based competition. We continue to provide our dealers with programs and tools to make doing business with us more efficient and effective. The dynamics of our auto business remain unchanged and tight credit remains a significant challenge.

The seasonally adjusted rate of sales improved sequentially from April through July. Our larger dealers are now forecasting a gradual improvement in vehicle sales during the second half of the year. The Cash for Clunkers program has certainly increased customer traffic in the dealer showrooms. Since our dealers continue to view LoJack as a product that contributes to their profitability, increased volume in dealerships means increased opportunity to sell LoJack.

Our well-known brand, proven technology and association with police make LoJack product that consumers continue to see value in. As a result, we are cautiously optimistic about steady improvements in our domestic unit sales for the second half of the year. The latest industry expectations for 2009 domestic auto sales are 10 million units with projections of an increase to 11 million to 12 million units in 2010.

Our motorcycle and construction businesses remain challenged. Unlike the auto market, the motorcycle market has not yet stabilized. Sales of metric bikes, such as Yamaha, Honda, and Suzuki have been particularly hard hit. Industry experts are not expecting the construction business to experience a rebound until 2010. These two businesses combined represent less than 10% of our domestic revenue.

While the domestic economy remains uncertain, we continue to be conservative in the management of our business. As a result, we took action last week to reduce our domestic organization to more clearly reflect the level of business. This reduction in workforce is in addition to the actions that were made in the fourth quarter of 2008 and the first quarter of this year, as Tim noted during his comments.

We continue to invest in our new programs. LoJack Supply Chain Integrity for the cargo market and LoJack SafetyNet for tracking and rescuing people at risk who wander. Both programs continue to show promise for the future. Our offering is seen in the cargo security industry as a new best practice for supply chain security. Our existing customers continue to increase their number of units.

The challenge is limitations on investments by new customers this year. We continue to assume that as companies again begin to invest in infrastructure, LoJack Supply Chain Integrity will be positioned well. We continue to make progress with our SafetyNet solution as well. As we indicated at the product launch, our initial focus is to expand the number of public safety agencies using the technology and we are successfully doing so with over 100 new agencies in the pipeline.

Consumer interest has been strong and continues to grow. Additionally, we have had strong interests from long-term and assisted living facilities. I'm pleased to note that our SafetyNet solution has led to several rescues of elders with Alzheimer's and children with autism since our introduction in February.

Our international unit volume in the second quarter increased threefold over the first quarter, though some of our larger licensees remain conservative in their buying patterns based on the uncertainties in the locum economies. We see the sequential growth as a very positive sign that reflects historical licensee purchasing patterns, which result in consecutive quarterly increases in unit volume throughout the year.

Our licensee business in Latin America and Europe was particularly positive relative to the first quarter this year. And the volume from South Africa has been minimal in the first half of this year, but should pick up in the second half. The political and economic environment could negatively impact volume in Latin America in the back half of the year.

Our business in Italy showed growth with unit volume tripling over the prior year, albeit not yet enough to counter our level in investment. The growth has come from several different channels including fleets, insurance companies, OEMs and large car dealerships.

I am pleased to announce we recently signed a license agreement for the LoJack network in the Netherlands, Belgium, and Luxembourg. These countries are part of a strategy to create a pan-European stolen vehicle recovery network. Our licensee will secure the local radio frequency network, build out the needed infrastructure and establish distribution.

As with the U.S., auto sales in Canada appear to be bottoming out. Though the Boomerang business continues to be impacted by the same credit challenges as our domestic business, we've expanded our new vehicle dealer business in Quebec. With this expansion, we are effectively targeting the mid-market vehicles in the region.

The analog to digital technology conversion is behind us so our customer base has become more stable.

The completion of the customer migration from analog to digital technology has enabled us to focus on building new activations and expanding the customer base.

This quarter, we took a write-down on goodwill related to Boomerang reflecting our latest estimates for the [car] fair value of the business, as we work to generate new customers in a particularly difficult economic climate.

Additionally, we have initiated a process to integrate Boomerang and LoJack operations into a single North American business to leverage synergies, realize additional deficiencies and more effectively grow the business. We expect that this integration will be complete in the first quarter of 2010.

As we noted on prior calls, our subsidiary LoJack Equipment Ireland is involved in an ongoing arbitration proceeding with our former licensee in China. The arbitration process is a multi-phased one. Phase 1 was to determine whether the contract was properly terminated and Phase 2 is to determine damages, if any.

The arbitrator delivered a decision on Phase 1 of the arbitration on March 17, 2009, and determined that LoJack Equipment Ireland improperly terminated the agreement. However, he also denied the former licensee's claim for treble damages. The hearing for Phase 2 is scheduled to take place in November of this year. We will continue to vigorously defend this case. Because the arbitration is ongoing, there is nothing else that I can comment on at this time but we will keep you updated on the outcome of Phase 2.

I want to reiterate that in the most difficult economic climate in six decades, we are managing our operations aggressively while making investments and strategic programs to diversify the business, leverage the strength of the LoJack brand, and drive long-term profitable growth. We expect to deliver positive operating cash flow for the full year.

With that, Rich, Tim, and I will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Paul Coster – JP Morgan.

Paul Coster – JP Morgan

A couple of housekeeping questions then a bigger picture question, on the housekeeping side, Tim, what was the $1 million of other income?

Tim O'Connor

It's a combination of a number of things. The other income in the quarter was foreign exchange of about $600,000 gain, a pickup of about $300,000 on the Absolute Software shares that we hold, and about $100,000 worth of dividend income from one of our licensees.

Paul Coster – JP Morgan

Tax rate moving forward any thoughts on that?

Tim O'Connor

I would still plan for that year in that I think we talked about it last call in the 20% to 25% range total year basis.

Paul Coster – JP Morgan

The restructuring that you've just done, how should we think about operating expenses sort of short-term midterm?

Tim O'Connor

For the ones that we just announced we don't see any significant impact in this year in that the savings will be offset by some of the severance and related cost that we had in Q3, but on a go-forward basis we should get a benefit of roughly $3 million annualized for that.

Paul Coster – JP Morgan

Are you guys starting to think about the operating sort of the business model that you're targeting post this downturn? If so, can you share with us any thoughts on that in what margin structure you're looking for?

Tim O'Connor

Well, I think from a business model perspective I think we're looking at a number of different things. I'm not certain that they'll have a significantly negative impact on margins. I think that we continue to look at how do we get at more the used car market in the states, in particular.

I think that we will continue to look at pricing and whether or not there are some opportunities from a pricing perspective, and the term of the LoJack historically in the domestic side it's been a LoJack for life and we're looking at opportunities to maybe reduce the price and have the LoJack service for a more limited time period.

Paul Coster – JP Morgan

Actually it brings me to my big picture question, which is that to some extent you kind of been so successful with the first generation of stolen vehicle recovery solutions. Is that also a problem in that you've got this communication infrastructure that doesn't support some of the kind of concierge services?

The two way communications, remote disconnects that sort of stuff we're seeing a little bit of with GM auto start, Mitsubishi stolen vehicle location rather than recovery and we think that Ford may be doing a similar initiative with some partners. Do you feel disadvantaged in going after that, or do you feel that's misconceived and not really what you're about at all? Just sort of curios as to how you see things playing out long-term there.

Tim O'Connor

Well clearly OnStar has been around for a while and there's discussion of what Ford is doing and I think there has been some discussion about Toyota in the past. We don't think that's been a significant negative for us.

Clearly we want to grow the business and as we look to the future I think that we continue to see security and security related activities as a strength as opposed to location base services. Not to say that by not considering the future. I think our challenge is to continue to get after the domestic auto market in particular the more expanded auto park and get into used cars.

And as I said I think we're looking at things from a pricing perspective and are there another channel opportunities to get after the broader car park. And I think as far as leveraging our infrastructure SafetyNet cargo clearly will leverage the infrastructure and we continue to look at creative ways from a technology perspective to take advantage of our other opportunities.

I take you back to July I think of last year where FCC ruled that we could use those other services and other services in addition to people at risk and cargo on our network. So I think there is an opportunity there. So we continue to see some positive opportunities to leverage the infrastructure and we'll continue to look at other ways to get at the domestic auto car park.

Paul Coster – JP Morgan

My last question is you've chosen to go with the licensing route in Benelux. Why did you go that route and not sort of the wholly-owned approach that you've adopted in Italy?

Ron Waters

We have a sort of a hybrid model so we have an investment there and just thought that it was a better way to go forward in those three countries and get us into the market place quicker.

Operator

Our next call comes from Bill Dezellem – Tieton Capital Management.