Management
Richard Riley - Chairman & Chief Executive Officer
Tim O’Connor - Executive Vice President & Chief Financial Officer
Paul Weichselbaum - Executive Vice President,
Paul McMahon - Vice President, Corporate & Marketing Communications
Analyst
Paul Coster - JP Morgan
Presentation
LoJack Corp. (LOJN) Q2 2010 Earnings Call August 4, 2010 9:00 AM ET
Operator
Good day everyone and welcome to the LoJack Corporation’s second quarter 2010 financial results conference call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. Please note, this call may be recorded and I will be standing by if you should need any assistance.
It is now my pleasure to hand the call over to Paul McMahon. Please go ahead sir.
Paul McMahon
Good morning and thank you for joining on our call this morning. Our moderator is Richard Riley, Chairman and Chief Executive Officer. He will be joined on the call by Tim O’Connor, Executive Vice President and Chief Financial Officer; and Paul Weichselbaum, Executive Vice President, who is responsible for domestic and international businesses. An archive of the webcast will be available through www.lojack.com in the Investor Relations section.
Any 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 factors that may cause such differences, please see the warning regarding forward-looking statements in our Form-10K for the year ended December 31, 2009.
I will now turn the call over to Richard Riley.
Richard Riley
Thank you, Paul. Good morning everyone. Thanks for joining us on the call this morning. I will start the call today with a brief overview of our performance in the second quarter touching on the broader domestic auto market in order to provide some context for my comments on our performance and expectations for the remainder of the year. I will then turn over to Tim who will take you through a more detailed review of the financial performance for the quarter. Then, I thought it will be helpful to review our key business initiatives for the immediate future. Finally, Tim or I will take your questions.
The second quarter was another important milestone for the domestic auto industry and by expansion for LoJack. After almost two and a half years of consistently disappointing news in the broader auto market, the first two quarters of this year reflected a healthy year-over-year increase in total light car and truck sales.
It’s important to note, however, that the trend for the first half of the year reflects a larger increase in fleet sales than sure retail sales, which is where we generate our business. Industry expert for now has remained at 11 million to 11.5 million total light cars and trucks will be sold in the U.S. in 2010, up from the 10.4 million vehicles sold in 2009.
As a point of reference for our business, the corresponding estimate for retail sales in 2010 by industry experts is in the range of 9 million to 9.4 million vehicles, up from 8.6 million vehicles in 2009. Our experience in the second quarter was consistent with the progress and the broader retail auto market in the US. We generated an increase in domestic revenue for the quarter of 3% of our prior-year levels driven by year-over-year increase of 13% in total units.
Tim will provide additional insight into the average revenue per unit dynamics during his comments. With the double digit increase on unit sales during the second quarter, our penetration rates remained stable despite the continued tight credit markets. This is encouraging news for us. The growth in our unit sales is driven primarily by the bulk install program, which continues to build as confidence begins to return in many dealerships.
Our international business for the quarter was also up 3% of our prior-year levels, as our licensees return to more normal buying patterns. In addition, several of our newer businesses, particularly LoJack Italia, cargo and SafetyNet contributed to the overall 6% increase in consolidated revenue for the quarter.
We continue to manage our cost structure very aggressively during the second quarter. As previously disclosed, we completed a strategic restructuring during the quarter, which resulted in approximately $2.4 million in severance cost. The restructuring will result in a benefit of approximately $3.9 million over the remainder of the year with annual savings of more than $7 million for the full year in 2011.
Finally, we established reserve against our U.S. deferred tax assets of $15.1 million in the second quarter due to the performance of our domestic business and the uncertain US auto industry over the last three years. The charge is a non-cash charge and it is important to know that this adjustment is for GAAP purposes with the assets still available for use from a tax perspective.
Tim will provide more insight during his comments. During the second quarter, we delivered positive operating cash flow of $5.5 million and ended the quarter with a cash balance of $33 million. What that as a backdrop, I will turn the call over to Tim.
Tim O’Connor
Thank you, Rich. Good morning, everyone. Before I review the operating financial results for the second quarter, I would first like to review the impact of the non-cash tax charge on our reported financial results. The company recorded a $16.1 million provision for income taxes in the second quarter of 2010. This includes the establishment of valuation allowance or reserve of $15.1 million against our US deferred tax assets.
The U.S. deferred tax assets are the result of temporary differences between book and tax accounting, primarily related to our deferred revenue in stock compensation. Current guidance on accounting for income taxes requires the establishment of a valuation allowance to reflect the likelihood of realization of such assets based on the ability of a particular entity to generate sufficient taxable income in the future.
To determine likelihood, on a quarterly basis we examined a number of factors including the cumulative losses in each jurisdiction over recent history using three years as an addictive period of evaluation.
In connection with the second quarter review of the US entity, the severance expenses incurred coupled with cumulative losses in previous periods and the uncertainty in the broader auto market led us to conclude that we needed to record a full valuation allowance. We will maintain this allowance until sufficient positive evidence exists to support a reversal.
It is important to note the company will continue to reflect any and all allowable deductions when filing its returns with the applicable jurisdictions. Moving on to the operating financial results for the second quarter, all comparisons will be against the second quarter of 2009 unless otherwise noted.
Consolidated revenue for the quarter increased 6% to $37.4 million over the prior year. Within our North America segment, US revenue grew 4% and unit shipments grew 13% over the prior year supported by the expansion of our bulk install program. The higher mix of bulk installs adversely impacted overall average price per unit by 4%. The mixed level of bulk install units in the second quarter reached 29% versus 18% in the second quarter of 2009, generating more than $1 million of incremental revenue.
Low royalties related to our agreement with Absolute Software adversely impacted US revenue by $5000 in the quarter. On a constant currency basis, revenue in Canada was essentially even with prior-year levels as the subscriber base remained stable. North America revenue reflects approximately $400,000 of foreign exchange benefit related to Canada.
Revenue in our international business in the quarter increased 3% to $10.3 million from $10 million in the second quarter of 2009. Product revenue from our international licensee business grew 11% to $9 million on unit shipment growth of 15%. The growth was driven by our largest licensees in South Africa and Latin America as buying patterns recovered to normal levels.
The growth in product revenue related to our international licensee business was somewhat offset by lower infrastructure component sales as well as low royalties in the current quarter. Compared to the second quarter of 2009, revenue in our Italy business more than doubled to $600,000 in the current quarter, as we continue to add subscribers. The impact of foreign exchange related to Italy was negligible.
Our SafetyNet and supply chain integrity businesses also contributed to growth in the quarter. SafetyNet reached approximately $700,000 of revenue, more than double 2009 levels supported by product shipments to project life saver.
SCI reached approximately $600,000 of revenue or 26% ahead of the prior year as we continue to expand our units and service across our customer base. Our consolidated gross margin for the second quarter increased 5% to $19.5 million and gross margin as a percentage of revenue in the quarter was 52% even with that of prior year. Gross margin as a percentage of revenue in the current quarter for North America was 51% versus 53% in the second quarter of 2009.
While the higher mix of bulk install units drove incremental gross margin dollars in the quarter, it negatively affected gross margin as a percentage of revenue by approximately 120 basis points. Additionally, increased warranty expense related to Boomerang Technology in Canada had an adverse effect of approximately 120 basis points.
Gross margin as a percentage of revenue in the current quarter for our international segment was 54% compared to 51% a year ago. The improvement was driven by higher mix of product shipments, which deliver stronger margins than shipments of infrastructure components.
Over the remainder of 2010, we expect the impact of higher bulk install mix in the US to continue at the same level while the adverse impact of higher mix of infrastructure shipments in our international licensees will likely increase as the year progresses. We expect the impact of the Boomerang warranty cost to diminish over the remainder of the year.
For comparative purposes, it is important to note operating expenses in the second quarter of the prior year included a non-cash charge of approximately $14 million associated with the impairment of goodwill and intangibles related to our Boomerang tracking business.
Operating expenses of $21 million in the current quarter were essentially even with the $20.6 million level of the prior year when excluding the Boomerang impairment charge.
Included in the current quarter, operating expense is approximately $2.4 million severance related expenses associated with workforce reductions and organizational changes announced during the second quarter. We expect to generate approximately $3.9 million of savings over the remainder of 2010 and approximately $7.4 million of annualized savings on our ongoing basis related to the reductions.
The severance expenses offset lower legal and marketing expenditure in the quarter compared to prior year as well as the benefit of lower headcount versus prior year across the company.
The impact of foreign exchange on the Canadian dollar adversely impacted operating expense by approximately $200,000 in the quarter. On a GAAP basis, the operating loss for the quarter was $1.5 million compared to an operating loss of $16 million for the same quarter of 2009. The company generated adjusted EBITDA of $1.8 million in the quarter compared to $600,000 for the same quarter in 2009.
Modest revenue growth, strong gross margins and tight cost management drove the improvement in adjusted EBITDA. On a GAAP basis, the net loss in the quarter was $18.2 million or $1.05 per diluted share compare to a net loss of $12.5 million or $0.73 per diluted share in the second quarter of 2009.
The net loss for the quarter includes a negative impact due to the valuation of our Absolute Software shares of approximately $300,000 in the current quarter compared to a gain of approximately $300,000 in the prior year. The net loss also includes approximately $1 million of negative impact related to foreign currency in the quarter. The company generated operating cash flow of $5.5 million in the quarter driven by higher revenues, continued cost control and strong working capital management.
Collections across both our US and international businesses drove our receivables balance slightly despite our revenue growth and we have not experienced any significant write-offs in the quarter. Net cash flow of $1.9 million in the quarter includes $3.2 million pay down of our debt in the quarter. As of June 30, 2010, we have approximately $7.9 million of debt outstanding against our multi-currency revolver and we are in compliance with all financial covenants.
Our cash balance as of June 30, 2010 was $33 million. Capital spending in the quarter was $600,000 and depreciation was $2 million. Stock-based compensation in the quarter was $1.2 million. Lastly, we did not repurchase any shares in the second quarter.
I will now turn the call back over to Rich.
Richard Riley
Thanks Tim. As I mentioned, I wanted to spend a few minutes reviewing our key business initiatives. While we have aggressively managed our cost structure over the last few years, we’ve recognized the need to restore revenue growth in order to provide a return to our shareholders and opportunities for our employees. To this end, we will focus on four specific areas.
First, we are repositioning the domestic order business in order to restore revenue growth. We will accomplish this in a number of ways. We will do our national account program as well as sophisticated dealers search for profitable offerings in a difficult economic and regulatory environment. We will capitalize on the anticipated recovery in the broader domestic auto market.
After of three years of disappointing industry-wide sales, experts are now forecasting modest, but consistent increases in each of the next two years. We will leverage improvements in the availability of credit to consumers, which is a critical component in our success. We have agreements with several large finance companies such as Toyota Financial Services and Chase Auto Finance a plan placed to pursue others.
We are developing dealer segmentation models using the past performance of existing dealers to identify new dealerships with significant potential. We will continue to [do well] on our new self-powered technology, particularly for hybrid cars, classic cars and those other models with sophisticated power management systems.
Second, we are working with our licensees as we return our businesses to historical purchasing levels after a significant drop in 2009. Our key international licensees have worked with their excess inventory in a difficult economic environment in the market and are confident in the business prospect for the remainder of the year. In addition, we continue to work closer with our licensees to update their infrastructure in order to support the new self-powered technology we have introduced.
Third, we will build on our recent success in Italy. Our aggressive approach of pursuing multiple business partners in Italy is now beginning to create consistent positive results. We’re now working with dealers, auto manufactures, insurance companies and brokers to drive unit sales and installations. We sold more than 1,000 new units every month this year after hitting that milestone for the first time at the start of the year in January.
Finally, we will continue building out a scalable business plan for SafetyNet as we target patients with Alzheimer’s and children with autism who are at risk of wandering and getting lost.
Our research over the last year has identified several customer segments within the broader group that we will aggressively pursue. As we’ve discussed in the past, the SafetyNet program leverages the powerful LoJack brand and our relation with law enforcement agencies while employing a business model that provides an ongoing revenue stream over the life of the relationship.
While we expected to growth economic recovery, could be bottled for over the remainder of 2010, we remain cautiously optimistic about our business. We will continue to make investments in our core auto business and in our strategic program such as SafetyNet and our business in Italy. We expect to deliver a modest increase in revenue, positive adjusted EBITDA, positive operating cash flow and healthy margins for the full year 2010.
Thanks for your time. We‘ll now take your questions.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from the side of Paul Coster with JP Morgan. Your line is now open.
Paul Coster – JP Morgan
Thanks and good morning. I just wanted to check through, obviously through the remainder of the year you expect to be cash flow [Inaudible]. Do you anticipate sequential improvements through the year or is it going to be a little lumpy than that?
Richard Riley
Well Paul, this is Rich. I really have to say that we expect it’s going to be a little bit lumpy I think. If you look at any analyst out there, it has been a lumpy year thus far. I think it was a disappointing January, February. It followed with a positive March and April, which created some optimism. A disappointing May and June and it appears more encouraging in July. So, I think it’s going to be a little bit lumpy as we go through the rest of the year.
Paul Coster – JP Morgan
Okay. And I’m wondering if, Tim, perhaps you could be a bit more explicit about how quickly the restructuring benefits, I assume it’s entirely an OpEx, and it’s primarily which segments of OpEx and how quickly does it impact?
Timothy O'Connor
Oh, it impacts immediately beginning July 1. And you are correct, the majority, all of it is in OpEx. The majority been in G&A and some in sales and marketing, very little in product development, but it’s as of July 1.
Paul Coster – JP Morgan
It’s about $7 million run rates for G&A, about right now for the quarter?
Timothy O'Connor
Yes. Well, for this year, I would say it’s about $2 million a quarter savings. So the run rate for G&A at $7 million is about right.
Paul Coster – JP Morgan
Okay got it. Lower royalties, it sounds like it was a function of inventory with your partners internationally. Is that probably correct, and I think I heard you say, Rich, that the inventory is now being flushed out and we should be back to a normal buying pattern from this point forward.
Richard Riley
Yes, I think Paul, its always easier to look at the business in high end sight, I think from an international perspective, the problems in the auto eventually hit there a little bit later than it did in the United States and so they continued to per se as if nothing happened for a period of time and then by the time they realized it, I think a number of our licensees had bought up some inventory, and they worked their way through that in the second half of 2009, and I think they are comfortable with where they are. The businesses have stabilized and I think they are comfortable with their outlook for the remainder of the year.
Paul Coster – JP Morgan
And what kind of tax rate should we use for projecting now?
Timothy O'Connor
I guess, I would move off of a tax rate Paul. I think the better way to do it is from a tax expense standpoint. So if you would look from an annual basis of $2.5 million of tax expense, the movements by quarter will vary, because really the only tax expense we will incurs our international entities.
Paul Coster – JP Morgan
Well, when do you think you will start paying, if it’s again domestically?
Timothy O'Connor
Not for the foreseeable future. As we generate income in the US entity, we’ll still be able to benefit or redact the asset that we have on the books even though we have a full reserve against it. So, in terms of paying taxes in the US, I don’t know what the projection is for the foreseeable future, but $2.5 million is a good number on an annualized basis.
Paul Coster – JP Morgan
Alright and than finally, I suppose it is still a little bit too soon to talk about long term margin outlook, but if you got any aspirations you can share with us that would be welcome?
Richard Riley
Yes, Paul. I think you are right, I think it’s a little bit early. I’ve been working on some things in terms of reducing our cost, but clearly as the market changes that are evolved, there is some pressure, although a slight pressure from our customers out there. So, we are working our way through that. We don’t see any significant changes one way or the other in the immediate future.
Paul Coster – JP Morgan
Alright. Thank you.
Timothy O'Connor
Paul, I’ll just to add on the margin, as we talked about little in the past number of quarters, we have done, what I would say is a very good job at making sure the variable nature of our install and operations workforce remains intact so as the volume moves up and down or as we move across our different install models from a sort of a standard install to a bulk install, we are able to flex the cost base there along with the volume and the revenue.
Paul Coster – JP Morgan
Got it. Thank you.
Operator
(Operators Instructions) And it appears that we have no further questions at this time.
Richard Riley
Thank you for joining our call today. We will be around today if anybody has any further questions and we look forward to talking to you next quarter. Thanks.
Operator
This does conclude today’s teleconference. Thank you for your participation. You may disconnect anytime and have a wonderful day.
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