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LoJack Corporation (NASDAQ:LOJN)

Q3 2010 Earnings Call Transcript

October 27, 2010 9:00 am ET

Executives

Paul McMahon – VP, Corporate and Marketing Communications

Richard Riley – Chairman, President and CEO

Timothy O’Connor – EVP and CFO

Analysts

Paul Coster – JPMorgan

Ali Hilaly [ph] – Ingalls & Snyder

Bill Dezellem – Tieton Capital

Bill Soho [ph] – Milwauk Capital [ph]

Jeremy Yaka [ph] – Milwauk Capital [ph]

Operator

Welcome to the LoJack Corporation’s third quarter 2010 financial results conference call. Later, you will have the opportunity to ask questions during the question-and-answer session. Please note, this call will be recorded. I’ll be standing by should you need any assistance. It’s now my pleasure to turn the program over to Mr. Paul McMahon. Please go ahead, sir.

Paul McMahon

Good morning, thank you for joining the call today. Our moderator is Richard Riley, Chairman and Chief Executive Officer. He will be joined in the call by Tim O’Connor, Executive Vice President and Chief Financial Officer; and Paul Weichselbaum, Executive Vice President responsible for our domestic and international businesses. An archive of the webcast will be available through 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 10-K for the year ended December 31st, 2009.

I will now turn the call over to Rich Riley.

Richard Riley

Thank you, Paul. Good morning, everyone. Thanks for joining us on the call this morning. I will begin the call today with a brief overview of our performance for the third quarter, along with our view on the trend in the auto market, in order to provide some background and context for my latter comments. I’ll then turn the call over to Tim, who will take us through a more detailed review of our financial performance for the quarter. Finally, after I provide some perspective on our core business initiatives and our focus for the next few quarters, Tim, Paul and I will open the call for your questions.

In summary, we’re encouraged by our strong progress on several fronts during the third quarter. Revenue in our international segment for the third quarter increased 46% over the prior year, driven primarily by an increase in orders from our licensees in Latin America and South Africa. Our licensees continued the recovery from a difficult 2009 and are returning to historical buying patterns, with year-to-date revenue in this segment up 29% over the first nine months in 2009. Based on our experience this year, and recent discussions with our licensees, we expect to finish up the year with strong growth in the international segment.

Turning to our North America business segment, revenue in the third quarter declined 7% from prior year levels. It’s important to note, however, that this year-over-year decline was driven entirely by the market trends in the U.S. marketplace, where the comparable period in the prior year included the U.S. government sponsored Cash for Clunkers program. This program generated a temporary spike in auto sales in the U.S. during the third quarter in 2009 and made for a challenging comparison for the third quarter this year.

Recovery in the broader U.S. market has been very choppy throughout the year, when viewed on either a monthly or quarterly basis. We’re encouraged, however, by the fact that our unit sales performance in the U.S. for the first nine months of the year has tracked the experience of the broader domestic auto market as a clear indication that we did not give up any ground to competing technologies. Our consistent performance once again demonstrates that our proven proprietary technology remains the standard in the stolen vehicle recovery space.

Our business in Italy continued to gain traction, as we added more than 2,600 customers during the quarter, even with the extremely low sales in the vacation month of August. We finished the quarter with more than 11,000 total subscribers in Italy, as our expanded business development approach drove success on a number of fronts.

Turning to our bottom-line financial performance, our profitability and strong cash flow in the third quarter reflects the aggressive steps we’ve taken to resize the business in a new global auto market. We are encouraged by the fact that we generated operating cash flow of $5.4 million, adjusted EBITDA of $4.9 million, and net income of $2.7 million for the third quarter.

We’ve now generated almost $11million in operating cash flow over the last two quarters alone, a clear indication of the strength of our underlying business model. This is particularly encouraging as we have now sized our operations for a global auto market, which is expected to experience modest growth over the next few years on the heels of a three-year period of unprecedented declines.

Finally, in the area of engineering, we are receiving positive feedback on the introduction of our self-powered technology platform, both domestically and internationally. The power draw of our new LoJack units was reduced by over 90%. The form factor of the unit was changed as part of the process and the interface between our tracking units and the underlying technology infrastructure was completely updated.

The new self-powered units make the installation process much quicker, enable their use in hybrid cars and those with sophisticated power management systems, can be hidden in more places and are much easier to install. We have introduced a new technology platform throughout the U.S. and have made a great deal of progress in doing the same in our major international markets.

Overall, we are pleased with our progress in the third quarter. We are confident that the domestic auto industry has stabilized, our international licensees are returning to historical purchasing patterns, our costs are under control, and our technology platform has never been stronger.

With that, I will turn it over to Tim.

Timothy O'Connor

Thank you, Rich. Good morning, everyone. As I review our third quarter financial results, all comparisons will be against the third quarter of 2009, unless otherwise noted. Consolidated revenue for the quarter increased 7% to $38.5 million over the prior year. Within our North America segment, U.S. revenue declined 8% and unit shipments declined 6% compared to the prior year, when the government’s Cash for Clunkers program drove abnormally high sales in the quarter.

As with previous quarters, our bulk install programs have continued to grow. The mix-level of bulk installs in the third quarter reached 29% versus 15% in the third quarter of 2009. The higher mix of bulk installs adversely impacted our overall average price per unit by 5% or approximately $700,000.

North America revenue reflects approximately $200,000 of foreign exchange benefit related to Canada. Revenue on our international business in the quarter increased 47% to $13.4 million from $9.1 million in the third quarter of 2009. Product revenue from our international licensee business grew 49% to $11.9 million on unit shipment growth of 61%. The growth was driven by our largest licensees in South Africa and Latin America, as buying patterns continued to recover to normal levels.

Prices across our international business in the quarter averaged 6% lower than prior year, driven by customer mix, as large customers benefit from our volume variable pricing methodology. Compared to the third quarter of 2009, revenue in our Italy business grew more than 50% to $500,000 in the current quarter, as our subscriber base reached more than 11,000. The impact of foreign exchange related to Italy was negligible.

Revenues in our SafetyNet and supply-chain integrity businesses for the current quarter were essentially even with the prior year. SafetyNet at approximately $200,000 of revenue was negatively impacted by minimal product shipments to Project Lifesaver during the quarter. Supply-chain integrity reached approximately $600,000 of revenue, or 12% ahead of prior year, as we continued to expand our units and service across our customer base.

Our consolidated gross margin for the third quarter declined 6% to $19.4 million, and gross margin as a percentage of revenue in the quarter was 50% compared to 57% in the prior year. It is important to note, gross margin in quarter three of 2009 included a one-time benefit of approximately $500,000 or 130 basis points related to a sales tax refund in Canada. For quarter three of 2010, gross margin reflects cost of approximately $600,000 or 150 basis points related to the discontinuation of our ProximityPlus GPS product line.

For our North America segment, gross margin as a percentage of revenue in the current quarter was 51% versus 55% excluding the one-time items previously mentioned. While the higher mix of bulk install units drove incremental gross margin dollars in the quarter, it negatively affected gross – North America gross margin as a percentage of revenue by approximately 290 basis points. Additionally, increased warranty expense related to the Boomerang technology in Canada had an adverse effect of approximately 190 basis points in the quarter.

Gross margin as a percentage of revenue in the quarter for our international segment was 54% compared to 56% a year ago, driven by a higher mix of product shipments to our largest customers who benefit from our volume-variable pricing methodology.

Over the remainder of 2010, we expect the higher impact – the impact of higher bulk install mix in the U.S., as well as the higher mix of shipments to our largest international customers to continue at the same level. We expect the impact of the Boomerang warranty costs to diminish over the remainder of the year.

Moving on to operating expenses, it is important to note the third quarter of the prior year included approximately $19.9 million of settlement and legal expenses related to the litigation with our former licensee in China. For comparison purposes, I will exclude these expenses in my comments related to operating expenses, adjusted EBITDA and operating income. Operating expenses of $16.4 million in the current quarter represents a 21% decline from the $21 million level of the prior year. This decline reflects the benefit of our workforce reductions and organizational changes announced during the second quarter, as well as other cost savings initiatives.

Operating expense for the current quarter includes approximately $1.5 million of investment across our Italy, SafetyNet and supply-chain integrity businesses, and approximately $1.7 million of depreciation and amortization expenses. Operating income for the current quarter was $3 million compared to an operating loss of approximately $400,000 for the same quarter in 2009.

The company generated adjusted EBITDA of $4.9 million in the current quarter compared to $1.9 million for the same quarter in 2009. The improvement in both operating income and adjusted EBITDA was driven by the $4.7 million reduction in operating expenses. This was somewhat offset by costs associated with the discontinuation of the ProximityPlus and Boomerang warranty expenses, as well as the higher mix of bulk install units in the U.S.

Net income in the quarter was 2.7 million or $0.15 per share compared to a net loss of 13.4 million or $0.78 per share in the third quarter of 2009. It’s important to note the net loss in the prior year includes an after-tax charge of approximately $14.6 million or $0.85 per share related to the legal settlement with our former licensee in China. The company generated operating cash flow of $5.4 million in the quarter, largely driven by the lower operating cost coupled with continued strong working capital management. Collections across both our U.S. and international businesses continue to drive reductions in our receivable balance, despite our revenue growth.

Net cash flow for the quarter was $4.5 million and capital spending was approximately $700,000. As of September 30th, 2010, we have approximately $8.1 million of debt outstanding against our multi-currency revolver, and we are in compliance with all financial covenants. Our cash balance as of September 30th, 2010 was $37 million. Stock-based compensation in the quarter was $200,000. Lastly, we did not repurchase any shares in the third quarter.

I will now turn the call back over to Rich.

Richard Riley

Thanks, Tim. As I mentioned earlier in the call, we’re pleased with our progress in the third quarter. We’ve taken specific steps to refocus the business on the core, to scale the size of the organization to current market conditions and to bring our costs in line. Results of these difficult actions are reflected in the strong financial results in the third quarter.

With the close of the third quarter, we’ve now experienced a three-year period in which the U.S. new car market has declined from a 10-year average sales level of just under 17 million vehicles to a range of 10 million to 11 million total vehicles. Even in a cyclical business, this has been a surprisingly dramatic and long downturn. We are confident that the U.S. auto market has now stabilized and will grow modestly from where it is today.

Based on the steps we’ve taken throughout our organization, we’re positioned to take advantage of this anticipated recovery in the domestic auto market and the improvements in the availability of credit to consumers over the next few years.

While we have aggressively managed our cost structure, we recognize the need to restore revenue growth. As I had mentioned on our second quarter earnings call, we have taken steps to reposition the domestic auto business through better dealer segmentation. We are effectively working with our licensees to restore their business to the historical levels. We continue to gain traction in Italy where we’re on track to have between 13,000 and 14,000 subscribers by year-end. And we continue to build a scalable business model with our offering to track and rescue people with (inaudible).

We remain encouraged by our prospect for the remainder of the year. For the full year, we expect to deliver a moderate year-over-year increase in consolidated revenue, positive adjusted EBITDA, positive operating cash flow, and healthy margins. Looking out a little further into 2011, we expect our domestic business to follow the forecasted gradual recovery of the overall auto market in the U.S.

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

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the side of Paul Coster with JPMorgan. Please go ahead, sir.

Paul Coster – JPMorgan

Yes, thank you. Looks like, with the stock indicating up pretty significantly this morning, that the market is beginning to reward the turnaround that’s happening here, so congratulations. I just want to follow through on a few things. First of all, can I just establish that the expense reduction is done, and that’s it? At this point, you’ll flex the R&D and sales, general, et cetera, expense with the business?

Richard Riley

That’s correct, Paul.

Paul Coster – JPMorgan

Okay. Gross margins, looking forward, it sounds to me like there is reasons why domestically anyway the gross margins might tick up a little bit with volume of course. But not – we are really sort of looking at fairly stable gross margin business with a sort of medium-term year or plus outlook. Is that correct?

Richard Riley

I would say, yes, Paul. I think (inaudible), the folks in the operational organization have done a wonderful job over the last couple of years really making those costs variable. If you recall, just a couple of years ago, it’s largely fixed staff of folks who did the installations with a fairly expensive unit. They have done a wonderful job in terms of both reducing the cost of the unit in connection with the new technology as well as the installation process that we have in place out there. So, we have taken as much out of that process as we can.

Paul Coster – JPMorgan

Now, judging by your revenue remarks, we should expect sort of generally – the typical seasonality for the domestic business in the fourth quarter, which would have it come down sequentially. But now, you’re seeing growth with market on a year-on-year basis. Internationally though, it sounds like we could have – and I know it’s very lumpy, that business, it sounds like we could have a pretty strong fourth quarter?

Richard Riley

I think the expectations are, we keep in constant contact with the folks here and get a pretty good sense in terms of how their business is. And so, I think we are looking for a reasonably strong quarter in the fourth quarter as well. And we had a pretty consistent performance in the International business this year and I think we would expect that to continue in the fourth quarter.

Paul Coster – JPMorgan

Got it. And would you expect – would you characterize the Italy business as accelerating at the moment?

Richard Riley

Clearly, we’re gaining momentum. I think, we have been through the statistics as we go through the year, we expect to finish up the year with 14,000 subscribers or 13,000 subscribers, and we started the year in the range of about 3,000. And so, it has been – I think it’s been a satisfying process this year. I think we have expanded the business development initiatives we have in place, and those are beginning to take hold, we believe.

Paul Coster – JPMorgan

Is the business breakeven here?

Richard Riley

No, we anticipate it will be breakeven next year.

Paul Coster – JPMorgan

And then as you – with what you’ve learnt now in Italy, is there opportunity for you to expand in Italy, but perhaps also in contiguous areas of Europe?

Richard Riley

Well, I would say that we will continue to develop the business in Italy. I think we want to make sure that we have that done and done well before we open up our eyes and look elsewhere.

Paul Coster – JPMorgan

All right. And then finally, you mentioned that you didn’t buy back any shares. How many shares are you approved to – authorized to purchase?

Timothy O’Connor

Paul, we still have authorization to repurchase 1.6 million shares or thereabout.

Paul Coster – JPMorgan

Okay, thanks very much.

Richard Riley

Thank you, Paul.

Operator

Our next question comes from the side of Ali Hilaly [ph] with Ingalls & Snyder. Please go ahead.

Ali Hilaly – Ingalls & Snyder

Hi, thanks for taking my call. Congratulations guys, good quarter.

Richard Riley

Thanks, Ali.

Timothy O’Connor

Thanks, Ali.

Ali Hilaly – Ingalls & Snyder

I just have a couple of quick questions. Am I correct that 1.5 million in expense between Italy, SafetyNet and SCI, that is net of revenues, right? So, that would – like if I were to look at the established businesses, I would add that 1.5 million to EBITDA?

Timothy O’Connor

The $1.5 million quote was as a number – subset of the 16.4 million in operating expenses.

Ali Hilaly – Ingalls & Snyder

Okay, so it’s not net of revenues?

Timothy O’Connor

It’s not net of revenues, no. It’s just an absolute number as part of our overall operating expenses for the quarter.

Ali Hilaly – Ingalls & Snyder

Okay. Can you give me an idea, I mean, I know SafetyNet was – sorry, SCI was 600,000, SafetyNet was 200,000?

Timothy O’Connor

And Italy was about 500,000.

Ali Hilaly – Ingalls & Snyder

500,000. Thank you. Can you elaborate a little bit about the warranty issues?

Richard Riley

The one related to Boomerang technology?

Ali Hilaly – Ingalls & Snyder

Yes. And also, you didn’t mention the gross amount, so maybe if you could just walk me through what happened there?

Timothy O’Connor

Sure. This was something that we actually discovered at the first part of the year. We had an issue with the network when it converted over from analog to digital. There was an issue with the resetting of the cell phone number or the cell phone board in the phone. We discovered that. We have a solution for it that we pushed out via an SMS text message to each one of the devices. However, there are a number of devices that we still have to bring back in and actually replace the full unit in the vehicle. So, that’s been going on. It has cost us around – anywhere between $300,000 and $400,000 a quarter. As I said, we anticipate that going away as we work through the backlog of devices that are out there. And that’s really the history of it. So, we have a fix both on the hardware itself, but also on the phone number we pushed out.

Ali Hilaly – Ingalls & Snyder

So, is it correct to assume that that was an expense of $600,000 in the third quarter and do you know how much more you will have to spend going forward?

Timothy O’Connor

It’s a little – it’s closer to 400,000 than it is 600,000.

Ali Hilaly – Ingalls & Snyder

Okay.

Timothy O’Connor

And it’s just a matter of working through the backlog. So, we do anticipate that...

Ali Hilaly – Ingalls & Snyder

A couple of more quarters or …?

Timothy O’Connor

Yes, we anticipate that going down over the next couple of quarters, yes.

Ali Hilaly – Ingalls & Snyder

Okay, great. There was also some mention of another lawsuit, did that have to do with this warranty issue or is that separate?

Richard Riley

Which lawsuit are you referring to? It’s just the – it was the comparison year on year, Ali, that I mentioned?

Ali Hilaly – Ingalls & Snyder

No, in the 10-Q that came out for the second quarter, at the end of it, there was mention of another lawsuit potentially being filed.

Richard Riley

I believe this is – Ali, there was a suit filed in California with respect to false advertising surrounding our motorcycle product.

Ali Hilaly – Ingalls & Snyder

That’s the one, yes. Do we have any information or is there any settlement on that?

Richard Riley

Now, we will update the 10-Q with respect to that.

Ali Hilaly – Ingalls & Snyder

Okay, great. Thank you very much for your time guys, and congratulations, good quarter.

Timothy O’Connor

Thank you.

Richard Riley

Thanks again, Ali.

Operator

Our next question comes from the side of Bill Dezellem with Tieton Capital. Please go ahead.

Bill Dezellem – Tieton Capital

Thank you. We had a group of questions here. First of all, relative to your key international markets, would you please discuss what’s happening with auto sales? Those markets are a little bit more difficult for us to get information on.

Richard Riley

Bill, there is two aspects of the business that we have international in almost in every country that we have. One is the general business sales has an impact on whatever they do. But, what is bigger in most every one of those countries is the relationship they have with insurance companies and the degree to which the insurance companies find it economically attractive for them to buy the units, either directly or to subsidize those things. And so, they are not as driven by the overall market conditions of the auto industry in those countries as we are here in the United States. It’s impacted, but a greater impact is the relationship with insurance companies.

Bill Dezellem – Tieton Capital

And do those relationships with the insurance companies change as the theft rate in those individual companies – countries either increases or decreases?

Richard Riley

Absolutely, they’re driven as you can imagine by some folks who sit there and kind of crunch the new statistics and the new data points out there on a regular basis. And so, those relationships, they change over time by make and model, by location, by frequency of theft, by recovery, by lots of different factors.

Bill Dezellem – Tieton Capital

This next question may be unanswerable here on this call, but I’m going to try anyhow because it sounds like it maybe a gist of the nuts and bolts of things, and that is the theft rate in your key international markets, what can you tell us about each of those?

Richard Riley

Well, we don’t typically report on that for a number of reasons. Most notably the data points are not reliable from all the different countries in which we do business. Specifically, in those countries where we’re most successful or where our licensees are most successful, there is great question with respect to the reliability of the information there.

But I think clearly, there is two aspects to that, like there is the actual theft rate and there is the perception of the theft rate there. And so, there are parts of the world right now where that perception is much higher than it has been and that has been helpful to the process. You know, I’m not sure I would say that there is any place where we see a decline in theft rate having a negative impact on our business.

Bill Dezellem – Tieton Capital

And that’s helpful, thank you. And as we continue down the international discussion path here, your unit volume was up 61%, and I think in the opening remarks, you mentioned that pricing in the international market was down 6% and yet revenues are down 47%. So, there seems to be something between the 47 and the 61 that’s not fully accounted for with price. Would you help us understand what’s causing that variance between revenues and unit volume?

Timothy O’Connor

Yes, Bill, it’s Tim. So, the price decrease of 6%, that average price decrease is really across all customers and it’s really a function of our largest customers who are – who’ve really driven the growth in the quarter. Basically, we had a lower price because of the volume that they buy. So, that’s the piece on pricing. If you look at – and I think we talked about it a bit last quarter. There is really three buckets of revenue within the international business. The numbers I quoted you on the revenue and the units are the product volume. There is also a number of – there is about $1 million worth of revenue across infrastructure and royalties that also take place in the quarter as well, as it relates to the licensee business.

Bill Dezellem – Tieton Capital

Thank you. And then, circling to Italy specifically, do you foresee a period of time where the – where number of units actually truly hits a hockey stick. I mean, it seems like 2010 could probably be described that way, but that would further be that way in the future?

Richard Riley

We are clearly – we are encouraged by what’s happened in 2010. So, I mean, you have to look at it and say, okay, we started the year with 3,000 and we expect to finish the year with 13,000 or 14,000. And that certainly was the most significant growth that we’ve had, and we have been in that marketplace for three or four years.

So, that’s been a big change for us. There’s a lot of dynamics going on in that marketplace. The auto industry is struggling mightily in Italy, they are great more so than here in the United States. But we are clearly; we’re making some ground there. So, this has been a transition year for us, we believe, in terms of what’s going on over there.

Bill Dezellem – Tieton Capital

And what do you see as the ultimate long-term potential in Italy? Clearly, it’s – there are more than 13,000 or 14,000 automobile in that country?

Richard Riley

Well, we think it’s an attractive market, that’s why we went into it. We think not only it’s an interactive market, but the dynamics of that market are a little bit different. So, the recurrent revenue model that exists in Italy doesn’t exist here in the United States. And as we’ve said when we first got into that, it requires a significant investment on the front-end to own that country rather than to license it. It takes a longer period of time to get it up to speed and ramp it up, but once you turn the corner and you have a significant subscriber base, it seems that that enterprise gets rewarded for the recurring revenue stream that it has.

And so, that’s why went into that marketplace, we are excited by the growth we’ve made this year. It’s been long in coming, but it’s been over a short period of time as a result of a more extensive business development approach. Some of those things are brand new to us, so we want to understand it a little bit better. But clearly, it’s a different business model that we are pursuing in Italy than we have available to us here in the U.S.

Bill Dezellem – Tieton Capital

And an entirely different question, your operating expenses dropped dramatically in the third quarter versus the second quarter. Would you please discuss how you actually made those cuts of that magnitude so quickly?

Richard Riley

Of course. Go ahead, Tim.

Timothy O’Connor

So, we talked a bit about it last quarter, Bill. The way we looked at the business is, again, we went across really the sales organization and looked at some of the regions we’re covering and some of the markets in the U.S. we’re covering with, what I’ll call, our own sales people and took a decision to do a different coverage model in those areas including use of agents and some other techniques.

Once we did that, we looked at the – sort of the structure and the levels within the sales team and the span of control in the sales team and then eliminated a number of positions in terms of levels in the organization in that group. So, that was kind of the one side of it. And then, we took the same exercise that relates to some of the corporate functions and support functions, in terms of both spans of control and the layers in the organization, and quite frankly, removed a number of layers in the organization.

That was facilitated by us stepping back and looking at our core business and making sure we can fully fund and fully support that core business to drive it, and really get, what I’ll call, a financial recovery or get us in a good place for where the market is today. So, that’s really what drove all that. That was – the majority of that was really driven by the reductions we took – that took place in June of this year. And that’s really provided great benefits for us, as you can see.

Bill Dezellem – Tieton Capital

And of the sequential operating expense reduction, presumably part of that is no longer having the cost of those cost reduction programs that you described, and the other part would actually be the benefit from those cost reduction programs. Is that a fair assessment and if so, would you be able to split that pie for us?

Timothy O’Connor

Sure. The cost associated with the reductions that took place in Q2 was about $2.4 million.

Bill Dezellem – Tieton Capital

Yes.

Timothy O’Connor

And the annual – sorry, the 2010 benefit was about $4 million. So, it’s about a $2 million benefit per quarter, a little bit more than that, but close enough.

Bill Dezellem – Tieton Capital

Approximately a $2 million benefit, you said?

Timothy O’Connor

Per quarter, correct.

Bill Dezellem – Tieton Capital

Right. Okay. Thank you.

Timothy O’Connor

You’re welcome.

Operator

(Operator instructions) Our next question comes from the side of Jeremy Yaka with Milwauk Capital [ph]. Please go ahead.

Bill Soho – Milwauk Capital

Thanks. Good morning guys. This is Bill Soho [ph]. Can you hear me?

Richard Riley

We can. We can, Bill.

Timothy O’Connor

Thanks, Bill.

Bill Soho – Milwauk Capital

Okay. Thank you. Just curious, sequentially – just want to be clear, it sounded like you expect revenue to be flattish to up sequentially based on, I guess, your strength internationally going to offset income at seasonal declines in the U.S. Is that kind of what you are communicating to us?

Richard Riley

No, as we go through the process, it has been as I have indicated in my comments kind of up and down here in the domestic auto market. And so, if you look at it from a month-to-month perspective, no one seems to really understand where it’s going. There was a difficult comparable this third quarter compared to last year because of the Cash for Clunkers. There is some question and speculation as to the impact that is going happen in the fourth quarter of this year on a comparable basis to the fourth quarter of last year. And so, we looked at it and said, we think we have a pretty good beat in terms where our international business is going to be and we think that – when we finish this year, that our domestic business will follow the trend for the domestic business for the full year.

Bill Soho – Milwauk Capital

Okay. And I’m sorry, just to get a little more clarity, traditionally, would you expect domestic business to be down, up or flat in fourth quarter?

Timothy O’Connor

Bill, I would say – it’s Tim, I would say we still plan on following whatever the market does at the moment because...

Bill Soho – Milwauk Capital

Okay.

Timothy O’Connor

As you can probably tell, the forecast for the market on any given month has been erratic at best.

Bill Soho – Milwauk Capital

Okay. And as you view it, what’s the forecast for the market? Is there some seasonal weakness in 4Q, or is there...?

Timothy O’Connor

Historically, there’s been a seasonal weakness in the fourth quarter, yes.

Bill Soho – Milwauk Capital

How much historically?

Timothy O’Connor

It can be anywhere on – it’s tough to call anything a normal year at the movement. And I would say, if we’re back at the – sort of the 16 million car sale revenue, it’s typically in the 85% to 90% of Q3, is typically Q4.

Bill Soho – Milwauk Capital

Okay, and what expectations out there from the forecasters that you look at?

Timothy O’Connor

If you look at JD Power, which is the one we tend to look at most often, they are projecting sort of a low double-digit growth in the fourth quarter versus prior year.

Bill Soho – Milwauk Capital

Okay, that’s fair.

Timothy O’Connor

That’s – again, that’s units.

Bill Soho – Milwauk Capital

Okay, great. So that should offset – that would offset the seasonal weakness from Cash for Clunkers, I believe, but we will (inaudible). And internationally, it sounds like you expect a nice increase based on your current (inaudible) programs. Is that correct?

Timothy O’Connor

Well, it’s certainly a cyclical nature as it relates to our international business as well. Typically, what you will see in the first half of the year, we do sort of 45% of the year in the first half and then 55% in the second half.

Bill Soho – Milwauk Capital

Okay. And just give me a little more detail, what drove that international growth so aggressively? I mean I know Star [ph] was down in Europe by, I guess, mid-teens and however, you grew like a weed. What drove that and kind of what should we expect going forward?

Richard Riley

Yes, I think we have talked about it on other quarter calls. Now, if you kind of look back at the history, towards the end of the 2008, when the market kind of fell out, our international licensees really didn’t get impacted by that until the – what I will call, the first quarter of 2009. So, they came out of 2008 with, I would say, more inventory than they anticipated coming out with. So, it really tempered 2009 business as they were working down the inventory they had within their own markets and within their own channels. So, really through the first nine months of 2009, our business was impacted quite a bit by that sort of getting inventory out of the system, if you will.

So in 2010, really from the beginning of the year, we have been back to, what I will call, normal business or normal buying patterns with the licensees. So, whether their business is growing dramatically or not, our shipments are back to normal rates where it was really understated, I’ll call it, in 2009.

Bill Soho – Milwauk Capital

(inaudible) of organic growth going out internationally aside from just kind of a reversal to the mean. Are you picking up additional licenses or (inaudible).

Richard Riley

The only market that we’ve opened up, or the markets we’ve opened up in the past year has been the Benelux markets. That’s the only one we have signed a license agreement and expanded into.

Bill Soho – Milwauk Capital

Okay, so it’s mostly just a reversion kind of event.

Richard Riley

One of the things I want to do, Bill, is I want to make sure – there is a lot of detailed questions with respect to what is going on in the fourth quarter, and I want to make sure that we reiterate the guidance that we’ve provided, right. Because we spend a tremendous amount of time on that guidance before we sit down and we talk the call. And so (inaudible) detailed questions, our expectation is to deliver a moderate year-over-year increase in consolidated revenue, as we said before, positive adjusted EBITDA, positive operating cash flow and healthy margins, and you guys see where we are for the first nine months of year.

It has been an erratic year, quite honestly, and so everybody expected January and February to be good, and it was horrible. And so, then they came back and they got very conservative with the speculative assumptions, and then March was good and April was better, and so everybody got optimistic again. And then May and June were lousy, and then July was surprising, and then August was disappointing, and so – I want to make sure that we temper the expectations that we have here, which is, it has been an eventful year at the end of two other eventful years, but it has been more erratic this year than it has in the last two years. And so, we’re cautious as we go through this process and we’re thoughtful about the guidance that we have provided. So, I just want to bring us back to the guidance that we have articulated as we went through the prepared comments.

Bill Soho – Milwauk Capital

I appreciate that. And then you also mentioned that you’re going to be making some investments. What sort of CapEx rate should I assume for you guys going forward?

Timothy O’Connor

Our CapEx rate is typically just about $1 million a quarter.

Bill Soho – Milwauk Capital

Okay. So that’s not going to change dramatically?

Timothy O’Connor

It’s been trending less this year, but that’s typically where we are about.

Bill Soho – Milwauk Capital

And your tax rates domestically, they are relatively stable, correct?

Timothy O’Connor

Since we took the reserve last quarter, we really don’t book a reserve in the U.S. anymore, at least for the foreseeable future, so what we’ve kind of guided people on is, on an annual basis, to $2 million, $2.5 million worth of tax expense for the year is about where we will be.

Bill Soho – Milwauk Capital

I’m sorry, I meant – I said attach rates, your remarks as a percentage of units relative to Star has remained?

Timothy O’Connor

It’s been pretty stable. We’re – again from a retail sales standpoint, we have been stable across the year. There has been (inaudible) we’re pretty flat in terms of our attach rates.

Bill Soho – Milwauk Capital

Okay, great. And pricing, has that remained stable, is there any notable changes?

Timothy O’Connor

For the year, it’s pretty much remained stable. If you look at the year-on-year mix, we’re down 4%, 5%, 6% depending on which quarter you’re looking at and it’s really driven by our install mix, not a pricing decline per se.

Bill Soho – Milwauk Capital

Great. And seasonally, is 1Q usually weaker than 4Q, or there isn’t any clear pattern there?

Timothy O’Connor

In terms of price?

Bill Soho – Milwauk Capital

Not price, just in terms of volume.

Timothy O’Connor

Q4 is typically the lowest.

Bill Soho – Milwauk Capital

Q4 is the lowest. Okay. Sorry to ask so many questions, I was very interested. (inaudible), where do you think your incremental margins would be on additional revenues?

Timothy O’Connor

We haven’t guided on it, Bill.

Bill Soho – Milwauk Capital

Okay. Thank you very much for your time, really appreciate it.

Richard Riley

No worries, thanks.

Timothy O’Connor

Thanks.

Operator

Your next question comes from the side of Bill Dezellem again with Tieton Capital. Please go ahead.

Bill Dezellem – Tieton Capital

Thank you. I actually had one follow-up to the cost reduction process. And you had mentioned, as you got a couple of million dollars roughly of benefit in the third quarter from the second quarter actions, and I guess we’d like clarity as whether the Q3 now has experienced a full run rate benefit from those cost reduction initiatives or whether there will be further incremental benefit in the fourth quarter?

Richard Riley

The third quarter has gotten the full benefit of the reductions that we did in the second quarter. There wasn’t any overlap there whatsoever. I would caution you going forward that – and we talked a little bit about it early on the call, now there is – there is certainly room to invest behind a number of the businesses, should one of them start to show signs of growth or show an opportunity for us to invest money in.

Bill Dezellem – Tieton Capital

So, qualitatively, the way that we should be thinking about this is that not to anticipate any further absolute cost reductions as we go forward whether it is in the Q4 or any of the future quarters, unless you make some specific actions, which I think you said you did not anticipate. And actually to the contrary, if you see opportunities, you could actually increase your expenses that – and you would do so if you thought that that would juice your revenue growth

Unidentified Company Representative

That’s a (inaudible).

Bill Dezellem – Tieton Capital

Great. Thank you.

Operator

We have another question from the side of Jeremy Yaka with Milwauk Capital [ph]. Please go ahead.

Jeremy Yaka – Milwauk Capital

Thanks. I just have one follow-up question. Just in terms of SafetyNet, can you give us any more details on potential growth initiatives there or bringing on new partners, or it’s a little too early to go into detail on that?

Richard Riley

Well, it’s still a little too early for that. I mean, for us, we are just beginning to flesh out the business model, so we are pleased with the relationship we have with law enforcement staffs here over a long period of time. We’ve had some large law enforcement agencies take that up and the next step for us is to figure out the business model that works best for our consumers out there.

Jeremy Yaka – Milwauk Capital

How many units do you have in the market again?

Timothy O’Connor

It’s – I would say, from a subscriber standpoint, we have less than 1,000 at the moment. But, the actual units that are out there that were sold through a partnership we had with Project Lifesaver is significantly higher than that. It’s in – the Project Lifesaver model, it’s not a subscription model. It’s a one-time unit that is funded by the non-profit who actually gives the units away.

Jeremy Yaka – Milwauk Capital

Okay. And is there any potential for you to enter into a big contract or partnership there? It seemed like you could (inaudible) different distribution channels, there may be a meaningful increase that can move the needle or is that kind of…?

Timothy O’Connor

I think there is certainly a number of different opportunities, whether it’s through non-profits or through subscribers, or building our own business. We are looking at all of them, quite frankly.

Jeremy Yaka – Milwauk Capital

Okay. Great, thank you.

Timothy O’Connor

Welcome.

Operator

(Operator instructions) We have no further questions at this time.

Richard Riley

Thank you all for your time today. As always, we will be available for any additional questions you have in the coming days or weeks. Have a good day.

Operator

This concludes today’s conference. You may disconnect, and have a wonderful day.

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