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LoJack Corporation (NASDAQ:LOJN)

Q2 2014 Earnings Conference Call

August 12, 2014 08:30 ET

Executives

David Calusdian - IR

Randy Ortiz - CEO & President

Casey Delaney - Acting CFO

Analysts

Brian Hollenden - Sidoti

Bill Dezellem - Tieton Capital Management

Operator

Welcome to the LoJack Corporation’s Second Quarter 2014 Financial Results Conference Call. I would like to introduce your host for today’s conference David Calusdian. Sir, you may begin.

David Calusdian

Good morning everyone and thank you for joining us. Hosting today's call are Randy Ortiz, LoJack's Chief Executive Officer and President; and Casey Delaney, - Acting Chief Financial Officer.

Randy will begin by reviewing LoJack's operations and recent achievements in the context of the company's growth strategy and review full year 2014 guidance. Casey will review LoJack’s quarterly financial results. Randy will make some concluding comments and then we'll open the call to your questions.

An archived replay of this call will be available on LoJack's website at lojack.com. Please note that during today's call we will be referring to slides that are available on the Investor Relations section of our website, lojack.com. If you are viewing the slides, please turn to slide two.

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 that involve risks and uncertainties.

Accordingly, actual results could differ materially. Such forward-looking statements speak only as of the date made. Except as required by law, the company undertakes no obligation to update this forward-looking statements.

For further information regarding the forward-looking statements and factors that may cause such differences, please see the company's Risk Factors in the annual report on Form 10-K and other filings LoJack makes with the Securities and Exchange Commission.

Turning to slide three, during this morning's call, management will make reference to adjusted EBITDA. This is a non-GAAP financial measure that the company believes helps investors gain a meaningful understanding of changes in LoJack's core operating results and can also help investors who wish to make comparisons between LoJack and other companies on both a GAAP and a non-GAAP basis.

For more information, please see the GAAP to pro forma non-GAAP reconciliation table in this morning's earnings release. The table has more details on the GAAP financial measure, that's most directly comparable to non-GAAP financial measures and the related reconciliation between these financial measures.

With that, I'll turn the call over to Randy Ortiz.

Randy Ortiz

Okay. Thank you David. Good morning everyone. Thank you for joining us as we review LoJack’s second quarter financial results, provide you with a strategic update on operational and financial initiatives of the company. First let me ask you to turn to slide 4, revenue for the second quarter was 34.4 million up 2% from the same period in 2013 and U.S. dealer revenues were down slightly compared with last year’s second quarter however dealer product revenue was up 3.7% on a 10% increase in volume.

Additionally LoJack continued a great trend and unit shipments as our domestic stolen vehicle recovery business grew faster on a year-over-year basis in the U.S. retail auto industry for the 7th consecutive quarter. Higher volume is being driven by the continued success for our preinstalled program which had another good quarter. Additionally as the weather improved in Q2, some of our largest established preinstall dealers still did not deliver the monthly sales we anticipated due in part the lower than expected inventory levels as a result of delayed deliveries.

Finally our second quarter results were also adversely affected by some key expenses incurred in the second quarter and Casey Delaney will delay those in a few minutes. As well as some under performance in our commercial segment and once again no orders licensee in Argentina.

Turning to our operational performance in Q2, and we have some additional details that relates to our U.S. domestic business. As discussed the U.S. auto industry has begun to snapback after the severe weather that affected manufactures, dealers in the first quarter and rail delays impacting shipments in the second quarter. As shown on slide 5, retail U.S. light vehicle sales are expected to total 13.4 million use this year up 4% over 2013 according to LMC Automotive.

But the sustained industry demand is only one factor that should benefit our domestic stolen vehicle recovery business and the other is at a mid-increasing competition and vehicle price transparency, dealers continue to gravitate toward value added aftermarket products that enable to under drive profits on increasing the efficiency of F&I Insurance Office.

Turning to slide 6, that further illustrates over the headwinds our preinstall program phase during the second quarter, rail backups delayed deliveries which resulted in inventory shortages and lower than anticipated volume from some of our large and well-established preinstall dealers certainly impacted our Q2 performance and feedback from our field indicates the lower inventory caused by these deliveries was certainly contributing to factor of the loss volume and reduce revenue in particular from mature preinstall dealers.

Turning to slide 7, our strategy over the past two years has centered on stabilizing and growing our domestic business through dealer preinstall program which makes us a much more relevant economic partner with the dealer. As the average preinstall dealer generates 12 times the revenue of a standard dealer selling LoJack one at a time. In the second quarter preinstall stolen vehicle recovery units accounted for 55% of total U.S. dealer channel volume up from 45% of the same period last year. Because the average preinstall dealer account generates approximately 12 times revenue per month and 11 times of direct contribution margin as a standard dealer install account, continues to use program such as revenue builder to incentive large dealers to become preinstall partners.

The preinstall program continues to experience a very high retention rate with approximately 90% of dealers added over the past 12 months still participating in the program. The preinstall program is up to drive strong dealer volume in our domestic business and as depicted on slide 8, Q2, marked the 7th consecutive quarter in which our U.S. dealer channel volume surpassed domestic light vehicle sales growth.

Our dealer volume grew by nearly 10% our retail volume in the auto industry increased by approximately 6% which is still a significant piece of growth when you consider our LoJack’s U.S. domestic unit sales growth for the full year 2013 was 25% year-over-year. Additionally prior to successful run LoJack had never recorded more than two consecutive months of outpace in U.S. domestic light vehicle sales growth.

I will note in the second quarter approximately half of the top 125 dealer group’s in our LoJack’s coverage area participated in the preinstall program. Total installations among this group were up 22% in the second quarter, a 2013 versus the same period last year.

In conjunction with the launch of our enterprise resource planning system next year, we’re looking to grow the base of preinstalled dealers who sell our ancillary products including extended warranty, early warning products and our other paper products. In addition to the subscription based billing support they will need to buttress our new Telematics business, the new ERP system will also enable us to be fair more effective in communication and sharing information directly with our viewers and obviously take on a much consultative role supported with timely data on the performance of LoJack’s product out in the auto dealership.

Moving to slide 9, our commercial business which grew at a strong clip for several quarters decreased in the second quarter with unit shipments down 25% at a 26% reduction in revenue. These results were largely attributable to seasonality, but we’re also seeing some of our largest customers buying less equipment this year than they did 2013 which was considered a boom year in their industry. We also continue to see this industry shifting to a broader inventory management solution for equipment including asset tracking and recovery which I will discuss in more detail shortly. For the long term we continue to see significant opportunities in the commercial segment not only for equipment recovery but for a broader asset management solution for our commercial customers.

On the international front we did not meet our expectations in the second quarter and as I mentioned no orders were seen from our Argentinian licensee due to that country’s ongoing import restrictions. That said we recently met with the Argentinian licensee and we remain optimistic that we will see orders come in during the second half of this year, but it's not likely we will see orders at the pace that would meet real market demand.

With respect to Brazil as we announced on May 13, the arbitration panel dismissed all claims filed against by Tracker do Brasil. As part of it's binding decision the panel also ruled in our favor on several counter claims filed against this licensee. Specifically the panel ruled the Tracker violated the terms of the license agreement, breached it's implied duty of good faith and fair dealing and engaged with unfair competition. The arbitration panel now will conduct a hearing to determine the amount of damages owed to LoJack by this Brazilian licensee, hearing date is being scheduled by the arbitration panel for February of next year. We will keep you informed as developments warrant.

Turning to slide 10, an update on our fleet Telematics program, we continue to invest in product development and expansion of our distribution channel and identification of new customers. Between our national fleet sales organization, our dealer referral program and our alliance partner TomTom, we’re developing a pipeline that currently represents potential opportunity of 40,000 new subscriptions. As you maybe aware as detailed in the recent press announcement LoJack’s fleet management entered into an agreement to provide Telematic services for the Boston Globe fleet of more than a 130 delivery and service vehicles.

The Global deploy LoJack’s fleet management powered by TomTom to help optimize the safety, efficiency and performance of their fleet. Our Telematics solution will enable operators to instantly update orders, dispatch service vehicles and track vehicles by receiving real time reports on working hours and driving time.

Turning to slide 11, TomTom business solutions is an outstanding Telematics partner for our initial LoJack’s fleet management product and we want to maintain that close collaboration as we move forward. To that end I’m delighted to announce that Torsten Gruenzig' formerly Vice President of Strategic Partnerships for TomTom has recently joined LoJack in an executive role. Torsten will report to Joe Castelli our Vice President of Fleet and Commercial Operations, will primarily responsible for overseeing and growing our relationship with TomTom and certainly growing our fleet management business. As we previously reviewed, as I’m still repeating, the local fleet market is a very large underpenetrated fragmented Telematics market and we believe LoJack as the brand, service distribution network, installation capability and high quality product with the right feature sets to grow our business in this segment as part of our overall LoJack’s strategic plan.

Now we have initially identified three markets for what I will call our business and consumer Telematic services. The small, medium sized local fleets, automobile dealers obviously is one of our core distribution channels in the international space, some work directly with OEMs and of course the burgeoning insurance Telematic segment

I know that Torsten’s decade plus of experience with Telematics deals will help LoJack achieve it's goal specifically as it relates to the fleet management opportunity. Now to further complement our strategic push into the Telematic space and to complement our alliance with TomTom on LoJack’s fleet management we have been looking to enter the off road equipment asset tracking space. Today we’re announcing that we have entered into a letter of intent with Trackunit of Denmark to sell their commercial off road equipment Telematics in North America. Trackunit is a leading edge Telematics company with deep expertise in mobile management of off road equipment. This includes heavy equipment use by contractors and machine rental companies as well as commercial and industrial sectors. Trackunit solutions give customers not only detailed asset tracking but a range of tools for safety, business intelligence, performance measurement, service of maintenance orders and resource utilization.

Based in Denmark, Trackunit has rapidly built an install base of more than 3000 customers and 90,000 units under subscriptions. Again according to expert estimates the space has in excess of 1.5 million pieces of equipment, we believe this can be a profitable market for LoJack and a great strategic fit for our brand.

The Trackunit alliance is another key milestone in the growth and expansion of our LoJack’s plan which looks to develop their brand beyond our core Stolen Vehicle Recovery roots and build a subscription base recurring revenue model for the burgeoning Telematics space.

Now before turning to guidance let me update you on our CFO search. As you know Casey Delaney was appointed as Acting CFO effective May 27th, following the departure of Don Peck. We retained executive search from Heidrick & Struggles and they are assisting us in our process of identifying candidates.

I’m happy to report we have met with a number of outstanding executives and are into second interviews and hope to have a new CFO in place soon.

Moving to guidance on slide 12, for the full year 2014 LoJack now expects net revenue to increase in the range of 5% to 7% over full year 2013 and expects adjusted EBITDA in the range of 5% to 6% of 2014 revenue. The company’s revised guidance primarily reflects reduced expectations from the Argentinian licensee and 1.7 million in cost related to a battery evaluation issued at I will get into more detail in a minute. The revised EBITDA guidance does not reflect potential additional cost related to the battery evaluation and we cannot predict other actions that will be required or otherwise taken by LoJack nor can we predict the outcome or estimate the possible loss with respect to such actions.

We expect to continue invest this year in building their foundation of our Telematics business, we’re also focused on reducing expenses and obviously improving cash flow. From my perspective our abilities to successfully create new recurring revenue business model at LoJack requires commitment to improving our operating efficiency and ensuring that our cost structure is directly aligned with our growth objectives, we’re bringing in the skilled and talented people to develop that segment of the business.

Toward that end we recently announced the elimination of approximately 18 positions and the U.S. is part of an expense reduction and restructuring program. We expect to complete this program by the end of September resulting in an anticipated pretax charge of 840,000 in Q3. We believe that taking this step now positions LoJack to produce higher returns for our shareholders over the long term to focus investments in a profitable Telematics strategy.

And finally before I turn the call over to Casey let me bring you up-to-date on the battery evaluation issue that impacts LoJack’s self-powered units. You may recall that we have begun discussing this issue last year and as discussed in our second quarter 10Q filed on Monday based on the ongoing review we determine that batteries included in certain self-powered LoJack units sold in the United States and to our international licensees are exhibiting virility and performance that could impact the ability to LoJack unit to transmit a signal.

We’re addressing this issue proactively by implementing a quality assurance program in the U.S., details of the program are available on our website but let me briefly summarize the planned steps. The U.S. vehicle customers are still covered under the either the original two year or extended warranty will be offered at free inspection. If the self-powered unit does not meet our quality standards, a new unit will be installed.

Original warranty customers will receive a new warranty while extended warranty customers will be covered for upto an additional two years or the remainder of the warranty whichever is greater. In inspection, new unit if necessary and warranty will provided to the customer for free.

Based on the best estimates we have reserved 1.7 million in the second quarter with respect to certain costs associated with this program, and another business concessions related to this battery matter. We’re continuing to investigate to determine the extent of the issue and at the same time we’re exploring a number of possible remedies. Our former battery manufacture, our contract manufacture and our insurance carrier have all been notified. With that let me turn the call over to Casey Delaney for the financial review. Casey?

Casey Delaney

Thanks Randy and good morning everyone. Please turn to slide 14 where you will see consolidated revenues for the second quarter were 34.4 million up 2% from 33.7 million in the same quarter last year. U.S. revenues for the second quarter came in at 23 million down 3% from the prior year period. As Randy mentioned dealer unit volume was 10% higher in the second quarter than the second quarter of 2013.

Our domestic preinstall business accounted for 55% of unit sales up 10 percentage points from the same quarter in 2013. A higher percentage of preinstall lowers our blended average revenue per unit which declined 6% in Q2, 2014 from the year ago period however it's important to know that once the preinstalled dealer is outside of the acquisition period our gross margins on these units remain similar on a unit basis to our standard delivery model because we’re able to spread our fixed cost over our higher unit volume. Revenue from ancillary products such as extended warranty, early warning and paper products was down 8% or 350,000 from the second quarter of 2013.

The Q2, 2014 decrease is due to a $550,000 drop off in deferred revenue contracts stated prior to the 2011 accounting changes. This decrease was offset by year-over-year growth in ongoing ancillary sales.

The 2011 accounting changes are expected to continue to degrade year-over-year performance in ancillary revenues through 2016. The annual drop off estimated at 2.2 million in 2014, 1.8 million in 2015 and 500,000 in 2016. International licensee revenue increased 20% or about 1.2 million in the second quarter to 7.3 million. Increases due to the uneven buying patterns of our international licensees with orders from Ecuador, Peru and Columbia occurring earlier in the year that we have seen in 2013. The Q2 International Results did not reflect any orders from our Argentinian licensee.

Revenue from our Italian subsidiary increased 65% both in the same quarter last year as our subscriber base increased over 40,000. Revenue related to our all other segments totaled 2.7 million in Q2.

Revenue from our Telematics program was de minimis in Q2. Keep in mind that we are recording revenue over the expected subscription period rather than upfront at the time of contract bookings. Over time as we continue to grow our Telematics business we believe it will yield gross margins comparable to our stolen vehicle recovery business and will deliver lucrative recurring revenues under the software service model. At the same time, we will be incurring some period expenses related to Telematics that will flow through both the cost of sales and operating expenses on a current basis. We have plan for this investment in our new fleet business in both our budgeting and our guidance for 2014.

Moving to slide 15, consolidated gross profit decreased in dollars 7.5% over the same quarter last year. In gross profit margin as a percentage of revenue was 49.4% compared with 54.5% during the same period last year. The decrease in consolidated gross profit was related to 1.7 million of cost associated with the expense of the quality assurance program and warranty vehicle customer notifications in the United States as well as business discussions related to the battery matter.

These cost lowered our gross margin by 490 basis points in the second quarter of 2014. Operating expenses were 19.9 million in Q2 of 2014 an increase of 1.7 million or 9.5% over the second quarter of last year. The Q2 cost include $900,000 in severance payment associated with the departure of several key executives of the company and 700,000 paid by the Company's Brazil limited subsidiary to settle certain state value-added tax assessments imposed by the State of Sao Paulo in 2011. As Q2 increase was also due to the absence of $600,000 in 2013 benefits related to the settlement of the California Wage & Hour Litigation as well as the $400,000 bad debt reversal that was booked in Q2 of 2013.

We also expended $450,000 in operating expenses related -- during the quarters on our new ERP system compared with 508,000 in operating expenses in Q2 of 2013. Total operating expenses related to this initiative are estimated to be $1.2 million in 2014 which includes $500,000 of depreciation. The plan to roll out our new ERP system in 2014 and early 2015.

We also had approximately $225,000 in corporate development expenses during the second quarter and move forward on strategic and product initiatives. Operating expenses related to LoJack’s fleet management roll out was 910,000 compared to 210,000 in Q2 of 2013. The above unfavorable operating expense variances were offset by favorable salaries and benefits of 1.2 million and favorable legal expense variances of 430,000 as we begin to see our legal cost decline as we enter the damages phase of our litigation with our Brazilian licensee.

We had an operating net loss of 2.9 million in the second quarter of 2014 compared with an operating income of about 200,000 in Q2 of last year. The Q2 results fell below expectations and below prior year primarily due to certain expense variances which amounted to $5 million and year-over-year variances. These include 1.7 million in the reserves related to the battery evaluation, $700,000 related to the Brazil settlement of the ICMS tax, 900,000 in severance cost, the absence of 600,000 favorable onetime cost in 2013 related to the California Wage & Hour Litigation. Favorable bad debt expenses in 2013 of 400,000, and our continued investment in fleet which was 700,000 higher in Q2 of 2014 than in 2013.

Stock based compensation in the second quarter was 359,000, depreciation and amortization was 1.1 million during the quarter. Other income and expenses were 419,000 in Q2 includes 374,000 in penalties and interest related to the total ICMS tax settlement of 1.1 million. Our tax provision of a 141,000 is largely the result of tax obligations of our Irish entity. Variances over Q2 of 2013 is primarily related to the release of tax reserves associated with the settlement of tax examination during the second quarter 2013.

Net loss in the second quarter was approximately 3.4 million or $0.19 a share at to net income of 2.6 million or $0.15 per diluted share in the second quarter of last year.

Turning next to slide 16, the balance sheet, we exited Q2 with 21.6 million of cash and additional borrowing capacity of 10.7 million. Our cash flow use by operations during the second quarter was 1.9 million, our net loss included approximately 1.4 million of non-cash stock based compensation and depreciation. Capital spending totaled 1.9 million during the quarter including approximately 1.4 million of labor and expenses related to our ERP implementation as well as additional investment in computer tracking and tooling.

During the second quarter of 2014 no shares were repurchased, shares approved and available for repurchase totaled 1,205,129 shares. With that I will turn it back over to Randy.

Randy Ortiz

Thank you Casey Delaney. So in summary on slide 17, with our preinstall business it continues to gain traction and we expect to see our domestic stolen vehicle recovery business really pick up steam in the back half and finish another strong year. Traditionally the third and fourth quarters of the year have been more robust for LoJack than the first and second quarters and while Argentina is expected to remain volatile and international revenues uneven, we do anticipate a solid performance from licensees and other territories and we do expect orders from Argentina in the second half of the year.

On the Telematics front we plan to continue to make the investments necessary to expand our Telematics and Connected Car initiatives. We do expect that expenses occurred early into the development of the fleet and asset tracking segment will outpace revenues with the result that the long term value of the subscription based model can generate significant profitability for the company overtime and drive enterprise value. With our sales infrastructure in place and our revenue underway we are encouraged about the outlook for this Telematics business.

With that Casey and I will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Brian Hollenden of Sidoti. Your line is now open.

Brian Hollenden - Sidoti

Can you tell us a little bit about the expense accrual for the battery, the 1.7 taken in the quarter. Do you expect that same amount in future quarters?

Randy Ortiz

Don’t know, can’t speculate on that yet Brian but that’s our best estimate right now as it relates to the units that are within the confines of the two year limited warranty and our extended warranty of self-powered units in the United States.

So we’re in a position where we obviously want to look at those units still in warranty as we detailed in the Q. We want to make sure because of the importance of recovery to our brand, make sure that we continue to look at this variability and performance in the self-powered units to ensure that they are meeting our quality assurance thresholds and that we see no degraded performance in actual stolen vehicle recoveries and I would point out at this point in time we have seen that degradation and our recovery rates but we have seen in our sampling program in the U.S. on those variability and the performance of these batteries to take the action to obviously get a closer look at these units.

Brian Hollenden - Sidoti

So in the third quarter you -- currently there is no accrual for these expenses?

Casey Delaney

That is correct.

Randy Ortiz

This is a program that obviously will play out overtime. We’re talking about you know the weeks and month ahead, often is certainly 2015 because it's a fairly for attractive process to contact customers and for those that respond to meet them, inspect their units and potentially replace them.

Brian Hollenden - Sidoti

Okay. Can you give us an update on the Brazilian court case in regards to the timing of the damages of arbitration and also has LoJack Ireland terminated it's license agreement yet with Tracker or is this something that you plan on doing, can you talk a little bit about that?

Randy Ortiz

So to answer that question first, we have not terminated as of yet although based on the findings of the arbitration panel we are within our rights to do that. We’re in an on-going dialogue with that licensee and their council. Right now the actual hearing date for the damages faced is scheduled for February of next year, so we’re in the process of preparing for that but we’re also on a parallel path talking to the licensee and their council about the other potential alternatives certainly as we have said in other calls, our goal is to activate the Brazilian market as quickly as possible.

So, we’re in a position where we want to continue to pursue the track that we have invested in which we have defended ourselves successful. We have now fielded our, we have got damages that can be claimed so we want to make sure that we continue to pursue that course but at the same time continue a dialogue with the licensee and their council to research any and all other alternatives because as I said our ultimate goal whether be through termination or whether it be through some other resolution is to activate the Brazilian market as expeditiously as possible.

Brian Hollenden - Sidoti

Okay swishing over to the win with the Boston Globe, can you tell us I know you mentioned that revenue was de minimis in the quarter but can you tell us over what period of time that revenue will be recognized over?

Casey Delaney

Yes. Most contracts are three year contracts.

Brian Hollenden - Sidoti

And do you have the total number of revenues that something that you could share?

Randy Ortiz

Not yet, no. We’re not disclosing that yet. But I will say this I mean obviously as I’ve mentioned in my remarks we’re really starting to see the pipeline fill. We have leads that could turn into 40,000 subscriptions, some significant progress there and on the continuum of accounts out there now it's some of the very small local fleets all the way up to relatively large fleets that upwards to the 400 units but obviously this is at this point in time a very competitive segment. Everybody is trying to make their way. It's still fairly fragmented and we would like to really get some of these leads closed and really start to get some critical mass pulled together before we start separating the actual unit and subscription information in a public forum. So we’re not there yet but certainly we are moving in that direction and I’m pleased with the progress that we have made in the recent past was some key wins in that space and obviously Boston Globe in our own backyard is a good bell weather example of significant win for LoJack’s Fleet Management.

Brian Hollenden - Sidoti

And if I can ask one follow-up question and then I will jump back into the queue. Can you just talk a little bit -- in that same vein how much you anticipate on investing in 2014 around the Telematics initiative?

Randy Ortiz

So it's been, I know in the past we have indicated that we would invest upwards to potentially $2 million but right now trajectory is around 900,000.

Casey Delaney

900,000 per quarter.

Operator

Our next question comes from the line of Bill Dezellem of Tieton Capital Management. Your line is now open.

Bill Dezellem - Tieton Capital Management

Actually I would like to just make sure, get clarity on the answer to the last question, you’re spending 900,000 in 2014 or 900,000 per quarter?

Casey Delaney

Per quarter.

Bill Dezellem - Tieton Capital Management

Okay that’s what I thought I heard you say but just wanted to make sure we were clear. Let’s circle back to the battery issues and can you help us understand where you think the problem emanates from? And how it made it through the initial screening process I guess.

Randy Ortiz

Yes this dates back to the development of the self-powered unit which goes all the way back to approximately 2009 and when the product was developed there were some performance thresholds as it relates to voltage that these batteries have to be able to provide under load, it's a close circuit voltage and we started to hear from some of our international licensees and in our own research started to witness some variability in the voltage and the batteries ability to perform beyond our quality threshold which guarantees that these units will transmit a signal when called upon to effect a vehicle recovery and so when we saw that kind of variability, you know obviously with the critical nature of our brand positioning we can get it back with LoJack, we don’t want to see any degradation in our recovery performance.

So we wanted to jump into it, take a hard look at it. We didn’t like the variability that we saw. As part of an enterprise risk management process we put in a couple of years ago, we had already started looking at a secondary battery source and so fortunately as we looked at our current battery -- our former battery manufacturer, UVE, we had the opportunity to switch to a new battery manufacturer, a Japanese manufacturer by the name FDK.

So we felt it was the right thing to do is to move away from that battery pack that transmit battery pack and take a hard look at these units in the U.S. to make sure that those are out there under warranty are doing what they are intended to do which is have those battery packs be able to transmit a signal when called upon. So that’s sort of the back story build, we have been looking at it and as you know it's been on some level of disclosed for several quarters now going back into last year but we’re at that stage where we needed to take a closer look and we needed to separate our relationship with EVE.

Bill Dezellem - Tieton Capital Management

And that battery manufacturer is not one I’m familiar with but assuming that they are the ones that are kind of the root cause of the problem. Do they have a financial wherewithal to backstop this?

Randy Ortiz

This is a Chinese battery manufacturer, they are publically traded and they are in the Shin Xen [ph] exchange and when last we checked they had a market capital of over a $1 billion.

Bill Dezellem - Tieton Capital Management

Let me shift if I may to gross margin and the gross margin adjusted for the battery issue was actually up versus the first quarter. Was that a function of simply having higher revenues, higher volumes? Or was there other factors coming into play?

Casey Delaney

Primarily a function of mix. Our international business was up in the second quarter and that has a higher gross margin.

Bill Dezellem - Tieton Capital Management

And then shifting to the fleet, you had mentioned that you had a 40,000 vehicle pipeline, would you please remind us how that compares to the first quarter?

Randy Ortiz

Yes, so it's -- we got off from 18,000 and then we continued to add on top of that Bill. So it's growing quite nicely, certainly those are active leads and there is no guarantee that you we will close them all but there is some significant volume opportunities there and that’s why I feel good about the activity that we’re generating on the fleet side of the business.

Bill Dezellem - Tieton Capital Management

And to make sure I’m clear you basically, your prospect pipeline doubled in the last quarter.

Casey Delaney

Correct.

Bill Dezellem - Tieton Capital Management

And maybe early to pose this question but what has been your close rate for prospects?

Randy Ortiz

Too early to close that and I will tell it's variable, Bill, because it really what I have just -- from a macro perspective it varies based on channel. So whether it be those opportunities that are coming through the dealer channel versus those opportunities we go to directly like a Boston Globe and I would tell you there is significant variability in the gestation of the deals because some of them are smaller deals come together pretty quickly no surprise and because of the significant investment required by a 100 plus unit fleets, it takes a lot more time to do the needs base analysis and really get them comfortable with our solution and in some instances not all but in some instances we’re actually replacing a solution.

My point is that with one of the learnings us for is that there has been some relatively long lead times with some of these larger opportunities but that said you know it's -- this is about you know building a business and recrafting this company for the future and this is what we intended to do and we’re basically a year into it and I think we have made a lot of good progress.

Bill Dezellem - Tieton Capital Management

And you had mentioned the different channels where the leads come from, are you reaching any conclusion that one particular channel is more or less desirable to the point that you would actually change how you address the market?

Randy Ortiz

Not there yet, no. Because we’re still just getting awareness in the dealer channel and starting to see some results there and obviously with our sales team in the field they are also getting out there and going directly to some larger accounts and so I'm not going to hazard a guess that you know one is better than the other yet because we have had success in on both fronts.

Bill Dezellem - Tieton Capital Management

And then finally you referenced the Trackunit agreement, would you provide a bit more detail behind that and how you found them? How you see that fitting in to all of the pieces of the puzzle, if you would please?

Randy Ortiz

Sure. So Trackunit and I want to be real clear on this, this is really about asset tracking in the commercial space not to be confused with the fleet management that we’re pursuing with TomTom. It's complimentary, it's focused on our commercial segment and really it was born out of the fact that in the commercial segment there is definitely a shift underway in that business to really use Telematics solution specifically GPS to manage inventory, and really track the utilization of those assets and as pointed out in my remarks and in our slide deck. We have customers that have 100s of 1000s of pieces of equipment strewn all over the U.S. and so while we provided a very nice model with a great return on investment getting stolen equipment back, we were missing a piece of the equation which was helping these key clients, manage that inventory, not only from a quick location as to where that inventory resides but certainly things like hours of operation and efficient deployment of that equipment to further maximize to the return on investments. So we think we have got the right solution with Trackunit, so not only can we provide a solution that allows these big accounts like United Rentals, like Sunbelt to manage their assets in a much more efficient fashion, understand things like hours of operation and certainly have a view into service intervals but certainly have that feel [ph] safe, if these things go missing we have got the LoJack’s unit on it to recover if in fact they are stolen.

So we think it's a complimentary offer and while we like to maybe position as offensive, in some ways it's a bit of defensive move too because there are certainly new players in the commercial space that are putting these Telematics asset tracking solutions out there and we obviously don’t want to see a very important segment for us erode and we think we have got the right complimentary solution in the LoJack’s unit and the complimented with the Trackunit device.

Bill Dezellem - Tieton Capital Management

In your opening remarks you referenced the commercial customers were looking for more than just SVR and this is what you were referring to when you made reference to that correct?

Randy Ortiz

That’s exactly right.

Bill Dezellem - Tieton Capital Management

And given that you’re going to have the traditional radio frequency stolen vehicle recovery unit along with the GPS. Does the GPS also work as basically now you’ve belt and suspenders for the stolen recovery aspect?

Randy Ortiz

Well certainly you will be able to get your last known location and I guess as we all know GPS isn't the most reliable when it comes to pure stolen vehicle or stolen equipment recovery, pretty easily blunted and blocked. So to have RF complemented by GPS which provides truly a suite of complementary services, we think is a pretty compelling an offer.

Bill Dezellem - Tieton Capital Management

That’s helpful and I actually would like to ask one more question if I may, going back to fleet, are you anticipating that fleet will have meaningful revenues next year as you start to convert some of these leads into revenue generators?

Randy Ortiz

Yes.

Operator

Our next question comes from the line of (indiscernible). Your line is now open.

Unidentified Analyst

First of all congratulations on settling the Brazilian litigation, getting stock price up, et cetera, et cetera. I just had a quick question regarding your proxy statement. There is some sort of interesting language in there on page 22 of the 2013 proxy. It said Mr. Ortiz was required to relocate from Michigan pursuant to your employment contract. In the 2014 proxy it said Mr. Ortiz was required to commute from Michigan and spend the business week in the executive offices. Does that mean that -- you have been with the company for last three years that you are literally commuting from Michigan to Concord and is there an explanation for that and I guess for taking one step further. For a guy’s making well over $100,000 a month, do you think it's fair for the shareholders to pick up your commuting and personal living expenses to the tune of about a $100,000 and if indeed that’s true what do you think that message that you’re sending to your employees, your vendors, your shareholders et cetera by not having the commitment to actually move from Detroit to Boston which is -- I don’t think that Concord is a slum by any stretch of imagination and then just sort of one other question here. Is -- you have been in the company -- going on three years, when you got to the company granted there is a lot of dislocation but the company has $50 million of cash that now has roughly $20 million of cash, so you burned through $30 million of cash on your regime.

Working capital is down over $20 million, book value is down over 6 million et cetera, as a Board member how much more patience do you think the Board is going to have in going down this path --

Randy Ortiz

First of all based on the relocation that was a position I was very clear on from the very beginning as a condition to my employment, okay. And so obviously you’re not familiar with community lifestyle because I would point out that when I’m here -- I am basically fully committed to this job and I’m here away from my family every day of the week so I’m here and our employees here know that I put in extraordinary hours because when I’m here I’ve nothing to do but commit myself to LoJack. So that’s the short answer to the first question on commuting.

So, I would say it's just the opposite. I think it's an extraordinary commitment to be away from my family as much as I’m because I’m committed to turning this company around. Secondly as it relates to cash flows and I think you’ve pointed it out there is a lot of things that needed to be fixed not the least of which was a very, very significant legal overhang, our systems infrastructure that hadn’t been addressed since almost the beginning of this company and if you looked at the cash flows, even going back from a year ago, there is over $14 million of what I would characterize as one timer’s that were investments in fixing and creating a future for this company.

So while I appreciate your concern, we think that we’re recrafting an entire company for future growth. And that’s my response to your two questions.

Relative to my performance, I think you would have to ask the Board members for their evaluation on that but at the end of the day I think since I’ve been here when the stock hit a low about a $1.72, it's gone in the right direction and notwithstanding the fact that we have still got things to fix and issues to address. We will make the right moves to create a new LoJack that is far more than just a stolen vehicle recovery company, that has a recurring revenue base and that will drive the kind of enterprise value that these SaaS companies enjoy and I would also point out that under my watch I don’t have control over the politics of Argentina and I also I have no control over our Brazilian licensee in their best years, those international licensees contribute over 30 million of top line. So it's a pretty big hole to dig yourself out of. So that would be my response to your questions.

Operator

And I’m showing there are no further questions from the phone lines. I would like to now turn the call back over to Randy Ortiz for any closing remarks.

Randy Ortiz

Okay, as usual thank you everybody. We appreciate your interest in LoJack and look forward to updating you on the further progress in the third quarter. Thank you.

Operator

Ladies and gentlemen thank you for participating in today’s conference. This concludes the program. You may now disconnect. Everyone have a great day.

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Source: LoJack Corporation's (LOJN) CEO Randy Ortiz on Q2 2014 Results - Earnings Call Transcript
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