LoJack CEO Discusses Q4 2010 - Earnings Call Transcript

Executives

Paul McMahon – Vice President, Corporate and Marketing Communications

Richard Riley – Chairman, President and Chief Executive Officer

Timothy O’Connor – Executive Vice President and Chief Financial Officer

Analysts

Paul Coster – JPMorgan

[Bill Fulgill] — [Malin]

Name - Company

Bill Dezellem – Tieton Capital

Roger Papazian -- Morgan Stanley

LoJack Corp (LOJN) Q4 2010 Earnings Call February 16, 2011 9:00 AM ET

Operator

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 31^st, 2010.

I will now turn the call over to Rich Riley.

Rich Riley

Thank you Kathleen. Good morning everyone, thanks for joining us on the call this morning. I’ll begin the call today with a brief overview of our performance for Q4 along with our view of the recent trend in the global auto markets, with a particular focus on the domestic market in order to provide some contrast for our later 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 coming year, Tim, Paul, and I will open the call to your questions.

Overall, we were pleased with our financial performance for Q4, and encouraged that we saw positive momentum from the second half of this year and into the new year, 2011. Consolidated revenue for Q4 was up 12% over prior year levels, on the strength of revenue growth of 27% in our international business and a 5% net increase in revenue in our North America segment. Year over year growth in the international business for the quarter was driven by a solid 23% increase in units, as our licensees return to historical buying patterns after a very difficult year in 2009.

For the full year in 2010, revenue in our international business segment was up 30% over prior levels, with strong performance throughout the year. Our business in Italy demonstrated continued growth, with revenue up 59% over prior levels for Q4, and up 89% for the full year. We added another 2200 new subscribers during Q4, and closed out the year with approximately 13,000 total subscribers in Italy.

Turning to the results in our North American segment, revenue for Q4 increased 5% over prior year levels, at an increase of 8% in the US was partially offset by a 12% decline in our Boomerang business in Canada, as we continue our integrated efforts there. Our revenue growth in the US was driven by an increase in units of more than 15% over prior year levels, as retail auto sales in the US reflected strong growth for the quarter. While a 15% increase in LoJack units sold in the US market matched our strongest relative performance for the year, it trailed down to broader auto domestic market for the quarter, as we were negatively impacted by a shift in historical brandex, with our most successful brand experiencing slower growth rates than the other brands. In response, we’ve developed and are investing in new programs to address the pressing need that auto dealers have to generate new sources of sustainable income in an increasingly competitive market place.

Our new sales programs will be rolled out to targeted dealers in 2011, with a specific goal of grabbing deeper penetration, increased profitability, and developing stronger, long term relationships with our dealer base. Looking at our bottom line financial performance, our profitability and strong cash flow in Q4 reflect the aggressive steps we have taken to resize the business in a new global auto market. As a result of these actions, OpEx for Q4 were down $3.4 million from prior year levels, and contributed to an increase in operating income of $5.6 million over prior year levels for the quarter.

Net income in Q4 was $2.8 million or $0.15 a share, compared to a net loss of $2.3 million in 2009. In addition, we generated more than $14 million of operating cash for Q4, as careful management of the balance sheet, combined with a tax refund of almost $8 million enabled us to end the year with a cash balance of almost $52 million. With that, I’ll turn the call over to Tim.

Timothy O’Connor

Thank you Rich, good morning everyone. As I review our Q4 financial results, all comparisons will be against Q4 2009 unless otherwise noted. Consolidated revenue for the quarter increased 12% to $40 million over the prior year. Within our North American segment, US revenue increased 8% on a unit shipment growth of 15% compared to the prior year. Consistent with previous quarters, our bulk install programs have continued to grow, with a mix level of bulk installs reaching 29% versus 19% in Q4 2009.

The higher mix of bulk installs adversely impacted our overall average price by unit by 4% or approximately $600,000. North America revenue reflects approximately $100,000 of foreign exchange benefit related to Canada. Revenue in our international business in the quarter increased 27% to $16.3 million from $12.9 million in Q4 2009. Product revenue from our international licensee business grew 22% to $14.3 million on unit shipment growth of 23%.

The growth was driven by our largest licensees in South Africa and Latin America, as cyclical buying patterns recovered to normal levels. Prices across our international business in the quarter remain consistent with those of the prior year. Historically, our international business is heavily weighted in Q4 as many licensees take advantage of our annual pricing incentives to secure business with their insurance partners. This has typically resulted in a lower level of revenue in Q1 of the following year.

Compared with Q4 2009, revenue in our Italy business grew more than 50% to $632,000 in the current quarter as our subscriber base reached approximately 13,000. The impact of foreign exchange related to Italy was negligible in the quarter. Revenues in our SafetyNet and supply chain integrity businesses for the current quarter were essentially even with the prior year, shaping it at approximately $60,000 of revenue was negatively impacted by minimal product shipments to product LifeSaver during the quarter.

Supply chain integrity reached approximately $600,000 in revenue, consistent with the prior year. Our consolidated gross profit for Q4 increased 12% to $20.4 million, consistent with our revenue growth, while gross profit as a percentage of revenue in the quarter was 51%, consistent with the prior year. The higher mix of business in our international segment offset the adverse effect of the higher mix of bulk install units in the US business.

For our North American segment, gross profit as a percentage of revenue in the current quarter was 48% versus 51% in Q4 2009, while the higher mix of bulk install units continues to drive significant incremental gross profit in the quarter, it negatively affected North American gross profit as a percentage of revenue by approximately 140 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 profit as a percentage of revenue in the current quarter for our international segment was 54% compared to 52% a year ago, as we benefitted from favorable country mix. OpEx of approximately $16.3 million in the current quarter represents an 18% decline versus the $19.8 million level of the prior year. It is important to note Q4 2009 OpEx included a one-time non-cash charge of $1 million associated with software development costs and other equipment placed in service in prior years.

Excluding depreciation and amortization, OpEx declined 13% to $14.6 million in the current quarter, versus $16.8 million in the same quarter 2009, a savings of $2.2 million. The lower comparable spending reflects the benefit of our work force in benefits reductions announced during Q2 2010. As the US auto market recovers in 2011, we plan to increase marketing support for our brand and restore certain benefits in order to remain competitive and retain our employees. This will effectively increase overall OpEx by approximately $2 million per quarter.

OpEx for the current quarter includes approximately $1.4 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 $4 million compared to an operating loss of approximately $1.6 million for the same quarter of 2009. The company generated adjusted EBITDA of $6.4 million in the current quarter, compared to $2.3 million for the same quarter 2009.

The improvement in adjusted EBITDA was driven by the strong revenue and gross profit growth of 12%, coupled with the $2.2 million reduction in OpEx. The additional improvement in operating income reflects the benefit of the unmatched non-cash charge of $1 million in 2009 as previously mentioned. Net income in the quarter was $2.8 million, or $0.15 per share, compared to a net loss of $2.3 million or $0.13 per share in Q4 2009.

Net income reflects approximately $900,000 of tax expense, largely attributable to our international operations. The company generated an operating cash flow of $14.5 million in the quarter, including tax refunds of approximately $8 million, though our operating costs, strong collections across both our US and international businesses and significant reductions in inventories drove the remaining positive operating cash flow. The company has generated more than $25 million of positive operating cash flow over the past three quarters. Net cash flow for the quarter was $14.3 million and capital spending was approximately $400,000, bringing our cash balance to $52 million as of December 31, 2010.

During Q4, we also entered into an agreement with our lenders which effectively extends the term of our credit agreement two full years. The credit agreement provides for multi-currency revolving credit facility in the maximum amount of $30 million with the right to increase that amount up to $50 million, subject to certain conditions. The agreement extends to January 2014 and provides for up to $10 million in stock buyback. We are pleased to receive this support from our lenders.

As of December 31, 2010, we have approximately $8.1 million of debt outstanding against our credit agreement and are in compliance with all financial covenants. Stock based compensation in the quarter was approximately $600,000. Lastly, we did not repurchase any shares in Q4. I will now turn the call back over to Rich.

Rich Riley

Thank you Tim. Again, we were pleased with our financial performance in Q4 of the year, and even more encouraged by the positive momentum we generated in the second half of 2010. After three years of unprecedented volatility and disappointment in the auto market, it appears that the market has finally turned the corner. Based on the consistent growth in retail sales in the US in each of the last three months of 2010, and the first month of 2011, there is growing confidence that the worst is finally behind us and we can reasonably expect modest but consistent growth throughout 2011.We have worked to reposition our domestic auto business without a dealer network that is quite different than it was in late 2007.

The business now for auto dealers is vastly different, with reduced margins on the sale of new cars creating a need for enhanced profitability in other areas of the business. LoJack offers a strong brand, high overall profit potential, a tangible product with credibility, and enjoys the strong support of law enforcement around the country. To develop even stronger (inaudible), we are strategically restructuring our relationships to make it easier for them to sell our solutions, increase their profits, and create a new business model. To this end, we are leveraging arrangements with major finance companies in order to improve the availability of credit for consumers. We are implementing a more robust system interface with our dealers, and we are offering expanded services to generate deeper penetration and stronger relationships.

Our international licensee has returned to historical buying patterns in 2010, after a disappointing year in 2009. Based on our experience of the last year, and the recent discussions with our licensees, we expect modest growth in this arena in 2011. The past year was also an important year for our business in Italy, as we added more than 10,000 new subscribers to the business. We expect to generate healthy growth in new subscriber accounts again in 2011, with the effect of the recurring revenue stream from the subscriber base generating strong revenue growth in Italy for the full year.

In 2011 we will also focus on building our SafetyNet business, which leverages our powerful brand, existing technology, and our unique integration with law enforcement. We have specifically targeted a number of geographic areas in the US to introduce the service, with the City of Philadelphia and certain areas of southern Florida open in 2010. The service was also launched last month in the City of Boston, and we’ve entered into relationships with two well know autism organizations, the Doug Fluty Autism Association of Massachusetts and the Dan Marino Foundation in Florida.

While we are still early in the process of launching this business, interested observers from public safety agencies, caregivers, and other associations is encouraging. During our last quarterly earnings call, I indicated that we have taken dramatic action at the end of Q2 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. The results of all those actions are reflected in the strong financial results for both Q4 and the second half of the year.

With the momentum generated in the broader domestic auto market over the last four months, we are encouraged by the outlook for the full year 2011. As the domestic market recovers, it is time for us to rebuild some of the critical advertising and sales programs that we eliminated during the sustained downturn over the last several years. In addition, after several years of reduced employee benefits and wage increases, we have restored what we believe are reasonable and necessary increases to retain our committed and talented employees.

We have built our budgets for the year assuming continued recovery in the domestic auto market, stable but slow growth in our international business, and a decline in our motorcycle, commercial, and Boomerang businesses. We are focused on delivering solid EBITDA growth and strong liquidity while making investments in our core business; our operations in Italy and in developing our SafetyNet business. Our 2011 budget reflects consolidated revenue of between $154 and $157 million, and adjusted EBITDA between $16 and $18 million for the full year.

Based on the steps we’ve taken, we are confident that we are positioned to take advantage of the anticipated and sustained recovery in the auto markets over the next few years. With that, Tim, Paul, and I will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions.) We’ll take our first question from Paul Coster with JPMorgan. Go ahead.

Paul Coster – JPMorgan

Yeah, thanks very much. Good morning gentlemen, I have a number of questions. Let me first start with international business. Why only modest growth this year, and is there anything different about the inventory levels going into the start of the year? Last year and the year before we saw very radical reductions in sales in Q1, should we expect the same again this year?

Rich Riley

Paul, this is Rich, a couple of points. One of the things we do is we stay very close to our international licensees and we’re talking to them on kind of a regular basis. As we’ve mentioned in the past, their business has been characterized by some of the folks out there as kind of lumpy, which it is. From time to time they’ll develop contracts with insurance companies or with OEM manufacturers and it’ll result in the significant addition of a number of units, in kind of a short period of time. I think 2009 was a very difficult year for our international licensees, I think there was a good recovery for many of them in 2010. I think if they look out at the business, their perspective is that it’s going to be modest recovery this year. They had a big increase in 2010, but I think barring any significant contract with insurance companies or OEMs I think they’re looking for modest recovery in 2011. All we have to go on is our interaction with them.

Timothy O’Connor

Paul, this is Tim; I’ll just add some historical in that to answer your question on the expected flow of revenue for them. So again, for the annual number it’s modest growth, so we still expect growth in the full year of 2011. If you go back and look at – and I would say that on a quarterly basis as well. If you look at it on a consecutive basis, Q4 is typically the high quarter and Q1 is typically the lowest quarter, so on a consecutive basis we expect that to continue, but on a full year basis we would still expect growth, if that helps.

Operator

And we’ll take our next question from Bill Fulgill with Malin. Please go ahead.

Bill Fulgill -- Malin

Hello, can you hear me? Great, congratulations on a great quarter and turning the company around meaningful. I’ve got a few questions. Firstly, after you’ve taken these costs out of the business and you’re seeing a resumption of growth, do you think over the next couple of years you could kind of get to historic levels of revenue and profitability? I don’t know if historically you’ve hit $1.00 of eps, I don’t know if that’s in the range of possibilities, as we move through this recovery.

Rich Riley

This is Rick, we don’t go out that far in terms of our guidance or talking about what our budget is going to be, particularly after the last few years this industry has been through. So if you take a look and the industry went through a ten year period of time where they averages somewhere between 16.5 and 17 million units, and then that which people say couldn’t happen, happened in 2008 when it dropped to 13.4 million units, and then it dropped even further to 10.2 million units.

You know, I think you don’t have to look any further than the year 2010 to look at the volatility that the market experienced. So they came into the year expecting huge increases in 2010, January and February were disappointing, so we revised the estimates down. March and April were a little bit better, and I think everybody revised their estimates higher than they had started the year. April and May and disappointing, June was good, July was bad. So we’re taking a very conservative look in terms of where we think the market is going. The broader market is going to grow, we think it’s going to be consistent, but we don’t see it returning back to 16 or 17 million units any time soon. We’re not budgeting for it.

Bill Fulgill -- Malin

And that’s an interesting comment you make on conservatism, because kind of when I take a look at what you guys have accomplished this year, your revised cost structure, what the SAR estimates are next year and the potential market share growth in foreign markets, as well as SafetyNet. I could get to much higher numbers than you guys have preliminarily laid out. It would seem to be, that based on your situation because you haven’t guidance and haven’t said anything for a while, that you’d continue that really conservative approach with giving guidance. Is that a fair conclusion I’m making?

Rich Riley

I think it is. I think perhaps we blew away every forecast that we made for the year 2002 through 2008, and we along with most everybody else in the state haven’t hit a single number over the last two year period of time. So quite honestly, we’re a little bit burnt by that process and we’re encouraged by the last four months, certainly, in the domestic auto market, but we’re not getting ahead of ourselves.

Bill Fulgill -- Malin

Because you guys have such phenomenal operating leverage; a few more million in revenues on the top line and you could print huge EPS, and EBITDA numbers. So I’m glad to hear that you’re being really conservative and you’re setting yourself up to beat meaningfully as the year goes forward.

Also, in terms of your capitalization, you guys are significantly over-capitalized with close to $50 million in cash. It’s almost dangerous; you guys become an aggressive kind of LBO candidate or a takeout candidate. What’s your philosophy around use of cash now, and might you see yourself selling yourselves to private equity investor or another player in the area, just given where you guys are?

Timothy O’Connor

Bill, this is Tim. You know, as we’ve talked about in previous quarters, we don’t really talk about what the future of capitalization of the company is. We’ll let the market determine that. In terms of the use of cash, again, as we’ve spoken before, as it relates to stock buybacks or the use of cash, we’re focused on growing the business meaningfully. We have a number of investments, whether it’s Italy, whether it’s our SafetyNet business, supply chain integrity business, and quite frankly our core business in the dealer side in the US. That’s where we would tend to spend our cash to meaningfully grow the business and grow penetration there before we buy back stock. That doesn’t mean stock isn’t on the list, but again, we’re focused on growing the business first.

Bill Fulgill -- Malin

Have you considered an LBO or a partnership with a private equity firm? I mean, SafetyNet seems to have a lot of potential, and again this speaks to the value of the company. I see other companies out there with things similar to SafetyNet and that asset alone is valued in the $100 to $200 million sort of range. How do you plan to monetize the grow that business this year? Is there a potential for a kind of a game changing partnership with a third party? How should we view the potential there over this coming year?

Rich Riley

I’ll tell you the way we look at it, which is one of the things that happened is that LoJack has been in the business, started a new business where a business didn’t exist before, sometimes that takes really long and sometimes it catches fire early on. More often than not, it takes kind of a steady investment on the front end and sorting your way through where the business is going. I believe that there’s a nice potential here, and I want to temper my comments here.

This fits all the things that LoJack does well, so it extends the brand very nicely, it leverages the relationship we have with law enforcement, it leverages the technology platform that we have, it enhances the brand because it does something good for society. It makes a meaningful difference in the lives of the people who are impacted by the thing, so I do believe that there’s good opportunity here. Having said that, there are a lot of people in the chain, so we have to go through with the law enforcement agencies and the public safety agencies. We have to go through the caregivers; we have to go through some of the organizations in the area, so it has taken us a little longer to navigate the kind of multiple layers than we would have thought in the first year or so of this.

I think we’re encouraged by our progress in Philadelphia and some parts of southern Florida. We just signed a relationship, I want to say four weeks ago or five weeks ago, in Boston, which is a big step forward for us. That comes as a result of a lot of work over the last 10 or 11 months. So like you, I believe it’s a perfect fit for what it is we do, it’s savvy, it’s a large base of people out there who are impacted, and it’s a growing base, which is even sadder still. It can provide us with the opportunity for a recurring revenue base, and so there are a number of areas where I think it dovetails nicely with what we’re currently doing.

Bill Fulgill -- Malin

Okay, great. And then LoJack for computers, I saw you guys announced an agreement where you’re going to be offering it to CompUSA and Circuit City. Is there any real meaningful potential for that business?

Rich Riley

That announcement actually comes from Absolute Software up in Canada, it’s a public company up in Canada, so we licensed our brand to that company, and so that’s where that source comes from.

Bill Fulgill -- Malin

Okay great. And the final thing I want to say is more of a comment than a question. As a meaningful shareholder of the stock, you guys have again, close to $50 million in cash on the balance sheet, just close to half of the market cap; as a meaningful shareholder, I would like to see you guys either buy back a substantial amount of stock, or distribute a significant amount of that cash to shareholders through some form of dividend.

You guys haven’t – you’re growing like a weed, you’re going off a lot of free cash flow; I know it’s been tough the last couple of years, but it’s time to reward those shareholders that have stuck around, and also might protect you guys from being acquired if you don’t want to. If you could get some of that cash out the door to shareholders. Thank you.

Rich Riley

Just real quick, we talk about this on a quarterly basis with our Board, we just happened to have had a Board meeting last Thursday and Friday and this came up as well. Your points are duly noted, I think you made them consistently and we take away your desires and your thoughts with respect to that, so thank you.

Operator

And we’ll be going back to Paul Coster with JPMorgan. Please go ahead sir.

Paul Coster – JPMorgan

Thanks, much to be pleased about here, and obviously I’m very pleased as well to hear that the guidance is conservative in nature. One area where I’m a little bit concerned is the creeping OpEx. It’s understandable that there’s some suppressed cost here. Can you first of all clarify what you mean by a $2 million increase? Is that based upon the run rates on Q4 or is that across the year?

Rich Riley

The run rate in Q4, and I’ll exclude the depreciation and amortization for you, Paul, so it’s about 14.6 per quarter on that run rate, so it’s $2 million incremental on top of that. And the split of that is really comp and benefits is about half and then marketing and I’ll call it other investment programs is about $1 million.

Paul Coster – JPMorgan

I can appreciate the need to increase R&D and sales and marketing, but I’m looking at general and administrative cost that still close to 20%, actually high ‘teens, and that just doesn’t seem right to me. Back in the ’04 to ’07 era I know things were different, but you were in the low to mid ‘teens. Are you sure you need to do this, and is the increase in G&A as well as marketing and R&D?

Rich Riley

We looked at this very hard, we spent a lot of time on it, we’re sensitive to the fact that we made some really difficult changes in the organization, particularly in Q2 this year. We didn’t do that to go back and do things irresponsibly on a going forward basis. Having said that, I’m going to say this kind of (inaudible) as I can, we kind of drained the swamp based on where the markets been the last two or three years with advertising and marketing expenditure in that period of time.

Quite honestly, we got to a point where I think we’ve been somewhat responsible in terms of moving the business forward, but we really understand this is an area that is critical to the long term success of both the brand and the company. And so we will be very careful, we budgeted some increased cost associated with that. We’ll be very careful before we put those things in there to make sure that we get the revenue on the other side of that.

Paul Coster – JPMorgan

Are we beyond the sort of break even phase for SafetyNet and supply chain, or they sort of negative contributors? If they are, is there some kind of decision point where you decide not to proceed any further if you don’t see a path to profitability?

Rich Riley

Let me run through the numbers on Q4 for you Paul. So if we take each one of those businesses, in Q4 Italy was about a $600,000 loss, LoJack SafetyNet was about a $300,000 loss, and SCI was break even for the quarter. So in that order, I would use that same order the other way around. So SCI would expect to be break even or better in 2011. It’ll be a slower turn for Italy, but still coming out of the year 2011 we would expect to be pretty close to break even, if not at break even. And then LoJack SafetyNet is still sort of in a build mode. On all three of those, the decision point really takes place every quarter.

Paul Coster – JPMorgan

Better than I’d appreciated, actually. And then my last question is in your prepared remarks you talked a little bit about recurring revenues for the dealers as part of this new strategic thrust. Can you explain what that might be?

Rich Riley

Part of the problem we have is we have been focused with our dealers on a kind of a transactional basis, so whatever happened in a given month, happened in a given month. We’re working again with some targeted dealers who we think have some higher potential for us to look at it in terms of a little longer term commitment from our dealers. So while it’s not a recurring revenue stream with the end consumer out there, they pay for it one time and they’re done, we’re looking for some kind of commitment on the part of our dealers that they’re going to generate volume at a certain level for a period of time with us. So we talk about it in a little bit different terms than we have historically. It’s not recurring revenue as we’ve historically talked about it; it’s just a commitment from our dealers on a monthly basis to deliver something to us.

Paul Coster – JPMorgan

Okay great. Thank you very much.

Operator

Next we are going to Bill Dezellem with Tieton Capital. Please go ahead.