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Iteris Inc. (NYSEMKT:ITI)

Roth Capital Conference

February 22, 2007 1:30 pm ET

Executives

Jack Johnson - CEO

TRANSCRIPT SPONSOR

Moderator

Our next presentation comes from Iteris, ITI. Iteris provides outdoor machine vision systems and sensors and operate in three segments, including Roadway Sensors, Automotive Sensors and Transportation Systems. Presenting today for the company is Jack Johnson, CEO. Jack?

TRANSCRIPT SPONSOR

Hayden Communications ("HC") is a premier information resource to institutions, hedge funds, independent portfolio mangers, buy-side and sell-side analysts, small to large retail brokerage firms and accredited individual investors. With integrity and knowledge, the team of investment professionals at HC draw from “Wall Street” and media backgrounds and continuously strive to maximize the ongoing corporate visibility and market capitalization of clients though a multi tier proactive program. Confidence is essential for a client to attract key investors, customers, and employees. Through a proven track record of exceptional performance, Hayden Communications has established confidence in the marketplace one investor at a time.

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Jack Johnson

Thanks Josh. Before I start, I would like to introduce a couple of other associates with me today. Abbas Mohaddes, Abbas is our Executive Vice President. He is my number two. Jim Miele, our CFO. Thanks fellows.

We have a wonderful business opportunity here at Iteris. I would like to say that every time a new vehicle rolls up the assembly line anywhere in the world, every time somebody new learns how to drive it increases the market for our products and our services.

Before I tell you about that here is our Safe Harbor Statement. And I give you guys about an hour to read that or maybe we will just go on.

Here is the problem that we address. Every year, globally, there is over a million people that are killed in traffic accidents. The total is absolutely enormous. And most people don't pay much attention to it just because it's a fact of modern life. But in the US alone, 40,000 people are killed in traffics on our roadway. And what most people don't know is that traffic is increasing 20 times faster, 20 times faster than the amount of new roads that are being built. So, if you think you are spending more time in your car than ever before, you are absolutely right. And the economic cost of all that is estimated by the US Government. For the US alone it's $220 billion a year.

So this is what we do. We provide proprietary intelligent vision systems and traffic management solutions that on one hand help to optimize the flow of traffic from within the infrastructure and the other one actually help to prevent fatalities in vehicles. So, our basic value proposition is really saving lives and saving time and saving money.

Just a little profile on Iteris: Formed about 10 years ago, headquartered here locally, about 230 people. Sales in the fiscal year, that was 3/31 '06, were about $50 million. We've grown between 15% and 16% at the nine-month point this year. And our ticker symbol on AMEX is ITI.

Now the core technology behind most of what we do is something called Object Recognition Software. It's the ability to teach a computer how to differentiate an object from a background when looking at a video image. And we are going to demonstrate how that works a couple of different times during our presentation, so you can understand it.

But basically, we use it to optimize traffic flow, and it's an active safety system in vehicles. We have spent a great deal of money to-date developing this technology. The good news is, is that it has also created some very significant barriers to entry because what we do is actually very difficult. So, it's not easy for competitors to come into our space.

The umbrella market is called Intelligent Transportation Systems or ITS. That means the use of advanced technology to make existing roadways safer and more efficient. If you think about what's going on in most of the major metropolitan areas, the answer to the transportation problems is no longer just laying more concrete.

Most of our major metro areas are built out. And the cost of these projects, the disruption that they cause during the tenure life, the acquisition of right away makes it very, very difficult to do those. So, if you can increase the throughput of existing roads by 10%, 15% or even 20% in some cases by deploying new technology, that's really the way to go. And so, that's the market that we support.

And we have two basic segments within that that we focus on. One is traffic management and control and the other one is vehicle safety.

Now, let's talk about traffic management and control. It's a terrific time to be in that market. I think there is a growing awareness of the need to not only sustain but also improve our existing transportation infrastructure, which after all is really the cornerstone for the entire economy.

Federal spending in this area is going up over 30% between now and 2010. There is a six-year bill passed. And not only that a lot of states and local agencies are passing important initiatives. Just to give you an example, in California in November, there were three transportation initiatives on the ballot, each of them was a multi billion dollar initiative. All three of them passed and we're seeing that happen all over the country right now. And this is a great situation for Iteris because we are a recognized leader in this market.

In vehicle safety, we have just come through a major period of qualifications with all of the major OEMs in the truck market, the heavy truck market which we'll talk about. But we are in a position to dominate this market that we actually created and it looks like there is a real opportunity to move into strong profitability in that business.

So first we are going to talk about traffic management and control. It's really two different businesses for us. One is called Roadside Sensors, the other one is Transportation Systems Consulting. And one thing that they have in common is that they both focused on the transportation infrastructure. It's really all about optimizing traffic flow.

So, think of, let say the fundamental unit within traffic is really the intersection and we optimize the flow of traffic at that level. The next level above that would be let say a major artery where we are trying to get a green wave affect, so traffic flows very smoothly. Ultimately you want to be able to optimize the flow of traffic over the entire metropolitan area and we operate at all those levels.

First, we will talk about what we do in an intersection. In this particular graphic, this is our Roadway Sensor business. We actually have deployed four cameras and their all highways. This is the Intelligent Vision System that I just talked about. What we have done is we setup an approach, we have one camera that overlooks each approach in this intersection and the whole idea is to maximize the green time in that intersection to use it most efficiently.

So, for example if you look at the school bus that’s right here in this left hand turn pocket. It's very important that we understand when it clears the queue, so that these folks over here can get a green light. So, it's all about optimizing green time within that intersection.

We are replacing a legacy technology there, which is over in the left side of the graphic called inductive loops where they actually cut; make cuts in the roadway buried wire. Vehicle comes over causes a change in the magnetic field indicating the presence of a vehicle. The problem with that is that in most municipalities 20% to 40% of these are not operational at any given time. They are buried in asphalt, asphalt deteriorates overtime. And so these things really cause a lot of maintenance issues. Now we have a non-intrusive form of detection, we're positioned 30 feet above the roadway and we have a design life of 10 years.

There is one very important difference beyond just the detection of a vehicle at the stop bar and that is you get a picture. And in many municipalities now, they want them to take that video feed and they want to take that back to our traffic operation center. Where they can see what's going on in an intersection in real time.

So for instance let's say a citizen calls up and says, I was at the corner of fifth and main and I didn't get a green light for three minutes and there was nobody coming. In the old days they would have to send out a guy in a pickup truck to watch the intersection to try to figure out what was going on. But now, more and more as they network the video back to the traffic operation center, they can observe the problem and take action right from the desktop of the traffic operations manger.

This business is a very good business for us this year. It's grown over 22% year-to-date. We are the U.S. market leader, nice growth. Gross profit is in the high 40% and a very nice and very strong rapidly growing business for us.

Let me just kind of show you how this image processing technology actually works in the intersection. We're looking at an image of feed from a video camera and what we do is we've drawn these detection zones. We actually drew ten of them at the stop bar. And what happens is that these little indicators that are going off and on, that you see in the left-hand turn pocket. They indicate the presence or absence of a vehicle. Now the indicators are off on the right side of that picture where the indicator is still on, on the left side indicating the vehicles are still there. So that means that the oncoming traffic that’s going to come in from your right there now has a green light. So that’s what we do.

An important thing to understand about this video is that we have to be able to operate under totally unpredictable weather conditions. Every approach to every intersection is as unique as your thumbprint. In this particular video it's now raining, an hour earlier it might have been bright sunshine, an hour later it might be pitch black, it could be snowing. And we have to operate under all those conditions and that's what I meant when I said that there is some significant barriers to entry and because it's very difficult to do what we do with a high level of accuracy. We're well over 98% in our level of accuracy.

The market opportunity in the U.S. alone, which is about one third of the world market. 325,000 signalized intersections right now approximately 10% to 12% of those have been penetrated with video. And most of the roughly 13,000 new intersections that are going in each year, that’s new or refurbished intersection, video has about a 50% share. So we're rapidly gaining share from loops.

We go to market through a dealer network, about a dozen dealers that sell everything that you could need for an intersection. We and there is a couple of other states that we go direct, but mostly through distribution. We are working on some additional applications and we also have a growing international presence. We are doing some activity right now in the Middle East and also in Asia.

So, our growth strategy in this area is, we believe that with all the money flowing into this space right now it's a good time to accelerate, time to market on some new products that we have in the pipeline, and we are increasing our sales and marketing activities. This business will grow in excess of 20% this year. And our objective is to maintain that level of growth or better.

The next area is called Transportation Systems. Think of this as let's say a consulting business that's focused on transportation. This is an example of one of the projects that we've done. Every project is unique in this business. In this particular graphic you see a traffic operation center in Greater Detroit. It covers 160 miles worth of freeway.

What we do is, we get inputs from sensors that are deployed in the roadway like video, like inductive loops, combine that with inputs from police and fire transits. It all goes back to a traffic operations center like this where there is a data fusion process that takes place. And the whole idea here is we can give traffic managers a comprehensive picture of what's going on in the entire metropolitan area. And that information can be passed on to motorist via radio, TV, cell phone and the Internet. So, a lot of the reports that you may hear on your way to or from work really emanate from centers like this. And we've done close to two dozen of these throughout the country. So it's an area of expertise for us.

We have over a 100 traffic engineers and transportation planners who've made it their life's work to understand how you analyze traffic flow and do you improve it.

I am not going to through all the projects, but I am just going to highlight a couple of them here. The City of Sacramento recently retained us to do what's called a Bus Rapid Transit System, that's BRT. And BRT is gaining a lot of favor throughout the country because it's used as a substitute for light rail. And often you can get all the benefits of light rail by deploying BRT, basically buses to do the same thing. And you don't have to deploy it anywhere near the infrastructure. And this is an important area for us where we've developed a lot of expertise about how do you integrate BRT systems into a normal traffic road infrastructure without disrupting everything.

Lastly, we also have the, what's considered by most people to be the most important cornerstone contract in the industry. The Federal Highway Administration actually retained Iteris to design what's called the National ITS Infrastructure. And that defines the standards and the architecture by which all of these major traffic operation centers communicate with each other.

That's important because for agencies to get Federal funding for these projects, which can be as much as 80%, they need to be in compliance with the national architecture. So, not only did we design it, but we traveled the entire country in service of the FHWA giving seminars to state and local transportation officials, as to how to be in compliance. It makes us one of the most visible companies in ITS and is really kind of a paid marketing opportunity for us.

Just a little bit more on that back. This part of the business will do probably closer to $21 million this year. A great thing about this business is that we have very high visibility. As we go into our new fiscal year, which starts April 1st, we will have between 80% and 85% of that year's business already in backlog. So, it's a highly visible, highly scalable business. It's been a consistent profit producer for us. The gross profit there is in the low to mid thirties. But if you think about that in comparison to your product business, the fact that the government pays for all of our R&D means that this acts like a business that has gross profits closer to let's say 40%.

Also, there are some nice consolidation opportunities here for growth. In most of the major metro areas, there are two or three firms that specialize in ITS, and there are some good acquisition candidates. Some of the growth that we have achieved up to this point has come from acquisition, and we are always on alert for new opportunities.

So, just to recap the infrastructure part of the business. The government spending is driving terrific growth opportunities. We've got this Proprietary Detection Technology in the intersection. We are a recognized leader in both the segments that we are in. And I think this is very important. We believe that we are in the early stages of a very long and profitable sustainable run in this part of the business that's going to go on for the next several years.

Okay. Now, I am going to focus on the Automotive Sensors side of the business. If you think about what's happened in the driving environment in the last few years, it's changed radically. Drivers are more and more distracted than ever before.

There is a 150 million cell phones in use in this country, 80% of them are used in vehicles. So, we've got that, we've got our navigation systems are high-end audio systems. Drivers are more and more distracted, so we invented a active safety system called Lane Departure Warning System. I must show you how it works.

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It's an imaging system. It's watching the lane markings on either side of the vehicle.

So as you can see, he basically started drifting on the road, our system which uses the same technology that we use in the intersection, detected the fact that he was leaving his lane. He didn’t have his turn signal on, he was going at freeway speeds and it gave him an audible warning that he could hear out of his left hand speaker or its right hand speakers.

It's important to understand that this is really only for freeway use, 40 miles an hour and up. And it only goes off if you're actually drifting out of your lane and you don’t have your turn signal on.

Now we think this is the most important new safety device since the seat belt. Here is why? These are [Missler] statistics. They believe they are saving about 3,200 lives every year by deploying air-bags, another 9,500 by seat belts. But this 25,000 is the number of lives they think are lost every year.

So, what they called unscheduled or unintended lane or road departures. Vehicles drifting out of their lane, colliding with other vehicles or leaving the roadway. The largest single cause of fatalities and one of the things that they have discovered is that, if you deploy rumble strips on roadways you can cut the number of fatalities by as much as 50%.

Unfortunately it would be a maintenance nightmare to try to do that on every major highway. Rumble strips are very expensive to put in and maintain. But we can put virtual rumble strips in every vehicle, and we can do it for let say several hundred dollars.

Two business models here, one is in the commercial trucks where we sell direct and the other one is in the car market where we have a strategic partner and get a royalty. We will focus on the truck market. We were the first to bring this technology and productize it anywhere in the world. We did it jointly with Mercedes. We sell direct to large OEMs and the fleets. We outsource the manufacturing. It's growing nicely for us.

This is a very important slide. On this slide we list all of the twelve largest truck OEMs in the U.S., and Europe. They make 500,000 units a year on the average. We're talking about the tractors and the 18 wheelers.

The ones in blue are all of our existing customers that offer our system as an option. The ones in orange are ones that we have qualified on their trucks in the aftermarket. The white are the only two customers that we don’t have currently. So basically we are qualified on 11 of the top 12 heavy truck OEMs in the U.S. and North America.

It's actually even a better market opportunity than that. In this pie-chart you see the 500,000 new trucks that are made every year. But the average life of these trucks is over 10 years. We think that any truck that’s three years old or less is a potential for putting our system in on an aftermarket basis, because there are extensive repair and refurbishment facilities all over the country to do that. So it’s a very significantly market opportunity.

So, just to summarize, we have 11 of the top 12 OEMs. We are also selling direct to fleets. We have 39 fleets to our standardized our system. We've got 65 more in test. And we expect to grow truck revenues very significantly.

We are also in the car market. There it's a different business model. We have a strategic partner called Valeo, and we get royalty on everything that they sell. Right now, it's in the FX, and M, and Q series vehicles for Infiniti. We've shipped about 43,000 to-date. And within one itself, there is a very significant opportunity just by themselves. And so, that's very significant for us.

A little word about our strategic partner. It's the Valeo Group. Think of them like a company like Visteon, or [Delphi], or Siemens or [Bose]. Only they are profitable. They are responsible for the manufacturing, sales and support of the product. They fund our developments and they pay us a royalty on every sale that they make.

Now that's a longer term business opportunity because of the royalty miles that overlays the opportunity in trucks, which is really a more immediate opportunity for us. So, the strategy here is to dominate the heavy truck market, be a leader in the car market and then replicate our success with other vision-based applications such as side obstacle warning, which would be like blind spot detection or enhance automated cruise control. So, this technology has a lot of legs on it. And there are some significant opportunities beyond lane departure warning.

Just a quick run through the financials. The company has more than doubled in size since 2000. We were a little bit flat in 2004 and 2005 because the last transportation bill got hung up in Congress for 23 months and it flattened our growth rate. But as you can see, we grew actually about close to 9% last year and so far between 15% and 16% this year.

On the P&L, the $14.5 million in sales last quarter was a new sales record for us. The $800,000 in operating income was over a year ago by a factor of three. The $42.3 million is a 15% to 16% growth over last year. Margins are down slightly, really mostly due to mix. Operating expenses have improved.

Last year at this time, we had a small loss, and we are $2.7 million better off than that this year. So, the company has emerged to be solidly profitable this year. And our guidance was 11% to 14% and it's actually closer to 15% to 16% at the nine-month point.

Just a little bit on the balance sheet. We have a current ratio that's about 1.4 to 1. The balance sheet is getting stronger every quarter. We have an $8 million line of credit with Silicon Valley Bank. We are into it by about 50% of that. And we have on our long-term liabilities includes basically $10 million worth of convertible debentures that we will probably convert to equity sometime between now and May of 2009. So, that's the balance sheet.

Just a summary, we have got very strong intellectual property for our vision systems. It's a great time to be in the infrastructure part of this business. We have an opportunity to dominate the truck market for lane departure warning. We are finishing this current year with double-digit growth and very solid profitability. I expect both of those metrics to ratchet up again next year.

Thanks very much. Do you have any questions?

Moderator

Thanks Jack. Actually, let's take questions in the breakout. The breakout will be in Pavilion II. Thank you.

Jack Johnson

Okay.

TRANSCRIPT SPONSOR

Hayden Communications ("HC") is a premier information resource to institutions, hedge funds, independent portfolio mangers, buy-side and sell-side analysts, small to large retail brokerage firms and accredited individual investors. With integrity and knowledge, the team of investment professionals at HC draw from “Wall Street” and media backgrounds and continuously strive to maximize the ongoing corporate visibility and market capitalization of clients though a multi tier proactive program. Confidence is essential for a client to attract key investors, customers, and employees. Through a proven track record of exceptional performance, Hayden Communications has established confidence in the marketplace one investor at a time.

Read all investor conference presentation transcripts here.

To sponsor an investor conference presentation transcript please contact us.

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