Audiovox Q4 2005 Earnings Conference Call Transcript (VOXX)

Audiovox (VOXX)
Q4 2005 Earnings Conference Call
February 14th 2006, 10:00 AM.

Executives:

Patrick M. Lavelle, President and CEO
Charles Michael Stoehr, Senior Vice President and Chief Financial Officer
Glenn Wiener, Financial Investor Relations

Analysts:

John Bucher, Harris Nesbitt & Co.
Richard Greenberg, Donald Smith and Company

Presentation

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter 2005 Audiovox Corporation Earnings Conference Call. My name is Angela and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question and answer session towards the end of this conference. If at anytime during the call you require assistance please key * followed by a 0 and a coordinator will be happy to assist you. As a reminder this conference is being recorded for replay purposes and now I would like to turn the presentation over to your initial host of today’s call, Mr. Glenn Wiener. Please proceed sir.

Glenn Wiener, Financial Investor Relations

Good morning everyone and welcome to Audiovox’s fiscal 2005 Fourth Quarter and Year-end Conference Call. As the operator mentioned, today’s call is being webcast from the company’s website www.audiovox.com under the Investor Relations section and a replay has been arranged for those who are unable to participate today. The replay will be available approximately one hour after the completion of the call or by dialing 888-286-8010 and entering pass code 15867938. Fiscal 2005 fourth quarter and year-end results were released yesterday after market close. If you have not received a copy of the announcement you can obtain one by calling my office after the completion of this call or by visiting the company’s website. Additionally, our Form 10-K for the year ended November 30th was filed this morning, it can be found on our website under SEC filings. Now, to the matter at hand, speaking from management this morning will be Patrick M. Lavelle, President and CEO; and Michael Stoehr, Senior Vice President and Chief Financial Officer. Both will make opening remarks before opening up the call for questions.

Before getting started, I have been instructed by legal council to read the following Safe Harbor statements. Except for historical information contained herein, statements made on today’s call and on today’s webcast that would constitute forward-looking statements may involve certain risks or uncertainties. All forward-looking statements made are based on currently available information and the company assumes no responsibility to update any such forward-looking statement. The following factors among others may cause actual results to differ materially from the results suggested in the forward-looking statements. These factors include, but are not limited to risks that may result in changes in the company’s business operations, our ability to keep pace with technological advances, significant competition in the mobile and consumer electronic business, relationships with key suppliers and customers, quality and consumer acceptance of newly introduced products, market volatility, non-availability of products, excess inventory, price and product competition, new product introductions, the possibility that review of our prior filings by the SEC may result in changes to our financial statements, and the possibility that the stockholders or regulatory authorities may initiate proceeding against Audiovox and/or and our officers and directors as a result of any numerous statements or other corporate actions. Risk factors with our business including some of the factors set forth herein are detailed in the company’s Form 10-K for the year ended November 30th 2005. Thank you again for you participation, and at this time I would like to introduce Patrick Lavelle, President and CEO of Audiovox Corporation.

Patrick M. Lavelle, President and CEO

Thank you Glenn and good morning everyone. I would like to start today’s call by briefly reviewing our fourth quarter and year-end results while addressing the business and industry issues that have impacted our performance. I will then turn the call over to Michael, who will provide more insight into our financials. Yesterday we reported fourth quarter sales of $156.3 million, which is an increase of about 5% versus the fourth quarter last year. For our fiscal year, however, our sales were up 4% coming in at $539.7 million compared to $563.7 million in fiscal 2004. We reported a net loss per share from continuing operations of $0.37 compared to a loss per share of $0.10 reported in the fourth quarter of last year, and for the year net loss per share from continuing operations was $0.30 compared to breakeven reported last fiscal year.

Including discontinued operations, we reported a fourth quarter net loss per share of $0.46 compared to a net income per share of $3.02 in the fourth quarter last year. Note, however, that last year’s net income included a $3.05 per share gain in the sale of our cellular business. Mobile electronics represented 63% of our sales versus 72% last year. Consumer sales were 37% this year versus 28% last year. Michael will cover our financials in just a few moments, but before he does, I would like to address the inventory write-down taken this quarter to explain why we have taken these charges now and will position us in the future.

The inventory write-down covers three very distinct areas. The largest at 6.8 million relates to discontinuance of certain aftermarket product lines and products. The second represents 2 million and relates to the end-of-life OE products and the third to the normal obsolescence cycles of the electronics industry. Let me cover the largest component first. We have discontinued the Audiovox navigation and Audiovox Rampage and Prestige autosound lines done as part of a long-term plan put into effect when we purchased the Jensen brand. And purchased because we believe that it was stronger than our existing ones in the autosound category. Our business strategy has been to launch our own Jensen products and based on network and consumer acceptance, eventually, move all of our autosound business to the Jensen and Phase Linear by Jensen brands.

In 2005, based on for the successful relaunch of the Jensen brand the prior year, we stopped bringing in new sound products under the Audiovox, Prestige, and Rampage and began closing our existing products. Additionally, the private label programs for Circuit City ended as well. We have essentially completed the closeouts and at this point the only sales under these brands that remain are returns and refer these goods, all of which can only be sold at distress gross margins.

Every year at the CE show in January, manufacturers announce post-polity pricing that sets new floors for pricing. Based on our review of prices after the show it became apparent to us that it would actually cost more to refurnish and handle the remaining inventories in these product lines than it would be to write them down. Newly established selling prices from the competition on similar product will be lower than what we could charged for these discontinued items. As an example, if it takes 35% to handle, refurbish, and ship a product, but its value is only $0.30 on the dollar. It is just not economically wise to refurnish. The same situation exists for our versatile video line.

In Q1 last year, I announced that we would exit the Video-In-A-Bag business as a response to the continued decline in the marketplace. By Q3, we had sold the bulk of our new product inventories and since that time most of our sales had been returns and refurbished models. Now, with post-holiday prices on portable DVD players reaching an all time low, we will be forced to sell the balance of this obsolete inventory $0.30 on the dollar, which simply does not make economic sense. Therefore, we have taken a charge on the remaining inventories of this brand as well as closing out the private labor liquid video program for Circuit City in favor of Jensen. As I said a few minutes ago, 6.8 million of the write-down can be attributed to these discontinued aftermarket products and brands. The second element of the write-down relates to OE products. By their nature, original equipment products have distinct life cycles, as they are developed for a particular vehicle model or particular model here.

At the beginning of 2006, we also evaluated the remaining inventories for several OE products that had reached the end of their life and determined that the remaining inventories would not be purchased by the customer and would have to be scraped or liquidated and finally there is the portion of the write down that relates to the normal obsolescence cycle of the electronics industry. Two factors control that lifecycle, one is technology and the other is relatively new and relates to price erosion by a new form of competition coming from our customer rather than manufacturers. The lifecycle of most consumer electronic products is short affected by technology developments that make manufacturing cheaper and create price erosion. This paves the way for the introduction of subsequent models of the same type of product often with more features and for less money than the original. As a result, Audiovox and many other consumer electronic suppliers write-down product every quarter. This obsolescence cycle is not going to go away. Technological advancements will continue and we are grateful that they do, as new product is the lifeblood of our company.

In addition, in recent years, big-box retailers sourcing products direct under house brands are becoming bigger components of price erosion issues. They bring in product on the direct basis and establish lower opening price points, which in turn effectively lowers all levels in the category. Our gross profit margins for the year were 11.3%, which is off considerably from the past year and well under the targets for our electronics group. Our margins were negatively affected by several factors. The write-down of discontinued brands in OE products, the shift to more consumer electronic sales that are at traditionally lower margins. Low margins on the satellite radio sales of Plug-N-Play unit were almost half the year. Increased trade cost associated with selling more units at lower prices to achieve the same sales targets.

Increases in freight cost to accommodate our growth of larger size LCD TV products and more MDF funds associated with the increase in the big box retail sales. For 2006, we are actively reviewing all operational issues with the intent to further reduce shipping and handling cost and mitigate the effect they have on gross margins. We have hired a new Senior VP of Operations with extensive logistics management experience, who comes to us from a $10 billion consumer electronics giant. We are looking to streamline our operations, force efficiencies, and simultaneously position us for growth.

In 2006, we do not expect to discontinue any brands or product lines. Therefore, we do not anticipate a reoccurrence of the charges taken this year. Also, our new arrangement with XM, which I will cover in a minute, should eliminate a recurrence of the write-downs on our Plug-N-Play systems that were taken in 2005. These steps coupled with new higher margin products scheduled for the second half should help us attain more traditional margins for 2006.

Now, if I may, I would like to address the year. The end of 2005 knowing that the year would be marked by substantial challenges, one of our largest product categories: mobile video was undergoing a major market shift and by the third quarter satellite radio, which had been pegged as one of our growth drivers for 2005 also underwent a dramatic change. We had just acquired Terk and we are working hard to assimilate them in to our marketing and distribution mix and finally we are adjusting to the divestiture of our cellular company and a subsequent changes to our administrative structure. All this in addition to the normal challenges of the consumer electronics business.

Our mobile electronic business, which consists primarily of mobile video, satellite radio, car audio, security, remote start, and mobile accessories at sales of $339 million, down almost 16% from the prior year. This reduction in sales was due primarily to the changes in the mobile video market. Excluding mobile video, sales in the mobile electronics group grew 10% year over year. Mobile video, once one of our biggest growth drivers continues to suffer from the ongoing shift from Video-in-a-Bag systems to lower cost, lower featured portable DVD players and the increased presence of OEs offering mobile video systems as standard equipment, not to mention, with continuing decline in SUVs. The changes in the mobile video marketplace have prompted us to exit the Bag business, and discontinue our versatile video brand so that we can concentrate our efforts on innovative installed video solutions such as our new removable DVD-PC headrest player and smaller footprint overheads that expand sales opportunities beyond SUVs to the new smaller crossover vehicles and passenger cars. We have introduced new headrest systems and overheads including ones with larger screens, not available at the early level and even dual screen overheads.

Customized solutions that should restore margins to more historical levels. Our DVD show product, which you heard a lot about last year, was recently named one of the ten best products by David Pogue of The New York Times and sales of this product continued to grow. As I said before, our dollar sales in mobile, mobile video that is, will not be what they were in the years passed, as the category has changed, but it is still a very viable market and one that we plan to continue to capitalize on. Despite the negatives of the past two years we remained a market leader and have been for five years in a row. We continue to introduce innovative products like the dual screen overhead that just won a CEA design award, our third in three years. We got strong relationships in place with our power retailers, OEs, and the 12-volt specialist. And finally, we expect mobile video to return to more traditional margins in 2006, as we have seen a 7% improvement to mobile video margins in the fourth quarter.

In satellite radio, we enjoyed strong unit sales despite the well publicized issues impacting the category. As you know, in the third quarter, one of our major competitors dropped prices on their plug-n-play units by half, which resulted in us adjusting pricing and taking an inventory write-down of $3.7 million for on-hand inventory. Unit sales for satellite radios were strong, however, we knew that product write-down would impact our fourth quarter sales as we moved through our Plug-N-Play inventories at pricing levels that were half of what we had anticipated and that little or no gross margin.

During last quarter’s call, I also said that we would need to change our business model in this category to mitigate exposure to the volatility of the market and prevent future recurrences, we have done that, and believe we will be able to maintain profitability in this category despite market changes that may occur. The agreement with XM should help us to achieve our goal of becoming the number one supplier of XM products in the aftermarket. We are excited about our product lineup in 2006, and especially with the new XM express Plug-N-Play unit and the exciting XM passport, an Audiovox exclusive.

For those of you who do not know about it, passport is the next generation of XM product. It is approximately 40 times smaller than the original trunk mount XM radio tuner introduced just four year ago and it will let an XM subscriber move the XM service from one passport compatible product to another, allowing them to receive XM satellite radio on many devices with only one subscription. The tiny passport cartridge contains the entire XM tuner needed to deliver XM satellite radio to a wider rate of XM ready products including home stereo, home theatre systems, DVD players, mini/micro shelf systems, car radios, clock radios, and boom boxes. The XM passport is inserted into a docking station connected to the product or is inserted directly into a port built in to the unit. During 2006, a wide variety of passport compatible products will hit the market. For manufacturers like Yamaha, Xenon, Onkyo, Pioneer, Sony, LG, JVC, Samsung, and a host of others and all of these units must use the Audiovox passport.

Car audio proved to be one of the brightest sparks of 2005, as market receptiveness to our Jensen mobile multimedia line was so good that sales in this category more than doubled over last year. At the CE show, we introduced a new series to the Jensen line called Intellicar. These products take advantage of the latest technology such as bluetooth, touch screens, satellite radio, navigation, windows media, iPod, and mp3. As the convergences of impart communications, navigation, and entertainment continues, we expect our Jensen Intellicar products to position us as a dominant player in this category.

In 2006, we will enter the growing portable GPS market with products in both our consumer and mobile electronic lines. Two consumer models will be available in the spring and the mobile unit shown on CNBC during the CE show will be ready in the early summer. All will be XM passport compatible and the mobile unit will double as an XM Plug-N-Play receiver, as well as a GPS unit. We believe the uniqueness of this particular GPS product will allow us to hold margin in a category that is growing very quickly and likely to see consumer electronics light margins as the competition pushes this product to a commodity level. We are expanding our collision avoidance product line as this category also is being catapulted into the media spotlight, thanks to legislation before Congress and that stopping the thousands of childhood deaths. We have a full line that includes backup sensors, rear-observation cameras, and two innovative products; a license plate frame camera and trailer hitch system. Again, this is a niche market, which should give us full margin.

Our 2006 mobile electronics lineup is strong with depth of product and respected brains. We expect to get back to traditional profit levels in this category making mobile electronics the profit driver it has been for most of our history. Sales in our consumer electronics group grew almost 25% year-over-year has we posted the best CE sales in our company’s history. Strong demand for LCD flat panel TVs and our portable DVD players fuel this growth as LCD TV unit sales more than double and according to NPD we achieved the #2 market share position in the portable DVD category.

In LCD TV, the 2006 product lineup features larger screen size. LCDs in 32