MICT, Inc.
Q3 2014 Earnings Call Transcript

Published: 10 Nov 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Micronet Enertec Third Quarter 2014 Results Conference Call. All participants are at present in a listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session. As a reminder this conference is being recorded. I would now like to hand over the call to John Nesbett of IMS. John, please go ahead. John Nesbett - IMS Good morning and thank you for calling in to review Micronet Enertec’s third quarter 2014 results. Management will provide an overview of the quarter followed by a question and answer session. Importantly, there is a slide presentation which management will use to review the quarter. The presentation can be found on the Investor Relations section of the Company website under events and presentations. There is also a link on the press release which you can link through to view the presentation and you will see it as it states November 6 presentation and you click on that for the PDF. Then you will need to forward to the slides in conjunction with management as they go to the presentation. I will now take a brief moment to read the Safe Harbor statement. During the course of this call management will make expressed and implied forward-looking statements within the Private Securities Litigation Reform Act of 1995 and other U.S. Federal Securities laws. These forward-looking statements include but are not limited to those statements regarding our continued growth, our strategy to become the major supplier of rugged tablets to the multibillion MRM growing market, the growth of our Aerospace and Defense business, our revenue expectations for 2015 and our expectations regarding future higher margins, profits. Such forward-looking statements and their implications involve known unknown risk, uncertainties and other factors that may cause actual results or performance to differ materially from those projected. The forward-looking statements contained in this presentation are subject to other risk and uncertainties including those discussed in the risk factors section and elsewhere in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 and in subsequent filings with the SEC. Except as otherwise required by law the Company is under no obligation to and expressly disclaims any obligation to update or alter its forward-looking statements whether as a result of new information, future events or otherwise. During this call management will present both GAAP and non-GAAP financial measures. These non-GAAP measures include – I am sorry exclude both share-based compensation expenses and the amortization of intangible assets, as well as non-recurring items. These non-GAAP measures are not intended to be considered in isolation form, a substitute for or superior to our GAAP results and we encourage you to consider all measures when analyzing Micronet Enertec’s performance. A reconciliation of GAAP to non-GAAP measures is included in today’s press release regarding quarterly results. In addition, please note that the date of this conference call is November 6, 2014 and any forward-looking statements that management makes today are based on assumptions that are reasonable as of this date. Management undertakes no obligation to update these statements as a result of new information or future events. On the call this morning, we have David Lucatz, Chairman, President and CEO; Tali Dinar, Chief Financial Officer and Shai Lustgarten, CEO of Micronet LTD. And again, as a reminder there is a slide presentation on the investor relations section of the site under events and presentations. You can also use the link on the press release to get to that. Okay with that, I would now turn the call over to David, as he will begin the presentation on slide four, please go ahead David. David Lucatz - Chairman, President and Chief Executive Officer Thank you, John and good morning everyone. We will start with Slide 4. The third quarter was a turning point for our Company. As you can see from the results issued this morning, it was a record quarter with very strong top line growth. There have been two tenants to our growth strategy and both made great stride in the third quarter. First, we are focusing the MRM business on the large and growing local fleet vertical. It is an attractive market for us and we have transformed our position to accelerate our penetration into the marketplace. Second, we are diversifying our customer base, not long ago our customer base was very concentrated with large customer (Nomu). We have an excellent diverse and growing list of customers thanks to the great job our team is doing. Finally, we have returned to EBTIDA profitability and have a clear path forward to enhance profitability. Moving to Slide 5, on Slide 5 I would like to steer to you for everyone the recent acquisition that we completed in June, this was a very significant deal for Micronet Enertec and this is a third quarter with this business entirely consolidated. First, we added a complementary product line with a strong presence in the local fleet market. Second, the acquisition moved the headquarter for our MRM business to the U.S., the largest and most advanced MRM market worldwide and gave us strong sales presence in the U.S. market. The acquisition was accretive with 2013 revenue of $11 million and combined with immediate and efficient consolidation of marketing and sales efforts was a key accelerator for diversifying our customer base. I am moving to Slide 6, Slide 6 shows our revenue for the quarter compared to the same quarter last year. Consolidated revenue grew 43.5% importantly this revenue growth came from both our MRM division which grew 29% and our Aerospace and Defense business which grew 60%, our Aerospace and Defense business was smaller than our MRM division has been a steady performer. It is a solution of kind of increasingly vital for the international unrest and missiles attack threats. Moving to Slide 7, on Slide 7, we see the sequential revenue performance compared to the second quarter of the year, revenue grew 73% sequentially primarily due to the acquisition we made but again you see that both of the division demonstrated strong growth with MRM growing 110% and the Aerospace and Defense business growing 23%. I am moving to Slide 8. On Slide 8, we see an important trend in our business, last year local fleet vertical accounted for approximately 18% of our sales. At the end of the third quarter this year, local fleet vertical accomplished for approximately 50%. Why this is important? First the local fleet vertical is considerably larger than long haul and heavy equipment. According to 1Licht and Associates this is over five times bigger than the long haul market. Second it’s growing rapidly. Licht predicts the local fleet market to grow from 4.2 million units in 2014 to 5.7 million units installed in 2016. I am moving to Slide 9. On Slide 9, you see a snapshot of our enhanced customer diversity with our MRM business. Last year, one very large account was 83% of our business while still a large customer of ours, our business will then has decreased considerably furthermore. The recent acquisition significantly diversified our customer base, hence now 10 customers account for 83% of our sales. Importantly, these are excellent customers with many of them in the local fleet vertical. I would now turn the call over to Tali, our CFO who will review the number in more details, Tali?

[Tali Dinar:]

Thank you, David. As David has reviewed consolidated revenue grew 43%. You will see that our gross margins for the quarter decreased from to25% from 45% in the same quarter last year. This decrease was primarily due to the first time full quarter consolidation of expense with a new U.S. based facility and different product mix. The Company expects gross margin to improve going forward as it completes the reorganization and consolidation of the U.S. operations. Total operating expenses as a percentage of sales came down slightly hence we see operating loss for the quarter. Slide 11 show the reconciliation of non-GAAP net income. You will see that for the third quarter of this year, we had $213,000 of amortization related to the U.S. acquisition and $93,000 related to Micronet acquisition for a total amortization of $306,000. We also had expenses related to the recent acquisition of $79,000, hence our non-GAAP loss was amounted to $123,000 for the quarter and we had a profit of $527,000 on the EBITDA basis. On Slide 12, you will see that our balance sheet is healthy, as expected cash came down and debt increased due to the acquisition of the U.S. Vehicle business. Nonetheless, our net working capital remains strong at $17.3 million and we have $14.6 million in stockholder’s equity. I will now turn the call back over to David. David? David Lucatz - Chairman, President and Chief Executive Officer Yes thank you, Tali. Moving to Slide 13, an important element of our growth strategy is forging strategic relationship to help bring our solutions to customers. Few examples from the quarter, we established a partnership with Verizon to make our mobile data terminal more widely available to the customers, us and channel partners. Furthermore, our Android enabled M-307 computer tablet were certified by XRS Corporation around the XRS solution. Our sales and marketing efforts have been enhanced significantly by our acquisition of the U.S. business and I expect continued momentum in establishing sales channels. I am moving to Slide 14, on Slide 14 I just want to take a momentum to address the Electronic Logging Devices or ELD mandate opportunities and this is a potential catalyst for our Company that I do not think many investors appreciate. By way of background, drivers are required to keep record of our service for example they cannot work over 11 hours per day and they are required to take rest periods. Historically these records were kept in paper log book but it is changing over to ELD which connect to the vehicle engine. In July 2012 Congress passed legislation requiring ELDs and this law is expected to be enhanced in January 2015. There will be a two year period for the industry to comply before it is enforced. Essentially, this will increase the amount of ELD equipped trucks from 500,000 today to approximately 2.6 million. Given our positioning in the vehicle market, we believe that we can potentially benefit on this law and we are working hard to make sure that customers understand the requirement and that we have the best solution for them. I am moving to Slide 15, turning to Slide 15 in summary there are trends work in our favor for our MRM business the local fleet were 50% of all MRM revenue are now revised, is growing rapidly also (indiscernible) international unrest our Aerospace and Defense business is a little into missile defense space and its looks like the need for the (lined up) technology is stable and may be increasing. Looking out of the near medium term, our third quarter revenue were above our expectation. While simply the acquisition is progressing very well and the market demand for our solution is robust. These results reflect a growth trend and momentum in our business which we expect to continue going forward into 2015. We also expect that we will be able to drive enhanced profitability through the consolidation of operations that are expected to save in protection, operating cost and continued growth as well of improved product mix going forward. I will now turn the call over to question, operator.

[Operator:]

Thank you. Ladies and gentlemen, at this time we’ll begin the question-and-answer session. (Operator Instructions) The first question is from Yi Chen of Aegis Capital. Please go ahead

[Yi Chen:]

Thank you for taking my questions. My first question is the gross margin for the third quarter of this year seems compared to the third quarter of 2013 has improved but it seems that compared to the first and second quarter of 2014 it has been decreasing, so looking forward, what kind of gross margin should we expect in let’s say in 2014 for 2015? David Lucatz Well, let me address this question in two separate answer, one is we still see the effect of the consolidation, the acquisition on the gross profit as well, so in the short one we probably will be able to increase the gross margin but 2014, 2015 we expect to have a much better gross margin going back to what we had in last few years.

[Yi Chen:]

Okay. And my second question is regarding the law requiring Electronic Logging Devices, so what’s your expected sales ramp up for Micronet between the law enacted in January 2015 and law enforced in January 2017? David Lucatz If I sum the question correctly you are asking about how dollar wide sales or number of devices?

[Yi Chen:]

It doesn’t matter, it could be units or it could be dollar wise? David Lucatz Well I can’t follow, I already discussed, we are positioned ourselves in a very strong position in the market to be able to take part of this market. We strongly believe that we will be able to take part of the market. I don’t want to do any forecast in terms of numbers but we definitely have very good position to take significant part of this market.

[Yi Chen:]

So if I understand correctly so between this two-year long window, so all trucks should be equipped with ELD device, right? David Lucatz Yes.

[Yi Chen:]

Okay, okay that’s all, thank you.

[Operator:]

(Operator Instructions) Michael Vermut of Newland Capital. Please go ahead.

[Michael Vermut:]

Hi quick question on the – we well two questions actually, one, so gross margin we should expect over the next year to get back to that 45% level? That’s the first one modeling and then the second with the ELD mandate between now and I guess 2017, and you got this structure going up six fold and would you expect to keep market share, gain market share, how are you thinking that because you just made the entrance in to the U.S. so would you expect market share to increase as the overall market increases by that amount? David Lucatz Okay, let me first start with the first question. Regarding the gross margin, so as I said before in the short run we see the effects of the acquisition, 2015 we believe we will come back to our other gross margin which was not 45%, it was in the range of 35% to 40%. One thing you should bear in mind also that gross margin affected by the mix of product and also by the ratio of the Aerospace and Defense business and the MRM each of them has little different gross margin. So on an annual basis, on average we feel very comfortable to say that we got to come back to our 35% to 40% that was last year. Regarding the second question, let me move the microphone to Shai – Mr. Shai Lustgarten, CEO of Micronet. Shai?

[Shai Lustgarten:]

Okay hi, what we know for sure is that this ELD is opening up a significant market for us like you mentioned, it is going to grow tremendously and the two year period will make sure that all drivers are equipped with the right hardware. We saw this trend, we are preparing for it for sometime now and I can tell you today that already our products are ELD compatible, we intend to be very aggressive and provide the best solution to the market and be the first to do that or try to be the first to do that. We already are prepared for it and closing the right that you see in the PRs and you’ve seen the presentation, we are making firm grounds for us to make, to really be a significant player in this market opening up.

[Michael Vermut:]

Great. Can you just give me in general, what was the margin in (three) divisions on the gross margin line? David Lucatz Can you repeat the question, we can hardly hear you?

[Michael Vermut:]

I am just trying to see in the segments where your gross margins are right now? David Lucatz Okay. Can I get – talking going forward of course I put aside effect of the acquisition so basically in the aerospace and defense we pretty much between 30% to 35% in the MRM we are around 35% up to 40%?

[Michael Vermut:]

Okay, but your margin as MRM increases your margin should continue to increase as well? David Lucatz Yes, yes and that’s why I talked about 2015 because in 2014 we still see that set of acquisition heavily, once while we move to 2015 we see less and less effect of it.

[Michael Vermut:]

Great, okay. So, then doing the math, the Company should be profitable assuming the trajectory in 2015? David Lucatz Yes.

[Michael Vermut:]

Okay, excellent and I assume nicely free cash flow positive, just extrapolating that margins moving back up. David Lucatz Basically yes, we are cash flow positive is also a question of where a side effect of working capital and the company grow very fast sometime it can affect the cash flow this year, but basically the picture is yes.

[Michael Vermut:]

Great, excellent. Well, great job and next year is going to be an exciting year. David Lucatz Thank you.

[Operator:]

The next question is from George Melas of MKH Management. Please go ahead.

[George Melas:]

Hi good morning, guys. David Lucatz Good morning George.

[George Melas:]

Good morning, David. Good morning, Shai, Good morning Tali. Tali, first question is for you, the cash that is residing at your Micronet subsidiary and how much is the cash and how much is the debt that’s at Micronet? Tali Dinar At Micronet, total cash of Micronet is around 9 million for the end of the quarter and the debt is around 5 million, this is due to the acquisition that we made.

[George Melas:]

Okay so that’s at the subsidiary? David Lucatz Yes. Tali Dinar Yes.

[George Melas:]

Okay, great. And then maybe that’s a question for, couple of questions for Shai, it seems like the gross margin was really impacted by the acquisition of Beijer, can you help us explain why it came down so much and then help us explain, how you think it can go back up because if you look at the incremental gross margin in the business on that division its looks negative? David Lucatz Provision on it, George it’s David.

[George Melas:]

David or Shai whoever wants to take it? David Lucatz Both of us, maybe then you can choose the, you can pick the right answer, okay, how about it? Anyway going back to the question we, there effects of the gross margins, a significant effect of the gross margin is the one effect which we already experienced during the last quarter and actually during the first half year is affect of the reduction in prices from our major customer, so this one thing which will affect gross margin obviously. Secondly, regarding the acquisition, the company that we acquired Micronet Inc. basically have a similar margin than ours sometimes it can go down 2%, 3% sometimes it can go up, so basically we are in the same range. We do have some effect, accounting effects on the gross margin especially in the, bill of material section where you have to be that the inventory, so it will effect the bill of material which effects the gross margin, that’s why I said before that once we see the effects disappearing, we got back to the gross margins which we had in the past. Did I address the question, George?

[George Melas:]

Yes, but I still don’t quite understand it, okay so let me just go back to the first point that you made, your large customer now is – has become a fairly small part of the overall sales of the business, right? David Lucatz Yes.

[George Melas:]

They are primarily long haul so they probably I don’t know 18% or 20% of revenue, so there is an impact there but it shouldn’t be that high and then the second impact, can you explain more sort of how the accounting works regarding the bill of material, is that you are making a product change and you have to write off some inventory and it has to fight for cost of goods sold. Tali Dinar No, no it’s Tali. Business amortization of acquired intangible assets related to the inventory, this is a result of the acquisition, so there is an amortization in the cost of goods, in the cost of sales that is related to the acquisition, it’s not an operational – operating expense, okay.

[George Melas:]

And how much was that number, Tali? Tali Dinar It’s around 3.5% out of sales.

[George Melas:]

Okay. And can you explain why you have to take that sort of and does that, so this isn’t, you are talking about a non-cash, a non-cash charge there, right? Tali Dinar Right, right this is PPA work once you acquire the company, you are making a market study which take the money which was paid for the company and related to tangible and intangible assets and then amortize it over different periods.

[George Melas:]

Okay, okay. David Lucatz George, just to make it more clear, it’s an accounting issue, it’s now on position which is part of the PPA which is the fairest opinion and it had nothing to do with non-cash and have nothing to do with operation, so back to your question, we don’t do anything with, we didn’t touch the bill of materials and you brought up, we are very pleased with the margins there and the product itself, it’s only an Company issue.

[George Melas:]

Okay, but that David I want to keep exploring this a little bit. Those two factors don’t seem to really explain a drop in gross margin from what should be 35% to 40% to probably less than 25% on the MRM side, so the Beijer product, you are saying the Beijer product have sort of a normal gross margin which would be 35% to 40% where if not 40s accounting issues, is that the case or are they in transition and at this point they have a lower gross margin? David Lucatz Well, it’s not one answer to such a wide question but in general there are two, three factors. First of all you take the 25% and you add the 3.5, you end up with close to 29%, if you add to, to it the share of our major customer so you end up with over 30%, so we are between 30% to 35%. I am not talking about the new acquisition. The new acquisition as I mentioned is basically in the same range but it’s also a question of a mix of product in the different customers who sometimes you sell them through a specific customer about 2%, 3% less sometimes. It’s really a question of the mix of the product and the mix of the customers, so overall we are getting close to 30% to 35%, George.

[George Melas:]

Okay. And so again what gives you confidence that you can grow gross margin back to 35% to 40% on the MRM side next year? David Lucatz What the question when or….

[George Melas:]

No, what gives you the confidence sort of what are the components of the, how does the gross margin go from where it is now to 35% back to 35% to 40%? David Lucatz I will quite, give the question a clear answer, one the affect of the new acquisition is going high and high, okay meaning that the rates or the part of the sale due are attributed to Micronet Inc. is quite a succession and there we know where the margin are pretty much to say that they are around the 35%, they have 2% or 3% less or 2% or 3% more, it really depends on the mix of product so this is one thing, secondly, the amortization that we experienced this quarter is not going to last forever, it’s going to go down more and more down, it’s not one time but it’s going to deteriorate in the next, in the near future. Thirdly, we are moving to the new product of Micronet, and we have mentioned it before, I would say before the product today, we have sending more and more from the new products which have average margin, so we will have a very good reason to believe and we know that 250 and the gross margin is going to be better.

[George Melas:]

Okay, great. Another question regarding that very large customer that you have that was such a big part of sales last year, I think they are doing, there is a product transition there, you’ve reduced prices for them, what do you expect in 2015? David Lucatz 2015 we expect two things, first of all we expect to see, to continue to sell them our product but less and less quantities and the reason is one, they are moving to the new product that they have. One of the product that they are moving into in is our product so we expect 2015 to be based on more and more of the new product, our new product and less and less from the old product. I believe I mentioned it last time and I also, we discussed it, we have a cycle for the product, the old product which our major customer is of course deteriorating and we are moving to the next product, we expect to have our new product in the market in beginning of 2015. This is of course the product which we don’t aim specifically only to the major customer but to the whole market but back to your question definitely we are going to, we believe we can sell them more and more of the new product which by the way also of course will effect our margins.

[George Melas:]

So, do you think that your sales in 2015 go up with this customer or do they flat, do they go down? David Lucatz We believe it will go up.

[George Melas:]

Okay. And then if I look at the net income attributable to non controlling interest which is your minority Micronet shares that’s a positive, so that sort of implies that the Micronet division had positive earnings and that the Aerospace and Defense had negative net income, can you comment on that, it seems like with this revenue growth and sort of the stability or what looks like the stability of that business, I am a little surprised by those results? David Lucatz George, no your conclusion are incorrect because both are positive, you have to add to it the cost of the MICT itself that’s why it’s brought to negative.

[George Melas:]

Okay. So, what you are saying is that if you break down the two divisions this quarter the MRM was – had negative contribution or a negative net income but the R&D was positive, A&D was positive? David Lucatz No, no both of them were positive, the reason you see loss that in addition to the two subsidiaries, we do have expenses of the corporate that’s why it brought it to negative.

[George Melas:]

Okay. Can you – did the corporate expenses go up significantly then this quarter or…. David Lucatz Well it goes a little up, we had some expenses but it’s not something which shows on a yearly basis exchange, we are still in the same rate of as last year or the way we see it next year also.

[George Melas:]

Okay, okay, great. Thank you very much and fantastic revenue numbers. David Lucatz Thank you very much George.

[George Melas:]

Congratulations.

[Operator:]

(Operator Instructions) At this point, there are no further questions. Before I ask David to make his concluding statement, I’d like to remind participants that a replay of this call will be available within two hours. In the U.S. please dial 1877-456-0009, in Israel please dial 03-9255-921, internationally, please dial 9723-9255-921. David, would you like to make your closing remarks?

[David Lucatz:]

Thank you, operator. So in conclusion I am very proud of a team here and how they have bring such transformational growth in the business in such a short period of time, we look forward to continue to growl the Company and thank you all once again

[Operator:]

Thank you. This concludes the Micronet Enertec Technologies’ third quarter 2014 results conference call. Thank you for your participation. You may go ahead and disconnect.