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2019-10-16 20:41:29

For VOXX International (VOXX), the investment case is reasonably clear at this point. Investors can argue about the exact value of the company's assets, but even conservative SOTP analyses suggest 100%+ upside from Tuesday's close of $4.49. The problem is that most reasonable investors — even those like myself who are long the stock — don't trust management to realize that value for shareholders.

Indeed, VOXX has seen a series of increasingly contentious conference calls in recent quarters. The transcript of the annual meeting in July is uncomfortable to read, which raises the question of what it must have been like to witness. Shareholders want VOXX, at the least, to aggressively repurchase shares, to avoid committing cash on the balance sheet to an acquisition, with some (myself included) also hoping the company will stop funding its cash-burning EyeLock subsidiary.

VOXX's fiscal second quarter report last week doesn't necessarily change the case all that much. Indeed, even a 5%+ gain Tuesday only puts the stock two pennies higher than it closed on Thursday before the after-close Q2 release. The quarter does look disappointing - but disappointment is priced in. I still believe patience will pay off someway, somehow, but it remains clear that the stock will require quite a bit of that patience.

The Numbers

On its face, Q2 looks awful. Revenue declined 17% after a mere 7% drop in fiscal Q1. Operating loss improved year-over-year, but that was due solely to impairments in the year-prior quarter. Adjusted EBITDA reversed from a $4.3 million profit the year before to a $0.7 million loss, the third consecutive quarter in which the figure came in red.

Looking closer, however, the news isn't quite as bad — though it's not great. Most of the pressure came from the Automotive segment, where revenue declined 33% year-over-year. Management cited launch delays for certain vehicle models as a key factor. Per figures from the 10-Q, OEM revenue declined 49% year-over-year after a 35% drop in the first quarter. Aftermarket satellite radio and headrest sales continued their negative trend, in large part due to higher inclusion of those products (particularly satellite radios) in new vehicles. Aftermarket sales have dropped 11% so far this year.

The lower volume and a mix shift away from higher-margin OEM revenue pressured margins. Gross margins fell over 400 bps, and owned Adjusted EBITDA (my calculation, which excludes one-time factors and equity profits from a 50% stake in distributor ASA) moved from a $5 million-plus profit to a $600K+ loss.

But VOXX also had a tough comparison: automotive segment revenue rose 22% in Q2 FY19. And CEO Pat Lavelle said the company had won a new five-year contract that could be worth as much as $55 million annually - roughly one-third of annual segment revenue over the past few years. Thanks in part to that award, on the Q2 conference call Lavelle forecast a rebound in the second half of fiscal 2021 and significant growth in fiscal 2022. This historically has been a lumpy business (albeit not quite this lumpy) and so Q2 alone doesn't mean it needs to be written off.

The larger concern might be elsewhere. The Consumer Electronics segment, which includes what formerly were broken out as Premium Audio and Consumer Electronics, saw revenue decline 7.8% year-over-year. SKU rationalizations in lower-margin consumer electronics were a factor. And the Q2 release cited higher sales of premium mobility and speaker products, likely coming from the company's Klipsch unit.

That said, Premium Audio revenue (again, using figures from the 10-Q) still declined 3.9% year-over-year. Lavelle said on the Q2 call that domestic premium audio sales were down modestly against a strong quarter the year before driven by initial sales of base speakers. But last year's consolidated sales in Premium Audio were basically flat - which Lavelle on that quarter's call attributed to a strategy of limited distribution that aimed to protect margins.

Klipsch unquestionably is the premier business under VOXX's ownership at the moment. In July, I conservatively estimated it was worth $100 million, a figure roughly equal to VOXX's current market capitalization and greater than a pro forma enterprise value of $72 million. But revenue declined 5% between FY17 and FY19, and the 4% decline in Q2 offsets some of the optimism that followed a 13% increase in the first quarter (which admittedly came against a much softer compare).

Meanwhile, even with SKU rationalizations and cost cuts that were supposed to help profitability in the former Consumer Accessories business (which was unprofitable on an EBITDA basis), EBITDA for the new reporting segment still declined 19% y/y in Q2 after nearly doubling in the first quarter. Tariffs are a factor, but regardless, EBITDA margins in Q2 were 4%.

Either the consumer electronics business (excluding premium audio) still is unprofitable - or Klipsch margins simply aren't very impressive. If it's the former, VOXX still has a lot of work left to do to prune its portfolio (of, it should be noted, some of the products that actually built the company in past decades). If it's the latter, Klipsch margins have come down from 10%+ in last year's first half. CFO Mike Stoehr said on the Q2 call that the business increased headcount, so it's likely there was some margin compression in premium audio.

The other attractive asset is ASA - and income from that equity investment declined 23% y/y in Q2, and 22% in the first half. The Q cited lower sales in certain markets , along with tariff impacts and recall costs. Given ASA's presence in marine and automotive markets, both of which look shaky at the moment, declines may continue in the second half and beyond.

Meanwhile, EyeLock generated just $254,000 in revenue. That's an increase from last year's $184K, and an improvement of $6K from Q1. But gross margins are negative, and even with cost cuts there, too, segment EBITDA was a loss of almost $2 million.

The Call

One piece of good news is that, as promised, VOXX finally repurchased shares. The company bought back 208,312 shares - over 0.8% of its count - at an average price of $4.72, spending nearly $1 million in the process. As a questioner noted on the Q2 call, those buybacks only offset the 200,000 shares issued to Lavelle under a reworked employment agreement. But given that VOXX has had an open but never-used authorization for years, the buyback is a modest step in the right direction. Management had discussed the possibility of a dividend at the annual meeting, but there was no mention of a payout after Q2. Given negative Adjusted EBITDA, I'd be surprised if the company moves forward on that front.

That aside, the call seems like more of the same. Major shareholder Thomas Kahn (who owns almost 17% of shares outstanding) chided management for a consistently optimistic spin . He and others asked for more repurchases, with one recommending a 10b5-1 plan. Stoehr replied that we'll take it under consideration . That's not quite the answer shareholders want to hear; most would prefer the company be much more aggressive, rather than limiting itself to open market windows.

For EyeLock, Lavelle highlighted several potential opportunities, with the product being approved by a major company in the healthcare vertical. The CEO also noted programs in the gaming, automotive, and security industries. As a result, he said, management believe[s] the next six to 18 months will validate EyeLock's position in the industry and potentially lead to other avenues of growth and profitability for VOXX .

The problem is that the commentary sounds awfully familiar. Over four years ago, on the Q1 FY16 call, Lavelle said the company had driven interest from financial firms, government agencies, automakers, and security manufacturers. Nothing really has come to fruition. Funding almost $2 million in cash burn (some of the losses in theory are attributable to non-controlling interests, but it's VOXX that appears to be funding EyeLock) per quarter is significant in the context of a $100 million-plus market cap. The 6-18 month timeline seems to suggest that management still is willing to throw good money after bad for quite some time.

At some point, the business needs to deliver. It hasn't, as witnessed by just $260K in first-half sales at negative gross margin (excluding released inventory reserves in Q1). A partnership with vending machine maker ViaTouch unsurprisingly has been no help so far, despite Lavelle a year ago projecting $500K in revenue. The insistence on finding an application in the gaming space is bizarre.

EyeLock spent months developing a slot machine in partnership with International Game Technology (IGT), an effort I called ridiculous last year. Lavelle said on last year's Q2 call that EyeLock could replace card readers in slot machines - which makes essentially zero sense. (Would a slot player allow a casino to make a record their iris? Would casinos, which have spent this entire decade pinching pennies, allocate labor to the effort which does almost nothing to improve the player experience?)

Automotive efforts have been made before, including a Jeep Wrangler displayed with EyeLock technology back in 2015. Here, too, is iris authentication necessary, or preferable to simpler technologies (such as using an app to unlock the car)?

Valuation and Management

In the context of the paper valuation, even funding EyeLock for another three years and ~$20 million doesn't necessarily ruin the bull case. But the subsidiary is a symbol of everything that remains wrong with management. There's no accountability. There's no focus on shareholder value. Foresight seems minimal, whether it's chasing patently absurd programs or waiting until 2018 to stop manufacturing clock radios, remotes, and other low-margin products that had been declining for years.

This isn't a new problem. I've called out management concerns for years now. Guidance has been missed repeatedly for this entire decade. The two major acquisitions - Hirschmann, which was flipped for a profit, and Klipsch - haven't actually been that bad. But the company has wasted millions on EyeLock. It's likely done the same with the accessories business - and still isn't getting that business in order. An agreed-to sale of the company's German accessories for $19 million spiked VOXX 11% in June. It fell through because the buyer couldn't get financing in a country where government bonds have negative yields.

I don't agree with the nature and tone of some of the public comments directed at Lavelle, who's basically the public face of chairman and founder John Shalam, who controls the company via a dual-class structure. Shareholders (again, myself included) knew well what they were getting into. But I'm sympathetic to the underlying sentiment driving those comments. There is an obvious path here to significant upside. Sell the businesses, shut down EyeLock, and return the cash to shareholders. Instead, Lavelle is getting half a million shares after VOXX has declined 67% in the fourteen-plus years he's been CEO. (Lavelle does have to hold at least $1 million in stock now, after he's spent years selling shares almost as soon as he receives them.)

The question is if the potential upside - or, alternatively, the floor on the downside - is worth the frustration. After Q2, I still believe that's the case, though I admit to wavering somewhat. The company has $37.5 million in net cash pro forma for its sale of real estate in Germany, which closed after quarter-end. Inventory built by nearly $13 million in the first half, which should reverse in 2H and further boost cash on the balance sheet. The ASA stake, even assuming equity profits drop from FY19's $6.6 million to ~$5 million (-24%, modestly worse than first-half performance) is worth $40 million. Klipsch, even with Q2 concerns, still seems likely to be worth at least $100 million. Those two businesses plus cash get to $180 million - over $7 per VOXX share. Some value in automotive (still profitable) probably gets to $9+, a clean double.

But, in the meantime, we wait. Investors will absolutely revolt if VOXX makes another acquisition - but it may well do so. On the Q2 call, Lavelle did float the idea of a tuck-in acquisition in automotive, itself a concern. That aside, the hope for minority shareholders is that management at some point realizes the futility of EyeLock and the challenges in the automotive and accessories business. The good news is that there's still value in the meantime. The bad news, after another disappointing quarter, is that management doesn't seem any closer to that realization.

Disclosure: I am/we are long VOXX, IGT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

seekingalpha.com Vince Martin
million voxx year quarter which lavelle years company revenue still after eyelock

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