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Edited Transcript of ITRN earnings conference call or presentation 28-Aug-19 1:00pm GMT

Q2 2019 Ituran Location and Control Ltd Earnings Call

Azuor Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Ituran Location and Control Ltd earnings conference call or presentation Wednesday, August 28, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ehud Helft

CCG Investor Relations Inc. - Managing Partner - Israel

* Eli Kamer

Ituran Location and Control Ltd. - Executive VP of Finance & CFO

* Eyal Sheratzky

Ituran Location and Control Ltd. - Co-CEO & Director

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Conference Call Participants

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* David Lee Kelley

Jefferies LLC, Research Division - Equity Analyst

* Peter A. Zdebski

Barclays Bank PLC, Research Division - Research Analyst

* Sasha Karim

Inflection Point Investments LLP - Partner & Portfolio Manager

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Presentation

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Operator [1]

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Ladies and gentlemen thank you for standing by. Welcome to the Ituran's Second Quarter 2019 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. You should have all received by now the company's press release. If you have not received it, please contact Ituran's Investor Relations team at GK Investor & Public Relations at 1 (646) 688-3559 or view it in the News section of the company's website, www.ituran.co.il.

I would now like to hand over the call over to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin?

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Ehud Helft, CCG Investor Relations Inc. - Managing Partner - Israel [2]

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Thank you, operator. Good day to all of you and welcome to Ituran's conference call to discuss the second quarter 2019 results. I would like to thank Ituran's management for hosting this call. With me today on the call are Mr. Eyal Sheratzky, the Co-CEO; Mr. Udi Mizrahi, Deputy CEO and VP Finance; and Mr. Eli Kamer, CFO. Eyal will begin with a summary of the quarter's results followed by Eli with a summary of the financials. We will then open the call for the question-and-answer session. I'd like to remind everyone that the safe harbor in the press release issued earlier today also cover the content of this conference call. And now Eyal, would you like to begin, please?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [3]

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Thank you, Ehud. I'd like to welcome all of you, and thank you for joining us today. There are some positive trends in our results for this quarter which makes me increasingly confident that our financial performance towards the end of this year and especially next year will be much improved. Most important is that our aftermarket subscriber growth rate, that is the non-OEM subscribers, exceeded 20,000 in this quarter, bringing us back to the strong growth rate we have seen in previous years.

If you remember last quarter, I explained that, over the past year, there have been changes in the Brazilian market, which meant insurance companies were becoming more selective about who they are selling to, which obviously impacted the subscriber adds in that region. Together with insurance companies we work with, we implemented changes in our system moving to a more dynamic pricing system related to the customer risk profile. In the second quarter, we launched a new system and service. I am pleased to say that all our change in that market has allowed subscribers growth in Brazil to return back to the more typical level we hope for.

In Israel, as you know, we launched a new and innovative service for insurance companies enabling them to sell usage-based insurance. This means the driver that use their cars less pay lower insurance premiums than heavy users. We signed our first agreement a few months ago with Harel Insurance, one of Israel's top insurance company, and we're already starting to see subscriber traction. We recently signed up a second insurance company Shlomo Insurance, and we believe we will sign up more before the end of this year. We see this product as highly valuable for our insurance company, providing a much more accurate risk assessment and personalization of insurance policies, lower cost. And to the customer, it provided an innovative and fully digital service. It also provides us full transparency and fair pricing based on a particular level of risk and vehicle usage. As I said last quarter, we already see significant market interest. And because this service makes so much sense for all participants, we believe that ultimately more and more insurance companies will join this trend.

For Ituran, while being by far the largest market player in Israel, our aftermarket business has traditionally been subject to the macro trend of new car sales in the country. At the same time, we have always looked into penetrating additional segments. An example from a few years ago was the lower market segment, which is successfully penetrated with our Ituran sales service. Our new UBI product, meaning usage-based insurance product, represents an additional and significant vector of growth for Ituran, and ultimately, across all the regions we operate. Long term, we aim to leverage our solution into all the countries in which we're now operating.

Moving to Mexico, again as you remember, last quarter, we discussed that it was recently announced that 2G networks in that country will be phased out. Our OEM customer in Mexico that currently use a 2G telematics system required us to upgrade the system that we supply them to 3G. In the first half of 2019, the customer has been lowering its existing inventory of 2G systems. As of August, purchases of our next-generation system have started, and we expect it to ramp in Q4. While product sales in Mexico is a small portion of Ituran's overall revenue pie, the absence of this product sales in the first half of the year did have some amount of short-term negative impact on us. We believe that by the end of the year, business in Mexico should go back to its normal healthy sales pace.

Before handing over to Eli, I would like to make a few comments with regard to our new OEM services. The Road Track acquisition was made primarily to give us a significant footprint as a major telematics player throughout Latin America. While our subscribers last year were predominantly in Israel and Brazil, we now also have subscribers throughout Latin America. In Israel and Brazil, our subscribers are mostly aftermarket, which we gain through direct sales and our relationship with the car dealers and insurance companies. While in our operation in Latin America, we also have subscribers which we achieved through OEM agreement with car manufacturers. Subscriber numbers through our OEM agreement doesn't stem on Ituran's performance, but more simply on how many cars the 2 major car manufacturers sell in their respective countries and how long those subscribers stay beyond the initial period, which is paid by the manufacturers themselves. Therefore, growth from this segment will come from penetrating additional OEM customers in both existing as well as the new territories, but mostly, from our ability to cross-selling Ituran's existing product portfolio into the newly [required] (sic) [acquired] geographies.

During the second quarter, one of our OEMs reduced the free trial period to its customers from 6 months to 3 months, which had a net negative impact on the number of OEM subscribers in the amount of about 47,000 subscribers. This will have an impact on the Q3 results, causing a onetime drop in the amount of approximately $1 million. Just to give you the numbers as of the end of the second quarter, our active subscriber base was 1.757 million, of which retail was 1.250 million and their OEM was 507,000. We added 21,000 aftermarket subscribers while on the OEM side there was a decline of 47,000, just to remind you that our aftermarket subscribers represent much higher profitability.

In terms of our financial summary, our second quarter non-GAAP revenue was $72 million and adjusted EBITDA was $20.6 million. From the financial perspective, as has been the case in recent quarters, the weakness in the number of the currencies that we operate in, especially the Brazilian real and the Argentinian peso, has had a very significant impact on the translation from local currencies in which we operate to U.S. dollars in which we report. If we remove the currency impact, in local currency terms, our revenues would have grown 33% and EBITDA would have grown by 24%, representing very nice year-over-year growth.

In summary, as we're moving to the end of 2019 and 2020, we believe that all the issues I discussed earlier are now behind us. Beyond that, we're working on identifying and realizing the strong synergies in our business between and inside each of the region in which we operate. We're working to grow our business by cross-selling our capabilities to newly acquired customers and vice versa. We have a strong foothold to penetrate services into new countries, and we're already launching additional services in our new geographies. Furthermore, apart from our ongoing work in building and realizing the synergies in our business, we have initiatives that we believe will begin to propel us forward already starting this year and more so next year. For example, our new usage-based insurance program. My goal is that Ituran will always remain at the forefront of technological advancement in the mobility sector in an ever-changing market.

Before handing over to Eli, I would like to add a few words about the buyback and dividend. As you know, it is our policy to share dividend amounting to at least $5 million a quarter. In addition, we have commenced the $25 million buyback that the Board approved last quarter. We believe that the dividend as well as the ability to buy back our own shares, depending on market conditions, allows us to share our ongoing financial success with our shareholders.

To conclude, as you can see, I'm very excited with regard to the growth potential ahead. And I now hand the call over to Eli for the financial review. Eli?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [4]

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Thanks, Eyal. I note that the results I present will all be on a non-GAAP basis, including adjusted EBITDA, which excludes revenue and costs related to the purchase price allocation. We believe this will provide a better understanding of our ongoing performance. For further details with regard to the reconciliation between the non-GAAP and the GAAP results, please see the table published with the press release.

Non-GAAP revenues for the second quarter of 2019 were $72.2 million, representing an increase of 25% compared with revenue of $57.7 million in the second quarter of 2018. In local currency terms, second quarter revenue would have grown by 33% year-over-year. Revenue breakdown for the quarter was $52.7 million coming from subscription fees, a 27% year-on-year increase. In local currency terms, subscription fees grew 37% over the same period last year.

Product revenues were $19.6 million, which were a 21% increase over the same quarter last year. The geographic breakdown of revenues in the second quarter was as follows: Israel, 38%; Brazil, 38%; and rest of the world, 24%.

Non-GAAP operation profit for the second quarter of 2019 was $15.5 million, an increase of 5% compared with an operating profit of $14.8 million in the second quarter of 2018. In local currency terms, this grew 13% year-over-year.

Adjusted EBITDA for the quarter was $20.6 million, an increase of 16% compared to an EBITDA of $17.8 million in the second quarter of 2018. In local currency terms, the increase was 24% year-over-year.

Net profit was $9.6 million in the quarter or fully diluted EPS of $0.46, a decline of 20% year-over-year compared with a net profit of $12 million or fully diluted EPS of $0.57 in the second quarter of 2018. In local currency terms, the year-over-year decrease was 13%.

The decrease in net income was primarily due to the finance expense primarily related to the acquisition of Road Track and due to increased losses in affiliated early-stage company, Bringg, which contributed $1.1 million loss from share in affiliate.

Cash flow from operation during the quarter was $16.3 million. As of June 30, 2019, the company had cash, including marketable securities, of $62.8 million and a debt of $76.2 million. This is a net debt position of $13.4 million or $0.64 per share. This compares with cash, including marketable securities, of $53.3 million and debt of $73.2 million, which is a net debt position of $19.9 million or $0.93 per share, as of December 31, 2018.

For the second quarter, a dividend of $5 million was declared. The dividend's record date is September 26, 2019, and the dividend will be paid on October 10, 2019, net of taxes and liabilities at the rate of 25%.

And with that, I'd like to open the call for the question-and-answer session. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from David Kelley of Jefferies.

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David Lee Kelley, Jefferies LLC, Research Division - Equity Analyst [2]

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I guess just to start, looking at the rebounding aftermarket subscriber growth, it came in above your 15,000 to 20,000 quarterly expectation. Just hoping you could provide some more color on that upside surprise. I mean how much of the ramp was tied to the dynamic pricing system launch? Anything else specific to call out in the quarter that drove that upside?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [3]

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As we said in the past, we absolutely, I would say, made almost a turnaround, and we did it thanks to some efforts that were done by us together with our partners, which are the insurance companies in Brazil and which -- generally, to explain it, we changed the pricing to the end user to the consumer market from a flat price, which hit us at the cost of the policies, to a more floating price, depend on the characteristic and the underwriting position and the risk of the customer. This allows us to recruit more customers for more segments and create more profitability to the insurance companies' files. So after doing it or established this system with a very smart algorithm, that the insurance companies can see it online. And if the customer buys online his insurance in less than 10 seconds, he can buy and get the best price in the market according to his risk. And once we launched it around March, April, for the first pilot, we saw that it's attractive, it is secure for the insurance companies, and it allows us to get back to high profitability per customer. So we're back to -- as we said and as we see it now, we're back to the historical numbers. We were conservative by giving the range of 15,000 to 20,000. We just started quarter ago. Now I feel more confident that this is the future rhythm, and I even hope that adding more marketing now, which we can do freely, we can even be more aggressive and get more and more customers and also out of the historical regions, which are São Paulo and Rio, and go to other municipal and cities in Brazil. And this is why I think that toward 2020 this will be absolutely integrated also in our financials, because when you are in the operating leverage model, it's taking time to ramp up the financials, but the subscriber movement now is very strong and very good.

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David Lee Kelley, Jefferies LLC, Research Division - Equity Analyst [4]

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Okay. Great. And as a follow-up, so you referenced kind of the outlook into 2020. It sounds like this is tied to the improved visibility to these aftermarket volumes in that 15,000 to 20,000 ramp. So I guess as a follow-up on the margin side of the aftermarket business, so your expectations, do you see that ramping as well just on the cost leverage? Is there anything else specific we should think about? And is this more of a 2020 event than a back half of the year 2019 event? Or should we expect some solid margin expansion in the aftermarket business and 2H '19 as well?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [5]

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Currently, the growth of the subscribers is absolutely the number that we showed. In order to see it on the financial results, of course, we need a little bit more numbers. When you have more than million subscribers, even if you grow 20,000 per quarter, it's taking time that it integrate more mature -- major numbers. But if it -- the reason that we're talking about 2020 is because if the rest of 2019 will continue in this rhythm, so we have more important customers -- new customer base joining and starts paying, this will appear more material in 2020, but we'll see it every quarter also in 2019. Regarding the influence on the profits and profitability, no doubt that when we are a subscribers business or a recurring revenue model, no doubt that it should improve our profits and profitability. And as long as the quarters will move with more and more subscribers, the costs, which are mostly fixed, will allow us to show more profits and specifically year-over-year in the future.

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David Lee Kelley, Jefferies LLC, Research Division - Equity Analyst [6]

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Okay. Great. And then one more from me. The 47,000 OEM subscriber decrease, I guess it sounds like this was largely a function of the lower renewal rates tied to that change in the subscription length, but was there also anything on the production side specific to your customers? I guess could you walk us through the impact there? And if we think about the change to 3 months from 6 months as it relates to this length of subscription, is that something that you expect to be a kind of a structural change and how this business is done on the OEM side? Or is this more kind of a next 6 to 9 months type impact and you expect that 3 months to ultimately go back to 6 months?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [7]

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First of all, I will explain how it is working, what is the influence. So first of all, the OEM subscribers and the OEM customer base is much less profitable than the aftermarket. When you work with 1 customer which is a very large customer and he has a very large customer base in our contract, of course, he has more power and he is taking the prices down, and he is taking the profitability down, so which mean that 47,000 OEM subscribers are contributing much less than the 20,000 aftermarket. So I always prefer to add more aftermarket customers, while at the same time, if there is no choice, so to lose only OEM customer subscribers. But the reason for this specific quarter was this our customer in Brazil, subject to his financial situation and to the Brazilian situation, they decided they no longer have the ability after firing almost half of their employees. And this is one of the larger OEM in the world, by the way, one of the large car manufacturers in the world. But this industry probably, and specifically Latin America, is suffering from the economy. So they decided, part of their shrinking budget, that they are no longer providing to their customers a free trial of 6 months, meaning paying us 6 months in advance, but only 3 months. While this happened in Q2, it's meaning that in one time they cut it about 3 months' worth of subscribers in 1 day. So it's happened only once. So this is why you saw the number of 47,000. By the way, the financial numbers didn't appear in Q2 because we get the money actually in advance. So it will appear only in Q3. And I said the damage will be about $1 million, approximately, a little bit less than $1 million of these 47,000 subscribers. Now what we're expecting in Q3 is that the subscribers level will be almost the same. And we already will have the tail of the money that we actually declined because of this onetime decline in the projects in Q2. And looking forward, I would say again, our ability to see what will be the longest future per subscribers and per OEM customers, it's much more difficult because it's less dependent on us. We're more dependent on the OEM and the manufacturer and their internal budgets and policy. But one thing, again, I think positive is that still the basic business, which is the aftermarket contribution, is much higher than the volatility of the OEM segment.

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Operator [8]

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The next question is from Tavy Rosner of Barclays.

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Peter A. Zdebski, Barclays Bank PLC, Research Division - Research Analyst [9]

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This is Peter on for Tavy. Congrats on the

(technical difficulty)

ask the question in a bit of a different way. Is there -- when you said in the third quarter that subscriber count there would be about the same, were you implying that it should stabilize at these levels? Or would you expect to see a continued decline because of that transition? And then if so, is there anything that might offset that?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [10]

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First of all, maybe I didn't clarify it, and I would like to say that when I'm talking about the same rhythm, I talked about only the OEM. Regarding the aftermarket, we're still in our position that we will do 15,000 to 20,000 per quarter in the coming quarters. I'm talking about the OEM subscriber base, but we expect that it will be much or less the same as in Q2, meaning not the same declining, but the same at this time, the same number that we finished Q2.

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Peter A. Zdebski, Barclays Bank PLC, Research Division - Research Analyst [11]

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Got it. And moving over to product sales. If I heard you correctly, the 2G to 3G headwind, that transition has mostly been resolved or is in a tail end? And if so, should that segment be able to return to growth in the second half?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [12]

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Absolutely, this is what we said. I don't know to tell whether it's behind us totally or it will take 1 or 2 more months. We have to understand that our customer, which is another OEM customer, car manufacturers in Mexico, and since usually they have some inventory for a few months, they still have the 2G that they want to get rid of. So they start to buy the 3G, which we already crossed the pilot phase and they start buying, but they, in a phase to reduce the 2G inventory, so I cannot say whether it'd be September or October, but based on the installation and based on the new customer that they recruit, we know that the rhythm should be back to again to the real phase that we expect. We expect that it will be between Q3, the end of Q3 to the beginning of Q4, but I cannot commit, but it will be this year. And for us, much important to see it start again. And then again, the future probably will be with the new rhythm, which we suffered from this problem first half of 2018 and probably few more months, but most of it is behind us, yes.

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Peter A. Zdebski, Barclays Bank PLC, Research Division - Research Analyst [13]

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Okay. Great. And then one last one just on the shares. Did -- have you -- did you exercise any of the buyback authorization in the second quarter? Or how should we think or sense then how should we think about share count going into the second half?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [14]

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Actually, we started it, of course, we didn't use all the authorization that we got from the Board, but we started it. And probably, before the end of the year, we will have some report about it.

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Operator [15]

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The next question is from Sasha Karim of IPI.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [16]

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Few from me, firstly, the services gross margin. I'm looking at GAAP gross margin there. It weakened quarter-on-quarter again. It's about 56.4%. After the 4Q results, you sort of guided that it would stay around the 58% level. So can you explain why it's been going down? Will that continue? Any sort of guidance you can give going forward?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [17]

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Yes. We mentioned in the past we saw the slowness in Brazil due to the fact of changing the model, as Eyal described before. And this has, of course, affected us from the margin point of view.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [18]

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Okay. So as the new model ramps up, should we expect the gross margin to keep falling?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [19]

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Yes, as long as we continue to increase our subscriber base as we did in the second quarter, I don't see any reason why it shouldn't go up.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [20]

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Sorry, the gross margin should go up?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [21]

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Yes.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [22]

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So why it has been going down recently?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [23]

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I said it went down recently due to the fact of the Brazilian model. Slowness of Brazil that had started, especially in 2018.

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [24]

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Since we didn't grow the subscribers in the aftermarket during 2018, the financial influence appears this year, specifically Q1, Q2, may be still we will see it in Q3 because we -- always when you are having changes in subscribers, what we report, for example, now 20,000, this 20,000 will fully appear only in Q3. So if I have 0 in this quarter and expenses will stay the same, Q3 would, for example, show with lower gross margins. Because of the operating leverage, the influence on the margins depend on growing in subscribers or declining in subscribers. And since in 2018, in the aftermarket, our growth of subscribers in Brazil was very low, the gross margin declined. Now as already mentioned, we expect that in 2 or 3 quarters from now we will show again more material change or good change in the margins.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [25]

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Got it. I think I got it. Just to check one thing there, are you saying that you have certain fixed costs, I guess it's your customer service center, whether or not you're not adding subscribers, yes?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [26]

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Yes.

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [27]

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Yes, exactly.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [28]

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Okay. That makes sense. My other question would be just back on the OEM issue. So just to check I understood it again, the 47,000 reduction in OEM subs in the second quarter, it reflects the free trial that your OEM partner in Brazil did already, but that has not yet impacted revenue. Is that correct?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [29]

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That's correct.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [30]

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Great. And then the Mexican issue should be resolving and you would actually expect now that, that one-off change in Brazil is out the way, you expect your subscriber numbers from OEMs be flat quarter-on-quarter, third quarter versus second quarter?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [31]

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That's correct, more or less the same.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [32]

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And then, I guess, as the Mexico issue resolves itself, you should be expecting OEM subscriber growth, shouldn't you, from fourth quarter and first quarter next year?

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Eli Kamer, Ituran Location and Control Ltd. - Executive VP of Finance & CFO [33]

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Yes. More or less, yes. But as we have mentioned before, we're depending on the OEM, and it's really hard to say what will be the market going in the future. But yes, if everything stays with the same condition as of today in the market, yes, I do not see any reason why the OEM will not go up.

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Operator [34]

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(Operator Instructions) There are no further questions at this time. Before I ask Mr. Sheratzky to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available tomorrow on Ituran's website, www.ituran.co.il. Mr. Sheratzky, would you like to make a concluding statement?

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Eyal Sheratzky, Ituran Location and Control Ltd. - Co-CEO & Director [35]

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Thank you, operator. On behalf of management of Ituran, I would like to thank you, our shareholders, for your continued interest and long-term support of our business. I look forward to speaking with you next quarter. Have a good day.

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Operator [36]

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Thank you. This concludes the Ituran's Second Quarter 2019 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.