Ituran Location and Control Ltd (ITRN) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran third-quarter 2008 results conference call. (Operator Instructions). As a reminder, this conference is being recorded November 24, 2008.

I would like to remind everyone that forward-looking statements for the respective Company's business, financial conditions and results of its operations are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated. Such forward-looking statements include, but are not limited to, product demand, pricing, market acceptance, changing economic conditions, risks in products and technology development, and the effect of the Company's accounting policies, as well as certain other risk factors, which are detailed from time to time in the Company's filings with the various securities authorities.

You should have all received by now the Company's press release. If you have not received it, please call GK Investor Relations at 1-866-704-6710 or 9723-607-4717. I will now hand over the call to Mr. Kenny Green of GK Investor Relations. Mr. Green, please go ahead.

Good day to all of you and welcome to Ituran's conference call to discuss the third-quarter 2008 results. I would like to thank Ituran's management for hosting this conference call.

With me today on the call are Mr. Eyal Sheratzky, Co-Ceo and Mr. Udi Mizrachi, VP, Finance. Eyal will begin with a summary of the quarter's results, followed by Udi with a summary of the financials. We will then open the call for the question-and-answer session.

I would like to remind everyone that the Safe Harbor statements in our press release also refer to the contents of this conference call. Now, Eyal, would you like to begin, please?

Welcome, everyone. Thank you for joining us today and thank you for your interest in our Company.

We are happy with our third-quarter results, in particular in regards to our strong profitability and bottom line. Now that given that we sold Telematics at the end of December last year, myself and Udi will be analyzing the results on a pro forma basis, which focuses on the core business, excluding Telematics and removes Telematics' contribution to last year's results. We believe that this enables investors to better compare Ituran historical results with current results on a similar basis.

Our revenues grew 28% over last year to $35.2 million in the quarter. This was primarily driven by the continued growth in the subscriber base over last year. In fact, we ended the quarter just shy of the $0.5 million mark, standing at 495,000 subscribers while at the same time last year we had 430,000 subscribers. In the quarter we grew by a net 16,000 subscribers, our normal quarterly expectation.

I would like to take a moment to make an important point with regard to our subscriber base in Israel and how large exchange rates swing effect our results. As of the star of the third quarter, we began charging our Israeli subscriber base in the local currency, the Israeli shekel, rather than the US dollar. The reason we decided to do this in order to better hedge ourselves against future exchange rate movements, which makes a lot of sense from a business perspective. In Israel, our cost base is in shekels and it makes sense therefore to charge our members in Israel in shekels.

We used an exchange rate of 4, which is about 40% higher than the actual exchange rate in the quarter, averaging around 3.5. We thought this was closer to the historic norm and would be acceptable to our subscriber base. And also we benefited by this in the third quarter. However, it is very important to note that as of this quarter, all our revenues and expenses are now dominated in the currencies of the geographies in which we operate, and our GAAP results are a simple translation from that foreign currency into US dollars.

Therefore, a strong increase in the US dollars against the Israeli shekel and the Brazilian real, such has been the case in the fourth quarter so far. We'll have the effect of defaulting our results in dollar and therefore [reporting] terms.

There is another exchange rate issue related to our financial income, which hedged the above effect and I discussed last quarter. Again, I see this as a purely cosmetic issue and doesn't play a role in any strategic or business planning.

As I mentioned, given that our functional currency in Israel is the Israeli shekel, for reporting purposes, the Company's accounts in Israel are prepared in shekels and then translated to US dollars. Given the fact that most of our cash is held in dollars for strategic reasons, and I note, not for financial reasons, and increases in the dollar versus the shekel provides us with a dollar financial income. Assuming the dollar/shekel exchange rate ends the quarter at current levels, we will see a relatively large US dollar financial income in the fourth quarter.

Now, talk to about the performance. In Brazil, we see a very significant growth potential in a country with a close 200 million people and around 25 million cars. Our services are gaining increased traction around the country now that we provide nationwide coverage. We have strong relationships in place with a number of insurance companies and we are beginning to see the reward of their efforts.

The recent regulation requiring all new cars from July 2009 to include location technology is being as strongly. As one of the leading suppliers of this technology in the country, combined with the relationships we have and are continuing to accumulate, we see ourselves in a prime position to capitalize on this.

In Israel, new car sales have been robust in the past year and this has increased our potential customer base. I would like to take this opportunity to address the sharp economic slowdown globally and how I see it to run as well positioned as a defensive play in this environment. Due to the slowdown, new car sales in Israel are expected to slow. We view our Israeli business as a strong cash generator for Ituran and therefore do not expect much growth there in the coming months. However, in Brazil, which we see as Ituran's growth engine, we do expect continued growth.

Historians suggest that at times of global economic slowdown we have two effects that offset each other. On the one hand, there may be a decline in new cars sales, but on the other hand, there is an increase in the rate of car theft and therefore more demand for our services, particularly by the insurance companies.

Most importantly, our unique business model is based on recurring revenue from an established and growing customer base with low churn rates and this underlines our stability and ability to continue growth in any environment. In addition, our exposure to Brazil, a very large and generally untapped market, with regulation in place requiring the use of location technology, provides us with growth potential in any market.

Finally, we have an exceptionally strong net cash position, standing at $57.6 million at the end of the quarter and this after sharing the fruit of our success with our shareholders in the past few quarters, including distributing the proceeds of our sale of Telematics by giving dividends and executing a buyback. In fact, just in the third quarter, we repurchased another 175,000 shares in the market and was another factor increasing our earnings per share in the quarter.

Most importantly, particularly in the current environment where cash is scarce and banks are unwilling to lend, plus an environment in which valuations have dropped substantially and in many cases are underpriced, our continued cash generation and especially strong net cash position bodes very well for us. It enabled us to continue growing our business, particularly at the expense of retail competitors, but also allows us to pursue and invest in opportunities which will further enhance our competitiveness and growth in the coming years.

With that I will hand over to Udi today. Udi?

As Eyal said, I will be using pro forma numbers, which exclude the contribution of Telematics to Ituran in 2007. Revenues for the third quarter of 2008 reached $35.2 million. This represents a 28% increase compared with the pro forma revenues of $27.5 million in the third quarter of last year.

Revenue breakdown for the quarter was $23.6 million coming from subscription fees from our location-based services, which shows a year-over-year growth of 43%, and $11.6 million coming from product sales, which as I said, exclude the Telematics business, showed a year-over-year growth of 5.5%.

The geographic breakdown of the revenues in the quarter was as follows -- Israel 55%; Brazil 34%; USA, 2%; Argentina, 9%. In terms of our subscriber numbers, we reached 495,000 subscribers at the end of September, a net increase of 16,000 subscribers in the last quarter. Gross margin in the quarter was 49.5% compared with a pro forma gross margin of 43.6% in the third quarter of 2007.

Operating profit for the third quarter of 2008 was $7.4 million or 21% of revenues compared with a pro forma operating profit of $4.6 million or 16.6% of revenues in the third quarter of 2007.

EBITDA for the quarter was $10 million or 28.4% of revenues compared to a pro forma EBITDA of $6.4 million or 23.3% of the revenues in the third quarter of last year.

Net profit was $5.6 million in the third quarter of 2008 or 16% of the revenues compared with a net profit of $3.2 million or 11.5% of revenues, as reported in the third quarter of 2007.

EPS in the third quarter of 2008 were $0.27 per diluted share compared with $0.14 per fully diluted share in the third quarter of 2007. As of September 30, 2008, the Company had a net cash position, including marketable securities, of $57.6 million compared with $53.5 million as of June 30, 2008.

Over average fully diluted number of shares for the quarter was 21.1 million shares. During the quarter, we repurchased 175,000 shares for a total of $2 million. And $1.1 million of financial gain was recorded as result of the appreciation of the US dollar against the Israeli shekel during the quarter. This, as previously explained, is due to the fact that most of the Company's cash is held in dollars, while its functional currency in Israel is the Israeli shekel.

Cash flow from operations during the quarter was $11.2 million. Excluding the above-mentioned financial gain cash flow from operations was $10.1 million.

With that, I would like to hand you back over to Eyal.

In summary, the third quarter of 2008 was another good quarter, particularly in terms of our strong profitability, down to our bottom line. Our results demonstrate the operating leverage inherit in our business model. This is down to the reward of our efforts and investment last year.

As we have shown by leveraging our cash position to buy back our own shares and our dividend distribution, we're very much focused on sharing the rewards of our success with our shareholders and we hope to continue to share our success with our shareholders through the coming years.

With that I would now be happy to take your questions. Operator.

(Operator Instructions). Maynard Um, UBS.

Just a few questions if I could. You previously talked about net add ranges in the 15,000 to 20,000 per quarter. Given the economic slowing, should we be thinking about a lower range of the 10,000 to 15,000 or do you think the recessionary period will result in increased demand such that we should probably still expect 15,000 to 20,000 this quarter?

Actually, the expectation that we can say published or really expected during this year was in the range of 15,000 to 20,000, but be of course since the changes in the international economy and the world economy, I would say that we're not yet measured future by numbers. But to make a long story short, yes, we should assume that a growing in net new subscribers will be smaller.

Okay. And then can you talk more specifically about uses of cash? Given your current share price, do you think you will be getting more aggressive in share repurchases as compared to the third quarter?

Up until now, we finalized the budget that we got from the Board, which is in total $30 million during the last year and a half. This is something that the Board not yet decide again. But, of course, it is an open issue. It might be from time to time we will increase it. But currently we finalize first tranche.

Related to cash, are you still anticipating looking at acquisitions?

We are looking, but to be honest, of course, as long as we were very conservative during the last two years of good economies, of course this time in one hand we believe that we see better opportunities, but on the other hand, we will be even much more conservative until the foggy of the world recession will not be more clear. So I think that in these times to hold a strong balance sheet with no big debt, no debt, no loans and strong cash position, it will be in the benefit of the Company, but we will be very conservative because this time a strong balance sheet is a big advantage.

Okay. And assuming the lower subscriber numbers, you'll obviously still see top-line growth but maybe not as much as we had originally anticipated. Can you just talk about what you're doing on the OpEx side to reduce any kind of operating expenses to match the revenues going forward?

First of all, part of reducing costs is always something that we're looking. We in Ituran since many years and people that know the company more in details like you, knows that we are considering cost, even in times of a good economy. Of course, when there is a recession. But don't forget that Ituran is a very profitable company with a high profitability. We're not expecting not to be with a high profitability next year. We even said that we expect to grow.

So there is not any reason to be in panic. With company -- in any company, in any time, should be conservative, should not be a lot of fat in the company, and this is how Ituran built in the past and will be in the future. So I want to announce that we're not going to not to reduce people, not to reduce costs, because we don't have fat here. Of course, if besides to grow, we suffer from reducing customers, and things like this, this is a different situation, but even in a worse expectation, this is not the case.

I said we will grow our subscribers, but maybe we will grow it in a lower number than it was in 2008. But still, we will grow. We will grow subscribers, and, hopefully, we will grow also the economic results of the Company.

But against that revenue, do you also then slow the amount of R&D spending or sales and marketing spending, aside from headcount, do you slow that spending to kind of match the slowing of the top line?

R&D in Ituran, since we sold Telematics, is a very, very low. It is something very, very -- not a material at all to our total OpEx. Regard sales and marketing, you see also that compared to company in three, almost four geographies, with a very strong brand in each geography around 7% of the total expenses with those kind of revenues for sales and marketing, it's very, very thin.

Of course we will judge again and we will see if there is a reason to reduce part of this cost. But I must say that if you judge it in dollars, even if we save 20% or 30%, it is low, no material. Most of our sales and marketing is quite low -- in a low rhythm.

Just last one for me. On investment income, I think I missed your comment about the fourth quarter. Did you say it would be as strong as the third quarter in terms of absolute numbers, including the gain or --?

During the fourth quarter? What we said --

The fourth quarter. Q4.

What we said is that as the currency rate as of today and because we held most of our cash in dollars in Israel, it means that we will have an income, finance income in the fourth quarter, which will be higher than what it was, let's say in the third quarter.

Higher than the third quarter?

Look, I would like to make it more clear. Actually since we have a strong cash position in our balance sheet, that it is held in dollars, and the operation of Ituran done with other currencies and mainly with the real, the Brazilian real and the Israeli shekel. So we have kind of a major hedging in our results. But the hedging is between what happened to the EBIT and then what happened under the EBIT.

If, in the first half of this year, our operating business based on real and shekel, it was very strong, we succeed to show high EBIT numbers. On the other hand, our financial results of the cash was very low. If you remember it was in a very strong negative influence.

Now when the currency exchange, it's now turned around towards a stronger dollar, so what will happen, our EBIT in Q4 with the assumption that the current exchange rate of the real, which is around 2.3 and the shekel, which is around 4 shekel per dollar, it means that the operating profits will reduce, maybe dramatically, when you compare it in dollar, when we publish it in dollars. But we have a major hedging, then you go to our financial income, which probably will be very, very dramatically high. This is, I think, what Udi said and how it should look like.

Paul Coster, JPMorgan.

So the net subscriber adds -- the rate of increase was slow. Will the churn rate increase? Are you experiencing a churn rate increase in any of your geographies at this time?

No, actually we don't see any increasing churn rate. Based on our assumptions, and based on our experience, by the way, and we said it, is that in one hand, there will be less new cars on the road in Israel, in Brazil, in other countries. But on the other hand in this recession in a very tough -- strong recession situation, usually and specifically in emerging markets, the crime is increasing. And in that case, it means that insurance companies and people that still have a high capital will do their best to save and feel safety from any [calsiv] or any other [berling], etc.

So I think that in terms of churn and in terms of new subscribers, will be still in a growth position. I don't think that the churn rate by itself will increase.

What are the early termination rules for your subscribers?

Eyal Sheratzky By definition unless it is a case of insurance company that uses the term, as we said, commodato, which is like leasing of the hardware, so a typical customer or end-user, is not signing with us for a long term. The reason that they stay with us, for example, in Israel for six or seven years is because insurance companies as a private regulator, let's call it, determine that if he wants to have the policy, the insurance policy, he has to have a location solution so is no choice. If he gives up for Ituran, if he turns from Ituran services, he will lose his insurance policy. So this is the main rule.

Udi perhaps you can help us a little bit understand why the growth rate on the subscriber business was in excess of 20% year-on-year, whereas the product business was a lot lower. What is behind that dynamic?

If I'm looking on the subscriber fees that you mentioned, most of the increase, of course, comes from the net -- comes from a couple of reasons. One of them is the net additional subscribers that we had compared with the last year, about 55,000 net subscribers. Especially in the third quarter -- especially in the third quarter we did of course transfer from linked US dollar to the shekel, and that contributes us also to the monthly fees.

This is regarding the monthly fees. If I'm talking about the sales, then if I'm looking at the sales, if you compare it to last year, more or less, the sales -- there was even an increase of $600,000. And if you compare it to the second quarter, to the previous quarter, then we saw a decrease, especially in Mapa, especially in the publishing division, which has the volatility between the quarters. And if we're talking about the business itself, in Israel, there was less sales of new cars, and that affected also our sales in the third quarter.

Thank you very much.

Yair Reiner, Oppenheimer.

I just want to return for a moment to the FX discussion. I want to make sure that I understand it correctly. So at this point if we look just to the income statement when there's a shift in FX am I correct in understanding there is no impact to operating margin, but operating profit will now basically mirror the change in FX?

Yes, the operating profit will be affected by the FX and on the other hand, especially if I am comparing the US dollar to the shekel, the strong dollar will benefit us in the financial income.

Very good. At this point you are two-thirds of the way through the fourth quarter. Can you give us a sense of how net adds are progressing? And I guess more specifically, what have you seen in terms of subscriber trends in Israel and in Brazil, I would say since the beginning of October?

We actually specifically for Q4, as you said, we're in the middle of the quarter so we have some sense, an actual sense. We think that it is still -- we believe, we expect that it will be under our quarterly expectation during every quarter this year, which is 15,000 net to 20,000. But those days, every month becomes difficult. But actually I still think that we're okay with this range.

Have you seen any change in the rate of collections?

The collection is almost -- no significant change over there.

Ziv Tal, Oscar Gruss.

Do you expect some slowdown in Brazil, given the implementation of the regulation, the second half of 2009?

Actually, we just got an update. What actually happened until a lot of pressure done by the car manufacturers still they decide to execute it from a mid 2009, but to spread some different categories of cars from 2009 to 2011. Fortunately, the first segments, which is about 20%, is the cars. Because they have cars; they have trucks and they have motorcycles. What Ituran is the most important segment is the cars and for these cars, it is still in line with the expectation from July 2009.

What will happen during a strong recession in Brazil, you know like every government now are working how supporting the local economy, the local manufacturers and the local businesses. This is something that I would not bet that things will not change. But for today it is under the same [period].

What I actually mean regardless of what we are seeing in the macro environment, do you think that bulk deals with insurance companies, will they be postponed to the second half of 2009 if the regulation goes through as planned, because the car manufacturers will pay for the hardware?

No, we see that we are now -- see some tenders. We see some negotiations. The other companies that already work with us, I think that actually the regulation will create a new segment of maybe lower cost of cars that some insurance companies will enjoy to use these services, which today they will not pay. But for the historical kind of cars, kind of models, and actuary needs, as well as the uninsured populations, I don't feel that they are influenced by a delay in this regulation.

The regulation should -- the main influence of the regulation is that new segments will increase potential growth of us -- of service -- of subscribers. But until the regulation is executing still, the insurance companies need it for specific model based on their actuarial needs. The uninsured population have no solution.

So nothing will decrease -- they will be delayed but of course potential growing will be slower if the regulation will delay. Only additional growth.

You spoke about cash. Do you expect a decrease in your cash position the beginning of next year?

We have cash. For cash there is three main reasons for us. First is strategic, to use it, of course, for growth. We don't need it for growing organically so it is need for acquisition. Second, it can be for a buyback. Third, of course, for a dividend.

I'm talking about the third option.

Currently one of the third options is not yet -- is not now in an execution mode. When it is happened of course we will report.

Okay. Just last for me, can you please tell us about what is going in Argentina, you know --?

Argentina, as we see today, again, regard our specific operation, we don't -- see a strong influence by the recession. Don't forget one of the funny, I can say, is that Argentina during the last 10 years was suffered a lot of recessions, not only today, when it starts in the US.

What actually happened is that historically when we came in 2002 the stealing car rates was very high. A lot of crime and a lot of crime toward stealing vehicles. During the last four years, we see its strong decline in care theft rates. But actually what we've seen in the last few months is that it is increasing again, meaning the market drivers will probably, will be much stronger and will allow us to penetrate more.

Again, we don't have to ignore, but it's also still depends on how many cars will come to the market. But even if there will be a recession, and less cars will come to the roads, no doubt -- Argentina by the way, we see it for almost three months, strong increase in car theft rates. And no doubt that our solutions, such as Ituran, will enjoy, if I can say, from this situation.

Jeff Rath, Canaccord Adams.

Just a couple of follow-on questions. Most of mine have been answered. I don't know if you do disclose it, but what is your churn rate right now as a percent?

Our churn rate is about 25% on an annual basis.

So 25% of your -- if I am understanding that correctly, 25% of your subscribers, if you held your subscriber number flat, 25% of your subscribers would turn over?

Yes. It has never happened, by the way, because this is with the assumption that a new car will not be pushed by insurance companies to install. Actually, the basic model, even in a recession situation is that insurance companies, for example, I just give you an example, of course. But you can illustrate it to any other market that we work. Is that in Israel, for example, even in a very strong recession, no Mercedes or no BMW, no Jaguar, or no four-wheel-drive car without Ituran inside. So of course, part of the situation that we've seen that we will not grow is because they will be less new Mercedes, less new BMWs, but still will be some of them. Once some of them are here, we will not reduce the total subscriber base. We will reduce the growth.

Got you. All right. So I guess I'm trying to understand, because auto demand in some of these emerging markets has seen a pretty material slowdown, if there is a tipping point, clearly your overall subscriber growth is a function of your new sub adds plus your churn rate. So I'm just wondering, if we look at the Israeli market, is there a number of new car sales on a year-over-year basis? If we got to sales down 50% or something like that, is there a number that you look at that you believe would hold your total subscribers flat? I'm just trying to get a sense of the threshold there.

Actually what the best thing to do is to go for our historical cases of the 15 years of operation in Israel. Only one here but it has happened, we suffered from reducing the total costs in about 2000. And it was 2000 subscribers in the net, I mean [meaningless]. It was the only situation and it was in a case of -- two things. The first thing was a strong recession in Israel, and second there was what used to be under the name of the Second Intifada, and in a specific quarter that influenced all the year, that the Israeli army was work very hard and very strongly in the West Banks and closed the border 100%. So what actually happened is that there was zero theft for three months. The insurance companies in this time were less dramatic requirements. On the other hand, there was a strong recession. And in this year we were in a flat situation. We reduced to 2000. It is almost nothing.

But if you're asking me to talk for it like a sensitive table, so I would say that if car importers in Israel will import less then 110,000-120,000 so we can find 110,000-120,000, we can find a small decrease in the customer base. But this in the worst-case scenario until now in Israel, it was 130,000. Of course, it can be the case, it can be the case. But the influence will not be dramatically. I'm saying the influence on the growth and we take -- and we say today, the growth in Israel probably will be much, much slower if at all. But if you're asking me to turn around to a minus net subscribers this cannot -- it's almost very, very low percentage that it will happen.

Great, that is what I was thinking. Thanks so much. Just a couple more questions, if I may. Can you, without knowing the future, can you talk about how you think about your capital expenditures, I guess for Q4 and then out through 2009?

Our CapEx on an annual basis is about $16 million, probably found in this range. In the last quarter it was around $4 million. And I do believe -- most of it, by the way, the majority of it comes from our operation through the commodato method, what we call the pre-lease or the loaning of the unit, especially in Brazil, and in Argentina a little bit. So if you're asking me, going forward to 2009, I do believe that the CapEx more or less will be at the same level of $16 million.

Just another question. Can you talk about your hiring plans in Brazil, in particular, given that there is -- it appears there is some visibility to a material growth opportunity there. How many people do you have in Brazil and over the next year what is your target?

We have recently 550 people. Actually like -- in Israel it is a different number but just on the [fundamentals], most of the employees in our Company is based on low salaries, mainly for operators, customer support, and etc. We believe based on -- you're talking about uninsured?

We do believe that this number of employees will be sufficient also for the potential growth that we --.

So even with this mandate looming, you don't really think of taking your headcount up materially?

No, as long as the newer regulation, if we will have strong benefits. I mean that we will grow so dramatically based on it, and it will not delay. So of course, we will have to add more human resources to support it. But again, since we're working on an operating leverage model, it's not saying that every 10 subscribers regard new employees. But I hope, and I dream that this will be the case, that so many new subscribers will require us to increase our costs. But as a current rhythm, we are very well suited for support and potential additional customers in the coming time.

Just one more question and then I will pass it along. It has to do just with a little bit more color around the Brazilian mandate, in particular. It is my sense that there was a mandate introduced a while back. The government has basically made some modest revisions, as you've talked about. But with the time growing short, it would appear to me that if I was an auto supplier, I would be having to move now in order to meet that mandate.

So I'm just curious, you made a comment that suggested you're just going to continue to wait and see, to see if the government changes the mandate again. But aren't we getting to a point which the auto manufactures are in fact going to have to stop lobbying and then start moving forward with the implementation? I'm wondering if you can help me understand that give and take. Thanks.

First of all, it goes every day. It didn't start yesterday. It started a few months ago. They already published the tenders for suppliers such as Simmons, such as Continental, such as Delphi. We are, at the beginning, thought to be, to participate in some way of these models. But we understood by reading and understanding the regulation that a company that supplies the hardware will not -- cannot provide services. Since Ituran focused on the service, focused on the operating leverage model, we prefer not to fight or not to compete, or not to go for tenders on the hardware and provide the services. But those players, those guys, are already negotiating and car manufacturers working parallel.

In one hand, they are working on solving the technical needs and the supplier, etc., and on the other hand, they are trying to delay it. But things are moving in Brazil toward executing from the middle of 2009. There are players already. There are tests -- there are already manufactures working. So it is -- nobody waits for the lobby to change, I think.

(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 in three hours on Ituran's website, www.Ituran.com. Mr. Sheratzky, would you like to make your concluding statement?

Yes. Thank you for joining our call today, everybody. I would like to thank all our employees for their hard work in the quarter. To our investors, I look forward to speaking with you next quarter. Thank you and have a good day. Bye.

Thank you. This concludes the Ituran third-quarter 2008 results conference call. Thank you for your participation. You may go ahead and disconnect.