Ituran Location and Control Ltd (ITRN) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran third-quarter 2011 results conference call. All participants are at present in listen only mode. Following management's formal presentation instructions will be given for the question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded November 16, 2011.

You should have all received by now the Company's press release. If you have not received it, please call CCG Investor Relations at 1-646-201-2946. I will now hand over the call to Kenny Green of CCG Investor Relations. Mr. Green, would you like to begin?

Thank you, operator. Good day to all of you and welcome to Ituran's conference call to discuss the third-quarter 2011 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. 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 would like to remind everyone that the Safe Harbor statement in today's press release also covers the contents of today's conference call. And now, Eyal, would you like to begin, please?

Thank you, Kenny. I would like to welcome all of you and thank you for joining us today. We are very pleased with the results of the third quarter of 2011, giving us a record level of revenues and net income.

We had revenues of $41.7 million, growing 12% over last year, and net income of $6.6 million, growing up 17% over last year.

We are also generating operating cash flow of $9.2 million in the quarter. This is very much a demonstration of the strengths and stability built into our business.

Subscription fees grow by 5.4% over last year, but [grew] by 4.7% since last quarter. It is important to note that our subscriber numbers have resumed their growth, growing by a net 4,000 since last quarter to 619,000, and is now heading back to its normal growth rate.

The reason for the sequential drop in revenues in the current quarter is mainly as a function of exchange rate changes, particularly the increased dollar strength as well as a shift in the way we record a portion of our revenues, which caused a decrease in some revenues and their associated expenses.

In terms of subscriber numbers, we believe that already by next quarter we will see a further improvement in the growth rate. And we expect that by the end of the fourth quarter and into 2012 we will be growing at our long-term average rate, which is in excess of 40,000 per year.

The steps we took in Brazil, which I discussed last quarter, which we believe will reduce the overall churn rate and increase the average amount of time a subscriber will stay with us, has already benefited us in the third quarter, and our strong margins and cash flow are evidence of this.

Our product revenues grow strongly over last year and last quarter. A large portion of the growth was due to one particular deal worth approximately $2 million with a higher than average gross margin in which we licensed Mapa data to a major provider.

I would like to go into some of the particulars of our performance this quarter and start by discussing our activities in Brazil. As explained, we made a few adjustments to our strategy in Brazil earlier this year. One of which was the increase of the installation fee to connect to our service. This was in order to lower the motivation for customers to leave our service since they have already made a small initial investment into installation. We are already beginning to see positive results from this move.

We also continued to increase our sales direct to the private sector in Brazil, enabling us to increase our ARPU and grow our margins in the region over the long term. Brazil, which is continually growing, we expect will remain a growth engine for our Company for the foreseeable future. Our strong performance there, combined with a strong market in general, underlie our continued optimism in this region.

In Israel our business continued its growth. New car sales in Israel continued its growth throughout the third quarter despite global economy worries. (inaudible) [to note] that was still growing the growth rate in September was slower than on July and August. Overall, Israel continues to remain a strong cash generating business for us, and we are very happy with our performance there.

In summary, our business performance remains solid. Our two main regions, Israel and Brazil, are both markets which we continue to maintain strong economies and have shown robust growth. Ituran remains on the right track for continued growth and growing profitability over the coming quarters and years. I will now hand the call over to Eli for the financial review. Eli.

Thank you, Eyal. Revenue for the third quarter of 2011 reached $41.7 million, representing a 12% growth over revenues of $37.1 million in the third quarter of 2010. Revenue breakdown for the quarter was $30.1 million coming from subscription fees from our location-based services, a 5.4% increase year-on-year growth.

Product revenues were $11.6 million, which was a 35% increase over the same quarter last year. The geographic breakdown of revenues in the quarter was as follows -- Israel 54%, Brazil 37%, Argentina 7%, and the United States 2%.

Gross margin in the quarter was 50.2% compared with a gross margin of 49% in the third quarter of last year. Operating profit for the third quarter of 2011 was $9.3 million or 22.3% of revenues, an increase of 23% compared with an operating profit of $7.6 million or 20.5% of revenues in the third quarter of 2010.

EBITDA for the quarter was $13.6 million or 32.7% of revenues, an increase of 17% compared to EBITDA of $11.6 million or 31.3% of revenues in the third quarter of 2010.

Financial income in the third quarter of 2011 was $0.9 million compared with the financial income of $0.4 million in the third quarter of 2010. We had another expense of $0.9 million, which were mainly litigation expenses related to Leonardo.

Net income was $6.6 million in the third quarter of 2011 or 15.9% of revenue, growing 17% compared with a net profit of $5.7 million or 15.4% of revenues as reported in the third quarter of 2010.

Fully diluted EPS in the third quarter of 2011 was $0.32 compared with a fully diluted EPS of $0.27 in the third quarter of 2010. Cash flow from operations during the quarter was $9.2 million.

As of September 30, 2011, the Company had net cash, including marketable securities and deposits short and long-term, of $56.9 million or $2.71 per share. This is compared with $53.6 million or $2.56 per share as of June 30, 2011.

Note that due to the recent Leonardo litigation ST arbitration which has already been accounted for in the financial statement in 2010, an amount of approximately $26 million is expected to be paid out in the coming months.

Our average fully diluted number of shares for the quarter was 20.97 million. And with that I would like to hand you back over to Eyal. Eyal.

Thank you, Eli. Looking ahead, as I said, I continue to remain excited with regard to our future. Our business in Brazil and Israel are both very strong and we remain very well-positioned as the leader in both our main two markets.

We remain on track to end 2011 as a record year for our Company in both profit and revenues. And with that I would now be happy to take your questions. Operator.

Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator Instructions). Paul Coster, JPMorgan.

I wonder if first we could provide a little bit more color around the Mapa deal that you did in the quarter? Can you just confirm it was $2 million, I think I heard? What was the margin on that deal? And is it a repeat business -- is it a one-off deal or do you expect to see the licensing deal roll forward, and are there any terms to the contract?

As I said, at beginning of my speech, this is -- we sold a license for a big provider. We are -- it is a confidential customer. For this specific customer it is one time. This is why we signed a license for a few years. But the transaction will include additional updates in the future which will provide additional fees. But this is not a typical sale of Mapa licenses.

What was the margin on this business? If we were able to strip it out, what was the effect it had on the corporate gross margins for the quarter?

Actually, as you can see in the products, its effect -- very positive. Because when you're selling license in that case that cost of the good is very, very low, so is effect -- the effect was quite material this quarter. And it is also affect the total gross margin. As you can see, this quarter was higher than 50%, the first time. I wouldn't expect this to be in the next quarter or two, and we will back to 48%, 49% probably.

Can you confirm how big that deal was? Am I correct in thinking it was about $2 million?

Yes.

You are exhibiting growth in both Israel and in Brazil. Is that growth in both the subs business and the product business, are both businesses growing in both locations?

As I said, regard the subscribers, the net subscribers numbers, we know that we changed the strategy in Brazil, which create two things. What we faced during the first three quarter of 2011 was the bad thing that companies declined that our new strategy was too expensive for them or didn't accept the change. Their customer -- their new customer stopped and it is happening three quarters.

On the other hand, when we went to the retail market, the uninsured population, and to new insurance companies we start see a new segment, a new growth from the beginning of the year, but it was less dramatic than the churn of those that left. But now the customers that decided to leave, they are almost finished their subscriber base at all.

And on the other hand, we are continued to grow and we see it very impressive on the other segments. It means that when we look forward, the churn will decline and additional new clients will increase even better than in the past. This is why I said that we are expecting that in 2012 we will back to the historical rhythm which is at least an average 10,000 per quarter.

I believe that we will see it start in Q4, that will show that the graph is ramping up.

Okay, got it. Do you expect litigation expense to fall now that these two pieces of litigation are resolved?

The two you mean there in Brazil, we have only the ICMS issue. That is what you mean?

Well, now that you have got Leonardo and ST behind you, will litigation costs fall or will the tax issue in Brazil mean that you maintain a fairly high level of legal expenses each quarter?

First of all, the litigation in Brazil already started in the administrative level, which will take a year or two. And after this almost there is a lot of chances that we will have to go to civil court for the next level of discussions, which will take additional years, a few years or more than this. And during this seven, eight years, no doubt that we will have litigation costs, which we already started.

Part of it is already in our expenses, part of our G&A expenses. We are not expecting it will grow, but then sometimes it can be higher in one quarter than the others, because it depend of the rhythm of the legal work. But when we talk about annual expenses, I believe that it will be in the same level as we get used to.

Regarding Leonardo, we filed an appeal. And also we will have costs, but since we had more than eight years of discussion in court with the first level with Leonardo, we already had some cost and it will continue. Unfortunately, I cannot say that it will decrease, but I hope that it will not increase.

Okay, my last question is, what is your latest thinking on M&A and on international expansion? Thank you.

We are -- I would say we are spending efforts -- we are spending attention, and from time to time we are even spending some money to find the best thing to acquire. Up until now -- and it has become like a cliche, we didn't succeed to do it. Historically we did only two acquisitions in Israel. But at least I am very proud that these two acquisition of (inaudible) Mapa and the control of ERM, were very success acquisition. We already return all our investments and even double it. And this is the way of looking of any other acquisition that we will do in the future, strategic more or less.

This is part of the major reason why many negotiations and many discussions that we have specifically in some other Latin America countries, as well as in other Western countries, didn't conclude in a deal. We always look for both items. One is the strategic and second is the financial-wise of the deal. Up until now, beside the two that we did in Israel, we didn't succeed, but we will not give up and we will continue in order to use our strong balance sheet and to live not only with our growth, the organic growth.

Thank you.

[Kaffiria Groh], [ION].

With regard to your guidance for 2012, can you tell us what are your assumptions for the car market in Brazil in order to deliver the 40,000 plus sub growth?

First of all, it is not the total guidelines. It is only an explanation of the ramping up of our strategy. And the way that it is ramping today gives us strong confidence to expect to have 40,000. The 40,000 that I talk, I talk overall the Company. I didn't talk specifically about Brazil, although I hope that we will do it only in Brazil, but I cannot expect it now.

Regard the car market in Brazil, we have to understand, I would like to divide Brazil characteristic for us than Israel, for example. In Israel, since the market penetration of our SVR unit is about -- it is more than 20% to -- even 25% in the total car market. In Brazil we are talking about very few of percentage among the total car market.

So the relation between growth of the car markets in Brazil is lower than in Israel. In Israel we have a full -- we depend fully on new car sales, whether it is higher or lower. In Brazil it is -- we are less sensitive to this, because we have enough space to penetrate, even if instead of 3.5 million cars a year there will be 2.5 million. All the penetration today a year is about 200,000, which is less than 10%, not include old cars.

I think that the main problem is in Brazil compared to Israel is that Brazil is less centralized. There are more insurance companies. There are more segments of population and the insurance industry and the insurance characteristic is very different than in Israel. People can -- sometimes do not insure their car or sometimes they insure their car and after six months they decide to quit of the insurance company, and in that case we see a churn.

This is something that is the problem that we had to handle in the past and we have to continue handle it now. Part of the things that we thought will help us is the new strategy to charge for installation, to charge for the installation. This is something which will motivate the customer to continue at least paying for our services.

As I said, the customers that decide to stay under this new policy, we see a higher cash flow, lower churn, and I hope that this is -- will be in the future.

Although in a shrinking market you might find the churn higher than net new subs, even though contrition is very low, or for -- at least for some -- for, I don't know, for a few quarters you can see [subs] going down, and at some point going back to the long-term trend, which is healthy, I agree.

Yes, but just one thing to add. Until now before the last three months, Brazil was in the highest, I think, almost ever nine months of new cars. After everybody felt that the recession of late 2008 is finished, and the Brazil economy, they had the new elections, and Brazil came to a very prosperity point, and still we didn't see that we are growing more than we faced during the recession.

So, generally speaking or mathematically, you may right, but practically since the market is so big, and our industry is still so small, the sensitivity is not one-to-one, but generally speaking no doubt that you are sensing what you are saying.

Maybe you can give us some color about -- from your point of view or from where are you standing out the car market -- how the car market looks right now. I mean, did the -- of the credit, of the -- what do you hear from producers or from the insurance companies?

I didn't understand the question.

I mean, what do you see now in the car market in Brazil? Do you see indication of contraction -- of slowdown or nothing yet?

First of all, during the year we saw, I should say, one or two months of slowdown, and recently is back to an average numbers. But I think that it is now -- it is typically like in Israel in September was lower than July and August, which is not a typical September.

We know that car industry are very related to the world economy. And we know that the world economy is not very stable these days, and this influence on investment, this influence on people's decision. So of course during the last few months I would say that there is volatility in this item.

But first of all, I give you information based on data that it was published and was communicated. I don't have my own data. Second, I am saying for sure that in our case the reason that we didn't grow in the net subscribers in Brazil, I think it is only because of our new change of strategy.

Because I know exactly the numbers that are in and out. And also I see what is going on today, which today -- I mean this month -- which again October, when you're talking the October and November, the world economy is still not stable. It is still people are not very optimistic. And we start to, I would say, reaping the fruits of our new strategy, although the economy is not in the best shape, so let's wait and see.

Although, half of the quarter is behind you, so when you say that you expect to grow in the fourth quarter, it is based on, I guess, on what you see up until now, correct?

Let's say that when I say something I try to make it reasonable. (laughter).

Okay. Two small ones. About the doubtful account level, do you see any ramp up in those or any other negative indications?

No, don't forget that what I think is nice and provide confidence in this ability, regard those accounts or others is that most of Ituran's revenues are coming from hundreds of thousands of customers that has to pay a very little amount per month; this is usually.

Of course, some of it comes from, and specifically in Brazil, from bigger accounts like insurance companies. Those insurance companies in Brazil most of them are publicly traded insurance companies. And even in the recession of 2008, which came from financial institutions, in Brazil all of the insurance companies stayed as triple-A. So we don't see any doubtful account.

In Israel, which is the other geography which we have a lot of sales, again, the end users must stay, otherwise they are not insured. They are breaching their policy. This is regard monthly fees. But in Israel we are selling the hardware through the channels, which is the car importers.

Again, the car importers in Israel are very solid and very strong entities. And although this is the case when we sell it to the installers or to some licensee of them, we have a very conservative payment methods and guarantees that we do. So if you take Ituran, I wouldn't say 16 years, but at least the last 10 years our doubtful accounts are very, very little, very close to zero, I would say.

Understood. Maybe you can explain again the shrinkage in the location-based services quarter-over-quarter, because the currencies were quite volatile, that is true, but at the end of the day didn't change much quarter-over-quarter. So how much of the shrinkage was currency and how much you said was the business model? And maybe you can explain why the new business model impacted the [market].

Okay, first of all, you have to consider that the way that we are judging the ForEx exchange on our P&L is not between the last day of the last quarter and the last day of this quarter. This is right only for the balance sheet. But for the P&L we are taking an average. Since our revenues are only -- on a daily basis we have an average revenues we have to consider the average foreign exchange of the quarter.

So when you take the average, since it was volatility still, in average we had differences of more than $1 million against us between this quarter and the last quarter -- in second quarter, more than $1 million, very close to $1.5 million. So first of all it is material.

Second, we had to do shift not because of the strategy that we took in order to change the installation, it is only because of some accounting changes that forced us to take some portion that we had to add to the revenues from subscribers fees, to take it out from the revenues and put it -- and also reduce the expenses.

We consider it as expenses. The accounting say that now we change the [GAAP pile]. The GAAP changed, there is a new regulation and it is a few hundred thousand of dollar, for example, that they told us don't put it in expenses, just reduce your revenues.

There is a way to do it, and I don't want to get into the accounting sense of it, but this is the situation. It is only an accounting issue. So this, plus the foreign exchange, at least is almost $2 million. So this is the main explanation.

But, what, the accounting change happened only this quarter or before?

What?

The accounting issue started this quarter?

Yes, only this quarter.

And last one, sorry. About the capital expenditures, I thought it went down by almost 50% or even more. Can you tell us if it is sustainable or you got maybe high inventories or other reasons?

So as I said in the past, we expect that this would be the case toward 2012. And there is three -- I would say three components that affect it.

First of all, I will remind everybody that our CapEx is based mainly on units that we are -- leased to our customers in Brazil and Argentina. The [regional] CapEx, what we call CapEx like in other companies, it is not more than $1 million per quarter.

So if we look backwards, we will see that about $4 million per quarter, a little bit less or more, was issued for units -- for hardware to provide the services. What I said in the past is, first of all, we reduce the cost that we are buying the units today. It was a process, but now we get to the period that we can buy it for a lower price.

Second, by changing the strategy and eliminate people from churn without calling us. So if somebody is leaving the service, now the insurance company has a motivation to let us know and allow us to get back the hardware. Because if somebody has a car and he stopped to be a customer, since he lists -- or the insurance company lists the unit they has to bring it back.

In the past it was very difficult to retrieve it, because of the IT and because of the no motivation for insurance companies, because today they have to pay a ticket for it. So when they bring it back they don't have to pay. The same as for the retainer. So we are recovering more hardware back to our inventory.

And, third, is that we increased our inventory based on the contract with our supplier that allow us to reduce much more dramatically the price of the unit. Since we know at least a year ahead how much unit we will need, it was better for us to finance it now to our inventory.

So in the end of the story, the price is low. We are recovering more units, and our inventory now is big enough that we don't have to buy on a quarterly basis. And I think that totally in 2012 the CapEx will be lower. I am not sure whether it will be like it was in Q3 now, but it will be much lower than it was in the past close to $5 million.

Great, thank you very much for your patience and the answers. Thank you.

(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 your concluding statement?

Yes, thank you. On behalf of the management of Ituran I would like to thank you for your continued interest and long-term support of our business. I do look forward to speaking with you and updating you again next quarter. Have a good day everybody.

Thank you. This concludes the Ituran third-quarter 2011 results conference call. Thank you for your participation. You may go ahead and disconnect.