Ituran Location and Control Ltd (ITRN) 2019 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran's First 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 will now hand the call over to Mr. Gavriel Frohwein of GK Investor Relations. Mr. Frohwein, would you like to begin?

Thank you. Good day to you all and welcome to Ituran's conference call to discuss the first quarter 2019 results. I would like to thank Ituran's management for hosting this conference call. With me today on the call are Mr. Eyal Sheratzky, CEO; Mr. Udi Mizrahi, Deputy CEO and VP of 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 also covers the contents of this conference call.

And now, Eyal, would you like to please begin?

Thank you, Gavriel. I'd like to welcome all of you, and thank you for joining us today. 2019 has started with Ituran being a company on a much larger scale with more potential for growth. Ituran now has a significant footprint and is a major telematics player in Latin America, and we now see many solid growth opportunities ahead of us. We provide our services to almost 1.8 million subscribers. While our subscribers last year were mainly in Israel and Brazil, we now also have subscribers throughout Latin America, including Ecuador, Mexico and Colombia. Looking ahead, the growth in our business now comes from a number of different legs. While in the past, our growth traditionally was driven simply by the net increase in the subscriber base in the aftermarket, today, there are additional legs driving our growth. One remains the traditional retail aftermarket subscriber rates in Israel and Brazil, the other leg is working with our existing OEM partners and adding additional OEMs in other markets in both new as well as existing geographies.

We now have a much stronger platform to penetrate, and we are in the early discussions with additional car manufacturer OEMs beyond the 2 that we are already working with. I would like to spend a few minutes discussing our business in Brazil. As you know, the economic situation in Brazil has been weak in recent years, which led to an increase in frauds and losses to insurance companies. While our pricing was flat rate in Brazil, insurance companies in the region have been increasingly raising their premiums and implementing more customer filters. The effect on us in the past year was a slowdown in subscriber recruitment in the region. This is the main reason for the decline in the gross rate in subscribers in the first quarter of 2019 and over the past year. In response, a year ago, we started to develop our own program, which allow us to profile customers and adjust our pricing from a flat rate to that based on the type of the customer. At the end of the first quarter, together with insurance companies, we completed a pilot program, which has been ongoing for the past few months. In April, and after the necessary adjustment, we launched a new system and service, and I'm happy to say that it is working very successfully. In the near term, we believe this will bring subscriber growth back to the typical levels we would normally expect already by next quarter and beyond.

In our other important market, in Israel, we believe that we will continue on the same growth rate as in past years subject to new car sales. As always, we consider how to penetrate additional segments. And as we announced recently, we signed a new and innovative agreement with Harel Insurance, Israel's leading insurance company, which we believe will accelerate our subscriber growth in the Israeli market. We are becoming Harel's provider of location-based services for its usage-based insurance, UBI program. Harel launched a comprehensive car insurance policy built around the Ituran solution for taking into account drivers' accumulated mileage. The product is supported by an application enabling the insurance company to monitor driver behavior. Harel Insurance will bear all the insurer's costs, including installation and monthly subscription fees to us. We see this product as a real advance to an insurance company providing a more accurate risk assessment and personalization of insurance policies, lower cost and providing an innovative and fully digital service for the customer. It also provides a real benefit to the end customers, enjoying full transparency and fair pricing based on their particular level of risk and vehicle usage. We already see significant market interest and expect throughout 2019 a number of other insurance companies in Israel will begin to offer UBI policies based on our solution. Longer term, we expect to leverage this solution into additional countries in which we operate.

Regarding Mexico, it was recently announced there that 2G networks in that country are being discontinued in the next couple of years. One of our OEM customers in Mexico, which uses a 2G telematics system, required us to upgrade the system that we supply to 3G, a process which will take a few months to the end of Q2. After this, our OEM customer in that country will start to take delivery of the next generation of systems. But right now, deliveries are on hold. The somewhat lower revenue from Mexico has and will have a slight short-term impact on us in Q1 and Q2. However, we believe that by Q3, it won't be an issue any longer, and our business there should go back to its normal healthy pace.

As of the end of the first quarter, our active subscriber base was 1,783,000, of which retail was 1,229,000 and OEM was 554,000. The net adds in the quarter were a total of 13,000, of which 8,000 were retail. We expect this number to be higher in the next quarters, and 5,000 subscribers were OEMs.

Looking ahead, we expect already by Q2 the retail part of the subscriber base to return to its normal growth rate of between 15,000 to 20,000 per quarter. And with regard to the OEM subscriber base growth rates, our visibility is lower, and the growth rate depends on the market positioning.

In terms of our financial summary, our first quarter non-GAAP revenue was $75 million. From the financial perspective, as has been the case in recent quarters, the weakness in a number of the currencies that we operate in, especially in the Brazilian real, has a very significant impact on the translation from the local currencies, in which we operate, to U.S. dollar, which is our reporting currency. If we remove the currency impact, our revenues would have grown 32% in local currency terms. However, our results were further impacted this quarter in Brazil and Mexico, as I discussed earlier.

We are working on identifying and realizing the strong synergies in our business between and inside each of the region in which we are operating now. We are looking 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. We are already launching additional services in those new geographies.

Furthermore, apart from our ongoing work in building and realize the synergies in our business, we have a number of initiatives that we believe will begin to propel us forward later this year, such as our new agreement with Harel to provide telematics for the usage-based insurance policies. My goal is that Ituran will always remain at the forefront of technological advancement in an ever-changing, customer-oriented market.

Before handing over to Eli, I would like to add a few words about the buyback and dividend we declared today. As you know, it is our policy to share dividend amounting to at least $5 million a quarter, which continues. We share a dividend on a quarterly basis, as we feel it is important to share our ongoing financial success with our shareholders. In addition, the Board approved the share buyback amounting of up to $25 million until the end of December 2020. We believe that the ability to buy back our own shares, depending on market conditions, is a tool that will contribute to shareholders' value over the long term.

In summary, as you can see, we are very excited with regard to our potential in the coming years. I will now hand the call over to Eli for the financial review. Eli?

Thanks, Eyal. Note that the results I present will be on a non-GAAP basis, including adjusted EBITDA, which excludes revenues 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 first quarter of 2019 were $74.6 million, representing an increase of 18% compared with revenues of $63.1 million in the first quarter of 2018. In local currency terms, first quarter revenue grew 32% year-over-year. Revenue breakdown for the quarter was $54.2 million coming from subscription fees, a 19% year-over-year increase. In local currency terms, subscription fee grew 36% over the same period last year.

Product revenues were $20.4 million, which were an 18% increase over the same quarter last year. In local currency terms, product revenues grew 21% over the same period last year. The geographic breakdown of revenues in the first quarter was as follows: Israel 38%, Brazil 37% and rest of the world 25%. Non-GAAP operating profit for the first quarter of 2019 was $16.2 million, an increase of 4% compared with an operating profit of $15.5 million in the first quarter of 2018. In local currency terms, this grew 24% year-over-year.

Adjusted EBITDA for the quarter was $20.9 million, an increase of 9% compared to an EBITDA of $19.2 million in the first quarter of 2018. In local currency terms, the increase was 29% year-over-year.

Net profit was $10.7 million in the quarter or fully diluted EPS of $0.50, a decline of 5% year-over-year compared with a net profit of $11.3 million or fully diluted EPS of $0.54 in the first quarter of 2018. In local currency terms, the year-over-year increase was 14%.

Cash flow from operations during the quarter was $14.9 million. As of March 31, 2019, the company had cash, including marketable securities, of $54.5 million and debt of $73.6 million. This is a net debt position of $19.1 million or $0.89 per share. This is compared 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 first quarter, a dividend of $5 million was declared. The dividend's record date is June 20, 2019, and the dividend will be paid on July 3, 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?

(Operator Instructions) The first question is from Tavy Rosner of Barclays.

This is Peter Zdebski on for Tavy. I was just looking at the revenue-per-subscriber trends and, obviously, there has been some compression in the fourth quarter and then again going into the first quarter. And I understand that the OEM segment is a bit lower margin than the legacy aftermarket segment. But all things being equal on the currency side, could you give us a sense of the trajectory of the revenue per subscriber from here?

Hello? Hello?

Could you just repeat the last part of your question?

Couldn't hear the last part.

Yes. I was just asking about -- if all things are equal on the currency side, is this about a good run rate for revenue per subscriber giving effect to Road Track and a bigger OEM contribution?

As you mentioned, there were 2 reasons. First reason is the mixture between the OEMs that we just start to publish from Q4 and, of course, now. So the OEM subscribers have lower margin and lower ARPU. So the mixture changed or decreased a little bit. And next, very important aspect is the currency exchange rates. So regard the future, as long as the currency exchange rate in the main markets, which is Israel, Brazil and Mexico, will be as it's now, so this is the run rate ARPU that you should consider, of course, but it's something that it's not dependent or it's not in our hands.

And approximately how much lower is the OEM ARPU than the aftermarket?

It's not very -- the differences are not very high. On the other hand, the margins are lower because the service cost for the OEMs required, let's call it, kind of automotive grade, which required higher cost. And it's not -- differences in the ARPU, we'll not give the right number or the specific number, but just to give you a rough information, general information, is lower, but not material.

That makes sense. And then a quick one on the operational side. It looks like R&D ticked up a bit also in the quarter. Was that related to the 3G conversion in Mexico?

First of all, even I would say a little bit historically -- we didn't touch it in our last conference call. So even historically, we increased, and we put more power and strength in our R&D divisions in order to be able, for example, to be the first and the dominant player of UBI in the markets that we operate and we now start to show it in Israel. Second is the OEM leg, which is a part of Road Track. When we acquired it, we acquired it with R&D facilities and R&D expenses in order also to support the OEM needs. So overall, the R&D expenses in the group is increased. Looking forward, I believe that the number that we show now, which is much higher than a year ago, it will be stable, and we are now fully loaded with the power and the resources that we need to support our growth.

The next question is from David Kelley of Jefferies.

You referenced ICS changing pricing model impact on subscriptions in Brazil. And just to clarify, are you expecting an immediate return to normalized subscription growth in Q2 now that we're post the test phase? Or is that still more of a second half tailwind for your Brazil market growth?

Regarding numbers of subscribers, as I said in my speech, we are absolutely see and believe or expecting that the number of subscribers will come back to our, I would say, historical trend in Brazil already in Q2. But, of course, we have to always remember that the influence on the financial numbers will take 1 or 2 more quarters because the nice thing in operating leverage, it helps us when we had declining in the growth, but when we will back to the growth in subscribers in 1, 2 or 3 quarters, it will be much more material the influence on our revenues from the customer base. So in terms of subscribers, it will be immediately -- we believe it will be immediately. The financial influence, the revenue and the profitability, of course, should be more -- materially more to the second half of the year and, of course, hopefully for the next coming years. Yes.

Okay. Perfect. And then maybe switching gears to the usage-based insurance agreement that you announced last week, appreciate the color on that. Could you just talk about maybe kind of the magnitude of size of that contract and maybe your view on the UBI opportunity over the next 1 to 2 years? And then I think you referenced an opportunity to take that to other markets beyond Israel. Where do you see some sort of natural fit going forward? Is it your legacy markets in places like Brazil? But would love to just get some more color on UBI.

Okay. I will start by saying that we identified and realized the new opportunity in UBI about more than 3 years ago, and we started to develop the softwares, the technology and all the backups to integrate it into insurance company's needs. We had the first contract a few years ago with AIG in Israel. But AIG those days were very small insurance companies for the vehicle, and second, their model was based on putting the cost of all these programs on the insurers. So it took off, but the numbers were not enough, but it was a good pilot for the market and for us. Since then of course, we moved forward much better, much more -- the technology is better. And we see now -- we saw during 2018 that the Israeli insurance market as well as other markets in the world are changing towards more digital insurance. There are more applications. The insurance companies are more open to change their historical models. And we used our dominance in the Israeli market and the relationship that we have. And of course, we started talk with all of them. And by the way, they checked not only Harel, but all the -- mainly other insurance companies that are now on their way to be in this program. They didn't check only our solution because it's a very strategic decision for insurance company to change the model of selling car insurance. In Israel, it's totally new, and Harel is one of the largest, if not the largest. And it means that they checked not 100% and 100 pilots, but 1,000% that we are the right horse to (inaudible). And it was like a tender process and many other companies from the rest of the world as well as other Israeli technologies and the software were, I would say, bid on this showroom and we won. We signed the contract. And being on this, my feeling is that -- or at least we believe that we will dominate this market in Israel, hopefully, as did with SVR Solutions. And in terms of numbers, we have to understand when those dominant insurance companies decide, I would say, to change their models, to change their markets, we should consider potentially for the next 5 to 10 years that all -- or there is no reason why an insurer they want to insure his car and he know what is the highest price he can pay and, along the year of the policy, he will -- always can only getting discounts that we keep the old rate. So believe that this way of selling insurance will become more and more part or the way to sell insurance for cars in Israel first. And we believe that we will dominate the market. In terms of numbers, it can be hundred thousand or millions or whatever the insurance market is. Of course, we are not aiming 100% penetration, we are not aiming to be the only player in the market. It will take time also for those insurance companies to educate their brokers if it's a direct insurance; to educate their marketing channels, it will take time. But as we see and, by the way, the Harel is already commercially and they spend millions of dollars currently for the people that live in Israel. Once they open the radio or television, they will see. It's called Harel Switch, I would say, almost every hour. So they spend a lot of millions of dollars in order to make this education and sales. So we believe that this is really giving us a new segment with a very large potential customer base for the future.

Now we are talking about ARPU, which is lower than the SVR ARPU. It's not the same numbers, but on the other hand, since everything is digital, everything is automatic, so all our service cost, which we -- you have an experience with our P&Ls is that we have control centers, we have customer support centers, all these are [deep case], the cost is mainly -- was the R&D and now the support, but everything is automatic, everything is a software. So although the ARPU will go down, the profitability of those subscribers are even much stronger than the SVR subscriber. So imagine, with additional few hundreds of thousand subscribers in the next 5 years that it can be very material to the Israeli numbers. Again, it just started with Harel. We are -- we believe -- we have discussions, and we have competitors, but as I said, I believe that in 2, 3 years from now, we are very optimistic regarding having tens of thousands of new subscribers. And this is by -- and I'm conservative here, I'm very conservative. So it can be material for the Israel market. Yes. Then as we saw in the past, when we get to Brazil, we've already been breakeven in Israel. It was many years ago, but it took us 3 to 5 years to become dominant in the market. I believe that Latin America, which is more emerging market than Israel, will be ready in a few years to accept and for us to duplicate this solution, but this is something that it's more for the longer term. It's not something that I can assure that in 2020 or 2021, we will be dominant in UBI in Brazil.

Okay. And just quickly, you mentioned the lower ARPU, but higher -- the margin accretive opportunity. It sounds like that -- is that based on the contract signed or you see it as the longer-term market potential even beyond Israel?

No, it's much easier in the contract side. Again, the SVR will depend on how we sell to the insurers because it was a pure B2C. Now we are talking about a pure B2B. Our client is the insurance companies. We have -- in the contract, we have the pricing, we have the process, everything is B2B between us and Harel. And in the future, it will be probably between us and the other additional insurance companies. Of course, the contract can be different from each other, but on average, it will be very close to each other. So we are talking about a situation that we get -- let's call it, we get a check every month based on the new insurers that both UBI premium from Harel and in the future from the others, so the pricing are part of the contract. As I said, I don’t want and I cannot disclose the prices. It's a B2B deal. But as I said, it's lower than the SVR, but it will be more profitability.

The next question is from Sasha Karim of IPI.

My first question would be on the return to 15,000 to 20,000 typical subscriber net addition per quarter. That number seems a bit low to me because you've acquired Road Track, and in the past, you had done between 20,000 and 30,000 in some quarters. Can you just comment on why the new normal is only 15,000 to 20,000? Is there some maturity perhaps in your markets now?

First of all, as I said, and maybe it wasn't clear, when we gave the forecast of the expectation for 15,000 to 20,000 per quarter after, for example, this quarter we did only 8,000, and I mean, it's only for the retail aftermarket segments, which historically the numbers that we had an experience, then we had the declining that I explained came from Brazil situation. Now we are on track again, and it will be only for the aftermarket retail segments. And I said that regarding the OEM, this is part of the acquisition that we did with Road Track. We have less visibility, and we are not providing number for forecast, but I want to add something. We acquired Road Track with an OEM subscriber base. The OEM subscriber base that we acquired has no potential to grow by itself because it's very solid, very dependent on the sales of those customers. It's about 3 customers in our 4 regions that are buying what they sell. The reason or the advantage that we see or the upside in acquiring Road Track is, first of all, to use it as a platform to duplicate our retail aftermarket segments in those geographies based on this platform; second, to use our additional services and other experience to grow and expand their OEM contracts; and third, to try to create more renewals, but regard the customer base that we bought, we didn't expect that this will grow by -- as is. And by the way, don't forget that there is also a matter of the price that we paid. We paid multiples, and we made transactions, which is fitting a company, which its potential by itself to grow is lower. You can see our report regard what we paid for what we get, and you will see that it was a very, very attractive price that was based on seller understanding that we are not buying a company that without us can grow.

That's very clear. And are you seeing a change in the behavior from your existing OEM partners? Yes, the lack of transparency, I understand, but are you also perhaps suggesting that some of those partners may be not pushing the product as hard as they would have done in the past and, therefore, there's a risk of decline in the subscriber base? Or is it generally low transparency?

It's something that we don't have control. We get -- usually, we get kind of planning inventory and planning sales for 3 to 6 months, but I must admit that this is kind of a forecast, and it's not always something that it's clear, and this is something that I don't want to take a risk and share the audience or the shareholders with it because many times, it's volatile from the historical expectation. And we learn that they by themselves not always have the right forecast. Second, we have confidentiality because no one of those customer want to be exposed with what they sold during the quarter. So by giving specific numbers, we also expose it, and we are not allowed to do it. And the third issue, to your question, yes, theoretically or practicality, we can find ourselves in some quarters with declining in OEM customer base, and this is something that can be reality. I'm quite confident that we are -- can be in a situation that, for example -- and this is what we start today, we show our OEM subscriber base and the retail subscriber base. The retail subscriber base contribution is much more material to the profitability and to the ARPU than the OEMs. So just to illustrate a situation that we will grow 20,000 in our retail and we will decline in 40,000 in the OEM in the same quarter, still we will show growth in revenues and in profitability because the weighted average of declining in OEM but growing in the retail is still positive. And this is important to understand. We have less control on the OEM. We have less growth in the OEM currently mainly because of the economic situation. You know that the car industry usually is the first to be held by recessions. And we've found it, and we have experience with this. And this is the situation in Brazil, recently in Mexico. So I believe that still, even if we will find some quarters with declining in OEMs customer base, we will continue to show or we'll start to show again growth in the retail, and the weighted average will be positive. So overall, I'm looking forward starting second half of this year and, hopefully, the next couple of years the result should be with a positive influence compared to Q1 as we saw now.

Got it. And then my last one would just be, you briefly touched upon some early-stage engagements with new OEM potential partners. Can you give us a feeling for maybe the time frame? I know you can't promise, but would you sort of hope to announce something more concrete by the end of this year?

First of all, we have to divide it into 2 type of, I would say, discussions. One discussion is with totally new brands, which our historical experience of negotiating, discussions, pilot, et cetera, we know that it's a very long cycle. This is not new. We already started. But we don't know exactly what will be the result of this discussion and how long it will take. But once it will take off, it can be material for this brand. Second is to expand the current relationship to other geographies. And this is something that should take lower time, lower -- faster cycle, but still those are, I would say, (kind of elephants) in decision taking and in their strategic decision. So it will take more time. It's not something for the one next 1 or 2 quarters. But I hope that in the mid-term we can be in a position that we will be -- or with other -- or another brand or in another 1 or 2 geographies with the current brand. But this is only -- I wouldn't say that we are in close period to do it or something, but we have discussions, and we see -- or we have confidence that our position now will support it.

There are no further questions at this time. Before I ask Mr. Sheratzky to go ahead with his closing statements, 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?

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

Thank you. This concludes the Ituran's first quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect.