Ituran Location and Control Ltd. (ITRN) Q4 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran’s Fourth Quarter and Full Year 2016 Results Conference Call. All participants are at present in listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. If you have not received it, please contact Ituran’s Investor Relations team at GK Investor 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. Ehud Helft of GK Investor Relations. Mr. Helft, please go ahead.

Thank you, operator. Good day to all of you and welcome to Ituran’s conference call to discuss the fourth quarter and full year 2016 results. I would like to thank Ituran management for hosting this conference call. With me today on the line are Mr. Eyal Sheratzky, the Co-CEO; Mr. Eli Kamer, the CFO; and Mr. Udi Mizrahi, VP, Finance. Eyal will begin with summary of the quarter 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 in the press release also cover the contents of this conference call. And now, Eyal, would you like to begin please?

Thank you, Ehud. I would like to welcome all of you and thank you for joining us today. We are very pleased with our results of 2016 as a whole and especially the results of the fourth quarter. We present our results which are at record levels, especially in terms of our profit with strong growth across the board. We reported record full year revenues of $200 million, up 14% versus last year, and in local currency terms, this grew 20% year-over-year, which is especially strong growth. This ongoing revenue increase is built on the back of our subscriber growth which added 109,000 net subs over the past year, predominantly in Brazil and Israel. Part of the contribution to our growth is the work we have done over the past two years to bring new products to market, which have expanded our addressable markets by targeting the lower end of the market in Israel and in Brazil, the uninsured segment of the markets. The inherent operating leverage built into our business model translated our top line growth into much stronger full year net income growth, which increased 28% versus last year and we reported $32.1 million in net income for 2016. We believe that our subscriber base continues to grow over the coming years. Our margins should be able to continue to expand. Our operating cash flow in 2016 was $41.5 million. Our ongoing strong cash flow and profits allow us to share the reward of our success with our shareholders. For the quarter, we declared a dividend of $8.5 million which amounts to $20 million for 2016 as a whole or 62% of net income for the year. Following feedback from some of our investors, the Board of Directors took the decision to adjust our dividend policy, while before we promised to give at least 50% of annual net income in dividends. Looking ahead, our policy is to give at minimum $5 million per quarter. We believe this move will increase transparency and allows for more predictable dividends, which will help our shareholders better understand and model our company as an investment. Moving on, I would like to spend a few minutes talking in more detail about our subscriber growth as there are some impacts on the net growth which affects the overall growth rate, but has minimal effect on the bottom line. The quarter’s subscriber growth was 22,000. This was within our expected range which we have talked about in the past which is between 20,000 and 25,000. However, as you also know, it is clear that in the past few quarters we reported subscriber growth ahead of this range and recently the quarterly rate has come down back to within the range. I want to take this opportunity to give you some more insight into the drivers behind our subscriber adds. I would like to highlight three recent effects in particular. Starting with the simplest one, as you know, Argentina is a country with significant economic difficulties and a high level of inflation, which is making it increasingly hard to grow our business profitability. However, we have decided to somewhat sacrifice stronger subscriber growth in Argentina for maintaining adequate profitability. While the lower subscriber growth in Argentina does have an impact on net subscribers overall, it has very minimal bottom line impact to Ituran. The second driver is a positive one. In 2016, while still a small percentage of our overall revenue spike, our U.S. business did very well and the U.S. subscriber base grew strongly making up for the slower growth in Argentina. The third effect is very positive overall, but optically looks like slower growth in Brazil. It is related to the IRT joint venture in Brazil. Because the new car owners of the country’s top manufacturers that we work with now gets our service directly through the manufacturer for the first year, the small portion that would have originally come to Ituran directly doesn’t need to do it anymore. There is therefore a small amount of cannibalization, where some potentially direct Ituran subscribers will now subscribe to us through our IRT joint venture. While this appears to reduce the subscriber acquisition rate in Brazil by around 15,000 to 20,000 per year, in place, we are getting hundreds of thousands of subscribers through our joint venture IRT. So, the net effect is significantly positive. Note that because the joint venture is 50% held by us, we don’t consolidate that subscribers from this joint venture and therefore we don’t report the subscribers’ numbers under IRT, but we will of course benefit strongly from their subscribers on our bottom line. Moreover, the higher the cannibalization effect, the greater the proof of the success of our joint venture and the demonstration that this business is on track. I will talk about IRT in a few minutes when I talk about our business in Brazil, but first to Israel. And our business there is continuing to perform well. As we are the major player in Israel, new car sales in the country impact our subscribers as these new owners signup for telematic services. The economy is performing well in Israel and this inevitably is leading to a solid level of new car sales in the country. I would like to add that in Ituran is less reliant on the growth in new car sales to maintain its growth than it was in the past. As I mentioned earlier, we have strongly penetrated the lower segment of the market, where only a few years ago we were not active at all. This is through our Ituran’s safe service, which also continues to perform very well. Overall, we remain pleased with the strength and stability of the Israeli business, which is also supporting the overall growth in net subscribers. In Brazil, as you know, we have seen strong growth over the last few years despite a weak economy there and this region continues to be a strong growth engine for us. Our business is still at an early penetration stage in the Brazilian market and we continue to see much potential to grow and expand our success there. In particular, analysts expect 2017 to be a strong year-over-year forecast sales in the region versus 2016. In particular, our Ituran stolen vehicle recovery services with basic theft insurance, is seeing continued traction in the market driving our strong accelerated growth in Brazil. This service is sold direct to the end customer and significantly cheaper than the full insurance alternative. In addition, as car owners choose to sign up to this service because they see the value that share rate is lower than average. As I mentioned earlier, the success of our 50% joint venture, IRT, means we are seeing slightly less subscriber growth you need to run Brazil as some of the new car owners which can sign up through IRT for the telematics services are in fact doing so and this is in line with our plans. As you know, IRT has an agreement is one of the major and global auto car makers in both Brazil and Argentina providing their customers with telematics services on various new car models they sell. Similar to what All-Star is in the U.S. These services can include vehicle security, personal safety, remote diagnostic, web and app application and concierge services. IRT strengthens our position in our target markets, enabling us to play with one of the hottest parts of automotive industry that of the connected car. After two decades of operating in the aftermarket segments only. IRT has the potential to bring us hundreds of thousands of additional subscribers using our services positioning us as clear market leaders. IRT is very much on track we already acquired many subscribers and we have reached the cash flow breakeven level ahead of plan. Already by the end of 2016, we expect the business to contribute to our bottom line in 2017. In summary we are very please with our performance in 2016 and especially with our strong margins and record profitability in the fourth quarter. Looking ahead, we continue to remain very well positioned to benefit from our ongoing growth in subscribers. We also look forward to IRT’s positive contribution in the short-term and growing contribution thereafter. We are working how to continue our success into 2017 and beyond and share their success with you, our shareholders. I will now hand the call over to Eli for the financial review. Eli?

Thanks Eyal. Revenues for the fourth quarter of 2016 were $50.4 million, up 15% when compared to revenues of $43.8 million in the fourth quarter of 2015. Revenue breakdown for the quarter was $37.3 million coming from subscription fees, a 16% year-on-year increase. Product revenues were $13.1 million which were a 12% increase over the same quarter last year. The geographic breakdown of revenues in the fourth quarter was as follows; Israel 50%, Brazil 39%, Argentina 7% and USA 4%. Gross margin in the quarter 52.4% compared with the gross margin of 50.9% in the fourth quarter of last year. Operating profits for the fourth quarter of 2016 was $13 million, an increase of 26% compared with an operating profit $10.3 million in the fourth quarter of 2015. EBITDA for the quarter was $16 million, an increase of 13% compared with EBITDA of $14.2 million in the fourth quarter of 2015. Net profit was $9.3 million in the quarter or fully diluted EPS of $0.44. This is compared with a net profit of $6.2 million or fully diluted EPS of $0.29 in the fourth quarter of 2015. Cash flow from operation during the quarter was $14.4 million. In terms of our full year 2016 numbers. Revenues for 2016 reached a record or $199.6 million, an increase of 14% compared with the revenues of $167.6 million in 2015. The significant strengthening of the U.S. dollar versus the Brazilian real and the Argentina peso compared with their levels in 2015 reduced the overall revenue in level – revenue level in U.S. dollar. Excluding the exchange rate impact, the increase in revenues would have been 20% over 2015. Revenue breakdown for the year was $141.9 million coming from subscription fee, up 11% year-over-year and product revenues were $57.6 million, up 20% year-over-year. Gross margin in the year was at 51.1% compared with 51.2% last year. Operating profits for 2016 was $48 million, up 18.1% compared with an operating profit of $40.6 million in 2015. Excluding the impact of exchange rates, operating profits would have increased by 28.4% versus last year. EBITDA for the year was $59.6 million an increase of 13.4% compared to an EBITDA of $52.6 million in 2015. Excluding the impact of exchange rates, operating profits would have increase by 23.4% versus last year. The share in the loss of affiliates net was $449,000 in 2016 compared with a loss of $2.4 million last year. The increase was due primarily to IRT, Ituran’s joint venture providing telematic services in Brazil and Argentina. Net income in 2016 was a record $32.1 million or fully diluted per share of $1.53. This is an increase of 29% compared with a net income in 2015 of $25 million or fully diluted earning per share of $1.19. Excluding the impact of exchange rate, net income would have increased by 40.5% versus last year. Cash flow from operations for 2016 was a record $41.5 million. As of December 31, 2016, the company had net cash of $31.5 million or $1.50 per share. This is the best compared with $28.9 million or $1.38 per share as at December 31, 2015. For the fourth quarter a dividend of $8.5 million declared for the full year of 2016, the total dividend declared including that of the fourth quarter of 2016 was $20 million representing 62% of the full year net income near the same rate as last year. The dividends record date is March 22, 2017 and the dividends will be paid on April 5, 2017, net of taxes and levies at the rate of 25%. And with that I would like to open the call for the question-and-answer session. Operator?

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] The first question is Ethan Etzioni of ‎Etzioni Portfolio Management. Please go ahead.

Congratulations on the great year. I wanted to ask about first of all the gross margin, I see it picked up 200 basis points I wanted to ask where is this coming from?

Basically it comes from two main things one is the portion of the service revenues compared to the hardware revenue. And in the service revenues we have a higher gross margin, this number one. And number two and this is exactly the operating leverage that we have in our model still as long as we continue growing our subscriber base, we see a growth in our gross margin.

So you will see this as sustainable?

Yes.

I see that the management cost went down $0.5 million from the third quarter, can you please explain?

Basically, there is obviously you are talking about administrative expenses and usually there is volatility between the quarters. There is nothing specifically for one quarter or to another. And usually you can compare it as a percentage to the revenue.

Okay. I wanted to ask you how do you see you said you expect IRT to be profitable in ‘17? I wanted to get a feel relative to the investments you made there, do you see the profitability passing $1 million within a year or will they take longer?

If we understand your question, you mean, if the profits of the joint venture will be more than $1 million a year or I didn’t understand your question?

Your share, yes, your share….

First of all, we made the investments and we entered to these projects for of course having something much more material, but it’s based on our business plan, there is always chances and risks. As I said before, we are ahead of our plans in terms of the cash flow. The P&L is also online with our expectation and we are still solid with our expectation that we will be positive on the accounting side during the beginning of 2017. We are not providing or we are not allowed to provide data, because we have not consolidated those numbers. It will appear on our profit during the quarters and you will see the changes. I can’t give the exact numbers. And by the way, it’s only our future expectation, because currently you have the results.

Thank you.

The next question is from Lena Rogovin of Chardan Capital Markets. Please go ahead.

Hello. Congrats on the great results. Couple of questions if I may. My first question is on the subscribers in your Brazilian JV, is there a chance to get some rough estimates to help us to forecast your net adds in Brazil and Argentina going forward, primarily in Brazil of course? And my second question is about the product revenue growth in Q4, what was the reason for that, because we can assume that net additions in Israel were lower Q-on-Quarter, so there should be something else which was a driver for revenue growth? And my last question is about the balance sheet, not just other current expenses which were up by $10 million year-on-year, what does it include? Thank you.

Okay. Again, the answer regards providing data about the subscriber of the JV is something that will not be published based on the accounting rules and based on the confidentials that whoever is the manufacturer. What I can say is regarding Ituran subscriber base, I also said it before and I would state it as a constant number, we are growing or we lost about 20,000 subscribers a year that came from car owners of these car manufacturers, but now we will get it with the rest of the buyers from these car manufacturers on our JV. At the bottom line, we will have more benefits from this than what we are losing, but regarding subscriber’s numbers, what you actually saw during 2016 and will continue in the next years is that we will add less 20,000 from this kind of customers. Regarding Ituran, which is not the JV, we expect that we will grow based on the averages number that we showed in the past, but again, we will not provide specific guidelines with regard to Brazil. Regards sales of hardware that you saw in the Q4 which is lower is we also most of our sales are in Israel, because as you know in Brazil and in Argentina, we do it as an accommodator, meaning we lease it. We don’t have sales. So, in Israel during Q4, it was almost one month of holidays. So, it’s only influenced sales of hardware and this is a specific volatility that we faced every year, nothing dramatic.

Regarding the other current assets, as you mentioned, there was an increase from 2015 to 2016. Basically, the main reason it relates to Brazil operation, where over there, there are two main reasons. The first one is the effects as the currency, the rate of the real as of the end of ‘15 compared to the end of ‘16 was much weaker. In the end of ‘15, it was $3.9 million and the end of ‘16 it’s almost $3.2 million. And the main reason is basically the model that we are working in Brazil, which is the ICS, Ituran com Seguro. In this model, we are actually paying the insurance company for the policy in advance. So, what happens in Brazil, you saw the big growth that we had in 2015 and also in ‘16 and this means that we are selling more and more this kind of product and this means that it’s like prepaid expenses. This is why the other current assets, has become much bigger.

Okay, thank you. I just wanted to clarify on the product revenue, what I meant that it was unusually high in Q4, not low, if you look year-on-year. So, I wanted to understand what was in there on top of Israel?

You are talking about other current assets, if you compare year-over-year…

No, no, sorry, I am talking about product revenues in Q4?

This year, the full holidays – actually all of the holidays came on Q4. Everything – all of their holidays was worrying. Basically, the main reason is that in this year the number of car sales in Israel were higher than last year and this was actually contributed to our product sales in our….

Q4 to Q3 we thought you asked Q4 compared to Q3.

No, I am asking about Q4 compared to Q4 ‘15?

So we told more. There were much more…

Okay. So there is a lag between actual car sales and Ituran product sales?

No. We are relating with the car sales, but our penetration at the market is higher than the growth of the car sales in Israel. We are growing. Our penetration is stronger than the growth of car sales in Israel.

Okay, understood. Thank you.

The next question is from [indiscernible]. Please go ahead.

Hi, good morning. I am rather new to the story. You said you had U.S. sales of 4% do you have a plan to grow them?

Actually, the percentage just illustrate compared to the rest of the business. We always do the best to grow each one of our geographies, but on the same time, as the U.S. business grows we continued to grow very materially in Israel and in Brazil. So actually, the percentage it’s not saying whether we grow or not. So, we will do our best to continue our growth in the United States. As I said, during 2016 compared to the rest of the years of the past, the U.S. operation grows much more than in the past and we succeed through first time to show magnificent growth compared to the rest of Ituran operation, it’s still small.

Obviously, U.S. would be a huge market, the companies you could joint venture with in America, are you talking to the car companies or do you have a strategic plan for that?

We have actually – we are growing few specific segments. Currently, we are not aiming car manufacturers or OEM deals. We are working more for the aftermarket deals. We are less focused on our stolen vehicle recovery, because it’s not a main problem in the states like in the emerging markets, the other emerging markets like Israel or Brazil or Argentina. We are more focusing on finance companies that are looking for repos like repossessing cars of more, getting more confidence with sub-prime customers. We also are heading efforts to the fleet management segments. We should be aware that the fleet management in the United States is a very – there is a high competition and very competitive landscape, so it’s depend on how much we are willing to invest and to risk. We are heading since we show higher growth. We are using all the profits. We are using all equity in the States in order to expand our penetration and we will see.

Okay. Finally, I know there is a problem with a lot of stolen rental cars, especially in Florida, have you thought about working with rental car companies?

We are working with some rental cars companies again as I said, but it’s still not material among our subscriber base.

Alright. Thank you for your answers.

Thank you.

The next question is from [indiscernible] Capital. Please go ahead.

Hi guys, congratulations for a good quarter and year. I have few questions, I will begin with the first one is regarding what is your revenue and profitability sensitivity to the new car sales in Israel assuming that in 2016 we have reached big sales and next year itself we will be down say by 10%, 20%?

First of all, I am not sure regard decreasing the level of new cars in the market. Based on the first quarter, I am not sure this is the situation, but may be. Regard our penetration, we have correlation between the growth of the car markets is Israel and our new subscribers. But still the correlation is we are showing that we are growing more than the growth of the car market. And this is thanks to main issue that about 4 years ago we decided to offer a low cost solution for low cost assignments of the car industry. And by doing this, we are still not in – we didn’t finish to or I would say depend, they are potentially still ahead of us. So we still have model and segments that we are in the middle of penetrating it. Yet to this, the new cars grows, the new cars important also. So together we still believe that we will continue to grow even I wouldn’t say okay growing at least like we did in the last 2 years. Again I am not sure that the car industry is going to decline 10% or 15% like you said, it’s not something that we see currently. There is another reason and Ituran in the last few years invested – we invested a lot of money in developing and offered systems which are not only for stolen vehicle recovery. We didn’t want to continue and be depend only on the insurance companies obligations, so we developed Ituran Connect which is a specific connect unit including all the multimedia class. The diagnostic of the car class connectivity to the garages of the car dealers and by doing this, we just start to offer it a few months ago we see a lot of traction from more than three to four car importers in Israel, with one we already signed a contract which is Toyota, some models of Toyota Israel are connecting with our units with our connected car. And this will again open for in the used segments and a new market for the future. Another solution is UBI, usage best insurance which we declared a few years ago, but probably we were ahead of the market, but recently some insurance companies adopted and they adopted our solution on an exclusive basis, one of them is AIG. It started with AIG Israel 100% of the UBI customers are using Ituran. We already sold tens of thousands – tens thousands of units and subscribers only for usage based insurance to AIG in Israel, of course its open markets for us outside of Israel. This is of course only at the beginning of discussions. This class of new car sales plus the lower cost segment allows me to have strong confidence that we will continue to grow in the Israeli market more and more.

Alright, great to hear about the new developments. I have a second question regarding the operating profit by geography mix, is it reasonable to assume that 50% of operating profit comes from Israel and 30% from Brazil?

We are not providing details regard it. And just to be honest sometimes there is also some expenses, because we own 100% of the subsidiaries or some of the expenses are transferring among the groups of even if I would it’s not so relevant, but we are not providing data regard it.

Alright. And the third one is it’s more a higher level question, how is the development of new technologies, are more technology-oriented cars or autonomous cars could impact the SVR business and the same question for development of services as car sharing?

I would say that in order to answer these questions in the few minutes that we are for this call it will not be serious, but just to say something very shortly, we are of course considering the changes in the or the future changes in the car market one of them is autonomic cars. There are something which are improving the needs for our services, some needs we will have to maybe changing the way of providing the services. And regard the car sharing as well we are not sleeping during the day we are considering supplementary technologies for us in order to provide the services. We recently joined some collaborations to find technologies that we will see that it’s helping us, but to be more clear, we don’t see it only as a risk, we see it as a chance and we believe that it will help it run to grow in the more far future more.

Alright. And the last question is regarding the fleet management results, could you confirm that the revenue are not material compared to the total service revenue?

First of all, I can’t confirm, because it’s dependent on how you calculate it. You have to understand it in for example in the Israeli market Ituran is a market leader and with a very high market share on the fleet management, probably we are the largest and we are the front end leaders of fleet management in Israel, because we have here a full capability to provide all the services. In Brazil we just penetrated this segment recently and we see more and more growth. Regard selling fleet management, out of the four geographies that we have full operation is something which I would say is a start-up in Ituran and compared to the start-up level it’s become more and more material. Compared to the rest of the operation results in Ituran still small, so it depends what you mean not material. If you are looking specific geographies and Israel is very material, but on the total, you are right it’s less.

Alright. Well, thank you very much for the answers and congratulations for a great quarter and year.

Thank you very much.

The next question is a follow-up question from Lena Rogovin. Please go ahead.

Yes. Hello, again. Just a short question, you had relatively low CapEx this year, is it something you can use as a reference point going forward as a percentage of revenue or it will go up?

Basically in 2015, we made a higher CapEx and in 2016 therefore we made a little bit less CapEx. It’s very hard to say what will be in 2017, but I am assuming that you can expect that more or less ‘17 will be more or less the same as ‘16.

Thank you.

[Operator Instructions] 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.itrn.co.il. Mr. Sheratzky would you like to make your concluding statement.

Yes. Thank you. I would like thank all of our employees and our team for their strong performance in 2016 and we look forward to another successful year. On behalf of the management of Ituran, I would like 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.

Thank you. This concludes the Ituran’s fourth quarter 2016 conference call. Thank you for your participation. You may go ahead and disconnect.