Ituran Location and Control Ltd. (ITRN) Q3 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran Third Quarter 2018 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 at www.ituran.co.il. I would now hand the call over to Mr. Kenny Green of GK 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 2018 results. I would like to thank Ituran’s management for hosting this conference call. With me today on the call today are Mr. Eyal Sheratzky, CEO; Mr. Udi Mizrahi, Executive 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 statements in today’s press release, also covers the contents of this conference call. And now, Eyal, would you like to go ahead please?

Thank you, Kenny. I would like to welcome all of you and thank you for joining us today. We are pleased with both the financial results of the third quarter as well as the significant strategic progress that we made in the quarter. Of course, I would be happier if the currencies would not move against us, but this is something well out of our control. While I will start with a brief general discussion of the financial results, I want to stress that our company today, in the fourth quarter of 2018 looks very different to what this roll number present. As you all know, we closed the acquisition of Road Track Holdings in mid September, the last 2 weeks of the third quarter, so while it had a significant impact to our balance sheet, there was a minimal impact to the P&L of the third quarter. However, currencies and primarily the weakness of the Brazilian real before the elections and the Argentinian peso had a very significant impact on the translation from local currencies in which operates the U.S. dollars, which is our reporting currency on our P&L. In addition, the New Year holiday season in Israel, which fell in the third quarter fully this year, while it was divided between Q3 and Q4 last year, also had a negative impact meaning that in Israel, our business would experience a relatively weaker Q3. However, the fact that our gross operating and net margins throughout the P&L are at good levels shows that our underlying business is healthy and is a demonstration of the inherent leverage in our business model. As our subscriber base continues to grow, we can bring more of the revenue down to the bottom line. Eli will discuss the third quarter financial results in a few minutes. Since mid September, we have been working hard to integrate Road Track into Ituran. As you know, Road Track has been our partner in our Brazilian joint venture, IRT, for a number of years. IRT has an OEM agreement in Brazil and Argentina with one of the world’s major auto carmakers providing their customers with telematics services on various new car models they sell for the first 6 months. Until the acquisition closed, we were not the majority owner in IRT. So we didn’t consolidate the results into our own and did not include the subscriber in our reported subscriber numbers. After consolidating the share, IRT subscribers as well as the new subscribers we gained from our acquisition which together amounted to a little over 0.5 million subscribers. Ituran now has well over 1.7 million subscribers. While our subscribers were predominantly in Israel and Brazil with a portion in Argentina and the U.S., we now also have subscribers in Ecuador, Mexico and Colombia. As the largest global independent telematics company, we now also had a much stronger platform to penetrate additional car manufacturer OEMs beyond the two that we are already working with. Beyond that, the acquisition gives us many potential areas of synergies to grow our business. It bring us the ability to grow and penetrate with our services into new countries in which we previously didn’t have foothold. In fact, we are already looking to launch additional services in our new geographies. In summary, we are pleased with our business performance in the third quarter as well as significant strategic steps that we took and we look forward to continuous growth over the quarter and years to come. I will now hand the call over to Eli for the financial review. Eli?

Thanks, Eyal. The acquisition of Road Track was closed on September 13, 2018. So there was minimum impact on the consolidated profit and loss statement, but the balance sheet and subscriber base as of the end of the quarter does include the full impact of the Road Track acquisition. Revenues for the third quarter of 2018 were $53.4 million compared to revenues of $60.6 million in the third quarter of 2017. 73% of revenues were from location based services subscription fees and 27% were from product revenues. Between Q3 2017 and Q3 2018 the weakening against the U.S. dollar of the Brazilian real which lost 25% of its value as well as the Argentinian peso which lost 84% of its value significantly impacted the U.S. dollar values of our revenues, gross profit, operating profit and net profit. Revenue breakdown for the quarter was $39.1 million coming from subscription fees versus $43.8 million last year and product revenues were $14.3 million versus $16.8 million last year. In local currency terms, subscription revenue grew 3.4% year-over-year while product revenues fell 13% year-over-year. The geographic breakdown of revenues in the third quarter which also includes 2 weeks of Road Track’s results was as follows: Israel 52%; Brazil 37%; and the rest of world 11%. Gross profit for the third quarter of 2018 was $28.9 million amounting to 54.1% of revenues compared with $38.5 million to 50.4% of revenues in the third quarter of 2017. The gross margin in the quarter on subscription fees were 65.3% compared with 66.7% in the same period last year, while the gross margin on products were 23.4% compared with 7.6% in the same period last year. While due to the mix, the gross margin on product sales this quarter was higher than usual and in the past few quarters, it was lower than usual, we expect the rate to generally average at the 10%, 15% rate. Operating profit for the third quarter of 2018 was $13.7 million compared with an operating profit of $13.9 million in the third quarter of 2017. In the local currency terms, operating profit grew 15%. During the quarter, Ituran had a one-time other income of $13.8 million. It was related to an accounting gain from an acquisition following the gains of control of the Ituran joint venture that Ituran has with Road Track Holdings in Brazil and Argentina which under GAAP rules, it accounted for the market value and was therefore re-evaluated. The total gain is net of the transaction related expenses. EBITDA for the quarter was $17 million representing a margin of 31.8% compared to the EBITDA of $17.4 million in the third quarter of 2017 representing a margin of 28.7%. In local currency terms, the EBITDA increased 13%. Net profit was $26.1 million in the third quarter of 2018 or fully diluted EPS of $1.24. This is compared with a net profit of $10.5 million or a 17.4% of revenues which is fully diluted EPS of $0.50 in the third quarter of 2017. Cash flow from operations during the quarter was $14.8 million. As of September 30, 2018, the company had cash including marketable securities of $57.4 million. The company also had short and long-term debt of $84.9 million. On a net basis, the net debt of the company was $27.5 million compared with a net cash of $40.4 million as of December 31, 2017. Let me also provide you with our pro forma numbers in order to help you understand how to model Ituran following the acquisition. Our pro forma numbers consolidate Road Track’s numbers from the beginning of 2018. The consolidated non-GAAP pro forma revenues for the first 9 months of 2018 were $217 million. Operating income was $59.2 million and net profit was $41.9 million. When assuming the constant exchange rates which is based on the average rate of 2017, our pro forma revenues were $286.8 million, operating income were $65.9 million and net profit were $46.6 million. For the third quarter, a dividend of $5 million was declared in line with the company’s dividend policy. The dividend’s record date is December 26, 2018 and the dividend will be paid on January 9, 2019. 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. [Operator Instructions] The first question is from David Kelley of Jefferies. Please go ahead.

Good morning. Thanks for taking my questions. Just a couple of quick ones. And I think you referenced maybe a little over 0.5 million subscribers in the quarter from Road Track, but just wanted to a) double check on that number and maybe if you could give us the underlying subscriber growth for the core business for the quarter? That would be great.

Actually, since this is the first quarter that we are consolidating the Road Track subscribers which overlapping some of our subscribers from the JV that we didn’t publish in the past and thanks to competitive situation. We will from now on provide the total changes in subscribers only in – like in the past only in the annual reports we will differentiate between geographies and this is a quarter which is a bit foggy, but from the next what you will see the changes that will happen through the quarter, we will never divide it between different segment and it’s what we are advised to do.

Okay, great. I understand. Well, thank you. And I guess another follow-up, could you provide a little bit more color on the big jump in the product sales gross margin. I think you referenced it should normalize somewhere in the 15% range, but I guess what with the product mix, regional mix what drove the big jump in the quarter and how soon should we see that kind of down shift back to that normalized margin rate?

As we saw in the past, the product mix between quarters and between seasons along the year and just reminding you that most of the product sales are done in Israel. In the future of course, we will have product sales from the Road Track segments. But regard Israel, the mix of product seasonality and in this case, even declining in sales because of the holidays still on the margins, we had a mixture, which allowed us to have a high gross margin. Just to be clear, this does not represent a constant gross margin, as well as having some quarters with a 5% is not constant. I would like to look on something around 15% as an average gross margin for the product line.

Okay, great. Thank you. I appreciate you taking my questions.

Thank you.

The next question is from Sasha Karim of IPI. Please go ahead.

Hi. Could you please give us the rough organic growth rate for Road Tracks business in the third quarter?

Yes. As we just answered the question, Road Track is part of the business now and we will not differentiate between different segments in the Group.

Would you even give us anything qualitatively like it was growing faster or slower than the core business?

Practically as we said, in Q3 the influence of Road Track was very minor on our P&L results since we are consolidating something like few days. So actually what you see is a very major represents the historical organic numbers. In Q4, of course, it will be much more substantial the contribution of Road Track, but for Q3 what you see is quite typical to Ituran historical organic growth.

That’s why I appreciate. I’m just trying to get a feel for going forward, once Road Track is fully consolidated in revenues if the growth of the – that the whole business combined should be faster or slower than before in organic terms?

Yes. So you can actually – you can actually I think look at the pro forma numbers that we published and this by small summary you can see the nine months how it’s look like and make your calculations.

Okay. Thank you. And then in terms of R&D in the third quarter, there seems to be a bit of a spike there. Could you explain and give us a feeling for what should happen going forwards?

It’s mainly because they had the same as it – it’s minor is again is some portion in Road Track, a high portion of their operational cost is from R&D, so it’s – this influence was a little bit more on the total P&L, but still it’s a minor strength.

And in addition, due to the acquisition there is a price purchase allocation that usually what we are making is – most of it is allocated to R&D and technology. So this one was depreciated for those days and this is also a small effect of that – effect on that.

Great. Thanks. And final one from me would just be going forward in terms of the balance sheet situation. Historically, you’ve always paid pretty high payout ratios of net income in terms of dividends. Now that you have net debt, is there any sort of change in the speed at which you would – you’d pay out net income?

Currently, the Board took a decision to continue with the dividend policy, which is representing $5 million per quarter and this is the situation today. Looking forward, we can’t say now. Now the policy is to continue with the dividend.

Great. Thank you.

Yes.

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

Hi. Thanks for taking my question and congratulations on the acquisition. Two questions. One is, first, you are showing the pro forma EBIT margin at 22%, and looking at this year, previously it had been somewhere along the lines of 25% to 26%. So, can you give any estimate as to how soon do you think that we might see the EBIT margin back at the previous levels or how do you see it going forward?

As you mentioned organically, Ituran was – is working with approximately 25% EBIT margin and the acquired business in the acquisition due to the segment that they are working over there is lower margin. The combined results together represent – will represent lower margin than the 25%. Of course, as the subscriber model as long as we continue to increase our subscriber base with this model, I don’t see any reason why this subscriber – this operating margin would not go up.

Can you give any estimate for example, one year from now, so they might be up?

We are not providing future forecasts, but as Udi just mentioned, I think that there is a high visibility regard our margins and specifically based on the pro forma that we supply, you can imagine that there is no high differences and high volatility in a longer-term period.

Exactly. Then just one small detail. Can you provide us with the number of shares, you provided the average number of shares, but you didn’t know the kind of closing numbers already, so it’s something like 21 million and maybe 300,000, but what’s the exact number?

Sorry about that. We didn’t understand the question regard the shares, what part of the shares, what – that is not appear in the financial –

The number of shares of the company, what’s the current exact number?

Sorry, we are not –

You mean for the acquired business?

No, no. The number of shares of Ituran. So, it used to be 20,968,000 and now you provided us with the average number of shares, which is a little bit plus 21 million and – sorry about that.

Okay. It’s actually almost the same. It changed with about 370,000 shares that was allocated as part of the price of the acquisition. So today we have 370,000 shares more.

So, it was 21 million and now going forward, it will be around 21.3 million shares.

Exactly. Thank you.

Welcome.

Next question is from Abba Horwitz of Old School Partners. Please go ahead.

Hi, good afternoon. I was – I have two questions. One is – is there any rush for you to pay down the debt and would this hinder you for making other acquisitions, the current debt position? That’s the first question, and then I’ll get the follow-on after that.

Hi. Good afternoon. No, we actually have the debt under payment conditions and a contract, of course, with the bank that gave this loan. We are not in a rush to pay it back and we will take any decision whether pay it back or not during the next years upon our needs for money. Regard additional acquisition, so from a financial point of view and a balance sheet point of view and a debt ratio, of course, I think that is very easy to see that we have the capabilities, but practically and operationally, I just want to mention that in the next couple of months or the next year, we are not expecting to make acquisition since we have a lot of work to do to create synergy and to create better results from the current acquisition.

Okay, that’s great. I applaud that. Second question, I don’t know if you mentioned this, I came on the call late, but did you talk about your Venture Capital investments, and if you didn’t, could you talk about them and where they are and valuation wise as well?

Yes. Actually, we have main, I would say, main three investments to where we have a very minor share which is only to have, I would say our footnote and relationship and of course the future upside. The third one which we should be more familiar with which is bring where we hold almost 25% and we are the largest shareholder and we already after 4 years since we were the first investors had three times of – three rounds that devaluation and the investors grow very materially. This company is doing very well. Of course we are not published, it’s a startup yet, we are not published any internal information, we are only show it in our P&L under the equity side, but from my perspective and the way that we see this company is that we are very optimistic in regard to the improved and going forward. We also have part in Israeli incubator, but there we are more talking about very, very early stage ideas, very early stage, if I can say companies. At that case, we are more using it for creating future solutions that we can adopt or as well with our partners which is if you are don’t remember, it’s Honda, it’s Volvo, it’s Hertz as together with us and of course we are measuring every quarter what is the more longer term possibilities to join forces with these technologies, but this is not something that you can see on the P&L right now, it’s something which is more a longer term being at the high and excellence of the Israeli automotive technologies that are as ideas of development.

Okay. And just to bring investment, do you expect to IPO this investment at some point, do you expect to completely monetize your 25%, is there currently a value in the private market for this 25% position that you own?

The last valuation which was less than a year of course was I remember was very close to $100 million and devaluation of Bringg. As I said, we are representing the largest shareholder. We have a major portion in the board, but it’s more and more going towards the market of shipment, market of real-time shipments. I believe that if the company will continue to grow as it was in the last 3 years, for the next 3 years no doubt that this company goal to become much larger and in some point of time, IPO is not an ugly word, but to say that this is the goal, it’s is not the goal, it’s to create, I wouldn’t the use the term, rather use the unicorn, but at least a small unicorn in airfield in each field.

And just, I am sorry I had one more is you have a very good story to tell especially now with the acquisition that you have done and it’s actually a major company even more valuable and more undervalued and I am wondering are you going to be telling the story to investors at any point? Would there be any sort of IR effort on your side?

I can’t argue with you. But yes, one of the things that we are now putting more gas, pushing more forward is IR. We are going to present in months from now soon after the beginning of next year at the Needham Conference in New York. And in 2019, our goal is to be more, I would say, acting and more aggressive in being in conferences and kind of roadshows with investors around the world and, of course, specifically, in the United States. Yes, absolutely, you’re right.

Okay, fantastic. Thank you, again, and good luck.

You’re welcome. 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 at www.ituran.com. Mr. Sheratzky, would you like to make a concluding statement.

Yes.

One moment, one moment, we have another question on the line. Following question is from Lee Kronzon [ph] of General American. Please go ahead.

Can you update us on the joint venture, the partnership you have in India and the progress you’re making there?

Yes. Again, as we mentioned when we established this joint venture few quarters ago, we just are now building the local infrastructure of the joint venture, that means first, we recruit the general managers and his team. We start few pilots with some large player in the industry. We are now at the stage of some RFQs and a price list. I believe that soon we will see some deals taking place there. The influence again on our financial results in 2019 I believe or to be conservative will be minor, but in terms of the trend that we are – see in India for adopting and welcoming our ideas, we are very optimistic, but I think that we need this emerging market, this big market and this very premature market more patient and understanding it’s a more longer term. Since we’ve been here all of us when we did it in Brazil in year 2000, 2001 and the first time that we actually start reaping fruits was 5 years later, I believe that first we can do it faster, but still we have a long way before it will be material or more material, but no doubt that this is a very, very potential and attractive market for what we have to offer.

There are no further questions at this time. Mr. Sheratzky would you like to make your concluding statement?

On behalf of the management of Ituran, I would like to thank you our shareholders for your continued interest and long-term support of our business. Have a good day. Bye.

Thank you. This concludes the Ituran third quarter 2018 results conference call. Thank you for your participation. You may go ahead and disconnect.