Ituran Location and Control Ltd. (ITRN) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran First Quarter 2020 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 and 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, would you like to begin?

Yes. Thank you, Operator. Good day to all of you, and welcome to Ituran's conference call to discuss the first quarter 2020 results. I would like to thank Ituran's management for hosting this call. With me today on the call are Mr. Eyal Sheratzky, the CEO; Mr. Udi Mizrahi, Deputy COO and VP Finance; and Mr. Eli Kamer, the CFO of Ituran.Eyal will begin with a summary of the quarter results, followed by Eli with a summary of the financials. We will then open the call for the questions-and-answer session.I'd like to remind everyone that 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'd like to welcome all of you, and thank you for joining us today. I hope you and your families stay healthy during these unprecedented times, and I wish all those would have been impacted by the virus a speedy recovery.As you all know, 2019 ended a tough year for Ituran, where we overcome multiple challenges. 2020 was off to a good start. We had strong expectations before the global effect of the pandemic began to materialize in late February. I believe that once the major impact of the pandemic on the world is behind us, we will return to the positive trend that already started at the beginning of this year.During this period, our top priority has been ensuring the health and safety of all of our employees as we continue to serve our customers around the globe and cut costs as a result of the sales decrease in this period. To achieve that, we eliminated all international travel by our employees and took steps to implement social distancing at all our facilities. For many employees, we provided the infrastructure and implemented work from home, limiting the office to only those workers whose physical presence was absolutely essential. Face-to-face meetings have been minimized, and we are utilizing video conferencing where possible, including for business development and sales meetings. We continue to follow local authorities' directives as they develop and adjusting as needed.Despite the logistical working challenges the COVID-19 pandemic has created for everyone, including us, I want to point out that our business is highly resilient. We have almost 1.8 million globally distributed subscribers, whereby the majority of them are paying us on an ongoing basis a monthly fee. Our starting point each month is already on the back of this.As you can see, this enabled us to remain profitable and cash flow positive during these unprecedented global crisis. Obviously, the lack of new car sales during this period impact our ability to recruit new customers and grow our business in the OEM business as well as the aftermarket business. And this is why we have taken steps to reduce our expense footprint and conserve cash, which I will discuss soon.I will spend the next few minutes diving into the details of both the corona impacts on the aftermarket business as well as the OEM business. In the aftermarket business, we added 17,000 new subscribers, in line with our typical range of 15,000 to 20,000 per quarter. The vast majority of these new subs joined in the first 2 months of the quarter. So you can see from the rate, we would have been at least at the high end of our typical subscriber growth expectations.Drilling down to the performance in our main market, Israel and Brazil. The aftermarket business in Israel remained stable in the first quarter until March, when corona started to shut down the country and brought new car sales to halt. The year started well in January and February. New car sales in Israel were about 7% ahead of those in same period last year. However, March was down about 35% versus last year and April was down 90%, essentially reflecting the timing of the shutdown, which was from March. Even so, during April and part of May, our subscriber base in Israel were minimal.I also want to point out that our churn rate also dropped substantially as nobody was selling their old cars. This has led to the situation that we expect to see a net subscriber loss in the second quarter, but this should be a minimum. As the country start opening up again, which as of now has begun to happen with shops and schools reopening while implementing social distancing, I do expect the new car sales to slowly start recovering over the coming quarters. In the long term, I'm optimistic that the aftermarket business in Israel will return to growth. Furthermore, it ran today as many other strategies for penetrating additional segments.As I discussed last quarter, one of our growth drivers in Israel is our UBI offering, usage-based insurance, and I expect this to become more significant to our subscriber growth in the future. There are insurance policies built around Ituran solution for taking into account a driver's accumulated mileage and behavior as it's related to use and safety. This allows insurance premiums to be directly related to usage, which is fair for the driver and better for the insurance company in terms of managing the risk. Many people in Israel had hardly used their cars for the past 2 months, yet are unfairly still paying for insurance. Thus, our service is gaining more interest in the new normal of today's world.As we spoke about in past quarters, we've already signed on two insurance companies for our usage-based insurance service in Israel, Harel and Shlomo Insurance, and saw good initial success. I am happy to say now that we have recently signed our usage-based services with additional three insurance companies in Israel: AIG, Akshara Insurance and Bituach Yashir, which means direct insurance and is the largest car insurance company in Israel. These are solid steps towards my goal of becoming the new gold standard in the insurance market.Now that we have proven the success in our home market of Israel, we have recently signed a UBI agreement in Argentina and we're negotiating potential UBI projects in Brazil now. This is the initial approach of our strategy to expand our UBI offering beyond Israel into the other geographies that we are now operating in.Looking at our aftermarket in Brazil, the market there has also been very weak since the start of the pandemic. Our results in Brazil have been compounded by the significant weakness in the real currency versus the dollar, which has lost 1/3 of its value in the past year. In Brazil, the new car sales in January and February already started the year slightly below those of last year, reflecting economic weakness in the country which existed even before the pandemic started. However, March new car sales were down 22% in Brazil to a 14-year low, and April sales are down 77%. While many of the car manufacturers have moved to online car sales, expectations are that new car sales will remain at these low levels over the next few months until the pandemic situation stabilized there as well.In Mexico, we continue building our new Ituran com Seguro program using our long-term success in Brazil and adjusting it for the Mexican market. This is an example of the synergies we are exploring from Road Track. We hope to launch and start selling the product toward the end of the year once the impact of pandemic situation is over.And now to our OEM business in Brazil and Argentina. Because of the weak economic situation in Brazil and Argentina already starting last year, our major OEM customer reduced their subsidized free trial period from 6 months to 3 months and then down to a month, which impacted our OEM results significantly in the second half of the year last year, in addition to reducing significantly the hardware sales. Now because of the impact of the coronavirus, the lack of new car sales is impacting our OEM customers, and we had a net loss of 4,000 subscribers on the OEM side in the first quarter. In the second quarter, we expect this effect to be even more significant.In light of the corona pandemic and its impact on Ituran, we implemented changes to preserve our profitability. This included across-the-board reduction employee salaries of up to 30%, which includes a reduction in head count while looking to take further measures to cut costs and improve efficiency. We have done this with full cooperation of our employees around the world, which have shown solidarity with our efforts and agreed to this reduction. And for that, I want to thank them now.Our quick actions to reduce cost has enabled us to maintain profitability during this period, and we expect we'll continue to preserve our profitability and positive cash flow in the coming quarters until the global situation improves and we come back to normal course of business. Furthermore, the Board decided to suspend our dividend payment for the time being in order to preserve and build our cash position faster. This will provide us a better cushion in which to weather this period while also providing us with capital to take advantage of any opportunities.In summary, while 2019 was a tough year for Ituran, we felt that 2020 would be a year of continued sequential improvement throughout the year, and we did start on the right foot. First quarter revenues were ahead of those of the fourth quarter, and we are indeed pleased with our performance, especially given the corona backdrop. As the impact of corona became clear, we have taken steps to ensure we maintain profitability and preserve cash.In the second quarter, we expect to see the most of the impact from corona with EBITDA lower than that of the previous quarter by 10% to 20%. However, while making sure we are fully prepared to weather the storm, I'm optimistic on the long-term potential for Ituran. Ituran is a company with a very resilient business model, whereby 1.8 million subscribers already provide us with a monthly and ongoing significant revenue base. We prove that even during such unusual times and the most severe global crisis in 100 years, we are able to remain profitable and generate cash. Beyond that, many of the challenges we had last year forced us to make improvement. And as we emerge from the corona pandemic, I believe we are well positioned to resume growth quickly.In addition, we continue to see growth engines. For example, as I mentioned, the UBI business in Israel and elsewhere. We will also continue to expand our existing services and competencies to the new countries in which we now operate. I'm confident that Ituran will emerge this period as a stronger and more efficient company.I will now hand the call over to Eli for the financial review. Eli?

Thank you, Eyal. While in the past year we have also been reporting non-GAAP results, the difference between GAAP and non-GAAP is now minimal, so we have now ceased our non-GAAP reporting. Furthermore, we feel that in the current environment, a comparison to the results of the previous quarter is a better benchmark for Ituran's current status. So in some cases, I will also refer to the change versus the previous quarter. You can also refer to the press release we published today in our results.Revenues for the first quarter 2020 were $68.4 million, a decrease of 7% compared with revenues of $73.6 million in the first quarter of 2019. Compared with that of the previous quarter, revenues grew by 4%, and excluding the currency effect, an increase of 7%.Revenues from subscription fees were $49 million. This represents a decrease of 8% over first quarter 2019 revenue and 1% decrease over period quarter's revenue. Excluding the currency effect, revenues would have shown an increase of 2% versus the period quarter.The subscriber base amounted to 1,794,000 as of March 31, 2020. During the quarter, Ituran added 17,000 aftermarket subscribers while the OEM subscriber base declined by 4,000. Product revenues were $19.4 million. This represents a decrease of 5% compared with that of the first quarter of 2019 and an increase of 22% over that of the previous quarter. The improvement over that of the period quarter was mainly due to Israel's car sales.The geographic breakdown of revenues in the first quarter was as follows: Israel, 46%; Brazil, 27%; and rest of the world, 27%.Operating income for the quarter was $10.1 million or 14.7% of revenues. This is a decrease of 25% compared with $13.5 million or 18.3% of revenues in the first quarter of last year. This is an increase of 3% compared with $9.8 million, 15% of revenue that we reported in the previous quarter, which excludes the impairment charge in the quarter. Excluding the currency impact versus the previous quarter, operating income would have grown by 6%.As mentioned in previous quarter, the main year-over-year decline was due to the OEM business as a result of selling of less hardware and reducing the free trial period of new subscribers.Net income for the first quarter of 2020 was $6.4 million, 9.3% of revenues or fully diluted earnings per share of $0.31. This is a decrease of 21% compared with $8.1 million, 10.9% of revenue or fully diluted earnings per share of $0.38 in the first quarter of last year. This is also an increase of 29% compared with a net income of $4.9 million or fully diluted EPS of $0.24, which excludes the impairment of $20.2 million in the previous quarter. Excluding the exchange rate impact, this growth would have been even higher at 34%.EBITDA for the quarter was $15.3 million, 22.4% of revenue. This is similar to that of the previous quarter at $15.5 million, 23.7% of revenue and a decrease of 21% compared with $19.3 million in the first quarter of last year. Cash flow from operations for the first quarter of 2020 was $10.7 million.As of March 31, 2020, the company had cash, including marketable securities of $50.1 million and a debt of $63.5 million, amounting to a net debt of $13.4 million. This is compared with cash, including marketable securities, of $54.3 million and a debt of $67.9 million, amounting to a net debt of $13.6 million as of December 31, 2019. I note that the cash balance was impacted in the quarter due to the $5 million payment of the first quarter's dividend and $4 million cash outflow from CapEx as well as the impact of local currency cash balances when translated to U.S. dollars for reporting.With regards to the buyback, as of March 31, 2020, Ituran had repurchased a total of 227,828 shares amounting to approximately $6 million.And with that, I'd like to open the call for a question-and-answer session. Operator?

[Operator Instructions]. The first question is from Tavy Rosner of Barclays.

This is Peter on for Tavy. I just wanted to ask about the geographic contribution. Could you give us some color on how you expect the recovery to proceed in Israel versus Brazil? Because it sounded like you -- Israel should recover more smoothly compared to the other regions. And it looks like the Israel contribution to sales is up about 10% from last year's first quarter. And I'm wondering if you would expect it to continue to grow versus Brazil and Argentina.

First of all, we should consider that Israel is actually advanced about 2 to 3 weeks compared to Latin America and specifically, to Brazil. And if we see now that Israel has already overcome the peak of the pandemic situation and the countries start to be released. And to be more specifically, when we are looking mainly for the car dealers and the car importers and the car showrooms, it's just less than a week ago. It's opened again. Of course, it's gradually become a normal situation. So we believe that Israel, of course, will be ahead of Brazil in this situation basically because of the time differences between the speeding of the coronavirus. Based on any other fundamentals, I don't know whether there is big differences. So maybe 2 months from now, we will see, hopefully, that everything is back to routines. And then each market will have to work with the micro situation. Generally speaking, also Israel and Brazil has a subscriber fees model, which includes very diversified recurring revenues, which we continue to get. It's right that we are not in a position to grow because car sales is very low and there were days when it was 0.But on the other hand, the additional source of revenues for Ituran, which is the current customer base, showed a very strong situation because -- and I told this when I made my speech, the churn rate, the churn numbers also declined because the major reasons for people in Israel and in Brazil to churn is usually when they sell their car and they buy the new one. So the situation happened is that, of course, people are not buying new cars, so people are much less selling their own cars. So we will not grow the subscriber base, but as we show in Q1, we hope that in Q2, the decline will be very, very low numbers, which allow us to continue to generate most of our revenues and most of our cash.

Okay. So your longer-term strategy in Brazil is unchanged on account of the epidemic.

Yes.

Okay. And just a quick follow-up. Have you -- did you say that you did any headcount reductions along with the cost savings? Or was it only the salary cut?

Okay. I will explain. It's very important for me. Since our DNA is to look for the health and the wellness of our employees, we did our best not to fire anyone. So most -- almost all of our reduction came by reducing salaries across the board, including us, the top management, the mid-management and of course, until the last employee of the business, almost 3,000. But in Israel, there was an ability because, of course, the service needs and the sales needs were declined dramatically. So we could relieve for a month, which now is over, and we brought back almost 90% of the people that we let them go to a vacation which paid by the, let's call it, kind of a vacation paid by the government in Israel. The Israeli people know this as a halat, unpaid vacation.And now we bring them back because of two reasons. One reason is because really the market is open again. And second, because they finished their time that they deserve this program, and we want to keep them and we want to allow them back to work. And the second place, which we also took out about 200 employees, it was installers, which working as subcontractors and wasn't on the payroll and they have a direct -- they have kind of a direct cost per installation. Since the installation declined to a very low number, so we released them.This is the only two situation when people are let out of the company, as I said, part of them already back. And the rest of the cost was done by reduction of salaries and reduction cost for our suppliers. By the way, which, by the way, we will keep it. We will keep it until the moment that we feel that really not the pandemic only behind us, but the economic situation and our business life in Ituran will allow us back to the historical salaries.

The next question is from David Kelley of Jefferies.

I guess, starting with a follow-up on the cost savings discussion. Could you provide some color quantitatively on how we should think about the magnitude of the savings in the second quarter? And ultimately, we're just trying to get a sense of the margin offset given the expected top line disruption related to the virus in Q2.

I would say the vice versa of my answer is that the reason that we did all this cost reduction is because we assume that we will not have new sales and new additional revenues. And we also considered some decline, which will come from churn of our customer base. At the beginning, by the way, we took a much more dramatic decline because there was a lot of more question marks than we know today how the market will react in Israel after 2 months or more than 5 months since the pandemic starts in China. And also, we now have experience of how to look on our Latin America subscribers' behaviors at this time. So practically, the actions that we took was very material. We will keep it. And since I'm not going to give a specific number for the cost reductions, I already said that we expect that, although we have no new sales so we're facing churn, we will show, we hope, we believe -- we expect to have results in Q2, which, by the way, all Q2 hurt by the pandemic, which is the largest crisis, I think, ever for the people that are on this call now. So all the change from Q1, which was quite fair, will be between 10% to 20%. And I believe that I'm conservative in order not to create high expectations, and of course, there is some question marks about the situation. But this is mainly thanks to making this cost efficiency and cutting those costs.

Okay. Great. Appreciate the color. And I guess kind of switching gears, the macro for auto manufacturers really deteriorated in the back half of March and you referenced a likely steeper OEM subscription decline in Q2 due to the virus disruption. I guess, is that largely a function of the auto sales declines? Or do you expect any incremental OEM pressures, whether it be trial length or pricing as well?

So I think as you ask -- you are asking is that it's really more, I would say, complicated is more reason. So first of all, for our OEM business in Brazil, Argentina, as you know, historically, since late 2018, since our customer suffered from more economic problems and sales problems so we always downgrade, okay, the contract and the size and the scale of the business with him. So our major health was in 2019. So of course, it's not going to be improved, but most of the reduction is behind us. And we are expecting that it will continue, but the number now of this contribution to our total P&L becomes much less material. So the interest will not be dramatic on the total numbers, but of course, this started before the corona. And of course, the corona in the macro situation in Brazil and Argentina will not make it better.It probably will make it worse. But I'm saying again, these specific markets on the OEM side is not material to our total results now. The other business that we have in OEM, which is mainly in Mexico, Ecuador and Colombia, which is in Ecuador and Colombia, it's a different model, different OEM model. I mean we are more -- let's say, we are providing more interest and positive cash to these car manufacturers that they need us more than we need them. So even if there will be decline in car sales, one, they will start selling again. We will continue to sell a very high percentage of our unit to these car manufacturers. There will be a decline or the -- to back to the numbers, before the coronavirus, it will take more time, but it will happen. And in Mexico, which is a totally different car brand, I must tell you that our situation, and I will remain -- I will remind you that in 2019, from about March to September, we had almost zero sales to this car manufacturer, not because of any commercial reason, it was because of the technical unexpected change of the cellular network to 3G.We overcome it in September. We're back to track to the numbers and the commercial life with this customer become good again. And now we have the pandemic. But the things that we are now seeing, when we are talking with this customer, is that although you think it will sell less car or it will take time to sell the same numbers as before, still they intend and they already put some POs, purchase orders, for much more units and services from us for the future. Although I can't say that it's committed, I can't say that -- but it showed us that -- and they told us they take it as a very important feature in order to market or to back to the market with their new cars. So I believe that looking ahead to 2020, no doubt that the OEM subscribers in Ituran customer base will decline, will continue to decline. Also, the damages to our results will come from this sector, which is the OEM. But looking a little bit further the pandemic and really further to the current situation, we believe that during 2021, the OEM will continue to grow again. And as I said, mainly in Mexico, mainly in Mexico. In Mexico, I see very positive signals that we should expect in the future, not less that we get used to in the past. Of course, in the end, it's a very -- it's 100% correlation to their car sales. So this is something that we depend on them. This is regard the OEM, if you asked.

The next question is from Asaf Chandali of Oppenheimer.

Congrats on a very solid quarter. Just on currencies, given the weakness of the real and maybe to a certain extent the shekel and 1Q '20 versus 1Q '19, we expected a more significant FX impact. When you're saying about 300 basis points year-over-year, was there any offsetting kind of factor here? Or maybe just walk us through that?

As you mentioned, yes, the effect is around $0.5 million, I mean, in the quarter compared to the previous year, Q1. But I think if you compare, when we are analyzing and translating into the U.S. dollar, we are using the average rate for the quarter. So when you use the average rate of the quarter, including all the currency and the mix between the real, shekel, for example, the real is getting -- was weaker by 30%, 40%. But if you look on the other currencies like the Israeli shekel, it's more or less the same. So this is more or less the effect that we have.

Okay. Okay. And then maybe on just use of capital, including the dividend moving forward. You mentioned in the press release that you might take advantage of any opportunities you guys are seeing in markets. Any bit of color on use of capital, including dividends?

Yes. First of all, it came from a defensive situation. Since there is a lot of question marks about the final date for all these crises, and although we did all the things we need to be done, still, nobody knows what the future will look like. Don't forget, we have some loans that we have to pay back. Of course, our positive cash flow and our expectation for the positive cash flow, even if it will decline a little bit, we'll not have a problem. And our credit lines are a way beyond it. But still, we are conservative. We've always been conservative. So first of all, we want to secure our cash position in the company. And then once we will see that we'll be too conservative or we see that the things start to release and we can continue to be more aggressive in using the cash for marketing, for sales and also for opportunities, so we believe, and that's what I see now with some of our competitors, are in a very bad situation.So we believe that even if the market will shrink, we can get more market share in the markets that we are operating. And it should be very dramatically. Because even if the market will go 20%, but we will increase our market share 30% or 40%, so we can grow based on our competitors. And then this situation, we can also think about using the proceeds to making some partnerships or M&As. I'm not saying that we have something concrete. But these days, nothing is concrete. So I think that in order to be ready to the sun that will shine, I want to be there with the right swimming suits.

The next question is from Sasha Karim of IPI.

I'm just interested in -- I know there is a lot of uncertainty, but in a scenario where economies generally reopen somewhat in the third quarter, let's say, at the beginning of the third quarter, would you therefore expect services revenue to increase off the 2Q base? Or reversely, could there be a rise in churn which stops that from happening?

First of all, I want again to remind and to explain our model. The good thing in the model that is in a crisis situation, we're very diversified and strong cash flow and income and revenues from those current subscriber base once the market will open. So of course, we believe that this will be the time that we can grow our subscribers. But we have to understand, just for -- to illustrate, if we have 1.8, just a general number, 1.8 million and we grow even 20,000 in Q3 compared to Q2, the additional revenues from this 20,000 when you compare it, if it's 1.82 million or 1.8 million, the difference is very -- it's not material. But as a company, you're looking forward, so you mean that if we will succeed or if the market will allow us and will be open, so we will grow our new subscribers Q3, and then hopefully, Q4, and then every quarter, so 1 day, we should be -- when it become more materialized dollars, of course, it's very important. So the first thing we want to do is grow our subscribers, always growing subscribers, grow your revenues and growing your profits. But I must make a note here. Even if we grow it in Q3 compared to Q2, the influence on the P&L is very low to see it on the specific quarters. This is the idea of this business model.

Got it. But it sounds like you're not ruling out that subscriber numbers could increase in third quarter, albeit a small amount?

Yes, yes.

[Operator Instructions]. There are no further questions at this time.There is a follow-up question from Asaf Chandali of Oppenheimer.

Just on gross margins and the cost-cutting measures you guys are taking, do you expect it to mean more on OpEx? How should we be thinking about gross margins for both the services business and the products business moving forward?

First of all, I just, again, want you to make it clear, most of our expenses is human resources and the human resources is also spread between the typical OpEx and the cost of our services. Because the cost of services is not like cost of goods. This cost is mainly cost of employees. So it's a little bit different than a typical company that are not dividing between like -- between service and hardware or service and software. And so generally speaking, we did our cost reduction across the board. It should -- it appeared in our gross cost of services and also in the regular OpEx, which is sales and marketing, G&A and R&D. In terms of percentage, it's very difficult for me now to give you estimation of the rate, but it should be stable like now. Okay?

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?

On behalf of management of Ituran, I would like to thank you, our shareholders, for your continued interest and long-term support of our business. I would also like to thank our employees for their understanding and efforts in these difficult times. While I feel we have taken the correct steps, and we have reacted quickly to the current situation in order to preserve our profitability, I'm also optimistic and we are preparing the company for return to the normal course of business as soon as things start to open up again. As we are currently not traveling, we will be holding virtual meeting with investors. I will be presenting at the Ituran Virtual Conference on May 19 at 8:30 a.m. You are all invited to listen and also to request one-on-one meeting with us. We are also open to speaking with investors that are interested until the end of the quarter. Please be in touch with our Investor Relations team. I do like -- look forward to speaking with you next quarter and hope that we will all see better times by then. Have a good day.

Thank you. This concludes the Ituran First Quarter 2020 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.