Ituran Location and Control Ltd (ITRN) Q1 2019 Earnings Call Transcript

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Ituran Location and Control Ltd (NASDAQ: ITRN)
Q1 2019 Earnings Call
May 21, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran First Quarter 2019 Results Conference Call. All participants are currently in a listen-only mode. Following management's formal presentation instructions will be given for the question-and-answer session. (Operator Instructions) As a reminder this conference is being recorded.

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?

Gavriel Frohwein -- GK Investor & Public Relations

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.

Eli -- Eyal will begin with a summary of the quarter's results followed by Eli with the 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.

Eyal Sheratzky -- Chief Executive Officer & Director

Thank you Gavriel. I'd like to welcome all of you and thank you for joining us today. 2019 has started with its run being a company on a much larger scale with more potential for growth. Ituran 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 come from a number of different levels. While in the past our growth traditionally was driven simply by the net increase in the subscriber base. In the aftermarket, today their are additional legs driving our goals.

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 existing geographies. We now have a much stronger platform to penetrate and we are in early discussions with additional car manufacturer OEMs beyond the two 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 a 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 growth 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 debt based on the type of the customer.

At the end of the first quarter together with the 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 am 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. Our Harel insurance will be all the insured costs, including installation and monthly subscription fees to us. We see this product as a real advantage for 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 in 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 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. There 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 piece. As of the end of the first quarter, our active subscriber base was 1,783,000 (ph) of which retail was 1,229,000 (ph) 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 rate, our visibility is lower and the growth rate depends on their 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 US dollars 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 impacts 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 customer and vice versa. We have a strong foothold to penetrate services into new countries. We are already launching additional services in those news geographies. Furthermore, about 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 a telematics for their usage based insurance policies.

My goal is that Ituran will always remain at the forefront of technological advancement in an ever changing consumer 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 buyback our own shares depending on market conditions is a tool that will contribute to shareholder 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?

Eli Kamer -- Chief Financial Officer & Executive Vice President-Finance

Thanks Eyal. I know that the results I present will be on a non-GAAP basis including adjusted EBITDA. Which excludes revenues and costs related the purchase price allocation. We believe this will provide a better understanding of our ongoing performance. For further details with regards to the reconciliation between the non-GAAP and GAAP result. Please see the tables 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, and 19% year-on-year increase. In local currency term 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 term, 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 operation 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 multiple 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 record date is June 20, 2019 and the dividends will be paid on July 3, 2019, net of taxes and levies at the rate of 25%.

And with that, I'd like to open the call for the question-and-answer session. Operator?

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time, we'll begin the question-and-answer session. (Operator Instructions) The first question is from Tavy Rosner of Barclays. Please go ahead.

Peter Zdebski -- Barclays -- Analyst

Good morning. This is Peter Zdebski on for Tavy. (inaudible) for taking my question. 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.

Eyal Sheratzky -- Chief Executive Officer & Director

Hello.

Peter Zdebski -- Barclays -- Analyst

Hello.

Operator

Hello. Can you just repeat the last part of the question?

Eyal Sheratzky -- Chief Executive Officer & Director

We didn't heard the last part.

Peter Zdebski -- Barclays -- Analyst

Oh, 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 getting affect the Road Track and the bigger OEM contribution?

Eyal Sheratzky -- Chief Executive Officer & Director

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

Peter Zdebski -- Barclays -- Analyst

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

Eli Kamer -- Chief Financial Officer & Executive Vice President-Finance

It's not very -- it's not -- 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 a higher cost. And it's not -- there are differences in the ARPU, we will not give the right number or the specific number, but just to give you a rough information or general information, is lower, but not material.

Peter Zdebski -- Barclays -- Analyst

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

Eli Kamer -- Chief Financial Officer & Executive Vice President-Finance

First of all, even I would say a little bit historically, we didn't touch it in our last conference calls. 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 market that we all 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 acquire it with a 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 a much higher than a year ago, it will be stable, we are now fully loaded with the power and the resources that we need to support our growth.

Peter Zdebski -- Barclays -- Analyst

Thank you.

Operator

The next question is from David Kelley of Jefferies. Please go ahead.

David Kelly -- Jefferies & Company -- Analyst

Good morning. Thanks for taking my questions. You referenced the 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?

Eyal Sheratzky -- Chief Executive Officer & Director

Regarding numbers of subscribers as I said in my speech, we are absolutely see and believe or expecting that the numbers of subscribers will come back to where 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 one or two more quarters because the nice thing in operating leverage hurts us when we had declining in the growth, but when we will back to the growth in subscribers. In one, two or three 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.

David Kelly -- Jefferies & Company -- Analyst

Okay, perfect. And then maybe switching gears to the usage based insurance agreements that you announced last week. Appreciate the color on that. Can 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 one to two 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 I would love to just get some more color on UBI?

Eyal Sheratzky -- Chief Executive Officer & Director

Okay. I would start by saying that we identified and realized the new opportunity in UBI, about more than three years ago and we started to develop the softwares, the technology and all the backups to integrate it into insurance companies needs. We had the first contract a few years ago with AIG in Israel. AIG those days were a very small insurance companies for the vehicle and second their model was based on putting the cost of all these program on the insurers. So, it's too cost, but the numbers were not enough, but it was a good pilot for the market and for us. Since then of course we move forward much better, much more, the technology is better and we see now or we saw during 2018 that the Israeli insurance market as well as other markets in the world are changing toward more digital insurance, more application, 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 start talk with all of them. And by the way, they checked not only Harel, but all the -- many other insurance companies that are now on their way to being these -- in this program. And 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's mean that they checked not 100% and 100 pilots, but 1000% that we are the right host to gain the loan. And it was like a tender process and many other companies from the rest of the world as well as other Israeli technologies and their software whereas these, I would say bid on these showroom. And we won, we signed the contract and being honest my feelings is that or at least we believe that we will dominant this market in Israel. Hopefully as we did with SVR solutions.

And in terms of number, we have to understand when those dominant insurance companies decide. I would say to change their models, to change the market. 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 you know what is the highest price you can pay. And along the year of the policy you will always can only getting discounts that we keep the old way. So we 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, you know, 100, 1000s or millions or whatever the insurers 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 its a direct insurance to educate their marketing channels it will take time, but as we see and by the way Harel is already commercially and they spent millions of dollars currently for the people that lives 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 in sales.

So, we believe that this is really giving us a new segments with 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 end since everything is digital, everything is automatic. So all our service costs which we -- you haven't experienced with our P&Ls, is that we have control center, we have customer support centers, all these are deep case, the cost is mainly was the R&D.

And now this supports, 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 100s, of 1000 subscribers in the next five years that it can be very material to the Israel -- Israeli numbers.

Again, we just started with Harel, we are -- we believe or we have discussions and we have competitors. But as I said, I believe that in two, three years from now, we are very optimistic regarding having 10s of 1000s of new subscribers. And this is by -- and I'm conservative. I'm very conservative. So it can be material for the Israeli market, yes.

Then as we saw in the past when we get to Brazil, we already have been break even in Israel. It was many years ago, but it took us three to five years to become dominant in the market. I believe that Latin America, which is more emerging market than Israel will be ready in few years to accept and for us to duplicate this solution, but this 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.

David Kelly -- Jefferies & Company -- Analyst

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

Eyal Sheratzky -- Chief Executive Officer & Director

No, it's much easier in the contract side. Again, the SVR will depend on how we sale to the insurers because it was pure B2C. Now, we're 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 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 a UBI premium from Harel and in the future from the others. So, the pricing are a part of the contract. As I said, I don't want and I cannot disclose the prices is a B2B deal. But as I said, is lower than the SVR, but it will be more profitable.

David Kelly -- Jefferies & Company -- Analyst

Great. Thank you. I appreciate all the color. Really helpful.

Eyal Sheratzky -- Chief Executive Officer & Director

Thank you.

Operator

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

Sasha Karim -- Inflection Point Investments -- Analyst

Good afternoon and thank you also very much for the extra color you gave on this call. My first question would be on the 13,000 -- 15,000 to 20,000 typical subscriber net addition per quarter. That number seems a bit low to me because you acquired Road Track and in the past you have done between 20,000 (ph) and 13,000 in some quarters. Can you just comment on why the new normal is only 15,000 to 20,000. Is there some mature -- maturity perhaps new markets now?

Eyal Sheratzky -- Chief Executive Officer & Director

First of all, as I said, and maybe it wasn't clear. When we gave the forecast or the expectation for 15,000 to 20,000 per quarter after for example this quarter we did only the 8,000 and I mean it's only for the retail aftermarket segments which historically that 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 regard 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 the Road Track with an OEM subscriber base. The OEM subscriber base that we acquired has now potential to grow by itself because its very solid, very depend on the sales of those customers. It's about three customers in four 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 to those geographies based on this platforms. Second, to use our additional services and other experience to grow and expand the 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 reports 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 resulted without us can grow. Clear?

Sasha Karim -- Inflection Point Investments -- Analyst

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

Eyal Sheratzky -- Chief Executive Officer & Director

It's something that we don't have control. We get -- usually we get kind of planning inventory, and planning sales for three to six months, but I must admit that this is kind of our 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 a 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 saw 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, yes. Theoretically or practically we can find ourselves in some quarters with declining in OEM customer base. And this is something that can be reality. I'm quiet confidence that we are -- can be in a situation that for example and this is what we start today to show our OEMs subscribers base and the retail subscriber base. The retail subscriber base contribution is a much more material to the profitability and to the ARPU than the OEMs. So just to illustrate the 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, currently mainly because of the economic situation. You know that the car industry usually is the first to be held by recessions. And we found it and we have experience with these and this is a situation in Brazil recently in Mexico. So I believe that still, even if we will find some quarter is declining in OEMs, customer base. We will continue to show or we start to show again growth in the retail and the weighted average will be positive. So overall, I am 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.

Sasha Karim -- Inflection Point Investments -- Analyst

Got it. Thank you. 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 there. Well, I know you can't promise, but would you sort of hope to announce something more concrete by the end of this year?

Eyal Sheratzky -- Chief Executive Officer & Director

First of all, we have to divide into two types of -- I would say of discussions. One discussion is with a totally new brands which share our historical experience of negotiating, discussions and pilot et cetera, we know that is a very long cycles. This is not new, we already started but we don't know exactly what will be the results of this discussion is that -- how long each 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 (ph) in decision taking and in their strategic decisions. So it will take more time, it's not something for the next one or two 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 one or two geographies with the current brand. But this is only, I wouldn't say that we are in a close period to do it or something, but we have discussions and we see or we have the confidence that our position now will support it.

Sasha Karim -- Inflection Point Investments -- Analyst

Thank you.

Operator

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 a concluding statement.

Eyal Sheratzky -- Chief Executive Officer & Director

Yes. 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, and I look forward to speaking with you next quarter. Have a good day. Bye.

Operator

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

Duration: 40 minutes

Call participants:

Gavriel Frohwein -- GK Investor & Public Relations

Eyal Sheratzky -- Chief Executive Officer & Director

Eli Kamer -- Chief Financial Officer & Executive Vice President-Finance

Peter Zdebski -- Barclays -- Analyst

David Kelly -- Jefferies & Company -- Analyst

Sasha Karim -- Inflection Point Investments -- Analyst

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