Earnings Call Transcript - ITRN Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran Fourth Quarter and Full Year 2020 Results Conference Call. All participants are in listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session. 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 will now hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin, please?

Ehud Helft, Investor Relations

Yes. Thank you, operator. Good day to all of you, and welcome to Ituran’s conference call to discuss the fourth quarter and full year 2020 results. I would like to thank Ituran’s management for hosting this conference call. With me today on the call are Mr. Eyal Sheratzky, the CEO; Mr. Udi Mizrahi, Deputy CEO 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 the safe harbor in the press release also covers the content of this conference call. And now Eyal, would you like to begin, please?

Eyal Sheratzky, CEO

Thank you, Ehud. I’d like to welcome all of you, and thank you for joining us today. I hope you and your families are continuing to stay healthy. We are very happy with the improvement in our results in the fourth quarter, which outperformed our expectations, concluding a very hard year for all of us. Despite being a difficult year for everyone, we are pleased that we maintained our profitability and strength. In particular, we generated record operating cash flow of $60 million. This is a solid demonstration of the trends in our business even in the toughest of times. For the fourth quarter of 2020, revenues were $63.6 million, growing by 3% year-over-year in local currency terms. And bear in mind that the year-ago fourth quarter was pre-corona. Our aftermarket subscriber growth was 21,000 net in the quarter, which is a growth rate we are very happy with, and at a level that we typically expect in normal times. I see this as a very positive sign for the coming quarters, and it shows that Ituran is well underway to recovery and renewed growth. On the profitability side, we have managed the business very carefully to ensure we remain lean and profitable. For the quarter, we reported EBITDA of close to $17 million, demonstrating growth of 17% year-over-year in local currency terms when excluding last year’s impairment. This shows that we continue to be successful in mitigating the impact of the pandemic on our improving profitability. It is a strong testament to the overall resilience and stability of our business model. On the cash side, fourth quarter cash flow from operating activities of $16.5 million brought our cash and marketable securities position to just under $79 million. Because of the continued cash generation, strong results, and improvement in the general market environment, the Board decided to restart the dividend payment policy to shareholders with a payment this quarter of $10 million for 2020, and the new policy of issuing at least $3 million on a quarterly basis. We are very pleased to renew the sharing of the rewards of Ituran’s success with our shareholders. Again, the Board is remaining conservative while the pandemic is still impacting us, and will review the policy as things develop.

Eli Kamer, CFO

Thanks, Eyal. I note that the results I present will all be on a GAAP basis, including adjusted EBITDA, which excludes revenues and costs related to the purchase price allocation. We believe this will provide a better understanding of our ongoing performance. Revenue for the fourth quarter of 2020 was $63.6 million, a decrease of 3% compared with revenues of $65.5 million last year. In local currency terms, fourth quarter revenue increased by 3% year-over-year. Revenues from subscription fees were $45.8 million, a decrease of 8% year-over-year. In local currency terms, subscription fees were at the same level as last year. The subscriber base at year-end was 1,768,000, an increase of 16,000 net over that of the end of Q3 2020. During the quarter, there was an increase of 21,000 in the aftermarket subscriber base and a decline of 5,000 in the OEM subscriber base. Product revenues were $17.9 million, an increase of 13% compared with that of the fourth quarter of 2019. The geographic breakdown of revenues in the fourth quarter was as follows; Israel 49%, Brazil 23%, rest of world 28%. Operating income for the quarter was $12.1 million, 90% of revenues compared with an operating loss of $16.4 million in the fourth quarter of last year. I know that fourth quarter 2019 operating expenses included an impairment loss of $26.2 million related to the acquisition of Road Track Holdings. In local currency terms and excluding last year’s fourth quarter impairment, operating income would have grown by 33% year-over-year. EBITDA for the quarter was $16.6 million, 26.1% of revenues compared with an EBITDA loss of $10.7 million in the fourth quarter of last year. In local currency terms and excluding the mentioned fourth quarter 2019 impairment, EBITDA would have increased by 17% year-over-year. Financial expense for the quarter was $2.2 million compared with financial income of $3.3 million in the fourth quarter of last year. In the quarter, we were impacted by non-cash expenses, primarily due to exchange rate changes on Ituran’s U.S. dollar cash holdings in Israel as well as the change in market value of SaverOne, while the financial income last year arose from the change in obligation to purchase the non-controlling interest of Road Track in the fourth quarter of 2019. Net income for the fourth quarter of 2020 was $6.8 million, 10.7% of revenues or earnings per share of $0.33. This compares to a net loss of $15.3 million and loss per share of $0.73 in the fourth quarter of 2019. Cash flow from operations for the fourth quarter of 2020 was $16.5 million.

Operator, Operator

The first question is from Tavy Rosner of Barclays. Please go ahead.

Peter Zdebski, Analyst

Hi, this is Peter Zdebski on for Tavy. Thanks for taking my question. Congratulations on a solid quarter. I was wondering if you could give us some more color on the gross margins in the quarter and maybe on the trajectory going into 2021, particularly on what seems to have a big uptick in the product gross margin in the quarter? And then as a follow-up, I just was wondering if you could give us an update on the Road Track operations and the current strategy there.

Eyal Sheratzky, CEO

Regarding the gross margins and the increasing hardware sales during Q4, I would say that this is not a typical and average quarter. The reason is that, if you remember, until around July, August, the plans and production lines were closed in Mexico and in Brazil. As you remember, our OEM business is conducted with two car brands in those regions. Soon after the lockdowns ended and the market started operating again, there was an impact on their need to increase their inventory. They automatically made a high purchase from us for the hardware and the plans that they are buying from us. So I would say that Q4 is not a typical quarter. This is something that can explain the growth in our gross margins, which reflects also in the growth of our operating profits from Q3, the sequence of the situation being more than $1 million difference, which is not a typical growth quarter-to-quarter in Ituran. To be more realistic and in order to be on the same page with the investors, I would say that we are not expecting this growth rate and gross numbers in the coming quarter. Saying that, I would like to repeat my remarks in the press release that we totally expect to continue the trend of growth. We see a very positive trend and a positive request in the markets that will be favorable for our growth. But the difference between Q4 and Q3 in this specific item is due to the explanation that I just provided.

Peter Zdebski, Analyst

Thank you. That’s great color. And then maybe just a brief update on the Road Track operations.

Eyal Sheratzky, CEO

The Road Track operation is very dependent on two customers. Both are car producers. We have one in Mexico and we have one as our customer in Ecuador, Colombia, Brazil, and Argentina. The one in Mexico shows enthusiasm to enhance the relationship and increase the installation to cover more models of cars from both hardware and service points of view. We are fairly certain that based on the discussions we have had that in 2021, we will install in Mexico a higher number, possibly the highest number of units ever. On the other hand, with the other car manufacturer in Brazil and Argentina, as we said two years ago, we are no longer a hardware provider. We are only a service provider. This previously showed a sharp decline during 2019 and even in early 2020. Now we do not expect any further decline. However, I cannot say we expect growth in these four geographies, but we aim to maintain profitability.

Operator, Operator

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

David Kelley, Analyst

Hi. Thanks for taking my questions. Maybe to start with the solid rebound in aftermarket subscribers. Just curious as to your view on the sustainability of that growth, or even if there’s opportunity for upside. I believe you referenced the robust January SAAR, but there could also be some pent-up demand driving that as well, especially with the vaccine rollout. Just curious how you’re thinking about the potential for this aftermarket subscriber growth rate going forward.

Eyal Sheratzky, CEO

First of all, I must mention that ultimately, there is a lot of influence from the pandemic, as we faced during mid-2020. Now I think and it looks like, of course, due to the vaccine aspect, but also I think that countries, governments, and people have understood that we all need to find a way to live with the circumstances and cannot shut down our lives or businesses permanently. It appears that – and by the way, in Latin America, there is not yet a vaccine, and they have chosen a different course from the lockdown strategy. The markets are open. There are some limitations, some obligations, some compliance, but from our perspective, the business is functioning. Of course, car sales are not at the level they were in 2019. However, the decline appears to be less steep than we anticipated. It’s not a decline of 20%, 25%, or 30%. We believe it will be only 10% to 12% less than pre-pandemic levels. We know how to overcome this by gaining more market share, offering more solutions and applications. Regarding Israel and the aftermarket subscribers, I want to be conservative, but also say that I believe that we’ll achieve numbers close to what we showed in Q4 when most of the markets were open in Israel, Brazil, and the U.S. Don’t forget that we are now in a position to benefit from our investments, primarily in UBI and applications for each customer that we charge for. We see that we are not just selling fleet management or traditional fleet management and traditional SVR, but UBI as well. We have improved and expanded our fleet management solutions and we also provide diagnostic services, which we didn’t have three or four years ago. Therefore, I believe that in the aftermarket, we will continue this trend of approximately 20,000, maybe it will be 17,000 or 22,000; I don’t want to predict, but certainly much larger growth than we experienced during 2020 and the pandemic.

David Kelley, Analyst

Okay, thank you. That’s helpful. And maybe just an update on some of your cost initiatives. There were some structural cost savings, but I believe compensation expenses started to ramp back up last quarter, offsetting that a bit. Could you walk us through the puts and takes of some of the cost initiatives that impacted Q4? Also, how should we view the cost structure into 2021?

Eyal Sheratzky, CEO

Regarding compensation, during Q4, the majority of our cost savings until Q4 reverted back to pre-pandemic levels. We adjusted the compensation for most of the group back to normal levels, with only a few exceptions, such as myself. The employees have been very effective, often working remotely when needed, and I am pleased that we made this decision in advance of deciding to pay a dividend because the employees are the core of Ituran. Regarding other expenses, there are minor savings. For example, we have fewer flights, and given that we operate globally, there are savings, albeit not material. Overall, I would say the significant portion of savings came from compensation, but we do not expect major growth in our expenses in Q4, slightly increased numbers for Q1, but nothing material.

David Kelley, Analyst

Okay, got it. Thank you very much. I’ll pass it on.

Operator, Operator

The next question is from Asaf Barel Chandali of Oppenheimer. Please go ahead.

Asaf Barel Chandali, Analyst

Hey, guys. Congrats on a really positive end to 2020, and it’s encouraging to hear that the company is looking to pay dividends. On the topic of the dividend, we fully appreciate that we’re not past COVID. The company operates conservatively but what factors might influence the Board’s thinking about dividend levels as the macro outlook normalizes? More broadly, on capital allocation, how should we interpret the term minimum when considering the minimum of $3 million?

Eyal Sheratzky, CEO

First of all, we need to ensure legal compliance as these policies carry legal implications. We obviously don’t want to find ourselves in a situation of zero flexibility. Historically, when we've established a policy or set a minimum of $5 million, it has always been $5 million. I would expect a minimum of $3 million per quarter. In the coming quarters, we will review the status concerning the pandemic and how things are changing globally; how the company is performing. While it may appear that, based on our balance sheet, one might wonder why we are not paying more, we must keep in mind that the world is still uncertain. I remain optimistic, and Ituran has proven that even in challenging circumstances, we can overcome, but our preference is to err on the conservative side. Therefore, I will expect around $3 million, and if changes to this policy are warranted, we will communicate that well in advance.

Asaf Barel Chandali, Analyst

Okay. Great. That’s very clear. I wanted to follow-up on a previous question about operating expenses. To clarify fully, while there may be minor management salary adjustments, should I assume that Q4 operating expenses would remain somewhat similar in Q1 and Q2? I realize foreign currency shifts may affect the numbers, but please clarify.

Eyal Sheratzky, CEO

Absolutely. I believe that Q4 expenses are very close to what actual expenses will be for Q1. Local currency adjustments always apply, and we provide translations in our numbers to illustrate how things would appear without currency effects, but overall, the changes in Q1 will be very minor, certainly not material to the results of the company.

Asaf Barel Chandali, Analyst

Okay. Great. Any updates on how the aftermarket plans in Mexico are progressing? Are there changes or accelerations in the timeline?

Eyal Sheratzky, CEO

The aftermarket in Mexico, which involves duplicating the ICS model that we have in Brazil, essentially involves selling Ituran along with insurance. We had some delays due to COVID-19, as we didn’t want to launch the first campaign while everyone was in lockdown with low market sentiment. We sought our marketing and advertising agencies' guidance. However, at the beginning of 2021, we launched our campaign. A significant development has been signing contracts with insurance companies to support the products that we are offering. People are purchasing a solution that includes an anti-theft component along with insurance from Ituran. Since we cannot sell insurance directly, we need partners. This strategy has been applied successfully in Brazil. Although we initially faced challenges educating the insurance companies, we have demonstrated that through our relationships and persuasion, the risks of cannibalization on their traditional sales will be minimal. I am optimistic, but we must recognize that this is the process of creating a new business model. In terms of contribution, we anticipate limited immediate impact. However, considering it operates on leverage, once we educate the market—likely taking one to 1.5 years—we expect this to become a substantial part of our future growth.

Asaf Barel Chandali, Analyst

Great. And regarding UBI in Israel, I assume it's contributing to the positive rebound we're seeing in aftermarket growth. Have you updated how you're thinking about going international with UBI? Any updates on timeline?

Eyal Sheratzky, CEO

You are correct. UBI is a significant factor in our aftermarket subscriber growth. Since the Israeli and Brazilian markets have returned to high vehicle sales, we have seen growth in both our traditional SVR solutions and our new UBI offerings. Initially, we expected growth only in UBI, but now, with car sales picking up, SVR subscriptions are also increasing. UBI is making a substantial contribution as we see momentum building. I want to remind everyone that we started this feature about 15 months ago, and we expected growth to be gradual, not significantly impacting 2020. However, in 2021, we anticipate UBI will have a major influence on subscriber numbers. We are not solely reliant on UBI, but it is a key driver. In international markets, especially in Latin America, we see similarities to the situation in Israel three years ago. Traditionally, insurance companies did not recognize the value of our offering, creating significant potential for expansion as the industry faces pressure from new digital competitors.

Asaf Barel Chandali, Analyst

Great. Great. Last question from my end. CapEx was lower this year relative to last. I know that currency also impacts this. What should we expect in 2021 in terms of spending? Were there any delays in spending that could push this number higher?

Eli Kamer, CFO

The majority of the CapEx relates to the end units that we sell as a commodity in Latin America, particularly in Brazil and Argentina. Due to the pandemic in 2020, there were fewer sales, resulting in less CapEx and fewer purchases of units.

Asaf Barel Chandali, Analyst

Any general figures or proxies for the CapEx in relation to product revenues? Any guidance would be helpful.

Eli Kamer, CFO

It’s quite challenging to provide specifics given the ongoing pandemic. If you want a range, I would suggest looking at a number between the averages from 2020 and 2019 for a baseline estimate for 2021.

Asaf Barel Chandali, Analyst

Okay. That’s great. Very helpful. Thank you, guys, for taking my questions.

Eli Kamer, CFO

Thank you.

Operator, Operator

The next question is from Ethan Etzioni of Etzioni Portfolio Management. Please go ahead. Ethan? 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 all participants that a replay of this call will be available tomorrow on Ituran’s website at www.ituran.co.il. Mr. Sheratzky, would you like to make your concluding statements?

Eyal Sheratzky, CEO

Thank you. On behalf of Ituran's management, I would like to thank our shareholders for their continued interest and long-term support of our business. I look forward to speaking with you next quarter, and hope that we will all see better times by then. Have a good day.

Operator, Operator

Thank you. This concludes the Ituran fourth quarter and full year 2020 results conference call. Thank you for your participation. You may go ahead and disconnect.