Earnings Call Transcript - ITRN Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran Second Quarter 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 the company's press release. If you have not received it, please contact Ituran's Investor Relations team. I will now hand the call over to Mr. Ehud Helft of Investor Relations.

Ehud Helft, Investor Relations

Thank you, Operator. Good day to all of you, and welcome to Ituran's conference call to discuss the second quarter of 2020 results. I would like to thank our management for hosting this conference call. With me on the call today are Mr. Eyal Sheratzky, Co-CEO; Mr. Udi Mizrahi, Deputy COO and VP Finance; and Mr. Eli Kamer, the CFO. 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 covers the contents of this conference call. And now, Eyal, would you like to begin, please?

Eyal Sheratzky, Co-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 stay healthy during this unprecedented time, and I wish all those who have been infected by the virus a fast recovery. During this period, our top priority has been ensuring the health and safety of all of our employees, and we continue to follow local authorities' directives as they develop and adjust as needed. Just as important, we continue to maintain business continuity and serve our customers around the globe. From a financial standpoint, even though our second quarter was particularly difficult, we are pleased with our achievements, especially given the unprecedented full economic shutdowns over part of the quarter in Israel, Brazil, and other geographies we operate in. We reported an adjusted EBITDA of $13.9 million, which was about 9% below that of the first quarter 2020. And excluding currency impacts, the decline would have only been 2%. I remind you that we expected second quarter EBITDA to be between 10% and 20% below that of the first quarter. So our result shows that we were successful in mitigating some of the impact. I note that this excludes a non-cash impairment in Road Track, which is an accounting effect mainly due to the sharp increase in the macro risk factors in the various countries in which Road Track operates and not related to Road Track's long-term performance or outlook specifically. The increase in country risk caused an increase in the weighted average cost of capital (WACC) calculation, which lowered the valuation of this business on our balance sheet. Excluding the non-cash impairment charges, Ituran remains profitable and continues to generate cash flow, in fact, with one of our strongest quarters of cash generation, with a positive operating cash flow of $19.3 million. Ituran's stability during this unprecedented global crisis demonstrates the overall resilience of our business model. You may remember that already in the first quarter, we took some early steps, focusing on cash preservation and reducing other expenses, matching expenses with expected revenue levels. Our ability to remain profitable and cash flow positive during this global crisis demonstrates the overall resilience of our business model. Despite the logistical work challenges the COVID-19 pandemic has created for everyone, including us, it is clear that our business is highly resilient. I remain optimistic over the long term, and I'm confident that Ituran will emerge from this period a stronger and more efficient company. Once we can all put this pandemic behind us, we have the platform for long-term, sustainable and profitable growth. Our subscriber base remains strong with close to 1.8 million subscribers, with the majority of them paying us ongoing monthly fees. This enabled us to remain profitable and cash flow positive during this current unprecedented global crisis. However, new car sales drive growth in this subscriber base, and the lack of new car sales, especially during April and May in many of our geographies, impacted our ability to recruit new customers and grow our business in both the OEM and aftermarket sectors. I will spend the next few minutes diving into the details of both the COVID-19 impact, first on the OEM business and then on the aftermarket business. I will start with our OEM business in Brazil and Argentina. As you all know, this business suffered last year prior to COVID-19 due to the weak economic situation in Brazil and Argentina, as well as the change in model where they used their own hardware and reduced the OEM paid term of service down to one month only. In 2020, the COVID-19 pandemic has taken a further toll on these economies and ultimately on our OEM business there. During the second quarter, we saw a net decline of 27,000 subscribers in the OEM segment as a whole. The higher country risk has increased the discount rate (WACC) used when calculating the value of Road Track on our balance sheet. This meant we had to reduce the value at which Road Track is written on our balance sheet and therefore write an impairment on this business during the quarter. I stress that the impairment is non-cash and does not reflect a specific worsening or lowering of long-term forecast for the Road Track business. The net amount was $13.5 million, of which $14.2 million was on the operating line, with an income of $0.7 million in financial income related to the liability to purchase the non-controlling interest. Despite the impact of the pandemic and the weak economic situation in Latin America on the business, we do feel that Road Track has brought Ituran strong synergies, giving Ituran access to new markets as well as an ability to cross-sell additional products and services into existing ones. Looking at the aftermarket business, we saw a net decline of 16,000 subscribers during Q2 2020, caused by the unprecedented complete economic shutdown, primarily in Latin America for a large portion of the second quarter, due to the pandemic. In Israel, the shutdown impacted April and May, while new car sales recovered in June to levels similar to those of June 2019. The subscriber base in Israel was more or less stable over the quarter. In Brazil, our other large aftermarket geography, new car registration in June were up from the lows of April but were still down 40% versus June last year. Our results in Brazil have been further compounded by the significant weakness of the real currency versus the dollar, which, at its peak in the second quarter, lost half of its value against the dollar in just one year. Elsewhere, in Mexico, we continue planning and building out the infrastructure for our new Ituran com Seguro program, using our overall 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 this year. As our markets start to open up again, I do expect new car sales to recover, and we are confident that our aftermarket business will resume growth and eventually put the fears behind us. Ituran today has a strategy for penetrating additional segments. Our UBI offering, whereby we can offer insurance companies a solution to bill the customer per usage and driver behavior, continues to gain traction. We have now signed on five insurance companies in Israel. The subscriber numbers are growing quickly, but are still small. We believe this will already have a positive impact on next year's results. Now that we have proven the success in Israel, we recently signed a UBI agreement in Argentina and are negotiating potential UBI projects in Brazil. I expect this business to become significant to our long-term subscriber growth in the future. In summary, the second quarter of this year was unprecedented with complete economic shutdown in our markets, significantly impacting our business. However, we are pleased with the resilience of our business model built on a revenue base of 1.8 million subscribers. Furthermore, we prepared ourselves in advance to weather the storm, and we are consistently ensuring that our expense level is matched to our revenue levels. Even during such unusual times and the most severe global crisis in 100 years, we are able to remain profitable and generate cash, and we expect that this will continue to be the case in the coming quarters while the pandemic is still with us. We have made improvements throughout our business to enhance efficiency, and as we emerge from the COVID-19 pandemic, I believe we are well positioned to resume growth and increase profitability. I will now hand the call over to Eli for the financial review. Eli?

Eli Kamer, CFO

Thanks, Eyal. You can also refer to the press release we published today with our results. Revenue for the second quarter of 2020 was $53.3 million, a decrease of 25% compared with revenues of $71.2 million in the second quarter of 2019. Revenues from subscription fees were $43.7 million, which represents a decrease of 15% over second quarter of 2019 revenues. Excluding the currency effect, revenues from subscription fees would have shown a decrease of 7% versus the previous quarter. The subscriber base amounted to 1,751,000 as of June 30, 2020, representing a decrease of 53,000 net subscribers compared to the end of the previous quarter. During the quarter, there was a decline of 16,000 in the aftermarket subscriber base and a decline of 27,000 in the OEM subscriber base. Product revenues were $9.6 million, a decrease of 51% compared with that of the second quarter 2019. The geographic breakdown of revenues in the second quarter was as follows: Israel 51%; Brazil 25%; and the rest of the world 24%. During the second quarter, Ituran's operating expenses were $32.5 million. The operating expenses included an impairment loss of $14.2 million related to the acquisition of Road Track. Excluding the impairment loss, operating expenses amounted to $18.3 million compared with $19.9 million in operating expenses in the second quarter of 2019. The operating loss for the quarter was $4.9 million. Excluding the impairment charge in the operating expenses, the operating income was $9.3 million, which is 17.5% of revenues. This compares with $13.6 million or 19.1% of revenues in the second quarter of last year, representing a decline of 31% year-over-year. In local currency terms, excluding the impairment, the operating income decline would have been 25% year-over-year. EBITDA for the quarter was a loss of $300,000. Excluding the above-mentioned impairment charge, EBITDA was $13.9 million, 26.1% of revenue, a decrease of 28% compared with $19.4 million or 27.2% of revenue in the second quarter of last year. In local currency terms, the decline would have been 20% year-over-year. It is noted that versus the previous quarter, the decline in EBITDA was 9%, and in local currency terms, this decline was only 2%, which was ahead of management expectations of a 10% to 20% sequential decline in EBITDA versus the first quarter. Looking ahead, we expect similar levels of EBITDA in our third quarter results. During the second quarter, one of our held companies, SaverOne, raised 26 million shekels, and as a result, our holding in the company was diluted. As a result, we had a capital gain of around $1.5 million, which is recorded as part of our financial income in the quarter. The net loss for the second quarter of 2020 was $6.3 million or a loss per share of $0.30. Excluding the above-mentioned impairment charge and excluding $1.7 million financial gain due to the reduced minority liability related to the impairment of Road Track, the net income for the quarter was $7.2 million, 13.4% of revenues or fully diluted earnings per share of $0.34. Net income excluding the impairment charge represents a decrease of 7% compared with $7.7 million, 10.8% of revenues or fully diluted earnings per share of $0.37 in the second quarter of last year. In local currency terms, the gain would have been 1% year-over-year. Cash flow from operations for the second quarter of 2020 was $19.3 million. As of June 30, 2020, the company had cash, including marketable securities, of $57.2 million and debt of $60.8 million, amounting to a net debt of $3.6 million. This compares with cash including marketable securities of $54.3 million and debt of $67.9 million, amounting to a net debt of $13.6 million as of December 31, 2019. And with that, I'd like to open the call for a question-and-answer session. Operator?

Operator, Operator

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. First question is by David Kelley of Jefferies. David, please go ahead.

Gavin Kennedy, Analyst

Hi, everyone. This is Gavin Kennedy on for David Kelley. You guys mentioned an expected return to aftermarket subscriber growth as the pandemic subsides. Can you just describe how you're thinking about OEM positioning going into the second half of the year?

Eyal Sheratzky, Co-CEO

First of all, at the OEM businesses, we have to mention that the plants and the production lines just reopened around the end of Q2, specifically in the geographies that we operate. We're absolutely expecting that we will restart selling new products and services to the plants. We have to understand that we recognize subscribers at the moment they are actually shipped and installed in the end-user cars, which creates some timing difference between starting to sell and realizing it as subscribers. So I would expect it more towards Q4 and beginning of next year, but I absolutely see this happening as our customers, the car manufacturers, are increasing their inventories and buying products from us.

Gavin Kennedy, Analyst

Great. And then just changing gears a little bit as a follow-up. Really solid gross margin performance this quarter despite the dip in aftermarket subscriptions. Can you just talk a little bit about the gross margin drivers this quarter and how we should think about modeling margins going forward for the rest of the year? I know there are a lot of moving parts with this pandemic.

Eyal Sheratzky, Co-CEO

It's important to mention that this time one of the major things that we did, as we mentioned even through the end of Q1, is that we prepared for the pandemic and the crisis by lowering our costs starting from salaries and compensations across all our geographies. Of course, we also reduced payments and changed conditions with suppliers. By doing this, we lowered our costs at the beginning. Probably we were conservative enough, and we still succeeded in retaining better revenues than we expected or less churn than we anticipated. So that leads to maybe a higher growth.

Udi Mizrahi, Deputy COO and VP Finance

In addition, the mixture between service revenues and product revenues affected gross margins. Due to the fact that product revenues were lower, due to the lower sales, and the gross margin in the service revenue is significantly higher, this also contributes to a higher gross margin for the whole group.

Gavin Kennedy, Analyst

Got it. And then, if I could just sneak one quick question in. You mentioned similar levels of performance in Q3 as in Q2. And I think in the follow-ups about the financials, you mentioned that maybe EBITDA would be at similar levels. But just, with that comment of similar performance in Q3, can you just describe what you're talking about there? And that's it from me. Thanks.

Eyal Sheratzky, Co-CEO

We said, in general, we expect to have the same profitability and the same numbers, mainly EBIT and EBITDA. Of course, we have to be conscious, and we take some short range, but we really expect that we will repeat. During this recovery time, we will succeed to again overcome the crisis and keep the same results in Q3.

Gavin Kennedy, Analyst

Great. Thanks, everyone.

Operator, Operator

Next question is by Asaf Chandali of Oppenheimer. Asaf, please go ahead.

Asaf Chandali, Analyst

Hey, guys. Thanks for taking my question. Congrats on the solid results. I guess, just following up on the gross margin, specifically in the services business, obviously, very strong and a nice reversal from steady declines. We discussed in recent quarters, specifically, cost-cutting measures relating to COVID and then, just generally, related to the shift away from OEM, with lower costs concerning supporting the business. To what extent can we model these elevated levels of subscriber or services gross margin moving forward?

Udi Mizrahi, Deputy COO and VP Finance

We believe that once the pandemic has passed, then the margin should be more or less the same as it was before the pandemic.

Asaf Chandali, Analyst

Okay. Understood. So at the 56%-ish levels?

Udi Mizrahi, Deputy COO and VP Finance

That's correct.

Asaf Chandali, Analyst

Cool. And so, given that we're now two-thirds of the way through the quarter, any sequential momentum that you want to highlight, whether Israel is coming back stronger? Do you see how Brazil and Mexico are doing overall in terms of your business?

Eyal Sheratzky, Co-CEO

I think we have to be clear. We know that even though after the lockdowns start being released and more car sales or more car dealers and car plants are starting to sell again, we still expect looking forward to 2021 that car sales worldwide will not be the same as back in 2019. It will recover compared to Q2 and maybe the beginning of Q3, but we know that car sales are very dependent on the economic situation, and we all know that the macro economy is not going to be as it was before the pandemic, at least not in the short term, let's say 2021 or 2022. People are buying cars depending on their wealth situation, their compensation, etc. I am not expecting that the growth can be as it was before the pandemic, but that leads us to be more efficient to save costs. Some of the costs we saved will probably continue to be saved. If we succeed to get to higher levels than Q2 and Q3, and if the car production lines start to turn again and if we succeed to show profits and profitability during the lockdowns, I am quite sure that we will succeed to show hopefully next year better results, but it will be very difficult to grow to double-digit numbers as it was in the past because our businesses depend on the car industry. We have two things which we created during the last quarters and something we will launch hopefully before the end of this year. One is the UBI, which is gaining traction in Israel, and although each subscriber represents something like half of a typical subscriber, the numbers we expect to have in 2021 and 2022 are going to be more and more material. This can create some growth for Ituran. Although the historical business will be less growing, it will be more stable. The second thing that we are very excited about and have expectations for is the ICS, which is our business that we created and became number one in Brazil, to do it also in Mexico. This should allow us to overcome the lack of car sales while still expanding into more segments, ultimately growing our subscribers and profits. This is not something we will be able to show yet in our financial results in the coming two or three quarters, but looking towards mid-2021 and 2022, to be fair and a bit optimistic is good to do in these days. We still think about coming back to growing our subscribers and enhancing our results across the board.

Asaf Chandali, Analyst

Okay. Thank you for the clarity. Just one last point from me. Any commentary on capital allocation specifically related to the dividend and the share buyback? I know it's off the table until things get back to normal, especially with some of the cost-cutting measures you are taking. But any thoughts you have on this, maybe longer term?

Eyal Sheratzky, Co-CEO

Historically, I think that Ituran's DNA is not to hold, I would say, excess cash. We always hold the cash that we need to operate the business. At some point, we may need it for small to mid acquisitions or partnerships. Ituran is in a very good position in terms of the balance sheet. I know many companies that are highly leveraged are struggling. We feel confident and safe, but on the other hand, I think the conservative approach is part of Ituran's nature. As long as our employees are cutting salaries, as long as our long-term suppliers are cutting prices, and while the pandemic creates uncertainty, we decided to be conservative. We are generating satisfied cash and maintain a good cash position. We will hold it for the uncertain short future. However, once the uncertainty shifts, and we feel more confident about stability returning and if business trends upward, I will recommend to the Board of Directors to make a decision about dividends, share buybacks, or both. It's important for Ituran, strategically, to not hold excess cash. But for the time being, it's a little different due to current conditions.

Asaf Chandali, Analyst

Okay. Thanks for taking my questions, and congrats once again on solid execution despite the challenges. Thank you.

Operator, Operator

Next question is from Sasha Karim of IPI. Sasha, please go ahead.

Sasha Karim, Analyst

Hi guys. Some of my questions were taken. But there's one more I'd like to ask, which is on the affiliate, which you mentioned had a funding round, and you've got diluted. Could you give us your stake post-dilution? And I think you said the company was called SaverOne. Could you talk a bit more about what it does and why you invested in it? Thanks.

Eyal Sheratzky, Co-CEO

This company, by the way, that you mentioned, is called SaverOne. It's a start-up that decided to make an IPO on the Tel Aviv Stock Exchange. We are part of a group of shareholders representing some players in the Israeli car industry, which includes car importers. We were part of the angel investors. It was interesting for us to invest because they have a unique solution that is not just an application like we can find hundreds in the world. They have a hardware and software solution to eliminate the ability of a driver to use their phone while driving. We know today that there are two main reasons for severe accidents: one is alcohol, and the second or even first is people texting and using their phones while driving. Since we have a strong relationship with the insurance companies in the industry where we are a major player, we are interested in this solution. Regarding the financial aspect, the company raised ILS 26 million, diluting the shareholders. Now it's a public company in Tel Aviv, and we now hold about 11%. We held 14% before the IPO, but after the dilution, we hold 11%. It's not a major investment, and it does not constitute a major portion of our P&L or balance sheet. But since the IPO happened just in Q2, we are providing this information.

Sasha Karim, Analyst

Thank you very much.

Eyal Sheratzky, Co-CEO

You're welcome.

Operator, Operator

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