Earnings Call Transcript - ITRN Q1 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran First Quarter 2020 Results Conference Call. 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. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin?

Ehud Helft, Investor Relations

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 covers the contents 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 stay healthy during these unprecedented times, and I wish all those who have been impacted by the virus a speedy recovery. As you all know, 2019 ended as a tough year for Ituran, where we overcame multiple challenges. 2020 was off to a good start. We had strong expectations before the global effects 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 adjust 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 an ongoing 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 this unprecedented global crisis. Obviously, the lack of new car sales during this period impacts 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 coronavirus 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 subscribers 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 markets, Israel and Brazil, the aftermarket business in Israel remained stable in the first quarter until March, when coronavirus started to shut down the country and brought new car sales to a halt. The year started well in January and February. New car sales in Israel were about 7% ahead of those in the 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 was minimal. I also want to point out that our churn rate 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 minimal. As the country starts 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, Ituran today has many other strategies for penetrating additional segments. As I discussed last quarter, one of our growth drivers in Israel is our Usage-Based Insurance offering, and I expect this to become more significant to our subscriber growth in the future. There are insurance policies built around Ituran's 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 have 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 an 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 that 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 stabilizes 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 the pandemic situation is over. And now to our OEM business in Brazil and Argentina. Because of the weak economic situation in Brazil and Argentina, which started 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 reductions in employee salaries of up to 30%, which includes a reduction in headcount 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, who have shown solidarity with our efforts and agreed to this reduction. For that, I want to thank them now. Our quick actions to reduce costs have enabled us to maintain profitability during this period, and we expect to 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 with 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 about 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 improvements. 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 from this period as a stronger and more efficient company. I will now hand the call over to Eli for the financial review. Eli?

Eli Kamer, CFO

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 a 1% decrease over the previous quarter's revenue. Excluding the currency effect, revenues would have shown an increase of 2% versus the previous 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 previous 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 the 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 that quarter. Excluding the currency impact versus the previous quarter, operating income would have grown by 6%. As mentioned in the previous quarter, the main year-over-year decline was due to the OEM business as a result of selling 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 of $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, Operator

The first question is from Tavy Rosner of Barclays.

Peter Zdebski, Analyst

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 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.

Eyal Sheratzky, CEO

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 are starting to release. And to be more specific, when we are looking mainly at the car dealers and the car importers and the car showrooms, they just opened again less than a week ago. Of course, it's gradually becoming a normal situation. So we believe that Israel, of course, will be ahead of Brazil in this situation basically because of the time differences in the spread of the coronavirus. Based on other fundamentals, I don't know whether there are big differences. So maybe two months from now, we will hopefully see that everything is back to normal routines. And then each market will have to work with the micro situation. Generally speaking, both Israel and Brazil have a subscriber fee model, which includes very diversified recurring revenues, which we continue to receive. It's true that we are not in a position to grow because car sales are very low and there were days when they were 0. But on the other hand, the additional source of revenues for Ituran, which is the current customer base, is showing a very strong situation because, as I mentioned in my earlier remarks, the churn numbers also declined because the main reasons for people in Israel and in Brazil to churn are usually when they sell their car and buy a new one. So the situation has meant that people are not buying new cars, thus, they are much less likely to sell their own cars. Therefore, we will not grow the subscriber base, but as we showed in Q1, we hope that in Q2, the decline will be very, very small numbers, which will allow us to continue to generate most of our revenues and cash.

Peter Zdebski, Analyst

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

Eyal Sheratzky, CEO

Yes.

Peter Zdebski, Analyst

Okay. Just a quick follow-up. Did you mention whether there were any headcount reductions alongside the cost savings, or was it solely a salary cut?

Eyal Sheratzky, CEO

Okay. I will explain. It's very important for me. Since our DNA is to look for the health and wellness of our employees, we did our best not to fire anyone. Most, almost all of our reductions came through reducing salaries across the board, including us, the top management, mid-management, and of course, down to the last employee of the business, almost 3,000. In Israel, there was an ability to take a break because, of course, the service needs and the sales needs declined dramatically. So we could put some employees on paid vacation for a month, which is now over, and we brought back almost 90% of the people that we let go on vacation paid by the government in Israel. The Israeli people know this as a halat, unpaid vacation. And now we are bringing them back because of two reasons. One reason is because the market is opening again. And second, because they finished their time that they deserved during this program, and we want to keep them and allow them back to work. In the second case, we also let go of about 200 employees; these were installers who worked as subcontractors and weren't on the payroll. They have a direct cost per installation. Since installations declined to a very low number, we released them. This is the only two situations in which people were let go from the company; as I said, part of them are already back. The rest of the cost reduction was achieved by reducing salaries and costs for our suppliers. By the way, we will keep it until we feel that not only the pandemic is behind us but also the economic situation and our business life in Ituran will allow us to return to our historical salaries.

Operator, Operator

The next question is from David Kelley of Jefferies.

David Kelley, Analyst

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.

Eyal Sheratzky, CEO

I would say the reverse of my answer is that the reason we did all this cost reduction is because we assume that we will not have new sales and new additional revenues. We are also considering some decline, which will come from churn of our customer base. At the beginning, we took a much more dramatic decline because there were a lot more question marks than we know today about how the market will react in Israel after 2 months or more than 5 months since the pandemic started in China. And also, we now have experience in observing our Latin America subscribers' behaviors during this time. So practically, the actions we took were very material. We will keep it. Since I am not going to give a specific number for the cost reductions, I already said that we expect that, although we have no new sales and are facing churn, we will show results in Q2, which, by the way, all Q2 will be impacted by the pandemic, which is the largest crisis, I think, ever for the people 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 are some question marks about the situation. But this is mainly thanks to making this cost efficiency and cutting those costs.

David Kelley, Analyst

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?

Eyal Sheratzky, CEO

As you mentioned, it’s quite complex with numerous factors involved. Firstly, regarding our OEM business in Brazil and Argentina, since late 2018, we have downgraded the contracts and the scale of our operations due to economic troubles and sales challenges faced by our customers. The major setbacks occurred in 2019, and while we don't anticipate significant improvements, most of the reduction has already happened. The contribution of this business to our overall financial performance has diminished considerably, meaning its impact on our total numbers won’t be substantial. However, these issues began before the pandemic, and the overall situation in Brazil and Argentina will likely worsen due to COVID-19. It is important to note that the OEM side in these markets is no longer significant to our total results. On the other hand, our OEM operations in Mexico, Ecuador, and Colombia follow a different model where we are offering essential support and positive cash flow, making us more valuable to these car manufacturers than they are to us. Even with a drop in car sales, once they resume, we expect to sell a large percentage of our units to these manufacturers. While there will be a decrease in numbers, returning to pre-pandemic figures is likely, albeit slowly. In Mexico, with a different car brand, we previously faced a nearly zero sales period from March to September 2019 due to an unexpected technical change. We resolved this in September and started seeing improved commercial relations with this customer. Now with the pandemic, our conversations with them indicate that even though they may sell fewer cars in the short term, they have placed orders for significantly more units and services with us for the future. While I can’t confirm this is guaranteed, it suggests they see us as a crucial component for successfully re-entering the market with new cars. Looking ahead to 2020, we anticipate a decrease in OEM subscribers will affect our results, but we are optimistic that in 2021, especially in Mexico, we will see continued growth in the OEM sector. Ultimately, our performance will remain closely tied to their car sales.

Operator, Operator

The next question is from Asaf Chandali of Oppenheimer.

Asaf Chandali, Analyst

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?

Eli Kamer, CFO

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 analyze and translate into U.S. dollars, we are using the average rate for the quarter. When you use the average rate of the quarter, including all the currency and the mix between the real, shekel, for example, the real was weaker by 30%, 40%. But if you look at the other currencies like the Israeli shekel, it's relatively the same. So this is more or less the effect that we have.

Asaf Chandali, Analyst

Okay. And then maybe on just the 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 the markets. Any bit of color on the use of capital, including dividends?

Eyal Sheratzky, CEO

Yes. First of all, it came from a defensive situation. Since there are a lot of question marks about the final date for all these crises, and although we did all the things we needed to do, 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 positive cash flow, even if it declines a little, we will not have a problem. Our credit lines are well beyond it. However, 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 see that we are being too conservative or we see that things start to improve, we can continue being more aggressive in using cash for marketing, sales, and also for opportunities. We believe that even if the market shrinks, we can gain more market share in the markets we operate in. And even if the market goes down 20%, if we increase our market share by 30% or 40%, we can grow even with our competitors facing challenges. In this situation, we can also consider using the proceeds for partnerships or M&As. I'm not saying that we have something concrete, but these days, nothing is concrete. Therefore, I think it’s important to be ready for the sun that will shine; I want to be there with the right swimming suit.

Operator, Operator

The next question is from Sasha Karim of IPI.

Sasha Karim, Analyst

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 Q2 base? Or conversely, could there be a rise in churn that stops that from happening?

Eyal Sheratzky, CEO

First of all, I want to remind and explain our model. The good thing in the model is that in a crisis situation, we're very diversified and have strong cash flow and income from our current subscriber base once the market opens. Of course, we believe that this will be the time that we can grow our subscribers. But we have to understand, just to illustrate, if we have 1.8 million subscribers and we grow even 20,000 in Q3 compared to Q2, the additional revenues from this 20,000 when you compare it, whether it's 1.82 million or 1.8 million, the difference is very small. But as a company, looking ahead, we mean that if we succeed or if the market allows us and opens, we will grow our new subscribers in Q3, and then hopefully Q4, and then every quarter. Eventually, we should be—when it becomes more materialized in dollars, of course, it matters. So our primary goal is to grow our subscribers, always growing subscribers, grow revenue, and growing profits. I must note here; even if we grow in Q3 compared to Q2, the impact on the P&L will be very low for this specific quarter, which is the idea of this business model.

Sasha Karim, Analyst

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

Eyal Sheratzky, CEO

Yes, yes.

Operator, Operator

There are no further questions at this time. Before I ask Mr. Sheratzky to proceed 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?

Eyal Sheratzky, CEO

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 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 reacted quickly to the current situation to preserve our profitability, I'm also optimistic that we are preparing the company for a 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 meetings 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 meetings 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 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 First Quarter 2020 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.