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Ituran Location & Control Ltd. (NASDAQ:ITRN)

Q3 2009 Earnings Call

November 17, 2009; 10:00 am ET

Executives

Eyal Sheratzky - Co-Chief Executive Officer

Eli Kamer - Chief Financial Officer

Udi Mizrahi - Vice President of Finance

Ehud Helft - GK Investor Relations

Analysts

Maynard Um - UBS

Yair Reiner - Oppenheimer & Co.

Ziv Tal - Oscar Gruss

[David Delayo] - Canaccord Adams

Operator

Welcome to the Ituran third quarter 2009 results conference call. (Operator Instructions)

You should have all received by now the company’s press release. If you have not received it, please call GK Investor Relations at 1-866-704-6710 or 9723-607-4717.

I would now hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft would you like to begin?

Ehud Helft

Thank you. Good day to all of you, and welcome to Ituran’s conference call to discuss the third quarter 2009 results. I would like to thank Ituran management for hosting this conference call. With me today on the call are Mr. Eyal Sheratzky, co-CEO, Mr. Eli Kamer the CFO and Mr. Udi Mizrahi, VP of Finance.

Eyal will begin with a summary of the quarter’s main events, followed by Eli with a summary of the financials. We will then open the call for the question-and-answer session. Before we continue I’d like to remind everyone that the Safe Harbor statements in today’s press release also cover the contents of this conference call.

Now Eyal, would you like to begin please?

Eyal Sheratzky

Thank you Ehud. Welcome everyone. Thank you for joining us today and thank you for your interest in our company. This quarter we are especially pleased with our strong growth in subscribers, positive development in Brazil as well as strong generation of cash.

In fact neutralizing currency exchange effect in our business, this quarter would have been a record quarter from the revenue and operating profit point of view. We generated record cash flow of $12.5 million of which four of them was primarily a one time tax refund.

Even if we exclude this additional $4 million dollars our cash flow was still very strong and it is a very strong attribute of the strength of our business. In fact we now end quarter in excess of $17 million in net cash. In the past quarter we have transferred most of our cash holdings from US dollars to Israeli Shekel. These moves will reduce the volatility of the exchange rates on our financial income or expense going forward.

Exchange rates still grew and will continue to affect our top end operating line as we charge our subscribers in their local currencies. Rather than dollar weakens and this currency increase in strength it increase our top line and vice versa. In particular, if we were to neutralize the effect of exchange rates our monthly subscription fees would have grown 15% in local currency terms over last year. We see particularly strong growth in subscribers in Brazil, which drove most of our net subscriber growth in the quarter.

Additionally, we crossed the milestone of 200,000 subscribers in that region in Brazil is approaching half of our subscriber base. We are very proud of our achievements and strong growth in Brazil over the past few years. We also have a stable and large subscriber base and business in Israel which is strong cash generating business for us.

In total, we stand on 549,000 subscribers as for the end of the quarter. With regard to our two main regions in Brazil our business continue to grow strongly, our services are constantly gaining increased traction, we are consistently growing our market share, developing new relationships with insurance companies and increasingly cementing ourselves there as the market leaders.

We won a tender for stolen vehicle recovery services for at least 50,000 vehicle installing over two years with a leading Brazilian insurance company, Sul America and recently signed the agreement. This contract is a demonstration of our market leadership in Brazil and provides us with increased visibility into our long term growth. In addition, after the sharp dip in new car sales at the end of last year and beginning of this year, new car sales in October were at the record in Brazil driving the sector four road and subsequently our business growth there.

We see the reward of our effort and investment in Brazil with continued subscriber growth there. For the foreseeable future, we believe that Brazil with its robust economy and the focus for continued strength in new car sales, we remain a strong growth engine for our company.

In Israel, while at the start of this year, new car sale slowed significantly compared with last year, macro signs are improving and there was a pickup in new car sales in the third quarter. While it is difficult to know, how new car sales in Israel will develop going forward, the third quarter growth in sales translated into a net few thousand new subscribers in third quarter.

This is a good sign for our business potential in Israel which despite the down trend has shown us stability and resilience with the number of net subscribers remaining mostly flat for the past few months.

As the economy in Israel improves the new car sales increase driving our subscriber growth. The significant operating leverage built into our platform that we have nurtured over the past few years would enable us to incrementally add every new subscriber in Israel at almost no cost. This will strongly benefit our cash flow and bottom line.

With that I would hand now to Eli.

Eli Kamer

Thank you, Eyal. Revenue for the third quarter of 2009 reached $32 million, while this represents a 9% decrease compared with last year it also represents a sequential improvement of 12%.

Revenue breakdown for the quarter was $24 million coming from subscription fees from our location based services. While this is only a $0.4 million or 2% year-on-year growth, the increase was reduced by approximately $3 million as a result of currency differences compared with that of last year.

In local currency terms, subscription fees grew 15% year-over-year. The increase in subscription fees was due to the increase in the subscriber base which grew 495,000 at the third quarter of last year to 549,000 at the end of the third quarter 2009. In the third quarter, our subscriber base grew by a net 16,000.

Product revenues were $8 million, $3.6 million below those of the same period last year. The decline in product sales was due to a number of factors. One, lower product sales in Israel due to the general weaker economic climate, two, moving to a full use of listing our products in Brazil rather than sales, three the relative strength of the US Dollar versus the Israel Shekel, Brazilian Real and Argentine Peso in the third quarter compared with that of the year ago.

The geographic breakdown of revenues in the quarter was as follows: Israel 52%, Brazil 37%, United States 3% and Argentina 8%. Gross margin in the quarter was 48% compared with gross margin of 49.5% in the third quarter of last year.

Operating profits for the third quarter of 2009 was $6.5 million or 20.2% of revenues compared with operating profits of $7.4 million or 21% of revenue in the third quarter of 2008. The operating profits recorded in the third quarter of 2008, was the highest in its launch history. Excluding the above mentioned currency effect; operational profits would have been higher than that of the third quarter last year.

EBITDA for the quarter was $9.7 million or 30.2% of revenues compared to an EBITDA of $10 million or 28.4% of revenues in the third quarter of last year. A financial expense of $700,000 was recorded, and was primarily as a result of the depreciation of the US Dollar against the Israeli Shekel during the quarter, compared with the previous quarter.

As of the end of the third quarter, the company had transferred most of its cash holdings into Israeli Shekels, its operating currency, and therefore fluctuation between currencies will have less effect on the financial income or expense going forward.

Net profit was $4.6 million in the third quarter of 2009 or 14.4% of revenues, compared with a net profit of $5.6 million or 16% of revenues, as reported in the third quarter of 2008. Fully diluted EPS in the third quarter of 2009 was $0.22, compared with fully diluted EPS of $0.27 in the third quarter of 2008, and fully diluted EPS of $0.12 in the third quarter.

As of September 30, 2009, the company had a net cash position, including marketable securities and deposits of $70.6 million or $3.36 per share. This is compared with $57.7 million or $2.75 per share on June 30, 2009. Our average fully diluted number of shares for the quarter was 20.98 million. Cash flow from operations during the quarter generated $12.5 million approximately $4 million of this was primarily a one-time tax refund.

With that, I would like to give it back over to you Eyal.

Eyal Sheratzky

Thank you Eli. In summary, as the global economy stabilize, we see acceleration in our progress with strong sequential growth in our net subscribers and strong cash generation. Our unique business model based on recurring revenues from an established and growing customer base as well as our exposure to Brazil underlines my confidence in both our long-term stability and ability to continue to grow in all environments.

The tender we won with a leading Brazilian insurance company, Sul America, is very much a demonstration of our market leadership in Brazil. One last thing I would like to discuss the board approved the change in our annual dividend policy, which strongly benefits all shareholders whereby the annual dividend policy has historically been to issue approximately 25% of annual net income, the dividend policy for 2009 and by on will be to issue a dividend on the basis of 50% of annual net income.

This decision was made based on our exceptionally strong balance sheet combined with our ongoing and continued strong results in cash generation. As this demonstrated the board of Ituran strongly believes in sharing the fruit of efforts by the company and its reward with all shareholders to the fullest extent.

At the same time, we intend to maintain the strength of our balance sheet and ability to make strategic acquisitions if and when it may be required. The decision to double dividend doesn’t affect this ability at all and we maintain more than enough cash on the balance sheet to obtain all our strategic goals.

To close, we aim to continue capitalizing on the inherent long term operating leverage in our business based on our stable core business and growing base of subscribers and sharing the rewards of success with our shareholders. And with that I would now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Maynard Um - UBS.

Maynard Um - UBS

Just on the wireless communications product gross margin, can you just talk about how we should look at those going forward? Are there any changes in trends that will move that gross margin in either directionally up or kind of where they are today and then I have a couple more follow up.

Eyal Sheratzky

Actually, as we can see during the last quarters, the last year, the way that we are selling our products in Brazil and Argentina and specifically in Brazil, which is the main growth engine for Ituran today is by making the comodato like a leasing, we are not selling it and this is part of the reason that you see the part of wireless product revenues is declining.

Regarding the gross margin itself, we are not expecting that this will grow although we are working very hard to decreasing our cost of good. But on the other hand our main goal is still to add as much as we can new subscribers even in Israel. So we will continue to keep low margins on the product but on the other end growing our subscriber base.

Maynard Um - UBS

Then secondly, on the Sul America deal, when do you start to see the net adds flowing into your numbers and do you think how will that be from a linearity perspective over the next two years?

Eyal Sheratzky

So first of all, I must give more picture about this transaction. Sul America is one of our client even before this tender. As you know we are working with all the major players in the insurance industry in Brazil but each terms of the relationship are different, and until this tender the relationship with Sul America was based on a daily basis relationship when they decide to add subscriber, they did it. So they were already our customer, but by wining this tender we get a much stronger commitment, with a much more potential numbers of subscribers that will come from this specific big insurance company.

So I wouldn’t consider all these 50,000 as net additional because we had some customer with them. And another issue is that this is the total and also don’t forget that our churn in Brazil is part of the total gain there. So I wouldn’t consider all these 50,000 as net subscribers but of course it will contribute to our future growth.

Maynard Um - UBS

And just related to that on your net subscriber additions, in the past, you noted ranges around 15,000 or 20,000. Do you think the strength in Brazil is sustainable enough to kind of put you back into this range now on a go forward basis?

Eyal Sheratzky

With an average of about 17,000 in 2008 which was the highest ever, I think that this quote there is showing that our next target is to be above it. And I hope that as it seems today with our leadership in the Brazilian market as with the growing of the market itself for 2010 we should expect be back to those numbers, yes.

Maynard Um - UBS

Okay. And then lastly, can you just give us directionally or quantitatively any guidance on your sales and marketing G&A in the next quarter? Thank you.

Eyal Sheratzky

Can you repeat? We couldn’t hear you.

Maynard Um - UBS

Just a question on sales and marketing G&A OpEx into next quarter, either directionally or quantitatively?

Eyal Sheratzky

I think that this is not going to change.

Operator

Your next question comes from Yair Reiner - Oppenheimer & Co.

Yair Reiner - Oppenheimer & Co.

First question on the balance sheet; now, that you have changed your cash into Shekels, how will that transfer onto the balance sheet as the price of the Shekel relative to the Dollar fluctuate?

Eyal Sheratzky

First of all of the parts, which is the operating part there will be no change. We still will be subject to those changes but when we’re talking about the excess cash, which mainly influence the financial expenses or gains, this will be declined dramatically because under the accounting method, once a Israeli company, which is our company holding their money in Shekels, so it does not influence the P&L and it goes only to the balance sheet, to the equity parts.

Yair Reiner - Oppenheimer & Co.

My other question is in terms of Brazil. I know you don’t give specific guidance for subscriber growth, but what do you think is a reasonable target for subscriber growth in 2010 for the company?

Eyal Sheratzky

You just mentioned that we are not providing guidelines and you asked for guidelines, I understand it. Actually I think that answer it more generally speaking when Maynard asked me, and I think that we should expect totally to reach numbers as we did in 2008, which is between 15,000 to 20,000 per quarter, and I think that this is very, that we have lot of reasons to feel confident by saying it. And of course, as long as the time will go on, maybe we can give different expectation, but today I wouldn’t get more details about it.

Yair Reiner - Oppenheimer & Co.

That is fine, that’s helpful. The question about the accounting around the comodato business model. For that the cost of the hardware and the depreciation of the hardware actually factored into the service, revenue and expenses.

Eli Kamer

That is correct.

Yair Reiner - Oppenheimer & Co.

Okay.

Eli Kamer

These are in the market gains and the depreciation of the cost of the unit is in the direct cost and the cost of the sales of the location based services segment.

Yair Reiner - Oppenheimer & Co.

Got it, and it’s depreciated over how long of a period?

Eli Kamer

Usually three years.

Operator

Your next question comes from David Rosenberg - Oscar Gruss.

Ziv Tal - Oscar Gruss

My question is with regards to the recent consolidation that we have seen in Brazil in the past quarter, where some of [Effesca] was acquired by JB Solution. We see additional liquidation by that. So, my question to you is how do you feel about the inter consolidation in Brazil. How do you see yourself and what do you see yourself in this consolidation?

Eyal Sheratzky

As I said before, with or without this consolidation, we are showing better results and we continue to gain market share. In the Brazilian market, we see more and more insurance companies as well as players from the car industry they are approaching us. Of course, we are doing the best effort to increase and to strengthen our relationships with them and actually I can’t say that the situation and the transaction that you mentioned influence or damaged our working.

Ziv Tal - Oscar Gruss

All right, and my next question is with regards to the strength of your brand looking into the possible implementation of the new resolution in Brazil. How strong is your brand and how much do you think you can benefit when the market is consolidating and you are not taking any specific action with regards to that?

Eyal Sheratzky

What do you mean we are not taking specific action?

Ziv Tal - Oscar Gruss

No, I mean you haven’t been consolidating or are you planning any maybe?

Eyal Sheratzky

You mean making acquisition or?

Ziv Tal - Oscar Gruss

That is correct.

Eyal Sheratzky

Actually, right now we didn’t do it and we don’t have a specific target to do it. We still know that the main player we are, we are having 200,000 subscribers which almost 100% of it comes from the stolen vehicle recovery, and I think that this has put us in a very-very high place in terms of leadership.

We don’t see the consolidation by itself anything that’s frightening us and with regard to the new legislation of course this should by definition are open and expend the market, hopefully dramatically in two to three years from now and this will be good for all the industry, but as a market leader I believe that the benefits for us will be the highest.

Ziv Tal - Oscar Gruss

And last one from me; during the quarter which segment in Brazil show the most growth? Was that the uninsured or the insurance business?

Eyal Sheratzky

The insurance company.

Operator

Your next question comes from Yair Reiner - Oppenheimer & Co.

Yair Reiner - Oppenheimer & Co.

First question here is about ARPU. It seems as though ARPU increased quarter-on-quarter even excluding the positive impact from FX. Can you talk about the factors that cause that to happen?

Eyal Sheratzky

No. As long as we have the data, the ARPU is quite stable. So I am not sure, if yes, it’s dramatically not happened because of any operating and pricing changes.

Yair Reiner - Oppenheimer & Co.

Okay very good. My final question is on Argentina and the U.S, neither has improved or gotten much worse over the last year. Can you talk about how you see those markets going forward and if you can talk about whether those markets are profitable for you at this stage?

Eyal Sheratzky

Regarding Argentina, Argentina as it was in the last year and this continue with the same rhythm of growth this year. The absolute number become smaller compared to what the contribution of Brazil. This is the reason that we are mentioning much strongly the Brazilian market, but Argentina continues to show the same growing results, and the reason that we are not expanding it is because of two main reasons.

First of all, the economic situation which Brazil succeeds to cover the bad period, bad international economic period and I think that everybody knows that Brazil industries and Brazil economy is quite well compared to the rest of the world. This is not the situation in Argentina or vice-versa, Argentina is suffering a lot.

Second is something that it’s an anomalic situation but in Argentina, during the last three years, the car theft rate declined. Usually, it should be the opposite when the economic situation is in distress, the car theft usually is increasing. Actually, the crime in Argentina is increasing but not specifically the car theft rate. So, these two items are blocking us from increasing our gross number and rates in Argentina but still we show better results quarter-over-quarter and year-over-year.

With regards to United States, I think that the U.S market is changing and this change seems to be in favor with us. If historically, feel about until this recession, logic was that the sole market leader with a very high market share, this thing was changed, new players entered the market. The market today is increased by different and new dealers.

The dealers’ need is changing, part of it is some more and more sub-prime rental car customers that those dealers need to control customers that they are not paying and they have no enough credibility and this start to be very dramatic numbers, and during this time of the market change, we change our management and we replaced the CEO about two years ago, we changed many things in the company and with the approach to the market, and recently it seems that we are getting on better tracks.

So we still contribute low numbers. I must admit that historically, and when I’m talking historically, I’m talking about a year ago, our US subsidiary contribute losses on accounting basis and recently we are improving it dramatically and I believe that if this trend will continue, we will change to net earnings in US during 2010 it’s still low numbers.

As early mentioned, it contributed about 3% of our total revenues but it seems that the trend is better today for us, for the market that we are in the segment that we are approaching and we are optimistic, but let’s wait and see.

Yair Reiner - Oppenheimer & Co.

One final question from me actually, the tax rate in the quarter was significantly lower than usual. How should we model the tax rate moving forward?

Udi Mizrahi

As you saw in the PR, the low tax rate is due to the tax refund that we had this quarter. Going forward, I believe that this will be again in the range of about 30% tax rate.

Operator

Your next question comes from [David Delayo] - Canaccord Adams.

David Delayo - Canaccord Adams

You talked briefly about the upcoming legislation in Brazil. Could we just get some color on any status update there whether anything has changed if not as far as timelines. Thanks.

Eli Kamer

Actually, until coming February, the legislation required the car manufactures and the car importers to take standardization level. Each one of them chose their OEM suppliers for the hardware and they’ll now check it and examine it with right authorities, the governmental authorities, and it’s not yet in the commercial phase, and under the regulation from February 2010, it will start be a commercially enforced and until the end of 2010 it will come gradually.

Every few months they were obliged to equip more and more models of cars and from the beginning of 2011, and of course, with the assumption that there will be no delays and no changes, 100% of the vehicles including motorcycles and heavy trucks in Brazil, will drive on the roads with hardware that company such as Ituran will have the ability to sign services with a potential costumer.

Operator

(Operator Instructions) 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 completing statement?

Eyal Sheratzky

Yes, I would like to thank all of you and I look forward to speaking with you next quarter. Thank you and good bye.

Operator

Thank you. This concludes the Ituran third quarter 2009 results conference call. Thank you for your participation. You may go ahead and disconnect.

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