Earnings Call Transcript - ITRN Q3 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran Third Quarter 2021 Results Conference Call. All participants are at present in a 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 and Public Relations at 1-212-378-8040 or view it in the News section of the company's website, www.ituran.com. 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

Thank you, operator. Good day to all of you and welcome to Ituran's conference call to discuss the third quarter 2021 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 CEO and VP Finance; and Mr. Eli Kamer, 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 question-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. We are very pleased with the results of the third quarter which were again ahead of our expectations. We grew our subscriber base at the highest rate we have seen for two years with 25,000 net adds. The OEM segment is showing recovery with 4,000 net adds and our aftermarket segment saw above-average growth at 21,000 net adds. This is ahead of our typical expected range of between 15,000 and 20,000. The growth we experienced in subscriber adds is a positive indication with regard to revenue growth in the quarter ahead. We continue to see strong aftermarket subscriber growth in many of the geographies in which we operate, even in a quarter which is seasonally weaker due to the holiday season in Israel. In particular, we see increasing contribution from one of our growth engines, Usage Based Insurance or UBI. The consumer market is now becoming increasingly educated to the value that they gain by using a usage-based insurance plan rather than fixed. This has led to increased traction and we are now working with all the seven major insurance companies in Israel. The Corona slowdown created plenty of new markets and opportunities and over that time, new car sales around the world went down. We identified a very strong second-hand car market in many of our geographies in Latin America, and new FinTech startups, as well as the large banks have come in to provide the financing in this specific market. However, they all needed occasion-based and connected car technologies service provider, such as Ituran, to monitor the cars and driver behavior and by this, reduce the risk of loss against the car. We therefore initiated an approach to these financing companies and offered our solution. Following on from these efforts, we are now working with a number of partners in this area and we see great potential in which to expand this business. While currently, we are only in the initial stage, we see the interest and we therefore believe this has the potential to be a significant growth engine for Ituran starting from the second half of 2022 and beyond. I would like to discuss the electronic component shortage and increasing prices that has been widely reported and is increasingly becoming an issue for everyone. To-date, we have successfully been managing through the shortages. It's important to note that as primarily a subscriber service business, the impact on Ituran to-date has been low, primarily on the product revenue side, which has a smaller effect on our bottom line. There is also a potentially indirect impact, due to the potential slowing of new car sales simply because of the inability of car manufacturers to produce cars at the required quantity. However, Ituran has a number of growth engines, which will increasingly benefit us in the quarters ahead, which will compensate for slows in global sales of new cars. In summary, we are performing well. But most importantly, we are seeding new growth engines, which will accelerate our growth in the years ahead. I am more excited now than ever about our long-term potential over the coming years. I will now hand the call over to Eli for a financial summary.

Eli Kamer, CFO

Thanks, Eyal. Revenues for the third quarter of 2021 were $65.7 million, a 9% increase compared with revenues of $60.3 million in the third quarter of 2020. Revenues from subscription fees were $48.3 million, up 9% year-over-year. The subscriber base amounted to 1,837,000 as of September 30, 2021, an increase of 25,000 net over that of the end of the prior quarter and an increase of 85,000 since the end of the third quarter of last year. During the quarter, there was both an increase of 21,000 in the aftermarket subscriber base and an increase of 4,000 in the OEM subscriber base. Product revenues were $17.4 million, up 10% year-over-year. The geographic breakdown of revenues in the third quarter was as follows: Israel, 52%; Brazil, 24%; Rest of World, 24%. Operating income for the quarter was $13.9 million or 21.1% of revenues, an increase of 32% compared with an operating income of $10.5 million or 17.5% of revenues in the third quarter of last year. EBITDA for the quarter was $18.5 million, or 28.1% of revenues, an increase of 23% compared with an EBITDA of $15 million or 24.9% of revenues in the third quarter of last year. Financial expense for the quarter was $2.7 million compared with a financial income of $2.8 million in the third quarter of last year. The difference being primarily due to the change in the Saver-One market capitalization during each quarter. Adjusted net income for the third quarter of 2021, which excludes the non-cash financial impact related to Saver-One was $9.6 million or 14.6% of revenues or diluted earnings per share of $0.46 compared with $6 million or 10% of revenues or diluted earnings per share of net $0.29. Cash flow from operations for the third quarter of 2021 was $11.5 million. As of September 30, 2021, the company had cash including marketable securities of $67 million and debt of $34.6 million, amounting to a net cash of $32.4 million. This is compared with cash including marketable securities of $78.8 million, and debt of $54.5 million amounting to a net cash of $24.3 million, as of December 31, 2020. For the third quarter of 2021, a dividend of $3 million was declared. During the quarter, Ituran purchased 71,000 shares for a total of $1.9 million until the end of September 30, 2021. Share repurchases were funded by available cash and repurchases of Ituran ordinary shares were made based on SEC Rule 10b-18. And with that, I'd like to open the call for the question-and-answer session.

Operator, Operator

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

Tavy Rosner, Analyst

Hi. Good afternoon. Thank you for the presentation. I have three questions, please. First one is just maintaining from my end, but with regards to SaversOne. What's the accounting treatment here? Are you marking-to-market your stake on a quarterly basis, or did you have it recorded at a certain value, and given the fluctuation you have to record an adjustment?

Eyal Sheratzky, CEO

Hi, Tavy. Actually, it's mark-to-market; it's like a financial asset.

Tavy Rosner, Analyst

Okay. Understood. Okay. With that out of the way, I wanted to talk about the OEM dynamics a little bit. If I remember correctly, I think you had a 1,000 increase, last quarter 4,000. Is it fair to assume it's coming from Latin America? And guess, can you remind us when in the accounting of those OEM you add, if any of this includes a free trial period that you give to OEM, I think, at some point you used to give us three months, that went down to one month, clearly what was needed for this?

Eyal Sheratzky, CEO

First of all, most of it is a free trial. The only country where the free trial lasts for one month is Brazil, and there are only a few thousand customers compared to other markets, with a few hundred in Argentina. This is essentially the tail end of our business in those markets. However, the majority of these OEM subscribers, particularly in Mexico, Colombia, and Ecuador, are on a free trial for at least 12 months, with some even longer, and 12 months is the minimum for the service.

Tavy Rosner, Analyst

Okay, understood. And then lastly talk about the new growth engines that you mentioned. You talked about the financial players that might be interested in your solution. So, would you believe that you would work in a similar way to the agreements you have for UBI and their insurance company, whereby they would purchase it from you and then pass on the cost to the end user?

Eyal Sheratzky, CEO

We have identified a new market segment as we sought to reduce our reliance solely on SVR and developed an advanced UBI solution, which is now nearly capturing the entire market share in Israel. Many insurance companies there are conducting multi-million dollar advertising campaigns, predominantly featuring our white-labeled offerings. We are currently acquiring thousands of new subscribers each month, demonstrating significant growth in UBI. During the pandemic, when car manufacturing was halted, particularly in Latin America, we considered how to expand our offerings. We recognized an opportunity in the second-hand market and with subprime customers, which we have been servicing in the US for about 15 years. In various dealerships, they utilize systems like ours to help finance cars, manage payments, and locate vehicles if necessary. We partnered with banks in Brazil and Mexico to provide solutions that facilitate financing for individuals with lower credit ratings. After convincing them that our platform would allow better management of these customers and their payments, they agreed to collaborate with us. Furthermore, with the surge in the Fintech sector, we have also addressed digital finance companies, receiving positive interest from these established players. We currently have three significant clients who are still in the early stages as we educate them, while they in turn educate their markets. This model aligns similarly to UBI, operating in a B2B capacity with well-capitalized clients, which mitigates our risks. After financing specific vehicles, the companies request installation of our units, for which they cover the initial costs and three years of service fees. Our average revenue per user is on par with what we see from aftermarket sales in Brazil and Argentina, showcasing strong margins. However, this is just the start and we anticipate rapid growth. If trends continue, this could be a pivotal aspect for 2023 and 2024 as we tap into a fresh market. Historically, we succeeded in winning clients in this space as the sole supplier. The pandemic's challenges have encouraged innovative thinking, leading us to enter a market previously devoid of competitors in Mexico and Brazil. Now, we're actively expanding and educating the market, aiming at the potential of millions of annual car sales in each region. While this may not reflect our ultimate market share, it illustrates the vast opportunity in both Brazil and Mexico.

Tavy Rosner, Analyst

Great. I appreciate the color. I’ll go back to the queue.

Operator, Operator

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

David Kelley, Analyst

Hey, good afternoon, and thanks for taking my questions. And maybe to start, I was hoping you could elaborate on the aftermarket net subscriber growth in the quarter and specifically the regional dynamics. We were just curious about the momentum in Israel and then in Brazil. I think there were some signs of stabilization last quarter. So I was hoping you could provide some color on what you're seeing there as well.

Udi Mizrahi, Deputy CEO

The main aftermarket growth stems from our traditional business in Israel and Brazil. While we do see some contributions from other regions, the majority of aftermarket subscribers come from these two countries, so I’ll focus on them. In Israel, we have three key segments: stolen vehicle recovery, fleet management, and usage-based insurance (UBI). Both stolen vehicle recovery and fleet management continue to grow alongside new car sales in Israel, as we've been operating in these segments for many years. However, we do experience churn among long-term customers, which slightly limits significant growth, although we have managed to see some increases this year. The standout area for subscriber growth in Israel is UBI, as we continue to attract more customers and integrate with more insurance companies, leading to exponential growth in that segment. Importantly, the churn rate for UBI customers remains very low since it's fairly new. Looking ahead, car importers in Israel are forecasting a decline in car sales for the upcoming quarters. Despite this, demand for cars is currently at an all-time high, with customers willing to wait for extended periods; importers believe that if they could bring in 500,000 cars annually, they would sell them immediately. This high demand illustrates potential growth in the market, despite the supply challenges facing the car industry, which might slow our subscriber growth slightly. Historically, we’ve noticed that most churn occurs when customers purchase new cars and sell their old vehicles, leading the new buyers to forgo subscriptions. During periods when people cannot buy new cars, they tend to stay with their existing ones, which results in lower churn rates. This trend was evident during the pandemic, when our subscriber base remained relatively stable. In Israel, hardware sales may decline, but profit margins are already very low, so we sometimes lose money on hardware sales. Despite challenges in the car sales market, I believe the impact on subscriber growth will be minimal, if at all. In Brazil, the market operates differently, mostly focusing on business-to-consumer sales, particularly through our Ituran Com Seguro (ICS) program. Over the last two years, this segment has driven the majority of our subscriber growth. Initially, we experienced negative churn during the pandemic, then reached a balance, and now we're back to positive growth, adding a few thousand subscribers each month. In Brazil, our focus on the second-hand car market helps shield us somewhat from fluctuations in new car sales. Many consumers who insure new cars typically drop coverage after one or two years, creating opportunities for us as they seek other insurance solutions. Additionally, while our focus has primarily been on business-to-consumer, we have started allocating resources to the business-to-business market, specifically in fleet management. We’re expanding this segment by bringing in more financial partners and lenders. I believe this approach will significantly contribute to our subscriber growth in Brazil over the next few years. Though we face challenges with new car sales, I still anticipate a continued increase in our net subscribers, particularly in the aftermarket.

David Kelley, Analyst

Okay. Got it. That's helpful. Thank you. And then maybe last one for me. Operating expenses, we started to see general and administrative costs pick up again in the quarter. So how are you thinking about the OpEx trajectory, this assuming that the post-COVID normalization continues here?

Udi Mizrahi, Deputy CEO

Okay. There are two relevant points I want to highlight. First, for this specific quarter, I believe it accurately reflects our operating expenses. Prior to this, some items were not executed as planned. We still have some salary reductions due to the pandemic which affected our Q2, and the majority of it has now shifted to Q3. As we are growing, we allocated some budget for advertising in Brazil, among other areas. But overall, I think this quarter is representative of our operating expenses. Second, we need to recognize that in various global divisions, the primary focus is on R&D personnel. We are finding it increasingly challenging to recruit talent, particularly in Israel, but also in other countries, as there is a general perception of high costs. This may lead to additional salary expenses, but I anticipate they will not be significant. I believe we can regard the operating expenses from this quarter as the right figure.

Operator, Operator

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

Sasha Karim, Analyst

Hi, Eyal. In your statement you mentioned the potential for buy here, pay here in LATAM to generate significant acceleration in subscriber growth in the second half of 2022. And then just now you also mentioned that the ARPU on those subs is similar to your LATAM aftermarket business. So that sounds like it should accelerate service revenue growth as well over that period. But it does sound different in the US, where buy here, pay here subs are low ARPU and low margin. So could you tell us, is there a reason for that difference to persist between the LATAM and US, or do you expect the ARPU on buy here, pay here in LATAM to also decline significantly over time?

Eyal Sheratzky, CEO

The US market is completely different from markets like Latin America or other emerging markets. The competitive landscape varies significantly, and the way dealers finance their customers is distinct as well, along with additional offerings like extended warranties. For the past 15 years, our sales approach in the US has been unique, which impacts our average revenue per user in that region. In Latin America, the model resembles a business-to-business approach where we lease hardware. In contrast, in the US, we sell hardware to dealers, who then earn a margin from it. Here, we operate under a model where the hardware remains on our balance sheet. This allows us to gather monthly returns along with services for periods of two to five years, which leads to higher average revenue per user. Additionally, the business mentality is different. I don’t foresee a decline in ARPU. If we achieve significant volumes with specific clients, like a bank committing to 100,000 or more, we would offer tiered pricing. However, this is a regular part of our commercial routine. Currently, without specific commitments, this is our ARPU. I would prefer commitments for larger numbers to reduce ARPU because, ultimately, achieving higher volumes is crucial for profit growth, even if it means a decrease in ARPU.

Sasha Karim, Analyst

Yes, that's a good problem to have. Can I also just ask about this industry in general, and this applies to the US as well. How sustainable is the growth, the recent growth in buy here, pay here? Do you think that the industry, the growth may unwind somewhat, once the pandemic truly ends, perhaps because people were buying cars this way to avoid using public transport, and they have no other way of getting a car?

Eyal Sheratzky, CEO

First of all, I'm not sure how to explain the situation in the US. We've been operating there for 15 years, and we've recently increased our market share. However, I'm uncertain if the overall market is expanding. To be candid, our market share in the US is relatively low, and we are not a dominant player there. In contrast, in Latin America, which we recently entered, I believe we will establish a strong market presence. Currently, we are the leading player, and while competitors may enter the market, such as FM in Brazil with the ICS, we still maintain a dominant position, and the next competitor is significantly behind us. I am optimistic that we will also find success in the financial segment in Brazil and Mexico. It’s important to clarify that our situation isn't a result of the pandemic; sadly, we were not able to develop this before because we were focused on stolen vehicle recovery and fleet management. When faced with pressure, that's when we often find solutions. In Latin America, particularly as an emerging market with lower salaries and security concerns, we recognized opportunities during the pandemic that already existed. The future of this market is certain; the question is what our market share will be. I don't mean to come off as arrogant, but I have strong confidence in our advanced technology and services. As we build trust with insurance companies, I believe we will also earn the confidence of financial institutions, allowing us to lead the market. If we achieve that leadership within a year or two, it will significantly enhance our results. I want to reiterate that it takes time, but we are currently expanding the subscriber base for this segment. Once we reach a substantial number of subscribers, it will have a major positive impact on our profits.

Sasha Karim, Analyst

Thanks. Okay. That sounds very encouraging. My last one, if I could. Could you just give us an update on two segments, I don't think you've touched upon, Ituran Con Seguro in Mexico, how that's going, any improvement there? And then fleet management, which you said last quarter was going to experience very strong growth to start to track it, if that's still coming through?

Eyal Sheratzky, CEO

Regarding the ICS in Mexico, there was a delay at the beginning due to the pandemic as we needed to find the right timing to launch it. We have since launched it, and the numbers are now growing, even rapidly. However, with 1.8 million subscribers, the monthly growth numbers are still small, so we are withholding detailed information for now. It’s still in a sort of soft launch phase. Although we see good interest and sales through the website, it’s too early to determine if this will have a significant impact. The service has only been operating since the start of this year, and since it targets consumers, we must educate a large market, which takes time. While it looks promising, we need to remember the difference between B2B and B2C approaches. As for fleet management, which I mentioned earlier, primarily in Brazil, it is growing alongside our finance customer segment. We consider it all part of the same brand. The fleet management aspect is divided into two: finance, which is still small, and the B2B component aimed at commercial clients who need control data for their fleets. This sector is expanding and is becoming a significant growth driver for us in Brazil for 2022. It's looking very promising and will contribute importantly to our numbers this year.

Sasha Karim, Analyst

Thank you.

Operator, Operator

The next question is from Abba Horwitz with OSP. Please go ahead.

Abba Horwitz, Analyst

Hi. Good afternoon. I was wondering if you mentioned it all Bringg? And if you didn't, could you speak about it?

Eyal Sheratzky, CEO

Yes, Bringg is a company in which we hold a 17% stake, making us the largest shareholder with a strong representation on the Board. Bringg has developed a solution for last mile deliveries, and their most recent funding round took place in the previous quarter. We discussed this in our last conference call, but I will reiterate that the company raised $100 million at a valuation of $1 billion. It operates as a typical SaaS company, catering to both enterprise groups and small to medium businesses, with most customers located in the US. Recently, the funding has enabled them to open accounts in Europe and Latin America, which will support their growth. I believe the funds they have and their progress indicate that they won't need to raise more capital soon. We also hope that their next steps will lead to either an IPO or an acquisition, although this is uncertain. The value of our investment is now greater than what we need to reflect on our balance sheet, as, unlike SaverOne, this investment is regarded as an equity investment by accounting regulations. Therefore, it does not appear on our balance sheet because we have already accounted for losses over the past five years, balancing the investment to zero. Once we realize value from selling our shares, it will directly contribute to our profits, without taxes. The current estimated value of our holdings is around $170 million, based on the latest funding round.

Abba Horwitz, Analyst

Okay. So, first of all, that's an off-balance sheet asset that my understanding is it's a very good asset.

Eyal Sheratzky, CEO

Yes.

Abba Horwitz, Analyst

Do you have any sense what the timeframe is for them to IPO? I've heard that they want an IPO. You know better than me, I'm just telling you what I've heard. Or you said M&A potentially? Is there a sense when this could happen? Is this a 2022 event? Is it later than that? Do you believe whatever will happen will happen in 2022?

Eyal Sheratzky, CEO

First of all, I don't think they will be able to disclose that. To be clear, there is currently no plan for an IPO. Based on my experience, this won't happen in the next six to eight months since that is typically the timeframe required, and startups may need even more time. So, I do not expect it to occur in 2022. I can't predict whether it will happen in 2023 or 2024, because an IPO can depend on market conditions as much as, if not more than, company conditions. Regarding M&A, while I mentioned it as a possibility, I believe that there are large enterprise companies that may require solutions for deliveries or last-mile services. I don't think it's impossible that one of these major companies would need such a solution. It's worth noting that Salesforce and Siemens are among the top investors in Bringg. I share this perspective based on my beliefs, but it's not rooted in any concrete evidence. I believe that if the company is strong, it will continue to grow. They have unique technology and are aware of global conditions. I hope this will evolve in the next year or two, but I don't have anything specific to rely on.

Abba Horwitz, Analyst

I have a final question regarding this. When we analyze the situation, there’s approximately $8 to $8.5 of real asset value based on the current valuation. This represents an off-balance sheet asset, which means it's not reflected on your financial statements at all. This is significant; typically, companies show $1 or $2, but here we have $8 to $8.5 of real value that isn't being acknowledged in the stock price. I'm curious if there's a way to address this, or if it would require a specific event, like an IPO or M&A. Additionally, I recall when your asset was valued at under $50 million.

Eyal Sheratzky, CEO

We can do two things, one to talk about it, because it's real, and second by shares. There is – not dependent on us. People know about it.

Abba Horwitz, Analyst

Okay.

Eyal Sheratzky, CEO

And this is exactly how you described it. However, until we can realize this value from manual to public shares, it won't show up in our direct financial statements due to accounting regulations. But you're right; this is a value that everyone can be aware of and can choose to include in their valuations or not.

Operator, Operator

There are no further questions at this time. Before I ask Mr. Sheratzky to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available tomorrow on Ituran’s website, www.ituran.com. Mr. Sheratzky, would you like to make your concluding statements?

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 do 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 third quarter 2021 results conference call. Thank you for your participation. You may go ahead and disconnect.