Earnings Call Transcript - ITRN Q1 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran First Quarter 2021 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.com. Now I would like to hand over the call 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 2021 results. I would like to thank Ituran's management for hosting this conference call. With me today on the call are Mr. Eyal Sheratzky, Co-CEO; Mr. Udi Mizrahi, Deputy CEO and VP Finance; and Mr. Eli Kamer, 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 would like to remind everyone that the safe harbor in this press release also covers the content 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. We are very pleased with the results of the first quarter, which outperformed our expectations. We demonstrated that Ituran is well on the way to full recovery and renewed growth. This is despite ongoing impact from the pandemic, which still affects many of the geographies in South America in which we operate. Not only have we maintained our profitability and strength, we grew our subscriber base at the highest rate we have seen for many quarters, with 20,000 net adds, while the OEM segment is stabilizing. The strength was driven by the aftermarket segment, which grew remarkably, adding 25,000 net subscribers. This rate is nicely ahead of our typical range of between 15,000 and 20,000. We are very happy with this strong increase, and it is a promising sign for potential growth in the subscription revenues over the many quarters ahead. For the first quarter of 2021, revenues were $67 million, 6% ahead of the fourth quarter and just 1% behind the $68 million reported in the first quarter of last year, prior to the pandemic. All this demonstrates that Ituran is now recovered to its former strength and is primed for renewed growth in the quarters ahead. On the profitability side, as you know, over the past year, we carefully managed the business, which allowed us to maintain our cash generation and profit. As we return to the growth trend in the coming quarter, we expect that the operating leverage inherent in our business model, which enables us to add subscribers on a relatively fixed operating base, will allow us to see the top-line revenue growth from the increase in subscribers drop down to the bottom line. From the profitability standpoint for the quarter, we reported EBITDA of $17 million, our highest level since before the pandemic. Again, it is a strong statement to the overall resilience and stability of our business model. On the cash side, we had first quarter cash flow from our operating activities at $9.2 million, bringing our cash and marketable securities position to $70 million. I'd like to go into more details on the various parts of our business. During the quarter, as I said, our aftermarket business returned to above its normal growth rate of 25,000 new net subscribers. The regions that were particularly strong were Israel and the U.S. It is worth mentioning that in Brazil, even though the situation with the pandemic still remains tough, we are pleased with the stabilization in the aftermarket subscriber base. I note that in Q1, Israel had its highest level of new car sales in history, an 18% year-over-year increase. This is another sign that 2021 has started well in our key geographies. Many countries in South America are still highly impacted by the virus, and the economies remain weak there, but we are seeing improving trends in Brazil and Mexico. During the quarter, we saw an overall decline of 5,000 OEM customers. This decline has slowed from last year and is moving in the right direction. One of the major goals of the acquisition of the OEM business was to harvest synergies across our entire business in all various geographies, cross-selling and replicating successful business models and sales from one region to another. We are very much in the process of doing this now and tapping our large subscriber base of almost 1.8 million regularly paying customers to bring them new and valuable telematics and related services, by which we can organically grow our sales. And in summary, overall, we are pleased with our start to 2021. Ituran has resumed its growth trend, and a strong increase in the subscriber base sets us up well for the coming quarters. And I will now hand the call over to Eli for the financial review. Eli?

Eli Kamer, CFO

Thanks, Eyal. I note that the results I present will all be on a GAAP basis, including adjusted EBITDA, which excludes revenues and costs related to the purchase price allocation. We believe this will provide a better understanding of our ongoing performance. Revenues for the first quarter of 2021 were $67.4 million, a decrease of 1% compared with revenues of $68.4 million in the first quarter of 2020. In local currency terms, first quarter revenues were at the same level as those of the first quarter of last year. Revenues from subscription fees were $45.6 million, a decrease of 7% over first quarter 2020 revenue. In local currency terms, first quarter subscription fees decreased by 4% year-over-year. The subscriber base amounted to 1,788,000 as of March 31, 2021. This represents an increase of 20,000 net over that of the end of the prior quarter. During the quarter, there was an increase of 25,000 in the aftermarket subscriber base and a decline of 5,000 in the OEM subscriber base. Product revenues were $21.7 million, an increase of 12% compared with that of the first quarter of 2020. The geographic breakdown of revenues in the first quarter was as follows: Israel, 52%; Brazil, 22%; and the rest of the world, 26%. Operating income for the quarter was $12.8 million or 19% of revenue, an increase of 27% compared with an operating income of $10.1 million or 14.7% of revenues in the first quarter of last year. EBITDA for the quarter was $17.1 million or 25.4% of revenue, an increase of 12% compared with an EBITDA of $15.3 million or 22.4% of revenues in the first quarter of last year. Financial expenses for the quarter were $1 million compared with the financial expenses of $700,000 in the first quarter of last year. Net income for the first quarter of 2021 was $8.3 million or 12.3% of revenues, or earnings per share of $0.40, which is an increase of 30% compared to a net income of $6.4 million and an earnings per share of $0.31 in the first quarter of 2020. Cash flow from operations for the first quarter of 2021 was $9.2 million. As of March 31, 2021, the company had cash, including marketable securities of $70.1 million and debt of $41.8 million, amounting to a net cash of $28.3 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 first quarter of 2021, a dividend of $3 million was declared. This is in line with the Board's current policy of issuing at least $3 million on a quarterly basis. And with that, I'd like to open the call for the question-and-answer session. Operator?

Operator, Operator

The first question is from Tavy Rosner of Barclays.

Peter Zdebski, Analyst

This is Peter Zdebski on for Tavy. Congratulations on the quarter. You had another very strong quarter in hardware, both on sales and margins. I recall last quarter that was related to some inventory restocking. Could you give some color on whether that continued in Q1? And then as a follow-up, have you or your customers been impacted by any supply chain shortages this year that we should consider for the outlook?

Eyal Sheratzky, Co-CEO

Yes. Usually, Q1 is very strong in terms of the OEM purchasing process since in Latin America, the OEM plants consider this the last quarter of the year. So they are increasing their volumes and their inventory. This is typically, I would say, the highest season from the OEM purchase point. Also, in Israel, as I mentioned, Q1 was the highest ever for sales of new cars in Israel, which, of course, creates a correlation between purchasing the hardware and installing it. So it was strong. And it's not a one-time occurrence, but it shows a little bit of seasonality in hardware sales for us. Usually, Q2 and Q3 are a little bit weaker than Q1 and Q4. But as you remember, still, the contribution of hardware sales to our overall profit is lower than, of course, the service revenues, but still, this is the reason for Q1, yes.

Operator, Operator

The next question is from David Kelley of Jefferies.

David Kelley, Analyst

Two for me, maybe to start, the step-up in the U.S. aftermarket subscriber business. Just hoping you could provide a bit more color on the drivers of the contribution there? And maybe remind us of the size of your U.S. business and kind of how the competitive landscape shapes up there would be great.

Eyal Sheratzky, Co-CEO

Okay. So just to remind everyone that our main segment in the U.S. market is what they call the buyer payer, which represents financing people to buy the costs in the dealers' shops. In some cases, those finance dealers would like to control payments of their customers, and they're using systems like ours and others in order to manage payments. And during last year, I think that after a while our solution showed a very excellent and reliable application, and we succeeded in increasing our penetration to additional master dealers in the U.S., a trend which I believe will continue. We are now putting more resources into marketing and sales because we found that we have an advantage that we need to turn into sales. So I think we are gaining more market share. I think we have a better solution. And fortunately or unfortunately, during the pandemic, we succeeded in increasing our market share and grow the subscribers there now. The U.S. market is very competitive, so the price dynamics based on this competitive landscape creates low margins. This is why when you see our annual results, the U.S. market profitability is low compared to the number of subscribers that we have there. But this was always the case. This is the mentality and the DNA of the U.S. competitive markets, but we are there. We are growing. We're gaining market share. And at the end of the day, we are increasing our profits. If this trend continues, which we are striving for, I believe it will be more material year-over-year.

David Kelley, Analyst

Okay. Got it. That's helpful. And maybe just to clarify on that last point. I mean it sounds like you're expecting to continue to be selective in your U.S. business while still trying to grow market share where it makes sense from a profitability standpoint. So just making sure that we understand kind of the approach there.

Eyal Sheratzky, Co-CEO

Can you repeat? I understand, but maybe I didn't understand your issue.

David Kelley, Analyst

Yes, yes. So just maybe another way of putting it. Do you expect to remain selective with your approach to the U.S. and focused on profitability? You noted it's a region with historically lower profit margins. So should we expect your approach to the market to remain as you've always approached it historically, meaning you're not willing to sacrifice margins for growth?

Eyal Sheratzky, Co-CEO

Okay. Our strategy is to maintain profits, keeping profitability, even if it means giving up some growth. Over the past 15 years, we’ve seen that most, if not all of our larger competitors, always lost money. Many of them have bankrupted or changed ownership over the years. We have consistently made money. Now fortunately, we’ve succeeded in showing that we have certain advantages, and we have increased our growth without sacrificing our profitability. Still, compared to other regions where Ituran operates, like Israel and Latin America, the U.S. business has lower margins, but we will always prioritize profits. To start giving, for example, units for free while also spending significantly to advertise isn’t a sustainable approach. The business must serve shareholders by creating profit. We will not sacrifice our profits. We always try to balance between growth and profitability. Now we are in a favorable trend, and I think we are starting to reap the benefits. We are growing, but without giving up on our profits. Of course, for the short term, we might increase our marketing resources and may not grow our profits in the next one or two quarters in the U.S., but we do it very consciously. We always understand that this will lead to increased profits. That is our primary focus: profits, profits, and profits.

David Kelley, Analyst

Okay. That's helpful. And then last one from me. Just curious to get your views on the setup in Brazil. I believe you noted stabilization in the aftermarket segment there in Q1. Can you talk a bit about what you're seeing in Brazil in Q2 to date?

Eyal Sheratzky, Co-CEO

First of all, when we compare the situation today to how things were in 2020, we are in a much better position because during 2020, until about October, sales were very low, not zero but very low. At the same time, churn is something that doesn't depend on the market. There is churn. We faced negative growth in our subscriber base, which is typically the opposite of our goal. However, since October, we’ve managed to improve the situation. We have backtracked on the decline, and we now see positive trends leading us back to growth of net subscribers. Our outlook is optimistic. We are close to full recovery. However, we see less car sales impacting us. People have less disposable income, and some customers have decided to delay purchasing new cars because many are still in quarantine. We observe that behavior in Brazil similar to trends seen in Israel and Europe. Thankfully, we are seeing a strong trend of vaccinations now in Brazil, particularly in São Paulo, which is a major economic hub for the country. Once we can navigate through the pandemic and return to more normalcy, I am confident we will see growth return. Even amidst the pandemic, our market share remains strong, and we have actually gained more and more market share during this challenging period. Our competitors have faced more severe economic hardships. Therefore, I am optimistic that Brazil's contributions will increasingly reflect positively on our results.

Operator, Operator

The next question is from Asaf Barel of Oppenheimer.

Asaf Chandali, Analyst

Congrats on a very strong quarter. Maybe we can just kind of revisit the product segment, because that's what really stood out to us in terms of surprise versus estimates. Obviously, I think that's part of what drove the kind of sequentially higher EBITDA generation. How should we be thinking about a normalized product revenue run rate? Should we go back to thinking about this as a $15 million quarterly business, or should we adjust that number up given maybe some newfound strength in the auto market globally and in the specific countries where you operate, like Brazil, Mexico, and Israel?

Eyal Sheratzky, Co-CEO

Asaf, as I mentioned earlier, there is a specific issue with the OEM during Q1 and in Israel, tied to the high growth of new car sales. However, when we look backward to 2020, it wasn't a typical year. When discussing this with investors and shareholders three or six months ago, we need to remember that we were in the midst of a pandemic. Even in Israel, vaccinations were just beginning. Our forecasts were based on previous data, which we couldn’t anticipate changing so quickly. Comparing now to a year ago shows a significant difference. Israel has effectively managed the pandemic. As we look across the states and into Latin America, people are now getting accustomed to living in these conditions. Q1 was robust in terms of the car industry compared to the same time last year, which was dramatically low. Looking to the future, I don't think we will see the lowest sales numbers again. If we saw about $17 million in sales a quarter last year, I believe we will be somewhere between last year's figures and Q1 sales. We will not see a dramatic drop, but Q1 was notably strong. A change of about $2 million in sales translates to a substantial impact. However, the margins on our hardware sales are less than 20%, which means they have lower weight on profits. While hardware sales are good, they mostly lead to subscribers down the line. This is what matters; those hardware sales convert into users over six to eight years, which ultimately provides high numbers. Hence, it’s promising to see hardware sales during Q1, and I anticipate growth in sales but with some quarterly fluctuations.

Asaf Chandali, Analyst

Okay. That's very clear. Very helpful. You mentioned earlier about the subscriber growth being strong, above the $15,000 to $20,000 run rate that we were at prior. When you talk about operating leverage, can you walk us through how that plays out between the services gross margin, which has stabilized at about 54.5% for the past couple of quarters? And then kind of walk us through the operating expenses because I think we're all asking what a normalized operating expense run rate looks like post-COVID? G&A seems pretty modest at these levels, but we have seen R&D come up. I know that there are some currency effects maybe playing in here. But what does a normalized spend rate look like in terms of OpEx? And any insight you can provide on the services gross margin over time would also be appreciated.

Eyal Sheratzky, Co-CEO

Last year, and I mention it every call, we significantly reduced our costs during the pandemic because we adopted a conservative approach. I was pleased that all our employees and managers supported the company's interests. After demonstrating that we overcame the pandemic and maintained robust operations into Q1, we returned to pre-pandemic cost levels. Meaning, the costs reflected in Q1 across the board, including operating costs and margins, represent normalized operating expenses for the group. As we grow our sales, we will need to incrementally add costs. However, operating leverage allows us to add costs at a rate less than the profits generated from sales. Looking at the short term, I do not see growth in our cost structure; we are now back to what I would consider normalized costs across all divisions and regions.

Asaf Chandali, Analyst

Okay. Can we get an update on the outlook for the Mexico aftermarket business and how that's going to play out over the next year? I think we all expect it to impact results more meaningfully in 2022, but how is it taking shape this year?

Eyal Sheratzky, Co-CEO

This is something I discussed during the last Shareholders' Meeting. As we previously mentioned, the launch of the ICS (Ituran's insurance plan) in Mexico was delayed. We officially started at the end of 2020 when we felt it was the right moment because launching it during quarantine and lockdowns would not be effective. So, we initiated it, and we are seeing a growth trend. While we are adding hundreds of new subscribers monthly, with a subscriber base of 1.8 million, this growth metric remains small relative to our overall performance, but it’s still a positive sign. However, I do not expect it to significantly impact our results in the near quarters. I believe that, similar to Brazil's experience, this marks the start of our penetration into the market. Additionally, we are engaged with leasing companies and initiating pilots with a large company in a buyer payer model that mirrors U.S. dealerships, with promising results so far. Educating the market takes time. Overall, I am satisfied with our integration into the Mexican aftermarket segment, though it may take time to make a more significant financial impact.

Asaf Chandali, Analyst

Great. Yes, that's very clear. We noticed that you can dismiss this if it's not relevant, but in case you can give us any insight into any other kind of subsidiaries. Net income attributable to non-controlling interests was quite strong this quarter, around $700,000. Anything you can comment there? It looks quite positive, but you can correct me if I'm misreading it.

Eli Kamer, CFO

Asaf, as you mentioned, we have minority interests, which contributed to the consolidated Ituran profit this quarter. Of course, some quarters, they contribute more, some quarters they contribute less. As of today, I think it’s crucial for us to maintain these minority interests because they play an active role in the company, and they are important to our overall business.

Asaf Chandali, Analyst

Great. I'll just finish up with a technical question here. Can we get an update on what the effective tax rate should look like? It hasn't been around 30% for a while. I know it fluctuates from quarter to quarter, and there's a big difference between marginal and effective rates. Given some of the shifts in revenues and profits, can we get an update on how we should think about the effective tax rate long-term or just for the next few quarters?

Eli Kamer, CFO

Yes. I think that approximately a 27% tax rate may make sense for us moving forward.

Asaf Chandali, Analyst

Okay. Great. And again, congrats on a great quarter, and hope to speak again soon.

Eyal Sheratzky, Co-CEO

Thank you, Asaf.

Eli Kamer, CFO

Thank you. Welcome.

Operator, Operator

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

Eyal Sheratzky, Co-CEO

Thank you. On behalf of 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. Have a good day. Bye.

Operator, Operator

Thank you. This concludes the Ituran First Quarter 2021 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.