Earnings Call Transcript - ITRN Q1 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ituran First Quarter 2022 Results Conference Call. All participants are present in listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded. You should have all received 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 1-212-378-8040, or view it in the News section of the company's website www.ituran.co.il. I will now hand over the call to Mr. Kenny Green of GK Investor Relations. Mr. Green, would you like to begin?

Kenny Green, Investor Relations

Thank you. Good day to all of you and welcome to Ituran's conference call to discuss the first quarter 2022 results. I'd like to thank Ituran's management for hosting this conference call. With me today on the line are Mr. Eyal Sheratzky, CEO; Mr. Udi Mizrahi, Deputy CEO and Finance; and Mr. Eli Kamer, CFO of Ituran. Eyal will begin with a summary of the quarter's 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 the Safe Harbor statement in today's press release also covers the contents of this conference call. And now, Eyal would you like to begin please?

Eyal Sheratzky, CEO

Thank you, Kenny. I'd like to welcome all of you and thank you for joining us today. We are very pleased with our financial results, kicking off 2022 with very strong subscriber growth in the first quarter, which is the clearest indication of our success. This is also reflected in the current quarter subscription revenues, which surpassed $50 million growing at 10% year-over-year. We grew our overall subscriber base with 43,000 net adds, bringing the total to over 1.9 million subscribers. The aftermarket segment added a record 59,000 subscribers during this quarter. This increase in subscribers came from both the growth in our traditional aftermarket business and was also boosted by the various growth engines that we have seen over the past few quarters. This includes increased traction from our usage-based insurance (UBI) business in Israel, partnerships with car financing companies in Brazil and Mexico, new activities with rental companies in South America, and continued performance from our U.S. business. As I discussed last quarter, we expect this type of subscriber growth to continue throughout this year, with an expectation of between 140,000 to 160,000 net subscriber adds. The first quarter subscriber adds clearly indicate that we are on the right trend. As you can see, Ituran is a very strong, healthy, and growing business, and I’m very proud of our recent achievements. This is despite the background of many macro challenges. The most notable macro issue impacting us is the supply chain constraint. This issue has already impacted us for much of the past year due to the shortage of parts. We have seen significant price increases on components we need, and we have had to buy some components on the spot market at inflated prices. This increases the cost of goods and lowers somewhat the gross margins of the products that we sell. Some of the cost increases we have been able to pass on, but not all of it. The second impact is on the larger original equipment manufacturers (OEMs) that we work with who sell cars in Brazil, Argentina, Mexico, Ecuador, and Colombia. The OEMs are unable to manufacture and sell cars to meet demand. Therefore, we are indirectly affected, as new subscriber adds are below the level of subscriptions that are coming to an end. This has led to a net decline of 16,000 in the quarter. During the quarter, we used our solid cash position to grow our inventory to ensure that we continue to have the components needed to build products, and that we have products ready for new customers, which is evidenced by the strong aftermarket subscriber growth. With regard to the UBI business, one of our main growth engines which has gained strong traction in the past year, we are now working with all seven major insurance companies in Israel. The Israeli consumer market is becoming increasingly educated on the value of using a usage-based insurance plan rather than fixed, especially since the work-from-home trend has significantly reduced typical accounts. Our rollout in Israel is proving to be successful, and we look to replicate this success in our other markets in the coming quarters and years. Our services to the secondhand car market are also gaining traction due to the shortage of components and new cars, which has strengthened the secondhand car market globally. This is evidenced by the increase in secondhand car prices in the past year. New FinTech startups, along with large banks, have entered to provide financing to this growing market. Ituran supplies the location-based and connected car technology to several financing customers in Latin America, which monitors the cars and driver behavior, lowering the risk of loans against the car. While there is currently a partial car shortage, we do not believe it will negatively impact our ability to grow. We are continuously looking to bring in new financing customers and broaden our services to additional geographies. We are excited about this business and see great potential for additional growth in the coming years. In summary, I am very pleased with our performance, both in our traditional business and especially in our growth engines, which we expect will accelerate our growth in the coming era. This solid performance can be seen from the jump in our subscriber base, which has grown well beyond our expectations. We are now at the threshold of having a subscriber base of two million customers regularly paying us for one or more of our services. We are satisfied with our financial performance, and while there may be some noise from currencies and mark-to-market financial expenses, the big picture shows that we clearly have a healthy and growing business. I am more excited now than ever about our long-term position in the coming years. I will now hand the call over to Eli for the financial summary.

Eli Kamer, CFO

Thanks, Eyal. I will provide the financial results. You can find the more detailed results as we issued in the press release earlier today. Revenues for the first quarter of 2022 were $72.1 million, an increase of 7% compared to revenues of $67.4 million in the first quarter of 2021. Revenues from subscription fees were $50.2 million, an increase of 10% over the first quarter 2021 revenue. The subscriber base amounted to 1,924,000 as of March 31, 2022. This represents an increase of 43,000 net over the previous quarter and an increase of 136,000 year-over-year. During the quarter, we saw an increase of 59,000 in the aftermarket subscriber base and a decrease of 16,000 in the OEM subscriber base. The decrease in the OEM subscriber base was primarily due to lower sales at OEMs, mainly as a result of the global supply chain issue and parts shortage. Product revenues were $21.8 million, an increase of 0.5% compared to the first quarter of 2021. The geographic breakdown of revenues in the first quarter was as follows: Israel 53%, Brazil 21%, and the rest of the world 26%. The gross margin in the quarter on subscription revenues was 55.9% compared with 55.1% in the first quarter of 2021. The gross margin on product was 23.7% in the quarter compared with 25.4% in the first quarter of 2021, and the product margin was somewhat impacted due to the product sales mix, as well as significantly increased spot prices of components due to the global shortage. EBITDA for the quarter was $19.3 million, or 26.7% of revenues, an increase of 13% compared to EBITDA of $17.1 million, or 25.4% of revenues in the first quarter of last year. I would like to address the financial expenses. Financial expenses for the quarter were $2.6 million compared with financial expenses of $1 million in the first quarter of last year. The increase was primarily due to the decline in the public market value of our holding in SaverOne, which amounted to $2.4 million in the current quarter. Net income for the first quarter of 2022 was $8.7 million or 12.1% of revenue, or diluted earnings per share of $0.43 compared with $8.3 million or 12.3% of revenues, or diluted earnings per share of $0.40. Cash flow from operations for the first quarter of 2022 was $7 million. As of March 31, 2022, the company had cash, including marketable securities, of $45.2 million and short and long-term bank credit of $26.5 million, amounting to net cash of $18.7 million. This is compared with cash, including marketable securities, of $54.7 million and short and long-term bank credit of $31.4 million, amounting to net cash of $23.3 million as of December 31, 2021. For the first quarter of 2022, a dividend of $0.14 per diluted share, approximately $3 million, was declared. This is in line with the Board’s current policy of issuing at least $3 million on a quarterly basis. Under the renewed buyback announced August 4, 2021, a total of 280,000 shares were purchased totaling $7.3 million. The buyback was renewed on April 1, 2022, and we will announce purchases in the second quarter in next quarter results analysis. Share repurchases were funded by available cash and repurchase of Ituran’s ordinary shares were made based on SEC Rule 10B-18. And with that, we would like to open the call for a question-and-answer session.

Operator, Operator

Thank you. The first question is from David Kelly of Jefferies. Please go ahead.

David Kelly, Analyst

David Kelly, thanks for taking my questions. It looks like OEM subscribers saw the biggest quarterly decline since the COVID-related downturn in early 2020. You touched on it briefly in the prepared remarks, but can you provide more details on what drove the subscriber losses here? And is it fair to assume that the clients will continue at this level, or should we expect improvement in the back half of the year as global auto production improves?

Eyal Sheratzky, CEO

As you know, the OEM sales are the only factor that influences our OEM installations. The shortage has dramatically impacted the car industry, and we see these effects in the markets we operate in and globally. There is a decline of approximately 20% in the sale of new cars. When we finish the free trial that the OEMs buy from us, we continuously work to renew the base of customers that start paying directly, which usually happens after about a year. If we note that the sales are 20% less than a year ago, assuming the conversion rates of the renewals remain stable, but new car sales are lower, it naturally creates a net decline in our subscriber base, which we report now. Looking forward, nobody expects this segment to improve in the next couple of quarters or a year because the shortage is uncertain. We assume that these numbers will persist during 2022. However, we know that demand is high, and similar to the post-COVID spike in car sales, once the shortage of components subsides, we believe that sales will rebound substantially in subsequent quarters. I want to emphasize that the profitability for Ituran in the OEM segment is significantly lower than our profitability in the aftermarket subscribers. So, while we lost 16,000 OEM subscribers, our growth in the aftermarket, which was over 50,000, is a much better situation overall. Our focus is on maximizing our aftermarket growth during these challenging times. I do not expect growth in our net OEM subscribers in the coming quarters, but I am satisfied that our aftermarket segment is performing exceptionally well, with numbers significantly higher than previous years.

David Kelly, Analyst

Great. And as a follow-up, the press release mentioned that product margins were negatively impacted by mix as well as increased spot prices of components. Can you quantify the impact of the shortages and increased spot buys had on your gross profit? Should we assume that second quarter gross margins will be at a similar level before improving in the back half of the year? Or do you expect gradual improvement in margins starting next quarter?

Eyal Sheratzky, CEO

First of all, you can analyze it from the gross margin that we have on product compared to last year. It's about 2% less, which translates to nearly a 10% reduction in product profitability. This has only occurred due to the inventory cost. What you see now is inventory purchased six or nine months ago, which represented the onset of the shortage. We initially bought at spot prices that were extremely high to secure our supply chain. Now, eight to nine months later, I am pleased to say that we no longer buy at those inflated prices; we have placed orders for over 18 months in advance, eliminating the necessity for spot purchasing and reducing costs moving forward. What is reflected in our P&L today is the cost of inventory we acquired previously. A rough estimate for this quarter indicates that costs exceeded $1 million due to these prior purchases. This impact will likely persist for the next quarter or two, but looking ahead, we anticipate improved inventory levels for mid to long-term operations. It's important to note that the cash flow this quarter looks lower due to previous high inventory purchases, but once sold, this inventory was acquired at significantly lower prices than current offers, potentially boosting our next profitability outlook.

David Kelly, Analyst

Great. Thanks for taking my questions.

Operator, Operator

The next question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner, Analyst

Hi, thanks for the presentation. Most of my questions have been asked. I wanted to ask about UBI. It sounds like a real differentiator, and I'm wondering what your go-to-market strategy is. I know you are very established in Israel, but outside of Israel, are you marketing these solutions to acquire new customers, and what potential do you see there down the road?

Eyal Sheratzky, CEO

At Ituran, we provide a comprehensive solution, akin to a black box with multiple modules tailored to specific market needs and customer requirements, which can vary by geography. The Israeli market is adapting quickly, and the insurance industry here has become more customized, aligning well with our offerings. While this is beneficial commercially, it also serves as a local pilot program for other markets. In Latin America, we are realizing interest from financial markets that seek to secure collateral. Discussions with potential customers, such as insurance and finance companies regarding UBI, have only just begun. These traditional sectors are inherently slow to adapt, and while we're conducting initial pilot programs in Brazil and Argentina, I don't expect significant contributions from outside Israel until 2022 or the first half of 2023. However, I am optimistic that our successes in Israel will help us expand these solutions to other geographies as the market evolves. Our experience with established services, such as Stolen Vehicle Recovery, demonstrates the time required to gain acceptance. I am confident that within a year or so, Ituran can lead the UBI market across Latin America.

Tavy Rosner, Analyst

Thanks. I appreciate the call; it was really helpful.

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.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 look forward to speaking with you next quarter. Thank you very much, and have a good day.

Operator, Operator

Thank you. This concludes the Ituran first quarter 2022 results conference call. Thank you for your participation. You may go ahead and disconnect.