Ladies and gentlemen, thank you for standing by. Welcome to Ituran second quarter 2019 results conference call. All participants are present in a listen only mode. Following management's formal presentation, instructions will be given for the question and answer session. For operator assistance during the conference, please press star zero. 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 Investor Relations team at GK Investor Relations at 1646-688-3559 or view it in the news section of the company's website, www.ituran.co.il. I would now like to hand over the call to Mr. Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin?
Thank you, operator. Good day to all of you. Welcome to Ituran's conference call to discuss the second quarter 2019 results. I would like to thank Ituran management for hosting this call. With me today on the call are Mr. Eyal Sheratzky, a Co-CEO, Mr. Udi Mizrahi, Deputy CEO and VP Finance, and Mr. Eli Kamer, the CFO. Eyal will begin with a summary of the quarter results, followed by Eli with a summary of the financials. We'll open the call for the question and answer session. I'd like to remind everyone that the safe harbor in the press release issued earlier today also cover the content of this conference call. Now, Eyal, would you like to begin, please?
Thank you, Ehud. I'd like to welcome all of you, and thank you for joining us today. There are some positive trend in our results for this quarter, which makes me increasingly confident that our financial performance toward the end of this year and especially next year, will be much improved. Most important is that our aftermarket subscriber growth rate, that is the non-OEM subscribers, exceeded 20,000 in this quarter, bringing us back to the strong growth rate we have seen in previous years. If you remember last quarter, I explained that over the past year, there have been changes in the Brazilian market, which meant insurance companies were becoming more selective about who they are selling to, which obviously impacted the subscriber adds in that region.
Together with the insurance companies we work with, we implemented changes in our system, moving to a more dynamic pricing system related to the customer risk profile. In the second quarter, we launched the new system and service. I am pleased to say that all our change in that market have allowed subscriber growth in Brazil to return back to the more typical level we hope for. In Israel, as you know, we launched a new and innovative service for insurance companies, enabling them to sell usage-based insurance. This means the driver that use their cars less pay lower insurance premiums than heavy users. We signed our first agreement a few months ago with Harel Insurance, one of Israel's top insurance company, and we are already starting to see subscriber traction.
We recently signed up a second insurance company, Shlomo Insurance. We believe we sign up more before the end of this year. We see this product as highly valuable for our insurance company, providing a much more accurate risk assessment and personalization of insurance policies, lower cost, and to the customer, it provided an innovative and fully digital service. It also provided full transparency and fair pricing based on the particular level of risk and vehicle usage. As I said last quarter, we already see significant market interest. Because this service makes so much sense for all participants, we believe that ultimately more and more insurance companies will join this trend. For Ituran, while being by far the largest market player in Israel, our aftermarket business has traditionally been subject to the macro trend of new car sales in the country.
At the same time, we've always looked into penetrating additional segments. An example from a few years ago was the lower market segment, which we successfully penetrated with our Ituran Safe service. Our new UBI product, meaning a usage-based insurance product, represents an additional and significant vector of growth for Ituran and ultimately across all the regions we operate. Long term, we aim to leverage our solution into all the countries in which we are now operating. Moving to Mexico, again, as you remember, last quarter we discussed that it was recently announced that 2G networks in that country will be phased out. Our OEM customer in Mexico that currently use a 2G telematics system require us to upgrade the system that we supply them to 3G. In the first half of 2019, the customer has been lowering its existing inventory of 2G systems.
As of August, purchases of our next generation system have started, and we expect it to ramp in Q4. While product sales in Mexico is a small portion of Ituran's overall revenue pie, the absence of this product sale in the first half of the year did have somewhat of short-term negative impact on us. We believe that by the end of the year, business in Mexico should go back to its normal healthy sales pace. Before handing over to Eli, I would like to make a few comments with regard to our new OEM services. The Road Track acquisition was made primarily to give us a significant footprint as a major telematics player throughout Latin America.
While our subscribers last year were predominantly in Israel and Brazil, we now also have subscribers throughout Latin America. In Israel and Brazil, our subscribers are mostly aftermarket, which we gain through direct sales and our relationship with the car dealers and the insurance companies. While in our operation in Latin America, we also have subscribers, which we achieve through OEM agreement with car manufacturers. Subscriber numbers through our OEM agreement doesn't stand on Ituran performance, but more simply on how many cars the two major car manufacturer sell in their respective countries and how long those subscribers stay beyond the initial period, which is paid by the manufacturers themselves. Therefore, growth from this segment will come from penetrating additional OEM customers in both existing as well as the new territories, but mostly from our ability to cross-selling Ituran's existing product portfolio into the newly acquired geographies.
During the second quarter, one of our OEMs reduced the free trial period to its customers from 6 months to 3 months, which had a net negative impact on the number of OEM subscribers in the amount of approximately 47,000 subscribers. This will have an impact on the Q3 results, causing a one-time drop in the amount of approximately $1 million. Just to give you the numbers, as of the end of the second quarter, our active subscriber base was 1,757,000, of which retail was 1,250,000, and the OEM was 507,000. We added 21,000 aftermarket subscribers, while on the OEM side, there was a decline of 47,000, just to remind you that our aftermarket subscribers will present a much higher profitability. In terms of our financial summary, our second quarter non-GAAP revenue was $72 million, and adjusted EBITDA was $20.6 million.
From the financial perspective, as has been the case in recent quarters, the weakness in a number of the currencies which we operate in, especially the Brazilian real and the Argentinian peso, has had a very significant impact on the translation from local currencies in which we operate to US dollars in which we report. If we remove the currency impact, in local currency terms, our revenues would have grown 33%, and EBITDA would have grown by 24%, representing very nice year-over-year growth. In summary, as we move into the end of 2019 and 2020, we believe that all the issues I discussed earlier are now behind us. Beyond that, we are working on identifying and realizing the strong synergies in our business between and inside each of the region in which we operate.
We are looking to grow our business by cross-selling our capabilities to newly acquired customers and vice versa. We have a strong foothold to penetrate services into new countries, and we are already launching additional services in our new geographies. Apart from our ongoing work in building and realizing the synergies in our business, we have initiatives that we believe will begin to propel us forward already starting this year and more so next year. For example, our new usage-based insurance programs. My goal is that Ituran will always remain at the forefront of technological advancement in the mobility sector in an ever-changing market. Before handing over to Eli, I would like to add a few words about the buyback and dividend. As you know, it is our policy to share dividend amounting to at least $5 million a quarter.
In addition, we have commenced the $25 million buyback that the board approved last quarter. We believe that the dividend, as well as the ability to buy back our own shares, depending on market conditions, allows us to share our ongoing financial success with our shareholders. To conclude, as you can see, I'm very excited with regard to the growth potential ahead. I will now hand the call over to Eli for the financial review. Eli?
Thanks, Eyal. I note that the results I present will all be on a non-GAAP basis, including adjusted EBITDA, which excludes revenue and costs related to the purchase price allocation. We believe this will provide a better understanding of our ongoing performance. For further details with regard to the reconciliation between the non-GAAP and the GAAP results, please see the table published with the press release. Non-GAAP revenues for the second quarter of 2019 were $72.2 million, representing an increase of 25%, compared with revenue of $57.7 million in the second quarter of 2018. In local currency terms, second quarter revenue would have grown by 33% year-over-year. Revenue breakdown for the quarter was $52.7 million, coming from subscription fees, a 27% year-on-year increase. In local currency terms, subscription fees grew 37% over the same period last year.
Product revenues were $19.6 million, which were a 21% increase over the same quarter last year. The geographic breakdown of revenues in the second quarter was as follows. Israel 38%, Brazil 38%, and rest of the world 24%. Non-GAAP operating profit for the second quarter of 2019 was $15.5 million, an increase of 5%, compared with an operating profit of $14.8 million in the second quarter of 2018. In local currency terms, this grew 13% year-over-year. Adjusted EBITDA for the quarter was $20.6 million, an increase of 15% compared to an EBITDA of $17.8 million in the second quarter of 2018. In local currency terms, the increase was 24% year-over-year. Net profit was $9.6 million in the quarter, or fully diluted EPS of $0.46, a decline of 20% year-over-year compared with a net profit of $12 million or fully diluted EPS of $0.57 in the second quarter of 2018.
In local currency terms, the year-over-year decrease was 13%. The decrease in net income was primarily due to the finance expense, primarily related to the acquisition of Road Track, and due to the increased losses in affiliates early-stage company GreenRoad, which contributed $1.1 million loss from share in affiliates. Cash flow from operations during the quarter was $16.3 million. As of June 30, 2019, the company had cash, including marketable securities, of $62.8 million and a debt of $76.2 million. This is a net debt position of $13.4 million, or $0.64 per share. This compares with cash, including marketable securities of $53.3 million and debt of $73.2 million, which is a net debt position of $19.9 million, or $0.93 per share as of December 31st, 2018. For the second quarter, a dividend of $5 million was declared.
The dividend record date is September 26th, 2019, and the dividend will be paid on October 10th, 2019, net of taxes and levies at the rate of 25%. With that, I'd like to open the call for the question-and-answer session. Operator?
Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. If you have a question, please press *1. If you wish to cancel your request, please press *2. If you are using speakerphone, kindly lift the handset before pressing the numbers. Your questions will be polled in the order they are received. Please stand by while we poll for your questions. The first question is from David Katz of Jefferies. Please go ahead.
Yeah. Good morning, guys. Thanks for taking my questions. I guess just to start, looking at the rebounding after-market subscriber growth, it came in above your 15,000-20,000 quarterly expectation. Just hoping you could provide some more color on that upside surprise. How much of the ramp was tied to the dynamic pricing system launch? Anything else specific to call out in the quarter that drove that upside?
As we said in the past, we absolutely, I would say, made almost a turnaround, and we did it thanks to some efforts that were done by us together with our partners, which are the insurance companies in Brazil, and which generally, to explain it, we changed the pricing to the end user, to the consumer market, from a flat price, which hit us at the cost of the policies, to a more floating price, depend on the characteristic and the other underwriting position and the risk of the customer. This allowed us to recruit more customers from more segments and create more profitability to the insurance companies' files.
After doing it or establish this system with a very smart algorithm that the insurance companies can see it online, and if a customer buy online this insurance in less than 10 seconds, he can buy and get the best price in the market according to his risk. Once we launch it around March, April, for the first pilot, we saw that it's attractive, it's secure for the insurance companies, and it allow us to get back to high profitability per customer. We back to, as we said, and as we see it now, we back to the historical numbers. We were conservative by giving the range of 15,000 to 20,000. We just started a quarter ago.
Now I feel more confidence that this is the future rhythm, and I even hope that adding more marketing now, which we can do freely, we can be even more aggressive and get more and more customer, and also out of the historical regions, which are São Paulo and Rio, and go to other municipal and cities in Brazil. This is why I think that toward 2020, this will be absolutely.
Integrated also in our financials, because when you are in the operating leverage model, it's taking time to ramp up the financials, but the subscriber movement now is very strong and very good.
Okay, great. As a follow-up, you referenced kind of the outlook into 2020. It sounds like this is tied to the improved visibility to these aftermarket volumes in that 15K to 20K ramp. I guess, as a follow-up on the margin side of the aftermarket business, your expectation, do you see that ramping as well, just on the cost leverage? Is there anything else specific we should think about? Is this more of a 2020 event than a back half of the year 2019 event, or should we expect some solid margin expansion on the aftermarket business in 2H '19 as well?
Currently, the growth of the subscribers is absolutely the number that we show. In order to see it on the financial results, of course, we need a little bit more numbers. When you have more than a million subscribers, even if you grow 20,000 per quarter, it's taking time that it integrates more major numbers. The reason that we're talking about 2020 is because if the rest of 2019 will continue in this rhythm, so we have a more important new customer base joining and start paying. This will appear more material in 2020, but we will see it every quarter also in 2019. Regarding the influence on the profits and profitability, no doubt that when we are a subscribers business or a recurring revenue model, no doubt that it should improve our profits and profitability.
As long as the quarters will move with more and more subscribers, the costs, which are mostly fixed, will allow us to show more profits, and specifically year-over-year in the future.
Okay, great. One more from me. The 47,000 OEM subscriber decrease, I guess it sounds like this was largely a function of the lower renewal rates tied to that change in the subscription length. Was there also anything on the production side specific to your customers? I guess, could you walk us through the impact there and, if we think about the change to three months from six months as it relates to this length of subscription, is that something that you expect to be a kind of a structural change in how this business is done on the OEM side? Is this more of kind of a next six to nine-month type impact, and you expect that three months to ultimately go back to six months?
First of all, I will explain how it's working, what is the influence. First of all, the OEM subscribers and the OEM customer base is much less profitable than the aftermarket. When you work with one customer, which is a very large customer, and he has a very large customer base in our contract, of course, he has more power, and he's taking the prices down, and he's taking the profitability down. It means that 47,000 OEM subscribers are contributing much less than the 20,000 aftermarket. I always prefer to add more aftermarket customers, while at the same time, if there is no choice of to lose only OEM customer subscribers.
The reason for this specific quarter was that our customer in Brazil, subject to his financial situation and to the Brazilian situation, they decided they no longer have the ability after firing almost half of their employees. This is one of the larger OEM in the world, by the way, one of the large car manufacturers in the world. This industry, probably, and specifically Latin America, is suffering from the economy. They decided as part of their shrinking budget that they are no longer providing to their customers a free trial of six months, meaning paying us six months in advance, but only three months. Why it happened in Q2, it means that in one time, they cut about three months of subscribers in one day. It happened only once. This is why you saw the number of 47,000.
By the way, the financial numbers didn't appear in Q2 because we get the money actually in advance. It will appear only in Q3, and I said, the damage will be about $1 million, approximately a little bit less than $1 million of these 47,000 subscribers. What we are expecting in Q3 is that the subscribers level will be almost the same, and we only will have the tail of the money that we actually declined because of this one-time decline in the project in Q2. Looking forward, I would say again, our ability to see what will be the longest future per subscribers and per OEM customers, it's much more difficult because it's less dependent on us. We are more dependent on the OEM and the manufacturer, and their internal budgets and policy.
One thing, again, I think positive is that still the basic business, which is the aftermarket contribution, is much higher than the volatility of the OEM segment.
Okay, got it. Appreciate it. Thanks for all the color.
Okay.
The next question is from Tavy Rosner of Barclays. Please go ahead.
Hello, this is Peter. I'm for Tavy. Congrats on the good. Ask the question in a bit of a different way. When you said in the third quarter that the subscriber count there would be about the same, were you implying that it should stabilize at these levels, or would you expect to see a continued decline because of that transition? If so, is there anything that might offset that?
First of all, maybe I didn't clarify it. I would like to say that when I'm talking about the same rhythm, I talked about only the OEM. Regarding the aftermarket, we are still in our position that we will do 15,000 to 20,000 per quarter in the coming quarters. I'm talking about the OEM subscriber base. We expect that it will be much or less the same as in Q2, meaning not the same declining, but the same number that we finish Q2.
Got it. Thanks for that clarification. Moving over to product sales, if I heard you correctly, the 2G to 3G headwind, that transition has mostly been resolved or is in a tail end, and if so, should that segment be able to return to growth in the second half?
Absolutely. This is what we said. I don't know to tell whether it's behind us totally or it will take one or two more months. We have to understand that our customer, which is another OEM customer, car manufacturers in Mexico, and since usually they have some inventory for a few months, they still have the 2G that they want to get rid of. They start to buy the 3G, which we already crossed the pilot phase, and they start buying, but they in a phase to reduce the 2G inventory. I cannot say whether it will be September or October, but based on the installation and based on the new customer that they recruit, we know that the rhythm should be back to, again, to the real phase that we expect.
We expect that it will be between Q3, the end of Q3 to the beginning of Q4, but I cannot commit, but it will be this year. For us, much important to see it start again, and then again, the future probably will be with the new rhythm, which we suffered from this problem first half of 2019 and probably a few more months, but most of it is behind us, yes.
Okay, great. One last one just on the shares. Did you exercise any of the buyback authorization in the second quarter, or since then, how should we think about share count going into the second half?
Actually, we started it. Of course, we didn't use all the authorization that we got from the board, but we started it, and probably before the end of the year, we will have some report about it.
Okay. Thank you.
Thank you.
The next question is from Sacha Karim of IPI. Please go ahead.
Hi. Few from me. Firstly, the services gross margin, I'm looking at GAAP gross margin there. It weakened quarter-on-quarter again to about 56.4%. Now, after the 4Q results, you sort of guided that it would stay around the 58% level. Can you explain why it's been going down? Will that continue? Any sort of guidance you can give going forward?
Yes. We mentioned in the past, we saw the slowness in Brazil due to the fact of changing the model, as Eyal described before, and this is, of course, affected us from the margin point of view.
Okay. As the new model ramps up, should we expect the gross margin to keep falling?
Yeah, as long as we continue to increase our subscriber base as we did in the second quarter, I don't see any reason why it shouldn't go up.
The gross margin should go up?
Yes.
Why has it been going down recently?
I said it went down recently due to the fact of the Brazilian model. Slowness of Brazil that we had started, especially in 2018. Since we didn't grow the subscribers in the aftermarket during 2018, the financial influence appeared this year, specifically Q1, Q2, maybe still we will see it in Q3, because always, when you are having changes in subscribers, what we report, for example, now 20,000, this 20,000 will fully appear only in Q3. If I have zero in this quarter and the expenses will stay the same, Q3 would, for example, show with the lower gross margins. Because of the operating leverage, the influence on the margins depend on growing in subscribers or declining in subscribers. Since in 2018, in the aftermarket, our growth subscribers in Brazil was very low, the gross margins declined.
As Udi mentioned, we expect that in two or three quarters from now, we will show again more material change or good change in the margins.
Good. I think I got it. Just to check one thing there. Are you saying that you have certain fixed costs, I guess it's your customer service center?
Right
When you're not adding subscribers, yeah?
Exactly.
Yeah. Okay. That makes sense. My other question would be, just back on the OEM issue. Just to check I understood it again, the 47,000 reduction in OEM subs in the second quarter, it reflects the free trial that your OEM partner in Brazil did already, but that has not yet impacted revenue. Is that correct?
That's correct.
Great. The Mexican issue should be resolving, and you would actually expect, now that that one-off change in Brazil is out of the way, you expect your subscriber numbers from OEM to be flat quarter and quarter, third quarter versus second quarter.
That's correct. More or less the same.
Then I guess as the Mexico issue resolves itself, you should be expecting OEM subscriber growth, shouldn't you, from fourth quarter and first quarter next year?
Yes. More or less, yes. As we've mentioned before, we are depending on the OEM, it's really hard to say what will be the market going in the future. Yes, if everything stay with the same condition as of today in the market, yes. I do not see any reason why the OEM will not go up.
Great. Thanks, guys, and well done.
If there are any additional questions, please press star one. If you wish to cancel your request, please press star two. Please stand by while we pull for more questions. 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?
Thank you, operator. 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.
Thank you. This concludes the Ituran second quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect.