ORBCOMM Inc.
Q2 2020 Earnings Call Transcript

Published: 2 Aug 2020

[Operator:]

Good morning, ladies and gentlemen, and welcome to ORBCOMM's Second Quarter 2020 Results Conference Call. [Operator Instructions] Please note, this event is being recorded, and a replay of this conference will be available from approximately 11 a.m. Eastern Time today through August 13, 2020. The replay service details can be found in today's press release. Additionally, ORBCOMM will have a webcast available in the Investors section of its website at www.orbcomm.com. I'd like to turn the call over to Mr. Aly Bonilla, ORBCOMM's Vice President of Investor Relations. Please go ahead, Aly.

[Aly Bonilla:]

Good morning, and thank you for joining us. Today, I'm joined by Marc Eisenberg, ORBCOMM's Chief Executive Officer; and Dean Milcos, ORBCOMM's Chief Financial Officer. On today's call, Marc will provide some highlights on the quarter and give an update on the business. Dean will then review the company's quarterly financial results and outlook. Following our prepared remarks, we will open the line for your questions. Before we begin, let me remind you that today's conference call includes forward-looking statements and that actual results may differ from the expectations reflected in these statements. We encourage you to review our press release and SEC filings for a full discussion of the risks and uncertainties that pertain to these statements. ORBCOMM assumes no duty to update forward-looking statements. Furthermore, the financial information we will discuss include non-GAAP financial measures. Reconciliation of these non-GAAP measures to GAAP measures is included in our press release. At this point, I'll turn the call over to Marc Eisenberg.

[Marc Eisenberg:]

Thanks, Aly, and good morning, everyone. Before we begin, we hope you and your families are staying safe during these unprecedented times. Our thoughts go out to those impacted by the pandemic. Earlier this morning, we issued a press release announcing our financial results for the second quarter ending June 30, 2020. Our results came in slightly better than analyst expectations with revenue add consensus and adjusted EBITDA well ahead, leading to substantial cash generation. Total revenue for the second quarter was $56.7 million, down 15% from prior year, but in line with guidance. We made great strides in Q2, offsetting revenue declines through reductions in costs. As a result, service margin increased 130 basis points to 67.3% and operating expenses were down $1.4 million over the prior period. These contributions led to adjusted EBITDA of $11.9 million or a 21% margin, which was better than expected. Our cash flow and liquidity position remains strong. We generated operating cash flow of $12.6 million in Q2, a pretty amazing increase of $11 million over last year's second quarter and our eighth consecutive quarter of positive operating cash flow. We ended the quarter with over $62 million in cash. This is after the repayment of $15 million on our revolving credit line, and a $10 million semiannual interest payment on our debt. Excluding these items, the company grew cash in Q2 by a record $17 million. And differently, while our cash balance is down $8 million from Q1, our debt is down $15 million. And looking forward, the third quarter doesn't require an interest payment. From a liquidity perspective, our company has proven to be resilient. We clearly have a sustainable business model, and we'll continue to effectively manage cash. As I mentioned last quarter, ORBCOMM is considered an essential business by most government authorities as we support customers. We're also being essential and play roles in transporting food across the globe, sustaining the flow of critical freights and supporting key infrastructure projects. Many of our employees continue to work remotely and have done a great job maintaining our business operations and supporting our global customers. Some of our locations have partially reopened and employees are returning to the office. We've implemented proper safety protocol to ensure they remain safe and healthy. Our manufacturing partner in Mexico continues to support critical production of our devices for on-time delivery. We shipped over 56,000 devices many late in the quarter, as early on, many customers were not able to receive product shipments. About 2/3 of our total revenues in Q2 were comprised of recurring revenues from customers who depend on our technology to optimize business practices. This is why our recurring service revenue is extremely stable with some of the lowest churn rates in the industry. Let's move on to our markets. In the third quarter, we're beginning to see customer demand improve in some of our international markets such as Europe and Asia, where the economies are starting to open again. South America is a growing hotspot for the virus, especially in Brazil, leading to lessening demands and currency weakness. Due to varying degrees of COVID-19 cases regionally across the United States, it's difficult to predict ordering cycles across a vast base of dispersed customers. Looking at our vertical markets, customers in cold chain transportation, we ship food, pharmaceuticals and other medical supplies, have continued to experience consistent demand for their services. On the other hand, non-refrigerated transportation customers, overall, have seen freight volumes decline. In heavy equipment, many of our OEMs dealt with an array of factory closures as employees are coming on and off furlough. Most of these OEMs are now operational, but continue to be subject to COVID-19 hotspots. We believe the markets for these customers are beginning to recover as businesses and governments move through various stages of reopening. And as a result, we'd expect our shipments to begin to recover as well. Although the pandemic has made it difficult for our sales teams to travel and engage opportunities on site at customers' facilities, we've made progress working remotely to win new customers and renew existing agreements. During Q2, we signed several dozen new customers across nearly all our product lines. Although it might take some time to fully deploy these products, we're building a solid pipeline, positioning more comp for future growth. While it's difficult to quantify, we overwhelmingly believe that companies operating with IoT deployments are significantly outpacing those who do not. If there was a strong case for an IoT deployment across your company prior to the pandemic, the case is only stronger now as more companies see the value of having command, control and visibility of their assets remotely as opposed to putting employees at risk, especially in the stay-at-home environment. Let's move on to our container programs. We're continuing to deploy our projects with the container business unit of the Carrier Corporation, one of the premier global shipping companies. In Q2, consistent with our remarks from last quarter's earnings call, we shipped about 9,000 devices, bringing the total to date to nearly 57,000. Looking at the second half of this year, we continue to anticipate shipping another 9,000 devices in both the third and fourth quarters. This will bring the total to roughly 75,000 devices deployed by year-end out of these 150,000 unit projects. We anticipate shipping the majority of the remaining devices throughout 2021. This project represented about 1/3 of the decline in total revenues between Q1 and Q2 and is a good example of how the current market conditions push revenue to the right but do not materially alter the opportunity. We're working on an additional project in support of a second shipping line customer. The opportunity consists of approximately 7,000 devices, of which we shipped about 2/3 in Q2 and expect to ship the remainder in Q3. In U.S. transportation, where 2019 saw a significant slowdown in freight loads leading to a subsequent reduction in freight rates and a dramatic falloff of new orders of trucks and trailers, we were seeing the beginnings of a market recovery in Q1. The pandemic slowed that progress in Q2 with new truck and trailer orders hitting new lows. According to industry analysts, new OEM orders declined 32% for trucks and 46% for trailers in Q2 compared to last year, though showed signs of recovery in June. Although we don't know precisely when OEM orders will return to fully normalized levels, there are many aging assets in the field that we expect to be replaced over time, positioning us for future hardware demand. We're making progress assisting transportation customers in preparation for the sun setting of 3G wireless service, starting with T-Mobile at the end of 2021 with other cellular providers soon to follow. One of our longtime customers, The Hub Group, has begun the retrofit of their fleet with ORBCOMM's next-generation asset tracking products. This feature-rich solar-powered device will provide Hub with complete visibility of assets and cargo status detection with its integrated cargo sensor for maximum efficiency. We shipped and began installing in Q2 and expect to ramp further in Q3. We're seeing increased demand from customers choosing a subscription model, which includes hardware as part of the service offering in a single monthly rate. We anticipate Q3 to be our largest subscription model quarter-to-date with about 6,000 devices expected to close. This would represent about $2 million in hardware revenue under our standard sales model that will instead be recognized as service over the next 3 to 6 years. In the long term, these deals expand our recurring service revenue base and lead to greater future growth. In our heavy equipment solutions group, we recently expanded our long-standing agreement with Terex, a global manufacturer of lifting and material processing products and services. There's a lot to be excited about with this partnership. First, Terex extended the service term of their current base of subscribers for up to 11 years, many of which were coming to the end of their contract, Second, Terex will offer the solution as standard across several of their brands including Powerscreen, Finlay, CBI, Ecotec and Evoquip. Third, Terex is a great example of how our integration strategy is working. When we signed Terex in 2014, we developed a customized web portal for them based on the FleetEdge platform we inherited in the MobileNet acquisition. Terex has now moved to ORBCOMM's OEM platform as part of the consolidation of our customer-facing web portals, delivering a state-of-the-art experience for their users, which includes expanded machine data collection and more robust analytics to drive further improvements across their businesses. Lastly, we've begun collaborating with Terex on our latest dual-mode telematics device, which ensures their equipment can operate anywhere in the world for years to come. Terex is one of many OEMs who are seeing the importance of dual-mode connectivity but are first to deploy this technology is standard fit. ORBCOMM's dual-mode offering is unique to the industry as well as a significant competitive advantage, and we're seeing demand increase in many of our key markets. Looking at ORBCOMM's strategy after 12 acquisitions, we're nearing the completion of our integration plan, which focused on streamlining our business, improving profitability and making better use of working capital. First, we've realized a 75% reduction in our SKU count after reengineering our product portfolio, which has also enabled us to achieve better inventory management and significantly increase product margins. Second, we improved our distribution channels to allow for greater cross-selling opportunities, which have led to increased double-play and triple-play wins. Third, we consolidated 13 different accounting systems into 1 ERP system, enabling a faster monthly close process, significant cost efficiencies, simplified billing and a better experience for customers. Lastly, we went live on the ORBCOMM platform and the OEM platform, which replaced the 25 existing customer-facing web portals. These new platforms provide customers with visibility to multiple asset types using a single sign-on and offer increased processing power, data bandwidth and scalability to support a 5G IoT ecosystem. All of these improvements achieved through our integration plan have led to greater scale, improved adjusted EBITDA margins and significantly increased levels of cash generation. We are now pivoting our focus from innovation supporting integration and innovation driving long-term growth. Our transition is centered around several key projects, many of which have been in the pipeline and are ready for release. There are over 15 projects, some of which include our new satellites as an accessory offerings, which adds dual-mode connectivity to almost any ORBCOMM telematics device as well as most other devices on the market and our Hali product for small vessel AIS tracking. We're also working to expand our OEM portfolio with Carrier with new products on refrigerated containers and trailers. We are implementing our machine learning strategy through an improved sensor portfolio as well as video on both cargo and in-cab assets to assist fleets with enhanced real-time visibility. In addition, we're helping customers gain deeper insights about their assets performance through advanced analytics, including benchmarks, historic trends and comparisons among asset types, enabling faster, more informed business decisions. Prior to 2019, ORBCOMM's annual organic growth averaged about 8%, leading to just 10% growth in adjusted EBITDA. We expect our investments in innovation to lead to greater levels of organic growth and our investments in integration to convert that revenue at higher incremental EBITDA margins. We're targeting long-term organic growth of 10%, leading to adjusted EBITDA growth of 20%. Summing up, despite a difficult global environment, there are a lot of good things happening in the business. We're in the home stretch of our integration plan, which we've heavily invested in for a number of years with our two platforms onboarding new and existing customers on a daily basis. Our business has shown resiliency during this pandemic and Q3 is trending higher. The company has turned the corner on positive cash generation, and we are now performing at significantly higher levels. We've developed best-in-class platforms and invested in multiple new products that are about to hit the market and generate incremental growth. With our substantial cash reserves on hand and a solid base of customers, we're confident we're in a great position and will come out stronger as the markets begin to stabilize and momentum grows in the back half of the year. With that, I'll turn the call over to Dean to take you through the financials.

[Constantine Milcos:]

Thank you, Marc, and good morning, everyone. Financial performance in Q2 came in at or better than expected. Let's start with the company's second quarter financial results. Total revenue for Q2 was $56.7 million, down 15% from the prior year period, in line with guidance. Q2 service revenues were $38.4 million, down 3.3% compared to the prior year. Of this amount, $37 million came from recurring service revenue compared to $38.5 million a year ago. Keep in mind, last year's revenues included about $1 million from AT&T/Maersk contract that expired at the end of 2019. Excluding this revenue from Q2 last year the current service revenue was down about $500,000 year-over-year. Considering one of the worst macro environments I have experienced in my career, with fluctuating foreign exchange rates, oil trading historic lows and factory closures, our recurring service revenues at 99% of last year's levels shows the stability of our business model. In Q2, we added approximately 18,000 net subscribers, which is lower than our historical average of around 75,000 subs per quarter over the last couple of years. The lower net subscriber adds for the quarter was a result of the challenging environment for shipping and installing our devices and a slight increase in the activations. Our total billable subscribers ended the quarter at approximately 2.22 million. Product sales in the second quarter were $18.3 million compared to $27.4 million in the prior year period. The decrease in revenues was primarily due to delays in customer deployments as a result of the pandemic. Turning to gross profit margin, the company realized a margin of 54.6% in the second quarter, a 390 basis point improvement over last year driven by growth in service margin and a higher mix of service revenues. Service margin in Q2 was 67.3%, a 130 basis point improvement over the prior year period due to lower direct service costs achieved through our cost reduction plans. Product margin in Q2 was 27.8%, a decrease of 60 basis points compared to the same period last year. Gross product margins were actually up from the prior year quarter but when we factor in roughly $2 million of fixed costs in both quarters, the overall margin was down slightly and should return as hardware sales improved. Operating expenses were $32.8 million in Q2, a decrease of $1.4 million compared to the prior year period. Year-over-year improvement was primarily driven by reductions in labor, professional services, travel and payment expenses and partially offset by higher bad debt expense of $1.6 million. Excluding the bad debt expense, the $3 million decline in operating expenses exceeded our cost reduction plan targets for the second quarter of 2020 as we tightly manage our spending during the pandemic environment. Lower product development costs also contributed to a decline in operating expenses. Adjusted EBITDA in Q2 was $11.9 million, a 21% margin, which was above our outlook provided to the last quarter, largely driven by higher service margin and reduced operating expenses. Turning to the balance sheet, the company ended Q2 with $62.4 million in cash and a $15 million decrease in debt from March 31 as we repay the full amount of our revolver in full. Looking at our cash flow statement, our cash flow in Q2 was strong given the economic environment. Cash flow from operations in Q2 came in at $12.6 million compared to $1.9 million in the prior year period. Cash generated in the quarter excluding the $15 million revolver payback was $7.2 million. Second quarter also included a semiannual interest payment on our debt of $10 million. Excluding this interest payment, our Q2 cash generation was $17 million. For the first half of 2020, our cash balances have increased $8.1 million compared to $1 million for the first half of 2019. And keep in mind, the $8.1 million in 2020 is inclusive of $2.5 million utilized in our stock buyback program. We're very pleased with this cash generation performance and expect to generate more cash in the second half of 2020. FX for the quarter was $5.7 million, a decrease of $400,000 compared to Q2 of last year as we continue to focus on reductions in spending and near the completion of our acquisition integration activity. Subscription model investments were $200,000 in the quarter. We're expecting CapEx of $20 million for the full year 2020, plus $3 million for investments in the subscription model. As a reminder, in 2017, our CapEx exceeded $27 million, and in 2019, the figure was just over $21 million. Let's move on to our outlook. We believe the largest impact from the pandemic to our financial results for most likely have occurred in the second quarter, representing the lowest point for our business and we anticipate improvements to begin in the third quarter. As a result, we expect total revenues in Q3 will be between $59 million and $62 million, in line with current analyst expectations. And we anticipate adjusted EBITDA margin will be approximately 21.5%, an improvement over analyst expectations. Due to the continued uncertainty surrounding the macro environment, we intend to provide fourth quarter guidance during the earnings conference call in late October. In closing, we're pleased with our performance in Q2. Adjusted EBITDA and cash generation exceeded expectations during these unprecedented times. We made great progress on our integration and cost reduction plans, resulting in higher margins and increased efficiencies. We've also substantially improved our liquidity position, demonstrating our disciplined cash management and further strengthening our confidence that we can emerge from this pandemic as stronger company. We're cautiously optimistic for the second half of the year as sales momentum builds. We continue to shift our focus internally from acquisition integration to longer-term growth through innovation. This concludes our remarks for the call, and we'll now take your questions.

[Operator:]

[Operator Instructions] First question comes from Ric Prentiss of Raymond James.

[Richard Prentiss:]

A couple of questions, if I could, as you think about the way 2Q played out, did you see any changes from April to May to June and now with July in the books as far as what you saw as far as business trends?

[Marc Eisenberg:]

Certainly, I mean U.S. transportation was the -- probably the most obvious. And that if you look at the industry trends, at least in terms of OEM purchases for new equipment, which is important for our shipping equipment. I've never quite seen anything like it, where April and May almost went to 0. And then June, it comes roaring back. I don't know how much of that is a makeup from April and June or if those are consistent toward future levels or there were factory closures, so they were unable to build products, and then it comes back. But June kind of looked like a normal month. When you kind of look at cargo loads, and we monitor our own usage of units in moving, then we kind of monitor just to see what shipments of goods look like. It was definitely a fall in April. It starts to improve a little bit in May, and it also gets a little bit better in June. So the movement of goods is coming back. And it was a lot more pronounced in -- I guess, as you kind of rank reefers, dry vans and rail, it was in that order, reefers showed the smallest reduction. Dry vans was the next lowest, and then rail significantly slowed down. But in rail, all of our big guys have placed orders for new builds that were expected to ship in Q3 against nearly 0 numbers in Q2. So that feels pretty well. And then lastly, to answer your question, and I don't know if this is a demand -- I mean, obviously, it's demand, but it's hard to place, but you're playing this whack-a-mole with factory closures for OEMs. Literally, you're shipping 0. Their orders moved or canceled. And it's difficult to call someone up that's furloughed and say, when are we shipping your order? And then all of a sudden, the factory opens and you got an 8-week build, and you got to get it out in 3 weeks. So it's just kind of all over the place. I think in a recession, we've been through it. We understand what the playbook is, right? We understand it's a reduction and it's not this binary 100 or 0 that we experienced in Q2.

[Richard Prentiss:]

As you think in July, further, like evidence of what you saw in June or even better recovery?

[Marc Eisenberg:]

I think we are guiding to an improvement. And for us to improve 6% or 7%, year-over-year doesn't sound like a lot, but quarter-over-quarter, that's a big number for us. And as you look at our numbers, I mean I understand the difference between Q1 and Q2 right there in the heart of the pandemic. 50% of it was a reduction in that 1 carrier order where they went from 16,000 subs to 9,000 subs. And then the -- a large part of it is the accounting change with AT&T and Maersk where it's an ugly comp between the quarters. Back those 2 things out, and that is half of the reduction between Q1 and Q2. So as it improves with that guidance in Q3, it feels like it's 40% of the way back, but it's actually closer to 60% or 70%.

[Richard Prentiss:]

Okay. And obviously, margins in the quarter were in a pleasant surprise. Dean called out some lower labor, professional services, travel and entertainment. The guidance for 3Q continues to show improved particularly on the cost side. Anything specific there that could revert back the other way that would cause pressure on cost? Or is it really just good cost control? I was just trying to think through the margin surprise in the third quarter guidance.

[Marc Eisenberg:]

So go ahead, Dean. You take it first, and then I'll answer, okay.

[Constantine Milcos:]

Okay. Yes. Sure, Ric. Yes, I think the cost containment is going to be consistent. I don't see cost increasing much, maybe a small amount for travel and a small amount for commissions. But I think costs are at this level for Q3 and Q4.

[Marc Eisenberg:]

And adding to that, Ric, so you understand where some of the costs are coming from. There was $1.6 million of bad debt in the second quarter that we won't repeat or we don't believe will repeat any -- you always could. So that's kind of something that will help in the third quarter results. But in addition, if you look at the high point before we started this integration plan between employees and company people. And we're about 64 people lighter right now. So certainly, the employees are lower, which is in good portion. And I think in terms of travel, we're not seeing vastly increased travel in Q3. Maybe it goes up a little bit in Q4. But if you're not a salesperson or an installer in ORBCOMM, you're probably not traveling right now.

[Richard Prentiss:]

Makes sense. Last one for me is, obviously, some good long-term target goals, 10% revenue growth, 20% adjusted EBITDA growth. What does it take to achieve that? Is there M&A that's required to kind of help achieve that type item? Just I think recon now M&A is off the table for the rest of this year, I assume. But what role does M&A need to play in that long-term targets?

[Marc Eisenberg:]

Yes. I think if we confused you on the call, that's my fault. But we're guiding to 10% organic growth, and 8% historically between 2019 was backing out acquisitions and that was organic growth. But we think 50% of that growth is just the company continuing to grow as we always have by adding customers, but a full 50% of it are products that have almost 0 sales right now that are coming into the business or new channels, for example, the ST 2100 that we talked about on the call, the new OEM stuff for carriers. They make this stuff standard. We sold Volvo a -- their satellites before they've always bought their satellite hardware from a third party. Any new bodies that we're hiring or going into the inside sales group to get us to smaller fleets, that's never been a strong point for us. It's the adoption of the solutions, offering the subscription model, where the first half of the year was slow. And then 6,000 units we're going to deploy or start to deploy in the third quarter. There's multiple initiatives to get that other half.

[Richard Prentiss:]

Great. Great. Good to know it's all on the organic side and M&A could be something on top of that if you find something you need or want.

[Marc Eisenberg:]

M&A is cheating, Ric.

[Operator:]

Next question is from Mike Walkley, Canaccord Genuity.

[Thomas Walkley:]

Great. And my congratulations on great results in this tough environment, especially on the margins. A quick follow-on question, just a lot of your competitors are having to give us price concession and even losing or contracting their subs in this environment. So one, just how do you see kind of ORBCOMM's market share improving in this tough environment? And then two, as you look to your Q3 guidance, how should we think maybe about your ARPU trends and the potential net adds tied in your guidance for the quarter?

[Marc Eisenberg:]

Sure. Dean, I'll start with the subscribers. So, subscribers, I think, or churn of subscribers in the quarter, I think, was 1.7%, which you kind of look at that on an annual basis. It was kind of trending between 6% and 7% where we always are. But, closer to the 7% than the 6%, so at the higher end of our normal range. So I don't think that churn is necessarily why these subscribers were off a few thousand from where we were anticipating. But as you kind of look at the difference, what did we churn in Q1 versus Q2 even though as a percentage, it was a rounding error, the difference was about 8,000 subs on 2.2 million subs. So like I said, you got to go a few decimal points in order to track that, but 8,000 subs would have been right in the middle of where you guys were expecting in terms of the sub count of a quarter. So we're seeing them a little bit, not enough to affect the EBITDA of the business, not enough to affect the cash generation of the business, but we are seeing that. The bigger issue with subs right now is these factory closures being open and close, just shipping new goods, getting them received in time, the subscription model, getting stuff installed in this environment, that was the bigger problem. But I think if you take our 58,000 or 56,000 units that we build, you take that 1.7% churn, and you'll be like, voila, 18,000. Got you that number. I think in terms of difficult markets, we've really been confronted with a couple of issues. So we are seeing a little bit of contraction, which is why we're not -- why we're at 99% of last year as opposed to 105% the last year. And there are some areas that are really, really struggling globally and we've got a reasonable-sized business in Brazil. And on the bright side, it's come back a little, but the real early in the quarter was just suffocating to the point where some of our customers were billing them more than they were billing their customers. And we have to work on that. Second, every quarter, we say, all right, we've reached the bottom of oil and gas, it can't get any worse. And then wow, it got worse. I'm sure you guys saw in the middle of the quarter where oil was trading, but there are a lot of oil service companies going into Chapter 11s and stuff like that. And we've made a significant amount of concessions there. And lastly, we renewed a number of AIS agreements and some of these agreements, there was less competition. And if you look at them now, you make some reductions in order to extend these guys for years to come. So that would be the third area. I think there's headwinds and tailwinds in terms of ARPU, as the last part of your question. There's certainly a large tailwind with subscription models, and that's starting to ramp up and do a whole lot better. I think there's an awful lot we're doing to enrich our subscribers, to get more value out of each subscriber, take a unit and make it dual mode, or take a telematics sub and make it an analytics sub. And long term, there's a lot of tailwinds to get that going. But in the short run, we still need to support these difficult areas of the business. And to help these guys stay in the business and successful and rise through the pandemic.

[Thomas Walkley:]

That's helpful. And just kind of a follow-up question, just on the competitive dynamics, Marc. I know M&A might be challenging at current time in the market. But are you seeing opportunities with some of the maybe private companies or smaller that late -- competitors struggle in this environment to take shares in certain verticals?

[Marc Eisenberg:]

Somewhat, I think during this integration in the last 2 years, as we've said, M&A is completely off the table. We couldn't -- we needed to get this integration done. And I think now the picture is starting the paint of why we need to do that, right? We needed to get the machine right. So as we process more incremental dollars they come through at the margins that we're all expecting and until the integration takes place, the company was subscale and just moving in the wrong direction and the ugliness coming out of that was higher inventory levels and lower margins. And gee, we got that fixed, and we feel like we're in a really good place. And if we wanted to engage in M&A, probably in 2021, we could probably do that. But let me be clear, there's no strategic assets that we don't monitor or track right now that don't already have or have some sort of visibility to within our own R&D. So -- but I don't think that's what you're asking me. In terms of would we do a deal to get better scale, something that's great for shareholders because we're trading at ex-EBITDA and we could buy it, synergize it to, would we do that? We probably would. There's absolutely nothing that we're closing in on right now that probably could close this year. But long range, it is something we would consider.

[Thomas Walkley:]

Great. Last question for me and I’ll pass the line. Just, Dean, I don't if you said it, I might have missed it, the AIS revenue in the quarter. And then with the 20% EBITDA growth in your new platforms, can you talk about the incremental margins for adding new subs? And just how we should think about services gross margin longer term?

[Constantine Milcos:]

Yes. The AIS revenue was $3 million in the quarter. And I don't know, Marc, if you want to talk about the second part of the question.

[Marc Eisenberg:]

Sure. There is a fixed component to both our services and our hardware, not just services. So if you are -- if you're growing 10% and a share of that is hardware, incremental hardware margins are north of 40%. And incremental service margins are between 85% and 90%. So if you figure the growth is 50-50, which is what it was prior to 2019, even though that's what gets us with a 10% organic revenue growth, leading to 20% adjusted EBITDA growth.

[Constantine Milcos:]

Yes. Marc, just to add to that. We have operating expenses in that model growing at 3%. We don't believe we need to add anything to get to that level of revenue as far as operating expenses based on the platforms we built and the back office we built.

[Operator:]

Next question is from Mike Latimore of Northland Capital Markets.

[Michael Latimore:]

I guess just, Marc, back on ARPU. So should we think of ARPU as relatively stable then? Or what should be the conclusion there?

[Marc Eisenberg:]

ARPU certainly fell in the second quarter. I think it probably would be relatively stable in Q3 and Q4. And then as we recover, some of the concessions that we gave were not long term. They were just to get people through the pandemic or companies. So hopefully, we recover some of those ARPUs early in the year.

[Michael Latimore:]

Got it, makes sense. And then just on the couple of the categories you've called out, oil and gas and then South America. What percent of revenue roughly were those categories? And what have they been historically? What would be a more normalized rate?

[Marc Eisenberg:]

Dean, I'm thinking oil and gas is like 5%?

[Constantine Milcos:]

Yes. No, it's about 4% of our total revenue. That's right.

[Marc Eisenberg:]

So, 4%, But 2 years ago, it was like 8%, right so...

[Constantine Milcos:]

Yes. Right.

[Marc Eisenberg:]

Right. As you can -- I mean, that was the entire -- well, there were lots of ups and downs in 2019, but that might have been -- the entire decrease was related to oil and gas. South America, I'm guessing is high single digits?

[Constantine Milcos:]

Yes. It's closer to 8% or 9%, largely through that skyway business, right?

[Michael Latimore:]

Okay. And then on the subscription offer here, you said I think it would affect about $2 million of hardware revenue in the third quarter. I guess should we think about that? Is that going to be sort of in that kind of run rate for several quarters? Or does that build over time where maybe that $2 million goes to $4 million, $6 million or early next year?

[Marc Eisenberg:]

So the $2 million is what we expect to close in the quarter. We don't expect to ship at all in the quarter. So -- and a bunch of it is some of the push from Q1 in the difficult environment. But let me give you a feel for it. I think we shipped less than 8,000 units in Q2, but we expect it to be 6,000, most of which has already been closed, right, and close that in Q3. So you went from a couple hundred grand in Q2 to $2 million in Q3. I think we previously guided to somewhere between $5 million and $8 million on an annual basis for subscription model deals.

[Michael Latimore:]

Okay. And just last one on your long-term growth rate 10% organic growth. Is service -- should service revenue grow at that rate as well? And then how are you thinking about the mix of satellite versus cellular versus dual mode in that?

[Marc Eisenberg:]

We're hoping to get to a world that you can't tell the difference between satellite and dual-mode and because all of these products kind of mix in into 1 offering. So we're seeing an awful lot of that. And historically, our biggest dual-mode customer was Walmart. And now we're seeing it kind of spread into, gee, Walmart and Terex. And Walmart, Terex and now all of a sudden, it's expanded into reefer fleet. And within the next 2 quarters, one of the products we're working on for Carrier is a dual-mode solution as well. So we're really seeing that spread from a couple of percent of the business and we're hoping it will get to 15% of the business, and that will show up in ARPUs. But I think the coolest thing about it is who can beat you, right? Who also has their own satellite networks that you can go and offer this stuff. So that continues to grow. Historically, when you look at that 8% growth, it was -- satellite was in the mid-single digits, and the solutions businesses were in the low teens.

[Operator:]

Next question is from Chris Quilty of Quilty Analytics.

[Christopher Quilty:]

Just want to follow-up on that dual-mode question. Interesting to hear that Hub is doing an equipment refresh. It seems like yesterday that you guys did that deployment. Is Hub still sticking with a single-mode cellular solution? Or are they expanding to add anything dual mode?

[Marc Eisenberg:]

So Hub is currently sticking with the cellular solution because if you look at the asset that Hub has versus the other ones that I mentioned, what all the other ones that I mentioned have in common is they have more access to power. They're drawing power off the reefers, or in Terex, they're drawing power off the engines. And Hub has the most difficult power environment and that they're reduced to nothing but sunlight, right, on these containers. And if you make the panel too big, these things, the way they get kind of banged around on rail, adds more risk. So purely for power consumption, Hub is sticking with a cellular solution.

[Christopher Quilty:]

Got you, and I remember the original deployment there was problematic. You've moved years ahead in terms of your ability to do professional services and install. Is that an installation you'll be doing or with a third party? And then just more generally, as you look to Q3, and shipments and installs, are there any bottlenecks around your ability to get to customer sites and install?

[Marc Eisenberg:]

Yes. It's -- every site is different, right? And when you look at these rail yards and places that you install, you're not installing in New York City. You're installing in Omaha or these disparate cities all over the country that the virus and the political situation and everything else is flaring up and coming down, and we're in the scheme of whack-a-mole. And if I were able to tell you where I'd be able to install over the course of the third quarter, I would have given you fourth quarter guidance. But because I have no idea where this thing is flaring up and what the political landscape is on every mayor and every town of every customer that I have, I just don't know. So that's -- I mean, you've hit on the very uncertainty that we're dealing with, right?

[Christopher Quilty:]

Understand. So looking at the shipments, it feels like they were improving in Q2. I'm assuming they'll improve in Q3 but in terms of actual net adds, we don't get back to a 60,000 or 80,000 sort of run rate level in Q3. Is that a fair assumption?

[Marc Eisenberg:]

Well, if I had to place a bet on it, I would say the Q3 number is like a three handle on it. So it's starting to recover, just kind of in line with sales. And then Q4, a little bit higher. And then hopefully, a six handle in Q1 or Q2.

[Christopher Quilty:]

Got it, you guys didn't pay an outside marketing firm to come up with the brand name on the ORBCOMM platform, I hope. But can you talk more about that with -- in terms of what that does with onboarding customers or alternatively, it sounds like you've got some customers that have made the shift. How seamless that was to move from a custom platform into with a generic but presumably customizable platform?

[Marc Eisenberg:]

Yes. So we did not hire a marketing company to come up with the name. But I understand the name from your viewpoint. Seems kind of odd, but the ORBCOMM platform in terms of internal to our customers made a whole lot of sense. But it's hard, right? I mean if you look at reefer track, that's the first thing that we built. There's thousands of man years that went into reefer track. And we deal with these big unwieldy customers that, as you onboard them, gee, I'll put you across my fleet. But what I really need you to do is integrate to this dispatch system or this yard system. And what I really want to know is, what is the fuel economy that I'm getting on a Carrier reefer versus a TK reefer? And what I really want to know is, how long am I dwelling at this customer versus that customer? And should I be charging for that fuel that's used? And those were the kind of things that you're focused on as you built this thing and you continue to build on it for 10 or 12 years. And each customer brought 3 or 4 of their own needs or desires, and you worked on that and did it over years. And then boom, you move them all over to a new platform. And you're starting to knock out with these -- between all the platforms, thousands of customers use in those platforms onto the new platform, which is why they're all running concurrently now as the switch gets done and we keep knocking out these one-offs that customers need, so that you can close down the other platforms. But I guess the sense, you're more on the other side. What is the benefit for the customers? And what is the benefit for ORBCOMM? Well, the benefit for our customers is you might have been using your reefers on 1 platform. Your drive ends on another platform. Your chassis on another platform or your truck on another platform. And gee, it all works on 1 platform, and you can kind of tie trucks to trailers and learn how to use 1 platform and out of multiple screens open. And wow, is that damn cool? And then we can kind of work on some of the cool features in marrying trucks and trailers and doing some of those neat things as it all comes together. But internal to ORBCOMM, imagine you've got 150 software engineers serving 25 platforms. So the average platform is fixed. You're saying, "Gee, 150 seems like a lot, but 16 is like nothing." So you're underscaled. And then you've got 80 people at customer service that are subscale because each of them are experts in 25 different platforms instead of being able to take a call from any customer on any platform. And then you've got these multiple builds that you're trying to work through from the old ERP systems where you're sending customers pages of bills because you're sending bills of different platforms. All subscale, all affecting the margins, all affecting the cash generation, all affecting the amount of employees that you need to effectively support it and boom, it all comes together. Millions or over $10 million or $50 million of cost went into this that our shareholders haven't seen the value from that, now all of a sudden, you're seeing it through cash generation, you've seen it through the margins. It's starting to hit home. But I think the message for today is look at what incremental growth now means to incremental EBITDA as opposed to almost a 1

[Christopher Quilty:]

Understand. And final question here, which you touched on cash flow. I missed it if you provided an update for the full year CapEx and if anything to add any color there. And cash flow, do you have a better sense of what the full year cash flow from ops might look like? And if you have any comments around application of the cash flow towards reinstituting the buyback or paying down debt? Any thoughts would be helpful.

[Marc Eisenberg:]

Dean, you start and I'll -- no.

[Constantine Milcos:]

Yes. Sure. Chris, I'll start off. The cash flow -- the question on CapEx, we do expect CapEx to be approximately $20 million for the full year. That's excluding the subscription model. So to model might be another $3 million in the investing section of the cash flow, and that would be $22 million total. For the first half of the year, we generated free cash flow of about $10 million, excluding the stock buyback. I think it will be similar in the back half of the year. So we would -- we should repeat what we did in the first half and the second half. With the $2 million of investments in subscription model, it's almost the same as a $2 million of investments we did in stock buyback in the first half of the year. So I would think a similar cash flow in the back half of the year for first half of the year. The other question on the refinancing. I don't know, Marc, do you want to take that?

[Marc Eisenberg:]

Sure. You have to excuse us, we're in different locations. We've never had do that before. But in terms of the refinancing, we're currently paying 8% on $250 million. And we're debating when to refinance that. And I think this quarter is going to go a long way in getting that refinanced in that not understanding what the cash generation was or ability to repay debt before the quarter. I think the banks will have a different feeling after the quarter. And then if we could show a continued improvement in Q3, there's a chance that we can refinance our debt by the April date, that the 4% penalty goes to a 2% penalty. And kind of the dream would be a five handle on debt, and probably more likely a six handle in terms of the rates that the banks are kind of telling us. So that is a significant change. And then listening to Dean's guidance on cash, we would end the year somewhere between $70 million and $75 million in cash. And then the question becomes, is the debt $250 million? Is it $225 million? What is the amount that you're going to refinance? And we need to kind of weigh 3 things. What's the value of buying back stock and where is the stock trading at? Number two, what is the value of the subscription model and how much do we want to invest in that? And number three, what is the debt rate that you get? And all of those 3 things are interchangeable. And then if you threw in a fourth thing, which would be M&A. What are the opportunities out there? We'll certainly take a look at all of that as well. But imagine sometime Q2 next year, it all gets resolved.

[Christopher Quilty:]

These are good problems to have. Congrats

[Marc Eisenberg:]

What do you do with cash? Yes.

[Operator:]

[Operator Instructions] Next question comes from Scott Searle with Roth Capital.

[Scott Searle:]

Guys, a nice job. A couple of quick cleanup questions and then some follow-ons. I'm not sure if I explicitly heard it, but professional services in the quarter, it sounded like backing out the recurring, that's around $600,000 or so. Is that correct? And then on the bad debt front, I think you said $1.6 million in the second quarter. Could you just give us some historical perspective on it? I don't have the numbers in front of me, but I want to say that's 2 to 3x where we had been in the first quarter and the fourth quarter last year. And I had a couple of follow-ups.

[Constantine Milcos:]

Yes. So professional services -- just to be quick, professional services is down about $500,000 for the quarter. Year-over-year, we have lower audit fees and legal fees, which we have planned on going into the year. For the -- for bad debt, our typical quarters are somewhere in the $400,000 range for bad debt, less than 1% of revenue for the year. We've done a pretty good job historically of collecting more than 99% of our revenues. So the $1.6 million is quite a bit higher, obviously, and we expect to get back to that $400,000, $500,000 a quarter range as the economy gets back to normal level.

[Scott Searle:]

Got you. And then on the product front, Marc, clearly, in terms of the guidance, it implies product and harbor starting to come back into the third quarter. In terms of the expected shipments in a couple of areas, I think container sounds like it's lower. There is some cannibalization from conversion to the SaaS model. But where are you specifically expecting to see the growth? It sounds like it's still early in the 3G sunsetting. It sounds like rail is starting to come back from 0. And is transportation part of that equation as well? And I was wondering if you could give us an idea of what the visibility on that front looks like at the current time for the third quarter.

[Marc Eisenberg:]

So the visibility on the 3G trade outs is pretty high. So we're working with a carrier on a number of fleets with a deadline of December 2021 to get all of these switched out and you may be saying to yourself, "Well, that's not a big issue." It's 18 months from now and not even 15 months from now. But to get it sold, to get it installed across entire large fleets, really needs to start now to the point where you can see Hub starting to ramp-up, which is 3G as well. So those are moving very quickly. And then we're starting to see new builds as well, which we have a view as a couple of months in advance. And you're seeing the rail guys starting to build new products in China and other places, and we're beginning to ship those as well. We're also seeing some latent demand from a number of our OEMs that about to buy in the second quarter because their factory lines were closed down. And I'm not saying that those lines are at 100% of normalized rates. But in a good portion of Q2, they were 0. So even halfway or 3/4 of the way to normalize is a whole lot better than 0. So that's the kind of recovery that we're seeing.

[Scott Searle:]

Okay. Great. And lastly, just on the services front. You talked about some deactivations in the quarter and you talked a little bit about the churn rate. But I'm wondering if you're seeing any reactivations. Maybe also, could you give us a quick update on Blue Tree and inthinc. And the 10% organic growth target, it's kind of extrapolating out looking, getting back to that 50,000 or 60,000 net adds per quarter, you just start to get into the mid- to high single-digit kind of organic growth rate. What's the time line or the current time line that you would expect to start to breach that 10% organic growth? Is that at 2022? Or does it take something beyond that?

[Marc Eisenberg:]

Yes. Well, I mean, it depends on what you're talking about, I mean, from like a 57 million in Q2. We expect to get there really quick. But if you're talking about from normalized levels, I think the goal for 2021 would be to get the company back up to normal and then to expand 10% beyond the normalized levels in 2022. But well, I'd be disappointed if 2021 didn't grow 10% over 2020 and based on this environment. That being said, vaccine, who knows, But assuming any recovery at all, gee, we should be growing 10% in 2021.

[Operator:]

At this time, there are no further questions. The company thanks you for participating on the call today and look forward to speaking to you again as we report the third quarter results. Have a good day.