ORBCOMM Inc.
Q2 2017 Earnings Call Transcript

Published: 3 Aug 2017

[Operator:]

Good morning, ladies and gentlemen, and welcome to ORBCOMM's Second Quarter 2017 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. A replay of this conference call will be available from approximately 1

[Michelle Ferris:]

Good morning and thank you for joining us. My name is Michelle Ferris, and with me today is Marc Eisenberg, ORBCOMM's Chief Executive Officer; and Robert Costantini, ORBCOMM's Chief Financial Officer. 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. I want to remind you that ORBCOMM assumes no duty to update forward-looking statements. In addition, the financial information we will discuss includes non-GAAP financial measures. A 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 Michelle. We are pleased with our performance in Q2 and have a good deal of momentum as we head into the second half of the year. This quarter we achieved record highs in both hardware and service revenue while shipping an unprecedented number of devices, totaling over 69,000. On this call, we'll update you on new customers and partnerships, our status on large deployments, some detail on our latest acquisition and then shift to operations. At that point I'll transition the call to Robert to walk you through the financials and wrap up with Q&A, so let's get started. Earlier this morning, we issued a press release announcing financial results for the second quarter ended June 30, 2017. ORBCOMM continues to grow organically as well as through acquisition is evidenced by this quarter's strong revenue performance. Total revenues reached a new high of $57 million growing nearly 14% or $6.9 million over Q2, last year. Keep in mind, Q2 was by far our strongest quarter of last year. Products continue to build or product sales and we're seeing path to conversion to the generation of high margin recurring service revenues. Service revenues increased in the quarter by 12% year-over-year to $31.1 million, a company record and are up nearly $1 million or capped organically just over last quarter. Q2 product sales increased 16% year-over-year to $25.9 million as we shipped over 69,000 units of hardware. Our subscriber count or subs grew in the quarter by over 62,000 net subs including subscribers obtained through the inthinc acquisition taking the base to 1.83 million subs at the end of June, 2017. Q2 adjusted EBITDA of $12 million was negatively impacted by $0.3 million from inthinc, while last year's adjusted EBITDA was positively impacted by $1.3 million one-time gain from the recruitment of a regulatory fee making for a tough comparison, otherwise adjusted EBITDA would have been follow up [ph] over the last year. Diving further into our second quarter results, we're seeing strong momentum in nearly every aspect of our business from transportation, heavy equipment and container import solutions to AIS, network services and RFID solutions. Our recurring theme to 2017 is been large volume deployments with lower margins at key accounts being installed far quicker than we had anticipated leading to the compression of overall margins. We've also been putting additional resources and supporting installations for these deployments that are affecting service margins as well. We do not believe these are long-term trends as we expect these shipments to taper off later in the year. If you think about, this is a pretty good trade off. Although margins suffer for a couple of quarters, the trade-off is having a quicker conversion to higher margin service revenues. As I mentioned earlier, we're already starting to experience this trend with large jumps in service revenues quarter-over-quarter which is core to our strategy and should lead to great start to 2018. inthinc contributed three weeks to the quarter as I mentioned earlier, the inthinc contribution led to a reduction in adjusted EBITDA of about $300,000. When inthinc was acquired it had a number of customer opportunities but little to know inventory in the pipeline of the $900,000 inthinc contributed to revenue over those three weeks in the quarter $700,000 was service revenue. In order for inthinc to contribute positively to adjusted EBITDA in the near term their plan will require a larger share of hardware sales. We're back in our way to delivering product and volume and inthinc should add about 4,000 subscribers in Q3 and over 13,000 by the end of 2017. We're excited about the prospects of inthinc, but it's going to take a quarter or two to get the business on track. I'll speak to inthinc in more detail in a few moments. Looking forward to Q3 from a revenue standpoint next quarter looks to break all new records. J.B. Hunt the postal service and our new heavy equipment OEM, we recently announced Oshkosh JLG expect to receive over 40,000 units. That's nearly 20,000 units more than we shipped these customers in Q2. With strong organic growth coupled with a full quarter of inthinc, the third quarter revenue should take another leap forward and reach the mid $60 million range. We do however anticipate the same short-term margin issues we experienced in Q2 as well as significant shift from service to hardware in the mix for the quarter, so while adjusted EBITDA should be fine. Adjusted EBITDA margins will most likely be temporarily softer than they have been in the past. Once again, we look at moving these projects along at a faster pace as extremely positive. We get service revenues ramping faster, we get these deployments completed and we get to move a good deal of our resources to a significant pipeline of opportunities. There is a lot we like about our position. Let's move onto the business highlight starting with heavy equipment. Over the past few quarters, we've talked about a new OEM using our end-to-end telematic solution for their global equipment. Last month, we announced that OEM is, Oshkosh the Fortune 500 Company and leading manufacturer of specialty vehicles. We're working on providing our solution to multiple divisions within Oshkosh starting with the JLG aerial work platform and telehandlers to enable them to proactively manage and maintain their customers fleets. JLG is offering our solution as both a factory installed option for new machines and an aftermarket option to retrofit machines in the field. In Q2, we shipped a few thousand devices to JLG and currently have orders for over 10,000 more that we expect to ship over the rest of the year. JLG is making solid progress on deployments in North America and Europe. And we expect the Middle East, Africa and Asia Pacific to follow shortly being selected by world class OEM like Oshkosh demonstrates a leading position in providing large scale customized solutions for the heavy equipment industry and we look forward to expanding our telematics program across many of Oshkosh's equipment divisions. We're continuing to execute on large deployments with J.B. Hunt and AT&T and support of the US Postal Service as I mentioned earlier. We're shipping these customers much faster than anticipated. We shipped over 15,000 systems between them in the second quarter and expect that pace to double in Q3. Our solution delivery and installation teams are fully engaged with J.B. Hunt to help deploy their entire fleet or more than 90,000 assets we hope to complete the overwhelming majority this year. We're also seeing progress in our shipments to AT&T for the US Postal Service. In Q2, we shipped over 6,000 devices to the Postal Service for their key leasing suppliers. We also began shipping to their third party haulers that carry mail and dedicated routes in Q3. Looking further into our transportation business in Q2, many of our longstanding transportation customers continue to place renewal orders such as Wal-Mart, Hub, [indiscernible] Prime, SpartanNash, Myer, CNS Wholesale, JNJ Express and Werner [ph]. We've also closed many new opportunities this quarter some of which include Ellen Distribution, Dedicated Logistics, PSC Medals and Domino's Pizza. In addition our Euroscan team is providing our dual mode container monitoring solutions to UNIT45, a leading European intermodal container OEM. UNIT45 specializes in diesel, electric, refrigerated containers which are uniquely positioned for transporting cargo by rail from China to Russia and Western Europe. We also had an exciting win in our Container and Port Solutions, our CAPS. TOTE Maritime Puerto Rico, a premier shipping carrier that moves cargo between the US mainland's in Puerto Rico is using our Vessel Connect solution to manage their fleet of smart refrigerated containers at sea. Vessel Connect extends connectivity to open water providing TOTE with seamless visibility and control of its assets along the cold chain. They completed deployment of the ORBCOMM solution in late Q2 and are realizing the benefits of their investments including reduce cargo damage, lower operating cost, better regulatory compliance and enhanced customer service. TOTE Alaska another division of TOTE Maritime that moves cargo between Tacoma, Washington and Anchorage, Alaska is also using Vessel Connect along with our asset monitoring solutions for their refrigerated containers, dry containers and trailers to improve the safety and efficiency of their supply chain operations. TOTE Alaska began deploying in Q2. TOTE is a great example of ORBCOMM's cross selling success by leveraging our broad portfolio of transportation solutions to meet customers, requirements for multiple asset types, market segments and geographies. M&A continues to be an integral part of our strategy to add vertical markets, geographies and technical capabilities to our IoT portfolio. In our transportation business, many of our customers have demand for fleet, vehicle telematics products and our strategies to be a one stop supplier for all transportation needs. The acquisition of inthinc which we completed in June provides an excellent entry point into the vehicle fleet market and helps build the need in our product portfolio. We are now able to provide customers who operate a wide range of assets with a more complete solution offering nearly every transportation market segment. Reaper, dry van, intermodal, rail, chassis, sea container and vehicles. Based in Salt Lake City, Utah. inthinc has an impressive service offering that provides vehicle fleet management and driver safety solutions to a broad range of industrial enterprises. A long-time customer of ORBCOMM wireless data services. inthinc telematic solutions improve operational efficiency, regulatory compliance, workforce optimization and driver safety through the two-way integration of in-vehicle and mobile devices, web applications and data management. We're making progress on integration inthinc's engineering sales and corporate functions and are working through some challenges to restart their product flow to meet their strong demand. As we expand inthinc's products toward transportation heavy equipment markets. We believe there is great potential for cross selling opportunities as with every acquisition we've done previously and look forward to reporting some exciting customer wins in the near future. ORBCOMM is now one of the largest industrial IoT players with hundreds of employees worldwide dedicated to commercial transportation. Supported by the most technically diverse engineering team in the industry. As we grow in size and scale, we're becoming extremely effective at solving customers problems and meeting their requirements for large customized deployments. We believe this gives us a unique advantage for being selected by some of the biggest names in the industry such J.B. Hunt, Wal-Mart, Carrier, Maersk, Swift, AT&T with the US Postal Service, Union Pacific, Prime and Hub Group. We're making positive strides and opening up new markets for our satellite connectivity services. We've recently signed an agreement with Beijing Marine Communication Navigation Company or MCM that allows ORBCOMM to provide IsatData Pro or IDP service in China for our customers with asset monitoring applications in the IoT markets. China is an important geographic market for ORBCOMM and our customers. This agreement broadens the reach of our satellite business and strengthens our service offering to better meet our customers' needs. We're continuing to win new customers within our government business, our partners Gov Mobile [ph] and Radio Mobile on separate contracts to provide the California Department of Forestry and Fire Protection known as CAL FIRE with an automatic vehicle location system that will provide a reliable constant connection on over 1,200 emergency response vehicles. The CAL FIRE program is a great example, we leverage our comprehensive IoT ecosystem in key partnerships to help government agencies, improve visibility and managements of their assets. Moving onto our application enablement platform or iApp, we're continuing to see momentum in the business marked by several new wins in Q2 including Pretivm Resources, a precious metals mining company. Pretivm will utilize our AssetWatch solution in conjunction with Wi-Fi RFID technology to track their underground miners and vehicles in real time the new Brucejack gold mine in remote British Columbia, enabling them to gain production efficiencies and improve miner safety. We've also expanded our opportunity with Lockheed Martin to include an RFID tracking solution for their space systems group to further improve visibility of their extensive manufacturing process. The iApp business was acquired about 2.5 years ago and we're seeing this group headed stride with a growing pipeline in number of cross selling opportunities with many of our current customers. Turning to AIS, Q2 set another record high with over $2.3 million in revenue driven by steady growth. We're now collecting over 28 million messages per day from over 200,000 unique vessels both milestones that we're well ahead of our competitors. We continue to expand our AIS business through our established contracts including a new order through our partner LuxSpace from the European Maritime Safety Agency to add an additional European country to receive our AIS data starting in September. Leveraging the new AIS products in our portfolio and our extensive network of channel partners, we expect to see continued growth in this business through the second half of the year. Let's move on to our satellite constellation, as a reminder we launched 17 OG2 satellites between two launches in July, 2014 and December, 2015 of these 17 satellites 12 are working without issue and performing as expected, two are written down in prior years. We've disclosed one with solar rays anomaly in Q1 that is struggling with loss of connectivity and two other OG2 satellites are experiencing loss of connectivity as well, one was our prototype. There is been little effect on message delivery times are no impact on message throughput and revenue. We've established a comprehensive investigation team that includes independent consultant as well as ORBCOMM engineering and OG2 contractors to determine root cause and associated corrective measures. Each satellite carriers a book value of about $10 million and our goal is to recover all three satellites. As we mentioned on previous call, each OG2 satellite has the capacity of over six OG1 satellites and the resiliency of the entire constellation, the increased capacity enables us to reposition satellites in events of these circumstances which reduces the impact on network service. OG2 satellites process about 80% of the networks message traffic which now totals approximately 1.2 million messages per day. overall our customers continued to be pleased with the networks performance and quality of service. Our diverse network offerings of low earth orbit, geostationary and terrestrial services enable us to provide the broadest set of connectivity options in the industrial IoT. For customers with latency sensitive applications, our Inmarsat based IDP network meet the requirements by offering the highest payload and lowest latency of any satellite IoT service. We're also near completion of our dual mode satellite modem leveraging the complementary technologies of the Inmarsat geostationary network, with ORBCOMM's low earth orbit network to provide customers with the most capable satellite connectivity. The results of these two powerful satellite network working together on a standardized platform will enable ORBCOMM to offer the best combination of geographic coverage, the most regulatory authorization, the fastest service and the largest message payloads. We expect to start shipping our modem in small quantities over the next couple of quarters. Let's wrap up with the product update in Q2, we continue to ship IDP terminals that utilize our new radio frequency integrated circuit or RFIC to a large fishing buoy OEM and completed our first shipment to a large fleet management company in South America. As a reminder, the RFIC is a custom chip that reduces the [indiscernible] by 600 components there by reducing costs. The RFIC terminal will be available to all customers in Q3 and we expect to start seeing the benefit of cost savings and efficiencies as we ramp up to full production. We also shipped first of our LTE enabled cold chain monitoring devices, the two large refrigerated transport companies in North America. The RFIC and LTE cold chain solution are just two of more than 140 active projects, our engineering team is working now. Innovation is by no means slowing down at ORBCOMM. Between now and 2018, we plan to rollout more than 20 new products and solutions ranging from feature enhancements to sensors and peripherals to product configurations to user interface designs. These projects span every aspect of our business as well as several new product categories. We believe the substantial investment we're putting into our in-house innovation is paying off. Let me reiterate, we shipped a record 69,000 ORBCOMM devices this quarter and it could be as many as 90,000 in Q3. Summing up, with the first half of year behind us, we feel good about the business it was a strong revenue quarter and we're positioned well in our markets. We're focused on a number of priorities including the integration of inthinc, executing on our large deployments, closing multiple new opportunities, rolling out several new products and working toward building our pipeline for 2018. We're seeing increasingly strong demand for our products across the business and we're excited about the host of new customers and markets we are now able to serve through inthinc. At this point I'll turn the call over to Robert to take your through the financials.

[Robert Costantini:]

Thank you, Marc. Good morning, everyone. Our second quarter top line results were excellent as ORBCOMM generate a new high, total revenues of $57 million, a 14% over the last year. Service revenues were up 12% to $31 million and product sales were up 16% to $26 million, both at record level. Contribution margins came in lower than anticipated 45.7% of total revenues as both service and product margins were lower affected by the rapid delivery and installation of large previously announced orders and a dramatic increase in lower margin product sales reflecting volume pricing. The rate of shipments for these large deployments are pacing faster than anticipated resulting in higher production and delivery costs. Related installation costs are also running higher to convert them quicker to service revenue. We anticipate that contribution margins will improve as these impacts lessen. Adjusted EBITDA for the second quarter totaled $12 million essentially flat to last year and was impacted by the lower contribution margins as well as $0.3 million a negative adjusted EBITDA from the inthinc acquisition. Adjusted EBITDA margin for Q2, at 21.1% of total revenues is down from 24.2% compared to last year that benefited from one-time recruitment of a regulatory agency fee. Growth in service revenue is mainly attributable to the growing subscriber base from several quarters of higher products sales and installations, along with growing AIS revenues. Service revenues for the second quarter grew 12.2% or $3.4 million over last year to $31.1 million with organic growth at high single-digits spread across almost all service offerings. AIS revenues continue to grow coming in at $2.3 million for the quarter almost $10 million on an annual run rate basis and sequentially service revenues were $1.6 million higher than the previous quarter and just under $0.7 million was contributed by the recent acquisition. Our contribution margins for service revenues, net of direct cost of service in Q2 were 65.7% of total service revenues. A decrease of 50 basis points from last year, partially due to the installation cost running higher than installation revenues as we're actively involved in the installation of large deployment to meet our customers' delivery schedule. A process typically less to the customer. This effort to accelerate highly visible long-term recurring service revenues has long-term benefits. Another impact to service contribution margin is lower service margins from the recent acquisition that should improve with increase scale over the next several quarters. Excluding these two items service revenues contribution margin would be 68% and trending higher than prior year in previous quarter. The underlying service contribution margin is in line with our long-term projections and an increasing service contribution margin and the short-term impacts described as not signally change in our long-term view. Product sales in Q2 were $25.9 million growing $3.5 million or 15.7% compared to last year. Demand across multiple product lines drove the increase and the acquisition added about $200,000 dollars. Q2 product sales also show our shipments to our new OEM customer JLG. Overall, we shipped over 69,000 devices in the second quarter and the company is expecting additional increases for Q3. Contribution margins for product sales net of direct cost of products for Q2 were at 21.6% of total product sales decreasing 150 basis points compared to last year and reflecting higher production and delivery cost coupled with already lower pricing for large volume orders. These factors are meaningfully impacting margins and we expect this compression to continue for the next couple of quarters. The contribution margin issues driving higher production and delivery and installation costs are connected and represent short-term activity cost that we believe will eventually taper off, but will likely continue to hamper margins over the next couple of quarters. SG&A expenses were $13.3 million versus $11.1 million last year. The increase in Q2 this year was due to the additional cost operate the new acquisition and the prior year benefit from one-time recruitment of a regulatory agency fee. Sequentially the increase from Q1 is about 11% reflecting higher SG&A for inthinc. Likewise product development cost are up sequentially over Q1 due to the addition of inthinc as well. Depreciation and amortization in Q2 was $11.4 million. Interest expense including amortized financing fees was $4.8 million versus $2.4 million last year higher due to the new debt offering. Interest expense for Q4 should be about $5.2 million including amortized financing fees. Acquisition related and integration costs for the second quarter were $1.3 million due to the acquisition of inthinc completed on June 9. Last year costs were $0.6 million for the Skygistics acquisition. In the second quarter of 2017, we reported a net loss of $10.7 million compared to a net loss of $4.2 million last year. with the increased loss, due to the higher interest expense of $2.4 million and a non-cash $3.9 million write-off of deferred financing cost and an early payment fee associated with the debt settlement in April. As well as the added operating cost for the recent acquisition. Looking at the balance sheet, cash totaled approximately $84 million at June 30, 2017 compared to $25 million at December 31, 2016 increasing $59 million. Cash increased from the issuance of $250 million senior secured notes partially used to refinance $150 million of debt and $15 million was provided by the private placement of common stock. Cash used in operations in the first half of 2017 was $2.3 million for increases in working capital from higher product sales receivables and inventories to meet product demand. In the second half of 2017, we expect operating cash flows to continue to reflect these increases in working capital. Supporting receivables and higher product sales as well as inthinc bundled pricing model for product sales and financing. For investing activities, $34.2 million was for the inthinc acquisition and $14.2 million for capital expenditures. In the first half of 2017, capital expenditures of $14.2 million included $2 million for our OG2 milestone payments, $3.7 million for sustaining CapEx for existing infrastructure and $8.5 million in investment CapEx covering our in-house innovation of new products and services. for the rest of 2017, capital expenditures are expected to be about $6 million per quarter, breaking down that $6 million quarterly capital expenditures further, $1.5 million is for sustaining CapEx and about $4.5 million for investment CapEx. Our total debt outstanding at June 30 is $246 million net of debt issuance cost. Moving now onto Q3 guidance, our total revenues for Q3, 2017 are expected to be in the mid $60 million range divided nearly equally between service revenues and product sales. Product contribution margins are expected to be in the mid to high teens given the margin pressures discussed earlier. Adjusted EBITDA margin as a percentage of total revenue is expected to be around 20%. This is softer than it has been recently given the significant increases in the hardware and short-term margin pressures. For the full year 2017, we are now guiding total revenues to the very top of the range for both service revenues and product sales between $230 million and $235 million without inthinc, and $240 million to $245 million with inthinc. Adjusted EBITDA margin for 2017 is now expected to be in the 20% range for the full year due to the higher mix of hardware in total revenues and should return to higher levels in 2018. This concludes our remarks for this call and we're now happy to take your questions.

[Operator:]

[Operator Instructions] we'll go first to Ric Prentiss with Raymond James.

[Ric Prentiss:]

Want to start with a couple of questions. First in the quarter, you mentioned 62,000 subs and 69,000 units shipped. How should we think about that trending out as far as shipment versus turning into subscribers? And how much did inthinc include in the 62,000 in the quarter?

[Marc Eisenberg:]

Yes, so there is a couple of factors moving that back and forth. The 62,000 is a net number so that is after churn, so if we're churning 6% or 7% a year you've got to take those subs off in the quarter. So you know that's why the numbers don't match up and in addition when units get shipped it may take a quarter for them to turn into subscribers when they get installed. So the timing is not perfect. Now I'm going to really confuse you on inthinc, there were so many factors that went into the inthinc subs. First of all, there were somewhere single mode, some were dual mode. A good portion of these cellular ones were already on the ORBCOMM network so they didn't affect subs. You know there were so much give and take in the inthinc subs. They have 35,000 subs but I don't know that 35,000 made it. Looking in subs, subs are definitely ramping. Looking at Q3, I was checking before this call we didn't quite get there but we almost got 20,000 activations just in July. So subs are definitely ramping.

[Ric Prentiss:]

Great. And then I think you mentioned inthinc would have 4,000 in third quarter. And then 13,000 was that for year in which you own them, just trying to understand, what the 13,000 is?

[Marc Eisenberg:]

Yes, so that we - imagine 4,000 pieces of hardware shipped in Q3 and 9,000 more in Q4. So I think if we had all 13,000 we can ship them tomorrow or the overwhelming majority of them. But there is a process to get them built and there was zero in the manufacturing pipeline when we bought the company which was why, you know in the first three weeks that we owned them which was three weeks the last quarter, they contributed next to nothing in hardware. And it's tougher them to be profitable with hardware being zero. It would be tough for ORBCOMM to be profitable, if hardware was zero. You know that's kind of what we experienced, but you could imagine, you take this company you add 13,000 more devices to their 35,000 units of that are out there reporting at these higher ARPUs. And this thing becomes pretty really quick. It's just going to take us a quarter or two to get there.

[Ric Prentiss:]

Okay and then I think, I think one of the more exciting things in the last couple of months was the JLG acquisition, you talked a little bit about it, as far as units shipping, how should we think about the ability to ramp in over the next couple of years. And what would that impact be, as far as on service margins and overall margins.

[Marc Eisenberg:]

JLG is shockingly huge. Seriously guys, when you're driving home and you see these aerial lifts or sometimes they're called scissor lifts, you know go and take a look and you'll see the JLG logo, I mean they're everywhere. And they make tens and thousands of these per year. I think the 10,000 that we guided to for the rest of the year is super conservative because we expect to ship all of them in Q3 and we don't expect Q4 to be zero. So but there is a little bit of how quick do they get the factory installs done and then, now that they're out in the market bidding on some of the units that have been fielded or should they retrofits. I don't want to steal their thunder, but I think they're doing really well and I think it's tens of thousands of units in the really short-term, what's really cool about this deal, is the deal was struck a year and half ago. It's not when is it coming story, it's a - we did this a really long time and it's, they waited till they were ready to make the announcement and we had shipped 3,000 or 4,000 units before we even made the release. So this one's coming quick.

[Ric Prentiss:]

A final question for me is on that same line is, obviously Oshkosh has other divisions, how do you see that playing out, your ability to penetrate deeper into them and how long would that sale cycle take?

[Marc Eisenberg:]

Really great question, think inthinc, think inthinc. They have a couple of products that it's a really good fit. I think we're quarter or two away.

[Ric Prentiss:]

Great. Thanks so much for the questions.

[Operator:]

And we'll go next to Mike Walkley with Canaccord Genuity.

[Mike Walkley:]

Great, thanks. Robert, just digging more into the gross margin. I understand your big customers are ramping, can you walk us through gross margin maybe for the rest of the year. obviously it's not going to be the 23% you thought with the Q3 guidance. How do we see that maybe recovering once you get through some of this big in rollouts?

[Robert Costantini:]

You know that's exactly the story, the faster delivery and installation effort has added those pressure and we want to meet their timeline, so that is like a couple of quarters that we're looking at and if we can continue to meet those delivery schedules, we should rebound. When you pull out some of this large order dynamic and we look at the rest of the business. Oddly enough, all that is trending well over 25% margin, so we see the rebound coming once we get through this kind of effort that we're dealing with now. So we like the rest of the business, that's our target, sometimes we do even better than that, sometimes we don't but the large volume pricing is going to be an impact as long with the additional cost for just next couple of quarter. you know I like way, 2018 would look in terms of what we've traditionally targeted on that score and that's kind of how we're thinking about it.

[Marc Eisenberg:]

I think there is, just to kind of add to that, there's two dynamics here. Number one, you've got more lower margin stuff being averaged into the hardware that's shift, but there is a second part that is caught us a little bit by surprise and that is some of these guys are demanding like J.B. Hunt is receiving a container a week and they fit almost 2,000 units in a container and pushing us to five containers a month instead of four and just being caught a little bit flat footed, you need to expedite some of the product. The cost that you're having there, weren't sure we're expecting plus the mix isn't what you're expecting and it's lightning strike twice. But this is really short-term, I mean this is going to be done in a quarter or two. And then, all that's going to be left is hundreds of thousands of units between the few big deals of service revenues kicking in and you already starting to see the subs ramp, service revenues shooting higher and this is going to be really pretty picture, we just have to swallow our pill a little bit here.

[Mike Walkley:]

Right to Marc and Robert, just building off that. As we get to 2018, maybe just to look out, can you just remind us kind of your longer term model, where you see the adjusted EBIT to margin, once you get through these issues just to help us in longer term modeling, given the step down in the short-term.

[Robert Costantini:]

So again we - we've looked at margin expansion on adjusted EBITDA primarily driven by service contribution margin expansion, which we see intact impact by these short-term pressures. We expect to sort of resume on that original ramp, so we were originally guided in 24 point, 25 point margin this year. I mean I'm expecting it to go back into that range with growth. We're not ready to give you guidance for 2018, but again we see this thing getting back on track. If you look over a long-term growth, this is not unusual for us as we acquired new companies and we continue to take these step up. Remember what subs used to be in 20,000 quarter range and then we went into the 30s and then we went to the 40s, now we're in the 60s. So there is always like this step up that we take and then we continue back on our growth in resuming our growth. But our long-term view on that model has not changed, from conversations we've had in the past.

[Marc Eisenberg:]

But you know to what Robert said before Mike, if you pull out those deployments, you're over the 25 point hardware margins, which means that you're well over 25 point EBITDA margins. So these deployments are quarter or two away from being completed. I mean this thing should just snap right back into place.

[Mike Walkley:]

No, that's helpful. And then just on the model Robert. Can you help us with OpEx with the full quarter of inthinc, what are you thinking about for sales and marketing and product sales? Sequential growth.

[Robert Costantini:]

I think we've got some right sizing to do there, around the organization anyway. So the number that we're sort of looking at above it's called 13.5, 13.7 for SG&A it's probably the new norm there. The $1.9 million for product development along with $11.5 million for D&A. it seems like the right number. I'm sorry we'll have acquisition related costs as well moving into Q3 as we wrap this up, so that would also be part of the story, but those are generally the range I have. You got to give me a little bit more time to operate this thing, but I think those would be comfortable levels to use.

[Mike Walkley:]

Okay, thanks and one last question from me now. I'll pass it on. Marc, maybe just talk a little long-term on the pipeline once you get through these very big installations. How do you kind of see the pipeline as you look into 2018 and continue to add subs of these strong levels, the last couple of quarters?

[Marc Eisenberg:]

We see a lot more deals, I can't tell you anything that's closed and concrete, but I think we may have a little less reliance on transportation, but we're seeing the rest of the business drastically step up. You look at our heavy equipment group, the guys that closed JLG and stuff. Funny enough we bought a company they had 3,000 subs and they're going to do something like 14,000 in this quarter. It's coming from everywhere. The momentum is really just awesome which is why the company has kind of grown in engineering and we keep investing in it. I mean I can't tell you the date, I could see $75 million quarters and $85 million not too far off.

[Mike Walkley:]

All right, thanks. Sorry a last one more question. Just with the inthinc acquisition you talked about the upselling and cross selling opportunities into your base. Do you think inthinc's enough for the vehicle section of your offering? Or do you think with your strong cash and balance sheet that's an area you could bolster for other verticals? Thank you.

[Marc Eisenberg:]

I think you kind of hit it, you've been watching us a long time. When we got into the transportation space, it kind of started with StarTrak and we put LMS in there and Euroscan in there, all of sudden you're a market leader. I think kind of the way we do it, core to our strategy is taking different types of assets and pulling them together and gaining scale. I think that's work for us and it's also way that you can get relatively affordable assets. We love broken and sub scale and turn them into, you couple them together and you build these powerful organization and I don't know our best skill set is picking these as much as it is managing them and gaining scale and putting the pieces together. We're probably better operators than buyers.

[Mike Walkley:]

Okay, thank you.

[Operator:]

And we'll go next to Andrew [indiscernible] with Macquarie.

[Unidentified Analyst:]

So first I guess with given these large deals, you probably had ARPUs that were below your average, but then JLG had this N10 solution that's likely above your average. I was just wondering, can you maybe map out what do you think ARPU is sort of gross for the next few quarters?

[Marc Eisenberg:]

I think ARPUs are fine. I do. I think the mix is ARPU is going to go up, let me start with that and let me tell you why. ARPUs are going to go up because you're going to get a full quarter of inthinc and inthinc's ARPUs are three or four times, where ORBCOMM's ARPUs are. So ARPUs are going to go up. But separating inthinc from it. I think we're in the mid-single digits as you average everything together. So I think it's not going to help or hurt.

[Unidentified Analyst:]

Got it. And then on the production obviously you're building a lot of devices, its having an impact on little on margins, but I was just wondering how much can you actually build on a single quarter realistically, can it be sustainable like the 90,000 mark you're potentially having in 3Q, could you see that going forward?

[Marc Eisenberg:]

Good news, first quarter I have not talked about issues in manufacturing and stuff sitting on the dock and shipped to the wrong place. I think we've got a handle on it and, do you remember last quarter I said that we're building 90,000 and we shipped 69,000. We're building 90,000 and we shipped 69,000 because this is the 90,000 quarter. so we continue to ramp up there. Let me give you a feel for how much we've grown. So if you look at the last eight quarters and I just looked at this week. Our low quarter in terms of manufacturing devices was 33,000. So we had a 33,000 unit quarter. I think it was a first quarter, it was maybe 2015 first quarter. and last quarter we built 90,000 devices so we've tripled our capacity in a year, while moving to a new contract manufacturer. We had some bumps and bruises but overall, if I can kind of - if a year ago, I'd say this is the run rate you'd take, would you take it? Absolutely. With years' worth of notice, we could probably go to a 250,000. I mean, [indiscernible] is huge. [indiscernible] is absolutely huge. And we're not even the biggest customer in that factory, I think Motorola is, or the old Motorola. So I think it's just a fraction. But where we struggle, we're sitting there at 90,000 and then all of sudden you put an order for 140, you get then noticed, but we do that.

[Unidentified Analyst:]

Got it. And last question from me. Are you seeing any increased competition in your verticals at this point or is it been relatively steady?

[Marc Eisenberg:]

There is a lot of verticals, right? But the overall trend is, yes there is smaller guys that enter the market, but at the same time there is a massive amount of consolidation out there, right? You get consolidation from private equity guys that put a couple of assets together. You get some consolidation from some of the big players that are looking for IoT strategies. So I don't know if you guys saw there was a transaction yesterday Sierra Wireless bought Numerex perfect example of what I'm talking about out there. So we're going to get some competitors from industry-to-industry there is no one that's kind of, has the breadth that we do across all the verticals, there is certainly competition and it's here to say. I think we run faster and harder than anyone out there. I look at the competitors, the little guys that are coming in with their six or seven engineers against, it's over 400 engineers and the stuff that we can do and the things that we can accomplish that smaller groups can't, I think it's pretty overwhelming and I think we're situated well. but we're going to have competitors.

[Unidentified Analyst:]

Got it. Thank you.

[Operator:]

We'll go next to Mike Malouf with Craig-Hallum Capital Group.

[Mike Malouf:]

Robert, can we go through that service margins just one more time and where the pressure is coming from and then, when do you think we'll start to see that recovery on the service side, particularly.

[Robert Costantini:]

Right, so you've got the two factors are the upside down nature of the installation cost versus installation revenues. This is never a big part of our quarterly picture. So installation revenues are reported and service and we're just running cost ahead right now, trying to increase the pace and improve the efficiency around that. So that's going to end with these, the end of these large deployments. The other factor impact that is just this new acquisition, so when you look at their margin - what they're layered in margin contributions lower than ours and again it's just purely because of subscale and getting back what we talked about, whether it would be SG&A product development, I need another quarter to really kind of work this, get through the integration pieces and right sized to place, but that's going only improve with scale because you know again like every platform you buy, you got to increase the scale and you got to get back to volume and growth. Those are the two factors. I think after the effort to get through these large scale installations, that thing should snap back similar in concept of what we talked about products, in our margins.

[Mike Malouf:]

Okay, great. And then you're guiding to about 20% adjusted EBITDA margins for the year. so that would imply basically kind of like they're around 18% for the back half of this year and that's versus say 26% where it was last year.

[Robert Costantini:]

Yes, so it's more like 19% to 20% for the back half. Like I said, trying to move aggressively on those SG&A cost and product development and so I run this thing for another quarter. wouldn't really be able to give you much better guidance than that.

[Mike Malouf:]

Got it and then, it looks like CapEx is a little bit higher than we were looking for and then the guidance because I know that previously you had guided to about $10 million.

[Robert Costantini:]

The $12 million.

[Mike Malouf:]

Yes, so that's and that's up this year, just because of some of these implementations or?

[Robert Costantini:]

No, no it has nothing to do with that. I mean it's just the sheer breadth of opportunities in front of us on this in-house innovation that we're doing in, everything from the R5C to that new dual network effort trying to address the all of these opportunities around JLG and that type of stuff, so that's what driving and its helping us win these large deals and we're going to continue to be rolling out product over the next couple of quarters. Can't think of any announcements now, but that's what driving it.

[Marc Eisenberg:]

We said in the script there is 20 new products coming out, within the next year. So each one of them should have its own revenue stream. I don't know Mike it's just, I think we've changed gears a little bit in that. We see a pretty thrilling market opportunity in front of us right now and we've kind of shift a little bit into high revenue gear to get us much market share as we can, get us much service revenue, on get this base of subscribers as up as high as we can, with these really low churn applications before we slow down a little bit.

[Mike Malouf:]

Got it and then one quick follow-up on the two OG2 satellites, can you go over that real quick again? You think you can get them back up and running, is that what you're saying?

[Marc Eisenberg:]

Yes that's the plan you know to get them back up and running. I don't know it's - the service that we're providing even like these satellites is fine. We're performing really well there is not a penny difference in terms of revenues that we're providing, but the goal is to certainly get them back. Our plan for satellites, we kind of went into this launch and as oppose to a backup plan being more satellites, the backup plan became an Inmarsat plan, right? We kind of moved into that and it became the OG3 plan where, OG3 is this mix of the two constellations, we went and put millions, I mean to this CapEx a good part you're talking about is, $10 million in this dual mode RFIC that sees both networks. Saying to yourself, do you want to pay $10 million in a modem or do you want to put another $300 million in spacecraft? Take your pick. So we end up putting the money into modem. So within the next year, you're going to be seeing the Inmarsat spacecraft overhead and then for difficult to reach positions and everything else. You've got the backup of the ORBCOMM stuff, a good portion of the low latency stuff has moved toward the Inmarsat stuff. The ORBCOMM is phenomenal because it's kind of cost reduced for people that don't have immediate latency constraints. The plan is basically on track.

[Mike Malouf:]

Great. Thanks a lot for the help.

[Operator:]

And we'll take our next question from Howard Smith with First Analysis.

[Howard Smith:]

I wanted to follow-up, it's kind of related to the conversation we just had. First of all, on the dual mode. I had an expected kind of shipments in the next couple of quarters. I thought it was still a little further out. Is that accelerated at anyway? And should we still think about in terms of material impact to the business more of 2019 than an 2018 phenomenon.

[Marc Eisenberg:]

Sure. When I read it our script, it kind of jumps into a dual mode RFIC and then we start talking about an RFIC. So our fault, we confused you. There's two separate products, so one of them is in Inmarsat based IDP RFIC that we co-built with Inmarsat. They're using it for BGAN, we're using it for IDP, but it's the same front end. RF portion on both and it takes 600 components outs and you take out, I don't know $60 or $70 in products and replace it with a $5 chip and which is cool as can be. That project started years ago and we started shipping in Q4 of last year to one customer, we added our second largest customer and by Q3, we're going to start pushing all customers toward that and we're going to end production of the product that uses the 600 discrete parts. That is one thing. So we go to the same manufacturer, of the chip in Ireland and we say okay. Can you ORBCOMM to this chip to become the dual mode RFIC? And we do a study to show that we can do it, we start spinning silicon, we get a pretty good spin in the last quarter and now we expect to start shipping those in prototypes really small quantities, this year. So we're going to start shipping that this year and it's really hard to plan that. Are you going to one spin? Or you're going to do two spins? You're going to do three spins. So really tough to time it, but I think we're going to start shipping pretty soon.

[Howard Smith:]

Well that's helpful. And then on the OG2 satellites. Can you just remind us, your intent is to recover these and have them working? But if you can't, where are we in terms of insurance and would this be kind of recoverable event, should you not be able to work it out.

[Marc Eisenberg:]

It's not an insurance event, it's not an insurance event. We're covered for one-year in orbit and then the launch and when we went to extend it just recently the deductible was large and we wouldn't have gotten, let's say if we were to unfortunate and not recover the two satellites, plus the T31, but if we weren't recovered, we wouldn't have gotten a dime anyway. So it just wasn't an insurance event. I think there will be a couple of satellites over the next couple of years like a kind of dumb down OG2 like an OG3, a few satellites which will supplement the constellation which will be in a polar orbit because it supplements Inmarsat, you know and those satellites. So we're kind of looking at that, but not an insurance event.

[Howard Smith:]

Okay, thank you. That's it from me.

[Operator:]

And we'll go to Mike Walkley again with Canaccord Genuity.

[Mike Walkley:]

Robert, just a quick housekeeping question to follow-up from me. Just on the OpEx again, with the full quarter of inthinc, you still think it's just slightly up sequentially and so that imply your product gross margins closer to 10% for this quarter to get to that 19%. Or should OpEx be little higher and those numbers you gave me, that where you targeted to come down do overtime as you do some cost cutting with the inthinc team? Thank you.

[Robert Costantini:]

Yes, no those were the ones that I was, I'm hoping to achieve. I mean if you want just kind of layer it in be more conservative about it. You're probably looking at 14.5% for SG&A and north of $2 million for product development, let's call it $2.3 million. But you know that hasn't been the MO at ORBCOMM's ever, for acquisitions. I was giving you what I thought would be a really good number. I think that's what you're asking, if that's question. I think if you want to just kind of roll it up let's say run rate basis, you're probably 14.5% and two in change for product development. I'll have to go back and piggyback [ph] your second part of the question in terms of the margin, but you know I think when you run service margins to a level where they are, into the product margin guidance that we provided in the high-teens for product margin and then you put in those cost like I just described, without any synergies. You'll probably get your about 20% margin, I mean that's what our model is showing. I could get back to you offline and see, what you have there. But that's how it rolls it for us.

[Mike Walkley:]

Okay, that's helpful. Thank you.

[Operator:]

And we'll go next to Steve Anderson with Venture Capital Management.

[Steve Anderson:]

I just have two quick ones. So the lag between installs and that upside down installation cost versus revenue. If you installed, you said over 15,000 for J.B. Hunt and 2018 [ph] you're supposed to service this last quarter, how many of those will be turned on by this point?

[Marc Eisenberg:]

From the ones last quarter, probably all of them.

[Steve Anderson:]

It's less than the quarter lag.

[Marc Eisenberg:]

For those two accounts, yes.

[Steve Anderson:]

Okay. And then the second one, obviously you're going to see large scale deployments in the future also more and more of them. How do you get better at this? Is this just a fact of life and business or do we see the same - and you see the same margin impact every time or is more of now a bigger base business, you don't this as much.

[Marc Eisenberg:]

First of all, yes this is biggest deal now that we did, the biggest deal anyone has ever done, so I guess we're kind of learning. But it is not unlike us to get a new product in a new market to over invest a little in the first customer and then you kind of get it back through the scale in the second, third, fourth and fifth customer. And specific to J.B. Hunt, this particular product it uses components from other products but it's basically a new product. We've never done it before, all of that investment and everything is kind of in that product and in those margins.

[Robert Costantini:]

And you're supporting an organization that's larger to do that, so that cost will then or that infrastructure will then be available to handle the next large volume. We lead large volumes or something that we do well and with moving into an unprecedented level of being able of capability to do it. So the infrastructure built around that and it's a matter of efficiency. I mean you just got to learn to be more efficient about it and we're learning what it means to do 90,000.

[Marc Eisenberg:]

Go ahead.

[Steve Anderson:]

Sorry, you were just saying that you guys are dedicating more of your resources to the installation side, which I can't get a bit of surprise to you. Is that consistent with what you expect to happen in the future or is it more just pricing it better.

[Marc Eisenberg:]

The answer is no, we don't expect it to happen. J. B. Hunt is a huge customer for us not just on the container side but across almost everything they do. And these guys had a business plan that required them to build as many of these as they possibly can while these things are kind of sitting there, ready for the big fourth quarter push and we kind of jumped in, the way we bid it, we had to put our resources there to help this customer get it across the line, they're our reference customer for any of you that have called them, you know I'm sure they had 99.5% great things to say about us. They're a phenomenal reference customer. It's a new product that we've never shipped and we invest in this project.

[Steve Anderson:]

Okay, great. Thanks a lot.

[Operator:]

We'll go next to Mike Latimore with Northland Capital.

[Unidentified Analyst:]

This is Rishi for Mike Latimore. I've a question on guidance. Can you please confirm the full year guidance including inthinc?

[Marc Eisenberg:]

240 to 245.

[Unidentified Analyst:]

Great. And the second one.

[Marc Eisenberg:]

I'm sorry, inthinc is just - the inthinc guidance is 10. So if you want to do without inthinc, 230, 235 which is right at the very top end where the company guided to, but we didn't want to stick inthinc and kind of make it look like it's organic growth or that we were planning on that, as part of the guidance. The organic guidance is very high end and inthinc's about 10 more.

[Unidentified Analyst:]

Sorry, I might have missed the gross margin guidance for the services segment in the third quarter. is it like around? Can you repeat that again?

[Robert Costantini:]

Yes, so all in gross margin will be around 50%, but I'm suggesting that people use the margin for Q2 for service. But bring product margin down to the high teens. So when you bind that all in.

[Unidentified Analyst:]

Okay. Thanks. And just one more question, what is the status of the large pilot with CIMC that you announced on the last couple of quarters?

[Marc Eisenberg:]

CIMC still moving along, they're piloting with large customers. We're hoping they're going to get some stuff closed. They started forming the global smart container alliance with some of their partners. They're moving from a marketing and from a pilot perspective. I can't say that we're fielding tens of thousands of deployments yet, but we're as anxious as you are.

[Unidentified Analyst:]

Okay, that's all from me. Thanks.

[Operator:]

[Operator Instructions] and we'll go next to Scott Searle with Benchmark.

[Scott Searle:]

Just couple of quick follow ups on inthinc. I want to make sure I've got some of correct numbers from a subscriber standpoint. We're coming in at 35,000 you're looking at adding 4,000 in the third quarter another 9,000 or 10,000 in the fourth quarter, is that correct?

[Robert Costantini:]

4-9 because we guided to 13.

[Scott Searle:]

Okay, very good. And then just Marc, I think you hit on this a little bit. But looking at the installed base, how much of that do you think is addressable in terms of the inthinc product that you can go back to now and try and resell, upsell the inthinc solution. So basically kind of the opportunity if you [indiscernible] in 2018 and beyond for conversion?

[Marc Eisenberg:]

We think inthinc is an asset that on the high end could add as much as 50,000 a year and with low end, 15,000 or 20,000.

[Scott Searle:]

Got you. And just last item, looking at your guidance in that 240, 245 implies also another strong quarter in December. I just want to make sure I'm calibrated properly looking at overall net ads somewhere in the 60 to 70,000 above the third quarter and the fourth quarter.

[Marc Eisenberg:]

Well we'll see where churn comes in, but from a growth perspective we're adding, we're adding like 100,000 a quarter.

[Scott Searle:]

Okay and just lastly, on the RFIC. What is the total BOM impact on that?

[Marc Eisenberg:]

We're reducing $60. What's my cost? I can't tell you that. [Indiscernible].

[Scott Searle:]

Got you. Okay, thanks so much guys.

[Operator:]

And there are no other questions in the queue. At this time, I would like to turn the conference back to the speakers for any additional or closing remarks.

[Marc Eisenberg:]

Thank you for your questions and participating in our call. We look forward to speaking to you again when we report our Q3, 2017 results in November.

[Operator:]

This does conclude today's conference. We thank you for your participation. You may now disconnect.