Sierra Wireless, Inc.
Q2 2018 Earnings Call Transcript

Published: 3 Aug 2018

[Operator:]

Good afternoon. My name is Susan, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Sierra Wireless, Second Quarter 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 session. [Operator Instructions] Thank you. Mr. David Climie, Vice President of Investor Relations, you may begin your conference.

[David Climie:]

Thanks Susan and good afternoon everybody. Thank you for joining today's conference call and webcast. On the call today is Kent Thexton, our Interim CEO; Dave McLennan, our Chief Financial Officer; Marc Overton, Senior Vice President of IoT Services; and Jason Krause, Senior Vice President of Enterprise Solutions. As a reminder, today's presentation is being webcast and will be available on our website following the call. Today's agenda will be as follows

[Dave McLennan:]

Great! Thank you David and good afternoon everyone. I’d like to note that we report our financial results on a U.S. GAAP basis. However, we also present non-GAAP results in order to provide a better understanding of the operating performance of our business. As a reminder, a full reconciliation between our GAAP and non-GAAP results is available on our website. Moving on to our second quarter results, we had a very strong quarter. Overall, consolidated revenue in the second quarter was $201.9 million, an increase of 16.4% compared to the same period last year. All three business units performed well and contributed to this year-over-year growth. Product revenue, which includes all revenues associated with the sale of embedded modules, gateways, routers and other hardware devices was $178.8 million in Q2, up 9.4% on a year-over-year basis. This reflects good operational execution in a tight component supply environment. I’ll also note that the supplier component reliability issue which we flagged when we provided Q2 guidance had a negligible impact on our Q2 results, which was good news. Service and other revenue which includes revenue associated with our cloud and cellular connectivity services, as well as engineering, support and warranty services doubled in Q2 from a year ago, driven by both organic growth and the acquisition of Numerex. Services and other revenue now represent 11.4% of our total revenue. Adjusted EBITDA at $15.6 million grew 5% compared to a year ago. Our performance relative to guidance really demonstrates just how strong our Q2 results were. Revenue was at the high end of the guidance range and at $0.27 per share, non-GAAP EPS was above the high end of our guidance range. Also worthy of note in Q2, non-GAAP gross margin was 34.4%, up a full percentage point from Q1.All three business units showed a sequential improvement in non-GAAP gross margin. OEM solutions gross margin was 30.4% in Q2, Enterprise Solutions gross margin was 50% and IoT services was 41.1%. This sequential improvement across all three business units reflects the absence of expedite costs associated with component shortages in OEM, the absence of network upgrade costs, which IoT services incurred in Q1 and favorable product mix in Enterprise Solutions. In addition, OEM solutions gross margin benefitted by $1.2 million from favorable settlements associated with two claims. This added 60 basis points to consolidated gross margin percentage in the quarter. Normalizing for these claims, the non-GAAP gross margin in Q2 would have been 33.8% and EPS would have been $0.24. Non-GAAP operating expenses in Q2 were up slightly from Q1. During Q2 we engaged in a third party consultant to assist us in driving greater efficiencies in the business and as a result we expensed approximately $1.5 million in G&A in the quarter on this program. No such expenditures were incurred in Q1. And finally the non-GAAP effective tax rate was very low in Q2 at 7.4%, which was lower than our expectations reflecting the jurisdictional mix of our income across our various legal entities. Looking at key non-GAAP metrics in the second quarter of 2018 compared to Q2, 2017, on a year-over-year basis consolidated revenue increased by 16.4% with 25% of the quarterly revenue coming from our high growth, higher margin enterprise and IoT services business. In Q2 OEM solutions revenue increased by 4.5% year-over-year, reflecting increased demand in automotive, enterprise networking and industrial. Design activity was strong in Q2. OEM solutions had a record number of design wins across a broad range of IoT segments and geographic markets. Enterprise Solutions revenue in Q2 was up 31.1% year-over-year. Enterprise growth was driven by strong revenue from AirLink Networking Solutions in the industrial and mobile markets. Customer wins in the second quarter were solid, including wins in energy, transportation and public safety. Specifically in public safety we secured our initial FirstNet ready design win for routers with a customer in California. IoT services revenue in Q2 was up 210% year-over-year. The Numerex business has stabilized and we are pleased with the progress we are making on the integration of platforms, operations and the sales teams. Excluding Numerex, IoT services continue to experience solid customer activity with new wins in industrial, energy and transportation. Looking at adjusted EBITDA and non-GAAP EPS on a consolidated basis, in Q2 adjusted EBITDA was $15.6 million, which was up 5% compared to $14.9 million a year ago and non-GAAP EPS was $0.27 or $0.24 after normalizing for the settlements that I referred to earlier, compared to $0.30 a year ago and reflects the dilutive effect of the Numerex acquisition. Please note that our second quarter 2018 financial results reflect the adoption of the new revenue recognition standard ASC 606. The competitive period in 2017 has been adjusted to align with the new standard and I refer you to notes in our financial statements for details of these adjustments. Moving on to the balance sheet, we ended Q2 with $73.4 million of cash and the company is debt-free. During the quarter we generated $11.3 million of cash from operations and after CapEx of $5.6 million, free cash flow in Q2 was $5.7 million. Our capital expenditures in Q2 were primarily related to factory test equipment, R&D development tools, network equipment and some capitalized software development. Overall, our cash position increased in the second quarter by $2.8 million compared to Q1. Moving on to guidance for the third quarter of 2018, we expect Q3 revenue to be in the range of $198 million to $207 million. Non-GAAP gross margin in Q3 is expected to be slightly down compared to the normalize Q2 gross margin of 33.8%. We expected non-GAAP OpEx to be lower sequentially from Q2 and I’ll note that our Q3 guidance includes third party consulting fees related to our efficiency program and it amounts slightly below the $1.5 million we incurred in Q2. Q3 non-GAAP tax rate is expected to be similar to the Q2 rate of 7.4% and we expect our Q3 non-GAAP earnings per share to be in the range of $0.22 to $0.30. With that, I’ll turn it over to Kent Thexton, Chairman and Interim CEO for his comments on corporate and strategic matters. Kent.

[Kent Thexton:]

Thanks Dave for the financial update. It’s a pleasure to speak with you all this afternoon after spending the past two months as Interim CEO. Our financial results in the second quarter were strong, and I was pleased that both revenue and adjusted EBITDA improved year-every-year and our higher margin businesses, namely Enterprise Solutions and IoT services grew nicely in Q2 and together represent 25% of our total quarterly revenue. During the quarter we continue to build a strong pipeline of new design wins and customer acquisition activity across all three of our business segments as we grow our IoT leadership position and device to cloud. In addition, our senior management team remains focused on our efficiency and effectiveness initiatives, which include synergies related to our acquisition of Numerex. In the second quarter, as Dave mentioned we engaged a third party consultant to help us accelerate our services business and achieve greater efficiencies across the company, so we can both enhance our bottom line and invest in key strategic initiatives. As you saw in our press release after markets closed today, we announce that we have received approval from the Toronto Stock Exchange for normal Course Issuer Bid, allowing us to repurchase up to 10% of our public float for approximately 3.6 million shares over the next 12 months, with the program starting on August 8. The board believes that Sierra’s current stock price is undervalued and it is in the best interests of our stockholders to use a portion of the company's cash to repurchase our shares in the open market for cancellation. Regarding the company search for a new CEO, the search committee of the board engaged an International Executive Recruiting Firm in Q2 and has been very active with potential candidates. I'm personally very involved in the process and have met the shortlisted candidates, and I’m pleased to say we have some very talented and qualified individuals who are enthused about the opportunity to Sierra Wireless. Although the board has not set a specific timeline on the search conclusion, I would say we are pleased with the progress to-date and our intent is to have an individual in the CEO position by early Q4 if not before. We need to ensure we select the best candidate with the right skill set and experience to lead the company in its transformation from Sierra 2.0 to Sierra 3.0. So you can see the board is taking clear and decisive action to drive shareholder value with our program on efficiencies, our repurchase of shares and the selection of a new CEO to help us drive our services vision. So let me take a minute to share our vision for Sierra 3.0 with you. The board believes Sierra’s built a very strong position in the global IoT marketplace on the hardware side of the business, including cellular embedded modules, where we are ranked number one globally based on share revenue, and in the cellular gateway business, where we are also ranked number one based on unit volumes shipped. Based on this leadership position and hardware, we are engaged early in the design process with customers who want to bring their machine, their device, their appliance online. With this early customer engagement, we are best positioned to deliver the complete solution of the module, connectivity and secure transport of their data to the cloud. We believe that delivering both the device and connectivity gives us a strong market differentiation. So we look to leverage this unique pure play position in the IoT ecosystem to accelerate the growth of our recurring subscription based IoT services business. In doing so we are working to provide our customers with fully integrated device-to-cloud solutions that allow them to get to market quickly, simply and securely, while reducing the complexity of launching their IoT deployments. In the process we strengthened our ongoing relationship with the customers as we provide them with a scalable solution that enables them to transform their business. We are seeing good account wins today with modular customers taking the full device to cloud stack from us, and Marc will share more of that with you. With our Sierra 3.0 vision, we see the advent of LPWA bringing low cost modules, lower bandwidth requirements and vast IoT adoption. As this market develops and expands, there will be many new customers wanting to get their devices, their machines and their appliances online, and with their lower data requirements we are uniquely positioned to provide a sustainably differentiated device to cloud solution to the market. The initial execution of the strategy business started back in 2015 when we acquired two MVNO’s in Europe and we added to that last year with the acquisition of U.S. based Numerex in December. We have put together the key building blocks of a world class Telco grade IoT platform that utilizes our own Sierra Smart SIM and our own cloud platform. We now have an IoT services business which is currently running at an annualized rate of approximately $90 million and are working together with our carrier partners, channel partners and global customer base. We plan to grow and expand that business organically going forward. Today we are seeing a number of our existing hardware customers adding Sierra IoT Connectivity Solutions from Sierra SIM Cards into their module or gateway, and we are starting to deliver fully integrated end-to-end solutions with their modules having Sierra Wireless Connectivity embedded in the factory. This gives us a low customer acquisition costs, because we're already working with our customers’ IoT design cycle process with our embedded module gateway, and we are adding solution selling capability to help us deliver the added layers of connectivity and cloud services to our customers. So as we fully integrate the Numerex platform into our IoT service business and continue to make the right investments in that business this year, we believe we’ll be extremely well positioned in the marketplace to scale our global IoT services business, which we expect will result in higher levels of recurring revenue, improved profitability and shareholder value creation. So with that I would like to introduce Marc Overton, our Senior Vice President of IoT services. Marc was recruited to Sierra Wireless just over a year ago in July 2017 from Cisco. Passionate about how connected technology is changing the way businesses operate, Marc's been responsible for IoT initiatives across global operators, enterprises and cloud providers. Marc spent 10 years at Orange in the U.K. where he built their Mobile Virtual Network Operator and IoT businesses. He then gained experience at First Data as Senior Vice President and General Manager for Europe where he deployed cloud based connected IoT solutions for the payments market. He then joined Jasper Wireless to oversee strategy and business development and was part of the leadership team that was acquired by Cisco. At Cisco, Jasper, he was responsible for global innovation and sales for Cisco's IoT business. We recruited Marc as part of our company's vision for being the global leader in device to cloud. So let me hand over the call to Marc to share some of his insights.

[Marc Overton:]

Thanks Kent. I'd like to spend just a few minutes talking about IoT services and some of the exciting developments that are happening in our business unit. What attracted me to Sierra was the company's strategic goal of becoming a global IoT services leader. I firmly believe Sierra is uniquely positioned to win a significant share of the global IoT services marketplace. With more than 250 employees in IoT services and a current revenue run rate of approximately $90 million annually, we are already a sizeable IoT services business, and now have the scale and assets needed to properly compete for global IoT connectivity deals. Following the acquisition of Numerex last December, we now have our own MVNO assets in the two largest IoT markets, namely Europe and the United States. That enables us to offer our customers truly global IoT Connectivity Solutions. With our own HLRs and our own Sierra Smart SIM, we provide our customers with flexibility on which network they use so they optimize quality of service and pricing. We also have our own cloud platform, which has significant capability and is tightly integrated with our hardware and services to enable secure and reliable device management, subscription management and firmware over the updates. This, combined with our 24/7 global connectivity support makes a compelling global IoT connectivity proposition. The acquisition of Numerex also bolstered our IoT position in the U.S. expanding our direct and indirect sales capacity in this strategic market. Through hard work in the first half of 2018, we have now stabilized the Numerex IoT business, and have made good progress in integrating the team and its operations. We still have work to do and our key integration program is to complete, but we're off to a good start. Given this platform, the IoT services business unit is now focusing on how we're going to accelerate or IoT services going forward. We plan to do that in four different ways

[Kent Thexton:]

Thank you, Marc. It is now my pleasure to introduce Jason Krause. Jason has been with the company for more than 11 years and part of the Senior Executive Team since 2011, leading the corporate development strategy, marketing and IR functions at Sierra Wireless before taking on the role of Senior Vice President and General Manager for our enterprise solutions business unit three years ago. Prior to Sierra Wireless Jason gained international experience in management consulting with Boston Consulting Group and the semiconductor industry at Altera Corporation, which is now part of Intel. We promoted Jason into the enterprise solutions leadership role to grow Sierra’s position in LTE networking solutions, routers and gateways, a high value growth segment that we have been active in for many years. With 33% year-over-year growth in the first half of 2018, we are showing clear market leadership in this area, exemplified by the fact that more than 50% of the top 100 police forces in the U.S. rely on Sierra’s router solutions. Jason has been doing a fabulous job growing this business segment, so let me hand the call over to him to explain more.

[Jason Krause:]

Thanks Kent. As Kent mentioned, the enterprise solutions business unit experienced strong growth in the first half of this year, as the investments we’ve made over the last three years in both our product portfolio and our expanded go-to-market reach, combined with accelerating industry growth have created a tremendous opportunity for Sierra Wireless. In enterprise solutions we are focused on providing secure, managed, LTE and soon to be 5G networking solutions for mission critical applications. We go-to-market under the Sierra Wireless AirLink brand, offering ruggedized router and gateway products and software solutions for both fixed industrial networking, as well as mobile in-vehicle networking applications. We focus on key vertical markets that require highly reliable, always-on cellular connectivity, combined with advanced enterprise networking. Examples of these verticals include utilities, electric, natural gas and water, the oil and gas vertical, including applications in both the upstream and midstream segments; the public safety verticals covering police, fire and ambulance fleets, as well as other applications such as security cameras and surveillance systems. The industrial equipment vertical that is increasing leveraging cellular connectivity for remote access and monitoring and finally, the enterprise vertical which includes the less rugged applications such as digital signage, kiosks and point of sale systems. The market for AirLink type networking solutions, also known as IoT routers and gateways is expanding rapidly, with the international research firm IHS estimating market revenue will reach $1.6 billion annually by 2021, with important short and long term trends driving this growth. For example, advances in cellular technology are driving the overall market, including the migration from 3G to 4G LTE, adoption of LTE Cat-M1 for Low Power Wide Area applications and of course adoption of 5G in 2020 and beyond. The public safety market is also undergoing significant change. With the launch of dedicated public safety networks such as FirstNet in the U.S. and ESN in the U.K., as well as rapid adoption of body-worn cameras and other connective technologies for first responders. Oil and gas spending is improving, particularly in North America, and the adoption of industrial IoT applications is accelerating across many different verticals as enterprises and OEM customers work to gather and process data at the edge of the network and then integrate it seamlessly with enterprise systems and business processes to enable new product offerings and services. Not only is the market large and growing, Sierra Wireless is well positioned to take advantage of the opportunity and we are investing to maintain and grow our position in enterprise solutions. Over the past three years we successfully refreshed our AirLink product portfolio and added important vehicle telemetry and telematics capabilities with the acquisition of GenX mobile in 2016. We've also enhanced our software and services offering, increasing value for our customers and adding new opportunities to attach recurring revenue to each router we sell. For example, the number of devices under management with our ALMS cloud platform has grown 35% in the last 12 months. And most importantly, we've been investing in a new go-to-market strategy, revamping our channel structure and programs and expanding the sales team, particularly in North America to enable more solution selling, provide higher levels of customer engagement and increase focus on growth. To illustrate the success that we're having in the market, I’d like to refer to two customer examples from the enterprise solutions business. The first example in industrial IoT is a leading manufacturer of industrial air conditioners, a long time device customer of Sierra Wireless, developing a next generation remote monitoring service and maintenance application to be launched globally. The customer did a broad survey of different kinds of IoT products available from leading vendors, and in the end selected Sierra Wireless for its device-to-cloud solution. Only Sierra could offer the three critical components they needed

[Dave McLennan:]

Thanks Jason. That concludes our prepared remarks for the second quarter. Suzanne, could you please open the line for Q&A.

[Operator:]

I’d be glad to. [Operator Instructions] Your first question comes from the line of Mike Walkley of Canaccord Genuity. Your line is open.

[Mike Walkley:]

Oh great! Thank you and thanks for all the details on the two business units. Maybe Jason, just since you descended, enterprise solutions have been strong; you've got some of these FirstNet wins. Can you talk maybe about the growth rate you're seeing in your business and this were just at the early stages of these higher levels of growth given all the opportunities you highlighted on the call.

[Jason Krause:]

Sure. You know as you mentioned in the prepared comments, we are excited about the market growth we're seeing and the drivers we mentioned; 3G to 4G conversion, 5G is coming FirstNet, all the industrial IoT applications, and as we said, you know we're very happy with our position. We feel well positioned to capture that growth. And by the way, that growth is not just in routers and gateways Mike. It’s also in all the software and service offerings around those gateways that drive recurring revenue. So I do – one thing I'll say before I end on the growth, we did mention some year-over-year growth numbers in the first half of 33%. What I will say is that yes, you did have a very strong second half in 2017, particularly around growth and hours of service and ELB type of applications related to fleets, maybe I’ll leave it at that.

[Mike Walkley:]

Okay great, and just building on that, as you do more software services, you know how do you see kind of gross margin trends in your business? I mean 50% was stronger than I expected this quarter. Can it go higher from here?

[Dave McLennan:]

Hi Mike, it's Dave. You know I think we're – you know the business really benefited from a couple of things in the quarter. One is mix, right, the AirLink product line is higher gross margin than the fleet business and the other thing is the services gross margin is higher as well. So as JK mentioned, as we blend that up and tax rates increase, I think yeah, those are nice drivers of improving gross margin in that business unit.

[Mike Walkley:]

Okay, that’s helpful. Last question for me since long script and I’ll pass on the line. Just on this consultant and the higher operating expenses in the short term, can you talk maybe about puts and takes, the operating expenses longer term. You just clearly want to grow your device to cloud strategies, so you need to invest maybe in the Numerex platform. So how should we think about just modeling OpEx, you know especially when these consultant costs come out. Thanks Dave.

[Dave McLennan:]

Yeah, it's Dave again Mike. You know we announced some initiatives earlier in the year and we're progressing well with implementing those and reducing costs, and you know since then as Kent mentioned we’re going further and you know we are getting some help with a third party consultant, you know to help us look at our business, look at metrics, operating metrics and you know design programs to not only reduce costs, but also to allow us to invest in new initiative to drive the services and device to cloud offering. So you know we’re working through that right now Mike. We are incurring some third party cost to help us with that and you know next step is to determine the time table and the scope of some of those initiatives.

[Mike Walkley:]

Okay, great, thanks for taking my questions. I look forward to seeing you next week at our conference.

[Dave McLennan:]

Yeah, great, we’ll see you next week.

[Operator:]

Your next question comes from the line of Thanos Moschopoulos from BMO, your line is opened.

[Unidentified Analyst:]

Hey, it’s Bill stepping in for Thanos. Thanks for taking my questions. So just a quick one on supplier component reliability issue; is that fully resolved now or is there a chance something will come in later on or is it all behind?

[Dave McLennan:]

Yes, that particular issue which is the one we flagged three months ago has been resolved and it you know fortunately had a very negligible, almost zero impact on the quarter.

[Unidentified Analyst:]

Great! In terms of component shortages mentioned in the last quarter and I think mentioned in your script earlier too; has that alleviated at all or do you see that continuing into the next quarter as well.

[Dave McLennan:]

I would characterize it Bill as you know supply is still tight. So it's certainly not – we're not experiencing the shortages that we did in the first quarter for instance, but you know things like memory NAND are still tight and you know we're managing that supply and demand very carefully.

[Unidentified Analyst:]

Got you. Okay, and then one quick one to close here. For Numerex I believe you mentioned their 2G subscriber base was a watch item in the last call. Is there anything to note there in terms of migration program in place or how is that coming along?

[Dave McLennan:]

Sorry Bill, you mention subscriber…

[Unidentified Analyst:]

Yeah, 2G subscriber base and kind of migrating them, having a technology migration for Numerex. Is that something that’s flagged from last quarter?

[Dave McLennan:]

Got it. Yeah, no question. Part of the Numerex subscriber base is 2G and that's not a surprise, but I think we’re well positioned with our device expertise, our SIM technology and also our network expertise to successfully drive a migration there.

[Unidentified Analyst:]

Okay, perfect. I’ll past the line, thank you.

[Operator:]

And your next question comes from the line of Scott Searle of Roth Capital. Your line is open.

[Scott Searle:]

Good afternoon and thanks for taking my question. I appreciate all the detail that’s provided on enterprise and cloud. Maybe to follow up on Mike's question for JP, I just want to get some clarity. Tremendous strength in the second half of last year, a lot of that EOD driven. You’ve got some new programs ramping up with FirstNet, but it's still early days. So I’m wonder if you could give us some idea. Do you expect enterprise to grow in the second half of this year or is it just tough comps and it'll take a little bit of time to really populate, get some more traction within FirstNet and get some of these other programs ramped up to be back on a high growth curve again.

[Jason Krause:]

Sure. Hey Scott, its Jason here. Well certainly we don’t comment on growth rates by business unit, so I’ll start there. You are right though about FirstNet. Overall it's just the start, right, and it is one growth driver, but it is just the start. You know we’re a leader in public safety networking in the United States, we’re the first batch certified products in the market and we're pretty confident that we're going to capture our fair share and more of that growth opportunity. With that said, it's early. You know AT&T is still completing its network build-out and that will take some time. Public agencies, private safety agents have to choose to use FirstNet. Many of them don't use AT&T today and also we have to go through a networking equipment refresh cycle. So that is a fairly long term secular growth curve.

[Scott Searle:]

Okay great, thank you, and maybe a question for Marc. You know getting very aggressive on the embedded front and when you think about the sizeable opportunity that you have in terms of modules and gateways that go out the door from Sierra every year, I’m wondering if you could give us some idea of what success looks like. You know two to three years out, are you hoping for a 10% attach rate or 30% attach rate. You know it's all set up into significant dollars over time, even for lower end connectivity. I’d love to just kind of get some thoughts on how you're thinking about that longer term and also just want to get some more color on some of the cost migration here. Are your costs going to be going up dramatically in the second half of this year than to support some of these initiatives or is that already baked into how we’re thinking about the cloud model?

[Dave McLennan:]

Hey Scott, it’s Dave. Let me take those questions please. So you know with respect to our Ready-to-Connect, look we've got to walk before we run here. We’re very, very excited about you know what it means and you know kind of the sustainable differentiation it gives us, but I think we've got to walk before we run here. We've got some rollout plans that we’ll see early product later this year and then into next year. So you know stay tuned, but it is an area of you know, I think good quality growth for us. With respect to costs, you know I think I would expect our OpEx to sequentially go down a little bit in Q3 from Q2. You know I think we are managing costs and that also includes investing in network technology for instance. So I think we've got a handle on our cost structure there.

[Scott Searle:]

Thank you. Very helpful.

[Kent Thexton:]

Scott, its Kent Thexton. I’ll just add that I think as you asked what attach rates look like, I mean you're thinking about the question in the right frame of mind. We are a leader in terms of the IoT modules and gateways market today and so we're looking to expand our value chain. That is going to take a period of time and I think LPWA is going to be an important aspect of that, which is going to increase both modules and the customer type of LPWA being often lower ARPU has us well positioned. So we're building for a strategic future, but we're not going to comment on the timeframe of those attach rate forecasts at this point.

[Marc Overton:]

Can I just add one last point. In terms of an MVNO, you’re only as good as the channel to market. You have in terms of a global IoT channel than having access to 17 million devices. Invariably it’s an early stage of their design process. It’s a unique opportunity to sell connectivity and cloud services.

[Scott Searle:]

Okay, thanks so much. One last question if I could for Dave. Thinking about the second of this year in OEM solutions and the auto design wins starting to ramp up, how are you thinking about gross margins in that unit on a blended basis. You had success this quarter granted even adjusted for the one-time benefit, but how are you thinking in terms of visibility? How aggressively that ramps up is an on track and kind of the gross margin impact, how you manage it? Thank you.

[Dave McLennan:]

Yes Scott, thanks. So you know we’ll see our automotive business ramp in the second half or increase in the second half I should say and that definitely does have a blending down effect on our OEM solutions gross margin. Now going the other way we're just not Sierra Automotive. We've got a lot of other businesses going on around that in OEM at higher gross margin, and of course we've got 25% of our revenue and growing more rapidly in higher margin businesses, meaning the enterprise business and the services business. So I think those factors certainly are good tools to allow us to see stabilized gross margins.

[Scott Searle:]

Great, thank you.

[Operator:]

And your next question comes from the line of Todd Coupland of CIBC. Your line is open.

[Todd Coupland:]

Great! Good evening everyone. A couple of questions; first on the tax rate. So 7% in Q3, is that the new normal or should we be raising it in the model past Q3?

[Dave McLennan:]

Todd hi, it’s Dave. You know I think you know 7.5% for both Q3 and Q4 is probably a reasonable assumption for your model. I would expect that to increase though in 2019 and we're modeling mid-teens in our modeling for 2019.

[Todd Coupland:]

That’s helpful. I wanted to ask a question on the recurring business $90 million of IoT services. What is the organic growth rate and churn in that business?

[Dave McLennan:]

You know we grew substantially year-over-year, partially because of Numerex, but also we saw good subscriber growth in our connectivity business outside of Numerex. Todd, we are not going to break out by specific business lines what organic growth rate was in Numerex, but be assured the non-Numerex business is growing nicely as well.

[Todd Coupland:]

Okay. I mean just as feedback for what it’s worth, I think the investment community probably is willing to apply some of the parts value given it’s a significant portion of your business now with the right kind of metrics. So something to think about as you’re looking at that business going forward.

[Dave McLennan:]

That said. It’s a key part of our strategy to grow our business mix overtime, right, and I think we've made tremendous progress with 25% of our revenue today coming from higher gross margin businesses and we are certainly not finished with that.

[Todd Coupland:]

No, I appreciate that. My last question is, so I get 5G is a little ways out in terms of how it impacts your business specifically, and we’ll start to see some cities turned up Ex later this year, early next year in the US. When will you be out trialing first 5G devices? What's the plan for that?

[Dave McLennan:]

Yeah, I think you'll hear a lot of activity in 5G, but to hear from the carriers is very topical. I think from a meaningful commercial perspective, from a device perspective Todd, that's really late 2019 going into 2020 and that's LTE, 5G LTE and then of course New Radio would follow that. But firstly, 5G LTE late next year from a kind of commercial volume launch perspective.

[Todd Coupland:]

That’s great. I appreciate the color.

[Dave McLennan:]

Thank you.

[Operator:]

And your next question comes from the line of David Gearhart of First Analysis. Your line is open.

[David Gearhart:]

Hi, good afternoon and thank you for taking my questions. You know you spend a good amount of time talking about the IoT services business in the context of connectivity and attach rates to embedded modules. But you know haven't really addressed the end-to-end solutions from the application layer. With Numerex you acquired you know tank monitoring solutions of vendor and security. Just wondering what your thoughts are going after vertical markets with full applications. Are you pulling back on that strategy and how are you thinking about it going forward?

[Dave McLennan:]

Hi David, its David McLennan here. Look, our job number one with Numerex was to be stabilize the business and I think as Marc said, a lot of hard work has happened in the first half of this year and we have successfully stabilized the business. You know going forward we need to think about the vertical businesses that came along with the network operations and I think we have some optionality there. But you know it hasn’t been a focal point to-date as we work to stabilize the network operations.

[Marc Overton:]

Can I just add a point to that. We absolutely are investing in some of the key verticals. One of the areas that Numerex hadn’t – you already sort of got the investment, so for example, its new devices. So we’ve actually in the last couple of months launched two new LTE devices. They didn’t have any LTE devices before in the up-link, the security proposition and we’ll be launching two more in the second half of 2018. So we got the right LTE products in each of the major vertical applications, that has to be the key focus and as a device organization we are hoping to make that much more efficient and effective.

[David Gearhart:]

Would it be out on the table in terms of when you talk about optionality of selling pieces of those businesses, if it doesn't fit your device-to-cloud strategy going forward?

[Dave McLennan:]

Yeah, I think we need to do some work there David and that hasn’t been the priority as we integrate Numerex up until this point.

[David Gearhart:]

And then you know Jason had mentioned strong attach rates on the enterprise side, enterprise gateway sites for the cloud management software. You know, just wondering how material is that at this point? Is it still a small piece of revenue and at what point will it drive meaningful margin expansion on enterprise.

[Jason Krause:]

Hi, its Jason here. It’s still somewhat early days and in terms of attach rate we've been offering those solutions for many years and growing them within our customer base and with new customers. Well you’ll see those. As these IoT deployments get larger, more complicated and also the concerns around security increase, you will see every one of these deployments managed going forward. So we are seeing dramatic increases in attach rate right now, but it’s starting from a small base.

[David Gearhart:]

That's it for me. Thanks for taking my questions.

[Dave McLennan:]

Thanks David.

[Operator:]

And your next question comes from the line of Paul Treiber of RBC Capital Markets. Your line is open.

[Paul Treiber:]

Thanks very much. Just first a housekeeping item, I don’t know if you disclosed it, I kind of called it late, but could you provide the revenue that Numerex generated in the quarter and then also is Numerex now at breakeven or profitable?

[Dave McLennan:]

Hi Paul, it’s David. When we gave guidance for Q1, we gave a revenue figure of about $13.5 million for Q1 and then here as we integrate we're not going to reports separately on product lines. I will say though that you heard me mention stability in that business.

[Paul Treiber:]

Okay, related to Numerex, just in terms of the integration, what’s the remaining from an integration point from here and what should we expect, particularly in regards to the cloud platform. You know what sort of the heavy lifting that’s remaining?

[Marc Overton:]

Hi, it’s Marc. We are integrating into the AirVantage cloud platform, so we are moving the customers, the vertical applications on to that, which is also a key component of our single pane of glass, our single proposition for connected devices across different operators. That certainly accelerated our capability. We’ve done a major upgrade of the network. So it’s now LTE enabled for MVNO in the U.S. and that's based on the call, Numerex capability. And as I said earlier, we’ve accelerated the new devices as well. So there is a huge amount of new capability being enabled because of the Numerex acquisition.

[Kent Thexton:]

Its Kent Thexton here, I’ll just add that as Marc outlined earlier in terms of the integration, I think it’s also using the scale that we have to increase our overall capability. So Marc mentioned the 24/7 global network operations center and coming from a carrier background, this is a key implementation for us to be able to manage and monitor our devices globally with a global operations center. So it’s a significant achievement and leveraging that to integrate into all of our devices globally is key.

[Paul Treiber:]

I mean just one last one from me. Just on the cloud and connectivity business, you discuss a lot on the attach rates, but I was just thinking about it from a win rate point of view, so thinking about it more from a competitive point of view. So if they're not going with you or Sierra Solution there, typically who are they using, not in terms of names, but in terms of are they using [inaudible] or they are using their own customer’s solutions and what are ways that – what just drives you to try to increase the win rate per say?

[Kent Thexton:]

Hi, its Kent Paul. If we look back historically, Sierra Wireless delivered modules and gateways, the solutions were somewhat more straightforward and then the end customers would get a SIM card from a carrier to be able to be connected. As we have machine builders, device builders, appliance builders wanting to connect globally, procuring network arrangements from multiple players becomes more challenging. So we worked to simplify that solution. So we are looking to provide an enhanced solution compared to dealing with a carrier in the country and many customers will still have those relationships and want to do that, and we enable that, and we support that. But we are trying to enable the next level of opportunities for our global customers and imbedded customers who want to have that simple out-of-the-box experience that the device lights up, the customer examples that both Marc and Jason delivered and they are able to have a faster time to market. There is one throat to choke in terms of the device and the network and the cloud, of being able to ensure that they are getting the data from their device into their ERP system. So they can get the return on investment they are looking for.

[Paul Treiber:]

Thanks so much, I’ll pass the line.

[Operator:]

And your next question is from the line of Steven Lee please go ahead, with Raymond James; your line is open.

[Steven Lee:]

Thank you. Guys, I might have missed this, but LPWA did you talk about it? I mean are you starting to bid on contracts?

[Dave McLennan:]

Hi Steven, its Dave here and yes absolutely, you know we have design wins, you know a good example is we have a design win in Japan with KDDI for a water metering solution and that commences shipping later this year. So we are very, very active with LPWA I should say, you know bidding on business.

[Steven Lee:]

Is this a high volume, example of a high volume application Dave or not?

[Dave McLennan:]

It is. I mean we view it as an expansion of the addressable market. I mean, think of it as you know first layer of really 2G replacement and then you know adjacent spaces. Water metering is a good example where there is no power to a water meters, so power management becomes very important. That's not something we would have been able to do with a non-LPWA module and then of course beyond that, there is just your myriad of use cases that given the low cost and low bandwidth characteristics of LPWA and power management that you know just opens up other applications that we don't see today, and feel it’s a very key driver to expansion of the marketplace.

[Kent Thexton:]

Hi Steven its Kent Thexton, I’ll just to add to that. This is a multi-year evolution of this marketplace with much lower cost modules, the battery life of 5 to 10 years and being able to have better radio characteristics because of the protocol for further delivery from cell site and building penetration. That LPWA modules will add a lot of devices that before it wouldn't have make sense to connect or replace WiFi because there's a greater dependability of the macro-network and the ability to have device management, SIM management to be able to control that. So many reports on the LPWA marketplace. We think over the years ahead of us this is going to expand the number of devices connected globally dramatically and that's what we're positioning for.

[Steven Lee:]

Very helpful, thanks. And Dave on the Numerex earlier, when you said stable, are you talking sequentially?

[Dave McLennan:]

Yes, we’ve stabilized the revenue trajectory, yes.

[Steven Lee:]

Okay and one more question for Jason. I think you were talking about the largest FirstNet router customer deployment. How much is left in the deployment or is it just starting?

[Jason Krause:]

Hi Steven, its Jason. Obviously I won’t comment on specific customers, but I will say FirstNet overall is early. The FirstNet LET routers just certified in the past weeks. So that particular deployment will use those particular products.

[Steven Lee:]

Alright, very useful. And Jason when we think of recurring revenues, how much would recurring present of the deal value, 10%, 20%?

[Jason Krause:]

Yes Steven, obviously we don’t break that out specifically. I will say – repeat my comments from earlier that it is increasing and will continue to increase at a faster rate than revenue overall.

[Steven Lee:]

Alright, thanks.

[Dave McLennan:]

Thanks Steven. Suzanne, we have time for one more caller if there is one.

[Operator:]

There's no one in the queue. [Operator Instructions]. It doesn’t appear we have any takers at this time.

[Dave McLennan:]

Alright, well thank you very much everyone for your attention today and as always, management is available for follow-up calls. Thank you.

[Kent Thexton:]

Thank you.

[Operator:]

And this concludes today’s conference call. You may now disconnect.