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Sierra Wireless, Inc. (NASDAQ:SWIR)

Q2 2013 Earnings Call

August 1, 2013 5:30 p.m. ET

Executives

Jason W. Cohenour - Chief Executive Officer

David McLennan- Chief Financial Officer

Analysts

Mike Walkley - Canaccord Genuity

Daniel Kim - Paradigm Capital

John Bright - Avondale Partners

Richard Tse - Cormark Securities

Paul Treiber - RBC Capital Markets

Peter Misek - Jefferies & Company

Todd Coupland - CIBC World Markets

Gus Papageorgiou - Duetsche Bank

Operator

Good afternoon, ladies and gentlemen, and welcome to the Sierra Wireless Second Quarter Results 2013 earnings results conference call and webcast. With all lines are in listen-only with. Following the presentation we will conduct a question-and-answer session. Instructions will be provided at that time. I would like to remind everyone that this call is being recorded today, Thursday, August1, 2013 at 5:30 p.m. Eastern Time.

I would now like to turn the meeting over to your host for today’s call, Mr. Jason Cohenour, Chief Executive Officer and Mr. Dave McLennan, Chief Financial Officer. Please go ahead, gentlemen.

Dave McLennan

Thanks, Laura, and good afternoon everybody. It’s Dave McLennan speaking. Thank you for joining today’s conference call and webcast. As a reminder, today’s presentation is being webcast and will be available on our website following the call.

Today’s agenda is as follows. Jason will provide a general business overview. I will then cover the second quarter 2013 financial performance as well as guidance for the third quarter of 2013, and following that Jason will follow up with a brief summary, and we’ll round up today’s call with a Q&A session.

Before we get started, I would like to reference the company’s Safe Harbor statement. A summary of our Safe Harbor Statement can be found on page two of the webcast and is now being displayed. Today’s presentation contains certain statements and information that is not based on historical facts and constitutes forward-looking statements. These statements include our financial guidance for the third quarter of 2013 and commentary regarding the outlook for our continuing business.

Our forward-looking statements are based on a number of material assumptions including those listed on page two of the webcast presentation, which could prove to be significantly incorrect. And our forward-looking statements are subject to substantial known and unknown material risks and uncertainties.

I draw your attention to a longer discussion of our risk factors in our Annual Information form and Management’s Discussion and Analysis which could be found on SEDAR and EDGAR as well as in our other regulatory filings. This presentation webcast should also be viewed in conjunction with our press release and with the supplementary information on our website.

With that, over to you, Jason, to provide highlights.

Jason W. Cohenour

Thank you, Dave. And good afternoon everyone. In the second quarter of 2013 our first quarter as an M2M pure play we drove record revenue of $109.6 million representing 15% year-over-year growth and 8% sequential growth. Revenue contribution from both our Enterprise Solutions and OEM Solutions product lines was solid including another strong quarter from the acquired Sagemcom M2M business. Strong revenue combined with solid gross margin of 33.4% and stable OpEx resulted in a return to non-GAAP profitability highlighting the earnings leverage in our operating model.

In addition to delivering improved operating results in Q2, we completed the sale of the AirCard business to NETGEAR on April 2nd. Since then we’ve been busy transitioning the team, assets, and projects to NETGEAR. I’m pleased to report that this transition is now nearly complete and we’ll soon be able to dedicate 100% of our focus and resources on growing our world leading M2M business. As the M2M leader we intend to be a key enabler of the Internet of things and we believe that this presents a great opportunity for long-term profitable growth and value creation.

As a clear market leader we believe we are exceptionally well positioned to capture the secular growth opportunity in M2M. We have an extensive blue chip customer base, strong global presence, unmatched innovation, and a product line that spans the M2M value chain. We have the industry’s broadest embedded wireless module product lineup from 2G to leading edge 4G covering multiple form factors and a range of embedded intelligence options. This enables us to meet the needs of nearly any global OEM operating in any region on any network around the world.

We have a range of intelligent gateways and routers that deliver a highly configurable plug-and-play solutions for corporate and government enterprises. And we have AirVantage cloud that works with our device platforms to enable the rapid development and deployment of M2M solutions. By providing device to cloud solutions we make it easier, faster, and cheaper for our customers to build, deploy, and manage their M2M applications. We believe this places us in a unique competitive position that enables Sierra Wireless to not only grow our share but to capture more of the value chain, to extend margins and to build competitor barriers.

As a reminder, we’ve refined our product segmentation and are now providing revenue and business highlights for two product lines, OEM Solutions and Enterprise Solutions. OEM solutions consist of all AirPrime embedded wireless modules sold predominantly to OEM customers, including OEM and consumer device manufacturers. Enterprise solutions consist of AirLink gateways and AirVantage cloud services sold predominantly to corporate and government enterprises. So let’s take a closer look at each of these product lines.

In OEM Solutions revenue from OEM Solutions was solid at $95.1 million representing 14% year-over-year growth and 7% sequential growth. Contribution from the acquired Sagemcom business was strong in the quarter and the key driver of year-over-year growth. Design win activity in Q2 was once again robust contributing to the growth of our customer programed pipeline, and the payment segment which secured important successor programs with a key customer solidifying our position with this customer for years to come.

In the automotive segment we secured an E-call design win with an European OEM. And in energy we secured a design win with a global leader in municipal lighting systems. As with all design wins integration, launch, and ultimately revenue contribution will take some time but I’m encouraged by the level of design win activity and the growing pipeline of customer programs.

Innovation is another key driver of our market leading position and in Q2 we continue to demonstrate our commitment to technology leadership. Together with Verizon Wireless we announced the AR7 series of automotive modules. The AR7 is the world’s first 4G LTE device that’s designed specifically for the rigors of the automotive segment. A version of the AR7 is now certified on the Verizon network and is sampling with perspective customers.

We also announced the launch of the AR7355, the first 4G LTE embedded module made specifically for the Sprint LTE network and with Tobisha we announced the launch of their new 4G LTE enabled protégé Ultra Book in Australia. The new protégé runs Windows 8 and features a detachable screen that converts into a Win 8 tablet.

With these and many other programs we have staged a clear market and technology leadership position in 4G LTE with shipments now exceeding 2 million devices many times more than any other player in the M2M industry. In addition to leading the way in LTE, we’re committed to innovation leadership in multi core embedded modules. First announced in With1 these modules platforms are absolutely unique in the market combining an advanced multi core architecture, new embedded application framework and pre-integrated AirVantage cloud services. The result is an entire M2M ecosystem on a module enabling OEM customers to develop and run their applications directly on the module in a dedicated core and being able to deploy and manage their devices in the cloud reducing overall development time and total cost of ownership. During Q2 we commit sample shipments of one of these unique devices, the AR6, to two automotive customers in support of new programs which we expect to enter production in 2014.

Moving to Enterprise Solutions, Q2 revenue from our Enterprise Solutions was a strong $14.5 million up 20% on a year-over-year basis. Our key growth driver in the quarter was continued adoption of our recently launched products particularly the LS440 LTE gateway. During the quarter we also commenced commercial shipments of the new LS300 a small rugged highly functional gateway ideal for applications in industrial environments. Given its small size and optimize cost basis we expect the LS300 to help us drive tire growth of our Enterprise Solutions in Europe. Our packaged AirVantage management service cloud offering is also showing signs of solid adoption. AirVantage management service is now offered as a bundled package in almost every new AirLink gateway sales opportunity.

Our solutions sales team is becoming more and more proficient with the offering and we are securing customer wins. During Q2 we secured AirVantage management service orders with customers in the utility, energy, and public safety segments. Also during Q2 we launched a fully integrated device to cloud solution with DOM, a world leader in environment services. Among many other products and services the (inaudible) offers ultra with water treatment and purification systems for labs and hospitals. Ultra pure water is the principle reagent for laboratory analyses and assures the reliability of clinical diagnosis. As you can imagine ensuring proper purity levels and water purification system uptime is critical in maintaining operational integrity. In response to this critical need we developed a solution based on our AirLink gateways and AirVantage cloud platform that offers customers a way to monitor water purification levels and equipment in real time.

The result for M2M customers is higher confidence in the purity of their water supply and improved system uptime. For (inaudible) the solution enables them to provide a higher level of service to their customers strengthening their competitive position. (Inaudible) offers another example of the power of our device to cloud offering providing the devices, tools and platform that enable our customers to rapidly and cost effectively build, deploy, and manage their M2M application. And in the process we become a long-term trusted partner while capturing more of the M2M value chain.

With that, I’ll now hand the call back over to Dave who will provide more detail on the Q2 financial results and Q3 guidance. Dave?

David McLennan

Thanks Jason. I note that we report our financial results on a UWITH. GAAP basis however, we also present non-GAAP results in order to provide a better understanding of our operational performance. Additionally with the sale of the AirCard business which closed on April 2nd, the result of the AirCard business I presented on our income statement as discontinued operations. In this presentation when we talk about revenue, gross margin, OpEx and earnings from operations we’re only referring to our continuing operations comprised of our M2M business. The sale of the AirCard business also resulted in us having one reportable segment, our M2M segment. This one segment is comprised of two product lines, OEM Solutions and Enterprise Solutions.

Focusing on our continuing operations, Q2 was a solid quarter with overall results at the high end of our guidance range. Revenue from continuing operations was $109.6 million solidly within our guidance range. Non-GAAP earnings from continuing operations at $1.5 million were toward the high end of our guidance range and non-GAAP net earnings from continuing operations of $1 million or $0.03 per share was also at the high end of our guidance range.

As a reminder the reconsolidation between our GAAP and non-GAAP results in provided in the press release as well as in the Investor Relations section of our website non-GAAP results excluding the impact of stock based compensation expense, gain on the sale of our AirCard business, acquisition and disposition costs, acquisitions amortization, asset impairments, integration costs, restructuring costs, foreign exchange gains or losses on the translation of balance sheet accounts and certain tax investments.

The next couple of slides show our key non-GAAP financial metrics starting with revenue. Revenue rose to a quarter record of $109.6 million up 15% year-over-year and 8% sequentially. Year-over-year OEM Solutions revenue was up 14% reflecting a strong contribution from Sagemcom. Organically meaning without Sagemcom we saw a decrease in PC OEM revenue compared to a very strong quarter a year ago with the balance of our OEM revenue being flat year-over-year. Sequentially OEM Solutions grew 7% compared to With1 reflecting broad based growth across our various OEM product lines. Enterprise Solution revenue grew by approximately 20% on both the year-over-year and sequential basis. This growth reflects growing momentum with recently launched 4G products.

Our non-GAAP gross margin in Q2 was solid at 33.4%. The sequential and year-over-year increase in gross margin percentage reflects the positive effect of an advantageous product mix and continued product cost reductions. At $35.1 million Q2 operating expenses were relatively flat compared to last quarter. As discussed with of year card divesture we are fully invested for growth in our continuing operations and expect to manage OpEx around the $35 million level as we grow the top line resulting in earnings leverage. With a return to profitability in Q2 we saw some of this earnings leverage in our results relative to With1 where sequential 8% revenue increase combined with improving gross margin and flat OpEx resulted in a significant improvement in our non-GAAP earnings from continuing operations which went from negative $1.4 million in With1 to positive $1.5 million in Q2.

Adjusted EBITDA which incorporates our non-GAAP adjustments was $4.9 million at Q2. This represents solid growth compared to $2.4 million a year ago and $1.8 million in With1 and further illustrates business model leverage.

Moving to our balance sheet the AirCard transaction gives us strong financial capacity to continue to drive our leadership position in M2M. In the second quarter the transaction generated $120 million in proceeds net of transaction costs and we ended the quarter with $176.6 million of cash. Cash flow from operations during Q2 was $8.1 million and we utilized $4.2 million for capital expenditures and a further $4.4 million for the repurchase of 386,000 of our own shares.

Coming back to the $120 million AirCard proceeds for a moment, this is the net proceeds realized in the quarter. Note that we incurred transaction costs prior to Q2 and going forward we will have cash outflows for items such as tax on the gain as well as cash inflows from the release of the escrow in 2014. Once completed, we now expect overall net proceeds to be approximately $110 million.

Moving to guidance for Q3, which is provided on a non-GAAP basis for our continuing operations, based on the expectation of growth in both our OEM and Enterprise Solution product lines we are forecasting Q3 revenue to be between $111 million and $115 million representing solid year-over-year and sequential growth. For Q3 we expect gross margin percentage and operating expenses to be similar to the second quarter levels. We expect Q3 earnings from operations to be between $2.2 million and $3.3 million. This represents a solid sequential increase from Q2 and reflects the business model leverage result from an expected growing revenue and continued expense management. Assuming an effective tax rate of 30% in Q3 we expect net earnings to be between $1.5 million and $2.3 million with $0.05 to $0.07 per share.

With that I’ll hand it back to Jason for the outlook.

Jason W. Cohenour

Thank you, Dave. Our singular focus on the M2M opportunity is all about driving shareholder value. Organically our goal is to continue to drive revenue growth and expanding profitability as we leverage our leadership position, capture share, and expand into new segments and geographies such as Brazil. We also plan to put our strong balance sheet to work in acquiring great M2M companies that help us further expand our position in value chain, strengthen margins, and drive growth. I believe our track record of doing this is proven.

In 2008, we’ve grown our M2M business organically and through acquisition from $158 million to $421 million and we’ve done this while improving our margin profile and defensibility. Our aim is to do more of this and in so doing, deliver a great return for our shareholders.

So to summarize our first quarter as an M2M pure play was very solid. We delivered record revenue, a return to non-GAAP profitability and demonstrated the leverage in our operating model. Our outlook for Q3 is for further steady growth and expanding profitability. As the clear global leader in M2M, we believe we are exceptionally well positioned to capture the M2M growth opportunity. We have significant scale, a Blue With customer base, strong global presence, and solutions that span the M2M value chain. I believe this collection of assets will not only enable growth but margin expansion and defensibility as well. Following the sale of AirCard, our balance sheet is fortified and ready to be put to work. Our goal was to accelerate growth and value creation through targeted M&A. we have successful track record of driving growth and value creation through M&A and our pipeline is active.

That concludes our prepared remarks for today. And we’ll now open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mike Walkley of Canaccord Genuity. Your line is open.

Jason W. Cohenour

Hi, Mike.

Mike Walkley - Canaccord Genuity

Hi, guys. The solid execution of finalizing the AirCard transaction of NETGEAR I just wanted to build on your last comment there, Jason.

Jason W. Cohenour

Hey, Mike, can you speak up? You sound…

Mike Walkley - Canaccord Genuity

Yes, is this better?

Jason W. Cohenour

That’s much better, yes.

Mike Walkley - Canaccord Genuity

Okay. Sorry about that, a little headset problem. Just on your comments at the end, just talking about a strong pipeline of acquisitions. Just, how do you balance maybe some accretive valuations in the market recently you know with the mandate to put some of your cash to work. Just how do you balance those two things.

Jason W. Cohenour

Well you know we’ve got plenty of cash. and we’ve been very clear that we plan to deploy a significant amount of that cash and get a driving growth through M&A but we’ve also committed to a balance approach of capital allocation that includes a return of debt to shareholders through buybacks. So as you saw we’ve done some of that. We purchased over a half of million shares in the first half. And that certainly continues to be you know an option for us in the second half notwithstanding the increase in share price recently. But our priority always has been M&A, Mike, and will continue to be. I think we’ve got you know good ideas that are maturing in our following and I suspect we’ll be successful in completing a couple of transactions in the coming periods.

Mike Walkley - Canaccord Genuity

Okay. Thanks Jason and then your point here successful M2M track record Sagemcom helping drive growth but if you go back to kind of your underlining ex-Sagemcom business, can you talk about maybe the reason it’s been more flat recently on a year-over-year basis. Is it ASP compression or is it just more, you know, Europe headwinds. Maybe just touch on kind of the core business and how you see that, maybe to the back half of the year.

Jason W. Cohenour

Sure, sure. And just be clear for Q3 we do, you know, we do expect to see organic growth. And with respect to what’s causing that headwind the last couple of periods, Europe continues to be a theme, Mike. It’s, you know if you look at our geographical mix, it’s, you know the theme clearly is Europe is holding us back and the Americas is growing. And then maybe getting into some more specifics in the Q2 specifically, PC OEM was down a bit year-over-year which was I would say the key driver to holding back organic growth. And you may recall that Q2 of ’12 was a very strong quarter for PC OEM because we had a large enterprise roll out in Japan. So we didn’t experience that in Q2 of ’13 and as a result PC OEM was down on a year-over-year basis.

Mike Walkley - Canaccord Genuity

Okay, good. Thank you. And just on (inaudible). I think I’ve got a bad line. I’ll pass it on.

Jason W. Cohenour

Mike, we can still hear. Can you talk?

Mike Walkley – Canaccord Genuity

I’m sorry. I’m hearing a bad echo on my end now. On the OpEx side just 35 million that’s the way we should consider it, in that range going forward just on your core business. Anything that would take that up ex-acquisition?

David McLennan

Yeah, I mean we’re very focused on managing the company around that OpEx, Mike and you know it bounces around a little bit but we’re focused on keeping it around that number.

Mike Walkley - Canaccord Genuity

Okay, great. I’m going to pass it on because I’m having trouble on my line on my end but looking forward to seeing you guys in our conference in a few weeks. Thank you.

Jason W. Cohenour

Okay, thanks, Mike.

Operator

Your next question comes from the line Daniel Kim from Paradigm Capital. Your line is open.

 Daniel Kim – Paradigm Capital

Good evening. Thank you. Just wondering if you could discuss a little bit of a leverage on the bottom line. I guess from my perspective, could you discuss the plan with Sagemcom and what type of leverage you would expect to during this cost integrated going forward in terms of how that was going to roll out over let’s say the next two to six quarters. And as a data point if I were to look at the guidance going into the third quarter, the leverage that was just recorded in Q2 was, I’d say on the bottom line as expected the sequential uptick on revenues. Q3 we have similar magnitude in terms of revenue sequential growth again but we’re not necessarily seeing that translate down to the bottom line. Wondering if you could explain a little bit of that and when we might expect to see a little bit better bottom line leverage going forward please.

Jason W. Cohenour

Sure, maybe I’ll respond to the bottom line leverage. You know I think if you take the midpoint of guidance, Daniel, you know that represents about 3% growth on the top line and we're doubling EPS. So I would say that the leverage is alive and well in the operating model. And with respect to the current cost structure and whether or not we bring that down through further integration with Sagemcom, you know we think we're about at the right cost structure here in order to take advantage of and capture this what we believe is a long term growth opportunity in M2M, you know, notwithstanding a couple of quarters here where the growth is modest. You know our expectations are this is going to be a big market. and we feel like we don’t need to ramp up that sub to capture the market opportunity but right now we, you know, we don’t think it would be a good idea to constrain our cost structure and bring our capacity down because we are investing to capture the opportunities. So I wouldn’t expect a lot there, Daniel, with respect to capturing the efficiencies through further integration of the Sagemcom business which is proving to be a pretty nice contributor here.

Daniel Kim - Paradigm Capital

Right, no, understood. More specifically the angle I was coming from was on an absolute dollar basis. Because your operating structure is relatively flat with the dollar contribution of the top line, I would presume that it would have been a consequent increase or even greater increase on the bottom line dollar contribution rather than on a percentage basis. That’s fine. Switching gears then, …

David McLennan

Yeah, Dan, maybe a little bit more color, you know, in our guidance we have assumed you know gross margin percentage and OpEx to be very similar to Q2 levels right? Whereas in Q2 we had a gross margin improvement over Q1 so …

Daniel Kim - Paradigm Capital

Right.

David McLennan

So that would, you know, add to the leverage we experienced in Q2.

Jason W. Cohenour

And maybe just lining up dollar for dollar and clearly Q1 to Q2 we saw a higher absolute dollar sequential jump …

Daniel Kim - Paradigm Capital

Right.

Jason W. Cohenour

Than we're guiding for in Q3. And I think that probably explains the disconnect for you, Dan.

Daniel Kim - Paradigm Capital

Okay. Okay. That’s fine. And I guess more a notional view in terms of long-term growth outlook, when we look at the primarily spaces where you play and they certainly have some pretty big forecast for unit growth in ASPs and all the rest. And when we balance that with the continue design wins that you continue to hit on most of your big verticals here, in terms of growth 15% was a nice year-over-year uptick for this quarter. it looks like you're going to see similar mid teen level for the third quarter. In terms of what you're seeing Jason with this, with new design wins ramping up, I guess expected over the next several quarters, would you expect this mid teen range to be a sustainable rate or would you in fact expect that to accelerate as these design wins starts to take hold?

Jason W. Cohenour

Yeah, I think we're at the, continue to be sort of cautious in our mid to long-term outlook, Daniel. So you know we're comfortable with 10 to 15% expectation mid to long term. And but I think we have an option also on accelerating growth. We just want to be careful not, you know not to say that we're definitely going to secure that jump in growth rate just yet. And you know as you can see we're kind of sailing through some choppy waters here with Europe that’s holding us back. I think with a, you know, with Europe strength coming back that would be a big help. That would certainly you know in my opinion secure the 10 to 15% but I don’t think we're going, we're not ready to take it up from there. The way I would think about it is we have an option on higher growth in the context of a healthy macro economy.

Daniel Kim - Paradigm Capital

Okay, great. And just one last question, AirVantage that you reference the fact that you're securing customer wins, I believe last time I check you guys has roughly eight carrier network wins. Is that win rate expanding as well?

Jason W. Cohenour

Yeah, the way to think about “carrier wins” we regard that way we're connected now I believe ten different operator networks and those are, you know when we connect to a carrier network think about that as opening up a channel with that network so that co-selling activity can take place rather than, you know, a direct revenue contribution. So, I would say where we are right now with you know ten and maybe adding a couple more we have sufficient global coverage and global access to the key, the largest wireless operators in the world. And the real focus is you know developing opportunities with players with VOM as an example and Atlas Cut Go and Expresso and getting more direct customers like that either through our direct selling efforts or through our channel partnerships and that’s what’s going to turn on the, that what’s going to drive growth in the subscriber base and recurring revenue base.

Daniel Kim - Paradigm Capital

Terrific. Thank you very much.

Jason W. Cohenour

You bet.

Operator

Your next question comes from the line John Bright of Avondale Partners. Your line is open.

John Bright - Avondale Partners

Thank you. Good afternoon, Dave and Jason. I’m wanting to follow up with …

David McLennan

Hey, John.

John Bright - Avondale Partners

Hey guys. And let me follow up with a number of questions in here. One, on the PC OEM business I don’t think you disclosed this but if you do the percentage of the revenues from the PC OEM number one. And then number two, you seem to be albeit down in the quarter I think you said talking the trend as the overall PC market. Talk to us about that. Is it market share gains or something else?

Jason W. Cohenour

Yeah, that’s the way I would think about it John. I'd think about it as share gains you know with Erickson backing out of the business and Novatel backing out of the business. That’s created a share gain opportunity for us. We’ve definitely achieve share gain with respect to design wins and platform launches. And the way I’m thinking about our PC OEM business now is that we're going through a bit of a transition as, you know, new platforms get equipped with our latest LTE devices and ultimately launch. We believe that’s going to be an interesting contributor to our growth in the coming periods.

John Bright - Avondale Partners

Okay, do you break out the percentage of revenues from PC OEMs?

David McLennan

We don’t, John.

John Bright - Avondale Partners

Okay. Next follow on, hey and it goes to the question regarding CL business and the guidance. Were you saying that gross margins, gross margins in this quarter I think were 33.3 on a non-GAAP basis. I could be wrong there but …

David McLennan

Thirty-three four, John.

John Bright - Avondale Partners

Thirty three four, excuse me. You’re saying they're going to be effectively full capping flat Q2 to Q3 sequentially.

David McLennan

That’s why we said both gross margin percentage and OpEx to be similar to Q2.

John Bright - Avondale Partners

Okay. And then in your prepared text, Jason you alluded to two automotive OEM, auto OEMs then talked about production in 2014. Can you give us some more color around that?

Jason W. Cohenour

Sure, so that was in the context of our new AR6 multi core embedded module. And think about that as almost an automotive subsystem on a check or on a module and we have secured two NetApp design wins. They are European OEMs for European launch and the target for those applications is to be compliant with the new E-call regulations. So those are actually 2G deployments. And I think I also mentioned a third design win with a different European OEM which is also E-call oriented design win.

John Bright - Avondale Partners

Are there any major pending bidding going on now for domestic OEMs?

Jason W. Cohenour

There is a, it’s a very active space is the way I'd characterize it John. And we are constantly working with you know trying to earn wins with domestic OEMs and also international OEMs, full launches in North America.

John Bright - Avondale Partners

Shifting the question to AirVantage, you talked about it as far as the CS process is concerned. You talked about it being part of CS process, are you able to monetize that software component.

Jason W. Cohenour

We are. It’s small though today, John, is the way to think about it. So, I would say that we are monetizing it in a significant way through differentiation and margin protection on our hardware, right. And then secondly we are slowing building a pipeline of recurring deals but the recurring revenue part of the contribution today is small. And our thinking around that is you know First of all, AirVantage gives us differentiation and stickiness and margin protection on the hardware. And second of all, creating this or building this recurring revenue pipeline will take time. And I think as that becomes a more meaningful contributor, we’ll, you know, get more specific on things like subscriber rates and APU and revenue contribution.

John Bright - Avondale Partners

So another question regarding M&A you mentioned a couple of transactions I think in the coming periods. Could you describe them? Describe today in optimal transaction.

Jason W. Cohenour

Large, massively profitable and big.

John Bright - Avondale Partners

I knew you were going to go there. I knew you were.

Jason W. Cohenour

Yeah, you know optimal, we are you know kind of, it’s a little different priority per setting, John. It’s really around moving up the value chain. And so you know we like businesses like our AirLink gateways and routers business as an example, right. So there a different number of examples like that in the funnel. We want to scale our services business. You know we were talking about AirVantage while a key part of our strategic initiatives is a small revenue contributor today. So you know there are ideas in the funnel that help us scale services revenue, right. So if there is a theme in terms of our priorities it’s about moving up the value chain. So higher margin, more defensiveable sticky customers.

John Bright - Avondale Partners

If you take away the or exclude the PC OEM business talk to the tone of the M2M business activity today. Is it still in that 10 to 15% range? Do you see an increasing interest, an accelerating interest, maybe and understanding Europe is weak, give us some color on the tone of that business excluding the PC OEM.

Jason W. Cohenour

Yeah, I think the activity levels are very high is the way I would characterize it and a lot of, I mean there is a lot of focus on the part of you know big ecosystem players like the carriers, like big industrial players, GE is an example, like players like Cisco, Erickson. So I figure we're on this floor that’s definitely coming up significantly I would say a deal flow is definitely robust. Revenue growth right now is you know it’s there but it’s, I would say relatively modest but I’m a firm believer that this level of activity notwithstanding the European headwinds but this level of activity will drive significant market growth in the coming periods.

John Bright - Avondale Partners

I have a question. After having sold the data card business, characterize today how you feel about other than relieved about the visibility that you have versus what your visibility was before?

Jason W. Cohenour

I would say it’s significantly improved. It’s, you know, the volatility is down significantly. By the way that doesn’t take away, it’s still a complex business to forecast as an example, but definitely volatility is way down. So you know when we put the penning on guidance it’s an easier exercise because you know when AirCard landed as you know we had three big customers grabbing the bus and you know one of them changed their mind in the middle of the quarter, that could be really good for our results or really bad, right. But it only took one customer to change their mind and in M2M there is many more levers and dials for managing the business. So that helps us keep volatility down and like I said the leverage of activity in the market has us very encouraged with respect to future growth.

John Bright - Avondale Partners

Not trying to pin you down on guidance for Q4 but you mentioned ’14 and your prepared text. We're talking about visibility, could you give us any characterization of timing of your visibility. So would you say that you’ve got more visibility today six months out, a year out, where is the increased, the length of time you’ve got visibility?

Jason W. Cohenour

It’s pretty, I would say it’s pretty far. So you know if we look at ’14 and I’m not going to of course share with you what our internal forecasts are for ’14 but as we look at ’14 as an example you know we can, we know which customers that’s coming from and which programs, right. It’s a function of already secured, very often already secured design wins or very close to secured design wins. So you know it’s not fully certain of course but it gives us confidence when we put together longer range forecasts because we know a, it’s coming from many customers and b, we know precisely what programs are coming from because they are programs that take a long time to gestate.

John Bright - Avondale Partners

Gentlemen, thank you.

Jason W. Cohenour

Thank you.

Operator

Your next question comes from the line Richard Tse from Cormark Securities. Your line is open.

 Richard Tse - Cormark Securities

A couple of questions, one you talked about activity levels being very high. How would you characterize very high relative to years. Is it higher than year? Kind of give us a sense of that change or if there has been a change there.

Jason W. Cohenour

It’s hard to flavor. You know I would say Richard, it’s roughly the same.

Richard Tse - Cormark Securities

Okay. And then when you talked about this AR7 with Verizon, I’m not sure how this is going to scale up. I think you said it’s on trial and now sampling so you know over the course of the next you know couple of quarters, you know what would sort of happen to that scale up.

Jason W. Cohenour

Well we need to go get some design wins with it, right. So I'd say the AR7 is a, I would say it’s an important stake in the sand. You know it’s the first 4G LTE device made specifically for automotive. It’s you know far ahead in my opinion of any of our competitors in terms of readiness. And we have to be successful in taking that benefit in securing big design wins and getting them deployed. And these are automotive design wins, right, so it’s going to take time to not only secure them but to integrate and ultimately launch. So you know think about revenue contributions from the AR7 to be two years out at least.

Richard Tse - Cormark Securities

And when you go out trying to bid on these design wins is Verizon involved in any expense or is this pretty much you saying that you're working with them.

Jason W. Cohenour

Yeah, I would say you know when it gets down to brass tacks in the selling situation it’s really about, you know, us and our tier one partners trying to secure the business with the automotive OEM. And you know while Verizon was very interested in being a enabler of this product and bringing it to market, that was really about loading their network and at the end of the day if loading their network comes from us, they're very happy but if it comes from one of our competitors they're, well, almost as happy, right, so.

Richard Tse - Cormark Securities

Right.

Jason W. Cohenour

So it’s really incumbent on us to take this advantage that we’ve calibrated with Verizon on and go get the design wins.

Richard Tse - Cormark Securities

Okay and then last question in regards to AirVantage, you talked about you know you’ve got wide coverage now. Can you give us a sense of what (inaudible) interest is, you know how many customers you have on it today versus last year and what that pipeline might be looking like.

Jason W. Cohenour

You know I’m very encouraged. You know we are, you know I mentioned kind of two pieces of AirVantage. You know one is our packaged device management, AirVantage Management Services and you know every one of our AirLink sales guys now are offering that as a bundle when we sell AirLink devices. And we're having a pretty good hit rate. Now these aren’t huge, these aren’t really high volume wins, right. They’re often times they're you know a utility or a policy agency. So you know the number in the low thousands of even hundreds of units. But we're definitely getting good traction there. And we're getting wins. And I’m very encouraged you know with deals like (inaudible). And we also have some very interesting traction with some very big players in the energy segment. So I’m very encouraged. It’s going to take time. I think the really neat thing is it’s definitely given us a differentiation. You know last quarter we shared with you a story about a manufacturer of air pressure values and you know we got a module design win because of AirVantage. And we also got the AirVantage win. and that’s kind of thing you know I’m hoping we can replicate pretty often because at the end of the day it not only gets us the hardware sale, it gives us the long term sticky customer and you know we kind of become this trusted partner over a much longer period of time.

Richard Tse - Cormark Securities

Great. Thank you very much.

Jason W. Cohenour

Sure.

Operator

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

Jason W. Cohenour

Michael?

Paul Treiber - RBC Capital Markets

Oh, hello. Can you hear me?

Jason W. Cohenour

Yeah, Michael, you just cut in here.

Paul Treiber - RBC Capital Markets

Okay, sorry about that. I just wanted to get into the rationale for M&A specifically in regards to the terminal piece. So as you mentioned that you already have one of the broadest product lines in M2M. So is the rationale for acquiring another terminal vendor, would it be specifically add another distribution channel to split existing products through it?

Jason W. Cohenour

You know what it’s, think about it as bolstering our position in different segments. So while it’s true we have a very broad product line and by the way when I say product line, I meant that in an abstract sense. You know if you look at the AirLink product line, while it is indeed broad it’s not you know, it doesn’t include our -- and work well across a lot of segments. However, in some segments like fleet management as an example they have very specific segment requirements where many times our AirLink devices are not the right perfect fit. So certainly there is a segment theme to some of the targets, some of the terminal targets in our fall. So we can bolster our position or build a position in different segments that we don’t serve as well today. And then secondly, geographical expansion, you know, the gateways market is a I would call it a highly fragmented market. And as you, you know, travel around the world in different markets there is very often companies that look like very small AirLink players and acquiring one or more of those can give us a very strong footprint in a new geography.

Paul Treiber - RBC Capital Markets

Okay and then still on the M&A, thoughts on M&A, there has been a lot of talk on the operating leverage and scale in your organic business. When you think about layering on top of that M&A do you also expect to see operating leverage as a result of M&A so that M&A would be a accretive to margins.

David McLennan

To date Paul each situation is going to be different but certainly you know we look for those situations and I'd point to Sagemcom where we you know it’s a good illustration. We had illustrated you know some leverage by bringing in some assets and you know getting more out of them from a profitability perspective.

Jason W. Cohenour

That was definitely accretion as …

David McLennan

Yeah.

Jason W. Cohenour

Certainly makes targets higher priority to the extent that they can accretive Paul.

Paul Treiber - RBC Capital Markets

Okay and this is specifically looking at automotive, you announced a number of design wins. Does it feel like you have, you're one of the vendors with some of the stronger momentum in this space? And then could you just talk around how you feel like your revenue share is on the existing automotive business. Or your design win share going forward compares versus competitors?

Jason W. Cohenour

I would say from a module provider standpoint and again it’s a pretty, it’s a complex segment albeit by saying that but as a discreet modular supplier I would say that we probably have leading global share in the automotive segment although our competitors and we don’t segment our results down to that level. And I would say that we’ve been over the past three years very successful from a, you know from a design win hit rate standpoint. I would say competitive. You know we haven't certainly haven't won them all and some of our competitors have won those, have won programs that we’ve competed for but I would say that we are with respect to the design wins we’ve secured, I would say that we are in a position to certainly protect our share and possibly build on it.

Paul Treiber - RBC Capital Markets

And in terms of the ecosystem for automotive, you have a relationship with Carman, how much can you leverage that or how much are you leveraging that to get into other OEM customers where you may not have a relationship. And you know can you explain the process in terms of how an OEM evaluates a potential vendor versus other vendors that are looking at it, specifically on a modular by modular basis or do they simply buy a system, an integrate system from maybe a supplier like Carman.

Jason W. Cohenour

Well, yeah, the automotive manufacturer is not usually involved in the module selection. Yeah, that’s not in all cases but I would say they are not usually involved in the module selection. Sometimes they're influential, sometimes they’ll actually mandate it but I would say the majority of the time they really rely on the tier one solution provider to make that selection. And to make sure that it, you know that it achieves approval by the automotive OEMs engineering teams and commercial teams. But that’s the way that we think about it. Now you know I’m not going to put a percentage on it, maybe for great than 50% of the time the automotive OEM is looking to tier one to make the right decision and then you know deliver the right solution on time and on budget.

Paul Treiber - RBC Capital Markets

Okay and then when you look at 2014 the number of different vertical markets out there, which one do you think is probably going to show the most growth or which couple do you think are probably the most attractive in 2014?

Jason W. Cohenour

You know I’m not, the same three we tend to mention. It’s automotive, energy and networking. You know there is a broad base, highly fragmented so there is always, you know, the next new interesting application that come along like water purifiers as you heard. But schematically, in terms of the big segments that move the needle for us it’s really those three.

Paul Treiber - RBC Capital Markets

Okay. Thank you. I’ll pass on.

Jason W. Cohenour

Sure.

Operator

Your next question comes from the line of Peter Misek from Jefferies. Your line is open.

Peter Misek - Jefferies & Company

Thank you. You mentioned small wins with police departments. What if, you know what kind of public safety on them product services are you winning. How does that environment looking like. That’s my first question and then I have a question on the tablet market.

Jason W. Cohenour

Yeah, sure, public safety has long been a key market for Sierra Wireless going back to, oh gosh, the 1990s. So we’ve got a long time relationship with public safety agencies predominating in North America. We’ve done very well with them and then when we purchased AirLink in 2007 that certainly bolster our position in the public safety space. So you know generally speaking our devices are used in police cars as you might imagine and they are either connected to or embedded in the rugged laptops used by the police officers and increasingly the applications are getting I would say more and more sophisticated with many more peripheral devices being connected into the gateway or router that’s onboard a police car. Anything from a video camera to you know shotgun racks to sensors that monitor the doors and the trunk lid. So I would say you know healthy, you know reasonably healthy environment. Of course funding isn’t all that great for state and local but I'd say very solid segment for us. And as band 14 becomes more real, I'd say it’s, in the future, a very interesting defensible growth opportunity and a profitable one for us.

Peter Misek - Jefferies & Company

The next question is around tablets and you know we're seeing increasing uptake of Wi-Fi only tablets. How should we think about your ability to go into some of this Wi-Fi trend where we're seeing you know Wi-Fi hot spots 2.0 consortium standardize and effectively allow the exchange or hand off of a cellular call. Do you see that as a threat? How do you think you can you know capitalize on that if there is an opportunity there for you?

Jason W. Cohenour

Yeah I don’t, you know penetration rates of wide area wireless inside laptops and tablets and by the way tablets I would say is a very small part of our PC OEM business right now. I would say it’s a, you know, penetration rates right now are still well below 10% and you know of course we would like to see them go higher and perhaps they will but there seems to be this you know core group of enterprise applications that Absolutely must have wide area wireless embedded in the laptop and that’s where we have our opportunity, both in terms of increased penetration but really more recently share gain for us. As you know as other players have backed away, we’ve been able to capture a lot of that share. So you know for us I'd say it’s an interesting business. we don’t view it as a high growth opportunity necessarily but we will, you know, we will follow the industry there and I don’t, in my opinion, I know there is a lot of downside risks from an overall segment standpoint in the PC OEM space and I think there is also interesting upside opportunity should penetration rates actually head north.

Peter Misek - Jefferies & Company

Last question I had was more on the M2M growth, sort of growth rates in the entire industry. They're okay but they're certainly not lighting the world on fire in spite of the you know, these proclamations of the Internet things et cetera. I ask this a lot of times. What do you think is the after burner or the fuel that gets us out of this sort of locked in gravitational pull. How do we get that lift off? How do we get that –

Jason W. Cohenour

Yeah, it’s a great question. I think you know I do think there is a macro overhang here, Peter. I think that you know for us, again if you look at our geographical segmentation Europe is definitely a headwind. It has not been fun. And I think M2M thrives in a healthy macroeconomic environment. So I think that is one key enabler. And I do think ultimately inertia takes over. I mean there is, you know, so much focus and attention and hand waving and investment that this will continue to you know push the rock up the hill if you will and increase awareness, stimulate demand, and over time accelerate the growth rate in the industry.

David McLennan

And I'd add structural things, Peter, like e-call in Europe, you know those are structural drivers in a particular market that could significantly add volumes in the future.

Peter Misek - Jefferies & Company

Great. Thank you, guys.

Jason W. Cohenour

Sure.

Operator

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

Todd Coupland - CIBC World Markets

Hey, good evening, everyone.

David McLennan

Hey Todd.

Todd Coupland - CIBC World Markets

I didn’t get this at the beginning so I apologize. It’s definitely been referred to but I just wanted you to clarify what was the growth rate, organic growth rate in your overall business in the quarter, if you exclude say Sagemcom.

David McLennan

Modestly down.

Todd Coupland - CIBC World Markets

Okay. And within that mix, I know you're not going to break out PC OEMs but how, what type of percentage decline did the PC OEM business experience in the quarter?

David McLennan

Yeah, Todd, we don’t really want to get that specific on a particular product line. You know the way to think of it is that PC OEM was down and balance of our modular business was fairly flat actually.

Todd Coupland - CIBC World Markets

Okay.

David McLennan

And those are the year-over-year comment and of course we experienced strong sequential growth though in, across the product lines.

Jason W. Cohenour

Yeah, I’ll also add that Q2 was a pretty tough call for PC OEM in that PC OEM was you know certainly the largest contributor to the organic business being down slightly.

Todd Coupland - CIBC World Markets

Yeah and basically your thesis on the PC OEM business is even though there is pressure that we all understand in the laptop space, you're thinking that the offset will be broader LTE, takeout. Is that the way you're thinking about that over the next few quarters?

Jason W. Cohenour

Well, actually I think the first thing is share gain, right. so that’s, you know for us it’s been about getting you know more design wins as competitors have kind of fallen away but getting more design wins in more platforms. And then hopefully ultimately increases in penetration rate driven by things like LTE. But I think for us to have, to be a nice business and actually even a growing business we don’t need penetration rates to go up all that much because we can grow our revenue through you know through the design wins we’ve already secured from competitors.

Todd Coupland - CIBC World Markets

Okay. And then the same point that I asked on PC OEM on Europe. I mean I know you're now going to break out the exact percentage but orders of magnitude how much of a decline is Europe on right now?

Jason W. Cohenour

Well, you know for several quarters and you know just a little bit mottled of course when you layer in Sagemcom but you know it, Europe continues to be (inaudible). I’ll have to leave it you know in general like that but Europe continues to be flat and the Americas continues to be the bright spot.

Todd Coupland - CIBC World Markets

Okay. The tax rate I think you said for the guidance was 30%. That seems like a step up to me in the tax rate from prior models. Or did I just not update my model. Have you been guiding to 30 for a while?

David McLennan

Yeah we have, Todd. That’s, you know we came up the last quarter I believe and you know, that’s where it came in in Q2 and that’s where we think you know the back half will be as well.

Todd Coupland - CIBC World Markets

Okay. My last question, there is a long-term obligation on the balance sheet. I think its accrued life, accrued royalties or something like that.

David McLennan

That’s the, yes, that’s the biggest component of that.

Todd Coupland - CIBC World Markets

Okay. How often will that get paid back? I mean do we need to net that against the cash or think of that as, how should we think about that that line item?

David McLennan

You know that accrual is there to cover all potential future licenses for third party IT. So you know where we don’t have a license and we believe we can size a you know royalty rate, we accrue for that, that amount.

Todd Coupland - CIBC World Markets

And then as you ship products, it’s just, it just flows through the P&L?

David McLennan

Yeah, think of it as you know we burden our cost structure with an accrual for those kind of estimated future liabilities or goods or cost of goods or product costs.

Todd Coupland - CIBC World Markets

Okay, that’s great. Okay. Thanks, gentlemen, I appreciate it.

David McLennan

You bet.

Jason W. Cohenour

And Laura, we’ll take one more caller.

Operator

Yes, of course. Your next question comes from the line of Gus Papageorgiou from Duetsche Bank. Your line is open.

Gus Papageorgiou - Duetsche Bank

Thanks. Just heading back to the auto for a second. So you had several, I think one or two auto design wins. Can you give information for the 2015 E-call mandate for the EU. How many more design wins are scheduled to go and what do think it’ll be wrapped up. Is it safe to assume that by the end of this year, all the assignments will have been determined? And then when do you think you will start recognizing revenue on this. I’m assuming since you would have to build the 2015 models, it will probably get delivered this time next year. And would it be roughly this time next year that you’ll start seeing revenues or if it could be a quarter ahead because you will start shipping to the OEMs. and then finally are these, are the auto guys, are they just kind of doing the minimum so are they just going for the 2G solution or are some of them looking to get the AR7 taking this opportunity to connect the cars to LTE.

Jason W. Cohenour

Well that’s a lot of questions Gus. Let me, so with respect to it’s arranged. Think of, I’ll start with your last question first. it’s really, you know whether or not it’s 2G, 3G or 4G is really, it really depends on whether or not the automotive OEM wants to be strictly OEM compliant with E-call or it they want to deliver you know a suite of value added services to the vehicle. Call it in flow attainment applications. So yeah, I’ll generalize very carefully here. I would say you know 2G if an OEM just wants to check the box, it is predominantly 2G today. Although we are seeing some automotive OEMs implement 3G for their E-call solutions. And that is less around, less about functionality and more about sustainability of the network service. And then higher end cars who are you know whose manufacturers are really focused on delivering a broader suite of services to the driver, are increasingly focused on 4G. So that’s the line up and we see programs across the spectrum. And even within a single manufacturer, you will see programs across the spectrum. And then you, you know getting out of E-call here for a moment, then you multiply that times the other geographies that the OEM wants to launch in.

With respect to the activity around E-call right now and where we are in terms of design wins and awards to be issued, I don’t know. I don’t, there is some activity. There is still bids so I don’t, you know I don’t think at this point in time that every automotive manufacturer has their plans firmly in place in terms of you know selected solutions and deployment for the market. So I think there is more deals to come and to be awarded. We still see a lot of activity across the number of OEMs.

And I think there was another question in there but I can’t recall…

Gus Papageorgiou - Duetsche Bank

When you think you will start recognizing revenue on the E-call initiative.

Jason W. Cohenour

On E-call? On E-call, yeah, I guess you could say we're actually recognizing some of it now because you know some car companies have selected certain models of the E-call compliant well ahead of when the regulation goes into effect. But you know in terms of you know I guess automotive, the most recent wins, you know it’s going to take a year. So I would say middle of ’14 is when we’ll start seeing revenue contribution from our most recent E-call wins.

Gus Papageorgiou - Duetsche Bank

So this part of next year?

Jason W. Cohenour

Yeah.

Gus Papageorgiou - Duetsche Bank

Okay. Thanks.

Jason W. Cohenour

Sure. And Laura, I think we are ready to wrap up the call so I don’t know if you have any comments you want to make.

Operator

Not at all, sir, you go ahead.

Jason W. Cohenour

Okay. All right. Good. Well thank you everybody for joining today's call and as usual management is available here in our Richmond office for any follow up questions. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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