ORBCOMM Inc. (NASDAQ:ORBC)
Q2 2016 Earnings Conference Call
August 4, 2016 08:30 AM ET
Michelle Ferris - Director of Corporate Communications
Marc Eisenberg - CEO
Robert Costantini - CFO
Ric Prentiss - Raymond James
Mike Walkley - Canaccord Genuity
Mike Malouf - Craig-Hallum Capital Group
Howard Smith - First Analysis
Jim McIlree - Chardan Capital Markets
Chris Quilty - Quilty Analytics
Good morning, ladies and gentlemen, and welcome to ORBCOMM’s second quarter 2016 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. [Operator Instructions] A replay of this conference will be available from approximately 1:30 p.m. Eastern time today through 1:30 p.m. Eastern time on August 18, 2016. The web link service details for the replay can be found in today's press release.
Additionally, ORBCOMM will have an audio webcast available on its website at www.orbcomm.com, an archive of which will be available for two weeks.
I would now like to turn the call over to Michelle Ferris, ORBCOMM's Director of Corporate Communications. Please go ahead, Michelle.
Good morning and thank you for joining us. My name is Michelle Ferris, and with me today is Marc Eisenberg, ORBCOMM's Chief Executive Officer, and Robert Costantini, ORBCOMM's Chief Financial Officer.
Before we begin, let me remind you that today's conference call includes forward-looking statements and that actual results may differ from the expectations reflected in these statements. We encourage you to review our press release and SEC filings for a full discussion of the risks and uncertainties that pertain to these statements. I want to remind you that ORBCOMM assumes no duty to update forward-looking statements.
In addition, the financial information we will discuss includes non-GAAP financial measures. The reconciliation of these non-GAAP measures to GAAP measures is included in our press release.
At this point, I will turn the call over to Marc Eisenberg.
Thanks, Michelle. We closed out the first half of the year with some pretty good momentum and are pleased with our second quarter. We’ve achieved some new highs across our financial metrics and have engaged in multiple new opportunities across the business.
On today's call, I will start with an overview of the business, update you on some of our key projects and transition to Robert to provide some additional color on the financials and wrap up the call with Q&A.
Before we get started, I want to thank those of you who were able to attend our first analyst day in May. It was great to see so many of you, and I hope it was a productive opportunity to learn more about the diversity of our business.
Earlier this morning, we issued a press release announcing financial results for the second quarter ended June 30, 2016. The quarter consisted of total revenues of $50.1 million, increasing 12% or $5.2 million over the prior year period, an adjusted EBITDA of $12.1 million increasing 17% or $1.8 million over Q2 last year.
Looking at the underlying components. Service revenues in the quarter increased year over year by 15% to $27.7 million, and product sales increased 7% to $22.4 million. Our subscriber count or subs grew in the quarter by 41,000 net subs which includes about 10,000 subscribers obtained through the Skygistics acquisition, taking the base to 1.65 million subs at the end of June 2016.
Overall, despite some macro headwinds in specific geographies and vertical markets, the business performed well in Q2, establishing record highs for service revenues, hardware revenues, as well as adjusted EBITDA. Growth in service revenues was attributed to increases in subscriber counts, higher rates of installations, as well as the enhanced capacity and coverage resulting from the improved service of our OG2 satellites. Product sales also reached new levels as we executed on numerous opportunities, both large and small, shipping 53,000 pieces of hardware in the quarter, also a new high. $12.1 million of adjusted EBITDA is a recent high as well.
Moving on to business highlights. Our North American transportation business continues to gain momentum. We received a large number of renewal orders from many of our longstanding transportation customers such as Prime, Bay and Bay, Marten, Target, C&S Wholesale, Frye Miller, KLLM, NAPA Transportation, CTL, CR England, Knight, Swift, Hub, and Werner.
In addition, we are engaged with a significant number of new customers, including Gulick, Northern Refrigerated, Barnes Transportation, Kings Express, Mayer [ph] and Spartan Stores. These new customers demonstrated our ability to consistently meet the customer needs for multiple fleet sizes, asset classes, or integration requirements. Many of these opportunities have already started shipping in Q3.
Over the past few quarters, we have made mention of our project we developed with a large cold chain OEM according to their design and qualification requirements. This morning, Carrier Transicold of United Technologies will announce it will be offering a customized cold chain telematics solution for their truck and trailer transport refrigeration units as a factory option. This solution will help carriers' fleet customers manage their refrigerated assets by enabling two-way remote monitoring, diagnostics, data management, and other value-added capabilities. We have made great progress on this program, as well as supporting Carrier Transicold successful field trials and are expecting the full release of the solution to start in North America in 2017, followed by rollouts in Europe and other regions of the world. We're pleased to have been chosen to support a global leader like Carrier and help them provide their customers with the latest tools to better track and monitor shipments.
We continue to make progress with China International Marine Containers or CIMC, the world's largest manufacturer of shipping containers. In the second quarter, CIMC placed an order for an additional 1000 OG2 modem chipsets to continue building their connected container solution. We are anticipating customer pilots to commence later this year and for their product to be commercially available in 2017. The partnership with CIMC extends beyond the container market as we are looking to partner together on additional opportunities.
We are continuing to see momentum in our containers and ports or CAPS business obtained through the WAM acquisition. We sold 3600 refrigerated container units through a large US cell provider and integrator in support of a leading marine, transportation and logistics company to track and monitor their sea containers. Whether on a ship or across the highways, these products give complete temperature, logistics and diagnostic visibility to transporters around the world.
We are currently tracking a number of opportunities in the CAPS business and hope to update you on further progress over the next few quarters.
We closed the Skygistics acquisition in late May and have quickly made progress on integrating the sales and distribution teams based in Johannesburg, South Africa. Skygistics, now called ORBCOMM Africa, expands our geographic presence on the African continents across multiple industries, and we expect it to generate opportunities for both our connectivity and solutions businesses in this fast-growing geographic market.
Our Q2 results included about one month of their revenue or about $300,000, and we expect it to generate about $1 million per quarter over the next few quarters. We have now closed on a significant number of acquisitions and believe each one has contributed to expanding our geographic reach, our technical capabilities, or our distribution into incremental vertical markets. We have added to our scale, level of expertise, and the quality of our service. Nearly every new large opportunity we pursue is supported through multiple resources and technologies we’ve gained by combining these acquisitions.
Turning to AIS, we continued to grow revenue which reached a record high of $1.7 million in Q2, an increase of 36% over the same period last year, which is partly due to the improved level of service from the new OG2 constellation. This is evident by the recent announcement that the European Maritime Safety Agency, or EMSA, awarded a four-year contract to our reseller and partner, LuxSpace Sàrl, to provide satellite AIS data. The multi-year contract is funded for up to $11.2 million in US, a good portion attributable to ORBCOMM, and is expected to start adding revenue in the fourth quarter of this year. EMSA will use the data for ship tracking and other maritime navigation and safety applications.
ORBCOMM was also recently selected by Genscape, a leading global provider of energy information for the commodity, shipping, and financial markets, to provide our AIS service to their customers. These exciting wins for ORBCOMM's AIS business reaffirm our position as the industry's preferred partner of satellite AIS data. In Q2, we shipped the first order of our dual-mode PT 6000, using a combination of cellular and satellite connectivity. This product combines our next generation cold chain monitoring device with an embedded OGI modem to enable one of the largest rail companies in North America to track, monitor, command and control their refrigerated assets across the continent.
We also began field trials for the PT 7000, our new heavy equipment telematics solution, which is available as a cellular device or dual-mode adding satellite that enables OEMs, dealers and end-users to proactively manage their fleets. The PT 7000 works with our newly enhanced FleetEdge web application delivering comprehensive dashboards, advanced reports and analytics, custom charts alerts and more. We expect the first shipments of the PT 7000s to begin in the near term and then larger volumes next year.
In recognition of our excellence in innovation, we received the 2016 Smart Grid Product of the Year Award from TMC and Crossfire Media. ORBCOMM's dual-mode satellite cellular solution enables utility companies to effectively manage their smart grids by monitoring and controlling reclosers and other distribution devices in real time.
By managing the information exchange and reporting process between the utility companies' control center on the equipment site, our smart grid connectivity solution helps customers improve the reliability and availability of real-time field data, making power grid decisions easy and manage the equipment regulating the distribution network. We will be showcasing these products and others at the CTIA show in Las Vegas in September. Feel free to stop by our booth if you are in town.
To wrap up my section, the business is moving along as expected. We are still battling macro headwinds in some geographies and vertical markets such as Brazil, heavy equipment and government. We are seeing strength in transportation, AIS, and our CAPS division.
Overall, we are pleased with our performance in the second quarter. We continue to trend toward our guidance metrics and are encouraged by some exciting new customer opportunities, as well as new products still yet to hit the markets. We continue to show leadership in innovation as a premier global IoT solutions provider, and we are encouraged by our position in our markets.
With that, I’d like to turn the call over to Robert to take you through the financials.
Thank you, Marc. Good morning, everyone. Overall, Q2 2016 performance reached a number of new highs, delivering total revenues of $50.1 million, service revenues of $27.7 million, and product revenues of $22.4 million, which resulted in $12.1 million of adjusted EBITDA. Service revenues are demonstrating sustainable growth from a higher subscriber base and benefiting from the OG2 network performance. Product sales rebounded as expected from Q1 levels, and cost and expenses are within our target ranges.
All in all, a productive quarter. Total revenues of $50.1 million were up about 12% in Q2 over the last year as both service and product revenues hit historic highs. The revenue mix reverted back to projected levels with service revenues of 55% and product sales of 45% in the quarter.
Service revenues took a step higher in the second quarter, exceeding our expectations and surpassing the analyst consensus estimate to a record $27.7 million, up 15.3% compared to the prior year period. Organic service revenue growth for ORBCOMM satellite and transportation solutions was 11% and AIS revenues grew 36%. The growth was partially offset by softer demand for IDP services in South America, leading to overall organic growth of 7% year over year. Gross profit from service revenues was $2.7 million higher than prior year.
Second quarter product sales increased $1.5 million or 7.2% over Q2 last year to a record $22.4 million. The quarterly year-over-year increase in product sales was largely driven by transportation solutions in the US and Europe and in new markets like containers, partially offset by lower hardware sales in the South American markets.
There were a broad range of product shipments for large and small orders compared to last year, which had a very large shipment to a single customer. Total gross profit of $23.5 million in the second quarter improved by $1.7 million or 8% over the prior year period due to increases in both service revenues and product sales. Service, gross margins for Q2 2016 were 66.2%, consistent with expectations, and 80 basis points higher than the prior year quarter.
Gross profit from product sales in Q2 was at 23.1%, lower than recent norms, predominantly driven by two factors: first, Q2 contained a number of large deals at lower margins, and second, we thought it was an opportune time to move some aging inventory to position it for future service revenue growth.
We continue to target 25% product margins for modeling purposes over the second half of 2016 as we cycled through the remaining inventory. The new highs in revenues contributed to a solid Q2 adjusted EBITDA of $12.1 million, growing $1.8 million or 17% over the $10.3 million in Q2 last year. The adjusted EBITDA margin of 24.2% in Q2 improved from 23% in the prior year quarter.
The company had a net loss of $4.2 million in the second quarter of 2016, improving from a net loss of $12.2 million for the same period last year. On a comparative basis, the last year 2016 had increased gross profit, but also higher depreciation and amortization and interest expense.
So last year's second quarter included a satellite impairment charge. Depreciation and amortization increased by $4.9 million in the second quarter to $11.6 million, mainly due to a $4.5 million increase in depreciation from the new satellites and service. For the third quarter of 2016, we expect depreciation and amortization expense to be roughly the same as Q2.
Acquisition-related and integration costs were $0.6 million in the second quarter, this year mostly from the Skygistics acquisition compared to $1.1 million in the same period last year. We expect between $200,000 and $300,000 of acquisition-related and integrated costs for Q3 of 2016.
Interest expense for Q2 was $2.4 million. For the full year 2016, interest expense should be about $9 million, including the amortization of fees.
Looking at the balance sheet, cash, cash equivalents, and restricted cash totaled $15.5 million at June 30, 2016, compared to $28.1 million at December 31, 2015, a decrease of $12.6 million. Cash provided from operations was $7.9 million through the first half of 2016, which reflected a $10.1 million use of cash for working capital purposes.
In addition, we paid $3.8 million for the Skygistics acquisition this quarter. Capital expenditures of $16.9 million included $6.7 million due to the completion of milestone and insurance payments for the OG2 program related to the final launch in 2015 and $1.6 million of capitalized interest.
Breaking down the capital expenditures further, $3.6 million related to sustaining CapEx for existing infrastructure and $4.9 million related to investment CapEx for new products and services. Our total debt outstanding at June 30 remains at $151 million with an available $10 million undrawn revolving credit facility.
For the full year 2016, we are reaffirming our outlook of approximately $200 million in total revenues with about 25 point margins for adjusted EBITDA. Given the growth and predictability of service revenues, the key determinant factor in achieving those numbers is our ability to ship roughly $85 million to $90 million in annual product sales. We see hardware shipments in Q3 being similar to Q2 and anticipate growing service revenues quarter over quarter.
So wrapping up, we are pleased with our Q2 performance and are encouraged by the trends, including the increasing number of shipments and our diversified business strength.
This concludes our remarks for this morning on this call, and we are happy to take your questions.
[Operator Instructions] We’ll first hear from Ric Prentiss with Raymond James.
Thanks, good morning guys. One kind of strategic question and one detailed question, if I could. Obviously, this week Verizon had the Fleetmatics deal announced. How do you think that impacts the space? And then, also, what does it do to potential M&A that you guys might be interested in?
Yes. That was a big deal, right? So Fleetmatics was the – it’s the biggest company that I am aware of that trades publicly that is solely dedicated to IoT, and we certainly love the valuations that Verizon paid.
From a competitive perspective -- let's start with that viewpoint. From a competitive perspective, they are in the fleet businesses, predominantly small fleets. They’ve got 30,000 something customers and 700,000 subs. Their average fleet size is something like 20 units. And ORBCOMM is in the commercial markets. We are not in fleets. We are predominantly in cargo, and we weren’t doing business with Fleetmatics anyway. So I don't see a change in terms of our markets. I don't see anything there. But, what else is kind of interesting that Verizon is kind of adopting ORBCOMM's strategy of rolling up some of these companies and adding scale. This is the third one that they have acquired, including Telogis and use Telematics.
So let's say neutral on the market side, but I think on the M&A side, I think there's a lot of folks looking at the opportunities that we were kind of the only guys out there in 2010. And valuations certainly have come up. That being said, I don't know that there is a relative change because the evaluations have -- companies like ORBCOMM have gone up as well. But I think there is a sweet spot there where other than the SkyWave acquisition, which was really large for us, in that middle to small range, we can still find opportunities out there that some of the big guys like Verizon wouldn't be looking at.
Makes sense. On the more detailed side, the AIS, I think, Robert, you mentioned up 36%. I think for a while, you've talked about maybe the quarter to quarter pacing growing $200,000. How is that playing out? How long can that play out? Just kind of give us an idea of the trends and the runway you see there.
Sure, Marc did that.
I think we are right on track and, Ric, you haven't followed us that long, but, gee, it feels like eight years ago we said this thing is a science project with one or two satellites, and it’s a $1 million or $2 million business. After launch one, we think we will be to a $5 million to $7 million business. And, sure enough, I think we are trending $6 million. And then, all-in, we think it’s a $10 million to $15 million a year business. And it’s funny because we are kind of talking down the estimates versus what our competitors do. Oh, my God, it’s a $500 million business. It’s not, and I hope I am wrong. But, I think what you are seeing is, as we closed the Genscapes, which is pretty big deal, and we closed the EMSA, which – it’s a really big deal. About half the EMSA revenue is attributable to ORBCOMM over four years. I think you can kind of see our runway as to some of the opportunities that get us to that $10 million to $15 million. I think you're going to see a $200,000 increase or close between Q2 and Q3 and, again, in Q4, and I think we're going to kind of run in that direction until we get to the $10 million to $15 million, and it’s just amazing that nothing has changed.
And we’ll move on to Mike Walkley with Canaccord Genuity.
Congrats on the record milestones for your company. Marc, on the Carrier news, now that it’s announced you are with Carrier, can you just talk about how that program is going and maybe how that might position you to reach maybe 300,000 reefers that you need to be compliant with the food safety monetization by 2018?
Sure. Sure. Did you sense it was Carrier? Was that your guess?
It was, yes.
Can't fool you. So what Carrier has done so far is they are out there piloting with key customers. So, for this year, the opportunities that we have are with some of these larger deployments that they have been targeting. And then, early next year, literally it becomes a stock keeping unit at the -- from an aftermarket perspective at their dealer network and something that you can order as a factory option. Long-term, we are hoping -- they haven't promised us this, but I believe that the goal is that -- or at least it has been for other OEMs and other industries that it becomes standard on every unit. And then, not only do you get the retrofits, but you can get 20,000 or so units per year on a going forward basis.
This Carrier product, it does things that are very, very cool that makes it -- that gives them an advantage in this business, at least in selling the Telematics in that it’s really well integrated with the refrigerated unit that you can download firmware over the year -- over the air, and you don't have to bring in the reefer to a dealer to get the latest firmware. You can update the intellisets or how they gauge temperature in the profiles over the air. And unless you are able to write to the carrier reefer, it’s not achievable, which really makes this thing special, and then it takes a lot of the risk out of the installation process because it can be installed at the factory.
I think it’s going to start off slow this year, I think it’s going to pick up momentum next year, and I think it’s a real winner. We were really excited about winning this opportunity.
Great. Thanks. And if you look at the other major OEMs, Thermo King, do you still have opportunity with them? Are they going with their own solutions and that precludes you from being on some of their end customers?
We are shipping on Thermo King units every day, and let me just explain. The Carrier product is a product that we built specifically for Carrier. So it’s got a Carrier logo. It’s hosted in a different center. It is in no way tied to the ORBCOMM product. So I think Carrier is going to do a really good job closing Carrier fleets, and ORBCOMM will do a good job with the mixed fleets. So there’s Thermo King customers out there. There’s Carrier customers out there, and there is mixed fleet customers out there as well.
So we sell as many Thermo King units today as we do on Carrier units. So, on the ORBCOMM product, absolutely nothing has changed in there. Thermo King sells a product as well. They have for years, and they do those on Thermo King-only fleets predominantly. And we hope they are successful there. On the container side, specifically the gen sets, Thermo King sells an ORBCOMM product. So we are partnered with them in some ways as well, and we consider them a good partner as well. So I think we have managed to fly pretty well.
And then just going to the product gross margin a little bit below, can you or Robert walk us through how much of that inventory is left? What kind of products is it for in terms of the impact in the short term? And then, also within product revenue, it’s flattish sequentially. It points to kind of a big Q4 sequential growth to come in the midpoint of your guidance. Is that kind of how we should think about it? Maybe a $22 million to $23 million in Q3 and then $26 million in Q4 for product revenue, is that kind of how you're seeing your business lineup?
I will let Robert explain the gross margin thing, and then I will just jump in with the Q4.
Okay. So the -- sort of the detail down there, there is a little bit of that inventory left. And even going back from our Q1 call, we were telling people to target those 25 point margins, and we had 39 point margins in Q1. And we had this opportunity to move some of this inventory. And typically, it was just -- it was inventory of the type that we had to either move because with the new manufacturer we are going to be getting sort of refresh product.
The inventory that’s left is a couple of million dollars. It’s probably going to bleed out in Q3. We are expecting to be fully transitioned to the manufacturer and start seeing some of those cost savings, I would say, in Q4 in terms of the manufacturing benefit. But I would say, again, let's continue to target the 25-point margins into Q3 and Q4, and that should pretty much take care of all of the remaining inventory that might be subject to those types of decisions.
Yes. And if I can add to that, I think we're going to come out -- there is a couple of more shipments that we will take care of in Q3, but we are going to come out with some pretty clean inventory. Not that we carry a ton of inventory. We don't. But it’s pretty nice to see the inventory number this quarter fall, and the receivables rise pretty healthfully.
Let me just explain the way the guidance works in the second half of the year. I don't -- from what I can see, we are going to sell a lot more hardware in the second half of the year than the first half of the year, even though that’s what I see. When we trip up -- I think you guys get the feel that we have got pretty good visibility to our business. When we slip up, it’s typically a quarterly slipup where what happened this quarter. Stuff that was supposed to ship on the end of Q1, moved a couple of weeks and it shipped in Q2, and the numbers kind of balanced just where they were supposed to. So when we look at the Q3 and the Q4 guidance, we are really sensitive to that, and I don't want to be the kind of guy that only warns you that hardware sales could be lumpy when times are bad. Q2 was a great quarter for hardware. And I am telling you right now, hardware sales could be lumpy. So when we guide you to Q3, we are trying to take into consideration that hardware sales can be lumpy.
Now, that being said, 2014, 2015, there was an awful lot of focus on Hub Group, some focus on Walmart, and some focus on Doosan, and those were some of the key deals. And then the question that we had on hardware is, okay, when those deploy, great news for service revenues, and you are seeing that. But how do you replace those revenues, and how do you grow this year and how does hardware grow? And there are a number of deals that we are watching. Some of them you are seeing close. You are seeing CIMC close on the service side. You are seeing EMSA close where, just winding down with another OEM that is going to be buying our hardware, we hope to make an announcement soon on that. That’s going to close.
But imagine that what you have got coming are instead of just Doosan and Hub, which were great deals, but imagine there is eight of them that we are working on now that are between the stages of working through a contract or just kind of finalizing pilots or in some sort of the end of some competitive process that we think that we can do well. There are hundreds of thousands of units that we are bidding on that we think that we are likely to win. I can't say that we are going to win every one. But I think that we are likely to win. And the thing that scares me is not winning them; it’s the timing. It’s what quarter they fall into and how much of it falls into Q4. So we keep guiding you to approximately that $200 million because we are sensitive to that, and that’s how the guidance is built.
Okay. That's very helpful. I get that. And then, last question for me and I will pass it on. Just on CIMC with them coming back and placing additional orders, can you help us size or just think about the opportunity now that you have been working with them longer, how it looks maybe into 2017 and beyond for this type customer? Thank you.
I think CIMC is going to be in the low tens of thousands units in the next couple of years, and then I think it’s going to grow from there. The upside, obviously, is, gee, they build 2.5 million containers a year. If these OEMs continue to standardize, that would be wonderful, but I can't guide you to that because I don't know that and I haven't said that. So -- but even at tens of thousands of units a year, it’s still a really big deal.
But CIMC doesn't stop there. CIMC is our partner in China. They are our partner in China. And if you have seen who owns CIMC, they are owned a whole lot by Costco, and Costco is the Chinese Maersk. So they have got a customer there, and they are partially owned by one of the Chinese banks and really good partners to have there. And, as I said, they are going to be our partner in the Chinese market, and they have gotten further in terms of getting ORBCOMM's license in China than anyone has ever gone before. And so they will be our partner on all deployments inside China and a whole bunch of containers outside of China. And this is an exciting deal, I mean, really exciting. And we will just keep working toward it.
And next we’ll move on to Mike Malouf with Craig-Hallum Capital Group.
Marc, I was wondering if you could talk a little bit about the MB&O business, and as the 2G sunset gets closer and closer, when do you expect the largest activity there, has it started? Maybe you could just give us an update on that.
Sure. So let's talk about the sunset first. The big one is AT&T, and AT&T will sunset the end of this year. That’s the plan. So we are only five months away. And so the way AT&T at least has done it with us is there is a quarterly decline in the amount of 2G subs that you have. So every day you need to be churning those subs, and then literally December 31, you have got a bunch of subscribers looking for a home.
So let's talk about the churn before we talk about the growth. So I think ORBCOMM is down to -- now, keep me to 1000 or 2000 -- I think we are down to something like 8000 2G subs left. So those will churn by the end of the year. And keep in mind, our competitors are talking about 1 million. So 8000 is what we have left, and we continue to work towards our customer in churning those.
A lot of them have been swapped out. We started in the 20,000 or 30,000 level. A lot of them have been swapped out, and what you have left is a lot of the older products that these guys will anticipate churning when they get a new reefer or when they get a new trailer as opposed to swapping out a unit on a really old piece of hardware. So that’s kind of what we are seeing. So you’ve got a lot of it in this quarter, which is why, gee, I am disappointed with 41,000 subs because 10,000 of them were Skygistics. I would have liked it to have been 40,000 without it, and you are getting a little bit of the 2G in there.
In terms of going forward, I think our guys are assigning a new 2G -- I'm sorry, a new terrestrial customer every couple of days. And what we are not getting is a ton of retro backwards because the complete sunset hasn't happened yet. What we are getting is an awful lot of new deployments going forward. So you sign a customer, you get a couple hundred a month in perpetuity, and we are seeing a whole lot of that. But in terms of the amount of deal flow that we are getting, really high and really promising going forward.
And then, with regards to CapEx, it sounds like you had about $8.5 million of CapEx, sort of direct CapEx with about $5 million of it which related to growth. Can you talk about a little bit more about -- I know you have sort of said that you want a good chunk of that to grow. Do you have a lot identified on the CapEx side for growth over the next year, and do you have any more clarity or any more color on that as you go forward?
Yes, we do. So these are programs, as a lot of you have heard on the analyst day that are in play -- or are in place. They are going to take many quarters to fully develop. So, again, our plans are still consistent with what we described back in May, which is roughly $16 million to $17 million of CapEx, excluding the OG2 related and breaking that up between sustaining and growth. So probably another $2.5 million to $3 million per quarter for growth CapEx in Q3 and also in Q4, and that seems to be like the run rate I am seeing right now. It won't dramatically change as we move into the new year because, again, these programs have to be all be vetted upfront, and then they are approved, and then they take several quarters to play out. So I think we are still right on track with where we expect it to be.
And next we’ll move on to Howard Smith with First Analysis.
First, we just hit the MB&O. Another theme from the analyst day maybe you can provide an update on is just the consumer business. I know it’s in its very early stages, but any update in your development thinking there?
So the first aspect of our consumer business is really that fell over router business. And we went from zero in Q4 of last year, and now we are shipping 100 or a couple of hundred a month. So it certainly is ramping up, and we’ve just become the premier customer that one of the major cellular providers is going to as they sell that. So we swapped out one of their incumbents. So we see that continuing to grow. We are currently evaluating a number of products that we would not be building from a hardware perspective and putting it through our portals, and we are entertaining some field trials and some other things for some devices tracking some consumer whether it be pets or people looking at that as well.
But I think the highlight is that back up your iPhone or your iPad with a satellite device, so when you are camping or on a ship or whatever, you can have a couple hundred dollar device that you can send texts or emails over the air. And the progress on that is kind of just in line with the progress on the ASIC that we are building with Inmarsat. So, as that develops and hits the market, which will result in drastically increased -- or I should say decreased product costs across everything we build, on the Inmarsat network, that product will come out as well.
Great. Thank you. And just kind of housekeeping questions. All the Skygistics revenue on the service line?
No. Historically, it’s about 60:40 service to hardware.
So not that different than your existing is. And lastly, the operating cash flow – I mean you are using a lot of working capital. Would you expect to start to see, though, more of the cash go to that operating cash flow line in H2?
Yes. Yes. We see that every year. That’s, I'd say, been pretty consistent since we have been in the hardware business over the last several years. So, yes. So receivables bounded up this quarter. Inventory stayed flat. We are working very hard on managing those components. So yes, those receivable should start turning around. Again, that will generate, again, cash flow. The only dynamic that we have to just continue to monitor is how the business keeps on growing. So we don't -- we think that’s a bit higher than it should be, so we are expecting receivables to come down and cash balances to increase into the second half.
There is a lot that we have taken on in the last couple of quarters. We are taking costs out of our products. We are moving from Singapore to a Tier 1 manufacturer in Mexico. In the middle of doing that, we are clearing out our old inventory. I think there was an awful lot of cleanup this quarter.
Yes, it’s nice when it is supporting growth, and congratulations on another busy quarter. It looks good.
[Operator Instructions] Next, we’ll move to Jim McIlree with Chardan Capital.
Thank you and good morning. If my notes are correct, I think Skygistics added about 10,000 subs in the quarter, which implies that the organic sub growth was a little bit lower than Q1. I was wondering if you can talk about that a little bit.
Yes, I don't think that satellite changed a whole lot, Jim. I think it’s just kind of what I explained, that we are turning down those -- the remainder of those 2G subs, getting to our number from an AT&T perspective. To give you a feel for it, I think that was like 7000 units in the quarter. So, as you add that back in, it’s a normal ORBCOMM sub number.
And then, on the Verizon acquisition of Fleetmatics, I am wondering if that -- if you think that might have any impact on the 2G transition. It may be Verizon is buying Fleetmatics in order to keep their -- in order to have a nice base of customers to transition to their non-2G service when Verizon ultimately cuts off 2G.
I bet. I don't play poker at their table. Those are different stakes than the game we play, but these guys go and take business from each other. One of them wins the OnStar account. They move over 1 million or a few million subscribers. I doubt -- I seriously doubt that the subscribers that are on the Fleetmatics switch are Verizon today. My guess is they are AT&T or maybe T-Mobile, but I am not quite sure. And that part of this is transitioning them over time. I think that is part of it. I think -- I am guessing. I haven't spoken to them, but the theory behind it was just to become an 800-pound gorilla in the fleet business.
I think, from my perspective, and, again, this is purely Marc Eisenberg; this isn't even an ORBCOMM statement. Verizon, when they started out with CDMA, they got off to a slow start in the IoT business because it’s not a global standard, and the costs on the hardware side were higher than the GSM products. So a lot of the developers, because of that, needed to develop on 3G and Verizon got a slower start than AT&T and T-Mobile, and maybe this is their way of buying back into the game. I don't know.
And then, lastly, are you going to be the only factory option on Carrier, or is it going to be -- are you going to be joined by others there?
Are you asking from a contractual standpoint or a practical standpoint?
Well, I was asking contractually, but if you want to answer contractual impact, that would be great.
So, contractually, this isn't exclusive. But practically, their resources have gone into this particular product, and we don't see anyone else coming down the line as a factory option. Now, that being said, there is a couple of other guys that do have Carrier protocols that can sell in the aftermarkets on Carrier devices. But, as you know, we have got an overwhelming share of that business.
And next we’ll move on to Mike Latimore with Northland Capital Markets.
Great quarter. I guess just on the MB&O real quickly, it sounds like there is some churn of the 2G, but in terms of gross adds, how many are you seeing kind of on a quarterly basis?
Oh, wow. Boy, maybe of the -- well, let me back up the math here. It’s not like I love math, but 41000, 38000, about 20,000 are satellite. Let's say 18,000.
About 18,000 a quarter is what they are adding?
But that’s not necessarily – that’s cellular ads. That’s not necessarily the MB&O business. You know the biggest customer is for our MB&O business, it’s ORBCOMM. It’s StarTrak and the others. And a portion of that are dual-mode as well, so you get some satellite there, a good portion of it. But I think we add about 15,000 to 20,000 a quarter.
I understand. On the service gross margin, where do you see that trending over in the next couple of quarters?
Yes, if you look at incrementally, this quarter was over 72 points, I believe, as it keeps that moving higher, so we -- again, it was up a point year over year. I think it should continue to rise. It’s hard for me to say exactly how quick it will be, but I’d say we could perhaps look at another point this year and we will get back to you as to what 2017 looks like.
Okay. And how about the heavy equipment vertical? I know it’s been soft obviously for a while. Is that stabilizing or continue to be a little uncertainty there?
I think it is stabilizing. It’s kind of different for us because in that business, probably 90% of the revenue is sitting on your switch before the year starts. And then you get the incremental growth. So, as a percent of our revenue, it’s still very, very healthy, but the incremental adds are roughly 60% or 65% of the highs that we experienced a couple of years ago.
And just last, you talked about markets -- I think you were working on eight deals or something like that. You are providing an illustration. I guess can you just elaborate a little bit on that? What verticals are they in, and do they represent -- you said several hundred thousand units potentially, something like that. Just a little more color would be great.
So it’s across everything ORBCOMM does. There is an awful lot of transportation, and transportation could be containers or sea containers or trucks or rail. In addition, there are some heavy equipment OEMs that still haven't -- have deployed Telematics, but are switching over to our unit. And some of them we have already mentioned. I mean, Carrier is going to start rolling out in earnest, and EMSA will start in Q4, and CIMC is starting to take units on a quarterly basis. But we are seeing some strength across our business. We are seeing the Brazilian business kind of leveling out. And last year was a disaster there. We shipped almost no hardware, but we are starting to see it come back. But that’s not one of the eight deals.
And next we’ll move on to Chris Quilty with Quilty Analytics.
Hey, Marc, just one question, if you can maybe give us a little bit of color on what you are seeing with the Food Safety Management Act. In terms of actual customer activity and where you think a lot of your potential customers might be in that process, is this one where people are putting it off to the last minute, or are they going to miss the deadline and then when somebody whacks their fingers, they will eventually implement it? Are we in early stages, or are we almost done?
It feels to me that you are kind of like about to round second base. The big guys are implementing Telematics on their units. If you look at the top 25, I would say 22 of them have started deploying or deployed something. So I think the big guys have certainly done their work. The midsize guys, let's say, in the 1000-unit range, I would say are in some stage of figuring out what they're going to do, and then the small guys are barely penetrated at all.
And do you have the right channel to get to the small guys?
Other than the dealer network like the couple of hundred Carrier guys around the world, I don't know how to get to them. That’s how you get to them. The guy who sells them the reefer has to sell them the telematics.
And what about your Carrier partners as a conduit? And, along with that, does the Fleetmatics acquisition change in any way your relationship positive or negative with Verizon?
I don't think the Verizon folks are -- they don't see us in the fleet business, so I'm guessing they are thinking it doesn't change our relationship at all. And I don't know that the Carrier's help with four trucks. These salespeople -- I think they are good at selling like trailer tracking or something relatively simple, but reefer is hard. There is – it’s a pretty complex product. And while they certainly could refer opportunities to us to our in-house sales folks, I doubt they would walk in with a box under their arm.
End of Q&A
And, Mr. Eisenberg, there are no further questions at this time. I will turn the floor back to you for any additional or closing remarks.
Well, thank you for your questions and for participating on the call. We look forward to speaking to you again in November. Thanks.
And that will conclude today's call. We thank you for your participation.
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