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Telular (NASDAQ:WRLS)

Q4 2012 Earnings Call

November 06, 2012 4:30 pm ET

Executives

Allise Furlani

Joseph A. Beatty - Chief Executive Officer, President and Director

Jonathan M. Charak - Chief Financial Officer, Senior Vice President and Secretary

Analysts

Noel J. Atkinson - Loewen Ondaatje McCutcheon Limited

Ellen Mo

Steve Shaw - Sidoti & Company, LLC

James Lee

James Gibson - Punch & Associates, Inc.

Russell Reed Silvestri - SKIRITAI Capital LLC

Cristan K. Blackman

Shai Dardashti - Dardashti Capital Management

Operator

Good day, ladies and gentlemen. Thank you for standing by, and welcome to the Telular's Fourth Quarter Conference Call. [Operator Instructions] This conference is being recorded today, Tuesday, November 6, 2012. And I would now like to turn the conference over to Allise Furlani with The Blue Shoot Group -- sorry, with The Blueshirt Group. Please go ahead.

Allise Furlani

Good afternoon, ladies and gentlemen, and welcome to Telular Corporation conference call to discuss operating results for the fourth quarter and fiscal year of 2012. By now, everyone should have had an opportunity to view the press release distributed this afternoon. If you need a copy of the press release, you can find it on the Investor Relations section of our website.

On the line with us today from Telular's management is Joe Beatty, President and Chief Executive Officer; and Jonathan Charak, Senior Vice President and Chief Financial Officer.

Before we begin, I would like to turn your attention to the fact that forward-looking statements may be made during the course of the call and certain factors may cause actual results or performance to differ materially from what is implied by these forward-looking statements. Please refer to the company's 10-K and other periodic filings with the Securities and Exchange Commission for a discussion of these factors.

During the call, we also refer to adjusted EBITDA, a non-GAAP financial measure. Adjusted EBITDA is a non-GAAP measure, which adds back interest expense, income taxes, depreciation, amortization and stock-based compensation expense to net income.

At this point, I would like to turn the call over to Mr. Joe Beatty.

Joseph A. Beatty

Thank you, Allise, and good afternoon, everyone. We're pleased with the recent results from our 3 businesses, Telguard, SkyBitz and TankLink, as we continue to build upon our stream of high-margin recurring service revenue. We ended the quarter with approximately 840,000 billable units in service, and in particular, we experienced strong demand for our 3G/4G Telguard units in the fourth quarter. Overall, our businesses are operating very well, and we're executing on our strategy to drive growth.

Cash generation remained strong and predictable, allowing us to reward our shareholders with a regular quarterly dividend payment, which we have increased for the second consecutive year since its initiation.

Looking forward, we have introduced fiscal year 2013 adjusted EBITDA guidance that reflects growth of well over 30%, an increase to our quarterly Telguard unit sales guidance as well.

I'll go into more detail on our progress this quarter, as well as our long-term strategy, later in the call.

First, I'm going to turn the call over to Jonathan Charak, our CFO, to review our financial results.

Jonathan M. Charak

Thank you, Joe. Good afternoon, everyone. We delivered strong fourth quarter and fiscal year 2012 financial results. For the quarter, we reported total revenue of $23.4 million, including $13.4 million from recurring services and adjusted EBITDA, a non-GAAP financial measure, of $5.5 million. For the full year, we reported total revenue of $79.8 million, including $46.4 million from recurring services and adjusted EBITDA of $17.8 million.

As we mentioned last quarter, we are now reporting the combined results of our Telguard and TankLink business lines within the Event Monitoring segment, while SkyBitz will be included in our Asset Tracking segment.

For the fourth quarter, Event Monitoring and Asset Tracking revenue was $15.3 million and $7.9 million, respectively. Adjusted EBITDA for Event Monitoring and Asset Tracking was $5 million and $1.5 million, respectively, excluding corporate expenses of $1 million.

For the full year, Event Monitoring and Asset Tracking revenue was $56.1 million and $22.5 million, respectively. Adjusted EBITDA for Event Monitoring and Asset Tracking was $18.4 million and $3.2 million, respectively, excluding corporate expenses of $3.8 million.

Within our Event Monitoring segment, total Telguard revenue was up 24% in the fourth quarter to $13.1 million, including $7.9 million of recurring service revenue. For the full year, total Telguard revenue was up 18% to $48.4 million, including $30.4 million of recurring service revenue.

During the quarter, Telguard activated over 35,000 new subscribers, and the total number of Telguard subscribers increased sequentially to 617,500.

Average revenue per unit, or ARPU, remained flat sequentially at $4.37. It would have increased modestly if the impact of certain customer credits had been excluded. These customer credits also directly impacted service margin, which would have otherwise been consistent with recent quarters.

Telguard product revenue for the fourth quarter was $4.2 million as we sold approximately 39,300 units, above our pre-existing guidance of 30,000 to 35,000 units. The average selling price, or ASP, for Telguard hardware unit in the fourth quarter increased sequentially to $134.

We continued to experience strong demand for our new line of 3G/4G products and are increasing the range of our guidance of Telguard unit sales to 30,000 to 40,000 new units sold per quarter through the end of fiscal 2013.

The other major component to our Event Monitoring segment is TankLink. In the fourth quarter, TankLink revenue increased 19% over the prior-year period to $2.2 million, including recurring service revenue of $1.1 million or 50% of total TankLink revenue. For the full year, TankLink revenue totaled $7.7 million including service revenue of $4.1 million, a 21% increase over the prior year.

In our Asset Tracking segment, for which SkyBitz is currently the sole line of business, revenue was $7.9 million, including product revenue of $3.4 million and recurring service revenue of $4.5 million.

SkyBitz revenue since its acquisition on February 1, 2012 totaled $22.5 million, including product revenue of $10.5 million and recurring service revenue of $12 million.

Telular entered the fourth fiscal quarter with a combined total of 840,000 billable units with an ARPU of $5.47. Additionally, on a consolidated basis, 50,700 hardware units were sold with an ASP of $184 during the quarter.

Turning to expenses. Operating expenses for the fourth quarter were flat sequentially at $9.4 million, including amortization of intangible assets identified with the SkyBitz acquisition of $1.3 million.

After the payment of our eighth consecutive quarterly dividend, which was $0.11 per share during the fourth quarter, we ended the period with a cash balance of $12.7 million, up from the previous quarterly balance of $11.1 million.

In conjunction with our new guidance for fiscal 2013 adjusted EBITDA of $23.5 million to $25.5 million, we are pleased to announce that the strength of our business and cash flow has allowed us to increase the quarterly dividend for the second consecutive year to $0.12 per share beginning with the dividend payable on November 30.

Now I'd like to turn the call back over to Joe to go into a more detailed discussion of our business.

Joseph A. Beatty

Thanks, Jonathan. I'm pleased with the results this quarter. We continue to grow service revenue; generate substantial free cash flow and reward our shareholders with a dividend.

In the Telguard business, we continue to benefit from focusing our efforts on selling to the small and midsize security dealers. Having said that, we are seeing increasing demand from the larger players in the security market as well. We believe that our early entry into the marketplace with 3G/4G cellular communicators has not only driven an acceleration in overall Telguard growth, but has also solidified our reputation among security dealers that we are the most forward thinking and have their best interest in mind.

Furthermore, because of how we architected the data transfer function in our communicators, our legacy 2G devices are performing better than all the competitors as wireless carriers shrink the amount of spectrum available for 2G in various metropolitan areas. Our 2G units will outperform all others increasingly over time as the migration of spectrum continues. Our security dealer customers know this and appreciate the fact that even though our 2G service is superior, we nevertheless also led the market into 3G/4G.

Once again, our reputation has been greatly bolstered over the past year, and the Telguard operating results are exhibiting this phenomenon.

At SkyBitz, we announced the integration of data from our trailer-tracking solution with TMWSuite, a key ERP system in the trucking space. TMW is a leader in transportation management systems software, and SkyBitz customers appreciate the ability to choose between using our in-site SaaS platform to view their data or to utilize other options, such as the several ERP system integrations we have with TMW.

Key partnerships, such as our relationship with TMW, provide added value for transportation companies that utilize SkyBitz. And this is one of the ways we create and maintain competitive advantage at SkyBitz.

And finally, we continue to grow our TankLink business by expanding margins as we grow the number of tanks monitored. This is evidenced by a record 74% increase in activations in the fourth quarter as compared to the prior-year period.

Furthermore, we announced a new Business Partner Program at TankLink. The program already has 12 partners signed on, and we are looking to add more in verticals such as Specialty Chemicals, Ag-Chem and Water Treatment.

We also are continuing to benefit from our long-time partnership with SMARTLogix, a leading technology supplier in the fuel and lubricant distribution space.

TankLink partners receive access to a complete line of leading-edge wireless remote tank monitoring solutions, comprehensive sales training, as well as technical and marketing support.

In summary, we continue to grow our high-margin recurring revenue streams in a profitable way. We're capitalizing on our market opportunity by increasing our distribution and expanding our advanced product portfolio. We've got strong visibility into our business and remain committed to free cash flow growth and, as you know, maximizing shareholder value.

With that, I'd like to turn it over to the operator to coordinate any questions that you might have.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question comes from the line of Noel Atkins with LOM.

Noel J. Atkinson - Loewen Ondaatje McCutcheon Limited

I was wondering if you could talk a little bit more about the big increase that you saw in the new activations. You mentioned in the prepared remarks a little bit about seeing the larger security firms coming into play. How much of that drove the new activations in the quarter?

Joseph A. Beatty

Sure. So in Telguard, really what's happening this year is there's a momentum built with our 3G and 4G initiative. We were the first to market. We converted the entire product line to 3G/4G. We sent the message to the industry earlier that, "Hey, it's in your best interest to never put a 3G device on a customer's wall anymore. We're going to make it easy for you." We converted our product line. We kept our prices the same. We made it very easy. We made it an issue in the market, and it got us substantial recognition from security dealers. It took a little time. They don't move quickly, but they did move over the last -- really, for all of 2012, this has been going on. The momentum is built. The message has been heard. And really, we've seen incremental demand equally from our small and midsize security dealer customers, as well as our existing large security dealer customers. So I would say the growth is equally distributed if you look at the numbers across all size customers in the industry. And really it's just the momentum build from 3G/4G, as well as, I would say, a couple of years of some real good incremental innovation and some of the features we've added with Telguard that we've talked about over the last 12 to 24 months here on these conference call.

Noel J. Atkinson - Loewen Ondaatje McCutcheon Limited

Okay. And then you mentioned the customer credits. Does that relate to the rebate program that you had for dealers?

Jonathan M. Charak

No. Noel, this is Jonathan. It was actually a billing error that we discovered and our customer discovered. And in the short, it was a onetime credit that was provided to them. And of course, when you credit an invoice like that, it only hits revenue. It doesn't hit an equivalent amount of cost of goods sold. So it impacted the ARPU, and it also impacted the service margins as well. A onetime issue, though.

Noel J. Atkinson - Loewen Ondaatje McCutcheon Limited

And how big was it, sorry?

Jonathan M. Charak

In total, it was a little bit over -- it was actually 2 different customers and -- with little bit of a different issue. It was about $200,000.

Noel J. Atkinson - Loewen Ondaatje McCutcheon Limited

Okay. And then, are you focusing any competition in the market like it sounds as if your largest customers are coming back to you for the 3G/4G? Are you seeing competition in the market from other 3G or 4G compatible communicators in the security market?

Joseph A. Beatty

Noel, the competitive level in the market feels about the same to me. Keep in mind that we're specialists in cellular for the security industry, and our competitors tend to be vertically integrated and cell communicators are just one thing they offer. So they don't pay particular attention to the issue as much as we do. So the degree to which competition is strengthened or weakened over time, it really has been fairly consistent, so keep that in mind as a backdrop. But in terms of the 3G/4G issue itself, our competition has finally started to come out with 3G/4G communicators over the past couple of months. And so, our time advantage is lessening, but I think again the fact that we were first, the message that we fill properly and have created an image of looking out for our customers, I think will carry us for some time to come.

Operator

And the next question comes from the line of Ellen Mo with Imperial Capital.

Ellen Mo

This is Elle in for Michael. So how strongly are alarm dealers focusing on the sunset of 2G at this stage? And could you quantify the demand for the 3G/4G Telguard unit?

Joseph A. Beatty

Could you just repeat the first part of the question again, Elle?

Ellen Mo

Sure, no problem. How strongly are the alarm dealers focusing on the sunset of 2G at this stage?

Joseph A. Beatty

Okay. So really, I would say, fairly strongly but not as strongly as I'd like them to. We've raised the issue. It's become relevant for some of them. The industry can be slow to react as well. So I wouldn't say that it's anything close to an all-out stampede or the #1 issue in the space. But I would say that there was a front-page article in the trade magazine for the industry, the Primary Trade Magazine, within the last 6 to 8 weeks that had our VP of Marketing and his counterpart at Honeywell, and there was an interview on the issues. So now it's I guess front-page news in the industry but maybe not the top issue. And so, like I said, I think it's helped us incrementally and really helped our reputation more so than the issue itself made.

Ellen Mo

Could you quantify the demand for the 3G units at this point?

Joseph A. Beatty

It's difficult to quantify, I mean, because everything we're shipping now is 3G. So for us, it's 100% of demand. I think that's a question maybe our competitors could address if they would talk you in the kind of detail we do on their conference calls, what percentage of units they're shipping that are 3G versus not. I think, frankly, at this point, they've only added -- they may have 1 unit available out of the various products and models that they manufacture. So whatever the demand, they really haven't fully converted like we have. So not a question I can really answer, I don't think.

Ellen Mo

Sure, it makes sense. That's pretty helpful. Just 2 more questions, so regarding interactive adoption. How is that impacting Telguard ARPU and service revenue? And what do you see in terms of take rate by new subs?

Jonathan M. Charak

Yes, it's still on the overall scheme of things. It's not super impactful in terms of the monthly ARPU overall compared to this 617,000-plus subscribers that we have, so it's still not a real meaningful number or mover of the ARPU. I think that in terms of the new units that are going out there, somewhere between 15% and 20% are being -- electing to have the interactive services attached.

Ellen Mo

Got it. So lastly, could you just go into a little more detail for TankLink? And regarding the new adjacent verticals, I know you guys mentioned Water Treatment and Specialty Chemicals. But are you beginning to see more activity or pipeline of opportunities in adjacent verticals? And how -- tell us about the adoptions by new customers and tank owners?

Joseph A. Beatty

Sure. I think really, we wanted to get more feet on the street in verticals outside of fuels and lubricants. We've been primarily focused on fuel and lubricants since we've had the company last few years. It was the ripest market segment to go after. We had and have a great partner there, SMARTLogix. But what we've recognized is that maybe we just need more feet on the Street in agriculture, in chemicals and in water. We have developed a couple of great large customers in chemicals to date with our direct sales force. But really what's going at TankLink for us is, creating a much larger indirect channel with agents. And so that's what we're out doing. We're out, trying to cover the U.S. state-by-state with representation in the agriculture, chemical and water markets for TankLink, and it amounts to a multiplication of the sales force, if you will. And so we still have the continuing strength of the business we've built in fuels and lubricants and expecting a lot more growth in the other segments as this channel, it's fully trained and fully brought on. And that's something that's going on right now and will continue on, frankly, through the next 6 to 12 months.

Ellen Mo

Got it. That's helpful. Actually just one more question, so regarding asset tracking, the SkyBitz business, what's been the activity for truck trailers versus like Department of Defense or other type of assets? I know you mentioned your new contract with TMW, but if you could give us a little more color on that.

Joseph A. Beatty

Sure. A couple of years ago, SkyBitz was 100% trailer tracking. And if you look at recent results, it's more in the 80s, first half of the 80s and a lot more oil and gas. We had an intermodal customer announcement in the last month. As that trend in intermodal picks up and those key carriers and intermodal add tracking, they've been behind their counterparts in the over the road trucking space. So 80% to 85% trucking and the balance oil and gas and a little bit of government in there, but not as much as we'd like. Yes, so we feel good about the diversification there and expect that trend to continue.

Operator

And the next question comes from the line of Steve Shaw.

Steve Shaw - Sidoti & Company, LLC

Can you just provide some color on how the international market is shaping up for TankLink?

Joseph A. Beatty

Sure. Steve, not as quickly as we'd like. And I should probably blame myself because we don't put a lot of resource into it. We've really relied on our legacy relationships in Latin America. We've got a small office in Miami, and we've got a lot of history with the major carriers who bought a lot of terminal equipment from us in the past. We've got a great partner down there, Telefónica, a MobileStar division. And they haven't had as much success as we'd like despite creating a brand for propane gas monitoring. So not as well as we'd like. We continue to be patient, but it's been a slower growth than we'd like. I think there's a lot of potential. It's a question of, do we just need patience? Do we need more resources? And we're examining that right now.

Operator

And the next question comes from the line of James Lee with Potrero Capital Research.

James Lee

The first question is more housekeeping. What is the debt on your balance sheet right now?

Jonathan M. Charak

It's 20 -- at the end of the quarter, it was $28.5 million at the end of the quarter.

James Lee

Okay. And then secondly on SkyBitz, it looks you have -- had another disappointing quarter since your acquisition. I have it down 10% quarter-over-quarter. Could you talk about what's going on there, and then what your assumption going forward for 2013, whether you see any growth at all, and what kind of growth, if any?

Joseph A. Beatty

Sure. Yes, it was a disappointing quarter for SkyBitz from my perspective. There was a customer credit issued there as well that maybe makes the quarter look a little worse than we thought. That was covered off in the amount Jonathan stated earlier, I think it's $200,000.

Jonathan M. Charak

Actually, I was just speaking at Telguard.

Joseph A. Beatty

Okay.

Jonathan M. Charak

That was a separate thing to the SkyBitz.

Joseph A. Beatty

A little bit of a credit -- one credit given there. And was not a huge amount, but that affected the quarter. I think bottom line though, demand in the space is down. We look at leading indicators like trailer, manufacturing and how many trailers are shipped to our customers, that's down in September, almost 8% over the prior September. And we look carefully to make sure that we're not losing to the competition, that is the reason our numbers aren't where we would like them to be, that is because of the overall market and not competition and we believe that's the case. We see customers deferring orders. I think the trucking industry has a lot of owner-operated entities that pay taxes at individual rates. And I think the uncertainty out there with the fiscal cliff, tax rates, et cetera has caused them to defer orders, defer decisions, frankly, to see what happens today with the elections. So -- but if you look at the hard data, trailer shipments are down, and that tells us a lot about the market condition. Also, the cancel rates for new trailer orders is up, almost twice as much year-over-year from 6% to 11%. So I think softness in the space is the primary reason, although we're diligent about looking in the mirror to make sure there's enough. One thing I would say is, recently, our order backlog has grown pretty strongly, so I feel good about the near-term. Our visibility there on a 3- to 6-month basis is decent because we tend to get orders, and they are oftentimes installed on new trailers. And those orders are shipped out over a period of months usually as those trailers are manufactured. So despite a poor quarter, the order backlog is pretty strong right now for the near future.

James Lee

So is your assumption -- EBITDA assumption for '13, is that -- it seems like it's building for -- is it decent growth out of SkyBitz or you assuming it's flat?

Jonathan M. Charak

No, it assumes decent growth out of SkyBitz for sure.

Joseph A. Beatty

Yes, so what happens in that business is, they can't defer order trailer -- trailer orders forever. They can defer them temporarily and then maintenance on the old trailers starts to be a problem. So we're counting on the fact that deferrals can't last forever in that space.

James Lee

Okay. So if SkyBitz is flat, using the last quarter -- last 2 quarters as a trend for next year, that puts some more pressure on EBITDA guidance for next year then, was that -- is that a fair assumption?

Joseph A. Beatty

No, I don't know. No, we're -- I would say, we have a history of being pretty good near-term forecasters for our business. So I don't feel any pressure. If I felt pressure, I would have -- not have the forecast where it is. I'm not sure if that answers the question, but...

Operator

And the next question comes from the line of James Gibson with Punch & Associates Investment Management.

James Gibson - Punch & Associates, Inc.

How does the spinoff of ADT affect your relationship with them?

Joseph A. Beatty

It marginally helps. So ADT, so Tyco spun off into 3 entities. And one of those entities is ADT North America, who's a great customer of ours. Another one of those entities include ADT's commercial monitoring business, which is also a good customer of ours. And the third entity includes a competitor of ours, so we're glad to see it separate from the other 2 as you might imagine. DSC competes with us, they sell communicators. So I think ADT is under less internal pressure to buy from its affiliate, and that's helpful. I would say it's marginally helpful.

James Gibson - Punch & Associates, Inc.

I think at one point, you mentioned that ADT was forced to charge -- had a surcharge to buy from the affiliate, is that still the case?

Joseph A. Beatty

Yes. So just to educate people, I mean, I know that issue. Yes, ADT goes to market 2 ways, the direct sales force, which is very large, and an authorized dealer group of independent but ADT authorized dealers. And if you are an ADT authorized dealer, you sell the system and install it directly for the end user. And then when you sign the service agreement, you are an agent for ADT, and ADT does the monitoring. So because of that relationship, ADT has an approved equipment list that those authorized dealers must adhere to. It's got a range of options for them. Telguard is on that list, but what they said was, to those authorized dealers, as a method of incentivizing them to use DSC, which was at the time a Tyco affiliate, they added a surcharge. So if you use Telguard, the contract has to be $2 more per month for each end user, and that had the effect of dampening demand for Telguard among ADT authorized dealers. So that's the backdrop. To answer your question, the surcharge is still in place, and some authorized dealers still choose to install Telguard anyway, which I think speaks to our value and regard in the marketplace. But certainly, we are selling a lot less Telguard service to that group of customers today than we were in the past.

Operator

And the next question comes from the line of Russ Silvestri with SKIRITAI Capital.

Russell Reed Silvestri - SKIRITAI Capital LLC

I had a couple of questions. One, relating to the tax rate, it seemed like it was a lot more than I've ever seen. And the second question I had was, if I take your midpoint of the EBITDA and compare that to the last year's or this year's -- or last year's EBITDA, you kind of come up with like a 30-plus percent growth in EBITDA. Can you help me translate that into what that means in terms of earnings?

Joseph A. Beatty

Okay. Well, your math is right. I can tell you, Jonathan is punching out some numbers right now to talk to you about taxes in a second.

Jonathan M. Charak

Yes, so the cash income tax expense for this quarter, the fourth quarter, Russ, was $298,000 or call it $300,000, which on the pretax income of -- is still -- it's -- I guess, it is a little bit higher than 10%. But there's nothing unusual there. We're always -- throughout the course of the year, we're making estimates of the quarter of that would be, and we sort of tightened things up at the end of the year. And there's nothing unusual or different, no changes in the tax laws that would have caused that to increase. It's just sort of a catch-up for the quarter. I think we're still in the maybe 6% or 7% range on a year-to-date basis from a cash income tax perspective.

Joseph A. Beatty

Yes. And the other question, you wanted to try translate EBITDA down to EPS?

Russell Reed Silvestri - SKIRITAI Capital LLC

Yes, but when you -- on the earnings per share for the quarter, I mean, it shows a provision for income taxes of $1.2 million.

Jonathan M. Charak

Yes. So a lot of -- the provision for income taxes is -- on a percentage basis, it should not -- going forward and the last several quarters, it should always be relatively somewhere between the 35% and 40% range, but much of that amount relates to the utilization of NOLs. So we have a deferred tax asset on the books of NOLs, and so as we use those NOLs and reduce our taxable income, that asset is removed, and there's a charge for the provision for that. But it's not a cash income tax expense. We're still, as I said, 5% to 6% in the past for cash income taxes, maybe it's creeping up a little bit, but again, no -- not due to any specific tax law change or anything of that nature. But the most of that provision is the utilization of a deferred tax asset, mainly now an NOL carry forward.

Russell Reed Silvestri - SKIRITAI Capital LLC

Okay. And then the translating the EBITDA growth into earnings growth?

Joseph A. Beatty

Yes, I mean, that's -- yes, I would say, give us a little time to get back to you because we are so EBITDA-focused that we'd have to look at a couple of other parameters to try to translate what that means in EPS perspective. But I don't know, I guess in the share-based space, if the tax rate -- things that come after EBITDA would -- between that and earnings would be depreciation interest expense.

Jonathan M. Charak

So the question -- please repeat the question for me.

Joseph A. Beatty

Please try -- yes, go ahead.

Russell Reed Silvestri - SKIRITAI Capital LLC

I'm just trying to understand, if you have 37% EBITDA growth, how is that going to translate into what kind of earnings growth are people going to be seeing or what kind of earnings growth are we going to be seeing on the bottom line when it comes to earnings per share growth or, call it, net income growth. And I know the share count varies somewhat, but...

Joseph A. Beatty

Yes, I think we have to get back to you, Russ. Those other elements, we want to think about for a minute.

Russell Reed Silvestri - SKIRITAI Capital LLC

Okay. And this is a follow-up in terms of the kind of the income statement, is there any seasonality into your expenses? I mean, it seemed like they were relatively flat quarter-to-quarter sequentially, but as you get into the December and the March quarter, how should we look at the operating expenses, which this quarter, I guess, ran at $9.4 million?

Joseph A. Beatty

Yes, there actually is a bit of seasonality in operating expenses for us. Because of employer taxes, the first calendar quarters of the year will be the highest. As you get later in the year and -- the employee base, much of which here is kind of white-collar professional, hits the caps on employer taxes, that eases the burden a little bit for operating expenses. Jonathan, anything else?

Jonathan M. Charak

Yes, so -- and there's -- and it's maybe not a predictable seasonality, but marketing spend here that we have to -- as the trade shows happen, we spend a decent amount of money in trade shows throughout the year, and there's some quarters where there might be 2 or 3 of them and others where there might be none. And so, that's a little bit of a variability in the sales and marketing line item as well.

Joseph A. Beatty

Yes, and I think the heavy times for that is Spring and Fall. So for us, that would be the second and the fourth quarter, fiscal.

Russell Reed Silvestri - SKIRITAI Capital LLC

And then -- the last thing, just if you look at SkyBitz year-over-year, how the growth been or lack thereof been under your aegis versus on their own?

Joseph A. Beatty

Yes, well, it's grown. I think when we bought it, we said it had $5 million of EBITDA, and the numbers we have here, the $6 million run rate of EBITDA roughly, so it's grown. It's doing fine. I expect it to do better than it did this quarter, and we're doing things to make sure that happens in the future.

Operator

And the next question comes from the line of Cris Blackman with Empirical Capital.

Cristan K. Blackman

Joe, I enjoyed meeting you at ATA, so I just wanted to follow-up from that meeting, if I may.

Joseph A. Beatty

Okay, yes.

Cristan K. Blackman

SkyBitz intermodal, you mentioned a contract you all had announced previously. Can you expand a little bit more on intermodal? And what percent of revenues in that division you think intermodal will represent, say, a year out? And maybe some of your plans to expand in that market?

Joseph A. Beatty

Sure. So intermodal is important. So intermodal, just for background, is -- these are the containers and now I watch the trucks as I drive down the roadways after having it for the SkyBitz. You see the regular trucks called dry vans, which are rectangular in shape box trucks, smooth surface. You see trucks next to you on the road with corrugated sides and they look a little bit longer, those are intermodal containers, and they're meant to go from a flatbed trailer on to the rail, a flatbed railcar. And it optimizes transport of goods around the country by combining rail and road, and these are different size containers than the ocean going ones, but a similar concept. And so, it's become an important part of transportation in America. The intermodal companies have not adopted trailer tracking or container tracking in their case nearly as rapidly as the dry van folks, partly because those containers are moved around a lot. They're lifted, dropped down and off of rail cars and flatbeds, and so they've had concern about shock and damage to electronics if you attach electronics to them. Our view is that our system can survive quite nicely even in an intermodal environment. And I think the carriers are coming around to that. They've tested them, some of the carriers. So the answer is, they've lagged their counterparts, but I think they're coming around. We announced COFC as a new intermodal customer in the last month or so. And we're certainly talking to a number of the other large ones. And so I think if I -- the future in terms of growth, we do expect more out of that space. I think in the next year, if it's 5% to 10% of unit shipments, I'll be pleased. And again, that will add to the diversity from the dry van market that has dominated SkyBitz performance historically.

Cristan K. Blackman

And literally almost going from 0, I mean, maybe 1% of shipments, something small.

Joseph A. Beatty

Right. Yes.

Cristan K. Blackman

Shifting over to your network capabilities, if you don't mind. I know you list 3 companies that -- 3 carriers you have agreements with. Is there any movement on your part to expand that or reason to expand that? I've seen figures on the estimates of M2M wireless connectivity quadrupling over the next 4 years. Is there a reason for you to expand that base?

Joseph A. Beatty

I don't think we need to -- you're referring to the cellular carriers or the wireless carriers?

Cristan K. Blackman

Yes.

Joseph A. Beatty

Yes, so again, for background, SkyBitz is predominantly satellite, so it's got several satellite carriers that we partner with there. But in terms of Telguard and TankLink and then also part of SkyBitz, it has a cellular offering as well. Our primary partner is AT&T for cellular service in the U.S. We've got agreement with Rogers in Canada. We've got an agreement with Telefónica for the rest of the world. And I don't -- I think we've got great partners to date. I think we can get anywhere in the developed world we want to, with those cellular carriers and Iridium as the satellite partner, with its global coverage. We feel very good about the network partners we have. So I don't think there's a need to expand.

Cristan K. Blackman

Okay, excellent. And then the number of dealers that you all added during the quarter, did you -- I missed the very beginning of the conference call. Did you all speak on the number of dealers you've added or how many you shipped products to during the quarter combined?

Joseph A. Beatty

We didn't speak to it. It's about 2,300. And that's about where it was last quarter. We've had a tremendous growth rate in active dealers, I think is the figure you're referring to, something we've talked about in the past. Those are dealers -- security dealers that have -- so we invoice -- the story we tell is, there's about 5,000 intrusion detectors dealers in the U.S. at any given time. We send invoices to about 4,000 of them, so 80% of dealers get a bill from us, that's pretty good. We then look at active dealers. How many of them installed a new unit in the last quarter? That number is about 2,300, still very good. And we make it our business to try to become more regularly used by more dealers. But truth be told, if you look at, of those 5,000 intrusion detection dealers, how many are really active in the business? In other words, is it their primary business to put in intrusion detection systems? And we look to -- as a proxy to measure that, we look of the ESA, which is an industry trade group. They have about 2,500 members. And those are really the core primary intrusion detection dealers in the country. So we've got 2,300 active dealers. We feel like we've done a pretty good job saturating those dealers in the U.S. that are everyday in and out doing intrusion detection systems. So you probably hear us talk less about the number of active dealers since we've saturated it. But that's the current status of active dealers.

Cristan K. Blackman

All right. And then the units per active dealer or I guess, we could probably do the simple math, but are you seeing that increase with the [indiscernible]?

Joseph A. Beatty

Yes, we have. We track -- without giving any numbers, we did track the growth since we first put the Telguard Advantage Program, which is our dealer loyalty program, in place a couple of years ago, we've been tracking our success at getting individual dealers to use us more often, and really substantial per dealer growth rates, strong double digits. So we're not making that a publicly disclosed figure, but we are tracking it. And we have seen our penetration within any given dealer increase. And I think that's what's, frankly, underlying our increasing growth in new units sold and the fact that we can increase our guidance for next year.

Jonathan M. Charak

And if you just look at this past quarter, you, as you said, just do the simple math, we held relatively flat on our active dealers but we increased our units from 32,000 to 39,000. So do the math. I mean, obviously, on a per active dealer count, that's an increase.

Cristan K. Blackman

Yes, excellent. And then finally, if I may, one other question. On the cable side, MSO side, is that an area that you expect to be moving into on the security side in an aggressive way at all?

Joseph A. Beatty

Yes, there's certainly a role for Telguard in the world of intrusion detection or security systems sold to consumers that are with backhaul over cable networks, which I think is what you're referring to. Some of the cable companies themselves are becoming security dealers, Comcast, Time Warner and Rogers. And we have some product and service ideas for how to back up that line because you can cut a cable coax line just like you can cut a phone line, and that is the origin of Telguard, is how to protect consumers and businesses from cable cuts from those burglars that are smarter than the average burglar and actually bring a pliers with them and cut lines. So there's a place for us. We're not -- at the moment cellular backup for those carriers is handled, particularly you think of the large ones, Comcast, they're large enough to have their own arrangements with the cell carrier. But I -- give us some time, and I think when the time is right, we'll have a service offering that will be appropriate for maybe the next tier of cable companies that may decide to get in the space, or even the traditional security dealers. When a copper phone line isn't in someone's home anymore, maybe we can use that broadband coax and then have cellular backing it up for all the other traditional security dealers. So more to come on that, but certainly a place for Telguard in that scenario.

Operator

And the next question comes from the line of Shai Dardashti with Dardashti Capital Market.

Shai Dardashti - Dardashti Capital Management

I remember when the company enterprise value was $23 million to $25 million for an enterprise, so it's great to see all the progress you've made. And I'm looking at Slide #7 of the August Investor Presentation where you break down the low cellular penetration in the security market. I'm wondering how you see that diagram evolving? Where do you see in 3 or 5 years the penetration for security going?

Joseph A. Beatty

Yes, so the answer is up, but let me again do a little bit of background. There's -- I think there's -- we now talk about 2 trends, Shai. We talk about, before we even get to cellular penetration among monitored premises, we talk about the number of premises that aren't even monitored today. So looking at that, there's about, call it, 125 million households and business locations in the U.S.. So these are physical places that are candidates for security monitoring. And today, only 24 million or so of those are monitored. So that's 1/5 of all premises are monitored. And we think one of the byproducts of a Comcast getting into security and advertising the heck out of it is raising awareness. And so we think penetration of monitored premises is going to increase because of that awareness and also because of the potential for combined offerings, so home automation offerings, energy management, that we can all combine together with security. So that penetration could go up over time and probably will. And then if you look within the number of monitored premises, the 24 million, we think that's about 4.5, yes, I think 17% or so is the penetration that we think fits us today in this -- cell only households are double that, 34% was the last number the government released. So those are households without copper phone lines or even derived voice over IP phone lines. So the trend is undoubtedly higher in terms of cellular in the monitored premises, as well as I think increasing monitored premises. Where can it go? I don't know why it wouldn't get north of 50%. And the question is, how many years is that? Is that 3 years, 5 years? It's anyone's guess, but I personally believe it's going to become the dominant, the majority percentage at some point in the 3- to 5-year time frame. But that's conjecture on my part.

Shai Dardashti - Dardashti Capital Management

And if I'm understanding correctly, Telguard is a $48.4 million revenue operation, is that correct?

Jonathan M. Charak

That was the revenue for this fiscal year, correct.

Shai Dardashti - Dardashti Capital Management

So if there's a 50% penetration, it's not going to be $50 million revenue forever. I mean, if there's 50% penetration at some point, what would that -- what's your reasonable market share? I mean, number 1, if there's 50% penetration, what's the addressable market? And then number 2 is, what's a reasonable market share I could assume in year x? How would I go about calibrating what this could mean?

Joseph A. Beatty

Yes, Shai I think you've got the right levers cited in terms of if you want to run a model and vary the key levers of penetration on market share for Telguard. We're pretty easy to model. You could come up with a number of scenarios, but I think I have to defer to you to do that because I know you've got the levers well understood. But certainly, there's a lot of potential depending on the assumptions that you put in there.

Shai Dardashti - Dardashti Capital Management

And going to Slide #22 where you talk about TankLink, I'm noticing that TankLink seems to be a top 3 player in the space and TankLink seems to be doing 7.7% of revenue. Does that mean that the top 3 companies seem to be doing $20 million collectively of revenue, is that a reasonable conclusion?

Joseph A. Beatty

Yes, I think it is, Shai. Our pricing is fairly in line certainly with Centeron, who we keep track of very closely, and it should also be in line with the other competitor on that list. The only exception that it's possible is if they finance the hardware, which we don't often do. In other words, obviously, you charge a lot more per month for a manage to offering in which there's no upfront charge for the hardware. We do a little bit of that as long as our competitors only do a little bit of that. And our revenues should be proportionate, roughly.

Shai Dardashti - Dardashti Capital Management

And if I go back to Slide 21, you're giving the addressable tank marketplace numbers and it's OGA report, Micro Matics, Mauser Tanks. Has anybody actually done the math of what the market -- of the market size would be from a third-party?

Joseph A. Beatty

No, no. We've looked to the government for -- the government's good at tracking underground storage tanks because those could leak and be an environmental issue until the federal government tracks that. And from a state government perspective, only 1 or 2 require owners of aboveground storage tanks to register. So there's no good governmental data. And even the industry research houses, no one's done a report on aboveground storage tanks. So we've definitely -- we cobbled together what we can to try to get a sense for how big our potential market is. We looked at manufacturers of tanks, see how many they produce in a year, try to get a feel for it and apply lifetime tank -- average lifetimes of a tank to determine the number. But -- so the short story needs to be rounded off, but there's millions of tanks and only a couple hundred thousand that are probably monitored. So hence, our discussion that really this is a bit of a greenfield. Our competition in TankLink is much more often convincing someone who manually reads their tanks to automate that for efficiency benefits and ROI rather than running into same competitor at the same time that's also in that account.

Shai Dardashti - Dardashti Capital Management

And going back to $20 million for a top 3 people combined, can you talk about how pricing how pricing happens? Are you able to raise prices? Are there any price conflicts that happen?

Joseph A. Beatty

Yes, mostly -- we have a wide range of ARPUs among our customers, which I think speaks to the fact that there oftentimes isn't a competitor in there at the same time we are. But, frankly, Shai, I think we do ourselves a disservice if we take advantage of the ability to charge high prices because again, the enemy there is justifying the ROI. So we've actually taken prices down a bit for that segment of our customer base who were heretofore we had sold at fairly rich margins. We try to see if we can get greater elasticity effects because I'd rather have the volume. Of course, it depends on the elasticity, but generally speaking, we want to see if we can get more volume. So, TankLink remains our line of business with the highest gross margins for service and hardware. But we wanted to pull that down a little bit, and we'll see what happens in terms of elasticity.

Shai Dardashti - Dardashti Capital Management

And finally, I'm noticing on Slide 17, there's a conversation about government sector, SkyBitz's future growth driving or growth driver. Can you clarify what that means?

Joseph A. Beatty

Yes, well, so there's many elements to the government. We -- from FEMA domestically to Department of Defense globally. And we've explored certain key applications with the Department of Defense for tracking emissions. We have a -- the emissions rating for qualification with the federal government. We have a GSA contract, so we have a contracting vehicle. But at the end of the day, it's about going after the individual opportunities and whatever governmental entity that you're targeting. And so, there isn't some broad contract you can go after. You'd really need to target whatever, whether it's a state government, a branch of the federal government. And we're working on that. Again, it's -- SkyBitz was fairly under-resourced when we acquired it, pretty lean operations, so it's not -- we don't have a huge governmental sales department right now. We're kind of picking our spots and determining how much resource to put into government based on its return.

Operator

[Operator Instructions] And the next question comes from the line of Tony Polak [ph] with Aegis.

Unknown Analyst

I was wondering if you could go a little more into detail on the $1 million increase in engineering and development expense, and whether you expect that to continue to increase or level off at those levels?

Jonathan M. Charak

Yes, so which period -- which 2 periods are you measuring when you're saying increase?

Unknown Analyst

The quarter-to-quarter.

Jonathan M. Charak

Meaning year-over-year?

Unknown Analyst

Yes.

Joseph A. Beatty

All right, so we didn't have SkyBitz a year ago. And that's got a meaningful size increase. And Jonathan, would you add anything?

Jonathan M. Charak

Yes, I mean, if you look at from last quarter, which was our first full quarter with SkyBitz under its -- under our operation, and this quarter, it was relatively flat. So what you're seeing from one quarter to the next is the impact of the acquisition of SkyBitz almost exclusively.

Unknown Analyst

Right. And do you expect that will continue at that level?

Jonathan M. Charak

Yes, there's no major plans for expanding the engineering department or the R&D costs. I mean, we're -- we've been steady, excepting for the acquisition of SkyBitz where we added bodies. But since then and certainly for the future, we expect to be relatively flat, obviously, there's salary increases from year-to-year and things of that nature, but for the most part, we don't have any major plans for strategically changing our R&D department.

Joseph A. Beatty

I will add, Tony, that more likely they'll go up and down because our business really relies on incremental innovation. So our engineering team is a big percentage of our overall team, a very important part of the company. And I'd be more likely to identify an opportunity for development in the product enhancement and increase it rather than decrease it.

Operator

And I'd like to hand back to management for any closing remarks.

Joseph A. Beatty

Great. Well, thank you. Now I just want to thank everyone for the time and attention. We feel great about the quarter, great about the trends in our business and appreciate your ongoing support. We'll see you next quarter. Thanks.

Operator

Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation, and you may now disconnect.

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