ORBCOMM Inc. (ORBC) CEO Marc Eisenberg on Q3 2018 Results - Earnings Call Transcript

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About: ORBCOMM Inc. (ORBC)
by: SA Transcripts

ORBCOMM Inc. (NASDAQ:ORBC) Q3 2018 Earnings Conference Call October 30, 2018 4:30 PM ET

Executives

Aly Bonilla - VP of IR

Marc Eisenberg - CEO

Michael Ford - CFO

Analysts

Mike Walkley - Canaccord Genuity

Rick Prentiss - Raymond James

Mike Malouf - Craig-Hallum Capital Group

David Gearhart - First Analysis

Chris Quilty - Quilty Analytics

Scott Searle - ROTH Capital

Operator

Good afternoon ladies and gentlemen, and welcome to ORBCOMM's Third Quarter 2018 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 session period. [Operator Instructions] A replay of this conference call will be available from approximately 9:30 p.m. Eastern time today through 9:30 p.m. Eastern time on November 13, 2018. The web link service details for the replay can be found in today's press release. Additionally, ORBCOMM will have an audio webcast available in the Investors section its website at www.orbcomm.com.

I would now like to turn the call over to Aly Bonilla, ORBCOMM's Vice President of Investor Relations. Please go ahead, Aly.

Aly Bonilla

Good afternoon, and thank you for joining us. Today I'm here with Marc Eisenberg, ORBCOMM's Chief Executive Officer; Mike Ford, ORBCOMM's Chief Financial Officer; and Dean Milcos, ORBCOMM's Chief Accounting Officer. On today's call, Marc will provide some highlights on the quarter and give an update on the business. Mike will then review the company's quarterly financial results and outlook for the year. Following our prepared remarks, we will open the line for your questions.

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.

ORBCOMM assumes no duty to update forward-looking statements. Furthermore, the financial information we will discuss includes non-GAAP financial measures. A reconciliation of these non-GAAP measures to GAAP measures to GAAP measures is included in our press release.

In addition, ORBCOMM routinely posts important information about the company to its website at www.orbcomm.com. As previously noted effective November 1, 2018, the company may use its website as a channel for distribution of material non-public information about the company and for complying with its disclosure obligations under regulation FD promulgated by the United States Securities and Exchange Commission. These disclosures will be included in the Investor section of the company's website at investors.orbcomm.com.

Accordingly investors should monitor this portion of the company's website in conjunction with the company's press releases, SEC filings and public conference calls and webcast. Also investors may automatically receive e-mail alerts and other information about the company by enrolling their email addresses using the email alerts link within the Investor section of the website.

At this point, I'll turn the call over to Marc Eisenberg.

Marc Eisenberg

Thanks, Aly and good afternoon, everyone. Before we begin I'd like to take a moment to thank Dean Milcos for stepping up as Interim CFO, while the company searches for a permanent replacement. Dean is a great asset to the company and will continue in his position as Senior Vice President and Chief Accounting Officer.

I'd also like to introduce Michael Ford, who joined the company on September 4th as our Executive Vice President and Chief Financial Officer. Mike brings a strong financial background to the role as well as focus on operational efficiency that will help us continue to build out our operations on a global scale. Mike has already hit the ground running in the short time he has been with us and I look forward to working with him as we continue to grow the company.

Earlier today we issued a press release announcing our financial results for the quarter ending September 30, 2018. There are a number of moving parts in the third quarter financials including positive and negative accounting entries that were onetime in nature. Primarily we had a number of swings in the reconciliation of our first year with InSync. Split between revenues and SG&A including a positive impact from the reserve for the earn-out portion of the purchase price, as well as a negative impact from various accounts that were either incorrectly classified or uncertain to paying full.

Overall the net impact to adjusted EBITDA was positive by over $2 million and negative to service revenues by about $800,000. Second, in preparation for the multiple new products being released in Q4, we sold off a significant amount of our aged inventory despite achieving our anticipated margin goal in hardware. This product transition still negatively affected hardware margins by about 3 percentage points. I'll talk about margins in more detail shortly.

We achieved record adjusted EBITDA of $17.4 million in the quarter, but without the InSync think adjustments it would have been approximately $15 million still a record. Excluding the aged inventory discounts, which impacted hardware margins by 300 basis points adjusted EBITDA would have been even better at over $16 million. Significant reductions in inventory levels, as well as growing margins led to positive operating cash flow of almost $12 million in the quarter. This is a pretty dramatic $23 million swing over last quarter.

Total revenues for the third quarter were $71 million, an increase of 2.4% compared to prior year. Keep in mind last year we're in the middle of deploying and installing large volumes of products for J.B. Hunt.

Let me try and paint a clear picture for you. While we shipped and installed hardware for J.B. Hunt in both 2017 and 2018, hardware and installation to J.B. Hunt this year is expected to be $15 million lower than last year. These comps are most difficult in the back half of the year. Regardless, in Q3 we were able to successfully grow our revenues thanks impart to our expanding customer base, as well as from starting many new deployments.

We added about 85,000 net subscribers bringing our total subscriber base to 2.3 million at the end of September 2018. While service revenues appear to be just about flat quarter-over-quarter backing out the InSync reconciliation that looks more like a $900,000 improvement.

ARPUs over the last couple of quarters are a little below our recent trends due to the greater share of cargo sales. However a good portion of our pipeline is in the in-cab space where ARPUs are significantly higher. Much of our recent effort has been around the product transition, which entails the cycling out of existing products into newer higher margin feature rich products.

Over the past few years we've invested over $20 million in creating or redesigning 20 new cost reduce products to meet the demands of the changing market. These investments have slowed our cash generation, but are now starting to yield results with more competitive price points to customers, significant improvements in margin as well as a 30% skew rationalization. Because of these investments, we anticipate not just getting back to prior margin levels, but to surpass them.

Looking at the Q3 results. Despite selling through a large portion of existing inventory reduced pricing, product gross margin improved to over 24% compared to about 13% last year. This is a direct result of completing low margin deployments with large customers, as well as the effect of these new cost reduce products shipping in larger quantities to new and existing customers.

Let's take a moment to talk about Q3 shipments. About 30% of our IsatData Pro or IDP shipments leverage the new dual-mode RFIC. Now this is up from 10% in Q2, but we anticipate this percentage to grow to over 50% in Q4 and reach nearly 100% of our IDP deployments for 2019. We also shipped our latest refrigerated product to about 50% of our Q3 cold chain deployments and expected to be completely converted by the second half of 2019. Additionally, we started shipping all of our Blue Tree fleet management products from the Sanmina facility in Mexico leveraging our component prices and manufacturing scale.

We've sold out of our GT1100 product line, which will finish shipping in mid-Q4 and anticipate starting to deliver our new GT1200 low-cost cargo tracker in Q4. Due to our ramp in manufacturing, we anticipate being able to build 6,000 of the new GT1200s in Q4 and they're all spoken for.

Overall this transformation of our product line with dozens of moving parts might be a few weeks late for a couple products, but overall it's relatively on time. There are always complications around regulatory approvals and recently our industry is experiencing an extremely difficult environment for components, but we're navigating through it. Our focus now turns to customer pilots and integration, fulfilling the pipeline and selling off any remaining aged inventory. Our 30% skew rationalization should allow us to hold lower levels of inventory in the future, maybe we level out at a quarters worth of sales.

In addition, we anticipate our investments in product development to remain at current levels, even as revenues grow so we can continue down our path of being a significant cash generator. In Q3 we took major strides in these initiatives.

Service gross margin were about 67% in the quarter, a significant increase compared to the 61% in the prior year, which contained a large amount of installation services at negative margins. As we've said on prior calls ORBCOMM is moving away from contracting directly with the third parties for installation services. We are however still going to train customers to perform installs and help them manage these third party field service teams.

Prior to this change, we were getting build by the hour by these third parties, while charging per installer to customers embedding the customer will have the assets ready to install. This change leads to significantly higher margins and more profitability, while still properly servicing our customers. There is however a corresponding annual decrease in non-recurring service revenues of about $5 million that we have adjusted in our guidance.

I'll kick off our business highlights by announcing a significant multimillion-dollar opportunity we recently won with the U.S. Department of Defense. With our partner Savi Technology to track and monitor almost 24,000 high value military assets. This previously awarded RFID 4 contract is utilized by the DoD and other government agencies to procure solutions that enhance the visibility and security of government assets.

The government is using ORBCOMM’s solar powered asset tracking solutions to provide end-to-end visibility, inventory information and logistic support for DoD assets, which greatly reduces the manpower associated with managing inventory and work processes.

We shipped over 10,000 of these units in Q3 and expect to ship the rest of the order in Q4. We're excited to be supplying the technology for this project, which offers a great opportunity to expand our government business to other groups within the DoD through this established secure contract.

Consistent with our theme of growing our base business and improving our distribution to multiple small and mid-sized companies, we're seeing momentum in our transportation business, including nearly 500 individual customer orders this quarter. What's resonating with customers is our ability to deliver solutions for multiple asset classes, utilizing a single integrated platform.

Associated Wholesale Grocers or AWG, one of the nation's largest grocery wholesalers is using ORBCOMM for their entire fleet of dry and refrigerated trailers. ORBCOMM is helping AWG gain real time visibility and control of their transport assets as they move across the supply chain.

Other customers were also leveraging ORBCOMM's integrated platform for fleets of all sizes include Chief Express who's using our in-cab and dry van solutions as well as Dutch Valley Foods and Freight Works were both using our in-cab and refrigerated solutions. These customers’ wins reaffirm our unique competitive advantage and leadership position serving commercial transportation companies.

We've also partnered with Drivewise to integrate its pre clear waste station bypass solution with the fleet manager platform enabling ORBCOMM's fleet customers with strong safety scores to bypass more than 700 fixed waste station in the United States and Canada. In today's ELD compliance environment. Drivewise can save fleets thousands of hours of lost driver productivity, reduce fuel costs and improve driver recruitment and retention.

The integration of Drivewise is another example of how ORBCOMM's continues to drive transportation companies ROI through innovation by adding features and functionality to offer the best telematics experience in the industry.

We achieved an exciting milestone with the availability of ORBCOMM's satellite services and solutions in China targeted for the heavy equipment, transportation logistics and maritime industry.

A gateway earth station is planned for construction in China for the back half of 2019 to serve as a network link between the ORBCOMM satellite system and its worldwide infrastructure, greatly improving service levels and coverage in the region. Being able to operate within China gives ORBCOMM a unique competitive advantage and enables us to deliver the benefits of our satellite services and solutions to a much broader customer base. Continuing with our satellite business, we shipped our highest quantity of IDP products to-date during the third quarter.

One of our newest opportunities is with Clearwater Tracking, a leading maritime intelligence and technology company based in the United Kingdom. Clearwater is integrated ORBCOMM's IDP maritime offering to monitor vessel performance and provide their customers with a complete picture of operator behavior and voyage routing. In addition, they are able to identify high risk vessel situations for insurance purposes. We shipped Clearwater, just a few units in the third quarter and expect to ship an additional 2,000 in Q4.

Turning to AIS, Q3 set another record quarter with $2.9 million in revenue, up 21% year-over-year, driven by steady customer growth. We've added several new multi-year licenses and signed significant contract renewals with government and commercial customers. Wrapping up the third quarter was a transitional quarter with a number of significant accomplishments. We increased shipments of our low cost products and have moved through a large amount of older inventory. Our margin improvement plan is seeing consecutive rises quarter-over-quarter, even with our new products still being left in 50% of the mix.

For those shareholders, who have been waiting for investments in product development to level off and for the company to be a significant cash generator, we have begun that trend and are seeing our cash generation ramp. Looking forward, as the new products continue to get released and move through the sales cycle revenue should rises as our pipeline has never looked better. We continue to focus on new customer opportunities, operational efficiency, higher profitability and cash generation setting the stage for a great 2019.

With that, I'll turn the call over to Mike to take you through the financials.

Michael Ford

Thank you, Marc and good afternoon, everyone. I'm honored to have the privilege to speak with you today and I look forward to talking with you over the coming months. Before we start, let me say that my two months -- that in my two months I've been with the company, I've been very pleased with the talented ORBCOMM team. I'm also impressed with the breadth and quality of our products, services and customer base. So far I have found multiple opportunities to help us drive further growth and efficiencies in the company.

Let's talk about the company's third quarter financial results. The quarter was highlighted by revenue growth, continued gross margin improvement, expanding adjusted EBITDA margin and increasing cash balance.

Let's start with revenue. Total revenue was $71 million, up $2 million or 2.4% compared to the same period last year. Keep in mind last year included an additional $8 million of hardware and installation revenue from the J.B. Hunt deployment. We've added over 400,000 net subscribers over the last 12 months, which drove service revenues in the third quarter to $38.5 million, an increase of $3 million or 10% over the prior year period. While recurring service revenues were slightly up sequentially Q3 included an $800,000 reduction due to accounting adjustments related to our InSync business.

Excluding these adjustments, our recurring service revenue improved about $900,000 sequentially. Other service revenues were $1.3 million in the quarter, down from last year by $800,000 as we have less installation service revenue this year. Product sales in Q3 2018 were $32.6 million, a decrease of almost $2 million or 5% compared to the prior year.

However, if we remove the impact of J.B. Hunt units from this quarter and from Q3 2017, we see a 27% year-over-year growth in product sales, which is widespread and across multiple product lines.

Looking at gross profit margin, the company realized a margin of 47.3% in Q3 compared to 37.6% last year. This year-over-year improvement was driven by robust gains in gross margin for both services and products.

Q3 service gross margin was 66.8% consistent with the second quarter sequentially and in line with our expectations. Compared to the prior year quarter service gross margin improved 570 basis points from 6.1%. About half of this improvement was due to product installations at negative margins last year and the other half the better half was from a larger subscriber base.

Product gross margin in Q3 was 24.2%, an increase of nearly 11 percentage points over last year. A good portion of which was due to our higher percentage mix of sales of our new cost reduced products in the current period. Product gross margins also improved for the third consecutive quarter, up 210 basis points sequentially from Q2.

Operating expenses in Q3 were $31.1 million compared to $60.3 million in the same period last year, which included an impairment loss for satellites of $31 million. Excluding last year's impairment loss, operating expenses in Q3 increased about $2 million, primarily for operating costs of Blue Tree Systems, an acquisition we closed in Q4 of last year.

In the third quarter of 2018, the company had a net loss of $3.3 million or $0.04 per share compared to a net loss of $39.7 million or $0.54 per share last year. Excluding the impairment loss last year the year-on-year improvement was $5 million or $0.06 per share.

The company achieved record adjusted EBITDA of $17.4 million in Q3, an increase of $6 million over Q3 2017. The $6 million improvement does include $2 million of one-time net positive items related to our InSync acquisition. These include a reduction in the earn-out liability of $4 million tied to service revenue growth and an increase in reserves primarily for bad debt of $2 million.

So if we look at our financial results excluding the favorable net adjustments our company's normalized adjusted EBITDA was approximately $15 million, a $4 million improvement over Q3 2017 and a $2 million sequential improvement from Q2 of this year. Q3 adjusted EBITDA margins continued their upward trend, with normalized margins reaching 21.1% in the third quarter, a 270 basis point sequential improvement from Q2.

Turning to the balance sheet and cash flows. The company ended Q3 2018 with $46 million of cash, $6 million higher than Q2. Total debt at the end of the quarter was $247 million, with $6 million of incremental cash, higher adjusted EBITDA and unchanged debt levels our company's trailing 12 months debt leverage ratio is now 3.9 times down from 4.6 times last quarter.

In the third quarter the company realized positive cash flow from operations of $11.6 million due to favorable operating results. CapEx in Q3 came in at $5.4 million for investments in new products and services.

Now turning to our 2018 outlook. We continue to trend to the middle of our full year guidance for adjusted EBITDA of between $55 million and $66 million, as well as between 350,000 and 400,000 net subscriber additions for the year. We are amending our full year revenue guidance to between $280 million and $290 million.

This change includes a $5 million reduction of non-recurring service revenue based on ORBCOMM's decision to minimize contracting directly with third party installers, as well as a reduction in hardware revenue due to the timing of getting new products released and manufactured in the quarter through the regulatory process and field trial to customers. While we do anticipate launching these products in volume in Q3, we don't expect to produce adequate levels to satisfy the entire Q4 demand and many of these shipments we’ll ship into 2019.

In closing, I'm not sure I've ever seen a company in the situation that ORBCOMM is in. Year-over-year fourth quarter hardware margins should double, service margins should be up 10 percentage points from the prior year quarter, adjusted EBITDA in Q4 will almost double the last year's number, and we expect to generate positive operating cash flow in the quarter even with a $10 million interest payment. I am very happy I joined this company.

That concludes our remarks for the call. And we'll now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to Mike Walkley with Canaccord Genuity.

Mike Walkley

Great, thanks.

Marc Eisenberg

Good morning Mike or afternoon.

Mike Walkley

Yes, good afternoon everybody. Great to see that the continued improvement in the hardware gross margins. Can you just walk us through, I think you said that once you get a full mix of the new cost optimized products you think you could be at a higher levels of gross margins longer term, can you help us frame that? And also with some large deals in your pipeline, how do you view potential discount volume cost versus your longer term margin target?

Marc Eisenberg

Yes. I think we're right on track. So while we cleared out a lot of inventory this quarter, didn't we? At one point we are up to some $48 million in inventory and now we’re down to the mid to high-30s. And that hurt us about 3 points this quarter selling that off, which considering -- I don't know that we were expecting to sell that much of at all this quarter. But if you pull that out we were already at 27 point margins.

So we said we'd be approaching 30 point margins not quite 30 but approaching at the end of the year. I don't know I feel a little more encouraged than I am discouraged right as we kind of move toward that plan. I think originally we were thinking we can kind of get to 30 and stay there. And now we're thinking we could probably creep a couple of points ahead of that.

Mike Walkley

Okay. And just building on that, it sounds like a little bit of your revenue reduction just due to regulatory and ramping some products. Can you Marc, maybe discuss the competitive environment and is there any risk to losing any customers given the short-term delay in getting the hardware that they want?

Marc Eisenberg

No, I don't think so. Listen we've got some new products. And every customer is different someone are running for a couple of weeks and someone are running for a quarter. So we're just getting those first units out there now. And I don't think -- I can't think of a single customer that we're going to lose. I think there is a few things, so that's the GT1100 going to the 1200. And here we are this quarter we get the GT1200 through the regulatory and then you start to build products. You don't build the product before because if you're wrong and you need to tweak it then you've got 20,000 paper waste out there. So you don't want to do that.

So we get through and then literally as fast as Sanmina can build that we think we can get 6,000 built and shipped this year. I think while Blue Tree is -- Blue Tree in Q3 a little bit soft. And I think the development cycle was a little bit longer than we thought it was. But, the pipeline at Blue Tree is so damn long, and they are absolutely going to carry this company in 2019, because there's so many great opportunities.

And this Drivewise that we talk about today and the reason we thought it was important to put on the call, it's just, one of the things in the development cycle that you need to do. So you've got a big trucker out there, they use this Drivewise, which is kind of like an easy path for waste stations. And, they're very focused on their driver experience and the retention of their drivers and they literally can't get to a new system that doesn't have that and have one of the drivers that are sitting at waste stations instead of getting paid per mile.

So, there's a whole lot of development that we're in the middle of completing, but I think we're going to surprise in a pretty positive fashion on that business as well.

Mike Walkley

Okay, thanks. Last question for me, I'll pass it on, Mike for you maybe just on the model and total operating expenses, should we anticipate little higher in Q4, obviously of that $2 million net reversal. So maybe around $34 million in operating expenses and kind of midpoint of your guidance would suggest improved adjusted EBITDA margins, maybe to 23% or so that is way to think about it?

Michael Ford

Yes, I think the $34 million number is a pretty good number. We came in at $31 million this year with the $2 million net improvement there. So I think that's probably a good number.

Mike Walkley

Okay, great. Thank you very much.

Operator

And we'll next to Rick Prentiss with Raymond James.

Rick Prentiss

Thanks. Good afternoon.

Marc Eisenberg

Good afternoon.

Rick Prentiss

Couple of questions. First, on the 2018 guidance update for EBITDA, the third quarter included the $2 million net onetime benefit, is that in the guidance and so $55 million to $60 million is that include even EBITDA coming in at $17 million or $15 million for third quarter?

Michael Ford

$15 million would be significantly down quarter and be a real disappointment.

Rick Prentiss

Yes, no, I get that. I'm just thinking like, if the guidance is $55 million to $60 million, what’s the third quarter number that goes into it? Is it the reported $17 million or the adjust $15 million?

Michael Ford

No. We think we're going to double or come close to doubling last year is $9 million.

Rick Prentiss

Okay, okay. And so…

Marc Eisenberg

So you want to stay toward the high-end of the adjusted EBITDA. Okay. You got it.

Rick Prentiss

And then Mike, you mentioned a couple of quick items there in your guidance update. Did I hear you say 2 times hardware margin for 4Q. But want to just make sure what that compares versus…

Michael Ford

So our hardware margins in last Q4 were 12.7%. We will -- we hope to have more than doubled that this year. We're looking at high upper teens, the upper 20s in where our product margin will be.

Marc Eisenberg

Yes, nothing has changed. Approaching 30%.

Rick Prentiss

Okay. Good. Yes, I just -- I couldn't -- I didn't hear the above 2x, I was thinking 2x again would be disappointing. When we think about InSync, but then you also made the Blue Tree acquisition last year. Is there any thoughts about a need to update the earn outs for Blue Tree and what timeframe and how much were they if you could remind us?

Marc Eisenberg

Yes. So let's just talk about InSync for a second. We've acquired stuff 13 times. And InSync is an unusual acquisition, because it had a $25 million earn out as opposed to like a Blue Tree, that is like an $800,000 earn out. So these earn out adjustments, they've happened basically 13 times, but they've been so small that they didn't rise to materiality. So we've never talked about it before.

But when you're dealing with a $25 million earn out and that earn out is based on service revenues and you kind of true it up just as you're about to pay it, their stuffs swinging in both directions. So adjusted EBITDA goes high and service revenues go low. Will it happen next quarter for Blue Tree probably, but take a zero off the end of it.

Michael Ford

If it does happen, it will be a much lower number.

Rick Prentiss

Got you. Okay. So we shouldn't expect that this EBITDA guidance isn't going to be made up with earn out misses from Blue Tree because Blue Tree has got some nice pipelines whatever I think?

Marc Eisenberg

Yes, the EBITDA guidance contains if anything a very, very small number for the Blue Tree earn out.

Rick Prentiss

Okay. And then final one, Marc you touched on it a little bit in your prepared remarks about the cargo being lower ARPU, but you got a lot of cab sales coming. Help us understand how the cross-selling opportunities are playing out. I think you also mentioned Blue Tree could help carry the company in 2019. But how do we think about the cross-selling opportunities and how you're attacking them and how big they could become?

Marc Eisenberg

The reason we bought Blue Tree is we think we know telematics experience starts in the front of the cab and moves backward as opposed to back to front. And the trucking industry today is all about drivers. They're really struggling -- there's almost no sense buying new trucks because there's no drivers out there to drive them.

So the cost of getting a loads on is certainly going up and these guys are getting a little bit more revenues per truck load. But a lot of the -- as we're sitting there pitching the Blue Tree acquisition, the CEOs are sitting there kind of looking at it like a trucker and they're bringing in some of their top drivers to evaluate that service. And when I bought the company I knew that Blue Tree the stuff was really, really cool. And I knew it was you know great but it was a satellite guy looking at a trucking application. But over the last quarter I was able to go out to truckers and kind of see their response and it was so overwhelmingly positive. It's tough to emphasize.

But I think it's -- to answer your question it’s swinging in both directions. So you have little Blue Tree that is the coolest product in the industry, but they're tiny and no one has ever heard of them and they're struggling to get views by the big trucking companies. So ORBCOMM buys them and who are our customers. Well, almost everyone right. So you're literally you don’t have to get them in the building you're already in the building.

So you got all of these folks that use this on the reapers or the dry vans that are taking a look at it and you've got this ELD mandate coming and our engineers are running around in 100 directions getting all of this integration done to get these deployments going and we can’t have a false start we have to get it right. And I think you're going to see some huge deals. So that's one way where the cargo helps us going forward because of the history of ORBCOMM and the customer sets.

On the other side some of the companies that we've kind of believed that we've won that we haven't announced yet are also evaluating us for cargo assets, which is a little more of a commodity business that they're looking at us with an awful lot more vigor because, wow one vendor one integration, one time in the ERP system, one time in the dispatch system, the yards system, just that one time integration is definitely resonating. So, it's swinging in both directions.

Rick Prentiss

Great, good luck for the rest of this year and into next. Thanks and welcome, Mike.

Michael Ford

Thank you.

Operator

We’ll go next to Mike Latimore with Northland Capital Markets.

Unidentified Analyst

Good afternoon, this is Pawan [ph] on for Mike Latimore, Northland Capital Markets. So does the DoD deal, DoD Savi deal include your service too or is it just hardware?

Marc Eisenberg

No, no it's basically including our hardware and our connectivity so the comm and we're integrating that into a Savi portal that the government uses. So they're not using our web portal, but they are using our communications and they are using our hardware. So imagine it's almost like a SkyWave deal.

Unidentified Analyst

Got it. And is the deal likely to be the largest in the 4Q?

Marc Eisenberg

Is it going to be the largest meaning is 14,000 to one customer the largest deal for hardware? Is that what you're asking?

Unidentified Analyst

Yes, yes.

Marc Eisenberg

Yes, I imagine it would be.

Unidentified Analyst

Yes, thank you.

Marc Eisenberg

Yes, I imagine it would be. We're going to ship we think about 6,000 units of GT1200. And it's going to be to one customer. So we're shipping to a number of customers that you know the names of. And it's enough to get them through their builds for the quarter to kind of pacify them until next quarter when we think we're going to receive another 20,000 of them. So those deals the 6,000 represents a base of maybe of 0.25 million that you can ship over a number of years, but it's their builds for that quarter.

Unidentified Analyst

Yes, got it. thank you.

Operator

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

Mike Malouf

Great. Thanks for taking my questions. I'd like to explore that $5 million impact just a little bit more. How does that breakout with regards to installation and reduction of hardware? And are you talking about a $5 million hit just for the back half year here for the September and December quarter or is it just -- maybe just give me a little bit of color on that.

Marc Eisenberg

No, we didn't update it last quarter, Mike on the installations. So that's $5 million over the course of the entire 2018.

Mike Malouf

Got it, okay. And then when you take a look at 2019…

Marc Eisenberg

We’re talking about it, but we just never actually did the math.

Mike Malouf

Okay, all right. And then when you take a look at 2019, how do you think that will impact your service gross margins. And then we talked about it, obviously we’re covering back up into the high-60s as it build does it approach 70 or do we stay sort of where we're at now for the next few quarters?

Michael Ford

So that revenue stream for the year is about $5 million, but we think we lost -- we know we lost money on providing that service. So we'll take out the $5 million with a revenue, but we should have an EBIT pickup $3 million to $5 million for the money we didn’t lose by providing that service.

Marc Eisenberg

I think that's right. So if you look at our guidance and Rick made a great point. Coming in at the high-end of the $55 million to $65 million. But pulling off $5 million in service is just purely a reflection of removing $5 million that cost you $7.5 million. I mean that's what we were doing, and we just kind of got fed up and said we're not going to do that anymore. So you’ve got the pickup, which gets you to the high end of the EBITDA, and you reduce the revenues.

The rest of your question. I think we had a lot of distraction the last year because of these installs and because of this large deployment. And then what we needed to do going forward was; A, show you that the company can get back on track and get back on track at the normal margins kind of pulling out those initial deployments. And I think if we haven't shown you that yet, I don't know how to convince you.

But the second part of that is now that you’ve put the new products out and continue to grow our service what does it looked it. So we talked a bit about product, but I think you have a really natural 67% service margin now. And then I think you can assume your 80,000 to 100,000 subs every quarter. I think you can assume they’re going to be between $5 and $6 in ARPU. I think you can assume that the incremental margin on that is somewhere like 90%. And then that's what should fall to service margins every quarter.

So I kind of see 67%, 67.5%, 68% and kind of creeping up to 70% and continuing to rise. And I think we are -- we will always be a innovative technology company on the hardware side. But what we're spending that $5 million or $5.5 million of CapEx is a number that we intend on freezing and then we continue to scale the revenues on the hardware. And then we think 25% of those sales will fall to the bottom line as well. So as you kind of average them over the years, we think that the EBITDA margins grow by us adding about $0.50 on every dollar to EBITDA now that we've made those investments going forward. And that’s the mix of hardware and service.

Mike Malouf

Good. And then just a follow-up, cash flow was great in this quarter and sort of looking out into 2019 cash flow is going to be pretty nice. What do you think the order of usage of cash as you go through the next year or so? And I guess sort of around about way of asking how does the acquisition environment look for you right now, and is that still high on your list?

Marc Eisenberg

It is not high in the list for 2019. 2019 we're seriously looking internally. And unfortunately I can't show you the pipeline that I see, but the best thing that we can do for our shareholders in the next year is to kind of clear out this customer base and get the integration done and get these Blue Tree products rolled out. And kind of getting the focus of our engineers and ops people on some third party or some acquisition as opposed to focus on that. We just do nothing to help us do a better job with what we have to get done. So 2019 should be a light year for M&A.

Kind of rephrasing your question. We would like to get our leverage ratio and we started talking about it this quarter. I think that 3.9 that Mike talked about, well you pulled out a $9 million EBITDA number and you put in a high-teens. And that's going to get you to the 3.5 already just from growth. But I think we want to be between 2 and 3 we don't want to be north of 3. So that is certainly one of the use of proceeds when the make whole ends in another year of the debt that we took on. So we're certainly focused on that.

Listen, I think prices. We'll see it after the last three weeks, because the world has turned it upside down a little bit. But pricing for acquisitions has certainly gone up this year. And we don't like to do deals that we don't think are accretive at least in a year or two. But -- and this company was kind of built in a recession when we did some smart investment. When we were buying assets for significant discounts and should the economy turn in the next few years, we certainly would want to be ready there.

Michael Ford

We've got plenty of opportunities still. We have opportunities still on our balance sheet to reduce our seamless balance. Marc mentioned earlier we have as we reduce the number of skews we can take some more money out of our inventory balances. And I think we can be a little more creative with couple of other our working capital balances to drive even more cash off our balance sheet. It can be smaller than it is now.

Marc Eisenberg

Yes, it's pretty cool next quarter, we have a $10 million payment on our debt it happens every other quarter. And we still think we're going to generate cash. And as good as Q3 was in terms of cash generation most of that inventory reduced the sitting in receivables now. Because it would shift within the periods it not that delayed [ph] it's just shipped towards the end of the quarter especially DLA. So it should have actually been much better.

Mike Malouf

Great. Well that will be well received. Thanks for the color. Appreciate it.

Marc Eisenberg

Sure.

Operator

We'll go next to David Gearhart with First Analysis.

David Gearhart

Hi, good afternoon. Thanks for taking my questions. Couple of housekeeping questions first. Last quarter you gave the organic services and hardware growth. Wondering if you could provide those numbers as well as the number of units shipped in the quarter?

Marc Eisenberg

Yes, Blue Tree did about $1.5 million of hardware and about $2 million in service.

Michael Ford

And organic product growth was about 10% taking out the acquisition activity of last year.

David Gearhart

And the numbers that we shipped?

Marc Eisenberg

86,000.

David Gearhart

86,000, okay. And then just going back to the services revenue the other segment. Just wanted to confirm what is exactly in that line if you're going to be outsourcing or pushing off the third party installations. Is it just going to be comprised of mainly licenses going forward? And should we think about it as roughly $1 million run-rate per quarter. Just want to clarify that?

Marc Eisenberg

Yes, I think that is not the goal. So let's talk about what’s in it and then let’s answer your other question. What's in it is professional services and licensing for like the InSync stuff. The stuff that is in subscriber base that we do. Because it's so the Lockheed stuff where they're licensing our software to manage their inventory in their factory or professional services might be some of the private labeling work that we do where a carrier would pay us NRE to do something specific.

So that's what's in there now. And I guess that million run rate seems to be pretty good for that. But we also think that the analytics business that we're building and we've got some deals that we're just about to announce in that business, but that would probably be a non-recurring too. So well it would be a disappointment if it stayed flat. But the margins will be significantly higher on those things than it would be versus installation.

David Gearhart

And then lastly for me you've talked about in the past you're working to unify seven platforms down to roughly two. Just wondering where that stands and any greater visibility on when that'll be complete?

Marc Eisenberg

Yes, it's expected to be completed in the first quarter. So it's coming up quick. We've got this massive base of engineers and there's almost 200 software engineers, but today it looks like seven teams of 30 instead of one team of 200. So getting that horsepower done and not doing everything seven times over is going to be a huge advantage to us.

David Gearhart

Okay, that's it for me. Thanks for the color.

Marc Eisenberg

Sure.

Operator

[Operator Instructions]. And we’ll go next to Chris Quilty with Quilty Analytics.

Chris Quilty

Thanks that was my question. But I'll follow on there, have you developed a sort of a rollout strategy for how you're going to take that to customers? And is there a -- basically a clear internal policy around how you're going to price the services and prioritize integration revenues versus longer term margins?

Marc Eisenberg

Yes, so we're talking about analytics right?

Chris Quilty

Correct.

Marc Eisenberg

Yes, so I think we're looking at two different approaches, I mean, using both. The stuff that is super customer specific it's just going to be like some sort of one time software fee because it's not something recurring. When we need to do work if there's some instance that they need to find out. But there's going to be something like imagine like instead of LinkedIn or LinkedIn premium where you take your subscriber base of 2 million subs and you add more significant services around it. So it could end up in higher ARPUs and in that case it would be recurring.

So let me give you examples of some of the things we're working on. So some of it is the predictive and the prescriptive analytics around. So one example might be adding something for specific engines and not just telling them what the engine status is, but doing that work where you can know that’s when it exhibit specific signs in the past then this particular event happened.

Or another example would be industry best practices, in other words we we're looking at 95% of the reefers out there, would it be nice to know what particular modes that they're operating in the fuel usage, across the base of every carrier unit out there in the country and just when you get that bigger scale you can start to identify what the norms are and the best practices in the industry. And we're kind of looking at that as like a premium ARPU.

Chris Quilty

Great. Also can you just talk generically Food Safety Management Act. We talked about that for a couple years as a big potential driver. Has it generated the amount of activity that you expected or do you think there are still further upside in installs that need to happen on a go forward basis?

Marc Eisenberg

So I think in fleets over 100 units it had the impact that we thought we'd have and we ship 3,000 reefer units and there's about 0.5 million or 450,000 in the United States. So we continue to ship about 3,000 every quarter, as we work toward filling up that pipe, we probably have 300,000 or just under 300,000 reefer units out there. So we've got, wow, that's a big share, right.

And if you look at the big fleets, those are pretty well penetrated. And, the guys that we continue to struggle to find is 20% or 30% of those units are in these fleets of 15 and less. And not a skill set of ORBCOMM's but a skill set of carriers and they're starting to make some hay, as well. So, yes, I think it's kind of lived up to its promise, what do you say.

Chris Quilty

I think so. Final question on China, presumably the gateway costs are there in the CapEx forecast and I don't think they're all that substantial, but do you need to build a partner network in China? Or is this a market where you will be using more of an OEM type approach?

Marc Eisenberg

Okay. So it's kind of a partner network on the solutions, and it's kind of a OEM model for the connectivity. So, they would sell to the local bars or local OEMs. And then I'm sorry, we would sell to the local OEMs and they would sell our solutions and our hardware to the local bar. It's kind of a hybrid approach, but it is there, it's their earth station and it's China telecoms license. So it's not different from the other models that you've seen out of us, Chris.

In terms of the CapEx, not a lot there. The unit is sitting on our books in our inventory. There's no big cost to building this, this is coming out of an inventory that already exists and we should be able to breakeven from our partner there on the installation. So I wouldn't expect a big pickup in costs. And this China Group that's marketing it is minority owned by CIMC. So I know that's probably going to be your next question.

Chris Quilty

Yes. Go ahead.

Marc Eisenberg

Minority owned by CIMC, they're involved in it and help push for the license. I'm not sure Chris maybe better than I do. But I'm not sure another American satellite company has a license there for IoT. This is like groundbreaking.

Chris Quilty

No, congratulations on that. It was only 15 years in the making.

Marc Eisenberg

There you go. Better late than never.

Operator

And we'll go next to Scott Searle with ROTH Capital.

Scott Searle

Hey, good afternoon. Thanks for taking my question. Hey, Marc, I apologize, I got on the call a little bit late. Two quick questions. Did you give a number for AIS? And then looking at the guidance for the year and the incremental EBITDA contribution margins and what you're guiding from a top-line perspective. It seems like the EBITDA assumptions are relatively conservative, at least to get to the middle or higher end of the annual guidance range. Is there something else that's in there, that I’m missing, that I missed earlier in the call? And if not, I can take it offline, but it just wanted to throw it out there? Thank you.

Marc Eisenberg

AIS was $2.9 million, up 21% year-over-year. And we think adjusted EBITDA in Q4 is in the high-teens.

Scott Searle

Okay, good. I'll take the rest offline. Thank you.

Marc Eisenberg

I think that gets you to the middle to the high-end of the original range.

Scott Searle

Thank you.

Operator

At this time, there are no further questions. The company thank you for participating on the call and look forward to speaking to you again when they report fourth quarter results in early March. Have a good day.