ORBCOMM Inc. (NASDAQ:ORBC) Q1 2019 Results Conference Call May 1, 2019 8:30 AM ET
Aly Bonilla - Vice President of Investor Relations
Marc Eisenberg - Chief Executive Officer
Dean Milcos - Chief Financial Officer
Conference Call Participants
Mike Walkley - Canaccord Genuity
Ric Prentiss - Raymond James
Chris Quilty - Quilty Analytics
Scott Searle - Roth Capital
Mike Latimore - Northland Capital Mark
David Gearhart - First Analysis
Mike Malouf - Craig-Hallum Capital Group
Good morning, ladies and gentlemen. And welcome to ORBCOMM's First Quarter 2019 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator instructions] Please note, this event is being recorded, and a replay of this conference will be available from approximately 11:30 am Eastern Time today through May 15, 2019.
The replay service details can be found in today's press release. Additionally, ORBCOMM will have a webcast available in the investors section of 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.
Good morning. And thank you for joining us. Today, I'm here with Marc Eisenberg, ORBCOMM's Chief Executive Officer and Dean Milcos, ORBCOMM's Chief Financial Officer. On today's call, Marc will provide some highlights on the quarter and give an update on the business. Dean 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 is included in our press release. At this point, I'll turn the call over to Marc Eisenberg.
Thanks, Aly, and good morning everyone. Earlier this morning, we issued a press release announcing our financial results for the first quarter ending March 31, 2019. Since we just reported eight weeks ago, my remarks today will be brief.
Starting with the financials. Total revenues for the quarter were $66 million, down $1.9 million from the same period last year. Keep in mind we completed the J.B. Hunt deployment in Q1 2018, which included over $5 million of hardware revenue. Excluding the J.B. Hunt revenue in both years, total revenues were up $3 million, but margins across our hardware sales were substantially higher. Continuing with margin, service margins in Q1 were almost 67%, an improvement over the 59% realized last year. First-quarter product margins rounded to 30% compared to about 22% last year. This is our fifth consecutive quarterly improvement in product margins, primarily due to shipping larger quantities of our newer product lines.
As a result of the strong year-over-year margin performance, Q1 adjusted EBITDA margin increased to almost 23%, compared to 15% in the prior year. The company achieved $15 million in adjusted EBITDA, an improvement of about $5 million, or up 49% compared to the prior year. There was a significant one-time accounting entry in the quarter associated with the inthinc acquisition, which resulted in a benefit of $2 million, but only $400,000 compared to last year, which had a $1.6-million benefit. We added about 70,000 net subscribers in the quarter, bringing our total subscriber base to 2.44 million at the end of March 2019.
Looking at cash flow, the company generated over $9 million in operating cash flow in the quarter, an increase of about $10 million compared to Q1 2018. We continue to generate cash, adding $4 million to our balance sheet in Q1 despite our first quarter typically having a large number of significant cash payments, including annual employee bonuses, taxes, as well as prepayments for licenses and insurance premiums. Let's move on to our business highlights. We're seeing momentum in our container programs.
The initial order that we announced last quarter from the OEM has now doubled in size to 20,000 units, and we're in the process of driving materials in anticipation of starting to shift the first 20,000 between Q3 and Q4. We expect to close the remainder of the fleet and continue to ship through 2021. We're excited to be part of this large project spanning five continents, enabling complete command and control of refrigerated containers for one of the industry's top shipping companies. In addition, we're running eight concurrent pilots for ocean vessels and intermodal containers and hope to have further updates soon.
In our heavy equipment business, we've continued to expand our portfolio to support further digitization in mining and construction equipment management, improving customers' operational efficiencies. Our enhanced FleetEdge web platform now allows mixed fleet managers to generate a consolidated view of utilization, fuel consumption, maintenance and other key parameters for all their assets on a single platform. We introduced the enhanced PT 7000, which now supports LTE and is available in a single and dual-mode solution, making real-time tracking and control faster and more comprehensive. We also launched our new GT 1020, our low-cost device equipped with LTE and an integrated antenna that is designed for a multitude of asset-tracking applications.
We were recently honored by Frost & Sullivan with the 2018 North American Company of the Year Award in recognition for a longtime leadership in heavy equipment telematics. Today, ORBCOMM monitors more than 650,000 heavy equipment assets worldwide. Turning to AIS, we continue to invest to support growth by enhancing our service offering. We're partnering with Clyde Space, who will build, launch and operate our two next-generation AIS cubesats.
As part of this agreement, we have an exclusive license for all data on these satellites. Our investment spend for both build and launch will be about $2.4 million, with about two-thirds in 2019 and one-third in 2020, which is embedded in our CapEx guidance. In addition to the AIS data we currently collect off our OG2 satellites, we purchase data off three other satellites that are nearing the end of their design life. Our two new cubesats, once launched, should have the annual cost similar to the existing three satellites, so we do not anticipate a rise in operating costs. But they are designed for better overall performance. These new spacecraft each can host three dedicated AIS receivers, including a highly versatile software defined radio.
The AIS cubesats feature an antenna concept to maximize AIS detections and are expected to outperform all other AIS satellites in orbit. We're launching these spacecraft to expand the coverage of our constellation, improve the probability of detections, increase visibility to smaller class B ships and enhance our polar footprints. We believe these satellites will enable our AIS revenues to continue to grow. They are expected to be launched on separate missions in 2020. We'll keep you updated on the progress of this project as new developments arise.
In the first quarter, our AIS business grew sequentially around $100,000, up 7% year over year. The government of Canada extended their contract through our partner Maerospace to provide AIS data for monitoring Canadian and global marine traffic through 2020. We've also renewed our contract with the Australian Maritime Safety Authority for another year through our partner, Kordia, to facilitate maritime surveillance and support their search and rescue efforts for both Australia and the surrounding regions. ORBCOMM's AIS service currently processes over 26 million messages from well over 200,000 unique vessels per day.
Moving on to operations and an update on our product transition about two-thirds of our shipments in the first quarter for asset management, coal chain, intermodal and IDP were the new higher margin, feature-rich products. We're continuing to see shipments of these products ramp as the inventory and demand for older products continue to transition. Over the next, I'm sorry, our next product to transition is our fleet device, which is scheduled in the first half of 2020. Summing up, we came into the year with an aggressive plan to improve revenues, raise margins and make better use of working capital.
Looking at this year versus last year, we achieved significant improvements in product and service margins, along with substantial reductions in inventory. We expect to see continued improvements as we continue to ship our new product lines in greater quantities. These achievements led to a 49% increase in adjusted EBITDA and took cash from operations from a negative $1 million in Q1 2018 to a positive $9 million this quarter. With many sizable customer opportunities in our pipeline, the outlook for the remainder of the year looks promising.
Before we move on to the finance update, I'd like to take the moment to congratulate Dean Milcos for achieving the role of CFO, which he held as an interim position in the past. Dean has been with ORBCOMM for six years as our chief accounting officer. He has intricate knowledge of our business and has been a strong contributor and a great asset to the company.
With that, I'll turn the call over to Dean to take you through the financials.
Thank you, Marc; and good morning everyone. First, let me say that I'm happy to step into the CFO role. One of my immediate priorities is to improve your visibility into our business and better communicate key insights and drivers. I'm also looking forward to seeing many of you in the upcoming months.
Now let me start with the Q1 results. Total revenue for Q1 was $66 million, down $1.9 million compared to the same period last year. As Marc mentioned earlier, down $1.9 million compared to the same period last year. As Marc mentioned earlier, Q1 revenues were up over the prior year, excluding the $5 million from J.B. Hunt harbor shipments that completed in Q1 2018.
Product sales in the first quarter were $27 million, similar to the prior-quarter's revenues and consistent with our comments on the last earnings call. Q1 service revenues were $39 million, up almost 3% compared to the prior-year period. Recurring service revenues in the quarter were up both over the prior year and sequentially from Q4 2018, though at a slower pace than what we've experienced historically. We received a number of questions regarding this point, and I thought it would be helpful to address it on this call.
There are a few key factors contributing to this trend, some of which are short term in nature. One of the factors is that deferred revenue upfront fees for the initial Maersk implementation prior to the acquisition of WAM. These upfront fees were $50 per unit, and they're amortized over a five-year period. There were a return [ph] of 50,000 active units at the time of our acquisition, with approximately $7 million of deferred revenue.
This has had a large impact on recent comparable periods for service revenues. For instance, Q1 2019, these upfront amortized fees accounted for less than $60,000, compared to $340,000 recognized in Q1 2018. A year prior in Q1 2017, we recognized over $740,000. So for over two years, we've been battling this downward trend, which clearly does not impact our cash flows but has had a large impact on service revenues recognized.
Going forward, this headwind in our year-over-year comparable results will dissipate over the next couple of quarters. The second factor contributing to lower growth rates in [Inaudible] service revenue are short-term declines and our inthinc service revenue. For those who have been following us for some time, over the past few years, we've acquired 13 subscale companies that needed our expertise in product design, manufacturing, cost reduction and distribution. Our inthinc acquisition was no exception.
Some of these issues impacted our year-over-year revenues from inthinc that include legacy customer payments, as well as hardware and software remediation. These issues translated into lower year-over-year service revenues, which, for Q1, was about $400,000 less than the prior-year period. After significant upgrades leveraging our leading technology, we believe the inthinc solution is now up to ORBCOMM standards. We have built a significant backlog and expect this headwind to turn into a tailwind with positive year-over-year growth in the second half of 2019 for inthinc.
Combined, these two factors impacted Q1 recurring service revenues by over $730,000 year over year. Not only do we expect these headwinds to dissipate in the second half of 2018, but we also anticipate significant positive growth. Excluding the impact from these two factors, our recurring service revenue in the quarter grew by about 4.5% over Q1 2018, which is still below our historical trends for growth. However, with large deployments anticipated to take place in the second half of the year, and with many new opportunities on the horizon, we look forward to returning to the 8% to 9% organic growth in recurring service revenues.
Separately from these two short-term factors, we have seen a decrease in ARPU associated with our device and solution mix over the past several years. With an average six to seven-year asset life, the units that are churning are predominantly satellite subscribers at mid to high-single digit ARPUs. Over the past few years, we've added numerous cargo solutions that ship in larger volumes but at lower-than-average ARPU. This has led to a vastly greater hardware business and significantly larger service revenues but at reductions to our average ARPU.
In the last year, we've added higher ARPU solutions from inthinc and Blue Tree, and we're starting to see momentum build for these solutions. So going forward, we expect ARPU to fluctuate based on future subscriber mix. To be clear, here are the company's goals to grow service revenues at higher incremental margins and not to maintain a specific level of ARPU. Other service revenues in Q1 were $1.5 million, slightly up sequentially and up $200,000 from the prior-year period.
Other service revenues in Q1 2019 include over $1 million of high-margin professional services and software licenses, an increase of $800,000 in these two categories compared to Q1 2018. Looking at gross profit margin, the company realized a margin of 51.4% in Q1 compared to 42.5% last year. This year-over-year improvement was driven by robust gains in gross margin for services and products. Q1 service margin was 66.6%, an improvement of 750 basis points over the prior-year period.
The year-over-year increase was partially attributable to eliminating product installations with negative margins. Product margin in Q1 was 29.6%, an increase of 800 basis points over the last year and up 200 basis points sequentially from Q4 2018. The improvement was primarily driven by a higher mix, higher percentage mix of sales for new products in the current period, and we expect further increases to be realized this year. Operating expenses in Q1 were $34 million compared to $33.1 million in the same period last year.
This year-over-year increase was due largely to higher product development costs associated with the new analytics service offering and the rollouts of the new product portfolio. We continue to focus on effectively managing these costs and reducing operating expenses as we improve efficiencies. Adjusted EBITDA in Q1 was $15.1 million compared to $10.1 million in the same period last year. Q1 2019 results included a $2-million reduction in earnout liability related to the inthinc acquisition while the earnout reduction in Q1 2018 was $1.6 million.
Excluding the earnout reduction in both years, adjusted EBITDA improved $4.6 million year over year. This increase was primarily driven by strong improvements in service and product gross profit while holding operating expenses relatively in check. Adjusted EBITDA margin was 22.9% in Q1, an increase of 800 basis points over the prior-year period. There are no remaining earnout liabilities on the balance sheet as of the end of Q1 2019.
Turning to the balance sheet and cash flows. The company ended Q1 2019 with $58 million of cash, adding over $4 million in the quarter. Total debt at the end of the quarter was $247 million. Our company's trailing 12-month net debt leverage ratio is now 3.1 times, down from 3.4 times last quarter and a significant improvement off our highs of 4.8 times in 2018 as we continue to generate incremental cash and improve adjusted EBITDA results.
Cash flow from operations in Q1 were $9 million, primarily due to favorable operating results. This is a significant improvement from the negative $1 million realized in Q1 2018. Capx for the quarter was $4.5 million. Free cash flow for Q1 was $4.5 million, our third consecutive quarter of positive free cash flow, demonstrating our focus and discipline on cash flow generation.
In 2018, we embarked on an initiatives to improve working capital metrics and generate positive cash flows. I believe we made great strides toward achieving this goal over the past year, and I'm pleased we've transitioned the company into a consistent generator of positive cash flows these past three quarters. Moving to our outlook. We expect Q2 2019 total revenues to be between $66 million and $69 million as many of our larger hardware deployments are anticipated to ship in the back half of the year.
We anticipate adjusted EBITDA margin to be approximately 21.5%, a significant improvement over the Q1 adjusted EBITDA margin of about 20% when you exclude the earnout adjustment. For Q2, we expect to add roughly the same net subscribers as we did in Q1. For the full-year 2019, we're maintaining our guidance of between 5% and 7.5% growth for recurring service revenue, with lower growth in the first half of the year and higher growth in the second half. Our full-year guidance remains the same for service margin of between 66% to 68% as we continue to grow our subscriber base at consistent margins, and for product margin over 30% as we continue the transition to our new cost-optimized products and ship them in greater quantities.
For the full-year 2019, we're reaffirming our guidance range of $70 million to $75 million of adjusted EBITDA, driven by expected growth in revenues, improvements in service and product gross profit and cost controls over operating expenses. For 2019, cash flow from operations is expected to be approximately $50 million, and we anticipate capital expenditures of approximately $25 million In closing, there were a number of positive items and trends in the quarter. We delivered another quarter of year-over-year service and product margin improvement. Adjusted EBITDA grew 49% over the prior year.
We generated another quarter of positive free cash flow, and we've continued to lower our net debt leverage ratio. This concludes our remarks to the call, and we'll now take your questions.
[Operator instructions] Our first question comes from Mike Walkley with Canaccord Genuity. Please go ahead.
Nice to see the solid results and reiteration of the full-year guidance. Marc, can you update us on the pipeline? I believe you're close to winning or have already closed some very large unit deals in different market segments. Can you give us some color on the potential timing of these deals and the impact it might have to your hardware margins?
Yes, I think there's a lot scheduled for that back half of the year, and unfortunately it gets pushed into the back half of the year because of the readiness of the new products, as well as a number of custom integrations for those new products. So that's the reason for the push. It's not really a change in demand. It's just a timing based on those, and then you've got, on top of that, these really large container deals.
And really exciting that the OEM has doubled their order. And the reason that they doubled their order the way they did is they know their six-month lead times. They don't want to stop their deployments. So that's just the cycle that you keep ordering what you expect to install as they get to that 6-month out period. So that's what we're seeing in well over 100,000 units that we believe we're going to end up shipping there, closer maybe to 200,000 or somewhere in between there.
In terms of the margins, there's a little bit of a shift where, we used to in a really good hardware quarter, margins used to fall sharply. And in a tougher hardware environment, margins would rise. That was always the pattern but with these reengineered devices, there is a fixed aspect to our hardware margins, which is the fixed asset is the cost to maintain our warehouse and the cost to ship and all of those things that are in the fixed costs.
So incremental hardware over what we're doing now actually has about 7% greater margins, but they're discounted a little bit because they're in higher volumes. So I think we're in a position now where incremental high-volume sales don't end up in a reduction in hardware. So I think that's good news going forward. I think we may top out at 31% or 32% margins through the course of the year. That's what we're anticipating. Is that was your question was?
And just to build on that for the acceleration of services revenue in the back half of the year, given the size of this container deal in your other pipelines, should we expect record net sub adds in Q3, Q4 timeframe relative to the history of the company, maybe over 100,000 per quarter?
Yes, we're hoping to get to 100,000 a quarter. We know we're going to ship these units, we just don't know the exact month that you go and recognize it, which is why for the first time in a bunch years we haven't given guidance for the year, this late in the year. So it's literally, we just don't know the quarters that these shipments fall into. So I'm hoping we get north of 100,000 subscribers again as we work through this backlog. That is what we are seeing. So yes, I think I'm hoping subscribers even go up a little bit this quarter. I'm looking at this morning's subscribers for the first month and the first month looks like 25,000, which is trending closer to the 75, but who knows.
These things are really lumpy as the quarter goes on. So I think subscribers are rising. Q2 looks better than Q1. We're already seeing that rising. Just to be clear, when we look at the way the company is performing, we're just discussing this morning. Transportation with these product transitions is struggling year-over-year. And it is timing, it's very big deployments, it's J.B. Hunt, which we finally get rid of these comps in Q2, and that has been the struggle as we transition to these products. If you look at the rest of the businesses, if you look at the SkyWave business, if you look at the European businesses and everything else, they're performing really, really well. And if you look at the service revenue growth just from inthinc, inthinc has this timing issue with ELD coming up where you got this hard stop to get these things installed by the end of the year. So you've experienced your churn, and now that's done.
And the only thing coming now is everyone getting prepared for this ELD mandate. So we had some 2G rollouts that stopped, and now we're installing the replacements and other things. So you hit like a floor in service revenue, and then you build it back by the end of the year. And this isn't pipeline that we see, that we think the company is going to sell more.
That's not what we're talking about with inthinc. We're talking about units that have already been sold that we're waiting to install with a deadline to get them installed. So we know service revenue is going up in inthinc, and wouldn't it be nice instead of what we've been experiencing the last year where it's contributing negative 1.5% growth to the total ORBCOMM service revenue where it can flip and return positive 1.5% growth by the end of the year. And I don't mean growth within inthinc.
I mean growth within all of ORBCOMM's service revenues. And 3%, when you're trending 4.5% gets you really close to our historic numbers. And then when you get rid of these license fees that don't really add, the deferred revenue that don't really add any cash or any value, those disappear at the end of the year too, and we're going to flatten out at 6%. Everything that we see says back to those historic high-single digit numbers.
Last question from me and I'll pass it on. You shared inthinc, maybe just follow up on Blue Tree. How's that pipeline looking? And has inthinc and Blue Tree maybe come back more to the model back half for the year? How does that look to maybe help your overall ARPU trends? Obviously, container deals might bring it down, but they should help offset some of the puts and takes in ARPU.
I think it's certainly going to help. I think there's more backlog for inthinc now, believe it or not, than the rest of our businesses comparatively. And these units are in extremely high ARPUs. And Blue Tree is doing very well too, especially as we as compare it to last year. So I think it definitely will bucket trend, but we could raise our total base of subscribers in this container business almost 10%, just from one or two deals at low ARPUs. And while it's very good business from a margin perspective and a cash perspective, it's a big nut to crack to compensate for hundreds of thousands of units.
Our next question comes from Ric Prentiss with Raymond James. Please go ahead.
I wanted to follow up on some of the inthinc M&A accounting benefits. Dean, you mentioned it was a $1.6-million benefit in 1Q '18 and about $2 million net benefit this quarter. Can you run us the numbers like throughout last year, 1Q '18 through 4Q '18 and what that impacts would have been from these items? And are we expecting any more…
Did you mean net impacts, because there were goods and bads across the year.
Yes, let's just go for the net impacts. Yes.
Yes. So Q1 we had the $1.6 million of the earnout reduction for inthinc, but we also had about $500,000 of some bad debt and write offs associated with the legacy business. Q2, we didn't have any adjustments. But Q3, we had the big adjustment of $4 million to the earnout, but we also took off some write offs of $1.5 million for inthinc. And this is just inthinc I'm talking about. And then Q4, it was a $1.7-million reduction to the earnout, with another $0.5 million of write offs. So that was the inthinc adjustments in 2018. We don't expect anything going forward as we've completed that write down of the earnout. Yes, so 2Q will be a cleaner quarter. Then third quarter, we've got a little tough comp because of that adjustment. 4Q, a little bit of an adjustment, but then starts getting clean.
That helps, just to make sure. And when you guys provided the 2019 guidance, you had anticipated the 1Q $2 million net benefit, right?
So we had an opportunity to go both ways. So either we were going get the $2-million benefit, or we were going to get the rise in the service revenues that would have been a benefit.
So it was implicitly, and they're saying we're either going to get it on one line or the other. So we're showing up on revenues that they'd hit their numbers, but it showed up more on the cost side, I guess, since they didn't hit the number. So was EBITDA either way then, no more expected for the rest of the year?
Correct, right. And we've gotten a couple of questions, I think I know the answer to it but I don't want to lead the question too much. But Intelsat had a failure of their 29e Epic satellite. You guys don't use any Intel satellites, do you? I know you've got some stuff with Inmarsat, but just want to get that clarified.
Definitely don't use any Intelsat. Their bands aren't conducive to ORBCOMM, but this Epic issue behind the scenes, we've been following really closely. It doesn't affect ORBCOMM's satellites or any satellite that we pull data off, but it affects some subscribers, depending on what customers do. So you've got, depending on what chipset they use, you might not be transmitting the day after that Epic thing. And for those who don't know what Ric's talking about, it's almost like a Y2K thing where they're pulling time off of GPS, and then there's like a reset and the units don't know what time it is. So wow, we skirted that. So we think that there were a significant number of customers that were affected, but none of them that used ORBCOMM hardware. But we were able to work around or make some fixes to make sure that they continued to report. And the impact was something but negligible. Negligible. But it's negligible because of six months of hard work.
And you guys do use some Inmarsat probably up in the polar area, but just what other satellites are you using directly for capacity off net?
There's some Iridium. There's some Globalstar. So Iridium is less than 10,000. Globalstar is maybe twice that. I haven't looked in a while, but it's in that range. And you've got the Inmarsats. Hundreds of thousands, hundreds of thousands.
And hey, can you give us just what the actual net add number was in the quarter? I know you said about 70,000 and that the base is 2.44, but do you have…
It's between 69,000 and 70,000.
69,000 and 70,000, and like you mentioned, 2Q should be similar to 1Q, but the April results suggest if it continues, you'll be doing better?
I think so, yes. Q2 is a lot better than Q1. It's funny, people ask if there's any seasonality in the business, and I always say that there really isn't. But now I'm realizing, even a 2% seasonality business across your service revenues is a big number. So there is some seasonality because we monitor a lot of buoys and fishing fleets. So it's, I don't know, tens of thousands of subscribers. But it is a big difference quarter over quarter.
Right, when you look at the add side, yes.
Our next question comes from Chris Quilty with Quilty Analytics. Please go ahead.
The discussion around the Maersk prepayments there had me thinking back to something we haven't talked about in a while, which is CIMC, which I think you were looking at the same, call it, fee type of arrangement. Can you give us an update on where that whole program sits and if there is any a financial impact that we're seeing that's material at this point?
The impact that you'll see this year is the installation of an Earth station. And there won't be, I think it's pretty neutral. So we're holding it in our warehouse. We own it. And then I think the contribution by CIMC and their partners on that Earth station will compensate for our costs, and it should be a relatively neutral transaction. So I don't think you're going to see much of an impact there. They're adding thousands of units, but they're home run hitters. They're not in this for thousands of units. But for their ORBCOMM products, they really do need that Earth station in China.
And remind me, I mean, you just got that approval in China in the last six months, was it?
Yes, last couple of quarters. Yes, that's true.
But the original CIMC, I was just saying the original relationship goes back a couple of years.
So yes, we do an awful lot with CIMC. That's not revenue-producing, like for example all of the hub units that get installed get installed at CIMC. So there's definitely a good partnership there. They definitely have designs, units, but I think before they can go and put these units out there
They definitely have designs, units, but I think before they can go and put these units out there, they have to have coverage in Asia, which, keep in mind who owns CIMC, one of the major banks in China and China Shipping company. So we're expecting an awful lot of Asia customer base.
But realistically, that's a 2020 event more likely that we will finally see that ramp?
Yes. I think we've been telling you all along. For that one, model it low and hope for the best.
Also, just a question on the hardware transition in terms of where you are like physically located in terms of most of the manufacturing now with your contract manufacturers.
So maybe 75% of our productions in Mexico at Sanmina. And then there's pockets of products that are built at other places or sourced. In some cases, we source complete products from like a Quake Global or Zergo or something like that. And then our European product is sourced in Germany.
And overall, how has Europe been performing in the past 12 months?
Yes, pretty steady incremental increase, yes.
And is there anything equivalent to what we're seeing here in the U.S. with regulations around refrigerated transport tracking that's equivalent in Europe?
Well, Europe came first. So Europe, you needed some breadcrumb trail of temperatures for years, and it wasn't done over the air. It was done via paper. It almost looks like a receipt you used to get out of an old taxicab. And there are a couple of companies that do that. But the largest company that does that is Euroscan. And Euroscan is owned by ORBCOMM. So we create a number of devices that aren't wireless, but they're paper based, knowing that that will be a wireless telematics device overtime.
And in the few years that we've owned Euroscan, we've roughly doubled the amount of subscribers, the wireless subscribers that they have. But the super exciting part of Euroscan is we believe that their partnership with Carrier will go standard in the next year. And then it will be lots of wireless devices. I'm imagining in terms of regulation. You were talking more broadly than FISMA. The other regulation that's coming around the corner is this ELD that gets deployed in Q4. We'll start in Canada next year. I don't know what the exact release date is, but it certainly has all the Canadian fleets scurrying for ELD. And if you can imagine, the Canadian oil and gas business is out of proportion to their population. So that's a good one for us as well.
And final question, the AIS deal that you cut with Clyde looks really similar to what you did OHB back five-plus years ago. Is that a good model to look at in terms of how you're contracted with them?
Yes. So I think we were trying to find a way to keep our CapEx in line and then have some operational expenses that keep us flat versus what we're paying now and do that over a period of time. There's advantages to these satellites over the initial OHB satellites in that these have a couple-of-year bigger design life. So they'll extend longer than the, or expected to extend longer than the OHB satellites. And then there's more redundancy on these units as well. And they're really built to maximize the ability to detect ships, not just the probability of detection, which for those of you who don't understand the AIS business, I mean, you heard the numbers I spit out. There's 200,000 units out there, but there's 26 million messages in a day. I mean, these things are pinging away all day.
And when they're super high, like an ORBCOMM satellite or an Iridium satellite, the transmissions happen at the same millisecond. It creates confusion onboard the satellite, and then you lose the message, where you lose both messages. So the way we're going to fly this lower and then there's multiple receivers so you've got some redundancy really maximizes the rates of detection. And then it's going to get us into the class B business.
I think the questions that we've been asked is how do you grow your AIS business? You've been saying 10 to 15, 10 to 15, 10 to 15, and you've been saying that for gee, since the beginning of time, Chris, right? I mean, that's been the guidance, but how can you make it bigger? And the way to make it bigger is to expand what you're able to monitor beyond these larger ships to get to those smaller class B ships, and also to show customers that you've got next-generation units out there or satellites out there. So I think that is 100% the theory. We guided to 25 million in CAPEX. We did $4.5 million or a $20-million run rate in the first quarter. We're talking about $1.6 million this year, and gee, it's looking like that 25 or under, doesn't it?
Our next question comes from Scott Searle with Roth Capital. Please go ahead.
Dean, congrats on the formal appointment. Just quickly, I wanted to clarify the guidance on the EBITDA margin for the second quarter of 21.5%. There are a couple of moving parts there with the inthinc benefit or comp in the first quarter. Just want to clarify what the difference looks like because you're absolutely EBITDA is going to be down. Is that predominantly the issue, or is there something else, just a one-quarter anomaly in terms of the trend we've seen on product gross margins and how product gross margin should trend over the remainder of this year? You've hit that 30% target you've been talking about. It looks like there's another way that it comes in the first half of '20. How do we expect that to progress over the course of this year?
Yes. So the comp really, the impact to Q1 is really the $2 million earnout adjustment. So I think we've said, taking that out, we were roughly 20% of an adjusted EBITDA margin in Q1. And we do expect that to grow incrementally each quarter for the rest of the year. So that's the main driver.
And, Dean, just for clarification, that's a contra OPEX item, or is that being reflected in the gross margins?
That's an OPEX item, that $2 million, yes.
And then, Marc, in terms of some of the pipeline, you addressed this I think in one of the earlier questions, but there are a couple of large deals out there, some of which you've won. But I think last quarter, you referenced that there were a half dozen or so, 100,000-plus type of unit opportunities out there. Could you refresh us on what that pipeline looks like, where some of that is in a decision-making process? And then just from a blended ARPU standpoint, gross margin standpoint, how that pipeline is shaping up so we can think about how ARPU should be trending as we look into late 2019 and 2020.
Yes, I think you're going to get something like between inthinc and Blue Tree, between now and the end of the year, roughly 15,000, the subscribers at $20 to $30 ARPUs. So that's your good guy. And on the container side, you're going to get this year somewhere between 20,000 and 30,000 this year I'm guessing, maybe another 65,000 or 75,000 next year through the course of next year, closer to the $1 ARPUs, so based on time that's going to be the pull and the push of the subscribers. And what's funny is the impact is almost 10:1 and the containers to those units is almost 10:1.
Our next question comes from Mike Latimore with Northland Capital Markets. Please go ahead.
In terms of just the accelerating service growth rate in the second half of the year, are you assuming you get to this 100,000 or so sublevel to reach that? Or does it assume something less than that?
I think you're going to get to the mid to high-single digits, just from getting rid of these Maersk license fees and just inthinc returning. That'll get you to 6% to 7% without barely closing anything, just treading water.
And then from a product standpoint, is the Blue Tree upgrade basically done? Or anything more that really needs to be done there?
I mean, there's tens of engineers at Blue Tree, and every product is unique. So one customer may have one specific integration and need, and another has a different need. So there is no finish date on that, unless you're referring to project synergy where we're talking about merging all the web portals together. Was that what you were referring to?
Yes, I thought there was something with regard to Blue Tree that was critical for this year's traction there.
Yes. Well, I mean for the specific customers that we're already engaged with, there's certainly some serious deadlines. And we're going to roll out some pretty good Blue Tree deployments in this quarter. So you move through those, and then you're on to the next one. So off the top of my head, there's two fleets for Blue Tree that we're rolling out that are in the just the two fleets, or just short of like 1,000 units. So you get to work on those, and then you move your engineering base over to the next units. But I think the larger integration is the project synergy where ReeferTrak and CargoWatch and it seems like simple this integration work that we've been doing, but imagine the world that we've been living in where maybe you've got 20 SKUs, but those 20 SKUs come in 200 variations. In other words, with Bluetooth or without Bluetooth.
In AT&T and in Verizon and the GT 1100 came in, single mode and dual mode and it came in 65 flavors. So you had these 200 different versions going through seven different web platforms through 11 different sets of books because you didn't have the ERP system. And you can imagine what preintegration, how difficult it was for the company to really synergize our resources. I mean, that was the problem.
So the first part of that is the ERP transition where we're a quarter away from one set of books, and that's it for the whole company. One set of books. And we're also a quarter away from taking those 200 SKUs with our nine-month lead times and the guessing at the end of the quarter, which stuff you're going to close and how to ship it and getting down to just a, from 200 variations maybe down to 40 where you can maximize your inventory and make really strategic guesses as to what you need with those nine-month lead times. And then the final one is this project synergy where, do you want those 40 variations going through seven platforms? Or do you want them going through one or two? And what we've been able to accomplish there is new deployments are going on that new synergy platform.
The older deployments, the stuff that's already been out in the field for years can see it or will be able to see it shortly on both platforms. But we haven't shut down the old platforms because there's 10 years of features that went into these things. And sometimes, they fall in love with a feature that we haven't been able to get on the new platform and we just continue to do that over, I don't know, over the next eight quarters. So it's going to diminish.
But we're not working on the old platforms anymore. So we're just working on keeping them up and running. So think of how much easier this company is going to be to run in terms of everything we do. Billing, collections, sourcing, managing our working capital on our inventory, being able to sell multiple platforms on one website.
All of that has been under consideration and part of this speed bump that we had over the last two quarters. But I think once we come out of it, wow, we're going to be a stronger company.
And last one just on the transition from the GT 1100 to the GT 1200. Can you just give an update on that?
So most of the customers are converted to the GT 1200, other than two real big ones. And the big ones are Walmart, which was a really large part of Q1; and J.B. Hunt, which, as we reported, was nearly zero in Q1. So J.B. Hunt will only buy when they build. So they build with CIMC in China, and then they'll order when they have a built cycle, which wasn't in Q1. Other than that, the GT 1200 is all new leads going forward. And I would say today, the GT 1200 has 75% of the functionality is the engineers work through it, that the GT 1100 did. But we're a quarter or two away from having 130% of the functionality. So we keep knocking it out. Some of these things we need in order to close some of these larger deals, which is like it's pushed to the second half of the year. And some of it we don't, which is why we continue to ship now.
Our next question comes from David Gearhart with First Analysis. Please go ahead.
My first question is in regards to Inmarsat with it going private. Just wondering if you could update us on your contract and relationship with them. When does it go for, and when is it up for renewal? And just some of the puts and takes about potential risks there with it going private, if you expect any changes in that relationship.
Sure, sure. So you've got me pretty fresh on that. Chris and I were at Inmarsat last month, so I think we're in great shape with Inmarsat. I think so the contract lasts through the life of these particular satellites today. And those satellites, our last meeting, they think are going to last through 2027. And there's been an influx of negotiations to get on the I-6 satellites, which, high 90 percentile chance that we're going to get done probably in the next month, which will give us 20 years of coverage on Inmarsat.
The relationship has never been stronger. A part of these negotiations, they're really spread among selling ORBCOMM's products and how we could do a better job as partners. And the new, well, we don't really know who the buyers are of Inmarsat yet, but assuming it's this Apex group that's leading the charge in Warburg and what is it, the Canadian Pension Fund Ontario, assuming that that's the one's going forward, I think the relationship is going to be better because there's a huge belief in IoT there. And they don't want to replicate the 20 years of work that we've done around building and designing units and platforms and everything else. So I think I would expect some really positive news there imminently.
And then lastly from me, just a housekeeping question, can you give us the number of units shipped in the quarter? I think you've done that in the past alongside the net sub additions.
Our next question comes from Mike Malouf with Craig-Hallum Capital Group. Please go ahead.
Just a quick question from me. As you look to expand the CapEx a little bit on the AIS, and I know, as you pointed out earlier in the call that you've been talking about a $10 million to $15-million market for a while. Does that change over the next few years? I mean, do you think we can get up to the $25 million to $30 million? Or are we talking a much bigger market as we look out? Thanks.
So we built these spacecraft anticipating over the next five years to continue to grow at 9% to 12%. That was the basis of the go forward on these particular spacecraft.
So really no change I guess into the end market.
I don't agree with that. We grew 7% 100,000 this quarter. So we've been growing at that 100,000. But I think, if you take 10% growth over the next five years, that puts you well beyond 15 million.
[Indiscernible] or base…
And then as you take a look at the cash flow over the next couple of years, can you just give us a sense of priorities? It sounds like you're just going to continue to pay down debt. But is there any other thing that we should be looking at with regards to uses of cash?
So I think indirectly there's an M&A question there. So there's still no desire to look at the M&A markets in 2019. So that is not a consideration. We have basically two years before it would make any sense to pay down debt. But that being said, we continue to build our cash knowing that that day is coming. I think when we would wake up, there's a bunch of reasons you do M&A, and there's a bunch of reasons that you don't. And the reason that you don't right now is we've got a big backlog, we've got a big product transition, we're busy. And I don't think we can effectively integrate another company right now with the pipeline that we have and the work that we have right now.
The second reason we're not doing M&A right now is there's no must-haves anymore. I think that the Blue Tree acquisition, the inthinc acquisition got us into markets that we were badly missing in order to do that, one service fits all your assets. And that is behind us. Would there be new applications that we'd like to have? Sure.
But in terms of the must-haves, it's gone. So as we look out to the future in terms of the like-to-haves instead of the must-haves, this company and this acquisition plan was built in the recession. So when multiples fall and ORBCOMM finds itself in a low-debt position from a ratio perspective, you might see us wake up again if the economy slows down in another couple of years. But today, we're staying the course.
At this time there are no further questions, the company thanks you for participating on the call, and looks forward to speaking to you, when they refer to the second quarter results. Have a great day.