司亞樂 (SWIR) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Sierra Wireless Incorporated Third Quarter 2006 Results Conference Call. At this time all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS]. I'll now turn the conference over to Jason Cohenour, President and Chief Executive Officer. Mr. Cohenuor, please go ahead.

Thank you John, and welcome everyone to the Sierra Wireless Q3, 2006 Earnings Call. With me today is Dave McLennan, our CFO. The agenda for today's call is as follows. Dave is going to read the forward-looking statements disclaimer. I'll provide a business update. Dave will cover our financial performance and Q4 guidance. I'll provide a summary and then, we'll open the line for some questions. Dave?

Thanks Jason and good afternoon everyone. It's Dave McLennan here. Our forward-looking statements disclaimer is as follows, certain statements on this conference call that are not based on historical facts, constitute forward-looking statements or forward-looking information within the meaning of the applicable securities laws. These forward-looking statements are not promises or guarantees of future performance, but are only predictions that relate to future events, conditions or circumstances, or our future results, performance, achievements or developments, and are subject to substantial known and unknown risks, assumptions, uncertainties and other factors that could cause our actual results, performance, achievements, or developments in our business or in our industry to differ materially from those expressed, anticipated, or implied by such forward-looking statements.

Forward-looking statements include all financial guidance for the fourth quarters of 2006, and disclosure regarding possible events, conditions, circumstances, or results of operations that are based on assumptions about future economic conditions, courses of actions, and other future events. We caution you not to place undue reliance upon any forward-looking statements, which speak only as of the date they are made. These forward-looking statements appear in a number of different places and could be identified by words such as may, estimates, projects, expects, intends, believes, plans, anticipates, or their negatives or other comparable words. Forward-looking statements include statements regarding the outlook for our future operations, plans and timing for the introduction or enhancement of our services and products, statements concerning strategies or developments, statements about future market conditions, supply conditions, end-customer demand conditions, channel inventory and sell through, revenue, gross margin, operating expenses, profits, and forecasts of future costs and expenditures as well as, statements about the outcome of legal proceedings and other expectations, intentions, and plans that are not historical fact.

The risk factors and uncertainties that may affect our actual results, performance, achievements, or developments are many and include amongst others, our ability to develop, manufacture, supply, and market new products that we do not produce today that meet the needs of our customers and gain commercial acceptance, our reliance on the development of next generation networks by major operators, the continuous commitment of our customers, and increased competition.

These risk factors and others are discussed in our annual information form which may be found on SEDAR at www.sedar.com and in our other regulatory filings with the Securities and Exchange Commission in the United States and the Provincial Securities Commissions in Canada. Many of these factors and uncertainties are beyond the control of the Company. Consequently, all forward-looking statements on this conference call are qualified by this cautionary statement and there can be no assurance that actual results, performance, achievements, or developments anticipated by the company will be realized.

Forward-looking statements are based on management's current plans, estimates, projections, beliefs, and opinions, and the Company does not undertake any obligation to update forward-looking statements should the assumptions related to these plans, estimates, projections, beliefs, and opinions change.

Thanks Dave. Starting with some general comments on the business, the third quarter of 2006 was a period of record new product introductions, continued global channel expansion, strong OEM design win activity, and technology transition with our largest customers.

During the quarter, we commenced initial shipments of four new products including two next generation AirCards and two next generation embedded modules. Q3 was a record new product introduction quarter for the Company and underscores the importance of new product execution and introduction to our strategy. In the Americas, we launched next generation AirCard products with our two largest customers and since quarter end, we have secured a key channel position with another major North American CDMA operator. We also continue to strengthen our channel position in Europe with the selection by Orange France of our AirCard 850 and by securing channel slots with several other operators around the region as well.

We continue to drive strong OEM design win activities securing next generation design wins with three of our existing laptop OEM customers. We successfully transitioned our largest customers, Cingular and Sprint, to our next generation AirCard products and despite this challenging transition, we posted year-over-year revenue growth of 91% and positive net earnings versus considerable losses one year ago. We believe that our overall market position continues to strengthen and that we're well-positioned for strong fourth quarter revenue growth and continued strong growth into 2007.

Moving to specific updates on our product lines, I'll start with our AirCard and MP products. AirCard sales were down approximately 9% compared to Q2 of 2006 and up 87% compared to Q3 of 2005. The sequential decline in AirCard revenue was driven primarily by our technology transition with Sprint and Cingular, as well as the decline in sales of Legacy EDGE AirCards. These declines were partially offset by stronger sales of HSDPA AirCards in Europe.

We believe we continue to have a very strong channel position with Cingular, and together with Cingular, we launched our AirCard 875 for HSDPA 3.6 networks. We commenced initial shipments of the AirCard 875 to Cingular during the third quarter and expect to receive revenue contribution from this product in the fourth quarter. The AirCard 875 is the first commercially available HSDPA 3.6 PC card in the world representing another HSDPA first-to-market accomplishment for the company.

Our channel position in Europe continued to improve with the selection by Orange France of our AirCard 850. We expect to launch the AirCard 850 with Orange and other European markets as well during the fourth quarter of 2006. We expect our UMTS HSDPA AirCard products to be certified and commercially available by the end of Q4 on two networks in each of France, Spain, Switzerland, and the UK. Additionally, our HSDPA AirCard products continue to be commercially available in Germany, Italy, the Netherlands, and other European markets. We believe that our recent strong channel progress highlights our continually improving market position in Europe.

We also launched and began commercial shipments of our AirCard 595 for EV-DO Rev. A networks with Sprint, and after quarter end, we secured a channel position and have purchased arrangements in place with another major North American CDMA operator for the AirCard 595. We expect to commence initial commercial shipments of the AirCard 595 to this new operator channel late in the fourth quarter. Sales of our rugged MP products were up 85% sequentially, compared to a weak Q2 for the product line, and down 57% compared to Q3 of 2005. In the short-term, we expect modest revenue contribution from the MP product line as we complete development of our first 3G MP products. We expect to commence commercial shipments of our new MP 595 for Rev A networks in Q4 of 2006, followed by the launch of the MP 875 for HSDPA networks in Q1 of 2007. Once this product line is fully refreshed, we expect it to return to being a consistent contributor of high gross margin revenue. We introduced our ExpressCard product line with the AirCard 597E for EV-DO Rev A networks. We expect to commence shipping of the AirCard 597E in the first quarter of 2007. ExpressCards for HSDPA networks are expected to follow later in 2007. We also introduced our AirCard USB wireless modems for EV-DO Rev A and HSDPA networks. We believe our USB modem products will enable us to access new markets for fixed and portable applications considerably expanding our total addressable market. We expect to commence commercial shipments of both the AirCard 595U for Rev A, and the AirCard 875U for HSDPA in the first quarter of 2007.

Moving to specific business development highlights in our OEM business, sales of our embedded modules were down about 1% compared to Q2 and up 340% compared to Q3 of 2005. About 50% of our OEM sales came from PC OEMs and 50% from non-PC OEMs. On a year-to-date basis, our sales to PC OEMs specifically are up by about 500% compared to the first nine months of 2005. We commenced commercial shipments of the MC5725 for EV-DO Rev A networks and the MC8775 for 3.6 HSDPA. We believe that the MC8775 is the world's first commercially available embedded module supporting HSDPA 3.6. We have design wins for both of these new products. We also announced that we are collaborating with Intel on a reference design that incorporates our 3G embedded modules into Intel's Ultra Mobile PC platform architecture. The resulting reference design will enable OEMs and ODMs to rapidly design and bring to market UMPC devices that incorporate our modules. We now have nine PC OEM customers including Lenovo, HP, Fujitsu-Siemens, Panasonic and Itronix. Six of our PC OEM customers currently have commercially available products featuring our 3G embedded module solutions representing approximately 28 distinct platform and airlink combinations. We believe that we have established a strong leadership position in this nascent but strategic market. Since the start of the third quarter, we've secured next generation design wins with three of our existing PC OEM customers. We believe that module shipments related to some of these design wins will continue well into 2008. We are also encouraged by our design win progress in the fixed wireless terminal market. We expect one of our customers, a major European network equipment manufacturer, to introduce their 3G enabled wireless router featuring our HSDPA embedded modules during the fourth quarter.

Some general comments, our channels continued to report strong sell-through of our products during the quarter highlighting growing market demand. Our bookings during the quarter were strong, and considerably higher than in Q2, giving us good visibility to Q4 revenue. During the third quarter, and into October, we saw the pace of deployment of high-speed 3G networks around the world accelerate. We expect that this deployment pace will continue at a high rate during the fourth quarter, and throughout 2007. We view such deployments coupled with the anticipated -- pardon me -- we view such deployments coupled with the anticipated aggressive promotional activities as an important growth catalyst for our business. We believe that our market position continued to improve in the third quarter and that overall market -- and that the overall market continues to expand, we believe that this positions us well for strong growth in Q4, and into 2007. We experienced some gross margin compression during Q3, driven by aggressive price competition in PC cards and lower sales of higher margin legacy AirCards and MPs. In response, we are focused on driving continued growth and share gains, reducing product cost, mostly managing our operating expenses and adding new higher margin products and services to our line-up such as our 3G MPs. And as I lose my voice I will pass it back over to Dave -- get some water.

Thanks Jason. On to our Q3 results, our results are reported in US dollars and in accordance with US GAAP. In the third quarter of 2006, our revenue was $52.5 million. Gross margin was $15.9 million, and our net income was $1.1 million or $0.04 per share. During the quarter, we reduced our estimate of certain royalty obligations. This was partially offset by a write-down of inventory. The net impact of these two adjustments increased gross margin by $700,000. Excluding these adjustments, our gross margin would be 28.9% and our net income would be $400,000 or $0.01 per share.

Our results include stock-based compensation expense of $1 million. 100,000 of this is included in cost of goods sold with the balance of 900,000 in operating expenditures. During the quarter, Cingular and Sprint each accounted for more than 10% of our revenue, and in aggregate, these two customers represented approximately 48% of our revenue. Our top five customers included one laptop OEM.

Results for the third quarter 2006 excluding the royalty and inventory adjustment of $700,000 relative to guidance provided in July were as follows. Third quarter revenue was $52.5 million, better than our guidance of $51 million. Gross margin was 28.9% less than our guidance of 31%. Operating expenses including stock-based compensation expense were $15.8 million better than our guidance of 16.9 million.

Net income was $400,000 or $0.01 per share, slightly better than our guidance of breakeven. Our cash flow was negative $7.3 million in line with our guidance of negative cash flow. Q3, 2006 results again excluding the royalty and inventory adjustment of 700,000 compared sequentially to Q2, 2006 were as follows. Revenue decreased to $52.5 million from $55.2 million in Q2. Gross margin decreased to 28.9% compared to 34.1% in Q2. Operating expenses decreased to $15.8 million from $16.7 million in Q2. We had solid expense management during the quarter, however, our operating expenses around product launches can be lumpy due to the timing of certain expenses such as certification costs. And we view our Q3 OpEx as low and not representative of our run rate. Net earnings decreased to $400,000 or $0.01 per share from $3.8 million or $0.15 per share in Q2.

Looking at our balance sheet compared to June 30, 2006, our cash short and long-term investment balance was $94.1 million compared to $101.6 million at the end of Q2. Accounts receivable increased to $39.1 million from $27.4 million in Q2. This increase is due to large shipments of our new products late in the third quarter.

Inventory levels increased during the quarter to $28 million from $19.7 million. The increase in inventory resulted mainly from an increase in HSDPA inventory in preparation to support increased customer demand. We expect that our inventory balance will decrease in Q4.

Looking at revenue on a segmented basis, in the third quarter revenue from PC cards was $36.2 million or 69%, OEM was $13.6 million or 26%, and within this OEM segment, sales to laptop OEMs were approximately $7 million. MP revenue was $1.4 million or 3% and we had $1.3 million of other revenue. Looking at revenue by geography again in Q3, the Americas contributed $33.9 million or 64%, Europe was $7.2 million or 14%, and Asia Pac was $11.4 million or 22%.

Our sales in the Americas declined partly as a result of declining sales of our legacy products as we transitioned our two largest customers to our next generation products. In Europe, our sales increased slightly and we are pleased with our continued progress as our channel position continues to improve. We expect further growth in Europe in Q4 as we expect to be shipping AirCards to two carriers in each of France, Spain, Switzerland and the UK. In the Asia Pacific region, our sales have increased primarily as a result of sales to laptop OEMs and their manufacturers.

On to financial guidance, we are providing financial guidance for the fourth quarter ending December 31, 2006. This guidance reflects our current business indicators and expectations. Inherent in this guidance are risk factors that are described in detail in our regulatory filings. Our actual results could differ materially from the guidance presented, our guidance includes a higher than usual revenue contribution from new product launches with new and existing wireless operator customers. There are uncertainties associated with the launch and early ramp of these products with new and existing customers that could affect our ability to achieve guidance. All figures are estimates based on management's current beliefs and assumptions that are subject to change. Our Q4 revenue guidance is $66 million. That represents a 26% sequential increase from Q2 revenue and a 76% increase from Q4 2005 revenue. Net earnings for Q4 are expected to be $1.7 million or $0.07 per share. This guidance includes approximately 1 million stock-based compensation expense.

With that, I'll turn it back to Jason to see if he can talk.

Okay, I think the voice is back temporarily. In summary, the third quarter of 2006 was a period of record new product introductions, continued global channel expansion, strong OEM design win activity, and technology transition with our largest customers. We commenced initial shipments of four new products including two next generation AirCards and 2 next generation embedded modules. A record for the company. We also secured strategic channel positions for our AirCard products including Orange and other operators in Europe, and another large CDMA operator in North America. We continue to drive strong OEM design win activities earning next generation design wins with three of our existing laptop OEM customers and securing a long-term position in key laptop platforms

We continue to expand our product portfolio with the introduction of two new product lines, ExpressCards and USB modems, both of which we expect to expand our addressable market. We successfully transitioned our two largest customers, Cingular and Sprint, to our next generation AirCard products. While this presented a challenging top line situation for us in Q3, we still posted year-over-year revenue growth of 91% and positive net earnings from significant losses a year ago.

Our bookings in Q3 strengthened considerably over Q2 giving us good visibility to Q4 revenue. We experienced some gross margin compression in Q3 driven by aggressive price competition in PC cards and lower sales of higher margin Legacy AirCards and MPs, and in which response were focused on driving continued growth, continued share gains, reducing product cost, closely managing our operating expenses, and adding new higher margin products and services to our line-up such as our 3G MPs.

During the third quarter and into October, while the pace of deployment of high speed 3G networks around the world accelerates, we expect this deployment pace will continue at a high rate during the fourth quarter and throughout 2007. We have used such deployments as important growth catalysts for our business. We believe that our market position continued to improve in the third quarter and our overall market position continues to strengthen. We believe that this positions us well for strong growth in Q4 and into 2007.

With that operator, I will turn it over for questions.

Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. [OPERATOR INSTRUCTIONS]. Your first question comes from John Bucher of BMO Capital Markets, please go ahead.

Yeah, John Bucher, question for you on the reduction in the royalty allegation, was that with more than one licensor? Was it due to the change in terms and conditions within an agreement that you had or should we expect similar adjustments going forward?

It's an adjustment to the estimates we make, John and it's something that we are constantly reviewing.

Okay. And then, looking at your fourth quarter outlook, what assumption are you making on gross margin with -- compared with the third quarter?

We are not providing gross margin guidance for Q3, John. And that just simply reflects the fact that there is a -- there is a lot of moving pieces in our business right now, and we believe the metrics to be focused on here are top line revenue growth and profitability through EPS. And we'll work the things in the middle to do our best to get there. So -- we are not putting the pin on any guidance expectation (multiple speakers).

Yeah. I'll add to that too. I mean gross margin is a -- it's a key area of focus for the company obviously as ASP pressure it is a real variable in our business. We've spoken about it before that we need to contend with. We still have a long-term business model of gross margins in the low 30s, but we also have to realize that we operate in a very competitive market and we are bring -- being cost competitive, price competitive, to win channel share and expand channels, and diversify our customer base. And, my view is we're making great progress in that area, and while we are doing that and driving growth as our number one priority, we are also focused on driving cost out and bringing higher gross margin products into the product line-up.

Your commentary addressed some of the reasons for the slightly lower than expected gross margins in the third quarter. Did you also see similar trends in your wholesale prices of the products that are distributed directly to carriers, sold directly to carriers?

I'm not sure if I understand the question there, John.

ASP, did you see similar ASP trends and as well as gross margin trends in the third quarter?

Yeah. Well, the gross margin compression was driven by ASP pressure. I'm not sure that answers your question or not, but as we open up big new channels with major operators, we are not going in commanding a high premium. We are going in with -- at a price competitive level and taking share.

Okay. Final one from me. Any constraints that you are seeing at all in the component market that might or that you are cautious about that that might impact the number of new products that you've got launching simultaneously in the current quarter?

Always, there is always concerns about the supply chain tightening up, worldwide demand continues to be pretty good for wireless components. So, we fight those battles every day. That's one of the reasons why you see our inventory level start to drift up. We've made forward commitments on key long lead time parts to get them into inventory so that we can build products and ship them to customers because our expectations for customer demand are high.

Thank you very much.

Your next question comes from George Iwanyc of CIBC World Markets. Please go ahead.

Thanks, Jason and Dave. First, when you look at the stock option contribution in the OpEx area, can you tell us how that 900,000 splits out amongst R&D and sales and marketing and the other categories?

We can George. In cost of goods sold, it's approximately $100,000. In sales and marketing, it's actually a credit of $230,000, and in administration, it's a $914,000 expense, and now it's just a little bit of geography between sales and marketing administration in the quarter and R&D was 189,000.

Thank you. And, when you look at the price pressure that you see, could you maybe give us some color either regionally North America versus Europe, maybe technology CDMA versus the GSM?

Well, if I had to characterize it generally, George, I would say the price competition is a bit more aggressive in Europe and of course by association a bit more aggressive in HSDPA [land].

Can you give the technology split for the quarter?

Between HSDPA and CDMA?

Yeah.

Then I have to -- I don't have that data immediately in front of me.

Here it is. I have got it here. George, it was 53% of our business came from GSM products including HSDPA most of that came from HSDPA. And 46% of our business came from CDMA products, and nearly all of our GSM business is driven by HSDPA.

Okay, and one final question. Can you maybe give an update on the competitive landscape and how you see your position in the embedded space in particular?

I think from a competitive standpoint, I made some statements in my opening remarks. I firmly believe that our market position has improved, and to take that a step further, I think we are taking share. And I think that's evidenced in our channel progress particularly in Europe, but I'll underscore as well that we continue -- in North America we continue to have a very strong position at Cingular and have effectively fought off a couple of strong competitors there and maintained a dominant channel share. We continue to be well positioned at Sprint and we have opened up a third major channel now in North America. So it continues to be a very competitive environment, but I think our performance relative to our competition has been very strong.

Thank you very much.

Your next question comes from Erik Zamkoff of Morgan Joseph. Please go ahead.

Hi. Good evening guys.

Hi Erik.

Certainly you guys executed well on the top line in a difficult quarter, but going forward focusing on -- I hate to beat a dead horse here, but focusing on the gross margins if your two fastest growing product areas, 3G cards and embedded, are experiencing pricing issues or in general, embedded has a lower gross margin in general than cards. And all of the players in the space are reporting margin issues and tightness in the component market, can you sort of help us get to how -- what new products or how the equation works to get north of 30% again?

Yeah. For us it's a -- we are a lot closer than our competitors I think. If you adjust one competitor's gross margin percentage for US GAAP.

No doubt.

But I think we have a less of a gap to close to get to our low 30s goal and that the levers and dials that we are working, Eric, include driving product costs down, volume helps that by the way because our operations cost as volume go up are divided over a larger number of units. So volume does help; adding differentiated products to the portfolio helps; and we have some initiatives underway to do that and that's not an instant fix, but those initiatives are currently underway. And we also have something that our competitors don't have, and that is a well established product category, high margin product category for us at CNP, which right now is suffering from low sales because we don't have a 3G product in the market, but we're actively refreshing that product line, and our view is, it's going to be a steady contributor when it gets back. So, volume is key to improving gross margin, driving cost out is key, adding more value, and adding higher gross margin products like our MP who can be more consistent contributors once they're in the market.

That's fair, and then one last question on the Nokia/Intel situation, what is your view in terms of how that potentially impacts the embedded market?

You know, we, well it certainly impacts the stock market, we saw that. We have felt, and I don't want to understate this threat, but in the market and with respect to design wins with our customers, we felt no impact. Let me underscore that. No impact from the Vindigo thing. And of course that's been a rumor, that's been around for a while long before the press release hit. So, we have -- we can't ignore it, right, because it's Intel, and it's Nokia. But we have serious questions about just how competitive the product can be from what we understand the specifications are going to be well behind us and our direct competitors for that matter when it comes to the market. So there's also a question on market timing. And in my view, there's also a question on the sustainability of the channel model. Nokia designs, develops, builds the module, hands it off to Intel as the channel. This in a space of course that already has low gross margin, and can't really support much margin stacking. So I have serious questions about the channel structure there. And we have lost no design wins to that solution, and to my knowledge, neither have Novatel on option. So far no impact; we are watching it closely, and I might also add that we have already secured a number of design wins for next generation platforms that we expect to be shipping on well through 2008. So far all of the OEM customers have spoken pretty loudly on that too, and to our knowledge there are zero design wins for that platform.

Fair enough. Thank you.

Next question comes from Dev Bhangui of Haywood Securities. Please go ahead.

Hi. Dave and Jason.

Hi, Dev.

Dave, how are you?

Well thank you.

Just quickly I guess, just in terms of -- I am going to ask this question in comparison with the competition because there are obviously only three players in this market, there is Option, Nortel and you guys. Having seen the results from the remaining two this morning and a couple of days back it looks like Sierra is making headway both in terms of market share on embedded modules as well as market share gains in terms of Europe and also now you guys have reported the major CDMA carrier -- the other CDMA carrier other than Sprint in North America. So my question is just in terms of, I guess, the Q4 guidance in terms of EPS is it that you guys will be shipping to all these new carriers including some of the big wins in major jurisdictions in Europe late in Q4 or is it going to be early in Q4?

With respect to Europe Dev, we have got a number of new channels opened up, and I alluded to the geography, the countries where those channels are. So in Europe they are going to be spaced out. So some of them are going to come late, some of them are going to come early. So they will be fairly well spaced out it is my view in Europe. And with respect to the channel of the new -- the new channel win in the US -- in North America, my view is that we'll be shipping into that channel late in the quarter.

Okay. And then you, I guess characterized major CDMA operators in North America, you obviously do not expect Bell Canada or Talus to be the major carriers in North America, right?

You know, I can't comment on that.

Okay. Just in terms of I guess the MP modem or the regularized modem high margin product refresh, one of them the Rev A is coming in Q4 in terms of being commercially shipped. Is that going to be again late in the quarter, Jason, or it is going to be early on because that is going to make a significant impact on the margins?

Yeah. I can't -- we are not going to get anymore specific than that right now, Dev, on the MP product.

Okay.

I will say this though. As it relates to a steady contribution from the MP product line, I don't expect that to happen until the product line is fully refreshed, which doesn't happen until sometime in Q1, right?

Okay. In terms of ExpressCard line-up, I guess have you secured any wins in Europe for the HSDPA version?

We haven't. We haven't disclosed any and I am not going to comment on that right now. We are committed to the ExpressCard space as we wrote in our press release during the quarter. Our first ExpressCard will be for Rev A, and we expect that product to be in market in Q1 of '07 and we expect our HSDPA ExpressCard to follow. We haven't given any specific release dates or capability or feature updates on our HSDPA ExpressCard for competitive reasons. We think, however, that when we launch our ExpressCards we will be in the market at the right time when the ExpressCard market is gaining critical mass, so I think as I look back on our priority decisions, we -- I think we made the right decisions. We could have as an example accelerated ExpressCards at the expense of PCMCIA cards, but while that transition is happening, clearly the market for PCMCIA cards is bigger and more important to most of our operator customers and that's why we focused there first, and we think we will be in the market at the right time with ExpressCards.

For both the ExpressCards, Jason, the Rev A as well as the 850, you guys have secured wins, right, on your commitments?

I haven't said if we have or we haven't, Dev.

Okay. And, can you give us some color, Jason in terms of I guess the commitments for USB modems? USB modem based AirCards, whether you are having wins in terms of carriers or is that more of a retail product and in what kind of geographies?

No, our main target for that will be operators, and we have a high degree of interest from a number of our operator customers in that product. The feedback we've gotten is that the product is quite differentiated compared to the other solutions that are available in the market. From an industrial design standpoint, I think it gets quite high marks. From an ergonomics standpoint, it gets high marks. We've actually added a battery to the unit, so it sufficiently addresses the low power output issues related with USBs. So I think we've done some pretty innovative things there, and I think the carriers we presented that product to acknowledge and recognize that it is in many ways a superior product to what's in the market now.

Can you make any comment regarding the commitments from carriers?

No, I can't.

And just I guess, some of the last questions, I guess Dave if you can just give us the cycling of the Q3 ending inventory breakdown in terms of finished goods, the work in progress, and raw materials please in terms of percentages, rough percentages?

Yeah, I am not going to break it down to that granularity Dev, but I would say a significant portion of that is product related to HSDPA that we build inventory for -- to meet future customer demand on HSDPA side of things.

Okay, and one more if you don't mind, with all this progress and all this kind of new customer, new jurisdiction, and huge kind of wins basically in France, Spain, and UK, as well as now in additional key channel slot in North America, I mean it looks like the $0.07 guidance is very conservative, any comments on that?

Of course not. We -- I mean I have -- that's a flippant response, but I think our guidance has good risk balance depth.

Okay.

There are lots of things we have to execute on in this quarter to achieve that guidance, we have some upside opportunities, we have some risk areas. So whenever we give guidance, it's risk balanced guidance. And, so what are the risk areas. Well, while we have some new products already done, skewing those new products up for specific customers particularly large ones is never an easy task, right. And, it takes a lot of collaboration between us and the customer to kind of tick all those boxes and get a product to market and that's happening with a number of customers here in Q4. So, there is always execution risk on those things.

So I think we have given a good risk balance number. I will say as we head into 2007, we feel pretty good about the growth trajectory because during 2004, we will be launching a lot of new channels, we'll have a lot of new products in the market, and at the top of '07, we will have even more products in the market and in our view, those are all good -- combined with the overall market growth, those are all good catalysts and I think good indicators for our growth trajectory.

Thank you, Jason and Dave, and I guess congratulations in terms of new wins, both in Europe as well as in North America.

Thanks very much.

Thanks Dev.

Your next question comes from John Bright of Avondale Partners, please go ahead.

Thank you, good evening. Jason, strategically lot of discussion here on gross margins, you are talking about some price pressure in the PC cards, when can we start thinking about the gross margins really stabilizing or in the same vein of discussion, at what point do you believe that consolidation may benefit or be beneficial for the industry?

Ah well, the old consolidation question. So anyways on gross margin, I think when do things stabilize, I don't think that -- we are not panicked that gross margin is going to fall through the floor. We believe that we have the right activities underway -- within our business, we think we've got the right activities underway, the right products coming into the product line-up over time and the right trajectory on the top line to drive a long-term business model with gross margins in the low 30s. So, we are very focused on running our own business and delivering over time good returns to shareholders, and I think we can do that through a combination of driving the top line and improving gross margin over time, so on that we have confidence.

So now with respect to consolidation, I am not so sure that breaks the ASP pressure in any way at all. The three innovators could all combine and we would all still be competing against Huawei, ZTE, and Pantech. So, price pressure doesn't go away there. Of course, you could drive -- you could theoretically drive some nice operating margin by reducing costs. That doesn't fundamentally change the pricing environment and some of the ecosystem things.

So, our job -- job one for us John, is really continuing to improve our business. I think we've done a remarkably good job in the last 12 months improving our market position and improving the financial metrics of our business. Yes, our gross margin is moving around a little bit, but we don't -- we're trying not to lose sight of the big picture which is we've doubled revenue and we've swung from major losses to profitability. And, we've got a nice growth trajectory underway, and our view is as a standalone business, we'll be able to drive over time nice earnings for shareholders.

Let me then follow with I guess in reverse order, two follow-ups; one then shifting slightly over to the fourth quarter, the rugged modem section in the fourth quarter, I think there is a transition going from 1xRTT to EV-DO, how is that progressing? Are you expecting to see a rebound in sales in the fourth quarter or this may be more of a first quarter event?

Yeah, I commented on that a little bit. I think that our expectations in the short-term are for modest contribution from the MP, and my belief is it's not until we have fully refreshed the product line, which will happen sometime in Q1 when we begin to get a steady contribution from that product.

Okay.

So, we're kind of -- that's a product when we were going through our troubles 12 months ago that's unfortunately one of the products we weren't investing enough time and attention in and consequently, the air link capability in that product got a little bit stale, right. So now we are going through our refresh. We continue to have a good strong base of loyal customers out there and a lot of them are waiting for the new thing, and I have confidence that we will get some steady contribution from that product once it's fully refreshed.

Which could be a margin -- a gross margin -- benefit to gross margins?

Quite clearly, I mean that's a product that has gross margins well over 50% and historically has for the -- even though it doesn't contribute a lot of revenue compared to our other products, we have seen that product move the gross margin needle one to two points in any given quarter, so.

Right, one last then on the current quarter results for you Dave, on the sales and marketing expenses low in this quarter and you commented I think that the total operating expenses aren't really a good run rate to looking forward. What caused the sales and marketing expenses to be lower, was it something particular, is this an expense that maybe you are going to experience or you experienced in the early portion of the fourth quarter? How should I think about that?

Yeah, I think there's a variety of timing things, John that just led us to conclude that Q3 OpEx run rate was really not representative of the ongoing run rate, so mainly some timing things that occurred in the quarter.

But with respect to sales and marketing specifically, we did have a couple of geography movements across the departments, right?

Right, with respect to some reclassification of [dot] comp expense into G&A.

Yes.

Okay and then.

That's why G&A appears a little bit high and sales and marketing a little low.

Got you, got you. The last one then, Dave could you break out the inventory written down versus the royalty change there and in what type of inventory that you wrote down?

Yeah, John we haven't got into that granularity, I think the important thing to focus on is, what is our product run rate gross margin and that's why we provided the net effect of those two adjustments, which is 700,000 but we are not going to break it out any further than that.

Alright. Thank you gentlemen.

Thank you.

Your next question comes from Deepak Chopra of National Bank Financial. Please go ahead.

Hey guys. I've got a couple of quick questions. Maybe first just bookkeeping thing. Dave, I missed the revenue split by product and channels, wondering if you can just repeat that?

Sure. In Q3, PC cards were 36.2 million, OEM was 13.6, MP was 1.4 and we had other revenue of 1.3 and then did you want it by channel as well?

Yeah. You typically give that as well.

Yeah. Carriers were 25.6; resellers were 12.3; PC OEM 7; other OEMs 7.3; and direct and other revenues of 0.3.

That's great. Jason maybe you can talk a little bit about channel inventory, what have you seen on both sides of the pond in terms of Europe and North America, what's sell-through looking like, maybe provide a little bit of color there?

Sure, sell-through is good, continues to grow. We saw a strong sell-through again in Q3 and with respect to channel inventories with our customers we are quite comfortable where that is. We don't anticipate any surprises there. We have decent visibility, not complete visibility but decent visibility into our -- certainly our major channels we do. So we are comfortable with the levels and we don't think that will be any [governor] on demand.

Okay. Fair enough. And on the embedded laptop front, there has been a lot of chatter, I guess, on all the conference calls, and still call it flexion point in this market, what's your view when you are talking to the laptop OEMs? Do you see -- when do you see volumes in the embedded side? Potentially you gave the PC card side, is that a 12 to 24-month time horizon or is that a lot further out? What is your view in terms of the market? And obviously things that will help drive that like carrier subsidiaries on laptops?

I think that we've said all along that 2006 was the kind of the learning year, the training wheels year for this. And I think all of us have learned a lot. We have, our competitors have, the OEMs have, the operators have. And it has gone, it's gone about as we expected. And on a percentage basis, it's up massive -- the business itself is up massively for us. It is not big dollars yet but the percentage growth has been quite remarkable. As we head into 2007, we are expecting continued growth. So when the inflection point, I'm not - I am one of those guys who believes there is never an inflection point. It just happens over time. Sometimes the growth curve is a little steeper than others and I think that's what's going to happen here. We think it's very strategic, we think that it will be a high growth category, and we think it's very important to be designed into current platforms and future platforms now and become the incumbent because we are believers in the growth curve.

At this point in the business given it is still in its infancy is there really much inventory the channels for embedded modems, I've got to assume for the most part sort of it is built as -- it is order to build type environment. So as customers order they will order it from you and then ship them out. So there is no real inventory channel, is that a fair or wrong assumption?

That's not a perfect characterization but certainly some of our OEMs that's exactly what it is. Some of the cases we actually own -- we own the inventory and it's a just in time -- just in time shipment to the customers. So my belief is and in the OEM channel we don't have perfect visibility into the channel, but my belief is that that is a pretty much a just in time environment and that there is very little inventory in the channel.

And Deepak, it is a bit of a different business model for us in that because it is more of a just in time inventory in the channel, it means that we to service that channel need to carry more inventory on our own books. So that is a bit of a different business model from our AirCard business.

Okay. That's great guys. Thank you.

You bet.

Your next question comes from Amy Nam of JP Morgan. Please go ahead.

It is Amy Nam for Paul Coster. Two quick questions. First of all, with regards to channel inventory of -- you have moved through the fourth quarter and into the beginning of next year. Do you have any concerns regarding, I guess, this initial kind of push into the channel of some of these new technologies and what that is going to mean as we go into the first quarter of next year in terms of demand and channel pull?

I have no concerns over that candidly. I mean maybe that's stating it too strongly, but the market has a lot of good growth catalysts happening right now. The acceleration to 3G deployment is happening, the aggressive promotion on the part of operators continues, new markets are getting lit up by the likes of Sprint, Cingular, Verizon every day. Same thing is happening in Europe. That all creates some pretty strong pull on the channel. So I don't think for us and our customers and it's probably the same for our competitors that there is a lot of channel stuffs going on in the channel -- my view is the channel is flowing quite quickly and in some cases it's hard to keep up with demand.

Okay. So I guess following on to that then, can you give us any color around the traction that you are seeing in your end market customers, what verticals are taking your product?

Well a long time ago we used to do a lot more end customer direct touch than we do now. And back in the olden days, we could tell you exactly what vertical markets and specifically which customers were taking the product. We can't do that now. We rely on big operator channels and big OEM channels. So with respect to clear visibility on who the end user customers are, I can give you some anecdotal commentary there --

Yes, please.

-- and that's about as good as I can get. So there is -- the way I divide the market there is the true blue vertical markets, cops, field service workers, and the like. And those markets have been using wireless data for 10 plus years, always will, and there is an upgrade cycle there as technologies improve. There is white collar vertical markets that are gaining a lot of momentum right now, is my view, and many of these customers are on their second generation wireless data deployments. And I consider those customers like white collar field service and insurance claims adjusters. And then there is the third group or bucket, which are really the mobile professionals, which transcend all vertical market boundaries and all application boundaries and these are people who just travel a lot and require real time access to email and corporate applications. And you can't say what vertical market they belong to because they belong to them all. And that's probably the fastest growing segment of the overall end user market.

Okay. And then, I guess, my last question, I believe, I heard you say that three of your OEM customers you've secured next generation wins, first of all, is that correct -- I heard that correctly? And number two, have you lost any next generation wins where you were the incumbent?

No. You did hear it correctly, and no, we haven't lost any.

Alright. Thank you.

You're welcome.

Your next question comes from Amit Kapur of Piper Jaffray, please go ahead.

Great. Thanks a lot guys. Just returning quickly to the OEM, the laptop opportunity, could you just remind us again, kind of, what the typical length of time is between when you get your design win and when those products hit the store shelves? You mentioned that you've already secured some wins that go into 2008. Is that typical?

It is -- I'd say that is typical, if you look far enough out. So how long does it take from a design win to get something on the shelf? That could take as quick as four or five months. It could take nine months. And it really depends on where that particular OEM is in the lifecycle of that particular targeted platform, and how that lines up with their launch cadence. So there is lots of factors that come into play. So if we get, like Lenovo is a great example. Lenovo, we got our initial design wins sometime ago. It took quite a while for us to get the first platform to market with Lenovo. Since then, however, we've added, I'm not sure how many, 7, 8 platforms. And those of course are much quicker -- quicker design wins and our hope is as we win next generation design wins that we can of course shorten that that time to market cycle, but again I'll caveat that with laptop PC OEMs, they have their own launch cadence that we need to fit into so just -- even if we have the product available and the integration is just about complete that may not fit with their go-to-market launch cadence, right? So we have to fit in with that.

Okay great. In terms of turning quickly to the AirCard line of products, can you maybe talk about when you talked to the carrier partners what level of promotional activity they are planning over the next couple of quarters and then are any of them waiting for some of the new form factors like the USB interfaces to accelerate the promotions, maybe just talk about the level of promotional activity you are seeing?

I see very high levels of promotional activity. With respect to pricing, I think hardware pricing has kind of stabilized, right? You have got anywhere from $3 to $99 or EUR1 to EUR99 seems to be about the band and so with respect to price promotional activities, things got settled in there.

With respect to advertising promotion and sales promotion and things like that, my view is that continues at a very high level. Television advertising, airport billboard advertising, and lots of direct sales engagement, and direct sales training and the like, so that continues at a very high level. We have got a training department here, who is very taxed at the moment and going through a lot of training ranging from B2B sales people to retail sales people, and if there's one new part of go-to-market, I wouldn't necessarily put it into the promotional bucket. But if there is one new part of go-to-market activity that we are actively engaged in and I think gaining some momentum on it, it is retail, it's carrier retail. So we are getting smart on that and working very closely with some of our key channels like Cingular and getting better at the whole retail go-to-market training and promotional activities.

Great. Thanks a lot guys.

Next question comes from Gus Papageorgiou of Scotia Capital. Please go ahead.

Thanks. Just on the MP product lines, generally we are seeing revenues there between 3 million to 4 million, and last couple of quarters we have been kind of sub 1.5 million. Is there a pent-up demand developing there? Do you think when that -- when the new products come out, the new technologies that we'll see kind of a burst in demand or do you think it'll just kind of slowly transition back to the old run rate?

That's right. I hope so. I hope there is pent-up demand, but I really can't say for sure Gus. So I certainly wouldn't -- I mean if you are working on a model, I wouldn't model it in, we are not modeling it in. What we believe though is that we will get good steady contribution once the product line is refreshed.

Okay. And historically that -- those product lines have been higher gross margin, I think, maybe you suggested at one point that it might be slightly better than 50%. But as we transition to the new EV-DO and HSDPA technologies, is there any reason to believe that that dynamic will change should we continue to expect that those products will have higher gross margins?

Yeah, you should. You should expect them to continue to have high gross margins.

Okay. And as I am thinking of the dynamics here, as long as pricing pressure doesn't increase and we see the mix come back towards those MP modems, is that enough to bring the gross margins you think back to above the 30% range or do you need to see pricing pressure ease to get back there?

No. I think we've got to work some additional levers there, Gus, too. It is not just about MPs and stabilizing ASPs. We think we also need to drive product cost and in addition to the MP bring more higher gross margin products into the product line-up over time.

Growing volumes will also have a positive impact.

Great. Okay. Thank you.

Operator, we will take one more question.

Your last question comes from Naser Iqbal of Salman Partners. Please go ahead.

Thanks a lot guys. I'll just make it brief. I guess in terms of just the product technology roadmap, Jason, I mean, do you think that for '07 that 7.2 will be the major technology, and when do you think maybe like HSUPA would that be more like a 2008 phenomenon?

No. I think 7.2 and UPA will be '07 phenomenons.

Okay. Well, that's great. That's it from me. It's late.

Okay.

Thanks a lot.

Thank you operator. I think that concludes the call.

Thank you. Ladies and gentlemen, this concludes the conference for today. Thank you for participating. Please disconnect your lines.