司亞樂 (SWIR) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Sierra Wireless Inc. Second Quarter 2007 Results Conference Call. (OPERATOR INSTRUCTIONS) At this time, I would like to turn the conference over to Mr. Jason Cohenour, President and Chief Executive Officer. Please go ahead, sir.

Thank you, Luke. And good afternoon everyone. Thanks for joining today's call. With me today on the call is Dave McLennan, our CFO.

The agenda for today is Dave will read the forward-looking statements disclaimer. I'll provide a business update on Q2. Dave will cover the specifics of our Q2 results and then also provide Q3 financial guidance and then I'll make some summary comments and then we'll go to Q and A.

So, with that, I'll hand it over to Dave.

Great. Thanks, Jason and good afternoon everyone. 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 applicable securities laws. These forward-looking statements are not promises or guarantees of future performance but are only predictions that relate to future evens, conditions or circumstances or are 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 third quarter of 2007 and disclosure regarding possible events, conditions, circumstances or results of operations that are based on assumptions about future economic conditions, courses of action and other future events. We caution you not to place undue reliance upon any such 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 can 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 thru, revenue, gross margin, operating expenses, profits and forecasts of future costs and expenditures. And 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 customers and gain commercial acceptance, our reliance on the deployment of next generation networks by major wireless operators, the continuous commitment of our customers and increased competition.

These risk factors and others are disclosed in our annual information form which may be found on CDAR and in 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 could 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 the forward-looking statements should the assumptions related to these plans, estimates, projections, beliefs and opinions change.

With that, I'll turn it back to you, Jason.

Thanks, Dave. The second quarter of 2007 was a period of strong growth, record quarterly revenue, record quarterly earnings, new product launches and business diversification. During the quarter, we had record revenue of $107.4 million, representing a 26% increase over Q1 2007 and a 94% increase over Q2 of 2006.

Our strong top line growth combined with solid gross margin helped to drive improved earnings from operations of $8.1 million, our best result ever. Our Q2 earnings from operations of $8.1 million compares to $5.5 million in Q1 of 2007 and $2.2 million in Q2 of 2006. We launched and commenced commercial volume shipments of our new USB products with several major operators, including Sprint, AT&T, O2, Telecom New Zealand and TELES. Sales of our new USB products were a key driver of our sequential revenue growth in the quarter. We also launched and commenced commercial volume shipments of our first ExpressCard with Sprint and Telecom New Zealand.

We closed our acquisition of AirLink a month ahead of schedule, an important step in diversifying our business into the growing machine-to-machine market and strengthening our high gross margin product lines. AirLink also contributed $3.6 million in revenue during the quarter at 50% gross margin.

Looking forward, we expect that our current product portfolio, combined with more new product releases, further channel expansion and the addition of AirLink will help drive continued revenue growth and profitability during 2007.

Moving to specific updates on our product lines, I'll start with our AirCard business, which by the way includes our new USB products. AirCard sales were up approximately 29% compared to Q1 of 2007 and up 109% compared to Q2 of 2006. Our sequential increase in AirCard revenue was driven primarily by strong sales of our new HSDPA and EV-DO Rev A USB modems and EV-DO Rev A ExpressCards.

We began commercial volume shipments of our AirCard 595U, USB modem and AirCard 597E ExpressCard to Sprint during the quarter. We now have three AirCard products commercially available from the Sprint channel. The AirCard 595U was also launched by TELES during the quarter in Canada. We commenced commercial volume shipments of our new AirCard 595U and our new 597 ExpressCard to Telecom New Zealand. Both of which were launched by Telecom New Zealand in early Q3. We also commenced commercial volume shipments of our AirCard 875U, USB modem for HSDPA to AT&T. We now have two AirCard products available in the AT&T channel. We also launched the 875 USB modem with O2 in the UK and with other channels in EMEA, as well.

Overall, shipments of our new AirCard USB products for both Rev A and HSDPA significantly exceeded our expectations. We expect to launch our Rev A USB modem with another major US carrier during Q3.

During Q2 development of our AirCards for HSUPA networks continued to progress nicely. Our HSUPA AirCards will be available in PC Card, ExpressCard and USB form factors. We expect to commence commercial shipments of our first HSUPA AirCards late in Q3. We have secured launch commitments for our HSUPA AirCard products from major operators in the U.S., Asia and Europe.

Moving to specific business development highlights in our embedded modules business. Sales of our embedded modules were flat compared to Q1 2007 and up 31% compared to Q2 of 2006. Sales to PC OEM customers, specifically, increased 13% compared to Q1 to $10.2 million. This amount represents about 57% of our total embedded module sales during the quarter. In total, we have 12 PC OEM customers, 9 of which have currently launched and have commercially available products featuring our mobile broadband embedded module solutions.

Amongst these customers who have launched, we have 47 distinct platform and AirLink combinations currently in the market. We introduced our new mini card embedded modules for HSUPA networks during the first quarter of 2007 and expect to begin commercial volume shipments in the third quarter of 2007. We have secured design wins for these new HSUPA modules.

Moving to our mobile and M2M products, mobile and M2M sales were $4.2 million in Q2, up approximately $3.4 million compared to Q1 and up $3.5 million compared to Q2 of 2006. This increase is due primarily to revenue of $3.6 million from mobile and M2M products acquired in the AirLink transaction.

During the quarter, our newly acquired Raven X and Pinpoint X platforms were certified and are now commercially available for use on the Verizon EV-DO Rev A network. With the acquisition of AirLink, combined with the recent launch of our first 3G MPs, we expect sales of our mobile and M2M products to continue to build momentum and to be a solid contributor to our financial results.

Onto an update on the AirLink acquisition. We completed the acquisition of AirLink on May 25th, 2007, one month ahead of schedule. During Q2, AirLink contributed revenue of $3.6 million at gross margin of 50%, operating expenses of $1.1 million and operating earnings of $700,000. The integration of AirLink is well underway and on schedule. To date, the integration costs have not been material. We expect the AirLink transaction to be accretive to earnings in Q3. We're enthusiastic about the growth prospects in the mobile and M2M business segments and we believe that our combination with AirLink establishes us as a leader in the profitable, rugged mobile market, diversifies our business into M2M and enhances our earnings power.

Onto some corporate items. During the quarter we favorable resolved two class action complaints. One complaint involved a claim against AirPrime for alleged violation of Securities laws prior to our acquisition of the company in 2003. As a success to AirPrime, we became a defendant in this complaint. I'm pleased to report that we have agreed to a settlement in the case, which as been approved and recorded by the U.S. District Court for the Central District of California. This case was settled principally with insurance and escrow proceeds and had no meaningful financial impact on the Company.

The second case involved class action complaints filed against the Company and certain officers following our early 2005 stock price drop. During the quarter, this complaint was dismissed by the U.S. District Court for the Southern District of new York. The Plaintiffs did not appeal and the appeal period has expired. On June 7th, the U.S. International Trade Commission issued an importation ban on future cellular handsets that contain certain Qualcomm chips that have features which were found to infringe on certain Broadcom patents. We note that the ITC ban specifically excludes data cards. After an extensive review of the ITC order and discussions with Qualcomm, we believe that the importation ban does not apply to any of our products and we expect the ban to have no effect on our business.

Our bookings during Q2 were strong and give us good visibility to Q3 2007 revenue. Our channels also reported strong growth and sell thru during the quarter. Our gross margin during Q2 2007 was roughly flat to Q1, in spite of an unfavorable product mix. We expect gross margin in Q3 to be up, sequentially, compared to Q2, driven mainly by a more favorable product mix, a full quarter of AirLink contribution, product cost reductions and solid ASP discipline. Overall, we're very pleased with our Q2 2007 results, as they highlight continued strong revenue growth and improvements in operating margins and business model leverage.

We believe that our strong new product and business development execution will continue to drive revenue growth and improved profitability in 2007. With that, I'll pass it to Dave to review our results.

Thanks, Jason. Onto our Q2 results. Our results are reported in U.S. dollars and in accordance with U.S. GAAP. In the second quarter of 2007 our revenue was a record $107.4 million. Gross margin was $29 million or 27% of revenue and our net earnings were $6.7 million or $0.25 per diluted share.

Our results include $1.2 million of stock based compensation expense, of which $100,000 is in the cost of sales line and $1.1 million is in the operating expense line, as well as $500,000 of purchase price amortization associated with the acquisitions of AirLink in May of 2000 and AirPrime back in 2003. On a pro forma basis, excluding these items, net earnings were $8 million or $0.30 per diluted share.

Our cash balance at the end of the second quarter was $90.1 million. This includes net cash of $11.5 million used in the acquisition of AirLink and the generation of $7 million of cash from operations.

Relative to the guidance we provided for the second quarter of 2007, the revenue of $107.4 million was better than our guidance of $94 million, including one month's contribution from AirLink. Earnings from operations of $8.1 million was better than our guidance of $6 million and net earnings of $6.7 million or $0.25 per share was better than our guidance of $5.5 million or $0.21 per share.

Comparing Q2 results, sequentially, to Q1 '07, revenue increased by 26% to $107.4 million from $85.4 million in Q1 '07. This increase was driven primarily by the sales of our newer HSDPA and EV-DO Rev A AirCards, particularly our USB modems. USB products contributed 45% of our revenue in Q2. During the quarter, AT&T and Sprint each accounted for more than 10% of our revenue and in aggregate, represented approximately 63% of our revenue. In Q1, AT&T and Verizon each accounted for more than 10% of our revenue and in aggregate at that time they represented 45% of revenue. We expect to see customer concentration in the third quarter decrease relative to the second quarter.

Gross margin was stable at 27% compared to 27.3% in the first quarter. This result reflects significant sales of lower margin USB products, partially offset by a favorable contribution from sales of higher margin AirLink products.

Our operating expenses increased to $20.9 million from $17.8 million in Q1. This increase was driven by product development, certification and launch expenses related to new product introductions, as well as the addition of $1.1 million of operating expenses from AirLink for one month of the quarter.

Earnings from operations increased to $8.1 million from $5.5 million in Q1. This reflects an improvement in profitability and represents a 7.6% operating margin, up from 6.5% in Q1. Net earnings increased to $6.7 million or $0.25 per share, up from $5.3 million or $0.20 per share in Q1.

Looking at key balance sheet items compared to March 31st, 2007. I spoke earlier about cash and, specifically, that we generated $7 million of cash from operations. Accounts receivable increased to $69 million from $49.3 million at March 31 and the increase is a result of our strong growth in revenue during the quarter and the addition of $4.8 million of AirLink receivables.

DSOs were 49 days at the end of Q2, consistent with the 48 days that we had at the end of Q1.

Inventory increased during the quarter to $36.1 million from $27.9 million in Q1. This increase resulted mainly from higher inventory levels of newer 3.5 G products to support anticipated increased customer demand and the addition of approximately $3.7 million in AirLink inventory.

Looking at our revenue by product line. In Q2, compared to Q1, revenue from AirCards was up 29% to $83.4 million, that represents 77% of our revenues. OEM revenue was flat at $18 million, representing 17% of our revenues. M2 mobile and M2M business was up significantly to $4.3 million or 4% of our revenues and that includes the contribution of $3.6 million of revenue from the acquisition of AirLink. And other revenue was $1.7 million or 2% of our revenue. I should also note that within the OEM category, sales to PC OEMs were approximately $10.2 million. That's up from $9.1 million in Q1.

Looking at revenue by geography. Again, Q2 '07 versus Q1 '07 revenue in the Americas was up 54% to $81.6 million, representing 76% of our Q2 revenues. Europe was down 26% to $11.9 million representing 11% of our Q2 revenues and Asia-Pac was down 15% to $13.9 million representing 13% of our revenue. The 54% increase in Q2 sales in the Americas, compared to Q1 is a result of strong sales of our AirCard products to AT&T and Sprint. Sales of our USB products were a significant contributor to our sequential growth in the Americas. Compared to Q2 of the prior year, our sales in the Americas increased 108%. The decrease in European sales compared to Q1 is a result of decreased AirCard sales. Compared to Q2 of the prior year, our European sales are up 70%.

And in the Asia Pacific region the 15% decrease in Q2 sales compared to Q1 sales reflects a decrease, as well, in our AirCard Products. However, compared to Q2 of the prior year, our Asia-Pac sales increased 54%.

We're providing financial guidance for the third quarter ending September 30th, 2007. This guidance reflects our current business indicators and expectations. Similar to the second quarter, our guidance for the third quarter includes a significant revenue contribution from expected new product and channel launches. There are uncertainties associated with the launch and early ramp of new products that could affect our ability to achieve guidance. As a result of our anticipated new product launch activity and a full quarter of AirLink expenses and integration costs, we expect our third quarter operating expenses to increase relative to the third quarter. We also expect a sequential improvement in gross margin percentage over the second quarter, as a result of having a full quarter of AirLink contribution, more favorable product mix and anticipated product cost reductions.

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. All figures are estimates based on management's current beliefs and assumptions and are subject to change.

To our guidance for Q3 '07 is as follows. On a GAAP basis we're guiding for revenue of $109 million. Again, on a GAAP basis, earnings from operations of $9.4 million, that's a 16% improvement over our Q2 earnings from operations and net earnings of $7.6 million or $0.27 per share.

On a pro forma basis, excluding stock-based compensation as well as purchase price amortization and integration costs associated with acquisition activity, we're guiding on a pro forma basis earnings from operations of $11.9 million and, again, pro forma basis net earnings of $9.5 million or $0.34 per share.

With that, Jason, I'll turn it back to you to sum up.

Thanks, Dave. Our results for the second quarter illustrate the continued momentum in our business. We achieved record quarterly revenue, volume and earnings. Our business model leverage continued to improve as we lowered operating expenses, as a percentage of sales, to 19.4% and delivered an operating margin of 7.6% compared to 3.9% a year ago. We launched important new products, such as USB modems and ExpressCards with several customers around the world and considerably expanded our product footprint within key customer channels. We favorably resolved bothersome and frivolous class action lawsuits, removing this overhang from our business and liberating management time and attention. We completed the acquisition of AirLink one month earlier than expected and got off to a fast start on integration. AirLink is already contributing to our results in a positive way and we expect the transaction to be accretive to earnings in the current quarter, well ahead of our expectations.

We believe that our combination with AirLink establishes us as a leader in the profitable, rugged mobile market, diversifies our business into the growing M2M segment and enhances our earnings power.

We believe that our market continues to experience a strong rate of growth. During the quarter, we continued to witness accelerating deployment of high speed mobile broadband networks around the world. We view such deployments, coupled with the anticipated, aggressive promotional activities as important growth catalysts for our business.

Looking forward, we expect that our current product portfolio, combined with more new product introductions, further channel expansion and the addition of AirLink will help drive continued revenue growth and improving profitability in the second half of 2007.

And with that, Luke, we'll open the line for questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question comes from Deepak Chopra of National Bank Financial. Please go ahead.

Good afternoon. I was wondering if you could talk a little bit, Jason, about the overall trends in the market, in terms of what type of volumes do you expect the market to see, in terms of growth over the next few years? It seems like, obviously, things are on fire across North America and picking up in Asia and Europe. Could you talk about sort of the overall trend you're seeing in terms of volume and what you think they will do for the next two to three years?

Yes. Our view is that market growth characteristics continue to be very healthy, Deepak. We're seeing this year probably 50% growth in the market. Most industry analysts predict similar growth over the next several years. So, we're looking at a compounded annual growth rate of anywhere from 40% to 50% and so I think it's got very healthy growth characteristics. I think that awareness continues to grow and as networks get deployed, the speeds get better. The end user experience gets better and I think those are all good catalysts for driving adoption and growing the market.

Could you talk about the pricing environment in that context? Are we in a normal environment versus something we saw last year or how would you characterize that?

I'd characterize it as stable. Once again, we had stable ASPs in Q2. A little irony, our AirCard ASPs were actually up a little bit, relative to the previous quarter, that was driven mainly by mix. Our USB products are a little more expensive than our card products, notwithstanding when they have lower gross margin. And our embedded module ASPs were down a little. So, I think that will bump around and our view is right now it's stable. It's an intensive pricing environment, but stable.

I was wondering, maybe very quickly just on AirLink, obviously, a great June there. Is that the type of run rate we should expect or was that a bit abnormally high? Maybe you can just provide us a little bit of color around that?

AirLink definitely had an exceptionally strong Q2 and we benefited from that in the last five weeks of the year. On a going forward basis, we would expect in Q3 that AirLink will contribute in the neighborhood of $9 million to the top line. And we're certainly hopeful that as we further integrate sales activities, both in the U.S. and outside, that we can continue to push the top line higher.

Okay and with that said, are you basically forecasting, then -- I guess the guidance implies that the core business will pull back a little bit in Q3. Is that the Company just being conservative or seasonality or product transition? And maybe you can provide --?

Well, let's not forget we just had a blow out Q2 so I would characterize the core business as basically flat Q2 to Q3. And what's going on there is we're coming off a massive Q2 where we enjoyed the benefit of new channel launches with a couple of big carriers. But I think we're going to take a little breather on that and I think we're going to get contribution from other carriers in the quarter.

So, I think we're going to have a more, what I would characterize as a more normalized core business and a bit less customer concentration and a bit less product concentration.

Terrific quarter. Thanks, Jason.

Thanks.

Your next question comes from Sarah Kim of Raymond James. Please go ahead.

Hi. Good evening. Congratulations on the quarter. I'm just wondering on the gross margin side, I think regarding prior disclosure it was around the mid 40's. Do you expect gross margins to turn down to the mid 40 level or to be sustainable at the 50% range?

Again, I think that we had a lot of things going for us with respect to AirLink in Q2 and including mix that drove gross margins nicely to 50%. So, I would expect gross margin contribution from AirLink to be somewhere between 45 and 50% on a going forward basis. We are now uncovering some opportunities for product cost synergies and hopefully as long as we can hold ASPs that will mean good things for the gross margin percentage on those product lines.

Okay. Great. And you referred to integration costs for Q3 related to the acquisition. Do you have an estimate of what those costs will be?

In Q3 we're looking at approximately $300,000 of integration costs.

Okay.

They were pretty minimal given it was just the last five weeks of the quarter.

Right. Okay. And with the improved operating margins, I'm just wondering, do you guys have an internal target or a target that you're willing to, I guess, disclose in terms of where you guys are aiming to go with the higher sales and profitability that you guys are working towards?

Yes. We've been pretty consistent on this. We want to drive the business to an operating model of about 30% gross margin and an operating margin of about 10%.

And do you have a timing on when you think you can reach the 10%?

You'll have to stay tuned to that.

Okay.

Obviously, in the last few quarters we've chipped away at it and our plan is to take another step towards that goal in Q3; our guidance supports that. So, we'll still -- we'll continue to push our way there.

And just quickly on geographic performance. I'm just wondering, the Europe and Asia Pacific being down in the quarter, was that a quarter specific or are you guys experiencing some slow down there? Or do you expect improvement with more channel expansion in the next quarter? I was wondering if you can provide a little bit more color?

I definitely will. I think the first thing to recognize is both Europe and Asia are actually up considerably first half over first half. Right. Europe for us is up 87% in the first half of '07 compared to the first half of '06 and Asia is up 105% first half of '07 compared to the first half of '06. So, both of those regions are growing for us and we expect that they're going to, on a year-over-year basis, on a full year basis, continue nice -- deliver nice growth for us in 2007.

So, why is it down, sequentially? Well, I think part of the reason is we had a very strong Q1 and Q4 in both of those regions, driven particularly by new product and channel launches. Asia benefiting from a lot of activity with Telstra in Australia as an example. Europe benefiting from some initial channel sales into Spain and France. So, both of those regions I would characterize as taking a bit of breather here. With respect to Europe, we expect significantly stronger growth in Q4, as we transition to HSUPA and we expect Asia to rebound similarly.

Okay. Great. Thank you very much.

Your next question comes from Mike Abramsky of RBC Capital Markets. Please go ahead.

Yes. Thanks very much. Hello. I just want to go back to this question raised earlier on the AirLink contribution and if you could just explain a little bit more helpful. Excluding AirLink it sounds like the quarter would have been 104. The guidance includes $9 million so that would take your Q3 at $100 million in guidance, which is down 4% which was sort of similar to what would happen last Q2 I guess. Now I recognize, as you say, it's a [lull] quarter but you have been doing an average of 25% quarter to quarter growth the last three quarters. So, is growth starting to slow here?

No, Mike. I mean, let's be straight on this, right? I mean Q2 blew away your own expectations and our Q3 is blowing away your forecasted expectations. So, be careful not to create a trend line out of this, right? For both quarters, we're blowing away expectations. So, we definitely have a growth business on our hand and what we're looking at here is we've got a couple of customers -- we had the benefit of a massive initial shipments to a couple of key customers with our USB modems. I believe we're going to take a bit of a breather on that in Q3 and I think we're going to have better distribution of our revenue during Q3.

So, please don't characterize this as anything more than a blow out in Q2 and a blow out in Q3.

I'm not trying to. Just over the last eight quarters, your average quarter-to-quarter growth has been 23%. So, are you suggesting a return to that growth rate is maybe another way to put it?

I think we're suggesting we're going to do $109 million in Q3 and the rest is up to guys like you. We have been overdelivering against expectations, I'm sure you have to admit, on a sequential growth basis. And our plan is to continue to grow the business significantly. I don't think we have anything to feel bad about on our Q3 guidance and our expectation is that we'll have significant growth in the back half of the year.

Okay. The AirLink margin is at 50%. If you pull out that, it looks like your margins were about 26, which was down from over 27Q1. And I think you previously stated expectations for stable margins quarter-to-quarter. I'm trying to use the language you used previously. Is there anything that occurred that was a headwind to your margin guidance in the non AirLink business? And is that perhaps related to the USB business?

That's exactly it. You hit the nail on the head. We had a blow out USB quarter and we've been very consistent that our USB products, our current generation USB products, have a lower gross margin profile because of our supply chain arrangement in bringing that product to market. So, the "lower" gross margin of a whole percentage point was driven by product mix and the mix being heavily weighted to USB. And again, I think we'll have a different looking distribution of revenue in the core business, in addition to adding AirLink, that will bolster gross margins in Q3.

Okay. Thanks. And then the last question is last year you gave Q4 guidance when you gave Q3 guidance and I was just wondering why you chose not to do that this time?

Well, basically because we got penalized twice for that guidance. So, we vowed never to make that mistake again. Last year we had a transition event in Q3 that had our revenue go down marginally and that scared a lot of people so we decided to give Q4 guidance and basically we hit both our Q3 guidance and our Q4 guidance, but we never got the reward for giving full guidance for both quarters. So, we're just not going to do that.

Okay. Thanks very much.

Sure.

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

Congratulations on the quarter.

Thanks George.

Jason, can you give us an idea of how the sales for the USB products proceeded through the quarter? And have you seeing reorders at this point on first shipments, after the first shipments?

We've definitely seen new orders flow in. I'm not going to comment which channels they came from, George, but we definitely have bolstered our USB back log. And we expect to have significant contribution of USB during the quarter, but not at the levels we saw in Q2.

And with the significant contribution from USB, how would you characterize those carriers adjusting their PC card orders? Are they still committed to both platforms?

They are. Yes. We're seeing that they're committed to both platforms, particularly in the U.S. And I think both us and the operators are kind of finding our way right now to see how the mix is going to shape up. Because we both fully anticipate, both us and the operators fully anticipate there's going to be some cannibalization, we just don't know how much yet. It's not a complete overlap; that much we're pretty confident of. I think with USB we definitely expanded the total addressable market and that's going to help us and operators and competitors, for that matter. But I think it's going to take a while to determine just how much overlap there is. Because there's definitely going to be some. With one of our customers who we have a healthy PC card business with, we continue to see during the quarter, very healthy PC card business and the USB was largely incremental. I don't think that's going to be sustainable, by the way. I think there's going to be some give and take and some cannibalization. But I think overall it does grow the market a bit.

Okay. Switching gears and looking at the embedded space. It sounds like on the PC side you're seeing incremental traction. How do you look at the holiday season coming up? Should that step up in the next couple of quarters?

I just don't know, George. We are expecting healthy contribution from embedded in Q3. Whether or not any growth there is going to be driven by holiday orders, I just don't know. It's so hard for us to tell which PCs are being bought with embedded modules that are bound for college students or gifts. We just don't know that yet. I will say that most of the platforms that the modules go into tend to be higher end enterprise oriented platforms. So, not your typical Christmas gift, but that's a situation that's just going to have to play out.

Okay. And one final question. Dave, with the stock option expense, can you give us the split for the various OpEx lines?

Sure. So for Q2, George, in cost of goods sold, $100,000; sales and marketing $200,000; R&D $200,000; and administration $700,000.

Alright. Great. Thank you.

(Inaudible).

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

Thanks. Dave, I was wondering if you could give us a breakdown of the products by technology? Like how much were GSM or GMA?

Okay. In the quarter GSM sales were 42% of revenues. GMA was 56% and other was 2%.

And can you give us an update of what your headcount is at currently?

We ended the quarter at 388 employees and that included a pick up of approximately 54 from the AirLink acquisition.

And could you remind me where you closed last fiscal year at?

298, something like that. We were 321 at the end of March. I just don't have the year end number in front of me.

Okay. And just a question for you. I mean, if you could kind of characterize year of year what you're seeing in terms of number of HSDPA networks rolled out? I mean, do you have any sense of where the numbers are? And then not just the numbers, but also in terms of penetration? I mean, it's one thing to cover one or two cities and another thing to blanket the country. Can you give us a sense of numbers and then also the level of penetration within countries?

Sure. Our view is that's a deployment of HSDPA is a continual event. Our information indicates there's now about 130 HSDPA networks deployed worldwide in about 60 countries. And trying to get into each of those 60 countries and see exactly what the percentage coverage is, is obviously a bit difficult. Anecdotally, I do know that AT&T in the U.S. has been very aggressive in their HSDPA deployment and continue to light up new markets and my personal experience has been the coverage continues to improve every time I hit the road and go to a city. So -- and another personal experience I'll highlight is go into Europe every three or four months or so and experiencing a definitively improving coverage footprint and roaming arrangements with European operators. So, I think some worry was put out there by one of our competitors a little while ago with respect to HSDPA deployment delays. We just don't see it, Gus.

I'm sorry, could you just reference, like you said, the 130 HSDPA networks in 60 countries. Could you give me what the year over year improvement is? Like where was it a year ago?

I don't have that information right in front of me, Gus.

Okay. That's fine, we can follow up later. Thanks.

Okay.

Gus, just to follow up. The year end headcount was 296.

Thank you.

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

Thank you. Good afternoon. Congratulations on a terrific quarter, gentlemen. The USB continues to just be very strong. Last quarter we talked about this, Jason. Any idea on what is it that's driving the demand for the USB form factor?

I must say the demand has surprised us, as well, John. And I really think that it's because the operators really view USB as a strong retail play because of industrial design. Because of the familiarity of USB. I do think users view USB with a little less fear. It's more perceived anyway as more plug and play and often actually is more of a plug and play experience versus a PC card. But I do think a lot of it is it's a very friendly retail product, with a bit lower fear factor and that's where we're seeing most of the success, in the retail channel.

Do you think many consumers are using it on a landline replacement basis?

Very possible, although we just can't see through that clearly, John.

Sure. On the margins associated with that product then. You've talked about supply chain management being the inhibitor to higher margins associated with this. Is this a temporary supply chain management issue that can be rectified? That's what's going to increase the margins in the upcoming quarter? Or how should I look at that?

You should look at it in a series of stages. Our first go to market strategy with USB we took kind of the low risk path. So, we effectively took our module and went to a partner in Asia who designed the USB and built the USB. So, we took the low OpEx route and are now paying for those services in strong design in product costs. So, for this first generation of USB we're going to run like that. We're not going to take the current design out of our partner's factory and place it into the Flextronics factory. That would be too disruptive given the strong demand environment.

In the third quarter we are seeing some better costs on our USB products from that particular partner. And then on a going forward basis for our future USB platforms, platforms that will probably launch late this year, early next year, those devices we'll be putting through our own supply chain and will have a fundamental different cost to goods profile on that.

Okay. Jason, something you and I have talked about in the past is visibility. How would you describe your visibility today versus, if you will, a year go in the business?

Well, I'd say it's getting a little bit better, John, mainly because we have expanded our roster of big channels. This time last year we had at least one less big channel. So, now we have about three or four nice big channels. And in addition to that, we have more than one product in those channels. So, that gives us, on an aggregate basis, gives us a bit more comfort with respect to our visibility on overall revenue. Of course the mix is always a tough thing to pick. But on overall revenue it gives us a bit more comfort because we have built in risk hedges because we have more products in those and more big channels. It just gets --

Are the channels -- go ahead, I'm sorry.

More pieces to balance the risk with.

Are the channels themselves giving you more visibility into their business?

I would say about the same as we had a year go. But we just have more arrows in our quiver to manage the risks and the bumps.

Two last questions. One, the competitor overseas is really struggling somewhat, as we speak now. What concerns do you have that because of those struggles that they may become more aggressive in the marketplace?

Well, I think they already have become much more aggressive in the marketplace. And that's concerning from an AFT stability standpoint. But that particular competitor has their hands full because they're very exposed to the European market and as we know, Roway has established a pretty strong presence in the European market.

So, there's a bit of geographical concentration and that's making for some tough sledding and I think that will drive some changes in the pricing behavior. I think that's reflected probably in their gross margin trajectory, as well. So -- that's just a fact of life in our business. We can't prevent that. And we've got to be competitive in the right situations and stand firm on ASP and in the right situations, as well.

And John, it's Dave. I think we also add that we have a more diversified business. We've got more geographical diversification. And we've got technological diversification by virtue of having both CDMA and HSDPA based products. We've got a thriving OEM business and now we're beginning to grow our mobile and M2M business. So, our business is more diversified.

Last question, gentlemen. It's a WiMax question. The noise continues to accelerate around this technology. We've seen the announcements that have come out today, for instance at Sprint and Google. Jason, your take on the technology and how's your wireless plans to participate in that?

You know I think that WiMax is becoming more real, but still has a long way to go. The fact that Sprint is backing it and that they've partnered up with Clearwire now, I do think gives WiMax a lot more legitimacy, so to speak. So, we're taking WiMax very seriously and the trick for us is, and we've done by the way, early R&D on WiMax platforms and the trick for us is really timing and picking our timing and the kind of products we're going to bring to market. If I had to make a bet now, John, I'd say, yeah, at some point and time we'll probably be in the market with devices that support WiMax, maybe combo devices that support WiMax.

But tough for us to give that a timeframe right now. We're carefully investing, but we don't want to be too early to market either. That's not a fun place to be.

Gentlemen, thank you.

Thanks.

Your next question comes from Amir Rozwadowski of Lehman Brothers. Please go ahead.

How are you guys?

Hi Amir, great, how are you?

Doing well. Just a quick question on AirLink, the revenue this quarter was certainly a bit above expectations. How should we think about sort of the longer term growth rate of that business? Is it performing better than the trajectory you folks have already highlighted?

I'd say through the first half AirLink was probably a bit ahead of their own internal plan. And we're looking for them to contribute perhaps as much as $9 million in Q3, which is probably a bit higher than we had expected initially. So, I'm optimistic. I think the market has good growth characteristics and I also think that by leveraging our international channel footprint, we've got a shot to goose the growth rate on that business.

And so how should we think about it? Is it 25% year over year sort of longer term?

That's what we have been --

That's what they did last year.

That's what they did last year and that's how we've been kind of characterizing it, Amir, as a 25% growth business. But our hope is we can drive that growth rate higher.

Okay. And then just quickly on the competitive environment. I mean there has been some chatter of potential new entrance into the U.S. by some other price leaders in the marketplace. I wanted to see sort of your take on that in terms of do you expect further price competition at some of your key channel partners?

Well, we don't expect anything imminently.

Okay.

And we already have -- in the U.S. market we already have a well established Asian price leader in Pantec on the CDMA side of business. I know the rumors you're referring to are probably the Roway rumors coming to fest.

Right.

We don't believe that's imminent, but we could be wrong. And but we stand by our confidence in our channel position with AT&T and if and when Roway comes to market, they're going to have a fight on their hands.

Okay. And then lastly, T-Mobile hearing sort of 3G build out is supposed to occur with that carrier. How should we characterize an opportunity for you folks there?

Well, it's an opportunity.

Okay.

I mean, I think that's the way to think about it. For us, it's not an imminent opportunity, but one that we're very interested in pursuing and I think their behavior in the past has been they can be very aggressive in the market and reset the service pricing bar and that could be very exciting for -- I think it'd be very exciting for all of us. So, they're definitely an attractive target and we're going to do whatever we can do to be part of that.

Okay. Well, thank you very much and again congratulations on the very strong quarter.

Thanks.

Your next question comes from Mike Walkley of Piper Jaffray. Please go ahead.

Okay. Thank you. Just a quick question on HSUPA, Jason. Can you talk about the competitive environment for that technology and also touch on maybe the pricing environment will give you any kind of gross margin up tick over HSDPA?

Yes. It's very competitive, Mike. I wouldn't expect that we're going to drive higher gross margin with UPA versus DPA. We're going to be fighting against the same guys that we fight against today in DPA land. You know against some of the competitors we might have a time to market advantage. But I expect it's going to continue to be a pretty intense competitive environment for UPA, just as it is in DPA.

And we're also seeing some new entrants in UPA on the embedded side. Ericson has indicated they're going to enter. Back in February they indicated they'd be entering the market. So, we're seeing a little bit more of them in the market as we visit our OEM customers. And their positioning themselves as a price leader, not a functionality leader. So, I think it's going to continue to be intense.

Okay. Great. And then just to understand in terms of timing, is this one of the bigger risk factors in your guidance? Just the timing of say the new UPA products? It sounds like it's late Q3 you said?

Yes. It is one of those risk factors we pointed to in the guidance and it seems to be more typical these days than not that we have some new product launch and new channel launch risk in the guidance and we have it again in Q3 and UPA is certainly an element to that, Mike. So, when we do guidance we do our best to risk balance all of those factors and count on a couple of things going wrong and a couple of things going right and hopefully we pick the right guidance numbers. But it is one of the risk factors.

Thanks. And then one last question. Dave, just on the tax rate. A little higher than expected this quarter and it looks like in your guidance around a 20ish, 21% rate. Can you just point us on the tax rate going forward that we should think about?

Yes. Last quarter we ranged the tax rate from 22 to 25 and this quarter we did come in at 25 and I think that's the right place to be for the balance of the year, Mike. And as we become more and more profitable, you should expect our tax rate to go above that in later years.

Okay. Great. Thank you.

Your next question comes from Kevin Dede of Morgan Joseph. Please go ahead.

Good afternoon. Congratulations. That's Kevin Dede, Morgan Joseph.

Cohenour: Thanks Kevin.

Jason, I guess what I'm wondering is I understand the strength at AT&T and Sprint. But I'm just wondering if you could just peel the onion back one further layer and give us a little more insight into your forecasting and how you might view the strength you saw this quarter and relay that to the confidence you have in the guidance that you've offered for the third quarter?

Sure. You know the way I characterize it, our business with Cingular is strong, stable and in an upward trend. So, we continue to believe that that business is going to head in that same direction. Sprint, we had a massive Q2 after a fairly weak Q1, with Sprint. So, I expect to come off that high with them during Q3, but do expect Sprint to be a steady contributor to our results in Q3 and Verizon down in Q2 after a really strong Q1 and I expect to get more contribution there in Q3. So, it feels like it's a more -- from the big three contributors to our revenue, I think it feels more normalized in Q3. And so I think we've got the revenue spread a bit more and not only amongst key channel partners, but also amongst -- over different product form factors. And that helps us lower the risk a little bit and helps us to smooth out the bumps. And I think that gives us a bit more comfort when we set the guidance.

What happened -- I mean at the time of the Q1 call, what happened during the course of the quarter that set things so far above your initial expectations? Was it just some large, lumpy orders that came in?

It was USB, plain and simple.

Okay. Looking forward, how do you see the carriers adjusting their service plans and how do you think that corresponds to the length of the cycle as I would call it in terms of driving USB sales?

I'm not sure if I'm getting the correlation. What do you mean by length of cycle?

Well, okay. So, I mean, in the history of this business as we've seen it, you've seen some really nice periods of strong growth, given service plans that carriers offer and the value proposition, that's really enticed more enterprise customers. But given the new form factor and service costs and service plans in general and availability, I'm just wondering how long you think this -- I mean, I know you talked about industry growth being pretty sizeable for the next couple of years, I'm just wondering if you factored into that changes in services plans and what your read is on your carrier partner service plan contract ideas?

Our growth expectations don't factor in any material change in the service pricing approach. Most of the industry growth confidence comes from the fact that the networks are better. The speeds are better and penetration is still extremely low. So, even the enterprise market is -- I think we're just scratching the surface. The penetration levels are still extremely low. There's still lots of upside to grow within enterprise.

So that does raise the question with respect to consumer and retail and new form factors like USB, do you have to do anything with service pricing to really kick that market into gear? Maybe. Although I don't think our business really depends on it.

Okay. One last look at the OEM space. I mean, you mentioned 12 partners, 9 of which seem to be ramping up. When do you think you'd see participation by all your partners there? And when do you think you'd get closer to maybe 100%output from them? Or in your case, I mean, up take?

Probably by the end of the year. By the end of the year we should probably, I would expect all 12 of those OEMs to have product in the market.

And how would you say that would affect your mix of sales by product group?

You know it's impossible to tell. If -- three months ago I would have never dreamed of telling you we were going to do 45% of our business is USB. So, it's a bit tough to predict. The way we've been characterizing OEM though and we're sticking by it is we think it's going to continue to grow nicely, but it's not going to go to the moon overnight.

Very good. Well, congrats again on a nice job in the quarter and thanks so much for taking my questions.

Thanks. You bet. And Luke, we'll take one more question.

Your last question comes from Glen Tracey of TI Financial Corporation. Please go ahead.

Thanks very much. Most of my questions have been answered. But quick ones here. On the HSUPA products, you mentioned that you're expecting them to be available late in the quarter. I think you were originally talking about having them ready around mid-year. I'm just wondering if there's a delay that's development related or perhaps a change in your strategy in terms of the focus that you're putting on those particular products, relative to other products in development?

No. I think our focus certainly hasn't decreased at all, Glen. I mean, we're driving to get those products in the market as fast as possible and there's just -- there's real technology building block impediments to doing that as fast as you'd like to do it. And I'm confident we'll be getting our UPA products in the market as fast as is feasible, given the current maturity level of the building blocks, the technology building blocks we need to make our products.

Okay. So, are you saying like suppliers of components are not quite up to speed?

Yes, that's right.

Okay. Can you give us some sort of indication as to what degree of dependence there is in your guidance for Q3, relative to these product launches for HSUPA products?

There is definitely some. I'm not going to share with you the specifics of our HSUPA forecast. But we are partially reliant on getting some of our UPA products to market in order to hit guidance.

Okay.

See, we were confident enough to put it in the guidance.

Right. Okay. It's just not clear as to what degree it's included in the guidance so it seems like it could be -- is it possible that there could be upside there relative to these products?

Always. There is upside and there's downside risk, too. And again, when we set guidance, we're pretty careful about trying to risk balance the view and again we count on some things not going right and we count on some things going right. And we try to risk balance the forecast and come up with something that is realistic. And I think we've been pretty good at doing that so far. And so, I think we've got a good risk balance to guidance out in the market now.

Okay. Last question. Option of course announced in beginning of June that it's going to come out with a new product and partnership with Intel in this LGA package, which is about the half size of a PCI Express mini card package. I'm just wondering what your view is on that type of form factor? And the sort of applicability of it to the market?

Yes. I must admit I don't -- I'm not very steeped in that. I mean, I understand what Option's announcement is and approximately what it means. But I just don't have a lot of visibility into the potential market uptake for that class of product. I will say that we did engage pretty early on with Intel's ultra mobile PC initiative. And if you recall, we did an announcement with Intel last year, last September, around those platforms and have been collaborating with Intel in some of their chosen ODMs in trying to develop the UMPC market. We have had modest results, is probably a nice way of putting it, from that initiative so far.

So, I don't know if that's a good barometer for what Option is doing or not, Glen.

Right. I guess the thing that I'm not really clear on is to what degree or whether or not you're seeing any indication from your customers that this is the type of form factor that they'd like to see from the market as a whole, as opposed to particularly from Option/Intel? Much the way PCI Express became the default form factor after previously Sierra and others had basically custom form factors for the embedded modules.

Yes, so far, no, Glen.

Okay.

And I'll also point out that Intel is not withstanding what they may be doing with Option, Intel is really -- our belief is it's really all about WiMax for Intel.

Right.

It's not about 3.5G.

Yes. I think that's probably a stepping stone to WiMax. Thank you very much. I appreciate it.

Thanks.

Mr. Cohenour, there are no further questions at this time. Please continue.

Okay. I think we're done now, Luke.

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