司亞樂 (SWIR) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Sierra Wireless, Inc. second quarter 2008 conference call.

(OPERATOR INSTRUCTIONS)

As a reminder, this call is being recorded today, Wednesday, July 23, 2008.

I would now like to turn the conference over to Mr. Jason Cohenour. Please go ahead, sir.

Thank you, Patty, and good afternoon, everyone, and thanks for joining today's call.

With me on today's call is Dave McLennan, the Company's CFO. The agenda for today's call is Dave will read the forward-looking statements and disclaimer, I'll provide a business update, and then Dave will review Q2 2008 financial performance as well as Q3 guidance. The call will then be handed over to me for a summary, and then we'll open the line for questions.

Now I'm going to hand it to Dave for the reading of the Safe Harbor statement.

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 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, circumstances, or our future results, performance, achievements, or developments. They 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 and financial expectations 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 and 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 customers and gain commercial acceptance, our reliance on the deployment of next-generation networks by major wireless operators, component supply limitations, 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, 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.

And, finally, 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.

Thank you, Dave.

In the second quarter of 2008, we experienced solid momentum in our business and achieved record quarterly revenue and operating earnings, despite growing economic uncertainty. During the quarter we grew revenue by 45% on a year-over-year basis, to a record $155.7 million. Our strong top line performance helped us grow earnings from operations by 77% on a year-over-year basis, to a record $14.4 million. Our year-over-year improvement was driven by record quarterly sales of our embedded modules, continued strength in sales of our PC adapter products, a full quarter of revenue contribution from AirLink and disciplined cost management. We also commercially launched several important new products, including two new USB products with breakthrough industrial design and features.

On the corporate development side, we announced a definitive agreement to acquire CradlePoint on April 7 for approximately $30 million. On July 7, we terminated our agreement to acquire CradlePoint as a result of one of the closing conditions not being met.

Moving to specific updates on our product lines, I'll start with our PC adapter business. PC adapter sales were flat compared to Q1 of 2008 and were up 25% compared to Q2 of 2007. PC adapter form factor mix continued to shift from PC card to USB, with USB contributing 73% of our PC adapter revenue, compared to 60% in Q1. In North America, we continued to have a strong position with AT&T for our HSPA PC adapters and also maintained solid sales of our EV-DO Rev A AirCards to both Sprint and Verizon.

During Q2 2008 we launched our new Compass 597 USB modem with Sprint and commenced commercial volume shipments. We're very excited about the Compass 597, as it is the smallest USB modem on the market and supports many innovative features, including integrated GPS, on-board memory for file storage, our TRU-Install software for rapid, easy installation without a CD and TRU-Flow, which substantially accelerates data throughput for end users.

Early in Q3, the Compass 597 was also launched by TELUS in Canada and Telecom New Zealand. We expect to launch the Compass 597 with another major operator in the current quarter.

In Europe, we continued to supply our HSPA PC adapters to several wireless operators, such as O2 and Telefonica. We also continued solid shipments of our HSPA adapters to operators in Asia, including Telstra, in Australia.

Early in Q3 we launched our new Compass 885 USB modem with O2 in the UK. The Compass 885 is the smallest HSPA USB modem on the market and supports the same robust feature set as the 597. We expect to launch our Compass 885 with additional operators in Europe, Asia and the U.S. starting in Q3 2008.

Moving to specific business development highlights in our embedded modules business, in Q2 we had record quarterly sales of our embedded modules. Revenue from the sales of our embedded modules was $40.7 million, up 45% from Q1 and up 126% compared to Q2 of 2007. Revenue from PC OEM customers represented about 61% of our total embedded module sales during the quarter, and was up 26% in Q1. We also achieved record quarterly sales of our embedded modules to vertical market OEM customers. Our revenue of $16 million from this category was up nearly 90% compared to Q1.

During the second quarter, Alcatel-Lucent chose our embedded modules for its wireless laptop security management and tracking solution. Additionally, Erco & Gener, a provider of communication systems for the French and export markets, also selected our embedded modules to provide HSPA network connectivity for their GenPro modem. We also introduced two new embedded modules, the MC8790 and the 8790V for HSPA data and voice networks, both of which provide our OEM customers with new highly functional, yet cost-effective solutions.

As we've discussed on previous calls, competition in the PC OEM space is continuing to intensify, and we expect to see some revenue erosion in this category starting in Q3. We expect this erosion to be partially cushioned by revenue growth with our vertical market OEMs. Over the past 10-plus years we have built a strong, highly diverse OEM business and have unrivaled experience in the space. We have over 50 OEM customers in total, representing a broad range of segments, including mobile computing, networking equipment, industrial handhelds and M2M. We believe that the avenues for growth are many, and we're investing to expand our position.

Moving to mobile and M2M gateways, mobile and M2M gateway sales were $8.3 million in Q2, up approximately 23% compared to Q1 of 2008. During the quarter, the Raven X, Pinpoint X and MP 881W with embedded Wi-Fi routing were certified for use on the AT&T BroadbandConnect network. We also commenced shipments of the Pinpoint XT to a customer in EMEA, representing our first sales of these products in the region.

We announced the addition of IPsec virtual private network security enhancements to ALEOS, the robust embedded intelligence available exclusively on our line of AirLink intelligent wireless gateways. This enhancement will improve data security on our ALEOS-powered platforms.

We view the mobile and M2M gateway market as highly fragmented from a segment, channel and competition standpoint, believe it is fertile ground for profitable growth. We plan to continue to invest in growing this business with new products and segments, geographical expansion, potential M&A transactions.

Some general comments overall, we're very pleased with our record Q2 2008 results. We continued to execute well in a highly competitive environment, launching important new products, expanding our channels and growing key segments such as M2M gateways and vertical market OEM.

Looking ahead, our short-term view is cautious given the expected erosion in sales of our embedded modules to PC OEMs combined with macroeconomic uncertainty in our key markets. We continue to be encouraged by the longer term growth opportunities in our market. Mobile broadband services continue to expand and improve around the world, customer awareness of these compelling services is growing, market segments and applications are expanding and overall market penetration is still very low. Based on this outlook and our confidence in our ability to execute, we are continuing to invest in further strengthening and broadening our market position.

With that I'll pass it back to Dave for a review of Q2 results and Q3 guidance.

Thanks, Jason.

Our results are reported in U.S. dollars and are in accordance with U.S. GAAP.

For the second quarter of 2008, our revenue was a record $155.7 million. Gross margin was $43.2 million, or 27.8% of revenue. And our net earnings were $11 million, or $0.35 per diluted share. Our results include $700,000 of transaction costs related to the termination of the CradlePoint acquisition and $1.6 million of stock-based compensation expense, of which $100,000 is in cost of sales and the remaining $1.5 million is in operating expense. Also included is $900,000 of purchase price amortization associated with the acquisitions of AirLink in May 2007 and AirPrime in 2003. On a pro forma basis, excluding these items, net earnings were $13.3 million, or $0.42 per diluted share. Our cash, short and long-term investments totaled $217 million at the end of Q2, which includes the generation of cash from operations of $14.6 million.

Relative to the guidance we provided for the second quarter of 2008, revenue of $155.7 million was better than our guidance of $154 million. Gross margin remained stable, at 27.8%. Earnings from operations of $14.4 million, which includes $700,000 of transaction costs related to the CradlePoint acquisition, was better than our guidance of $13.9 million. The net earnings of $11 million, or $0.35 per share, was in line with our guidance. Excluding the costs related to the termination of the CradlePoint acquisition, our net earnings would have been $11.5 million, or $0.36 per diluted share. Our guidance had not contemplated the costs associated with the termination of the CradlePoint acquisition.

Comparing Q2 '08 results sequentially with Q1, revenue increased by 10%, to $155.7 million, from the $141.9 million we did in Q1. This increase was driven primarily by an increase in sales and embedded modules to PC OEM and vertical OEM customers. Total OEM revenue was $40.7 million in Q2, compared to $28.1 million in Q1. During the quarter, AT&T and Sprint each accounted for more than 10% of our revenue, and in aggregate these two customers represented approximately 48% of our revenue. In Q1, AT&T and Sprint collectively represented 53% of our revenue.

Q2 gross margin of 27.8% was consistent with the 27.7% we did in Q1. Q2 operating expenses increased to $28.8 million from $28 million in Q1. Excluding CradlePoint termination costs of $700,000, Q2 operating expenses were flat from Q1, reflecting solid expense management during the quarter. Q2 earnings from operations increased to $14.4 million, compared to $11.4 million in Q1, resulting in an operating margin of 9.3%, compared to 8% in Q1. Again, excluding the CradlePoint termination costs, earnings from operations would have been $15.1 million in Q2.

Q2 earnings increased to $11 million, or $0.35 per diluted share, from $9.7 million, or $0.31 per diluted share, in Q1. Excluding CradlePoint, EPS was $0.36 in Q2.

Looking at key balance sheet items compared to March 31, I spoke about cash earlier. Accounts receivable decreased to $98.4 million from $100.7 million at the end of March. DSOs were 49 days at the end of Q2, down from 54 days at the end of Q1. Inventory decreased to $26.9 million from $30.1 at the end of May -- end of March, sorry, mainly as a result of a decrease in HSPA inventory.

Looking at revenue by product, Q2 compared sequentially to Q1, revenue from PC adapters was flat, at $104.1 million, representing 67% of our Q2 sales. OEM revenue was up 45% relative to Q1, to $40.7 million, representing 26% of Q2 sales. Mobile and M2M was up 23%, to $8.3 million, representing 5% of sales. And other revenue was $2.6 million. Within the OEM product line, sales to PC OEMs were approximately $24.7 million in Q2, up 26% from Q1, while sales to vertical OEM customers generated revenue of $16 million, up 88% from Q1.

Looking at revenue by geography, again Q2 compared to Q1, revenue in the Americas increased 7% in Q2, to $104.1 million, representing 67%. Revenue in Europe increased 6%, to $14.7 million, representing 9%. And, finally, revenue in Asia-Pacific increased 18%, to $36.9 million, representing 24%.

The increase in the Americas was primarily due to the sales of our USB modems and embedded module products. Compared to Q2 of the prior year, our sales in the Americas increased 28%. The increase in our European sales was due primarily to increased sales of PC OEM customers. Compared to Q2 of the prior year, our European sales were up 23%. And, finally, in Asia-Pac, the increase in Q2 sales was due primarily to increased sales of our embedded module product. Compared to Q2 of the prior year, our Asia-Pac revenue grew 166%, primarily the result of increased sales to PC OEM customers and sales of our HSPA PC adapters.

On to financial guidance, we are providing financial guidance for the third quarter ending September 30, 2008. This guidance reflects our current business indicators and expectations. Our guidance for the third quarter reflects the expected erosion in sales of our embedded modules to PC OEMs, combined with macroeconomic uncertainty in our key markets. 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.

On a GAAP basis, our guidance for Q3 is as follows. Revenue of $140 million; earnings from operations of $11 million; net earnings of $8.5 million, resulting in diluted EPS of $0.27 per share. On a pro forma basis, excluding stock-based compensation and purchase price amortization of acquisitions, our pro forma earnings from operations would be $13.4 million, and pro forma net earnings of $10.1 million, resulting in pro forma EPS of $0.32 per share.

With that I'll turn it back to Jason.

Thanks, Dave.

Overall, we believe our record Q2 2008 results illustrate our continued ability to execute well and to drive strong year-over-year growth. During the quarter we achieved record quarterly revenue and earnings from operations, launched important new products with key channels and expanded key segments such as M2M gateways and vertical market OEM.

Looking ahead, our short-term view is cautious, given the expected erosion in sales of our embedded modules to PC OEMs combined with macroeconomic uncertainty in our key markets. However, we continue to be encouraged by the longer term growth opportunities in our market. Mobile broadband services continue to expand and improve around the world. Customer awareness of theses services is growing. Market segments and applications are expanding. And overall market penetration is still very low. Based on this outlook and our confidence in our ability to execute, we are continuing to invest in further strengthening and broadening our market position.

With that, Patty, we can open the line up for questions.

Thank you.

(OPERATOR INSTRUCTIONS)

Our first question comes from the line of George Iwanyc, from Oppenheimer. Please go ahead.

Thank you for taking my questions, Jason and Dave. Jason, can you give us an idea of how much of the sequential decline is actually coming from embedded and how much is coming from the challenging economy?

Most is coming from embedded. And safe to say with respect to the rest of our business, we feel good about the strength of our product cycle. We feel good about our channel position. But we are just not expecting the same level of sell-through growth in Q3 that we've seen in quarters past.

And is most of the weakness coming embedded from Gobi, or are you seeing it from competitive pressures outside of Gobi, as well?

It's primarily Gobi, but I would add Ericsson to that mix, as well.

Okay. And do you expect this to be kind of a sequential decline over the next several quarters, or does this account for most of the adjustment?

Well, it's tough to tell exactly what's going to happen in Q4, so I'm not going to go there yet. But clearly, as I've mentioned to you before, we believe there's been a bit of a share shift to the benefit of Gobi and Ericsson and not to the benefit of us.

Okay. And I guess one more question on the embedded impact. Do you see this having an associated impact on the PC adapter business at this point? Do you see increased competitive pressures for external adapter sales going towards embedded over time?

You know, we really don't. We still are very bullish on the outlook for the market for PC adapter sales. We think that's going to be strong. We do think we're hitting some economic headwinds here, but the overall macro picture, in our view, is unchanged. Penetration is still very low. The market growth factors are still very strong with respect to awareness growing and networks getting expanded. So, but we still feel very good about the PC adapter space. We also, by the way, feel good about our other two key growth areas, and that is vertical market OEM, where we saw some excellent sequential growth, and mobile and M2M gateways.

Okay. One last question, this one for Dave. Can you give us an idea of how the stock option expense breaks out between sales and marketing, R&D and administration?

Sure, George. In total, the expense was $1.6 million. Spread out over cost of goods sold, $100,000; sales and marketing, $400,000; R&D, $300,000; and admin, $800,000.

Thank you very much.

You're welcome.

Thank you. And our next question comes from the line of Jeff Kvaal, from Lehman Brothers. Please go ahead.

Hey, Jason and David. Amir for Jeff.

Hi, Amir.

Hi.

Hi. Just a quick question on some of the timing of the new product launches. How should we think about sort of your guidance as relation to some of the additional -- potential additional timing of some of the new product launches in Q3 you had mentioned between the US and Europe and so forth?

Yes, well, I think with a couple of customers we'll be taking them through a product transition here in Q3, so that is probably a small contributing factor to the sequential decline. And those launches are going to be happening over the course of Q3. Some may come in Q4, as well, but we think we're going to be doing quite a few new channel launches -- I should say channel launches for the new products in Q3. And that kind of very quickly you conclude that that probably involves some product transition with a couple of major customers.

Okay. Okay. And then, in terms of CradlePoint, obviously, off the table at this moment, what do you think? Are there additional acquisitions that you folks are targeting, or additional means that you folks are looking for for deployment of your cash balance?

Yes. And the primary use of the cash balance continues to be on the M&A fronts. So we are still very active on evaluating a number of M&A opportunities of both significant size and smaller. So I think you should expect to see more announcements coming from us in the future. I can't put that in a time frame for you, and, of course, can't comment on specific opportunities. But we have a pretty healthy funnel, and we're working the funnel pretty aggressively. We're engaged with a number of different management teams, too. So we're being cautious, obviously, and, but clearly that's a key area of capital deployment for us.

Great. Okay. Thank you very much, Jason and Dave.

Thank you. And our next question comes from the line of Mike Abramsky, from RBC Capital Markets. Please go ahead.

Yes, thanks very much. Could you just elaborate a little bit, Jason, on your comment regarding the short-term view? What -- I was wondering if you could help us understand what visibility that you have regarding how long these headwinds are going to last on your embedded business and what would be sort of your view of signs that these headwinds are lifted or not.

Well, so a couple of different concepts there, right? On the embedded side, I mean, really in PC OEM land, what we're talking about is some share erosion. Right? And so we need to call that what it is. And we're going to continue to compete in that space and win profitable business, but where it's not profitable we're going to have to take a pass. And so clearly I don't see a big rebound there in the near future. We're going to have to get some new design wins and reload the gun there.

On vertical OEMs, we've had good momentum with respect to new design wins. Some of those have turned into pretty nice volume, and we're focusing a lot of our energy there. That's good, profitable business, with a smaller customer base but good gross margins. So we're focusing a lot of effort there. You saw some good sequential improvement with vertical market OEMs, and clearly our intent is to continue to drive that.

The economic headwinds we refer to is really what we're experiencing, I think, in our PC adapter business. We had -- if you asked us not too long ago we would've expected a lot stronger sell-through for our PC adapters than we're expecting to see now in Q3. So when are the economic headwinds going to disappear? I'm not sure, you know. Certainly we would hope they start to dissipate around Q4, but it's just too early to tell, Mike.

And so when you say economic headwinds, could you just clarify whether that means that the market's becoming more cost sensitive and so others are taking share because of their, shall we say, as you said, different, maybe, view of or flexibility on pricing and margins than yourself or whether they also, across the board, will be affected?

Yes, I would say it's more the latter is my view. I mean, clearly, there's always concern about cost and price when you're selling into the operator channel. That I don't see changing. And we don't view the share situation as having changed at all. In fact, our view is that share is stable. Within any individual accounts we are probably up a little bit in some and down a little bit in others. So overall we would characterize the share situation as stable, and we are just expecting in the short term a slowdown in the sell-through growth.

Now, another kind of factor within the factor there is we kind of did an ASP transition here, too. So while volume has gone up from Q1 to Q2 pretty significantly, you saw that, in PC adapter land, you saw that our revenue was roughly consistent. And that's because we've taken a bit of the ASP erosion on, in particular, USB products. However, our new USB products, as we've messaged in the past, come with a significantly better cost basis. So we haven't given up any gross margin percentage on that, but we did give up some top line revenue on the -- some top line revenue.

Okay. Just a couple more cuts at this, your outlook. Can you help us reconcile your strong Q2 PC OEM versus the Q3 declines? It's not clear, given how strong it was, and usually economic headwinds tend not to have such a dramatic shift. And so could you sort of help us understand a little bit behind the difference between the two quarters?

Yes, Mike, maybe I'm not making myself clear. On PC OEM the fall is share erosion. On PC OEM the fall is share erosion. And so why is that happening so rapidly? Well, the reason is there are new laptop platform launches happening now from PC OEMs that have competitors' embedded modules inside. Right? So that's what's driving that rather rapid change in PC OEM revenue. You're actually not seeing dramatic change in our PC adapter revenue. Right? As I indicated earlier, most of the sequential decline between Q3 -- from Q2 to Q3 is driven by PC OEM share erosion.

I think I understand that. I guess what I'm asking is, has -- what has caused the situation to change where you're not winning those new deals as dramatically in one quarter as perhaps before? Was there -- are these other players, as you said, in these share shifts, coming in at lower pricing, or what is going on that has shifted the landscape to cause you to lose share with this level of impact?

Yes, well, I think we've messaged on that in the past. I mean, clearly there's some very low pricing being pitched by some of the competitors. And as a result of that we've walked away from business that wouldn't be profitable for us. And that's really the key driving force. It's been price.

So what visibility do you have to that dynamic changing going forward in your OEM business?

Well, you know, we'll have to see how that plays out, Mike. We've got clear visibility to new cost-reduced platforms from our suppliers that look very attractive to us that we think will be attractive to our customers. So we're pursuing them. And we're pursuing some other avenues of growth in that space, too.

Okay, thank you. Last, very briefly, is there a risk that your OpEx structure is going to need to change given this dynamic to deliver 10% EBIT margins, given the lower revenue outlook?

Well, first of all, we don't feel -- in any given quarter do we feel compelled to make sure that we deliver 10% EBIT margins. We're certainly continuing to invest for top line growth. So if I'm leaving you with the impression that growth is gone, please let me take that off the table. That is not the case. Our view is, longer term, this is a growth business, and we're continuing to invest.

So I think there's very little risk that you'll see OpEx go down in this short-term period that we're facing, and in fact we're going to continue to invest hard in the business, because we think that there's lots of opportunities for growth, and that's going to take investment in new products, and that's been in go-to-market activity, and we're just not going to stop doing that because we've had one down sequential quarter.

Okay. Thanks very much.

Sure.

Thank you. And our next question comes from the line of Dev Bhangui, from Haywood Securities. Please go ahead.

Hey, Jason and Dave. How are you?

Hi, Dev.

Jason, I just want to continue, I guess, in terms of the PC OEMs. Well, see, the non-PC OEMs we don't mind. Obviously, I'm looking at the overall picture here, not just that particular segment of business, but overall I guess earnings from operations as well as the net income is lower. And I'm looking at the fact that while the PC OEM business will continue to be lower, and it's not going to be a one-quarter thing, as you mentioned, because it's a platform win, your non-PC OEM or the vertical [OEM] model business is ramping up sequentially. [These are the] higher margin. And going into the next quarter, for which the guidance has been lower, you're going to transition around into new product areas, which obviously carry higher ESPs, lower COGS and higher margins.

So is it that given the overall macroeconomic situation you guys are being conservative? Because I see from this level of guidance, based on your [qualitative] commentary, I would say material upside based on what I've just mentioned here. Am I completely out of the ballpark here?

Well, Dev, I think you know us by now. We call it like we see it. Right? And we're not giving you intentionally low guidance for Q3 just so we can watch our stock price get crushed. I mean, we're calling it like we see it. And is there potential for upside if everything goes right? Absolutely. But that's the case with every quarter we give guidance. It's a risk-balanced number. And I don't think that we're being overly conservative or overly cautious. We're just calling it like we see it.

Okay. Thanks, Jason. And just in terms of the Verizon [itself], what product is Verizon, or the [bulk] of the product that Verizon is taking up right now? It's still the older version of the USB (inaudible) product?

Most of our sales to Verizon in Q2 were of the PC card, our AirCard 595.

Okay.

And so it's still mainly an enterprise play through that channel.

Okay. Okay. And in terms of, I guess, since you mentioned that some of these product transitions may not necessarily have started in the beginning of Q3, which we are already one month underway, and obviously that is the case, because of which the numbers are a little bit on the low side. You will continue to see the transition into Q4. And in that case, Q4, though I know that you don't want to go there, Q4 would take up probably some of the slack, if I can call it, in Q3 in terms of revenues and in terms of the pickup of the new product from your customers. Is that a correct characterization?

Well, yes, I mean, I think, you know how product transitions can go. You've seen them in our business before, particularly with major customers. And as that happens, sometimes you'll see a falloff of sales of the old thing and a mid- to late-quarter ramp of sales of the new thing. And as long as those transitions go well, it should set you up nicely for the next quarter. But I'm just not going to go there right now, given the uncertainty we're feeling. So I think we'll have -- we still feel very good about the strength of our product cycle. We still feel very good about the strength of our channel position. And we're just uncertain about what the overall market's going to deliver us in terms of demand. Right? So --

Yes. No, I'm just asking this, Jason, of you because there are obviously some elements in the market who feel as if the sky has caved in and fallen, and I guess before joining the group I just wanted to find out whether you think the sky is falling apart. Because based on your commentary, you all feel very bullish, and I'm bullish, too. But I just want to make sure that that should not be the characterization we should take away. Because obviously I don't see the sky falling.

Yes, no, there's no Chicken Little here. So please don't take that away. I mean, we think we're feeling some -- and, by the way, we're not alone, right? I think there's been a pretty steady string of sober outlooks for Q3, in fact, and specifically in wireless. So I guess we're finding out we are not immune. We were hopeful, frankly, because of the low penetration rate in our market, that we wouldn't feel the economic headwinds, but it appears we are. And, no, I'm very bullish long term. I think we've got a short-term patch here that we've got to power through, but I see no share erosion. No bogeyman is taking our business away, outside of PC OEM. We have some challenges there. But in our core business of PC adapters, vertical market OEMs and mobile and M2M gateways, I'm very bullish.

Okay. And one last quick question. Would you like to comment anything in terms of the Fujitsu Siemens alliance dissolving and Siemens taking a back seat? Do you see that impacting your business with them through the PC OEM embedded modules and other partnerships on the carrier side that you might have used that particular alliance for?

Well, that's interesting. Actually, that's a piece of information I wasn't aware of, so I'll have to drill down on that. Now, having -- so commenting here in real time, and we actually have very strong relationships with both Fujitsu Siemens -- Fujitsu Asia and Fujitsu Japan. In fact, we've launched with Fujitsu Japan in Japan and with Fujitsu Asia in Hong Kong in the Lightbook platforms. So I would certainly not expect any structural change there to have a big impact on our business, but it's something certainly we've got to drill down on.

Okay. Thanks, Jason and Dave, for taking my questions, and all the best.

Thanks, Dev.

Thank you. Our next question comes from the line of Charles Johnson, from Piper Jaffray. Please go ahead.

Hi. It's actually Mike Walkley here. Most of my questions have been answered here. I just wanted, Jason, just a little color maybe on some regional outlook. We had Vodafone out this week a little cautious on consumer spending but indicated data cards were strong in markets like the UK. Can you update us maybe what you're seeing in the macro on Europe? And just a follow-up on the Asia region, I know you talked about improving relationship with a carrier in Japan for a USB product. Is that still on track to ship by year end?

We are -- so just talking on Japan, so we are focusing more effort there, and we've had some success in the OEM side. We've got a carrier channel, and as we messaged earlier on, our USB on a USB modem. We certainly hope that we're in a position to launch by year end with that carrier, although it's probably not going to be a significant revenue contributor in Q4. If I had to make a call on it now, Mike, I would look at that as more of a momentum driver starting in '09.

Okay.

And we're working other opportunities in that region, too. So we like that region. We're probably going to put more investments in that region. With respect to the overall macro picture in the US, I think that's pretty clear. We're feeling some economic headwinds in the US. And I think we're seeing some of that in Europe, as well. Of course, we don't have as much exposure to Europe as some other players do, but if you look at various countries in Europe, I mean, clearly we're seeing some signs of macroeconomic sluggishness, and I think Spain's a good example of that. Right? They're having some capital markets challenges themselves, as well as credit challenges themselves, and a bit of a real estate bubble deflating there, too. So (inaudible) we do have exposure to, it looks like they're a bit sluggish right now at a macro level.

Okay. No, that seems pretty fair, given the environment we're in out there. Just a follow-up question in terms just competitive landscape more on the USB modem-PC card side. It doesn't sound like there's any change, but I thought I'd just ask if you see any more aggressive pricing or any major changes in terms of some of your competitors' behavior.

You know, no major changes there, Mike. It's equally intense now as it was for the past several quarters. Right? And so it's a bit of a barroom brawl, but that's okay. We're okay with that. We think we're competing pretty well. And, like I said earlier, we feel pretty good about our share right now. And we've got -- it's something we have to be paranoid about, and we are, and we operate our business that way. But right now we feel pretty good about our share position.

And, Mike, it's Dave. We've got -- in the past three months we've got two new USB modems in the market that have a lower product cost structure. So that gives us ability to (inaudible).

Yes, I might add, a lot of significance to -- significantly more of our R&D investment is going to cost reduction than it did in the past. Most of our R&D in the past was really all about getting to the next new fastest AirLink. And we're continuing to do that, but a lot of our incremental R&D investment is in cost reduction.

That's fair. So I appreciate you taking my questions. Just had most of it answered, like I said, so I'll pass it on to the next person.

Thank you. And our next question comes from the line of John Bright, from Avondale Partners. Please go ahead.

Thank you, Jason, Dave. Let's stay with the embedded modems. Jason, strategically speaking, looking forward, we don't want -- people may paint this as Gobi and Ericcson coming into it on a low-cost basis, and this is the type thing where it's the beginning of a long downturn on the market share gain for Gobi and Ericcson on the embedded side of the equation. You're in the front seat to view this. How do you see this market, this particular segment evolving? And then just, so we make sure we're talking about the right numbers, what percentage of the business are we talking about? We're talking about the OEM, all of the OEM or just a percentage of it, so we can be completely clear.

To be clear, in Q2, our revenue from PC OEMs was what?

$24.7 million.

$25 million in Q2 from PC OEMs. And our view is that that will go down in Q3. So how is the market going to play out? We're going to continue to compete, John. And we've got some good new design wins with players like Fujitsu Siemens and NEC in Japan. And we have the right solution at the right price, the right support services, the right capability to integrate and get them to market. And I think we're going to continue to get our design wins based on those capabilities and our products. So we're not giving up on the market.

And, by the way, Ericcson and Gobi, we're not sure how long they're going to continue to be in the market. Maybe they'll be in the market forever and maybe not. Some of the pricing behavior we've seen out of some players doesn't appear to us to be sustainable, so either they're going to have to start pricing in line with rational business models or ultimately it's just not going to work from a business standpoint. Right? So we're going to continue to compete, and we think we have some other interesting avenues to explore in order to get us more competitive in that space, which of course I'm not going to disclose to you.

Okay. And then on your economic headwinds comment, I assume you're not just pulling back the reins on some of the expectations. It's more so you're seeing that in order flow already. Is that correct?

Yes, we're seeing it -- the way I characterize it, John, is we're seeing that in forecasts from our customers.

Got it.

That's the key barometer for us for putting the pin in on our own forecasts.

Got it. Two last ones, then. You talked about reinvesting in the business. You just mentioned, I think, a moment ago, reinvesting in cost reductions to be more competitive in some of the bids. Is this something we should think about an uptick in OpEx looking forward? And also, how would you describe the priorities of your investments?

Well, priorities for our investments, well, so just on a going forward basis, so OpEx was stable Q1 to Q2 if you take out the --

CradlePoint -- yes, that's right.

-- CradlePoint termination costs. And looking forward to Q3, we think it'll continue to be stable. There's a few pieces. Some things are coming out and some investments coming in. So I think overall we'll probably be stable with respect to OpEx in Q3. Beyond that, I'm just not going to go there right now.

So what are we investing in? We're investing in R&D, of course, and R&D, put it in a few different buckets. One is new products, and in particular new products that support new and higher speed AirLinks. We're putting it into cost reduction. And we're putting it into new products for a new segment. And in particular I'm referring to our mobile and M2M group there. And in addition to that we're investing in go-to-market capability, and go-to-market capability is really all about channel support and technical support.

Have we reached a point, do you think, Jason, where the technological changes have slowed to the point where some of the low-end players can come into the business without doing the amount of R&D as we've historically seen?

Well, clearly, there are some chip set solutions that are making it easier and easier, of course. Right? I mean, that's what good chip set suppliers do. They make it easier for their OEMs. And in some respects the barriers to entry have been lowered.

But I will point out that our own R&D expense is not going down. It's actually going up. It's not going up as fast as revenue, but it's going up. And that's because there's lots more opportunities in terms of AirLink innovation. I don't see AirLink innovation slowing down, by the way. I think that it's going to continue a rapid pace. Now, I'd see opportunities for new geographies that require new AirLink support, and I see opportunities in cost reduction and new form factors.

So I don't think -- I don't want to leave anybody with the impression that it's taking less R&D strength or bandwidth to get into this business, because it's not. And I think we're a good barometer of that. Our R&D expense is not going down. It's going up. And it's not because we want to spend the R&D dollars for our health. It's because we see opportunities for new products in new areas.

Share repurchases, I think in the prepared remarks or in the press release there was no -- no shares had been purchased as of June 30. What's the thought on executing on that?

Well, the thought is that we, of course, put the NCIB vehicle in place. The NCIB vehicle has been approved by the TSX, so we're hoping to make purchases on both the TSX and the NASDAQ. Our message in the past has been that we want to use the NCIB vehicle on a -- in a very targeted way. And an example that we gave was using it to soak up dilution from potential M&A transactions. And our position on that hasn't changed, John.

Would you consider it if your stock was under significant pressure?

Well, certainly there's a capital allocation discussion there to be had. And certainly it's something we talk about here internally and with the board. And whether or not we pull the trigger on it remains to be seen.

Gentlemen, thank you.

You bet.

Thank you. And our next question comes from the line of Kevin Dede, from Morgan Joseph. Please go ahead.

Good afternoon, gentlemen. Nice job on the sales.

Thank you.

Jason, can you talk a little bit to the linearity through the quarter in terms of order rates that you've seen from your customers, especially on the adapter side, that suggest this cautiousness?

In order flow in Q2?

Yes, on a month-to-month basis, just sort of linearly as you --

No, it's -- there's no order flow pattern that would lead us to this conclusion necessarily, Kevin. It's really more about the forecasts that we're seeing.

Okay.

And (inaudible). We don't just gear up our supply chain based on orders. We gear it up based on forecasts. And that's what we use to build our own -- our internal forecasts. Customer forecasts to build our internal forecasts.

Would you mind giving us a little more granularity in terms of unit volumes as you look back to, say, the past three quarters, just so we can get a better feeling for some of the ASP erosion?

Well, you know, I'm not going to give you a historical trend line on that, Kevin. I will tell you that in Q2 we shipped a little over a million units, though.

And how -- can you give us an idea on how that changed, roughly, from Q1 or Q4?

No, I can't.

Okay.

I will tell you, though, ASPs -- I'll give you some directional commentary on ASPs.

Well, you did mention that you've seen pressure, but I was just hoping you might be able to quantify it a little bit.

Yes, so I'll give you a little help there, because we're stepping into a disclosure area that we just don't provide information on, and I don't want to be sloppy on that. But with respect to ASPs and embedded module land, stable. In PC card land, stable. In mobile and M2M gateways, stable. And in USB, down. But that's not a panic sign for us, because you remember our older USB models had a significantly higher cost basis. We had to charge a higher ASP to make meaningful margin there. So with our new platforms we have moved on ASP, but the cost basis is much lower. So we're not giving up any gross margin percentage there.

So you're referring to the 597 and the 885?

That's right. That's right.

So in looking down the product cycle maybe one more turn, do you see that same sort of dynamic staying in place, I mean, the same type of ASP erosion and the same type of cost savings that you might be able to get out of your subsequent product cycle?

I can't comment on the rate of cost reduction and the rate of ASP erosion, but clearly, as I mentioned earlier, directionally we are investing more in cost reduction than we have in the past.

Okay. Your vertical OEM business doubled sequentially. Can you talk to the sustainability of that and sort of the applications that you think are driving it and your competitiveness there?

Yes, well, I think we've got a very strong market position in 3G embedded modules for vertical market or M2M OEMs. It's tough to put a number on share, but I'm quite sure in that space we're the leader. And the applications cover a broad eclectic range, candidly.

Networking equipment has some momentum, ranging from router manufacturers like Cisco to industrial router manufacturers like Digi to more SOHO router manufacturers like Ericcson and a number of others. So that seems to be an interesting space for consuming our embedded modules.

Industrial handhelds has always been a good space for us, and that includes players like Motorola Symbol and Intermec. We continue to do quite well there. MRM applications are also a good space for us, and that's into applications ranging from transportation to public safety to field service environments. So that's a -- it's a business that's quite fragmented, and that's one of the reasons why we can drive some good profitability there.

And I guess what I'm wondering, too, is are you basing that business sort of at a stable level, or continued growth there? Is that what --?

Yes, we're probably not going to double sequentially every quarter, but we do view it as a growth business. And we are investing to drive more growth there. We think it's a good, healthy market, and it's a growth market.

And it's quite a profitable line of business for us.

Okay. So on the mobile products side, some nice improvement there, as well, but still not back to Q4 levels, and I'm wondering how you might look at that.

Yes, well, the way we look at that is it feels like economic headwinds. And in fact I think we probably saw it in that part of our business earlier than in our PC adapter or embedded business. That is a -- it is a pure enterprise sale environment, and even while we see very strong improvements in our sales funnel and the dollars in our sales funnel growing, deals are just closing a little bit more slowly. So I think it's going to take us a little while to get back up to the levels we saw in the second half of last year.

Last question for me is on CradlePoint. Can you talk to sort of the product side that attracted you to that, and given that it's not going to go through now, do you still see a market for the products that you thought you might be able to squeeze out of that acquisition, and whether or not you're planning to chase those down on your own?

Well, clearly, we like the space. Right? We liked what CradlePoint was doing, and we think the convergence and specifically personal hotspot space is interesting. And we've got a couple of competitors in that space, as well. They find it interesting. So I do think there's some potential for growth there.

Right now, Kevin, we've terminated our deal with CradlePoint, but we continue to have a constructive relationship with them and plan to collaborate with them in the market. And we're continuing to sell embedded modules to players in the router space. So that's a very good play for us in this whole convergence and potentially personal hotspot space, playing the role of the provider of embedded modules.

Now, whether or not we get into that business on our own and sell our own fully integrated product, that's something that would be a bit longer term for us, and something we just -- we have to reevaluate whether or not that's a space we are going to enter organically or through another acquisition or just continue to supply modules to all manufacturers.

Very good. Well, thank you, gentlemen, and thanks for keeping the line open for me.

Sure.

Patty, I think we have time for one more question.

Thank you. And our next question comes from the line of Barry Richards, from Paradigm Capital.

Yes, a follow-up from a couple of earlier questions. So you've admitted the outlook's a little more cautious, at least, from an economic side on some parts of your business. Did you modulate your spending on the operations side? You did admit OpEx was basically flat with Q1. Did you make it so? Did you moderate your spending to reflect the more cautious view?

Dave, do you want to comment?

Yes, Barry, it's Dave. I think OpEx is always a constant focus for us, and really what we calibrated it to was the product cycle and the developments going on there to build and launch new products. So that's really what we calibrated it to. But it's something that we carefully, carefully watch all the time, and you see that evidence with it being flat Q2 over Q1.

And then, as that plays out, if the economic environment gets weaker, is there a lot of discretionary spending that you have that you can cut back or is it pretty much committed at this point based on the new products you're pursuing and so forth?

Yes, I mean, I think we're still very focused on building and launching new products, because we see lots of opportunity to do so. So our mindset is along those lines. But, again, that's something that we monitor.

Yes, we added people in Q2, to be clear. I mean, we haven't made any structural changes to take our cost structure way down. We think it's actually more important for us to continue to invest and drive growth in the business. Again, it's [about] a single quarter guidance thing here that everybody's reacting to, but we're investing to grow this business. We believe there are good growth prospects in this business. We're not going to let one or two or even three quarters knock us off that track. Now, if this is a -- ends up being a long, protracted economic slowdown that hurts everybody, then, yes, I mean, we can make some changes. But clearly we are not planning to do that.

Understood.

[Some context], Barry, with our guidance we're still delivering close to an 8% operating margin, so we're focused on profitability, but balancing that with investing properly to grow the (inaudible).

Yes, [I think] we understand. It's at the margin that I'm asking about the changes that you might see in operating expenses. But I understood the answer. Thanks and good luck.

Yes, thanks.

Thank you.

Okay, operator, I think it's time to wrap up the call. Patty, are you there?

Yes, gentlemen, and do you have any closing remarks?

I just want to thank all the callers for taking the time to be on the call, and as is usual, if anybody has follow-up questions, management is available here in our Richmond office.

And, ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.