司亞樂 (SWIR) 2013 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Sierra Wireless Second Quarter of 2013 Earnings Results Conference Call and Webcast.

At this time, all lines are in a listen-only mode.

Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time.

I would like to remind everyone that this call is being recorded today, Thursday, August 1, 2013 at 5.30 PM Eastern Time.

I would now like to turn the meeting over to your hosts for today's call, Mr. Jason Cohenour, Chief Executive Officer, and Mr. David McLennan, Chief Financial Officer. Please go ahead, gentlemen.

Thanks, Laurel, and good afternoon, everybody. It's David McLennan speaking. Thank you for joining today's conference call and webcast.

As a reminder, today's presentation is being webcast and will be available on our website following the call.

Today's agenda is as follows. Jason will provide a general business overview, I will provide a more detailed review of our second quarter 2013 financial performance, as well as guidance for the third quarter of 2013, and following that, Jason will provide a brief summary, and we will round up today's call with a Q&A session.

Before we get started, I'd like to reference the Company's safe harbor statement. A summary of our safe harbor statement can be found on page two of the webcast, which is now being displayed.

Today's presentation contains certain statements and information that is not based on historical facts and constitutes forward-looking statements. These statements include our financial guidance for the third quarter of 2013 and commentary regarding the outlook for our continuing business.

Our forward-looking statements are based on a number of material assumptions, including those listed on page two of the webcast presentation, which could prove to be significantly incorrect.

Our forward-looking statements are subject to all substantial known and unknown material risks and uncertainties.

I'd draw your attention to a longer discussion of our risk factors in our annual information form and management's discussion analysis, which can be found on SEDAR and EDGAR, as well as in our regulatory filings. This presentation should also be viewed in conjunction with our press release and with the supplementary information on our website.

With that, over to you, Jason, to provide the highlights.

Thank you, Dave, and good afternoon, everyone.

In the second quarter of 2013, our first quarter as an M2M pure play, we drove record revenue of $109.6 million, representing 15% year-over-year growth and 8% sequential growth.

Revenue contribution from both our Enterprise Solutions and OEM Solutions product lines was solid, including another strong quarter from the acquired Sagemcom M2M business.

Strong revenue, combined with solid gross margin of 33.4% and stable OpEx, resulted in a return to non-GAAP profitability, highlighting the earnings leverage in our operating model.

In addition to delivering improved operating results in Q2, we completed the sale of the AirCard business to NETGEAR on April 2. Since then, we've been busy transitioning the team, assets, and projects to NETGEAR. I'm pleased to report that this transition is now nearly complete and we will soon be able to dedicate 100% of our focus and resources on growing our world-leading M2M business.

As the M2M leader, we intend to be a key enabler of the Internet of things, and we believe that this presents a great opportunity for long-term profitable growth and value creation.

As the clear market leader, we believe that we are exceptionally well positioned to capture the secular growth opportunity in M2M. We have an extensive blue-chip customer base, strong global presence, unmatched innovation, and a product line that spans the M2M value chain.

We had the industry's broadest embedded wireless module product line-up, from 2G to leading-edge 4G, covering multiple form factors and a range of embedded intelligence options. This enables us to meet the needs of nearly any global OEM operating in any region on any network around the world.

We have a range of intelligent gateways and routers that deliver a highly configurable plug-and-play solution for corporate and government enterprises, and we have our AirVantage Cloud that works with our device platforms to enable the rapid development and deployment of M2M solutions.

By providing device-to-cloud solutions, we make it easier, faster, and cheaper for our customers to build, deploy, and manage their M2M applications. We believe this places us in a unique competitive position and enables Sierra Wireless to not only grow our share but to capture more of the value chain, to expand margins, and to build competitive barriers.

As a reminder, we've refined our product segmentation and are now providing revenue and business highlights for two product lines, OEM Solutions and Enterprise Solutions.

OEM Solutions consists of all AirPrime embedded wireless modules sold predominantly to OEM customers, including PC manufacturers, and Enterprise Solutions consists of AirLink gateways and AirVantage cloud services, sold predominantly to corporate and government enterprises.

So let's take a closer look at each of these product lines.

In OEM Solutions, revenue from OEM Solutions was solid at $95.1 million, representing 14% year-over-year growth and 7% sequential growth.

Contribution from the acquired Sagemcom business was strong in the quarter and the key driver of year-over-year growth.

Design win activity in Q2 was once again robust, contributing to the growth of our customer program pipeline.

In the payments segment, we secured important successor programs with a key customer, solidifying our position with this customer for years to come.

In the automotive segment, we secured an [e-call] design win with a European OEM.

And in energy, we secured a design win with a global leader of municipal lighting systems.

As with all design wins, integration, launch, and ultimately revenue contribution will take some time, but I'm encouraged by the level of design win activity and the growing pipeline of customer programs.

Innovation is another key driver of our market-leading position, and in Q2, we continued to demonstrate our commitment to technology leadership.

Together with Verizon Wireless, we announced the AR7 series of automotive modules. The AR7 is the world's first 4G LTE device designed specifically for the rigors of the automotive segment. A version of the AR7 is now certified on the Verizon network and is sampling with prospective customers.

We also announced the launch of the MC7355, the first 4G LTE embedded module made specifically for the Sprint LTE network.

And with Toshiba, we announced the launch of their new 4G LTE-enabled Portege ultrabook in Australia. The new Portege runs Windows 8 and features a detachable screen that converts into a Win 8 tablet.

With these and many other programs, we have staked a clear market and technology leadership position in 4G LTE, with shipments now exceeding two million devices, many times more than any other player in the M2M industry.

In addition to leading the way in LTE, we're committed to innovation leadership in multi-core embedded modules. First announced in Q1, these module platforms are absolutely unique in the market, combining an advanced multi-core architecture, new embedded application framework, and pre-integrated AirVantage cloud services.

The result is an entire M2M ecosystem on a module, enabling OEM customers to develop and run their application directly on the module in a dedicated core and being able to deploy and manage their devices in the cloud, reducing overall development time and total cost of ownership.

During Q2, we commenced sample shipments of one of these unique devices, the AR6, to two automotive customers in support of new programs which we expect to enter production in 2014.

Moving to Enterprise Solutions, Q2 revenue from our Enterprise Solutions was a strong $14.5 million, up 20% on a year-over-year basis. A key growth driver in the quarter was continued adoption of our recently launched products, particularly the GX440 LTE gateway.

During the quarter, we also commenced commercial shipments of the new LS300, a small, rugged, highly functional gateway ideal for applications and industrial environments.

Given its small size and optimized cost basis, we expect the LS300 to help us drive higher growth of our Enterprise Solutions in Europe.

Our packaged AirVantage Management Service cloud offering is also showing signs of solid adoption. AirVantage Management Service is now offered as a bundled package in almost every new AirLink gateway sales opportunity.

Our Solutions sales team is becoming more and more proficient with the offering, and we are securing customer wins. During Q2, we secured AirVantage Management Service orders with customers in the utility, energy, and public safety segments.

Also during Q2, we launched a fully integrated device-to-cloud solution with Veolia, a world leader in environmental services. Unlike many products and services, Veolia offers ultra pure water treatment and purification systems for labs and hospitals.

Ultra pure water is the principal reagent for laboratory analyses and assures the reliability of clinical diagnoses. As you can imagine, ensuring proper purity levels and water purification system uptime is critical to maintaining operational integrity.

In response to this critical need, we developed a solution with Veolia based on our AirLink gateways and AirVantage cloud platform that offers Veolia customers a way to monitor water purification levels and equipment in real-time.

The result for end customers is higher confidence in the purity of their water supply and improved system uptime. For Veolia, the solution enables them to provide a higher level of service to their customers, strengthening their competitive position.

Veolia offers another example of the power of our device-to-cloud offering, providing the devices, tools, and platform that enable our customers to rapidly and cost effectively build, deploy, and manage their M2M application, and in the process, we become a long-term trusted partner while capturing more of the M2M value chain.

And with that, I'll now hand the call back over to Dave, who will provide more detail on the Q2 financial results and Q3 guidance. Dave?

Thanks, Jason.

I note that we report our financial results on a US GAAP basis; however, we also present non-GAAP results in order to provide a better understanding of our operational performance.

Additionally, with the sale of the AirCard business, which closed on April 2, results of the AirCard business are presented on our income statement as discontinued operations.

In this presentation when we talk about revenue, gross margin, OpEx, and earnings from operations, we are only referring to our continuing operations comprised of our M2M business.

The sale of the AirCard business also resulted in us having one reportable segment, our M2M segment. This one segment is comprised of two product lines, OEM Solutions and Enterprise Solutions.

Focusing on our continuing operations, Q2 was a solid quarter, with overall results at the high end of our guidance range. Revenue from continuing operations was $109.6 million, solidly within our guidance range. Non-GAAP earnings from continued operations of $1.5 million were toward the high end of our guidance range, and non-GAAP net earnings from continued operations of $1 million, or $0.03 per share, was also at the high end of our guidance range.

As a reminder, the reconciliation between our GAAP and non-GAAP results is provided in the press release, as well as in the Investor Relations section of our website. Non-GAAP results exclude the impact of stock-based compensation expense, gain on the sale of our AirCard business, acquisition and disposition costs, acquisition amortization, asset impairments, integration costs, restructuring costs, former exchange, gains or losses on the translation of balance sheet accounts, and certain tax adjustments.

The next couple of slides show our key non-GAAP financial metrics. Starting with revenue, revenue rose to a quarterly record of $109.6 million, up 15% year over year and 8% sequentially.

Year over year, OEM Solutions revenue was up 14%, reflecting a strong contribution from Sagemcom. Organically, meaning without Sagemcom, we saw a decrease in PC OEM revenue compared to a very strong quarter a year ago, with the balance of our OEM revenue being flat year over year.

Sequentially, OEM Solutions grew 7% compared to Q1, reflecting broad-based growth across our various OEM product lines.

Enterprise Solutions revenue grew by approximately 20% on both a year-over-year and sequential basis. This growth reflects growing momentum with recently launched 4G products.

Our non-GAAP gross margin in Q2 was solid at 33.4%. The sequential and year-over-year increase in gross margin percentage reflects the positive effect of an advantageous product mix and continued product cost reductions.

At $35.1 million, Q2 operating expenses were relatively flat compared to last quarter. As discussed at the time of the AirCard divestiture, we are fully invested for growth in our continuing operations and expect to manage OpEx around the $35 million level as we grow the top line, resulting in earnings leverage.

With our return to profitability in Q2, we saw some of this earnings leverage in our results relative to Q1, where a sequential 8% revenue increase, combined with improving gross margin and flat OpEx, resulted in a significant improvement in our non-GAAP earnings from continued operations, which went from negative $1.4 million in Q1 to positive $1.5 million in Q2.

Adjusted EBITDA, which incorporates our non-GAAP adjustments, was $4.9 million in Q2. This represents solid growth compared to $2.4 million a year ago and $1.8 million in Q1 and further illustrates business model leverage.

Moving to our balance sheet, the AirCard transaction gives us strong financial capacity to continue to drive our leadership position in M2M. In the second quarter, the transaction generated $120 million in proceeds net of transaction costs, and we ended the quarter with $176.6 million of cash.

Cash flow from operations during Q2 was $8.1 million, and we utilized $4.2 million for capital expenditures and a further $4.4 million for the repurchase of 386,000 of our own shares.

Coming back to the 120 million AirCard proceeds for a moment, this is the net proceeds realized in the quarter. Note that we incurred transaction costs prior to Q2, and going forward, we will have cash outflows for items such as tax on the gain, as well as cash inflows from the release of the escrow in 2014. Once completed, we now expect overall net proceeds to be approximately $110 million.

Moving to guidance for Q3, which is provided on a non-GAAP basis for our continuing operations, based on the expectation of growth in both our OEM and Enterprise Solution product lines, we are forecasting Q3 revenue to be between $111 million and $115 million, representing solid year-over-year and sequential growth.

For Q3, we expect gross margin percentage and operating expenses to be similar to the second quarter levels. We expect Q3 earnings from operations to be between 2.2 and $3.3 million. This represents a solid sequential increase from Q2 and reflects business model leverage resulting from expected growing revenue and continued expense management.

Assuming an effective tax rate of 30% in Q3, we expect net earnings to be between 1.5 and $2.3 million, or $0.05 to $0.07 per share.

With that, I'll hand it back to Jason to wrap up.

Thank you, Dave.

Our singular focus on the M2M opportunity is all about driving shareholder value. Organically, our goal is to continue to drive revenue growth and expanding profitability as we leverage our leadership position, capture share, and expand into new segments and geographies, such as Brazil.

We also plan to put our strong balance sheet to work in acquiring great M2M companies that help us further expand our position in the value chain, strengthen margins, and drive growth.

I believe our track record of doing this is proven. Since 2008, we've grown our M2M business organically and through acquisition from $158 million to $421 million, and we've done this while improving our margin profile and defensibility. Our aim is to do more of this and in so doing, deliver a great return for our shareholders.

So to summarize, our first quarter as an M2M pure play was very solid. We delivered record revenue, a return to non-GAAP profitability, and demonstrated the leverage in our operating model.

Our outlook for Q3 is for further steady growth and expanding profitability.

As the clear global leader in M2M, we believe we're exceptionally well positioned to capture the M2M growth opportunity. We have significant scale, a blue-chip customer base, strong global presence, and solutions that span the M2M value chain. I believe this collection of assets will not only enable growth but margin expansion and defensibility, as well.

Following the sale of AirCard, our balance sheet is fortified and ready to be put to work. Our goal is to accelerate growth and value creation through targeted M&A. We have a successful track record of driving growth and value creation through M&A, and our pipeline [is active].

That concludes our prepared remarks for today, and we'll now open the line for questions.

(Operator Instructions)

Mike Walkley, Canaccord Genuity.

(Inaudible) AirCard transaction to NETGEARs. Just wanted to build on your last comments there, Jason.

Hey, Mike, can you speak up? You sound far away.

Yes, is this better?

That's much better, yes.

Okay. Sorry about that, a little headset problem. Just on your comments at the end, just talking about a strong pipeline of acquisitions, how do you balance maybe some increased valuations in the market recently with a mandate to put some of your cash to work? Just how do you balance those two things?

Well, I think we've got plenty of cash, and we've been very clear that we plan to deploy a significant amount of that cash in driving growth through M&A, but we've also committed to a balanced approach of capital allocation that includes a return of that to shareholders through buybacks. So as you saw, we've done some of that. We purchased over 0.5 million shares in the first half, and that certainly continues to be an option for us in the second half, notwithstanding the increase in the share price recently.

But our priority always has been M&A, Mike, and will continue to be. I think we've got good ideas that are maturing in our funnel, and I suspect we'll be successful in completing a couple of transactions in the coming periods.

Okay, thanks, Jason. And then pointing to your successful M&A track record, your Sagemcom is helping drive growth. But if you go back to kind of your underlying ex-Sagemcom business, can you talk about maybe the reason it's been more flat recently on a year-over-year basis? Is it ASP compression, or is it just more Europe headwinds? And maybe you can just touch on kind of the core business and how you see that maybe driving growth in the back half of the year.

Sure, sure. And just to be clear, for Q3, we do expect to see organic growth. And with respect to what's causing the headwinds in the last couple of periods, Europe continues to be a theme, Mike. If you looked at our geographical mix, the theme clearly is Europe is holding us back and the Americas is growing.

And that may be getting into some more specifics. In Q2, specifically, PC OEM was down a bit year over year, which was, I would say, the key driver to holding back organic growth. And you may recall that Q2 of '12 was a very strong quarter for PC OEM because we had a large enterprise rollout in Japan. So we didn't experience that in Q2 of '13, and as a result, PC OEM was down on a year-over-year basis.

Okay, great. Thank you.

And then, Dave, just on -- I think I've got a bad line, so I'll pass it on.

Mike, we can still hear you. Just finish up.

I'm sorry, I'm hearing a bad echo on my end now.

So, Dave, on the OpEx side, this $35 million, that's the way we should consider it in that range going forward just on your core business? Anything that would take that up or -- ex an acquisition?

Yes, I mean we're very focused on managing the Company around that OpEx level, Mike, and it bounces around a little bit, but we're focused on keeping around that number.

Okay, great. I'm going to pass it on because I'm having trouble on my line on the end, but look forward to seeing you guys at our conference in a few weeks. Thank you.

Thanks, Mike.

Daniel Kim, Paradigm Capital.

Gents, wondering if we can discuss a little bit of the leverage on the bottom line. I guess from my perspective, could you discuss the plan with Sagemcom and what type of leverage you would expect in terms of cost integration going forward, in terms of how that's going to roll out over, say, the next two to six quarters?

And as a data point, if I were to look at the guidance going into third quarter, the leverage that was just reported in Q2 was a nice uptick on the bottom line, as expected with the sequential uptick on revenues. Q3, we have similar magnitude in terms of revenue, sequential growth again, but we're not necessarily seeing that translate down to the bottom line. Wondering if you can explain a little bit of that and when we might expect to see a little bit better bottom line leverage going forward, please.

Maybe I'll respond to the bottom line leverage. I think if you take the midpoint of guidance, Daniel, that represents about 3% growth on the top line, and we're doubling EPS. So I would say that leverage is alive and well in the operating model.

And with respect to the current cost structure and whether or not we bring that down through further integration with Sagemcom, we think we're about at the right cost structure here in order to take advantage of and capture this, what we believe is a long-term growth opportunity in M2M.

Not withstanding a couple of quarters here where the growth is modest, our expectations are that this is going to be a big market, and we feel like we don't need to ramp OpEx up to capture the market opportunity, but right now, we don't think it would be a good idea to constrain our cost structure and bring our capacity down because we are -- we're investing to capture the opportunity.

So I wouldn't expect a lot there, Daniel, with respect to capturing efficiencies through further integration of the Sagemcom business, which is proving to be a pretty nice contributor here.

Right, no, understood. More specifically, the angle I was coming from was on an absolute dollar basis because your operating structure is relatively flat. With the dollar contribution on the top line, I would've presumed that there would've been a coincident increase or even a greater increase on the bottom-line dollar contribution rather than on a percentage basis, but that's fine.

Switching gears then --

Yes, Daniel, just maybe a little bit more color. In our guidance, we've assumed gross margin percentage and OpEx to be very similar to Q2 levels, right, whereas in Q2, we had a gross margin improvement over Q1.

Right.

So that would add to the leverage we experienced in Q2.

And maybe just lining up dollar for dollar, I mean clearly Q1 to Q2, we saw a higher absolute dollar sequential jump --

Right.

-- than we're guiding for in Q3, and I think that probably explains the disconnect for you, Daniel.

Okay, okay, that's fine. I guess more of a notional view in terms of long-term growth outlook. When we look at the primary spaces where you play, and they certainly have some pretty big forecasts for unit growth and ASPs and all the rest, and then we balance that with the continued design wins that you continue to hit now on most of your big verticals here, in terms of growth, 15% was a nice year-over-year uptick for this quarter. Looks like you're going to see a similar mid-teen level for the third quarter.

In terms of what you're seeing, Jason, with new design wins ramping up, I guess, expected over the next several quarters, would you expect this mid-teen range to be a sustainable rate, or would you, in fact, expect that to accelerate as these design wins start to take hold?

Yes, I think we're going to continue to be sort of cautious in our mid to long-term outlook, Daniel, so we're comfortable with 10% to 15% expectation mid to long-term, but I think we have an option, also, on accelerating growth. We just want to be careful not to say that we're definitely going to secure that jump in growth rate just yet.

And as you can see, we're kind of sailing through some choppy waters here with Europe. That's holding us back. I think with Europe's strength coming back, that would be a big help. That would certainly, in my opinion, secure the 10% to 15%, but I don't think we're going to -- we're not ready to take it up from there. The way I'd think about it is we have an option on higher growth in the context of a healthy macro economy.

Okay, great. And just one last question. AirVantage, you referenced the fact that you're securing more customer wins. I believe last time I checked, you guys had roughly eight carrier network wins. Is that win rate expanding, as well?

Yes, the way to think about carrier wins, quote unquote -- by the way, we're connected now to, I believe, 10 different operator networks, and those are -- you know, when we connect to a carrier network, think about that as opening up a channel with that network so that co-selling activity can take place rather than a direct revenue contribution.

So I would say where we are right now with 10 and maybe adding a couple more, we have sufficient global coverage and global access to the key -- the largest wireless operators in the world. And the real focus is developing opportunities with players like Veolia, as an example, and Atlas Copco and Espresso and getting more direct customers like that either through our direct selling efforts or through our channel partnerships. And that's what's going to turn on the--that's what's going to drive growth in the subscriber base and recurring revenue base.

Terrific. Thank you very much.

You bet.

Your next question comes from John Bright of Avondale Partners. Your line is open.

Thank you. Good afternoon, Dave and Jason. Let me follow up with--hey, guys. Let me follow up with a number of questions in here. One, on the PC OEM business, I don't think you disclose this, but if you do, the percentage of the revenues from the PC OEM business, number one. And then, number two, you seem to be, albeit it down in the quarter I think you said, bucking the trend of the overall PC market. Talk to us about that. Is it market share gains or something else?

Yes, that's the way I would think about it, John. I'd think about it as share gains. With Eriksson backing out of the business and Novatel backing out of the business, that's created share gain opportunity for us. We've definitely achieved share gain with respect to design wins and platform launches. And the way I'm thinking about our PC OEM business now is that we're going through a bit of a transition as new platforms get equipped with our latest LTE devices and ultimately launched. We believe that's going to be an interesting contributor to our growth in the coming periods.

Dave, do you break out the percentage of revenues from PC OEMs?

We don't, John.

Okay. Next follow up, and it goes to the question regarding scaling the business and the guidance. Were you saying that gross margins--gross margins this quarter I think were 33.3 on a non-GAAP basis. I could be wrong there, but--.

--33.4, John.

33.4, excuse me. You're saying they're going to be--you're effectively forecasting flat Q2 and Q3 sequentially?

That's right. We said both gross margin percentage and OpEx to be similar to Q2.

Okay. And then, in your prepared text, Jason, you alluded to two automotive OEM--auto OEM, then talked about production in 2014. Can you give us some more color around that?

Sure. So that was in the context of our new AR6 multi-core embedded module. And think about that as almost an automotive subsystem on a chip or on a module. And we have secured two new design wins. They are European OEMs for European launch. And the target for those applications is to be compliant with the new eCAL regulations. So those are actually 2G deployments.

All right.

And I think I also mentioned a third design with a different European OEM, which is also an eCAL oriented design win.

Are there any major pending biddings going on now for domestic OEMs?

There's a--it's a very active space is the way I'd characterize it, John. And we are constantly working with--trying to earn wins with domestic OEMs and also international OEMs for launches in North America.

Shifting the question to AirVantage, you talked about it as far as the sales process is concerned. You talked about it being part of the sales process. Are you able to monetize that software component?

We are. It's small though, today, John, is the way to think about it. So I would say that we are monetizing it in a significant way through differentiation and margin protection on our hardware. Right? And then, secondly, we are slowly building a pipeline of recurring revenue deals. But the recurring revenue part of the contribution today is small. And our thinking around that is, first of all, AirVantage gives us differentiation and stickiness and margin protection on the hardware, and second of all, creating this or building this recurring revenue pipeline will take time. And I think as that becomes a more meaningful contributor, we'll get more specific on things like subscriber adds and ARPU and revenue contribution.

To another question regarding M&A. You mentioned a couple of transactions I think in the coming periods. Could you describe today an optimal transaction?

Large.

Massively profitable and--.

--I knew you were going to go there.

Optimal--we are kind of--if you look at the priorities we're setting, John, it's really around moving up the value chain. And so, we like businesses like our AirLink gateways and routers business, as an example. Right? So there's a number of examples like that in the funnel. We want to scale our services business. We were talking about AirVantage. AirVantage, while a key part of our strategic initiatives, is a small revenue contributor today. So there are ideas in the funnel that help us scale services revenue. Right? So if there's a theme in terms of our priorities, it's about moving up the value chain, so higher margin, more defensible, sticky customers.

If you take away the--or exclude the PC OEM business, talk to the tone of the M2M business activity today. Is it still in that 10% to 15% range? Do you see an increasing interest, an accelerating interest? Maybe--and understanding Europe's weak, give us some color on the tone of that business, excluding the PC OEM.

Yes. I think activity levels are very high, is the way I would characterize it. And a lot--I mean, there is a lot of focus on the part of big ecosystem players like the carriers, like big industrial players. GE is an example, like players, like--big players like Cisco, Ericsson. So I'd say the awareness floor is definitely coming up significantly. I would say deal flow is definitely robust. Revenue growth right now is--it's there, but it's I would say relatively modest. But I'm a firm believer that this level of activity--notwithstanding the European headwinds, but this level of activity will drive significant market growth in the coming periods.

Final question. Having sold the data card business, characterize today how you feel about--other than relieved, about the visibility that you have versus what your visibility was before.

Well, I would say it's significantly improved. It's--the volatility is down significantly. It's--by the way, that doesn't take away--it's still a complex business to forecast, as an example, but definitely volatility is way down. So when we put the pin in on guidance, it's an easier exercise, because in air card land, as you know, we had three big customers driving the bus. And if one of them changed their mind in the middle of the quarter, that could be really good for our results or really bad. Right? But it only took one customer to change their mind. And in M2M there is many more levers and dials for managing the business.

So that helps us keep volatility down, and like I said, the level of activity in the market has us very encouraged with respect to future growth.

Not trying to pin you down on guidance for Q4, but you mentioned '14 in your prepared text and we're talking about visibility. Could you give us any characterization of timing of your visibility? So would you say that you've got more visibility today six months out, a year out? Where's the increased length of time you've got visibility?

It's pretty--I would say it's pretty far. So if we look at '14--and I'm not going to, of course, share with you what our internal forecasts are for '14. But as we look at '14, as an example, we can--we know which customers that's coming from and which programs. Right? It's a function of already secured--very often already secured design wins or very close to secured design wins. So it's not fully certain, of course, but it gives us confidence when we put together longer range forecasts because we know, a, it's coming from many customers, and, b, we know precisely what programs they're coming from because they are programs that take a long time to gestate.

Gentlemen, thank you.

Thank you.

Your next question comes from the line of Richard Tse from Cormark Securities. Your line is open.

A couple of questions. One, you talked about activity levels being very high. How would you characterize being very high relative to last year? Is it higher than last year? Or kind of give us a sense of that change, or if there has been a change there.

Oh, gosh, it's hard to put--I would say, Richard, it's roughly the same.

Okay. And then, when you talked about this AR7 with Verizon, I'm not sure how this is going to scale up. I think you said that it's on trial and out sampling. So over the course of the next couple quarters, what would sort of happen and how would that scale up?

Well, we need to go get some design wins with it. Right? So I--the AR7 is a--I would say it's an important stake in the sand. It's the first 4G LTE device made specifically for automotive. It's far ahead in my opinion of any of our competitors in terms of readiness. And we have to be successful in taking that benefit in securing big design wins and getting them deployed. And these are automotive design wins, right? So it's going to take time to not only secure them, but to integrate and ultimately launch. So think about revenue contribution from the AR7 to be two years out at least.

Okay. And when you go out and actually try to bid on these design wins, is Verizon involved to any extent, or is this pretty much you saying that you're working with them?

I would say when it gets down to brass tacks in the selling situation it's really about us and our tier one partners trying to secure the business with the automotive OEM. And while Verizon was very interested in being an enabler of this product and bringing it to market, that was really about loading their network. And at the end of the day, if loading their network comes from us, they're very happy. But if it comes from one of our competitors, they're, well, almost as happy. Right?

Right.

So it's really incumbent on us to take this advantage that we've collaborated with Verizon on and go get the design wins.

Okay. And then, last question in regards to AirVantage. You talked about--you've got wide coverage now. Can you give us a sense of what the level of interest is, how many customers you have on it today versus last year, and what that pipeline may be looking like?

I'm very encouraged. We are--I mentioned kind of two pieces of AirVantage. One is our packaged device management, AirVantage Management Services. And every one of our AirLink sales guys now are offering that as a bundle when we sell AirLink devices. And we're having a pretty good hit rate. Now, these aren't huge--these aren't really high volume wins. Right? They're--often times they're a utility or a police agency, so they number in the low thousands or even hundreds of units. But we're definitely getting good traction there and we're getting wins. And I'm very encouraged with deals like Veolia. And we also have some very interesting traction with some very big players in the energy segment.

So I'm very encouraged. It's going to take time. I think the really neat thing is it's definitely given us a differentiation. Last quarter we shared with you a story about a manufacturer of air pressure valves. And we got a module design win because of AirVantage, and we also got the AirVantage win. And that's the kind of thing I'm hoping we can replicate pretty often. Because at the end of the day, it not only gives us the hardware sale, it gives us a long term sticky customer and we kind of become this trusted partner over a much longer period of time.

Great. Thank you very much.

Sure.

Your next question comes from the line of Paul Driver of RBC Capital Markets. Your line is open.

Hello? Can you hear me?

Hi, Paul Driver. Yes, you just cut in here.

Okay, sorry about that. I just wanted to dig into the rationale for M&A, and specifically in regards to the terminal piece. So I think you mentioned that you already have one of the broadest product lines in M2M. So is the rationale for acquiring another terminal vendor, would it be to effectively add another distribution channel to put existing products through it?

You know what? Think about it as bolstering our position in different segments. So while it's true we have a very broad product lineup -- and, by the way, when I said broad product lineup, I meant that in an abstract sense. If you look at the AirLink product line, while it is, indeed, broad, it doesn't include our modules.

But, and the AirLink product line, it does very, very well, and they are designed to be general purpose terminal devices that spread across many segments and work well across a lot of segments. However, in some segments, like fleet management, as an example, they have very specific segment requirements, where many times our AirLink devices are not the perfect fit. So certainly there's a segment theme to some of the terminal targets in our funnel. So we can bolster our position or build a position in different segments that we don't serve as well today.

And then secondly, geographical expansion. This gateways market is a, I would call it a highly fragmented market. And as you travel around the world in different markets, there's very often companies that look like very small AirLink players, and acquiring one or more of those, can give us a very strong footprint in a new geography.

Okay. And then still on the M&A, thoughts on M&A, there's been a lot of talk on the operating leverage and scale in your organic business. When you think about layering on top of that M&A, do you also expect to see operating leverage as a result of M&A, so that M&A would be accretive to margin?

Paul Driver, it's Dave. Each situation's going to be different. But certainly, we look for those situations. And I'd point to Sagemcom, where we -- it's a good illustration of we illustrated some leverage by bringing in some assets and getting more out of them from a profitability perspective.

Definitely accretion is --

Yes.

-- it certainly makes targets higher priority to the extent they can be accretive, Paul Driver.

Okay. Specifically looking at automotive, you announced a number of unnamed wins. Does it feel like you're one of the vendors with some of the stronger momentum in the space? And then could you just talk around how you feel like your revenue share is on the existing automotive business or your design win share going forward compares versus competitors.

I would say from a module provider standpoint, and, again, it's a complex segment. I'll lead in by stating that. But as a discrete module supplier, I would say that we probably have leading global share in the automotive segment, although, our competitors and we don't segment our results down to that level. And I would say that we've been, over the past 3 years, very successful from a design-win hit-rate standpoint. I would say competitive. We certainly haven't won them all, and some of our competitors have won those, have won programs that we've competed for.

But I would say that we are, with respect to the design wins we've secured, I would say that we are in a position to certainly protect our share and possibly build on it.

And in terms of the ecosystem for automotive, you have a relationship with HARMAN. How much can you leverage that or how much are you leveraging that to get into other OEM customers where you may not have a relationship? And could you explain the process in terms of how an OEM evaluates a potential vendor versus other vendors, [like] looking at it specifically on a module-by-module basis? Or do they typically buy a system, an integrated system from maybe a supplier like HARMAN?

Yes, the automotive manufacturer is not usually involved in the module selection. Now, that's not in all cases. But I would say they are not usually involved in the module selection. Sometimes they're influential. Sometimes they'll actually mandate it. But I would say the majority of the time they really rely on the tier I solution provider to make that selection and to make sure that it achieves approval by the automotive OEM's engineering teams and commercial teams.

That's the way I would think about it. I'm not going to put a percentage on it, maybe greater than 50% of the time, the automotive OEM is looking to the tier I to make the right decision, and then deliver the right solution on time and on budget.

Okay. And then when you look at into 2014, the number of different vertical markets out there, which one do you think is probably going to show the most growth? Or which couple you think are probably the most attractive in 2014?

You know what? The same thing we tend to mention. It's automotive, energy, and networking. There's a broad-based, highly fragmented, so there's always the next new interesting application to come along, like water purifiers, as you heard. But thematically, in terms of the big segments that move the needle, for us, it's really those three.

Okay. Thank you. I'll pass the line.

Your next question comes from the line of Peter Misek from Jefferies. Your line is open.

You mentioned small wins with police departments. What kind of public safety product services are you winning? How is that environment looking like? That's my first question. And then I have a question on the tablet market.

Yes, public safety has long been a key market for Sierra Wireless, going back to, oh, gosh, the 1990s. So we've got a long-time relationship with public safety agencies, predominantly in North America. We've done very well with them. And then when we purchased AirLink in 2007, that certainly bolstered our position in the public safety space.

So generally speaking, our devices are used in police cars, as you might imagine, and they are either connected to or embedded in the rugged laptops used by the police officers. And increasingly, the applications are getting, I would say more and more sophisticated, with many more peripheral devices being connected into the gateway or router that's onboard a police car, anything from a video camera to shotgun racks to sensors that monitor the doors and the trunk lid.

So I would say healthy, reasonably healthy environment. Of course, funding isn't all that great for state and local. But I'd say very solid segment for us. And as [band] 14 becomes more real, I'd say it's, in the future, a very interesting potential growth opportunity and a profitable one for us.

The next question's around tablets. We're seeing increasing uptake of WiFi-only tablets. How should we think about your ability to go into some of this WiFi trend, where we're seeing WiFi hotspot 2.0 consortium standardize and effectively allow the exchange or handoff of a cellular call? Do you see that as a threat? How do you think you can capitalize on that, if there's an opportunity there for you?

Penetration rates of wide-area wireless inside laptops and tablets -- and, by the way, tablets, I would say it's a very small part of our PC OEM business right now. I would say penetration rates right now are still well below 10%. And of course, we'd like to see them go higher and, perhaps, they will. But there seems to be this core group of enterprise applications that absolutely must have wide-area wireless embedded in the laptop. And that's where we have our opportunity, both in terms of increased penetration, but, really, more recently, share gain for us. As other players have backed away, we've been able to capture a lot of that share.

So for us, I'd say it's an interesting business. We don't view it as a high-growth opportunity necessarily, but we will follow the industry there. And I don't, in my opinion, I don't think there's a lot of downside risk from an overall segment standpoint in the PC OEM space. And I think there's lots of interesting upside opportunity, should penetration rates actually head north.

Last question I had was more on the M-to-M growth, sort of the growth rates in the entire industry. They're okay, but they're certainly not lighting the world on fire, in spite of these proclamations of the Internet of things, et cetera. I ask this a lot of times. What do you think's the afterburner or the fuel that gets us out of this sort of locked-in gravitational pull? How do we get that liftoff? How do we get that [block] --?

Right. Right. Yes, that's a great question. I do think there's a macro overhang here, Peter. I think that for us, again, if you look at our geographical segmentation, Europe is definitely a headwind. It has not been fun. And I think M-to-M thrives in a healthy macroeconomic environment. So I think that is one key enabler.

And I do think, ultimately, inertia takes over. I mean, there is so much focus and attention and hand waving and investment, that this will continue to push the rock up the hill, if you will, and increase awareness, stimulate demand, and, over time, accelerate the growth rate in the industry.

And I'd add, structure things, Peter, like eCall in Europe. Those are structural drivers in a particular market that could significantly add to volumes in the future.

Great. Thank you, guys.

Your next question comes from the line of Todd Coupland, from CIBC. Your line is open.

I didn't get this at the beginning, so I apologize. It's definitely been referred to, but just wanted you to clarify it. What was the growth rate, organic growth rate, in your overall business in the quarter, if you exclude Sagemcom?

Modestly down.

Okay. And within that mix, I know you're not going to break out PC OEMs. But what type of percentage decline did the PC OEM business experience in the quarter?

Yes, Todd, don't really want to get that specific on a particular product line. The way to think of it is, PC OEM was down, and the balance of our module business was fairly flat, actually.

Okay.

And that's a year-over-year comment. And, of course, we experienced strong sequential growth, though, across the product lines.

I'll also add, Q2 was a pretty touch comp for PC OEM, and that PC OEM was certainly the largest contributor to organic business being down slightly.

And basically, your [thesis] on the PC OEM business is, even though there's pressure that we all understand in the laptop space, you're thinking that the offset will be broader LTE take-up? Is that the way you're thinking about that over the next few quarters?

Well, actually, I think the first thing is share gain, right? So that's, for us, it's been about getting more design wins as competitors have kind of fallen away, but getting more design wins in more platforms. And then hopefully, ultimately increases in penetration rate, driven by things like LTE.

But I think for us to have it be a nice business and actually even a growing business, we don't need penetration rates to go up all that much, because we can grow our revenue through the design wins we've already secured from competitors.

Okay. And then the same point that I asked on PC OEM, on Europe. I mean, I know you're not going to break out the exact percentage. But orders of magnitude, how much of a decline is Europe on right now?

Well, for several quarters, and gets a little bit muddled, of course, when you layer in Sagemcom. But Europe continues to be tough. I'll have to leave it, in general, like that. But Europe continues to be tough, and the Americas continues to be the bright spot.

Okay. The tax rate, I think you said, for the guidance, was 30%. That seems like a step-up to me in the tax rate from prior models, or did I just not update my model? Have you been guiding to 30% for a while?

Yes, we have, Todd. We came with that last quarter, I believe, and that's where it came in, in Q2, and that's where we think the back half will be as well.

Okay. Last question. There's a long-term obligation on the balance sheet. I think it's accrued royalties or something like that.

Yes, that's the biggest component of that.

Okay. How, ultimately, will that get paid back? I mean, do we need to net that against the cash or think of that as -- how should we think about that line item?

That accrual is there to cover all potential future licenses for third-party IP. So where we don't have a license and we believe we can size a royalty rate, we accrue for that amount.

And then as you ship products, it just flows through the P&L?

Yes. Think of it as we burden our cost structure with an accrual for those kinds of estimated future liabilities.

Cost of goods.

Our cost of goods. Our product cost.

Okay, that's great. Okay. Thanks, gentlemen. Appreciate it.

And, Laura, we'll take one more caller.

Yes, of course. Your next question comes from the line of [Gustavo Gregori] from Deutsche Bank. Your line is open.

Just heading back to the auto for a second. So you've had, I think 2 or 3 auto design wins. In preparation for the 2015 eCall mandate for the EU, how many more design wins are scheduled to go? And when do you think they'll be wrapped up? Is it safe to assume that by the end of this year, all the design wins will have been determined? And then when do you think you start recognizing revenue on this? I'm assuming since these have to be built into the 2015 models, they'll probably get delivered this time next year. And would it be roughly this time next year that you'll start seeing revenues? Or do you think you'd be a quarter ahead, because you'll start shipping to the OEMs? And then finally, are the auto guys, are they just kind of doing the minimum? So are they just going for the 2G solution? Or are some of them looking at the AR7 and taking this opportunity to connect the cars to LTE?

Well, that's a lot of questions, Gus. So with respect to -- it's a range. Think of the -- I'll start with your last question first. It's really, whether or not it's 2G or 3G or 4G is really, really depends on whether or not the automotive OEM wants to be strictly and only compliant with eCall or if they want to deliver a suite of value-added services to the vehicle. Call it infotainment applications.

So I'll generalize very carefully here. I would say, 2G, if an OEM just wants to check the box, it is predominantly 2G today, although we are seeing some automotive OEMs implement 3G for their eCall solutions. And that is less about functionality and more about sustainability of the network service. And then higher-end cars, whose manufacturers are really focused on delivering a broader suite of services to the driver, are increasingly focused on 4G.

So that's the lineup. And we see programs across the spectrum. And even within a single manufacturer, you'll see programs across the spectrum. And then, getting out of eCall here for a moment, then you multiply that times the other geographies that the OEM wants to launch in.

With respect to the activity around eCall right now and where we are in terms of design wins and awards to be issued, I don't know. There's still activity. There's still bids. So I don't think, at this point in time, that every automotive manufacturer has their plans firmly in place in terms of selected solutions and deployment to the market. So I think there's more deals to come and to be awarded. We still see a lot of activity across a number of OEMs.

And I think there was another question in there, but I can't recall what it was.

When do you think you'll start recognizing revenue on the eCall initiative?

On eCall, I guess you could say we're actually recognizing some of it now, because some car companies have selected certain models to be eCall compliant well ahead of when the regulation goes into effect. But in terms of, I guess these most recent wins, it's going to take a year. So I would say middle of '14, is when we'll start seeing revenue contribution from our most recent eCall wins.

So this quarter next year?

Yes.

Thanks.

And, Laura, I think we are ready to wrap up the call. So I don't know if you have any comments you want to make.

Not at all, sir. You go ahead.

Okay. All right. Good. Well, thank you, everybody, for joining today's call. And, as usual, management is available here in our Richmond office for any follow-up questions. Thank you.

This concludes today's conference call. You may now disconnect.