司亞樂 (SWIR) 2018 Q2 法說會逐字稿

Good afternoon. My name is Suzanne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sierra Wireless Second Quarter Results Conference Call. (Operator Instructions) Mr. David Climie, Vice President of Investor Relations, you may begin your conference.

Thanks, Suzanne, and good afternoon, everybody. Thank you for joining today's conference call and webcast. On the call today is Kent Thexton, our interim CEO; Dave McLennan, our Chief Financial Officers, Marc Overton, Senior Vice President of IoT Services; and Jason Krause, Senior Vice President of Enterprise Solutions.

As a reminder, today's presentation is being webcast and will be available on our website following the call. Today's agenda will be as follows: Dave will provide a detailed overview of our quarterly results as well as guidance for the third quarter. Kent will then provide his comments and introduce both Marc and Jason, who will discuss their respective business units, and then we'll open up the call for Q&A.

Before we get started, I will reference the company's safe harbor statement. A summary of our safe harbor statement can be found on Page 2 of the webcast and is now being displayed. Today's presentation contains certain statements and information that are not based on historical facts and constitute forward-looking statements. These statements include our financial guidance and commentary regarding the longer-term outlook for our business.

Our forward-looking statements are based on a number of material assumptions, including those listed on Page 2 of the webcast presentation and could prove to be significantly incorrect. Additionally, our forward-looking statements are subject to substantial known and unknown material risks and uncertainties. I draw your attention to a longer discussion of our risk factors in our AIF and management discussion and analysis, which can be found on SEDAR and EDGAR as well as other regulatory filings.

The presentation should also be viewed in conjunction with our press release. With that, I'll now turn the call over to Dave McLennan for his review of the second quarter.

Great. Thank you, David, and good afternoon, everyone. I'd like to note that our report -- we report our financial results on a U.S. GAAP basis; however, we also present non-GAAP results in order to provide a better understanding of the operating performance for our business.

As a reminder, a full reconciliation between our GAAP and non-GAAP results is available on our website.

Moving on to our second quarter results. We had a very strong quarter. Overall, consolidated revenue in the second quarter was $201.9 million, an increase of 16.4% compared to the same period last year. All 3 business units performed well and contributed to this year-over-year growth.

Product revenue, which includes all revenues associated with the sale of embedded modules, gateways, routers and other hardware devices, was $178.8 million in Q2, up 9.4% on a year-over-year basis.

This reflects good operational execution in a tight component supply environment. I'll also note that the supplier component reliability issue, which we flagged when we provided Q2 guidance, had a negligible impact on our Q2 results, which was good news.

Services and other revenue, which includes revenue associated with our cloud and cellular connectivity services as well as engineering, support and warranty services, doubled in Q2 from a year ago, driven by both organic growth and the acquisition of Numerex. Services and other revenue now represents 11.4% of our total revenue.

Adjusted EBITDA at $15.6 million grew 5% compared to a year ago. Our performance relative to guidance really demonstrates just how strong our Q2 results were. Revenue was at the high-end of the guidance range, and at $0.27 per share, non-GAAP EPS was above the high-end of our guidance range.

Also worthy of note in Q2, non-GAAP gross margin was 34.4%, up 1 full percentage point from Q1. All 3 business units showed a sequential improvement in non-GAAP gross margin. OEM Solutions gross margin was 30.4% in Q2, Enterprise Solutions gross margin was 50% and IoT Services was 41.1%.

This sequential improvement across all 3 business units reflects the absence of expedite cost associated with component shortages in OEM; the absence of network upgrade cost, which IoT Services include -- incurred in Q1; and favorable product mix and Enterprise Solutions.

In addition, OEM Solutions gross margin benefited by $1.2 million from favorable settlements associated with 2 claims. This added 60 basis points to consolidated gross margin percentage in the quarter. Normalizing for these claims, the non-GAAP gross margin in Q2 would have been 33.8% and EPS would have been $0.24.

Non-GAAP operating expenses in Q2 were up slightly from Q1. During Q2, we engaged a third-party consultant to assist us in driving greater efficiencies in the business. And as a result, we expensed approximately $1.4 million -- $1.5 million in G&A in the quarter on this program. No such expenditures were occurred -- were incurred in Q1. And finally, the non-GAAP effective tax rate was very low in Q2 at 7.4%, which was lower than our expectations reflecting the jurisdictional mix of our income across our various legal entities.

Looking at key non-GAAP metrics in the second quarter of 2018 compared to Q2 2017. On a year-over-year basis, consolidated revenue increased by 16.4% with 25% of the quarterly revenue coming from our high-growth, higher-margin Enterprise and IoT Services business.

In Q2, OEM Solutions revenue increased by 4.5% year-over-year, reflecting increased demand in automotive, enterprise networking and industrial.

Design activity was strong in Q2. OEM Solutions had a record number of design wins across a broad range of IoT segments and geographic markets. Enterprise Solutions revenue in Q2 was up 31.1% year-over-year. Enterprise growth was driven by strong revenue from AirLink networking solutions in the industrial and mobile markets.

Customer wins in the second quarter were solid, including wins in energy, transportation and public safety. Specifically in Public Safety, we secured our initial FirstNet-ready design win for routers with a customer in California. IoT Services revenue in Q2 was up 210% year-over-year. The Numerex business has stabilized, and we are pleased with the progress we were making on the integration of platforms, operations and the sales teams.

Excluding Numerex, IoT Services continue to experience solid customer activity with new wins in industrial, energy and transportation. Looking at adjusted EBITDA and non-GAAP EPS on a consolidated basis, in Q2, adjusted EBITDA was $15.6 million, which was up 5% compared to $14.9 million a year ago, and non-GAAP EPS was $0.27 or $0.24 after normalizing for the settlements that I referred to earlier compared to $0.30 a year ago, and reflects the dilutive effect of the Numerex acquisition.

Please note that our second quarter 2018 financial results reflect the adoption of the new revenue recognition standard ASC 606. The comparative period in 2017 has been adjusted to align with the new standard, and I refer to your notes in the financial statements for details of these adjustments.

Moving onto the balance sheet. We ended Q2 with $73.4 million of cash, and the company is debt-free. During the quarter, we generated $11.3 million of cash from operations. And after CapEx of $5.6 million, free cash flow in Q2 was $5.7 million. Our capital expenditures in Q2 were primarily related to factory test equipment, R&D development tools, network equipment and some capitalized software development.

Overall, our cash position increased in the second quarter by $2.8 million compared to Q1.

Moving on to guidance for the third quarter of 2018. We expect Q3 revenue to be in the range of $198 million to $207 million. Non-GAAP gross margin in Q3 is expected to be slightly down compared to the normalized Q2 gross margin of 33.8%. We expect non-GAAP OpEx to be lower sequentially from Q2, and I'll note that our Q3 guidance includes third-party consulting fees related to our efficiency program in an amount slightly below the $1.5 million we incurred in Q2.

Q3 non-GAAP tax rate is expected to be similar to the Q2 rate of 7.4%. And we expect our Q3 non-GAAP earnings per share to be in the range of $0.22 to $0.30.

With that, I'll turn it over to Kent Thexton, Chairman and interim CEO for his comments on corporate and strategic matters. Kent?

Thanks, Dave, for the financial update. It's a pleasure to speak with you all this afternoon after spending the past 2 months as interim CEO. Our financial results in the second quarter were strong, and I was pleased that both revenue and adjusted EBITDA improved year-over-year. And our higher-margin businesses, namely Enterprise Solutions and IoT Services, grew nicely in Q2, and together represent 25% of our total quarterly revenue.

During the quarter, we continue to build a strong pipeline of new design wins in customer acquisition activity across all 3 of our business segments as we grow our IoT leadership position in device to cloud.

In addition, our senior management team remains focused on our efficiency and effective -- effectiveness initiatives, which include synergies related to our acquisition of Numerex. In the second quarter, as Dave mentioned, we engaged a third-party consultant to help us accelerate our services business and achieve greater efficiencies across the company. So we can both enhance our bottom line and invest in key strategic initiatives.

As you saw in our press release after markets closed today, we announced that we have received approval from the Toronto Stock Exchange for normal-course issuer bid, allowing us to repurchase up to 10% of our public float or approximately 3.6 million shares over the next 12 months, with the program starting on August 8.

The board believes that Sierra's current stock price is undervalued, and it is in the best interest of our stockholders to use a portion of the company's cash to repurchase our shares in the open market for cancellation.

Regarding the company's search for a new CEO, the search committee of the board engaged an international executive recruiting firm in Q2, and has been very active with potential candidates. I am personally very involved in the process, and have met the shortlisted candidates. And I'm pleased to say we have some very talented and qualified individuals who are enthused about the opportunity at Sierra Wireless. Although the Board has not set a specific timeline on the search conclusion, I would say we are pleased with the progress to date and our intent is to have an individual in the CEO position by early Q4 if not before.

We need to ensure we select the best candidate with the right skill set and experience to lead the company in its transformation from Sierra 2.0 to Sierra 3.0. So you can see the board is taking clear and decisive action to drive shareholder value with our program on efficiencies, our repurchase of shares and the selection of a new CEO to help us drive our services vision.

So let me take a minute to share our vision for Sierra 3.0 with you. The Board believe Sierra has built a very strong position in the global IoT marketplace on the hardware side of the business, including cellular embedded modules, where we are ranked #1 globally based on share of revenue.

And in the cellular gateway business, where we are also ranked #1 based on unit volume shipped. Based on the leadership position in hardware, we are engaged early into the design process with customers who want to bring their machine, their device, their appliance online. With this early customer engagement, we are best positioned to deliver the complete solution of the module, connectivity and secure transport of their data to the cloud.

We believe that delivering both the device and connectivity gives us a strong market differentiation. So we look to leverage this unique pure play position in the IoT ecosystem to accelerate the growth of our recurring subscription-based IoT Services business. In doing so, we are working to provide our customers with fully integrated device-to-cloud solutions that allows them to get to market quickly, simply and securely, while reducing the complexity of launching their IoT deployments. In the process, we strengthened our ongoing relationship with the customers as we provide them with a scalable solution that enables them to transform their business. We are seeing good account wins today with modular customers taking the full device to cloud stack from us. And Marc will share more of that with you.

With our Sierra 3.0 vision, we see the advent of LPWA bringing low-cost modules, lower bandwidth requirements and vast IoT adoption. As this market develops and expands, there will be many new customers wanted to get their devices, their machines and their appliances online. And with their lower data requirements, we are uniquely positioned to provide a sustainably differentiated device-to-cloud solution to the market.

The initial execution of the strategy business started back in 2015, when we acquired 2 MVNOs in Europe. And we added to that last year with the acquisition of U.S.-based Numerex in December. We've put together the key building blocks of a world-class telco-grade IoT platform that utilizes our own Sierra Smart SIM and our own cloud platform. We now have an IoT Services business that's currently running at an annualized rate of approximately $90 million, and working together with our carrier partners, channel partners and global customer base who plan to grow and expand that business organically going forward.

Today, we are seeing a number of our existing hardware customers adding Sierra IoT connectivity solutions from Sierra SIM cards into their module or gateway. And we are starting to deliver fully integrated end-to-end solutions with our modules having Sierra wireless connectivity embedded in the factory. This gives us a low customer acquisition cost, because we're already working with our customers' IoT design cycle process with our embedded modular gateway.

And we are adding solution-selling capability to help us deliver the added layers of connectivity and cloud services to our customers. So as we fully integrate the Numerex platform into our IoT Services business and continue to make the right investment in that business this year, we believe we will be extremely well positioned in the marketplace to scale our global IoT Services business, which we expect will result in higher levels of recurring revenue, improved profitability and shareholder value creation.

So with that, I would like to introduce Marc Overton, our Senior Vice President of IoT Services. Marc was recruited to Sierra Wireless just over a year ago, in July 2017 from Cisco. Passionate about how connected technology is changing the way businesses operate, Marc has been responsible for IoT initiatives across global operators, enterprises and cloud providers. Marc spent 10 years at Orange in the U.K., where he built their mobile virtual network operator and IoT businesses. He then gained experience at First Data as Senior Vice President and General Manager for Europe, where he deployed cloud-based connected IoT solutions for the payments market. He then joined Jasper Wireless to oversee strategy and business development and was part of the leadership team that was acquired by Cisco.

At Cisco Jasper, he was responsible for global innovation and sales for Cisco's IoT business. We recruited Marc as part of our company's vision for being the global leader in device to cloud. So let me hand over the call to Marc to share some of his insights.

Thanks, Kent. I'd like to spend just a few minutes talking about IoT Services and some of the exciting developments that are happening in our business unit. What attracted me to Sierra was the company's strategic goal of becoming a global IoT Services leader. I firmly believe Sierra is uniquely positioned to win a significant share of the global IoT Services marketplace. With more than 250 employees in IoT Services and a current revenue run rate of approximately $90 million annually, we're already a sizable IoT Services business.

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scale and assets needed to properly compete for global IoT connectivity deals.

Following the acquisition of Numerex last December, we now have our own MVNO asset in the 2 largest IoT markets, namely Europe and the United States. That enables us to offer our customers truly global IoT connectivity solutions.

With our own HLRs and our own Sierra Smart SIM, we provide our customers with flexibility on which network they use so they can optimize quality of service and pricing. We also have our own cloud platform, which has significant capability and is tightly integrated with our hardware and services to enable secure and reliable device management, subscription management and firmware over the updates.

This combined with our 24/7 global connectivity support makes a compelling global IoT connectivity proposition. The acquisition of Numerex also bolsters our IoT position in the U.S., expanding our direct and indirect sales capacity in this strategic market.

Through hard work in the first half of 2018, we have now stabilized the Numerex IoT business, and have made good progress in integrating the team and its operations. We still have work to do. And there are key integration programs to complete, but we're off to a good start. Given this platform, the IoT Services business unit is now focusing on how we're going to accelerate our IoT Services going forward. We plan to do that in 4 different ways: firstly, we're going to continue to leverage Sierra's leadership position in hardware, customers and channels. We have strong cross-selling opportunities with our other 2 business units. And as we said before, approximately 50% of our connectivity leads come from OEM and Enterprise Solutions.

Secondly, we will continue to enhance and improve our cloud platform offering. Having delivered global IoT platforms, I know that the ability for an enterprise to manage all their connected devices across different operators through 1 screen on 1 platform is a key enabler for growth of IoT.

Thirdly, we have built a truly global operations center, and have converged on a set of processes and tools for monitoring their network, operating in services, managing changes to its infrastructure and managing service affecting events globally. All operations are now hubbed around the 24/7 global network operations center, which we're currently expanding in our Atlanta premises. And finally, today we shipped more than 17 million hardware devices annually. And this continues to grow. We've been building our ready-to-connect service, where we provide the customers with a module or gateway that is pre-integrated with our Sierra Smart SIM on our global MVNO and IoT cloud platform.

The immediate benefit to our customers are to reduce the complexity of integrating connectivity device in cloud solutions so we can speed up their time to market and improve security. We preload our modules and gateways with our embedded connectivity and cloud service so that when the customer boots up the device, they're immediately connected wherever the device is. While we're piloting this right now with a limited number of our modules and gateways, I plan on launching this later this year with some of our LTE modules and gateways.

This is a game-changing way to provide the customer with a simple, scalable and secure IoT solution. It is our goal to grow our subscription-based service revenue through improved detach rates. And given our expertise in software services and devices, we believe that no one else has the ability to offer a ready-to-connect service for IoT like Sierra. It is out of the box, preloaded with everything the customer needs to connect.

So who is interested in our integrated end-to-end IoT solution? I thought that I'd provide you with a couple of real customer examples. Remember, the real pain point for customers is the complexity of integrating edge devices with connectivity and the cloud platform. I believe this is one of the reasons IoT has had a slower adoption rate than some analyst have predicted. For an enterprise looking at IoT solutions, it is not easy to stitch all the pieces together. And customers want to improve their time to market and time to revenue, while reducing the risk of implementation.

That's why Sierra is uniquely positioned to sell their problems. In one recent example, we had a global fleet management customer that came to us looking for a fully integrated IoT solution it could deploy as quickly as possible for tracking and monitoring assets worldwide. It is a scalable solution with a quick time to market. So we responded with a complete end-to-end solution using our HLA embedded modules, Sierra Smart SIM and AirVantage cloud platform for device management, subscription management and over-the-air firmware upgrade.

This IoT service opportunity came with a healthy monthly ARPU, given the customer's data requirements, providing a strong return on investment for our customer and massively higher customer lifetime value to Sierra Wireless.

Another example is we had a security customer talking to us about their global connectivity requirements, because they were planning to launch a new IoT solution. Their specific pain points were having to integrate all the pieces to the IoT ecosystem as well as having to work with different regional carrier networks around the world on connectivity services. So we are providing with -- them with a global multi-carrier reach of our Smart SIM connectivity as well as our AirVantage cloud platform. And we're now working with them on a next-generation roadmap that includes our LPWA, ready-to-connect pre-integrated solution.

This is a great example of the type of long-term business partnership we're looking for where we can provide the customer with the service that utilizes all our resources, capabilities and IoT expertise. As the IoT marketing expands, Sierra is uniquely positioned to provide the complete solution for customers and grow our recurring revenue base.

We're progressing many opportunities together as we move from onetime device sales, to a fully integrated device-to-cloud solutions with many times higher customer lifetime value for Sierra Wireless.

With that, I'll now turn it back to Kent.

Thank you, Marc. It is now my pleasure to introduce Jason Krause. Jason has been with the company for more than 11 years and part of the senior executive team since 2011, leading the corporate development, strategy, marketing and IR functions at Sierra Wireless before taking on the role of Senior Vice President and General Manager of our Enterprise Solution business unit 3 years ago.

Prior to Sierra Wireless, Jason gained international experience in management consulting with Boston Consulting Group and the semiconductor industry at Altera Corporation, which is now part of Intel. We promoted Jason into the Enterprise Solutions leadership role to grow Sierra's positioning in LTE networking solutions, routers and gateways, a high-value growth segment that has been -- that we have been active in for many years.

With 33% year-over-year growth in the first half of 2018, we are showing clear market leadership in this area, exemplified by the fact that more than 50% of the top 100 police forces in the U.S. rely on Sierra's router solutions. Jason has been doing a fabulous job growing this business segment. So let me hand the call over to him to explain more.

Thanks, Kent. As Kent mentioned, the Enterprise Solutions business unit experienced strong growth in the first half of this year as the investments we've made over the last 3 years in both our product portfolio and our expanded go-to-market reach, combined with accelerating industry growth, have created a tremendous opportunity for Sierra Wireless.

In Enterprise Solutions, we are focused on providing secure managed LTE and soon-to-be 5G networking solutions for mission-critical applications. We go to market under the Sierra Wireless AirLink brand, offering ruggedized router and gateway products and software solutions for both fixed, industrial networking as well as mobile and vehicle networking applications.

We focus on key vertical markets that require highly reliable, always-on cellular connectivity, combined with advanced enterprise networking. Examples of these verticals include utilities; electric; natural gas and water; the oil and gas vertical; including applications in both the upstream and midstream segments; the public safety vertical, covering police, fire and ambulance fleets as well as other applications, such as security cameras and surveillance systems; the industrial equipment vertical is increasing -- that is increasing leveraging cellular connectivity for remote access and monitoring; and finally, enterprise vertical, which includes less rugged applications, such as digital signage, kiosks and point-of-sale systems.

The market for AirLink-type networking solutions also known as IoT routers and gateways, is expanding rapidly with the international research firm IHS estimating market revenue will reach $1.6 billion annually by 2021, with important short and long-term trends driving this growth. For example, advances in cellular technology are driving the overall market, including the migration from 3G to 4G LTE, adoption of LTE Cat-M1 for low-power, wide-area applications and, of course, adoption of 5G in 2020 and beyond. The public safety market is also undergoing significant change with the launch of dedicated public safety networks, such as FirstNet in the U.S. and ESM in the U.K. as well as rapid adoption of body-worn cameras and other connected technologies for first responders. Oil and gas spending is improving, particularly in North America. And the adoption of industrial IoT applications is accelerating across many different verticals as enterprises and OEM customers work to gather and process data at the edge of the network, and then integrate it seamlessly with enterprise systems and business processes to enable new product offerings and services.

Not only is the market large and growing, Sierra Wireless is well positioned to take advantage of the opportunity. And we are investing to maintain and grow our position in Enterprise Solutions. Over the past 3 years, we successfully refreshed our AirLink product portfolio and added important vehicle telemetry and telematics capabilities with the acquisition of GenX Mobile in 2016. We've also enhanced our software and services offerings, increasing value for our customers and adding new opportunities to attach recurring revenue to each router we sell. For example, the number of devices under management with our ALMS cloud platform has grown 35% in the last 12 months. And most importantly, we've been investing in a new go-to-market strategy, revamping our channel structure and programs and expanding the sales team, particularly in North America, to enable more solution selling, provide higher levels of customer engagement and increase focus on growth. To illustrate the success that we're having in the market, I would like to refer to 2 customer examples from the Enterprise Solutions business. The first example in industrial IoT is a leading manufacturer of industrial air conditioners, a longtime device customer of Sierra Wireless developing a next-generation remote monitoring service and maintenance application to be launched globally.

The customer had a broad survey of different kinds of IoT products available from leading vendors, and in the end selected Sierra Wireless for its device-to-cloud solution. Only Sierra could offer the 3 critical components they needed: A global single SKU, industrial IoT Gateway that can be usually integrated into the air conditioners at the time of manufacture with an embedded application framework for edge processing and machine data.

Second, a global connectivity offering with a single SIM and only 1 contract, so wherever the air conditioners are shipped in the world, they would light up and start communicating without intervention. And third, a secure enterprise-scale cloud platform that enables device management SIM management and machine data aggregation at 1 place with seamless integration to the Microsoft Azure Cloud.

With Sierra Wireless, not only are all these components readily available, but they are integrated together into a single device-to-cloud solution that provides end-to-end security and enables rapid product development to accelerate time to market, just as Marc described earlier.

Switching gears, the second example is related to the launch of AT&T FirstNet, the nationwide public safety network for first responders in the United States. Sierra Wireless is actively working with AT&T and other partners in launching new products and solutions for FirstNet to continue to build on our great track record and leading market share position in public safety. And as a result, we've announced the industry's first and currently only FirstNet certified LTE routers, the AirLink MG 90 and the AirLink MG 70, focused on advanced mobile networking for police cars, ambulances, fire trucks and other types of vehicles.

We are shipping these products today and our leadership in FirstNet has led to landing our single largest public safety fleet customer ever for deployment of FirstNet LTE routers as well as device management and network management software applications, driving both onetime revenue as well as significant recurring revenue.

We expect to build on this success as more and more regional and state agencies in the United States adopt FirstNet as their public safety network of choice.

And with that, turn the call back over to David.

Thanks, Jason. That concludes our prepared remarks for the second quarter. Suzanne, can you please open the line for Q&A?

(Operator Instructions) Your first question comes from the line of Mike Walkley of Canaccord Genuity.

Maybe Jason, just since you descended, Enterprise Solutions have been strong, you got some of these FirstNet wins. Can you talk maybe about the growth rate you're seeing in your business, and therefore just at the early stages of this high levels of growth given all the opportunities you highlighted on the call?

Sure. As we mentioned in the prepared comments, we are excited about the market growth we're seeing and the drivers we mentioned. 3G to 4G conversion, 5G is coming, FirstNet, all the industrial IoT applications. And as we said, we're very happy with our position. We feel well positioned to capture that growth. And by the way, that growth is not just in routers and gateways, Mike, it's also in all the softwares and service offerings around those gateways that drive recurring revenue. So I do -- I won't -- last thing I'll say before I end on the growth, we did mention some year-over-year growth numbers in the first half, up 33%. What I will say is that the SBU did have a very strong second half in 2017, particularly around growth in hours of service and ELD type of applications related to fleets. So maybe I will leave it at that.

Okay. Great. And just building that as you do more software services, how do you see kind of gross margin trends in your business? I mean, 50% was stronger than expected this quarter. Can it go higher from here?

Mike, it's Dave. I think we're -- the business really benefited from a couple of things in the quarter. One is mix. The AirLink product line is higher gross margin than the fleet business. And the other thing is the services gross margin is higher as well. So as J.K. mentioned as we blend that up and attach rate increase, I think those are nice drivers of improving gross margin in that business unit.

Okay. That's helpful. Last question for me since long script, and I'll pass on the line. Just on this consultant and the higher operating expenses in the short term. Can you talk maybe about puts and takes operating expenses longer term? Clearly, you want to grow your device-to-cloud strategy, so you need to invest maybe in the Numerex platform. So how should we think about just modeling OpEx, especially when these costs come out?

Yes, it's Dave again, Mike. We announced some initiatives earlier in the year, and we're progressing well with implementing those in reducing costs. And then since then, as Kent mentioned, we've -- we're going further, and we are getting some help with a third-party consultant to help us look at our business, look at metrics, operating metrics and design programs to not only reduce cost, but also to allow us to invest in new initiatives to drive the services and device to cloud offering. So we're working through that right now, Mike. We are incurring some third-party cost to help us with that. And next step is determine a timetable and the scope of some of those initiatives.

Your next question comes from the line of Thanos Moschopoulos from BMO.

This is [Bill] stepping in for Thanos. Just a quick one, a supplier component reliability issue. Is that fully resolved now? Or is there a chance it will come in later on or is it all behind us?

Yes, that particular issue, which is the one we flagged 3 months ago, has been resolved. And it fortunately had a very negligible, almost 0 impact on the quarter.

Okay. Great. In terms of component shortages mentioned in the last quarter and I think mentioned in your script earlier too, has that alleviated at all or do you see that continuing for the next quarter at all?

I would characterize it, [Bill], as supply is still tight, so it's certainly not -- we're not experiencing the shortages that we did in the first quarter, for instance. But things like memory NAND are still tight. And we're managing that supply and demand very carefully.

Got you. Okay. And then just one quick one to close here. For Numerex, I believe you mentioned their 2G subscriber base was a watch item in the last call. Is there anything to note there in terms of migration program in place or how is that moving along?

Sorry, [Bill], you mentioned subscriber?

Yes, 2G subscriber base and kind of migrating them having a technology migration for Numerex, is that something supplied in the last quarter?

Got it. No question. Part of the Numerex subscriber base is 2G, that's not a surprise. But I think we're well positioned with our device expertise, our SIM technology and also our network expertise to successfully drive a migration there.

And your next question comes from the line of Scott Searle of Roth Capital.

I appreciate all the detail provided on enterprise and cloud. Maybe to follow up on Mike's question for J.P. I just want to get some clarity, tremendous strength in the second half of last year. A lot of that ELD driven. You've got some new programs ramping up with FirstNet, but it's still early days. So I wonder if you can give us some idea. Do you expect enterprise to grow in the second half of this year? Or is it just tough comps and it will take a little bit of time to really populate, get some more traction within FirstNet, get some of these other programs ramped up to be back on a high-growth curve, again?

Sure. Scott, it's Jason here. Certainly, we don't comment on growth rates by business units. So I'll start there. You are right, though, about FirstNet overall. It's just the start, right? And it is 1 growth driver, but it is just the start where the leader in public safety, networking in the United States, we have the first net -- first FirstNet certified products in the market. We're pretty confident that we're going to capture our fair share and more of that growth opportunity. That said, really it's early. AT&T is still completing its network build-out, and that will take some time. Public agencies have to choose to use FirstNet. Many of them don't use AT&T today. And also you have to go through a network equipment refresh cycle. So this is a fairly long-term secular growth curve.

Okay. Great. And maybe a question for Marc. Getting very aggressive on the embedded front. And when you think about the sizable opportunity that you have in terms of modules and gateways that go out the door from Sierra for the year. I'm wondering if you can give us some idea of what success looks like? 2 to 3 years out, are you hoping for a 10% attach rate, a 30% attach rate? It starts to set up into significant dollars over time, even for lower end connectivity. I'd love to just kind of get some thoughts on how you're thinking about that longer term? And also, just want to get some more color on some of the cost migration here. Are you costs going to be going up dramatically in the second half of this year, then, to support some of these initiatives? Or is that already baked into how we're thinking about the cloud model?

Scott, it's Dave. Let me takes those questions, please. So with respect to our ready-to-connect, look, we got to walk before we run here. We're very, very excited about what it means and the kind of a sustainable differentiation it gives us. But I think we've got to walk before we run here. We got some rollout plans that will see product -- early product later this year and then into next year. So stay tuned, but it is an area of, I think, good quality growth for us. With respect to costs, I think -- I would expect our OpEx to sequentially go down a little bit in Q3 from Q2, so we've -- I think we're managing costs and that also includes investing in network technology, for instance. So I think we've got a handle on our cost structure there.

Scott, it's Kent Thexton. I'll just add, I think as you ask what attach rates look like, I mean, you're thinking about the question in the right frame of mind. We are the leader in terms of value to modules and gateways market today. And so we're looking to expand our value chain. That is going to take a period of time. And I think the LPWA's going to be an important aspect of that, which is going to increase both modules and the customer type with LPWA being often lower ARPU has us well positioned. So we're building for a strategic future, but we're not going to comment on the timeframe of those attach rate forecasts at this point.

Can I just add one last point? In terms of an MVNO, you're only as good as the channel to market you have. In terms of a global IoT channel then having access to these 17 million devices, invariably it's an early stage of their design process. It's a unique, and I emphasize unique, opportunity to sell connectivity in cloud services.

One last question if I could for Dave. Thinking about the second half of this year, and OEM Solutions and the auto design wins starting to ramp up, how you're thinking about gross margins in that unit on a blended basis? You had success this quarter. Granted, even adjusted for the onetime benefit, but how are you thinking in terms of visibility? How aggressively that ramps up? Is it on track? And kind of the gross margin impact, how you manage it?

Yes, Scott, so we'll see our automotive business ramp in the second half or increase in the second half, I should say. And that definitely does have a blending-down effect on our OEM Solutions gross margin. Now going the other way, we're just not Sierra automotive; we've got a lot of other businesses going on around that in OEM at higher gross margin. Then, of course, we've got 25% of our revenue and growing more rapidly in higher margin businesses, meaning the enterprise business and the services business. So I think those factors certainly are good tools to allow us to see stabilized gross margins.

And your next question comes from the line of Todd Coupland of CIBC.

Couple of questions, first on the tax rate. So 7% in Q3, is that the new normal? Or should we be raising it in the model past Q3?

Todd, it's Dave. I think 7.5% for both Q3 and Q4 is probably a reasonable assumption for your model. I would expect that to increase though in 2019, and we're modeling mid-teens in our modeling for 2019.

That's helpful. I wanted to ask a question on the recurring business $90 million of IoT Services. What is the organic growth rate and churn in that business?

We grew substantially year-over-year, but -- partially because of Numerex, but also we saw good subscriber growth in our connectivity business outside of Numerex. Todd, we're not going to break out by specific business lines what organic growth rate was at Numerex, but be assured the non-Numerex business is growing nicely as well.

Okay. I mean, just as a feedback for what it's worth, I think the investment community probably is willing to apply some of the part's value given its significant portion of your business now with the right kind of metric. So something to think about as you're looking at that business going forward.

With that said, it's key part of our strategy to grow our business mix over time, right? And I think we made tremendous progress with that with 25% of our revenue today coming from higher gross margin businesses. And we're certainly not finished with that.

Okay. I appreciate that. My last question is, so I get the 5G is a little ways out in terms of how it impacts your business specifically. We'll start to see some cities turned up next -- later this year, early next year in the U.S. When will you be out trialing first 5G devices? What's the plan for that?

Yes, I think you will hear a lot of activity in 5G, particularly from the carriers. It's very topical. I think from a meaningful commercial perspective, from a device perspective, Todd, that's really late 2019 going into 2020. That's LTE, 5G LTE, and then, of course, new radio would follow that. But firstly, 5G LTE late next year from a kind of commercial volume launch perspective.

And your next question comes from the line of David Gearhart from First Analyst (sic) [Analysis].

You spent a good amount of time talking about the IoT Services business in the context of connectivity and attach rates in your embedded models. But you haven't really addressed the end-to-end solutions from the application layer. With Numerex, you acquired take monitoring solutions of vendor and security. Just wondering what your thoughts are ongoing after vertical markets with full applications? Are you pulling back on that strategy? And how are you thinking about it going forward?

David, it's Dave McLennan here. Look, our job #1 with Numerex was to stabilize the business. And I think, as Marc said, a lot of hard work has happened in the first half of this year, and we have successfully stabilized the business. Going forward, we need to think about the vertical businesses that came along with the network operations. And I think we have some optionality there. But it hasn't been a focal point to date as we were to stabilize the network operations.

Can I just add a point to that? We absolutely are investing in some of the key verticals. So one of the areas that Numerex hadn't already sort of got the investment, for example, is new devices. So we've actually in the last couple of months launched 2 new LTE devices; they didn't have any LTE devices before in the uplink, the security proposition. And we'll be launching 2 more in the second half of 2018. So that we got the right LTE products in each of the major vertical applications, that has to be the key focus. And as a device organization, we're hoping make that much more efficient and effective.

Would it be out on the table in terms of, when you talk about optionality of selling pieces of those business if it doesn't fit in your device-to-cloud strategy going forward?

Yes, I think we need to do some work there, David. And that hasn't been the priority as we integrate Numerex up until this point.

Okay. And then Jason had mentioned strong attach rates on the enterprise side, enterprise gateway side for the cloud management software. I'm just wondering how material is that at this point? Is it still a small piece of revenue? And at what point will it drive meaningful margin expansion on enterprise?

Jason here. It's still somewhat early days in terms of attach rate. We've been offering those solutions for many years, and growing them within our customer base and with new customers. When you see those -- as these IoT deployments get larger, more complicated and also the concerns around security increase, you'll see every one of these deployments managed going forward. So we're seeing dramatic increases in attach rate right now, but it is starting from a small base.

And your next question comes from the line of Paul Treiber of RBC Capital Markets.

Just first a housekeeping item. I don't know if you disclosed; I caught the call a little bit late. Could you provide the revenue that Numerex generated in the quarter? And then also is Numerex now a breakeven or profitable?

Paul, it's David. When we gave guidance for Q1, we gave a revenue figure of about $13.5 million for Q1. And then as we integrate, we're not going to report separately on product lines. I will say, though, that you heard me mention stability in that business.

Okay. Related on Numerex, just in terms of the integration, what sort of remaining from integration point from here? And what should we expect, particularly in regards to the cloud platform, what sort of the heavy lifting is remaining?

It's Marc. We're integrating into the advantage cloud platform. So we're moving the customers the vertical applications onto that, which is also a key component of our single pane of glass, our single proposition for connected devices across different operators. That certainly accelerated our capability. We've done a major upgrade of the network. So it's now a LTE-enabled full MVNO in the U.S. And that's based on the core Numerex capability. So as -- and as I said earlier, we've accelerated the new devices as well. So there's a huge amount of new capability being enabled because of the Numerex acquisition.

It's Kent Thexton. I'll just add that as Marc outlined earlier in terms of integration, I think it's also using the scale that we have to increase our overall capability. So Marc mentioned the 24/7 global network operations center. And coming from a carrier background, this is a key implementation for us to be able to manage and monitor our devices globally with a global operations center. So it's a significant achievement and leveraging that integrate into all of our devices globally is key.

And just one last one for me. Just on the cloud and connectivity business, you discussed a lot in the attach rates, but I was thinking it about from a win rate point of view. So think about more from a competitive point of view. So if they're not going with you or Sierra solution there, who or typically who are they using, not in terms of names, but in terms of are they using SCIs or using their own custom solutions? And what are ways that -- what's your strategy to try to increase the win rate per se?

It's Kent, Paul. If we look back historically as Sierra Wireless delivered modules and gateways, the solutions were somewhat more straightforward. And then the end customers would get a SIM card from a carrier to be able to be connected. As we have machine builders, device builders, appliance builders wanting to connect globally, procuring network arrangements from multiple players becomes more challenging. So we worked to simplify that solution. So we're looking to provide an enhanced solution compared to dealing with the carrier in country. And many customers will still have those relationships and want to do that, and we enable that and we support that, but we are trying to enable the next level of opportunities for our global customers and embedded customers who want to have that simple out-of-the-box experience that the device lights up, the customer examples that both Marc and Jason delivered and they're able to have a faster time-to-market. There is one throat to choke in terms of the device and the network and the cloud. We've been able to ensure that they're getting the data from their device into their ERP system so they can get return on investment they are looking for.

And your next question from the line is Steven Li of Raymond James.

Guys, I might have missed this, but LPWA, did you talk about it? Are you starting to bid on contracts?

Steve, it's Dave here. Yes, absolutely. And we have design wins. A good example is we have a design win in Japan with KDDI for a water metering solution. And that commences shipping later this year. So we're very, very active with LPA -- LPWA, I should say, bidding on business.

Is this a high volume -- example of a high-volume application, Dave, or not?

It is. I mean, we view it as an expansion of the addressable market. I mean, think of it as first layer of really 2G replacement. And then adjacent spaces. Water metering is a good example, where there is no power to a water meter, so power management becomes very important. That's not something we would have been able to do with a non-LPWA model. And then, of course, beyond that, there's just a myriad of use cases that given the low cost and low bandwidth characteristics of LPWA and power management that it just opens up other applications that we don't see today and feel it's a very key driver to expansion of the marketplace.

Steven, it's Kent Thexton. I'll just add to that. This is a multi-year evolution of this marketplace with much lower cost modules, the battery life of 5 to 10 years and being able to have better radio characteristics because of the protocol for further delivery from cell site and building penetration. That LPWA modules will add a lot of devices that before it wouldn't have made sense to connect or replace WiFi because there's a greater dependability of the macro network and the ability to have device management, SIM management to be able to control that. So many reports on the LPWA marketplace, we think over the years ahead of us. This is going to expand the number of devices connected globally dramatically. And that's what we're positioning for.

Very helpful. And Dave, on the Numerex earlier, when you said stable, you're talking sequentially?

Yes. We've stabilized the revenue trajectory. Yes.

Okay. And one more question for Jason. I think you were talking about the largest FirstNet VAR tech customer deployment. How much is left in that deployment or is it just starting?

Steven, it's Jason. Obviously, we're coming on specific customers, but I will say FirstNet overall is early. The FirstNet -- the first FirstNet LTE routers just certified in the past weeks. So that particular deployment will be part -- will use those particular products.

All right, very useful. And Jason, when you think of recurring revenues, how much should recovery represent for the deal value? 10%, 20%?

Yes, Steven, obviously, we don't break that out specifically. I will say -- repeat my comments from earlier that it is increasing. And we will continue to increase at a faster rate than revenue overall.

(Operator Instructions) It doesn't appear we have any takers at this time.

All right. Well, thank you very much everyone for your attention today. And as always, management is available for follow-up calls. Thank you.

Thank you.

And this concludes today's conference call. You may now disconnect.