Sierra Wireless, Inc.
Q1 2021 Earnings Call Transcript

Published: 14 May 2021

[Operator:]

Good afternoon, and welcome to the Sierra Wireless First Quarter Earnings Call. I would like to turn the call over to David Climie, Vice President, Investor Relations.

[David Climie:]

Thanks, and good afternoon, everybody. Thank you for joining today's conference call and webcast. On the call today are Kent Thexton, President and CEO; and Sam Cochrane, our CFO. 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

[Kent Thexton:]

Thanks, David. I expect this will be my last quarterly update before my planned retirement. I'm happy to report that the Sierra Wireless transformation continues to gain momentum, with strengthening demand being offset in the near-term by global supply chain environment. I will start my comments on our first quarter results and highlights. Total revenue in Q1 was $108.1 million, up 4.9% year-over-year. As we announced on March 23, the ransomware incident shut down our production facilities for 1 week, and as such, we were slightly behind the consensus of $109.8 million. We also noted during our Q4 results report that our demand was running about 15% higher than our expected revenue due to global supply chain challenges. During the quarter, orders continued to materialize, increasing this figure to 20%. In the first quarter, our connectivity, software and services revenue was $33.7 million, up 26.1% year-over-year. We are seeing this revenue grow as one

[Samuel Cochrane:]

Thank you, Kent. Good afternoon, everyone. Note that we report our financial results in U.S. dollars and on a U.S. GAAP basis. We also present non-GAAP results to provide a better understanding of our operating performance. A full reconciliation between our GAAP and non-GAAP results is available on our website. Total revenue in the first quarter was $108.1 million, up 4.9% compared to Q1 2020. Connectivity, software and services revenue, which we had previously called recurring and other services revenue was $33.7 million in Q1, up $7 million or 26% year-over-year. Our total revenue in the first quarter was constrained by 2 main factors

[Operator:]

. Your first question comes from the line of Mike Walkley.

[Thomas Walkley:]

Great. Lots of positive developments, but wanted to focus on the supply area, with a nice up sequential revenue growth in indications, demand $20 million above this, any idea if this demand goes away if you can't fill it? Do you see any double ordering going on from your customers given the tight supply? And then how is your ability maybe to meet that supply improving in the second half of the year?

[Kent Thexton:]

Sure. Thanks, Mike. Good question. This is I think consuming the executive suites of almost every product manufactured globally right now. We're -- we've been working very closely with our customers overall. So on your first part of the question, will this demand go away? For the most part, no. Most of our customers are single-sourced with us. And we take our responsibility to get product to them very seriously. So I'm on frequent customer calls and I'm on frequent supplier calls to make sure that we are getting those parts there. Secondly, in terms of over-ordering, we have strong visibility, and I can tell you from the dozens of customer calls, it's real customer need. It's not building buffers. It's not the COVID toilet paper shortage. These are real needs for customers. And what we've been doing is we've been pushing out our order lead time to all of our parts suppliers, and we've been requesting enhanced lead time from our customers. And we've been doing that. We have orders into Q1 '22 in some parts of our business as we significantly work to expand our visibility so that we can order more parts earlier and ensure that we can supply to customers. So it's been a significant amount of work, continues to move along. Our suppliers have been tremendous. We have got a lot of support. We've been able to increase our allocations in many areas. I feel that we're doing well in this difficult environment, but it is going to remain tight for the foreseeable future.

[Thomas Walkley:]

Great. I think it's great that you have the balance sheet to use to your advantage because certainly your competitors certainly might not have that balance sheet to build up as needed for customers. I guess my follow-up question, and I'll pass the line is, thanks for sharing the new monthly recurring revenue data. I think that's pretty straightforward. Just your thoughts longer term as you get out of supply issues, the 27% CAGR, is that sustainable, too low given the initiatives you have in place or too high given you're now growing off a larger base on a -- large numbers? Just your thoughts on that. And before I pass the line, just best wishes to you in your retirement.

[Kent Thexton:]

Great. Thanks, Mike. Well, as you know, we've been talking about the transformation, and we've been talking about LTARR to show the design wins that we're getting. So I think that we're -- we remain on trajectory towards the $200 million recurring revenue by mid-2022 that we've talked about. And we see continued growth moving forward. We had 25% growth in Q4. We had, in the comps there, we added M2M into our business in the early part of 2020. So this growth, which is even stronger than Q4, there's no benefit of that acquisition. It's in the Q1 2020 numbers. So this is organic and a very strong number, and we'll continue to drive from here. And I think that the reporting MRR helps give a good view and shape to the CAGR. We do have some seasonality in quarters, but I think the trend data is clear. As we said in that, we had 27% over the past 2 years, 30% in the past year. So we are seeing that continue to improve.

[Operator:]

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

[Thanos Moschopoulos:]

How should we think about margins for the next little while, I mean, in light of the supply constraints? And obviously there was some noise in Q1 with the ransomware attack. But I mean, should we think about margins kind of going back to kind of Q4 levels? Or what would your expectation be?

[Kent Thexton:]

Hi Thanos, thanks for that. And I'll ask Sam to jump in here in a second, but we're getting benefits of mix. So we're seeing increasing recurring revenue and our enterprise revenue, which is high margin, was held back by supply and late quarter issues with the ransomware, where we had a lot of our enterprise build planned for the last part of the quarter. So those mix elements help us, but there are headwinds with some extra costs from supply chain. So Sam, do you want to talk to that?

[Samuel Cochrane:]

Yes. Thank you. So in the enterprise business specifically, we had some increased costs due to some parts that we had to procure in the gray market. So that's going to be a headwind for the next little while. We're not giving guidance on margins, but with better mix and growing high-margin recurring revenue in the connectivity, software and services space and then the headwinds from the component parts constrained environment going away in the future, you're going to see improvement. But in the short term, it's going to be about where it is.

[Thanos Moschopoulos:]

Okay. And then as far as OpEx, was there anything meaningful associated with the ransomware attack from an OpEx perspective? And then should we think about Q1 being indicative of the run rate or what's the dynamic there?

[Kent Thexton:]

Go ahead, Sam.

[Samuel Cochrane:]

So the cyber event, if you look into the financials, I believe there was about $500,000 of net cost, and that was about the insurance deductible. So -- and that was disclosed in other expenses, so not in the run rate of OpEx. The OpEx reflects the cost initiatives that we put in place. So again, about at the level we expected.

[Thanos Moschopoulos:]

Okay. On the cost side, though, is there -- I mean, I guess things like maybe travel expense is going back. Or I don't think you had much benefit from COVID wage subsidies, did you?

[Samuel Cochrane:]

Not much. But again, if you look at the non-GAAP rec, it's in there, I think it was about $2 million for the quarter, but we non-GAAP it out.

[Thanos Moschopoulos:]

Okay. Okay. And then finally, Kent, in terms of I guess you mentioned some of the applications driving 5G. And sorry, I don't think any comments as far as geographic area. Is that primarily a North American dynamic? Or where are you seeing that?

[Kent Thexton:]

No, we're seeing 5G interest and demand globally. So we have significant activity going on in Europe with the demand for our 5G products. We're selling to many routing customers globally that are looking to deliver -- take our 5G modules and deliver 5G connectivity. We have a number of customers in Asia, particularly in Japan with interest. And then, of course, North America is very strong with the significant activity that you've seen from the carriers, and we've made announcements with work with T-Mobile and with AT&T and with Verizon, who are all very active in the 5G space.

[Thanos Moschopoulos:]

And actually, I mean, given the record of 5G, that should be a positive for margins almost equal. Should it not? I mean, appreciating you have some other constraints and headwinds going on, but all those equal higher 5G mix drive margins, right?

[Kent Thexton:]

Well, 5G products are still quite expensive. And so our margins are good on a dollar basis. You won't see a big impact on a percentage basis because it's a bigger ticket item. And those prices will come down over time, and I think will give us more opportunities, but we're still in the very early innings of 5G. As I said in my comments, we're off to a good start. We have -- and I couldn't be happier with our design win space in terms of number of people that are relying us for their 5G products. But they're just in the early stages of those rollouts. So we'll see that grow throughout the year, and we think that 2022, and as we get to further maturity of the standard, we'll see a significant growth.

[Thanos Moschopoulos:]

Great. Thanks, Kent. Best wishes for your retirement.

[Kent Thexton:]

Thanks, Thanos.

[Operator:]

Your next question comes from the line of Josh Nichols from B. Riley.

[Michael Nichols:]

And really good to see the demand outlook for 2Q, given some of the headwinds the company faced in the first quarter. Could you provide a little bit more color on what the expectation is? I know gross margins were impacted by around 100 bps quarter-over-quarter. Do you think you're able to maintain the current level or the expectations going forward with the supply chain?

[Samuel Cochrane:]

Yes, like I said...

[Kent Thexton:]

Yes, I'll let Sam elaborate on that.

[Samuel Cochrane:]

Yes. Like I said earlier with Thanos' question, as we have better mix in growing high-margin connectivity, software and services revenue, that mixed with the improvement in the supply environment will get more gateways and routers out, which are higher margin. So that mix will improve our margin. And then also having to buy more expensive parts in the gray market and extra engineering cost to rework products will improve. So in the short term, I think it's a good level where we're at in Q1 here, but lot of tailwinds for the future.

[Michael Nichols:]

And then just kind of tangentially on that point that you just made. I know you mentioned before that the company's enterprise pipeline kind of doubled last year. I know it was down a little bit in the first quarter because of this ransomware attack. But how is that pipeline looking as we kind of move into like the back half of this year? It's obviously higher margin and fairly accretive to the business? And what are your expectations on that front?

[Kent Thexton:]

Sure. Our Q1 was strong from an orders perspective. And our orders for the first half of the year are up over 50% from our orders in the first half of 2020. So the demand continues to be robust. Challenge to ship all of that product. So it's not about demand side. So our -- the work we've been doing with customers, products, partners has been going very well, and we see that continuing as we move forward. We think we're going to be able to catch up on a lot of product in Q2. One particular supply shortage part in Q1, we were able to alleviate a lot of that late in the quarter, but then with the ransomware we weren't able to get those products shipped. So hence, the slight down year-over-year, which is disappointing because it's not reflective of where our orders were at, and we're working tirelessly right now to get more product into the hands of our customers that definitely need it.

[Michael Nichols:]

And then last question for me. I don't know if you could or how easy be able to do. But if you could try and quantify the revenue impact regarding like the cyberattack and also some of the component shortages, I'm just trying to get a ballpark figure for how much of an impact that had to the revenue for this quarter, as I think about longer term opportunities?

[Kent Thexton:]

Well, I think that as you look at the -- our release that we put out, we said that we had talked before that we thought that the impact of supply chain shortages was going to mean that there'd be 15% orders above what we had in revenue and said now in Q1, that looks like 20% above orders that we weren't able to ship. And then Sam added in his guidance that our midpoint of guidance is $120 million for Q2, but we have orders 20% higher than that number that we'll have to work through the supply chain and get those shipped as soon as possible, but mostly sliding into Q3. So that's sort of the nature of the world right now where we're working to get orders with as much lead time as possible. Anything that comes in a short lead time is likely going to be unable to get shipped as we work to get the component parts to be able to build those products. And for the -- okay. Go ahead, Sam.

[Samuel Cochrane:]

I was going to just mention that for the ransomware incident, we recovered quite quickly from that, as you could tell from the discovery to when we resumed production. So you can kind of estimate from that brief period what the impact would have been from the quarter. And I think a few analysts did.

[Kent Thexton:]

Does that answer your questions, Josh?

[Michael Nichols:]

Yes. Thanks for the clarification. Appreciate it. That's it.

[Kent Thexton:]

Great. Thanks.

[Operator:]

Your next question comes from the line of Scott Searle from ROTH Capital.

[Scott Searle:]

In the enterprise end markets, Kent, I was wondering if you could provide a little bit of color in terms of where you're seeing the demand from an end market perspective, if things like CBRS are starting to play in? And then also the opportunity for recurring services in and around the enterprise router opportunity, kind of like CradlePoint, like type of services, if you're seeing that opportunity out there, and if that would stay within that business segment when you're reporting enterprise going forward?

[Kent Thexton:]

Sure. Thanks, Scott. Thanks for your questions. Good to hear from you. So we're seeing enterprise demand in a number of areas. So yes, you asked -- specifically your question, that is driving demand. We're seeing quite a few -- quite a bit of interest in those deployments, working with a number of partners like Motorola and others on CBRS deployments. And so that's a nice growth area. Public safety remains very strong. And so we're winning a lot of business as needs in public safety happen. We're also in our commercial area and with utility and smart grid applications, seeing good growth in those areas. So we're -- areas that we focus on are all performing well, and we're focusing on delivering product into that and continuing to build our strong pipeline as we move through that. On the recurring revenue side, yes, we do attach our software solutions and support to our gateways. With our new 5G launch, and we've rolled out, I think I mentioned previously, but a couple of years in development, a complete new support cloud service to attach. So we think that we have opportunities to continue to grow that area of attach and more sophisticated cloud support for our gateways to our customers. So we continue to drive recurring revenue there. Also, in some instances, we will attach connectivity to our gateways. But for the most part, it's around our cloud and support with our gateways.

[Scott Searle:]

Great. Very helpful. And lastly, if I could, I know you're not providing guidance in terms of the immediate gross margin outlook. But backing into the numbers in terms of the new revenue lines that you provided, it seems like the module side is -- still remains challenged, a little bit under 20% gross margins. I'm wondering how you're thinking about that business longer term? Is this going to be a 25% gross margin business in '22, assuming a normalized component environment? Or is this something where you could get the 30% plus? And Kent, best of luck in your retirement.

[Kent Thexton:]

Okay. Thanks, Scott. So I think that if we work to pivot to solutions. So we're not just selling a module. We built in -- are ready to connect built-in SIM technology into our modules so that we can drive the connectivity. And so sometimes the gross margin on the module may be very low, but we're adding a high-margin recurring revenue stream to that. So there's slight timing differences, you'll sell the module and recognize that low 20% gross margin, but then you're seeing 40% to 50% recurring revenue gross margin that extends for the length of that asset. So I think that the overall value that we see from each one of our deployments is increasing as we increase our attach rates. The competitive environment remained very tight on the module side. And that's why we came up with our strategy of being the complete and trusted IoT solution leader as being able to provide that complete device to cloud solution to customers. And so as we've described with our design wins, with our LTARR wins, and you can see it now coming in our recurring revenue growth, we're winning out in the marketplace with that offer, and we expect the competitive environment on the module-only space will remain tight. But we have the opportunity to grow significant revenue and gross margin from being that complete solution provider.

[Operator:]

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

[Paul Treiber:]

Just on cash flow, I was hoping you can delve into your comments on next quarter in terms of cash flow being flat, although you mentioned -- you said you'd recover from the ransomware attacks. Was just hoping you could just outline for next quarter, what are some of the moving parts of cash flow?

[Kent Thexton:]

Sure. Hi Paul, and I'll let Paul -- I'll let Sam jump into that one.

[Samuel Cochrane:]

Thanks, Kent. Thanks for the question, Paul. You're going to see revenue improve. You're going to see OpEx -- we've already seen that big improvement in 2021 versus 2020 from our cost reduction initiative. So you'll start to see kind of better cash from operations. You're going to see a little bit of continued investment in working capital as we are combating an unprecedented environment in supply. And you'll see some recovery in the -- from the ransomware incident in terms of insurance recovery plus being able to do our AR factoring program, which we do at a pretty low cost, around 1%. So those are the big moving pieces for the quarter.

[Paul Treiber:]

So is it right to characterize that the factor and the benefit from factoring coming back in maybe that recovery of the insurance recovery a little bit there would be offset by the investment in -- on the supply side?

[Samuel Cochrane:]

That's basically the right way to think about it. The other big investment in the quarter, not huge numbers, but we're investing in next-gen 5G. So we're a big believer in 5G and we're putting some investment in CapEx dollars there. So that will be another sort of smaller piece, buy, yes, that's a good way to think about it.

[Paul Treiber:]

Okay. That's helpful. And then, Kent, I mean, good luck in your retirement. On the -- you mentioned this via the last conference call. Is there an update on the CEO search? I noticed some costs in the quarter. How is that going? When do you expect that to be completed?

[Kent Thexton:]

Sure. Thanks for your good wishes. The CEO search is going well, and the Board's run a strong process in many good candidates. They've converged on a candidate at this point and expect you'll see us make an announcement early in Q3. So I -- likely going to be around a little bit longer than my June 30 target that I had put out there, but expect we'll make that transition. So my goal is to deliver a very strong Q2 and then help a very successful transformation, building off the momentum that we have. And so you'll hear from us in Q3 in that regard.

[Operator:]

. The next question comes from the line of Derek Soderberg from Colliers Securities.

[Derek Soderberg:]

Kent, I want to start with 5G and sort of the competitive environment there. As it relates to the hardware piece alone and then the entire solution, how do you feel about your product differentiation versus what's out there? And do you guys expect to take share of the market as this 5G rollout accelerates?

[Kent Thexton:]

Sure. Good to talk to you, Derek. Thanks for the question. So we've done very well on 5G and Sierra Wireless has great history and depth of bringing new air interfaces to market. So we're really the trusted partner in the industry as 3G came, as 4G came and now with 5G. So we've been able to deliver this product. And very complex, lot of antenna challenges and obviously the most complex product ever brought to market. So we've been -- we have picked up share and slots with many players in the router industry and working to deliver to them. And then the second part is our modules into our own gateways. We've launched and just made a press release this week on our 2 new 5G gateways that we brought to market, our XR80 and XR90. And we're very proud of those. One of the leading global carriers in their analysis told us that we were by far the best gateway that they had seen from a overall performance and management perspective. So we're proud on both aspects of that. What we're doing with the 5G technology to provide the high bandwidth and low latency connectivity link and then being able to leverage that into our gateways for customers that are looking to take advantage of that. So we're -- this is where we're at our best, and I'm very proud of our team in terms of what they've delivered here in the 5G space.

[Derek Soderberg:]

Great. And then just a quick question on the 2 new segments as it relates to recurring revenue. I'm wondering how much of that recurring revenue that you report is coming from the separate IoT and Enterprise Solutions? If you can kind of split that out, what that looks like?

[Kent Thexton:]

Sam, do you want to talk to that?

[Samuel Cochrane:]

Yes, sure. I mean we're not sort of providing that level of detail, but more of the recurring revenue of the connectivity software and services piece is in the IoT solutions segment. But there is a decent chunk in the Enterprise Solutions piece as well. So think 60-40-ish would be fine to think about.

[Operator:]

The floor is now closed for questions. There are no questions in the queue. I would now like to turn the call back to Kent Thexton. Please go ahead, sir.

[Kent Thexton:]

Thank you. Well, thank you, everybody, for participating in our Q1 earnings call and good questions. I set out the vision in 2018, 2019 to transform Sierra Wireless to the leading IoT solutions player with complete device to cloud offers. So as you can see, we've innovated in our solutions offers and rebuilt our go-to-market to help customers quickly get their IoT deployments, delivering valuable edge data and control. We've been winning valuable design wins over the past 2 years, and the hard work is showing with our strongly growing connectivity, software and service revenue, our new definition for our recurring revenue. I'd like to thank the dedicated and hardworking team at Sierra Wireless for driving this successful transformation. So thanks to all. I'll be speaking to many of you in the coming days. Meanwhile, I'll focus on delivering a strong Q2. All the best. Cheers.

[Operator:]

This concludes today's conference call. Thank you all for joining. You may now disconnect.