Sierra Wireless, Inc.
Q1 2017 Earnings Call Transcript
Published:
- Operator:
- Good afternoon. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sierra Wireless First Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Vice President of Investor Relations, David Climie. You may begin.
- David Climie:
- Thanks, Julie, and good afternoon, everybody. Thank you for joining today's conference call and webcast. With me today on the call is Jason Cohenour, our President and CEO; and Dave McLennan, our Chief Financial Officer. 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. Jason will provide a review of our first quarter results, Dave will then provide a more detailed overview of our quarterly results as well as our guidance for second quarter of 2017. Following that Jason will provide a brief summary, and then we’ll finish with a Q&A session. Before we get started today, I’ll reference the Company's Safe Harbor statement. The summary of our Safe Harbor statement can be found on Page 2 of the webcast that 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 the business. Our forward looking statements are based on a number of material assumptions including those listed on Page 2 of the webcast presentation which could prove to be significantly incorrect. Additionally, our forward looking statements are subject to substantial known and unknown material risks and uncertainties. I draw you attention to a longer discussion of our risk factors in our annual information form and management’s discussion and analysis, which can be found on SEDAR and EDGAR, as well as other regulatory filings. This presentation should also be viewed in conjunction with our press release. With that, I will now turn the call over to Jason Cohenour for his comments.
- Jason Cohenour:
- Thank you, David, and good afternoon, everyone. I'll begin with a summary of our first quarter 2017 results. Overall, Q1 financial results were above our expectations. Consolidated revenue was $161.8 million, up 13% on a year-over-year basis. We saw year-over-year revenue growth in each of our business segments and in each of our three regions. Our year-over-year revenue growth combined with strong gross margin and good cost management led to profitability results that were significantly above our expectations with adjusted EBITDA of $12.4 million and non-GAAP EPS of $0.24. During the quarter we also continue to see good in new product and new customer program momentum, including in the emerging LPWA space. I’ll also add that were excited to announce the launch of the world's first cellular IoT devices with pre-integrated global connectivity, operations management and security services. As launch represents an important milestone for the Company as we intend to dramatically simplified the global deployment of IoT solutions by bundling connectivity and cloud services with more and more of our devices. We believe that this will simplify the lives of our customers, while also accelerating our services line of business. During the quarter we also continue to expand our leadership position in OEM solutions with the acquisition of the assets of GlobalTop Technology's GNSS business. With the acquisition of the GlobalTop assets this quarter and the Blue Creation assets in November of last year we're now in a position to supply more of the solution elements that our OEM customers need while also expanding our addressable market. Taking a closer look at the business segment performance. I’ll start with OEM solutions. Q1 revenue in our OEM solutions segment was $133 million, up 10% compared to the first quarter of 2016, non-GAAP gross margin was solid at 31.7%. As expected we saw demand improve on a year over year basis with our established base of OEM customers and programs across a broad range of segments including automotive, energy, networking, payment and mobile computing. Revenue contribution from new OEM customers and programs also continued to grow in line with our expectations. Q1 design win activity was good as we secured a higher than usual number of wins resulting in an aggregate lifetime value roughly in line with our recent quarterly average. Our design wins were spread widely across a number of segments and across our three regions. We continue to gain momentum in the emerging LPWA space as well and are now actively engaged in a number of LTE Cat-M1 trials with carriers and key OEM customers around the world. Our first Cat-M1 product is now certified on Horizon’s M1 network and we are also engaged in a Cat-M1 smart metering trial with Landis+Gyr and Telstra in Australia. We are excited about the opportunity to penetrate new segments and use cases with LPWA and expect to be making additional product announcements later this year as we continue to advance our solutions for this expanding technology. And finally, we are pleased to welcome the GlobalTop GNSS team to Sierra Wireless and the OEM Solutions business unit based in Taiwan. GlobalTop brings to the Company proven GNSS products and capabilities as well as established sales channels. Integration activities are underway and we are introducing GNSS products to Sierra customers and channels. Moving to Enterprise Solutions, in the first quarter revenue in our Enterprise Solutions business grew 45% year-over-year to $21.7 million. Our strong year-over-year revenue growth in enterprise was driven by a combination of revenue from new products, investments and go-to-market capability, and contribution from GenX Mobile which we acquired in Q3 of last year. Non-GAAP gross margin for the Enterprise Solutions business unit was 48.3% down a bit from Q4 as a result of higher revenue contribution from the acquired GenX products which have lower gross margin than the average gross margin for the business unit. New products introduced in 2016 including the RV50 Industrial Gateway, MP70 Mobile Router, and the MG90 Mobile Networking Platform contributed to our year-over-year revenue growth. We also saw significant growth in our subscriber base for AirLink Management Services, a comprehensive suite of tools for operational and device management powered by our AirVantage cloud. Our improved product lineup and targeted investments in direct and indirect sales are leading to new customer wins. In Q1, our enterprise BU won deals across several of our target segments including industrial, public safety, energy, and transit. I am pleased to report that we had a strong contribution from the sale of GenX products in Q1. We are also leveraging the telematics know-how of the GenX team to incorporate enhanced telematics capabilities more broadly in our AirLink product line. We also took additional steps in the integration of this business including increasing production capacity and integrating our own embedded modules into our latest telematics and asset tracking device roadmap. Now on to Cloud and Connectivity Services, Cloud and Connectivity revenue in Q1 which is comprised mainly of recurring services revenue was $7.1 million, up 2.1% on a year-over-year basis. Our Cloud and Connectivity business continue to face some foreign exchange headwinds in the first quarter as the U.S. dollar strengthened year-over-year against the Swedish krona and the euro the currencies in which the majority of our Cloud and Connectivity business unit revenue is denominated. On a constant currency basis, Cloud and Connectivity revenue was up 4.4% year-over-year. Non-GAAP gross margin in Cloud and Connectivity was 43.8% in Q1, up from 39.3% in the fourth quarter of last year due to favorable business mix and lower non-recurring expenses. New customer acquisition activity continued to be strong in the first quarter expanding our customer program pipeline in several targeted segments including digital signage, asset tracking, payment and retail. We also continue to see strong cross business unit sales collaboration with more than 50% of our new Cloud and Connectivity wins originating in our OEM and Enterprise Solutions business units. We are also pleased to see many of our new Cloud and Connectivity customers adopting our patented Smart SIM technology and choosing our integrated device to cloud solutions using our edge devices, connectivity services and cloud platform. As we move forward, the key goal for the Company is to continue to enhance our device to cloud offer and to dramatically reduce the complexity of IoT deployments, one of the biggest challenges facing the industry today. With this goal in mind, we recently launched our first devices with pre-integrated global connectivity, operational management and security. This new offer is much more than simply a SIM in a device. We view it as an industry breakthrough that truly simplifies the IoT ecosystem by reducing or eliminating several of the steps and decisions that customers need to make today with their deployments. With our pre-integrated solutions, customers can focus all of their efforts on transforming their business and rely on us to securely connect monitor and collect data from their devices at the right time, with the right SLA and at the right cost. We also expect that over time growth of our recurring revenue from Cloud and Connectivity Services will benefit directly from our pre-integrated device to cloud solutions. I'll now turn the call over to Dave, who will provide more detail on the Q1 financial results and our guidance for Q2.
- David McLennan:
- Great. Thanks Jason and good afternoon everyone. Please note that 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 our operating performance. As a reminder, a full reconciliation between our GAAP and non-GAAP results is available on our website. Comparing our first quarter of 2017 results to guidance, results were ahead of expectations with both revenue and non-GAAP EPS above the top end of our guidance range. Revenue of $161.8 million was a bit above our guidance range, reflecting a slightly higher than expected contribution from enterprise mobile computing. On a GAAP basis, we had a net loss of $200,000 or $0.01 per share, included in our GAAP results is a $3.7 million impairment charge of an intangible asset related to a Wireless Maingate service offering, which we have now replaced with a more advanced solution that is being developed by our integrated Cloud and Connectivity Services team. On an after-tax basis, this negatively impacted GAAP EPS by about $0.09 per share. This impairment charge has been excluded from our non-GAAP results. Moving on to those non-GAAP results, our non-GAAP gross margin in Q1 was 34.5%, up modestly from Q4 four reflecting continued focus on managing product costs. The higher than expected revenue combined with solid gross margins drove Q1 adjusted EBITDA to $12.4 million and non-GAAP net earnings to $7.7 million or $0.24 a share. Our Q1 non-GAAP effective tax rate of approximately 16% was lower than expected. This resulted from a favorable mix of income among our various legal entities, which when consolidated produced a lower overall effective tax rate. This favorable tax rate improved our Q1 non-GAAP EPS by approximately $0.02 a share, relative to our tax rate expectations going into the quarter. Looking at key non-GAAP metrics in the first quarter compared to the same period in 2016, on a year-over-year basis, revenue increased by 13.3%. OEM revenue increased 10% reflecting improved demand from established OEM customers and programs across a broad range of segments, including automotive, energy, networking, payment and enterprise mobile computing. Revenue contribution from new OEM customers and programs also contribute to the growth. Enterprise Solutions revenue was up 44.8% year-over-year. This growth was driven by a combination of revenue from new products, investments in go-to-market capabilities and the contribution from GenX Mobile, which was acquired in Q3 of last year. And Cloud and Connectivity Services revenue was up 2.1% compared to Q1 of last year. Looking adjusted EBITDA and non-GAAP EPS, in Q1 we realize a significant year-over-year improvement in adjusted EBITDA and non-GAAP EPS. This reflects a return to topline growth, improved gross margin and business model leverage. Adjusted EBITDA was $12.4 million represented a 7.7% margin compared to $6.7 million or 4.7% margin a year-ago, and non-GAAP EPS of $0.24 in Q1 was three times higher than the non-GAAP EPS of $0.08 report in the first quarter of 2016. We continue to have a strong position, cash position of $92.5 million on the balance sheet and the Company's debt free. In Q1, we consumed a total of $10.3 million of cash. We had significant working capital demands in Q1 of approximately $13.8 million. This was driven by unusually high payables at year-end which have now been normalized. Prepayment for new product components this year supply and increased inventory to support the growth of our business. These working capital demands drove our operating cash flow to negative $2.1 million. After CapEx of $3.7 million our Q1 free cash flow was negative $5.8 million. We utilized a further $3.2 million on the acquisition of GlobalTop Technology GNSS business which we acquired at the end of March and we repurchasing canceled $2.8 million worth of stock under our normal course issuer bid program during the quarter and this program as now expired. Other items provided $1.5 million of cash. Moving on to guidance for the second quarter. We anticipate an exceptionally strong quarter in Q2 on both a sequential and year-over-year basis driven by continued solid demand from established customers and programs and contributions from new programs and new products. I also note that this Q2 guidance includes a full quarter contribution from GlobalTop. In Q2 2017 we're expecting revenue in the range of $165 million to $175 million. Gross margin percent to be consistent with the level we just reported in Q1 and non-GAAP earnings per share in the range of $0.24 to $0.32. Our non-GAAP tax rate assumption for Q2 and the balance of the year is between 15% and 20%. While we are not providing guidance beyond Q2. I note that we do expect some gross margin compression in the second half of 2017 resulting from an existing high volume automotive program transitioning to a next generation platform at a lower gross margin level than the current program is replacing. With that, I'll now turn it back to Jason for summary comments.
- Jason Cohenour:
- Thank you, Dave. So to summarize we had a strong first quarter of 2017 with solid year-over-year revenue growth and profitability that was ahead of our expectations. In Q1 we continue to strengthen our customer program pipeline winning many new programs across our business units and regions. Additionally a growing number of our new wins for our whole device to cloud suite and other result of continued strong cross business unit sales collaboration. These device to cloud wins are critical to our long-term vision and growing our base of recurring revenue. We also continue to acquire new technologies and capabilities to fill important gaps and to launch new products and services that strengthen our overall strategic position in the Internet of Things market. We expect that our new products, new services, new customers and acquisitions will be important drivers of future growth. We continue to be excited about the opportunity ahead. We are the clear global leader in cellular connectivity solutions for the Internet of Things. Our three business segments expose us to a large and valuable market opportunity. We believe that we are better positioned now than ever before to capture a significant share of this opportunity. We also plan to stay active in M&A that supports our device to cloud strategy and that helps us to accelerate long-term growth and value creation for shareholders. Thank you. And Julie, this concludes our prepared remarks. You can now open the line for questions.
- Operator:
- [Operator Instructions] Your first question comes from the line of James Kisner with Jefferies. Your line is open.
- James Kisner:
- Hi, guys. Thanks for taking the question and congratulations on the nice quarter.
- Jason Cohenour:
- Thanks James.
- David McLennan:
- Thanks James.
- James Kisner:
- Yes. So just wanted to dive into enterprise margins, I’m not sure if you comment on that and looks to me like it was pretty like more the drivers there and any thoughts on if those drivers would remain in place in the next few quarters?
- David McLennan:
- Hi, James, Dave here. One of the things that is going on in enterprise is as we integrate the GenX products into enterprise the GenX margin profile is lower than the average of the other enterprise products. So that's the principal reason of – seen a blending down of gross margin from Q4 to Q1. As we continue integration we certainly hope to improve those margins, but that is the main driver of the impact.
- Jason Cohenour:
- Yes. Our business model for that business unit James is to be over 50%.
- James Kisner:
- Okay, great. So you think you could be there I guess in two quarters, I mean next quarter any thought on how quickly you could resolve it?
- Jason Cohenour:
- We are working on it.
- David McLennan:
- Yes. We are working on it.
- James Kisner:
- Okay. Similarly in automotive, I really appreciate the commentary about margin – size that, I mean are we talking about $50 million in the back half, also is that likely to remain at that lower margins through the life of the program or might it get better over time, just you would help us understand this automotive impact in the second half?
- David McLennan:
- Sure. I will provide some color commentary James without getting precise on the overall margin impact. Frankly rate of transition is a bit of an unknown. I'll start by saying that it's an existing customer and that existing customer is already in transition from old programs to new program, so a little bit of it's been in our results for three quarters. We do expect that transition to accelerate in the back half of the year and it's really focused for the most part on a single large automotive OEM customer that's going through this transition. So what's happening in the second half is we think that the new solution will go into more and more of the models that this OEM sells into the market. Now these are long programs as you know, long life cycle to the program, so over time we do expect the margin profile to improve as we continue to drive down product cost, but as it is pretty typical with large automotive programs, the early margins that you see on these programs are thinner than they are later in life.
- Jason Cohenour:
- And we are experiencing that right now. James, the program that’s ending is add to higher gross margins and they haven't always been like that, we've grown into them. And then the transition to the new program is to a lower margin which we would have hope to ramp up over time over the life of the program.
- James Kisner:
- Okay. Final one related to the automotive, I mean we've all got pretty excited about this VW win, these wins that you’ve announced with them. I'm just wondering if you got anything in the pipeline that you maybe will end up announcing this calendar year that will be interesting like that one. Thanks.
- David McLennan:
- We certainly hope so. So I'd say the VW win was exceptional James, so those don't come around every quarter for sure, but the connected car environment continues to be very, very active and we are exposed to a number of additional automotive opportunities and certainly we plan to be and hope to be successful in securing some of those opportunities.
- James Kisner:
- Great, thanks. I’ll pass it.
- Operator:
- Your next question comes from the line of Thanos Moschopoulos with BMO Capital Markets. Your line is open.
- Thanos Moschopoulos:
- Hi. Good afternoon. Maybe to summarize as we look at the upside in the quarter relative to your prior expectations, I think our takeaway should be that it was broad-based across several industry programs, is that accurate?
- Jason Cohenour:
- So I'll comment that two ways Thanos. The year-over-year growth is very broadly based and we guided for a good quarter based on broadly based growth of both existing customers and programs as well as new programs. And that happened, but also we exceeded our expectations a little bit on top of that and that was driven by a little bit of over performance in the enterprise mobile computing space in Q1.
- Thanos Moschopoulos:
- Okay. How is your outlook for that part of the business specifically? I think that's probably a segment were [feasibility] maybe especially challenging, but how would you characterize the outlook there?
- Jason Cohenour:
- Yes. We don't guide by segment Thanos. Yes, it's good business for us and we have good continuity there and just leave it that.
- David McLennan:
- Yes. I'll say, I think our strong Q2 guidance ought to give us some hint there, we expect to see in the quarter a continued strong demand on a broad basis across virtually all of our segments and regions in Q2.
- Thanos Moschopoulos:
- Okay. It looks like the tax guidance, [indiscernible] the tax rate is for a lower tax rate than previously, what's driving that and is that something we should expect to stay in longer term?
- David McLennan:
- Yes. You're right, when we spoke earlier in the year we were looking at more in the low-20’s area. Actual Q1 non-GAAP rate was 15.6% and it's very sensitive to the mix of income in the various jurisdictions or legal entities that we have. So the relatively small minor changes in that mix can really change the percentage ETR and that's exactly what happened in the quarter. And we do expect the outlook for our tax rate to be in the 15% to 20% for the balance of the year.
- Thanos Moschopoulos:
- Okay. And then on the Cloud and Connectivity business margin certainly showed some improvements, you mentioned that it was due to favorable mix. Will you expect these levels to be sustainable or we bounce around a little just given how the mix might evolve?
- Jason Cohenour:
- I think at this level of the scale Thanos. We'll probably bounce around this level a little bit, but as that business scales, there's virtually – but it’s very small incremental cost as revenue goes particularly on the Cloud side as you might expect, close to Connectivity side carries along some variable costs, but our long-term model for that business is to be 50% plus on gross margin and clearly as we grow the business, we expect to close the gap from where we are today to that goal.
- Thanos Moschopoulos:
- Okay. And then maybe finally on that part of the business, you've certainly been expanding your offering, the scope of your offering. How have you seen the pipeline evolve as you've been introducing these no new offerings the market?
- Jason Cohenour:
- Well, I think – so I’ll answer that cut in from a couple of different directions. First of all on the kind of the day-to-day meat and potato sales activity, it's going quite well. The rate of new customer wins is going up and the cross-BU collaboration continues to be strong. So I think we're building a very nice pipeline there of programs. And by the way, they have a gestation period similar to OEM programs because many of them are OEM programs. So they take a while before you alternately launch the programs and then they take a while of course to wrap. So I think we're building a nice pipeline much like we've built our OEM pipeline. And so that aside, we're optimistic that that's going to drive future revenue growth and then on new services that we're launching such as a pre-integrated connectivity and cloud services within our devices. Over time, we clearly see that as an opportunity to accelerate the growth of our recurring services revenue even further. So I think kind of need to look at both what we're doing today, which I think is building a nice pipeline and the new services we're launching today, we believe over time will accelerate our results in that area of the business.
- Thanos Moschopoulos:
- Great, thanks guys and congratulations on the quarter.
- Jason Cohenour:
- Thank you.
- David McLennan:
- Thanks, Thanos
- Operator:
- Your next question comes from the line of Mike Latimore with Northland Capital. Your line is open.
- Mike Latimore:
- Hey, thanks. Nice quarter. In terms of the segments verticals you highlighted, what percent of revenue they represent, and then can you give a little more detail on energy in payments? What applications there kind of driving demand there or what bigger customers are driving demand there?
- Jason Cohenour:
- Yes, I’ll take that Mike. So as I'm sure you might know, we don't disclose beyond our business segments, which we run a business units. We don't disclose any financial metrics. What we do try to do is point out those segments that are driving either growth above our expectations or year-over-year growth and we've named those. Now with respect to what we're seeing in those specific verticals you mentioned, energy, still largely dominated by smart metering and we are very actively engaged in smart metering deployments in both Europe and the U.S., which are pretty key drivers. Beyond that we're seeing a pretty nice start with more smart grid applications. So those tend to be lower volume, but higher value implementations. So those are the – I would say the two key drivers around energy and then with respect to diversification within energy, we see a growing level of activity in water and gas whereas today's business is predominantly driven by electricity. And on payment, the principal driver in payment is handheld payment terminals. Ingenico is a large customer of ours and they're the largest payment terminal manufacturer in the world. Beyond that we see a smattering of other payment applications such as vending and connected retail, but predominantly it's a handheld payment terminals today.
- Mike Latimore:
- And then just on the tax rate I know you've guided sort of for this year is there any you know clear direction the longer-term is it more likely to go down or up longer-term?
- David McLennan:
- I would apply that the range of 15% to 20% into 2018 as well Mike.
- Mike Latimore:
- Okay. Thank you.
- Jason Cohenour:
- Thanks.
- Operator:
- Your next question comes from the line of Paul Treiber with RBC Capital Markets. Your line is open.
- Paul Treiber:
- Thanks so much. I just want to go back to the discussion around gross margins and automotive again I mean if you look out a couple years automotive should ramp significantly? How do you that having any impact or not on your the O.E.M. gross margins. If automotive becomes a bigger percent of that business.
- Jason Cohenour:
- So Paul, it’s Jason. It would tend to be within the OEM family I would predict that a growing percentage contribution from automotive would be gross margin percentage dilutive based on what we see today. And in particular as I said earlier as new programs launch they almost invariably come in at lower gross margin and then we work over the five-year plus life span of the program to drive cost out and to improve gross margin over the life of the program. But I think on balance if automotive grows as a percentage of contribution in OEM that would be dilutive to gross margin percentage accretive to gross margin dollars. Now on a consolidated basis of course we're working very hard to drive the overall mix of the business to favor higher growth in both enterprise and cloud and connectivity. So with respect to consolidated gross margin percentage, well into the future when these big automotive programs ramp it's a bit difficult to predict and give you good guidance on that right now. Because the company is pushing very hard both organically and through acquired assets to ship the mix of our business to favor the higher gross margin areas of our business.
- Paul Treiber:
- [Indiscernible] a little more precise in terms of the magnitude maybe talking historically about the automotive business, could it conceivably some of these products be close to zero margin at the onset and I don't know how quickly would ramp up towards that typical 30%.
- Jason Cohenour:
- We can't give you any more precision on that Paul.
- Paul Treiber:
- Okay. Fair enough. Moving to non-cellular for moment we've guided some products like make Bluetooth a navigation. Could you breakout a non-cellular versus cellular in terms of OEM revenue at the moment and then how do you see that the opportunity for non-cellular ramping over time?
- Jason Cohenour:
- So a couple things is first off that it's your first question it's de minimus today. So it's a very, very small percentage Blue Creation was a small company and GlobalTop’s a small company in the press release we gave the trailing revenue was $5 million. So it's a very, very small portion of overall OEM revenue today of course we expect that will grow. With respect to the size of the market opportunity we think it's - we think it's very, very interesting. On a volume basis larger than the cellular module market. On a revenue basis in the same snack bracket as the cellular module market. So we're you know significantly growing our serviceable market with the addition of these assets. And I think you know we've got a lot of channel leverage right. So we get a lot of customer and channel leverage as we bring those products in. Of course kind a take us time by the way to make these products very nicely and elegantly integrated with our overall product roadmap lineup. But even today we're introducing those products to existing customers and channels and we expect to see traction there and certainly we expect to accelerate the growth of those products when compared to the previous owners of those products. Simply because we have a lot of customer and channel synergies. By the way many of our customers put all of those technologies into their end products, right. Many of our customers have not just cellular connectivity in a single product, but also Wi-Fi, and Bluetooth, and GNSS. So we can service a lot more of the waterfront that our customers require for their OEM solutions.
- Paul Treiber:
- The go-to-market strategy for non-cellular is that predominantly a cross sell within the existing customer base as opposed to going out and looking for new customers, new non-cellular customers?
- David McLennan:
- Well, it's a bit of both Paul, it's a bit of both and I will say, obviously the early – so we're going to get early traction in two places, the acquired company's channels and customers which sometimes are not traditionally cellular customers, and Sierra Wireless’s channels and customers many of whom require these local area technologies as well. Now I will say our emerging LPWA activity within cellular is also going to take us into new segments, new channels, new kinds of customers and I would expect – I predict that we will see a lot of customer overlap there between the acquired local area customer base and the new LPWA customer base. I think we'll see a lot of overlap there and leverage.
- Paul Treiber:
- Great. Thank you. I’ll pass the line.
- Operator:
- Your next question comes from the line of Steven Li with Raymond James. Your line is open.
- Steven Li:
- Thanks. Hey, Jason. One more margin question. So the compression in the second half if I understood correctly, this is not a one-time event, as you said recent design wins also have this similar gross margin profile?
- Jason Cohenour:
- Yes, exactly. It’s very difficult particularly in long life projects like automotive to start the lifecycle of that product at low gross margin and then over time to improve the gross margin as you drive cost out. And as Dave alluded to this particular program we're talking about that's in transition that we do believe will put some gross margin compression into the business in the second half followed that exact cycle. So the products that we're shipping today on that program are at significantly higher gross margin than when we started the program four or five years ago. So we certainly expect that this new program with the same customer will follow a similar gross margin cycle.
- Steven Li:
- That's in Next Gen 2018 and you wouldn’t expect to be back to today’s level gross margin?
- Jason Cohenour:
- I don’t recall Dave allowing me to give gross margin guidance for 2018.
- Steven Li:
- Okay. All right. I’ll ask another question, you made comments 50% of connectivity originates from your OEM and enterprise business units, the other 50% that’s not tied to your OEM and enterprise business units. Do you see a higher level of customer churn or is it about the same?
- Jason Cohenour:
- Yes. That’s an interesting question. I must confess, I don't know the answer, but I would expect to the extent that the customer is a device to cloud customer and this is just a prediction, I don't have data to back this up. I would predict that that would be a stickier customer than a customer who was only buying connectivity.
- Steven Li:
- Great. Okay. All right, thanks.
- Operator:
- Your next question comes from the line of Richard Tse with National Bank Financial. Your line is open.
- Unidentified Analyst:
- Thanks. This is actually Steven in for Richard. You made some comments earlier about M&A in your prepared remarks, I was wondering if you could provide any more color maybe the types of targets you'd be interested or the size?
- Jason Cohenour:
- Sure. This is Jason, Steven. We've been pretty consistent on this. We have our top priority on M&A is to target services companies, so companies that help us to accelerate our recurring revenue business. In 2015 we were successful in acquiring three such assets, 2016 we were not, but certainly we continue to spend most of our time and place the highest priority on those services targets typically in the connectivity space.
- Unidentified Analyst:
- In the Connectivity, okay.
- Jason Cohenour:
- Now I want to quickly add to that. I want to – just to add that doesn't mean we stop M&A activity in the other areas of our business, such as industrial and mobility gateways. So we continue to have activity there and as you saw with the GlobalTop, we’ve also done some smaller transaction within our OEM solutions business unit. So as you look at our priorities that's kind of in number one, number two, and number three priority from an M&A standpoint.
- Unidentified Analyst:
- Great, thank you. That’s helpful. Maybe one last one, I was wondering if you could provide any color on your pipeline in general, I know you mentioned you had some comments in your pipeline in the various different businesses, maybe how it's trended over the past couple of quarters? And maybe even how long you'd expect some of those bookings to take to convert to revenue?
- Jason Cohenour:
- Sure. I can't give you any specifics on the size of the customer pipeline, directionally we do comment on number of design wins and we comment directionally on lifetime value of those. We've had positive trends is what I would – is how I would characterize it over the past few quarters. Our view is that our program pipeline across all of our business units is healthy and growing and we expect that to contribute to the future growth.
- Unidentified Analyst:
- All right, thanks. I think that’s it from me.
- Jason Cohenour:
- Sure.
- Operator:
- Your next question comes from the line of Paul Streep with Scotia Capital. Your line is open.
- Paul Streep:
- Great. Jason, can you maybe talk a little bit, it looks like in the back end of last year auto was sort of a consistent acceleration throughout the year. What changed or what's changed in terms of your market position or your go-to-market position internally in terms of the team that's led to this, and then certainly looks like a positive trend?
- Jason Cohenour:
- Yes, good question. I would point to the fact that we've built inside a bit of a virtual business unit around automotive. So we have a dedicated segment marketing, dedicated product line management, dedicated sales, even dedicated R&D and dedicated operations people around automotive. So it is quite a very focused almost end-to-end business unit built around automotive. Now we have a lot of leverage across the rest of our business OEM, business as you might expect. But I think that you're managing that that business in that way has led to a lot of our success and I'll also say, our execution with big OEMs took some scar tissue, but our execution with big OEMs, the things we've done in our factory with respect to quality programs and automation. Leads directly to wins and so I guess to put it plainly Paul it really has been about focus on that market.
- Paul Streep:
- And then just one last quick one for me, on Enterprise Solutions, if I look at the organic numbers there as we calculate them apart from maybe Q3 of last year was a little bit of a hick up, and really nice trend setting in there. Has anything obviously made the acquisitions you've added those in, what's different with that team because it would certainly seem like their execution is dramatically improved, and based on guidance that sound like it’s continuing?
- Jason Cohenour:
- Yes. We believe that execution in that business unit has improved, as indeed improved dramatically and there too we made some significant organizational changes Paul. We have in fact we broke it off as a separate business unit used to be combined with our AirVantage Cloud. We broke it off as a separate business unit under dedicated leadership. We have made significant changes in our go-to-market strategy organization and personnel. And in addition have ramped that. So a combination of I would say an already healthy product pipeline, which was coming to market plus dedicated focus leadership plus significant changes and further investments around go-to-market has led to a strong recovery in that business.
- Paul Streep:
- I’ll sneak one last one, with Cloud and Connectivity have you approached your auto OEMs to determine whether or not you have the scale and sort of offering that they'd be interested in even on a regional basis. Thanks.
- Jason Cohenour:
- Yes, now we've had several conversations with our existing automotive customers. And we've had several conversations with automotive customers who are automotive players who are not currently our customers. And I think to date Paul it's been a been largely a learning exercise there's definitely interest on the part of OEM they like what we're doing, they like the differentiation we have. And I think over time we will be in a much stronger position to meet their requirements on a global basis. I don't think we're quite there yet. Although the customer interest is there, we're spending a lot of time with automotive customers. I think we've got work to do before we can really support the needs of a large OEM on a global basis, but that I'm confident we're going to get there.
- Paul Streep:
- Even regionally Jason like would you see that you’d need to put money into infrastructure people or it's just you need time to sort of groom it up?
- Jason Cohenour:
- I think that's an interesting point clearly there are certain regions in the world such as Europe. So if there was a single regional player like Europe we would be in a much better position today to tackle that.
- Paul Streep:
- Perfect. Thanks guys.
- Jason Cohenour:
- Sure.
- Operator:
- [Operator Instructions] Your next question comes from the line of Scott Searle with Benchmark. Your line is open.
- Scott Searle:
- Hey, good afternoon. Thanks for taking my question.
- Jason Cohenour:
- Thank you.
- Scott Searle:
- Last couple of quarters on the OEM front business has been very strong. We entering a sustained period of where you could see double-digit growth on this front, the comps get a little bit more difficult. But love to just kind of hear your thoughts as you're thinking no further on the time horizon. And as well you had some comments as related to M1 starting to rollout. I was wondering how you expect that to kind of filter into the results I would assume it's mostly geared towards 2018 and also could you just comment on other LPWA solutions. Jason are you getting involved in some of the other RF protocols that are out there or is it mostly centered around LTE at the current time.
- Jason Cohenour:
- Maybe I'll start with that Scott. We are very focused on the three GPP standards for LPWA at this time. We've looked at LoRa, we’ve looked at Sigfox we're probably going to continue to look at those guys, but right now in the interest of focus and execution. We're really dedicating our resources today to LPWA to the 3GPP standards around LPWA. That includes Cat-M1 and NB-IoT and EC-GSM, right. So there is really three different protocols in the 3GPP world and we are focused on supporting all of those in a significant way I would say today and we'll watch the other ones, we will continue to watch the other ones. Cat-M1, how do we see it coming into the business, we're engaged now rights, so we are engaged with real life customers like Landis+Gyr and big carriers like Horizon and Telstra who are going to roll out the service. We think that the kind of the natural transition Scott is for existing 2G or Cat-1 customers to move into Cat-M1 and NB-IoT and that's exactly what we're seeing so that would be like. Smart metering is a good place to start. We're seeing a lot of interest around LPWA technologies in smart metering, so we think it's going to start there. And then over time there's a belief that we're going to be able to expand into new segments as well that previously had not been served by cellular, and I think that's going to take some time. So in terms of significant commercial contribution for us it's really 2018 and beyond event for Cat-M1and the other 3GPP technologies. On your question about OEM momentum, you are absolutely right that we are performing well today against easy comps. And what we saw last year, early last year in particular was some of our big OEM customers, we just saw demand slowdown. And those customers didn't go away, they were just buying less. And we've seen stability return to those big existing OEM customers and programs, so we are cautiously optimistic, so there is still some caution in our outlook, but we're cautiously optimistic that we've found sustained stability with those customers and we have continued to see good contribution from new programs as they launch and ramp. So there's still a dose of caution as we look into the future Scott, but certainly it feels a lot better today than it did a year ago.
- Scott Searle:
- And one last question if I could, Jason on the SIM front, just hoping to get a little bit more color in terms of differentiation versus some of the other players out there, the timeline of when this starts become a little bit more prevalent and gross margin impact? Thanks.
- Jason Cohenour:
- Sure. So with respect to – let's call it SIM and connectivity, I think we're unique in that and that we own the devices, we own the backend cloud and we own our own network. We are a true MVNO. We have our own core network. We have our own SIMs. We have our own intellectual property riding on those SIMs, including multi-enzyme capabilities. So we're not simply reselling, a big MNO SIM. We're selling our own SIM and we have multiple enzymes riding on that SIM. So that the SIM itself can make a decision, which network is best to connect to or from our cloud, we can make a decision, which network our SIM should connect to, and that gives us very interesting and unique capabilities to assure the highest quality of service, if that's what a customer requires or to optimize cost of service, if that's what our customer requires and of course we have to be very tuned in to cost of service. So I think we have – and because we have both ends, I think we're in a very unique position to bundle that capability with devices as they go into the market. And we fully expect that's going to enable us to grow that business over time and as we put SIMs in more and more of our devices to accelerate our growth there.
- Scott Searle:
- Great, thanks so much.
- Jason Cohenour:
- Sure, thanks.
- Operator:
- Your next question comes from a line of Steven Li with Raymond James. Your line is open.
- Steven Li:
- Hey, Jason, just your last comment, so Cat-1 into Cat-M1, would that not erode ASP? Thanks
- Jason Cohenour:
- Cat-M1, will that erode ASP. Well, I think Cat-M1 will over time bring lower ASPs compared to Cat-1. Although Cat-1 is pretty low ASP today, and I think Cat-M1, I would think of it Steven is more analogous to 2G from an ASP standpoint and that is the most natural replacement opportunity if you will. So in terms of the concern of a potential dilutive effect to ASP, we don't see that in the short-term. It's something that we need to manage longer-term for sure depending on what the mix of our business is between LPWA technologies and the ever increasing speeds going up in categories. So longer-term we just don't know what that impact is going to be. But I think overall it gives us clearly a very interesting opportunity to sell more volume into more segments.
- Steven Li:
- All right, that helps. Thanks.
- Jason Cohenour:
- Thanks. Julie, we’ll take one more question if there are any more questions. End of Q&A
- Operator:
- [Operator Instructions]
- Jason Cohenour:
- As there are no more questions, I'll thank everybody for joining today's call and as usual management will be available if you have any follow-up questions. Julie, you can now wrap up and terminate the call.
- Operator:
- This concludes today's conference call. You may now disconnect.
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