Sierra Wireless, Inc.
Q4 2017 Earnings Call Transcript

Published: 9 Feb 2018

[Operator:]

Good evening. My name is Chris and I will be your conference operator today. At this time, I would like to welcome everyone to the Sierra Wireless Fourth Quarter and Year End Results Conference Call. [Operator Instructions] David Climie, VP, Investor Relations, you may begin the conference.

[David Climie:]

Thanks, Chris, and good afternoon, everybody. Thank you for joining today's conference call and webcast. With me today on the call is Jason Cohenour, President and CEO and Dave McLennan, 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 fourth quarter results. Dave will then provide a more detailed overview of our quarterly and year end results as well as our guidance for the first quarter 2018. And then, we'll finish with a Q&A session. Before we get started, I will reference the Company's Safe Harbor statement. The 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, 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 your 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 fourth quarter 2017 results. Overall, Q4 financial results were strong and at the higher end of our guidance range. Consolidated revenue was $183.5 million which includes $3.1 million from Numerex for the 24 days of December that we owned the company. Overall, total Q4 revenue was up 12.6% year-over-year with revenue growth in each of our three business segments. Solid Q4 revenue led to adjusted EBITDA of $13.9 million and non-GAAP earnings per share of $0.28 compared to $0.27 in the same quarter last year. For the full year 2017, consolidated revenue increased 12.4% and adjusted EBITDA grew by 23.4% to $54.2 million. We successfully completed the acquisition of Numerex on December 7 and we're pleased to have the deal completed ahead of schedule and we're now working diligently on integration. In the quarter, we also continued to strengthen our leadership position in the Internet of Things market with new technology initiatives, new product launches and solid customer acquisition activity across our lines of business. Taking a closer look at the business segment performance, I'll start with OEM solutions. Q4 revenue in our OEM solutions segment was $139.8 million, up 3.4% compared to the same period in 2016. Our Q4 non-GAAP gross margin in OEM was 29.7%, which was flat to Q3. In Q4, we experienced solid revenue contribution from our established OEM customers and programs across a broad range of segments, including automotive, sales and payment and mobile computing. Revenue contribution from new OEM customers and programs continued to grow as expected in the fourth quarter. Design win activity was solid in the fourth quarter as we secured a growing number of new programs across a range of segments, including automotive, networking, transportation, energy and mobile computing. We also secured the second largest design win in the company's history with a large international automotive customer. We expect that program to start shipping in late 2019. We also introduced the smallest lowest power multimode LPWA module on the market. Our AirPrime HL78 module supports LTE Cat-M, NB1 and optional fall back to 2G. With its industry leading power management specs, this model can operate on a single lithium ion cell for up to 15 years. The HL78 also integrates SIM, security and GNSS capabilities into a very small package. We're now sampling the HL78 with lead customers and have already secured design wins, including for a large smart metering deployment in Japan later this year. We're also very pleased to see the continued growth and market traction for our unique open source hardware initiative mangOH. Earlier in 2017, we released the mangOH Red rapid prototyping platform, which has now been adopted by key channels, developers and even large carriers to support their IoT initiatives. mangOH Red is also capturing industry recognition including an IoT breakthrough award in January of this year. Moving to enterprise solutions, in the fourth quarter, revenue in our enterprise solutions business grew an impressive 52% year-over-year to $31.8 million. Non-GAAP gross margin in enterprise solutions was 47.5% in Q4, down slightly from the prior quarter. Year-over-year revenue growth in enterprise solutions was led by an exceptionally strong contribution from telematics devices for local fleets combined with strong growth in AirLink networking solutions for the public safety, energy and industrial segments. With regard to our strong sales of telematics devices, we've been benefiting in the past two quarters from transportation customers moving quickly on their fleet deployments in order to comply with the hours of service regulations mandated by the Federal Motor Carrier Safety Administration in the US. We expect to see continued higher than normal demand trends in this segment through the first half of 2018, followed by a return to normalized demand levels in the second half. In March of 2017, AT&T was awarded a very large 25-year contract to deploy and operate FirstNet, a national broadband network specifically for US first responders that leverages the dedicated LTE band 14. Prior to this award, several states and municipalities had deployed their own LTE networks on the dedicated band 14. We've had several successful deployments with public safety agencies on these early band 14 networks in the past two years. We're also working closely with AT&T to ensure that our embedded modules and AirLink networking solutions are fully compliant with FirstNet as it rolls out. Our position in the US first responder market, including fire, police, EMS is very strong. We believe that the deployment of FirstNet presents an important secular growth opportunity for our enterprise solutions business and we are investing in FirstNet compatible solutions and go to market capability to capture a leadership position. Overall, new enterprise solutions customer wins in the fourth quarter were strong, particularly in the public safety, transportation and industrial markets. Our sales funnel and pipeline in this segment of our business remains very healthy. Now on to IoT services, the business segment formerly known as cloud and connectivity services. Following the acquisition of Numerex, we've implemented a name change for this segment to reflect the broader range of IoT services we offer and customers we serve. More than 90% of the revenue generated in this line of business is subscription based and recurring. In Q4, IoT services revenue was $11.9 million, up 73.5% on a year-over-year basis. Excluding a revenue contribution of $3.1 million from Numerex during December, organic revenue increased 27.6% on a year-over-year basis. Our organic revenue growth was driven primarily by subscriber growth across the market segments we serve. IoT services also benefited slightly from FX tailwinds as the Swedish krona and euro strengthened year-over-year against the US dollar. Non-GAAP gross margin in IoT services in the fourth quarter was 44.2%, down slightly from the prior quarter due to services mix. New customer acquisition activity was solid in Q4 as we secured new customer program wins in the industrial, transportation and energy markets. We had continued strong sales collaboration across our business units with more than 40% of our new services wins originating in our OEM and enterprise BUs. And we're really excited about joining forces with Numerex and believe that this combination places us in a unique and powerful position to scale our IoT services, to lead in the market and to create significant customer and shareholder value. The full integration of Numerex will take some time, but we're off to a fast start and the teams are working very well together. We've implemented the new combined organization and we expect to capture significant growth, cost and operational synergies as we progress through the integration process. I'll now turn the call over to Dave for a view of fourth quarter results and guidance for Q1.

[Dave McLennan:]

Great. Thanks, Jason. Please note that we report our financial results on a US GAAP basis. However, we also present non-GAAP results in order to provide a better understanding of our operating performance. As a reminder, a full reconciliation between our GAAP and non-GAAP results is available on our website. We completed the acquisition of Numerex on December 7. Accordingly, our Q4 and full year 2017 results include Numerex for the stub period from December 8 to the 31. Numerex was not included in our Q4 guidance, which was provided before we closed the acquisition. Looking at our fourth quarter non-GAAP results, excluding the contribution from Numerex during this stub period, our revenue and non-GAAP EPS were both at the high end of the guidance range. Revenue of 180.4 million was slightly above our guidance range, driven by a strong contribution from fleet telematics gateways and enterprise solutions and continued strong subscriber growth in IoT services, combined with OEM solutions performing as expected. Our non-GAAP gross margin on an organic basis was in line with our expectations at 33.6% and up slightly from 33.4% in the prior quarter. Non-GAAP operating expenses in Q4 on an organic basis were 50.7 million, which was slightly higher than our expectations and up sequentially primarily due to an increase in sales and marketing expense in the quarter. Adjusted EBITDA was 13.9 million and non-GAAP earnings per share were $0.28 in Q4, which is at the high end of our guidance range. The non-GAAP effective tax rate was 7.2% in Q4, below our guidance range of approximately 15% to 20% as a result of a favorable geographical mix of income across our various entities. So a strong quarter relative to expectations going into the quarter. During the December 8 to 31 stub period, revenue from Numerex was 3.1 million, resulting in consolidated Q4 revenue of 183.5 million. Q4 consolidated gross margin, including Numerex, was 33.8%. During the stub period, Numerex OpEx was 1.8 million, resulting in consolidated operating expenses of 52.5 million. Numerex had no meaningful impact on our consolidated adjusted EBITDA or EPS in Q4. Looking at key non-GAAP metrics in the fourth quarter compared to the same period in 2016, on a year over basis, consolidated revenue increased by 12.6%. OEM revenue increased 3.4%, reflecting improved demand in automotive, sales and payment and mobile computing, partially offset by lower revenue year-over-year in energy and networking. Enterprise Solutions revenue in Q4 was up 52% year-over-year. This growth was driven by strong contribution from fleet telematics devices and AirLink networking solutions for the industrial and mobile markets. IoT services revenue increased 73.5% year-over-year, driven by organic subscriber growth and the addition of Numerex late in the quarter. Excluding the Numerex contribution, IoT services revenue grew 27.6%. Looking at adjusted EBITDA and non-GAAP EPS on a consolidated basis, in Q4, adjusted EBITDA was 13.9 million, representing a 7.6% margin. Adjusted EBITDA was down compared to the 15.5 million a year ago, but up sequentially compared to 13.1 in Q3 and non-GAAP EPS of $0.28 in the fourth quarter compared favorably to $0.27 in Q4 of ’16 and improved sequentially from $0.23 in the prior quarter. And as I indicated before, Numerex had no meaningful impact on our consolidated adjusted EBITDA or EPS in Q4. Looking at key non-GAAP metrics for fiscal year 2017 compared to 2016 on a consolidated basis. Overall our revenue increased 12.4% year-over-year with all three business units delivering growth. OEM grew 8%, enterprise grew 42% and IoT services grew 26%. Looking at consolidated adjusted EBITDA and non-GAAP EPS, in 2017, adjusted EBITDA was 54.2 million, representing a 23.4% increase over the prior year and non-GAAP EPS of $1.04 in 2017 was up 52.9% compared to the $0.68 per share reported in 2016. Moving on to the balance sheet, we ended the year with 65.2 million of cash and we have no debt. During the quarter, we generated 13.5 million of cash from operations and after capital expenditures of 3.5 million, free cash flow was $10 million. We used approximately $19 million to retire the Numerex debt, net of cash acquired, resulting in an overall use of cash in the quarter of about $9 million. Moving on to guidance, for the first quarter of 2018. There's a lot going on in Q1. The outlook for the quarter has many moving pieces and some unusual non-recurring items, including the fact that we've just completed the acquisition of Numerex and Numerex is currently executing a network upgrade and customer migration. We're also experiencing significant component supply shortages. This is combined with typically seasonal higher OpEx in Q1. So with these factors in mind, we are expecting revenue to be in the range of 181 million to 189 million. Tight component supply is constraining our revenue guidance by about $5 million to $6 million. Our revenue guidance includes Numerex, which we expect will contribute approximately $13 million in the first quarter. This is roughly flat sequentially with Q4 of 2017. We expect non-GAAP gross margin in Q1 to be relatively flat to Q4, reflecting some product cost pressure as a result of component shortages and network migration costs, offset by the addition of Numerex revenue, which on a normalized basis, delivers gross margin percentage in the mid-40s. We expect non-GAAP operating expenses in Q1 to be unusually high at approximately 59 million and not an accurate reflection of our go forward OpEx run rate. First quarter OpEx includes a full quarter of Numerex operating expenses, including some expenses that are related to the necessary network upgrade and customer migration. We expect expenses associated with the upgrade and migration to be incurred mostly in Q1, seasonally higher OpEx in the first quarter, as we have several large sales and marketing events and a step up in R&D expenses for several programs and certifications in the quarter. In Q1, our non-GAAP tax rate is expected to be approximately 15% and approximately 13% for the full year. The expected higher percentage effective tax rate in Q1 relative to the full year is a function of small absolute numbers in the quarter. As a result, we expect our non-GAAP earnings per share to be in the range of $0.04 to $0.10 in Q1. Additionally, with the integration of Numerex, we have commenced various efficiency and effectiveness initiatives. These initiatives are focused on capturing synergy opportunities as we integrate Numerex and efficiency gains in other areas of our business. We expect these initiatives to drive stronger profitability leverage as we continue to grow revenue. The initiatives that we are undertaking are expected to reduce costs of goods sold as well as operating expenses. As a result of implementing these initiatives, we are targeting a quarterly non-GAAP operating expense rate of 56.5 million in Q4 of this year. We expect these initiatives result in a restructuring charge of approximately 4.5 million and this will not impact our Q1 guidance. With that, I’ll now turn the call over to Jason to sum up.

[Jason Cohenour:]

Thank you, Dave. So to summarize, we had a strong fourth quarter of 2017 with operating results at the high end of our guidance range. We delivered year-over-year revenue increases in each of our business segments with particularly strong growth in our high margin enterprise and IoT services lines of business. We continued to strengthen our customer program pipeline, winning many new programs across our business units and capturing the second largest design win in the company's history with a large international automotive OEM. We strengthened our position in the IoT market with new leading edge products and solutions that expose us to new growth opportunities such as LPWA and FirstNet and we've significantly scaled and strengthened our IoT services business with the addition of Numerex and are now better positioned than ever before to expand our differentiated IoT services globally and to grow our base of subscription based recurring revenue. In the short term, we have many moving parts to manage as we integrate Numerex, implement important network upgrades and battle a challenging component supply environment. These items are clearly constraining our Q1 revenue and profitability outlook. However, looking through the short term view, we believe that we are taking the right steps to capture synergies, to lower costs and to drive profitable growth. We continue to be excited about the opportunity ahead. We’re the clear global leader in device to cloud solutions for the Internet of Things and our three business segments expose us to a large and valuable market opportunity. Our device to cloud strategy supported by the organic and inorganic investments we've made places in a unique position to lead this market and to drive growth and value creation for shareholders. Thank you and Chris, this concludes our prepared remarks. You can now open the line for questions.

[Operator:]

[Operator Instructions] Your first question comes from Richard Tse with National Bank Financial.

[Richard Tse:]

Dave, what was the quarterly OpEx for Numerex prior to acquiring it and what's the run rate going to be based on your sort of Q4 run rate? I’m trying to get a sense of before and after on that name.

[Dave McLennan:]

Yeah. I mean, prior to -- I'll focus on our -- the company in our hands, Richard and Q1 OpEx for Numerex is approximately $7 million.

[Richard Tse:]

And I think it's pretty clear you have gone through the Numerex filings and a bunch of the press releases through the year, like they had certainly some challenges in the past. Can you give us a bit of color in terms of where you see the opportunities? Certainly, that's along the cost side it seems, but on the revenue side that they could not capitalize on.

[Jason Cohenour:]

Richard, this is Jason. Hi. Yeah. I think speaking in general, as we combined with Numerex, we doubled the size of our business platform in terms of people and capabilities. We scale our recurring services revenue by about 250% and or in just a much stronger position as a business platform to both stabilize the challenges that Numerex was experiencing over the past couple of years and to begin to re-vector and focus on growth. So I'm pretty confident we've got a very good integration effort underway that's going to yield us, not only cost and operational synergies, but growth synergies as well, as we've essentially doubled the size of the sales team. And just adding to that, as you know when we first did the transaction to acquire Numerex, we acknowledged the challenges they've had over the past couple of years and that it was our call that the worst was behind them and that soon after we had it in our hands, we could focus on a return to growth and we still feel that way and believe that. And I think a decent indication, hopefully an early indication of that is we expect Q1 revenue from Numerex to be flat to Q4 and given what's happened there in the past couple of years, I think that's a minor victory. Right. So I think while we still have work ahead of us, I'm confident that together we're going to be stronger and we can return to growth.

[Richard Tse:]

And then if you look out, let’s say, over the next 12 months or maybe 18 months, it seems that you definitely have a pretty strong foundation or building one to building that recurring revenue stream. Do you guys have a target that you want to be at over that period of time or how do you think about that in terms of your planning?

[Jason Cohenour:]

Well, interesting question, Richard, because we're in the process of refining that now, because our original goal, you might remember was to have at least 10% of our revenue coming from recurring IoT services. And now with Numerex, we're beyond that. So we’re resetting that target and I would expect that we'll be targeting at least 15% in the coming few years of total consolidated revenue coming from recurring services and I think a pretty good indication of the progress we're making, if you look at where we are on a pro forma basis in Q4, approximately 27% of consolidated revenue came from our higher margin business lines.

[Richard Tse:]

And just one last one for me, with respect to some of the older businesses, when you look at 2G, 3G, CDMA, do you guys have sort of a mix that you can share with us today, what that would be and how that would compare to last year, that’s my last question.

[Jason Cohenour:]

On the hardware side Richard, our 2G sales are about 8%. 3G is 19%. 4G is 61% and other which is services and other is 12%. If you compare that to a year ago, 2G was 15% as an example and 3G was 30%.

[Operator:]

Your next question comes from Mike Walkley with Canaccord Genuity.

[Mike Walkley:]

Jason, just want to get a little more color on the component shortages. What are the types of components and can you walk us through maybe which division that’s hitting in the overall impact to gross margins.

[Jason Cohenour:]

So, the theme is memory. I mean, there is a few things. RF is okay. RF has been a problem in the past. It’s okay now. I think if there's one central theme to point to, it's memory and primarily NAND, which we use, well, in all of our products of course and that's kind of the major -- that's the major challenge of the day and it is significantly constraining our OEM business, both on the top line and it is in the short term here also impacting cost of goods because in addition to having not enough components to meet demand, we are having to pay expedite fees and the like in order to get whatever we can get. So it's kind of a -- we're getting hit twice, we're getting hit on the top line and in cost of goods as a result of these shortages.

[Mike Walkley:]

And then just in terms of the enterprise business, quite strong to close the year. Can you talk maybe about the competitive environment you're seeing in that business and should we expect 2018 to be a similar strong growth, year one, some of these supply shortages are worked through.

[Jason Cohenour:]

Sure. And it's a lower volume business, right. So the shortages there are not quite as intense, but so it's a -- I’d say over the past two years, competition in that area of the business has intensified, notwithstanding our strong growth and I think strengthening position, the competition is pretty intense and broad based, ranging from smaller players to larger players. We are very bullish on the long term outlook of enterprise. We've invested a lot in refreshing the product line. As you know in the past, we're continuing to do that and we've invested a tremendous amount in re-architecting and bolstering our go to market team and strategy. And I think it's showing results. Now short term here, I think we're having unusual tailwinds with this hours of service, compliance initiative in the US. So telematics devices and think about those that we acquired from GenX have been a pretty big surprise in the past couple of quarters, including in Q4. We think that's going to last a couple more quarters and then normalized, but the underlying fundamentals of that business are very good, including organic AirLink networking solutions growth. So that's a strong double digit growth and I'm not saying we expect another 42% growth in 2018, but we're expecting that part of our business to grow faster than the overall business.

[Mike Walkley:]

Just for you and Dave on the gross margin, so congratulations on another large automotive win. I believe Volkswagen kind of starts to ship this year and then ramps next year and it sounds like this other one kind of comes in the model second half of ’19, how should we kind of frame the revenue and then gross margin impact as these automotive deals start to impact the model?

[Jason Cohenour:]

Sure. It's tough to give you a precision on that, Mike. I will say in 2018, we do expect to start shipping on our first VW program. We expect the revenue contribution in 2018 to be relatively small. So I don't think you'll see much impact in gross margin percentage this year. You are right. 2019 is a pretty big ramp year on Volkswagen and other programs and 20 is when we really expect to see a very large contribution from these large automotive programs that we've won. Clearly, our expectation that is within the OEM solutions business unit that that will be dilutive to gross margin percentage, not gross margin dollars. But it's tough to comment on the impact on consolidated gross margin because we're doing a pretty good job rapidly growing the other higher margin business lines within the company, so that will counterbalance the dilution we expect to see in OEM solutions. So we are still very focused, Mike, on achieving and surpassing our 35% gross margin goal, including of course contribution from the automotive programs.

[Dave McLennan:]

And, Mike, just to add to that, we’ve got an Enterprise Solutions business that’s a $100 million business now. So it's got scale and that's running just shy of 50% gross margin and now we have a services business that's approaching 100 million and again running it 40%, 50% gross margin. So, that's, well, we might have some dilution in OEM. We've got some other moving pieces that are helpful to consolidated gross margin.

[Operator:]

Your next question comes from Thanos Moschopoulos with BMO Capital Markets.

[Thanos Moschopoulos:]

You provided some color on where you are trying to get OpEx to with the restructuring. That's helpful. Would you be able to comment on what you're targeting for gross margins once the restructuring initiative is complete?

[Dave McLennan:]

Yeah, Thanos, we’re sort of flat this quarter to last quarter and I think we're not going to be guiding beyond that in gross margin, although I will say some of the initiatives that we are undertaking are designed to improve cost of goods sold.

[Jason Cohenour:]

I’ll add a little bit to that Thanos also that, we've directionally guided gross margin percentage flat in Q1 versus Q4 and that guidance includes some unusual items that are nonrecurring items that are inflating our cost of goods. Without those items, we would see gross margin percentage tick up a bit in Q1 compared to Q4.

[Thanos Moschopoulos:]

But maybe directionally is it fair to say that with the restructuring, we should see gross margin improvements perhaps in cloud, in IoT Services as you integrate Numerex and then maybe to some extent in the OEM business as well. Would those be the two segments where you’re going to be focused on?

[Dave McLennan:]

We are targeted on improving gross margin for sure. And to give you a precision beyond what we've said is difficult. I’ll also say, as I quite remember, a long term target is 35% and the moves we are making are in part intended to get us there.

[Thanos Moschopoulos:]

Jason, on the automotive win, any additional color you can provide in terms of the characteristics of that deal, perhaps relative to the Volkswagen deals, anything different or unique about that, very similar in terms of why you won that or in any nuances that you can provide in terms of what that deal looks like or how you came about to win the deal?

[Jason Cohenour:]

Sure. So it’s with an existing customer. So I’ll start there. So we did have the power of incumbency and a demonstrated performance track record with this particular customer. It is however a deal that adds significantly incrementally to our business with that customer because with this new design win, the program goes from a single region to a global deployment. So it represents quite a step up in terms of revenue and volume with this particular customer. So beyond that, we didn't have the power of incumbency of course as VW, right, so we had to win on other factors as including our embedded application framework that did also factor here with this particular customer, but we also had a proven track record, so that helped a lot.

[Thanos Moschopoulos:]

And then finally just on the strength in IoT services with the 27% growth ex-Numerex, anything you can highlight there as far as geographies or specific verticals or is it kind of broad based across a number of areas.

[Dave McLennan:]

So maybe to give you a little bit of a color there. So that business, we've got kind of a broadband business, our broadband services that we sell primarily in the US and we saw excellent growth in that area of our business. That's low volume, high ARPU business and then in the more conventional IoT businesses, energy, transportation, fleet that kind of stuff, that growth was also quite strong and that came mainly from Europe.

[Operator:]

Next question comes from Don Morton. Investor Don, your line is open.

[Unidentified Analyst:]

I guess I have a very basic question and that is, if your supply chain product has been disrupted, what are the alternatives to prevent this from escalating and continuing where, is it because of the manufacturing on that or is it because of competition for the same good?

[Jason Cohenour:]

Yeah. Don, supply chain is a complicated thing, but it's basically because worldwide demand for the components we buy, so not only demand from us, but demand from others and not just direct competitors, others, has increased significantly which is extending lead times. So what do you do to combat that? Well, essentially, we've got to plan ahead farther in advance. So we've got to be more precise and longer term on our forecasting and we've got to place bigger and longer term orders for the components in question and get that material in house faster. So the way to think about it is, a product that used to have a, I'll make it up a six week lead time has now gone to any 18-week lead time and we have to plan accordingly. So that kind of ripples through our supply chain organization and basically we have to take more risk on the supply chain and buy more and buy earlier.

[Unidentified Analyst:]

So it's not a manufacturing era, it’s from your suppliers, it's actually competition?

[Jason Cohenour:]

Exactly. Yeah. It’s global competition for the material.

[Operator:]

Your next question comes from David Gearhart with First Analysis.

[David Gearhart:]

Piggybacking on the prior question, I just wanted to ask do you have any sense of when that might ease and falloff as an issue.

[Jason Cohenour:]

So I think our supply situation, we expect to improve in Q2. That is mainly as a result of our own changes in planning by the way, David. We do expect overall tightness in the market for NAND will, for the parts we buy, the NAND parts we buy will certainly continue through the first half and likely beyond that. So what we are doing to combat that, like I said is, we are changing our planning and our purchasing patterns to bring the material in faster and in more volume, but I think from a global supply standpoint, we expect to see these constraints continue, we just expect to get more of the parts.

[David Gearhart:]

And a similar effect on revenue and gross margin throughout the year or that should actually improve just given your efforts to place order?

[Jason Cohenour:]

Well, we expect revenue to improve because we'll have the material, right. Hopefully, I don't want to declare victory, right, but we should have the material earlier and faster so we'll be able to protect customer demand and thus revenue. We should be able to avoid more unusual expedite fees. And then thirdly I’ll say there is a bit of pricing power that has shifted to the suppliers because of the worldwide demand and that portion -- that impact on gross margin we probably won't be able to recover because they'll continue to enjoy a very strong demand environment and unlike a lot of businesses that goes right to pricing.

[David Gearhart:]

On to my next question, in regards to cloud and connectivity or what you’re calling IoT services now, gross margin down from Q3 to Q4. You called it out in your prepared remarks, but in regards to services mix, and if you layer on Numerex, I know it was at a higher gross margin. Is the gross margin coming down? Is it more of a function of some of the accounting and some of the differences there that's causing the mix, because I thought you’d get a rise instead of a compression in Q4?

[Jason Cohenour:]

No. I think so a couple of things on that, David. So very small contribution from Numerex in the quarter and you're right, it came in at gross margin a little bit, well, higher than the corporate average, just put it that way. I will say that the gross margin in cloud and connectivity services or IoT services, while down to Q3, was higher than the first half of 2017 and that's really a mix thing. I think as we add scale in that business, my firm belief and our plan is to get that business on a track to operate at over 50% gross margin. Now, it's going to take us a little while to get there, but I wouldn't view Q4 gross margin in that part of our business as normal. Our goal and expectation is to see gross margin go up with scale.

[David Gearhart:]

And then lastly, I wanted to ask a little bit about the Numerex network refresh and migration. I know when you acquired the company, you had mentioned that the company had cut a little bit too close to the bone in terms of R&D and other initiatives, was this something that you were well aware of before acquiring it or was it something that you got in there, got under the hood and experienced that after close?

[Jason Cohenour:]

Yeah. I think we knew we had work ahead of us, David. I don't think this particular network upgrade was on our list when we closed on December 7 necessarily. But as we got into integration, our call was that some network upgrades were desired and in some cases necessary because network infrastructure equipment was out of date and no longer supported and our view was, we're going to shift to growth mode here. In order to do that, we need the right network, the right supported network infrastructure going forward. So we're now making those calls and implementing the upgrades.

[Dave McLennan:]

And David that is consistent with our acquisition model where we factored in the need to make certain investments in our acquisition model for the reasons that you just said, the business had been managed very carefully up until that point from a cost –

[David Gearhart:]

Can you give us some sense of how much the impact is for that network investment for the quarter since it's a one-time so we kind of get a sense backing that out with the earnings profile would be for the company as a whole of Sierra itself?

[Dave McLennan:]

Yeah. Dave, that's a pretty -- in a business with lots of moving pieces, that’s a pretty detailed thing. I don't think we're going to give you that specificity.

[David Gearhart:]

And last one from me and sorry for the number of questions, but I know they were also going through to a 2D migration and since we're in the topic of Numerex in their network, is that still an issue with Numerex in terms of subs coming off for 2G, or is that we behind the company or we're waiting for other large carriers to close their 2G and that could be an issue going forward in the year.

[Jason Cohenour:]

Numerex still has a large 2G subscriber base. This particular network upgrade does not change that in a material way. It changes it around the edges I would say because some customers, we are migrating off of 2G as part of this move in Q1 to other air interface protocols that will have a longer lifetime, but that doesn't materially change the fact that there was a 2G base there David that we need to migrate and we are very busy putting together migration plan for those subscribers and we expect to execute that over the next two years.

[Operator:]

Your next question comes from Paul Treiber with RBC Capital Markets.

[Paul Treiber:]

Just want to follow up on the last question. So in regards to Numerex, the revenue outlook that you gave for Q1, 13 million. I guess it's positive, it’s flat sequentially, but it's still down slightly from what Numerex reported in Q3. I think, it reported 15 million. Is it the 13 million run rate, is that what you assumed the level would be when you made the acquisition or whether sort of incremental total headwinds that perhaps push it down further than what you expected? And then if it is stable or in line with expectations, what signs are you seeing that would lead to stability at this point?

[Dave McLennan:]

Paul, it’s Dave here. I think it is within the bounds of our expectation at acquisition and we view it, as Jason said, a positive thing that we're seeing stability from Q4 to Q1 and we would certainly expect that that number would improve going forward.

[Paul Treiber:]

And just regards to stability beyond the revenue numbers, is there signs you're getting from customers or partners in that business that lead you to be content that it will remain at these levels going forward before you can see that growth that you're talking about.

[Jason Cohenour:]

I think it's too early to call a complete victory Paul. So, as we said when we completed the transaction, we've got work to do. I will tell you our expectation and the way we're driving the business is that we expect it to grow from here. But, as we step through the process and meet with customers and put in place migration plans and new equipment and the like, we're going to get more clarity. I'd say helping us to stabilize and migrate key customers is the fact that we're launching a bunch of new hardware with Numerex as well moving many of the hardware products that enable service from older air interface protocols to 4G. And that gives us confidence. I think, we've got a team that – a combined sales team that's pretty pumped up. We're going to give them the right products that are going to go on the right network infrastructure and provide the right services, but this is going to be the stuff of a multi quarter rollout, as Dave said. We take some comfort that we see stability Q4 to Q1. But we're paranoid enough not to declare full victory yet. So we're going to keep focused on it and make sure that we give our customers the right services, the right technology, so that they stay with us.

[Paul Treiber:]

Just in regards to – shifting to OEM, it seems like year-over-year growth rate did decelerate versus earlier in the year. Was there anything unusual in Q4 that may have slowed down the growth rate versus some of the prior trends and if you could just comment on the demand environment for OEM Q4?

[Jason Cohenour:]

So, it wasn't a spectacular growth rate, you're right, but our view is, it was a pretty solid quarter in OEM. So in particular, we saw really good year-over-year trends in automotive, sales and payment, mobile computing. We saw a little bit of a year-over-year weakness in energy, but energy can be quite cyclical because it's often project driven, smart metering deployments happen and then they're done. You've got to get the next smart metering deployment, so that can be a little bit cyclical. Networking, down a little bit, which was a little bit of a surprise perhaps, but our view was that business delivered as we expected it would and as we look forward, I think we're going to have segments like automotive drive a secular growth phase here and not every segment is going to fire on all cylinders, right, but looking forward, we've got confidence, particularly as we see key initiatives like automotive get off the ground and LPWA is very encouraging and we're getting some early new design wins in that new technology area as well.

[Operator:]

[Operator Instructions] Your next question comes from Scott Searle with Roth Capital.

[Scott Searle:]

Jason, just to follow up on the Enterprise Solutions front, nice quarter there. It sounds like you've got some near term positive impacts going on in terms of FirstNet and ELD initiatives. Two things. First, in terms of FirstNet, how big of an opportunity is that for you? I'm not sure if you'd be willing to put a number on that or how big that could be in terms of percentage of revenues within enterprise? And then as it relates to some of the logging and tracking applications, given that it seems like it's front end loaded in the first half of this year, do you continue to expect sequential growth over the course of this year or is it going to be front end loaded and then things stabilize or even down in the second half? And then I had a couple of follow-ups.

[Jason Cohenour:]

Sure. So without getting too precise, Scott, our expectation on telematics is that it's kind of front end loaded and then returning to normalized demand patterns in the back half of the year and then on a go forward basis. And that the mix shifts in the back half of the year to say a higher percentage of our enterprise revenue, coming from AirLink networking solutions to kind of the core public safety and industrial markets. With respect to FirstNet, yeah, we think it's a very interesting secular growth opportunity. I think the, well, it’s going to be about $100 billion spent over the next several years in deploying and operating the FirstNet network. This is going to represent, both a, I think an opportunity to capture new customers in the first responder category as well as upgrade customers, as customers on current technologies move to the FirstNet compatible network support. So I'm not ready to put a number on that Scott, but we're pretty juiced up about it. We think it's a great growth opportunity and we think that we're very well positioned to take advantage of it, because of the strength of our position in those key first responder markets.

[Scott Searle:]

And just quickly two other items, the competitive landscape, a lot going on in the industry right now with potential M&A activity with Gemalto, issues with Telit and even in the case of some of the Chinese OEMs related to their persona non-grata status in the United States, so kind of wondering how the competitive landscape is shaping up for you guys right now? Are you doing better in some of those competitive bid situations? Have you seen guys becoming less active because of their own issues going on? And then as it relates to the LPWA front and the AP77, sounds like it's a very exciting product for you guys. Can you give us an idea of when you expect to see first revenue again? And I'd be curious as to the level of design activity that you're seeing, is it M1 driven, is it NB-IoT driven and how big of an opportunity is this as you look to the latter portion of this year and to 2019.

[Jason Cohenour:]

Sure. So on the competitive front, Scott, yeah, we've seen a lot of moving parts. It's pretty interesting with Gemalto apparently being acquired here and Telit having some challenges and we have seen a resurgence of some of the smaller Chinese competitors, so a little bit of a shift perhaps in the competitive landscape, but it's not materially changing our world right now. Candidly, it's still a pretty intensely competitive environment. We'll see some segments such as automotive be a lot more risk averse than others and I think that favors us with respect to how the competitive landscape is changing from one of our former competitors perhaps to some new emerging ones. So I think that's helpful in a small way I would say. And with respect to LPWA, it's tough to put a precise number on it, Scott, but this is the kind of technology movement that could move the industry from a couple hundred million devices to over 1 billion devices and new applications being adopted. So I think that's going to take a while to play out though. I do think that with our initial launches, with the WP77 and our new launch with the HL78, we're super excited. I think we're in a really differentiated position, particularly with the HL78 in terms of power management and size and capability on the device, our own embedded SIM inside. So I think it's got – it’s highly differentiated. I think that's already proven out now in our early design win successes. We've had a few, including a very large one with the metering manufacture in Japan that I referred to earlier. From a revenue generation standpoint, it's still early days. LPWA is not going to be a huge factor for us in ’18. It'll be significantly larger factor in ’19 and beyond.

[Operator:]

[Operator Instructions] There are no more questions at this time. I'll turn the call back over to the presenters.

[Jason Cohenour:]

That's great. Thank you so much, Chris and I thank everybody for joining today's call. As usual, Sierra management will be available should you have any follow-up questions. Chris, you can now terminate the call.

[Operator:]

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