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Edited Transcript of SWIR.OQ earnings conference call or presentation 12-Nov-20 11:00pm GMT

·48 min read

Q3 2020 Sierra Wireless Inc Earnings Call RICHMOND Nov 13, 2020 (Thomson StreetEvents) -- Edited Transcript of Sierra Wireless Inc earnings conference call or presentation Thursday, November 12, 2020 at 11:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * David Ian Climie Sierra Wireless, Inc. - VP of IR * Kent P. Thexton Sierra Wireless, Inc. - President, CEO & Director * Samuel Cochrane Sierra Wireless, Inc. - CFO ================================================================================ Conference Call Participants ================================================================================ * Paul Michael Treiber RBC Capital Markets, Research Division - Director of Canadian Technology & Analyst * Thanos Moschopoulos BMO Capital Markets Equity Research - VP & Analyst * Thomas Michael Walkley Canaccord Genuity Corp., Research Division - MD & Senior Equity Analyst * Todd Adair Coupland CIBC Capital Markets, Research Division - MD of Institutional Equity Research ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Sierra Wireless Third Quarter Conference Call. I will now turn the call over to David Climie, VP of Investor Relations, and you may begin. -------------------------------------------------------------------------------- David Ian Climie, Sierra Wireless, Inc. - VP of IR [2] -------------------------------------------------------------------------------- Thanks, and good afternoon, everybody. Thank you for joining today's conference call and webcast. On the call today are Kent Thexton, President and CEO; and Sam Cochrane, our CFO. As a reminder, today's presentation is being webcast and will be available on our website following the call. Today's agenda is as follows: Kent will provide his corporate update, and Sam will provide a detailed review of our third quarter 2020 results, followed by Q&A. Before we get started, I will reference the company's cautionary note regarding forward-looking statements. A summary of our cautionary note 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 within the meaning of securities laws. These statements include our strategy, goals, objectives, expectations and commentary regarding the 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, forward-looking statements are based on our management's current expectations, and we caution investors of forward-looking statements, particularly those that relate to longer periods of time, are subject to substantially known and unknown material risks and uncertainties that could cause actual events or results to differ significantly from those expressed or implied by our forward-looking statements. I draw your attention to a longer discussion of our risk factors in our AIF and management discussion and analysis, which can be found on SEDAR or EDGAR, as well as other regulatory filings. This presentation should also be viewed in conjunction with our quarterly earnings release. With that, I will now turn the call over to Kent for his corporate update. -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [3] -------------------------------------------------------------------------------- Thanks, David. I will start my prepared remarks today with an update on the divestiture of our Automotive product line, followed by some comments and highlights from our third quarter. Regarding the sale of our automotive product line for $165 million, which we announced in July, things continue to remain on track, and we expect it to close in the coming weeks. The purchaser, Rolling Wireless, has received the regulatory approvals it requires to proceed, and the Tier 1 Automotive customers have also provided their approval and are moving ahead with the transition. Given this progress, we are not expecting any impediments to completing the transaction. The divestiture of the Automotive Business enables us to accelerate our efforts in our device to cloud IoT Solutions that generate higher value recurring revenue. It also allows our R&D teams to focus on market-leading 5G programs, including new embedded modules for mobile broadband and new 5G gateways for our enterprise networking customers. With the transaction on track, we are reporting continuing operations in the third quarter with Automotive product line under discontinued operations in the income statement. And in our earnings release and during our webcast today, we will be providing GAAP and non-GAAP financial information on the continuing business on a stand-alone basis as well as combined with the discontinued Automotive product line. Sam will review that in more detail in the summary of the third quarter. So now turning to some highlights of the continuing business in Q3. Total revenue, excluding auto, was $113.4 million in Q3, up sequentially from the second quarter. Our business transformation is proceeding well, with 2 quarters of sequential growth in Q2 and Q3, and we are expecting sequential growth again here in the fourth quarter. Recurring and Other Service revenue was $29.8 million in Q3, up 22% year-over-year and 11% sequentially as our focus on IoT Solutions continues to generate positive results. Looking at service wins in Q3 as measured by LTARR, or long-term annual recurring revenue, we achieved wins totaling $34.4 million, higher sequentially and year-over-year. In the first 9 months of this year, we've secured $95 million in LTARR wins, which is 62% higher than the first 9 months of 2019. And this year's win rate was achieved during the pandemic, so credit goes to our global sales team on that achievement. Our hardware design wins also have been strong year-to-date, up over 20% compared to last year. And as you can see from our notes in the Q3 earnings release related to discontinued operations, the Automotive Business had an exceptionally strong Q3, as the automotive industry ramped up quickly following the shutdowns in Q2 as a result of the pandemic. If we combine the revenue from discontinued operations with revenue from continuing operations in Q3, then total revenue was $180.3 million, ahead of our expectations. Sam will provide some more commentary on this in his review. As I mentioned previously, LTARR in the third quarter was $34.4 million, up 76% sequentially and up 62% year-to-date versus 2019. We continue to secure strong IoT Solutions wins, and I'd like to share 3 examples from the third quarter. One of our new global customers is an energy solutions company focused on distributed power, electrical efficiency and mobile charging stations. They required an IoT connectivity solution that would allow them to quickly deploy their solution globally. Our first project with them is focused on enabling their electric vehicle charging stations in Europe and North America. The differentiator in this deployment was our end-to-end solutions, where we provide them with our LPWA module, our Sierra Smart SIM and cloud platform, so they have a single source solution that's immediately scalable and reliable. The services LTARR associated with this design win is expected to be $3.2 million, and the hardware value is about $1.4 million. Another new customer is a global provider of remote diagnostic medical solutions. This customer needed an IoT solution that could gather realtime data 24/7, so physicians can provide patients with continuous care. The solution required reliable IoT edge connectivity for their medical gateways to provide both secure video and data links. We were able to provide a leading management platform and a 4G connectivity solution for them in Europe and North America. This is primarily a services win with LTARR expected to be $2.9 million and a small hardware component of about $100,000. A third example is with a leading manufacturer of video surveillance and fleet management solutions. One of their key end markets is school and transit buses, where they are providing connectivity for mobile classrooms. We are providing them with a bundled solution with our MP70 cellular gateway. It also enables WiFi and Bluetooth connectivity. The customer wanted a one-stop shop where they can get hardware, connectivity and cloud management and not have to deal with 3 or 4 different vendors. Our single solution met their requirements. The services LTARR associated with this win is expected to be $4.6 million and the hardware value is about $5.6 million. These 3 design wins are solid use case examples of how we bundle our devices with recurring services to win against the competition, increase our subscription-based revenue while simplifying the IoT journey for our customers and driving shareholder value for Sierra Wireless. As we look ahead into next year, I'm excited about the market opportunities with our new 5G embedded modules [on] our 5G gateways and routers. 5G is the most technically challenging evolution in wireless history because of the introduction of micromillimeter wave technology. Our customers rely on us to get them to market on time with secure 5G connectivity, and they trust us to navigate the complexities of 5G New Radio and dynamic spectrum sharing. Some of the key end markets for 5G applications include enterprise networking, public safety, public transit and asset monitoring. In enterprise networking, we recently announced the availability of the industry's first multi-network 5G gateway solution for first responders, field services and transit applications. Our new MG90 5G gateway allows customers to leverage existing 4G infrastructure and automatically connect to 5G networks as they are rolled out regionally. Our patented switching algorithm for multi-network routing moves traffic between different cellular networks instantly to provide high-speed ultra-low latency coverage for moving vehicles. To drive our rollout, we are partnering with carriers on 5G certifications and working to expand the new 5G ecosystem in North America and Europe. To accelerate our efforts, Steve Harmon, Senior Vice President of Americas, who joined us in May, is working hard to build out our go-to-market programs in North America. He has been fine-tuning his sales team, and we are seeing positive bookings coming in with the pipeline improving 50% year-over-year. We recently held a successful launch with Motorola Solutions to strengthen our partnership with them, and we've also added a new distributor, SYNNEX in North America. We are pleased with the progress we are making with our partners as we see this as a big part of our growth strategy going forward. Overall, we remain focused on delivering devices, connectivity solutions and cloud management for our customers. We are seeing more industrial and enterprise IoT customers adopting our end-to-end IoT solutions because they have a faster time to market, they scale both easily and globally and have a lower total cost of ownership. We continue to leverage our advantage of working with customers early in the design cycle, starting with our devices. And our ability to [give them] hardware with integrated connectivity solutions and 24/7 network operating support is a key differentiator when we're up against the competition. Globally, our team at Sierra remains very focused on delivering innovative IoT solutions that generate a higher-margin subscription-based recurring revenue as well as delivering our 5G programs that I just mentioned. With that, I will now pass over to Sam for his review of the third quarter results. -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [4] -------------------------------------------------------------------------------- Thank you, Kent. Good afternoon, everyone. As a reminder, our third quarter financial results report in U.S. dollars and on a U.S. GAAP basis. We also present non-GAAP results to provide a better understanding of our operating performance. A full reconciliation between our GAAP and non-GAAP results is available on the IR page of our website. Before I begin with a review of the quarterly results, I would like to point out the sale of our Automotive product line is near completion, as Kent described in his comments. Given the transaction is expected to close in the next few weeks, we have prepared our third quarter financial statements in compliance with U.S. GAAP and segregated the Automotive product line from continuing operations. The assets and liabilities that are associated with the Automotive Business are held for sale on the balance sheet. We are also providing some GAAP and non-GAAP information regarding the discontinued Automotive Business in the notes to the third quarter financial statements and in our webcast presentation today. Total revenue for continuing operations in Q3, excluding the Automotive product line, was $113.4 million, a decrease of 17.1% compared to the same period last year. In Q3, revenue from continuing operations grew sequentially, which was in line with our expectations as we saw some business improvements compared to Q2, which was a challenging environment due to the pandemic. Non-GAAP gross margin in the third quarter, excluding the Automotive Business, was 34.7% compared to 36.3% in the third quarter last year. In Q3, we initiated some actions to begin rightsizing the business. And as a result, OpEx was down $2.6 million or 4.8% sequentially. Our non-GAAP adjusted EBITDA was negative $7.4 million compared to adjusted EBITDA of $3.5 million in the prior year. Operationally, we experienced tight component supply issues in Q3. This is an industry-wide situation, and it continues to remain tight here in the fourth quarter. Revenue in our IoT Solutions segment was lower by 15.4% year-over-year. Within our IoT Solutions segment, recurring and other services revenue was $29.8 million, up 22% year-over-year, driven primarily by growth in the number of connected devices. Recurring and other services revenue represented 26% of our total revenue in Q3. The growth in recurring revenue was offset by lower hardware revenue, primarily due to the impact of the pandemic and some related supply constraints, slower activity in transportation, public safety and oil and gas sectors, which also impacted some of our gateway business, and continuing pressure from low-priced competitors in hardware-only segments. Revenue in the Embedded Broadband segment, excluding the Automotive Business, was lower by 21% year-over-year, primarily due to lower mobile computing revenue, the result of prior design win losses that we referred to in 2019. Total gross margin was $39.4 million or 34.7% in Q3, compared to 36.3% the prior year. The year-over-year decline in gross margin was primarily due to embedded broadband gross margin of 28.5% compared to 33.4% in 2019 due to lower mobile computing margins, the result of design win losses we referred to in 2019. If we look at Q3 on a combined basis with our continuing operations and the discontinued Automotive Business, then the total combined revenue in Q3 was $180.3 million. The year-over-year increase of 3.6% in Q3 was primarily the result of Automotive revenue being up significantly, as the supply chain improved quickly following the Q2 manufacturing pandemic-related shutdowns. Total gross margin on a combined basis in Q3 was $49.2 million or 27.3% compared to 31.7% the prior year. This decline in Q3 was primarily due to higher automotive unit volumes at lower gross margin. Adjusted EBITDA on a combined basis in the third quarter was close to breakeven at minus $400,000. At the end of the third quarter, we had $72 million of cash. Specifically during the quarter, cash flow from operations was negative $7.7 million, which was negatively impacted by the unwinding of our receivables factoring program related to the Automotive Business prior to the completion of the divestiture. If we had not undertaken this pre-closing step, then our receivables factoring program would have generated approximately $10 million in additional cash flow, and our Q3 cash flow from operations would have been positive by approximately $2.3 million. During the quarter, our capital expenditures were $2.9 million. And in Q3, borrowing increased by $19.4 million, with $10 million from our existing line of credit, and a term loan agreement of $9.4 million with CIBC, backed by a Canadian government financing program. These activities resulted in a $9.5 million increase in our cash balance from the second quarter. Regarding full year 2020, the impact of the pandemic on our global business continues to remain uncertain. Given these conditions, we are continuing to not provide guidance, although we do see continued improvements in our continuing operations. In conjunction with the recently announced divestiture of the Automotive Business and our focus to grow the business profitably, we have initiated actions to reduce our operating expenses by approximately $25 million to $30 million on an annualized basis. The cost reduction program includes the divestiture of the Shenzhen-based automotive team and some additional resources there, as well as other broad initiatives underway across the company, including the restructuring of our R&D team located in Hong Kong. That has already taken place. That ends my prepared remarks today. Operator, I would now like to open the call for questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions)Our first question comes from the line of Mike Walkley from Canaccord. -------------------------------------------------------------------------------- Thomas Michael Walkley, Canaccord Genuity Corp., Research Division - MD & Senior Equity Analyst [2] -------------------------------------------------------------------------------- I guess, Kent, first question for me is just on the enterprise Gateway sales. Just wanted to maybe get your thoughts on the weakness in that business. Are there certain end markets or verticals doing quarterly as some of your competitors in that business have seen some better year-over-year trends? I'm just curious maybe where you're seeing some areas of weakness. And is it more some clients may be waiting for the new 5G products? And then lastly, within that area, just what are your thoughts on the Cradlepoint sale to Ericsson? How might that change the competitive environment? And also, how can that maybe show that this business of yours might be undervalued locked into your stock price? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [3] -------------------------------------------------------------------------------- Yes. Thanks, Mike, thanks for that question. So in the enterprise gateway market, we have a couple of areas that we lead in, in public safety and ruggedized mobile commercial environment. In the commercial side, markets like oil and gas have traditionally been large for us and other markets like that have been more disrupted by COVID, oil and gas this week and other areas where there needs to be a lot of human involvement for installations. We've seen some slowness there. Public safety has kept along pretty well. In areas like transport, that whole sector is being impacted. So in buses and trains and other markets where our gateways get installed, they're either slowing their plans or they're not doing implementations right now. But I'm quite bullish about where things are going with our enterprise business. As I mentioned in my remarks, we put quite a focus on this, rebuilt that team. We've grown our pipeline of deals we're working on by 50% so far this year. And so I expect to see -- as we work through and everyone gets more even without an end to COVID, but working through the challenges to see that progress. We're seeing that through our distribution partners, where their businesses are picking up. And I mentioned also some important new relationships, working strongly with Motorola. They're a strong leader in public safety, and we enable a number of things that they do, such as their body-worn cameras and other aspects in public safety, and SYNNEX is a large distributor. So we've had some areas where things have slowed. Forward-looking for us is tracking pipeline and the strength that we have there and the deal activity in flight, I think, is encouraging. On the second part of your question with regards to Cradlepoint, I think we've seen a few transactions in this space now. The Cradlepoint acquisition was at about 6x revenue and other transactions have been around 3x revenue. So clearly, our Enterprise business is not being valued at those multiples within their space. I think what Ericsson talked about as driving their acquisition was strong overall growth in the enterprise sector. We believe in that as well, and we think that it's going to be an important part of growth. We compete well in that sector. We -- our products are highly valued. I don't think the market is waiting overly for 5G. We have launched our high-end 5G gateways with more product coming in Q1. Our 5G products not only connect to 5G, but they support the highest, fastest speed of 4G LTE called Cat 20. And so as companies start to future proof, I think that's a good upgrade cycle that is coming. And we're launching an entirely new cloud management stack during 2021 as well. So lots going on in the enterprise sector. And we expect that to be a good growth area for us in 2021 and certainly think that we're not getting recognized in our share price yet, the strong position we have in enterprise. -------------------------------------------------------------------------------- Thomas Michael Walkley, Canaccord Genuity Corp., Research Division - MD & Senior Equity Analyst [4] -------------------------------------------------------------------------------- Great. That's very helpful. Second question for me, and I'll pass the line. Just on the $25 million to $30 million in cost savings, any help you guys could give us just in terms of how much of that comes out right away in Q4 with the divestiture? Or maybe you can help us with maybe a non-GAAP run rate for the business post the divestiture? And then how much more of that $25 million or $30 million comes out over the course of time? Is it maybe a year or so to take out that 25% to $30 million? Just trying to help us build out our models. -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [5] -------------------------------------------------------------------------------- Yes, sure, Mike. Let me make a few comments, and I'll ask Sam to provide some more data as well. So we've -- we're really looking at our continuing operation without Auto. So the -- we expect the Auto transaction to close in the next few weeks. Obviously, that creates a very strong balance sheet for us. You'll see in the current results that we put out there, the split between continuing operations and auto. The accounting rules are that any sort of shared resources get allocated to the main business. So I would say it flatters the profitability from Auto. And equally, it's less flattering to the ongoing business profitability. We've been making a number of changes already. So we've produced an R&D center. We will have an entire R&D center going out. As part of the transaction we're doing both auto and other work. So those are some of the activities that are happening and will occur over Q4. So I think you can see a lot of the run rate will have occurred so that we have a cleaner year in 2021. But Sam, if I could ask you to comment as well. -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [6] -------------------------------------------------------------------------------- Yes. Thank you, Kent, and thanks for the question. So as you look into Q4 for revenue, the majority of the decrease from the Automotive divestiture closing and rightsizing the business, most of that will show up in 2021. You'll start to see it earlier in the first half of 2021. So a big chunk of it is not going to be late in the year, if that helps. Also in Q4, we have some lumpiness in spend on certification. So to help you on the model building, thinking of OpEx as sort of flattish to down a bit from the quarter Q3 is probably the right way to think about it. -------------------------------------------------------------------------------- Operator [7] -------------------------------------------------------------------------------- Our next question comes from the line of Thanos Moschopoulos from BMO Capital. -------------------------------------------------------------------------------- Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [8] -------------------------------------------------------------------------------- Looking at the services revenue, there was a nice uptick from the June quarter. If we look at the preceding quarters prior, that it was kind of in the $26 million range for 3 quarters, and then it kind of had a nice $3 million bump up sequentially. Any dynamic there? Was there maybe a backlog of things that you weren't deploying during the lockdowns? Or was there some other dynamic that drove that uptick just in the June quarter? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [9] -------------------------------------------------------------------------------- Thanks, Thanos. Good to hear from you. So we're expecting just a continued growth in our services revenue. We've talked about the leading indicators with our design wins. We're starting to see more of those play through. And so I think that's just an ongoing trend. Q2 was held back, I think, hurt the curve just because of a number of our customers that had pay-per-use sort of activity that were much lower in revenue in Q2. So while we still showed sequential growth in Q2, it wasn't as strong as the underlying trends. And so there was some of that catch-up in Q3. We've had -- we did $93 million of LTARR in 2019, we're already at $95 million this year. That's all future revenue value that is working through the system right now. So as those design wins go into production, that will continue to tick up on a quarterly basis. So this is just what I've been talking about now for almost 2 years just in terms of -- in Q1 of 2019, we started to vector our business and our resources to be able to drive full IoT Solutions with both devices and connectivity. The -- what I'm excited about, Thanos, is you're seeing this continued growth, this turning of the corner from winning new business. So while it's been a competitive market and some low-cost competitors out there, our overall design wins, both on services and on hardware have ticked up nicely year-to-date. And so our offers out there to the market are being well received. We're winning more business. We've seen our win rates increase. And so that will drive through. On the hardware side, you have some things like LPWA, which are lower ASP. So those don't help the overall revenue growth. But when they carry service activity with them, then you can see that come in our higher-margin and more predictable recurring revenue kicks in. I think that the design wins that I talked about, the 3 examples here are reflective of what we see going on in the market. So lots of good value being created by delivering a complete solution for customers. It helps with their speed to market. It's helping customers get their IoT Solutions and getting the value that they need from that edge data. And it's certainly a positive business model for us. So yes, it's a good quarter, more to come. -------------------------------------------------------------------------------- Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [10] -------------------------------------------------------------------------------- Great. Looking at the Embedded Broadband gross margins, I know they're down versus last year because of mobile computing. But if I look at the last couple of quarters, there's been some volatility there. There was a spike in margins in Q2. Just to clarify what drove that Q2 spike? And then as far as the run rate, should we think about Q3 as being more representative for what the gross margin trajectory looks like there with the current mix? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [11] -------------------------------------------------------------------------------- Sure. Sam, I'll queue you up for that one. I just want to say, in Q2, auto was low. Q3 auto was high. Stripping out auto, I think you'd see some more stability, but Sam, over to you. -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [12] -------------------------------------------------------------------------------- Yes. No, exactly right, Kent. And also in Q2, our automotive margins were particularly high because of the low volumes. We were able to take advantage of some better pricing at the lower volume. So automotive was lower, plus at better margins in Q2. Now Q3, since Embedded Broadband-only has the remaining business in there and auto is carved out, that's more indicative of margins going forward. -------------------------------------------------------------------------------- Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [13] -------------------------------------------------------------------------------- Sorry, I was looking to go at the -- we [segment it], so the 35% margin ex auto on Embedded Broadband in Q2? -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [14] -------------------------------------------------------------------------------- So to clarify the question, you're saying, you're looking at just the Embedded Broadband margin without auto in Q2... -------------------------------------------------------------------------------- Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [15] -------------------------------------------------------------------------------- Exactly. Looking at the restated numbers, there has been a spike in Q2. -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [16] -------------------------------------------------------------------------------- Yes. Understood. Yes. No, I think in that case, if you're looking at just that number, a blend of the 2 would be -- a blend of those 2 margins will be a better one going forward. So sort of, if you look at Q2 and Q3 and blend them, then that will be more indicative going forward. But yes, we can chat more about it later, but that would be a good way to model it. -------------------------------------------------------------------------------- Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [17] -------------------------------------------------------------------------------- Okay. Great. And last question for me is just on the supply constraints. Can you comment on, I guess, the -- are you seeing some improvement as time is progressing? And any way to quantify the impact that had in this quarter? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [18] -------------------------------------------------------------------------------- Well, no crystal ball. So we're working with our suppliers, and we've worked very well with them, of our suppliers, solved a lot of the problems, not all of them. And then you get new pinch points that come up. So it's constant work, I would say, in the current environment. Some of the big impacts in Q2 where shutdowns in some areas affected components more clearly. Those are less of the case today. But whenever you cause a disruption in a system, there's still some ongoing activity. So we're still working through it. We're working with our suppliers. And we're working with our customers as well to increase lead times to ensure that we can get the components that are required. So we're solving the problems in many ways, but it remains tight. -------------------------------------------------------------------------------- Operator [19] -------------------------------------------------------------------------------- Our next question comes from the line of Paul Treiber from RBC Capital Markets. -------------------------------------------------------------------------------- Paul Michael Treiber, RBC Capital Markets, Research Division - Director of Canadian Technology & Analyst [20] -------------------------------------------------------------------------------- You mentioned your services win rate has been strong and favorable. Can you elaborate on how your services win rate or attach rate has been trending this year? Have you seen any meaningful change versus previous years? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [21] -------------------------------------------------------------------------------- Thanks, Paul. Good to hear from you. So I think in terms of our attach rate, yes, we are seeing that trend up. We -- up 61% on our design wins of services, I think, is reflective of that. So we -- I think the other piece is we really -- we're building out our capability to sell full solutions. In 2019 we built -- brought in more talent on a solutions basis to our sales force. That's had time to embed in the existing salespeople that we've had involved in the services side and are now able to sell. So we have our full global sales force able to offer both hardware and full solutions. And so that's definitely helping our overall win rate. So yes, I'm very happy with -- we had our LTARR wins in Q2 with COVID, were down. We've bounced back and at $95 million year-to-date despite COVID being ahead of our entire design win from 2019, I think, is very positive, and I expect to end the year strong. -------------------------------------------------------------------------------- Paul Michael Treiber, RBC Capital Markets, Research Division - Director of Canadian Technology & Analyst [22] -------------------------------------------------------------------------------- Could you delve a bit further into the competitive dynamics for services? Like when you look at your competitive advantage, is the biggest one the fact that you're an integrated end-to-end provider? Or maybe looking at it another way, is how successful is your services business? Or how does the attach rate or the win rate without leads coming from your hardware business? So on top of third-party or competitor hardware? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [23] -------------------------------------------------------------------------------- Sure. Yes. No -- insightful question. So first of all, it's a big competitive advantage for a customer that's looking to get out into global markets. And I talked about some of my examples in my script, we're able to provide that complete solution. So with embedded connectivity in our devices, as they're shipping their charging stations or their medical solutions to multiple countries, they're not having to worry about the logistics of different SIM cards in different countries, different partners, if they have connectivity issues, different people to call. We handle that globally. We manage all issues proactively through our global NOC. And our -- with multiple carriers per country, it means that we're able to offer better overall quality of service. So when we're selling into an industrial IoT and you're in a factory, when we have multiple carriers and can choose the strongest signal, when you're in a constrained or an environment that's not going to have great coverage because you're indoors, that's a big advantage for customers. So again that's our competitive advantage. And then on your question of, has it just come about from having hardware leading to connectivity? Well, it's a big advantage for us because most customers start designing their hardware before they get around to thinking about their -- how they're going to attach that. So when we're in there working on the hardware design and we can build in our services, it gives us, earlier in the customer's design cycle, the ability to share what we can do for them on the connectivity side. However, we also win deals where their customers are just looking to take advantage of our global connectivity, being able to have our Smart SIM that works seamlessly across 200 countries globally and able to have that multiple carrier access. And then that often leads to us then working with them on winning the hardware. So we can come at it from hardware to services, but we also have quite a number of positive examples are going from services to hardware. So it's good for our salespeople to be able to sell those solutions in both directions, and we're seeing progress on both fronts. -------------------------------------------------------------------------------- Paul Michael Treiber, RBC Capital Markets, Research Division - Director of Canadian Technology & Analyst [24] -------------------------------------------------------------------------------- And last one for me. You mentioned in the prepared remarks, you're seeing the impact from low-priced competitors as being the case for a number of years or a long time in this industry. Has the -- I don't think the tariff environment would have had any impact, but the global move away from Huawei, has that had any impact in the module space at all? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [25] -------------------------------------------------------------------------------- So I wouldn't say it's been a substantive impact at this point yet, although it is starting to drive more awareness, there's been quite a -- first, the U.S. moved on Huawei activity and now a number of European countries from a 5G network infrastructure basis. And I think that there -- really, what we provide is both high quality and high security. And I think those are very important. What we do when we sell complete solutions that have both hardware and connectivity, trust becomes a very major factor, and I think that's a great brand strength and position that we have. We've seen a couple of examples where customers want to ensure that they're having that high degree of security with their solution. It is becoming more prevalent, but they're -- it's not a tariff issue because modules when they're built into a product. Tariffs are built, are based on the whole product entity, not where the module comes from. It's not a tariff impact part of the business, but it's more a business decision for customers. We are seeing increasing strategic alignment with Tier 1 industrial IoT companies where they're trying to digitize all of their assets. I've talked with a number of chief product officers, CEOs and multibillion-dollar companies that this is becoming strategic for them now, and they want to digitize their assets in the marketplace. And in those cases I think that our 26-year history in the market and our strong position on security and dependability give us a big advantage. -------------------------------------------------------------------------------- Paul Michael Treiber, RBC Capital Markets, Research Division - Director of Canadian Technology & Analyst [26] -------------------------------------------------------------------------------- And do you think -- I mean, taking it a bit further, do you think the move away from Huawei and maybe some other China-based vendors, do you think that will alleviate the pricing pressure at least marginally? Or do you think it's pretty much a fact of life in this industry? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [27] -------------------------------------------------------------------------------- So I think that on some of the first IoT use cases that came out and [with the] move to LPWA, I think there can be a lot of price pressure, and that can be relatively low-margin hardware-only business. But when we bundle it -- and a couple of quarters ago, I gave an example of a design, we have an industrial lighting customer. And so that was about $1 million worth of hardware but growing to $1.8 million of recurring revenue per year. And so from the margin produced from a design win, the vast majority of the gross margin comes from our recurring revenue versus from the hardware. So offering the whole solution allows us to be as competitive as we need to be up front to win the total package. And our overall recurring revenue business is very healthy. So we think that we provide great value to our customers, but also get to get recurring revenue at higher gross margin. So the low-priced LPWA market elasticity of demand will drive a lot greater growth in the total IoT market. All those devices need to be connected and so we're in a good part of the value chain for the significant growth in LPWA projects that we're seeing out there right now. -------------------------------------------------------------------------------- Operator [28] -------------------------------------------------------------------------------- Our next question comes from the line of Todd Coupland from CIBC. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [29] -------------------------------------------------------------------------------- I had a couple of cleanup questions and then some business questions. What will the pro forma cash be post the sale? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [30] -------------------------------------------------------------------------------- Sam, do you want to take that? -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [31] -------------------------------------------------------------------------------- So are you asking like what the year-end balance of cash will be? Or what... -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [32] -------------------------------------------------------------------------------- Yes, yes. More or less. Yes. -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [33] -------------------------------------------------------------------------------- Yes. I mean so we'll close the sale. There'll be a small amount of taxes and fees, but the vast majority of that will be on our balance sheet, and we don't expect to burn a lot of cash in Q4 and moving forward. Q4, we have some CapEx going in to upgrade the network. So maybe approximately about $5 million of cash to burn in Q4, but we expect the rest to remain on our balance sheet. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [34] -------------------------------------------------------------------------------- Okay. And when you say minimal taxes, what, like 2%, 10%? So is it like... -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [35] -------------------------------------------------------------------------------- $3 million to $5 million. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [36] -------------------------------------------------------------------------------- Okay. So you'll basically be adding post the sale over $155 million in cash to the... -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [37] -------------------------------------------------------------------------------- Well... -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [38] -------------------------------------------------------------------------------- $72 million. $72 million. -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [39] -------------------------------------------------------------------------------- Yes. You have to read the $19 million of cash is staying with the buyer on the deal. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [40] -------------------------------------------------------------------------------- $19 million out of the $165 million? -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [41] -------------------------------------------------------------------------------- Yes. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [42] -------------------------------------------------------------------------------- Yes. And working capital... -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [43] -------------------------------------------------------------------------------- So $165 million minus the $19 million minus some fees for the bank and minus the tax and the rest is cash, then we'll burn about $5 million of CapEx in the quarter, in Q4, so -- and then you'll get your ending balance or a good approximation of it. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [44] -------------------------------------------------------------------------------- Okay. Okay. And then in terms of the OpEx, if I did my math right in Q4 without sort of like nonrecurring items, it's in the, what, $49 million range or something like that. And you're basically saying... -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [45] -------------------------------------------------------------------------------- I think around $51 million, I think. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [46] -------------------------------------------------------------------------------- Oh, $51 million. Okay. So $51 million. Okay. -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [47] -------------------------------------------------------------------------------- Yes. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [48] -------------------------------------------------------------------------------- So $51 million, and you're basically saying that, that -- in Q4, that's sort of flat to down with restructuring to date, and then that will sort of trend down over '21? Or is that going to go up modestly because you're making other investments? -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [49] -------------------------------------------------------------------------------- No, no. It will definitely go down in 2021. That's the 25% to 30% on an annualized basis. And those actions we're taking in Q4, the vast majority of them. So in Q1 and moving forward, you will see a much lower run rate of OpEx. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [50] -------------------------------------------------------------------------------- Okay. I just -- I mean you can correct me on this point as well. Sierra Wireless has had a number of restructurings and often the savings have been reinvested in the business and -- which is fine. But you're basically saying you're going to get $8-ish million, near $8 million off the $51 million. So you'll bring it into the mid-40s at the very least in Q1 and then bring it down a little bit below that over the course of the year. Is that the messaging? -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [51] -------------------------------------------------------------------------------- I think that's the right way to think about it. You're close, right? I mean it's a bit high. We said 25 to 30, so 6 or 7. And we're not reinvesting those at this time. We're committed to growing the business. Like Kent said, we've been growing sequentially over the last few quarters. And we continue to grow the business, and we're going to do it profitably. So we'll have key investments in areas that we need to, where we see strong growth and that have a strong ROI case. But overall, you'll see the -- our OpEx run rate come down to the lower levels in 2021. -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [52] -------------------------------------------------------------------------------- Todd, if I can just comment a bit further on that. So when we made some first moves on expense reduction to get the company leaner, we were investing in the move to selling services on our network side. So there was some [outage mingling], but an example that I mentioned before is we reduced our R&D that was based in Paris, about 100 R&D staff there that were at circa $165,000 a year cost. And we've been focusing on new operating centers like Taipei, Taiwan, where we're at average cost per head of just over $50,000. So there's some big savings out of getting to lower cost centers. With this move, we -- with selling of our auto business, we sell a fairly large center that's based in Shenzhen. And we've also announced that we are moving out of doing R&D in Hong Kong. And so again, reinforcing our major centers in Richmond and in Taipei. So we no longer need to make any further reinvestment in the services side. That part of our strategy is complete and producing results, as I outlined here. So -- and also, a big part of selling our auto business was being able to get a real focus on the key parts of our business, so driving our industrial IoT business and driving our Enterprise business. And with that focus and the number of centers that we've reduced from an R&D perspective, I look for us to be much more efficient going forward, and you'll see that show up in our OpEx in 2021. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [53] -------------------------------------------------------------------------------- Okay. Perfect. One sort of last cleanup, and then I want to ask you about the business. So the gross margin is more or less 35%. Is that the right way to sort of think about the gross margin? Is it like -- I mean you talked about some puts and takes before, but is that like a reasonable base as -- with modest sales growth? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [54] -------------------------------------------------------------------------------- Sam, do you want to jump in there? -------------------------------------------------------------------------------- Samuel Cochrane, Sierra Wireless, Inc. - CFO [55] -------------------------------------------------------------------------------- Yes, sure. No, I do think 35% is a good way to think about the business. Kent just mentioned to you, the LTARR that we have been winning. Those design wins are going to, are indicating that in the future as these turn on, we will get a good ramp-up there. You start to see real improvement of that in 2022. So I think 35%, as you're looking into 2021 and Q4 is a good way to think about the business with some small improvements on that number. And in 2022, you start to see even more improvements as you kind of ramp up connected devices, you get better pricing from scale and the business is -- continues to grow. But in the near term, that's a good way to think about margins for the consolidated business. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [56] -------------------------------------------------------------------------------- Okay. Sorry, one follow-up on that. So have you guys talked about what the sort of post-2022 LTARR or recurring revenue gross margin might look like? I mean is that like typical SaaS margins, 50%, 60%, 70%? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [57] -------------------------------------------------------------------------------- What we've talked about, Todd, previously is that our overall services revenue was around 40% gross margin. It's not like SaaS in that it's not all software, we have direct COGS associated with the wholesale deals we have with carriers. We do get scale advantage on the network part that we own in our MVNO. And as we get more scale, we get better leverage on our total cost with the carriers overall. But I think that's more of a modeling point on gross margin on services. We have some software aspects that can be higher gross margin, particularly in our cloud management of enterprise products, but the services part is very good for the industry but not to SaaS levels yet. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [58] -------------------------------------------------------------------------------- Okay. That's certainly fair. Very good. And then just on the recurring piece, you're starting to break out details on that, which is certainly good to see. What about retention in churn? Is that something you're wanting to talk about at this point? Is it above 100%? Is it like -- sometimes people look at that group of programs you win and they just wonder whether the enterprises will actually move forward on them. So what's your thinking on that? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [59] -------------------------------------------------------------------------------- Yes. I think it's a bit of a complicated formula, but let me try to break it into a couple of big blocks for you. I think on the new business that we win, and we're now connecting global machine makers. So pumps, compressors, HVAC, lighting, the churn is very low. We get into product there, for the life of that product we're shipping data, there is almost never a truck roll to go and change the network settings on that. And as we provide our global network operating support to customers, that's a very positive, low churn metric. We acquired businesses to get in scale. And so those were less attached to some, sort of the global machine activities. So our acquisition of Maingate in Scandinavia and Numerex in the U.S. had some parts of those business that do have some attrition with them. So we have been growing overall despite some attrition on those legacy acquired businesses. Now I would note that in the -- what were the assets from Numerex, our team has been doing a very good job of managing those customers. That part of the portfolio, we've returned to growth, and it's going to continue to grow as we move forward into 2021 and growing at very healthy margins. So there is some churn from legacy programs, but our overall growth of new connected devices is far outrunning that. And in some areas of legacy, we've also turned that back around to growth as well. So in our plans we've talked about for overall recurring revenue growth, we have a strong view on customer retention. All those devices need to continue to be connected unless the machine is taken out of service. And so we work to provide that continuously for our customers. -------------------------------------------------------------------------------- Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [60] -------------------------------------------------------------------------------- Okay. Good. Okay. My last question is on 5G. I was interested to hear you talk about millimeter wave. My impression in the U.S. was that wasn't available in too many places, and it's airports and sports stadiums, which aren't really getting used that every much. So what's sort of the path to millimeter wave? Is it like a decent chunk of the LTARR at this point? And how significant is that technology that you called out? Is this a material growth driver for the company? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [61] -------------------------------------------------------------------------------- Sure. So thinking about 5G, most of our early revenue from 5G is always all going to be equipment revenue. We're not working to connect many 5G devices. You have that sort of higher end, higher bandwidth. We work with our carrier partners on that connectivity in the main. What we're seeing is sale of 5G modules. So we have -- I mentioned the previous quarter, a number of design wins that we've had in 5G. So we've done a very strong job of winning 5G module business to connect other network providers' equipment. We're working to get that certified with carriers around the world and starting to ship product. And the other side is in our network gateway business. We launched our first high-end MG90 5G gateway and providing that in both what you'd call the lower speed 5G or sub-6 and then the higher capacity, low-latency, millimeter-wave. Our products do both varieties of that. I think that a lot of times when you're acquiring equipment, you want to future-proof it. So the split between sub-6 and millimeter wave, I think it will be years before we know exactly how that goes. For the industry to get true massive capacity increase, it's going to be on millimeter wave. That -- those are new frequencies that bring more capacity. The nature of high-frequency means you need smaller cells, but smaller cells give you much more capacity, and it also has the benefits of low latency. So I think a lot of applications that are going to rely on the high speed, low latency are still in the invention process. But like 4G brought the advent of many products that wouldn't have worked with the speed of 4G, 5G will do the same. So right now for '20 -- for Q4, 5G revenue is going to be small. There's a lot of proof of concepts going on. In 2021, there's still some variability in terms of how rapid the rollouts, customers are working to make sure they get product out there. 5G is still significantly more expensive as a product than equivalent 4G devices or gateways. I think that, that price premium will fall over time and the benefit to [need] for that speed will increase. So we'll see ever-increasing 5G as time -- we move forward. A similar adoption cycle we saw in the move from 3G to 4G. This is just a bigger one in terms of the price gap is higher, but the performance potential of 5G is also significantly higher. -------------------------------------------------------------------------------- Operator [62] -------------------------------------------------------------------------------- Our last question comes from the line of Richard Tse from National Bank. -------------------------------------------------------------------------------- Unidentified Analyst, [63] -------------------------------------------------------------------------------- Congrats on the win this quarter. This is -- I'm here calling in for Richard. Just had a quick question for you. Regarding the rolling lockdown there starting in Europe and possibly coming in North America. Just wondering if you guys are seeing any impact on the business and how you're thinking about that going into 2021? -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [64] -------------------------------------------------------------------------------- Yes. Good question. Thank you. Well, we -- sure, we all would like to be able to get back to normal and sit in customers' offices and be able to spend more face-to-face time. But we have gotten pretty used to selling through video calls and dialogue. Our field engineers are able to practice safety protocols when required to help with field aspects. So the lockdowns that we've seen coming across Europe, it's not been an impact to the same degree as we saw in Q2. I think people have figured out how to do business more. So it's not ideal, but it's not of that nature overall. We're -- our sales teams, I think, have done a great job. Our product marketing people have been able to get information out. I think that overall, the need for digitization is becoming more apparent with the new world that we live in now. So people want to have their assets digitized, being able to get that information without needing to have humans to go out to the machines, as the speed at which that happens is somewhat constrained by COVID, but we have lots of strong projects going on. So I just sort of reiterate some of the key points. We've seen a very strong growth in our design wins for services. So I think that despite the COVID activity, being up 61%, we've grown our design wins on hardware by over 20%. And this has all been done in this non-face-to-face selling world. We've grown our enterprise pipeline for projects we're working on in the enterprise business by over 50%. So we're working through this and may be a little slower to get all those deals papered and launched, but the velocity of what's coming in has been increasing very nicely. -------------------------------------------------------------------------------- Operator [65] -------------------------------------------------------------------------------- There are no more questions on the phone line. -------------------------------------------------------------------------------- Kent P. Thexton, Sierra Wireless, Inc. - President, CEO & Director [66] -------------------------------------------------------------------------------- Okay. Great. Well, I thank everybody for their attention. I'm very pleased to share what's going on with the Sierra Wireless business. And we'll be speaking to many people as there's follow-up and sharing activity. As we close the Auto business, we'll be putting out an announcement about that as well. And we will wish everyone the best of health and safety in these challenging times, and we will come back with updates on our progress. So many thanks. -------------------------------------------------------------------------------- Operator [67] -------------------------------------------------------------------------------- Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.