Sierra Wireless's CEO Presents at UBS Global Technology and Services Conference (Transcript)

| About: Sierra Wireless, (SWIR)

Sierra Wireless, Inc. (NASDAQ:SWIR)

UBS Global Technology and Services Conference Call

November 15, 2012 2:30 pm ET

Executives

Jason W. Cohenour – Chief Executive Officer

Analysts

Amitabh Passi – UBS Securities LLC

Amitabh Passi – UBS Securities LLC

Okay thank you everybody. My name is Amitabh Passi. I’m the Networking Supply Chain Analyst at UBS. Thanks. It’s my pleasure to welcome Sierra Wireless and presenting on behalf of Sierra Wireless is Jason Cohenour, the Chief Executive Officer. Thanks Jason.

Jason W. Cohenour

Good afternoon everybody. Spread out make yourself comfortable. You’ll begin hearing me over the echo. Anyway thanks for taking some time to learn a bit more about Sierra Wireless.

As you would expect today’s presentation is covered by the company’s safe harbor statement. You can speed read that or visit our website afterwards and get the full meal deal. So, a bit about us. So we are a global leader in providing wireless solutions to a couple of what we think are very interesting growth markets, machine to machine and mobile computing, very broad product line up predominately hardware, but a growing footprint in software and services that we produce to service these two target markets. And a team of guys who is very, very familiar and deepened the technology of wireless standards from 2G up to 4G and in particular embedded firmware and solutions as well.

LTM revenue were about $630 million, got about 1000 people in the company, half of that is R&D and we’ve got pretty strong R&D presence in Europe, North America and in Asia, and we manufacture in China.

So our vision is, we are enabling this connected world, you probably heard of bunch of talking heads talking about this opportunity but it’s often referred to as the Internet of things and you see it on television from Cisco the next 50 billion devices. We are really focused on enabling this vision of a connected world where in the fullness of time anything, any device in our lives they can benefit from our connection will indeed be connected. And we embrace this because well we’re doing it. Our devices today are shipped well in to the millions and you find our devices inside smart meters, connected cars, electric vehicle charging stations, wind farms, coffee machines you name it. And in everyday candidly it seems like there is a new kind of device to be connected to our network and on the back-end some cloud service or enterprise applications. So this is what we are chasing and we are chasing these two markets with very distinct strategies in our two lines of business, so we treat machine-to-machine quite differently than we treat mobile computing.

So what’s machine-to-machine, well for us machine to machine is collection of products. They are packaged, embeddable wireless devices, cellular devices, 2G right up to 4G that our customers take and sought it down on their PCVs or do a pin to pin connection inside their device and their factory and they create a solution whether it’s a smart meter or a car and deliver to their marketplace.

Also included here are we make industrial gateways and routers that you will find in the trunks of top cars or in smart grid deployments and we also provide cloud services that link basically link the machines in a customers environment back to enterprise applications.

So in this space we are focused on global leadership. We are playing to win, investing to win. We are building on our number one share position and we are focused on value chain expansion. So leadership and value chain expansion is the mantra for us in machine-to-machine. When I talked about a value chain expansion, the M2M value chain is very complex, lots of different links in the chain and what we’re focused on is taking more of those links in the chains and delivering that directly to our customers, including cloud services and in some cases even wireless services.

So mobile computing on the other hand, we are profitably maximizing. We are very focused on a core set of customers. We’re not making a lot of speculative investments in this space. In this business, we make wireless or mobile hotspots, somebody who called the MiFi, I hate when you do that, because that’s a competitor’s brand name. And also the USB dongles, those are what we call our AirCard products we make those for operators. And in this business line, we have also sale embedded modules to Tablet and PC OEM. So this is what we call mobile computing.

And again very focus, if you look at our AirCard product line, AT&T, Sprint and Telstra stop drive roadmap. These are the guys that drive our business in our roadmap for AirCards. We have more customers on those three. But we don’t make speculative investments believing or diluting ourselves that after $10 million of spend will break into Vodafone in a big way.

So controlling OpEx, running this line of the business very profitable, and both lines of business get a lot of leverage out of common core capabilities in the company by including a supply chain as you would expect. So we run one single supply chain that supports the needs of our 3 million mobile computing devices in our 9 million machine-to-machine devices.

So we get the economics of scale there by combining our volume, and good technology leverage to. So as you would expect mobile computing is all about the need for speed. We have to be the technology leader when AT&T launches LTE we have to be there first.

So we leverage our 4G first-to-market expertise from mobile computing and rapidly take those platforms and create machine-to-machine products and our first in the market with leading edge machine-to-machine products like LTE way ahead of our competition. So this is the technology platform leverage we get.

So two vary different strategies, so a little bit on each line of business, so machine-to-machine, reminder, leadership, value chain creation, Q3 was a record revenue quarter $86.1 million and represents about 14% year-over-year growth. I would call Q3 extraordinary for M2M. I would say a couple of non-recurring things benefit the quarter.

Nonetheless, we had good broad-based growth across our key vertical markets including networking, lot of customers are basically replacing wired services with wireless services. So you might go to Verizon’s website today and you’ll be able to buy our customers NETGEAR by one of their Wi-Fi routers with our 4G module inside and your internet connection in your home is now 4G instead of DSLR cable. Lot of our networking customers are doing this.

Automotive of course the connected car and we are rapping now with the lot of our new customers who are bringing their solutions to market and payment. Payment, we are benefitting from an acquisition we closed during the quarter a company called Sagemcom, more on that in a moment.

And of course during the quarter, we continue to focus on product innovation. That really is what differentiates us in machine-to-machine. So we launched a new version for our AirVantage cloud, so completely re-designed user interface, it’s more scalable, simpler to use and our AirVantage cloud now has two very distinct function. So we have a management service where our customers through our platform can manage their subscriptions on almost any network around the world.

They can manage their devices and download firmware over the air if their devices need a fix and they can also manage the embedded applications at the edge of the network. So if you want to change the configuration or change the application that’s embedded in our module, you can do that through our portal and push that out to your devices. So that’s the basic packaged management service, and then we also offer an enterprise platform where we collect that data from the customers machines. We can warehouse that data and we provide very elegant web APIs so that customers can take that data, populate existing applications or create their own applications using our tool set.

So that was launched in October. We also announced a collaboration with Amazon Web Services. So in addition to creating an application using AirVantage you can run this on Amazon Web Services. So for virtually zero capital investment, a customer can be up and operating with their machine-to-machine application. By the way AirVantage works with computing devices as well as, it’s open to computing devices.

We launched interesting USB key or automotive great USB key with krusell in collaboration with one of our carrier partners weak and friends, and so this is an aftermarket solution. So krusell driver can plug the USB key into the dash board and connects them to all kinds are really interesting driver services on the back end and some new module activity as well. So overall machine-to-machine excellent Q3, good execution on some key things like the acquisition of Sagemcom and the integration of Sagemcom this is about an 80% team. Their China team is now been fully integrated into our China office and by the end of the year the Paris team will be fully integrated into a new office, that we secured in Paris.

We’re also doing some other consolidation. We are closing an office we have in Silicon Valley and relocating that activity up to our Richmond BC office, and again that’s really an efficiency move. And kind of news here in machine-to-machine is while we’ve been investing in this business for several years it is now profitable and with a very accretive contribution from Sagemcom in Q4 profitability grows again.

And I’ll repeat we are the clear global leader in this space. This is an interesting secular growth opportunity ABI Research has us as the gorilla in this industry at 34%, and number two is 10 percentage points down. So we’ve got a very strong leadership platform here, business platform here, in addition to that ABI ranked us in one of their other studies as the most competitive player in the industry as well in terms of innovation and in implementation. Basically that’s our range of capabilities they ranked us much higher than any other player. So number one; and best positioned to stay number one.

Okay, mobile computing. Profitably maximizing mobile computing, but we also have to be a technology leader, because those customers we focus on AT&T, Sprint, Telstra that’s what they demand of us, that’s what they pay us for. So, solid Q3 in mobile computing, it was down off of the monster Q3, but still solid at $76.5 million on the top line that represents 7% year-over-year growth, big driver of that growth was sales to PC OEMs and as you can see PC OEMs was up 44% on a year-over-year basis. So that continues to be a growth story for us selling embedded devices to PC OEMs.

And once again a very profitable contribution, even though it’s coming down off of the monster Q2 even at $76.5 million a very profitable contributor to our consolidated results. So continue to have very strong AirCard position with our key operator customers AT&T, Sprint, Telstra, if you talk to Sprint they will tell you that we have a dominant share there, AT&T and LTE land right now we have 100% share of their LTE business that’s going to change we believe, but very, very solid share with the big three and we’ve been awarded follow on design wins as well. So for new AirCard devices that will be launching in the first half of 2013. So we have continuity with these big guys as well.

And in addition to that we got solid contribution from a small constellation of other guys who basically take the products we designed for our big three and we make minor modifications in the firmware and launch them with the likes of Rogers, Bell, and DNA of Finland and that’s nice what I would call opportunistic business.

And in PC OEM land again a good growth story there and also a segment where we’ve clearly taken a strong technology leadership position and also a share leadership position. so on share last year, our biggest competitor Ericsson, announced that they were exiting the business. in last week, our second biggest competitor, Novatel announced that they are exiting the business that kind of lease well, Sierra Wireless. and so we got a very strong share percentage and a fairly small segment admittedly, but a very strong share percentage and also we’re the technology leader, so we’re delivering very thin form factor LTE devices, and we’re the only guys delivering Windows 8 compatible devices.

And in fact and during the quarter, both Samsung and Lenovo launched their first LTE enabled Win 8 platforms. so based on strength of our position, some competitors leaving and our growing share position, we’ve got a very good position in the segment and we’ve been awarded new design wins as well. So consolidated revenue up on a year-over-year basis by about 11% if you ex out of small contributions from Sagemcom that was up on an organic basis about 8% year-over-year.

You can see the mix here of about 53% coming from M-to-M and 47 coming from mobile computing. But pretty solid year-over-year growth and I love this chart, because really underscores the operating leverage in the model. so consistent on gross margin percentage by the way. this has to start with the three, we know that. but right around the 30% mark that consistent from last year, OpEx consistent in spite of the fact that we took on two months of OpEx from Sagemcom. So you add $14 million of additional revenue, all the gross margin dollars go to the bottom line. So it really does highlight the leverage in the operating model. $8.3 million in earnings from operations, non-GAAP earnings from operations was well ahead of our expectations.

Balance sheet continues to be very strong, very strong cash position, debt-free, you can see we used a bunch of cash, because we bought a company, but coming off, master cash flow generation in Q2, we generated $18.5 million in free cash flow in Q2. we did use a bunch of cash in Q3 through the acquisition of Sagemcom, we spent about $55 million.

We used some cash in building inventory, and also kind of a regular run rate on CapEx of about $4 million a quarter, a very strong balance sheet. we also fortified the balance sheet of the quarter. we extended a credit facility from $10 million to $50 million. Just to demonstrate the financial capacity. But very strong balance sheet and about $2 a share in cash, is the way to think of this.

And then we put up guidance, so guidance for the current quarter Q4 kind of flattish and so why is it flat. Well, the kind of the moving pieces are this. we expect machine-to-machine to be up a little powered mainly by a full quarter contribution from the acquired Sagemcom. We expect mobile computing to be down a little as we work through a couple of product transitions and we do expect a competitor to enter with us at AT&T. So that kind of equals flat on the top line.

We expect gross margin to drift up hopefully starting with a three. We expect OpEx to drift up a little bit based on the timing of certification and a full quarter of OpEx from Sagemcom. So that all equals earnings from operations roughly in line with what we saw in Q3. We are assuming a 22% tax rate that gets us to net earnings of between $0.18 and $0.22. So on the year will be about $640 million on the top line.

If you take the mid range of guidance that is about 10% growth earnings from operation will be – will deliver at $34 million – that is up from $3 million in 2011. So great growth and earnings from operations, still not quite where we want to be. And EPS going from $0.12 to about $0.95 2011 to 2012. And again that EPS of $0.95 compares to a share price today of eight bucks and we’ve got $2 in cash. So you do the math.

So quick summary leader in two very interesting growth spaces and remember we believe in the four months of time – you can argue timing that this market is going to go from a few hundred million connected devices to several billion connected devices and we believe we are well positioned to take a growing share of a growing market. And a big part of that is going to come form end –to-end where we’ve got the clear global leading franchise. I think and we are well positioned to maintain that position we are fortifying it through acquisition like Sagemcom and we are playing across the valley chain to create a long-term defensible franchise in machine-to-machine.

And in mobile computing, profitable contributor where we are techno focused –technology leader and a leader with PCOEM’s where we have a – I would say an interesting option on some potential growth with PCOEM’s in a segment that is very under-penetrated and we are virtually the last player standing in a very under-penetrated market.

So notwithstanding all laptops are going down because of the pressure from tablets notwithstanding all that chatter we have a very under-penetrated market where we are the strongest players. So with the people we’ve got lots of upside with PCOEM’s and we are delivering - we are delivering on an operational basis. We are making good acquisition by decisions. We are integrating them quickly and we are delivering top line growth and bottom line growth and we will achieve them. And follow up on the floor for questions.

Question-and-Answer Session

Amitabh Passi – UBS Securities LLC

Excellent, we have a question over there.

Jason W. Cohenour

It is more advanced technology to being able to sort of blend to a more reasonable price curve in that type of business. When most of the technologies today or the use cases today don’t really demand more key technology to data…

Unidentified Analyst

Yeah.

Jason W. Cohenour

The data to requirements is not there.

Unidentified Analyst

Yeah.

Jason W. Cohenour

So that’s a great question. So it’s our module group and that’s the biggest part of our machine to machine franchise, no doubt has pricing pressure. However, through mix, our ASPs have been stable year-over-year. So ASPs in that for modules and M2M about 35 bucks last year about 35 bucks, and lot of that has to do with mix.

So as our 2G modules come down in price, because that’s the kind of we called the commodity area that’s most under pressure. We’re growing the mix of 3G and 4G devices through a lot of applications; don’t require that bandwidth, but our growing number do. So the mix is favoring, the higher ASP devices.

And I’ll also add within that mix even in 2G, we have mix within mix. So we got the $15 device you can buy to competing us guys Telit. But we also had 2G devices that we sell for $25. So our job is to make sure that more customers choose the $25, why would they choose $25 device? Well, we embed in that, our own real time operating system, our own application framework, so in many cases customers throw out their application processor, and they use our device as both the app processor and the connection to run their application right on our module.

So we lowered their overall cost of goods and they pay us extra for that. And that’s almost that incremental 10 bucks of ASP is almost all pear margins, right. So we can work on improving that mix within the mix as well as the overall technology mix.

By the way stay tuned on technology transitions, because I think you probably going to see it, have been pretty quickly that 4G only devices will be coming to the market and we quickly in M2M term. So end of 2013 into 2014 and 2015, cost optimized LTE only devices because one the costly features of a 4G device today is all the fall back capability, right.

And all the RF chains and bands that you need to support. So if you support limited bands and LTE only device you can really optimize cost, and get the benefits of network efficiency and latency, and maybe not even speed because you might not need the speed, so you can actually dummy down an LTE device and deliver a real cost optimized solution and still deliver on the latency benefit and the network efficiency benefit.

Unidentified Analyst

Jason, maybe I can ask you one.

Jason W. Cohenour

Yeah.

Unidentified Analyst

I’m curious as you look at your mix today between M2M and mobile computing, is there sort of a target mix that’s just driving towards, do you care which one of the two segments is larger than the other?

Jason W. Cohenour

Well, clearly we are favoring machine to machine, so we want machine to machine to be a growing percentage of the overall mix. So we’ve taken it from, sub 10% to 53% and in the fullness of time, I wouldn’t care if it’s 90% generally, because I think the bigger value driver has got more leverage and dials around defensibility.

Unidentified Analyst

Okay. And maybe you could just expand the differentiability aspect, I mean the margin profile seems relatively comfortable between the two or would you say better?

Jason W. Cohenour

It’s better 10 percentage point difference roughly. So think of mobile computing in the mid 20s grow on a gross margin basis and think of M2M in the mid 30s.

Unidentified Analyst

Okay.

Jason W. Cohenour

And with respect to long-term defensibility I think there is both technology and commercial barriers if you will to entry. So Huawei come in and steal this business like they did in AirCard line as an example. And I would say there is a bad D&A fit for them in machine to machine. It’s a very fragmented market, hundreds of customers, all of them require lots of hand holding some of which require customization, very different D&A from taking a device and shipping it a multimillion through a single channel one or two channels very different.

And in addition to that, we are talking more the value chain. So we are providing a lot of this solution differentiation deeply embedded we own our protocols SAC in 2G, it’s almost unheard up, right, but for us it’s a key differentiator, because it’s tuned to machine to machine requirements. We have embedded application frameworks running right on to the device. This is all deeply embedded differentiation, I think is very difficult for just about anybody to recreate and you will combine that with playing up right up to the cloud and enterprise. This is just the kind of stuff we can do and I think some of the biggest players is just not a good D&A fit.

Amitabh Passi – UBS Securities LLC

We have one more question back there.

Unidentified Analyst

Jason with your cloud computing services that you have, are you being pushed by customers to do those kinds of services or is that something you are looking at growing long-term and adding more value added services that are kind of related to the hardware that you sell, but also a new revenue generating?

Jason W. Cohenour

Yeah, so it’s both of these, right. So it is a, we look at in two ways, it’s margin protection on the hardware, right, because our customers and the option to use our device management services you may be able to want to use them day one, they have the option to use device management services and our enterprise services. So if I can get an extra buck in ASP for that, that’s a real value driver when I am shipping 12,012 million units, right.

And in addition to that in the fullness of time and this will take time in the fullness of time, we want to drive a strong recurring revenue stream through platform services as well.

Unidentified Analyst

Excellent. I think with that we’re out of time.

Jason W. Cohenour

Great. Thank you very much.

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