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Sierra Wireless, Inc. (NASDAQ:SWIR)

Q1 2010 Earnings Call Transcript

April 29, 2010 5:30 pm ET

Executives

Jason Cohenour – President and CEO

Dave McLennan – CFO and Secretary

Analysts

Spencer Churchill – Westwind Partners

Bill Choi – Jefferies & Co.

Amir Rozwadowski – Barclays Capital

Matthew Hoffman – Cowen & Company

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Todd Coupland – CIBC World Markets

Ilya Grozovsky – Morgan Joseph & Co.

Operator

Thank you for participating in the Sierra Wireless, Inc. first quarter 2010 results conference call. I would like to introduce your speakers, Jason Cohenour, President and CEO; and Dave McLennan, Chief Financial Officer.

Jason Cohenour

Thank you, Jessica, and good afternoon everyone. Thank you for joining today's call and web cast. With me on the call today is Dave McLennan, the company’s CFO. As a reminder, today's presentation is being web cast and will be available on our website following the call.

The agenda for today's call is as follows. I will first provide a general business update and then turn the call over to Dave, who will cover Q1 2010 financial performance and Q2 financial guidance. I will then return for some brief summary comments and questions and answers.

As a reminder, today's web cast and call is subject to the company's safe harbor statement. We are not going to read the statement into the record today. The statement is being displayed right now on the web cast on slide number two, and I will pause now for everybody to read it.

This presentation should also be viewed in conjunction with our press release and with the supplementary information on our website, where you will find complete reconciliation of GAAP and non-GAAP results.

I will begin with a brief financial summary. Overall, I'm very pleased with our performance in Q1. Our revenue of 151.3 million represents solid sequential growth of 5% and 36% growth on a year-over-year basis and was above our guidance of 150 million.

Our growth was driven by continued strength in our Machine-to-Machine business, including a 49% year-over-year increase in the revenue from the Wavecom business that we acquired in March of 2009. Non-GAAP gross margin was 30.7% in the quarter, in line with our target business model and consistent with our expectations and guidance.

Non-GAAP operating expenses were 42.3 million in the quarter, an improvement of $1.5 million over Q4 of 2009. This improvement is the result of our ongoing focus on cost reduction and our continued efforts to realize synergies from the integration of Wavecom. As we’ve stated on previous calls, we remain committed to reaching our target of 40 million in non-GAAP operating expenses per quarter.

The combination of revenue growth and operating expense reductions lead to improved non-GAAP earnings from operations of 4.1 million, and non-GAAP earnings per share of $0.13. During the quarterly we also achieved an important milestone in the acquired Wavecom business. Driven by the revenue growth I mentioned earlier plus higher gross margin and 28% reduction in operating expenses, the Wavecom business achieved breakeven results in the first quarter compared to a loss of 12.3 million one year ago.

Additionally, our balance sheet remains very strong. At the end of Q1, we had 122.4 million in cash and cash equivalents and no debt. And finally, we're quite pleased to see strong bookings and an improving sell through trend line during the quarter.

At this point, I'm going to take a moment to introduce how we will be presenting our segmented business results going forward. In the Wireless space, we are targeting two high growth segments, Machine-to-Machine and Mobile Computing. Machine-to-Machine, also known as M2M is probably familiar to most of you who follow the company. The M2M market represents an exciting growth opportunity for us, and as a segment that is receiving growing focus from operators and OEMs globally.

Our definition of M2M alliance with the majority of the industry analysts following the market. It includes a broad range of applications and connected devices, from emergency communication in the automotive sector to smart metering in the energy sector, to e-readers and personal navigation devices for consumers.

We are the global leader in the wireless M2M space and provide solutions across the value chain from embedded modules and fully integrated intelligent gateways to hosted end-to-end solutions and an M2M service delivery platform. Starting this quarter we will provide a revenue split for the M2M business to help investors better understand the size and scope of our M2M franchise, and its importance to the overall business.

Our M2M revenue includes AirPrime embedded modules, excluding sales to PC OEM customers, AirLink intelligent gateways and routers and our advantage solutions and service delivery platform. Our second line of businesses is mobile computing, which is focused on providing mobile broadband connectivity for notebooks and netbooks. We are a technology leader in this space often coming first to market with devices that support the latest high-speed services being deployed by operators around the world.

We have strong relationships with key operators such as AT&T, Sprint and Telstra and we supply them with AirCard mobile broadband devices including USB modems, mobile hotspots and PC cards. We also have strong relationships with leading PC OEMs such as HP, Lenovo, Panasonic, Fujitsu and others to whom we provide embedded mobile broadband solutions.

Going forward, the venues for our mobile computing business will include all sales of our AirCard mobile broadband devices, as well as sales of our AirPrime embedded modules to PC OEMs. In our M2M business we had a very strong start to the year. In Q1, M2M revenue was $88.7 million, up 15% over last quarter and up over 187% compared to the first quarter of 2009. The M2M revenue was broad-based, however we saw exceptionally strong growth in the consumer space where our embedded modules are used in e-readers, personal navigation devices, and other products.

We are rapidly building a leadership position with our AirPrime intelligent embedded modules. We secured new design wins around the world, reached important keystones in key segments, such as automotive, launched our new SL series of sorter down [ph] LGA devices, and announced a new smart metering design win with long-term partner EDMI.

AirLink intelligent gateways and routers continued to be a solid contributor delivering 10.5 million in the quarter. Our international expansion efforts with our AirLink products are beginning to bear fruit with significant new wins in Europe, Latin America, and China. We also launched a unique bundled M2M offering with Bouygues Telecom of France.

Moving further up the value chain, the Air Advantage [ph] services delivery platform continues to gain momentum as well. In Q1, we achieved new design wins in industrial M2M and outdoor advertising, and we had a successful launch of our services platform with ORBCOMM. We also made good progress in our deployment of the Air Advantage services platform with our first cellular operator customer. We expect to live with this customer in the second half of 2010.

We also made excellent progress during the quarter in our continuing effort to tightly integrate our AirPrime and AirLink products with our Air Advantage solutions and services platform, strengthening our ability to offer end-to-end solutions and to drive differentiation across our product lines.

Overall, we are excited about the progress we've made in M2M and believe we are the global leader in wireless M2M solutions. Looking forward, we expect to see a small sequential decline in M2M revenue in Q2 driven by channel launch cycles for consumer devices. We do expect to see continued strong year-over-year growth in this segment.

Turning to mobile computing, we saw a sequential decline in revenue of 6% as weaker than expected sell through in Q4 continued to impact sales early in Q1. Despite the weakness in Q1, we are confident in our AirCard business. We believe we've got a strong product portfolio and pipeline, and leading channel positions with key operators. We also saw good order flow for existing and new products, and an improving sell through trend throughout the quarter.

Our operator customers continue to rely on us for innovative, first to market mobile broadband products. So far this year we’ve launched the Overdrive, a 3G/4G Mobile Hotspot with Sprint, and the AirCard 890 with AT&T. We also demonstrated our first to market dual carrier HSPA plus device with Telstra at Mobile World Congress. We expect the launch of this product, supports speed of up to 42 Mb per second later this year with Telstra in Australia.

During the quarter we also secured channel slots for future products, including our first LTE awards. We are also making good progress in rebuilding our PC OEM business. During the quarter we announced production design wins with Fujitsu and Panasonic and saw our sales to PC OEMs increase sequentially for the first time in several quarters. We also have new opportunities with tier 1 PC OEM manufacturers, and expect to secure design wins for platform launches in 2011.

Overall, we see solid moment in our mobile computing business, and we expect that our improving sell through, solid bookings, new design wins and expected new product launches will drive sequential growth in Q2.

Before turning the call over to Dave for a more detailed financial review, I would like to take a moment to make a comment on the transition occurring at Sierra Wireless. Recognizing the M2M opportunity early on, we have been investing in this market for some time, organically as well as through the acquisition of Wavecom in 2009 and AirLink in 2007. The charts on this page clearly illustrate the success of our sustained investment, both in terms of revenue growth and diversification.

Our higher margin M2M revenue is now 59% of total sales, and we are successfully navigating the transition from a company solely dependent on mobile computing to a diversified leader in wireless solutions for both M2M and mobile computing, while also capturing the powerful synergies between the two lines of business.

I believe we are making excellent progress on this strategic transition, and that over time it will prove very profitable for all our stakeholders.

Dave will now take us through the Q1 financial results in more detail as well as Q2 guidance.

Dave McLennan

Thanks, Jason, and good afternoon everyone. As a reminder, we report our financial results on a GAAP basis. However, we also present non-GAAP results in order to provide a better understanding of our operating performance. Non-GAAP results exclude the impact of stock-based compensation expense, acquisition amortization, Wavecom integration costs, restructuring costs, foreign exchange gains or losses, tax adjustments and noncontrolling interest related to the non-GAAP adjustments.

As Jason stated in the beginning of the call, consolidated revenue in the first quarter was 151.3 million. That is up 36% from Q1 ’09 and 5% sequentially from Q4 ’09. Consolidated GAAP gross margin was 30.6%, and after excluding stock compensation expense, gross margin was 30.7% on a non-GAAP basis. The sequential decrease in gross margin from 33% in Q4 was in line with our expectations, and it was a result of lower AirCard margins. This is all about mix within AirCards. So we experienced a mix shift to lower margin newly launched products.

In our M2M business, gross margins improved relative to Q4 as a result of product cost reductions and good ASP discipline. In the quarter, AT&T, Barnes and Noble’s and Sprint each contributed greater than 10% of our sales, and together these customers represented 46% of sales.

On a GAAP basis, operating expenses were 50.8 million and the loss from operations was 4.5 million in the quarter. On a non-GAAP basis, operating expenses were 42.3 million in the quarter, compared to 43.8 million in the fourth quarter of 09. The decrease of 1.5 million was from lower R&D spending, which declined from 14.3% of revenue in Q4 to 12.3% of revenue in Q1.

Non-GAAP earnings from operations improved to 4.1 million in the quarter, an increase of 0.4 million compared to Q4 and up 1.9 million over the first quarter of 2009. Non-GAAP earnings from operations in Q1 excludes $3.5 million of purchase price amortization primarily related to Wavecom, 1.7 million of stock-based compensation, 1.6 million of restructuring primarily related to the additional headcount reductions, and 1.8 million of integration costs as our ERP conversion project and other systems projects related to the Wavecom integration proceeding.

On this slide, we provide a summary of the key financial GAAP and non-GAAP metrics compared to our guidance. I have previously commented down to the operating income line. Our GAAP results include a loss from other of $3 million. This is comprised of a FX loss of 3.8 million, offset by a tax recovery of 0.7 million, and noncontrolling interests of $100,000. On a GAAP basis, other income was nil.

Looking at net earnings in the quarter, the gap net loss was 7.5 million or loss per share of $0.24. On a non-GAAP basis, net earnings were 4.1 million and earnings per share were $0.13 in the quarter. Non-GAAP net earnings and EPS were above our guidance of 3.3 million and $0.11 per share respectively. I would also mention that non-GAAP EBITDA in the first quarter was 9.4 million.

Please note that a complete reconciliation of GAAP to non-GAAP results is available in the investors section of our website for your reference.

So overall, I think we have a pretty good quarter and we are pleased to deliver results that exceed our expectations and will show significant improvement year-over-year and sequentially from Q4.

Turning to the balance sheet for a moment, our financial capacity remains strong. We ended the quarter with 122.4 million in cash and short-term investments, equivalent to approximately $4 per share. The cash balance is entirely unrestricted and the company is debt free. Although our cash balance declined in the quarter, the decrease was primarily driven by an increase in working capital to support revenue growth. For instance, during Q1 accounts receivable increased by $12 million in the quarter. During the quarter, operating activities used 7.9 million in cash, which includes this increase from receivables and capital expenditures were $2.9 million.

Moving to guidance for the second quarter of 2010, were providing guidance on a non-GAAP basis, which as previously stated excludes stock-based compensation expense, acquisition amortization, Wavecom integration costs, restructuring costs, FX gains and losses, tax adjustments and noncontrolling interests related to the GAAP adjustments. In the second quarter of 2010, we expect revenue to grow to between 155 million and 160 million.

Non-GAAP earnings from operations are expected to be between $2 million and $4 million, and non-GAAP net earnings are expected to be $1.7 million and $3.6 million or $0.05 to $0.12 per share. This guidance is based on our expectation that mobile computing revenue grows sequentially on improving AirCard sell through and new product launches, and our expectation that Machine-to-Machine revenue declines slightly as sales to consumer Machine-to-Machine normalizes following initial launch volumes in Q1.

On a consolidated basis, we expect gross margins to be between 28% and 29% for the quarter. We expect gross margin in the M2M to increase, however we expect this improvement to be offset by a decline in the mobile computing gross margins driven by the launch of new AirCard products that ramped during the quarter.

We also expect non-GAAP operating expenses to be approximately flat in the quarter compared to Q1. Finally, please note this guidance also reflects an uncertain macroeconomic environment as based on current beliefs and assumptions, which are subject to change. Actual results could differ materially from guidance, and the risk factors are described in our regulatory filings.

With that I like to turn the call back to Jason for some closing comments.

Jason Cohenour

Thank you, Dave. So to summarize our first quarter of 2010. I believe we have an excellent start to the year. Our financial results were solid and we exceeded both revenue and earnings guidance. We are also experiencing good momentum across

all of our lines of business as evidenced by our revenue growth, new customer design wins, new product launches, and improving sell through during the quarter.

Our organic and inorganic investments have resulted in a strong growing and profitable end-to-end business that represented 59% of total revenue in the quarter. Our mobile computing business is also well positioned with key operators and OEMs, and expect it to return to growth in Q2. As a result, we now have a well diversified company with two solid lines of business both contributing to our goal of becoming a global leader in wireless solutions for M2M and mobile computing.

We are making good progress on operating expense reductions and continue to drive to our quarterly non-GAAP operating expense target of 40 million. While we are doing this, we are growing our top line, gaining share, and working towards our long term target business model of 30% gross margin, 20% operating expense, and 10% operating margins.

And with that operator, we will open up the line for some questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Spencer Churchill. Your line is now open.

Spencer Churchill – Westwind Partners

Hi guys. I just wanted to drill down a little bit further on the gross margin for the next quarter. You mentioned the mobile computing is going to be down on the new AirCard launches. Is that a one-quarter phenomenon, do you think as you're getting those ramped up for the first time and then we could see that go back up in the back half of the year?

Jason Cohenour

Spencer, this is Jason. I'm going to be careful not to say it's strictly limited to one quarter, but we do view it as temporary if that's helpful. You know, we do expect that we will get back to 30% gross margin over time, and yes, I do think that our new launches are disproportionately burdened with higher cost of goods during the early ramp phase.

Dave McLennan

And I might also add that Spencer that the Machine-to-Machine gross margins are improving and I expect it to improve in Q2. So we've got some other things going the other way.

Spencer Churchill – Westwind Partners

And I guess when the Wavecom acquisition was made, we were hoping that blended margins would kind of start to increase. They did for a couple of quarters and now they're coming back and how would you characterize the long-term outlook now? Is it perhaps a little bit lower than it was when you made the acquisition just because of the strength you're seeing from some of the embedded products and perhaps a little bit of weaker on the AirCard side or how do you – how have you seen the transition since the acquisition to sort of what we're guiding to for next quarter?

Dave McLennan

The way I see it is gross margins in our Machine-to-Machine business are up, and in fact since we acquired business – acquired Wavecom one year ago the gross margins coming out of sales from Wavecom products are up as well. They're up about 200 basis points. So you know, I think that's gone the way we wanted it to go. Overall Machine-to-Machine gross margins are strong and as Dave said we expect them to get stronger in the current quarter again, and this is really about a mix, you know, a mix phenomenon.

We expect a significant jump up in our AirCard revenue, something we got revenue – that we are criticized for weak revenue last quarter, as you may recall and we're seeing that snap back in Q2, which I think overall is a good sign although that is bringing some negative blending effect to the overall consolidated gross margin.

Spencer Churchill – Westwind Partners

Okay, and just one more thing, on the tier 1 OEM opportunities that you mentioned, I think it's the first time you talked about that in a little while. Is this sort of playing out the way you had expected that some of the business that was lost two years ago is now coming back up for renewal and you're finding yourself in a better position?

Jason Cohenour

Yes. That is playing out as we expected and you know, we've been pretty, you know, we are pretty specific on our progress in that area. We've gotten a couple of nice wins with longtime tier 2 partners and shipments are building a little bit there and you saw that in the results. So sales to mobile computing PC OEMs were up in the quarter as I indicated up for the first time in several quarters, probably up for the first time in more than a year.

And I think we've got pretty good visibility to getting you know, one or two tier 1 laptop OEMs wins as well, though as we don't think will contribute to the top line, however, until 2011, but it is playing out as we expected.

Spencer Churchill – Westwind Partners

Great thanks, guys.

Jason Cohenour

Sure.

Operator

Your next question comes from the line of Bill Choi. Your line is now open.

Jason Cohenour

Hi Bill, you’re on.

Bill Choi – Jefferies & Co.

Okay, great. Just first, is there a way that you can actually give a, I don't know if I missed the gross margins guidance.

Dave McLennan

Sorry Bill, you cut out there, what was the question?

Bill Choi – Jefferies & Co.

Did you actually give a range for gross margins?

Dave McLennan

Yes, we did. In Q2, the guidance implies a range of 28% to 29% consolidated.

Bill Choi – Jefferies & Co.

Right. Now you said it might last more than a quarter and just want to make sure I understand this a little correctly. You obviously have a new 4G product shipping. Is that largely just due to one product or is it overall category, if you could define the mobile computing gross margin threshold a little further.

Dave McLennan

Yes, I'd be a little bit careful there. It's – you know, it's confined to a couple of products, mainly the newer products, and as I indicated often for some period of time following a new product launch those products are unduly burdened with higher cost of goods and that's proving out, and we've got some time now I think that we can step through cost reductions, but it'll take a little time to get up to full ramp and to get you know, get some of our product cost reductions into the gross margin results.

Bill Choi – Jefferies & Co.

Right and you had to step through that as you went from 2G to 3G. I am curious if there's anything a little more unique in 4G that might take shorter or longer time to get costs down versus some of the transitions you've gone through in the past?

Jason Cohenour

No. I would view it you know, conceptually the same. There is no significant pluses or minuses driven by 4G.

Bill Choi – Jefferies & Co.

Okay, and then you did mention that you thought Q1 mobile computing sales were somewhat impacted by fluid [ph] sell through that began in Q4 and then early part of Q1, so did you really see the business pick up towards the end of the quarter that you could point to for your expectations for sequential growth rate in AirCards?

Jason Cohenour

We did. Yes, we saw a little bit, we saw revenue pick up in March. We saw overall sell through for Q1 actually be above sell through for Q4, which never happens. So that was an interesting thing to see and the order book. So you know, between those factors plus our expected new product launches that's driving our expectations for growth in the AirCard space.

Bill Choi – Jefferies & Co.

That's interesting. What do you think inventory levels are? Is it at historical lows and they need to replenish here in the next couple of quarters?

Jason Cohenour

You know, I think they're probably where they should be and where they have been over the past several quarters, you know, operators are continuing to be careful not to be too fat on inventory , and I wouldn't characterize them as extraordinarily low when compared to the last few quarters, and I wouldn't characterize them as high either. You know, they're probably about where they should be anywhere from 4 to 6 weeks.

Bill Choi – Jefferies & Co.

One last question just it's good to see Barnes and Noble’s get to be over a 10% customer here and just given that they just launched a product and started marketing it heavily and there's probably some time to digest it, I am curious if you could at all size how Barnes and Noble’s compares in terms of relative size versus your other two 10% customers, and how quickly you think that Nook [ph] business comes back, how long it takes to digest some of the initial shipments? Thanks.

Jason Cohenour

Sure. Well, they are a 10% customer. I can’t give you anymore granularity than that but no, they were good , very strong contributor in the current quarter and you know, part of that was kind of you know, initial ramp on a new product and new product launch and I think you know, Barnes and Noble’s is quite pleased with this sales of Nook and are planning to bring on new channels over time and our view is, that's probably going to take a little time to get some of the new channels up and on stream and we’re you know, obviously very closely watching the sell through trends so that we can respond and meet their demand.

Jessica, is there another question?

Operator

Yes. Your next question comes from the line of Amir Rozwadowski. Your line is now open.

Amir Rozwadowski – Barclays Capital

Thank you very much and good afternoon Jason and Dave.

Jason Cohenour

Hi Amir.

Dave McLennan

Hi Amir.

Jason Cohenour

Jason, in discussing the AirCard business, I mean certainly it seems as though some of the new product introduction and sell through have given you optimism for sequential growth here in the second quarter. I was wondering if you could talk a bit about how you feel the trend should progress through the course of the year. Obviously we saw sort of a tempering of demand in the fourth quarter of last year, but it does seem like you have some new product introductions and momentum working in your favor for at least the duration of this year and I was wondering if you could give a little bit of color there?

Jason Cohenour

Yes, I think you know, I think we’re in a share gain position in at least one of our big channels, and that's driven by some of the new product launches, you know, 4G launches and I think that's going to help us. You know, we’ll have to wait and see how sell through goes, but clearly we believe that our sales with 4G partners are going to be robust, and across-the-board you know, our key operators are promoting the category pretty hard.

We've seen television advertising get switched back on and that generally helps. And like I said sell through, and this is prior to the launch of any additional new 4G products. Sell through activity in Q1 was actually a bit better than Q4, which was surprising. So again sell through plus new product launches leads us to you know, to expect sequential growth, and beyond Q2 tough to tell, Amir candidly. You know, we'd be watching sell through pretty closely.

Amir Rozwadowski – Barclays Capital

Okay, and then Jason if you could talk a bit about sort of the Machine-to-Machine space, are there particular areas of strength that you're seeing in terms of the vertical markets? Right now, given some of your customer penetration and where you're seeing some of those trends I mean, do you have a sense at least of now how we should think about some of the growth trajectories for those specific vertical markets?

Jason Cohenour

Well, I think you know, we've said a few times, we think that the you know, kind of the industrial Machine-to-Machine category ought to be growing in a healthy environment, ought to be growing 20% to 25% a year and that's pretty broad based. I think I know, as we look at individual segments whether it's automotive or networking or payment or security or fleet management, all of those seem to be in a, you know, a band of 20% to 25% in terms of what industry analysts expect and you know, we think in a healthy macroenvironment that's probably not too far of.

We think that we are well positioned broadly in all of those markets, and probably particularly well positioned in automotive, where we've got an automotive specific product lineup and a number of new design wins coming on-stream over time. So you know, between Denso [ph] and a new auto customer we will be shipping to here shortly. I think that's a, you know, particularly interesting segment for us. But you know, having said that I think energy has some great macro growth drivers as well. So – we think across the board it feels pretty good and then you know, on the consumer side of that we view that as you know, interesting opportunities to catch good volume and you know, we've seen that in the e-reader category, and clearly a number of the products that we have in the product lineup fit the consumer PET [ph] category quite well and we're going to continue to chase those opportunities.

Amir Rozwadowski – Barclays Capital

That's helpful and then lastly, Jason, we saw an announcement obviously by Qualcomm, one of your partners in expanding their Gobi platform to the Machine-to-Machine arena. I was wondering if you could give us some of your thoughts there and are we going to see a replication of the prior challenges with Gobi entering the PC OEM arena or is this – do you see this as sort of a different trend in terms of how they're positioning the product this time around?

Jason Cohenour

Yes, I see it as a little bit different. You know, my expectation, we certainly don't expect to be competing head-to-head against Qualcomm in the Machine-to-Machine space and that's you know, that's kind of how it developed in the early stages with PC OEMs, and as we've indicated with PC OEMs that model has changed and certainly, you know, our expectation is that that the, you know, competing directly against Qualcomm in Machine-to-Machine is not going to you know, is not going to happen. We are a Gobi licensee, might we had take advantage of Gobi for certain opportunities, that is certainly possible, but our expectation right now is our organically developed product lineup is going to be – it is going to represent the vast majority of our sales into the Machine-to-Machine segment.

Amir Rozwadowski – Barclays Capital

Great. Thank you very much for the incremental color.

Jason Cohenour

Sure.

Operator

Your next question comes from the line of Matthew Hoffman. Your line is now open.

Matthew Hoffman – Cowen & Company

Hi Dave, Jason, another question for you on the comment you made on the AirCard market because you sound pretty bullish. So you had already spoken about the lower gross margins and regard those as part of the mix. Are we really seeing elasticity of demand at the lower price points? I mean, you've brought the price points down on the USB and AirCards widely. Is this a sign that at these lower price points consumers are walking in and wanting the product and there's more promotional dollars available?

Jason Cohenour

I don’t think it has little to do with hardware pricing really, you know, because in most of the volume slots where we participate, the hardware has been priced at zero with a two year commitment for some time. So I think I know, with respect to hardware ASP that has little to do in our view with – or any change that has little to do with any up-tick in demand. So you know, I think probably, you know, what’s driving the up-tick in demand is, you know, stabilizing in the macro environment, a turning up of the promotional efforts on the part of the wireless operators, we're seeing more television advertising again. And in the case of us specifically, I think that you know, our expectation is – part of our growth expectation is driven by a share gain expectation in one of our key channels as well.

Matthew Hoffman – Cowen & Company

So you've seen subsidies on AirCard remain relatively constant or are operators really subsidizing less at these points and just taking more in terms of profits?

Jason Cohenour

No, I think it is pretty constant.

Matthew Hoffman – Cowen & Company

Okay. Another question, Dave, you did touch on the accounts receivables trend. Look, DSOs were up 20 or more days. Is that a trend that is going to reverse here and is it a sign really that you were just closing business late in the quarter, responding to March demand that Jason was referring to earlier?

Dave McLennan

Yes, Matt. Just a correction on DSOs. They were fairly consistent relative to Q4. So, hovering around 50 days. What we saw in the quarter was a growth from receivables. I think it really reflects two things. One is, the business is growing and secondly the quarter was not sequential so we had more revenue in March that ended up in receivables at the end of the quarter. So I just think it is a healthy use of cash to support our growing business.

Matthew Hoffman – Cowen & Company

Okay, and last question, any thought to diversifying your base band and chip supplier base with Qualcomm coming into your market a little bit? Are you looking at some of the other base band suppliers out there?

Jason Cohenour

Well, first of all, to be straight on this we view Qualcomm as an important partner, and I think we have got a great relationship there. It is probably stronger now than it has been in a couple of years. So they are a good partner and a good supplier. And second of all, we already do have a diversified platform strategy.

So all of our 2-G products, or I should say none of our 2-G products, which are a big part of our volume are Qualcomm platforms. Most of them use ST-Ericsson platforms. And I will also point out that our USB 305 product that AT&T is selling branded AT&T LaptopConnect Lighting is a 3-G product based on an Icera [ph] platform. So we have got a diversified lineup. Clearly though Qualcomm has been our largest partner with respect to 3-G, and like I said they continue to be a good partner.

Matthew Hoffman – Cowen & Company

Great, thanks guys.

Jason Cohenour

Sure.

Operator

Your next question comes from the line of Chris Umiastowski. Your line is now open.

Jason Cohenour

You are there, Chris?

Operator

Chris Umiastowski, your line is now open.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Can you guys hear me now?

Jason Cohenour

Can hear you now.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Oh, sorry about that. Okay, so I have a few questions. The M2M market obviously going well, like we alluded to some of the stuff in the consumer space, how much of the volume in M2M would you say is coming from stuff that could be volatile, based on product cycles in the consumer market, and I would think the Nook is a good product to put in that category versus some of the stuff you're doing in the automotive segment, where I would think you probably going to see a bit more quarter-to-quarter stability?

Jason Cohenour

Yes. It is a good question. We are going to be careful not to get too specific here, because we do have a big contribution from one of the consumer products companies, Barnes and Noble's. So I will say the vast majority of our M2M revenue comes from the, what I will call, the more industrial Machine-to-Machine markets, and we view it the same way you do Chris. So that is kind of a baseline business that is healthy, growing nicely, has very solid gross margin.

But we are chasing these high-volume opportunities as well. And to your point yes, they can be volatile, but for us it is great leverage because it uses products that we have. It uses the sales team that we have already, and it is great incremental business.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Okay, yes I agree. I agree that sounds logical. Now just to be clear, when you say the vast majority, you're talking about Q1 as well?

Jason Cohenour

I'm talking about Q1 as well, yeah.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Okay and how high does the number have to be for you to say vast majority?

Jason Cohenour

It is got to be way above 50% than it is.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Okay that's as much pushing as I'll do on that one, thanks.

Dave McLennan

Chris, I think the important point here is that we view that category really as a portfolio, and so you know, we have got many customers and many products, and that allows us to take on what might be more of a volatile business, because we balance it with other longer-term design wins with our other customers.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Yes, I don't think anyone can knock you for going out for the volatile stuff. It's still revenue. Okay, let me ask you another – I wanted to ask about the USB modem business. We heard some questions about gross margin. What's going on in terms of pricing? I think we know you guys can cost down the products in time, but how is the customer base treating you and your competitors with respect to ASPs?

Jason Cohenour

You know, it is the same as it has been in the last few quarters. It continues to be intense from a competitive standpoint, and our roster of operator customers, they do recognize and pay for our value add, but we have to price competitively. So I don't think that has changed dramatically, and interestingly if you look at our AirCard ASPs as a family, they are actually up in Q1 even though gross margin is down a bit. So it is really a cost of goods thing that we need to get our arms around.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Okay and you're confident there's no fundamental change to the business that would stop you from getting costs out this time around?

Jason Cohenour

No.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Okay.

Jason Cohenour

It might take some time, but I don't think there is any fundamental obstacles there.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Okay, it sounds reasonable to me. The next one I wanted to ask you is about opportunities in form factors. Just understanding your embedded in the mobile computed space, you say you have notebooks and netbooks and then we've got this emerging category of tablets with the iPad on the scene. I'm kind of wondering a couple of things here. First of all, do you see opportunity in the tablets, based with some of the traditional PC guys coming in to compete? And second of all, is this market affecting at all people's perception of demand for eBook readers?

Jason Cohenour

Well, the latter part of your question to be determined. I think the emergence of iPad, whether or not that is going to cannibalize things for things like ereaders, really it remains to be seen, although we have the same thought in the back of our head. So we're watching that closely and it is just too early to see if there is any impact there.

With respect to opportunities in the tablet space, yes, we definitely see opportunities in the tablet space, and we have designed into a couple of tablet computers. I wouldn't characterize them as high-volume by the way, but we have already designed into a couple of tablet computers, and if iPad has significant success in the market, I would expect that there is probably going to be some iPad competitors who will enter as well and clearly we would view those manufacturers as good opportunities for our modules.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Okay that's reasonable. And then lastly, I wanted to ask you about the comment you made about expecting some share gain in one of your channels. Are you looking to gain share in a North America channel or an international channel?

Jason Cohenour

It is a North America channel, and you know, we have said previously that we expect to launch, much like we have launched a 3-G, 4-G mobile hotspot.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Oh, okay.

Jason Cohenour

We expect to launch a 3-G, 4-G USB device. It is probably pretty obvious where we have share gain opportunities for that.

Chris Umiastowski – TD Newcrest/Waterhouse Securities

Yes, enough said there. Okay and then I think you have answered all my questions, so that's it for me. Thanks, guys.

Jason Cohenour

Thanks, Chris.

Dave McLennan

Thank you.

Operator

Your next question comes from the line of Todd Coupland. Your line is now open.

Todd Coupland – CIBC World Markets

Yes, good evening everyone.

Jason Cohenour

Hi, Todd.

Todd Coupland – CIBC World Markets

Just following on the 4-G, 3-G point, you are actually finding that the demand for that device is being used for tablets on the Sprint network?

Jason Cohenour

Well, I will be candid Todd. If you are referring to our Overdrive of course, it is hard for us to see through the channel and get clear visibility on the use case for end-users, but you know clearly Sprint is promoting the Overdrive as a connectivity tool for anything that is WiFi enabled and we have certainly done a lot of work technically to make sure a broad array of WiFi enabled devices from itouches to play stations to laptop computers work well with the Overdrive system.

So I can tell Sprint is certainly positioning it as a connectivity tool for a broad range of those devices and I'm relatively certain they are having some success in connecting such devices to Overdrive, but it is just – we don't have clear enough visibility to tell you that is 30% or 20% of the volume. We just don't know.

Todd Coupland – CIBC World Markets

Okay, I mean there's certainly speculation that unlocked iPads are showing up using this device.

Jason Cohenour

Great.

Todd Coupland – CIBC World Markets

Okay, and then your USB point, I'm assuming you're still talking about the Sprint network. You're not talking about initial LTE deployments?

Jason Cohenour

Yes, we will not be deploying LTE devices in the second quarter.

Todd Coupland – CIBC World Markets

Yes, yes okay, so that's just a different form factor getting to the same point. Okay, and then the last point is, for me, so I understand your target model, 10% operating margins. It doesn't sound like that's happening anytime soon. So, when you see gross margins slipping below 30%, I understand the product maturity point, but it is still a reality of your business. New products are going to be coming out on a regular basis I would assume. Is that $40 million OpEx number the right number or are you going to need to re-think that, and maybe have another step function down? Maybe just talk to us about your thoughts about that.

Jason Cohenour

Well, yes, sure. I mean just doing the math the assumed 30% gross margin and $40 million OpEx, we have got to be pretty far north of 155 million of 160 million to achieve 10% operating margin. So clearly the $30 million OpEx target, the 30% gross margin target requires growth to get to the 10% operating margin, and clearly that is our preferred path to get there. And we believe we're competing well in a couple of growth markets and have a path to get to the top line we need, but if we determine along the way that you know we're not going to get there as soon as we would like, then we would have to look at other parts of the P&L. Right.

Todd Coupland – CIBC World Markets

Okay, so is your view today that you'll sort of let those product plans play out in 2010, it is likely, if it is going to be revisited it is likely later 2010, 2011?

Jason Cohenour

Well, I'm not going to give any timeframe on when, but I will tell you this, we revisit that thought processes approximately once a week.

Dave McLennan

We are pretty hawkish on that.

Jason Cohenour

Yes, so that is daily managing the business thing, and…

Todd Coupland – CIBC World Markets

Just for what it's worth, I mean, obviously there's a lot of leverage in your business model, and we sort see it every quarter, right? We've seen it for four quarters in a row now, up and down so and–

Jason Cohenour

Right.

Todd Coupland – CIBC World Markets

Right around that point is – well, right around that sort of tipping point, I mean if you were down at $38 million nobody would be complaining about, for example, nobody would be complaining about 29% operating margins because you'd be at $0.15 plus for the quarter. So whereas you are at 43, or at $0.06 to $0.12 and sort of half of that.

Jason Cohenour

Yes, I know, we can do that math. We understand it. And believe me, we're looking at it very closely and you know, these things are only the balance, right. So I can tell you today that tomorrow will be at 38, and we could make it happen. However, we made throw a giant speed bump in front of our corporate strategy of leadership in Machine-to-Machine and mobile computing in doing so.

So we have got to balance the tactical early returns against our strategic goals, and make sure we are doing the right things. Not just short-term, which is important, not just short-term but also long-term.

Todd Coupland – CIBC World Markets

Yes, yes and take my comments in that context, please.

Jason Cohenour

Sure.

Todd Coupland – CIBC World Markets

Thanks very much.

Operator

Your next question comes from the line of Ilya Grozovsky. Your line is now open.

Ilya Grozovsky – Morgan Joseph & Co.

Thanks guys. Actually my question has been answered. Thank you.

Operator

There are no further questions at this time. I will turn the call back over to the presenters.

Jason Cohenour

Great. Okay, we will wrap up this call. I want to thank everybody for participating in our Q1 financial results call and as is typical, management is standing by here in our office in Richmond, and will be happy to answer any additional questions you may have. And Jessica with that we can end the call.

Operator

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

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Source: Sierra Wireless, Inc. Q1 2010 Earnings Call Transcript

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