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Sequans Communications SA (NYSE:SQNS)

Q1 2014 Earnings Conference Call

April 24, 2014 8:00 AM ET

Executives

Georges Karam – President and CEO

Deborah Choate – CFO

Analysts

Tristan Gerra – Robert W. Baird & Co.

Anthony Stoss – Craig Hallum Capital Group

Quinn Bolton – Needham & Company

Operator

Ladies and gentlemen, welcome to the Sequans First Quarter 2014 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference is being recorded.

Before I turn the conference over to our host, Mr. Georges Karam, I would like to remind you of the following important information on behalf of Sequans. This call contains projections and other forward-looking statements regarding future events or our future financial performance.

All statements other than the present and historical facts and conditions discussed in this call, including any statements regarding our future results of operations and financial positions, business strategies, plans and our objectives for future operations are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27(NYSE:A) of the Securities Act of 1933 as amended, and Section 21(NYSE:E) of the Securities Exchange Act of 1934 as amended.

These statements are only predictions and reflect our current beliefs and expectations with respect to future events and are based on assumptions and subject to risks and uncertainties and subject to change at any time.

We operate in a very competitive and rapidly changing environment. New risks emerge from time-to-time. Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Actual events or results may differ material from those contained in the projections or forward-looking statements. More information on factors that could affect our business and financial results are included in our public filings made with the Securities and Exchange Commission. Please go ahead, sir.

Georges Karam

Thank you very much operator. Good morning ladies and gentlemen. This is George speaking. I’m with Deborah Choate, our Chief Financial Officer. And Deborah and I’m pleased to welcome you all to our first quarter 2014 results conference call. The first quarter revenue came in at the low end of our guidance, but this was not an indication of any significant change. In fact, at current levels, any minor timing shifts or lumpiness in non-product revenue can affect a particular period as it did this quarter.

Other than this, the first quarter was rich in positive events. We achieved important technology milestones and more important closed new design wins and landed new business with our partners specifically in China.

In brief, we still feel that, we are on track for a strong run in shipments and revenue in the second half of the year. As a start to the new design wins, we closed in the first quarter, in fact, we closed three of them. The first one is in the home and mobile router category, whereas you know we have the most design wins so far across multiple regions and carrier. As you know, we have more than 15 design wins in this segment already. The second one is in the machine-to-machine space and this is for the United States. This gives us a total of three design wins in the segment of Internet of Things. And the third one is a new design win in mobile computing space and this is also for the United States.

As you know, in this segment, we announced three mobile computing design wins during the fourth quarter of 2013. This category includes devices such as tablets and notebook. And presently, one of these three design wins is not moving forward for reasons completely unrelated to us. This project was with the well-known global electronic company and it was progressing toward the spring launch target, which meant to right on track to exceed our internal goal for the second quarter revenue. Then it was canceled and because the parent company sold the division. While this development is not a reflection on us or on the relationship, we obviously are disappointed.

The good news here is that, we expect with a new mobile computing design win, I’m announcing here to contribute to revenue this year and this will help to compensate for the cancellation for the other projects. So, despite this cancellation, we still have three active mobile computing design wins targeting launch in the second half of this year.

Let me also stress that, during the first quarter, we have gained some additional visibility regarding the launch timetable for our ongoing design wins across all device categories. Assuming no further major surprises, we believe the general magnitude of the revenue assume by the analyst model for the 2014 is attainable. We have numerous opportunities at an advance stage and some of them could still be finalized in-time to contribute revenue this year. Therefore, we believe we are on track to achieve a dramatic improvement in revenue during the second half followed by further growth in 2015.

Before moving forward and giving more details and colors on the business progress, I would like to mention just if you of the other highlights that happened in the first quarter. The invitation to participate in Verizon’s high profile superbowl event demonstration LTE Broadcast acknowledged our technology leadership. We followed with the successful demos of both our LTE Broadcast and carrier aggregation capabilities at Mobile World Congress in Barcelona. We also showcased in the same event our new LTE-advanced platform called Cassiopeia.

The feedback from customers has been excellent. While we can correlate it to near-term revenue, our track record of delivering what we promise, our ability to show advanced features actually working in reload setting and our aggressive roadmap for the future are important elements of building confidence that will translate into higher market share over the long-term.

Now, I’ll provide some additional color for each category and discuss developments in the various geographies. The home and mobile router category continue to generate most of our revenue and we are gaining traction with a wide range of carriers across all geographic regions. But the dual-mode LTE solution and the single-mode LTE solution are doing well shipping to emerging Greenfield operators across the world.

We see existing operators expanding their deployment and more operators starting to deploy. As an example in the first quarter, we are now in – Italy is using our dual-mode solution and we understand they have been installing home routers at the rate of 100 per day. We expect further growth in demand for this kind of router products as we move through the year and we are pursuing new opportunities in both Europe and Asia, which will help support further growth in 2015.

Turning to Japan, we continue to ship our WiMAX chips for the triple-mode 4G mobile router for KDDI. We understand that, this product is a top seller and we expect orders to continue for quite some time. Meanwhile, SoftBank is moving slowly on their router project in Japan. In China, we had a notable success during the first quarter. As you recall from our previous announcement, we worked with two different OEM partners to gain a nice share of China Telecom’s first bid for single mode TDD-LTE home routers.

We were the only one non-Chinese chip vendor to be successful in the single-mode portion of the market. Overall quantities for this bid are small, a few tens of thousands of units, this positions us as an approved vendor so that regional processing units can buy devices using our chips. This is significant because we expect Asians to be responsible for the bulk of the buying going forward. We expect to increase our shipments to China in the second half weighted more toward the fourth quarter because we continue to be somewhat cautious about the timing.

In India, we continue to ship small quantities to our partners, addressing Reliance and while we could see a pick-up toward the end of the year, we are not giving this as strong rating in our expectation at the moment as we remained cautious on the timing of the commercial launch. And on the other hand, our major U.S. design win in the router space remains on track to launch in the second half of the year as expected.

Turning now to the mobile computing segment. So far our mobile computing design wins, which includes tablet and notebook are all for the U.S. market, but we expect this to change next year. In addition to the Kurio 7-inch tablet for kids, which was announced at CES in January and the second non-identified design that we announced in the fourth quarter last year, we have now a new design win for a device to be sold by a major retailer in the U.S. Thus, we have three active mobile computing designs wins all on track to launch by the end of the third quarter this year.

We are also working on a number of additional opportunities in this category, a few of which are quite advanced. Looking out to next year, our level of activity with other operators in the U.S. is accelerating. Together with our OEM and ODM partners, we are developing a better understanding of each operator’s specific requirements, certification processes and plans. We also see demand developing outside the United States, primarily initial demand in Europe and some acceleration activity happening in China. Not also that our public safety design win in the United States is progressing well and we still expect these designs to generate revenue in the first half of 2015. We have also identified additional opportunities for similar projects in several different countries that can help us to grow the business of this segment.

Finally, I’ll give you an update on the newer category called Internet of Things, which includes machine-to-machine and consumer electronic devices. Currently, most of our activity in this category is in the United States, although we continue to ship small quantities for the M2M projects we have in South Korea. As expected, we closed a new design win during the first quarter for a metering application in United States and made good progress on a few others. There has been an observable pick up in interest in machine-to-machine during the first quarter, and we are engaged in a number of discussions, some of which could be closed in time to contribute to 2014 revenue. We are also beginning to see interest coming from other regions outside the U.S. which would help to fuel our future growth.

Thus device category is developing very much as we expected. Our strategic decisions almost two years ago to introduce a family of products called Streamlight LTE optimized Internet of things is proving to be an important one. This providing us with a first mover advantage in a segment that’s extremely promising now that LTE is reaching full coverage in more places.

Clearly, adequate LTE coverage is the first requirement for this market to develop. But in addition, machine-to-machine applications required an optimized combination of price relative to performance, power consumption and size. Another requirement is a future-proof network environment because it’s simply not practical to retrofit such long-lived devices after they’ve been deployed. Some operator in the world already implementing plans to shutdown 2G networks and reform the spectrum. LTE is the only network that can be guaranteed to remain in a place during the 10-year plus time horizon required to justify end-to-end deployments.

The Internet of Things includes a wide variety of potential application some like smart meters that require the future-proof network aspect of LTE, but need only 2G speeds may be particular price sensitive. However, there are a host of other devices and application like health monitoring, video, surveillance and home security that are likely to require the throughput of 4G LTE. Therefore, we believe our fully optimized solution for the Internet of Things will help to expand the size of the market. Going forward as the single-mode market continues to evolve and mature, the importance of having a broad family of optimized solutions will become increasingly abstract.

So in summary, we expect our growth next year and beyond to come from a combination of three factors. First, to continue to have more of the same types of devices with the current customers and engaged operator. Second, to have more operators in various regions, reaching coverage level to justify single-mode devices. And last but not least, more and more new business models application and connected devices based on a broader scope of single-mode solutions for Internet of Things.

So now, I will turn the call over to Deborah for the financial discussion including our guidance for the second quarter.

Deborah Choate

Thank you George and good morning everyone. Revenues in the first quarter of 2014 were $4.5 million. This was a 10% decrease from the fourth quarter and a 96% increase, compared to the first quarter of 2013. Revenues in the first quarter were at the low end of our guidance, primarily because some non-product revenue did not come in the quarter as we had expected.

We shipped approximately 300,000 units in the quarter. We had two 10% customers in the quarter, Huawei with 34% share and GenTek with a 28% share. We realized an overall IFRS gross margin of 39.5%, which was slightly below expectations, mainly due to a less favorable revenue mix than we had expected.

Operating expenses were $10.1 million in the first quarter, down slightly from Q4 and our first quarter operating loss, which increased stock-based compensation expenses was $8.3 million, compared to an operating loss of $8.2 million in the fourth quarter and an operating loss of $9.3 million in the first quarter of 2013.

Net loss was also $8.3 million in the first quarter, the same as in the fourth quarter and this compares to a net loss of $9.4 million in the first quarter of 2013. Basic and diluted loss per share was $0.14 in the first quarter 2014, based on 59.1 million shares outstanding, compared to a net of $0.17 in the fourth quarter, which was based on a 50.3 million shares. Basic and diluted loss per share was $0.24 in the first quarter of 2013.

To facilitate comparisons, we have also reported our results on a non-IFRS basis, which excludes stock-based compensation expense from the net loss. Non-IFRS net loss was $7.9 million in the first quarter, compared to a net loss of $7.6 million in the fourth quarter and a net loss of $8.8 million in the first quarter of 2013. Non-IFRS basic and diluted loss per share was $0.13 in the first quarter, compared to a basic and diluted net loss of $0.15 in the fourth quarter and $0.23 in the first quarter of 2013.

Cash used by operations in the first quarter was $8.4 million, compared to $300,000 in the fourth quarter. The difference was due to the collection in the fourth quarter of $4 million in French research tax credits as well as the timing of customer collections and supplier payments. The French research tax credit for 2011, which we had hope to collect in the first quarter, we now expect to collect in Q2. And we continue to expect to collect the 2013 credit in the second half of 2014. These tax credits are reflected on the balance sheet as a receivable in current assets.

Our cash position at March 31, 2014 was $27.9 million, compared to $37.2 million at the end of Q4. Accounts receivable at March 31, 2014 were $4.2 million, reflecting DSOs of approximately 61 days, compared to 96 days at the end of Q4. Inventory decreased in the quarter to $5.6 million at the end of March from $6.6 million at the end of December as we continue to work down our remaining WiMAX inventory.

Looking forward, we expect revenues for the second quarter of 2014 to be in a range of $5 million to $6 million, with non-IFRS gross margin of around 40%. We expect non-IFRS net loss per diluted share to range between $0.13 and $0.15 for the second quarter of 2014, based on approximately 59.1 million weighted-average diluted shares. The net loss guidance reflects our expectation of a concentration in Q2 of certain cost related to our headquarter office relocation and new product finalization costs.

Our guidance for non-IFRS net loss per share excludes stock-based compensation expense, which we expect to be around $300,000 in Q2. We continue to expect a significant ramp in our LTE revenues during the second half of the year and we continue to target exiting 2014 at a revenue level that will allow us to approach breakeven results with therefore a significantly lower cash burn in the second half compared to the first half of the year.

And now, I’ll turn the call back to Georges.

Georges Karam

Thanks, Deborah. So to conclude, on this conference call, I would like really to stress or to give you three points to take you view at the end of this call. First message is really that, we remained confident and we really are progressing well on our plan for revenue acceleration in the second half of the year as planned. And this is by the way across the three business segments we are working on whether home portable router, mobile computing and the new segment we are engaging with Internet of Things that covers machine-to-machine.

The second point, I mean, regarding this plan is just to understand. This plan is built on the fact that, we have already designed and production phase, generating revenue and growing across the year. And specifically here I would mention or the development I mentioned with emerging carriers where we are seeing acceleration of the business with the new carrier adopting our technology.

Second type of device here or projects we see it is all the product that we have them ready, so we want them, we have them ready, we are making initial shipment. So, they still at small shipment like in China and other places like this and all the revenue around depends really on the commercial launch of the carriers and this really helped to accelerate revenue. And the third type of design wins supporting this plan is, all those designs that we won and they are currently under development to sample to market in the second half of the year. And as I said before, we still working on some advanced designs that we are working on now some of them can still conclude in the year and generate revenue at the end of the year.

And the third message is really beyond 2014, is that, we keep working on new designs and additional carrier engagement, you know other carrier in the U.S. but as well expanding to Europe and other carrier that will help us expand our business from 2014 to 2015.

So, this concludes my talk here and I will open it now for the questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question will come from Tristan Gerra with Baird. Go ahead please.

Tristan Gerra – Robert W. Baird & Co.

Hi. Question is on China and what percentage of – contracts you think would be at a time allocated to a single-mode LTE and if you could provide us with some color for each of the three carriers?

Georges Karam

Yeah. I mean, good question, Tristan. It’s essentially the situation is a little bit complicated in China because we have the three carriers, all of them have plans to move on LTE. The one that we are talking here was really relate to China Telecom and as you know at China Telecom they have a CDMA networks and when they move to the LTE, they used all the mobile devices because they are not ready yet to their LTE network. We left them multi-mode. So, on the first bid, all the mobile devices that they came with were multi-mode because they essentially CDMA and supporting really the 3G-CDMA.

However, all the home routers devices that they requested in the bid, they came simply-single mode. And in this bid, we came with major market share here I believe. To give numbers, we came with more than around 30% about 30% of the bid that came to Sequans and the other two-third went to Chinese vendors if you want to would chipset vendor in China. So, this is on the specific of the bid.

Obviously, now how do we expect the evolution there overtime, we believe what the study and saw in there, I mean, we believe that this will continue expanding even this year and the next year and at least the fixed home routers can still go in single-mode. There is no question about it. So, this is one is clear with China Telecom. And obviously overtime, the more coverage that we will have, they could start to moving have the portable routers supporting on a single-mode before reaching the full mobile devices in the future. So, this is on China Telecom.

On China Mobile, the equation is a little bit different because they have strong coverage as you know in terms of LTE. But, still for many political reasons China Mobile was insisting on getting so far TD-SCDMA as a part of the devices including by the way home routers.

So, the original engagement we had with the China Mobile when we won designs with them we had a product that they had to support the LTE plus the TD-SCDMA. However, we are getting some if you want input from China that we hope that this will develop overtime and we will be moving because it’s really – from cost point of view, it doesn’t make sense and we expect to see in the year, may be towards the end of this year even China Mobile start having some market or some devices only going with single-mode LTE that will open for us further opportunity.

And there is obviously a discussion about all this gray market in China, where the rule is not really in the hand 100% of the operator because you could have just only tablet and – where there is no obligation to support TD-SCDMA and have those kind of devices going only with single-mode LTE. So, we believe it’s a big potential for us. We are very well-positioned with many partners on all the segment there. We already have designed a certified and selected and moving in business and obviously it’s just only question of timing of the ramp of the revenue between this year and next year that would reflect the level of revenue we can generate in China.

Tristan Gerra – Robert W. Baird & Co.

Okay. That’s useful. And then just follow-up, the pace of the ramp that you expect from your large and U.S. customer in line with higher expectation for the second half of this year?

Georges Karam

Yes.

Tristan Gerra – Robert W. Baird & Co.

Okay. Very good. Thank you.

Operator

Thank you our next question comes from Anthony Stoss with Craig-Hallum. Go ahead please.

Anthony Stoss – Craig Hallum Capital Group

Hi, Deborah and George. First further question for Deborah. If you would mind sharing with us given what you expect gross margin and OpEx what’s your breakeven point is for revenues per quarter also what the gross margin drivers might be? And then for George on the M2M side, I am just curious, it seems like it’s more on these fixed asset size. Are you working on anything from more of a mobile asset tracking? Thanks.

Deborah Choate

Hi, Tony. In terms of our breakeven point, we continue to – I’ll work backward, we continue to target a 50% gross margin on chip sales and we’re expecting to keep our operating expenses fairly flat, a little bit higher in the second quarter as I mentioned because we’ve got some one-off cost coming in. But assuming that, we stay around $10 million in operating expenses that implies we need about 20 million in chip sales to meet the breakeven point. And we are off-course introducing some modules into the mix.

The gross margin on modules tends to be more in the 25% range. So, if we are shipping a lot of modules than that raises the breakeven point, but we’re not yet sure of exactly the mix between those when we are looking at the fourth quarter.

Georges Karam

And Anthony, regarding the M2M application, as you know, I mean, essentially we have a lot of engagement in the M2M space. So, it’s really we can go all the variety of application. We are seeing a lot, lot of interest. And as you know, Internet of Things is really kind of hike. I mean many, many guys are thinking about the application. So, when you filter it down you have always the readiness of those projects to move forward. We are really focusing on what can really generate revenue as soon as possible and engaged. There is also another angle as you know that we are still talking about this time in single-mode LTE.

So obviously, there is the step there, where the people are moving because of single-mode LTE today is really 100% pushed by horizon. AT&T not yet there I tend to say, but motivated to move in this direction.

So all this is really we see the market happening. It’s not like exploring I see 100 of opportunities you hunt on the table and many, many customers we’re discussing with. Many of them are in a phase of discussing thinking if they move, they don’t move that depends on their engagement with the carrier as well not only a decision of Sequans. For us, it is quite easy because the fact that, we have this module easy link strategy help us a lot because we can come with our modules and enable the solution very quickly.

So definitely, the mobile asset tracking is one of the segment of filters. As I mentioned, the home automation, home surveillance, metering as well some automotive stuff. So, it’s really across many, many application that we see there, and we are quite pleased with the developments. Still, it’s going to take some time to put all this in a music with the carriers so we can have more and more real projects generating revenue.

Anthony Stoss – Craig Hallum Capital Group

Okay. Great thank you.

Operator

(Operator Instructions). Next we have Quinn Bolton with Needham & Company. Go ahead please.

Quinn Bolton – Needham & Company

Good morning, George and Deborah. Wanted to start with the portable router design win for that horizon that worked at, targeted to launch in the second half of the year. If I recall, I think that was one of the bigger design wins that would contribute to the revenue ramp in the second half. If that’s still the case or have some of the mobile computing and IOHE or M2M applications now sort of diversified your dependency on that one particular portable router design?

Georges Karam

Well, as I said, it’s still in the second half of the year. I didn’t say, it’s a portable router just to correct this. So, we talk about the segment of home router and portable router to be more... So, the design is there still for the second half. The difference if you want in the mobile computing space, in the mobile computing space the designs are much more under control in term of timing if you want, the launch because it chooses module, so it’s a business of module from Sequans, and obviously the integration is easy, the certification is easy.

So you control a little bit more the execution and the timing. When you go to a design from scratch and the chip level, so depending on the complexity of the bucks you’re doing, this could be plus minus shifting to LTE.

So, the exact timing is not that easy to predict even six months in advance because you can have a shift of one months, two months for whatever reason that really depend not on Sequans. So, we still rely on this piece as well as a part of the revenue as well. So, obviously the mobile computing are important contribution, the three design I spoke about, I talked about to our revenue in the second half, but also the design win in the home and portable router space.

Quinn Bolton – Needham & Company

And may be perhaps, would you be able to give us some sense of your revenues split might look like across the three segments, home portable routers and mobile computing and machine-to-machine exceeding 2014? I think in your prepared comments you said that, today most of the revenues is from the portable and home router. Does that become more balanced by year end maybe I guess the question I was trying to get at?

Georges Karam

I believe the machine-to-machine, it will be present for this year but may be not big in general. I mean, may be if I add and if I may be if I mobile computing plus machine to machine will be may be 50% and the other 50% will be home router and portable router in general.

Quinn Bolton – Needham & Company

Okay. Okay, great. And then I know you seem to remain cautious in your outlook for the India market. But, can you give us any update what you are hearing in terms of the launch timing for the Reliance network? That still sounds like it’s set for second half launch or do you think that there is some risk to that may continue to slip?

Georges Karam

There is honestly, I mean, there is no major change if you want in terms versus the previous quarter. In the sense, they are still planning for June, July time frame to expand that trial on various cities. They have more cities to launch and as I said they will be shipping to those trials. And if you talk about the full launch in Q4, commercial launch in Q4. So I remained, I am cautious not because getting if you want any news there, the information is same.

But I am cautious a little bit relevant to the history because we planned in the past a little bit more – we predicted that this will happen and it didn’t happened. So, I remained cautious on this. But there is no other negative news there.

Quinn Bolton – Needham & Company

Okay, great. Thank you.

Operator

And Mr. Karam. We have no further questions.

Georges Karam

Okay. Thank you very much gentlemen. Thanks for ladies and gentlemen obviously who joined our call and looking forward for our next conference call and may be before this if I meet some of you face-to-face or on conference call. Thank you.

Operator

Thank you and ladies and gentlemen that does conclude our conference for today. Thank you for your participation and using AT&T Executive teleconference. You may now disconnect.

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