Sierra Wireless Q1 2006 Earnings Conference Call Transcript (SWIR)

Apr.21.06 | About: Sierra Wireless, (SWIR)

Sierra Wireless (NASDAQ:SWIR)

Q1 2006 Earnings Conference Call

April 20, 2006, 5:30 p.m. EST

Executives

Jason Cohenour - President and CEO

David McLennan - CFO

Analysts

Deepak Chopra - National Bank Financial

John Bucher - Harris Nesbitt

Andrew Lee - TD Newcrest

Mike Abramsky - RBC Capital Markets

Jeff Kaval - Lehman Brothers

Dev Bhangui - Haywood Securities

Sarah Kim - Raymond James

Operator

(Operator instructions) Thursday, April 20, 2006, at 5:30 p.m. eastern time. I’ll now turn the conference over to Jason Cohenour, President and CEO. Mr. Cohenour, please go ahead.

Jason Cohenour

Thanks, John, and good afternoon, everyone. Thank you for joining the Sierra Wireless Q1 2006 earnings call. Joining me today on the call is Dave McLennan, our CFO.

The agenda for today’s call is as follows: following the reading of our safe harbour statement, I will provide an update on our business, and then Dave will provide a detailed review of our Q1 financial results, as well as Q2 guidance. I’ll then provide a brief summary and open the line up for questions. Over to Dave for the reading of the safe harbour statement.

Dave McLennan

Thanks, Jason, and good afternoon everyone. Our forward looking statement disclaimer is as follows: certain statements in this conference call that are not based on historical facts constitute forward-looking statements or forward-looking information within the meaning of applicable securities laws. These forward-looking statements are not promises or guarantees of future performance, but are only predictions that relate to future events, conditions or circumstances, or our future results, performance, achievements, or developments, and are subject to substantial known and unknown risks, assumptions, uncertainties, and other factors that could cause our actual results, performance, achievements or developments in our business or in our industry to differ materially from those expressed, anticipated, or implied by such forward-looking statements.

Forward-looking statements include all financial guidance for the second quarter of 2006, disclosure regarding possible events, conditions, circumstances, or results of operations that are based on assumptions about our future economic conditions, courses of action, and other future events. We caution you not to place undue reliance upon any such forward-looking statement which speak only as of the date they are made.

These forward-looking statements appear in a number of different places in this conference call, and can be identified by words such as may, estimates, projects, expects, intends, believes, plans, anticipates, or their negatives or other comparable words.

Forward-looking statements include statements regarding the outlook for our future operations, plans and timing for the introduction or enhancement of our services and products, statements concerning strategies or developments, statements about future market conditions, supply conditions, and customer demand conditions, channel inventory and sell-through revenue gross margin, operating expenses, profits, forecasts of future costs and expenditures, the outcome of legal proceedings and other expectations, intentions and plans that are not historical fact.

The risk factors and uncertainties that may affect our actual results, performance, achievements or developments are many, and include among other things our ability to develop, manufacture, supply and market new products that we do not produce today but meet the needs of customers and gain commercial acceptance, our reliance on the deployment of next generation networks by major wireless operators, the continuous commitment of our customers and increased competition.

These risk factors and others are discussed in our annual information form, which may be found on CDAR, and in our regulatory filings with the Securities and Exchange Commission in the United States and the Provincial Securities Commissions in Canada.

Many of these factors and uncertainties are beyond the control of the company. Consequently, all forward looking statements in this conference call are qualified by this cautionary statement, and there can be no assurance that actual results, performance, achievements or development anticipated by the company will be realized.

Forward-looking statements are based on management’s current plans, estimates, projections, beliefs and opinions, and the company does not undertake any obligation to update forward-looking statements. Should the assumptions related to these plans, estimates, projections, beliefs and opinions change.

Now, with that, over to you, Jason, for a business update.

Jason Cohenour

Thank you, Dave. The first quarter of 2006 represented our third consecutive quarter of strong operational execution and improving financial metrics following the restructuring of our business in mid-2005. Our business recovery continues to gain momentum.

During the first quarter, we ran production in shipments of our new HSDPA AirCards to customers in North America and Europe. We continued strong shipments of our AirCard 580 for EV DO networks. We significantly expanded our embedded modules business with several new design wins and growing shipments.

We grew revenue by more than 20% over the fourth quarter of 2005, resulting in record first quarter revenue.

We also had strong gross margins driven by growing volume, product mix, some cost reduction, and ASP management.

Finally, we achieved higher-than-expected net profit.

Intense focus on our core business of wide area wireless for mobile computing is driving this recovery and is strengthening our competitive position in a market which we believe has significant growth opportunities.

While we’re very pleased with our Q1 results and the strength of our business recovery, we also recognize that continued hard work and strong execution is required before we achieve the goals we have set for ourselves in terms of product line strength, market position, and financial results.

Moving to business highlights, I’ll start with activities in our AirCard business. A significant part of our overall sequential revenue growth in the quarter was driven by increasing sales of our AirCard products. Our increased sales of AirCard products was driven mainly by growing sales of our HSDPA AirCards, specifically the AirCard 860 for North America and the AirCard 850 for Europe.

When we launched our HSDPA AirCards in Q4 2005, they were the world’s first fully functional HSDPA PC cards. Since launch, we have rapidly built production capacity for these products in order to meet growing demand.

Our AirCard 860 volume in the quarter was driven mainly by Cingular Wireless in the U.S. We’ve earned a strong channel position at Cingular for our AirCard 860, and are benefiting from increasing demand for our product combined with Cingular’s broadband connect service.

We commenced shipments of our AirCard 850 to several customers across EMEA, including carriers and distributors in Spain, France, Portugal, Italy, Switzerland, and South Africa.

While it is still early days for HSDPA in Europe, we are experiencing the benefit of our first to market launch of the AirCard 850. After tripling our revenue in Europe from Q3 to Q4 of 2005, we continue to see strong growth in Q1 of 2006.

During the quarter, we grew our revenue in Europe by 50% over Q4, resulting in record revenue for the region.

We view our initial traction with the AirCard 850 as an important first step in re-establishing a strong position for ourselves in the European market.

In our EV DO AirCard business, we continue to have strong sales of the AirCard 580 to Sprint in Q1, and continue to see solid sales of the product in Canada, Australia, and New Zealand as well.

Moving to new product development activities in our AirCard and rugged mobile business, the development of our next generation EV DO Rev A and HSDPA 3.6 AirCards continues on track. During Q1, we achieved key product development milestones for our AirCard 595 for EV DO Rev A networks ahead of our competition. Together with Lucent and Nortel, we achieved the industry’s first over the air REV A calls using a pre-commercial, yet form factor compliant, version of the AirCard 595.

These early interoperability tests with leading infrastructure providers represents an important step in bringing a solid, high-performance product into the market ahead of other manufacturers.

We also did extensive live demonstrations of the AirCard 595 with Lucent, Nortel and Sprint at the CTIA wireless trade show in early April, achieving impressive data transfer rates on both the downlink and uplink channels.

The AirCard 595 is now available to operators and [customers] for testing and integration purposes. We anticipate that the AirCard 595 will be commercially available in the third quarter of 2006.

Development of our next generation HSDPA AirCard, the AirCard 875, is also on track for launch in the second half of 2006. The AirCard 875 will offer peak data rates of 3.6 MBPS, and will also support tri-band HSDPA as well as quad-band operation on EDGE and GPRS networks.

The AirCard 875 will be a truly global, wireless broadband communications device. We view the AirCard 875 as another important product for further strengthening our position in the U.S. market, and for continuing to grow our business in Europe.

Our AirCard 875 is now making live over-the-air calls in our development labs.

Additionally, we have projects underway to bring next-generation versions of our rugged mobile products to market.

Our MP products have a loyal customer base in the public safety and field service segments, and are an important contributor in gross margin. We expect to launch two next generation versions of the MP; one for EV DO Rev A and one for 3.6 HSDPA later this year and early next year.

Moving to highlights in our OEM business. Sales of our embedded module products grew once again in Q1 and contributed a growing percentage of our overall revenue mix. The growth in our OEM business was driven primarily by increased sales of our legacy embedded module products to our traditional OEM customer base.

Sales of our new EV DO mini-card embedded module, the laptop OEM’s, were flat in Q1, relative to Q4 of 2005. We view our Q1 sales in this segment as consistent with the nascent stage of this new and potentially high growth market.

During Q1, there were several industry developments, announcements, and promotions in the embedded for laptop space, which indicate to us that momentum is building.

In our own business, we made significant progress on design wins, OEM platform expansion, and product development that we believe will be important growth catalysts for our business.

We remain bullish yet patient on the embedded for laptop sector and believe that we are well-positioned to capture a leading share in this potentially high-growth market.

We have design wins with Lenovo, HP, and Panasonic for our EV DO modules, and commenced commercial shipments of these products in the second half of 2005.

Our fourth quarter launch with Lenovo represented the first commercial deployment of an embedded 3D wireless mini-card by any laptop manufacturer, making us and Lenovo first to market.

Early in Q1, HP also announced the availability of their first laptop platform incorporating our EV DO mini-card. Since announcing these initial design wins, Lenovo, HP and Panasonic have all incorporated our EV DO embedded module solutions into multiple laptop platforms. As these new platforms launch, the addressable market for our embedded module products grows considerably.

Since our first-to-market EV DO mini-card launch, we’ve announced design wins with both Lenovo and Fujitsu Siemens for our MC 8755 mini-card for European UMTS HSDPA networks.

We’ve completed development of the MC 8755 on schedule and commenced initial commercial shipments of the product during the first quarter.

During the first quarter, we were also awarded an additional HSDPA design win with a major laptop OEM. We also secured several new design wins with manufacturers of fixed wireless terminals for both our EV DO and HSDPA embedded modules. We’re encouraged to [fire] early success in the fixed wireless terminal segment and believe that this space, like the laptop market, could be an important growth contributor to our business.

Moving to new OEM product initiatives. As mentioned, the development of our MC 8755 mini-card module for European HSDPA networks is now complete and production is ramping. Our MC 8765 for North American HSDPA networks is nearing completion. We expect to launch the product during the current quarter.

We have OEM design wins for both of these products.

Development of our next generation mini-card modules for EV DO Rev A and HSDPA 3.6 are also on track. We expect to launch both of these next generation products in the second half of 2006.

During the first quarter, we announced that our new MC 5725 EV DO Rev A mini-card module is now available to OEM’s, infrastructure partners, and carriers for integration and testing purposes.

As we achieved with the AirCard 595, we performed the industry’s first over-the-air Rev A calls using pre-commercial versions of the MC 5725, with both Lucent and Nortel. These interoperability tests with leading infrastructure providers represents an important step in bringing solid, high-performance product into the market ahead of other manufacturers.

We also did extensive live demonstrations of the MC 5725 with HP, Lenovo, Panasonic, Lucent, Nortel and Sprint at the CTIA wireless trade show event in early April.

I believe these early demonstrations and integrations highlight our strong R&D execution in Rev A.

Moving to some more general comments about the state of our business, our channels reported strong sell-through of our products in Q1, highlighting growing market demand. Bookings in Q1 were also strong, as they were in Q4, giving us good visibility to Q2 2006 revenue.

We were also able to strengthen our inventory position during the quarter on select products, putting us in a better position to respond quickly to increases in customer demand. During the quarter, we witnessed continued aggressive deployment of high-speed 3G services by many of the world’s leading operators. We view this deployment, coupled with the associated promotional activities related to high speed wireless data, as an important catalyst for our business.

We believe this trend will continue throughout 2006 and beyond.

I’ll now turn it back over to Dave to cover our Q1 financial results.

Dave McLennan

Thanks, Jason. Looking at our first quarter 2006 results, our results are reported in U.S. dollars and are in accordance with U.S. GAAP.

For the first quarter of 2006, our revenue is $45.2 million, gross margin was $16.7 million, or 36.8%. Operating expenses were $14.8 million, and our net income was $2.6 million, or $0.10 a share.

During the quarter, Cingular and Verizon each accounted for more than 10% of our revenue, and in aggregate, these two customers represented approximately 38% of our revenue.

As a result of adopting new accounting standards for stock based compensation, our first quarter results include a non-cash stock based compensation expense of $900,000. Prior to 2006, the impact of stock-based compensation was not reflected in our income statement. Because this is new, and to assist you in understanding the impact of stock-based compensation expense on the various components of our cost structure, the Q1 results, as reported in the financial statements presented in our press release, include stock-based compensation as is follows: the cost of goods sold, approximately $90,000; in sales and marketing, approximately $275,000; R&D, $170,000; and administration, approximately $350,000.

Looking at the results for the first quarter of ’06 relative to the guidance we provided on January 26 for the quarter: fourth quarter revenue was $45.2 million, approximately 13% better than our guidance of $40 million; gross margin was 36.8%, above our guidance of 33.5%; operating expenses, excluding stock-based compensation expense, were $14 million, in-line with our guidance of $13.7 million; operating expenses, including stock-based compensation expense, were $14.8 million, in-line with our guidance of $14.7 million; net income of $2.6 million, or $0.10 per share, was better than our guidance of a net loss of $800,000, or a loss per share of $0.03.

Excluding stock-based compensation, our net income of $3.5 million, or $0.13 per share, was better than our guidance of break-even to slightly positive earnings.

Our free cash flow, being cash flow from operations less CapEx for fixed assets and intangibles, was -$2.2 million, consistent with our guidance of negative cash flow. Contributing to the negative cash flow in Q1was a royalty payment of $5 million to an intellectual property owner for historical sales. The royalty payment was made as per an agreement entered into in December, 2005. The expense related to these royalties was accrued for in prior periods.

Looking at our Q1 ’06 results compared sequentially to Q4 2005, revenue increased to $45.2 million from $37.6 million, an increase of 20%. This growth primarily came from the sales of our new HSDPA PC cards in North America and Europe. EV DO and EDGE PC cards were fairly consistent quarter on quarter.

Overall, OEM sales were up during the quarter, driven by sales of our legacy embedded module products to our traditional OEM customer base. Sales of mini-card embedded modules to laptop OEM’s were flat in Q1 versus Q4, consistent with the nascent stage of this product category.

In terms of gross margin, gross margin was 36.8% in Q1 compared to 38.6% in Q4. Recall that Q4 gross margin included a 3.2% favourable impact from the finalization of a royalty agreement, the cost of which has been accrued for at higher rates in prior periods.

Q1 gross margin showed improvement over the normalized Q4 gross margin, driven by growing volume, product mix, ASP management, and some product cost reductions.

Looking at OpEx in Q1 versus the fourth quarter, for purposes of comparison, if we exclude stock-based compensation expense, our operating expenses were $14 million in Q1 versus $14.6 million in Q4. Most of the sequential decline is due to a drop in sales and marketing costs as Q4 was a heavy new product launch quarter.

Finally, net earnings -- again for the purposes of comparison, excluding stock-based compensation expense -- net earnings were $3.5 million, or $0.13 per share in Q1 versus earnings in Q4 of $900,000, or $0.04 per share, reflecting the impact of higher revenue, continued strong gross margin, and good OpEx management.

Moving to the balance sheet compared to December 31, 2005, our cash, short and long-term investments decreased by $2.4 million to $101.7 million at the end of Q1. The decrease in cash reflects the improvement in operations, less the $5 million royalty payment referred to earlier.

Inventory levels increased during the quarter from $3.3 million to $11.2 million, as we were able build inventory positions on select products in order to be able to quickly respond to increasing customer demand.

We expect to continue to strengthen our inventory position in Q2.

Looking at our revenues by product line, PC cards represented 72%, or $32.3 million of our revenues in Q1, compared to 68%, or $25.5 million in Q4.

Our OEM business represented 18%, or $7.9 million in Q1, compared to 17%, or $6.5 million in Q4. Our MP business was 8%, or $3.8 million in Q1, compared to 9%, or 3.4% in Q4. And other was 2% in Q1 versus 6% in Q4.

The growth in our PC card revenue during the quarter was driven primarily by increased sales of our new HSDPA AirCards to customers in the U.S. and Europe. OEM sales were up during the quarter, driven by sales of legacy embedded module products to our traditional OEM customer base.

Looking at revenues by distribution channel, carriers were 51% in Q1 versus 51 in Q4. Resellers were 30% in Q1 versus 31% in Q4. OEM was 19% in Q1 versus 18% in Q4.

Looking at revenues by technology, GSM based revenues, which include EDGE and HSDPA, were 49% in Q1 versus 47% in Q4. CDMA was 49% as well in Q1 versus 50% in Q4, and other was 2% in Q1 versus 3%.

During Q1, sales of HSDPA AirCards added significantly to our GSN based business. We also experienced solid growth in our CDMA revenue, driven by increased sales of rugged mobiles and embedded module products.

Finally, revenue by geography. In Q1, revenue in the Americas was 69%, or $31.2 million versus 67% or $25.3 million in Q4. Revenues in Europe were 18%, or $8 million in Q1 compared to 14% or $5.2 million in Q4. In Asia Pacific, revenues were 7% or $3.3 million in Q1 versus 12% or $4.4 million in Q4. In our worldwide PC OEM segment, revenues were 6%, or $2.8 million in Q1 versus 7%, or $2.7 million in Q4.

We had strong growth in the Americas in Q1, driven primarily by increased sales of our AirCard 860 for HSDPA to Cingular in the U.S. in support of their nationwide broadband connect rollout.

In Europe, we saw a growth in Q1 ’06 of 50% over Q4 ’05, reflecting our initial traction with the AirCard 850.

AsiaPAC sales declined modestly, and the worldwide PC OEM sales were relatively flat, reflecting the nascent stage of this market.

On to guidance for the second quarter of 2006. We are providing guidance for the second quarter ending June 30, 2006, which reflects our current business indicators and expectations. Inherent in this guidance are risk factors that are described in detail in our regulatory filings. Our actual results could differ materially from the guidance presented.

Our guidance for the quarter includes a significant contribution from recently launched products. There are uncertainties associated with the launch and early [ramp] of new products that could affect our ability to achieve this guidance.

All figures are estimates based on management’s current beliefs and assumptions and are subject to change.

We expect Q2 to show continued sequential revenue growth over the first quarter. Our guidance for Q2 revenue is $52 million. Gross margin guidance is 34.5%. Operating expense guidance is $16 million, and that results in a net income of $2.6 [million], or $0.10 a share.

This guidance includes stock based compensation expense of approximately $1 million.

The expected increase in OpEx relative to Q1 reflects third party certification costs in advance of new product launches scheduled for the second half, as well as some measured investments in new products and infrastructure to strengthen our core position and drive growth.

Additionally in Q2, we expect cash flow to be slightly negative to slightly positive, depending on our level of ending inventory.

With that, I’d like to turn it back to Jason for a summary.

Jason Cohenour

Thanks, Dave. During the first quarter of 2006, we saw continued improvement in the financial metrics of our business and continued strong execution on new product development, production wrap, and sales. Revenue for the first quarter was up 20% compared to the fourth quarter, driven by growing sales of our HSDPA AirCards and CDMA embedded modules. Gross margin was strong on the quarter and we managed operating expenses effectively. All of these factors contributed to a better than expected net income result.

We expanded the customer base for our HSDPA cards, particularly in Europe, where we experience 50% sequential growth and had record revenue. We saw good growth in our traditional embedded modules business, and continued to execute well in the emerging embedded module for laptop space.

The strength of our execution is highlighted by the commencement of commercial shipments of our first HSDPA mini card, and by securing a third design win with a major laptop OEM for HSDPA mini cards.

We showcased our strong development progress in EV DO Rev A, achieving the industry’s first live Rev A calls with pre-commercial devices, and by demonstrating both our AirCard 595 and MC5725 with an impressive roster of industry leaders at the CTIA show in early April.

Development continues on track for our next generation HSDPA AirCard and mini-card products as well, and we expect to commence commercial shipments of these products in the second half of the year.

Our focus for the balance of 2006 is to continue to execute on our new product pipeline and the business development activities related to bringing these new products to market, as it’s these activities that are providing the foundation to our strong recovery.

While execution on our current programs is our first priority, we are also focused on making select additional investments in new product development and support infrastructure to strengthen our position in wide area wireless for mobile computing. We believe that the market for wide area wireless for mobile computing will continue to grow at a healthy pace, and a continued strong execution and careful reinvestment will enable us to capture a growing share of this growing market.

Given the robust industry demand outlook, and our continued strong execution on new product development and the related sales, marketing and production activities, we anticipate further gross in our business in Q2, and in the second half of 2006 as well.

While our second half outlook is bullish, it is still too early to illustrate for you the shape of our growth curve, given several factors that need to play out, such as precise timing on product launches, technology transitions, new OEM platform launches, and seasonality.

While we are very pleased with our Q1 results and the strength of our business recovery, we also recognize that a lot of hard work and strong execution is required before we achieve the goals we have set for ourselves in terms of product line strength, market position, and financial results.

With that, John, I’ll open the line up for questions.

Question and Answer Session

Operator

Thank you. (Operator instructions) The first question comes from Deepak Chopra of National Bank Financial. Please go ahead.

Deepak Chopra - National Bank Financial

Great quarter, guys. I was wondering if you could talk a little bit about the trend line you saw in the quarter in terms of ordering pattern. Did you have a book-to-build ratio of better than 1? Also, if you could maybe comment on inventory that you’re seeing in your different respective channels.

Jason Cohenour

Well, I’ll give you a directional commentary on bookings, and I mentioned it already and what we don’t do typically, Deepak, is provide book-to-build ratios, but we did mention that bookings were strong in the quarter, as they were strong in Q4 as well. Those two strong booking quarters in a row gives us good visibility on Q2 revenue.

With respect to channel inventory, again, kind of a directional commentary for you. Our channels reported strong sell-through during the quarter, very strong sell-through, in fact, so we are comfortable with the channel inventory levels.

Deepak Chopra - National Bank Financial

Did you struggle meeting demand during the period?

Jason Cohenour

Well, we were in a better position in Q1 to meet demand than we were in Q4 and Q3.

Deepak Chopra - National Bank Financial

Fair enough. Maybe just one last quick question, in terms of pricing pressure on the HSDPA side, are you seeing anything there right now relative to what’s typically normal? Has it become more aggressive, the environment? Or is it following patterns you’ve seen over the last two quarters?

Jason Cohenour

It’s aggressive. I don’t know if it’s any more intense, Deepak, but it’s definitely aggressive, particularly in Europe where incumbent players are defending their turf aggressively. That’s anticipated, and frankly, in order to crack that market and continued growth in that market, we need to be aggressive on pricing as well.

Deepak Chopra - National Bank Financial

Thank you, great quarter.

Jason Cohenour

Thanks.

Operator

Next question comes from John Bucher of Harris Nesbitt. Please go ahead.

John Bucher - Harris Nesbitt

Thank you very much. I think you all indicated that the OEM module for the Rev A and HSDPA were relatively flat fourth quarter to first quarter. I’m wondering, do you think that the looming availability of your Rev A and 3.6 HSDPA might be overhanging decisions to incorporate those modules in large orders?

Jason Cohenour

I honestly don’t think so, John. First a clarifier -- during the quarter, we really were only shipping the EV DO mini-card in any meaningful volume. Our HSDPA mini-card, we had initial commercial shipments. They were quite modest in the quarter.

So I think lots leads up to a design win and an integration effort, and candidly, once the train kind of leaves the station on commencement of integration work and go-to-market planning, it’s awfully hard to stop that, right?

So the fact that we had a product road map which, by the way, our OEM customers have seen for quite some time that had Rev A and 3.6 HSDPA devices on it, I don’t think that’s playing into their decision with respect to Rev 0 and when 1.8 launches.

In fact, we’ve seen just the opposite. We’ve had additional design wins in the first quarter for our Rev 0 and 1.8 products, and in addition to that, some of our existing laptops have now expanded those modules to more of their platforms, [and we’re] seeing the results of that expanded platform activity as well, those new platforms are just now getting completed and certified and getting ready for launch.

John Bucher - Harris Nesbitt

Okay, even though we’re almost at mid-year and you’re going to be launching the Rev A and 3.6 HSDPA, you don’t think that’s having a significant impact on people’s decisions to move forward?

Jason Cohenour

[It’s too late.] I mean, all of the decisions related to embedding wide area wireless inside a platform have been made months ago.

John Bucher - Harris Nesbitt

I’m speaking more not of the OEM manufacturers but rather some of the enterprise decision-makers and buyers who would be procuring this equipment…

Jason Cohenour

Oh, I see, the end-to-end use…

John Bucher - Harris Nesbitt

Yes, sir.

Jason Cohenour

You know, I don’t know. I mean, you could ask the same question about AirCard sales, right? There’s always something new and faster coming down the pipe, same with notebooks. So that’s always a factor, John. I don’t think that’s a factor in our flat quarter over quarter sales though, or our flat sequential sales. I think the bigger factor there is it’s early.

John Bucher - Harris Nesbitt

Point taken. Were there any components scarcities, or any supply chain limitations, where you’re having to order significantly? I noticed your inventory did come up a bit and you indicated that next quarter we should expect them to come up a little bit more too. Are there certain long-lead items, and if you could say what they are?

Jason Cohenour

Well, we would prefer not to comment on what they are, but there are a number of them that are long-lead and difficult to get. Worldwide demand for wireless products is very high and increasing as you’ve seen from announcements by QualComm, Nokia and others, and that does put pressure on supply chain.

You know, we’ve been aggressive. We saw that coming, too, so we’ve been aggressive on supply chain now for six to nine months, knowing that worldwide demand was increasing and the supply chain was tightening on myriad components, not just one, two, or three components.

So we are purchasing farther ahead against both demand and new product launches. We’re actually purchasing components now much earlier in the new product development cycle so that we’re ready at launch, and we have to do that given the strength of worldwide demand for wireless components.

John Bucher - Harris Nesbitt

You’ve got the balance sheet for it, anyway. Final question, with respect to Verizon wireless, they were mentioned as a greater than 10 percent customer. I’m guessing that must have been traditional embedded modules that were going to Verizon?

Jason Cohenour

No, we don’t sell embedded modules to Verizon or any operator, for that matter. If we do, it’d be very unusual. So what we sell to operator customers are our finished products. So during the quarter with Verizon, we did have sales of AirCard 580’s. I would characterize that as modest. We had robust sales of our NP products to Verizon.

John Bucher - Harris Nesbitt

Okay, congratulations on a profitable quarter.

Jason Cohenour

Thanks, John.

Operator

The next question comes from Andrew Lee of TD Newcrest. Please go ahead.

Andrew Lee - TD Newcrest

Jason, the comment on the HSDPA design win, did you comment whether it was North American or Europe for the embedded module?

Jason Cohenour

No, I didn’t.

Andrew Lee - TD Newcrest

Okay, and have any of the OEM’s gone to dual sourcing yet, to your knowledge?

Jason Cohenour

Yes, Panasonic has.

Andrew Lee - TD Newcrest

Right, but of the tier one’s, any of them gone?

Jason Cohenour

I don’t believe so, Andrew.

Andrew Lee - TD Newcrest

Okay. So this is the first time to my knowledge that you guys have actually disclosed the mini PC revenues. Are you going to do that on a go-forward basis?

Jason Cohenour

We are. We, and frankly some of our competitors have made lots of noise around it and we believe it’s a strategic initiative for us and operators and OEM’s, and it’s certainly important enough that we spotlight it and give you guys the information, because we’re making significant investments in that area.

Andrew Lee - TD Newcrest

So the growth in the OEM’s, as you said on the legacy side, what were the applications they were going into?

Jason Cohenour

On the legacy side?

Andrew Lee - TD Newcrest

Yes.

Jason Cohenour

A basket of applications. A lot of it mobile computing oriented but also a lot of it vehicular-based systems for vehicle tracking and dispatch and the like, as well.

Andrew Lee - TD Newcrest

Okay. [Novetel] has made some comments with regard to express card development. You guys haven’t talked about yet, is that something on your roadmap?

Jason Cohenour

It is on our roadmap. We have not disclosed specific timing for product launch for competitive reasons.

Andrew Lee - TD Newcrest

How do you view that opportunity? When would notebooks start offering that slot in addition to the type II slot?

Jason Cohenour

Well, they already are. It’s very nascent, but there are a handful of platforms that are in the market today that have both express card slots and PCMCIA slots. I believe Dell has a platform that actually has only express card slots, targeted at consumers, primarily.

So our view is there’s going to be a significant overlap period here where both slots are in existence in the market, and over time, there’s going to be a slow transition over to express card only.

Our view is it’s going to start with consumer platforms, and in most cases, it’s going to start with both slots in a given platform. Then, over time, migrate over to all express card, but that migration in our view will take years.

Andrew Lee - TD Newcrest

That’s helpful. Just on taxes, how do we think of the tax rate for the rest of this year and for next year?

Dave McLennan

In terms of 2006, you saw that we did book a tax expense. It’s a non-cash tax expense in this quarter. I would use a range of 15% to 20% throughout this year would be a range to model it around.

Andrew Lee - TD Newcrest

Does that drop next year or go up next year?

Dave McLennan

I would expect that to increase next year, and we’d need to put in some management strategies, but I think longer term, a target would be approximately 25%.

Andrew Lee - TD Newcrest

Okay, great. Thank you.

Operator

Your next question comes from Mike Abramsky of RBC Capital Markets. Please go ahead.

Mike Abramsky - RBC Capital Markets

Thanks very much. Congratulations on a really great quarter, and good guidance.

Could you give us a bit of insight into, to the extent that -- I realize you don’t break this down, but Sprint was a 10% customer last quarter, they’re not this quarter, and you just discussed shipping robust NP to Verizon, so it really sounds like the lion’s share of your card momentum is going to roll it at Cingular. Is that a fair assessment of what’s going on?

Jason Cohenour

No, I wouldn’t characterize it that way. I think it’s fair to characterize that our growth in the quarter was driven by HSDPA, largely at Cingular and in Europe, but we continue to have strong consistent sales of our EV DO AirCard as well during the quarter, and I think that bears out in our technology breakdown as well.

I mean, you can back into the math. It was fairly consistent and strong, and that goes for Sprint as well. Now, they weren’t a 10% customer in the quarter, but revenue was up 20% as well, so we were still big and important.

Mike Abramsky - RBC Capital Markets

Okay, good. Built into your guidance, do you see the similar sort of aggregate Cingular/Verizon share coming in the next quarter?

Jason Cohenour

Well, we don’t give specific guidance per customer, but directionally we anticipate strong sales continuing into Cingular. We anticipate strong sales continuing into Sprint, and we anticipate some further traction in Europe, as well as expansion in our embedded modules business.

Mike Abramsky - RBC Capital Markets

You discussed earlier the pricing is aggressive, particularly in Europe. What’s your strategy on preserving margins over market share penetration for Europe? May we see that come into your European margins as a whole, if you chose to make a big push there?

Jason Cohenour

Well, you know, there’s not a lot of magic here, candidly. We need to continue to be aggressive on cost reduction. That’s one key area of bolstering gross margins, but of course, cost reduction takes time. You can’t do that over night.

A salesman with the stroke of his pen can cut out a lot of gross margin, and it takes you a year to get that back in cost reductions, so we continue to do basic strong blocking and tackling on cost reduction. That’s going to be key.

Over time, we’re going to be adding differentiation to our product line-up as well. You know, we’re not going to disclose exactly how that’s going to come in, whether or not there’s tiers of product or we just add differentiation to a single product and charge more for it.

We believe that we need differentiation, and we also believe that we need a portfolio effect in our product line, which is probably too narrow today to have that portfolio effect, that will enable us to over time blend gross margins to a strong level.

Notice I fell short saying blend gross margins up -- blend them to a strong level. We’ve said it repeatedly in the past. While our gross margins have been very strong the last couple of quarters, we’ve got pretty solid gross margin guidance. Our longer term view of our business is even with a portfolio effect, that our gross margins will be in the low 30’s as volume goes up. That’s just the business we’re in.

Mike Abramsky - RBC Capital Markets

So you’re sort of implying that this diversified portfolio will give you more market penetration, and more kind of bullets in the gun in regard to that, but at the expense to some extent of perhaps some of the gross margin strength you have now, but you’ll still be within your guided range.

Jason Cohenour

I guess that’s a fair characterization.

Dave McLennan

The blending portfolio approach.

Jason Cohenour

Yes.

Mike Abramsky - RBC Capital Markets

Okay. Do you see in the big picture that the advanced speeds of Rev A are going to drive the same demand curve as what EV DO is driving now? EV DO is still a relatively early technology, as far as deployment is concerned, adoption.

Jason Cohenour

Well, our EV DO PC card has been in the market three years now, so we don’t consider it very new.

Mike Abramsky - RBC Capital Markets

For you guys, yes. I just meant for the average consumer.

Jason Cohenour

I think it will. You know, speed drives adoption, for sure. We’ve learned that over and over across many generations of technology. By the way, we have yet to see what HSDPA speeds are going to drive in Europe in terms of increased adoption. That’s going to play out, we anticipate. Speed’s going to grow the market there just like it has in North America.

I think Rev A is a really important technology, we believe. It’s important to us because we’ve got a three-year old EV DO card in the market right now, so whether or not it has Rev A in it, which our AirCard 595 does, it also gives us an updated platform, a little bit more flexibility with respect to driving cost out, so even as a Rev 0 card, it’s important in our product line-up.

You know, on top of that, we do view Rev A as an important technology that we hope will drive further adoption. Now, we have no idea what percentage growth that’s going to drive, candidly, but it’s a pretty compelling speed increase on the uplink in particular, and that does open the door for a myriad of new applications that just aren’t possible with Rev 0. We’ll have a similar situation, of course, sometime next year when HSDPA gets deployed by the leading GSM guys.

Mike Abramsky - RBC Capital Markets

Last question, is there an efficiency limit that you’re going to reach with regard to some of your cost-cutting measures? Do you see more room there? What’s the next kind of phase in driving improved profitability, or is it really top-line at the next point?

Jason Cohenour

Top line. It’s all about top line. In fact, we dropped a little hint there. We’ve raised off ex guidance in Q2. In truth, most of that, better than half of that is driven by third party costs that are relatively non-recurring related to new product launches.

The remainder of that is careful reinvestment in our business.

Our view is this market is growing strong now. It’s poised for continued strong growth, and A, we can’t afford product holes, and B, we want to blend in that product portfolio effect that we were just talking about a minute ago, and that takes some careful reinvestments. We believe that’s going to drive a significant change in scale.

Mike Abramsky - RBC Capital Markets

Thanks very much.

Operator

The next question comes from Jeff Kaval of Lehman Brothers. Please go ahead.

Jeff Kaval - Lehman Brothers

Thanks very much. Jason and Dave, I wanted to investigate your outlook for the June quarter in a little bit more detail. It seems revenue’s up quite a bit, but it sounds like you’re looking for the margins to come down a chunk. I’m wondering if that is a an ASP phenomenon, or a mixed shift, and if it’s a mixed shift back to OEM, is that based on module sales or more legacy products?

Jason Cohenour

It is going to be a combination, we believe, of mixed and a steadily increasing shift in our OEM business, growing our OEM business. Also, we’re enjoying some decent margins on some legacy products that we would expect to diminish over time as well, so you’ll see some movement within the product categories as well, so it’s really a function of both pricing and mix.

Jeff Kaval - Lehman Brothers

Okay, and if the mix shifts back to OEM, that would presumably be for the PC modules rather than for legacy products? Is that the way we should think about that?

Dave McLennan

I think it would be a combination of both, Jeff. You know, our legacy products are doing well in the OEM segment, and we have expectations of it increasing with mini-cards, laptop OEM’s.

Jason Cohenour

I do think in terms of growth-rate, Jeff, certainly our expectations are that the growth rate of mini-cards inside laptops will be significantly higher than the growth rate related to our legacy embedded modules business.

Jeff Kaval - Lehman Brothers

Okay, so we should see a resumption in the growth rate of those products after a flattish first quarter?

Dave McLennan

[There could be some timing there].

Jason Cohenour

Exactly. So if it doesn’t happen in this quarter in a big way, we would certainly expect it would happen in the future.

Jeff Kaval - Lehman Brothers

All right. That I guess makes sense.

Could you talk a little bit about where you would like your inventory to be, sort of in terms of a days number, or absolute number? It certainly feels like it was up a chunk this quarter, and I wanted to take a look at where you would like to run that, because I know components are tight too.

Dave McLennan

Yes, you know, it would be nice to get it into the one to two month range of inventory, and we’re very much focused on getting key components, so a very targeted buy of certain key components, but I think if we can drive inventory to a target of two months or less, that would be [worth] targeting for.

Jason Cohenour

You know, there’s a bit of an over-performance goal there if you will, Jeff, with respect to inventory because you know that we have in past quarters struggled sometimes to meet customer demand. Sometimes, well, usually that customer demand is just not forecasted that well by the customer or by our sales guys, so we need to be in a stronger responsive position in anticipation of those spikes in demand.

Jeff Kaval - Lehman Brothers

That makes sense, it makes sense. The last question is it seems still like in the Cingular channel, the option card debuted at a bit of a premium to where you and Novetel were priced. That premium seems to have disappeared over the past couple of weeks. I’m wondering if there’s anything going on, if we should read into that at all in terms of shared dynamics, or which card is featured at that moment.

Jason Cohenour

Well, we stated qualitatively, Jeff, that we feel like we’ve got a very strong position in the Cingular channel, and they represent a significant part of our Q2 guidance, which is pretty good.

Jeff Kaval - Lehman Brothers

Indeed. Are you in a situation where there’s more demand that you might have met at Cingular? Have components been easier to obtain?

Jason Cohenour

You know, I’d rather not comment on that at any specific level, Jeff. Yes, I think that you will find that Cingular has been satisfied with our ability to respond to their demand.

Jeff Kaval - Lehman Brothers

Okay, excellent. Thanks very much.

Jason Cohenour

You bet.

Operator

Your next question comes from Dev Bhangui of Haywood Securities. Please go ahead.

Dev Bhangui - Haywood Securities

Hi, good afternoon, guys, and congratulations Jason, as well as Dave and the team for a quarter exceeding our expectations.

Jason Cohenour

Thanks, Dev.

Dave McLennan

Thanks, Dev.

Dev Bhangui - Haywood Securities

My question was in terms of Europe. Since the European sales have been lapping up, and obviously they’re lapping up on the PC card side, you guys have been shipping to some of the carriers in Europe and those names have not yet been announced, right?

Jason Cohenour

Correct.

Dev Bhangui - Haywood Securities

Would they be classified as major carriers?

Jason Cohenour

I would classify them as important carriers to us.

Dev Bhangui - Haywood Securities

Okay.

Jason Cohenour

I’m sorry, I’m not trying to be cute there, Dev.

Dev Bhangui - Haywood Securities

No, I understand.

Jason Cohenour

I have to be careful with disclosure there.

Dev Bhangui - Haywood Securities

Sure. Just [looking at] from North America itself, for the Cingular, or any other carrier, as they kind of move on the HSDPA from the 1.8 to 3.6 transition, what is the usual life that you expect, based on what you see right now?

Jason Cohenour

The usual life in the 1.8 card, you mean?

Dev Bhangui - Haywood Securities

Yes, in the sense what carrier, whether it’s in Europe or North America, will shift from the current 1.8 to 3.6, and will start demanding from you as well as your competitors the 3.6 version. What is the usual timeframe that you expect?

Jason Cohenour

I’ll look back in history and give you my answer, and by the way, that’s -- as you guys like to say, it’s no guarantee of future performance, but there is usually, in all of our products, there’s a longer tail on the older thing than we ever anticipate.

To give you an example, we’re stilling selling 1X PC cards. We’re about out of them, but believe it or not, we’re still selling 1X PC cards, and who would’ve thought that 3+ years after we launched our EV DO card we’d be still selling 1X PC cards, but we are.

The same goes for EDGE, by the way. We’re still selling EDGE PC cards -- by the way, to Cingular as well. We always go into these technology transitions believing that there’s a cliff on the old thing, a man falls off a cliff. In reality, what generally happens is there’s a longer tail than you expect.

Dev Bhangui - Haywood Securities

Okay. Thank you. I guess I was just kind of flip-flopping between Europe and this question. In terms of the Q2 guidance and going forward, obviously the ramp in terms of Q2 guidance over the Q1 guidance, I would still say that the European sales of PC cards would have not yet been factored. Would that characterization qualitatively be right?

Jason Cohenour

You mean, if I read into your question, are you saying that you think in our guidance, European sales are flat?

Dev Bhangui - Haywood Securities

No, I’m saying that the European wave, if at all we can expect a European wave in terms of revenue growth for Sierra Wireless, that is yet to come in terms of the guidance that we see in Q2.

Jason Cohenour

In terms of rapid growth?

Dev Bhangui - Haywood Securities

Yes.

Jason Cohenour

Yes, I think that’s safe to say.

Dev Bhangui - Haywood Securities

Okay, moving on to the OEM channels. The new round of OEM wins, and I guess everybody’s kind of working on that right now…

Jason Cohenour

Dev?

Dev Bhangui - Haywood Securities

Yes?

Jason Cohenour

Just a little more color on the European commentary. You know, part of that is it’s kind of a weird environment there now where you don’t have a lot of HSDPA networks up and operating, and the ones that are, are with smaller carriers. So it’s kind of a bit of a strange technology transition no-man’s land, and that of course has a dampening effect on demand, notwithstanding our performance. It has a dampening on demand.

I think once HSDPA networks get fully deployed by the major groups, and high speed is actually available to European customers, that will have a positive impact on demand overall, and we are clearly hopeful that we’ll a beneficiary of that demand growth.

Dev Bhangui - Haywood Securities

Thank you. In terms of the OEM wins itself, I guess I wanted to find out whether second order OEM wins, is that going to be on the EV DO Rev A and the 3.6 HSDPA platform respectively, or is it still on the previous one?

What is going to be the timing of this particular round? Not in terms of announcements, in terms of you guys really enjoying the revenues out of those round wins.

Jason Cohenour

Out of round two?

Dev Bhangui - Haywood Securities

Yes.

Jason Cohenour

I guess it’s a 2007 thing for us, in terms of actual revenue, I think.

Dev Bhangui - Haywood Securities

Early or mid?

Jason Cohenour

That’s about as far as I’ll go on that, Dev, because currently, my crystal ball doesn’t go that far out. There is a laptop cadence though. New laptop OEM’s tend to launch, new laptop platforms, roughly once a year. Often that’s at the start of the year. Sometimes late in the previous year there’s a modest refresh, but generally speaking, there’s a target of late in the year or early in the following year for new platform launches, and that’s the most convenient time to upgrade your airlink capability as well.

So for our next generation sales, Rev A and 3.6 HSDPA, it’s more of a late ’06 and into ’07 sort of phenomenon.

Dev Bhangui - Haywood Securities

Okay. A quick question to Dave. Dave, and I think Jason also in your read commentary, you guys mentioned about cost structures and ASP management. Can you give us a little bit more color in terms of that, and whether that’s going to be like a short-term, one or two quarters phenomenon? Or is it going to be a long-term phenomenon?

Dave McLennan

In terms of product cost, Dev?

Dev Bhangui - Haywood Securities

Yes.

Jason Cohenour

With respect to product cost, Dev, you know it’s what typically happens is you begin negotiating major product cost reductions, component reductions, manufacturer of value-add reductions, you tend to do that, you know, as the year winds down.

Often they’re implemented at the start of a new year. If you have lots of inventory, then it takes a while for those product cost reductions to kind of flow through and for you to get the benefit of it.

That didn’t happen to us this year, right, because we were in a weak inventory position at the start of the year, and we were able to, based on forward-looking demand trends, able to negotiate pretty good cost reductions, so we have an immediate impact of those cost reductions in the first quarter.

So what happens between now and the end of the year? It’s more modest grinding is the way I would characterize it, Dev. Usually you have a little step function at the start of the year and you’re able to ground modestly on that over the course of the year.

Dev Bhangui - Haywood Securities

Okay.

Jason Cohenour

With respect to ASP’s, that’s going to move around a bit, frankly. The more revenue we get from big, major high-volume channels, the more ASP pressure we’re going to have, and the more we get volume from smaller channels, where we get better ASP’s, the better our blended ASP is going to be.

That moves around quarter to quarter.

Dev Bhangui - Haywood Securities

Okay.

Jason Cohenour

We have time for one more question, Operator.

Operator

Your last question comes from Sarah Kim of Raymond James. Please go ahead.

Sarah Kim - Raymond James

Hi, thank you very much. Just wondering in general terms, when do your design wins for newer network technologies take place? If you have EV DO Rev A products that are ready to be commercially shipped in Q3 but are going through the [interop] and innovation testing right now, is the design win activity for Rev A happening now? Or do you expect that to happen once it’s commercially available?

Jason Cohenour

We are certainly always working on new design wins for existing and next generation platforms. So that’s kind of an ongoing thing, you can’t pinpoint whether or not that’s just started now or last week or it’s going to start next week. It’s kind of a constant thing.

Sarah Kim - Raymond James

Okay, just so that I understand, it happens while you’re developing the product, or while the product is near completion?

Jason Cohenour

It’s happening many times even before you start developing [the product].

Sarah Kim - Raymond James

Okay.

Jason Cohenour

You know, it does vary a bit, but part of winning an OEM, getting a design win and winning an OEM relationship is roadmap. Some of the things on your roadmap, you don’t have an engineering team on it yet, but you know that you’re going to commence it at a certain time and release it at a certain time, and that becomes part of the overall relationship discussion and actually winning that customer.

Sarah Kim - Raymond James

Okay, great. For design wins, how easy or difficult do you think it will be to displace your competition from other OEM’s, I guess with future platforms? You mentioned that every year, there’s opportunity to replace airlink.

Jason Cohenour

Yes, well, every time a next generation requirement comes up from an OEM, typically there’s some kind of process, right? There’s a bid process, sometimes it’s formal in an RFP process, and whenever that happens with one of our competitors’ customers, it’s a competitive situation, so we have an opportunity to bid on that business, and if it’s the right business for us to win from a profitability standpoint, to aggressively compete and hopefully win it.

I think pretty much the way you should look at it is it’s a design win business. You win a design for a certain generation or a certain platform, and then when the customer goes on to the next new platform and the next new airlink, it’s a competitive situation and you have to re-win the customer.

Sarah Kim - Raymond James

Okay, great. Last question, I know you haven’t disclosed your part development plans beyond the Rev A. I’m just wondering, can you talk about what percentage your R&D spending is going towards the 3.6 and Rev A versus newer network technologies, such as 7.2 and Rev B, maybe?

Jason Cohenour

We can’t provide that at this point in time, Sarah. I will say this: we have two R&D teams, one in San Diego that is mainly CDMA oriented, and one here in Richmond, B.C. that’s mainly GSM oriented. They’re roughly the same size.

Sarah Kim - Raymond James

Okay, great. Thank you very much.

Jason Cohenour

Operator?

Operator

Gentlemen, there are no further questions. Please continue.

Jason Cohenour

As I said, we had time for one more question. I think that was it, John.

Operator

Great. Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your line.

Jason Cohenour

Thanks very much.

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