Sierra Wireless, Inc. (NASDAQ:SWIR) Q4 2018 Results Earnings Conference Call February 13, 2019 5:30 PM ET
David Climie - Vice President, Investor Relations
Kent Thexton - President and CEO
Dave McLennan - Chief Financial Officer
Conference Call Participants
Mike Walkley - Canaccord Genuity
Thanos Moschopoulos - BMO Capital Markets
Steven Li - Raymond James
Scott Searle - ROTH Capital
Paul Streep - Scotia Capital
Todd Coupland - CIBC Markets
Paul Treiber - RBC Capital Markets
Richard Tse - National Bank Financial
David Gearhart - First Analysis
Good afternoon. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sierra Wireless, Inc. Fourth Quarter and Year End Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
Thank you. David Climie, Vice President, Investor Relations, you may begin the conference.
Thanks, Chris. Good afternoon, everyone. Thank you for joining today’s conference call and webcast. On the call today is Kent Thexton, President and CEO; and Dave McLennan, our Chief Financial Officer.
As a reminder, today’s presentation is being webcast and will be available on our website following the call. Today’s agenda will be as follows, Dave will provide a detailed overview of our fourth quarter and full year 2018 results. Kent will then provide his corporate update and Dave will provide the company’s guidance for full year and first quarter 2019, that will be followed by Kent summary comments and then we will open up the call for Q&A.
Before we get started, I will reference the company’s cautionary note regarding forward-looking statements. A summary of our cautionary note can be found on page two of the webcast and is now being displayed. Today’s presentation contains certain statements and information that are not based on historical facts and constitute forward-looking statements within the meaning of applicable securities laws. These statements include our financial guidance, statements on our strategy, goals, objectives and expectations, and commentary regarding the outlook for our business.
Our forward-looking statements are based on a number of material assumptions, including those listed on page two of the webcast presentation, which could prove to be significantly incorrect. Additionally, forward-looking statements are based on our management’s current expectation and we caution investors the forward-looking statements particularly those that relate to longer periods of time are subject to substantial known and unknown material risks and uncertainties that could cause actual events or results to differ significantly from those expressed or implied by our forward-looking statements.
I draw your attention to a longer discussion of our risk factors in our AIF and the Management’s Discussion and Analysis which can be found on SEDAR and EDGAR, as well as other regulatory filings. This presentation should also be viewed in conjunction with our quarterly earnings release.
With that, I will now turn the call over to Dave McLennan for his review of Q4 and full year 2018.
Thanks very much, David, and good afternoon, everyone. Note that we report our financial results in U.S. dollar and on a U.S. GAAP basis. However, we also present non-GAAP results to provide a better understanding of our operating performance. As a reminder, a full reconciliation between our GAAP and non-GAAP is available on our website.
We had solid financial performance in the fourth quarter. Overall, consolidated revenue in Q4 was $201.4 million, an increase of 9.7% compared with the same period last year. OEM Solutions and IoT Solutions both had year-over-year growth and were in line with our expectations. Enterprise Solutions was slightly below our expectations, due to timing of some shipments late in the quarter, which resulted in revenues being slightly below the midpoint of our Q4 guidance.
Product revenue, which includes all revenues associated with the sale of embedded modules, gateways, routers and other hardware devices was $178.2 million in Q4, up 5.3% on a year-over-year basis.
Services and other revenue, which includes revenue associated with our cloud and cellular connectivity services, as well as engineering support and warranty services was $23.2 million, up 63% from Q4 2017, driven by organic subscriber growth and the Numerex acquisition that included only three weeks of revenue in the comparable period a year ago. Services and other revenue was 11.5% of the company’s total revenue in Q4.
Adjusted EBITDA was $15.3 million, an increase of 9.6% compared to a year ago. Non-GAAP EPS was $0.25 per share roughly in the middle of our guidance range.
In Q4, non-GAAP gross margin was 32.7%, compared to 33% -- 33.1% in Q1 -- in Q3, pardon me. OEM Solutions non-GAAP gross margin was 27.1% similar to Q3 GM of 27.3%. Enterprise Solutions gross margin was 51.6% in Q4, compared to 54% in Q3. The sequential decrease was as expected and resulted from the impact of U.S. tariffs, which negatively impacted our cost of goods sold for our enterprise products by approximately $1.1 million. And finally, IoT Services gross margin improved to 44.6% in Q4 from 41.1% prior quarter in part due to improved -- an improvement in wholesale carrier cost during the quarter.
Our non-GAAP OpEx in Q4 was $55.7 million, down slightly from the third quarter. We continue to show good cost control and I am very pleased we were able to slightly exceed our target which we set at the start of the year to reduce our quarterly OpEx to $56.5 million by Q4. The non-GAAP tax rate in Q4 was 12.2%. Our tax rate reflects the jurisdictional mix of income across our various legal entities. Our full year 2018 rate was 8.3%.
Looking at key non-GAAP metrics in the fourth quarter of 2018 compared to Q4 2017. On a year-over-year basis consolidated revenue increased by 9.7% to $201.4 million, with 26% of quarterly revenue coming from our higher growth, higher margin, Enterprise Solutions and IoT Services businesses.
In Q4, OEM Solutions revenue was $148.7 million, up 6.4% year-over-year, reflecting increased demand in transportation, energy and industrial, partially offset by lower sales in mobile computing, and sales and payment.
Enterprise Solutions revenue in Q4 was $30.3 million, down 5% against a strong comp prior year, with our telematics business was running at a high quarterly run rate due to the bump in demand from implementation of the hours of service legislation in the US fleet transport industry.
Support and Services revenue and Enterprise Solutions, which includes our AirLink Management Services grew 32% year-over-year and continues to add to our recurring base of subscription-based revenue.
Revenue in IoT Services was $22.4 million, up 89% year-over-year. This was driven by organic subscriber growth, as well as the impact of the Numerex acquisition.
Looking at adjusted EBITDA and non-GAAP EPS on a consolidated basis, in Q4, adjusted EBITDA was $15.3 million, which was up 9.6%, compared to $13.9 million a year ago and non-GAAP EPS in Q4 was $0.25, compared to $0.28 a year ago.
Key metrics for the full year 2018 compared to 2017. On a year-over-year basis consolidated revenue increased by 14.9% with 26.5% of revenue in 2018 being generated by our higher growth, higher margin Enterprise Solutions and IoT Services businesses.
OEM Solutions revenue was $538.2 million, up 5.2% year-over-year. Enterprise Solutions revenue was $119.9 million, up 18.1% year-over-year and IoT Services business was $90.5 million, up 161% year-over-year, driven by both organic subscriber growth and the acquisition of Numerex.
Adjusted EBITDA for the full year was $55.9 million, which was up approximate 2.2% compared to the prior year and non-GAAP EPS for the full year was $0.90, compared to $1.05 in 2017.
Looking at the balance sheet, we had strong cash flow generation during Q4, generating $16.9 million of free cash flow. In addition to strong free cash in the quarter, we also sold our tank monitoring business, known as iTank. This was a business we acquired through Numerex and we determined that it was not strategic to our core IoT Services business.
We divested iTank for proceeds of $6 million, of which $5 million was paid at closing, with $1 million being held in escrow pending achievement of certain milestones during 2019. The iTank transaction closed on December 31, 2018. During 2018, iTank generated $2.6 million of revenue and incurred a small operating loss. Overall, our cash position improved in the fourth quarter by $21.6 million and we ended the year with $89.1 million of cash and no debt.
I would like to now turn the call over to Kent for an overview of our corporate and strategic initiatives. Kent?
Thanks, Dave. In the fourth quarter we delivered solid results with 10% year-over-year growth in both, revenue and adjusted EBITDA, as well as good operating expense control. We also ended 2018 on a strong cash position on our balance sheet.
Now let me take you through our strategy for 2019 and also share with you where we expect weakness in some areas of our OEM business in 2019 that will dampen our overall revenue growth for the year. This masks a strong expected growth in the highest value part of our business, our higher margin hardware and recurring revenue segments.
Let me share with you our strategic agenda going forward and how we plan to manage the transformation of the business to build on our strong and differentiated market position with a view to creating shareholder value in the years ahead.
As a new President and CEO of Sierra Wireless, I spent significant time with our customers, suppliers, partners and employees. I have a lens of CEO than as a Board member. I see tremendous opportunities over the next three years to four years, but I am also focused on short-term challenges that I am taking rapid action on.
Strategically intend to accelerate the transformation of Sierra Wireless to become the leading global IoT solutions and services provider. We believe the total Sierra Wireless addressable market for IoT Solutions is expanding rapidly, growing over $10 billion by 2021. I believe Sierra is in the strong position globally to win with our highly differentiated device to cloud value proposition. However, we need to move faster to capture strong share of this IoT growth opportunity. So I have been taking action and together with the Board of Directors making strategic and organizational changes to transition the business and invest in the future of the company.
In addition to these changes I am implementing a program to both invest in activities to drive growth and high value solutions capabilities in key product technology, as well as implement efficiency and cost reduction programs to fund these initiatives.
Organizationally, as I mentioned during our last call, I have appointed Jason Krause to the position of Chief Operating Officer and he has been working diligently with our engineering, operations and product and solution teams over the last four months to roadmap a strong portfolio of products and solutions to enable us to more rapidly expand our integrated IoT solutions offering.
To do this Jason has centralized our three development teams into a single R&D entity that has brought greater efficiency, rigor and improved focus on execution. In addition to refining and streamlining our R&D processes, we have also centralized our product management to bring an integrated approach to providing end customer solutions and our operations team has been working with our component suppliers and contract manufacturers to seek ways to improve our process and efficiency, and reduced our cost of goods sold.
At the front end of the business I have reorganized our go-to-market teams to prioritize on key IoT market segment so who we can attack the $10 billion TAM that I referred to before and target customer opportunities. I reorganized our sales team into a single unified sales and marketing organization focused on leveraging our IoT module leadership position into more highly integrated device to cloud solutions targeting the most profitable IoT segments. To allow us to get our customers to market faster and enable them to scale deployments quickly, modernize and create new revenue streams.
We recently completed our Global Sales and Solutions Conference in January, focusing our global sales leadership on the opportunities ahead and lining up our sales resources under Marc Osgoodby, our Global Sales leader. And announcing our global solutions capability under Mark Overton, our Chief Solutions Officer and along with industry veteran René Link as Chief Marketing Officer, we have much better alignment in our global sales team today under new leadership and our people are excited about selling new and existing customers a bundled solution of devices, conductivity, cloud management and security.
We are also rolling out realign compensation structures toward solutions and recurring revenue. I have combined the leadership of our strong global channel distribution activities to increase effectiveness and efficiency. Our channel partners are a key part of our go-to-market program.
As Dave mentioned earlier in his comment, we are also divesting some small assets that came with the Numerex acquisition, which are non-core to our strategic initiatives. We have a strong balance sheet and we are taking the opportunity to simplify our business and give us focus and resources for the major market opportunity before us.
On the cost side I am driving significant and sustainable programs to get more efficient. We are taking steps to reduce our cost of goods sold and operating costs by approximately $40 million to $50 million over the next 18 months to 24 months. We have undertaken this cost reduction program with assistance from our third-party consultant and we believe this transformation will lead to an improved operating model provide capacity to reinvest in the business and create long-term shareholder value.
Decentralization of our R&D resources as part of our efficiency and effectiveness move and so far we have closed several small R&D sites as part of the centralization process and in addition we have commenced efficiency initiatives in other areas. We believe that our target savings of approximately $40 million to $50 million is achievable.
While I am driving cost reductions to enable a more profitable long-term business model, I am simultaneously leading us to make important investments today in advance of our anticipated cost savings delivery to accelerate our leadership in device to cloud solutions and increase the flywheel effect on our driving subscription-based revenue.
To accomplish this we need to invest in important technologies and innovations such as developing our intelligent edge software capabilities to enable improved data management between the cloud and the edge of network, enhance our global embedded software initiative which we call Ready-to-Connect and our global conductivity footprint and capability, designing leading-edge 5G embedded modules for the growing automotive and enterprise market, as well as incorporating this technology into our gateway and router devices, and increasing our security capabilities for data management from cloud to the edge.
Additionally, we are investing in our sales systems and people to support the sale and delivery of recurring revenue solutions, and we also plan to leverage our strong device position to capture market share in two significant growth cycles. One, the mass deployment of LPWA, Cat-M1 and NB1 technology globally, which started in 2018. And two, deployment of 5G LTE and 5G new radio that will begin in the next couple of years.
We believe that LPWA modules will lead to mass IoT adoption with industry volumes growing several hundred million units annually over the next three year to five years and that 5G is going to have a meaningful impact starting in 2022.
As evidence of our focus on solutions, we announced in January that our Ready-to-Connect solution has gone into production on selected embedded modules and will be rolling out across a broader range of our embedded module product line in 2019. Ready-to-Connect has all the key elements required for fast deployment of an IoT application, it include Sierra Wireless cellular module with an integrated SIM that is already pre-connected to global networks and supported by our AirVantage IoT platform.
By removing the complexity around SIM integration, it allows our customers to innovate in one-third of the time and eliminates the need to manage numerous vendors and platforms. Ready-to-Connect uses our multi operator Sierra Wireless Smart SIM to provide reliable global IoT conductivity allowing businesses to use the same solution wherever they deploy.
We believe this technology is a game changer and other then Sierra we are not aware of any other significant player in the IoT space to have a global MVNO that own multi-IMSI SIM, a leading cloud platform and 25 years of device expertise.
Some IoT players may have disparate parts. However, they don’t have the ability to provide a fully integrated end-to-end IoT solution like Sierra can, one that is simple, scalable and secure. We already have some significant design wins in our Ready-to-Connect solution in Europe and North America. They should be ramping up later this year and we are receiving very positive responses from customers globally. I will be sharing more with you about this Ready-to-Connect win at our Analyst Day meetings in Q2.
As I have discussed previously, when we sell our full solution versus just our hardware, we increase customer lifetime value by 3 times to 5 times and with a lower modular cost with LPWA, the ratio becomes much larger and recurring revenue a key value driver.
The opportunity before us is significant. Today we sell approximately 20 million modules per year, with the market accelerating and with the beneficial impact of LPWA we see strong module volume growth over the next few years.
For example, if we assume in the future 40 million modules sales per year and assuming a 25% attach rate, I would hope to achieve more. We would add 10 million recurring revenue devices per year at a minimum revenue assumption of $10 per year that could potentially have $100 million of incremental recurring revenue per year.
I have talked to many customers and they find our solutions offering highly appealing and differentiated. They tell me that implementing an IoT project can be very complex and expensive. In fact, study show that today over 70% of IoT projects fail. Our complete solution offering is designed to solve this challenge.
Here is some examples of new device to cloud wins. We secured a new design win with Unimar, a global supplier of tower lighting products related to the aviation industry. Unimar need to collect mission-critical data from the edge of the network to ensure that flight path hazards are properly marked and complying with FAA protocols. To reduce complexity and to get to mark quickly Unimar selected our Airlink RV50 Gateway, our SIM and our AirVantage cloud platform.
Another good example is our device to cloud solution is our customer with MANN+HUMMEL, a large European-based company that is using IoT for preventative maintenance on mobile equipment. With this customer we are providing our Sierra Smart SIM Conductivity service and AirVantage platform and we are working with them on LPWA Cat-M1 solutions with real-time monitoring of their mobile equipment MANN+HUMMEL can save approximately $750,000 per year on maintenance costs on an fleet, so there is rapid payback on IoT application.
I want to share with you the way we are looking at the market and looking at our business and two components and I will talk about both. We are currently evaluating these two business segments to manager focus and more clearly delineate our solutions activities. As a result, we are looking at one business area focus on what we call embedded broadband and the other focused on IoT Solutions and Services.
The embedded broadband segment would be comprised of our high-speed cellular embedded modules that are used in the automotive, mobile computing and networking markets. These are valuable segments to drive overall volume and cash flow for us but with lower gross margin and higher variability as we are not typically able to attach conductivity services to these devices. We have a strong customer base in these embedded broadband businesses that will be transitioning from 4G, LTE to 5G. This is a high-volume business with some very strong global customers. As an example we expect our existing automotive OEM design wins to-date, excluding any potential new 5G wins to deliver approximately $1.1 billion in revenue over the next five years.
At times this embedded broadband group can be affected by macroeconomic headwinds and various design win cycle as we have seen. Before taking over as CEO, certain product investment decisions were made to favored investing in automotive to the detriment of some requirements of our mobile computing and networking customers. Consequently, while we are enjoying success in the automotive segment, we expect our market share to decline in mobile computing until the next cycle of 5G design wins. These past positions are negatively impacting our financial performance in 2019.
With some decline in our PC OEM and networking segment and automotive ramping later in the year, Q1 revenue has some additional time weakness. Thus we expected the embedded broadband segment which was slightly less than half of our 2018 revenue will decline in 2019. In addition, due to the ramping of lower margin automotive business and some one-time declines in higher margin mobile computing and network business, we expect gross margin overall profitability for this segment to be significantly weaker this year.
I am disappointed in this situation, but have now refocused the company on regaining our traditional market leadership, we have extremely valuable global customer relationships and we are investing in our 5G embedded module roadmap where other module players may not be. I believe there is a great opportunity to win many new design wins going forward and to drive long-term growth and value in this part of our business.
The other business segment that we are evaluating is IoT Solutions and Services. This would include our existing IoT Services business, our Enterprise Solutions Gateway and Router business and our IoT module businesses, where we have the opportunity to provide our customers with subscription-based conductivity services.
We believe this is an attractive business for Sierra, because we can provide our customers with a fully integrated end-to-end IoT Solution including device be it module or gateway together with connectivity services and cloud-based management. We can provide a differentiated offering with greater edge intelligence, security and integrated device management. In 2018 this business was slightly more than half our revenue and going forward we expect to grow this high-margin IoT Solutions and Service businesses faster in our Embedded Broadband business. In 2019 we expect this segment to grow strongly at over 10% year-over-year with gross margin in the high 30% and increasing.
So in three years to four years we would target to have a total revenue well in excess of $1 million with approximately 60% of revenue coming from IoT Solutions and Services with gross profit margins in this business segment being north of 40% and growing.
We have a large focus on growing recurring revenue and our objective is to realize approximately 30% of this segment’s revenue from recurrent revenue services in three years to four years and growing from their as customers further rollout their IoT Solutions. We view the IoT Solutions business as a strong value creator for Sierra, with higher gross margins, good growth and valuable recurring revenue and should attract the commensurate rerating as this becomes more apparent.
This new business segmentation is a work in progress and we will be providing you with more information on this work in our Q1 results call in May and planned Investor Day presentations, but I wanted to give you a few preview of our direction today.
I will turn the call back over to Dave to outline financial guidance for 2019.
Thank you, Kent. I will now provide our guidance for full year and first quarter of 2019. For the full year of 2019 we expect revenue to be flat compared to 2018, within that in OEM Solutions we expect a modest year-over-year percentage decline of a mid-single digits driven by factors in two major segments.
Firstly, in our automotive business we expect the ramp commencing of in Q2 of two new design wins including Volkswagen, be more than offset software overall in this sector, resulting in solid year-over-year automotive growth. This is offset by a decline in our PC OEM business.
In Enterprise Solutions we expect our Gateway and Router business to grow at a similar rate as the 18% year-over-year growth we realize in 2018 driven by product and go-to-market investments. And in IoT Services we expect a year-over-year percentage growth rate in the high-single digits adjusting for the sale of the iTank business at the end of 2018.
We expect non-GAAP gross margin to be in the range of 31.5% to 32% for the full year and as we make investments ahead of the impact of our cost-reduction initiatives, we expect our OpEx to increase throughout the year resulting in full year adjusted EBITDA of approximately $35 million and non-GAAP EPS of approximately $0.30. We estimate our 2019 full year non-GAAP tax rate to be approximately 12%.
In the first quarter of 2019 we expect revenue to be the range of $170 million to $174 million. Our Q1 revenue guidance reflects several important factors in our OEM customer base. Our mobile computing customers are continuing to experience a shortage of Intel CPU processors, which in turn is impacting demand for our cellular modules in Q1.
We are seeing a slowdown in the global auto sector, consequently some of our large customers are working down inventory levels in Q1, negatively affecting demand in the quarter compared to Q4. In addition, we are experiencing lower demand from certain networking customers and generally some macroeconomic headwinds. We expect sequential revenue growth in Enterprise Gateways and IoT Services to be relatively flat sequentially from Q4.
Our non-GAAP gross margin in Q1 is expected to be in the range of 31.5% to 32%. This range is based primarily on product mix at our OEM Solutions and Enterprise Gateways businesses. We expect non-GAAP OpEx in the first quarter to be up slightly compared to Q4, we typically have higher sales and marketing costs in Q1 driven by the timing of major trade conferences and training events.
As a result we expect first quarter adjusted EBITDA to be in the range of $2 million to $4 million and non-GAAP EPS to be there in the range of negative $0.02 to negative $0.06. Our Q1 non-GAAP tax rate is expected to be approximately 12%.
With that, I will turn it back to Kent for summary comments.
Thanks, Dave. So as a new CEO, let me recap on the future for Sierra Wireless. We are in an exciting market that we believe has significant growth potential. We believe the acceleration of the IoT market will be led by providing full solutions to enterprise and industrial customers to get their valuable edge data to the cloud and build new revenue streams and to reduce costs.
Our IoT Solutions and Services business is of scale today with over $400 million in revenue, 22% recurring revenue and high 30s gross margin. We are targeting growth in this area to exceed 10% in 2019 and to accelerating future years as our service offerings mature, I have reorganized the company and we are investing to accelerate growth and results here.
As presented, as we look at this business three years to four years out, we would look for it to be over 60% of our $1 billion plus revenue to have gross margins north of 40% and growing, and with recurring revenue to be approximately 30% and growing.
We have a strongly differentiate offer to enable enterprises and industrial customers to improve their time to market increase their ROI on IoT projects. Our IoT Solutions focuses position to create strong shareholder value.
Our Embedded Broadband segment is expected to have a week year in 2019, as a result of expected macro headwinds and some mix design cycles, but our customer relationships remain very strong.
To enable our transformation, I am focusing on reducing cost by approximately $40 million to $50 million, realigning organizational leadership, disposing of non-core assets and improving overall business predictability. Simultaneously, I tend to lead substantial investment in our IoT Solutions capability to accelerate our growth in this area.
In conclusion I am very excited about the prospects for the company and I look forward to transforming the business. We had a lot -- we have a lot of work to do and 2019 is an investment year for Sierra Wireless, but I believe we are now on the right path and we are making the right investments as we enter the next phase of global growth in IoT.
Thank you. Chris, we can now open up the conference call for Q&A.
Certainly. [Operator Instructions] Your first question is from Mike Walkley with Canaccord Genuity. Your line is open.
Hey. Thanks. Maybe just starting with the Embedded Broadband business, can you help us break out how much PC was in terms of that mix in 2018 and how much it’s down in 2019? I am just trying to connect the dots from some more positive commentary on IoT hardware companies relative to your guidance, I want to see how much PC impact that relative to that the rest of the business on the module site? Thank you.
Hi, Mike. It’s Dave. We have got three big buckets in the Embedded Broadband or in the OEM business, I should say. Automotive would be the larger of the buckets. PC OEM is large, but it’s not the largest, but we haven’t -- we don’t break it out specifically.
Okay. And then just on LPWA, clearly an investment area, where do you guys think you are relative to the competition, you think you are little behind and some people are getting on earlier start or you feel like that roadmaps on track, is that impacting your guidance off of 2019?
No. We think we are in a very strong position on LPWA. We have rolled out lived customers we have embedded advance power management features and we also have our embedded connectivity that we can roll with that service. So we are -- I think it’s just early days, carriers rollout of LPWA’s are not complete yet. In Europe we will be focusing on 2G fall back with our LPWA modules, so that we can -- and again we have some competitive advantages there using our own 2G IP. So we are strong.
And the other major component we are doing that, I talked about the management at the edge as we have a unique value proposition that that is significantly ahead of the market where we embed our device and conductivity along with the ability to do edge processing which allows customers to get their edge events to the cloud without having to do what would regularly acquire a lot of integration work, a lot of design work, we have an end-t-end solution that implement quickly. We had one of the early customers on our latest protocol speaking on our sales and marketing conference and talking about how from first devices they were able to get edge data in two hours and previously they were looking at two months to two years to be able to make the whole system work. So we are feeling very strongly about LPWA.
Okay. Thanks. And last question for me and I will pass on. Dave, just on the model, with -- I guess, with auto ramping is the old OEM Solutions business, I am not sure, you guys are going to change how we report going forward, but given that business unit kind of the back into your guidance and getting maybe a mid-25% gross margin for that business, is that kind of a bit way to think about it, given change in mix and lower revenue? Thanks.
Yeah. It might be a little bit more compressed than that, Mike. But you are pretty close.
Okay. Thank you.
Your next question is from Thanos Moschopoulos with BMO Capital Markets. Your line is open.
Hi. Good afternoon. Maybe just expanding on the last question, as we look at the gross margin compression you are anticipating in Q1, is that entirely coming from OEM and our margins expect to be relatively stable in Enterprise and Services?
Hi, Thanos. This is Dave. So OEM will be down we think sequentially a little bit, but not a huge amount and so will enterprise gateways business down a little bit, that’s more of a short-term customer mix and enterprise driven by similar telematics lower margin gateways than our Airlink gateways. And then we expect an improvement in our gross margin on the services side.
Has the tariff issue have been full resolve at this point in the gateway business?
Close to, we move quickly and move production in Q4 from China to Vietnam that cost us about $1.1 million in move costs and direct tariffs. There will be a little bit in Q1, probably, around $300,000 impact would be the current view and going into Q3 we will be producing most things in Vietnam that won’t be subject to tax.
Tariffs I should say.
And in terms of the mobile computing market, should we be looking for recovery in the second half of the year as Intel shift its new chip, I guess, notwithstanding, your earlier commentary about market share?
Yeah. We have pretty conservative expectations of that and also in that part of our business, as Kent mentioned, we design cycles come and go and we are also experiencing in the near-term the Intel CPU shortage, so we are pretty carefully on our outlook there.
And remind us, I mean, PCM, sorry, PC OEM margins are higher than the OEM average, are they not?
Yes. They are.
Yeah. Okay. And then maybe just one last one for Kent, maybe it’s too early to comment, but start shipping some Ready-to-Connect modules in December. Any early feedback, any positive proof point as far as attached rate for services or it’s just too early to really make any conclusion at this point?
Well, still very early, we have a number of design wins and the customer feedback has been very strong. So the design wins we have right now are 100% attach rate. We are -- to get to the overall attach rate we need to have more of our modules lined up and we are working to sell more broadly across and see which customers and which applications they want the end-to-end solution from us and which customers want to be able to manage their carrier conductivity discreetly. So those we will be -- we are doing investor meetings in May. We will talk more about our services business, but we are not ready to forecast attach rate yet, although that is a key and important metric that we will be watching.
Great. Thanks. I will pass the line.
Your next question is from Steven Li with Raymond James. Your line is open.
Thank you. Hey, Kent, Dave. A few questions, Dave, can you repeat how much growth you are expecting for OEM Enterprise and IoT in 2019, I missed that part?
Sure. For the OEM business and this refers to the existing business unit, not the new segmentation that that we are working on. But for the OEM business we are expecting a, probably, a mid single-digit decline year-over-year. And enterprise we are expecting the Enterprise Solutions and Gateways we expect that to be growing at or above the 18% year-over-year growth that we realized in this year in 2018. And with IoT Services, if you exclude the impact of the iTank sale in 2018, we expect that to grow in the high single digits year-over-year.
Okay. And so on the idea OEM, given Volkswagen has been ramping, so does that mean just the database is just the macro factors you have talked about in auto, that is responsible for it?
It’s that, so it’s -- we do expect to growth in automotive, but it is the ramp of Volkswagen and another new program that’s offsetting, more than offsetting the headwinds in the overall industry. But we also expect our PC OEM business to decline as well.
Right. Right. Okay. And on that the PC OEM, were these share losses unexpected? And why would you have to wait for the 5G cycle to regain share? Thanks.
Well, it’s a function of when we design products we have to make some choices and so we have designed for servicing the automotive business which made us a little less competitive in servicing the PC OEM capability. So, yeah, those design wins will roll-off and but we will be hard at it, developing new 5G product, which we expect to have a shot at reearning those design wins. And then we will also continue a stable smaller PC OEM throughout the piece as well.
Steven, this is Kent here. On the PC OEM marketplace, in Sierra Wireless history here’s been other design cycle losses and then those customers have been won back, so we have been a strong player there. But as I said, I am disappointed from how some of that is played out in our plans for the year ahead is strong work on 5G and to be back winning our leadership position in those marketplaces.
In terms of your question of why wait for 5G. So you essentially have a particular technology that’s going to go with a particular product line and once this designed in there is typically no change to that. The next interface comes along and for later computer product lines and that’s the way that market goes. It’s therefore lumpy which is caused challenges in the past and it is part of our focus on growing our IoT Solutions business with higher recurring revenue and much more predictability.
Okay. That’s helpful. And on the restructuring can you quantify the cash impact, how much restructuring disbursement should we expect in 2019?
Steven, it’s Dave. We are working through various plans right now. So as we get closer to working on those initials, we will be clear about that.
And the timeframe for the $40 million to $50 million cost reduction, is that exiting 2019?
It is actually a bit of a longer horizon, 18 months to 24 months, Steven.
18 months to 24 months. Okay. And then last question for me, which quarter would be the bottom for gross margin in 2019?
You can see that our Q1 gross margin range is similar to our full year, so I think it will bounce around in that range a bit.
Oh! Right. Great. Thanks.
Your next question is from Scott Searle with ROTH Capital. Your line is open.
Hey. Good afternoon. Thanks for taking my question. Just to follow-up quickly on the cost reduction of the $40 million to $50 million, as you are looking at 18 months to 24 months. Clearly it’s certainly in 2020 timeframe where it impacts you, but in interim OpEx is actually going to be increasing as you are making that investment into software, into 5G, into LPWA’s is that correct over the next couple of quarters besides the seasonality that we see in the first half, that number does on an annual basis ‘19 is still going to be higher than 2018, given your sales and gross margin guidance, is that correct?
Yeah. Scott, you say that very well. We are investing to drive services growth and drive some technology investments and that will increase OpEx in 2019. Well, we are hard at it taking cost our of the business as well.
Just clarification, we manage those very discreetly, so we are very clear on where we are taking cost out with efficiency and then very discreet in our investments to drive future growth.
Got you. And just a couple of clarifications, in terms of the PC OEM share loss, is -- do you see the segment then going to near zero over the next 18 months to 24 months until we are waiting for 5G cycle to start and will you be changing reporting segments as well, given how you are breaking out sales in your earlier comments?
The first question, Scott, on the PC OEM segment. No, we have got many customers there, so we will -- we have got Tier 1s and Tier 2s and so we expect to continue to be a meaningful supplier to some of those customers. But others will go away as the design wins end and we will be pitching that business with new 5G product.
With respect to segmentation, we kind of work in progress, we shared our thoughts with you on the two segments Embedded Broadband and IoT Solutions and Services. We will be refining that over the next quarter and then when we reported in Q1 we will be very clear on any new segmentation if we have made some determination there.
Got you. And if you could as well just restate, the attach rates that you are talking about for a device cloud and Ready-to-Connect with other software and SaaS based services. What was the target that you are driving to over the next three years to five years?
We didn’t talk about attach rate targets. We said that IoT Solutions today would look like 22% recurring revenue and we will look to continually grow that and within the three-year to four-year cycle mentioned we would be at 30% in growing recurrent revenue. So that’s the focus we have. Attach rate is something that will speak to as we build more experience in that area.
Got you. And just lastly, if I could, your thoughts in terms of how big will LPWA be as you are exiting calendar ‘19, your thoughts on 3G sunsetting? And lastly, Kent, a lot of what you are talking about terms of transforming the organization, is really a large investment in software, whether it’s edge processing, it’s some of the stuff that you doing to Ready-to-Connect and otherwise device to cloud strategies, right? So it is really a DNA shift, right, in terms of the organization. I just love to get a little bit more of your thoughts in terms of how you are approaching and managing that, because it is a major shift in terms of where the organization has been in the past? Thank you.
So I think that on the transformation of the business and the size of the LPWA market. So we look at all of the perspectives on LPWA and it talks about shipping billions of devices, I mentioned hundreds of millions of LPWA devices. We are seeing lots of appetite, again I draw attention to the fact that today about 70% of IoT projects fail, because the challenge for the OEM or Enterprise to be able to get that edge data in usable fashion without a lot of complexity is difficult.
So our -- we have been making investments already. We have -- if you go to our website, you will see a product called Octave, which is very advanced edge processing and end-to-end solution and it’s solutions like that that we are accelerating and that’s -- we are having tremendous response to that from customers and partners.
In terms of the investment in software, we have been building our cloud and software side of the business for some time, but we are working to accelerate that with three discrete R&D divisions before we were somewhat diluted in doing that and under one centralized approach now, we are putting more emphasis in that area.
I think the DNA shift is as critical within our go-to-market side and being able to sell a complete solution to customers versus just hardware. And so we have significant reorganization in go-to-market resources to be able to have one global sales team, with a strong incentive and training to help drive services and supported by our global solutions capability to be able to go out there and make sure the customer is getting the best product and getting connected in the we are managing that ongoing conductivity. So it’s been a work on both sides, both on the R&D and on the go-to-market.
Then, Scott, on your 3G sunset, we are -- we have already seen quite a substantial rolling off of 3G business, let’s says, it’s down to about 14% of our technology mix at the end of last year. So, yes, it will continue to climb, but I think, we have seen the big trajectory behind us so far?
Okay. Thank you.
Your next question is from Paul Streep with Scotia Capital. Your line is open.
Great. Thanks. David, can you just give us a sense of how we should think about that savings split out between the cost of goods sold and operating expenses? Thanks.
Yeah. Scott, just -- at this point think of it at the contribution margin line and will we continue to refine programs over both COGS and OpEx.
Your next question is from Todd Coupland with CIBC Markets. Your line is open.
Hi. Good evening, everyone.
Hi. Dave, one OpEx question and then a couple of follow-ups, so a $56 million rising a little bit is baseline, once you get through the investment period, would you anticipate that that is actually going to fall what -- materially, I guess, $10 million to $12 million a quarter would be the $40 million to $50 million, I guess, some may go in COGS, but is that how you are thinking about it beyond 2019?
Yeah. Certainly beyond 2019 is a big investment year for us, Todd. So you will see OpEx rise. I think after that we can start to garner more of the savings to the bottomline, but I am not going to make a prediction as to when…
A strong emphasis on COGS reductions, as well as OpEx reduction, so on your quick math there, you need to take into account that sum of the savings were going to after COGS area and then the -- the rest in OpEx you will see flowing through over the next 18 months to 24 months to get the complete savings target we have into the numbers.
And when you think about your base of modules that you ship a year 20 million a year more or less, how much of that would you view to be, I guess, you can’t really target in terms of recurring revenue potential. So what’s really the baseline that you need to bring up to $40 million? How should we think about that?
Well, okay, if you look at this -- the segmentation I mentioned of Embedded Broadband and IoT Solutions. Embedded Broadband a little less than half of our revenue today and that’s an area where it is difficult to drive attached to. Our IoT Solutions is over half of our revenue and that’s where we are focusing our attach on and we expected to be the fast-growing part of our business.
And then just lastly I know it’s early on your connect business, but what are some sort of real examples on some of the design wins that you like to call out, give us a sense of the $10 per year payers of the product?
Yeah. I think there is quite a few segments that, so when you say $10 per year, that would be slightly higher and it’s probably in LTE module segment. LPWA will bring revenue expectations down more in the dollar type of range. I mentioned two examples of this, our design list that we have and the customers that are in process with us is extensive, but haven’t cleared many of those to announce the names. We have -- we have been making announcements most weeks about our new service connect customer and we will continue to be doing so. We have some exciting customers to talk about and driving those solutions and their names that you recognize, but got it clear about customers before I call them out.
Okay. Great. Appreciate the color. Thanks a lot.
Your next question is from Paul Treiber with RBC Capital Markets. Your line is open.
Thanks very much. Good afternoon. Kent, when you with the Board and when you first took on that the role, did you anticipate that the magnitude of this transition or restructuring or was it something that you came across as you dug into the role?
Hi, Paul. Well, I think that from November to now there has been some significant weakening in PC OEM and automotive numbers for the year and describe how those lead to a down year in that segment part of the market.
The cost restructuring work we are doing, I think, is good business practice to get lean and efficient and work to drive money to the bottomline. The degree to which driving investment into succeed in the future part of this market, I become more apparent, as I said, talking to customers, suppliers and employees about how we are going to make the transformation happen.
So Jack Welch once talked about you need to eat today and dream tomorrow, it’s getting that balance right. We could have just cut costs and improve profitability and not be ready to win for this big market segment that it had. So I am very excited about the IoT Solutions opportunity. The IoT market is poised for its next leg of growth up and we are very well-positioned to do that. But we have to be strong.
On the question about the software shift but also our capability of selling and servicing customers. So the -- from my perspective as CEO versus Board member, it is more clear to me the exact components of the lift that we have to make happen. The revenue shortfall in the Embedded Broadband this year has made that all somewhat more challenging and so I want to lay out the vision here that we are -- we have a strong and growing IoT Solutions business with the strong gross margin today, a good topline growth and improving recurring revenue and so that that is the part of the business that we are working to accelerate and we think that, when you look at businesses that would be of that scale, with that degree of recurring revenue, they are highly valued. And so that’s the investment part. We see a very strong building of shareholder value with that and so the investments being contemplated and reviewed extensively and done with that in mind.
And then looking at the Embedded Broadband business, the -- I mean, when you are speaking about mobile computing versus automotive, it felt like your -- you would have prefer that the company prioritized mobile computing over automotive, was that a fair characterization? And then, more broadly just, what’s your view on the automotive business longer term?
So two questions there, the -- on my -- I would rather have more revenue in 2019, so that an answer to the question, I leave it at that. You can’t do everything but I think that you have to work on prioritizing. I have made quite a few changes to our overall sales force leadership and our ability to design and forecast and I am making sure that we are funding our roadmap so that we can be investing in the products that we think are going to be important to the market to grow our future revenue. So there was some decisions made that has -- it is going to result in some short-term revenue weakness in 2019 and the embedded side of the business, but we are absorbing that and moving on from that. But I would rather not have a dip in PC OEM but we are just laying out what’s going on the marketplace.
And dip I would add to has been the Intel shortage has really been a big moving parts in terms of our volume as we look at what’s going on in Q1 and Q2, so it has been a meaningful impact that lowered our expectations for revenue from that sector.
Just on a longer-term question on automotive, how do you think about business?
So the key auto players are looking and we are responding to their request for information about 5G in every car and so we are working through those sorts of programs. So it’s a segment that’s going rapidly towards ubiquitous penetration of connectivity. So we have -- we are the leading global market share player in that segment. It’s the good aspects of it are that there are typically five-year design awards so were able to look at the NPV from those auto awards. The nature of them is that they are generally for us low gross margin in the early period and increasing gross margin later as we have the opportunity with time and volume to reduce our component costs.
So as we have some strong design wins, starting to scale in 2019 that hurts our gross margin but it’s now a business that we have to compete for every year, it’s longer-term design cycles and as I mentioned $1.1 billion of revenue that we see coming from the -- from that automotive group. The next real design cycles will be around 5G and that’s driving capability and the penetration in auto further. So I don’t know if that answers your question of what I think about auto.
Again thanks for taking my questions.
Your next question comes from the line of Richard Tse from National Bank Financial. Your line is open.
Yes. Thanks. Just a two quick ones here for me, David, if you take out the guidance for Q1, the implied guidance for the remainder of the year, call it, like $207 million on average per quarter, can you maybe sort of share with us the linearity of that ramp and that’s I think sort of highest we have seen on record for you $207 million, so is that largely coming from VW here?
That’s certainly going to be a factor Richard starting next quarter where, I mean, to be clear we are shipping now, but the big ramp is coming on in Q2 and then also in automotive. We have got a situation where some of our big customers are winding down their inventory, some of them have year end of March 31st so they are being very careful with ordering patterns and we expect that to recover in Q2 as well with the ramp. And then we have got to ramping elsewhere in our business such as gateways, aspects of industrial IoT and the services business.
Okay. And for Kent, I appreciate the comments around the investments, should we consider that investment to be sort of all organically driven or are you contemplating acquisitions with that?
No. That’s all organic today. As I have mentioned previously we don’t see the need to buy in anymore MVNO or service capability. We believe we are at sufficient scale and we will grow that scale organically. Our differentiated market-leading solutions is an area that we have some of the best people in the world working on those and we are continuing to expand in those areas, so it’s organic.
Okay. Great. Thanks.
Your next question comes from the line of David Gearhart, First Analysis. Your line is open.
Hi. Good evening. Thank you for taking my question. Just really quick on the iTank sale, as it relates to kind of a broader theme, iTank was proprietary hardware with a proprietary application. So just wondering how you are thinking about owning the entire solution from modules, gateways, infrastructure platform, connectivity and application. Are you moving away from actually owning the application layer and your thoughts there? And then also Numerex had a few other businesses including the offender monitor application, just wondering if that is still being supported, going to be supported or is it still being considered for potential divestiture as well?
Let me -- it’s Kent here. Let me start by talking about the big market segments we are going after. So when we look at, what we call the industrial IoT edge, so every piece of industrial equipment over $10,000 should be connected to the cloud. Some infrastructure smart city and mobile IoT edge, every mobile asset of over $5,000 should be connected to the cloud. So those three segments of the marketplace are broad. They will have some vertical aspects of it, but it can mostly be done in software and those are the areas that we are putting our emphasis.
Some markets like iTank were not large. We weren’t having scale in that business. As Dave mentioned, we were losing money in that area and so we don’t want to invest in that sort of discrete small growth area, we are investing into the big market segments in those growth areas. So -- no comment in other aspects of our business I think at this point in time, but that discipline is what we are trying apply throughout.
Okay. Thanks for the color.
We have no further questions at this time. I will now turn the call back over to the presenters.
Okay. Well, thank you very much to everybody. We -- Dave, myself, Dave Climie here are available for follow-up calls and discussions. We have -- as I said, I am very excited about the future opportunities in the business, look forward to that dialogue. We were -- and we also are planning Investor Day meetings in North America and Europe after our results in May. So thank you very much and we will be speaking to many of you shortly.
This concludes today’s conference call. You may now disconnect.