Sierra Wireless Inc

TSX:SW

Earnings Call Transcript

[Operator]

Good evening, ladies and gentlemen. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Sierra Wireless third quarter conference call. [Operator Instructions] David Climie, Vice President of Investor Relations, you may begin your conference.

[David Ian Climie, Vice President of Investor Relations]

Thanks, Denise, and good afternoon, everybody. 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 quarterly results as well as guidance for the fourth quarter. Kent will then provide his corporate update, and we'll open up the call for Q&A.Before we get started, I will reference the company's safe harbor statement. A summary of the safe harbor statement can be found on Page 2 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. These statements include our financial guidance and commentary regarding the longer term outlook for our business. Our forward-looking statements are based on a number of material assumptions, including those listed on Page 2 of the webcast presentation, which could prove to be significantly incorrect. Additionally, our forward-looking statements are subject to substantial known and unknown material risks and uncertainties. I draw your attention to a longer discussion of our risk factors in our Annual Information Form and management's discussion and analysis, which can be found on SEDAR and EDGAR as well as our other regulatory filings. This presentation should also be viewed in conjunction with our press release. With that, I'll now turn the call over to Dave McLennan for his review of Q3.

[David G. McLennan, CFO & Secretary]

Great. Thank you, David, and good afternoon, everyone. Note that we report our financial results on a U.S. GAAP basis. However, we also present non-GAAP results in order to provide a better understanding of our operating performance. As a reminder, a full reconciliation between our GAAP and non-GAAP results is available on our website.We had strong financial performance in the third quarter. Overall, consolidated revenue in the third quarter was $203.4 million, an increase of 17.9% compared to the same period of last year. All 3 business units realized year-over-year growth and Enterprise Solutions was modestly ahead of our expectations due to some early demand fulfillment ahead of the implementation of U.S. tariffs.Product revenue, which includes all revenues associated with the sale of embedded modules, gateways, routers and other hardware devices was $179.4 million in Q3, that's up 11.1% on a year-over-year basis in a tight component supply environment.Services and other revenue, which includes revenue associated with our cloud and cellular connectivity services as well as engineering, support and warranty services was $24 million, that's up 118% from Q3 2017, driven both by organic subscriber growth and the acquisition of Numerex, which was not in the comparable period a year ago.Services and other revenue was approximately 12% of the company's total revenue. Adjusted EBITDA was $16 million, a strong increase of 21.1% compared to a year ago. And based on our financial performance in the third quarter, revenue was slightly above the midpoint of our guidance range, and non-GAAP EPS at $0.29 per share, was at the high end of our guidance range.Also worthy of note in Q3, gross -- related to gross margin, OEM Solutions gross margin was 27.3% in Q3 compared to 30.4% in the prior quarter due to product and customer mix in the third quarter, including higher automotive volume. Enterprise Solutions gross margin was 54% in Q3 compared to 49.9% in Q2, driven by growth in sales of our higher-margin RV50 and MG90 gateways in the third quarter.And IoT Services gross margin was flat at 41.1% compared to the prior quarter. Overall, the company's non-GAAP gross margin was 33.1% compared to a normalized 33.8% in the prior quarter. Just a reminder that our reported gross margin in Q2 was 34.4%, which included approximately 60 basis points of margin associated with 2 favorable onetime claim settlements in Q2.The cost reduction initiatives, which we spoke about in February are having the desired effect. Non-GAAP operating expenses in Q3 were $56.5 million, down $2.5 million sequentially.Included in Q3 non-GAAP G&A expenses was approximately $1.4 million of external consulting fees related to strategy work. And the non-GAAP tax -- effective tax rate was 3.2% in Q3, which was lower than our expectations and down slightly from 7.4% in the prior quarter. This tax rate reflects the jurisdictional mix of our income across our various legal entities.Looking at non-GAAP metrics in the third quarter compared to a year ago. On a year-over-year basis, consolidated revenue increased by 17.9% with 27% of quarterly revenue coming from our higher growth, higher margin Enterprise Solutions and IoT Services businesses.In Q3, OEM Solutions revenue was $148.3 million, up 7.6% year-over-year, reflecting increased demand in automotive, enterprise networking and energy. Partially offset by lower sales in mobile computing and transportation.Enterprise Solutions revenue in Q3 was $32.1 million, up 22% year-over-year. The business continue to show very strong growth driven by AirLink sales into the industrial and mobile markets.Support and services revenue, which includes our AirLink managed services, grew 55% year-over-year and continued to add to our recurring base of subscription-based revenue. Revenue on our IoT Services business was $23 million, up 173% year-over-year. This is driven by solid organic subscriber growth as well as the addition of Numerex, which we did not yet own in the comparable period a year ago.Numerex revenue has stabilized and we're starting to see a return to growth in parts of the business. Looking at adjusted EBITDA and non-GAAP EPS on a consolidated basis. In Q3, adjusted EBITDA was $16 million, which was up 21.1% compared to $13.2 million a year ago, and non-GAAP EPS in Q3 was $0.29 compared to $0.24 a year ago.Moving onto the balance sheet. During the quarter we generated $2.6 million of cash from operations. We had CapEx of $5.1 million, primarily related to additional -- the purchase of additional factory test equipment that was partially driven by production moves from China to Vietnam to mitigate the impact of tariffs on certain of our gateway products. We also bought network equipment, R&D development tools and we capitalized certain software developments.During Q3, we used $3.1 million of cash to repurchase our shares under our buyback program. Overall, our cash position decreased in the third quarter by $5.9 million. We remain well capitalized with a cash balance of $67.5 million and no debt.Moving on to guidance. For the fourth quarter of 2018, we expect Q4 revenue to be in the range of $200 million to $208 million. Q4 guidance includes 2 factors that we're seeing in our customer base. The first one is our mobile computing customers are experiencing a tight supply situation, primarily related to Intel CPU shortages, which is affecting their demand for embedded modules.And secondly, we're seeing some slowing in the automotive sector. Non-GAAP gross margin in Q4 is expected to be down slightly compared to Q3, as a result of the impact of tariffs on goods imported into the United States, which we expect will add about $1.25 million to our cost of goods sold in the fourth quarter. And we also expect some unfavorable product mix in our OEM Solutions group.We expect non-GAAP OpEx to be similar to Q3 levels. And our Q4 non-GAAP tax rate is expected to be slightly higher than the Q3 rate, but remain below 10%.As a result, we expect our Q4 non-GAAP earnings per share to be in the range of $0.22 to $0.30. This includes the negative impact from tariffs of approximately $0.03 per share.Excluding the impact of tariffs, the midpoint of our Q4 guide -- EPS guidance results in full year EPS of $0.94, in line with consensus estimates for the full year.And just a final word regarding tariffs. Up until this quarter, most of our gateway and router products were manufactured in China. In Q3, with the looming U.S.-China trade dispute, we commenced a program to move over volume gateway and router production out of China to Vietnam.This program will largely be completed in Q4, and therefore, we expect the impact of tariffs to be minimal in Q1 of next year.With that, I will now turn the call over to Kent for comments on corporate and strategic matters. Kent?

[Kent P. Thexton, President, CEO & Director]

Thanks, Dave. In the third quarter, we delivered strong results, and each of our business units showed year-over-year revenue growth. We demonstrated good OpEx control in the quarter, and as a result, adjusted EBITDA increased 21% compared to a year ago.We experienced strong financial performance in Q3 and had strong design win activity across many verticals, including energy, transportation, automotive and networking.I would now like to provide a short update regarding our corporate activities in recent board announcements. The last time I had the opportunity to speak with you was during the Q2 conference call in August, and at that time, I was the Interim President and CEO of the company. I'm pleased now to be taking the role on a permanent basis, which the company publicly announced on October 16.Over the last several months, I have worked very closely with our senior management team and gained a more in-depth appreciation of the potential opportunity ahead for Sierra Wireless. There were 3 factors that really stood out to me during this interim period. The first is the market opportunity for IoT continues to expand globally. Many of our OEM and enterprise customers, such as Swiss-based security alarms, which we just announced yesterday as a new European connectivity customer are wanting to move faster on their IoT deployments and gather more data from their end points, so they can do advanced analytics and improve their business models.They also said that IoT was complex, often hard to deploy and difficult to scale globally. They say having a partner like Sierra who can integrate all disparate pieces together for them, is valuable because it decreases their time to market, reduces their deployment risk and speeds up their time to revenue.Additionally, with our rollout of low-power wide-area solutions, such as our battery-operated module is being deployed by KDDI for smart gas metering in Japan. Our customers are now looking at new and different way to deploy connected solutions. The second factors at Sierra has a very unique set of capabilities in the IoT value chain: that we have world-class capabilities in cellular modules and gateways. Two, in IoT cloud performance. And three, our global MVNO connectivity services. Sierra has the building blocks necessary to provide a unique integrated solution to our customers.And this puts us in a very enviable position in the market. I also believe that our first mover advantage in this space can be strengthened with more partnerships within the IoT ecosystem. I know that it's a leading market share player in modules and gateways. We involve with our customers early in the IoT design phase, which affords us a customer acquisition costs compared to other providers in this space.And with LPWA, our sales teams will be focused on integrating our Cat-M1 embedded modules with connectivity services to improve the lifetime value of the sale beyond just the module.The third factor is that we have a strong management team and a deep talent pool within the company. I visit many of our operating sites and R&D teams, and we have a strong core expertise in the IoT space. There are skills and capabilities that we need to build on as we move into the more bundled IoT solutions and we started working on this already.So as CEO, I'm looking forward to driving the company into its next phase of exceptional growth. And given my unique experience over the last 25 years, which includes running wireless businesses at scale in both Rogers and O2, building an MVNO in the U.S. and managing a technology venture fund, I believe I have the right skill set to accelerate the transformation of the company to a leading global device-to-cloud IoT solutions provider.In my role, I plan to spend a lot of time with the front end of the business, with our go-to-market teams so we are hyper focused on key verticals and customer segments that can leverage our #1 position in modules and gateways into a subscription-based recurring revenue.We sell more than 17 million devices annually, and growing. And as I mentioned, we want to build a much higher rate of service attachment to these devices. And we're putting together processes internally to do that, to focus on that, so we can improve our selling -- our solution selling. We also announced this past quarter the opening of our new network operating center in Atlanta that provides 24/7 service coverage for our connectivity customers globally. With MVNO assets located in 2 of the largest IoT markets, namely the U.S. and Europe, we're now capable of offering our customers global connectivity solutions. And with the NOC in Atlanta up and running, we are now moving ahead to the launch of our ready-to-connect IoT solutions.In simple terms, our ready-to-connect solution provides customers with a device, be it a modular gateway that already has our global smart SIM embedded in it, and therefore, is preconnected to the mobile network anywhere in the world. As a result, the customer has greater flexibility on selecting which carrier, which SLA and what price they want to pay, while reducing the headache of inventory and logistical costs associated with loading SIMs.The customer also has only one vendor and one contract to deal with for the end-to-end IoT solutions. They can manage their endpoints no matter what network connectivity they use, through a single pane of glass using our unified device management platform. So we are starting to rollout our ready-to-connect solution later this quarter. And while it will only be available on select Sierra modules currently, we have a road map to expand this to a much broader set of devices over the next 12 months.As I will be spending more of my time at the front end of the business, I'm pleased to announce the appointment of Jason Krause to the position of Chief Operating Officer of the company. Many of you already know Jason as he has been Senior Vice President of Corporate Development and most recently Senior Vice President and General Manager of the Enterprise Solutions business. Jason spoke on our last quarterly call.Over the past 12 years with the company, Jason has done a great job building teams, executing on strategic plans and growing our business. As he will now be overseeing the engineering operations and product and solutions teams at Sierra, he will be focusing on 4 key objectives along with the rest of the senior management team as we scale the business.Number one, accelerating our integrated device-to-cloud IoT solutions, both from a portfolio and execution perspective. Second, trading a seamless customer experience for all our Sierra Wireless customers. Third, building our differentiating capabilities to sustain our growth and right to win. And number four, continuing to find ways to improve our efficiency and effectiveness so we can fund key strategic initiatives.We're already moving ahead on important programs to provide our customers with more intelligent edge devices that provide distributed data orchestration. We plan to continue to innovate as we move up the stack in selected areas to continue to differentiate our IoT solutions.Regarding our recent Board of Directors announcements. On October 16, the board appointed Robin Abrams to the position of chair. Robin has served as the Director of Sierra Wireless since 2010, and she has more than 30 years of experience in the global technology industry. And on October 24, we announced the appointment of Joy Chik to our board. Joy is Corporate Vice President for the Identity Division at Microsoft's Cloud and Artificial Intelligence Group and brings great technical insight and industry experience to the board. We're very pleased to welcome Joy to our board. These 2 announcements follow the appointment of Russ Jones, former Chief Financial Officer of Shopify to the Board of Directors. The addition of Russ and Joy brings great software and recurring revenue expertise to our board and reflects our focus areas for the future.So with that, I'd now like to open up the call to questions.

[Operator]

[Operator Instructions] Your first question comes from Mike Walkley with Canaccord Genuity.

[Thomas Michael Walkley, MD & Senior Equity Analyst]

Kent, congratulations to the CEO position and to Jason Krause as the new COO. Building on some of your comments, just about building on your module leadership to drive more recurring subscription revenue, what are some of the verticals, Kent, that you think are most prime for that strategy to start taking hold for Sierra Wireless?

[Kent P. Thexton, President, CEO & Director]

Thanks, Mike. Broadly in the industrial IoT markets, so there -- what we're seeing is people are trying to connect their assets and their devices more broadly. So in -- we talked last call about Girbau, the industrial washing machine maker across all sorts of industries, we're seeing companies wanting to connect their devices. And the complexity of having to select a device, different networks globally, with all of the settings to get their data securely to the cloud has slowed the market down. When we've been able to speak to customers and being one solution for that end-to-end, they've been very receptive to that. So we're seeing strong early wins in industrial IoT. We also think that the growth in LPWA is going to enhance this part of our strategy as well. LPWA with lower cost modules, 5- to 10-year battery life and the optimized connection. So less data usage required means that the elasticity of demand for IoT solutions should be significant. We're early, early in that cycle having just deployed our first customer. But for a customer to be able to provide that connectivity, we're reaching deeper into the market, the IoT market than has happened to date, and providing a complete solution to the later adopters to the market is seen as very favorable.

[Thomas Michael Walkley, MD & Senior Equity Analyst]

All right. And just building on that with LPWA, how do you see that impacting the OEM Solutions business? Do you see it just as opening new doors for opportunities or somewhat dilutive to ASPs over time as customers migrate from older 2G or other technologies?

[Kent P. Thexton, President, CEO & Director]

Yes, very good question. The dilutive impact, I'll talk to first. So with many LPWA applications today replacing 2G, it's not that dilutive on ASPs, but the 2G is being sunsetted in some geographies, and as the LPWA is a much more optimized technology for IoT than 2G ever was. So it's a better solution at an effective cost point. We've been in an industry where ASPs have continued to decline and LPWA will be part of that. However on the other end with 5G, that's a complex device. It's going to be at much higher ASP. So we have somewhat of a bifurcation in the marketplace between high end and low end. And the penetration of those 2 markets will have a somewhat balancing position on overall ASPs. But in the LPWA market, our strategy of adding services more broadly, means that we go from dealing with a lower ASP onetime gross margin business to a much stronger lifetime value. And we're seeing good early examples of those sorts of deployments. And that's where I'm focused on building our go-to-market capability for solution selling, and Jason on the execution side to have a focus on that end-to-end device plus connectivity, plus cloud in a seamless fashion. So that's the -- with the advent of LPWA, we're ahead of the curve on preparing for that, and being able to actually see stronger lifetime value per instance than we have in our past.

[Thomas Michael Walkley, MD & Senior Equity Analyst]

Great. Last question for me and I'll pass the line. Dave, just on the gross margins Enterprise Solutions, you're very strong in the quarter. Obviously, it sounds like it's going to be impacted because of the tariff issue in Q4. But as we just think kind of longer term, the puts and takes, where you think's kind of a good run rate to think about modeling Enterprise Solution gross margin on a longer term basis; 54 was I think the highest in quite a long time?

[David G. McLennan, CFO & Secretary]

Yes. Mike, I think as we -- yet to think of it as a portfolio of product. So we've really enjoyed a nice uptick in gross margin here as we're selling more of the higher value, higher gross margin RV50s and MP products, MG products. And I think you should expect that trend to continue relative to our lower margin telematics offering. So I think there is some continued blending upside of gross margin. I wouldn't overheat that, but I think there's some continued pressure there on the Enterprise side.

[Kent P. Thexton, President, CEO & Director]

And just adding to that Dave, the -- when Jason Krause spoke last quarter, we also talked about FirstNet as a new and growing opportunity within our Enterprise segment. So that again is a positive trend.

[Operator]

Your next question comes from Paul Steep with Scotia Capital.

[Paul Steep, Analyst]

Dave, could you maybe talk just -- you touched briefly on it on the comments on the tariffs, but for the OEM business can you may be comment around what you've seen in the market in terms of how it's impacting you in that segment as well as competitors? And then maybe talk a little bit about the gross margin there. We've seen it, I guess, blending down somewhat? Is it mainly tariff related or should we think more about recovery over time?

[David G. McLennan, CFO & Secretary]

Yes, firstly on the tariffs, Paul. From an OEM module perspective, really it's just negligible if any impact. I mean very few of our modules are imported directly to the United States. They tend to go to other countries where they are built into other products. And so we're really not seeing any demonstrable impact on tariffs on the specific segment, OEM segment, where we do see -- where we have seen impact has been in the gateways where we are importing finished goods into United States. And that's the $1.25 million impact that I spoke about earlier in the quarter. I would like to stress though that we've moved quickly to move production from China to Vietnam with those gateways. And so we expect to have very little impact, a small amount of impact in Q1, but nowhere near what we're seeing in Q4 on that side of our business. With respect to gross margin and OEM, it's really all about mix. This quarter, we saw some increase in automotive sequentially from Q3. And that blends down gross margin and we also saw some decrease in our mobile computing business, which is running at above average, our OEM gross margin average, and that blends it down as well as those volumes decrease a little bit. So it's really all about product mix within OEM.

[Paul Steep, Analyst]

Is there anything -- just to finish on that, Dave, is there anything you're going to do in terms of cost action or it's solely mixed and there's really not much in the way of levers, you can pull sort of drive it north of 30%, again?

[David G. McLennan, CFO & Secretary]

No. We are very, very focused on managing our cost of goods sold. We've got programs underway to focus on build materials, manufacturing costs, the entire supply chain. You've heard us talk in the past about having some advisers in to help us work through some of these things, and that's really a focus on driving cost down. So we're not standing still. And I think we have done a good job in reducing -- taking costs out and we just need to continue to focus on that very carefully.

[Paul Steep, Analyst]

Great. One quick wrap-up on, Kent, congratulations. The question, I guess, for you would be, how should we -- how should investors think about what you're going to do with the capital that's on the balance sheet. You got a strong balance sheet. You've talked about accelerating the move and the strategy. Should we think of that as a more aggressive M&A stance or is it a stronger investment back into the core of the business?

[Kent P. Thexton, President, CEO & Director]

Thanks, Paul. The -- I mentioned last quarter that we are not looking to acquire more MVNO assets, that we feel we have global scale in that regard. And that our growth of recurring device-to-cloud revenue is mostly going to happen organically. And that's a significant opportunity as we've shipped over 17 million modules and gateways in the past year, and that is a growing number. So the -- that recurring revenue growth and on the previous question about OEM, we're growing our enterprise and our services segments most quickly, and we will continue to focus on that. The cash in our balance sheet we feel that at a good level right now. We're going to be focusing on driving our efficiencies so that we can fund our activities into new key segments and drive our product capabilities as we described, and do that with self-funded activity. So that's an efficiency focus. Jason's new role, where we're providing a centralization of a number of our R&D and delivery functions for just some opportunities in that regard. So we -- as we continue to push deeper into recurring revenue sides, we could find some opportunities with M&A, but currently right now it's to drive our solutions capability and to drive the organic growth of our recurring revenue as the main near term focus is.

[Operator]

Your next question comes from Thanos Moschopoulos from BMO Capital Markets.

[Thanos Moschopoulos, VP & Analyst]

Can you expand a little on what you're seeing in the auto space? You mentioned there's been some slowing in that market. Does that seem to be a short-term inventory rebalancing or is that something that could persist into early next year? And can you comment on the ramp of your large auto program and how that's proceeding?

[David G. McLennan, CFO & Secretary]

Thanos, it's Dave here. We -- what we're seeing as we go into Q4, is a slowing of demand from our automotive -- our existing automotive customers. I think that's consistent with some of the industry reports you may have seen as we got into the early fall period, you saw some of the automotive OEMs reporting some slowdown in their numbers. So I think that's a phenomenon we're seeing right now. Interest rates is clearly a factor there as interest rates go up and consumers do change their buying patterns accordingly. So I think that is a factor here in the near term. Sorry, what was your second question?

[Thanos Moschopoulos, VP & Analyst]

The ramp of your large auto program and...

[David G. McLennan, CFO & Secretary]

Ramp. Yes. Sorry. So yes, we have -- good news, we've commenced shipping there. So that's good news. I would stress though that the volume ramp is really a 2019 phenomenon, and you should expect this to see ramping later in the first half of the year on that program. But we have commenced shipments. And we're very pleased with the progress we've made there.

[Thanos Moschopoulos, VP & Analyst]

Great. And then on the OpEx side, there was a fair bit of a step down in R&D versus last quarter. Was that just reflective of wrapping up the integration of Numerex or is there some other dynamic that drove that?

[David G. McLennan, CFO & Secretary]

There are a lot of moving pieces there, Thanos. So yes, we've been active on the integration side. There is some timing of expenses that move from quarter to quarter with things like certification. But really, one of the big drivers was, we spoke to you in February about some cost out initiatives, and we implemented $30 million for one of those right at the end of June. So we had the benefits of a full quarter of that impact. And that was mainly in R&D related to a facility we had in Asia.

[Thanos Moschopoulos, VP & Analyst]

Okay. That make sense. And then finally on the IoT Services side. Help us think about operating leverage as that business grows into next year. I mean, on the short-term basis, should the margins remain kind of at these levels or should there be quite a significant ramp as volumes increase for the services line?

[David G. McLennan, CFO & Secretary]

Yes, certainly scale matters there. And we do have decent scale in our operating jurisdictions. But we're also being competitive with ASPs as we've been on design wins. So think of that business as an area of investment for us. We're focused on the financials, but we are growing that business and we are investing in that side of the business as well.

[Operator]

Your next question comes from Todd Coupland with CIBC.

[Todd Adair Coupland]

On the mobile side with the Intel shortage, what's your view of how long that's a drag on results?

[David G. McLennan, CFO & Secretary]

You have to check with Intel on that, Todd. Certainly they are building capacity to try and relieve the shortage. But I think, it's for the foreseeable future here, that's going to be a factor.

[Todd Adair Coupland]

Okay. And as we think about the company under your leadership, Kent, does the target model for the company in terms of aspirational targets, double-digit growth, 10% EBIT margins over time, is that still something that is a keen focus? And maybe talk to what you think are the key levers to get there and any other thoughts you have on the matter?

[Kent P. Thexton, President, CEO & Director]

Sure. We think that the IoT market is an exceptional long-term growth market. We've done quite a bit of strategic work in that and the market segments that we think will grow most rapidly. So we see large opportunities ahead. I think overall global IoT growth has been somewhat slower then marketed. And we think we're solving some of those problems by being a complete solutions provider. The disparate parts and putting it together has been somewhat of a challenge. So our revenue growth is going to be driven by a couple of factors. I think that the continued deployment of IoT systems, some of that is going to be driven with deeper penetration with lower cost LPWA modules and also greater capabilities that are happening with 5G. But more particularly, we're looking with our strategy of providing a complete solution and we'll be targeting on particular segments that are -- that we're best positioned to provide that solution. At that point in time, when we are selling a module, an LPWA module, is typically fairly low cost but we're adding the monthly recurring revenue that goes with that. You will see that the revenue build like a SaaS company over time. When we're shipping a module into a machine and device, hardware, that's a nice long-term recurring revenue stream, not like the consumer cellular market where a customer might change their mind. When you have a piece of equipment that you're providing important data for, you're there for the life of that equipment -- driving up our growth rate. As we said today, we are at 12% of our revenue is recurring and we're going to be focusing on growing that percent and we believe that increases the value of our business.

[Operator]

Your next question comes from Paul Treiber with RBC Capital Markets.

[Paul Treiber, Associate]

I just wanted to follow-up on your last comment that you made in terms of the growth of recurring revenue in LPWA. Do you see an opportunity for new or perhaps more aggressive business models, perhaps like in the consumer telecom world, where you could subsidize some module with multi-year subscriptions?

[Kent P. Thexton, President, CEO & Director]

That is certainly something that may occur in some instances. Our focus so far in the customers we're speaking with is to have them recognize the value of our hardware, and then have them recognize the benefit that we can provide with a bundle of connectivity, security, cloud services. And we look to make margins on both parts of that business. As you get to lower cost modules, the outer year view of LPWA modules could be in the $5 to $10 range in significant volume, then you can quite rapidly be making up lost margin on the front-end with the recurring revenue stream. I think that it's an important shift in the business model as this market grows strongly into the future. So the -- we're not going to try to take this market down, many years of experience with subsidies in the cellular marketplace. And while it can spur growth, it becomes a bit of a headache. These are becoming fairly low cost modules. I think that the other part of this is, there is some activity for the customer to design their systems. We're involved in that, and where we can provide advice, support, professional services, we'll monetize that as well. So we see many opportunities for monetization. For large customers, we'll be working with them on -- are they looking for a CapEx or OpEx-type solution to suit their business needs, and we'll have some flexibility. But in general, we'll have a price list on our modules and a price list on our connectivity. On connectivity, we can be very creative because customers don't really think in megabytes, they think about events. And by owning the device layer and the network layer, we can do leading-edge things like bill customers per event, which suits their business model, but also can be a strong margin business for us.

[Paul Treiber, Associate]

And earlier you mentioned that there's an opportunity to increase the attach rates on services. When you look at what the strategy has been to date or the execution to date on attach rates are -- driving higher attach rates, why do you think it has been less than ideal to date? And what do you think the strategy would be to increase it?

[Kent P. Thexton, President, CEO & Director]

Sure. And we'll try not to get too deep into the plumbing to answer that question. But in the past, we've shipped all our modules and gateways with an empty SIM slot. And while for the last short while, we've had standards Sierra SIMs that you could put in versus a carrier SIM, there wasn't much change in process. And the expertise of our sales force was strongly around hardware. The ready-to-connect program that I mentioned is important because actually getting a global SIM to have 1 SIM card that can work anywhere in the world, is a pretty significant technical achievement. Our customers previously would use different SIM cards for deployments in different parts of the world. It gives them a logistics and cost hassle. So we've moved to our global Smart SIM that can light up anywhere in the world and provide connectivity. The ready-to-connect program then builds that capability and directly into our module or gateway, so as that product is shipped and it shows up in various parts of the world, it lights up the global Sierra Wireless network and starts reporting data to the cloud. So those 2 developments with our Smart SIM technology and then our integration into our modular gateway makes it a much easier deployment for the customer. And we've been working on training our sales force to be able to share the advantages of that with the customer. So we will be deploying that ready-to-connect across our footprint during 2019, so that the attach rate of our services is a very straightforward activity. From our Smart SIM, we can move that if a customer wants to be on a specific carrier, we can put them on that carrier, but to provide 1 global solution, we can put them on the Sierra Wireless solution. So we are providing a great service for our customers and it is simple and easy to use. We have many reasons why we think we have a much greater benefit to the customer who are going with Sierra Wireless end-to-end. And especially when we get into these LPWA and market expansion use cases, not having to go through a modules selection process, getting to understand and know all of the SIM solutions globally, along with how to manage the cloud part of the process, we can bring that all together for the customer. That complete solution really is -- has just been coming together over the last short while. And that is something that we're focused on in 2019 to have it deployed across all of our selling capability to be upping our solutions capability in the field with training and with talent. And be focusing on customer statements where we see this need.

[Operator]

[Operator Instructions] Your next question comes from Richard Tse with National Bank Financial.

[Richard Tse, Managing Director and Technology Analyst]

If you go back to Todd's question earlier, I'm just kind of curious if you can maybe give us a bit more color in terms of whether there is sort of a specific aspirational target on services as a proportion of the base? Is it sort of roughly are you trying to get to 1/4 of the base, 1/3? And also what would the rough timeline be on something like that?

[Kent P. Thexton, President, CEO & Director]

Richard, you realize that I didn't provide you with a specific number. I'll make a couple of comments and ask Dave to comment as well. My official first day as CEO was November 1. We sit here on November 8 and I don't have crisped up targets to give you at this point in time. We are focused on growing our recurring revenue and we see a lots of opportunity there. We will get to the point where we can provide better targeting for you in that regard, but it's too early in the game to get specific yet.

[David G. McLennan, CFO & Secretary]

Rich, this is Dave. I would emphasize though that we're at 12% right now in terms of recurring revenue, and we've made some pretty good progress in that over the past several years, where we were virtually 0% in 2014. So we're making progress through both organic growth and acquisition growth. And we've really focused on how to accelerate our growth in services. And that's part of the advisory work that's going on right now within the company is to help us identify opportunities to drive harder and faster the growth in services. So not sticking on any target there, but we're very, very focused on growing that as a business.

[Kent P. Thexton, President, CEO & Director]

I would go back to one other part, Richard, is that we talked at the beginning that our higher margin, higher value segments in enterprise and services continue to grow rapidly. So that is an area that we will broadly have a focus on. So 27% of revenue from those 2 higher margin segments and OEM, some segments like automotive, they've gone to scale way down gross margins. And we're counteracting that with growth in services and growth in enterprise. And we will continue to do that over time. The services attach rate will drive significant growth in margin from that part of the business. And in OEM sale, that may look lower gross margin up front, will actually have a high lifetime value.

[Richard Tse, Managing Director and Technology Analyst]

That's helpful. And last question for me. One of your big competitors has said that they have some high-profile challenges over the course of the last year. Are you seeing any sort of change to your business and pipeline because of those challenges?

[Kent P. Thexton, President, CEO & Director]

We see many competitors in the industry and so that I would say from the -- your reference to Telit is they continue to be hungry in certain market segments. We're seen as a high-quality provider and our win rate continues to be high. When we look down the curve or around the corner in terms of where the market goes, I think it will be a different sets of competitors that are important to us in time as this market goes to scale, and that's where we see our position as a solutions provider being unique in the marketplace today. Nobody has assembled a complete set of assets that we have. And we're working to execute so that we can -- we continue to lead with our work with Jason Krause and his COO position in driving centralization of our R&D functions and product management, gives us more capability and cycles to drive greater innovation into this part of our business as well, the combination of hardware and services to provide a differentiated solutions to customers. So we're excited about that opportunity.

[David G. McLennan, CFO & Secretary]

Richard, this is Dave here. I'll just add one thing. It is a design win-driven business, right. So things don't -- when a competitor hits those kinds of bumps, it's not necessarily an immediate share opportunity, but as we bid on new design wins, I think we have a very strong, credible story to tell to potential new customers from a competitor's perspective relative to Telit.

[Operator]

Your next question comes from Howard Smith with First Analysis.

[Howard Shepard Smith, Managing Director]

My question has to do with the OEM gross margin. You talked a little bit about enterprise, the trends there being positive with mixing, sustainably so once the tariffs are done perhaps. On the OEM side, it sounds like some of these trends with auto and then ramping up your new auto customer, which has lower margin in its initial phase until you get to scale with that and get a little more experience and the mobile, it sounds like the margins there could be under pressure. We shouldn't expect any material pick-up here in the near-term due to mix or am I reading the tea leaves wrong?

[David G. McLennan, CFO & Secretary]

Howard, it's Dave here. I think directionally those comments are correct. I mean, we're very focused on managing gross margin from a build materials and cost of manufacturing and supply chain perspective. So we are taking cost out of the products every day. But the mix, you should expect as we see those trends, will put pressure on OEM gross margins. And that's why we have a business with many other customers and different profiles, right. We've talked about services and gateways, which is now 27% of our revenue mix and much higher gross margin and growing faster as a mitigating factor to a pressure on OEM margins.

[Howard Shepard Smith, Managing Director]

And just a follow-up, a slightly different line. The GenX asset, you had some things that were going really well and you thought that they would tail off in terms of demand for that. I know you talked about the main drivers are some of these higher end enterprise products, but in that line, did that fall -- did that actually stay up better than you expected as the year has gone on here?

[David G. McLennan, CFO & Secretary]

Yes, I mean, we've seen -- the trend we saw with our, I'll call it our mid-tier telematics products where we had a tremendous ramp in Q3, Q4 into Q1 of this year on the backs of the hours of service legislation in the United States, that was a nice bump to the business, and not surprising, that's tailed off as that regulation has run its course. But in parallel to that, as we brought new higher-end AirLink gateways to market, they've really hit their stride here, and we've seen strong growth that has been able to offset and more the change, the reduction of telematics, our mid-tier telematics business. So and that's a great trade because those -- the gross margin on those higher-end products is much higher than what we're seeing on the mid-tier telematics products. So that's a good equation for us.

[Howard Shepard Smith, Managing Director]

And that enterprise business does look really strong right now.

[Operator]

There are no more further questions queued up at this time. I'll turn the call back over to the presenters.

[Kent P. Thexton, President, CEO & Director]

Okay. Thank you very much for good questions and paying attention to our presentation. We will wrap the call at this point in time, and are open for follow-up discussions and interaction and excited about the opportunities ahead of us. Thank you.

[Operator]

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