Sequans Communications S.A. (NYSE:SQNS) Q4 2022 Earnings Call Transcript

Sequans Communications S.A. (NYSE:SQNS) Q4 2022 Earnings Call Transcript February 14, 2023

Operator: Greetings, and welcome to the Sequans Communications S.A. Fourth Quarter 2022 Financial Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. . As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Kim Rogers, Managing Director of Hayden IR. Thank you, Kim. You may begin.

Kim Rogers: Thank you, Maria, and thank you to everyone participating in today’s call. Joining me on the call today from Sequans Communications are Georges Karam, Chairman and Chief Executive Officer; and Deborah Choate, Chief Financial Officer. Before I turn the call over to Georges, I’d like to remind our participants of the following important information on behalf of Sequans. Sequans issued their earnings press release this morning, which was posted to the company’s website at www.sequans.com under the Newsroom section. Before we start, I’d like to remind everyone that this conference call contains projections and other forward-looking statements regarding future events or our future financial performance and potential financing sources.

All statements other than present and historical facts and conditions contained in this call, including any statements regarding future results of operations and financial positions, business strategy and plans, expectations for future product sale, potential for future strategic licensing deals or other strategic transactions, the impact of the COVID-19 on our supply chain and on customer demand, the impact of component shortages and manufacturing capacity, our ability to convert our pipeline to revenue, and our objectives for future operations, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

These statements are only predictions and reflect our current beliefs and expectations with respect to future events and are based on assumptions and subject to risk and uncertainties, and subject to change at any time. We operate in a very competitive and rapidly changing environment. New risks emerge from time-to-time. Given these risks and uncertainties, you should not rely on or place undue reliance on these forward-looking statements. Actual events or results may differ materially from those contained in the projections or forward-looking statements. More information on factors that could affect our business and financial results are included in our public filings made with the Securities and Exchange Commission. And now, I’d like to hand the call over to Georges Karam.

Please go ahead, Georges.

Georges Karam: Thank you, Kim. Good morning, ladies and gentlemen. Welcome to our fourth quarter and full-year 2022 financial results conference call. I’m pleased to report that we ended 2022 with solid financial performance results showing $60.6 million of yearly revenue and 71% gross margin. Year-over-year, this represents 19% growth in revenue and 17.4 basis point increase in gross margin. Consequently, we achieved non-IFRS operating profit of $1.6 million for the full-year 2022 compared with a non-IFRS operating loss of $13.2 million in 2021. These results are a particularly outstanding achievement given our industries, supply chain and inflationary challenges in 2022. In fact, the supply chain disruption was the principle cause of the delay we faced on our design win project launches in 2022.

A significant factor in achieving a year of growth and improved operating results was our ability to leverage our 5G asset and it’s scarcity value to create a new IP licensing business that was able to compensate for product shipment delays and boost our gross profit. Looking back at the key highlights 2022. There were three notable accomplishments that benefited our results, and more importantly, will position Sequans for sustainable long-term growth in the cellular 4G, 5G, IoT market. As said before, the first milestone was securing 5G licensing revenue. We closed the multi-year strategic 5G licensing partnership for our Taurus 5G platform valued at more than $50 million. The deal adds licensing revenue over three years and will position to royalty payments for up to 10 years once the Taurus platform starts shipping to customers.

The licensing revenue from this deal supported our revenue growth, increased gross margin, and narrowed our net loss in the second half of 2022. The second key highlight was the growth of our product sales pipeline to over $700 million of three-year-life revenue with $350 million in design wins primarily driven by our LTM and B-IoT Monarch 2 platform. These design win projects are expected to convert into $100 million in annualized peak revenue at full ramp. We also have further potential from the other half of the pipeline that covers the advanced design-in opportunities, which have at least a 50% probability of converting to design wins. The third key accomplishment was the continued innovation in our product line that positioned Sequans with the comprehensive 4G, 5G portfolio optimized for IoT.

The market reception of our second-generation Cat 1 chip Calliope 2 has been incredible and the platform is already adding new design wins and design-ins to our revenue pipeline. In tandem innovation in our LTM and B-IoT Monarch 2 platform added new features and improvements for furthering our leadership in this sector. Lastly, we made tremendous progress on our Taurus 5G platform and plan to sample the 5G NR platform this year. Let me go into each of these in more detail. Taking a closer look at the financial results, the fourth quarter revenue increased year-over-year by 15% in line with our expectations. The contribution of licensing revenue and the mix of products between chips and modules lifted our gross margin to over 75% significantly exceeding our forecast.

The improvement in gross margin delivered a substantial improvement in our bottom line, improving our net loss by $2.8 million compared to the fourth quarter of 2021. For the full-year, the primary growth drivers were the nearly 40% increase of Massive IoT LTM revenue, despite project delays, and over 50% growth in Broadband IoT from our 5G licensing revenue. These gains were offset by the expected decline in our first generation Cat 1 product revenue, mostly due to higher than normal revenue in 2021 from this product line as one main customer built over six-month of inventory to avoid a potential supply shortage. Consequently, the net result is a nearly 20% total revenue growth in 2022, despite the various delays we had with customers, products, lunches that were expected in the second half of the year.

The delays were mostly due to the supply challenges our customer were facing with their legacy products, which caused them to prioritize fixing shortages in existing all generation products and reduce the priority of new projects with Sequans. The good news is that none of these new projects was canceled. And as the supply shortage issue appears to be behind us, customers are pushing to finish developing their new products. We expect the mass production launches to start in 2023 and early 2024. Turning now to look at the $700 million product sales pipeline and our success in various markets. Today, over 80% of the product sales pipeline is in Massive IoT. The Broadband IoT portion is expected to accelerate in the future with the launch of our 5G Taurus platform.

Keep in mind that the sales pipeline KPI represents the sum of three years of revenue of all sales opportunities starting from the market launch date of each customer project. Half of the sales pipeline is from secure design win projects with some in mass production, already generating revenue and others in the design phase with revenue to come once our customers launch their products. The other half is about advanced design-in opportunities we are working on to win. Note that we are not counting here all opportunities our sales team sees, but only those with at least a 50% chance to be one and we call advanced. About 70% of the Massive IoT design win pipeline is dominated by our LTM NB-IoT Monarch 2 platform, and the remaining is with Cat 1.

The fantastic market reception to Cat 1 Calliope 2 platform is already adding to the design win pipeline and this will be our next product growth lever with design wins expected to accelerate this year. Calliope 2 has the potential to double our addressable Massive IoT market. Given that Sequans recognized early on that Cat 1 would be required in many IoT applications and would complement LTM NB-IoT, we now have a competitive advantage that will enable us to take significant market share in this segment. In terms of Massive IoT applications, we have secured many customers and projects in smart city, specifically in the smart meter. These applications represent over 40% of our Massive IoT design win pipeline. The power consumption performance of Monarch 2 was a critical advantage in this segment, now estimated to be about 30% of the Massive IoT market and expected to grow threefold in the next few years.

Also, the Cat 1 product category is required for some smart metering, specifically electrical meters in Japan. With nine customers in metering mostly Tier 1 players, we should be able to grow our market share to over 40% and secure a sustainable revenue source for the next 10 years. That said, keep in mind that meter qualification can take at least a year longer than other IoT devices before deployment. Thus the metering segment revenue round is slower than other applications. We are entering 2023 with a couple of metering projects in mass production, a few others planned to launch in 2023, and several more to launch in 2024, and even early 2025. Patience is the price to pay to enter this large and persistent market. Another key Massive IoT vertical, where we are having great success is asset tracking and telematic fleet management.

Sequans platforms are ideal for these applications where both LTM and Cat 1 are required. Today, applications in this vertical represent about 20% of our current Massive IoT design win pipeline. The balance is made up of wins in a smart home and security, both important segments, and other smaller vertical like medical and a few other industrial applications. Let’s analyze how the three-year-life revenue of our design win pipeline will convert to yearly revenue. Considering our Massive IoT design win pipeline, we estimate that when all the customer projects are launched, the annualized peak revenue of in-hand design wins will exceed $100 million. Reaching this level depends only on the launch date and the ramp up rate of each project. Currently less than 20% of our design win projects are in full production.

Based on customer’s plan, we anticipate launching another 45% in 2023 towards the second half of this year, and the balance in 2024. This gives us a high level of confidence that despite the level of product shipment we have to-date and the headwinds from excess inventory in the channel; we could attain the $100 million in 2025, just by supporting our current customers to move their projects into production. This would not include future design wins and more specifically those currently in the advanced design-in stage that constitute the other half of the $700 million in our sales pipeline. I haven’t focused on this portion in past calls. But I want to call your attention to the potential this portion of the pipeline has for future revenue.

If in 2023 we can move 50% of advanced design-in projects to design wins, the design win portion of the three-year-life revenue pipeline, KPI would grow to over $500 million by year-end. This would increase the design win annualized peak revenue to $150 million mainly based on sales of Monarch 2 and Calliope 2. The success of Calliope 2 significantly contributed to our design-in pipeline in 2022. About 60% of the advanced design-in pipeline is Calliope 2, which also reflects the higher ASP of Cat 1 versus LTM. We are uniquely positioned. There is a big Cat 1 market and we primarily compete with Chinese technology. Keep in mind that our channel partners have helped us grow our sales pipeline and this will continue in 2023, specifically with Renesas, who will be launching new modules integrating our chips.

The Renesas partnership has been highly successful for Sequans. They assisted us in increasing our market reach and solidifying our brand trend. Together, we can provide bundled technology to customers combining Sequans cellular IoT products with other IoT technology from Renesas, as they have a large product portfolio. Together, we closed many Tier 1 design wins and are working on many more potential wins for 2023. Our third key accomplishment in 2022 was our continued innovation and product launches. The most exciting news here was the Calliope 2 launch and interest has exceeded our expectations. The goal was to expand our market share in Cat 1 beyond what we achieved with our first-generation Calliope platform, giving us a comprehensive Massive IoT product roadmap that offers multiple cellular IoT variants for a broad scope of use cases.

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Ideal applications for Calliope 2 are in smart home and security that use video and voice where LTM capabilities are limited. We also see an opportunity for Cat 1 speed in some electrical metering and telematic applications, particularly when mobility is required. Since the Cat 1 standard was conceived as a derivative of the Cat 4 category, most cellular networks have better coverage with Cat 1 than LTM or NB-IoT, particularly in Europe. So to ensure better coverage, many mobile applications even with low data rates consider the small price premium worth the better coverage of Cat 1. To-date, we have secured three Tier 1 design wins with Calliope 2 and are engaged in over a dozen additional advanced opportunity some of which may close this quarter.

Calliope 2 positions us to become the market share leader in Cat 1, and my confidence level in delivering returns on this investment is extremely high. Other innovations we delivered in 2022 include improving our Monarch 2 platform offer with the new advanced features to maintain our leadership in the LTM NB-IoT. Two new capabilities, GNSS and iSIM have been added with higher ASP that bring 15% more revenue per unit as well as improve the gross margin. Sequans GNSS supports most of the IoT tracking use cases and is fully integrated with Monarch 2 software. It provides a very competitive low power GNSS solution, delivering accuracy on par with legacy GNSS chips. We have customers adopting this and we’ll have Monarch 2 shipments with GNSS enabled this year.

Another key technology differentiator we released in 2022 is our iSIM enabled Monarch 2, where a fully secured SIM IP is embedded directly into the chip. Sequans was the first to put this capability on a modem chip. We are working with several partners to bring an end-to-end solution to market with remote SIM provisioning for IoT device. A few Alpha customers are now engaged and we should start shipping iSIM enabled Monarch 2 this year. We’re also seeing strong interest in metering and other IoT applications that may remain in use for years and may need to change SIM provisioning during the device’s lifetime. Another improvement on the Monarch 2 platform was a 20% reduction of power consumption in connected mode operation, which is crucial for gas metering applications.

Also, we have enabled the integrated low power sensor hub feature resulting in a lower cost solution. Last but not least, we have made significant progress in developing our 5G Taurus platform. We sampled the radio transceiver chip last year and are on track to sample the baseline chip this year. We have engaged many customers building various 5G broadband devices. And the feedback on Taurus specifications and cost structure is highly attractive to them. We are very excited about bringing this platform to market this year and start adding another growth lever to our sales pipeline. Our 5G Taurus addressable market will exceed $1.5 billion of chip sales by 2025, plus doubling the size of our Massive IoT market. One last item I want to discuss is IP licensing, which is a new growth lever for Sequans.

We successfully launched an IP licensing platform with our 2022 5G licensing and a royalty partnership. This deal is progressing very well and we met all deliverables and milestones as planned. The size the three-year licensing revenue, we firmly believe this program will generate royalty revenue beyond the three-year period. Our partner has a substantial market share in two market segments where the sales of the Taurus platform should provide Sequans an additional $5 million to $10 million of yearly royalty revenue. Also, we are having new discussions with our partner to expand our collaboration on a couple of fronts. Particularly, we are discussing an exciting Massive IoT opportunity with the product revenue to Sequans. We hope to update you on this development in the near future.

Now from this first licensing win, we plan to scale this 5G IP platform to new applications and market. Currently, we are engaged in discussions for several new potential IP licensing opportunities for our 5G Taurus technology. Our discussions are advancing and we are targeting to close at least one licensing agreement by the end of the second quarter. This IP licensing and our royalty business is practically a full margin business that will add to our product revenue to improve gross margin and profitability. We are convinced that the scarcity value of our 5G IP can be leveraged to drive our growth and profitability and this will create more value for shareholders. As we look to 2023, we anticipate product revenue growth to resume in the second half of the year.

We are not experiencing a demand issue as evidenced by the significant increase in our sales pipeline over the year. The issue we face is a matter of timing related to our customer launches. Across the semiconductor industry, high inventory supplies are pressuring forecast for the first half of 2023. We are also seeing this particularly with one key customer who was regularly buying $2 million to $3 million per quarter. Industry consensus sees a bottoming of this effect in the second quarter and a resumption of growth in the second half of the year. Our outlook for the year and the first quarter, which has historically been a seasonal — seasonally lower quarter for us, aligns with this market view. In summary, 2022 was a solid year in terms of our financial performance, a significant growth of our design win pipeline, the acceleration of our competitive position in the product landscape, and the monetization of one of our most valuable assets.

We’re tapping multiple growth levers. We have built differentiated, innovative, and comprehensive product portfolio covering all Massive IoT market segments. We have a growing sales pipeline with Tier 1 customers. The risk of losing design win projects is low. Our team and channel partners focus on bringing more opportunities into the pipeline. Sequans has significant wins in 2022, giving us a solid foundation to build over the next few years. Taurus 5G is a unique asset with a great potential for both product and licensing revenue streams. Sequans has a well-defined diversified strategy to grow. In 2023, we intend to further monetize our pipeline, win new projects, close at least one more IP licensing deal, and sample our Taurus 5G solutions.

Finally, let me stress that Sequans unique position in the cellular IoT space makes us attractive to many potential partners. We have numerous avenues open to us, and the Board has formed a special committee to explore strategic options as well. We will evaluate every tool in our toolbox to unlock shareholder value. My confidence level has never been higher for our enduring success. I’ll now turn the call over to Deborah.

Deborah Choate: Thank you, Georges, and good morning, everyone. Revenues for the full-year 2022 increased 19% from $50.9 million in 2021 to $60.6 million in 2022. Gross margin improved to 70.8% versus 53.4% in 2021, due to the significant increase of licensing in the revenue mix. Product gross margin improved as well moving from 27.7% in 2021 to 32.7% in 2022. Our top-line and margin improvements combined with only a 2.7% increase in operating expenses meant that we were able to reduce our IFRS operating loss to $3.8 million, down from $18.3 million in 2021, as well as reduce our IFRS net loss to $9 million from $20.3 million in 2021. On a non-IFRS basis, we achieved operating income of $1.6 million in 2022, compared to an operating loss of $13.2 million in 2021, and we achieved a net loss of $5.4 million in 2022, down from $19.5 million in 2021.

Moving to Q4, our revenue for the fourth quarter was in line with our guidance at $15.9 million. This is an increase of 15% versus Q4 2021 and down slightly compared to $16.5 million in the third quarter of 2022. Product revenue increased sequentially but declined compared to the same quarter last year. Revenue from Massive IoT product sales in Q4 2022 continued to account for nearly all of our product revenue. Licensing revenue all in the Broadband IoT segment declined slightly from the elevated Q3 2022 level as expected. Year-over-year, licensing revenue increased significantly due to the revenue recognized from the strategic 5G licensing deal. For the quarter, we had one customer and one channel partner that each represented 10% or more of our revenue.

IFRS operating expenses were $13 million in the quarter, up 11.7% from $11.6 million in Q3 2022. The increase was primarily due to a nearly $700,000 increase in non-cash stock-based compensation expense hitting mainly in the G&A line and the impacts of our large 5G government grant being fully recognized by October 2022 and therefore no longer reducing R&D spend beginning in Q4. Year-over-year, IFRS operating expenses increased 8.8%, compared to $11.9 million in Q4 2021. Non-IFRS operating expenses, which exclude stock-based compensation expense, were $11.2 million in Q4 2022, up sequentially from $10.5 million in Q3. Our fourth quarter operating loss was $986,000 a significant improvement compared to $4 million operating loss in the fourth quarter of 2021.

In the prior quarter, operating income was $1.2 million. The sequential change in the quarter is due to a slightly lower gross margin on lower revenue, along with the increase in operating expenses. Our net loss in Q4 was $5 million or $0.10 per diluted ADS and included non-cash income of $1 million from the revaluation of the embedded derivatives related to our convertible debt. In the fourth quarter of 2022, we recognized income tax expenses of $907,000. Our net loss compares to the net loss in the fourth quarter of 2021 of $7.7 million or $0.21 per ADS, which included a non-cash loss on the revaluation of the embedded derivatives of $1.2 million. In Q3 2022, we had a net loss of $2.9 million or $0.06 per ADS, which included a non-cash loss on the revaluation of the embedded derivatives totaling $1.2 million as well as income tax expense of $1.6 million.

The majority of the sequential increase in net loss was due to non-operational below the operating line fluctuations in non-cash items, including the unrealized foreign exchange loss in Q4 versus a gain in Q3. On a non-IFRS basis, our net loss for Q4 was $2.8 million or $0.06 per diluted ADS compared to a non-IFRS net profit of $424,000 or $0.01 per ADS in the third quarter, and a net loss of $3.5 million or $0.09 per diluted ADS in the fourth quarter of 2021. In Q4, we had a loss on foreign exchange of $1.5 million or $0.03 per ADS, primarily related to revaluation of Euro denominated net liabilities on the balance sheet. This compares to foreign exchange gain of $1 million in Q3 and $135,000 in Q4 2021. Investors should be aware that possible changes in foreign exchange rates related to balance sheet items and the marking to market of our embedded derivative related to the convertible debt can cause significant differences in net income or loss from quarter-to-quarter.

While the impact of swings in the value of the embedded derivatives is excluded from our non-IFRS presentation, foreign exchange gains and losses whether realized or unrealized are not. Cash and short-term deposits totaled $10.7 million at the end of Q4 compared to $5.8 million at the end of Q3. We have close to $7 million in milestone payments from our 5G licensing agreement scheduled to be received in each of Q1 and Q2 this year, as well as later in the second half. Cash used by operations for the full-year 2022 was $1.8 million of which approximately $2 million came from the buildup of inventories to above normal levels. We expect this inventory — excess inventory to be absorbed over the first half of 2023 and therefore purchases of inventory during this period should be extremely low.

Turning to the outlook for Q1. We are targeting revenues of around $12 million, reflecting the impact of excess inventory in the channels, but primarily at one key customer, as well as the delay by our customers in the launch of design wins into mass production. However, as the revenue mix should still be weighted toward licensing revenue, we are targeting gross margin to be about 70%. We expect non-IFRS operating expenses in 2023 to average about $12 million per quarter, assuming a stable Euro dollar exchange rate. We expect interest expense in Q1 2023 on an IFRS basis to be approximately $2.5 million. This comprises the contractual interest expense of around $1.1 million and the IFRS adjustment that we deduct to come to our non-IFRS net result of about $1.4 million.

Most of our interest expense is pick-related interest on our convertible debt and is not paid in cash. We are not providing guidance on any impact of revaluing the embedded derivative or possible foreign exchange gains or losses given this is largely determined by market conditions. Finally, for modeling purposes, the number of ADS’s outstanding today is $48.4 million. At the conclusion of this call, we will post a written version of our formal remarks in the Investor Relations section of our website on the Webcasts and Presentations page, the same location where you will find the audio replay. Now, I’ll turn the call back to Georges.

Georges Karam: Thank you, Deborah. Operator, we are now ready to open the call for Q&A. Please go ahead.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. . Our first question comes from Scott Searle with ROTH. Please proceed with your question.

Scott Searle: Hey, good morning, good afternoon. Thanks for taking the questions. Hey, just a quick clarification first, Georges, on the $700 million pipeline in that $350 million design win opportunity, it sounds like, right, there’s no 5G in that currently, and a majority of that is Cat M driven at the current time, the Cat 1 production is starting to really ramp up in that design activity, is that correct?

Georges Karam: It’s 80% of this is Massive IoT, Scott, I mean the remaining is a Broadband 20%. So in other words, if you take Massive IoT only we are a little bit below $300 million like $280 million, $290 million. And the Broadband has some 5G, but it’s really longer run because we have some design win as you remember from the — from day one on this deal. And we have some product revenue expected in the pipe to come once the product will launch. But indeed, 80% if you take like of the $700 million when I said $300 million, I’m counting deficit, the design win. If you take the $700 million by completely with design win and design-in 80% of this is pure Massive IoT, which means Monarch 2 mainly and Calliope 2.

Scott Searle: Perfect. And maybe just look into the product ramp up in the second half of this year. It sounds like part of that is related to the expectation of new projects going into production. I think you said 20% are in production now and you expect 45% in the second half. I’m wondering two things. The — it seems like there’s a lot of comfort for that ramp up in the second half. What sort of visibility do you have to the one large customer in terms of their inventory build that gives you comfort on that front? And then do you have actual timelines of when you expect these projects to kick in to revenue in the second half of this year or some of that’s still fluid?

Georges Karam: I mean few elements in your questions, Scott. I mean one which is related really to the inventory with one specific customer. Reality all the customers that they bought last year have some inventory. And this is really the reality of the industry. Most of them, they have maybe one quarter to like five months if you want excellent inventory. In our case, the measure — I will say we have a couple of them here and there. Maybe if they add all up, maybe it’ll be around $1 million, $1.5 million. But we have one measure, one who typically does an average $2.5 million per quarter. He — the extra, I will say he purchased more than needed last year as everybody was really building inventory and their customer is building inventory and he’s reaching year-end with too much inventory.

That’s why we put on hold the sales to this guy in Q1 and Q2, to some extent, some of Q2, even if we have by the way, backlog — we have some backlog from them that we’re not shipping as planned originally for Q1, Q2. Just to let them absorb, I will say the inventory they have. So this is what I will call it really one case not related to our ramp, not related to the project, the design win momentum we have creating a challenge for us at the beginning of the year, extra challenge. The others, as I mentioned, and I wanted really to extend hopefully enough time so everyone can appreciate how we move from a design win pipeline, which is big. But as I said, this is really three years of revenue for each project. So obviously if you average this, you need to average this on maybe 4.5 years, depending on the launch of every project.