Sequans Communications S.A. (SQNS) Earnings Call Transcript & Summary

Greetings, and welcome to the Sequans' 5G Strategic Partnership Announcement. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kim Rogers with Hayden IR. Thank you. You may begin.

Thank you, operator, and thank you to everyone participating in today's call to discuss the 5G strategic announcement. On the call today from Sequans Communications are Georges Karam, Chairman and Chief Executive Officer; and Deborah Choate, Chief Financial Officer. Before turning the call over to Georges, I'd like to remind our participants of the following important information on behalf of Sequans. Sequans issued a press release this morning, announcing the closing of a multiyear strategic 5G licensing agreement, which was posted on the company's website at www.sequans.com under the Newsroom section. Before we start, I would 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 position, business strategy and plans, including the expectation that the potential agreement will fully fund the development of our first 5G platform, expectations for Massive IoT sales, the impact of COVID-19 on our supply chain and customer demand, the impact of component shortages in 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 risks and uncertainties and subject to change at any time. We operate in a 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.

Thank you, Kim. Good morning, everyone, and welcome to our call to discuss our new 5G strategic partnership. I'm pleased to announce that we have closed a multiyear 5G licensing and commercialization agreement with a new strategic partner for our Taurus platform development technology. The deal is expected to fund the balance of Taurus development and expand our addressable market to China, the market currently not served by [ Sequans ]. Under the terms of the agreement, Sequans will receive a licensing fee in excess of $50 million, and our partner has the rights to manufacture and sell the Taurus platform exclusively in the Chinese market and will pay royalties for up to 20 years on sales of their products based on our 5G technology. Approximately 25% of the licensing fee is due up in deal signature and the balance is scheduled as milestones to be received regularly over the next 3 years. Consequently, revenue generated by this agreement will be in excess of $50 million for the first 3 years, corresponding at a minimum to the licensing fee. Then starting from 2024 and for up to 20 years, we expect additional revenue from the royalties on 5G products sold by our partner, which could exceed a few million dollars per year. We expect licensing revenue from this deal to have a significant positive effect on our financial results. When combined with our current expectations for the rest of our business, the higher gross profit contribution is expected to enable us to achieve non-IFRS operating profitability, generate cash from operations for the second half of 2022 and allow us to target non-IFRS operating breakeven for calendar year 2023. Regarding our outlook for the third quarter of 2022, we anticipate sequential revenue growth of at least 10% with a gross margin over 65%. This strategic partnership strengthens our capabilities to deliver on our 5G roadmap by expanding our SAM to a region previously excluded from our addressable market and enhancing our financial position. The licensing revenue will enable stronger cash flow generation and improved operating results. Today's announcement and our robust product pipeline reinforce our confidence in our ability to navigate our business in the current economic environment and to deliver sustained long-term growth. With the development of the 5G platform secured, we are firmly positioned to expand our market share, grow revenue and improve profitability. In closing, I would like to state our appreciation for the patience of our shareholders in standing by us during the extended period it took to close this deal. Operator, we are now ready to open the call for Q&A.

[Operator Instructions] Our first question comes from the line of Scott Searle with ROTH Capital.

Georges, Deborah, congratulations. I know this one has been a long time coming. Georges, maybe to just dive in quickly on the license fee. Sounds like you get a nice chunk upfront. I just wanted to clarify in terms of the remainder of that, is that milestone based? Or is that just ratably over the life of the contract? And then I just want to clarify as well, in the China opportunity, is this a terrestrial application? Do you have to do customization in terms of the part? And just to clarify again that this is for -- this is exclusively for the Chinese marketplace. Is that correct?

Yes. I mean Scott, to take directly maybe your second question, yes indeed, this is exclusive for China. There is no customization as such, if you want to [indiscernible] as is the partner has the ability to make derivative, if you want, on his own, this -- he will continue to pay a royalty for this. But if he does some modification around, it will be on his cost and done by him, not by Sequans. So this will not add extra cost to go straight, I would say, to the [ Sequans ] of the question. There is no cost -- extra cost, I would say, related to this licensing from Sequans, other than, obviously, the cost you need to put to support the partner and address these questions and some minimum support. So the gross margin expected there is well above 90% for this deal. And going back to the remaining payment after the upfront, it's -- obviously, everything is related somehow to milestone in a sense that, as you know, the product is under development, or this technology is under development. We have a portion of it already developed because we are quite advanced in our program. We still have something to do. So obviously, we need to deliver to get paid. So somehow, we could not say there is no milestone related for this. But the way it's scheduled is scheduled as well with the -- almost -- around every 6 months, more or less, we have major payments coming in.

Great. And lastly, if I could, just to clarify, this is for -- this is not exclusive. You have other opportunities that you're pursuing in the pipeline. And not to move on too quickly from what is a very, very large transformative agreement, but there are other opportunities in the pipeline as well. Is that correct? Congrats and thanks again.

Yes. I mean definitely, Scott, I mean this is -- doesn't block us from continuing with other opportunity and explore other market, and we have other discussions about. As I said, this is really exclusive to China, in a sense, obviously, we cannot do the same deal or the same term in China with another partner. So from this angle, it's exclusive reciprocal, if you want, for them and for us. But outside of this application and I will say that the market segment where this is playing, we are completely free to continue operating directly or indirectly with other partners that can bring on board to help us.

[Operator Instructions] Our next question comes from the line of Craig Ellis with B. Riley Securities.

I'll echo the congratulations on a real transformative deal. I just wanted to start by clarifying what will rev rec initially with the deal. So Deborah, I know from Georges' comments, it sounds like there will be $12 million of cash that's taken in, in the third quarter, but how much of that rev rec? And as we look ahead to the fourth quarter, can you give us some color on expected rev rec there too?

Yes. So we expect that there will be obviously a bump in revenue in the second half of the year as we deliver IP that's already been developed. And then it will go down to a lower level over the remaining 2.5 years of the deal. So we have -- again, the specific guidance for Q3 is already included in Georges' comments, and we expect an additional income from this background IP delivery in the fourth quarter. And then the amount will be lower on a quarterly basis, moving forward.

Yes. Got it. And then following up on the prior question, Georges, you progressed quite significantly with Taurus development, but there are more milestones. Can you just identify some of the bigger things that the team needs to accomplish later this year and next year, so we have some sense on what the technology development triggers are and what you hope to deliver over the next 18 months?

I mean, definitely, Craig, we -- I'll say, in summary, to build this platform, you have the RF transceiver, the baseband and the software and the system, I would say, globally, and the integration of all those 3 technology, software, RF and baseband. We already said to the market that we have already engineering sample of the RF in hand, under test. And by the way, the results are very promising. I mean we -- the chip that -- the tester have done proved that all what we have done was right. And there is no issue at all in the samples we received. So we continue in the qualification to take it to mass production. And we should have the baseband component coming to the market in the first half of next year. And from there, it will be the second half. Obviously, in the meantime, we are developing the software and all this will be integrated. So to put it in -- actually, the coming year is an important year for us. Somehow towards the second half next year, we should start seeing from Sequans the full solution and is something more than -- in other words, the baseband, the RF and the software are all integrated. And obviously, the following year, we start taking this to mass production with partner and customer. So this will give you color on this. But obviously, the project is more than halfway progressed. When we talk about the -- something the baseband in the first half, this means we are already almost 90% of the execution on this chip of baseband already done and executed.

Very helpful. And the next question I wanted to ask was just taking a step back and looking at the bigger picture and how you feel about where partnerships are overall and some of the momentum you have from those in the back half of the year next year because we've got the NXPI deal, we've got the Microchip deal. You've significantly enhanced your geographic and supply capability with Renesas. And now we have an exclusive agreement for fixed wireless access into China. Can you just talk about how you're looking at the momentum the business has from those partnerships as you look at the back half of the year and into 2023, Georges?

I mean, Craig, I mean, essentially, if you look today, again, I always said this more and more, Sequans is really in a unique position there. Obviously, we have a big, giant, I'll say -- who handle all the cellular technology. But just after this guy, there is only Sequans, who was able to develop 4G ,5G technology for the IoT market. And obviously, with the focus outside of the smartphone, give us more freedom there. And the size of the company and the flexibility that we have allow us to create business model really completely out of the box. It's like a deal like this, which is we know for us, it's complicated to go and sell in China. And on the other side, we could find a way to milk and create value from what we have done in the new segment and expand our addressable market and strengthen our position. So definitely, this is what we have done. And in the [ net ] of IoT, it was more the go-to-market approach because it's a market which is very fragmented, and this is where we rely on the [ MCO ] partner. And we built this relationship, and as you mentioned, whether we have at least 3 with them very engaged and with Renesas really deep engagement, I should say, because they resell the technology of Sequans. So all this is moving on track, and we expect this to continue building up. But it's not stopping there because this partner, this relationship and the uniqueness of Sequans with 5G technology continue attracting partner, not necessarily by the way, partner, they build the silicon to sell that could be as well to use this application for their own custom use, if you want, as they both can leverage this technology and this IP to generate more value, at the end of the day, for the company and for the shareholders. So this is -- but again, the way to position it today, we have the massive IoT business, which, as you know, we are well ahead in terms of product portfolio, Cat 1, Cat M building the product pipeline. And relying there on a partner in terms of go-to-market, like the MCO partner you mentioned, to help us scale further and attract more customers and win more business, whether in geographical regions or some big name and big customer. And we had, on the other side, the investment in 5G, where we have already a couple of partners, but it was not enough to take it really further ahead. And this new partnership, this is what helps because it completely is helping complementing the funding of the 5G and obviously, boost the financial situation of the company because with this, we are really in a position to be breakeven and generate cash soon when we add this deal to the rest of the business we are developing.