Sequans Communications SA (SQNS) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank for standing by.

Welcome to the Sequans Second Quarter 2017 Results Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded.

Before I turn the conference over to our host, Mr. Georges Karam, I would like to remind you of the following important information on behalf of Sequans.

This call contains projections and other forward-looking statements regarding future events or our future financial performance.

All statements other than present and historical facts and conditions discussed in this call, including any statements regarding our future results of operations and financial positions, business strategy and plans, sources of funding 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 our 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 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.

Please go ahead, sir.

Thank you, Greg.

Good morning, ladies and gentlemen.

This is Georges speaking.

I'm with Deborah Choate, our CFO, and we welcome you to our Second Quarter 2017 Results Conference Call.

Business during the second quarter was in line with our expectations.

We are particularly pleased with our progress in IoT with CAT 1 ramping and a strong pipeline of business for LTE M and NB-IoT set to accelerate our growth next year.

We also had a very positive development in the broadband area with the launch of the Verizon-branded SmartHub, which will be another source of revenue, similar to the new version of Jetpack.

On the negative side, we had an exceptional product return from an early 2016 sale related to our old tablet business, which affected the optics of our results by reducing revenue by $740,000.

Otherwise, we would have reported about $14 million, well within the range of our guidance, and a 41% increase versus second quarter of 2016.

Deborah will give a full explanation of the financial details.

I will focus here on the business strategy and highlight some details of our progress.

Since we have some new shareholders, I'll start by spending a minute on our business strategy.

Long before the IoT hype began, we decided to focus on 4G only solutions because we believed they would enjoy rapid growth once operators' 4G coverage reached parity with 2G/3G.

LTE-only connectivity offers the benefit of a smaller footprint, better battery life and lower cost than multi-mode solution that fall back to 2G/3G.

And obviously, LTE networks are more efficient to operate.

We have seen multiple proof points that support our strategy.

4G networks deployments, which initially began in the developed regions like the U.S., Japan and Korea have spread rapidly throughout the world, making LTE the fastest-growing cellular technology in history.

There are announcements everywhere by carriers that they are switching off their costlier 2G and 3G networks and reallocating the 2G/3G spectrum to use for 4G.

And last but not least, recognizing the superior economics of LTE networks and solution based on the new narrowband LTE standards designed for IoT, all Tier 1 carriers worldwide are upgrading their LTE networks to CAT M1 and/or CAT NB1 and want to launch IoT services as quickly as possible.

This will improve the economics of legacy M2M applications as well as make new applications, like asset trackers and wearables, feasible for the first time, in terms of both battery performance and cost.

Recent market research indicates that there will be 1.2 to 1.5 billion LTE devices for broadband and IoT applications shipped between 2017 and 2021.

With the LTE-only portion growing much faster than the total market, since CAT M1 and NB1 devices that take full advantage of the new narrowband LTE standards are, by definition, single-mode LTE devices.

In terms of product strategy, our approach was: first to come with the best optimized LTE chip, as we have done it with Monarch, and partner with category leaders to integrate other functionality for certain applications, for example, Skyworks for RF front-end, STMicro for MCO and GPS, et cetera.

Then based on the market segment and the attach rate of the given complementary technology, come with a derivative chip integrating our core LTE IP with such technology.

This helps us maintain our leadership by focusing on core LTE, and expand our value add in an opportunistic way by leveraging our strong partnership ecosystem.

We believe this strategy has been well-received by customers and operators and the design win momentum we have is the best proof.

A concrete example of this strategy is our Monarch SX system-on-chip, which is the next step in integration for us with CAT M technology.

Monarch SX is optimized for wearable applications, and it combines our Monarch LTE IP with an ARM Cortex-M4 processor, an audio and voice processing engine, a GPU with display controller and a hub for external sensors.

In the future, we plan to address other IoT market segments with a dedicated chip and/or platform in line with the strategy I have just explained.

Having focused exclusively on the 4G LTE market since the beginning, our product roadmap is based on years of input from customers and carriers.

We have already achieved major differentiations versus our closest competitor, who is coming with various platform versions, but all designed using their smartphone chip adapted via software to serve our market.

We strongly believe that the only way to be competitive in the LTE only market in the long run is to do what we have done: Architect a fully optimized single-mode chip from the ground up.

Our strong relationships with operators, our long list of partners, and our growing base of direct customers all demonstrate our reputation as the LTE-only experts, built over nearly a decade by bringing 4 generations of single-mode LTE products to market.

We are leading the move to narrowband LTE for IoT applications with Verizon and AT&T and have many other carriers eager to work with us and many potential strategic partners engaging with us.

Given the length of time it takes to develop both the knowhow and the relationships with each carrier and customer, the barriers to entry in our space are much higher than generally perceived.

So the field of competitors is not likely to become crowded anytime soon, and therefore, Sequans represents a scarce and valuable resource.

Our commitment to shareholders is to preserve and enhance this value.

Now I'll make a few comments on specific developments in each area of our business, beginning with IoT.

We are pleased to see our CAT 1 business ramping in the U.S. As you know, T-Mobile is offering a module subsidy program, so several customers took the advantage of this and are implementing product launches with T-Mobile.

This allows us expanding the CAT 1 module business to 2 carriers in the U.S. We have half a dozen CAT 1 module customers, with 2 we consider major.

We are also working with some CAT 1 customers to expand their products to the AT&T networks.

In addition, we continue to ramp CAT 1 chipset shipments to Gemalto, primarily for the U.S., but also for Japan.

And we see this accelerating toward the end of the year and beyond.

With all this in hand, we expect our CAT 1 business, both modules and chipsets, to grow substantially in 2018.

CAT M1/NB1 continues to be the most exciting area, mainly because this will be a truly global market, with opportunities wherever 4G coverage exists.

Also some opportunities have the potential to be quite large compared to our typical CAT 1 IoT projects until now.

We are very pleased with our success in attracting module partners.

We have announced 8 of them and have a couple more in the pipe.

Our goal is eventually to work with all the major module makers in the world.

Huawei recently announced the availability of their first CAT M modules targeting the U.S. market via AT&T.

Most of our other module partners are in various stages of the certification process with Verizon and AT&T, aiming for availability in Q3 or Q4.

Given the normal design cycles, this supports our expectation that the CAT M ramp will happen in 2018.

In addition, we are making big progress with many IoT device customers working on applications covering metering, telematics, e-health and various types of trackers and wearables.

Some of them are looking to use module vendors and some are exploring chip-on-board solutions.

Specifically, most of our CAT 1 module customers are also designing CAT M solutions and we are working with a few Tier 1 customers on proof-of-concept designs where they want to be very secure about having the best possible design before moving full speed in their projects.

On the operator side, we have certified our CAT M solution at Verizon

(technical difficulty)

Ladies and gentlemen, please stand by.

Okay, sir, you're back on.

Please continue.

Sorry, guys, we got disconnected.

So just to be sure I'm lining up my stories, so I was in the business update on IoT market and I covered our position with the module makers, essentially having a device on the IoT.

And I was moving to talk a little bit on the operator side with the IoT business.

So on the operator side, we have certified our CAT M solution at Verizon and we are in a leading position for AT&T certification and aiming to power their first mass production modules.

Also we are engaged with the T-Mobile who have announced interest in NB-IoT, and with Sprint on both CAT 1 and CAT M. Outside the U.S., we are engaging with carriers in Canada as they expect to have their CAT M networks ready in 2018.

We are also working with 3 Japanese carriers -- with the 3 Japanese carriers on CAT M and NB-IoT and with both South Korean operators.

In Europe, we are actively engaged with Vodafone and Deutsche Telekom on CAT and NB1, and with Orange, Telefonica and others on CAT M1.

Also, we are in discussions with operators in Australia and New Zealand who are planning to deploy CAT M and NB-IoT.

And finally, we are exploring a few opportunities with the carriers in China, leveraging our Chinese module partners.

Other than deploying their networks, all those carriers are actively engaged with device vendors for product development and determining launch schedules.

Once it begins to ramp next year, CAT M1 and NB1 promise to be much larger markets than CAT 1, fueling strong growth all around the world.

Considering the duopoly situation, with only 1 other CAT M1/NB1 product available, and the level of design wins we already have in hand, we are aiming to have a significant market share.

Turning to the broadband business.

In the second quarter, Verizon launched a new version of its popular Jetpack mobile router and a new Verizon-branded product called SmartHub.

With the addition of SmartHub, we are nearly doubling about broadband sales for the Verizon network going forward.

We're also very pleased to see several of our OEM partners shipping to new operators in the second quarter.

In addition, we have several new potential opportunities in the U.S., Canada and other regions.

However, in the emerging markets, we are seeing some softness in the demand and price pressure.

Some relates to the isolated inventory situations and delays in orders from operators, which as we know is only temporary.

In the meantime, we are a bit cautious about the broadband emerging business and have reduced our related growth expectation for the second half of the year.

Nevertheless, we remain confident in the long-term potential of this market.

Soon we'll be introducing a new CAT 4 platform optimized for emerging markets, which will enhance our leadership position.

For the next year, we are planning a new CAT 6 solution in 28 nanometer, and we believe this new product will help us continue to gain share as the market transitions from CAT 4 to CAT 6. Finally, our vertical market business is moving well.

There have been successful flights to test the air-to-ground LTE link enabled by our technology in a project with Thales and Nokia.

Now deployment is beginning and service will soon be available to passengers on several European airlines.

This is a very successful collaboration with Thales, and we believe it will lead to more business in the future.

Projects with Motorola, Lockheed Martin, and other partners are also moving well, and we continue to believe vertical markets represent excellent potential for high-margin business.

Since the media is full of stories about 5G, I will say a few words about our ongoing activities.

Our collaboration with TCL continues to be quite successful and mutually beneficial.

We are also beginning to ramp -- beginning to plan for our support of millimeter wave frequencies on which high speed 5G services are likely to rely.

Recently, we have officially become a member of the CBRS Alliance in the U.S. For those of you who aren't familiar with it, the CBRS spectrum is the 3.5 gigahertz band in the U.S., which is now in the hands of the Department of Defense, being used for a variety of radar and space-to-Earth operations.

For several years, the FCC has been working on freeing up access to the 3.5 gigahertz spectrum for shared use without interfering with existing users, and it's currently being considered as one of the lower-band options to support 5G services.

Several of the U.S. carriers have joined the CBRS Alliance and are looking at this spectrum.

If this moves forward, we are in a particularly good position.

We have had the RF at 3.5 gigahertz shipping in volume for a long time, since it's used for fixed broadband in many other countries.

It appears that the focus today on CBRS in the U.S. is also for broadband applications, and we have some customers beginning development.

We can also implement IoT applications in CBRS spectrum if that's the way the opportunity develops.

So to summarize, as we enter the second half of the year, we are confident that our strategy is the right one, that operators around the world are moving aggressively on CAT M1 and/or NB1, and that we'll continue to benefit from our time-to-market advantage.

We continue to be approached by a growing number of potential partners, which further validates our leadership, and positions us as the LTE connectivity partner of choice.

We expect to see more competitors entering the market as it matures.

We saw recently some of them announcing product, but focusing on China with NB-IoT only.

But in any case, we don't see a very crowded field developing and we are confident that we are well positioned to continue our leadership role as the market evolves over the long term from 4G to 5G.

Now I would like to turn the call over to Deborah.

Thanks, Georges, and good morning, everyone.

I'd like to add some details about our Q2 results and discuss the outlook, including our guidance for Q3 of 2017.

Our revenue was $13.2 million, after giving effect to the accounting treatment related to a product return.

Specifically, in 2016, we were supplying tablets destined for Walmart pursuant to firm purchase orders.

When sales were disappointing, our customer could not pay.

And we spent a long time trying to find a solution.

We were able to find another customer to use the product for a different application, and they are currently completing their certification with Verizon.

However, they were not able to commit for all of the units upfront.

So ultimately, we decided to take some of the product back into inventory until a new customer is ready for it.

Excluding the effect of this return, our total revenue would have been $740,000 higher or nearly $14 million and well within the range of our guidance.

In the quarter, we had 3 10% customers ranging from 10% to 11% each, but one of them is distributor serving a total of 5 Asian OEM and ODM customers.

Our gross margin was 42.1%, reflecting a higher proportion of modules in the product mix this quarter.

Our operating expenses were $9.6 million in Q2, down from $10.1 million in Q1.

This quarter, we capitalized some development costs related to our CAT M product.

And our sales and marketing expenses were lower because Q1 expenses reflect 2 major trade shows.

We expect operating expenses to return to slightly above $10 million per quarter going forward.

Our second quarter operating loss was $4.1 million, compared to an operating loss of $4.2 million in the first quarter, and an operating loss of $5.7 million in the second quarter of 2016.

Net loss was $6 million in Q2, compared to a loss of $5.6 million in Q1 and compared to a loss of $5.1 million in the second quarter of 2016.

As a reminder, Q2 2016 had included a large noncash benefit from the change in the fair value of our convertible debt embedded derivative.

Our Q2 2017 results included a higher than usual foreign exchange loss of about $600,000 primarily due to the remeasurement of euro-denominated net debt into a weaker U.S. dollar compared to the end of Q1.

Nearly half of this remeasurement loss related to long-term items.

The basic and diluted loss per share was $0.08 in the second quarter of 2017 based on 75.9 million average shares outstanding compared to net losses of $0.07 in the first quarter based on 75 million shares and $0.09 in the second quarter of 2016 based on 59.3 million shares.

The increase in weighted average shares outstanding reflected the equity offerings in September of 2016 and June 2017, as well as some stock option exercises and conversion of $160,000 in debt.

The total number of shares and ADSs outstanding after the offering in June is 79,762,000.

We have also reported our results on a non-IFRS basis, which excludes from net loss the noncash items related to stock-based compensation expense and the noncash fair value and effective interest adjustments related to the convertible debt and other financings.

As the conversion prices are now fully fixed for both convertible debt issues, the fair value has been fixed, and so from Q3 2016 on we have no longer revalued the convertible debt embedded derivative.

Non-IFRS net loss was $4.9 million in Q2 2017 compared to net losses of $4.7 million in Q1 and $5.8 million in Q2 2016.

Non-IFRS basic and diluted loss per share was $0.06 in the second quarter, which was at the midpoint of our guidance despite the impact of the product return and the higher-than-expected foreign exchange loss.

Non-IFRS net loss was $0.06 in the first quarter of 2017 and $0.10 in the second quarter of 2016.

Cash used in operations in Q2 was $4.4 million compared to $9.9 million in the first quarter of 2017.

The total amount of cash used during the quarter also reflected a reduction in the use of our receivables financing facility by $4.5 million.

At the very end of the quarter, we were unable to finance some of our receivables for reasons including a credit insurance limitation for one customer and the inability to complete the paperwork in time for a new customer when we decided to switch distributors.

We have worked on putting in place a bank line of credit, but instead were able to improve our existing credit agreement with Natixis to enable us going forward to factor receivables for some services as well as for product sales.

Including net proceeds from the June offering of $15 million, our cash and short-term deposits at June 30, 2017 totaled $19.5 million compared to $14.5 million at the end of Q1.

During Q3, we expect to receive approximately $3 million from the French government for the reimbursement of the 2016 research tax credit as well as confirmed payments for various research grants.

Because of this plus the added flexibility in financing receivables, we expect cash used to be less in Q3 compared to this quarter.

Accounts receivable at June 30, 2017, were $17.2 million, reflecting DSOs of approximately 102 days, again, due to a concentration of shipments at the end of the quarter.

Inventories increased slightly to $8.5 million compared to $8.2 million at the end of Q1.

And as mentioned previously, our short-term debt from financing receivables decreased $4.5 million in the quarter to $7.4 million at June 30, 2017.

Looking forward, we expect revenues for the third quarter of 2017 to be in the range of $15 million to $17 million.

We expect non-IFRS gross margin in Q3 to be above 40%, and non-IFRS net loss per diluted share to range between $0.05 and $0.07 based on approximately 79.8 million weighted average diluted shares.

Our guidance for Q3 non-IFRS net loss per share excludes noncash stock-based compensation expense, effective interest adjustments related to the convertible debt and other financings, and any other relevant noncash or nonrecurring expenses.

With signs of temporary softness in broadband from emerging markets that Georges mentioned, we are cautious about the ability of the broadband business to exceed a $10 million quarterly run rate exiting the year as we previously expected, but we believe we will come close.

And we continue to expect our revenue growth to accelerate in 2018 as CAT 1 continues to grow and CAT M begins to ramp.

Even with a slightly more conservative short-term outlook for the broadband business, we continue to believe that we won't be far from operating breakeven on a quarterly basis by the end of this year.

This means that we could come close to cash flow breakeven by year end or at least limit further cash burn to a small amount.

Before I turn the call back to Georges, I'd like to cover a couple of housekeeping items.

In the coming weeks, we expect to be filing a new shelf registration statement to replace the one that is about to expire.

As you know, these shelf filings are good for 3 years, and we have no near-term plans to access the capital markets.

Also, a reminder that 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.

That's the same location where you will find the audio replay.

Georges?

Thank you, Deborah.

So to wrap up, I'm happy to say that we are pleased with the progress of all our businesses, despite the cautious we have expressed on emerging market, as this has limited impact on us, in my opinion.

The exciting development remains on the IoT, where all signs are positive on all fronts, market development on one side, where we see all carriers worldwide moving full speed to upgrade their LTE networks with CAT M1/NB1; all marketing studies confirming the size of the opportunity for IoT and CAT M1/NB1.

The pipe of opportunities we are seeing keeps expanding with a variety of applications and many Tier 1 players.

And the other point is our leadership where each day we have a confirmation of our strong position in this market, whether from the product angle, performance and cost, time to market, readiness with carriers, ecosystem of partners.

So we are very confident that we'll capture a big market share and translate this for growth and acceleration for our company.

So my team and I are working hard to keep good execution and enhance the value to our shareholders.

I will turn it now to take your questions to the operator.

Greg?

(Operator Instructions) Your first question comes from the line of Scott Searle from Benchmark.

Deborah, just quickly to follow up on the capitalized software cost related to CAT M1.

Can you just give us a figure on that front?

It sounded like you don't expect that to continue going forward.

And then I had a couple of margin questions.

We capitalized about $800,000.

We're likely to have some more capitalization in Q3, probably slightly less and finishing up in Q4.

We would then expect to get amortizing it in R&D expense from, most likely Q1.

Got you.

Georges, congrats on the Verizon's SmartHub win.

When do you expect that to start to contribute?

And what's the magnitude of a design win of that size?

It sounds like it could double your current Verizon run rate, but how quickly will it ramp up to those levels?

Scott, so this has started already in the same quarter, so some of the revenue are coming from SmartHub and we are backlogged for Q3 and maybe some for Q4.

So it's -- we don't have much the similar of experience as we have on the Jetpack where we have 3 years of shipments.

So this is a new product shipping.

The launch looks fine, looks in line of our expectation.

And if all continued to be like this, we expect to -- this is something where can contribute to us around $1.5 million per quarter.

Okay.

And just in terms of -- 2 more things and I'll hop back in the queue.

But certification now for M1, how many carriers have actually certified at the current time?

You've won, it sounds like, now up to 8 design wins on the module front.

But what is the timeline for additional carriers for certification?

Will we get a lot of them by the end of this year?

And than M1 contribution, will we see that in the fourth quarter?

And when do you expect to see NB-IoT contribution?

Yes.

So the -- in terms of certification, obviously, as you know, some of the carriers -- big carriers, they have a process, fixed process for certification; others, they will turn it to lab and the do some kind of IoT.

So today, the carriers that they are organized and started the certification process are Verizon and AT&T only.

The other guys are only doing trials or testing IoT with their infrastructure.

And obviously, we're engaged with a few IoT with many guys.

But specifically in terms of formal certification, it's Verizon and AT&T today where we have engagement.

Verizon it's done and even recertified, I tend to say, because we have done it in January and then we follow up.

We certify even with customers of us that they -- already they have products certified.

And we have many others in the last step, I intend to say.

And AT&T, I mean, we are very close.

We have engaged in Q2 strongly and this is something should happen soon.

And also we have other customers, some of them publicly mentioned a focus on AT&T, for example of Huawei, so they will be already on AT&T first in terms of certification.

And regarding the business ramp, obviously, in terms of big opportunity, we still see it really next year, but we expect a little bit in Q4.

It's very hard to see today because this will be the initial quantity coming to us with some orders.

We have some people even requesting the chips and initial preparation in Q3, but not major in terms of dollar.

But we hope a little bit of revenue in Q4.

As I mentioned in the past, maybe $0.5 million up to $1 million could be coming from CAT M business.

And on NB1, still the market is kind of 6 months behind M1 activity, coming from the fact the ecosystem is a little bit -- came all in second step.

Whether the vendors, the carrier readiness and so on.

But you are fully engaged already with IoT, with the infrastructure vendor with our NB1.

And in Q3, we'll be engaged as well with some carrier testing on NB1 as well.

Georges, just last one if I could.

Could you talk a little about the magnitude of some of the design activity in terms of units?

We're moving from the smaller design wins to potentially, it sounds like, millions of units per design when you start to think about things like wearables.

If there's any color or commentary you could provide on that front would be helpful.

Yes.

I mean, in general, when you look to the old IoT business, which was really M2M market building on 2G, 3G.

And even if you see 100 million units on a year, when you go down the path and look for those 100 million units sold on a yearly basis, except you could have few exceptions where people talk about millions, but in general, the 100,000s, 200,000, 300,000s units a year for a design looks big in M2M environment.

If you talk to our friends of the module play, this is what they would tell you and this is their business.

And even if they average on the number of customer, you come with an average, which is almost below 50,000 units per customer or in the 10,000s and so on sometimes.

In the -- thanks to the power advantage and the cost advantage and obviously the engagement of all the carrier across the board, so you have many, many new applications coming.

And people, they're not questioning anymore the use, I'll say, of cellular technology for IoT application.

While in the scope of the M2M, they were using cellular technology only because they have no other option.

Here, they take it like their first -- the choice #1.

And as such, we are seeing a lot of projects, some of it related to logistics and people talk about millions of projects.

Obviously, you have the fleet management, all the asset tracking and not to talk about wearables.

So all those projects becomes really -- all the big projects are there and you have Tier 1 guys, without naming the guys.

But you will see really with the top-notch company engaged with the project and they would like to use the IoT to serve, I would say, some kind of application.

And here, people start with the 1 million unit and I tend to say the smallest projects talk about 500k as a starting point.

So we see really an order of magnitude difference in terms of projects and this is very encouraging.

And this supports, by the way, the 1.2 billion, 1.3 billion units we are talking about for the coming 5 years to cover all those.

Even if it has some broadband, the majority of this is really IoT application.

Your next question comes from the line of Mike Walkley from Canaccord.

Georges, just going back to the broadband business.

Can you elaborate a little bit on the softness in emerging markets?

And then for the broadband business, maybe to exceed that 10 million per quarter, do you need the new CAT 6 product next year?

Or do you see it kind of steadily growing throughout 2018 from exiting the year right around 10 million?

Mike, I mean, essentially, the emerging market -- the complexity of the emerging market, we're not talking about 1 carrier.

When you look to a business like Verizon and so on, so it's established, you're talking about maybe almost 1 device, 1 SKU like the Jetpack can go close to 800k unit a year.

And we have a track record and it's device branded and so on.

When you go to the emerging markets, which is under this umbrella, we are counting there maybe 20 carriers behind the scene.

And those carriers, they buy essentially CPE and it's always driven by cost.

And it's -- they do it on the PO-by-PO basis.

It's not like, obviously, you need to be selected, so our OEM, ODMs that we work with, they are the strong player in this space.

But they don't win if you want a deal for 1 year, 2 year.

They win in PO.

They win in PO for deployment for 6 months, then another PO for another 6 months, and so on.

So this segmentation, if you want, give us less, if you want, doesn't help us in the production, in you want, as we are able to do it with big carriers like Verizon, AT&T and others.

So we -- and what we saw in this quarter, if you want, some of the orders didn't come as expected to our customers, not us because due to some extent this is more in their projection.

So we're seeing a little bit in some situation carriers, they didn't issue the PO.

Some situation, our customer didn't win the PO themselves and maybe went to Huawei, which is -- Huawei is a strong competition there.

We saw a little bit of price war as well, happening at the CPE level, at the device level.

So all this put the kind of condition a little bit towards some project get shift and so on.

And we felt little bit nervous about maintaining the level of growth we were expecting in the second half.

So this is really -- we don't have anything.

That's why we believe, it's not like a big problem happening, just only feeling about how things were turning and coming together for the third quarter.

And we felt like, okay, maybe we need to be a little bit cautious on this.

On the other side and this is related to a question on the CAT 6 and importance of CAT 6. Definitely part of our strategy that we believe will be even very positive for Sequans is the transition from CAT 4 to CAT 6, because this will defend ASP.

Because when you talk about the growth here, we're talking about dollar growth, and I'm not talking about their volume because you look to the volume somehow, it's just not that bad.

But because you have an erosion in the CAT 4 pricing, the growth is a little bit tougher to keep it strong.

Hence, the importance of the CAT 6. So we have a CAT 6 product already today, and we are pricing this aggressively to transition our customer.

But we believe that the new chip we are developing, which is -- we should have it at -- it's really in advanced stage in our development.

It's not like we're starting the design now, will help us coming with more aggressive position in terms of pricing and help the carrier to transition to CAT 6 much easier, knowing that the emerging market is very sensitive to price.

So they need the CAT 6, they like it, but they don't want to switch if the difference is $5.

If the difference is $1 or $2, then they be -- they will make the step, if you want.

And this is what we are trying to do.

So on back to this $10 million per quarter, we're hoping really to be well above this $10 million on the basis of SmartHub, we are confident on Verizon doubling the revenue, and this is happening and this is there.

But unfortunately, what's happening is this extra we get in terms of design win on Verizon shipping got moderated somehow by weakened emerging as we are seeing for Q3, and maybe projecting as well this for Q4.

So again, this is a picture and feeling more than really facts because this can vary a lot quarter to quarter.

I could have next quarter something happening and then big PO coming and this will give us more strength on this.

But we still believe in this market and, very frankly, we're seeing beyond the emerging with the U.S. and other carriers, more new application coming for the broadband.

Because more and more carrier feel confident now about moving to single-mode LTE, because you need to keep in mind that our growth potential there is coming from the fact carrier are moving to single-mode devices.

And obviously, the CAT 6 will play a strong role for us there in emerging as well outside the emerging market.

Great, Georges.

And just further on that question when you look at your pipeline for accelerating growth in 2018.

Can you just kind of walk us through your pipeline as you look at the broadband business, vertical markets and then the IoT, just how you see kind of that mix in your business changing over the next 12 months?

Well, very frankly, the broadband, I mean, we already said, even if we have -- even if we go with a pessimistic scenario and saying that broadband is going to have, let's say, 10% growth year-over-year, not more, we still believe that the major growth, obviously, for the company will be coming from the CAT 1 where this can double year-to-year today based on the hockey stick nature of our business.

Because this is going well.

It's just only a matter that the shipment is -- this year is happening towards the end of the year, and it continue accelerate, mainly Gemalto as a customer, they will be going -- they will be accelerating more and more with other markets in Japan all deploying starting in Q4 with their customers.

So we see the CAT 1 doubling.

And, obviously, the CAT M is fully new business, so all this has an upside.

So the -- if I look in the total picture of next year only, I believe we should have more than 50% IoT business versus broadband.

Obviously, some portion there still for the vertical projects and -- which is going well, if I compare this year, and we expect to see it continue next year.

Great.

And then last question for me.

Deborah, just on that mix, how should we think maybe about gross margins over time?

Where do you think they could go given the mix shift expected next year?

Well, next year, with the CAT 1 business we'll still have modules in the mix.

But the CAT M business is chipsets, not modules, so that should help improving the margin.

And once the business is really much more chip reliant, which is -- I'm not sure if that's if going to be second half of next year or little bit farther out, then we should be targeting more of a solid chip gross margin in the upper 40s.

In fact, Mike, if you look to all the CAT M, the way we predict it today, it's all chip.

We may sell some modules, but looking to the strong penetration we have with the module players and the sensitivity to pricing, very likely it's going to be 99% business chip.

CAT 1 is half-half, the way to model it.

And obviously, broadband is chip, and public safety as well is services and chip.

So all this make it look like module business will be below 20%, maybe 15% of our total business.

So the impact in terms of gross margin should be to the favor of the chip in this sense.

(Operator Instructions) We have a question from the line of Quinn Bolton from Needham & Company.

Just curious in the current quarter, can you give us some sense of the split between the broadband business and the IoT business?

And then within broadband, obviously, you talked about some of the pricing pressure and caution you're seeing on the emerging markets.

How much of the broadband business comes from emerging markets versus the Verizon business?

Quinn, so just start to the end.

Obviously, it depends on the emerging because the emerging is varying.

But what I said, typically our broadband business on Verizon, I mentioned that this is now with the SmartHub, should be $3 million to $4 million per quarter.

So on a picture, if you assume broadband around $10 million in the projection of where we are targeting, so this will be around 40% of this coming from this, and 60% from the emerging if we are considering $10 million.

In Q2, the picture on IoT was ramping up because we have strong sales of CAT 1 modules.

As I mentioned we have 2 strong customers in the module space, they moved full speed in initial order, I mean, and accelerating and we're start seeing for the picture.

So if I think in terms of broadband, this is broadband IoT, what, it's 5?

It's, what, 40% was kind of IoT and 60% broadband.

Great.

And of the 2 module partners for CAT 1, does that include the Gemalto business or are you separating Gemalto from those (inaudible)?

No, no.

Gemalto is split, so I'm not -- because of again, just already confusion.

In CAT 1, we have real, as I said, half a dozen end customer buying module from us.

Some of them were public like Geotab doing fleet management and so on.

So those guys buy module directly from Sequans.

And obviously, we have Gemalto, who -- they have their own modules for U.S. and Japan and they serve dozen of customers behind them with our CAT 1 chip.

So we see kind of today's split or next year's split, maybe half-half between chip and modules.

And this is essentially Gemalto and the other customers' CAT 1 business.

Sorry, Georges, just to clarify, you had said that you're seeing strong activity in the CAT 1 business right now driven by 2 module, I thought you said partners, but maybe you said customers.

Are those guys buying (inaudible)...

No, no, 2 customers buying module business.

Obviously, Gemalto, I mentioned as well that they are ramping up.

I don't want to qualify yet reaching my expectation, but it's better and better each quarter and we have forecast and it's ramping up.

So I remain strongly positive for next year, even if it's a little bit slower than what I hoped originally.

But it's moving well.

But my indication about this strong customer we had on the CAT 1 this quarter, they were module partners -- module customers, if you want, customer buying module from us, not Gemalto.

Buying the Sequans-branded modules, got it.

Okay, great.

And then the second question, just wondering if you can give us an update on any of the operators looking at qualifying voice on their CAT M networks.

I know you mentioned AT&T and Verizon are sort of in the process of qualifying their CAT M network, but just wondering if you're seeing any voice trials for CAT starting to take place?

Yes.

I mean, this is very -- one of the key differentiations between CAT M and NB1, as you know, is that they are built to support voice.

And when you talk about supporting voice, you have 2 ways of doing this.

You can support voice over the top, which is an ID.

You cannot do it NB1 because the speed is so low, so you need to do it on CAT M1.

And/or you can do it VoLTE, in other words, run it embedded in the protocol stack of the LTE that the carrier prefer to have because they control the quality and they control as well the redundancy and many things there.

So obviously today, Verizon and AT&T and all those carriers will be implementing Voice-over-LTE for CAT M. We have done some trials already ourselves with Verizon, and we are working on the full integration and certification of CAT M with VoLTE.

So we have this program going on, and we should be -- I intend to say the carriers should be ready end of the year in terms of having the proof that everything is fine and 100% guarantee will work.

And now, when they are going to announce this officially?

They may announce it beginning of next year or they can delay it 6 months, if they want to launch the service.

So very frankly, I don't control this date.

But I know that they technically today, have the proof that this is working and we are finishing the certification and the extensive testing, if you want, so they can define the service to the end customer what they can get on CAT M voice And this is important for (inaudible) and is important as well for all -- there are many applications in the IoT you require voice as well.

Great.

And then just a quick question for Deborah.

The converts or at least a portion of converts moved from long-term to short-term liability.

So looks like you've got about a year left on those converts.

I assume that we're still well above the conversion price on those converts and you would expect those converts to convert into equity rather than having to repay them, assuming the stock price stays where it is.

But can you just remind us what the conversion price is on that -- on those converts?

Yes.

The first issue comes to term in April 2018 for a nominal value of $12 million and the conversion price is 185.

(Operator Instructions) And we have a question from the line up Caroline Gangi from Cougar Capital.

I apologize, I jumped on the call late.

But in the press release, you had a comment about being approached by a number of potential partners to discuss various forms of cooperation.

I was hoping you just could elaborate on that, please.

Okay.

Yes, I mean, definitely.

This is not new, I tend to say, because from the leadership position that we have in the LTE space and the acceptance or let's say, becoming the market, the LTE for IoT is becoming a must have for any players who wants to play in IoT.

Because you can get connectivity through Bluetooth, you can get connectivity through the Zigbee, but all those technologies you need to go through a gateway.

And when you look to the use cases, many of them, many of the use cases require the connection to the network.

And today, the only connection that makes sense to use is really CAT M1 and NB1.

Not -- maybe in some private networks you can go LoRa, but in general, this is a must have.

And you look to scarcity about Sequans, because as I mentioned, today, if you want to get the product, you have 2 guys that they have the product.

Our closest competitor and 1 lone company and Sequans.

And this technology, if you want to get anything to offer as a platform, you need to get Sequans [to ready that].

And this is, obviously, attracting all the partners who like to play in the IoT space.

And this is very important for our strategy because it complements our position by offering a full platform where if you need MCU, if you need GPS, if you need Bluetooth, so you have all those partners that they can provide this and Sequans providing the LTE technology.

So this reinforces our position and -- with those partners.

And you have a follow-up from the line of Scott Searle.

Georges, just real quickly to follow up on the VoLTE front.

What -- how many design wins -- is that an active portion of the discussion or requirement for those design wins?

And also on some of the vertical markets, could you -- I'm not sure if I missed it, but could you qualify a little bit in terms of the air-to-ground opportunity?

And what you're seeing more in the traditional PMR or Motorola type markets?

Okay.

So in terms of VoLTE, this is -- today, you have 2 places where you need the VoLTE.

One is the wearable or the alarm system, call it, in general, a security, home security and so on.

The home security is really a traditional market and we have many design win already using the CAT 1 technology.

And we offer VoLTE on the CAT 1 technology and this is really one of the major differentiations of our CAT 1 model.

If you compare to other competitors, they don't offer VoLTE.

And Sequans is really strong on this because we have the VoLTE on Verizon and T-Mobile and people appreciate this and they use it.

So obviously, all those guys would move to CAT M in the future and for some applications, they don't need the camera and VoLTE is part of it.

But on the other side, they are not in a rush because they are already launching their CAT 1 with VoLTE there.

On the wearable it is little bit more challenging because some of the wearable, they can go with voice the over the top, so they will not wait for Verizon and AT&T to launch their service.

And they will be happy to get VoIP service over LTE.

But some others, they are really looking for guaranteed service, and so on.

And those kind of design wins or, call it, launch projects, they will need some assurance from the carrier that they are going to launch the service and the quality is going to be there.

On the vertical market, in general, as I mentioned, the major differentiation what we have there in vertical market is people coming to us and they say, "Okay, I want to use this LTE technology, which is a commercial LTE technology, but I want to you, Sequans, to modify it because you control the software and the RF and so on to make it to work in my environment." The air-to-ground system, this is what that is.

It's also about connecting a flight and, obviously, you have Doppler effect, you have big round trip delay, and so on.

And we made the proof of all this and the system is working.

We had many trials, very successful trials, and in principle, they start already equip the flights and we are going to see the service.

They even announced some services on it with November timeframe across Europe.

But the good things about this is that, independent of the potential of the business there because, obviously, it's not a lot in terms of units, the number of flights, and so on.

So it was more a deal with the projects with NRE.

But it's opening the cooperation with Thales who is playing on many, many other segments, and we have other projects in discussion with them other than this.

And obviously, the Motorola, where we have already project working and they buy chips from us.

But they have as well some new projects coming and we are discussing with them.

And we are in full development with Lockheed Martin.

I'm not allowed to say what kind of network will be there, but it's also interesting and the volume there will not be negligible neither, as well.

But this is a long-term project because it takes kind of 18 to 20 months to launch the project.

So it's a deal that we have with them will go until almost beginning of 2019 to get the service launched.

And at this time, there are no further questions.

Okay.

Thank you, Greg.

Thanks all of you for listening and for all the questions and looking forward to have you with us on the next call.

Thank you.

Ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and for using AT&T Executive TeleConference.

You may now disconnect.