Sequans Communications SA (SQNS) 2021 Q2 法說會逐字稿

Welcome to Sequans Second Quarter 2021 Results Conference Call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the call over to Kim Rogers of Hayden IR. Ms. Rogers, you may begin.

Thank you, Maria. Thank you to everyone participating in today's call. Joining me on the call 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 the earnings press release this morning and was posted to the company's website at www.sequans.com/investors under the News 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 massive IoT and portable router sales, the impact of 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 risks 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.

Thank you, Kim. Good morning, ladies and gentlemen. Welcome to our second quarter 2021 financial results conference call.

Massive IoT was the primary driver of growth in the second quarter. This category increased 14% sequentially and 120% year-over-year despite the order fulfillment delays we faced in the quarter due to supply chain challenges that are impacting industries in many sectors around the world. Broadband CBRS business and the new vertical deal have also contributed to our growth in the quarter.

Supply chain issues limited our ability to achieve our quarterly growth target, but normalizing our revenue comparison for the absence of any contribution from the Verizon Jetpack portable router, which we believe shows the true performance of Sequans current business. Our second quarter revenue increased 14% sequentially and 88% year-over-year. The increase in service revenue in the quarter lifted our gross margin which, along with the benefit of a onetime net reduction in R&D, narrowed our operational loss this quarter.

There are a couple of key growth drivers that I want to discuss, primarily products and partnerships, which are expanding our penetration into the many IoT markets. Let's drill down into products performance, starting with Massive IoT.

The considerable momentum in Massive IoT with Tier 1 customers is fueling our growth. We are having continued success with our first-generation products, and our second-generation products are getting fantastic traction. We continue to build out a robust Massive IoT pipeline with 10 projects this quarter moving from engagement phase to design wins, and more than 10 of existing design wins approaching the manufacturing stage with the customers placing preproduction or production orders. Demand continues to increase. In Q2, we added well over a dozen of new interesting projects that we have anticipated securing this year including projects from our MCU and module partners.

Our first-generation Cat 1 Calliope business is exceeding our plan, and we are shipping to tens of end customers in the U.S. and Japan. Calliope 2, our second-generation Cat 1 chip is now sampling and undergoing testing in our labs. Calliope 2 is our 5G compliance single chip designed for low power and cost-effective support for IoT applications that require voiceover LTE and/or [data rate] above Cat M speed, give or take more than 100 kilobits per second, like wearable and smart city or smart home IoT devices.

Calliope 2 reduces the solution cost versus the Cat 1 first generation by over 30% and brings a lower power advantage on par with Cat M/NB technology. We are seeing excellent customer traction, and the Calliope 2 platform has started contributing to our pipeline with more than half a dozen customer opportunities currently in advanced engagement.

The Calliope 2 software and module footprint are compatible with our Monarch 2 LTM and the IoT platform, which enables easy migration among Cat 1, LTM and NB-IoT low-power cellular IoT technologies. With the Calliope 2 and Monarch 2 platforms, Sequans has the most advanced, comprehensive and unique offering for the Massive IoT market.

In the Cat M/NB category, shipments of our first generation Monarch are tracking to our plan with the majority of them in the U.S. Since launching our second-generation Monarch 2 last year, the majority of our new Cat M/NB design wins are based on this new platform.

In addition to cost improvement, Monarch 2 brings many advanced features, including over 50% reduction in power consumption that enables better long battery life essential for Massive IoT devices. We have already secured many Monarch 2 design wins in numerous innovative IoT applications, including metering, health care, smart home, tracking and environmental monitoring.

Initial application, we have multiple customers with at least one being a major player in such a space. We are happy to say that Monarch 2 production is ramping, and we are shipping in volume to our earlier design wins. Monarch 2 design win projects are progressing as expected, with almost no exception, and all the projects are placing orders for either the production ramp phase or for full production and building our backlog.

I'm pleased to see that we continue to add new customers in all the market segments of Massive IoT. This quarter was reached with new opportunities in metering, tracking and wearables. Monarch 2 is now the primary drivers of our sales pipeline development and fueling our future growth.

Switching to Broadband IoT. Overall, the sector of our business had a mixed performance profile. On one side, Jetpack is a headwind, but CBRS and Taurus 5G are doing very well. Starting with the legacy Cat 4/Cat 6 business. Jetpack is a significant headwind for year-over-year growth with a greater than $20 million decline over last year that we are making up with the growth in Massive IoT, broadband CBRS and verticals. Our business in emerging markets is flat with our existing ODM customers in Asia. However, we recently won a new customer in the region that we believe can deliver growth and increase our market share.

In addition, we are pursuing new Cat 4/Cat 6 deals in the U.S. and Europe that could bolster growth next year. CBRS continues to be an attractive market for us. It offers a short-term driver to strengthen our Broadband IoT business in the U.S. and gives us the ability to expand our broadband business to the enterprise space, making it less carrier-centric. We are making progress with educational institutions for remote learning applications and large public and private facilities and campuses that require private networks.

Sequans Cassiopeia Cat 4/Cat 6 CBRS modules are optimized to accelerate Broadband IoT deployment on private CBRS networks, and we have the leading product in this category for these applications. Overall, we are making considerable progress in our CBRS business with increasing volumes and several customers now in production. We expect to exit the year as planned with a quarterly run rate of more than $1 million in revenue.

We are especially excited about our recent headway with one customer building a ruggedized CBRS tablet that's moving to full production. For Sequans, the long-term growth of Broadband IoT will be driven by our 5G Taurus platform, which is under development and remains on schedule for product revenue to begin in 2023. Mobile broadband and fixed wireless access continue to be the primary focus, which will be followed by high-end industrial and private 5G applications with potential expansion into other markets through partnerships.

We are on track with our major strategic 5G partner and fully engaged with Renesas for 5G modules development. As we approach the Taurus platform sampling date in 2022, we anticipate attracting more strategic partners and customers to support us even during the development phase.

The Vertical Category performed well in the second quarter. 5G/4G over satellite projects are the main driver of this business category with contribution from other projects for public safety, military and avionics applications.

I'm pleased to announce that we have closed a new deal with Sky5, whereby we are adapting our Cassiopeia platform for a specific use case in satellite and avionics. Please remember that the revenue report for this category also includes the over $35 million NRE deal from our major 5G strategic partner that we recognize over the period of Taurus platform development.

Let me move now to our go-to-market partnership. Partnerships are becoming a significant growth driver for Sequans as they are key for our Massive IoT business. We continue to develop a close working relationship with Renesas, NXP and Microchip and are now also engaged with a few new MCU partners. Our current relationships cover up to 60% of the MCU market and give us tremendous market reach. These partnerships also strengthened our position with Tier 1 customers, providing access to larger projects. Meaningful progress has been made by our teams on various projects and design opportunities with our partners.

In particular, we launched the Renesas Monarch-based module in May. The sales pipe generated by the launch looks very promising. Renesas has already landed a few design wins and attracted several deals with meaningful revenue potential.

Thales/Gemalto is an outstanding module partner on both Cat 1 and Cat M/NB platforms. The business from them in both categories is growing, and we are eager to begin shipping to them our second-generation platforms, Monarch 2 and Calliope 2 for future modules.

We are engaged with other module partners looking to differentiate their product offering with Sequans second-generation platforms, and we anticipate extending our relationships and securing new projects in the future.

Our Skyworks relationship continues to develop. We previously announced a joint offer for a tiny form factor, Cat M/NB system in package, featuring special packaging to sustain harsh environment found in water and gas meter applications. This first-generation SiP, or system in package, was based on Monarch and is now shipping to a few customers who are in production. We are now developing with Skyworks a second-generation SiP based on Monarch 2 with the goal of achieving the full benefit of power and cost improvement brought by our newest Cat M/NB technology. This new system in package has been selected for a major metering design win project with substantial revenue potential.

Our product and go-to-market strategies are delivering notable results as evidenced by the high Massive IoT growth and advancements in our CBRS business. Our next-generation products are advancing and gaining solid traction in multiple markets. The highlight in 2021 has been the success we've had with our partnerships that are allowing us to scale our sales capability and expand penetration in this large fragmented market with many enterprise and industrial customers. These growth levers will continue to work together to strengthen our market position and are expected to drive our growth for the remainder of this year and for the future.

Let's shift gears to talk about the supply chain challenges that are impacting the semiconductor industry and end market across the globe. I'm sure you're familiar with this theme and have heard this from other companies.

For Sequans, this is obscuring the magnitude of our performance and masking the acceleration in the Massive IoT demand. We are a leader in the IoT cellular market. We are moving forward with discipline and energy toward our goals, confident that we have a meaningful long-term opportunity to radically grow our business.

If we did not have the headwind from the supply chain challenges, we would be covering more ground faster. Long lead time components that we use to build our Cat 1, Cat M/NB and CBRS modules are having the biggest impact on our module business. Unfortunately, these challenges are increasing in Q3, specifically for our Massive IoT modules.

Sequans operations team is working with our suppliers to expedite what we can this year and anticipating our 2022 production to limit future impact.

With TSMC, we have secured most of the wafers we need through the end of the year. We are now shifting focus to the challenges we could face in 2022 as the semiconductor supply constraints environment may extend one more year. We continue to stay close to TSMC with regular dialogue and are optimistic that the industry will have some relief in the second half of 2022.

Last but not least, let's address the substrate shortage. In addition to some price increases, lead times have gone from 60 days up to more than 300 days. We did qualify various sources to have more options for our chips, but this was not enough to cover all of our demand for the second half of 2021. This major issue is specifically limiting Q3 chip production. We have placed purchase order to cover a large portion of 2022 production, and we are hopeful that we will receive our allotment for H1 2022, putting us back on track.

Orders are not being completely fulfilled, and we are delaying shipments until we can get the items manufactured. That said, the year-on-year growth outlook for Massive IoT remains strong for the second half of 2021 despite supply chain headwinds. Thus far, we have been able to support new customers in our pipeline, with allotment of chips or modules needed to support their production ramp despite the overall demand for material exceeding the available supply.

We do not believe the supply chain issues are putting us at a competitive disadvantage. The dynamics driving our growth are still in place, and Sequans is emerging as category leader.

Our top 10 Massive IoT customers could generate annual revenue close to $50 million next year and grow 50% per year in the next 2 years. Importantly, given the robust demand we are experiencing, we believe our overall growth trajectory and the investment thesis for our business remain intact. And we anticipate achieving our medium- and longer-term growth objectives as industry-wide supply challenges subside.

Let's now transition to the most compelling aspect of the Sequans story, our pipeline for future -- of future business. This quarter, we have grown our sales product pipeline to well over $600 million, with the design win portion accelerating, increasing by 18% to $280 million. We are now working on nearly 100 design win projects with over 40 projects in the production phase, primarily in Massive IoT application as well as several CBRS products. The remaining 60 design wins are advancing to revenue generation as customer projects move to manufacturing, and 15 of them placed preproduction and production orders in the second quarter.

Although demand currently exceeds the availability of materials for chips and modules, we are managing our capacity to serve new customers who are in the design phase and requesting chips in preparation for the production ramp. Our bookings are building up, and we have good visibility on the projects not yet in production phase where some customers are securing their supply in advance and are placing production orders.

In summary, we have a record backlog, a growing pipeline and increasing design wins, many of which began contributing to revenue this year, along with continuous strategic traction in our 5G.

We have a sound balance sheet with over $30 million in cash at the end of the quarter. Our significant progress in Massive IoT and broadband CBRS and our growing relationships with modules and MCU partners position Sequans for continued leadership in cellular solutions for Massive and Broadband IoT.

The development of our revenue streams in the past 2 years demonstrates that our business is evolving from being a majority carrier-centric business to being dominated by Massive IoT and CBRS, both of which are about enterprises and industrial businesses. This evolution is expected to result in a larger base of diversified customers with customer projects tending to have 5 to 10 years lifetimes. Our current analysis of our sales pipeline indicates that absent supply issues, we could approach $100 million in revenue in 2022 and grow on average of 50% per year for the following few years.

With tremendous confidence, we continue to execute our long-term strategy on 3 fronts: continued growth in Massive IoT and CBRS Broadband IoT, expansion of our go-to-market channels and ongoing development on our 5G product line.

I'll turn now the call over to Deb.

Thanks, Georges, and good morning, everyone. Our revenue for the second quarter was $12.9 million, an increase of 5.1% versus Q2 of 2020 and an increase of 4.4% sequentially, short of our previously announced 10% growth target, primarily due to the continued supply chain constraints for materials. However, and more importantly, demand for our solutions remain strong. And with orders in hand, the revenue we expected to recognize in the second quarter has not been lost but merely shifted out 1 or 2 quarters.

Revenue from Massive IoT in Q2 2021 increased by approximately 14% from Q1 2021 and 120% compared to Q2 a year ago. Both Cat 1 and Cat M revenue increased in 2021, and Massive IoT accounted for over half of total revenue.

As expected, Broadband IoT revenues decreased from Q1 2021 and from Q2 2020 due to lower revenue related to Jetpack portable routers. However, excluding the Jetpack business, Broadband IoT grew 7% quarter-on-quarter and more than 400% year-on-year. The vertical category, which includes service revenue generated by our major 5G strategic deal, increased in Q2 2021 compared to both Q1 and Q2 2020.

For the quarter, we had 2 customers and a channel partner that each represented 10% or more of our revenue. As Massive IoT design wins move into production, we expect the number of end customers served to diversify. Gross margin in Q2 2021 increased materially to 56.6% from 48.3% in Q2 a year ago and up from 50.1% in the first quarter of 2021 due to a shift in revenue mix that included higher service revenue and compared to Q2 2020, a lower level of module sales.

IFRS operating expenses decreased from Q1 to $10.7 million in Q2, reflecting a net benefit of $1.2 million from a onetime R&D grant and other onetime items. Non-IFRS operating expenses, meaning without stock-based compensation expense, totaled $9.6 million in Q2 2021, down from $10.9 million in Q1.

Our second quarter operating loss was $3.4 million compared to an operating loss of $5.8 million in the first quarter of 2021 and a $5.6 million loss in the second quarter of 2020. Our net loss in Q2 was $1.3 million or $0.04 per diluted ADS and included noncash gains of $6.6 million from the revaluation of the embedded derivatives related to our convertible debt and from the reimbursement of debt. This compares to a net loss of $11.4 million or $0.33 per diluted ADS in Q1, which included a noncash loss on the revaluation of embedded derivatives of $4.1 million. And the net loss in the second quarter last year was $19 million or $0.70 per ADS, which also included a noncash loss on the revaluation of the embedded derivatives of $9.1 million.

On a non-IFRS basis, our net loss for Q2 was $5.6 million or $0.15 per diluted ADS compared to a non-IFRS net loss of $5.1 million, also $0.15 per ADS in the first quarter and a net loss of $7.5 million or $0.28 per diluted ADS in the second quarter of 2020.

In Q2, we had a foreign exchange loss of $964,000 or $0.03 per ADS, a large portion of which was unrealized and noncash related to the revaluation of euro-denominated net liabilities on the balance sheet. This compares to a foreign exchange gain of $1.4 million in Q1 and a loss of $505,000 in Q2 2020.

Investors should be aware that possible changes in foreign exchange rates related to balance sheet items and the marking to market of the 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 are excluded from our non-IFRS presentation, foreign exchange gains and losses, whether realized or unrealized are not.

Cash flow generated by operations for the first 6 months of 2021 was $6.5 million compared to $9.2 million used in operations in the first 6 months of 2020. Cash and short-term deposits totaled $30.3 million at the end of Q2 compared to $18.5 million at the end of 2020.

Turning to some other balance sheet items. Accounts receivable at June 30, 2021, decreased to $7.4 million from $17.3 million at the end of 2020. DSOs were 32 days compared to 73 days at the end of 2020, reflecting an improvement in the on-time payment performance of our customers. Inventories decreased to $5.2 million compared to $6.2 million at the end of 2020, reflecting lower finished goods.

Current trade payables increased to $16.2 million versus $15.7 million at the end of 2020, and short-term debt from financing receivables decreased to $10.8 million from $14.2 million at the end of 2020.

Our convertible debt, which is all classified as long term, increased to $32.9 million from $26.1 million reflecting, on the one hand, the conversions and repayment of the convertible notes issued in 2015 and 2018, but more than offset by the issuance of new convertible debt in April 2021.

Turning to the outlook for Q3. While customer demand would allow for sequential revenue growth, given the increasing impact of the continued supply chain constraints for materials on our ability to ship orders, we are not giving guidance for the quarter ending September 30, 2021.

We do continue to expect that non-IFRS operating expenses should average $11 million to $11.5 million per quarter in 2021, assuming a stable euro-dollar exchange rate. And we expect non-IFRS financial expenses to be around $2.3 million in Q3, excluding any foreign exchange gain or loss. This takes into account the current level of debt and assumes interest accrued at the pick rate of 6% on the new convertible debt.

Unless we exercise our option to pay the annual coupon on the new debt and cash to benefit from a lower rate of interest of just over 5%, we expect that cash payments and interest expense going forward will be minimal given the lower rates of interest on our government debt and receivable financing.

Finally, for modeling purposes, the number of ADSs outstanding today is 37.4 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 Webcast and Presentations page, the same location where you will find the audio replay.

And now I'll turn the call back to Georges.

Thank you, Deborah. Operator, we are now ready to open the call for Q&A, please.

(Operator Instructions)

Our first question is from Mike Walkley with Canaccord Genuity.

I hope everybody is well on the call. I guess, first question for me -- thanks for breaking out Jetpack to help us understand the underlying growth rates of the business. Given the issues that your end customer, should we assume this remains kind of 0 for the foreseeable future? And how should we think about overall broadband revenue in the second half of '21?

Mike, obviously, the distribution is still -- I mean, we don't have really any what I'll call it final statement of what could happen for this business in the future. If we can come back or not. I believe the dispute has not ended yet. And for the time being, I could not comment on the likelihood of getting this business as is back. It does mean that we will not have other business with [resin] and other deals and so on that we are working on that could be coming as a new business to replace this old one, but the business as such, cannot comment on it for now. And we made the assumption that nothing is going to come back for the second half of the year, so was last quarter, that's what I mentioned on the call.

And for the rest of the business, we're talking about our CBRS business is doing well, as I said, because this is really going in line of our target at $4 million this year and we should exit at higher level of the year for next year. So things are going very well with the broadband business.

And the emerging business is kind of flat this year. We were running around kind of 1 or so -- $1 million per quarter. And -- but we are adding a new customer as well recently. So this is set for the -- I should look to this for the year globally, it should be kind of low [2-digit] or very close to low 2-digit without the Jetpack.

Okay. Great. That's helpful. And then I guess a follow-up question with the shift to more Massive IoT in your product revenue mix, offset by maybe some expedited shipments and supply issues, how does that impact maybe the product gross margins for the second half of the year?

Well, obviously, we had some expedite fee to pay and some price increase I mentioned specifically for the substrate. This really -- it was major even on the substrate, but thanks, God, that the portion of the cost of the substrate and the total cost of the chip is minor. I mean minor, it's very small.

And on the other side, I mean, we follow the policy as well to -- for all new order increase our pricing as well with customers. So customer accepted as well the price increase that we reflect to compensate some of these costs. So we don't see a major impact on our product gross margin in the second half. Deborah?

Yes. That said, with the revenue mix we're expecting in Q3, I expect gross margin will be somewhat lower in Q3 temporarily. But overall for the year, still on a good trend and not any impact on our overall targets.

Last question for me and I'll pass the line. Just to -- for your Massive IoT business, I know you're not giving guidance, but can you give us just kind of thought process in terms of how much supply could limit the ability to ramp and what the ramp might look like in the second half of the year absent some of the supply constraints?

Well, Mike, as I said, really, the demand is huge. And just as I mentioned, to give you just the amount of ramp, I was explicit by saying we have like 15 projects moving to production now and adding up. And so the demand is really not the gating item. The backlog is strong and we could have really -- in principle, without the supply challenges that we have, we could have a decent target easily achieved quarter-to-quarter growth because the book is there.

The challenge I have really by giving a number is really that I don't have the full picture on my supply in a sense like we're fighting to expedite some stuff to solve some of the situation that they are stuck by calling the partners that we work with to accelerate and so on. And until the last minute, we have visibility every day, I will say, some improvement here, some improvement there without giving us the full picture.

So obviously, the -- this will continue. We expect that site to continue standing well at least versus the Q2 and growing from there. But the amount of this growth between is it going to be flat quarter-to-quarter? Or am I able to make it further growth, it's not going from the fact that I don't have order in hand to ship. It's more limited to -- am I able to build all this new capacity.

Our next question is from Scott Searle with ROTH Capital.

Georges, just to jump in, in terms of -- I just want to clarify quickly again that you said unconstrained for next year in '22, you'd be approaching $100 million in sales based on the pipeline and growing thereafter at a 50% CAGR for the next couple of years. I think that's what you said.

Also in the release, you talked about returning to that target growth rate of 50% sometime in the medium to long term. So I'm wondering if you could clarify that, put some color around when you expect that to come back? And it sounds like you're expecting some of the substrate issues perhaps to start to improve sequentially from the third quarter to fourth quarter, I was wondering if you could provide some color around that?

Scott, I mean, I give -- I said a few things in the script. One which is to say, first of all, I give you a color about just business in hand, what we have in hand winning. And I said, like just if I look to the Massive IoT projects secured, in other words, really customer -- whether we are shipping to them or they are -- we're going to ship to them this year. And if I pick just only my top 10 customers, I can build a funnel of $50 million in Massive IoT for next year and obviously, to continue growing from there.

And obviously, if we look to the wall pipe, the complete pipe, taking into account not only Massive IoT design win in hand but also the design in within the close -- the year it didn't finish. We still hope to close on new projects to land the new projects in Q3 and Q4. So we have the potential to have much more in Massive IoT.

If you add to this as well the broadband business that we have in hand and design win in CBRS and the vertical, we could be approaching the $100 million. It's really the pipe easy to see this. Now we could be a little bit below, a little bit above depending on the variation I could have with the remaining deals that we are closing, if you want, for the short term. And this is definitely solid.

And if I project from my pipe, a projection, if I take the pipe and look for '22, '23, '24, we see this trend continuing for the coming 3 years and quite solid. So it's really the only issue we have is really on the supply chain. But honestly, we did a lot of things anticipating next year. The -- we feel good with TSMC for the -- I tend to say maybe the first half, and I'm hoping that beyond this, life will get better. It's not going to continue like this.

I mean the capacity build that TSMC is building, people are going to realize that they anticipated too much and they will start using their inventory and hopefully have more room to support our growth rate because we need really -- we have a high growth versus other company. So this is one angle.

On the substrate, it was a question of lead time, more than really -- so the lead time, we -- as I said, it moved to 300 days overnight. So this blocked us from securing, I would say, short term. But for next year, we secured big capacity.

And we are moving to a mode where we are considering long lead time more than 9 months on the modules. So we put -- we did all what we have to do to secure, if you want, next year. So I don't want to say I'm 100% confident, but we should be far much better than what we are today. And the problem for Q3 is really the -- not too much time, if you want. Whatever you have to do, you need to -- it was not enough for us to get, for example, the substrate, all what we need on time on some of the components. Even if we are not giving up, we'll continue pushing and hopefully, we can secure more than what I'm thinking will be the minimum for us this quarter.

Got you. Very helpful. And if I could, to follow up on Mike's question related to gross margins. If you look at the mix, right, the product gross margins were in the 30s. I'm wondering if you could help us understand, in a normalized environment, how do you feel about the gross margin profile for the next-generation products, in particular, Cat 1 and Monarch 2? Are they going to be getting up to the 50%-plus gross margin level?

That is -- I continue to repeat the same. On the chip level, we don't have any challenge and we have a profile at 50%. Obviously, we vary around it. It could be a little bit higher, a little bit less, depending where we stand also in the cycle of the product, but we don't -- we are really on this profile.

The product gross margin is always impacted by the percentage of modules versus chip that we could have. And mainly our Cat 1 module, they have lower margin than versus Cat M in general. So this could impact our gross margin profile on the product, which is as compensated to the service revenue bring us back to the 50%. So that's how we see it.

Now down the road, when I believe were shipped, we will be heading above $100 million, and our challenge becomes really the profile because you could imagine that the company going, let's say, the $150 million and the service revenue staying at $15 million, $20 million, but the rest of the product, if a big chunk of our product is modules, then this can create different profile in terms of gross margin and reduce us below 50%.

But the solution for this is already in place to implement it, and this can be moved through partners and distributors to turn any module business that we have to turn it completely to chip business and just only (inaudible), I will say the business and keep it with the gross margin close to the 50 -- above 50% and close to 50%.

So this is really not at all a challenge and a concern for me. It's a part of the execution plan that we are working on. And in the short term, this is not an issue because as we said, the percentage of services is by far compensating the module low margin.

Great. And lastly, if I could, on the strategic front, you've added Sky5 to the list. But could you update us on what that the strategic opportunity pipeline looks like and the timing of some additional opportunities? I think as well, you indicated now you're working with the MCU providers that represent about 60% of global units, are there some other things going on in that front as well with additional potential MCU partners?

I mean, definitely, the go-to-market, I believe this is remains one of the solid angle of Sequans. And the key component there is to partner with the MCU vendors as well people like Skyworks and some module vendors as well to accelerate, I would say, or ease our go-to-market in this fragmented market, which is more not carrier-centric. It's more businesses that you need to address them and the number is very large. And here, obviously, the partner we are working with, the relationship is great. And as I said, we start seeing results in the pipe.

And we have a new MCU partner that we are working on. You can name a couple of the big guys left that didn't mention their name. You could assume that we are engaged with them. We have a project with them, not public yet, but it will become public when time will come.

But the similar relationship is really expanding the game. Sequans is really can be seen as the cellular provider to all those MCU partners that they miss cellular to complement their connectivity, their wireless connectivity with the MCU.

Our next question is from Rajvindra Gill with Needham & Company.

This is actually Denis to ask questions on behalf of Raji. Georges, I have a few related ones here for you. Could you speak a little bit more about these substrate issues? I know which specific component are you missing the -- what are you going to have in trouble putting together?

And additionally, I think you had mentioned something about first half improvements. Are these some kind of comments from TSMC? Or what are you referring to? And can you provide any more kind of general commentary about maybe the wafer supply situation?

Denis, the -- on the substrate, I mean, obviously, when you build the chip, you need to die the wafers from TSMC and then you need to package it, and you go to a packaging houses where they use some substrate to finish the assembly, I would say, of the product.

So this is really maybe a negligible piece of the product. But unfortunately, with all those supply shortage and for many, many reasons, very hard, even long list to go with, but the lead time of those components or access to the substrate came from something really 60 days absorbed by the TSMC, in other words. In the normal days, you will never think about it, and it became like 300 days.

And obviously, this happened almost overnight. So if you don't have in the pipe substrate reserve for your chips enough, you will have a problem because you are not able to finish the assembly of the chips. And this is, by definition, impact all our chips, broadband, Massive IoT and so on.

It happens, depending on the situation, we -- I'll say where we are selling the [most] is obviously Massive IoT. So the demand is big there. So obviously, the challenge we have more challenge on Massive IoT than broadband because in terms of inventory, what we had in hand was more enough to absorb than on the Massive IoT.

And as I said, what we did there is essentially selecting new substrate suppliers, go through qualification process, which is -- takes 3 months to get something like this, qualify it and from there, have more options. But unfortunately, the lead time is very, very hard.

I mean we improved some of them below 300 days. Otherwise, I'll not be able to ship anything in Q3, but this was not enough by paying some expedite fee and so on.

So this is really the challenge. And obviously, if you have the wafers and you don't have the substrate, you'll have a problem. But the substrate is not limited in a sense like it was just only a lead time. In other words, we placed order already for next year. We cover enough quantity that we believe we are good. But for the short term, it was not enough to get everything we need.

And on the wafer, what I said on TSMC, I believe, obviously, the claims today is still that the shortage will remain all next year. But we know all that the capacity -- more capacity will be ready for production in Q4 next year. So if you put the equation, you could say like, "Okay, if there is a new capacity coming in Q4, people ordering 1 quarter ahead of time to keep their inventory strong, they are going to start using their inventory to optimize the inventory in general and on their balance sheet." And this, hopefully, will alleviate the demand in the second half next year.

It's my theory, Denis. It's not really -- I'm reading this by looking to what's happening in the market. I believe the challenges are going to continue next year, but I'm hoping like mid next year, we start getting the relief and on the wafer challenge.

Got it. And then I think you -- there was one comment you've made about, I believe it was Monarch 2 and Calliope 2 and shipments. I think were you referring to shipments to Renesas? And could you speak more about that and provide some clarity there?

I mean -- no, I mean, Calliope 2 is not shipping yet. Calliope 2 is sampled and it's under test. It's however, we have engagement with customers and building the pipe. Monarch 2 is definitely shipping. And for first design win, we got at the beginning of the year or late end of last year, and this is moving into production.

And if I talk about Renesas, Renesas has adopted reselling a module with Sequans using Monarch and Monarch 2. And the first generation of modules using Monarch has been launched. They launched this in May, so it's public information. And obviously, they have, as I mentioned, nice pipe and many design wins. So it was a very successful launch, if I have to phrase it with minimum words. And obviously, this is moving to business. But at the same time, we are working now with them on Monarch 2 because they will be launching as well the platform with Monarch 2 to complement their offer to market. And later on, they will launch as well Calliope 2 platform. With Renesas, we have comprehensive partnership covering all the portfolio of Sequans, including, by the way, 5G Taurus in the future.

Our next question is with Craig Ellis with B. Riley Securities.

Georges and Deborah, thanks for all the detailed information so far. So I just wanted to start with a clarification. I know there's a lot of interest, Sequans, and more broadly around what exactly is happening with the supply chain gives and takes, and you've detailed that considerably. But is it possible if we look back at the second quarter to quantify the revenue impact of the either wafer or substrate or back-end issues that were in play in 2Q's revenues?

In 2Q revenue, it depends on the reference, I have to say. Because we could do a couple of million dollars more in Q2. Honestly, from the beginning of the quarter, because I know where my limitation was, I believe, at the end, we were like -- we had some unfortunate issue in the last couple of days with some of the supplier. They didn't ship on time. They have a couple of days delays and so on, that was impacting by around [$700,000], if I have to give a number for the quarter.

But we could do more originally, if you want. It's not -- it was just only from the minimum we were hoping we get extra impact with some issues, I would say, because you need to keep in mind that the supply chain, one of the challenge is not only that you have limitation and you cannot scale. But once someone is promising you something, this promise is valid until you need to wait until he delivers to know if it's true or not because any issue happening in the production could impact them because everything is on the edge, and an issue there could delay a week, 2 weeks here and there and can impact the production promise to you.

That's helpful, Georges. And then a follow-up, you mentioned the new MCU partner unannounced, but work is underway. So exciting to see that potentially another large player joins your list of existing partners. The question is really this with both the MCU partners and the distributors in this environment that we've been in for 2 to 3 quarters where component constraints are really tight, how is that impacting just the day-to-day with you and your teams as you work with those entities since, typically, I think most of the work would be on design wins and converting design wins to revenue, but now we have the supply chain issues.

You're clearly getting very good incremental momentum with new design wins and bringing new projects towards the revenue-generating phase. But what does that mean as you work with your partners with the overhang of the supply issues that we have? And what will it mean when it's not there?

Well, you're absolutely right, Craig. I mean, obviously, some piece of it is not impacted at all because it's part of the design win and turning conversion customers. But definitely, as we have, for example, in Q3, we have some major shipment to some MCU partner without naming which one, but we have some design wins there coming from the MCU, and we have order, and they want them in Q3, and I don't know if I will be able to deliver before end of September or October or how much I delivered in September, how much in October.

So we have those challenges. They are part of, I would say, the challenges we have as well with our direct customers that we want. Obviously, the way we are managing this, and this is very important, we are giving some priority, if you want. We were not cutting customers because we have some customers, for example, as some customer asking for 100,000 units. And I have, let's say, 5 other customers, they are in preproduction each is asking for 2,000 units. So obviously, we don't want to cut those 5 because we want them to move. And to some extent, we are cutting the guy who has 100,000 to give him 90,000 and take 10,000 from him to distribute it to 5 other customers.

So we are doing all those optimization where the main interest there is to keep all our customers moving without delaying their lunch. And this is okay. I mean, I don't see any issue today. And customers appreciate what we are doing for them. We have a lot of positive feedback because everyone is living in the same environment.

That's really helpful. And then, Georges, you mentioned that you're on track for parts sampling in the second half of '22 and then revenue generation in '23. Can you just talk about some of the key milestones between here and there to help illuminate what some of the bigger issues and milestones are that the team needs to get through so that we're on track with that important project?

Yes. I mean, obviously, the first milestone, which is really getting the tip out of the chip, we have something happening this year. We're still on time. We have RF and (inaudible) chip. I don't want to give more details for competitive reasons. But one of our tape-out will be going this year as planned, and the other tape-out will be beginning of next year as planned. So this is really key.

And then obviously, we expect like mid next year to start getting the solution in the Q3, showing the full solution with all the software and all the integration happening and start preparing for certification with carriers.

Got it. And then lastly, not to ignore you, Deborah, anything as we look at the third quarter that we should be aware of with respect to either cash benefit or cash use beyond just the things that we would see as we look down the P&L and think about typical working capital gives and takes?

No. In the third quarter, there are no sort of unusual items that are expected.

(Operator Instructions)

Our next question is with Tristan Gerra with Baird.

Yes. Can you hear me now?

Yes.

Quick question on gross margin. You talked about how the impact of supply/demand imbalances will have -- will still be pretty neutral to gross margin this year, even though there's a bit of an impact in Q3. What about next year?

Do you think you can basically mitigate the supply-demand situation by improving the mix? What about your ability to pass on some of the cost increases to customers until you get better wafer availability, which you mentioned will be second half of next year? Or is it going to be a margin-neutral event as well for next year?

Well, Tristan, I mean the good news is there, honestly, is that the TSMC -- and maybe this is something good about TSMC, I mean, they announced publicly they didn't increase the price. So at least the biggest bulk of the cost of the chips coming on the wafer level, this didn't increase. It's -- we had an increase on the substrate, on other material for the modules. And as I said, all this globally, we are able to contain it.

And we managed to pass price increase. We know we have already orders for next year at higher price from the same customer, where they accepted our price increase that we took to some to customers. So we apply this to all our customers and established with the price increase, and we promised to bring back the cost -- the price to the same level as soon as our costs will go down. So honestly, it's not really a major concern, and it will be on the limit. If there is an impact, it will be really on the edge.

Okay. And then what are the potential from a revenue standpoint from your 5G Taurus line when it went in '23? What are the initial indications from customer? And do you think that -- how do you think the revenue stream eventually is going to compare with what you've been able to achieve in the past few years with your 4G modem?

I mean, the good things about the 5G, I mean, if you went from this angle, the 5G ASP is very high. We were talking about today, well above $50 a chipset. So if this even will go down, we believe this will go below 50%. So the ASP will be high. And just to compare it to a router on 4G, if you compare router on 5G to a router on 4G, where on 4G today, when we were selling the Jetpack, you do like $10 in average, let's say, ASP per device. And you are going to make at least 3, 4x this level when this will be shipping. So we are quite bullish on this.

And we obviously depends on the market share and the number of units will be selling. Now 2023 will be the beginning, obviously. And then 2024, it will be a full year in terms of production. We know you know that we have already customers waiting for us, and we have potential there. So this could start maybe making easy in 2023, the $10 million, $15 million. And then from there scale to $50 million the following year, just coming from the 5G.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back over to Dr. Karam for closing remarks.

Okay. So thank you again for joining the call today. We look forward to catching up with you and again, our third quarter earnings call. Thank you very much. Thank you, operator.

This concludes today's conference. You may disconnect your lines at this time. Thank you for participation.