When Sierra Wireless (NASDAQ:SWIR) released fourth-quarter 2015 results four weeks ago, the stock's 24% plunge the following day made it seem as though the sky was falling for investors in the Internet of Things pure play. Revenue declined 2.8% year over year, to $144.8 million, well below the company's guidance for $148 million to $151 million. And adjusted net income dropped over 70% to $2.5 million, or $0.08 per share, below analysts' consensus estimates for earnings of $0.10 per share.
But if management's comments during the subsequent conference call are any indication, Sierra Wireless' current weakness should prove little more than a temporary inconvenience for patient, long-term investors. Now that the dust has settled, let's take a closer look at some of the key points Sierra Wireless management covered during the call.
OEM solutions is doing just fine
Revenue in our OEM Solutions business was $121.5 million in Q4, lower by 6% compared to the same period last year. OEM revenue also declined sequentially from Q3. Some of the sequential decline was expected, and some was not. As expected, the large automotive customer we referred to in our Q4 guidance was lower sequentially. Also as expected, revenue improved sequentially from mobile computing, but it's still on its way back to normalized levels as we continue to navigate the PC industry's transition to the new Intel Skylake platform. In addition to these items we experienced some unexpected demand softness from a small group of OEM customers across different segments. We do not believe that this softness represents any share shift. However we do believe it's likely reflective of some caution on behalf of customers given the current uncertain economic environment. Notwithstanding current weakness in this line of business and an uncertain economic environment, we're very optimistic about the mid- and long-term outlook for OEM Solutions.
-- Sierra Wireless CEO Jason Cohenour
First, keep in mind OEM solutions is Sierra Wireless' core segment, so its relative under-performance represents the primary reason Sierra Wireless fell short of expectations in Q4. As Cohenour notes above, the blame appears to lie with "caution" being exercised by several smaller customers in this segment given current macroeconomic concerns. However, this does not indicate a deeper problem with Sierra Wireless' business, and by all means the company appears to be maintaining its industry leadership position. As macroeconomic concerns ease, Sierra Wireless' OEM Solutions business should rebound.
The enterprise solutions segment is making progress
Revenue in our Enterprise Solutions business was $16.5 million in Q4 and gross margin was solid at 53.6%. While Q4 revenue was lower year-over-year our enterprise business continued to improve compared to the first half of 2015. Enterprise revenue in the second half of 2015 was up 19% compared to the first half. Second half drivers included large deployments with new public safety customers, as well as the launch and sales of our new AirLink RV50 gateway for industrial applications.
More specifically in the fourth quarter, enterprise solutions revenue fell 15.3% year over year on a reported basis. But that was primarily because Sierra Wireless broke out revenue from the new cloud and connectivity segment (more on that below) from within it. So investors should be particularly encouraged to know that not only is enterprise solutions' gross margin still healthy at 53.6%, but it also is expected continue outpacing growth of the core OEM Solutions segment going forward.
Cloud and connectivity will be much more profitable going forward...
Revenue in our Cloud and Connectivity business was $6.8 million in Q4 with blended gross margin of 41.4%. Note that revenue from our AirVantage cloud just recently achieved gross margin breakeven. So as we scale this business we expect gross margin to improve. On a sequential basis this revenue which is comprised mainly of recurring service based contracts benefited from a full quarter of revenue contribution from MobiquiThings, which we closed in September of 2015. We now have a fully integrated team comprised of Maingate, MobiquiThings, Accel and AirVantage team members and there's a lot of work to do.
Next, the new cloud and connectivity segment is comprised primarily of revenue from products of three key acquisitions Sierra Wireless made last year in the managed connectivity space, including Maingate, Accel Networks, and MobiquiThings. As it stands, the segment likely drew the ire of the market given the hindsight of margins made available by Sierra Wireless; cloud and connectivity segment gross margin was 39.3% in the first quarter, rose to 43% for both the second and third quarters, then showed a worrisome decline to 41.4% in the fourth quarter.
However, investors should keep in mind Sierra Wireless is still working on building a single unified platform for products between the three formerly disparate companies so, in Cohenour's words, "customers can manage their devices, global cellular subscriptions, and machine data through a single portal, enabling them to deploy Internet of Things applications faster and more cost-effectively than ever before." That platform should be launched in the next few months, which should in turn allow Sierra Wireless to scale the cloud and connectivity segment into a much larger, more profitable beast.
...and both segments will pave the way to greater returns
As we grow our business, we also intend to drive our gross margin-accretive mix shift as growth from Enterprise and Cloud and Connectivity outpaces growth from our OEM Solutions business. Our growth goals and mix shift goals will drive our organic and inorganic investments. And when we achieve $1 billion in top line, we expect revenue from higher margin Enterprise Solutions and recurring Cloud and Connectivity services to expand from 14% of consolidated revenue today to approximately 30% of consolidated revenue. We believe this will enable us to derive consolidated gross margin exceeding 35%, and an operating margin above 10%. And we believe that achieving this goal will create a clear sustainable leader in device to cloud solutions for the [Internet of Things] and drive significant returns.
For perspective, Sierra Wireless management's initial $1 billion revenue target represents growth of nearly 65% from the company's 2015 revenue of $607.8 million. And even as OEM solutions should enjoy modest growth going forward, Cohenour's comments above indicate outsized growth at both enterprise and cloud and connectivity should mean the two segments combined will account for around $300 million of that total, up from just under the $85 million they tallied in 2015. Assuming they also continue to improve profitability as they grow, Sierra Wireless should be poised to handsomely reward shareholders in the process.
A "very interesting value creation opportunity"
We plan to be in the market soon, repurchasing our shares as we see a very interesting value creation opportunity at this time. Notwithstanding our planned return of capital, we still expect to stay active in M&A to accelerate our strategy and to drive growth. Longer term, we are very focused on capturing a big part of the $20 billion opportunity, on driving sustain revenue growth to $1 billion and beyond and to driving our gross margin accretive mix shift and expanded operating earnings. We believe that this formula will drive significant value and a strong return for shareholders.
Finally, here Cohenour is referring to Sierra Wireless receiving approval from the Toronto Stock Exchange of its "Notice of Intention to Make a Normal Course Issuer Bid," which is effectively a kind of controlled share repurchase authorization. Under its bid starting Feb. 9, Sierra Wireless was able to purchase and retire up to 3,149,199 shares of common stock -- or 10% of its public float -- with a ceiling of 22,269 common shares per day. In short, Sierra Wireless knows the market doesn't currently hold a favorable view of its stock. But given its longer-term growth ambitions, Sierra Wireless also believes now is the right time to put its money where its mouth is and buy its own shares. For long-term investors willing to watch that growth story play out, I think now is the perfect time to follow suit.
Steve Symington has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Sierra Wireless. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.