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Did Sierra Wireless Just Fire a Warning Shot on the Internet of Things?

Nicholas Rossolillo, The Motley Fool

The Internet of Things -- that oft-used and generic term that describes the internet-connection-enabling technology being placed in virtually everything -- has been hyped for years. And why not? According to tech researcher IDC, spending on the IoT is supposed to grow to $1.2 trillion by 2022, a 14% growth rate each year from now until then.

That should be great news for IoT hardware and software provider Sierra Wireless (NASDAQ: SWIR), because the IoT is all the Canadian technologist concerns itself with. As internet connections continue to expand around the globe, sales at the company have climbed higher, and that happened in 2018 once again. However, flat outlook for 2019 -- including a new cost-cutting initiative that's usually reserved for companies exiting high-growth mode -- would indicate all's not well for the IoT specialist or the sand box it plays in.

A good year, but...

That isn't to say Sierra Wireless had a bad year. In fact, the company did post sales growth in line with IDC's long-term outlook for IoT spending. The problem was with the bottom line, where inconsistent performance has plagued the company for years.

Metric

Full-Year 2018

Full-Year 2017

Change (YOY)

Revenue

$794 million

$691 million

15%

Gross profit margin

33.3%

33.9%

(0.6 p.p.)

Operating expenses

$283 million

$234 million

21%

Earnings (loss) per share

($0.68)

$0.14

N/A

Adjusted earnings per share

$0.90

$1.05

(14%)

Data source: Sierra Wireless. YOY = year over year. P.p. = percentage point.  

It's worth noting that part of Sierra's top-line growth is attributable to the acquisition of Numerix, an IoT software provider that helped Sierra's services segment double to $94 million in 2018. That was a good move as the gross margin on services (52.3% on the year) is better than Sierra's average and helps broaden the company's reach. Nevertheless, higher expenses -- especially the 44% surge in administration expense -- did a good job dragging down the bottom line.

Higher expenses thus explain management's decision to put cost-cutting measures in place over the next couple of years. Research and development has been consolidated into a single team, as have the sales and marketing and product management teams. Total savings should be $40 to $50 million over the next 24 months.

Paired with an outlook for flat sales growth in 2019 (including an expected 7% to 9% year-over-year drop in the first quarter), cost-cutting initiatives don't exactly inspire confidence. However, Sierra is still posting growth in its newest and highest-profit segments, and reducing expenses is signaling a shift in focus rather than problems with the IoT industry.

An artist's illustration of the IoT. Data and charts are shown being shared around the globe

Image source: Getty Images.

The 2019 comeback story?

CEO Kent Thexton said that expected cost savings will be used to invest back into new product development, especially device connectivity to cloud-based networks, mobile 5G networks, and embedded SIM (a programmable mobile network management chip). Thexton said Sierra's total addressable market should grow to $10 billion a year by 2021, and investing in research will be key to keeping up. With 2018 revenues just shy of $800 million, that means there is plenty of room for the company to capture more sales in the next few years. That should also ease investors' worries that the IoT mega-trend is the problem.

What about the sluggish outlook for the new year? The flat outlook implies there will be a rebound later in 2019 after the expected sales drop in the first quarter. So, this looks like a temporary speed bump more than anything. Plus, Thexton said the connected auto segment is slowing, and profit margins are thinner than average, masking stronger performance in the company's network IoT business. The focus going forward will be on the latter, but there will be a transition period before results start to ramp higher again.

2019 could be an ugly one for Sierra Wireless, but the chip maker and software provider should be just fine -- as will the massive IoT movement. After taking a big tumble after fourth-quarter 2018 results, the stock is worth considering as part of a larger Internet of Things investment strategy.

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Nicholas Rossolillo and his clients have no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Sierra Wireless. The Motley Fool has a disclosure policy.