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Novatel Wireless Inc. (NASDAQ:NVTL)

Q1 2010 Earnings Call

May 6, 2010 05:00 am ET

Executives

Julie Cunningham – VP, IR

Peter Leparulo - Chairman and CEO

Ken Leddon - SVP and CFO

Analysts

Jason Schmidt - Craig-Hallum

Kevin Manning - Bank of Montreal

Operator

Good afternoon, ladies and gentlemen thank you for standing by. Welcome to the Novatel Wireless First Quarter 2010 Earnings Call. During today's presentation, all parties will be in a listen-only mode and following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today Thursday May 6, 2010

I would now like to turn the conference over to Julie Cunningham, Vice President of Investor Relations. Please go ahead.

Julie Cunningham

Thank you and good afternoon everyone. Joining me on today's call is Peter Leparulo, Chairman and CEO and Ken Leddon, Chief Financial Officer. As a reminder, this conference call is being broadcast on Thursday May 6th, 2010 over the phone and the internet to all interested parties.

The information shared in this call is effective as of today’s day and will not be updated. During this call, non-GAAP financial measures will be discussed. Reconciliation to the most directly comparable GAAP financial measures are included in our first quarter earnings release which is available on the investor relations page of our website at www.novatelwireless.com.

The audio replay of this call will also be archived there. Today’s discussion may contain forward looking statements. These forward looking statements are not historical facts, but rather are based on the company’s current expectations and belief. The company’s actual result may differ materially.

Please refer to your SEC filings for a detailed discussion of the potential risk. Now I’d like to introduce Peter Leparulo, Chairman and CEO of Novatel Wireless.

Peter Leparulo

Thanks very much Julie. Before we recap our first quarter results, I’d like to address recent reports of battery issues related to my MiFi 2372, a model which was introduced in December 2009 and has been sold principally in Canada. Here are the current facts, we received two reports of battery over heating issues on the MiFi 2372 from our Canadian customers. This issue does not affect the CDMA based WiFi 2200 which represent approximately 90% of our shipment today. We undertake ongoing analysis of battery returns and that analysis shows that overheating is caused by user induced damage such as puncturing the battery with a sharp object or applying excessive force when removing the battery cover.

As a preventative measure we are conducting an exchange program for our Canadian customers to replace the MiFi 2372 battery and battery door to make it easier to open. In addition as a proactive measure, since the MiFi 2352 is based on a similar design we have been shipping all new MiFi 2352 devices with the new battery door. Included in our first quarter results is a warranty cost of $450,000 for estimated expenses associated with this exchange program.

In summary, we believe our program goes beyond what is required to address the current facts and this issue is being properly handled under standard warranty and customer return processes. We will continue to monitor this for any additional developments.

Now turning our attention to Q1 results. Revenues for the quarter were $72.2 million, a modest increase over last year and slightly ahead of our guidance. Gross margins were also ahead of expectations and we kept expenses generally flat leading to non-GAAP net loss of $0.07 per share. In addition our balance sheet remains strong with nearly $185 million in cash and investments or $5.92 per share.

While it was a mixed quarter, we are encouraged by our continued progress with MiFi sales increasing at $34 million or 47% of total revenues. By the end of the first quarter, we achieved cumulative sales over a $114 million on our MiFi platforms in less than one year since its introduction. During the first quarter, we launched MiFi with four operators and two MVNOs including [eight] network at DOCOMO MVNO and internet communications in Japan.

We received notice that the MiFi trademark is now registered and we intend to continue to in force our brand in marketing. As well as in our customers marketing campaigns, MiFi was also named the most innovative non-handset product at the 2010 mobile news awards in the UK last month. The continued critical acclaim for the MiFi platform points our competitive differentiation.

We believe our operator customers understand this product differentiation and the future potentials of our platform that goes well beyond internet connectivity. The MiFi platform is the perfect solution for the new wave of tablet pc’s and similar devices that are now coming to market. And we are working closely with the operators on the next generations of the MiFi family which will offer substantial differentiation over our first generation products.

We are currently in the certification process with our first MiFi open development platform. This product is based on North American HSPA and will include on board application processing and storage powered by the MiFi open operating system. In addition it will feature the MiFi dynamic random page as well as software bundle options that include both NovaDrive Cloud- Storage and (inaudible).

The additions of the apts processor and OS enables native and third party applications and services. Today we also enhance the selection of [pocket year] to host our MiFi App store which we intend to launch in the fall. We are very pleased with the level of operator interest and are excited to see open sell for platform move to commercialization. This feedback combined with the positive and consistent sell through data from our largest customers gives us confident that our MiFi open platform will gain traction as we ramp in the second half of the year.

Turning to our core products, we introduce the Expedite E120 embedded model during the first quarter. The E120 is a mini card embedded module that integrates high-speed data connectivity into e-books, and other portable entertainment devices for 3G mobile data applications.

This E120’s thin contour occupies 23% less volume than a standard PCI Mini Card, because it was designed to be thin, it is ideal for the next wave of low profile devices.

In addition, we have several new opportunities with large PC OEM customers for 2011 laptop models, including an LTE design win with a Tier 1 manufacturer.

We expect to (inaudible) with 4G technologies including Dual Carrier HSPA plus, WiMax and LTE to improve both the functionality and competitive landscape for our products. Currently, we faced competitive margin pressure on our core modem market as 3G reaches the mature phase of its lifecycle. ASC compression in late stage products is typical prior to industry wide technology transitions.

We stand to benefit from the move to 4G and we intend to lead the market with the innovative devices and applications that take advantages of the enhanced functionality that these technologies will offer.

With that, I’ll now turn the call over to Ken, who will provide some details on the financials.

Ken Leddon

Thank you, Peter. I will begin with the financial overview of the first quarter and then we’ll provide our second quarter outlook. Unless specifically noted, all comments about our financial results exclude the impact of share-based compensation expense under ASC Topic 718. Share based compensation expense net of taxes was approximately $1.1 million in the first quarter of 2010.

Let’s begin with our first quarter results. Revenues for the first quarter was $72.2 million and compared to $70.4 million reported in the prior year period.

Revenues by product category are as follows:

Core products which include USB, ExpressCards and combination products, accounted for 36.6 million or 50%. MiFi product accounted for 33.8 million or 47% and embedded products of 2.1 million or 3%. Revenues by technology, EVDO products were 89% and HSPA products were 11% of revenues.

From a geographic perspective, North American revenue account were approximately 92% of total revenues and international revenue was 8%. In addition, we achieved our software bookings in the closings in the first quarter and although still small we expect software bookings to build through out the year. During, the first quarter, we shifted seven operators and three OEMs in 27 countries. Leading customers in that quarter included Bright Star, Sprint, Telefonica, Verizon, and Virgin Mobile.

Gross margin of 24.8% was slightly above our guidance primarily due to product mix. First quarter operating expenses were 29.4% of revenues or 21.2 million. Total operating expenses and absolute dollars were up 14% compared to prior year and nearly flat on a sequential basis.

R&D expenses totaled $10.8 million or 15% of revenues. Sales and marketing was $6.5 million or 9% of revenues which includes $1.9 million in market development funds. And finally G&A was 3.9 million or 5% of revenues.

Including the share-based compensation charges of $1.1 million net of taxes, we reported GAAP net loss for the quarter a $3.4 million or $0.11 per share. On a non-GAAP basis excluding the share-based compensation charges, we reported net loss of $2.3 million or $0.07 per share.

Cash flow from operations during the quarter was $9.9 million. Now, I will review some balance sheet highlights at March 31, 2010. We had approximately $184.6 million in cash and investment or $5.92 per share with no debt. Accounts receivable was down approximately $2.8 million from last quarter at $33.5 million and DSO was slight at 43 days with excellent receivables quality.

Inventory decreased sequentially by $5.9 million in the first quarter to $19.1 million which equates to 10 turns per year. Now turning to second quarter 2010 guidance. It’s in our current view, we expect MiFi revenues to decline in advance of our product transitions to open MiFi platform and a WiMAX version of MiFi. We expect core products to grow on a sequential basis however and we expect gross margin pressures to continue until four key products are introduced.

Given the shift in the product mix our guidance for the second quarter of 2010 is as follows: We expect revenues of approximately $70 million, we expect gross margins of approximately 22%. We expect non-GAAP operating expenses to be approximately $2 million lower sequentially. And based on our current view, we expect GAAP results to be $0.12 loss per share and non-GAAP results to be $0.09 loss per share. These estimates are based on approximately $31 shares million outstanding.

Now I will turn the call back to Peter.

Peter Leparulo

Thanks very much, Ken. Our focus over the next three months will be on achieving four primary objectives certifying the launching the first MiFi open platform product in late Q2 or early Q3, diversifying our customer base with new customers and market enterant including the cable companies. Leading a transition of 4G on all of product lines, working closely with our development partners on each of the major 4G technologies. And capitalizing our growth opportunities with PC OEM and other customers ending embedded space. And now Ken and I would be happy to answer your questions.

Operator please open up for Q&A.

Question-And-Answer Session

Operator

Thank you, sir. We’ll now begin the question-and-answer session. (Operator Instructions). Our first question comes from the line of Mike Walkley with Piper Jaffray. Please go ahead.

Unidentified Analyst

Thanks. This is Charles speaking for Mike Walkley. Hi Ken, hi Peter. Maybe just two quick ones. First one, in terms of modifying the core product, if you could just walk us through maybe the seasonality, the seasonal trends in the back half of the year and what’s expecting from these two product segments and then second kind of a two part question, just if you could give us some more color on this App store which is getting launched in the fall and what kind of feedback you have been getting from developers and on the developer lounge that you all have opened up, if you have seen what kind of fraction are you seeing from the developers? Thanks.

Peter Leparulo

Sure, thanks [Charles]. With respect to the first question on the seasonal trends on Mifi and the core market. Let me take the core market first. What we are doing is developing as quickly as we can to migrate our entire core market over to 4G. We expect that to phase in through the second half of the year depending on what the 4G interface is. For [factor just] in Q4 embedded as well as in our core market and we likewise view that that will begin to ramp in the second half of the year in two different places, we believe it will begin to ramp in mobile content devices such as e-book readers which have been delayed for us but in the second half of the year we expect those to ramp likewise we expect the PC OEM space at the very end of the year to ramp for us as well.

On the MiFi front we are, as we said in our prepared statements the MiFi front is more (inaudible) because what we are trying to do is move the product category in two different directions simultaneously in the second half of the year. The first direction is to move it up to the next generation air interface, the second direction is move the category to what we really view as our vision of the category potential, the open software platform. We’ve got good responses from the operators on that and we believe that, that's the right direction to go in with the product category and we’ll see the result of that in the second half of the year with the up-tick.

On the App store we have been in the second phase of our developer community and we are also putting support in place for the final phase which would be full open developers community support and I can tell you in the second phase we have seen some very compelling submissions for used cases both in small business and consumer as well as in vertical markets. We are working with each of these submissions and filtering through them, but so far we are pretty pleased with the response that we have seen as we move into third and full phase of the open developer community.

Operator

Our next question comes from the line of Mark Hoffman with Cowen and Company. Please go ahead.

Unidentified Analyst

It's Brian in for Matt. Peter, could you give some additional color on the nature of the MiFi battery door issue? It sounds like an industrial design or molding issue for when I read in the release in the filings, but if the company is already shifting in HSPA fixed, for the 2352 product, does that mean you are also anticipating you (inaudible) with that product in Europe?

Peter Leparulo

The 2352 product, we’ve done forensics on every battery that had come back through the process. And every one of those has shown that we have examined has shown the user induced damaged to the battery pack. But we have nevertheless let done though is taking a proactive measure on that with a 2352 units and we’ve been shipping all the units with a new door to prevent and reduce the probability that any user, uses either a sharp object to or some excessive pressure to open the door. So we don’t believe that this issue will, what we believe our 2352 is that it will simply go through the normal RMA process for the battery door.

Unidentified Analyst

Okay. So there’s no plans for similar exchange programs in Spain or UK?

Peter Leparulo

There is no current plans and for anything on the 2352 other than the battery to continue to ship with the new batter door on it.

Unidentified Analyst

So quickly, more on MiFi, the product family is closing down to 50% of revenue, but I believe I heard you guide MiFi revenue down sequentially in 2Q?

Peter Leparulo

That’s correct.

Unidentified Analyst

So does that mean that the (inaudible) velocity is slowing or that its simply product transition, product mix from one, the first generation to the next generation product. Could we see to then a return to say 3Q, ‘09 or 1Q, 10 run rate on MiFi revenue as the platform expands in the back-half?

Peter Leparulo

It’s a very simple product transition, the sell through actually, we are very encouraged by the sell through that we have seen which continues at our top customers to increase month-over-month going forward over six months right now are largest customers. Its been a consistently upward sloping in line for sell through. And our customers on the product category is getting accepted. What we are doing is, we are in the process of transitioning the category to the open software platform, which simply can’t be done seamlessly given where the interfaces is in the network for upgrading. So we are going to enter in the market with our view of the product category that will be in the second-half of the year.

Unidentified Analyst

So it sounds like there is a lot of 4G products in the back-half, but the opportunity for HSPA growth outside the US seems to still be pretty significant and relatively on a drastic, is there anything underway that the company is doing to push greater international acceptance of HSPA and WiFi?

Peter Leparulo

We are, we believe that that will take place. There is an upgrade cycle even on HSPA to dual carrier and we’ll address that product category and we believe that would be with operator that are migrating to dual carrier that we do have an opportunity to expand our customer base.

Operator

(Operator Instructions). Our next question comes from the line of Jason Schmidt with Craig-Hallum. Please go ahead.

Jason Schmidt - Craig-Hallum

A few housekeeping items. How many [times to do you think customers] in the quarter what with the final headcount ending March?

Ken Leddon

The two top customers in the top over 10% customers is Version and Sprint and what was just that question.

Jason Schmidt - Craig-Hallum

Head count.

Ken Leddon

Head count is about 365.

Jason Schmidt - Craig-Hallum

All right and I know you guys that you are not exchanging any of the 23, 72 versions of MiFi in Europe. How about in any other geographies outside of Canada?

Peter Leparulo

Well the 2372 is only a North American product so that doesn’t apply to the European space. There is a little bit that we just want in Asia, but that’s primarily North America on that product category. And I am sorry were you talking about just generally other category, Jason

Jason Schmidt - Craig-Hallum

Yeah.

Peter Leparulo

2200 is a that’s the overwhelming volume of our sales today, the 2200 is a completely different design it has different RF components to it. There have been no reports on this we believe this issue does not impact the 2200 in any way.

Jason Schmidt - Craig-Hallum

Okay and then finally on what your guys backlog cover is to guidance going in to Q2?

Ken Leddon

We typically don’t give that backlog in is we don’t believe as a great indicator of future on revenue in the short run. Your hours like the front line can be very short in our course can be somewhat non-linear. So we don’t really provide that disclosure as a relevant matrix for us.

Operator

(Operator Instructions). And our next question comes from the line of Kevin Manning with Bank of Montreal. Go ahead.

Kevin Manning - Bank of Montreal

Couple of quick questions. What did you say the design win was for, is that a PCOEM, next year?

Peter Leparulo

The design win was with a PC OEM on LTE.

Kevin Manning - Bank of Montreal

And is that a Gobi integration or is that an embedded module?

Peter Leparulo

We offered Gobi now, we’re licensed with Gobi, so we do offer Gobi now but that would be a Novatel developed module for LTE.

Kevin Manning - Bank of Montreal

Okay. And then, with WiMAX, will it be DVD or Rev A in WiMAX dual-mode product?

Peter Leparulo

It will be a dual-mode products to address the WiMAX base, correct.

Kevin Manning - Bank of Montreal

Okay. So, we should likely expect lower gross margins on a product like that?

Peter Leparulo

Well, we actually believe that will be when we enter in to the WiMAX space for the dual-mode that will have the best-in-class product on the cost side and that will also be a product-based that’s consistent with out vision for this category so, we believe that the gross margin on that will be at the higher end.

Kevin Manning - Bank of Montreal

Okay. And then, one last question. Any LTE core or MiFi design wins through yearend that you mentioned?

Peter Leparulo

LTE MiFi?

Kevin Manning - Bank of Montreal

Or core?

Peter Leparulo

Or core, yes, we do have operator slots and development partners in the core space across just all of our product portfolio for LTE.

Kevin Manning - Bank of Montreal

Operator slots, can you give me a little bit more on that?

Peter Leparulo

Sure. So the operator slot means that, our products are on the operator’s road map for launch so we have development partners on LTE across our product portfolio

Operator

And there are no further questions in queue. I'd like to turn the conference over to management for closing remarks.

Peter Leparulo

Thank you and thank you everybody for your time and all your thoughtful question and we look forward to updating you as we progress next quarter. Thanks.

Operator

Thank you ladies and gentlemen. This concludes our conference for today. We thank you for your participation and you may now disconnect.

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