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Executives

Bill Wachovia - Vice President of Finance and Investor Relations

Peter Leparulo - Chairman and Chief Executive Officer

Ken Leddon - Chief Financial Officer

Analysts

Mike Walkley - Canaccord Genuity

Matthew Hoffman - Cowen and Company

Anthony Stoss - Craig-Hallum

Novatel Wireless Inc., (NVTL) Q3 2010 Earnings Conference Call October 28, 2010 5:00 PM ET

Operator

Good afternoon ladies and gentlemen, thank you for standing by. Welcome to the Novatel Wireless Third Quarter 2010 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will open for questions. (Operator instructions)

I would now like to turn the conference over to Bill Wachovia, Vice President of Finance and Investor Relations. Please go ahead sir.

Bill Wachovia

Good afternoon. And thank you for joining us on our call today. Today’s call will include a business overview from Chairman and CEO, Peter Leparulo, and a financial overview with fourth quarter guidance from Chief Financial Officer, Ken Leddon.

As a reminder, this conference call is being broadcast today Thursday, October 28, 2010, over the phone and the internet to all interested parties. Information shared in this call is effective as of today’s date, and will not be updated.

During this call, non-GAAP financial measures will be discussed. Reconciliations to the most directly comparable GAAP financial measures are included in our Third 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 will contain forward-looking statements. These forward-looking statements are not historical facts, but rather are based on the company’s current expectations and beliefs.

The company’s actual results may differ materially. Please refer to our SEC filing for a detailed discussion of potential risks.

And now, I’d like to introduce Peter Leparulo, Chairman and Chief Executive Officer of Novatel Wireless.

Peter Leparulo

Good afternoon everyone.

I’d like to begin with a quick recap of our third quarter 2010 results, and then talk about our recent developments and our future plans.

Revenues for the third quarter was 75.6 million, a 5.3% sequential quarterly increase and within our guidance range. We generated cash flow from operations of 9.2 million, bringing total year-to-date cash flow from operations to 13.9 million. The GAAP loss per share was $0.22 and was better than the range that we had forecast. Although the non-GAAP loss was $0.01 more than our forecast at $0.14 per share.

However, our unit sales are higher than ever for core products and MiFi 2372 Intelligent Mobile hotspots.

In Q3, we also set the stage for strong year-over-year growth and positive EBITDA in Q4. We are currently projecting a more than 45% sequential increase in revenues in the fourth quarter. Importantly, the fourth quarter will be primarily driven by our 3G technologies even as we begin to introduce next generation products across our full product portfolio. These will [indiscernible] growing backlog of orders from multiple channels.

Moving now to our business update for the third quarter, we continue to focus on our C strategies and during the quarter, they made significant progress. First, we are moving aggressively to prepare for the upgrade by the major carriers to support the next generation inter-phases. These include dual [indiscernible] and Wi-Max. This development initiative continues across our entire product portfolio, from USEs to PC cards to MiFi 2372 Intelligent Mobile hotspots. We are working closely with lead operator development partners across each pair interphase and have made significant progress in R&D programs for each one factor.

Our products will be on the leading edge in terms of the dramatic increase in speed and bandwidth that we’ll provide, and our technology will maximize these capabilities. We are in various stages of commercializing a number of next generation products, many of which are now nearing completion or the certification process with our customers. In the fourth quarter, we expect the first launches of our next generation products.

We will continue to launch new 4G products in 2011, with products continuing throughout the year. We also have been successful in securing a number of design wins for several LTE variance of our 4G embedded model. We are undertaking a significant joint development effort in cooperation with these partners including leading manufacturers of PCs, netbooks and other mobile internet devices.

We expect sales of embedded modules to pick up significantly towards 2011 as these OEMs begin to ramp up production of 4G enabled platforms in both North America and Europe. We look forward to announcing product launches with our partners beginning in the first quarter of 2011. As a result, the embedded module category will once again become a meaningful revenue contributor over the next year.

We also continue to move forward in developing a solutions based approach to the market with our intelligent software platforms, providing better customer stickiness and barriers to entry. This includes the next generation MiFi product lines that will incorporate the MiFi operating system and MiFi applications tool. This platform is an important part of our strategy for the future as we move the product category beyond connectivity.

As we demonstrated at the recent CTIA Trade Show in San Francisco, our MiFi OS will power onboard application processing and rich functionality, including the capability to download software applications. We’re expecting to do some MiFi OS with carrier partners starting in the fourth quarter. We’re also very excited that our first operator launch of the MiFi OS software platform will include MiFi home, our browser based web user interphase that could provide seamless access to MiFi resources and widgets. Virtually any WiFi enabled device will also have access to mobile broadband applications in content which can pit onboard to MiFi. MiFi home will enable operators also to offer mobile content and applications that are personalized and customizable.

Although MiFi hotspots will generate usage pattern and increased avenues for product differentiation, our current MiFi offering continues to gain tractions as the best activity option for new portable WiFi enabled devices such as the iPad, tablet PCs, MP3 players and gaming devices, allowing users to stay connected with up to 5 devices simultaneously.

As a further example of MiFi as a change driver in the industry, drive and wireless Apple announced that the iPad will be sold in more than 2,000 Verizon Wireless stores, download with our MiFi 2200. And the iPad is not the only WiFi enable product that quickly and easily connects to broadband cellular networks using our MiFi mobile hotspots. We expect a continuing rollout of new devices that will have an extensive WiFi capabilities and rely on our MiFi hotspots to connect to the internet anywhere and anytime.

The strength of our MiFi brand also continued to build during the quarter with a recent in depth article and photo in the New York Times as well as demos on CNBC and various broadcast media. In addition, a recent independent test of competing mobile hotspot devices conducted by PC World rated our MiFi intelligent mobile hotspot as having the best combination of speed and reliability.

In summary, we’re optimistic about the continuing success of our rollout of next generation technologies across all form factors and on all major air inter-phases. The launch of our embedded products as we enter 2011 and the continued success of our MiFi product line. As we begin to commercialize these efforts, we expect significant improvement in our financial results beginning in the fourth quarter and beyond.

And with that, I’ll now turn the call over to Ken who’ll provide some information on our financials.

Ken Leddon

Thank you Peter. I will begin with the financial overviews of third quarter and then will provide our fourth quarter outlook. Please note that non-GAAP results exclude stock based compensation charges, as usual, which were $1.5 million this quarter. We also excluded M&A related charges and a non-charge tax benefit from non-GAAP results as we detailed in the reconciliation tables contained in our press release.

Revenues for the quarter was 75.6 million, a 20% decline from the 94.3 million reported in the prior year period, but a 5.3% sequential increase from the second quarter. The year-over-year decline was due to lower embedded module sales and lower average selling prices for our modern products and MiFi devices in advance of the transition to next generation technologies.

Revenues by product category are as follows; core products, which include USB modems, Express cards and combination products accounted for $43.6 million or 58% of sales. MiFi products accounted for 31.8 million or 42% of sales, and embedded products, 4.2 million.

Now looking at sales by technology, EBDO products were 86% of sales and HSPA products, including HPSA + were 14%.

From a geographic perspective, North American sales accounted for approximately 96% of total revenue and international sales for 4%. During the quarter, we shifted 7 operators and 3 OEMs in 19 countries. Leading customers in the quarter included Bell, Bright Star, Comcast, Sprint, Verizon, Virgin Mobile and WSA Distributing.

Gross margins were below our guidance, primarily due to product mix. With our higher than anticipated proportion of lower margin USB modems, margins were also affected by substantial increases in shipping charges. We expect improvement in gross margin as we begin to rollout our new product lines for the technology upgrade in next generation wireless technology.

Non-GAAP operating expenses were 18.8 million or 25% of revenues, a decline of 2.2 million from the prior year period. Breaking down non-GAAP operating expenses by category, R&D expenses totaled 11 million or 14.6% of revenues, sales and marketing were 3.9 million or 5.2% of revenues and G&A expenses were 3.9 million or 5.2% of revenue, which is a reduction of nearly $1 million from the prior year.

We have been adding to our engineering team as we take on a challenge of introducing a wide range of next generation products and supporting new OEM programs. These are major complex efforts, which are adding to our R&D expense, but will be the foundation for new initiatives that we are taking over the next year. Other income and expenses impacted by our second quarter’s M&A activity, this is due to a 2.4 million bridge loan fee related to our Centurion bid. Excluding this charge, interest income was $86,000 and other income reflected a $420,000 foreign currency gain.

Moving onto income taxes, during the third quarter, we recorded a non-cash tax benefit related to an over-accrual of an uncertain tax liability in prior period. Details of the adjustment are included in the press release so I won’t repeat them here other than to say that they’ve been excluded. We have excluded these gains from our non-GAAP results.

In summary, on a non-GAAP basis, we reported a net loss of 4.3 million, or $0.14 per share. This is $0.01 below our guidance range due to lower than expected gross margin. On a GAAP basis, we reported a net loss of 7.1 million or $0.22 per share. This is better than our guidance range primarily due to the tax benefit.

Cash flow from operations was 9.2 million for the quarter and 13.9 million year-to-date. Capital expenditures for the quarter was $2 million and EBITDA was a negative 2.9 million.

Now turning to the balance sheet, the temporary items related to the second quarter M&A activity were unwound during the third quarter. In particular, the restricted cash became unrestricted, the bridge loan was paid off and approximately $70 million of cash has been reinvested in marketable securities. As a result of our free cash flow, except number 30 of our cash and marketable securities of approximately 183 million with no outstanding debt.

Accounts receivable of 32 million were down approximately 13 million from 45.4 million at the end of the second quarter and our DSO at September 30 was 44 days with expert receivables quality. Inventory decreased slightly from the second quarter to 16 million, which equates to 13.6 turns per year.

Strong part demand as well as industry wide component shortages are keeping inventories at the lower normal level.

Now turning to fourth quarter 2010 guidance, based on the strong demand for MiFi products, including the initial inventory build for the Verizon iPad promotion, we currently expect fourth quarter revenues to be in the range of 110 to $115 million. We expect gross margins in the range of 19 to 20% and based on this currency, we expect non-GAAP earnings of 0.02 to $0.05 per share. These estimates are based on approximately 31 million shares outstanding.

Now, I will turn the call back to Peter.

Peter Leparulo

Thanks Ken. Our focus over the next several months will be to continue our momentum in 3 principle areas; leading the transition of 4G on our entire product portfolio, capitalizing on new growth opportunities in multiple segments of the embedded phase and certifying and launching mobile MiFi OS platforms in both new and existing channels and across multiple inter-phases.

And now Ken and I would like to answer your questions. Operator, please open up for Q and A.

Question-and-Answer session

Operator

Thank you. We’ll now begin the question-and-answer session. (Operator instructions). One moment please for the first question. And our first question from the line of Mike Walkley with Canaccord Genuity. Please go ahead

Mike Walkley - Canaccord Genuity

Thank you very much and congratulations on the strong revenue outlook. Just building with the [Ranson] revenue, I thought we might see a little more gross margin leverage, I understand it’s a module product, but maybe can you help us either think about LTE transition and how we should think about gross margins as that mix improves into 2011.

Ken Leddon

Mike, this is Ken speaking. Yeah, we [indiscernible] today is that gross margins of the 14 products will be improved over the 3G legacy products. The drop in margins on a 3G legacy products are not a surprise, we’ve seen this before and as we transition to 4G, we expect to transition the entire margin products with the new technologies.

Mike Walkley - Canaccord Genuity

Should we expect gross margins similar to prior inter-phase upgrades, maybe going back to ’07 or ’04 levels -- high 20s, low 30s, is that feasible or are the industry dynamics a little different today?

Ken Leddon

I think that -- our view today is that there’s going to be a much wider range of products going forward. We expect our product portfolio to not only consist of 4G products but also a significant mix of 3G for some period of time and then within the 4G product, the embedded products, you should probably know from the past, tend to have lower margin levels than the other USB products and MiFi type products due to the level of IT content in the products. And again, it’s kind of hard for us to predict what that mix will be, but I think going forward, our first objective was to grow revenue and get back on a revenue growth trend which I think we’re doing and then secondly to [indiscernible] an operating income, that’s the bottom line for us, I think, going forward is how we can grow that operating income line as the revenue base grows and as we maintain our spending discipline on the operating expenses.

Mike Walkley - Canaccord Genuity

Thanks. That makes a lot of sense. And Peter, maybe if you could just talk a little bit about the embedded modules. It seems like [indiscernible] especially as it relates to LTE, how should we think about that, do you think that business can get back to how it was maybe in ’08, ’09 revenue when [indiscernible] wasn’t as much of a competitor?

Peter Leparulo

Sure Mike. First of all, we’ve spent a lot of time putting strategic alliances in place. We fetch market with 4G on the embedded side and we’ve also spent a lot of time with the GO1 OEMs and some very interesting internet devices on the embedded side so we’re very pleased with our progress on the sales side. When you look to how they ramp, all the GO1s have different plans on how they’re going to ramp. Some are going to have enterprise lines that are enabled with 4G, some of them are going to embed 4G and other lines and wait for the activations. We think it’s going to be a meaningful contributor of revenue as it ramps throughout 2011. We think we’ll begin to see it in the first quarter. We hope that it gets to a return to stroke levels for a couple of reasons; number one, the OEMs are always searching for how to increase their [tax] rate and some of the rate plans are becoming more usage based, more session based. That creates a certain amount of elasticity in the [tax] rates. As well, the [true foot] speeds are going to be dramatically increased so the user experience from before, we think will also increase the [tax] rate so we’re very hopeful on this space, it’s difficult to forecast into 2011 because the ramps are going to be fazed according to different platforms, but the forecast that we’ve seen and the rollout plans that we’ve seen make us very optimistic about this phase.

Mike Walkley - Canaccord Genuity

Great. Super. Thanks a lot. And one more question then I’ll pass it on. Can you talk a little bit about component constraints given your impressive ramps and revenue, is there any component constraints holding you back? Can you talk about maybe the component environment given your [indiscernible] and revenue? Thank you.

Peter Lepaluro

Sure. We work this everyday. There are component constraints. They are industry-wide constraints and we are relying on deliveries more on order than what’s on hand but we work this every day, we think we have it under control and we push everyday to get our allocation. But you’re absolutely right in suggesting that -- that’s where our effort is this quarter on component constraints. Lead times have also stretched out somewhat over the buildup of our backlog so it’s a big effort but we work it everyday.

Mike Walkley - Canaccord Genuity

Thanks very much and good luck.

Peter Lepaluro

Thank you

Ken Leddon

Thank you.

Operator

Thank you. Our next question comes from Matthew Hoffman with Cowen and Company. Please go ahead

Matthew Hoffman - Cowen and Company

Again, congrats on the Apple, Verizon and their guys and the outlook. Obviously you’re going to need a lot of questions about the follow through now that you have the big win in hand. So as you look into the first quarter, the LT ramp would seem to be the obvious catalyst, can you first talk to us maybe is there a [cliss] in 1Q, and if there is, does LT handle it or do you expect kind of a smoother ramp? I know you said 2011 but I’m really trying to zero in on 1Q. Thanks.

Peter Lepaluro

Sure. It’s difficult to look into the future Matt, and how it goes, and you’re certainly right in saying that there is a component of Q4 that is based on individual promotion. I will say though that our 4G rollouts are not a large component of our Q4 guidance so at the end of the quarter, we expect to have significant product ramps and then to get 4 quarters of those product ramps in Q1, which kind of will be a seasonal quarter in telecom equipment as you know. As to how much those offset each other, it’s difficult to say but we still nevertheless believe that among the growth drivers we’ve put in place, which are the embedded, the new [indiscernible] MiFi and then the upgrade of everything of our product portfolio to both a dual carrier WiMax and LTE, those growth drivers will come online at the end of Q4 and moving into Q1.

Matthew Hoffman - Cowen and Company

Okay, and as you discuss the LTE rollout with your customers, it seems a little bit later that maybe some of the networks are going to be launched. Are you not going to be in the wave of promotions or are you just being conservative in terms of what you were discussing with us?

Peter Lepaluro

We expect to be in the first wave of promotions

Matthew Hoffman - Cowen and Company

So as the networks are launched, do you expect to know the [indiscernible] DLT networks are launched, know the top products ought to be there?

Peter Lepaluro

We are all hands on deck for that

Matthew Hoffman - Cowen and Company

Got you. And last question on the embedded side, [indiscernible] for Ken but for you. Just as you look at the embedded opportunity, obviously it’s been below here for a few years but you’ve been really working hard to rebuild that business. You mentioned netbooks and notebooks. You didn’t talk about tablets. What other form factors can you take the embedded wins into, can you get into the tablets base as well?

Peter Lepaluro

Sure. Good question. Absolutely, and we do have tablet design wins which we expect to be rolling out in 2011 as well for 4G. In addition, some of the other internet devices are items like TDAs, sometimes types of combination devices or a [quasite] E-book reader with a netbook on it. But netbooks is outside of the traditional PCs. Netbooks are probably the second largest device that we’re looking to in terms of design wins and rollout.

Matthew Hoffman - Cowen and Company

Alright, and a quick housekeeper for Ken. Ken, OCF in the quarter -- I see the 9 month number, I’m just trying to reconcile and make sure I’ve got it right, something around 10 million in the quarter, is that right?

Ken Leddon

The OCF number?

Matthew Hoffman - Cowen and Company

The operational cash flow?

Ken Leddon

Yeah, we mentioned that. Let me go to that real quickly here. OCF was 13.9 for the 9 months and the quarter was -- hold on a second, 9.2 for the quarter Matt.

Matthew Hoffman - Cowen and Company

Thanks Ken

Ken Leddon

Okay.

Operator

Ladies and gentlemen, (Operator instructions). And our next question comes from the line of Anthony Stoss with Craig-Hallum. Please go ahead.

Anthony Stoss - Craig-Hallum

Hi guys, Peter, just wanted to be straight on your guidance. Are you assuming anything from LTE, either the MiFi device or USB sticks in your guide for Q4?

Peter Lepaluro

LTE in our guidance? Yes we do have assumptions for LTE in our guidance.

Anthony Stoss - Craig-Hallum

Okay. Also can you -- maybe Ken can handle this also, number of different MiFi customers in Q3 -- what you assume for Q4. Does that number go up or it stays the same? Then I have one follow up.

Ken Leddon

I don’t have the number of MiFi customers in front of me. I can get that to you today Tony in terms of the actual number. In Q4, we expect to expand out our customer base on MiFi as we have developed it into the full operating system so we expect new customers on MiFi in Q4.

Anthony Stoss - Craig-Hallum

Okay, in addition to Verizon, you’ve seen other US based carriers talk about launching the iPad. Is it fair to assume that some of these new customers are in the US?

Ken Leddon

That point was more specifically -- I think what you’ll see is anything like that, we would do any type of announcement in conjunction with the program rather than ahead of it.

Anthony Stoss - Craig-Hallum

Okay. Also your international biz was running below kind of normal. Any views on when you can pick that up? Do you think LTE or other flavors of 4G -- is that going to be impactful as you start to go forward in early 2011 on the international side?

Ken Leddon

Good question. Europe certainly has quite a few issues to get results and it’s difficult when they get results. Some macro issues over there. As you know, it’s a very highly subsidized market with the operators. What we think we’ll do is we will really, in a few different areas, we will engage with Europe on the MiFi operating system because it feeds into quite a few of the operators in Western Europe into some of their models for the delivery of mobile content applications. Also, we engage with them in LTE exactly as you say, we have engaged with them on dual carrier for rollouts and have anchor customers on dual carriers as we go into 2011, and on the embedded side on the laptops, we have on our roadmap for platform launches on European operators.

Anthony Stoss - Craig-Hallum

Last question for you Peter, you talked about LTE products being in various stages or close to being final certification process. Is it fair to look at your guide as more in the conservative side than you’d normally be?

Peter Lepaluro

I would characterize our guidance as a balanced view of our current visibility and the number that we put out is based on that type of analysis so I wouldn’t go conservative or ambitious. I would simply say that it’s a balanced view of what we see today.

Anthony Stoss - Craig-Hallum

Okay, thanks guys.

Peter Lepaluro

Okay.

Operator

Thank you, and I’m sure no further audio questions at this time. I’ll turn the conference back to Peter Lepaluro. Please go ahead.

Peter Lepaluro

I’ll answer that. Thank you very much everybody for your time and your questions today and we’ll talk to you in the near future and look forward to it. Operator, you can end the call now please.

Operator

Thank you sir. Ladies and gentlemen, this concludes the Novatel Wireless third quarter 2010 earnings conference call. We thank you for your participation and you may now disconnect.

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