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Executives

Peter Leparulo - Chairman and CEO

Ken Leddon - SVP and CFO

Analysts

Mike Walkley - Canaccord Genuity

Kevin Manning - Bank of Montreal

Novatel Wireless, Inc. (NVTL) Q2 2012 Earnings Call August 7, 2012 5:00 PM ET

Operator

Good afternoon and welcome to the Novatel Wireless second quarter 2012 earnings conference call. (Operator instructions) Your presentation will begin now.

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Good afternoon. And thank you for joining our second quarter 2012 conference call. We will begin with a business overview and outlook from Chairman and CEO Peter Leparulo followed by a financial overview with third quarter guidance from Chief Financial Officer, Ken Leddon. We will then open the call for questions.

As a reminder, this conference call is being broadcast on Tuesday, August 7, 2012 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 the earnings Release, which is available in the Investors section of our website. The audio replay of this call will also be archived there.

Please also be advised that 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 the risk factors described in our Forms 10-K, 10-Q and other SEC filings which are available on our website.

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

Peter Leparulo

Good afternoon and thank you for joining our call today. Overall results for the second-quarter showed improvement on a sequential quarter basis in both business segments. We were near or above the top of our guidance range in all three key metrics, revenue, non-GAAP gross margin and EPS. We do expect a temporary decline in revenue in the third quarter due to the impact of a competing product at our largest customer as orders received outside of required (indiscernible).

Clearly we are not satisfied with the third quarter forecast. However we expect a strong rebound in the fourth quarter as we stated in our press release. In the fourth quarter we also expect to demonstrate concrete progress in reducing both customer concentration and product concentration through key new customer relationships, significant product introductions in both mobile computing and M2M solutions and new sales channels.

There are a number of catalysts that are expected to result in significant financial improvement in the fourth quarter. These include an exciting new MiFi launch with a major North American carrier that is not a current customer; revenue growth in embedded modules as our OEM customers launch new platforms that include our products and third, growth in sales of our M2M solutions.

We are putting the pieces together that are building the foundation for growth and sustainable value creation over the longer term. There are a number of reasons for our optimistic long term outlook. Most important is the continued strength of MiFi brand, even in the face of competition. We believe that our MiFi sales will continue to advance position as the dominant global hotspot brand in North America.

As I mentioned we are working with a major carrier on a significant launch later this year of a new MiFi product that will reflect our solutions based approach to the market. The launch of this next generation MiFi will culminate over 12 months of development and will significantly advance the product category. Among other things, our proprietary operating system will enable new usage patterns together with cloud based application support which can be hosted by us and enterprise or operators.

This will be the first in a number of additions to our MiFi portfolio that address a variety of use patterns. From those connected 27x7 with multiple interactive devices, to those for whom price and value are key factors in purchase decisions. We have anchored tier 1 carrier customers for each of these product development initiatives. With the steady rollout of new MiFi products that address new use cases rather than simply air interface cycles, we expect to gain a leading mobile hotspot position at all three major carriers in 2013.

We are also optimistic about the future of our mobile computing embedded module product line. By way of background, we provide both 3G and 4G embedded modules to PC OEMs but our competitive focus has been on 4G. Unfortunately a majority of the PC OEM market is still based on 3G technology which has constrained our sales.

However we see a number of catalysts that should cause this to change. These include lower-prices to end-users of 4G capable laptops and tablets, a reduction in the number of 3G platform offerings than 4G platforms, and the launch of Windows 8 OEM platforms for business content. As a result, we expect to see growth in our mobile computing embedded module sales by year end as existing 3G platforms begin to migrate to 4G.

The third fundamental reason for our optimism is progress that we are making in launching our M2M products, both integrated platforms and embedded modules. We are working diligently to supplement our M2M products with CDMA and HSPA capabilities, not only for our integrated solutions product portfolio but also for our footprint compatible M2M embedded modules.

Along with this expansion of our portfolio we are seeing new customer traction in every stage of the sale cycle. Overall more than 20 strategic customers worldwide are engaged in beta trials of our CDMA and HSPA based products that will be commercially launched over the next several quarters.

Keep in mind that sale cycle for these M2M products average six to 12 months or more as customers evaluate, integrate and then large volume deployments. Let me mention just a few examples. We have recently won a Fortune 100 customer who’s launching vehicle and asset tracking solutions to its worldwide dealer network based on our integrated platforms and our communications and management software.

We also have a new fleet tracking customer in Latin America which manages one of the largest fleets of vehicles in that region. We also signed a supply agreement with NexTraq, a leader in vehicle tracking and fleet management. Under the agreement we will supply NexTraq with our MT 3000 featuring GPS locations, ignition, geo-sensing and event reporting. The SC3000 will be part of NexTraq’s fleet tracking platform. We are also partnering the applications providers to offer specialized solutions of our targeted vertical markets. We recently entered the market in corporation with two new partners to win deals that are now generating early-stage revenue for both hardware and our CMS software.

In M2M embedded solutions, on feature report new design wins here also with our HS 3001 M2M module in security and remote monitoring and control verticals. We currently have early production run quantities which we expect to ramp up over time.

As we plan for 2013 and beyond, we have set aggressive goals for new customer growth supported by a broad portfolio of new products and best in class customer support. And finally we are excited about entering new markets with some completely new product lines that we expect to introduce over the next year. We are actively engaged with development partners on these initiatives which will expand our industry-leading technology into new areas. We look forward to discussing these in more detail as we get closer to launches.

On the operational side, we are making progress in our efforts to tightly manage our operating expenses to improve our return on R&D investment. Our non-GAAP operating expenses have declined by $700,000 on a sequential quarter basis and by $1.7 million compared to the corresponding quarter of 2011. At the same time we are balancing these cost control efforts against the investments in promising opportunities that are in hand and others that we are evaluating.

To discuss these operating results in more detail, I will now turn the call over to Ken.

Ken Leddon

Thank you, Peter. I will begin with a financial overview of the second quarter and then will provide our outlook for the third quarter of 2012. Please note that our Q2 non-GAAP results exclude stock-based compensation charges of $1.8 million and non-cash charges for amortization of purchased intangible assets of $500,000. A complete GAAP to non-GAAP reconciliation table is included in our press release.

Revenue for the second quarter was $102.4 million, near the top of our guidance range of $92 million to $104 million. Mobile broadband devices accounted for $87.1 million or 85% revenue of revenue. This includes MiFi revenues of $75.7 million and $11.4 million of USB modems, combination cards and related products.

Embedded solutions accounted for $9.1 million or 9% of revenue. This included $5.7 million in sales of M2M modules and $3.4 million of PC OEM modules. Asset management solutions and services revenue was $6.2 million and included $4.2 million of M2M integrated solutions. LTE related products comprised $76.2 million or 74% of revenue during the quarter.

From a geographic perspective, sales in the U.S. and Canada accounted for approximately 93% of total revenue. The non-GAAP gross margin in the second-quarter was 23.2%. This was slightly above our guidance range of 22% to 23%. Non-GAAP operating expenses totaled $25.9 million, about $700,000 below the $26.5 million in the first quarter.

Looking at operating expense by category, R&D expenses were $13.9 million, down from 14.5 million in the first quarter. Sales and marketing expenses were $6.9 million, down from $7.3 million in the first quarter, and G&A expenses were $5.1 million and compared to $4.8 million in the first quarter.

Our non-GAAP net loss was $2.2 million or $0.07 per share versus $0.14 per share in the first quarter. Second-quarter capital expenditures were $2.4 million, and we ended the quarter with cash and marketable securities of $52.4 million.

Now turning to guidance for the third quarter of 2012. We currently expect third-quarter revenues to be in the range of $76 million to $84 million. However as we said in our press release we believe this revenue decline will be reversed in the fourth quarter with growth continuing into 2013 as we generate revenue from a number of new products and customers. We anticipate that non-GAAP gross margins in the third quarter will be in the range of 22% to 24% of sales.

Finally, we expect non-GAAP EPS to be in the range of 33 to $0.21 loss per share. These estimates are based on approximately 32.7 million shares outstanding.

Now I will turn the call back to Peter.

Peter Leparulo

Thanks Ken. In summary, we believe that the second-quarter saw progress and improving our financial results as well operational milestones. Although we expect competitive pressures to impact third quarter sales, we should restore revenue growth in the fourth quarter and beyond.

We are excited about a number of new products that will be introduced in the coming months. In particular in 2013 we expect our MiFi intelligent mobile hotspot to gain a leading position at all three major North American carriers. We expect sales of LTE based embedded modules to improve significantly as the market moves from 3G technology to 4G where we are the market leader.

In our M2M segment, we are bringing CDMA and HSPA in our portfolio across the common footprint powered by the intelligence about of our CMS software platform. We are setting the stage for growth in each of our three current product categories and expect to enter new markets in 2013.

Now Ken and I would be happy to answer your questions. Operator, please open up the call for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Mike Walkley from Canaccord Genuity.

Mike Walkley - Canaccord Genuity

Peter, just to follow up on the guidance and then your expectations for much stronger Q4, is the program at your leading customer, just due to heavy promotions on a competing product, can you talk about maybe sell-through trends relative to that product given I believe there is one undercutting in MiFi right now?

Peter Leparulo

Just like you say the current situation in terms of our leading customer is that there is a competing product which is being fairly heavily promoted. I might add in consumer channels. The good news within that is that we are still in the B2B channels and have the majority split between it as in a competing product. As we go forward on that, the way that we currently see it right now is channel positions ebb and flow and we have seen this happen before. But as some new products are introduced, and there are promotions put behind products, we believe right now as we see it that, that current situation will change to our benefit as a result of that.

For now unfortunately though, we are caught between that cycle and getting the brunt of it. But as I say, we believe that that will change in Q4. In addition on top of that, we think that what we put in place and worked pretty hard to do, is to minimize our exposure to exactly the type of thing, and we believe that what you will see in Q4, is the result of those efforts by having more diversified customer base with some of the launches that we talked about as well as product diversification with what we believe will be fairly evolutionary products that will move ahead so that we don’t get copied and put in this situation again.

I am sorry, the second part of your question Mike?

Mike Walkley - Canaccord Genuity

That was it. Peter, it’s more just on the snapback in Q4 some of the new products launching, without giving specific guidance, would you think you would be profitable on a pro forma basis in Q4 or are we talking more back to maybe the June quarter level just, directionally kind of just how you have seen the business come together in order for the last quarter of the year?

Peter Leparulo

Sure, we are driving towards profitability that’s certainly our goal. But we are not prepared to give guidance towards that yet. But what we see right is a significant return to the top line with folding in the new product launches and that’s our goal. Our goal is to be profitable on an EBITDA and then income basis in Q4, and we are working towards getting there.

Mike Walkley - Canaccord Genuity

And overall on the OpEx cost structure, you said slowly coming down, are these basically the levels kind of mid-20s where you guys think it’s a good place to keep OpEx or do you think you will taking more cost out just in terms of driving towards the sustained profitability?

Ken Leddon

Hey Mike, this is Ken speaking. Our view of OpEx right now is that we’re going to probably be in the range that we’ve been in the last couple quarters. There will be little bit of flexibility in that as we drive certain products to launch if we incur certification and outside services costs. But we continue to refine our organization as we integrate four and continue working on optimizing organization for as much cost efficient as we can. I think you can see our headcount has dropped fairly dramatically since the end of the last year, we are down about 37 heads between contractors and employees as we streamline the business unit to yourself. We are always focused on it but I think as we drive a very full roadmap to launch in the next couple of quarters, so I think we will still be somewhere at near we have been the last quarter or two, up or down $0.5 million.

Mike Walkley - Canaccord Genuity

Just on the LTE imbedded modules, can you talk about the cadence of the design wins, maybe with the PC OEMs and how you see that business shaping up, maybe over a longer term period, I know (indiscernible) is just coming more to mix now, just how you see that business ramping over the 18 months period?

Peter Leparulo

Good question, Mike. This has been a focus of ours and as I said in my prepared remarks, 3G really has been dominant for a variety of reasons. Longer term, we expect that both the carriers and the OEMs will emphasize the transition to 4G. I think they can do it the right ways based on some of the feedback that we’ve gotten, there are discussions among some of the PC OEMs to offer only 4G which obviously would play to our strengths, and that’s been where we focus.

Again, there is a reduction between the disparity of 3G and 4G in terms of the end price of the embedded device, the embedded either tablet or PC platform. To the end user, there has been quite a disparity between 3G and 4G on that, a reduction in that disparity, we also think will be a driver in the space. And again, the feedback that we have gotten from our PC OEM customers is that that’s another possibility to be a catalyst for this space.

There is also on the operator side some motivation behaviour, ecosystem behaviour for the carriers who obviously want to try to transition as to the much more efficient 4G for most of their distribution channels on it. So overall we think that there will be a migration over to it but it also depends on a number of platforms and attach rates, but we expect to fit to be a space that there is a spotlight on over the next 12 to 18 months. In terms of us, there were some protracted RFQs on this as there were some form factor rationalization that needed to take place, among the tier one PC OEMs. We think we have our share of the opportunities in the space that are -- based on the feedback from the PC OEMs we are very satisfied with how we have done in this space in terms of the design wins going forward.

Operator

Our next question comes from Matt Hoffman from Cowen and Company.

Unidentified Analyst

Hi good afternoon gentlemen. It’s Brian for Matt. A couple of quick questions. You alluded to some new customers coming online through the balance of the year, just wanted to see if there is anything outside North America, that you’d point to for LTE in the MiFi space, obviously Korean and Japan significant growing very, very fast, much faster than expectations, maybe because the maturity of install base of 3G?

Peter Leparulo

I think you are right. Korea and Japan are the places, the rest of certainly Europe we expect to stay overwhelmingly 3G for the next 12 months or so. Frankly, Brian, our only customers are going to be in North America where we are focused on that, that’s where our design wins are, that’s where we believe that there has been the greatest penetration of the MiFi product category for mobile computing. So the carriers in North America are primarily focused that I was talking about in our prepared statements.

In terms of the embedded space, that is a space where we do expect 4G to have a chair in Korean and Japan. But that again will go through the tier 1 PC OEMs in the integration of the platforms that we have into those markets. So it would be derivative of the embedded PC OEM design wins that we have.

Unidentified Analyst

So basically the MiFi customer diversification is North America centric with limited Asia exposure, or Apac exposure. Second quarter, you guys just were awarded the 517 patents, could you elaborate a little bit more on that and how that might play into some of your efforts to protect your IP in the space?

Peter Leparulo

517 patent is really a part of several patents we have which are key to both the core of MiFi as well as some of the functionality of the MiFi. Without speaking to the exact claims under that patent, what we have done over the last couple of years is some of the G technology on the radar side and some of the MiFi functionality since we embedded this product category we have what we believe are defensible key patents which are necessary to MiFi.

They range from a variety of things. They range from how a MiFi product hotspot pace out WiFi based on usage patterns and based on GPS and different locations, all the way down to the ease of use and user experience on it, the architecture that causes that user experience around it. That’s one of those patents that we also believe is a key patent around it. Most of it is around these structural and operational features of the user experience with respect to that patent. What we will do with this is we fully intend to win in the marketplace commercially but we are very mindful about protecting our IP. We have taken action to protect our IP and what we are doing right now is going through some claims matching to see whether or not that particular patent is crossed and whether we include that in our patent prosecution.

Operator

Our next question comes from Kevin Manning from Bank of Montreal.

Kevin Manning - Bank of Montreal

Just a couple of quick questions. Did you give us an update on the number of embedded PC LTE wins that you have?

Peter Leparulo

You mean for 2012, as you know these go by sort of product cycles and we are just sort of coming out to 2013 product cycle design wins. Are you talking about --

Kevin Manning - Bank of Montreal

Planning for future revenues, what should we be expecting?

Peter Leparulo

Sure, most of the RFQs address those 3G and 4G in that and we will announce these in tandem with our OEM customers. We are pretty satisfied. We believe that based on the forecast of the OEM customers where we have design wins that we have the lion’s share of design wins based on the unit forecast from those PC OEM customers. So I think I could state that directionally without speaking out of term in terms of exactly which tier 1s that we are development partners.

Kevin Manning - Bank of Montreal

And are those traditional PCs or is this Win 8 that we are talking about?

Peter Leparulo

Going forward we expect the majority of it to be Win 8 – Win 8-enabled but it’s also tablets as well as traditional PC OEMs. If you’re talking about form factors or you’re just talking about the Win 8 operating systems which have underlying devices –

Kevin Manning - Bank of Montreal

Yeah. And then you mentioned something on the new form factor for MiFi, when can we expect to learn more about that?

Peter Leparulo

I will try on course and speed, we expect that product to launch in the fourth quarter of this year.

Kevin Manning - Bank of Montreal

And you imply that will be at all three – top three US carriers?

Peter Leparulo

No, at the top three US carriers, what we believe – what we have put in place going forward is that we think there will be segmentation among the top carriers, high end, low end, as well as trying to reach different demographics. So we will have a full product portfolio for that diversification if you will at three of the tier 1 operators in North America. This will begin in Q4 but we believe this will also take us through 2013, we are full by portfolio at the tier 1.

Kevin Manning - Bank of Montreal

I think we have been kind of expecting to see a gross margin improvement from LTE and not sure it’s quite pulled through yet. Any thoughts on gross margin when that might get better?

Peter Leparulo

We are relentless on this in terms of gross margin. On LTE there is a variety of gross margin profile because we are now on second generation, so there is generational difference, there is also a mix difference between embedded as well as external devices. And then frankly there are also channel differences in the gross margin. We are doing our best to optimize all of those both the mix as well as the channel differential on gross margins. And I can tell you we spend a lot of our time on the product cost side of that as well as channel price to optimize it. We think the next generation that we launch will have improved gross margins in some elements of that product mix, not all of them, there will still be a differential.

Ken Leddon

I think also Peter, we do still have some – impact of legacy 3G product in our mix in Q2 and as that 3G phased out into some of the channels we currently sell into, that will take some of the low end out of the range of our current product mix.

So what I am saying is Kevin, it’s kind of overriding some of the better margins we are seeing with some LTE product.

Operator

This concludes our question and answer session. At this time, I would like to turn the comments all back over to Mr. Leparulo for any closing remarks.

Peter Leparulo

Thank you, operator and thanks everybody for your time and attention and your questions today. And we look forward to updating you on our progress next quarter. Thanks operator.

Operator

Ladies and gentlemen, today’s conference has now concluded. We thank you for attending today’s presentation. You may now disconnect your telephone lines.

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