Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Julie Cunningham - Vice President, Investor Relations and Communications

Peter V. Leparulo - Chairman of the Board, Chief Executive Officer

Kenneth G. Leddon - Chief Financial Officer, Senior Vice President

George B. Weinert - President, Chief Operating Officer

Analysts

George Iwanyc - Oppenheimer

Matt Hoffman - Cowen & Company

Samuel Wilson - JMP Securities

Kevin Dede - Morgan Joseph & Company

Anthony Stoss - Craig-Hallum Capital

John Bright - Avondale Partners

Novatel Wireless, Inc. (NVTL) Q2 2008 Earnings Call August 19, 2008 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Novatel Wireless second quarter 2008 conference call. (Operator Instructions) I would now like to turn the conference over to Julie Cunningham, Vice President Investor Relations and Communications. Please go ahead, Madam.

Julie Cunningham

Good afternoon, everyone and thanks for joining us. The agenda for today’s call is as follows: Peter Leparulo, Chairman and CEO, will provide an overview of the second quarter of 2008; and Ken Leddon, Chief Financial Officer, will review our preliminary financial results for the second quarter. Also joining us on the call is Brad Weinert, our President.

As a reminder, this conference call is being broadcast today on August 19, 2008 over the phone and Internet to all interested parties. The information shared in this call is effective only 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 preliminary second 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 be archived there for 30 days.

Today’s discussion contains forward-looking statements including our preliminary financial results for the second quarter and our outlook for the third quarter of 2008. 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 could differ materially. Please refer to our SEC filings for a detailed discussion of potential risks.

Additionally, as previously announced, the company’s actual results may differ materially as a result of the outcome of an ongoing accounting review as described in more detail in our preliminary earnings release.

Now I would like to introduce Peter Leparulo, Chairman and CEO of Novatel Wireless.

Peter V. Leparulo

Thanks, Julie and thanks to all of you for joining us today. As Julie stated, we are providing preliminary financial results for the second quarter of 2008. These preliminary results are subject to change as a result of the audit committee’s ongoing review of the company’s revenue cut-off procedures, internal control, and accounting for certain customer contracts. With that in mind, revenues for the second quarter of 2008 are expected to be approximately $89.8 million. Earnings per share on a GAAP basis for the second quarter of 2008 is expected to be approximately break-even, significantly impacted by the cost of the audit committee’s ongoing accounting review.

Our preliminary second quarter results include approximately $3.4 million of revenue and approximately $131,000 of pretax net income that was previously included in our first quarter results, which were announced on May 1, 2008.

Non-GAAP EPS, which excludes stock-based compensation, is expected to be approximately $0.03 per share. Second quarter results on a pretax basis include: an inventory valuation write-down of $1.7 million in cost of goods sold; a bad debt reserve of $900,000 in G&A; and fees and expenses related to outside professionals in connection with the accounting review of $2.6 million in G&A. The non-GAAP EPS impact of these items totals approximately $0.11 per share.

Today, I would first like to give you a brief update on the status of the ongoing review by our audit committee. After that, I will walk you through some of our key initiatives, which we believe will lead us to return to growth in the fourth quarter.

As previously announced, the audit committee is conducting an expanded review into the company’s revenue cut-off procedures, internal controls, and accounting related to certain customer contracts. During the course of the review to date, six transactions have undergone further accounting review, principally as to whether revenue from these shipments was recognized in the appropriate quarter. These shipments involved aggregate revenues of $9.1 million and pretax income of $1.1 million.

The review has resulted in a preliminary determination to move approximately $3.4 million of revenues from the first quarter to the second quarter of 2008. I do want to reiterate that the accounting review is ongoing and may identify other issues.

To date, no determination has been made as to whether a restatement of our 2007 audited financial statements will be required. Upon completion of the audit committee’s review, a decision will be made as to whether a restatement is required.

Following the completion of this review, we will finalize our financial statements for the first and second quarters of 2008.

Finally, I would like to remind you that the accounting review is being conducted by our audit committee with the assistance of outside advisors. We are not therefore in a position to respond to questions regarding the status of this review beyond what is contained in the preliminary earnings release and our prepared remarks.

And now let’s turn back to discussing our business -- our preliminary second quarter results and our current outlook for the third quarter do reflect the transition in our business, as we introduce new products and open new markets for our technology. We believe our market continues to grow but we have seen a more cautious approach by many carriers, which may reflect some normal summer seasonality, along with the impact of current macroeconomic environment factors.

In this environment, we are focused on three immediate goals: first, we are looking to solidify our existing customer relationships and introduce new products into our core market; second, we are introducing a number of new, differentiated, evolutionary products; and third, we are focused on expanding our addressable market opportunity by introducing innovative mobile content delivery devices. We do believe we are making solid progress toward each of these goals but we do not expect to see significant benefits from these programs until the fourth quarter.

Our third quarter outlook is being impacted by our next generation products launching in Q4, which is later than expected due to regulatory technical issues not specific to Novatel Wireless. Another more modest factor impacting our outlook has been the transition of our embedded business. Over time, we expect our embedded business to move away from traditional laptop customers towards other content specific devices and new customers, as many of our current laptop customers will move to alternative platforms, such as Qualcomm’s Gobi. Our role in supporting the Gobi platform is still being developed and may be significant but is not currently factored into our long-term outlook.

We are still experiencing significant order flow from customers such as Dell, as they require the customization and support Novatel Wireless can offer for a wider range of carriers than others currently support.

Moving forward, we have first focused on our position in our core market. As you may have seen, we won back a key promotional slot at Verizon that went live in mid-July with our MC-727 USB product. Verizon is our largest customer and we continue to work closely with them on both our current products and future initiatives.

Additionally in the second quarter, we successfully completed interoperability testing for the Expedite EU-870D on NTT DoCoMo’s 3G Network in Japan.

We also announced the availability of Ovation MC-930D on O2’s network in the U.K.

We launched the Ovation MC-950D on Vodacom’s network in South Africa, and we announced that Bell Canada was introducing the U-727 across its network in Canada.

To serve our core market, our biggest focus is on accelerating the development of all products to the greatest extent possible. Moving forward, we are currently embarking on our most aggressive product launch cycle in Novatel’s history. We expect to launch a significant number of new products by year-end, including our third generation of USB products, which will be launched across multiple technologies and form factors with our largest North American customers in the fourth quarter. We are also launching our next generation embedded module specifically for content delivery devices in Q4.

We expect these product introductions to significantly improve our competitive end market position by the end of this year.

Our second focus is on the next generation of evolutionary products. These include both software offerings for our core products and differentiated standalone products that will provide end-to-end wireless application solutions, broaden the reach of WAN technology, and enhance the broadband network.

Evolution products will allow us to ship additional products into our tier one carriers and OEM customers. One example of a product in this category is Nova Speed, which we announced at CTIA, and has now launched with a major North American carrier.

Our third strategic focus is expanding our addressable market with mobile content devices -- delivery devices. The first example of this is our innovative application with our partner, Autonet Mobile. Autonet will enable passengers to easily surf the web, check mail, and play games online, as well as access personal content using any WiFi enabled device within close proximity of the vehicle. Chrysler recently announced that it will be offering its UConnect product, which is powered by Autonet Mobile, in next year’s Chrysler, Dodge, and Jeep models. We expect to begin shipments to Autonet in late Q3.

Additionally, we are also working with a major retailer on the next generation wireless content delivery device that we currently expect to start shipping in the fourth quarter. Because these two non-carrier customers -- between these two non-carrier customers, we expect to see a material contribution to revenues in the fourth quarter and are working closely with potential partners on a new category of products and devices which are enabled by wireless broadband connection.

Overall, we think this category can be a strong growth vehicle for us in 2009 and beyond.

To summarize, we are currently in a transition period as we work hard to roll out the next generation of products and solidify our relationships with key strategic partners. We are winning business and customers and we expect our initiatives to return the company to solid growth in the fourth quarter.

And now I would like to turn the call over to Ken, who will give a financial review.

Kenneth G. Leddon

Thank you, Peter. Before I provide the second quarter preliminary results and third quarter guidance, I would like to add to what Peter said earlier regarding the accounting review.

Pending the completion of this review, our preliminary results for the first and second quarters of 2008 remain subject to change, to reflect any adjustments resulting from the review, which could be immaterial. Additionally, our first and second quarter results may be adjusted for changes in quarter ending accounting estimates, including estimates of inventory, accounts receivable, and other items resulting from better information about these items that will be available at the time the Form 10-Qs are filed.

We continue to work diligently with our auditors to finalize the financial statements for the first and second quarters as soon as possible after the review is completed.

The professional fees and expenses related to the review that were incurred through June 30 2008 total approximately $2.6 million on a pretax basis, significantly above our initial expectations.

Turning now to preliminary second quarter results, unless specifically noted, all comments about our financial results exclude the impact of share-based compensation expense under FAS-123R. Share-based compensation expense net of taxes was approximately $1 million in the second quarter of 2008.

We currently expect to report revenues for the second quarter of $89.8 million, which compares to $97.4 million reported in the June quarter a year ago. As a result of the preliminary conclusions from the review, these second quarter revenues include approximately $3.4 million that was previously included in our first quarter results announced on May 1st.

Now let me provide a few key metrics associated with our second quarter sales -- USB products are expected to be approximately $48.2 million, or 54% of revenues. Embedded products are expected to be approximately $29 million, or 32% of revenues. PC and express cards are expected to be approximately $12.5 million, or 14% of revenues. EVDO products are expected to account for 57% of our revenues; HSPA products are expected to account for 43% of revenues.

During the second quarter, we shipped to nine operators and ten OEMs in 24 countries. Leading customers in the quarter included Verizon, Sprint, Dell, Telefónica, Vodafone, Panasonic, Sony, and Toshiba.

From a geographic perspective, domestic revenue is expected to be approximately 62% of total revenues and international revenue is expected to be 38%. On a non-GAAP basis, gross margins are expected to be approximately 24% and include an inventory valuation charge of $1.7 million on a pretax basis, or $0.04 per diluted share for data cards. The non-GAAP gross margin impact of this charge is approximately 2%.

Our operating margin is expected to be approximately $800,000, or 1% of revenues.

Operating expenses are expected to be approximately $20.9 million, or 23% of revenues.

R&D expenses are expected to be $8.8 million, or 9.8% of revenues.

Sales and marketing expenses are expected to be $4.8 million, or 5.3% of revenues.

G&A expenses are expected to be $7.3 million, or 8.1% of revenues. This includes $2.6 million related to the ongoing accounting review and a bad debt charge of $900,000.

On a non-GAAP basis, excluding non-cash compensation charges, we expect net income of approximately $1 million, or approximately $0.03 per diluted share.

EBITDA is expected to be approximately $3.6 million.

Free cash flow, defined as EBITDA less capital expenditures, is expected to be approximately $1 million.

Including the share-based compensation charges of $980,000 net of taxes, we expect GAAP net income to be approximately $25,000 for the quarter, or approximately break-even.

Now I will review some balance sheet highlights -- at June 30, 2008 we had approximately $135.2 million in cash and investments, with no debt. Our cash and investments represent a net decrease of approximately $10.7 million from the prior quarter. The reduced cash balance reflects the impact of the $25 million stock repurchase program that was announced on March 6, 2008. The program has been completed.

AR is expected to be approximately $66.7 million, a decrease of approximately $2.9 million from last quarter.

DSOs are expected to decrease to 62 days.

Inventory is expected to be $37.7 million in the second quarter, as compared to $33.5 million in the first quarter, which results in annualized inventory turns of approximately 6.9 times per year.

Prior to covering third quarter guidance, I want to remind you that the accounting review is ongoing and the final results of the review could result in additional revenue moving from quarter to quarter. In addition, third quarter guidance remains subject to change as a result of the accounting review as well.

With that, our guidance for the third quarter of 2008 is as follows: we expect revenues of approximately $80 million to $85 million; we expect gross margins to be approximately 22% -- this decrease is primarily due to the sale of legacy products; we expect gross margins to improve in Q4 with the introduction of several new products; based on our current view, we expect GAAP results to range from break-even to a loss of $0.03 per diluted share, excluding approximately $1.2 million to $1.5 million of expenses associated with our ongoing accounting review; we expect non-GAAP results to be in the range of break-even to $0.03 per diluted share, based on approximately 31 million shares outstanding.

Now I will turn the call back to Peter.

Peter V. Leparulo

Thanks, Ken. Although this has been a challenging period for Novatel, we are confident in our path forward and believe it is validated by the design wins, commitments, and level of enthusiasm from our partners for our next generation products. We do look forward to demonstrating our progress over the next few quarters with you.

And now Ken, Brad, and I are happy to answer your questions. As a reminder, we will not be able to respond to questions regarding the ongoing audit committee review but Operator, please open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of George Iwanyc from Oppenheimer.

George Iwanyc - Oppenheimer

When you look at your guidance, can you give us an idea of how the gross margin is breaking down between the various categories and where you are seeing the biggest pressure?

Peter V. Leparulo

We actually don’t break gross margins down by either product or category, other than generally. And what we talked about in the past is that embedded gross margins, albeit with lower selling expenses, due tend to have lower gross margins and the other higher content technology products are higher gross margin products.

But the real impact -- gross margins are always very much dependent on mix and are subject to quarterly fluctuations. Where we stand right now is that we are between product cycles.

The biggest effort and initiative that we are undertaking is to roll next generation products out with our operator customers. Those products will have higher gross margins associated with them pretty much across the board, mostly because they are next generation and because we believe that they will be more highly differentiated products.

So in some way, I would say it is dependent on product mix and it really is the end of the lifecycle of our current products that we are going through the beginning stages of an upgrade cycle, which are the most impactful on gross margins.

George Iwanyc - Oppenheimer

So with all the new product activity that you are going through right now, how should R&D trend next quarter, and then in the fourth quarter? Is it increasing and then decreasing? And do you see the same type of trend with sales and marketing expenses?

Kenneth G. Leddon

In the third and fourth quarters, we do see an increase in the R&D expenditures as we bring the new products online. Sales and marketing will grow as the market grows, due to commissions and compensation related issues due to the growth and the new products coming online.

George Iwanyc - Oppenheimer

Okay, and then one more question on the guidance -- the decrease that you are looking for, is that coming primarily from embeddeds during the drop-off? Or is it just the new product transition? And following up on that, how do you see embedded trending over the next 12 months?

Peter V. Leparulo

I’ll take the first part of this -- there is some softness in the market, which is somewhat due to seasonality in the summer, especially in Europe, so there are those macro elements.

But principally, our guidance reflects the move to the new product launches to drive sales in Q4, which will have higher gross margins associated with them. Because we are in between those product cycles, that’s the principal driver of our guidance.

Moving forward, we are rolling out a lot of products in all of our markets over the next several months and several quarters, including evolutionary products as well as mobile content devices. We expect that as we transition forward to that, we will see the results in Q4 on that.

I will turn the embedded over to Brad, actually.

George B. Weinert

On the embedded side, we certainly are still seeing robust demand across our existing customer base, although we do anticipate some of our laptop OEM customers to migrate to alternate chipsets and alternate modules going forward. However, we are seeing an increase also and additional new opportunities across what we call content-specific appliances and vertical markets.

So we are replacing some drop-off. We might be seeing a laptop OEM with new customers, so the overall demand for OEM is actually very robust. And as we mentioned also in the script, we are going to be introducing a new module as well, so there are product lifecycle changes happening across the board, including in the embedded space right now.

George Iwanyc - Oppenheimer

Brad, just following up on that, have you seen any of your embedded customers on the laptop side start to embrace Gobi? Is this something that will impact mix in the next two quarters?

George B. Weinert

I think the Gobi is being embraced unilaterally at this point at varying levels within a given customer but certainly, I’m not aware of any OEM that does not have plans to use Gobi in certain platforms.

But we also see other modules being used there as well, so we are seeing more of a differentiation between platforms based on what the applications are, so certainly the laptop platforms that are truly geared towards a global roaming solution are migrating towards Gobi, but a lot of the ones that are being used more in a nomadic application are using Novatel modules or other modules.

So there are changes happening. It really depends on laptop OEM to laptop OEM but that being said, we certainly are and have declared ourselves to be and are very much involved with the Gobi program. We do see opportunities there as well going forward, with both sales of hardware as well as potential software and other solutions to some of our customers.

George Iwanyc - Oppenheimer

Thank you.

Operator

Thank you. Our next question comes from the line of Matthew Hoffman from Cowen & Company.

Matt Hoffman - Cowen & Company

First, Peter, could you add a bit more color on the new product status? I think you indicated there was a regulatory issue that was creating a bit of a product slip here from 3Q to 4Q, but maybe you indicated it was outside of your control. Now, you’re not suggesting that it’s more on the chipset side but more on the appliance side of the equation there?

Peter V. Leparulo

Matt, what it really is -- we framed in terms of regulatory/technical. What it really is that -- it certainly is external to Novatel, as you say. There are fixed elements of both certification and regulatory approval that overlap and have continuum to them and have interlocking elements and that’s really what -- that is one of the principal drivers of it.

That does manifest itself in things like protracted firmware development as you go through that but it’s really the -- well look, we have done everything under the sun to pull in the development of these new products but what we are running into is the [fixed parts] of the entire development and certification cycle that really cannot be shortened.

Matt Hoffman - Cowen & Company

What’s your level of conviction that these issues do get resolved here in 3Q, or in time for 4Q sales of the new products?

Peter V. Leparulo

Good question. There’s always active dynamics on this as you go through the last elements of certification but based on what we have seen, having launched many, many products over years, is that we are confident that we will get these into the market in the fourth quarter.

I can tell you we already have launch commitments on these products from principal customers, so not only we but others are counting on us doing it as well.

Matt Hoffman - Cowen & Company

All right, another question here; looking forward, it looks like G&A was maybe a $0.07 to $0.10 hit in the second quarter. Obviously the profit is little light here in the 3Q guidance also, and I think Ken gave us some pretty specific numbers there. That 7.3 G&A for 3Q, is that really -- a lot of that is the accounting review, maybe $3 million or $4 million worth? And are you pretty sure that that’s the right number? It may not go higher, it may go lower -- what are the pushes and pulls on that number? Thanks.

Kenneth G. Leddon

On the G&A, as we said in the press release, I believe, there’s $2.6 million in Q2 that impacted the G&A, and then the $900,000 on a bad debt reserve that we had to take on an account that aged out on us is really what caused the G&A to go up. Other than that, G&A was pretty stable compared to prior periods and in the future, we don’t expect a large growth in G&A in the short run but there will be we believe additional charges as we finish the accounting review that we’ve estimated at $1.2 million to about $1.5 million in Q3.

Matt Hoffman - Cowen & Company

Okay, last question -- inventory in the channel, Peter, I think you indicated some seasonal softness out there right now. Your inventory is up just a bit. Are you worried about Huawei product or somebody else out there in the channel with too much just maybe slowing things down in Europe? Thanks.

Peter V. Leparulo

Well, channel inventory we still see as, like the operators are very good at doing, as sell-in matching sell-through. So the channel inventory is something that we certainly watch but I wouldn’t put that in a category of concern.

Our inventory levels, what they really are, Matt, is we -- they are related to the launch in the first quarter of Nova Speed, so we had a build-up in inventory in anticipation of that launch, which is reflected in the June 30th inventory number.

I don’t have the exact number. We can get it to you after the call but certainly a sizable portion of that has already been shipped in the first month of this quarter.

Matt Hoffman - Cowen & Company

Great. Thank you, guys.

Operator

Thank you. Our next question comes from the line of Samuel Wilson from JMP Securities. Please go ahead.

Samuel Wilson - JMP Securities

Good afternoon. So first question -- on Q1, if you take the revenue numbers back out, what would non-GAAP EPS have been for Q1? What’s the new non-GAAP EPS for Q1?

Peter V. Leparulo

If we had not moved the numbers out?

Samuel Wilson - JMP Securities

No, post moving the numbers out -- after you move the numbers out, what’s the new EPS for the first quarter?

Peter V. Leparulo

We are not reporting on Q1 at this time. We really want to wait for the accounting review to be completed, Sam. Once we are convinced that there are no further issues in Q1 -- but so far, no large changes. But again, we would really like for us to complete the review and put out Q on file so we can give you good, solid numbers for Q1.

Samuel Wilson - JMP Securities

Okay. Secondly on the embedded business, if you just look out one year, two years on the laptop OEM business, on the laptop computer business, should we start to think about modeling this down to zero over time?

George B. Weinert

Well, Sam I think that -- well, in terms of a Novatel perspective no, I don’t think that would be a good thing to do. I think that what you will see, however -- this is Brad talking, by the way -- is that our revenue may become less dependent on hardware and more dependent on value-added services and solutions and software that would fit on top of that.

We see that particular portion of the OEM business morphing more into -- I don’t want to classify it as services. It’s more of a combination of value-added services and software and some opportunistic hardware plays.

But certainly the way this is going -- when we get to LTE and we have a very stable long-term platform for the laptop manufacturers, we should expect to see a de facto standard for modules which will go across all the platforms. And at that point, certainly our position has been that we are going to be playing in that market but probably not in the way we are playing in it today.

So you could model our existing module sales the way they are today probably down to zero by the time LTE comes out, as it applies to laptops. But again, that a small portion of the overall OEM business as well.

Samuel Wilson - JMP Securities

Right. I just want to make sure that we get on the right wavelength here.

George B. Weinert

Absolutely -- it is the right way of thinking about specifically on laptops.

Samuel Wilson - JMP Securities

Yes, specifically just on laptops -- and then lastly, just some more comments on the international business. You talked a fair amount about domestic U.S. business and your new slot at Verizon and those things. You’ve had some growth in your international business over the last year. If you could just give us sort of a color update -- any single region that did better or worse than expected, et cetera?

George B. Weinert

Sure, Sam. We have very strong positions still at Telefónica. That would be our leading vendor or carrier in Europe, and certainly strong sales in certain Vodafone op-cos.

We are seeing a very competitive environment where the product lifecycle is having a lot of impact. In fact, one of the big impacts to us is the product lifecycles changes that we are going through right now. Certainly with the competitive pressures from the likes of [VP] and Huawei, it has created more of an opportunistic type of environment where we have to play with value-added and high-end solutions as opposed to going after mass market solutions.

We are also seeing some opportunities develop in the developing countries, the eastern block countries; however, I would say that we are approaching those with a bit of caution as the networks are not fully deployed yet and these can be more long-term business development type operations than they are true sales opportunities at this point.

But in general, we are seeing strong demand across the board in the traditional countries of Europe -- Spain, Germany, Italy, U.K. markets are doing very well and we are selling as a differentiated solution, not trying to go head to head with the major Asian competitors over there.

Samuel Wilson - JMP Securities

And my last question, specifically on your guidance for the third quarter, is there some sense here that you see, at least based on your discussions with carriers, that the U.S. consumer, U.S. back-to-school is more subdued than in the past? That just the credit crisis or whatever, the macroeconomic conditions are such that people are less willing to buy these products?

Peter V. Leparulo

I guess I would [categories in terms of] we have seen more caution by the operators.

Samuel Wilson - JMP Securities

Perfect -- thank you so much.

Operator

Our next question comes from the line of Kevin Dede from Morgan Joseph.

Kevin Dede - Morgan Joseph & Company

Peter, if you had to take a shot of the 80 to 85 expected in September, could you give us an idea on what the mix might look like?

Peter V. Leparulo

Product mix among form factors?

Kevin Dede - Morgan Joseph & Company

Well, yeah -- I mean, as you usually describe it, right? Between embedded and cards --

Peter V. Leparulo

Sure. I would expect it probably -- in Q3, I would probably expect it to be somewhat similar to Q2, maybe a little bit more USB. I’m actually trying to see if we can get something closer to that for you but it looks like by technology, that it would be a bit more EVDO. What I am looking at in technology is 70% EVDO and about 30% HSPA.

And then in terms of form factor, I would anticipate the form factor to be pretty much the same -- a little bit more USB, a relatively constant embedded, and then PC and express cards to being going down to the extent that they are supplanted by USB devices.

Kevin Dede - Morgan Joseph & Company

So the inventory write was on the PC express card side, or the PCM CIA?

Peter V. Leparulo

The inventory was the express --

George B. Weinert

HSPA.

Peter V. Leparulo

HSPA express.

Kevin Dede - Morgan Joseph & Company

Okay.

Peter V. Leparulo

So what’s really happening is the express is being supplanted by USB at a fairly rapid pace.

Kevin Dede - Morgan Joseph & Company

Okay. Then, I am still little confused on what’s restraining your new product introduction. I mean, understand it’s not on your side but I guess, and you are doing everything you can to get them out, but I’m not sure exactly what’s entailed -- is it a regulatory review or a carrier review?

George B. Weinert

Let me try to add a little bit of color to what Peter already said, because there’s multiple issues here. It’s not one product. We have several products that we are trying to get out at the end of Q3 and into Q4, so there are -- as Peter alluded to, there are certain parts of the cycle which cannot be shortened. So when you go into, for example -- I’m not saying that this is the exact issue, but SEC approval can take eight to 14 weeks and there’s not a lot of stuff that you can do to move that. And that’s tied to certain events having to happen ahead of that. So when you get into some of these things and the schedule starts to move to the right a little bit, you get into these fixed areas that we really don’t have any control over.

So that’s kind of what we’re alluding to there. We’ve also had a couple of customers that have slightly delayed the launch of their platforms as well, so it’s a mix of things that are happening here. But most of them have to do with regulatory and certification issues that -- for example, the Verizon certification cycle is a fixed amount of time. There’s not much you can do to change the amount of time it takes to get through that. So once you get into it, you have a fairly -- with a -- usually within a few days, you have a reasonable expectation of when you are going to be able to ship and so as some other things move to the right and you enter these periods of time, it becomes something you can’t affect is really what we’re alluding to here.

Kevin Dede - Morgan Joseph & Company

Okay, and is the plan still to address specific carriers with products that meet their needs specifically?

George B. Weinert

Absolutely.

Kevin Dede - Morgan Joseph & Company

Okay, so it’s not really what’s being asked for?

George B. Weinert

No, we’ll have specific products for Sprint, specific products for Verizon, specific products for Telefónica, Vodafone --

Peter V. Leparulo

In fact, our next generation products are probably the highest branding content that we’ve ever done before.

Kevin Dede - Morgan Joseph & Company

Okay, and do you think that will be enough to put your gross margin closer to historical ranges versus what you’re expecting in the third quarter, and what you expect in the second quarter too?

Peter V. Leparulo

We are certainly not satisfied in any way, shape, or form with gross margins in the third quarter. Moving forward -- I guess I would say this; the more differentiated, the more branded our products, the more optimistic we are about gross margin improvement.

I think in our prepared remarks, what we tried to convey was that those are the products that we’re launching in Q4 and in subsequent quarters are higher technology-based products, higher branded products, and more differentiated products and that always makes us more enthusiastic that we can move towards our long-term business model on the gross margin side.

Kevin Dede - Morgan Joseph & Company

Can you talk a little bit about the pricing environment on USB?

Peter V. Leparulo

The pricing environment on USB, USB itself is competitive. The ASPs on USB are competitive but they have always been competitive.

We are having an exaggerated impact, which is impacting gross margins, because of the stage of the lifecycle. So if you do a trajectory, the ASPs fall off at the end of a lifecycle as you migrate into next generation. The cost, however, typically on USB is lower. Our products have already been fully cost reduced the more legacy they are, so that gets us on the COGS side as well, which we believe is a quarterly fluctuation in the third quarter.

But even our next generation USB products, we believe will have gross margin improvement because they will have lower product costs associated with them than our current USB products.

So the gross margin improvement, despite ASP, will come from the associated product cost advantage we believe we will have.

Kevin Dede - Morgan Joseph & Company

Can you relate that, the pricing dynamic to maybe just sort of an abstract measure of units in the first quarter versus the second quarter?

Peter V. Leparulo

I’m not sure I could do that in real-time right now but if you give us a chance, I think we can get back to you on that.

Kenneth G. Leddon

Yeah, we could do that and I think what you would see, Kevin, is if you looked at ASP reduction, which is really what you are trying to get to, I think that we are still seeing a fairly predictable quarter over quarter ASP cost reduction. But I think what you are seeing here is that we’ve gotten to the end of our ability to reduce the product costs.

So if you look at something like the 727 product, which has been in the market now for about 14 or 15 months, we have gotten to about as far as we can get in terms of product cost out of manufacturing, so it’s important that we move to the next generation chipsets and new designs so that we can go back to doing really, really strong cost reductions quarter over quarter to maintain the sort of ASP reduction that we need to be able to get back up into the gross margins that we all like much better than where we are at right now.

I don’t think we have the number in front of us right now but it wouldn’t be real shocking. I think what you are really seeing is that the product cost has not changed much in the last couple of quarters. ASP continues to come down at a fairly predictable rate but we’re at the end of the product lifecycle in terms of being able to reduce the overall bought cost of the product is what’s happening.

Kevin Dede - Morgan Joseph & Company

Okay, last question for me -- can you relate that ASP decline to the technology cycle? I mean, if we have to wait until the introduction of LTE before you see a change in complete product makeover, then should we expect to continue to see this type of erosion?

Peter V. Leparulo

We don’t believe so. We believe that it will -- within the technology, there are efficiencies in the products and optimization of the product, even within the same standards before you get to next generation standard.

Kevin Dede - Morgan Joseph & Company

Okay. All right, gentlemen, thanks very much.

Operator

Thank you. Our next question comes from the line of Anthony Stoss from Craig-Hallum Capital.

Anthony Stoss - Craig-Hallum Capital

A comment about, you know, in the past, you’ve said your target gross margins are in a range of 28% to 30%. Have we down-shifted? Is there a new range or can you give us a sense of what that might be on a go-forward basis? And I’ve got a couple of follow-ups.

George B. Weinert

No, we have not changed our target. We believe this is a bit of an aberration caused by, like we said, product lifecycle issues. But we have not changed our -- and we think with our product mix, that we certainly can have that target going forward as our product mix changes to next generation products.

Anthony Stoss - Craig-Hallum Capital

You mentioned that one of your current customers is deploying Nova Speed -- can you give us a sense of how many more might be deploying, how many different customers might be deploying by the end of this year?

George B. Weinert

By the end of this year, we have pretty much an exclusive arrangement with this particular customer through the end of the year and then starting at the very beginning of ’09, we expect this to be deployed in a non-exclusive arrangement with several carriers, both in Europe and in North America.

Right now, it’s being deployed with a North American carrier exclusively through the end of the year.

Anthony Stoss - Craig-Hallum Capital

Peter, or Brad, I guess -- could you guys talk about if you think you are losing share, if there is kind of share shift? If so, with what accounts?

Peter V. Leparulo

It is difficult to talk about individual accounts. I think in some places, we’re in the lead. We have to take that lead into other operators with next generation products, so there is an ebb and flow to it.

Tony, I would hesitate to talk about individual accounts on that but suffice it to say, in some we are in the lead; in others, they are certainly key customers that, if we are not in the lead, we expect to work to get to the lead position again.

Anthony Stoss - Craig-Hallum Capital

Also, Peter, can you talk about what kind of controls you are putting in place on the accounting side? Are we beefing up staff or are we understaffed? Help us understand why we are so off-kilt on Q1 and Q2, and what kind of assurances investors might have for Q3, Q4 or whenever, that something is not going to pop-up again?

Peter V. Leparulo

Sure. Like we said, these involve principally revenue cut-off procedures relating to the timing of revenue. We have not seen any significant issue about the validity of any revenue. So because they involve revenue cut-off procedures, we are putting in place controls at the end of the quarter to make sure that the items related to deliveries at the end of the quarter [inaudible].

They get fairly technical, Tony, in terms of what the actual controls will be but suffice it to say that there has not been any control that has been recommended by any outside advisor that we do not intend to implement, if we haven’t already, in the next several months.

Kenneth G. Leddon

We can’t really talk about the results of the review yet and what remediations there may be but there will be a full report at the conclusion of the review and we will be glad to share that with you then.

Anthony Stoss - Craig-Hallum Capital

Peter, could you comment about -- if you had a [inaudible] in 2009 in terms of mix, what percentage of your overall revenue do you think embedded might be as a whole for 2009 -- just a ballpark?

Peter V. Leparulo

2009 embedded?

Anthony Stoss - Craig-Hallum Capital

If we’re running 30% now, what is the overall blend for ’09?

Peter V. Leparulo

If you factor in the Gobi impact with an offset of additional vertical markets in the embedded space, together with the offset of mobile internet devices, I would probably put it somewhere at 25% to 30% for ‘09.

Anthony Stoss - Craig-Hallum Capital

And then a couple of housekeeping questions, last two -- what was the headcount at the end of June?

Kenneth G. Leddon

It’s low 300s, Tony -- about 320.

Anthony Stoss - Craig-Hallum Capital

And then Peter, you completed your share buy-back. I’m just wondering -- do you have any thoughts on reloading that? Or if you can give us the number of shares you bought back in the quarter?

Peter V. Leparulo

The board would certainly consider that. I believe they would do it once we get through this entire process, considerate with financials on file.

In terms of the number of shares that were bought back, I think the way to back into that is to give you the number of shares outstanding now.

Unidentified Participant

It’s about 2.5 million, approximately.

Peter V. Leparulo

Approximately 2.5, Tony.

Anthony Stoss - Craig-Hallum Capital

Okay. Thank you.

Operator

Thank you. We have time for one final question -- it comes from the line of John Bright from Avondale Partners.

John Bright - Avondale Partners

Peter, on the embedded question versus the new products, what do you think that transition, Peter, is going to look like? Are we going to see a trough on embedded maybe in the first quarter as the new products start ramping in the first quarter? How should we think about that as it relates to your 25% to 30% answer to the previous question?

Peter V. Leparulo

I think what you will see is you will see -- you will see a couple of things happening, John. Part of it on the embedded is already happening on some platforms, and then other platforms where there is more of a focus on differentiation and customization, those are the ones that have the most prolonged life.

So as Brad suggested before, those platforms where the ease of integration and the ability to be on multiple networks, albeit perhaps at a higher product cost, are important to a laptop environment, those are the ones that are taking place first.

But as you can see, there are offsetting elements to those, both in a short-term and there’s we believe offsetting elements as we enter into the embedded through mobile content delivery devices, as well as the embedded through systems integrators and outside of the high-volume laptop PC OEMs.

So there is an active dynamic between the two of those, between all of those.

Go ahead, Brad.

George B. Weinert

Just one thing I want to add to that -- it’s not a black-and-white cut-off, so just realize that for example, with Dell, we will be supporting certain platforms throughout 2009 that they have elected not to upgrade to differentiated chipsets, and the same as some others. So there’s not a -- it’s not a cut-off where one day you are shipping and then next day you are not. What you will see is more of a gradual morphing from one module to another.

So we’ve kind of built this into our strategy to go out and find replacement customers and continue to grow the OEM business. So we don’t see a steep drop-off and then slow incline back up. We really just see a change in the mixture between customers like Dell and Toshiba and customers like Autonet and our retail customers and others.

And I wouldn’t downplay that we see significant opportunities even playing within the Gobi environment as well.

John Bright - Avondale Partners

How would you hope the respective gross margin profiles would look like, first as embedded and then new product categories?

Peter V. Leparulo

Well, we are seeing -- it’s really interesting, and the customers that are lower volumes, you know, the hundreds of thousands unit type of volumes instead of the millions of units, we are seeing gross margin that are more in line with what we would typically see with more of our commercial products going to carriers, so typically in the higher 20s and low 30s.

It really depends on how much support and software and value add we are going on to. Where we tend to see the most gross margin pressure is where it becomes less and less of a services business and more of just a hardware type of a platform.

So it’s a mix but we do actually like the smaller customer. We certainly get more margin out of the smaller customer than we do larger customers.

John Bright - Avondale Partners

So shifting then to the inventory write-down in the quarter, is this something that’s just going to be a piece of the business looking forward? Or is it going to be possible to prevent that in the future in the next product transition?

Peter V. Leparulo

Well, we try to anticipate it as much as we can. Of course, we have to basically forecast demand to then forecast the inventory requirements that we purchase from our contract manufacturers. So I think when we get a surprise, when our -- when our customers’ forecasting is not as accurate as what we would like, we end up in an over-stock situation, I think.

But what the rapid acceleration of the acceptance of the USB product as compared to the express cards, I think we all got caught by surprise how fast that form factor took over the marketplace and left us with a higher than what we had hoped or what we had planned for inventories in the express card category.

Again, I think it is due to the change of the technology and the form factor in a marketplace that was very accelerated that kind of caught us by surprise. Hopefully this won’t happen again and we keep our eye on it and these things happen quickly. Our customers come to us with feedback that’s very rapid and kind of surprising sometimes.

John Bright - Avondale Partners

Last question -- can you categorize the bad debt -- the [type of customer] that the bad debt represented?

Kenneth G. Leddon

What that was, we have an international distributor customer that [inaudible] over in our [inaudible] and required us to take a look at that account and reserve it out of conservatism. We are still working closely with the customer to facilitate our highest possible recovery on the account. We are still very hopeful that we preserve the account and a lot of the recovery in the AR.

John Bright - Avondale Partners

Thank you.

Operator

Thank you. At this time, I would like to turn the call back over to Peter Leparulo for any closing remarks.

Peter V. Leparulo

Thanks, Operator and again, everybody, thanks very much for being on today’s call. We very much look forward to updating you on our progress over this quarter and in the future. Operator, thanks very much.

Operator

Ladies and gentlemen, that does conclude the Novatel Wireless second quarter 2008 conference call. If you would like to listen to a replay of today’s conference, please dial 303-590-3000, or 800-405-2236, with an access code of 11118056. Once again, those numbers are 303-590-3000, or 800-405-2236, with an access code of 11118056.

Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Novatel Wireless Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts