Novatel Wireless' CEO Discusses Q3 2012 Results - Earnings Call Transcript

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Novatel Wireless, Inc. (NVTL)

Q3 2012 Earnings Call

November 7, 2012 05:00 pm ET


Matthew Hunt – Director, Investor Relations.

Peter V. Leparulo – Chairman and Chief Executive Officer

Kenneth Leddon – Senior Vice President and Chief Financial Officer


Peter Misek – Jefferies & Co., Inc.

Bryan Prohm – Cowen and Company, LLC


Good evening, and welcome to the Novatel Wireless Incorporated Third Quarter 2012 Earnings Conference Call. All participants will be in listen-only mode. (Operator instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator instructions) Please note this event is being recorded.

I would now like to turn the conference over to Matthew Hunt of The Blueshirt Group Investor Relations. Please go ahead.

Matthew Hunt

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

As a reminder, this conference call is being broadcast on Wednesday, November 7, 2012 over the phone and internet to all interested parties. The 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. A reconciliation to the most directly comparable GAAP financial measures are included in the earnings release, which is available on the Investors section of our website, and 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. For discussion of factors that could cause actual results to differ materially from expectations, please refer to the risk factors described in our Forms 10-K, 10-Q and other SEC filings which are available on our website.

Now, I would like to introduce Peter Leparulo, Chairman and Chief Executive Officer of Novatel Wireless.

Peter V. Leparulo

Good afternoon and thank you for joining our call today. While Q3 was a difficult and challenging period as we anticipated, we have made substantial progress towards our goals, a clear and driving focus of Novatel Wireless is to return to profitability and position the company for long-term and sustainable growth.

I want to spend our time today discussing some of our key business decisions of the quarter and how we believe this will positively impact our business moving forward. After our prepared comments, Ken and I will be happy to answer any questions that you might have.

As you know, we have three primary businesses, Mobile Broadband, our OEM business selling to laptop manufacturers and our M2M business, which consist of embedded solutions and integrated platforms. Mobile Broadband had a down quarter in Q3 and as expected, we experienced hike in competition on our largest customer, as we share the channel in the quarter to lower price Chinese competitor. This competition will continue in Q4.

Our products are in many channels, including company-owned stores, direct B2B sales, local and national retail and others. Although, year-to-date sales were actually higher in direct B2B channels for quality and security are highly valued, we have been impacted in consumer channels or differentiated device pricing impact sales at a more cost driven. Our focus to address all of these channels in Mobile Broadband is to continue to lead the market in innovation, expand our customer base and expand our product set at existing customers, all built up on our industry leading type of portfolio.

Earlier this quarter, we announce that we will be launching our touch screen MiFi 2 with AT&T, which individually achieved sort of these goals, technological leadership and expanding our customer base. Our MiFi 2 being marketed by AT&T as a MiFi Liberate introduces an entirely new user interface based on a large multi-touch interactive color display, setting users control the MiFi device with the touch of the finger, added functionality minimal its design, a great through user experience, and industry leading performance have been among the positive feedback that the product has received in preliminary reviews.

MiFi’s results were media hub, which allows users to share movies, music and presentations. Importantly, this is also our first joint development product with AT&T. As started what we heard will be a long-term partnership with this important customer. We’ll be happy to discuss the unique features and performance of the MiFi 2 after the formal launch of the product in select channels later this quarter, followed by a broader distribution rollout in the first quarter.

One of the advantages of developing products for the 4G frequency band is supported by AT&T is that, there is technology commonality with other carriers worldwide. As a result, we expect to launch the MiFi 2 with other carriers in 2013. Additionally, we are launching two new products with our partner Verizon Wireless, which we believe will allow us to recapture the two most important product slots at our largest customer.

The first product which we just launched is an expanded battery MiFi 4620, which takes over the best-in-class slot with this carrier. The second product which we hope to launch in the fourth quarter, but made cushion to the first quarter is a streamline MiFi, which will become Verizon’s lead product in those channels, which are more cost driven end user sales.

These are channels that we shared with a competitor in Q3 negatively impacting our sales. With the launch of this new MiFi product, we expect to regain the so lead spot in consumer value driven sales at Verizon. We believe that the introduction of these two products clearly shifts our product momentum at Verizon as we move into the fourth quarter and fiscal 2013.

In mobile broadband, we believe that our superior performance, best-in-class user experience, advanced security, and reputation for quality is resonating with carriers. We will continue to introduce the highest quality products and win our customers in the marketplace. But we also will continue to fight manufacturers who clearly infringe on our patents and IP.

During the quarter, we field the lawsuit against Chinese manufacturer ZTE for infringing on a key Novatel Wireless patent. The suit was filed in federal court and as the second patent infringement lawsuit Novatel Wireless has filed against ZTE related to proprietary technology in mobile hotspots.

Moving to our PC OEM business, which primarily sell through our top manufacturers. While we have repeatedly demonstrated our ability to when key customers in this area, the market for this business has changed significantly. Any associated R&D expenditures are significant as well. Because the volumes have not materialized to match the projections of our customers, this segment has incurred significant losses. Given these challenging economics, we are significantly changing our approach to this business. While we plan to continue to support our legacy products, we are now only taking our new projects where our inventory and R&D investments will be adequately supported by our customers.

Following these circumstances, we have decided that our best strategy interest to agent this business on a long-term basis. While this always difficult to make a decision of this nature, we firmly believe, this is the right business decision, decision that is inline with our primary focus on improving profitability. It will also allows to develop immediate resources to business we already have been awarded that is more promising over the long-term, again tough a decision, but a good one.

Our final business area is our M2M business, where we sell those integrated solutions and embedded modules. On the surface based on our financial results in this area, this looks like a challenging area for the company. But the underlying growth in this business is encouraging and tells the very different story. Let me examine that.

They were a two made challenges in to our M2M business. First, we needed to supplemental our portfolio with CDMA and 3G technologies. I’m pleased to report that we’re on track to launch of CDMA embedded modules together with several integrated solutions of this quarter. For commercial telematics, fleet management, user-based insurance, and the high margin fixed telemetry market. I believe we will have turned the corner on this transition, and these market leading products that will make a real difference in our sales.

The second challenge for our M2M business has been the transition of the business to more direct sales model for integrated solutions, rather than one dominated by a few large distributors. We believe that moving to a direct model focused on high-end enterprise sales will drive sustainable growth. For example, just two distributors contributed to nearly half of the M2M integrated solutions sales in 2011. While this transition away from these distributors was not as we would have like. The result is the right long-term direction from our business.

As evidence, in 2012, we have added over 40 new customers to our M2M integrated business and 15 new design wins with new customers in our M2M embedded business. Many of these customers are just beginning to purchase products from us and after the potential to significantly ramp over the period of multiple quarters and multiply years. We expect to begin to see the results of these efforts in Q1. A great example of this is FleetMatics, a clear leader in fleet tracking intelligence worldwide, providing commercial fleet management to 16,000 businesses, who collectively track over 280,000 vehicles.

We had a distinct competitive advantage to win this business. Many of our direct competitors in our M2M verticals source third-party technology and our dependant on third parties for integration of their products into M2M customer applications. We on the other hand control all the significant touch points for successful application platform rollout by our customers.

This includes full of module development from our ownership, GPS, the next development, smart agents, on-board security protocols and other parts of the support chain. We are a one-stop-shop for efficient integration with and rollout of M2M service provider applications. Let me just give you a few more examples of the underlying data in this business.

Excluding the two distributors, our integrated M2M solutions of the business grew 37% year-over-year. Several of every customers are top worldwide mobile resource management companies, including not only FleetMatics, but also NexTraq, a leader in cloud-based GPS fleet tracking and vehicle management platforms. As these customers ramp, they are the type of customers who can be key partners for us for many, many years.

And approximately 30% of our new integrated solution customers have also began to purchase products in our asset tracking line, one of the benefits of having a direct relationship with and visibility to enterprise direct sales. With this type of growth and the highest gross margin in our product portfolio, you can see while we are very excited about the long-term prospects for the business.

To summarize, our performance in Q3 while expected was disappointing and we had to make some hard business decisions. We are transitioning out of an OEM business model that was weighing on our overall results. We’re concentrating our resources on where we see the greatest return for the company and our shareholders. This will enable us to continue to innovate in mobile broadband, while expanding on the underlying momentum of our M2M business.

And with that, I would like to turn the call over to Ken to go over the financials in more detail.

Kenneth Leddon

Thank you, Peter. I will begin with a financial overview of the third quarter and then we’ll provide our outlook for the fourth quarter of 2012. Revenue for the third quarter was $71 million. As we expected, this quarter was a transitionary period in which we experienced a challenging environment for our legacy product sales.

To break that revenue performance down by business segment, our Mobile Broadband revenue in the quarter was $65.2 million. This includes $50.2 million of MiFi revenues, $9.9 million of USB modems, combination cards and related products, and $5.1 million from our PC OEM business. Our M2M products and solutions totaled $5.8 million.

From a geographic perspective, sales in the U.S. and Canada accounted for approximately 93% of our total revenue. GAAP net loss was $31.9 million or $0.97 per share. This result included the impact of an estimated non-cash and non-operational goodwill and intangible asset impairment charge of $20.5 million related to the acquisition valuation of our M2M business. In addition, our GAAP results in the quarter include non-cash charges of $1.8 million in share-based compensation expense and $94,000 of income tax adjustments.

From hereon, I will discuss the results of on a non-GAAP basis. Our non-GAAP results exclude the impact of the impairment charges and stock-based compensation. Non-GAAP gross margin in the third quarter was 21.3%. This is below our guidance level of 22% to 24% due to the inventories lower our cost for market adjustments. Non-GAAP operating expenses totaled $24.2 million, down about $1.7 million from the prior quarter.

Now looking at operating expense by category, R&D expenses were $14.1 million and compared to the prior quarter of $13.9 million. Sales and marketing expenses were $5.9 million, down from $6.9 million in second quarter and the G&A expenses were $4.2 million, down from $5.1 million in the second quarter. Our non-GAAP loss was $9.1 million or $0.27 per share.

Shares outstanding at the end of the quarter were $33.1 million. Third quarter capital expenditures were $433,000 and we ended the quarter with cash and marketable securities of $62.5 million. As Peter discussed, we have made the decision to exit our old OEM business model. While we will continue to support our customers in this business, and evaluate near-term projects as they arise based on the criteria Peter discussed, we are planning to relocate the associated personnel and resources into growth areas with higher profitability.

Now, turning to guidance for the fourth quarter of 2012; as we discussed, we are in various stages of launching three major products in our MiFi product line, one of which is going to carrier certification, and two of which are new product launches. The wide guidance range is attributable to the uncertainty related to forecasting the sell-through volumes for the two new MiFi products and the uncertain timing of the launch of the third MiFi currently being certified.

Our new product introductions will have a greater impact on Q1 than on Q4 and we also expect our M2M business to around more significantly in Q1. As such, we currently expect fourth quarter revenues to be in the range of $67 million to $80 million with revenues improving in Q1. As we generate revenue from a number of new products and customers as Peter discussed.

We anticipate that non-GAAP gross margins in the fourth quarter will be in the range of 22% to 24% of sales, and finally, we expect non-GAAP EPS to be in the range of a $0.31 to $0.20 loss per share. These estimates are based on approximately 33.2 million shares outstanding.

Now, I will turn the call back to Peter for closing comments.

Peter V. Leparulo

Thanks, Ken. In summary, while the third quarter was a transitional period, we have made important progress in our business, I will set the stage for the fourth quarter and 2013. In mobile broadband, we continued to lead the market in innovation, expand our customer base, and expand our product set at existing customers. We have significantly changed our approach in the PC OEM business and we gained solid new customer traction in our M2M business.

And with that and then I would now be happy to answer any questions you may have. Operator, please open up the call for Q&A.

Question-and-Answer Session


We will now begin the question-and-answer session (Operator Instructions) The first question comes from Peter Misek of Jefferies. Please go ahead.

Peter Misek – Jefferies & Co., Inc.

Thank you, gentlemen. Can we walk through a little bit potential cost reduction strategies you guys can imply in a little more detail. Where exactly do you think we can take cost out? Are we talking about sale, distribution, R&D. I know you said that you are changing the OEM model, but a little bit more clarity and color there, I’d be glad and then I have a follow-up.

Kenneth Leddon

Hi, Peter, this is Ken. I’ll be glad to address that. What we experienced in the OEM PC business is a lack of return on some of the, on the R&D investment we’ve made. But at the same time, we’ve got so many design wins for next year that we really have to make some priority changes. And I think a lot of the resources that were previously on the OEM PC business are being transitioned over to the new products that we believe have a much higher level of profitability at lower risk.

At the same time there are some indirect costs and cost related to OEM, that are specific to OEM that will be avoided in the 2013 and end of Q4 this year.

Peter Misek – Jefferies & Co., Inc.

Can you give us any color on revenue trends or sales trends through the quarter and what we are seeing so far in calendar Q4? Has there been any change in consumer spending patents behavior, for example as the iPhone 5 had any impact on MiFi sales, hotspot capability, anything like that you’ve seen that you can give us granularity on that? That’s my last question. Thank you.

Peter V. Leparulo

We haven’t seen impact from the iPhone 5 or generally even an impact from hotspot capability on the smartphones. The things that we see are no different from other quarters in terms of operating behavior with shorter levels of inventory and shorter selling cycles. But we’ve seen that for quite some time now.

Peter Misek – Jefferies & Co., Inc.

Great, thank you.


(Operator Instructions) We have a question from Bryan Prohm of Cowen and Company. Please go ahead.

Bryan Prohm – Cowen and Company, LLC

Hey, good afternoon gentlemen. I apologize that I was late joining the call. There is number of different calls we’re working on this afternoon.

Peter V. Leparulo


Bryan Prohm – Cowen and Company, LLC

Hey, could you talk a little bit about the lawsuit, the infringement lawsuit against ZTE? This is the second lawsuit against ZTE, if I recall correctly, specifically related to MiFi mobile hotspots or to mobile hotspot and wireless data modem technology that you’ve patented in the MiFi family.

I probably understand is ZTE, I think Samsung as well, but we’ve also already heard about there is no impact from on sales or at least it appears to be no impact to sales momentum from Wi-Fi hotspots, it’s created into smartphones. Why the smartphone aims not to target of patent infringement lawsuits, it’s just simply the implementation of the hotspot on those devices that’s different from the standalone data only device?

Peter V. Leparulo

It’s not, we believe that actually some of our patents could cover elements of MiFi for mobile hotspot implementation, smartphones as well. But what you do is when you initiate one of these lawsuits, several factors go into it, including what are the infringing products and what is frankly the patent portfolio, is there a defensive patent portfolio at the parties that you are looking at.

ZTE in particular has a direct mobile hotspot, which competes with ours and which we believe crosses over technology that we invented. So their defending products on it are pretty much direct hits on this, which is why they’ve been a defendant. But recent lawsuit relates to the implementation of gateway of our technology, which just as you say is covered by mobile hotspots, key to mobile hotspots, it’s also key to M2M gateways any gateways.

But some of the other patents that we’ve put in our prior lawsuit to have better have a defending products by ZTE against it. It includes some of the key elements of the hotspot technology. But when you look out many factors when you initiate one of these, which is we’ve done and that’s why we began these lawsuits against the defendants.

Bryan Prohm – Cowen and Company, LLC

Okay, just want to clarify, is that an ITC, or there is a court lawsuit whereas this…

Peter V. Leparulo

Sure, it’s not ITC, it’s a District Court, Federal District Court.

Bryan Prohm – Cowen and Company, LLC

Okay. What’s the timeframe for, were there some timeframes that we should go watching on this trial.

Peter V. Leparulo

Yeah, it’s hard to tell, we just initiated this and it will go through some type of mediation process. It’s a longer process than going through the ITC, so we’ll keep you abreast, but frankly it’s too early to really put timeframe on it.

Bryan Prohm – Cowen and Company, LLC

Okay, understood. I apologize if this is in your prepared remarks. Of the revenue guidance what percentage of the revenue guidance relates to the new Mifi products that are coming on in the quarter roughly?

Kenneth Leddon

I would say it as a percent of the total, the new products are probably about 20% to 30% of the total quarter guidance. Again, these are partial quarter potential outcomes where we are not going to get a full quarter channel on either one of these, it looks like the AT&T product will have a few more weeks than where the Verizon product may even go to Q1, Again, that’s why I made the comments about the wide range of the guidance. So a lot of will depend upon how these go into channel and how the sell-through develops at the end of this quarter and whether we get the Verizon unit in Q4 and maybe the channels are whether we have to wait until Q1.

Bryan Prohm – Cowen and Company, LLC

Okay. Thanks for that. And last question guys is, this data share plan that have been launched, have you seen any impact to sell through as a result of the 10 to 1 data share plans? I know there was something you would mention mid-year as a possible catalyst for device sales? Thanks.

Peter V. Leparulo

Sure. We do think this is the catalyst. We don’t get that information directly as to what the activation rate plans are for our products. So if we read what you read that these are successful of the operators and certainly they should drive greater broadband device sales. But we don’t have the visibility into individually plans on that.

Bryan Prohm – Cowen and Company, LLC

Okay, that’s something we’ll just have to watch then as these operators get around Q4 results. Thank you very much for your time.

Peter V. Leparulo

Thank you.

Kenneth Leddon

Thank you, Bryan.


At this time, I would like to turn the conference back over to Peter Leparulo, Chairman and CEO for any closing remarks.

Peter V. Leparulo

Thank you. And thanks everybody for your time and your attendance today, and we will look forward to updating you on our progress next quarter.


Please note that a replay of this conference is available one hour after the end of the conference call by dialing 1-877-344-7529 or 1-412-317-0088 and use conference number of 10018896, again conference number 10018896. The conference has ended. You may now disconnect your line.

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