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NOVATEL WIRELESS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following information should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included in Item 1 of this report, as well as the audited consolidated financial statements and accompanying notes and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2012 contained in our Annual Report on Form 10-K for the year ended December 31, 2012. Overview and Background We are a provider of intelligent wireless solutions for the worldwide mobile communications market. Our broad range of products principally includes intelligent mobile hotspots, USB modems, embedded modules for machine-to-machine (M2M) and mobile computing OEMs, integrated asset-management M2M devices, and communications and applications software. Our products currently operate on every major cellular wireless technology platform. Our mobile hotspots, embedded modules, and modems provide subscribers with secure and convenient high-speed access to corporate, public and personal information through the Internet and enterprise networks. Our M2M products enable devices to communicate with each other and with server or cloud-based application infrastructure. Our mobile-hotspot and modem customer base is comprised of wireless operators, including AT&T, Sprint, and Verizon Wireless; laptop PC and other original equipment manufacturers, or OEMs, including Dell and Hewlett-Packard; as well as distributors and various companies in other vertical markets. Our M2M customer base is comprised of transportation companies, industrial companies, manufacturers of medical devices and geographical-location devices, providers of security systems, application service providers and distributors. We have strategic relationships with several of these customers for technology development and marketing. We sell our wireless broadband solutions primarily to wireless operators either directly or through strategic relationships, as well as to OEM partners and distributors located worldwide. Most of our mobile-computing product sales to wireless operators and OEM partners are sold directly by our sales force, or to a lesser degree, through distributors. We sell our M2M solutions primarily to enterprises in the following industries: transportation; energy and industrial automation; security and safety; and medical monitoring. We sell our M2M solutions through our direct sales force and through distributors. We intend to continue to identify and respond to our customers' needs by introducing new product designs with an emphasis on supporting cutting edge wide area network, or WAN, technology, ease-of-use, performance, size, weight, cost and power consumption. We manage our products through a structured life cycle process, from identifying initial customer requirements through development and commercial introduction to eventual phase-out. During product development, emphasis is placed on innovation, time-to-market, performance, meeting industry standards and customer product specifications, ease of integration, cost reduction, manufacturability, quality and reliability. 18 -------------------------------------------------------------------------------- The hardware used in our solutions is produced by contract manufacturers. Their services include component procurement, assembly, testing, quality control, and fulfillment. We have agreements with Inventec Appliances Corporation, or IAC; Hon Hai Precision Industry co., LTD; and Benchmark Electronics for the outsourced manufacturing of our products. Under our manufacturing agreements, contract manufacturers provide us with services including component procurement, product manufacturing, final assembly, testing, quality control, and fulfillment. In addition, we have an agreement with Mobiltron for certain distribution, fulfillment and repair services related to our business in Europe, the Middle East and Africa, or EMEA. Factors Which May Influence Future Results of Operations Net Revenues. We believe that our future net revenues will be influenced largely by the speed and breadth of the demand for wireless access to data through the use of next generation networks including demand for 3G and 4G products, 3G and 4G data access services, particularly in North America, Europe and Asia; customer acceptance for our new products that address these markets, including our MiFi line of Intelligent Mobile Hotspots; and our ability to meet customer demand. Factors that could potentially affect customer demand for our products include the following: • economic environment and related market conditions; • increased competition from other wireless data modem suppliers as well as suppliers of emerging devices that contain a wireless data access feature; • demand for broadband access services and networks; • rate of change to new products; • timing of deployment of 4G networks by wireless operators; • decreased demand for EV-DO and HSPA products; and • changes in technologies. We anticipate introducing additional products during the next twelve months, including 4G broadband-access products, M2M solutions and software applications and platforms. We continue to develop and maintain strategic relationships with wireless and computing industry leaders like QUALCOMM, Sprint, Verizon Wireless, AT&T, Texas Instruments, and major software vendors. Through strategic relationships, we have been able to increase market penetration by leveraging the resources of our channel partners, including their access to distribution resources, increased sales opportunities and market opportunities. As a result of the extremely competitive market for wireless devices, we have experienced significant downward pressure on the average selling prices of our products. This pressure has the potential to materially adversely affect our results of operations and financial condition in future periods and we cannot predict the magnitude or timing of future reductions in the average selling prices of our products. Cost of Net Revenues. All costs associated with our contract manufacturers, as well as distribution, fulfillment and repair services are included in our cost of net revenues. Cost of net revenues also includes warranty costs, amortization of intangible assets, royalties, operations overhead, costs associated with the Company's cancellation of purchase orders, costs related to outside services and costs related to inventory adjustments, including write downs for excess and obsolete inventory. Inventory adjustments are impacted primarily by demand for our products, which is influenced by the factors discussed above. Operating Costs and Expenses. Many of our products target wireless operators and other customers in North America, Europe, and Asia. We will likely develop new products to serve these markets, resulting in increased research and development expenses. We have incurred these expenses in the past and expect to continue to incur these expenses in future periods prior to recognizing net revenues from sales of these products. Our operating costs consist of four primary categories: research and development costs; sales and marketing; general and administrative costs; and amortization of purchased intangibles. Research and development are at the core of our ability to produce innovative, leading-edge products. This category consists primarily of engineers and technicians who design and test our highly complex products. As we work to expand our portfolio of products and remain competitive, it may be necessary to increase our research and development costs in the future. Sales and marketing expense consists primarily of our sales force and product-marketing professionals. In order to maintain strong sales relationships, we provide co-marketing, trade show support, product training and demo units for merchandising. We are also engaged in a wide variety of activities, such as awareness and lead generation programs as well as product marketing. Other marketing initiatives include public relations, seminars and co-branding with partners. 19 -------------------------------------------------------------------------------- General and administrative expenses include primarily corporate functions such as accounting, human resources, professional legal fees, administrative support, and professional fees. This category also includes the expenses needed to operate as a publicly-traded company, including Sarbanes-Oxley compliance, SEC filings, stock-exchange fees, and investor-relations expense. Although general and administrative expenses have been relatively stable and are not directly related to revenue levels, certain expenses such as litigation settlements, legal expenses, and provisions for bad debts may impact future general and administrative expenses. Amortization of purchased intangibles includes the amortization of customer relationships, covenant-not-to-compete agreements and trade name intangible assets purchased through the acquisition of Enfora. We also subject our intangible assets and goodwill to impairment assessments when required which can result in charges when impairment occurs. As part of our business strategy, we review, and intend to continue to review, acquisition opportunities that we believe would be advantageous or complementary to the development of our business. If we make any acquisitions, we may incur substantial expenditures in conjunction with the acquisition process and the subsequent assimilation of any acquired business, products, technologies or personnel. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and disclosures of contingent assets and liabilities. Actual results could differ from these estimates. Critical accounting policies and significant estimates include revenue recognition, allowance for doubtful accounts receivable, provision for excess and obsolete inventory, valuation of intangible and long-lived assets, valuation of goodwill, litigation, provision for warranty costs, income taxes, and share-based compensation expense. Valuation of Intangible and Long-Lived Assets. We periodically assess the valuation of intangible and long-lived assets, which requires us to make assumptions and judgments regarding the carrying value of these assets. We consider assets to be impaired if the carrying value may not be recoverable based upon our assessment of the following events or changes in circumstances: the asset's ability to continue to generate income from operations and positive cash flow in future periods; loss of legal ownership or title to the asset; significant changes in our strategic business objectives and utilization of the asset; or significant negative industry or economic trends. Our assessment includes comparing the carrying amounts of intangible and long-lived assets to their associated undiscounted expected future cash flows, which are determined using an expected cash flow model. This model requires estimates of our future revenues, profits, capital expenditures, working capital and other relevant factors. We estimate these amounts by evaluating our historical trends, current budgets, operating plans and other industry data. If the assets are considered to be impaired, the impairment charge recognized is the amount by which the asset's carrying value exceeds its estimated fair value. The timing and frequency of our impairment test is based on an ongoing assessment of triggering events that could reduce the fair value of our long-lived assets below their carrying value. We monitor our intangible and long-lived asset balances and conduct formal tests on at least an annual basis or earlier when impairment indicators are present. We believe that the assumptions and estimates we used to value intangible and long-lived assets were appropriate based on the information available to management. The majority of our long-lived assets are being amortized or depreciated over two to ten years. As most of these assets are associated with technology or trade conditions that may change rapidly; such changes could have an immediate impact on our impairment analysis. Goodwill. Our goodwill resulted from the acquisition of Enfora (M2M Products and Solutions) in the fourth quarter of 2010. In accordance with the FASB Accounting Standards Codification ("ASC") Topic 350, Intangibles - Goodwill and Other ("ASC Topic 350"), we review goodwill for impairment at least annually at the beginning of the fourth quarter of each year, and more frequently if events or changes in circumstances occur that indicate a potential reduction in the fair value of the reporting unit below its carrying value. During the year ended December 31, 2012 impairment charges were recorded for the full remaining amount of goodwill resulting in a zero balance in goodwill at December 31, 2012. 20 -------------------------------------------------------------------------------- The significant accounting policies used in preparation of these consolidated financial statements for the three months ended March 31, 2013 are consistent with those discussed in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012 in all material respects and in Note I to the consolidated financial statements included in this report. The critical accounting policies and the significant judgments and estimates used in the preparation of our condensed consolidated financial statements for the three months ended March 31, 2013 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 31, 2012 in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates." Results of Operations Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012 Net revenues. Net revenues for the three months ended March 31, 2013 were $85.9 million, a decrease of $14.2 million or 14.2% compared to the same period in 2012. The following table summarizes net revenues by reportable segment and net revenues by product categories during the three months ended March 31, 2013 and March 31, 2012 (in thousands): Three Months Ended March 31, 2013 2012 Net revenues by reportable segment: Mobile Computing Products $ 75,620 $ 90,878 M2M Products and Solutions 10,301 9,272 Total $ 85,921 $ 100,150 Net revenues by product categories: Mobile Broadband Devices $ 70,158 $ 85,616 Embedded Solutions 9,413 5,718 Asset Management Solutions & Services 6,350 8,816 Total $ 85,921 $ 100,150 Mobile Computing Products. Net revenues from our Mobile Computing Products segment for the three months ended March 31, 2013 were $75.6 million, a decrease of $15.3 million or 16.8% compared to the same period in 2012. The decrease is primarily attributable to lower sales of Mobile Broadband devices caused by increased market competition at our two largest customers. M2M Products and Solutions. Net revenues from our M2M Products and Solutions segment for the three months ended March 31, 2013 were $10.3 million, compared with $9.3 million for the same period last year. The increase is primarily due to increased sales of our recently launched HS3001 device to our largest M2M Products and Solutions customer. Product Categories. We have categorized the combined product portfolios of the mobile computing and M2M businesses into three categories (1) Mobile Broadband Devices, (2) Embedded Solutions and (3) Asset Management Solutions and Services. These categories were established due to the different markets and sales channels served. We believe this product categorization facilitates the analysis of our operating trends and enhances our segment disclosures. The Mobile Broadband Devices category includes all external data modems including MiFi intelligent hotspots, USB modems and PC cards. These devices are sold primarily through wireless operator enterprise and retail channels, telecom equipment distributors and consumer retail chains. 21 -------------------------------------------------------------------------------- Embedded Solutions products include wireless-broadband modules and related software and services sold to manufacturers of laptop computers, tablets, and other wireless computer devices. This product category also includes M2M modules sold to manufacturers of various asset tracking and monitoring products. Our products are sold directly to OEMs or through distributor channels. Asset Management Solutions and Services are mobile intelligent wireless broadband terminal devices and communications management software, or CMS, that transmit information about the assets into which these products interface. These hardware and software products can be bundled or sold separately. The CMS software activates the terminal device onto the wireless network and manages its functionality and data received from the terminal device. Cost of net revenues. Cost of net revenues for the three months ended March 31, 2013 was $69.1 million, or 80.4% of net revenues, as compared to $79.2 million, or 79.0% of net revenues, for the same period in 2012. During the first quarter of 2013, the cost of net revenues as a percentage of net revenues increased due to higher warranty costs during the quarter, partially offset by lower quarter over quarter purchased intangible amortization expense decreasing to $84,000 during the quarter ended March 31, 2013 as compared to $961,000 in the comparable quarter of 2012. The cost of net revenues as a percentage of revenues is expected to fluctuate in future quarters depending on revenue levels, the mix of products sold, competitive pricing, new product introduction costs and other factors. Increased competitive pressures may continue to negatively impact the average sales prices of our products. This may require us in future periods to record inventory write downs to reflect lower of cost or market adjustments and revalue certain assets that may become impaired. Gross profit. Gross profit for the three months ended March 31, 2013 was $16.8 million, or a gross margin of 19.6% of net revenues, compared to $21.0 million, or a gross margin of 21.0% of net revenues for the same period in 2012. The gross margin decrease was primarily attributable to the changes in net revenues and cost of net revenues as discussed above. We expect that our gross margin percentage will continue to fluctuate from quarter to quarter depending on revenue levels, product mix, competitive selling prices, our ability to reduce product costs and changes in unit volumes. Research and development expenses. Research and development expenses for the three months ended March 31, 2013 were $13.8 million, or 16.1% of net revenues, compared to $15.8 million, or 15.8% of net revenues, for the same period in 2012. Research and development expenses for the three months ended March 31, 2013 were lower as compared to the same period in 2012, due to reduced labor cost attributed to headcount reductions and lower outside service costs. We believe that focused investments in research and development are critical to our future growth and competitive position in the marketplace and are directly related to timely development of new and enhanced products that are central to our core business strategy. As such, we expect to make further investments in research and development to remain competitive. Research and development expenses as a percentage of net revenues are expected to fluctuate in future periods depending on the amount of revenue recognized, and potential variation in the costs associated with the development of our products, including the number and complexity of the products under development and the progress of the development activities with respect to those products. We may increase our investment in research and development to continue to provide innovative products and services. Sales and marketing expenses. Sales and marketing expenses for the three months ended March 31, 2013 were $5.8 million, or 6.7% of net revenues, compared to $7.7 million, or 7.7% of net revenues, for the same period in 2012. Sales and marketing expenses for the three months ended March 31, 2013 were lower as compared to the same period in 2012, primarily due to a decrease in salaries and related expenditures. While managing sales and marketing expenses relative to net revenues, we expect to continue to make selected investments in sales and marketing as we introduce new products, market existing products, expand our distribution channels and focus on key customers around the world. General and administrative expenses. General and administrative expenses for the three months ended March 31, 2013 were $6.3 million, or 7.4% of net revenues, compared to $5.5 million, or 5.5% of net revenues, for the same period in 2012. General and administrative expenses for the three months ended March 31, 2013 were higher as compared to the same period in 2012 primarily due to increased legal fees, partially offset by reduced labor cost attributed to headcount reductions. While we are closely monitoring and working to control general and administrative costs, we expect these costs to be negatively impacted by legal fees to defend the claims described in Note 9 to our condensed consolidated financial statements included in this report. During the first quarter periods in 2013 and 2012, the Company incurred $2.3 million and $1.1 million in legal expenses, respectively. The increase in legal expenses is primarily due to external legal fees related to litigation and resulting settlement agreements reached during the three months ended March 31, 2013. The settlement amounts were recorded in the fourth quarter of 2012. 22 -------------------------------------------------------------------------------- Goodwill and intangible assets impairments. No impairments were recorded during the three months ended March 31, 2013. During the first quarter of 2012, based on actual operating results, and reductions in management's estimates of forecasted operating results of the M2M products and solutions reporting unit principally due to an updated view of competitive pressures impacting average selling prices, customer product and technology selections, and the loss of certain customers, the Company determined there were sufficient indicators of impairment present to require an interim impairment analysis. Based on the fair value tests performed, the Company recorded a pre-tax goodwill impairment charge of $6.6 million and a purchased intangible asset charge of $22.8 million during the first quarter of 2012. Amortization of purchased intangible assets. The amortization of purchased intangible assets for the three months ended March 31, 2013 was $140,000, compared to $437,000 for the same period 2012. The decrease in amortization expense for the three months ended March 31, 2013 was caused by the lower net asset value of the intangible assets resulting from impairment charges recorded during 2012. Interest income, net. Interest income, net, for the three months ended March 31, 2013 was $57,000 as compared to $83,000 for the same period in 2012. The weighted-average interest rate earned by the Company on its cash, cash equivalents and marketable securities was 0.40% and 0.40% in the first quarter of 2013 and 2012, respectively. Other income (expense), net. Other income (expense), net, for the three months ended March 31, 2013 was $77,000 of expense as compared to income of $7,000 for the same period in 2012. Income tax expense (benefit). Income tax benefit for the three months ended March 31, 2013 was $83,000, as compared to $184,000 of expense for the same period in 2012. The effective tax rate for the three months ended March 31, 2013 is different than the U.S. statutory rate primarily due to a valuation allowance recorded against additional tax assets generated in the first quarter of 2013. Net loss.For the three months ended March 31, 2013, we reported a net loss of $9.1 million, as compared to a net loss of $37.9 million for the same period in 2012. The improvement in net loss primarily resulted from no impairment being recorded during the three months ended March 31, 2013. During the same period in 2012, we recorded pre-tax goodwill impairment charges of $6.6 million and a purchased intangible asset impairment charge of $22.8 million. Liquidity and Capital Resources Our principal sources of liquidity are our existing cash, cash equivalents and marketable securities and cash generated from operations. To address short term liquidity requirements resulting from working capital changes the Company entered into a margin credit facility with a bank in 2011. The use of this margin credit facility allows the Company to meet short-term cash requirements and avoid selling cash equivalents and marketable securities. Borrowings under this facility are collateralized by Company cash and cash equivalents and marketable securities on deposit at the bank. During the three months ended March 31, 2013, the Company borrowed approximately $7.0 million, and had outstanding borrowings of $4.8 million under this facility at March 31, 2013. Under the terms of the credit facility, the bank may liquidate any of the Company's cash equivalents or marketable securities held at any time in order to recoup the outstanding balance of the facility. Accordingly, a like amount of cash equivalents and marketable equity securities have been classified by the Company as restricted cash and restricted marketable securities on the balance sheet at March 31, 2013. At March 31, 2013 the Company had restricted cash of $661,000 and restricted marketable securities of $4.2 million related to the outstanding borrowings under the credit facility. The Company's borrowing limit at March 31, 2013 under the credit facility was $5.9 million. In September 2009, we filed a shelf registration statement with the Securities and Exchange Commission, or the SEC, that will allow us to sell up to $125 million of equity, debt or other securities described in the registration statement in one or more offerings by us from time to time. As set forth in the shelf registration statement, the net proceeds from the sale of our securities may be used for general corporate purposes, including working capital, capital expenditures and acquisitions. As of the date of this report, we had not issued any securities under this registration statement. 23 -------------------------------------------------------------------------------- Working Capital, Cash and Cash Equivalents and Marketable Securities The following table presents working capital, cash and cash equivalents and marketable securities (in thousands): March 31, 2013 December 31, (unaudited) 2012 Working capital(1) $ 51,282 $ 67,199 Cash and cash equivalents (2)(3) $ 18,272 $ 16,044 Short-term marketable securities (2)(4) 25,834 38,064 Long-term marketable securities 9,862 1,201 Total cash and cash equivalents and marketable securities $ 53,968 $ 55,309 (1) Working capital is defined as the excess of current assets over current liabilities. (2) Included in working capital. (3) Excludes restricted cash. (4) Excludes restricted marketable securities. Our working capital decreased $15.9 million from December 31, 2012 to March 31, 2013. The decrease was primarily due to investment of short-term marketable securities maturities into long-term marketable securities. As of March 31, 2013, cash and cash equivalents and marketable securities decreased by $1.3 million from December 31, 2012. The principal components of this net decrease was the cash used to pay for acquisition of property, plant and equipment of $2.9 million, partially offset by cash provided by our operating activities of $1.9 million. 24 -------------------------------------------------------------------------------- Historical Cash Flows The following table summarizes our condensed consolidated statements of cash flows for the periods indicated (in thousands): Three Months Ended March 31, 2013 2012 Net cash provided by (used in) operating activities $ 1,883 $ (18,223 ) Net cash used in investing activities (3,447 ) (6,841 ) Net cash provided by (used in) financing activities 3,857 (240 ) Effect of exchange rates on cash and cash equivalents (65 ) 15 Net increase (decrease) in cash and cash equivalents 2,228 (25,289 ) Cash and cash equivalents, beginning of period 16,044 47,069 Cash and cash equivalents, end of period $ 18,272 $ 21,780 Operating activities. Net cash provided by operating activities was $1.9 million for the three months ended March 31, 2013 compared to net cash used by operating activities of $18.2 million for the same period in 2012. Net cash provided for the three months ended March 31, 2013 was attributable to net losses in the period, offset by a net increase in cash caused by changes in working capital accounts, and non-cash charges for depreciation and amortization and share based compensation expense. For the three months ended March 31, 2012, net cash used by operating activities was primarily related to net losses for the period, along with decreases in cash caused by a reduction in accounts payable, and increases in accounts receivable, inventories, and prepaid and other assets. These were partially offset by non-cash charges for impairments of goodwill and intangibles, depreciation and amortization, and share based compensation expense, and an increase in accrued expenses. Investing activities. Net cash used in investing activities during the three months ended March 31, 2013 was $3.5 million compared to $6.8 million used during the same period in 2012. Cash used in investing activities during the three months ended March 31, 2013 was related to purchases of property, plant, and equipment for approximately $2.9 million, and net purchases of marketable securities of $595,000. Cash used in investing activities during the same period in 2012 was primarily related to net purchases of marketable securities of $5.7 million, and purchases of property, plant, and equipment for approximately $1.2 million. Financing activities. Net cash provided by financing activities during the three months ended March 31, 2013 was $3.9 million compared to cash used of $240,000 during the same period in 2012. Net cash provided by financing activities in 2013 was primarily related to proceeds received from borrowing on our margin credit facility, partially offset by principal repayments and restricted cash on our margin credit facility borrowings, and payroll taxes paid on behalf of employees for restricted stock units which vested during the period. Net cash used in financing activities in 2012 was primarily related to payroll taxes paid on behalf of employees for restricted stock units which vested during the period and principal payments for capital lease obligations. Other Liquidity Needs We expect to incur ongoing professional fees and expenses to defend litigation filed against us or related to our products, which litigation is discussed in Note 9 to our condensed consolidated financial statements included in this report. These costs cannot be estimated at this time. During the next twelve months, we currently plan to incur approximately $5.0 million for discretionary capital expenditures, including the acquisition of additional software licenses. We believe our cash resources from cash and cash equivalents and marketable securities, together with anticipated cash flows from operations will be sufficient to meet our working capital needs for the next twelve months. Our liquidity could be impaired if there is any interruption in our business operations, a material failure to satisfy our contractual commitments or a failure to generate revenue from new or existing products. 25 -------------------------------------------------------------------------------- We may raise additional funds to accelerate development of new and existing services and products, to respond to competitive pressures or to acquire complementary products, businesses or technologies. There can be no assurance that any required additional financing will be available on terms favorable to us, or at all. If additional funds are raised by the issuance of equity securities, our shareholders could experience dilution of their ownership interests and securities issued may have rights senior to those of the holders of our common stock. If additional funds are raised by the issuance of debt securities, we may be subject to certain limitations on our operations. If adequate funds are not available or not available on acceptable terms, we may be unable to take advantage of acquisition opportunities, develop or enhance products or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations. |