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NVTL > SEC Filings for NVTL > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for NOVATEL WIRELESS INC

Form 10-Q for NOVATEL WIRELESS INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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, 2011 contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

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 PCI and wireless PC-card modems, and communications and applications software. In addition, our Enfora division provides asset-management solutions utilizing intelligent platforms, customized service-delivery software, and machine-to-machine, or M2M, communications devices.

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 Nextel, 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 and providers of security systems. 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.


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. 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 growth 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 12 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, Dell, QUALCOMM, Sprint Nextel, Verizon Wireless, AT&T 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 price 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 price 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 group expenses, 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 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 expense; general and administrative costs; and amortization of purchased intangibles.

Research and development is 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.


General and administrative expenses include primarily corporate functions such as accounting, human resources, legal, administrative support, and professional fees. This category also includes the expenses needed to operate as a publicly-traded company, including Sarbanes-Oxley compliance, Securities and Exchange Commission ("SEC") filings, stock-exchange fees, and investor-relations expense. General and administrative expenses have been relatively stable and are not directly related to revenue levels.

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 will 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.

ASC Topic 350 requires that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques. The goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill to measure the amount of the impairment loss, if any. The implied fair value of goodwill is determined in the same manner as in a business combination. Determining the fair value of the implied goodwill is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge.

In order to perform the annual goodwill impairment analysis, we are required to estimate the fair value of our M2M Products reporting unit. The fair value is calculated as though the M2M Products and Solutions reporting unit were to be sold in its entirety in an orderly transaction between market participants, using an estimate of fair value based on a blended sum resulting from the use of two valuation methods. First, we use the guideline public company method utilizing a multiple of the reporting unit's revenue. Second, we perform a discounted cash flow analysis using forward looking projections of an estimate of our future operating results. These approaches use significant estimates and assumptions, including the size and timing of product deployments by our customers and related projections and timing of future cash flows, discount rates reflecting the risk inherent in future cash flows, perpetual growth rates, stage of products in development, determination of appropriate market comparables and determination of whether a premium or discount should be applied to comparables. The resultant estimated fair value of our M2M Products and Solutions reporting unit is compared to the net book value of the reporting unit to assess whether any impairment exists.

The significant accounting policies used in preparation of these consolidated financial statements for the three and nine months ended September 30, 2012 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, 2011 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 and nine months ended September 30, 2012 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 31, 2011 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 September 30, 2012 Compared to Three Months Ended September 30, 2011

Net revenues. Net revenues for the three months ended September 30, 2012 were $71.0 million, a decrease of $42.2 million or 37.3% compared to the same period in 2011.

The following table summarizes net revenues by reportable segment and net revenues by product categories during the three months ended September 30, 2012 and September 30, 2011 (in thousands):

                                              Three Months Ended September 30,
                                                2012                   2011
   Net revenues by reportable segment:
   Mobile Computing Products               $        65,189       $         102,691
   M2M Products and Solutions                        5,828                  10,572

   Total                                   $        71,017       $         113,263

   Net revenues by product categories:
   Mobile Broadband Devices                $        58,275       $          93,250
   Embedded Solutions                                7,666                  13,769
   Asset Management Solutions & Services             5,076                   6,244

   Total                                   $        71,017       $         113,263


Mobile Computing Products. Net revenues from our Mobile Computing Products segment for the three months ended September 30, 2012 were $65.2 million, a decrease of $37.5 million or 36.5% compared to the same period in 2011. The decrease is primarily attributable to lower sales of Mobile Broadband devices caused by increased market competition at our largest customer.

M2M Products and Solutions. Net revenues from our M2M Products and Solutions segment for the three months ended September 30, 2012 were $5.8 million, compared with $10.6 million for the same period last year. The decrease is primarily due to the reduced sales volume and pricing of our 2G GPRS M2M modules in the North American market as it transitions away from 2G GSM networks. We are currently developing CDMA and 3G GSM modules and integrated solutions to address this market. These products are expected to launch in the fourth quarter of 2012 and the first half of 2013.

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.

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 communication management software, or CMS, that transmit information about the assets into which these products are integrated. 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.

Cost of net revenues. Cost of net revenues for the three months ended September 30, 2012 was $56.4 million, or 79.4% of net revenues, as compared to $86.6 million, or 76.4% of net revenues, for the same period in 2011. During the third quarter of 2012, the cost of net revenues as a percentage of net revenues increased due to higher inventory obsolescence charges and lower average pricing on 4G MiFi products sold, partially offset by lower quarter over quarter purchased intangible amortization expense decreasing to $289,000 during the quarter ended September 30, 2012 as compared to $705,000 in the comparable quarter of 2011. 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 and volume sales 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 September 30, 2012 was $14.6 million, or a gross margin of 20.6% of net revenues, compared to $26.7 million, or a gross margin of 23.6% of net revenues for the same period in 2011. 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 September 30, 2012 were $14.7 million, or 20.7% of net revenues, compared to $15.1 million, or 13.4% of net revenues, for the same period in 2011. Research and development expenses for the three months ended September 30, 2012 were lower as compared to the same period in 2011, due to reduced labor cost attributed to headcount reductions and lower software amortization costs.

We expect to maintain our investment in research and development to continue to provide innovative products and services. Research and development expenses as a percentage of net revenues are expected to fluctuate in future quarters depending on the amount of net revenues recognized, and potential variation in the costs associated with the development of the Company's products, including the number and complexity of the products under development and the progress of the development activities with respect to those products.


Sales and marketing expenses. Sales and marketing expenses for the three months ended September 30, 2012 were $6.3 million, or 8.8% of net revenues, compared to $7.2 million, or 6.4% of net revenues, for the same period in 2011. The $900,000 decrease for the three months ended September 30, 2012 compared to the same period in 2011 was primarily due to reductions in outside consulting expenses, and 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 September 30, 2012 were $4.8 million, or 6.8% of net revenues, compared to $6.2 million, or 5.5% of net revenues, for the same period in 2011. General and administrative expenses for the three months ended September 30, 2012 were lower as compared to the same period in 2011 primarily due to reduced outside consulting and legal expenses, and a decrease in salaries and related expenditures. 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 consolidated financial statements included in this report. During the third quarter periods in 2012 and 2011, the Company incurred $941,000 and $1.3 million in legal expenses, respectively.

Goodwill and intangible assets impairments. During the third 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 and forecased sales volumes, 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, during the third quarter of 2012 the Company recorded a preliminary pre-tax goodwill impairment charge of $13.2 million and a preliminary purchased intangible asset charge of $7.3 million. Based on the fair value tests performed, during the third quarter of 2011 the Company recorded a pre-tax goodwill impairment charge of $3.5 million. See Note 4 in the condensed consolidated financial statements included in this report.

Amortization of purchased intangible assets. The amortization of purchased intangible assets for the three months ended September 30, 2012 was $227,000, compared to $644,000 for the same period 2011. The decrease in amortization expense for the three months ended September 30, 2012 was caused by the lower net asset value of the intangible assets resulting from an impairment charge in the first quarter of 2012.

Interest income, net. Interest income, net, for the three months ended September 30, 2012 was $72,000 as compared to $60,000 for the same period in 2011. The weighted-average interest rate earned by the Company on its cash, cash equivalents and marketable securities was 0.46% and 0.37% in the third quarter of 2012 and 2011, respectively.

Other expense, net. Other expense, net, for the three months ended September 30, 2012 was $45,000 as compared to $679,000 for the same period in 2011. This other expense in 2011 was related to foreign currency losses on South Korean won denominated trade payables, foreign exchange currency losses on foreign denominated bank accounts and trade receivables, and other-than-temporary loss recognized on our marketable equity securities.

Income tax expense (benefit). Income tax expense for the three months ended September 30, 2012 was $107,000, as compared to $11.2 million benefit for the same period in 2011. The income tax benefit in 2011 related to the release of $11.8 million of the Company's liability related to uncertain tax positions due to the expiration of the applicable statutes of limitations for certain tax years.

The effective tax rate for the three months ended September 30, 2012 is different than the U.S. statutory rate primarily due to a valuation allowance recorded against additional tax assets generated in the third quarter of 2012.

Net loss. For the three months ended September 30, 2012, we reported a net loss of $31.9 million, as compared to net income of $4.5 million for the same period in 2011. Net income was negatively impacted due to the impairment charges recognized in the third quarter of 2012.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

Net revenues. Net revenues for the nine months ended September 30, 2012 were $273.6 million, a decrease of $19.5 million or 6.6% compared to the same period in 2011.


The following table summarizes net revenues by reportable segment and net revenues by product categories during the nine months ended September 30, 2012 and September 30, 2011 (in thousands):

                                               Nine Months EndedSeptember 30,
                                                 2012                  2011
    Net revenues by reportable segment:
    Mobile Computing Products               $       248,620       $       258,268
    M2M Products and Solutions                       24,993                34,800

    Total                                   $       273,613       $       293,068

    Net revenues by product categories:
    Mobile Broadband Devices                $       231,033       $       242,797
    Embedded Solutions                               22,618                32,073
    Asset Management Solutions & Services            19,962                18,198

    Total                                   $       273,613       $       293,068

. . .
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