Business context and reporting period
Novatel Wireless, Inc. (the filing says its reorganized parent was expected to be named Inseego Corp. and trade as INSG effective November 9, 2016) filed this unaudited Form 10-Q for the quarter ended September 30, 2016. The company reported one segment, spanning wireless hardware and IoT, fleet-telematics and related SaaS, software and services. Results reflect acquisitions including Ctrack and Feeney Wireless (FW), and the sale of certain hardware-module assets to Telit.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $60.9 million | $54.3 million | $190.6 million | $159.4 million |
| Gross profit / margin | $22.9 million / 37.7% | $14.5 million / 26.7% | $67.3 million / 35.3% | $42.4 million / 26.6% |
| Operating loss | $(11.9) million | $(7.5) million | $(22.9) million | $(23.5) million |
| Net loss attributable to Novatel | $(18.6) million | $(20.8) million | $(33.2) million | $(37.9) million |
| Net loss per share, basic and diluted | $(0.34) | $(0.38) | $(0.62) | $(0.73) |
| Operating cash flow | Not presented separately for the quarter | $0.1 million | $(26.3) million |
At September 30, 2016, cash and cash equivalents were $17.2 million and working capital was $24.8 million. Current assets were $97.0 million against current liabilities of $72.2 million. Total liabilities were $177.8 million and stockholders’ equity was $7.8 million.
Debt included $120.0 million principal of 5.50% convertible senior notes due 2020, carried net of discount and issuance costs at $88.8 million. The notes’ effective interest rate was 16.95% for the first nine months. There was no balance on the revolving facility; approximately $6.9 million was available to borrow. DigiCore bank facilities were $2.7 million current liabilities.
For the first nine months, investing activities provided $6.2 million, including proceeds from asset sales, while financing activities used $1.5 million. Cash increased by $4.6 million from year-end 2015. Q3 gross-margin improvement reflected a shift toward higher-margin SaaS, software and services.
Material changes versus comparable periods
- Q3 revenue rose 12.2%; nine-month revenue rose 19.6%. SaaS, software and services revenue increased sharply, to $14.8 million for Q3 and $41.2 million for nine months, primarily due to Ctrack. Hardware revenue fell 11.4% in Q3 and 3.2% year to date, reflecting the Telit divestiture and focus on selected products.
- Gross margin increased by 11.0 percentage points in Q3 and 8.7 points for the nine-month period. Despite higher gross profit, Q3 operating loss widened, with higher sales and marketing, general and administrative, amortization and impairment costs.
- Net loss narrowed compared with 2015, but the comparisons include unusual items: 2015 had a non-cash acquisition-escrow loss of $10.5 million in Q3 and $10.3 million for nine months. 2016 included a $2.6 million intangible-asset impairment and Telit-related gain activity; Q3 included a $2.4 million reduction to the gain recognized earlier in 2016.
- Interest expense increased to $11.7 million for nine months from $3.3 million, principally due to the convertible notes and related discount and issuance-cost amortization.
Outlook, commentary, risks and unusual items
- Management said cash, revolver availability and anticipated operating cash flows should cover working-capital needs for the next twelve months. The company remained loss-making; management noted that achieving profitability depends on revenue and mix supporting its cost structure and that missed plans could require further expense reductions or restructuring.
- The company agreed to sell its MiFi hotspot and USB-modem business for $50 million, subject to working-capital adjustment and closing conditions, with closing expected in Q1 2017. Conditions included stockholder approval, CFIUS approval and resolution of the company’s status under the convertible-note indenture. The transaction was not completed as of the filing. Management anticipated lower revenue but potential cost savings and improved gross profit; these expectations depended on assumptions and were not assured. The purchase agreement includes a $4 million termination fee in specified circumstances.
- On September 29, 2016, a Telit resolution set total consideration for the hardware-module asset sale at $11.7 million, including $11.3 million cash and $0.4 million in net-settled liabilities. The company recorded a $1.5 million liability for remaining assets to be delivered.
- A royalty-related contract claim was settled for $2.8 million, payable in eight quarterly installments; $2.5 million remained outstanding at quarter-end. The filing also describes patent litigation and customer indemnification obligations, which management did not expect to have a material adverse effect based on its assessment.
- Customer concentration was significant: the largest customer accounted for 55.3% of Q3 revenue and 54.6% of nine-month revenue. The company also highlighted reliance on third-party manufacturers and sole-source suppliers, including Telit for certain components, as well as competition, product execution, foreign currency and transaction-completion risks.
- Other items included $2.1 million of nine-month FW retention-related compensation expense, $6.7 million of earned FW acquisition-related amounts still outstanding, and $2.6 million of impairment primarily related to FW-developed technology. Restructuring charges were $1.7 million for nine months; the 2016 initiatives were expected to cost about $0.9 million and were completed in October 2016.
Most important facts for investors to verify
- Whether the proposed $50 million MiFi sale closed, its final working-capital adjustment and the resulting impact on retained-business revenue, margins and costs.
- Convertible-note repayment, conversion or other treatment required for the sale, along with the company’s actual liquidity and borrowing availability.
- Whether SaaS growth and gross-margin improvement persist apart from acquisition effects, and whether operating expenses can be reduced enough to improve profitability.
- Exposure to the largest customer and continuity of manufacturing and component supply, particularly for components sourced from Telit or other sole suppliers.
- Final cash timing and obligations for the Telit resolution, FW acquisition payments, royalty settlement, restructuring and any litigation or indemnification matters.