SQNS

Business Context and Reporting Period

Company: Sequans Communications S.A.
Filing Type: Form 6-K (Report of Foreign Private Issuer)
Reporting Period: Unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2013.
Business Overview: A leading fabless designer and supplier of 4G LTE and WiMAX semiconductor solutions for wireless broadband applications. The company operates a single segment focused on the design and marketing of semiconductor components.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 49% in Q3 2013 and 54% in the first nine months of 2013 compared to the prior year periods. Product revenue dropped 48% (Q3) and 60% (9 months), driven primarily by a significant decline in WiMAX product sales.
• Margin Compression: Gross margin fell from 48.0% to 25.1% in Q3 2013 and from 52.3% to 31.0% for the nine-month period. This was caused by low absorption of fixed costs due to lower revenue volumes and the introduction of lower-margin LTE modules.
• Operating Expenses: Total operating expenses remained relatively flat in Q3 (0% change) but decreased 9% for the nine-month period. Research and Development (R&D) expenses increased 14% in Q3 due to lower research tax credits recognized, while Sales and Marketing expenses decreased 25% (Q3) and 41% (9 months) due to cost reduction efforts.
• Liquidity: Cash and cash equivalents decreased from $28.8 million at December 31, 2012, to $15.0 million at September 30, 2013, reflecting cash burn from operations and R&D.

Outlook, Risks, and Management Commentary

• Market Trends: Management expects WiMAX product revenue to continue declining due to a general market downturn, particularly in the U.S. Conversely, the company is transitioning to LTE products, having started selling LTE modules for tablets and consumer electronics in Q3 2013.
• Customer Concentration: Revenue concentration has shifted. In Q3 2013, Huawei represented 37% of revenue, while two other customers (one China-based, one U.S.-based) represented 29% and 28% respectively. HTC, a major customer in 2012, generated no revenue in Q3 2013.
• Liquidity and Going Concern: The financial statements are prepared on a going concern basis. Management believes existing cash plus potential government funding and additional financing will be sufficient for at least the next 12 months.
• Legal and Tax Contingencies:
  • Tax Audit: French tax authorities proposed adjustments totaling approximately $1.2 million regarding research tax credits for 2008 and 2009. The company disputes these and has recorded a provision of $327,000.
  • Securities Litigation: A class action lawsuit regarding the 2011 IPO is pending. Parties reached an agreement in principle to settle in June 2013, subject to a final agreement. Settlement costs are expected to be covered by insurance.
• Foreign Exchange: The company faces significant currency risk as nearly 100% of revenue is in U.S. dollars while approximately 59% of operating expenses are in euros. A 10% fluctuation in the USD/EUR rate could impact operating expenses by approximately $1.8 million.

Key Facts for Investor Verification

• Cash Burn Rate: Verify the sustainability of the $15.0 million cash balance against the $24.1 million operating cash outflow for the nine-month period.
• WiMAX vs. LTE Transition: Assess the timeline and volume of LTE product sales required to offset the continued decline in WiMAX revenue.
• Customer Dependency: Monitor the stability of the top three customers (Huawei and two others) which collectively accounted for 94% of Q3 2013 revenue.
• Tax Dispute Resolution: Track the outcome of the French tax audit regarding the $1.2 million proposed adjustment.
• Capital Needs: Evaluate the necessity and timing of future capital raises given the current cash runway and ongoing R&D expenditures.