Exhibit 99.2
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MANAGEMENT DISCUSSION AND ANALYSIS
For the six months ended June 30, 2007
Norsat International Inc. | SYMBOL: NII (TSX)
110- 4020 Viking Way | Richmond | British Columbia | Canada | V6V 2N2.
tel : 604-821-2800 | fax: 604-821-2801 | www.norsat.com
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Norsat International Inc. | Management Discussion & Analysis |
1.0 Introduction
The following management discussion and analysis of Norsat International Inc. (“Norsat” or the “Company”) as of August 13, 2007 should be read in conjunction with the unaudited interim consolidated financial statements for the six months period ended June 30, 2007 and related notes included therein, as well as the audited consolidated financial statements and related notes and the Management Discussion and Analysis for the year ended December 31, 2006, which has been prepared in accordance with generally accepted accounting principles in Canada (Canadian GAAP).
All amounts following are expressed in Canadian Dollars unless otherwise indicated. Additional information relating to the Company, including the Company’s annual report and 20F for the year ended December 31, 2006, may be found on the Company’s web page at www.norsat.com and atwww.sedar.com.
Forward Looking Statements Statements in this report relating to matters that are not historical fact are forward-looking statements based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially. Factors that could cause or contribute to such differences include, but are not limited to, general economic conditions, changes in technology, reliance on third party manufacturing, managing rapid growth, global sales risks, limited intellectual property protection and other risks and uncertainties described in Norsat’s public filings with securities regulatory authorities. |
2.0 Business Overview
2.1 OVERVIEW OF THE BUSINESS
Norsat International Inc. (“the Company”) designs, develops and markets satellite ground equipment, which enables high speed transmission of data, audio and video over commercial and military satellites. The Company’s equipment is located on earth and thus falls under the broad category of “satellite ground equipment.” Norsat concentrates on ground equipment that is central to the transmission and reception of content for commercial and military applications, as opposed to consumer applications such as direct-to-home broadcasting.
Norsat’s business operates through two business segments - Microwave Products and Satellite Systems.
The Microwave Products segment designs, develops and markets receivers, transmitters and power amplifiers. The Satellite Systems segment designs, develops and markets portable satellite systems, related accessories and services. These Microwave Products and Satellite Systems are designed to interoperate with geostationary satellites orbiting the earth. The products permit users to establish a broadband communications link (up to 9 Mbps) between any two points on earth. This broadband communications link is capable of transporting a broad range of content including voice, data and moving video.
Norsat’s common shares trade on The Toronto Stock Exchange under the symbol NII and on the OTC Bulletin Board (OTCBB) under the symbol NSATF.
2.2 PRODUCTS
Microwave Products
Microwave components enable the transmission, reception and amplification of signals to and from satellites. The Company’s product portfolio of microwave components includes a comprehensive range of satellite receivers (LNBs), transmitters (BUCs), transceivers, solid-state power amplifiers (SSPAs) and other customized products.
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Norsat International Inc. | Management Discussion & Analysis |
Norsat is a leader in its microwave products markets. The Company has developed a reputation for quality, reliability and innovation through more than two decades of participation in the business. Management believes that the Company has the largest market share of any of its competitors in this space. The overall market tends to demonstrate steady but moderate growth in the 4 - 6% range.
Satellite Systems
Satellite Systems provide rapidly deployable broadband connectivity over satellite where traditional communications infrastructure is insufficient, unreliable, damaged or non-existent. The Company’s product portfolio of portable satellite systems includes the Norsat GLOBETrekkerTM and OmniLinkTM satellite systems.
The GLOBETrekkerTM is an intelligent, ultra-portable satellite system that enables users to establish a reliable broadband connection on short notice. It is designed to be carried in a backpack, is airline checkable, and fits in small vehicles. The GLOBETrekkerTM is ideal for users who are highly mobile. Examples of such users include special forces, first responders, business continuity managers, search and rescue personnel and journalists.
The OmniLink™ product family also addresses the demanding needs of users seeking to establish broadband connectivity on a temporary basis but for longer periods of time. This product line is ideal for use by government and peacekeeping agencies, broadcasters, resource exploration companies, distance education institutions, financial institutions, and large corporations.
Norsat is an early entrant into the portable satellite systems market. The Company believes its technology offers superior functionality, usability and portability compared to competitive offerings. Several companies offer satellite systems that provide similar functionality, but they are generally larger than GLOBETrekkerTM or OmniLinkTM, and the Company believes they are therefore unsuitable for the markets the Company targets. Because the ultra-portable category is still in early development stages, market share data is not readily available.
2.3 MARKETS AND TRENDS
Satellite-based communications employ satellites that are orbiting the earth to transmit and receive content. The Company’s equipment interoperates with satellites that orbit the earth at the same speed that the earth rotates. The satellite thus appears to be at the same point relative to the earth’s surface, thus giving the impression that the satellite is “stationary.” These satellites are known as geostationary satellites, or satellites in geostationary orbit (orbiting approximately 22,300 miles above the earth).
While geostationary satellites are operated on a commercial basis and are fairly standard in their operation, some are owned and operated by militaries and may have unique characteristics. The Company’s equipment has been standardized so that it can operate on most satellites, without further customization.
The satellite industry is seeing a broad-based recovery across all sectors of the market including the commercial and military markets. Satellites are proving to be particularly attractive to user communities who are on the move and need to access greater bandwidth than that offered by most other wireless terrestrial technologies. The Company’s products operate primarily on widely deployed commercial Ku-band satellites. However, some products operate on other commercial (C-band and Ka-band) and military (Ka-band and X-band) satellites as well.
Management believes that a number of industry trends are influencing demand for the Company’s products. In general, satellite terminal users are continually looking for greater bandwidth, increased portability, and improved ease of use. Specific trends include the following:
Ø | There is a growing expectation that organizations and individuals are always “connected” to some type of communications infrastructure, regardless of where they may be positioned geographically. As companies are increasingly required to look beyond traditional locations to meet the world’s demand for natural resources, there has been a proliferation of remote sites far removed from existing infrastructure. At the same time, demand for bandwidth is ever-expanding as users increasingly expect that video and audio files are capable of being transmitted, and that the transmissions will occur in real time. |
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Norsat International Inc. | Management Discussion & Analysis |
Ø | In the era of 24 hour news coverage, viewers have come to expect media to be able to cover a breaking story nearly instantaneously, regardless of where it occurs around the world. Media outlets need to be able to deploy quickly to meet this expectation. |
Ø | Major media are experiencing competition from alternative news sources that typically make content available over the internet. Partly in response, governments and non-governmental organizations are increasingly producing their own content relating to events they deem significant, and making this available to third parties or directly to the public. |
Ø | The nature of modern military operations is such that mobility and rapid establishment of communication links in the field are considered vitally important. |
Ø | Major organizations are increasingly aware of, and planning for, the need to maintain business continuity in the event of natural or man-made disasters. Their plans often include establishing communication capabilities that are not dependent on terrestrial infrastructure. |
Ø | A number of large scale disasters in recent years have instilled the importance of first responders being able to establish rapid communications links to coordinate recovery efforts. |
Ø | Experience with information technology and communication equipment in recent decades has conditioned users generally to expect such hardware to become smaller and more portable over time, while offering improved functionality. Providers who are able to meet this expectation can realize competitive advantages. |
Ø | Applications of satellite technology are becoming ubiquitous. From their traditional role in the broadcast and telecommunications fields, communications satellites have more recently been extended to such applications as broadband services, cellular and internet backhaul, location-based services, satellite imagery. As a result, a broader base of users has a need for ground-based satellite equipment. |
2.4 STRATEGY
Norsat’s primary value proposition is rooted in its longevity and reputation for quality. Customers with critical applications for which reliability of performance is absolutely essential tend to place significant value in the quality of Norsat products and the after sales support infrastructure. In addition, the Company has a track record of introducing innovative new products to the satellite industry. These attributes will remain core elements of Norsat’s strategy, and in fact they form the foundation on which the Company intends to grow.
Norsat plans to continue to invest in research and development to maintain its status as “best in class.” R&D efforts will be directed toward enhancing existing product lines and introducing new products. The Company recently began to give key suppliers a broader mandate to perform R&D activities related to the elements of the products for which they are responsible. This strategy serves to take better advantage of expertise in the Company’s supply chain, while reducing direct R&D costs. Furthermore, it allows Norsat to focus its development resources on the most critical functions, including the overall setting of product direction.
The Company sells most of its microwave components and portable satellite systems, other than those bound for the US Government, through resellers. Almost all of the portable satellite systems sold to the US Government have been through the Company’s direct sales force with a few exceptions. Over time, the Company intends to continue to grow its roster of active reseller partners as a means for expanding into new markets. The Company’s long-term diversification objectives include entering new geographic markets, broadening its customer base, and expanding into new market verticals.
A key component of the Company’s growth strategy is to expand the breadth of solution it provides to each customer. Currently, the vast majority of the Company’s revenues are comprised of the hardware it manufactures. Management believes there are a number of opportunities to bundle ancillary services and third-party hardware components with the core products. Customers would benefit from an “end-to-end solution provider” approach, and would be assured that all of the elements of its satellite communications solution are configured to work well together, and that Norsat would be able to provide comprehensive support. The Company would benefit from stronger customer relationships, and increase in the average sale, and in the long-term, the development of a stable recurring revenue stream. The Company also plans to pursue opportunities to cross-sell its newer product lines to its existing customer base.
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Norsat International Inc. | Management Discussion & Analysis |
3.0 Second Quarter Review
3.1 SECOND QUARTER HIGHLIGHTS
Ø | Revenue increased to $4.5 million, up 18% from $3.8 million in Q2 2006 |
Ø | Gross margin was 59%, compared to 47% for Q2 2006 |
Ø | Net earnings were $0.6 million, representing Norsat’s third consecutive quarter of profitability, compared to net loss of $1.0 million in Q2 2006 |
Ø | Eliminated debt position |
Ø | Secured $1.0 million in portable satellite system orders from the United States Army |
Ø | Launched Chinese language version of the portable satellite system user interface, LinkControlTM, a line of Low Noise Amplifiers and a Satellite News Gathering variant of GLOBETrekker |
Ø | Won, as part of a consortium, a five-year, indefinite delivery indefinite quantity (IDIQ) contract under the US General Services Administration SATCOMM-II program |
3.2 SECOND QUARTER REVIEW
The second quarter of fiscal 2007 represented the third consecutive profitable quarter under the administration of Dr. Amiee Chan. A number of factors impacted the second quarter’s results; however, it was mainly driven by the successful implementation of the Company’s strategies aimed at expanding the breath of solution for its customers, adding or improving new production lines and cost restructuring.
Sales for the quarter totaled $4.5 million, 18% higher than the $3.8 million reported in the same period last year. Gross margins improved to 59%, up from 47% for the same period last year. Operating expenses were $1.8 million, or 33% below the $2.7 million incurred in the same period last year, due in large part to the cost restructuring efforts initiated in September 2006. Net earnings were $0.6 million, compared to a net loss of ($1.0) million in the same quarter in the previous year.
In March 2007, the Company paid off the US$2 million convertible debt through cash generated from operations and a renewable short term loan facility of $1.2 million. On May 30, 2007, the Company paid off its remaining debt obligations.
As at June 30, 2007, the Company had working capital totaling $4.1 million compared to $2.3 million as at December 31, 2006. Working capital increased by $1.8 million primarily due to reduction in short term debt.
The Company continues to believe that the long term prospects in the satellite industry remain strong, driven by the net-centric transformation of militaries, growth in homeland security spending and the emergence of non-traditional applications such as business continuity and content production by novice entities.
Key factors that will be expected to affect the Company’s revenue growth in the near term remain the timing of the award of major military and certain other commercial projects. It is expected that competition will continue to intensify as more companies focus on opportunities in this market which will likely put pressure on gross margins.
Having restructured the Company, management is very focused on implementing a business model which will serve to (i) add a recurring revenue stream through a range of services, (ii) broaden the Company’s portfolio to include the sale of comprehensive solutions, (iii) actively recruit and cultivate reseller channel partners, and (iv) diversify the base of customers to include non-defense customers.
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Norsat International Inc. | Management Discussion & Analysis |
3.3 Selected Annual Financial Information
Annual Financial Data
(Expressed in thousands of dollars, except per share amounts)
Year Ended December 31 | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
$ | $ | $ | ||||||||||
Sales | 15,256 | 18,116 | 17,521 | |||||||||
(Loss) earnings from continuing operations before taxes | (4,397 | ) | (5,888 | ) | 424 | |||||||
Net (loss) earnings | (4,348 | ) | (5,889 | ) | 1,153 | |||||||
(Loss) earnings per share from continuing operations | (0.09 | ) | (0.14 | ) | 0.01 | |||||||
(Loss) earnings per share, basic and diluted | (0.09 | ) | (0.14 | ) | 0.03 | |||||||
Total Assets | 9,820 | 10,524 | 12,199 | |||||||||
Long-term debt | nil | 2,008 | 1,468 |
3.4 Results of Operations
Three months ended June 30, 2007 | Six months ended June 30, 2007 | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Sales (in $000’s) | $ | $ | $ | $ | ||||||||||||
Microwave Products | $ | 2,497 | $ | 2,317 | $ | 5,180 | $ | 4,229 | ||||||||
Satellite Systems | 1,869 | 1,408 | 3,436 | 2,454 | ||||||||||||
Other Sales | 161 | 39 | 319 | |||||||||||||
Total | $ | 4,527 | $ | 3,764 | $ | 8,935 | $ | 6,683 | ||||||||
Gross Profit margin | % | % | % | % | ||||||||||||
Microwave Products | 53 | 47 | 49 | 46 | ||||||||||||
Satellite Systems | 66 | 43 | 62 | 39 | ||||||||||||
Average gross margin | 59 | 47 | 56 | 43 |
Three Months ended June 30, 2007 compared to Three Months ended June 30, 2006
Total sales for the three months ended June 30, 2007 was $4.5 million, up from the $3.8 million earned in the same period of 2006. Second quarter sales reflected a contract backlog from the previous quarter.
Sales from Microwave Products were $2.5 million, up 8%, compared to $2.3 million in the same period last year, reflecting the introduction of new microwave products and strong support from the resellers. Sales of Satellite Systems were $1.9 million, up 32%, compared to $1.4 million in the same period last year. The increase was primarily a result of increased military market penetration.
Due to the nature of the Company’s business, management expects sequential sales will be uneven. Norsat has a relatively small base of customers who often place orders that represent a significant share of sales for a given quarter, and the timing of those orders is unpredictable. The Company is positioned to maximize sales growth in the long-term.
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Norsat International Inc. | Management Discussion & Analysis |
The overall gross margin in the three months ended June 30, 2007 was 59% compared to 47% in the same period last year. The improvement in gross margin was a result of new product introductions in both business segments.
The gross margin for Microwave Products was 53% compared to 47%, due to the launch of new products for high-end commercial and government markets. The gross profit margin for the Satellite Systems increased to 66% in the second quarter of 2007 compared to 43% in the same period of 2006. This increase was driven by the addition of complementary products and new accessories to the product line as part of the Company’s efforts to become an end-to-end solutions provider. In addition, in Q2 2006, satellite system gross margins reflected an increased provision for obsolete inventory and work in progress adjustments for customer orders. Management expects that the gross margin generated by the Satellite Systems segment in the second quarter of 2007 is approximately 10 - 20% higher than the sustainable level, although margins are expected to vary from quarter to quarter.
Six Months ended June 30, 2007 compared to Six Months ended June 30, 2006
Total sales for the six months ended June 30, 2007 was $8.9 million, compared to $6.7 million in the same period of 2006 due to a strong backlog from 2006 in both business units.
Sales of Microwave Products were $5.1 million for the six months ended June 30, 2007 compared to $4.2 million in the same period last year, an increase of 21% due to increased volumes through resellers. Sales of Satellite Systems were $3.4 million compared to $2.4 million in the same period last year, an increase of $1 million, or 42%, primarily due to a larger number of military contracts in first two quarters of 2007.
The overall gross margin increased to 56% from 43% in the same period last year due to increased margins on both business units.
The gross profit margin for Microwave Products increased to 49% from 46% due to a shift to a higher margin product mix. The gross profit margin for Satellite System increased to 62% from 39% due to two major factors: sales mix consisted of higher margin products and the Company recording an increased provision for obsolete inventory and work in progress adjustments for custom orders in the first six months of 2006.
Three months ended June 30, | Six months ended June 30, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Expenses (in $000’s) | $ | $ | $ | $ | ||||||||||||
Selling, general and administrative | 1,532 | 2,289 | 2,843 | 4,222 | ||||||||||||
Product development | 185 | 243 | 447 | 1,060 | ||||||||||||
Amortization | 85 | 160 | 160 | 284 | ||||||||||||
Total Expenses | 1,802 | 2,692 | 3,450 | 5,567 |
Three Months ended June 30, 2007 compared to Three Months ended June 30, 2006
For the three months ended June 30, 2007, total operating expenses decreased by 34% to $1.8 million from $2.7 million in the same period last year.
Throughout the quarter, the Company’s new management team, appointed by the Board of Directors in September 2006, continued to focus on meeting customers’ needs and developing strong partnerships with resellers in key markets.
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Norsat International Inc. | Management Discussion & Analysis |
Selling, general and administrative (SG&A) expenses decreased to $1.5 million in the second quarter of 2007 from $2.3 million in the same period of 2006, mainly due to the cost restructuring initiatives commenced in 2006. The savings achieved included a $0.2 million decrease in rent expenses, and a $0.4 million reduction in salaries and consulting fees. Other administrative expenses were reduced accordingly in the second quarter including insurance premiums and trade show costs.
Product development expenses remained relatively the same at $0.2 million in the second quarter of 2007 as compared to the same period of 2006.
The aggregate volume of R&D activities meanwhile, was much higher in both periods when one considers those expenses which were capitalized and those which were undertaken by strategic partners. Neither of these expenses is captured as product development expenses. In the second quarter of 2006, the company capitalized some of its GLOBETrekker-related materials purchases. Meanwhile, in the second quarter of 2007, a strategy shift helped offload development expenses to strategic suppliers. The company continues to take responsibility for its core R&D activities, and plans to continue to lead the market with introductions of innovative new products.
On-going development activities are focused on projects generating near-term revenue from the portable terminals business segment and modifications required to the existing line of microwave products.
Amortization expenses were reduced to $0.08 compared to $0.2 in the second quarter of 2006. The Company purchased an ERP system at a cost of nearly $0.4 million at the end of the first quarter. However, amortization of this expenditure did not commence until full implementation was completed in May 2007.
Six Months ended June 30, 2007 compared to Six Months ended June 30, 2006
Selling, general and administrative (SG&A) expenses for the six months ended June 30, 2007 decreased by $1.4 million to $2.8 million as compared to $4.2 million for the same period mainly due to decreases in marketing, legal fees, salaries, and rent expenses.
Production development expenses decreased by $0.6 million to $0.4 compared to $1.1 million for the same period last year. This was mainly due to the offloading of development expenses to strategic partners.
Amortization costs for the period decreased to $0.2 million from $0.3 million for the same period last year as a consequence of certain assets being fully amortized.
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Norsat International Inc. | Management Discussion & Analysis |
Earnings (loss) (in $000’s except earning per share)) | Three months ended June 30 | Six months ended June 30 | ||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
$ | $ | $ | $ | |||||||||||||
Earnings (loss) from continuing operations before other expenses and income taxes | 872 | (939 | ) | 1,553 | (2,678 | ) | ||||||||||
Other expenses | 292 | 129 | 433 | 170 | ||||||||||||
Earnings (loss) from continuing operations before income taxes | 580 | (1,068 | ) | 1,121 | (2,849 | ) | ||||||||||
Net earnings (loss) per share Basic and diluted from Continued operations | 0.01 | (0.02 | ) | 0.02 | (0.06 | ) |
Three Months ended June 30, 2007 compared to Three Months ended June 30, 2006
Earnings from continuing operations before taxes and other expenses were $0.9 million in the second quarter, compared to a loss of $0.9 million in the same period of 2006. The improvement was mainly due to increased sales in both business segments, accompanied by reduced administrative costs such as rent, staff and insurance premiums.
Other expenses for the second quarter were $0.3 million compared to $0.1 million during the same period of 2006. Although interest expense was reduced, the primary factor contributing to the year-over-year increase was a larger loss in foreign exchange compared to the same period last year, as a result of the strengthening Canadian dollar against the US dollar.
The combined effect of the above was net earnings of $0.6 million or $0.01 per share in the second quarter of 2007, compared to net loss of $1.0 million or ($0.02) per share in the same period last year.
Six Months ended June 30, 2007 compared to Six Months ended June 30, 2006
Earnings from continuing operations before taxes and other expenses were $1.5 million for the six months ended June 30, 2007, compared to a loss of $2.7 million in the same period of 2006, mainly due to increased sales and reduced administrative costs.
Other expenses for the six months ended June 30, 2007 were $0.4 million compared to $0.2 million during the same period of 2006. The factors contributing were a combination of foreign exchange losses in the second quarter of 2007 as well as interest paid to vendors in the first quarter of 2007.
The combined effect of the above was net earnings of $1.1 million or $0.02 per share for the six months ended June 30, 2007, compared to net loss of $2.8 million or ($0.06) per share in the same period last year.
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Norsat International Inc. | Management Discussion & Analysis |
3.5 | Summary of Quarterly Results |
Quarterly Financial Data (unaudited)
(Expressed in thousands of dollars, except per share amounts)
Q1 | Q2 | Q3 | Q4 | |||||||||||||
Mar 31 | Jun 30 | Sep 30 | Dec 31 | |||||||||||||
2007 | $ | $ | ||||||||||||||
Sales | 4,408 | 4,526 | ||||||||||||||
Earnings (loss) from continuing operations before taxes | 541 | 580 | ||||||||||||||
Net (loss) earnings | 541 | 578 | ||||||||||||||
Earnings (loss) per share from continuing operations - | 0.01 | 0.01 | ||||||||||||||
Basic and diluted | - | - | ||||||||||||||
Earnings (loss) per share - basic and diluted | 0.01 | 0.01 | ||||||||||||||
- | - | |||||||||||||||
Weighted average common shares outstanding - basic | 50,486 | 50,558 | - | - | ||||||||||||
Weighted average common shares outstanding - diluted | 50,486 | 55,371 | ||||||||||||||
2006 | $ | $ | $ | $ | ||||||||||||
Sales | 2,919 | 3,764 | 3,149 | 5,424 | ||||||||||||
Earnings (loss) from continuing operations before taxes | (1,782 | ) | (1,068 | ) | (2,030 | ) | 481 | |||||||||
Net earnings (loss) | (1,782 | ) | (1,068 | ) | (2,030 | ) | 532 | |||||||||
Earnings (loss) per share from continuing operations - | (0.04 | ) | (0.02 | ) | (0.04 | ) | $ | 0.01 | ||||||||
Basic and diluted | - | - | - | - | ||||||||||||
Earnings (loss) per share - basic and diluted | (0.04 | ) | (0.02 | ) | (0.04 | ) | $ | 0.01 | ||||||||
Weighted average common shares outstanding | # | # | # | # | ||||||||||||
Basic and diluted | 44,003 | 47,063 | 47,063 | 48,557 | ||||||||||||
2005 | $ | $ | $ | $ | ||||||||||||
Sales | 2,519 | 6,155 | 4,721 | 4,721 | ||||||||||||
(Loss) earnings from continuing operations before taxes | (1,188 | ) | (1,241 | ) | (1,377 | ) | (2,083 | ) | ||||||||
Net (loss) earnings | (1,188 | ) | (1,241 | ) | (1,377 | ) | (2,083 | ) | ||||||||
(Loss) earnings per share from continuing operations - basic and diluted | (0.03 | ) | (0.03 | ) | (0.03 | ) | (0.05 | ) | ||||||||
(Loss) earnings per share - basic and diluted | (0.03 | ) | (0.03 | ) | (0.03 | ) | (0.05 | ) | ||||||||
Weighted average common shares outstanding | # | # | # | # | ||||||||||||
Basic and diluted | 42,052 | 42,052 | 42,259 | 42,518 |
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Norsat International Inc. | Management Discussion & Analysis |
3.6 Liquidity and Financial Condition
The Company’s principal cash requirements are for working capital, capital expenditures, and interest payments on the Company’s debt.
The Company's cash balance as at June 30, 2007 was $0.5 million, a decrease of $1.3 million from $1.8 million as at December 31, 2006. During the three months ended June 30, 2007, cash provided by operations totaled $1.1 million. Cash consumed by debt obligations was $1.2 million.
The Company’s working capital requirements are mainly for production materials, selling, operations and general administrative expenses. The Company’s working capital may be improved by increasing sales, shortening collection and payment cycles, enhancing of inventory controls and reducing debt levels.
As at June 30, 2007, the Company had working capital totaling $4.1 million compared to $2.3 million as at December 31, 2006. Working capital increased by $1.8 million mainly due to the reduction of debt obligations which had been classified as current liabilities.
Accounts receivable, which was $2.4 million as at June 30, 2007, is in line with the balance as of December 31, 2006. The bad debt provision is reviewed at the end of each financial period according to the Company’s policy which is based on the credit terms of its customers and historical collection data. The policy is reviewed regularly by the Company. Having determined that the accounts receivable turn over was slower due to military sales, the Company’s bad debt provision is considered to have been reasonably assessed as at June 30, 2007.
Accounts payable and accrued liabilities were $2.3 million, a decrease of $1.2 million, compared to $3.5 million as at December 31, 2006, reflecting a shorter accounts payable cycle.
Inventory as at June 30, 2007 was $ 3.4 million, unchanged from December 31, 2006. With the increased sales volume in the second quarter, the consistent inventory level reflected new purchases to meet the anticipated future sales demand and the reduced inventory obsolescence provision. The Company’s inventory level for Microwave Products is replenished on a just-in-time basis. The inventory turns for Satellite Systems are regularly slower than microwave products due to a longer lead time for certain parts. The Company continues to focus on reducing its satellite system inventory level, which had built up due to over purchasing in the past year, in order to achieve improved efficiency in its inventory control and cash management.
Shareholders’ equity has increased by $1.7 million compared to December 31, 2006 primarily due to the net proceeds of $0.5 million received from the private placement and net profit resulting from the first two quarters’ operations.
3.7 Capital Resources
The Company’s capital resources as at June 30, 2007 included cash and cash equivalents. Cash flows are funded primarily through operations and, where necessary, liquidity requirements may be funded through the issuance of debt, and/or equity.
During the three months ended June 30, 2007 the Company completed the following financing transactions:
1. Repayment of $1.2 million short-term loan
On May 30, 2007, the Company paid off the $1.2 million short-term loan in full.
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Norsat International Inc. | Management Discussion & Analysis |
3.8 Contractual Obligations
The following table presents the aggregate amount of future cash outflows for contractual obligations as of June 30, 2007 under various purchasing commitments, loan commitments and operating lease agreements for each of the next five years:
CONTRACTUAL OBLIGATIONS | 2007 | 2008 | 2009 | 2010 | 2011 | |||||||||||||||
$ | $ | $ | $ | $ | ||||||||||||||||
Inventory purchase obligation | 3,297,124 | | | | | |||||||||||||||
Operating lease obligations | 284,627 | 509,865 | 464,162 | 464,162 | 427,109 | |||||||||||||||
Total | 3,581,751 | 509,865 | 464,162 | 464,162 | 427,109 |
In the normal course of operations the Company enters into purchase commitments. The Company has accrued for estimated losses, if any, when determinable, including losses on disputed purchase commitments with suppliers. Included in 2007 commitments are inventory and material purchases of $ 3,297,124.
The Company believes most of its working capital can be funded through its operations. The Company may also pursue other financing facilities to fund its working capital and meet its debt obligations from time to time.
Due to consistently changing economic conditions which may not be under the control of the Company, there can be no assurance that additional financing will be available when needed or, if available, that it can be obtained on commercially reasonable terms.
4.0 Outlook
The Company believes that overall demand is growing in both of its market segments. The Satellite Systems segment is likely to offer more attractive growth rates for the foreseeable future, given that the markets the Company is targeting are relatively new or even untapped. The Microwave Products segment is a more mature market, which still offers attractive returns for a leading participant like Norsat.
While results will fluctuate from quarter to quarter, Management believes that recent efforts to rationalize the cost structure will enable the Company to maintain and grow profitability over the long-term. The Company plans to execute a balanced growth strategy which incorporates new product introductions, continued enhancement of existing product lines, diversification by region and by industry vertical, and a broadening of the solution provided to customers.
5.0 Off Balance Sheet Arrangements
Not applicable.
6.0 Transactions with Related Parties
On March 22, 2007, the Company received a $150,000 bridge loan from an officer of the Company. This short term loan was repaid on May 3, 2007.
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Norsat International Inc. | Management Discussion & Analysis |
7.0 Proposed Transactions
Not applicable.
8.0 Critical Accounting Estimates
The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in Canada, and makes estimates and assumptions that affect its reported amounts of assets, liabilities, revenue and expenses, and the related disclosures of contingent liabilities. The Company bases its estimates on historical experience and other assumptions that it believes are reasonable in the circumstances. Actual results may differ from these estimates.
Management has discussed the development and selection of the Company’s critical accounting estimates with the Audit Committee of the Company’s Board of Directors, and the Audit Committee has reviewed the following disclosures.
The following critical accounting policies reflect the Company’s more significant estimates and assumptions used in preparing its consolidated financial statements:
Ø | The Company maintains an allowance for doubtful accounts for estimated losses that may arise if any of its customers are unable to make required payments. Management specifically analyzes the age of outstanding customer balances, historical bad debt experience, customer credit-worthiness and changes in customer payment terms when making estimates of collectability of the Company’s accounts receivable balance. If the Company determines that the financial condition of any of its customers has deteriorated, increases in the allowance may be made. At June 30, 2007, $12,550 (December 2006 - $198,170) as a reduction to accounts receivable. |
Ø | The Company values its finished goods and work-in-process inventories at the lower of weighted average cost and net realizable value. Net realizable value reflects the current estimated net selling price or value in use of the item in inventory in a non-forced sale. The Company assesses the need for inventory write-downs based on its assessment of estimated net realizable value using assumptions about future demand and market conditions. When the results of these assumptions differ from the Company’s projections, an additional inventory write-down may be required. In addition, changes in the underlying factors used in the Company’s projections may necessitate additional write-downs in the future. Market factors are generally outside of the Company’s control. At June 30, 2007 the Company has recorded an estimate for obsolescence provision in the amount of $1,765,951 (December 2006 - $1,919,881) as a reduction to inventory. |
Ø | The Company generates a portion of its revenue from multiple elements sales arrangements. Revenue is recognized for each element when there are no remaining performance obligations required and is based on their relative fair value at the inception of the sales arrangement. If fair value cannot be determined, either due to changes in contract elements or other factors, it will be necessary to defer revenue until objective evidence of fair value exists or when the final elements are delivered. |
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Norsat International Inc. | Management Discussion & Analysis |
9.0 Changes in Accounting Policies including Initial Adoption
The Company did not adopt any new accounting standards or change any accounting policies during the three months ended June 30, 2007 except the following:
Comprehensive Income
In the second quarter ended June 30, 2007, the Company has adopted CICA Handbook Section 1530, “Comprehensive Income”, which defines and establishes the reporting requirements for comprehensive income. Comprehensive income is the change in shareholders’ equity during a period from transactions and other events and circumstances from non-owner sources. Under this section, the Company is required to present comprehensive income and its components in a financial statement showing (a) net income for the period; (b) each component of revenue, expense, gain and loss that is recognized in other comprehensive income and (c) the total of (a) and (b). As at the end of June 30, 2007, the Company has no other comprehensive income.
As a consequence of adopting Section 1530, the Company has also adopted the Section 3251, “Equity”, Section 3855, “Financial Instruments - Recognition and Measurement”, Section 3861, “Financial Instrument - Disclosure and Presentation”, and Section 3865, “Hedges”.
10.0 Financial Instruments and Other instruments
The Company’s financial instruments include cash and cash equivalents, short-term investments, accounts receivables, accounts payable, accrued liabilities, short term loans. The carrying value of cash and cash equivalents, short-term investments, accounts receivables, accounts payable, and accrued liabilities is approximate to their fair values due to the short-term nature of these financial assets and liabilities.
The Company is exposed to foreign currency exchange risk as a result of its sales and cost of sales being predominately denominated in United States dollars. To manage its exchange risk, the Company holds cash and cash equivalents denominated in United States dollars and has entered into financing in United States dollars. The Company has not entered into any derivative agreements to further mitigate this risk.
11.0 Outstanding Share Data
The following details the share capital structure as at August 13, 2007:
Remaining life / Expiry date | Exercise price | Number of securities | Total | |
Common shares | 50,628,526 | |||
Share purchase options | ||||
3.71 years | $0.50 to $2.39 | 1,698,950 | ||
3.37 years | $2.40 to $4.29 | 94,250 | ||
3.37 years | $4.30 to $6.19 | 94,250 | 1,887,450 | |
Warrants | April 8, 2009 | $1.09 | 1,206,811 | |
March 8, 2008 | US$0.475 | 3,065,232 | ||
November 6, 2008 | US$0.45 | 1,250,000 | ||
January 12, 2009 | $0.58 ($US0.475) | 532,984 | 6,055,027 |
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Norsat International Inc. | Management Discussion & Analysis |
12.0 Risks and Uncertainties
12.1 RISKS ASSOCIATED WITH FINANCIAL RESULTS
The Company’s inability to generate sufficient cash flows from its operations. The Company’s consolidated financial statements have been prepared on a going concern basis, which presumes the realization of assets and the settlement of liabilities in the normal course of operations. The application of the going concern basis is dependent upon the Company having sufficient available cash resources and achieving profitable operations to generate sufficient cash flows to fund continued operations. Should the Company fail to generate sufficient cash flows from operations, it will require additional financing to remain a going concern. At June 30, 2007, the Company has accumulated a deficit of $45,053,240. The Company started to generate net profit from its continued operations through the fourth quarter of 2006 to the second quarter of 2007. However, it cannot be used as an indication of the Company’s future performance.
On May 30, 2007 the Company paid off its $1.2 million short-term debt. The retirement of this loan reflects on this team’s commitment to strengthen the Company’s financial foundation on a compressed schedule.
In view of these conditions, the ability of the Company to continue as a going concern is dependent upon achieving profitable operations and on the ability of the Company to obtain additional financing. The outcome of these matters can not be predicted at this time. These financial statements do not include any adjustments to the amounts and classification of assets and liabilities that might be necessary should the Company be unable to continue in business.
The Company’s inability to accurately forecast its results from quarter to quarter may affect its cash resources and result in wide fluctuations in the market price of the Company's stock. The operating results have varied on a quarterly basis in the past and may fluctuate significantly in the future as a result of a variety of factors, many of which are described below. Due to these and other factors, most of which are outside of the Company’s control, the quarterly revenues and operating results are difficult to forecast. As a result, the Company may not be able to accurately predict its necessary cash expenditures during each quarter or obtain financing in a timely manner to cover any shortfalls. The Company also believes that period-to-period comparisons of its operating results may not be meaningful and one should not rely on any such comparisons as an indication of its future performance.
12.2 RISKS ASSOCIATED WITH BUSINESS AND OPERATIONS
The Company’s exposure to business and operation risks includes but is not limited to the following:
Ø | The Company cannot be sure it will be able to identify emerging technology and market trends, enhance the existing technologies or develop new technologies in order to effectively compete in the satellite communications industry. |
Ø | The Company has customer concentration. A significant portion of the Company’s revenues have been recognized from a limited number of customers. While the Company has been diversifying its customer base, the efforts to date may be insufficient to offset the effects of the quarterly variance of sales and delays associated with selling to the Government sector. |
Ø | The Company cannot be sure that it will be able to compete effectively with the current competitors. |
Ø | The Company has limited intellectual property protection. |
Ø | The Company depends on its key employees and it cannot be sure that it will be able to keep these employees or hire and train replacements. |
Ø | The Company sells products which may, in certain instances, be subject to export and/or re-export restrictions. The Company may also be subjected to penalties and fines should there be a breach in its processes. The Company has formed a committee to actively oversee compliance with all such export regulations. |
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Norsat International Inc. | Management Discussion & Analysis |
Ø | The Company buys components and products which may, in certain instances, be subject to contractual obligations to purchase minimum quantities during a given period, maintain resale records and abide by certain resale restrictions. Failure to fulfill any or all of these may negatively impact liquidity should the Company be forced to take ownership of any un-purchased units. It may also affect the Company’s ability to continue supplying products as originally specified and thus affect obligations to fulfill customers. |
Ø | The Company may be subject to product liability claims, which are not fully covered by insurance. |
Ø | The Company intends to expand its international operations. It thus faces a number of risks including tariffs and other trade barriers, political and economic instability in foreign markets and fluctuations in foreign currencies. Those external risks may not be under the Company’s control. While the additional resources are required for the expansion, the Company cannot be sure its success and a failure of such expansion would have reversed impact on the Company’s business. |
Readers are advised to assess to Form 20F filed under www.sec.gov/edgar.html for the full contents of “Risks Associated with Business and Operations”.
12.3 RISKS ASSOCIATED WITH THE VALUE OF NORSAT SHARES
The exercise of the existing outstanding options, warrants and warrants to be issued may substantially dilute the value of the Company’s common shares. The Company has 75,000,000 shares of Common Stock authorized, of which 50,628,526 were outstanding at June 30, 2007 and an additional 7,965,007 common shares have been reserved for issuance upon the exercise of outstanding options, warrants and warrants to be issued as of such date. Although the Board of Directors has no present intention to do so, it has the authority, within parameters set by the Toronto Stock Exchange (the “TSX”), without action by the shareholders, to issue authorized and unissued shares of Common Stock. Any series of Preferred Stock, if and when established and issued, could also have rights superior to shares of the Company’s Common Stock, particularly in regard to voting, the payment of dividends and upon liquidation of Norsat. Convertible debt, if issued to raise additional working capital for the Company could also have dilutive effect on the shareholders.
12.4 RISKS ASSOCIATED WITH FOREIGN EXCHANGE
The Company is exposed to foreign exchange fluctuations in the U.S. dollar. A stronger Canadian dollar reduces U.S. dollar-denominated revenues and expenses. Net income is also reduced because a higher percentage of revenues than expenses are generated in U.S. dollars. Although majority of the Company’s sales are in U.S. dollars, it has a natural hedge in that it also purchases majority of its inventory in US dollars. The Company does not engage in any formal hedging transactions at this time but has plans in place to hedge its position for large sale transactions.
13.0 Disclosure Controls and Internal Controls over Financial Reporting
13.1 DISCLOSURE CONTROLS AND PROCEDURES
Disclosure controls and procedures are designed to provide reasonable assurance that all relevant information is gathered and reported to senior management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) on a timely basis so that appropriate decisions can be made regarding public disclosure.
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Norsat International Inc. | Management Discussion & Analysis |
An evaluation of the effectiveness of the design and operation of disclosure controls and procedures was conducted as of June 30, 2007, by and under the supervision of the CEO and CFO. Based on this evaluation, the CEO and CFO have concluded that the disclosure controls and procedures, as defined in Canada by Multilateral Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings, and in the United States by Rule 13a-15(e) under the Securities Exchange Act of 1934 (“the Exchange Act”) are effective to ensure that (i) information required to be disclosed in reports that are filed or submitted under Canadian securities legislation and the Exchange Act is recorded, processed, summarized and reported within the time periods specified in those rules and forms; and (ii) material information relating to the Company is accumulated and communicated to the Company’s management, including the CEO and CFO, or persons performing similar functions.
13.2 INTERNAL CONTROLS OVER FINANCIAL REPORTING
Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with Canadian GAAP and the requirements of the Securities and Exchange Commission in the United States, as applicable. Management is responsible for establishing and maintaining adequate internal controls over financial reporting for the Company.
The Company’s management, including the CEO and CFO, has evaluated the effectiveness of the internal controls over financial reporting. Based on this evaluation, management has concluded that internal controls over financial reporting were designed effectively as of June 30, 2007.
As a result of this review it was determined that there were no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting.
While the Company’s CEO and CFO believe that the Company’s internal controls over financial reporting provide a reasonable level of assurance that they are effective, they do not expect that the Company’s disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. A control system, no matter how well conceived or operated, can only provide reasonable, not absolute, assurance that the objectives of the control system are met.
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