Full year results

30 April 2018

Telit Communications PLC

Full year results

Telit Communications PLC ("Telit", "the Group", AIM: TCM), a global enabler of the Internet of Things (IoT), has published its results for the year to 31 December 2017 today.

Key corporate developments

· Change in management following departure of former CEO

· New board of directors

· Initiation of cost optimisation plan based on product and activities review

· Integration process of hardware and services business units initiated, addressing the strategy of becoming a leader in end-to-end IoT solutions

· Automotive division being considered for sale - range of proposals being evaluated

Financial highlights1

· Revenues $374.5 million (2016: $370.3 million)

o Cloud and connectivity revenues up 7% to $27.7 million (2016: $25.9 million)

· Gross margin of 35.1% (20162: 40.3%) with gross profit of $131.6 million (2016: $149.4 million)

· Adjusted EBITDA of $18.1 million (2016: $53.3 million) reflecting lower gross margin and increase in operating expenses

· Adjusted EBIT loss of $10.7 million (2016: profit of $33.1 million). Operating loss of $49.7 million (2016: profit of $19.4 million) which includes $29.8 million of non-recurring expenses3 

· Adjusted loss before tax $17.8 million (2016: profit of $31.7 million). Loss before tax of $56.8 million (2016: profit of $17.9 million) which includes $29.8 million of non-recurring expenses3

· Adjusted basic loss per share of 16.4 cents (2016: earnings per share of 25.4 cents). Basic loss per share of 41.9 cents (2016: earnings per share of 13.4 cents)

· Negative cash flow from operating activities $4.8 million (2016: cash generated $46.8 million)

· Net debt at 31 December 2017 $30.2 million (31 December 2016: $17.7 million)

Operational highlights

· Acquisition of GainSpan in February 2017 - added ultra-low power Wi-Fi to capabilities

· Strong growth in the Automotive business with new designs in North America and Asia

· New partnership with Idemia to deliver SimWISE - embedded SIM card within low category 4G modules

· Received the certifications for:

o CAT-1 modules, including VoLTE from the two main mobile operators in US

o new LTE CAT-M and CAT-M1 modules

· New collaboration with Wind River®, an Intel® company, to accelerate Industrial IoT (IIoT) adoption

· Rationalisation of product portfolio and operating costs result in a restructuring plan implementation - will contribute to $10 million reduction in cash expenses in 2018

1 - For the definition of 'Adjusted' figures and reconciliation from IFRS financial results to adjusted financial results see note 5.

2 - 2016 figures are presented following a restatement. For further details, see note 4.

3 - Comprised of $16 million exceptional items related to restructuring; $5.4 million other non recurring expenses; and $8.4 million impairment of internally generated development assets. For further details see Finance Director statement.

Richard Kilsby, non executive Chairman, commented:

"As a revitalised Board following the management overhaul, we have implemented wide-ranging and fundamental changes to the business. We are pleased that the early signs are that these changes, especially to the Group's activities and cost base, have led to positive operational progress since the beginning of 2018."

Yosi Fait, Chief Executive Officer, said:

"2017 was a very challenging year for Telit - declining revenues and margins in our module business, together with slower than expected growth in our IoT services business and a sharp increase in operating expenses, resulted in poor financial performance.

With a strong first quarter, I believe that the double-digit growth planned for 2018, together with stabilisation of our gross margins, and cost optimisation we are implementing, should bring a better financial performance and improve our cash flow generation."

For further information:

Chairman's statement

I joined the Board relatively late in the year, and I report on behalf of the Board on what has clearly been a year where the Group has fought through challenges at every level. The Group is changing rapidly and 2018 will be very different to 2017, as well as very different to the years before.

As a revitalised Board, we have implemented wide-ranging and fundamental changes to the business. We are pleased that the early signs are that these changes, especially to the Group's activities and cost base, have led to positive operational progress since the beginning of 2018.

Financial performance

The financial performance of the business was clearly disappointing.

As the year progressed, Telit was adversely affected by several key factors, including later than expected certification from leading North American mobile network operators (MNOs) of our LTE CAT 1 Voice over LTE (VoLTE) modules; delays in several existing projects; and the faster than expected transition from mature technologies to the lower gross margin LTE technology.

These operational and management changes impacted the short term financial performance in the second half of the year. These issues have stabilised and we do not expect this short term impact to continue into 2018.

One result of the disappointing financial performance in 2017 was that we were required to seek waivers of actual and potential breaches of bank covenants in a facility agreement with our lead financing bank. As we have announced, we obtained these waivers and in March 2018 we agreed to amend the financial covenants with that bank.

The new covenants are more appropriate for the Group following the rationalisation of product lines and costs. They are also more easily measured and therefore more predictable and the Board is closely monitoring compliance.

Managerial upheaval

Shortly after the release of the first half year results in August, the Board became aware of media speculation that the then CEO, Oozi Cats, was a fugitive from US justice, and that an indictment against him remained outstanding for matters unrelated to Telit, which occurred many years before the Group's establishment.

An independent review found an indictment was issued against Mr Cats in the US and that this fact was knowingly withheld by him from the Board. While the Board was in process to dismiss Mr Cats, he resigned and left the business on 14 August 2017.

Following the departure of Mr Cats, Yosi Fait was appointed interim CEO and in late November was appointed CEO (having previously been Telit's President and Finance Director) and Yariv Dafna stepped into the role of Group Finance Director, a position that he had also previously held.

Recognising investor concern, the Board initiated a programme of reviews of Telit's corporate governance and financial reporting and controls.

The Board will endeavour to ensure the reporting and controls within the Group are appropriate for what is a very complex business. In particular, going forward we will ensure that the business is run in a prudent manner. The Board also commissioned an external report on its corporate governance compliance in order to bring the Group up to the highest standards of corporate governance and transparency relative to a company of Telit's size.

The Board has taken steps to implement the recommended changes, including Simon Duffy's and my appointment as new non executive directors and other changes to the composition of and responsibilities of the Board of directors. We continue to make progress in 2018, and indeed, after the year end welcomed Shlomo Liran and Miriam Greenwood as non executive directors.

The Board also engaged Grant Thornton to perform a review of certain elements of the Group's financial policies, controls, and procedures related to consolidation, third party distributors and revenue process. No material issues relating to our reported financial performance were identified by this review in relation to matters already completed, and several process and control improvements which were identified have been addressed.

Operational review and rationalisation

On appointment as CEO, Yosi Fait and the team, with the support of the new non executive directors, conducted a thorough review of Telit's activities, cost base and product portfolio. The review concluded that Telit should significantly rationalise the Group's activities to concentrate on the product portfolio which allow us to upsell our services.

We reduced our R&D centres and decided to focus future growth in R&D spend in low-cost centres. The Group also reduced its sales and general and administrative costs, mainly by optimising headcount. We expect cash operating expenses in 2018 to be reduced by approximately 10% and to be $10m lower than 2017.

Telit has made significant progress in reducing its costs and realigning its operations and activities and we move into 2018 with a better focus on the product portfolio, as well as reduced development and product maintenance costs.

FCA investigation

In March we announced that the FCA has commenced an investigation into Telit with regard to the timeliness of announcing certain matters included in the interim results published on 7 August 2017. Telit has cooperated fully with the FCA in its enquiries to date and will continue to do so.

Outlook

I am happy to report that from an operational standpoint, Telit has made substantial progress and as a result, from the beginning of the current financial year we delivered revenues in line with our projections.

The established transition to LTE means we are now able to better manage the new mix of products and technologies and focus on stabilising the gross margin.

IoT remains a fast growing and exciting space, and Telit is well positioned in this market. We are fully committed to continue to position Telit as a leading enabler in the IoT space, delivering value and growth for our business.

As previously announced, we considered the future of a number of product lines which may not fit the Group's long-term strategy leading to a process for potentially selling our Automotive business unit. We are currently reviewing a range of proposals in this regard.

Despite a challenging and disappointing 2017, we are confident that our performance in 2018 will significantly improve and see double-digit growth, stabilised gross margins and the implementation of cost optimisation. Trading in the first quarter of the current financial year was strong and well ahead of last year, overall we are on course to meet the Board's expectations.

Chief Executive's statement

Operational overview

2017 was a very challenging year for Telit. Declining revenues and margins in our module business, together with slower than expected growth in our IoT services business and a sharp increase in operating expenses resulted in poor financial performance.

Although our strategy in recent years, to invest heavily in IoT services and in our hardware portfolio is correct, our execution was missing a key component. The business was not sufficiently focused on operating expenditure, free cash flow generation and did not address the decline in the gross margin, a phenomenon that started during the first half of 2017 and accelerated during the second half of the year.

The pressure on margins is mainly attributable to the fast adoption of 4G technology, at the expense of the mature 2G and 3G technologies, which are optimized technologies and have better gross margins (2017: 35.1% gross margin compared to 40.3% in 2016). Accordingly, it was clear that there was a need to optimise our costs.

In addition, the two acquisitions we made to enhance our short-range product portfolio, which remains important technology in the growing IoT market, Stollmann (BLE) in 2016 and GainSpan (Ultra low power Wi-Fi) in February 2017, have significantly increased our operating expenditure, while revenues in these two business lines are growing slower than expected. These businesses are both making operational losses in the short term. We are now refocussing our portfolio of the short-range products to include only those that could be sold with our cellular module or as part of our end-to-end IoT offering.

We initiated a comprehensive analysis of our product portfolio and our 11 R&D sites, with the aim to optimise our product portfolio and product development plan (based on ROI parameters), during the second half of 2017. We have decided to reduce the number of R&D centres during the next three years and shifting our investment into lower cost R&D centres. This will lower our short and, more importantly, long-term cost of our product development, which is the biggest cost for a technology company like Telit.

We also worked to reduce our cost base elsewhere - particularly the sales & marketing and general & administrative categories of expenses - with a target to achieve a reduction of 10% in cost run rate compared to October 2017. I am pleased to report that this cost optimization plan is on track, and we expect to achieve it in full.

I believe that the double-digit growth planned for 2018, together with stabilisation of our gross margins and the cost optimisation we are implementing, should bring the Group to a better financial performance on the operational level and improve our cash flow generation.

Strategy

IoT is the prime driver of the digital transformation for enterprises with spend in the IoT market by 2021 forecast by IDC to reach $1.4 trillion.

Our strategy continues to focus increasingly on the development of our IoT solutions capabilities and become a leading end-to-end IoT provider that enables enterprises' digital transformation. To address our strategy, we have started to change our organization by unifying our module and IoT services sales and product teams across our three geographical regions.

The integrated business will enable us: to better define and develop the products required for the market; to focus much more on synergies from leveraging the combination of our modules (cellular and short range) and the IoT Platform and Portal; to better utilise Telit's sales force; and generally, become a more efficient and focused organisation.

A key element of our strategy is to continue our growth by expanding into the enterprise market, as companies of all sizes around the world are now exploiting more and more digital transformation via IoT that will drive down their cost base, improve efficiencies, will lead innovation and will create new revenue streams. Despite its tremendous potential to impact the enterprise, IoT project delivery remains complex and difficult. Telit is well positioned to deliver the key components and the necessary know how to complete IoT projects successfully.

Together with our extensive ecosystem of blue chip customers and suppliers, technology partners, system integrators, implementer communities and MNOs, we will have best in class products for our customers, and will continue to be an innovative global leader for IoT solutions.

Operational review - divisions and geographical

Group revenues marginally increased to $374.5 million (2016: $370.3 million), of which Cloud and connectivity revenues were $27.7 million (2016: $25.9 million), an increase of 7%.

Hardware (modules) - Revenue growth was disappointing. We suffered from a significant delay in several projects, some of which due to the delay in the LTE CAT1 certifications. In addition, during December, we suffered from shortage of several components, mainly memories, which negatively affected our performance in the last month of the year.

IoT solutions - The 7% increase in Cloud and connectivity revenues was also disappointing, after recording rapid growth in the last few years. In the Cloud unit, we faced a slower than expected ramp up of certain projects in our IoT factory unit. On connectivity, we enjoyed significant growth in EMEA which was offset by a weakness in the US, derived from substantial customer churn due to the closure of the 2G networks, as well as a sharp decline in the average revenue per user (ARPU), which was traditionally much higher in this market.

In Q1-2018 we saw stabilisation in the ARPU in the US as well as encouraging growth in terms of new connections and activations.

Americas- revenues were up by 7.5% to $160.2 million (2016: $149.0 million), but this was well below our expectations. The overall market for LTE products continued to grow, with additional certifications of our CAT-1 and CAT-M1 products but our growth in the region was impacted by a significant delay in certifying our CAT-1 products with VoLTE. In addition, the major US carriers have announced plans to shut down the CDMA network in 2018 and to focus exclusively on LTE, with a significant impact on our CDMA-based revenue during the year.

We managed to complete the delayed certifications and to certify additional CAT-M1 products and we are therefore well positioned in 2018 with our family concept to enable customers to migrate from 3G and CDMA designs towards LTE, either CAT-1 or CAT-M1.

EMEA- revenues increased by 7.4% to $147.4 million (2016: $137.3 million). This growth came from the strong performance of our Automotive business. EMEA continues to be impacted by cellular technology stagnation, with deployments remaining in 2G and 3G and growing competition from Chinese vendors.

The uncertainty of the timing of MNOs in the region moving to new LTE technologies, remains a significant factor but it is now expected that low category LTE will start to ramp up in 2018. Telit's portfolio includes a full set of products supporting the new LTE technologies with fall-back to the legacy 2G and 3G networks, to allow customers to go through this uncertain period with as little disruption as possible to the serviceability of their devices in the field.

Telit foresees that the move to NB-IoT will also significantly impact the adoption of IoT for new verticals and will contribute to the growth of total number of units sold in Europe in the coming years and we are developing new modules following our family concept and form factors to be well positioned for this growth opportunity.

APAC- revenues were down to $66.9 million (2016: $84.0 million), mainly as a result of the loss of a design with one of our major customers in the region. While we were expecting to offset this design loss with a significant new design from a different customer, this project was delayed which negatively impacted our overall performance in this region.

We released new LTE products for the Japan and Korea markets and plan to bring this region back to growth in 2018 on the back of the ramp up of the delayed project as well as additional adoption of our modules for new designs and deployments in the region.

Research and development

We will continue to invest and develop best in class IoT products and services including our IoT connectivity and IoT platform, and utilise one of our stronger assets, our IoT know-how, which has been accumulated over almost two decades. This investment and know-how is positioning Telit as the recognised leader in delivering operational technology (OT) System Integration Services (IoT technology, services and know-how) which can help our customers increase their digital transformation velocity while reducing risk and complexity.

Constant innovation is key in delivering our strategy. A recent example is our simWISE solution, an embedded software technology for cellular modules that acts as a replacement or complement to the traditional SIM card. simWISE technology reduces total cost of ownership and improves functionality. simWISE technology is applicable across all industries and markets. We are the first to introduce such a solution in our 2G product portfolio, and are now expanding it into our 4G product line together with IDEMIA, a world leader in SIM card technology and security.

Telit's end-to-end capabilities

Today's competitive markets demand creative and innovative solutions to stay ahead in business. The new digital transformation impact is being felt broadly. The underlying objective is to collect the right information, process it into actionable knowledge, transmit that knowledge to the right person, and act on it - achieved with increasing affordability. In doing so, this allows us to solve an increasing number of problems, including many that we had never thought of.

Telit's business is at the forefront of this digital transformation - providing the key ingredients critical to fulfil the need for real time data from the physical world. These include the following components:

- IoT Products. A diversified portfolio of connected modules that allow "things" to be connected using the best available and most suitable technology (Cellular - from 2G to 4G, Wi-Fi and BLE) for the application being developed. These provide cost performance and a significant reduction in time-to-market.

The Group markets its IIoT modules to numerous verticals including asset tracking, health care, security, telematics, point of sale, wearables, telemetry, industry and energy and smart metering. These verticals are set to continue to grow significantly during the next few years, with a substantial number of projects already in advanced stages around the world.

In order to cater all these verticals, Telit continues to develop a wide range of cellular LTE products and a wide range of CAT-M1 and NB-IoT modules.

- Dedicated IoT Connectivity services. These allow scaling and global deployments of customers' IoT solutions with a single point of contact. We deliver the ease of a single bill and dedicated 24/7 IoT support services at competitive rates, without the need for in-house know-how, mapping and contracting separately with multiple global MNOs. The Group continues to invest and develop its IoT connectivity business, which covers all customer connectivity needs and provides a recurring revenue stream.

- IoT Platforms. Allow customers to create value by using data to solve problems. The challenge is that the data needed to solve a problem has often been difficult or expensive to collect, or needs to be enriched with other related data. Telit's deviceWISE IoT platform is an industrial grade suite of software that provides Connectivity Management, Device Management and Application Enablement, which allows for the creation and management of IoT Applications.

From standalone applications such as metering and asset tracking to more robust Industry 4.0/IIoT and factory automation solutions.

o The IoT Portal is designed to enable customers to manage their IoT deployments through a single portal that makes them easier, more efficient and cuts time to market. The IoT Portal provides customers with access to Connectivity Management, Device Management, Data Management and facilitates interaction with MNOs, dash boarding tools, security and administration.

The Telit IoT portal ties with our modules in the field and is a significant tool to manage any IoT deployment very efficiently, save costs, be flexible, solve issues remotely and more.

o The Telit IoT platform, deviceWISE, integrates any devices, production assets and remote sensors with web-based and mobile apps and enterprise systems. deviceWISE reduces risk, time-to-market, complexity and cost of deploying solutions for monitoring and control, industrial automation, asset tracking and field service operations across all industries and market segments around the world.

o deviceWISE provides an easy way to collect, normalise and transport real time manufacturing data to allow processing for improved uptime, better efficiency, predict failures and improved compliance.

o The IoT Factory Solutions business unit, through deviceWISE, is designed to easily connect production machines and processes with enterprise resource planning (ERP), manufacturing resource planning (MRP) systems and Supervisory Control and Data Acquisition (SCADA) applications in addition to native integration into emerging cognitive analytic services such as SAP Cloud Platform, IBM Watson and leading IaaS Data Centric Clouds such as AWS and Microsoft Azure.

Overall, Telit enables the creation of solutions and applications for fast deployment of IoT projects with complete life cycle management (long and short-range connectivity devices, global data plans and IoT platform), both in the traditional IoT verticals such as asset tracking, logistics, remote industrial monitoring, automated utility meter reading, telematics, mobile health devices, and for the fast-growing enterprise market.

Telit's investments in the last few years include not only the development of each of the above-mentioned components but also, increasingly, the integration of the different components in order to transform our products and services into a cohesive solution which is ready to connect and send data.

Finance Director's Statement

As stated in the Chairman's and Chief Executive's reports, after the departure of the former CEO, we commenced a review of the Group's activities, cost base and product portfolio in order to address the issues around decreased gross margin and increased operating cost base.

As a result of this review, we took several actions to rationalise the Group's activities and our operating cost structure including:

· Declaring a number of our products and services portfolio "end of life", which will reduce the R&D and operations investment in maintaining products with low contributions and reduce operating costs. In some cases, this led to write-off of capitalised development assets and inventory (both finished goods and components). These write-offs were recorded under restructuring costs in the 2017 income statement.

· Reducing the number of R&D centres by 2019. We already closed one expensive R&D centre and transferred its knowledge to lower-cost sites. Future growth in R&D spend will be focused on our low-cost centres.

· Adjusted the headcount of our sales and administrative teams in each region to align them with the actual group growth globally. Cost rationalisation will continue in 2018 and we expect that these measures will reduce the cash operating expenses in 2018 by approximately $10 million over comparable costs in 2017.

· Accelerated the strategic review of our Automotive business unit and started a process for potentially selling the business - process is ongoing and several proposals received.

Restatement of 2016 figures

During the preparation of the 2017 financials, we discovered an error in the 2016 financials related to the booking of a $2.0 million credit note from a supplier in 2016, of which $1.2 million should have been recorded in 2017. In addition, comparative amounts have been reclassified in order to correct presentation of certain items and present them on a basis consistent with the current year. Correcting these errors led to a restatement of our 2016 results, see note 4.

Financial results

Adjusted EBIT is defined as Earnings Before Interest, Tax, share based payment expenses, amortisation of acquired intangibles, impairment of intangible assets, exceptional expenses related to restructuring and non-recurring expenses; Adjusted EBITDA as Adjusted EBIT plus depreciation and other amortisation; Adjusted Profit before tax as Profit before tax plus share based payment expenses, amortisation of acquired intangibles, impairment of intangible assets, exceptional expenses related to restructuring and non-recurring expenses; and Adjusted net profit for the year as net Profit for the year plus share based payment expenses, amortisation of acquired intangibles, impairment of intangible assets, exceptional expenses related to restructuring and non-recurring expenses less change in deferred tax assets, net.

Revenues

Group revenues marginally increased to $374.5 million (2016: $370.3 million), out of which Cloud and connectivity revenues were $27.7 million (2016: $25.9 million), an increase of 7%.

In the hardware business, we suffered from a significant delay in several projects, some of which were due to the delay in the LTE-CAT1 certifications. In addition, during December we suffered from a shortage of several components, mainly memories, which negatively affected our performance in the last month of the year. The 7% increase in Cloud and connectivity revenues was also disappointing, after recording rapid growth in the last few years. In the cloud side we faced a slower than expected ramp up of certain projects, mainly in our IoT factory unit and on the connectivity side, we enjoyed significant growth in EMEA which was offset by a weakness in the US, derived from substantial customer churn due to the closure of the 2G networks as well as a sharp decline in the average revenue per user (ARPU), which was traditionally much higher in this market.

Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker in the Group. The chief operation decision-maker, who is responsible for allocating resources and assessing performance of the operating segments and makes strategic decisions, has been identified as the Chief Executive. Segment performance is evaluated based on operating profit or loss.

Telit's activities in the IoT services business unit have grown in recent years and, although operational results from this business unit still comprise less than 10% from the Group's results, it focuses more and more on IoT services and end-to-end IoT solutions, as the future growth engine.

Segmental information for each business line is presented below:

(1) There are no transactions between business unit segments.

(2) Unallocated expenses principally including general and administrative expenses such as director's compensation, salaries of certain senior executives, professional fees and other expenses which cannot be directly allocated to one of the segments.

The split of revenues by geographical markets is as follows:

Revenues in Americas were up by 7.5% but this was well below our expectations for double-digit growth. The decline in revenue in APAC was mainly due to a loss of a design with one of our major customers in the region, combined with a delay in delivering for a significant new design from a different customer.

Gross margin and gross profit

The decline in the gross margin was another of the main reasons for the weak performance of 2017. Gross margin decreased from 40.3% in 2016 to 35.1% in 2017. The sharp decline was mainly due to the faster than expected shift from 2G and CDMA, both mature technologies with higher gross margins, to LTE, which is a relatively new technology, with lower margins at this stage.

LTE product margins are expected to improve through the maturity and growth in volumes, as it is normal to ramp up new products with lower gross margin and improve it over time. However, we expect that future gross margin will be in-line with the gross margin recorded in 2017 and we are working to adjust our cost structure to this new level.

Our position in the IoT industry, further improvements in the hardware business and the increasing share of cloud and connectivity services business revenues with its higher margin will assist us to stabilise the gross margin.

Gross profit was $131.6 million (2016: $149.4 million), affected by the minimal growth in revenue with the sharp decline in the gross margin.

Operating expenses

· Gross R&D expenses as follows:

(1) Gross research and development expenses increased to $71.4 million (2016: $57.4 million) mainly due to the full year impact in 2017 of the increase in headcount and resulting salary costs in the second half of 2016, increase in certification costs, due to more LTE certifications, which are more expensive than mature technologies, and the acquisition of GainSpan in February 2017.

(2) The amount capitalised in respect of internally generated development assets remained flat but decreased, as a percentage of gross R&D expenses from 53.5% in 2016 to 43.6% in 2017. This amount is mainly related to the development of high category LTE products for both industrial and automotive and low categories including the CAT-M1 and NB-IoT for the industrial IoT.

(3) The amortisation of internally generated development assets increased by 56.9%, relates mainly to further release of 4G products to the market.

(4) A non cash impairment loss on capitalised development assets as a result of decrease in future revenues from specific products.

· Selling and marketing expenses increased to $66.8 million (2016: $63.8 million). The increase was mainly due to the acquisition of GainSpan in February 2017 and the increase in the sale force of our IoT services business.

· General and administrative expenses decreased to $28.6 million (2016: $30.0 million). Excluding the former CEO compensation, the costs were $27.1 million (2016: $26.6 million).

· Other non recurring expenses:

(1) Costs related mainly to the GainSpan integration including $1.3 million for impairment of goodwill related to GainSpan workforce in the San Jose site which the company decide to close.

(2) Costs related mainly to legal and advisory costs in association with the crisis management following the departure of former CEO and the covenant breach.

(3) Net gain in relation to the termination of the relationship with the former CEO, affected mainly by the reversal of unvested share based payment charges.

Restructuring plan

Following the review of the Group's activities, cost base and product portfolio, we took several actions in order to rationalise our operating cost structure and improve future profitability as part of a restructuring plan. The restructuring plan was approved by the Board in Q4 with the aim of cutting approximately 10% of the annualised cash operating expenses.

The restructuring plan will be implemented over 18 months (until Q1 2019) and the impact on 2018 expected to be a reduction of $10 million in cash operating expenses compared to 2017.

Restructuring costs recognised in 2017 include the following:

(1) Although operating expenses increased, mainly as a result of an increase in overall headcount, following the management change there were some headcount reductions which resulted in termination costs.

(2) The restructuring plan included a classification of several products and services as "end of life" led to non cash write-off of capitalised development assets, acquired technology and goodwill which recorded under restructuring costs in 2017 income statement.

(3) The rationalisation of the product portfolio made some inventory (both finished goods and components) redundant which resulted in non cash impairment charges.

Finance costs (income), net

(1) Interest expenses related to loans and overdrafts increased by $0.7 million, due to an increased utilisation of our bank facilities.

(2) The $4.5 million increases in the exchange rate differences is the main driver for the sharp increase in the total finance costs. The negative exchange rates derive mainly from the increase in the euro and the Israeli shekel over the US dollars.

Profitability

We measure our profitability based on adjusted figures to eliminate non-recurring and share based charges. The adjusted figures exclude a share-based payment charge of $1.8 million, net of reversal of unvested awards related to employees who left in 2017 (2016: $8.1 million), restructuring costs of $16.0 million (2016: nil), other non-recurring expenses of $5.4 million (2016: $0.8 million), impairment of capitalised development assets of $8.4 million (2016: nil) and amortisation of acquired intangible assets of $4.8 million (2016: $4.9 million).

At the end of 2017 and while planning the 2018 budget, we adopted the "profit in cash" performance measure which together with revenue and adjusted EBITDA, are the most important KPIs. The profit in cash is defined as Adjusted EBITDA less R&D capitalisation less capital expenditures. In 2017 the loss in cash was $27.0 million (2016: profit in cash of $12.7 million). We expect to generate profit in cash in 2018.

Gross profit decreased to $131.6 million (2016: $149.4 million), due to the sharp decline in the gross margin.

Adjusted EBITDA decreased to $18.1 million (2016: $53.3 million).

Adjusted EBIT was a loss of $10.7 million (2016: profit $33.1 million). The operating loss was $49.7 million (2016: profit of $19.4 million). This decline was caused by the decrease of $17.8 million in gross profit, $29.8 million increase in non-recurring and exceptional expenses, and the remaining due to increase in operating expenses which were increased based on expectation to a higher level of revenue.

Adjusted net loss for the year was $20.5 million (2016: profit of $29.3 million) and reported net loss was $52.2 million (2016: profit of $15.5 million).

Adjusted basic loss per share was 16.4 cents (2016: earnings per share 25.4 cents). Basic and diluted loss per share was 41.9 cents (2016: basic earnings per share 13.4 cents; diluted earnings per share 13.0 cents).

Dividend

The Board is not proposing to pay a dividend for the period (2016: 7.4 cents per share).

Net debt and cash flow

As at 31 December 2017, net debt was $30.2 million (2016: $17.7 million). The $12.5 million difference, together with $49.7 million raised in May 2017 from the placing of new ordinary shares, represent a cash spent of approximately $62 million during the year.

The cash spent comprised mainly from the loss in cash of $27.0 million, an increase of approximately $9.4 million in net working capital, $6.7 million spent on acquisition, tax and interest of $6.3 million, a cash dividend of $5.7 million and non recurring cash expenses (including restructuring and integration cost) of $5.3 million.

Cash flow used in operating activity moved from net cash generated by operating activities of $46.8 million in 2016 to net cash used in operating activities of $4.8 million. The change was mainly driven by the net loss for the year.

Cash flow used in investing activity was $51.9 million (2016: $56.1 million). The decrease was mainly due to a decrease in the amount spent on acquisition.

Cash flow provided from financing activity was $72.2 million (2016: $8.2 million). The increase was mainly due to the proceeds of $49.7 million from issue of new shares and the remaining mainly from the net increase in borrowings.

Bank covenants

Telit relies on financing mainly in the form of committed credit facilities from HSBC Bank plc and certain of its affiliates and Bank Hapoalim B.M. ("Credit Facilities"). In October 2016 the Group entered into committed credit facilities with HSBC Bank plc and certain of its affiliates ("HSBC") and Bank Hapoalim B.M. ("BHI USA") for an aggregate amount of $110 million (the "Facilities"). See note 6 for further details of the Facilities.

One result of the disappointing financial performance in 2017 was that we were required to seek waivers of actual and potential breaches of bank covenants in a facility agreement with our lead financing bank. As we have announced, we obtained these waivers and in March 2018 we agreed to amend the financial covenants with that bank.

The new covenants are more appropriate for the Group following the rationalisation of product lines and costs. They are also more easily measured and therefore more predictable and the Board is closely monitoring compliance. See note 3 for further information in this regard.

Balance sheet

Internally generated development assets, net

As at 31 December 2017, the net amount of internally generated development assets increased by $4.9 million to $74.7 million (2016: $69.8 million). The split of the net assets by technology is as follows:

Internally generated development assets that completed the development phase, moved to mass production phase and which have started to be amortised, decreased to 47% of the total internally generated development assets (2016: 60%). The period of amortisation is three to five years.

The net assets that are in development phase, before starting to be amortised, are mainly 4G products and IoT services software.

Total equity

In 2017, the Group issued 11,593,000 ordinary shares for a net value of $49.7 million and paid $5.7 million in cash as final dividend for the 2016 financial year.

Net shareholders' equity increased from $119.2 million as at 31 December 2016 to $124.5 million as at 31 December 2017 with the dividend and the net loss offsetting the capital increase from May 2017.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

* Certain amounts shown here do not correspond to the 2016 financial statements and reflect adjustments made. For further details refer to note 4.

** Adjusted EBIT is a company specific non GAAP measure which excludes share based payment charges, exceptional expenses related to restructuring, impairment of internally generated development assets, other non-recurring expenses and amortisation of intangible assets acquired. The Group's management believes that non-GAAP measures provide useful information to investors to evaluate operating results and profitability for financial and operational decision-making purposes and to provide comparability between the companies in this sector, as they eliminate non-cash items and non-recurring expense, which are not inherent to the business. 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (continued)

4 - Adjusted basic profit per share is defined as adjusted profit for the year divided by basis weighted average number of equity shares.

5 - Adjusted diluted profit per share is defined as adjusted profit for the year divided by diluted weighted average number of equity shares.

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

* Certain amounts shown here do not correspond to the 2016 financial statements and reflect adjustments made. For further details refer to note 4.

CONSOLIDATED STATEMENT OF CASH FLOW

* Certain amounts shown here do not correspond to the 2016 financial statements and reflect adjustments made. For further details refer to note 4.

CONSOLIDATED STATEMENT OF CASH FLOW (continued)

(1) amount paid in cash in the period in respect of exceptional items was $5.3 million (2016: $0.7 million).

* Certain amounts shown here do not correspond to the 2016 financial statements and reflect adjustments made, For further details refer to note 4.

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

Year ended 31 December 2017 (audited)

Year ended 31 December 2016 (audited) (restated*)

* Certain amounts shown here do not correspond to the 2016 financial statements and reflect adjustments made. For further details refer to finance director statement.

NOTES TO THE PRELIMINARY ANNOUNCEMENT

1. This financial information is consistent with the consolidated financial statements of the group, for the year ended 31 December 2017. The Group's consolidated financial statements have been prepared in accordance with International Financial Reporting Standards as adopted by the EU.

2. The financial information set out above does not constitute Telit's statutory accounts for the years ended 31 December 2017 or 2016. Statutory accounts for 2017 will be delivered to the Registrar of Companies. The auditors have reported on the 2017 and 2016 statutory accounts; their reports were (i) unqualified, (ii) did not include references to any matters to which the auditors drew attention by way of emphasis without qualifying their reports and (iii) did not contain statements under section 498 (2) or 498 (3) of the Companies Act 2006.

3. Going concern and covenants compliance

The Group relies on financing its day to day working capital requirements mainly on committed credit facilities from HSBC Bank plc and certain of its affiliates and Bank Hapoalim B.M. ("Credit Facilities"). The availability of the Credit Facilities is conditioned upon the Group complying with the terms of the Credit Facilities, including meeting certain financial covenants (the "Financial Covenants"). The Company agreed to comply with certain Financial Covenants on its consolidated financial statements. During 2017, the Company did not meet certain covenants imposed by one of the financing banks. In each case the Company obtained a waiver. In March 2018, the Company agreed a series of new and amended Financial Covenants. The new covenants are more appropriate for the Group following the rationalisation of product lines and costs. In particular, the covenant, which in broad terms measured the ratio of free cash flow against debt service obligations, is replaced for 2018 by another covenant that works better for the Group. In addition, the Group has received long-term preferential rate loans supported by the Ministry of Trade and Commerce in Italy. See Note 6 for details on the borrowings.

One result of the disappointing financial performance in 2017 was that we were required to seek waivers of actual and potential breaches of bank covenants in a facility agreement with our lead financing bank. As we have announced, we obtained these waivers and in March 2018 we agreed to amend the financial covenants with that bank.

The new covenants are more appropriate for the Group following the rationalisation of product lines and costs. They are also more easily measured and therefore more predictable and the Board is closely monitoring compliance.

In assessing going concern, the Board has considered the risks related to (a) the level of demand for the Group's products which may also affect the possibility of utilising some of these facilities since they depend upon the level of sales in specific markets and in some instances to specific customers; (b) the fluctuations in the exchange rate and thus the consequence for the cost of the Group's raw materials; (c) compliance with the Financial Covenants, as a condition to the continued availability of the Credit Facilities in the foreseeable future; (d) the continuity of supply from key suppliers; and (e) the company's budgets and forecasts in current market environments.

The Board has also carefully reviewed the Group's budget for 2018, its medium-term plans, including the restructuring plan, and assessment of compliance with amended financial covenants. The Directors are mindful that the Group operates in the IoT sector which remains a rapidly growing industry subject to ongoing change in technological and competitive landscape.

In reviewing the Financial Covenants compliance calculations and sensitivity analysis the Directors noted: a) under sensitised conditions, there is headroom available for each of the Financial Covenants, however it is limited for certain covenants at certain measurement points; and b) the Financial Covenants are sensitive to changes in revenue and gross margin. Should the Gross Profit reduce by 10%, without adjusting the operating expenses this might result in breaches of certain covenants, however the Directors believe there are sufficient mitigating actions available within their control, that render such breaches of covenant unlikely and continue to apply the going concern basis in preparing the consolidated financial statements.

After making enquiries, the directors are confident that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the financial statements.

4. Correction of errors

1. During the preparation of the 2017 financials, we discovered an error in the 2016 financials related to the booking of $2.0 million credit note from a supplier in 2016, of which $1.2 million should have been recorded in 2017. Correction of this error led to a restatement of our 2016 results.

The error has been corrected by restating each of the affected financial statement line items for 2016, as follows:

Impact on equity (decrease in equity):

Impact on statement of comprehensive income (decrease in profit):

Impact on basic and diluted earnings per share (EPS) (decrease in EPS):

The change did not have an impact on OCI for the period or the Group's operating, investing and financing cash flows.

2. Comparative amounts have been reclassified in order to correct presentation of certain items and present them on a basis consistent with the current year. These reclassifications do not affect profit or loss. These classification changes relate to:

Group:

Company:

Impact on cash flows:

Group:

Company:

None of prior year corrections had impact on the prior year opening balance sheet, therefore the prior year opening balance sheet is not presented.

5. Reconciliation of operating profit, profit before tax and net profit to the adjusted figures:

EBITDA is not a financial measure defined by IFRS as a measurement of financial performance and may not be comparable to other similarly-titled indicators used by other companies. Adjusted EBIT, adjusted EBITDA, adjusted profit before tax and profit in cash are provided as additional information only and should not be considered as a substitute for operating profit/loss (EBIT) or net cash provided by operating activities. 

Adjusted EBIT is defined as Earnings Before Interest, Tax, share based payment expenses, amortisation of acquired intangibles, impairment and non-recurring and exceptional expenses; Adjusted EBITDA as Adjusted EBIT plus depreciation and other amortisation; profit/loss in cash as Adjusted EBITDA less capitalisation of internally generated development assets, less acquisition of tangible and intangible assets net of proceeds from disposal of assets.

Adjusted (Loss) / Profit before tax as (Loss) / Profit before tax plus share based payment expenses, amortisation of acquired intangibles and non-recurring and exceptional expenses; and Adjusted net (loss) / profit for the year as net (Loss) / Profit for the year plus share based payment expenses, amortisation of acquired intangibles and non-recurring items less deferred tax (credit) / expense. The Group's management believes that these non-GAAP measures provide useful information to investors to evaluate operating results and profitability for financial and operational decision-making purposes and to provide comparability between the companies in this sector, as they eliminate non-cash items and non-recurring items, which are not inherent to the business. Consequently, Adjusted EBIT, Adjusted EBITDA, (loss) / profit in cash, Adjusted (loss) / profit before tax and Adjusted net (loss) / profit for the year are presented in addition to the reported results.

* Certain amounts shown here do not correspond to the 2016 financial statements and reflect adjustments made, refer to note 4.

6 - For the breakdown of exceptional expenses related to restructuring. For further details refer to finance director statement.

7 - For the breakdown of non recurring expenses. For further details refer to finance director statement.

6. Net debt position

The table below presents the net debt position at the year-end:

(1) Short term borrowings, less than one year, based on committed credit facilities used for working capital. The credit facilities of up to $70 million bear interest at a rate of 2.10% to 3.70%.

(2) Representing long term loans from HSBC in the amount of $19.2 million with interest at a rate of LIBOR plus 2.7% and is being repaid in 7 half year instalments that commenced in October 2018 and long term loans from banks in Italy- (i) for $0.6 million with interest at a rate of Euribor 3 months plus 3.25% and is being repaid in 20 quarterly instalments that commenced in September 2013, and (ii) $3.6 million with an interest rate of Euribor 6 months plus + 5.5% and is repayable in 6 semi-annual instalments that will commence in December 2020

(3) Representing preferential long term loans (i) for $23.6 million with fixed-rate of 0.5% and is repayable in 14 semi-annual instalments that will commence in December 2016, supported by the Italian MISE (Ministry of Economic Development) to develop an innovative platform for the application of M2M technologies and, (ii) for $1.0 million with a fixed-rate of 0.74% and is repayable in 10 annual instalments that commenced in March 2009, supported by the Ministry of Trade and Commerce in Italy, provided in connection with the Group's business development program in Sardinia. The loans are initially recognised at fair value and subsequently measured at amortised cost.

(4) Representing a preferential rate loan of $2.3 million from a regional fund in Italy provided in connection with the Group's acquisition of the campus used for the Company's main R&D facility in Trieste, Italy. The mortgage loan is denominated in Euro, attracts interest at a rate of 80% of Euribor 6 months, with a minimum interest rate of 0.85%, and is repayable in 15 semi-annual instalments that commenced in June 2012. The loan is initially recognised at fair value and subsequently measured at amortised cost.

The directors believe that the credit facilities will remain available to the Group in the foreseeable future and that therefore the Group will be able to continue to fund its operations from these credit facilities.

The information communicated in this announcement is inside information for the purposes of Article 7 of Regulation 596/2014.