Inseego Corp (INSG) 2017 Q2 法說會逐字稿

Hello, and welcome to Inseego Corp.'s Second Quarter 2017 Financial Results Conference Call. Please note that today's event is being recorded. (Operator Instructions) On the call today are Dan Mondor, President and Chief Executive Officer; Tom Allen, Interim Chief Financial Officer; and Cobus Grove, Senior Vice President and General Manager of the company's Ctrack unit.

During this call, non-GAAP financial measures will be discussed. A reconciliation to the most directly comparable GAAP financial measures is included in the earnings release, which is available on the Investors section of the company's website. An audio replay of this call will also be archived there.

Please also be advised that today's discussion will contain forward-looking statements. These forward-looking statements are not historical facts, but rather are based on the company's current expectations and beliefs. For a discussion on factors that could cause actual results to differ materially from expectations, please refer to the risk factors described in our Form 10-K, 10-Q and other SEC filings, which are available on our website. Please also refer to the Cautionary Note Regarding Forward-Looking Statements section contained in today's press release.

Now I would like to turn the call over to Dan Mondor, President and Chief Executive Officer of Inseego.

Thank you, and good afternoon, everyone, and thank you for joining today's call. I'm very pleased to be with you today. Since joining Inseego as CEO in June, I can safely say it's been a busy 2 months and a rapid learning curve.

I've met with customers and channel partners and the majority of the Inseego team in our various locations. I spent a great deal of time with the Ctrack team in South Africa, and the Inseego North America team in Eugene, Oregon, and of course, the MiFi team and Inseego Corporate team at our headquarters in San Diego.

My travel plans over the next few weeks is to meet the Ctrack teams in the U.K., Germany and Holland, so it's been quite a learning curve. I've talked to many of our customers and channel partners, and I can report to you that they are loyal and committed to a long-term partnership with Inseego. The entire Inseego team is very talented and are energized. We have great technology and the spirit of innovation. So it's clear to me we have a very solid platform to build upon.

So I'll start with the progress reported in our cost savings and growth initiatives announced on June 7, and then I'll provide some product highlights.

We are on track to achieve our stated objective of $15 million per year in annualized expense reductions. We are implementing the underlying plans for all identified cost reduction initiatives, and we expect the bulk of the OpEx cuts to be realized in the fourth quarter. In addition, we have taken steps to stabilize our supply chain and are working with our supply chain partners, specifically to improve MiFi gross margins, which is a company priority. We expect to see a substantial portion of the gross margin improvement still within, but later in the fourth quarter than originally projected. So this could impact the timing of realizing our initial guidance stated on June 7. In other words, the plan has not changed, however, it's taking a little longer than expected to complete what we call the 1.0 transition phase.

We are managing the transition diligently through the establishment of a restructuring program office, which is chaired by me. Additionally, I've directed the leaders in each business area to adopt what we've called the self-funded model for growth initiatives. This translates to greater accountability at all levels, better visibility on the top and bottom line, on OpEx and gross margins. For example, we are increasing the utilization of lower-cost product development outsourcing in MiFi to reduce OpEx, and as I mentioned, increasing -- increased supply-chain efficiencies to reduce cost of goods sold and, in turn, increase gross margins.

In Ctrack, we are currently evaluating 2 additional OpEx reduction opportunities over and above what we previously discussed, each of which provides substantial cost reductions and positions that business for future growth. Overall, the company-wide strategy is pragmatic and centered on increasing the value of our largest and most important assets.

It's important to note that the restructuring plan does not rely on revenue growth to deliver the EBITDA targets we provided on the June 7 announcement. So as we capture new business, it provides upside to the plan. And the litmus test we're using on any new opportunity under consideration is based on answers to 3 questions: Is the opportunity real, is it worth it and is it winnable? The answer has to be yes to all 3 before we'll consider it.

Now turning to some of the product highlights for the quarter. At MiFi, I'll start with a recent major win. We have been awarded new business for a next-generation MiFi hotspot with a Tier 1 North American service provider. The underlying technology supports the highest LTE category available to date, leveraging one of the most advanced modem cores on the market and employs pre-5G radio technologies to achieve over 1.2 gigabit per second performance.

In North America, we launched a wireless home phone with the best-in-class Voice over LTE functionality that also supports legacy landline features to enable the migration of traditional wireline voice service to 4G wireless for the home market.

We also launched a new USB device in July that supports one of the industry's first LTE unlicensed technologies. Both devices were launched with Verizon. We launched the MiFi 7000 with Bell Canada in this quarter. In addition, we expect to launch a new wireless home phone product to a new Tier 1 wireline service provider towards the end of this year, which will displace the competing solution. While we are early in the process of our strategy shifts in MiFi, we believe our core technology strengths can be leveraged to add new business that grows and diversifies our customer base and, therefore, the value of the MiFi asset.

Additionally, North American as well as Latin American service providers are the first and the most logical targets since current MiFi products' value proposition play well with very minor or no product adaptation expense.

We expect new business in the coming quarters, which makes it revenue upside to our plan. We are also evaluating the product requirements in determining what modifications are needed for Western Europe as well as the most effective channel to market, and we will provide an update on our strategy for the European market in the future quarters. All new MiFi opportunities will be supported by a business case if incremental investment is required.

Now moving to our Ctrack products. Our continuing emphasis on growing recurring revenues is beginning to pay dividends, as we saw double-digit year-over-year growth in both subscribers and recurring annuity growth. We continue to have important wins in our fleet business, with recent customer acquisitions in the U.K., Holland and South Africa. Additionally, we renewed a large insurance customer in South Africa for another year, which maintains our recurring revenue stream in that vertical. While we will continue to focus on subscriber growth at Ctrack, we're shifting our customer acquisition investment strategy to higher-ROI segments such as fleet and small/medium business.

More specifically, we expect to see continued growth in our fleet business in the third quarter with less growth in the unprofitable consumer segment, which is capital intensive, characterized by low ARPU and long payback periods. In other words, we are dialing back and pursuing subscriber growth at all cost. We're already seeing the benefit from more focused Ctrack sales and product teams, and we expect the results to follow.

We are also aggressively targeting expansion in the Ctrack market in select large-fleet verticals in the North American market, with a focus on the airport segment, where we are the clear global leader in EMEA and APAC. The airport value proposition is the same across all markets. We have the technology and know-how, multiple proof points and customer references, which makes it the best initial target in North America.

We have engaged a large U.S.-based airline in this sector and have received positive feedback from them as they move forward in their selection process. We are further fleshing out our North American strategy across other high-growth, high-profit margin verticals, which we will discuss in future earnings calls.

Turning to our Inseego North America products. DMS subscriber counts continue to grow sequentially, primarily due to the growth of our primary customer, T-Mobile. As a reminder, DMS is our SaaS-based mobile subscriber management system that allows wireless carriers to automate procurement, provisioning, tracking and billing analysis for strategic enterprise accounts. We continue to have conversations with other T1 carriers and expect to add a new customer in the second half of this year.

Additionally, major enterprise wins for IoT-LTE connectivity solutions have driven 40% year-over-year growth of our Skyus product line. One major win in the quarter included our IoT-LTE connectivity solution for a Tier 1 smart city award. This growth has been offset by declines in legacy and lower-margin third-party OEM hardware products. Combined with OpEx reductions at INA and as the mix shifts to higher gross margin sales, we expect higher profit margins in 2018.

Now I'll turn the call over to Tom, who will discuss our Q2 financial results and Q3 guidance. Tom?

Thanks, Dan. As noted, Q2 was a transitional quarter for us, and Q3 will be, too. Just as a preamble, although there was minimal impact on our Q2 operating results relating to our June 7 restructuring announcement, in Q3 we'll begin to see some meaningful reductions in operating expenses from that restructuring. And by the first quarter of 2018, we should see the full benefit of all of our cost-saving initiatives. As noted in our release this afternoon, total revenues for Q2 were $59.9 million, up sequentially from the first quarter by 8%. On a year-over-year basis, total revenues were down by 5%.

Hardware revenues in Q2 drove most of the sequential quarter gain and the year-over-year decline in total revenues, with the sequential gain of 9% in hardware revenues driven by the January and April launches of our latest MiFi hotspot and home telephone products, and the year-over-year decline of 5% due primarily to the sales of Enfora products in Q2 a year ago and lower hardware sales at Ctrack and Inseego North America, and finally, lower year-over-year MiFi revenue.

We generated $14.9 million in SaaS software and service revenues in Q2, up 7% sequentially and 9% year-over-year as a result of increased subscribers at both our Ctrack and INA operations. Sales, software and services revenue as a percentage of total revenues held steady in Q2 at about 25% compared to Q1, and are up from 22% a year ago. Ctrack's total revenues, which include a mix of hardware and SaaS, software and services revenues, were $15.3 million for the quarter, about even with Q1 '17, but down about 3% compared to a year ago, primarily related to the contract restructuring in Q1 this year with a large usage-based insurance company that we discussed on last quarter's earnings call.

Cost of net revenues for the quarter included an impairment provision of $1.4 million, which reflects the additional write-down of the value of certain inventory related to product lines we abandoned and announced in Q4 '16. The Q2 provision was net of about $950,000 in legal settlement from a former customer regarding its unfulfilled purchase orders related to the same product.

Our Q2 GAAP operating expenses, despite including the $1.4 million restructuring charge primarily related to our June restructuring activities, were down sequentially 16% from Q1 and down 18% year-over-year on lower headcount and legal expenses. Our net GAAP loss per share for the quarter was $0.21 compared to a net loss of $0.28 in Q1 and a net loss of $0.05 per share in Q2 2016.

Turning to our non-GAAP metrics. Our consolidated non-GAAP gross margin for the current quarter was 32.1%, slightly higher than the 31.8% in Q1 '17, but down from 37.9% a year ago. Most of the year-over-year decrease relates to the lower margins on this year's MiFi product launches, which I'll address shortly. Non-GAAP gross margins for our SaaS, software and services revenues improved to 75.9% from about 68% sequentially, returning to the levels we saw last year where our year-over-year quarter was 74.2%. Most of these margin movements relate to quarterly mix changes, but we would expect them to stay in a fairly narrow range of 70% to 75% in the near term.

On the hardware side, our non-GAAP gross margin declined sequentially to 17.5% from 19.7% in Q1, and year-over-year from 27.8%. And again, our MiFi current year product launches are driving this near-term margin compression. As we noted in our June 17 (sic) [June 7] announcement, and as Dan commented on earlier, we have been focused on getting pricing concessions from our current contract manufacturers and suppliers in an effort to improve our gross margins on our hardware, particularly our MiFi products.

As we discussed on our Q1 earnings call, the then-pending TCL transaction, with the expectation that our future CM work would be either performed by or controlled by TCL, put us in a difficult position to fully negotiate pricing on the latest hotspot product that we launched for Verizon this past January. We are currently working hard to drive the cost down on that product and our other hardware products the company sells, and we expect to show improving margins beginning in the fourth quarter.

Our non-GAAP gross margins for overall Ctrack products was 68.7% in the second quarter compared to 65% in Q1 and 67% a year ago, all in a fairly narrow range, with movements reflecting slightly different mixes of hardware and SaaS, software and services revenue. Our non-GAAP operating expenses decreased to $20.2 million for the quarter, a decrease of 12% sequentially and 17% year-over-year. Our declining expenses have been driven primarily by cost reduction actions over the past 18 years -- 18 months, albeit occasionally distorted by increased legal expenses like in Q1, when we incurred significant legal costs associated with the Carucel IP infringement lawsuit, which we won in a jury trial in April. Obviously, we expect the continued downtrend in our OpEx as a result of the cost-cutting initiatives we've recently undertaken.

Our adjusted EBITDA for the second quarter of '17 was $1.1 million as compared to negative $3.2 million for the first quarter of '17 and positive adjusted EBITDA of $1.7 million a year ago. Ctrack generated $2.3 million of adjusted EBITDA in the second quarter of '17, essentially unchanged from the previous quarter and just slightly down from its prior year Q2 adjusted EBITDA of $2.4 million.

Our subscriber base grew during the quarter by 5%, ending at 664,000 compared to our March 31 subscriber count of 633,000. On a year-over-year basis, we added 107,000 subscribers, an increase of 19%, and both Ctrack and INA contributed to these growths. Our non-GAAP net loss per share in the second quarter was negative $0.08 compared to a non-GAAP net loss per share of negative $0.14 in Q1 and negative $0.06 in Q2 a year ago.

In terms of how we calculate our non-GAAP financial results, as always, a reconciliation of our GAAP and non-GAAP financials is contained in our earnings release.

Now turning to the balance sheet. Cash and cash equivalents were $8.7 million at the end of the second quarter, increasing from $6.4 million at the end of the first quarter. The term loan we took in May '17 raised a little over $17.5 million, net of issue discount and closing costs. We used approximately $6.2 million to pay down or pay off, I should say, uncollateralized Wells Fargo loans and letters of credit. And we paid down then-outstanding key accounts payable, including our contract manufacturers that where extended because of the drawn out CFIUS approval process that eventually led to the termination of the TCL deal.

Other big outflows for the quarter included our $3.3 million semi-annual interest payment made on our convertible notes in June, and the payment of calendar 2016 incentive compensation to employees in April 2017. Regarding our liquidity, management is keenly aware of the May '18 term loan maturity date, and while we still expect to start generating free cash flow by the first of the year, as you might imagine, we're focused on exploring capital and other transactions that will give us the runway we need to complete the transition we've started, and we expect it -- we expect to have something to announce on that front before the end of the third quarter. As an example of the steps we're taking to improve our liquidity, last month we sold the remaining inventory of our older-generation hotspot model in a single transaction at a discounted price to both improve our liquidity and reduce our inventory risks. Obviously, this was a calculated step to sacrifice potential near-term gross profits for immediate cash and inventory derisk.

Finally, on our share count. Our weighted average shares outstanding for Q2 were just under 58 million, an increase of about 0.5 million shares from the 57.5 million outstanding for the first quarter. In Q2, a year ago, our weighted average shares stood at around 53.6 million. The increase sequentially relates to the vesting of employee RSUs, and the near 3 million share increase over the prior year relates primarily to the issue -- shares to be issued or issuable to the Ralstons in connection with our acquisition of Feeney Wireless in March 2015.

Speaking of that acquisition, as we noted in our Q1 10-Q, this past May 11, we filed suit against the Ralstons for fraudulent inducement and misrepresentation relating to both the original acquisition of Feeney Wireless in March 2015 and the amendment to the purchase agreement that we entered into in January '16. The Ralstons filed their response to that complaint in July, and as an important note, all of the liabilities previously agreed upon between the parties are still reflected on our balance sheet.

Moving on to guidance. We're pleased that the company was able to meet the Q2 guidance that prior management provided 3 months ago. As for third quarter guidance, we expect our total revenues to be in the range of $57 million to $63 million, our consolidated adjusted EBITDA to be in the range of $1.4 million to $2.4 million. And this should mark a noted improvement from our second quarter EBITDA of $1.1 million for 2 reasons: one, the continued impact of the restructuring efforts announced and commenced in June; and two, the continued reduction of legal expenditures. Our Ctrack revenues are expected to be in the range of $15.3 million to $15.7 million in the third quarter of '17, growing sequentially again from Q2, with Ctrack non-GAAP gross margins in the range of 65% to 70% and adjusted EBITDA from Ctrack in the range of $2.3 million to $2.7 million. And finally, just some housekeeping. We'll be filing our 10-Q for the second quarter this Wednesday, August 9. And that ends my prepared remarks.

And at this point in time, we'll turn the call back over to the operator to start our Q&A session. Thank you.

(Operator Instructions) Our first question comes from Jaeson Schmidt with Lake Street Capital Markets.

Just wanted to start with your earlier comment about dialing back, pursuing subscriber growth at all costs within the Ctrack business. Should we interpret that as you guys will look to get a bit more focused from a geographical perspective? Or how should we think about your geography expansion plans going forward within that business?

Yes, thanks for the questions. Dan here. I'll provide a few comments, and I'll ask to Cobus here to -- if he has any additional comments. But what we're specifically referring to there is what we call a consumer segment of the Ctrack, if you will, subscriber base or market vertical. And the characterization of that segment is pretty low ARPU. It's typically high single digit or low double digits, think in the neighborhood of $10 per month. If you think of fleet, that's more in the neighborhood of $30. The other point we referenced to is the payback period. Typically, relatively short-term contracts, perhaps in the neighborhood of 2 years. And our calculations show the payback period happens pretty well near the end of that contract term. So it's very difficult to recover on that basis, and it also is a cash upfront from the standpoint of the initial starting of the SaaS deployment off. So there's a number of things in combination that makes the consumer segment problematic. And so what I meant by that comment is that we are going to focus on the high-ROI, cash-upfront, if you will, segments, and defocus those that are financially less rewarding. And that -- and with that, we're pointing to the consumer segment meaning that. So subscriber growth can -- will continue. We're going to focus, as I said, on fleet and SMB. As far as market expansion, we see a very good opportunity in North America. We're a household name in airports and carriers in Europe and other parts, KLM, Schiphol, Lufthansa, there's several others in there. So we see starting off in North America with an airport-focused strategy as the logical starting point for North America. And I referenced in my remarks, an engagement we have underway. Cobus, if you have any other comments?

Nothing.

Okay. That's helpful. And then, I know it's a fragmented market, but just looking at the telematic space, with all the holdup with selling the MiFi business, do you think your share within this space has seen a significant decline over the past 6 to 9 months?

Cobus, you want to take that?

I can answer it. Definitely not. As you look at our subscriber numbers that has been provided, there has been a -- specifically on the fleet subscribers, we've seen a 4.8% increase. So we've definitely not seen a decrease. What you've seen is -- you're probably asking the question on the back of the reduction in our revenue number from quarter 2 this year compared to last year. And maybe just something to highlight there is the biggest implication there or the biggest reason for that was our mix between hardware sales and annuity. If you really have a look at our annuity revenue, as Tom indicated, our subscriber growth as well as our annuity revenue has increased with double digit numbers. More specifically, our annuity revenue is growing, with 13% year-on-year in the fleet space. So actually, as a matter of fact, at this point, we're actually in a growth point, and we're actually picking up clients that we're growing our market share within this space.

Okay. And then just shifting to the hardware gross margin. Understanding what's going on from the manufacturing side, should we look for hardware gross margin to increase in Q3? Or is it going to be down again?

Let me take it. This is Tom. I think in Q3, we'll be challenged because of the referenced kind of onetime sale of our older MiFi business. That obviously will be at a very slim, if any, margin. And the improvements on our costs and conversion rates from our contract manufacturers is probably not kicking in until Q4, and not fully in Q4 either. I think the full kick-in of those benefits will be by Q1. So I would say, we probably are a little bit more under pressure in Q3 than we actually have seen in Q2.

What I would say, adding to that, it was a conscious decision to move older inventory rather than hang on to it and trickle it out over time, which is obviously a cash infusion. So that was a conscious trade-off we made and relative to a lot of the cost-reduction initiatives from supply chain, cost of goods sold, et cetera. As Tom said, there's a contract manufacturer and key component supplier discussion that are ongoing. And we plan to launch a new contract manufacturer in the fourth quarter, as Tom referenced. So we'll see those as a general and continued trend up as we move forward, Q1 '18 and onward.

Our next question is from Rob Stone with Cowen and Company.

So you commented, Dan, in your prepared remarks that getting to your adjusted EBITDA target isn't predicated on revenue growth, but you pointed out a number of opportunities to achieve that. And one I was curious about if you could provide any color is what impacts you see and over what time frame from signing up new customers and projects for the MiFi business.

Yes. Well -- yes, great question. Thanks for it. The journey over the -- since I've joined is a little bit of discussions around the post-TCL acquisition termination. And so we've spent a lot of time -- I spent a lot of time meeting with customers, and I'm pleased to report that we've been able to essentially stabilize any ripples in the relationships or uncertainties or concerns. So we've been able to work at that and move that forward. And so from the standpoint of existing customers, principally Verizon for that product line, as you know, we feel we're in good shape now and have a lot of confidence going forward, working with them and speaking with them. I've met with them a number of times. And then, in general, the sales team I put to work on a new account-capture strategy, and they are incented to do so. So we've been having a lot of conversation about expanding our customer base, which is, I think, well known as a need for MiFi. I made references to a couple of opportunities that we landed and a couple in the works. So when we look at all of that and base our plan on not relying on revenue growth, I look at that as you secure the downside and then protect -- and then have the opportunity to benefit from the upside. So my expectations on that will be discussions on the next couple of quarters about our progress there, but we're, I think, pointed in the right direction.

Great. Are you able or willing to break out the revenue and non-GAAP gross margin from MiFi in Q2?

We're not yet. I think that is something we're going to be considering going forward because we know it's of interest. But if we do, that will be a Q3 metric that we'll start disclosing.

There's no problem with doing that and we understand the nature of the need. We have to just change our reporting mechanism. So that's -- there's a little prep work on doing that. But I expect that we'll be doing that in the near future.

Okay. A couple of questions for Tom then. You talked about the timing of expense reductions, that the run rate EBITDA target was going to take a little longer to get to. I had the impression that, that shift in timing is more to do with the gross margin impact than an OpEx impact. So that was -- some color there was one question. And then how should we think about sort of the quarterly cadence of non-GAAP operating expenses? Obviously, they're going to be trending lower, but if you could give us a sense of -- is that a gradual line? Or is there a particular step function, what you should be looking for in a given period?

Okay. You have that generally correct, Rob. I mean, clearly, the expense cut, if you will, that requires the longest lead time is kind of the manufacturing side. The other 2 buckets, if you will, of expense cuts are headcount related and other operating expenses that aren't headcount related. We really will see a pretty good size impact on the headcount-related expenses in Q3, but that won't be all of it because we've phased -- even though we let people know in June, obviously, a lot of those employees were phased out over the third quarter. So in some cases, people were let go immediately; others were kept 30 or 60 days. So Q4 on the headcount-related expenses, at least with respect to the June announcements we made, should be fully baked in by Q4. As I think we both said pretty clearly, at least between the lines, the GM and -- the gross margin improvements will start to show in Q4, but will be really fully realized in the early part of 2018. And in terms of trends, you have it exactly right that obviously you should expect to see a declining non-GAAP OpEx number quarter-over-quarter here for the next -- certainly the next 2 quarters, maybe even into Q1 of next year if we find other areas to become more efficient. And the only caveat to that, of course, is what we've seen in the past, if we have any real spikes in legal comps that kind of offset some of those expense savings. We're very focused on trying to manage better our legal expense. Clearly, a lot of it historically comes in the way of IP infringement cases, but there is obviously corporate cases as well, including the Ralstons, that can have an impact on our legal expense. And to a certain extent, those are obviously less controllable than other expenses. But believe me, we're trying to make legal costs a very controllable expense to the extent we can.

Okay. And my final question is on cash. It was nice to see the cash balance up a little sequentially, and you talked about the sale of the older MiFi product as negatively impacting the gross margin to some degree, but should generate cash in this quarter. So not looking for a specific target, but would you expect to see cash increase sequentially in Q3 as well? And how much, more or less, does the inventory still contribute?

Yes, hard to want to quantify that. But I think just directionally, apart from a financing, which obviously would have a much different impact on our cash, but apart from it, a transaction, therefore, kind of on status quo basis, we would expect a build of cash during Q3. It's a quarter that we don't have a payment on our convertible notes. And as we've said, kind of both in the June release and referenced in today's call, we're clearly focused on improving our cash flow and expect to get to kind of positive free cash flow by the first part of 2018. That implies that we won't quite get there back half of the year in total, but I think if you take out the semiannual payment of interest, which will happen next in December, that we would expect Q3 ending cash balances to bounce up a little bit.

This concludes our question-and-answer session. I would like to turn the conference back over to Dan Mondor for any closing remarks.

Yes, thanks. So just a couple of remarks. First, I wanted to thank everyone for joining today's call and for your ongoing support of Inseego. As we discussed today, we've embarked upon a new direction for the company that is laser-focused on increasing shareholder value and value for all stakeholders in the company, in both the near term and, obviously, for the future. The strategy creates a more efficient company, which will allow us to -- more opportunity for technology innovation to drive growth than in recent past. Lastly, I want to thank every employee of Inseego for your tireless efforts and commitment to achieve success. I look forward to providing you progress reports on future earnings calls, and since I'm new at the helm, to meeting you all in person. Thanks again.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.