Inseego Corp.
Q1 2017 Earnings Call Transcript

Published: 13 May 2017

[Operator:]

Hello and welcome to the Inseego First Quarter 2017 Financial Results Conference Call. [Operator Instructions] Please note, today’s event is being recorded. On the line today are Sue Swenson, Chief Executive Officer; Michael Newman, Chief Financial Officer; Tom Allen, Interim Chief Financial Officer; Michael Sklansky, Investor Relations. I would now like to turn the conference over to Michael Sklansky. Mr. Sklansky, please go ahead.

[Sue Swenson:]

Thanks, Keith. 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. Now, I would like to turn the call over to Sue Swenson, Chief Executive Officer of Inseego.

[Sue Swenson:]

Thank you, Michael. Good afternoon, everyone and thank you very much for joining today’s call where we will share our first quarter 2017 results and provide an update on our key initiatives. I will cover three main topics on today’s call. One, an update on the proposed sale of MiFi to T.C.L.; number two, an update on each of Inseego’s business areas, including Ctrack’s positioning within global telematics; and three, management’s view on strategic alternatives. As most of you are aware, we announced the proposed sale of our MiFi business to T.C.L. in September of 2016. In November 2016, we filed for CFIUS approval of the transaction. For the past several months, we have been working with T.C.L. to develop solutions to mitigate any potential issues. We believe MiFi hotspots are a commodity product. I am sure that every listener on this call already has a hotspot via their smartphone. MiFi devices do not use apps and do not have excess memory, so introducing malware is virtually impossible. And most perplexing to both Inseego and T.C.L. is the fact that T.C.L. already sell hotspots and smartphones to U.S. carriers

[Michael Newman:]

Okay. Thanks, Sue. As Sue mentioned, Q1 was a challenging quarter for the company. As our sale of the MiFi business to T.C.L. stretched out, we did not generate consistent improvements to our business as we would expect. As compared to Q1 a year ago, our core metrics in Q1 2017 all showed substantial growth. But on a sequential basis, as compared to Q4, we did not maintain our momentum. In other words, we took a step backwards after five quarters of success. However, our core businesses remain strong and are squarely aligned with the growing global market opportunity. And as always, execution is the key to success. Total revenue in the first quarter of 2017 was $55.4 million, down 17.2% from $66.9 million in the first quarter last year. This decline was driven by the company’s strategic shift towards SaaS, software and services with reduced standalone hardware revenues as compared to last year. We generated $14 million in SaaS, software and service revenues in the first quarter of 2017, an increase of 9.4% from $12.8 million a year ago. These are our most profitable revenues and represented 25.3% of our total revenue mix in the first quarter of 2017 compared to 19.1% in the first quarter of 2016. Despite this annual growth, we did misstep from an execution perspective in Q1. Our SaaS, software and services revenue decreased sequentially from Q4 due to reduced sales from third-party products and associated service offerings from Inseego North America as well as reduced revenues from our South African user-based insurance and consumer telematics offerings. A Ctrack contract with our largest UBI customer was restructured. And while that negatively impacted short-term growth in SaaS and services revenue, over the longer term, we believe that sets the stage for sustained growth with that UBI customer as well as other potential UBI business. Our UBI and consumer telematics offerings in South Africa represent approximately 25% of our global Ctrack business. The consumer UBI business lines have a lower value proposition and, therefore, lower ARPU than our Ctrack fleet products sold in South Africa, the UK, Europe and Australia. Pricing continues to remain stable in these core markets and product sets. Our hardware revenues declined to $41.4 million in the first quarter of 2017, down 23.5% from $54.1 million in the first quarter of 2016. While this year-over-year decline was driven by our strategic de-emphasis of the standalone hardware sales, revenues from our MiFi products actually increased sequentially from Q4 2016 as our next generation MiFi hotspot product launched with Verizon in early 2017. While this product is not part of our long-term strategy at Inseego, the product launch itself was quite successful and we have received positive feedback from Verizon and end customers alike. I also want to remind you that we divested our hardware modules business to TELEC last year and there were $4.2 million of revenues associated with that business in Q1 2016. Our Ctrack operations contributed $15.3 million of revenue in the first quarter of 2017, growing 2% from $15 million a year ago. Ctrack revenues experienced the same seasonal decline in Q1 from Q4 as we have seen in the past. We had hoped to buck this trend in Q1 2017, but could not overcome it due to the pricing adjustments with our largest customer in the UBI space as well as other executional challenges in the consumer stolen vehicle recovery market in South Africa. In terms of subscribers, our subscriber base grew in the first quarter by 18.5% to 633,000 total subscribers at the end of Q1 2017 from approximately 534,000 subscribers at Q1 2016. More specifically, in the first quarter, our Ctrack fleet subscriber base grew year-over-year by 15.2%, ending the quarter with 189,000 Ctrack fleet subscribers. Our other Ctrack telematics subscriber base grew year-over-year by 16% to 239,000 subscribers, although this group of subscribers declined on a sequential basis from Q4 based on the challenges we experienced in the UBI and consumer SVR markets in South Africa. Our Inseego North American IoT subscriber base, which is formerly known as FW, grew year-over-year by 25% to 205,000 subscribers. Non-GAAP gross margin was 31.8% in the first quarter of 2017, decreasing by 3.4% from 35.2% in Q1 a year ago, driven by a decline in gross margins for MiFi mobile broadband products that offset the company’s strategic transition towards the improved mix of higher margin IoT solutions with the significant SaaS and recurring revenue components. The launch of our next-generation MiFi hotspot product came with a reduction in gross margins as compared to the prior-generation MiFi hotspot largely due to the distractions and challenges of launching a major product while in the midst of a publicly announced divestiture. For example, we experienced an unwillingness of certain core suppliers to match price concessions from prior MiFi product releases for two reasons

[Sue Swenson:]

Mike, thank you. And before I turn the call over to the operator for Q&A, I’d just like to take a moment to publicly thank Mike Newman for his contributions over the past several years. He joined the company at a very turbulent time and has been key to the transformation of the business. The partnership that we had and our shared vision and values enabled us to work very well together as we worked through some very tough challenges. I know that Mike will remain interested in the future of Inseego and I know I’ll be able to count on him for sage advice and counsel. I also look forward to working with Tom Allen again. He, too, has worked with us during turbulent times in the past and understands the business and the challenges that still face us. Having worked closely with Tom during his last interim assignment, I am confident that he will be able to provide us the support we need while we search for a permanent CFO. With that, I will now turn it over to the operator for Q&A.

[Operator:]

[Operator Instructions] And the first question comes from Jaeson Schmidt with Lake Street.

[Jaeson Schmidt:]

Yes, thanks for taking my questions. Just want to start on that UBI contract negotiation, was it more – was the impact more due to the timing of the contract or early negotiating of the terms?

[Michael Newman:]

Hi, Jaeson. Good question. That’s a contract that the company has for a while now and it really was the first of its kind and largest UBI deal, not just in South Africa, but probably in the world. And I think, between ourselves and our UBI customer, it just got to the point that the economics of that arrangement really weren’t working going forward in terms of attracting and growing the business the way that they would like. And while we obviously would have, over the short run, preferred not to restructure the contract because it’s a short-term hit to our revenue, over the longer term, having a restructured arrangement that allows for growth and a platform for growth and expansion is better than having a contract that was really going to run its course. It also positions us better as we continue to try to prioritize UBI in other regions to take this opportunity to those places as well.

[Jaeson Schmidt:]

Okay. And then, just shifting gears to the SMB product, any update you can provide on how traction and the reception is going in the North American market?

[Sue Swenson:]

Yes. Thanks, Jaeson. As you know, we revamped the UI, UX a while ago and we have been in trials with a variety of customers around North America and we have gotten very good feedback. We have taken a look at – you have heard me comment that we’ve done a recent review of our regions and the opportunities in those different regions. And we think we have a pretty good opportunity that – maybe even better than North America in our Australia organization, partly because they are established. They have got an organization. They have got infrastructure. It doesn’t mean we won’t continue to expand the opportunity in our other regions, but we did a little bit of a pivot as a result of some analysis that we did about the different regions. So we are pretty pleased with the progress that we’re making and the feedback has been very, very positive. We’ll continue to develop that platform and add features and functionality as we see it appropriate, but we think we have a pretty robust and attractive offer based on what we’ve developed to-date.

[Jaeson Schmidt:]

Okay. And then, so you are just going back to your comments in the prepared remarks about being able to grow the Ctrack business 25%. Any sort of timeline you can provide and how we should think about that target?

[Sue Swenson:]

Yes. Well, first of all, let me correct you. I think I said 20%, but we can certainly aspire to do 25%, but I think I said 20%, but thanks for the confidence. And based on – like I said, Jaeson, we have been doing quite a bit of work on – as you know, we have done a variety of things here in the old Novatel past. And I think Ctrack has done a number of things and we are really honing in on those markets and those products that we think have the best opportunity for growth. So that’s why we feel very good about it because of that analysis that we have conducted over the last 3 months. It’s been great to have Cobus Grove here in the United States because we can have the opportunity to interact with him more, and he certainly understands his markets and his people. So that’s why we are feeling much, much better and more confident about that.

[Jaeson Schmidt:]

Okay, that’s helpful. And the last one and I will jump back into queue. Just want a clarification on your comments regarding strategic alternatives and potential routes you may pursue if this deal doesn’t get done. Do those comments relate strictly to the MiFi business or the entire Inseego umbrella of products?

[Sue Swenson:]

Yes. No, I think it’s a great question. In my comments, I said that obviously MiFi is a priority and it’s something that we have obviously thought about for quite some time and set probably back to the early 2016 timeframe when we were thinking about the sale of this and have been considering this for quite some time, but I think I really said at the end of my comments, we’ll begin exploring strategic alternatives for all parts of the Inseego business. So I think it’s important for people to understand we’re taking a very comprehensive look of what we have to do because we think there is great value here and we want to make sure we maximize it. So as far as I am concerned, nothing is off the table.

[Jaeson Schmidt:]

Okay, thanks a lot, guys.

[Operator:]

Thank you. And the next question comes from Rob Stone with Cowen & Company.

[Rob Stone:]

Hi, Sue. I wanted to follow-up a little bit on the comments in your prepared remarks about seasonality X unexpected turbulence from things that you had mentioned with the divestiture process. How do you think about normal seasonality? If it’s Q1 down sequentially, what’s the typical shape of your SaaS business for quarters two through four?

[Michael Newman:]

Yes. That is a good question. So I will take it instead of Sue. So Ctrack folks haven’t historically seen the quarterly seasonality in Ctrack since Ctrack was a first base company listed on the Johannesburg Stock Exchange and they reported in 6-month cycles. We look at it on a quarterly cycle. Q4 likely to seen, Q1 tends to seasonally step down from Q4, then you get a step up seasonally in Q2 since June 30 was Ctrack’s historic fiscal year end. Then it’s flattish, a little bit flattening across from Q2 to Q3 and then a step up in Q4. Now, Ctrack is just one portion of our SaaS and services business. We have the Inseego North America business, which is formally known as the FW business. That has a more traditional North American seasonal trend where it’s – you sometimes get a little push there in Q4 due to budget flush, but that’s much smaller than the Ctrack business, particularly when it comes to the SaaS and service offerings. So it’s really the Ctrack seasonal trend that impacts that line.

[Rob Stone:]

Okay, great. That’s helpful. A couple of housekeeping items, probably I’ll ask for you, Mike. One, you mentioned the expense reduction year-over-year from planned actions already undertaken. Are you expecting to see more of that or as the revenue steps back up sequentially, should we see expenses move up a little bit along with that? Just sort of a general directional comment on OpEx.

[Michael Newman:]

Yes. So in the very, very short run in Q2, you should see expenses step down in large part due to savings on the legal side as a result of that litigation item. So as a result of that one item, it will step down in Q2. But overall, I mean, look, right now, as evidenced by the EBITDA and the EBITDA margin, negative, obviously something – you can take steps to align the cost structure with the company’s revenue profile and, now, new gross margin profile of what we saw in the MiFi business. So that’s not just a MiFi-related subject though. It really cuts across the whole business because we had a whole business to run. And so I would expect continued aggressive management of the costs to align with the revenue as opposed to wishful thinking for the revenue to magically pop up and support all the costs. Now, that doesn’t mean we don’t expect to see growth in revenue. We are guiding to revenue growth for Ctrack. We are guiding to revenue growth for SaaS and services and the company looks to get back to consistent sequential improvement, not some dramatic onetime blip on the revenue side. So we will manage that revenue. We will manage to the planned revenue growth, which is not wishful thinking growth, but actual realistic reasonable believe growth and the cost structures got to align to that.

[Rob Stone:]

Great. A question on the credit line. So you have put in sufficient capital to do what you need to for a year, I guess, $2 million to effect that transaction. Were you in a position to repay that sooner, let’s say, in the next couple of months? Are there any additional fees to prepay the line before the end of a 1-year term?

[Michael Newman:]

Not at all, not at all. Good question. There is no prepayment fees, prepayment penalties. If we prepay, we simply would pay accrued interest at that time, but there is no penalty fees or other charges for prepaying. And in fact, when the MiFi business is divested or if it’s not divested, if there are any other divestitures, those proceeds under the loan are called for to repay the loan, again with no fees or penalties.

[Rob Stone:]

Great. Alright. But just to make sure I am not leaving Sue short on questions, one more for you. You mentioned targeting new carrier relationships. Obviously, there is a particular skill dealing as a small company with much bigger ones. How do you think about the lead time to stand up a relationship like that? And I recognize none of this is brand new since you have been working with one or more big carrier customers for quite a while, but just when might we see that crop get harvested?

[Sue Swenson:]

Yes. That’s a great question, Rob. Each of the carriers is a little bit different. We have done quite a bit of work at looking at our global carrier strategy. And depending on the relationships we have today, which are many I think the opportunities are probably have a shorter cycle time. We obviously want to try to deepen the relationships with the ones we have, which, again, I think would shorten the cycle time. We also think there are some interesting target ones that we don’t have an opportunity with, but I think we are – it’s certainly an important relationship for us. And we do have some fairly high level relationships in most of the carriers, which certainly facilitates movement. We don’t have to start at the midlevel management. We can start at a more strategic level, which, when that comes top down in the carrier world, things happen faster. So I don’t think I can give you specifics, but I think we’re well-positioned within the global carrier, call it, ecosystem. I think it’s also important to think about the evolution of the carrier world because certainly they are changing. I think the things we have to offer today are more interesting for them because of, obviously, the penetration they have within their base business. And as you know, there are several carriers who view the kind of business we’re in very attractively. So we think we will see where that leads us, but I’m pretty pleased about the progress we’re making there and the relationships we have. So we hope to give you more information as the quarters evolve. I think I gave a little bit of a preview on some things we have underway. And hopefully, as the quarters evolve, we will be able to announce some specific transactions with them.

[Rob Stone:]

Great. That’s all I had. Thank you.

[Sue Swenson:]

Thank you, Rob.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from Mike Walkley with Canaccord Genuity.

[Mike Walkley:]

Great, thank you. Just a clarification for me. On the cost cuts, I think you have talked also in the call about the need to invest in Ctrack, etcetera. So, the cost cuts mainly on the MiFi business or are there other areas where you think you can cut costs? It’s the first question.

[Michael Newman:]

Yes. I think it’s more of a holistic approach in terms of trying to assess where we are overspending against the return that we are getting. So I wouldn’t confine that to any particular business. I mean, obviously you’ve heard us talk in the past about certain areas of business that we think are underperforming and can be cut back. At this point though, I think, as with the strategic transactions discussion that Sue covered earlier, I don’t think there is really any areas of rationalizing our costs against our revenues that are off-limits.

[Sue Swenson:]

That’s correct.

[Mike Walkley:]

Okay, thanks. And then just on a bigger picture, just with – assuming this – you get the approval on MiFi sold as any kind of thoughts on how we should think about longer term EBITDA targets or 12 months out EBITDA margins for the standalone businesses any of those type targets that you are willing to share at this point?

[Michael Newman:]

Yes. Nothing has really changed from the prior view in terms of what that standalone business looks like. We talked about on this call a lot of what the factors that turned positive EBITDA into negative EBITDA related to reduced gross margins for the MiFi business, that litigation item, which also relates to the MiFi business. We weren’t pleased with how either the Ctrack or Inseego North America businesses performed, but neither one of them – while they both underperformed against our expectations, neither one has more recurring-oriented businesses, neither one really fell off the map by more than hundreds of thousands of dollars. I think, as we look ahead, I don’t think the outlook for those businesses really changed. We had talked about whenever the MiFi sale to T.C.L. closed. We talked about emerging from that in the first quarter following the closing with a $90 million revenue run-rate for the new business with a 5% to 10% EBITDA margin. And I think that continues to be the goal and the focus. I don’t think anything has changed there at all. And I think when you look a year out from that, whenever that may be, I think you would expect to see growth in the top line. Whether that translates into EBITDA margin expansion or not over time ultimately depends on how much of that growth is reinvested to drive further growth, but we certainly would expect to see growth in the top line as well as stable if not expanding, EBITDA margins over time.

[Mike Walkley:]

Okay, thanks Michael. That’s helpful and best wishes to you and your family as you move on. Last question for me and then I will pass the line is any kind of run-rate we should expect kind of for modeling or to think about Inseego North America given some of the changes and how you are pursuing that business from less hardware upfront sales? And is that $90 million still the right target for the combined company, given the Inseego North America kind of changing their strategies since the last time you shared that number?

[Michael Newman:]

Yes. I think the $90 million is still the right target. I think when you think about Inseego North America, you have to remember – Sue may have said this earlier, you have to remember that when you are converting from a hardware-based revenue system to one that relies on SaaS and services, hardware tends to be recognized upfront and SaaS and services over time. The lifetime value of the customer is obviously much greater with SaaS and services, but in the short-term, as you are making that transition, it’s hard to get revenue growth – total revenue growth because you are losing hardware revenues while you are on a – you are growing the lifetime value of those customers faster, but in the short-term, the revenue is – the offsetting revenue is growing slower. So I think you should continue to think of the – our Eugene-based operations as relatively flattish from a revenue perspective while the mix improves.

[Mike Walkley:]

Okay, that’s helpful. Thank you.

[Operator:]

Thank you. And the next question comes from Cobb Sadler with Catamount.

[Cobb Sadler:]

Hey, guys. Thanks for taking the questions. Just a first question on the CFIUS process, and I don’t know if you are talking about that today or not, but like from this time around, are you doing anything different or just more of the same and explain your case better? Because, I mean, I agree with you. I walk into AT&T, there is three hotspots. Two are made by the ZTE, which is a Chinese manufacturer. I just don’t understand the situation. As you mentioned, T.C.L. already sells hotspots in the U.S. So the case to me is clear cut, but are you doing anything different this time around to help your case and when might that conclude? Sorry, yes.

[Sue Swenson:]

Yes. Let me comment on that. I hope you could tell by my comments the – kind of the frustration that I felt out of the whole thing. We have done everything asked of us since we started the process with them, Cobb. And as you could tell by my comments, we are confident that we are not a problem, but the opaqueness of the process has caused us to take, I would call them alternative routes, which I really don’t feel comfortable disclosing at this point in terms of what those are. But I would tell you we are dealing with obviously directly with the CFIUS entity within the federal government and continuing to try to answer questions for them, but we are exploring some different routes to see if we can get our message across more clearly. Interestingly, I have a secret clearance as a result of the work I do in another area. And even that was indicated to us by CFIUS that they could not share the – any concerns that they have. So we are, as I said, exploring any and all alternatives available to us, of which there are several. And I will just leave it at that. I would just tell you, from a timing perspective, I don’t expect and Mike can say something differently, but I don’t expect that we’ll be talking about this in the next quarter.

[Michael Newman:]

Go ahead, Cobb.

[Cobb Sadler:]

Got it. And then just I want to talk about EBITDA. I mean, you guided next quarter for, what, $2 million to $3 million. And so maybe the business – the Ctrack business that it is probably $12 million for the year or something like that. I know you are not guiding for the year, but – so that’s kind of a base. Your churn hasn’t been that high. And then, Mike, could you tell me – so, let’s say, if you grew 20% off of that business, maybe it’s 14 million extra or something like that next year. And usually you have got this EBITDA margin, but then you have what incremental EBITDA would be. So like, for new revenue, you are not going to have any G&A increase associated with that revenue as it relates to EBITDA. You are not going to have probably much more marketing expense, and you are not – sales expense would probably be there. But like for each incremental dollar next year, what is kind of – what kind of dollar – so let’s say you do $14 million just to round up, just a number of 20% x for next year, how much would drop down in dollars to – for EBITDA? So, I guess, your gross margins are maybe 65%, 70% or something like that. It certainly won’t be that high, but it’s certainly not going to be as low as the corporate EBITDA margin, because again there is no G&A associated with new revenue. So what I am trying to figure out how much revenue that – or how much EBITDA that $14 million revenue is going to kick out. What’s the number you think?

[Michael Newman:]

So it’s a complicated question, Cobb. Swenson, it’s a complicated question because you are hypothesizing that everything else stays the same and there’s going to be – there will be some restructuring activities, cost savings activities to align with the current revenue. So there will be a lower cost base against that increasing revenue that you’re describing. But yes, if you assume, let’s just assume for argument’s sake that it’s a 60%, 65% gross margin revenue dollar because it’s a Ctrack revenue dollar, you don’t scale – you wouldn’t typically scale operating expenses dollar-for-dollar or $0.60 on $1 to match that. You’re obviously going to have some sales expense, but you gain leverage as the company – as you have more revenues as a company. The real question is, ultimately, as you do that, do you reinvest those dollars in operating expenses towards growth in other regions. Let’s say, you’re driving growth in Australia with the SMB product, which you described earlier and its gaining real traction. You’ve got to make a choice then. Do you reinvest that to grow the UK market because you’re now seeing the – it perform well in Australia to grow the UK market? I think the answer is you probably reinvest some to keep growing. And then, obviously, given the company’s overall situation, you’d like to see some drop to the EBITDA bottom line. So that’s why I said I can’t imagine in that type of environment that you’re talking about, the company’s EBITDA margin is going to decline. The company is not going to spend like crazy to drive further growth. It would stay flat to go up. I would imagine it’s going to go up. Other companies in this space are doing 20%, 30%, 35% in EBITDA margin. I know that there are times where we may it look very difficult, but it really isn’t rocket science. If other companies can do that, so can we and those growth – those EBITDA margins out there are ultimately achievable as they have been for other companies.

[Operator:]

Okay. And this does conclude the question-and-answer session and the conference call. So I would like to thank you for your participation and you may now disconnect your lines.