Inseego - Q3 2022

Transcript

Operator (participant)

Hello, and welcome to Inseego Corp.'s third quarter 2022 financial results. Please contact the conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity for analysts to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. On the call today is Mr. Ashish Sharma, CEO, and Mr. Bob Barbieri, Chief Financial Officer, and other members of the management team. 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 investor 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 those 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 statement section contained in today's press release. I would now like to turn the call over to Ashish Sharma, Chief Executive Officer. Please go ahead.

Ashish Sharma (CEO)

Thank you, operator, and welcome to Inseego's third quarter fiscal 2022 earnings call. As mentioned in previous calls, Inseego is currently in a transitional phase. We shifted from being a company solely focused on designing and manufacturing hotspots to one that leverages core technologies to provide a full suite of connectivity and mobility solutions to enterprises via our fixed wireless and SD-WAN products. Our results this quarter reflect this transition, and we believe we are on the right path. We delivered a strong top-line performance this quarter with revenue of $69.2 million. This level of activity met our expectations on revenue. In the quarter, we benefited from initial volume shipments of our next-generation hotspot, the MiFi X PRO, to Verizon in the U.S. and Telstra in Australia.

While this is an important validation of our products, as you may have heard us say, that this start carrier business carries lower gross margins, which is a contributor to why we saw our gross margin tick down this quarter. Our adjusted EBITDA was a loss of $2.5 million. EBITDA was lower than we anticipated due to the ongoing impact of high supply chain costs and a non-cash adjustment to previously capitalized development expenses that elevated reported R&D in the quarter. The majority of these costs were non-recurring in nature. We expect our gross margin to rebound and our reported R&D expenses to decline in short order. In Q3, our 5G revenue increased 22% year-over-year and now comprises 49% of total revenue. Our software solutions represented 21% of total revenue in Q3.

Both of these metrics are important as we transition the company and move towards our financial targets. In Q3, we made good progress towards our most important goal of approaching cash flow breakeven by year-end. This progress was driven by the initial ramp of our enterprise FWA business. That business now accounts for over 13% of our revenue and importantly, boasts a much stronger margin profile than our traditional hotspot business. We've now sold 5G products to over 600 enterprises this year, with our enterprise base exceeding 1,000 customers, all in various stages of deploying 5G. Many of these enterprises follow the same path, purchase and test 20-50 Inseego devices to test and evaluate, with the goal of deploying devices along with our software across their entire footprint. These deployments are mission-critical, with full deployment occurring over multiple quarters.

It is also important to note that the vast majority of these wins are coming at the expense of competitors such as Cisco and Cradlepoint. We've also added a lot of new enterprise customers to the list of ongoing pilots. Thanks to the breadth of our 5G portfolio, we are seeing a trend of more and more customers choosing Inseego over the competition. Before I provide additional Q3 highlights, I want to share three reasons why we are confident we will approach cash flow breakeven by the end of this year. First, as many of you know, we've made substantial investments in product development and go-to-market initiatives over the past few years. This positions Inseego as the leading provider of best-in-class 5G fixed wireless access or FWA solutions to enterprises. Second, we continue to tightly manage all of our costs.

We've already taken our close to $20 million cost out of the business annual run rate year to date, and we'll continue to remain dedicated to our free cash flow goals no matter what 2023 will look like. On the R&D side, we've completed several key mid-band certifications over the past two quarters that will enable us to lower expenses going forward. Third, the dramatic increases in the available spectrum and network performance made possible by 5G will give rise to a host of new enterprise service offerings, and we are hearing this in all of our dialogues with our tier one carrier partners. Lastly, our carrier partners are only now beginning to roll out meaningful enterprise-focused FWA services and the plans to support them.

Those are becoming more commonplace, and we expect to see real expansion of this in 2023. Let's get into some examples of the customer momentum we saw in the quarter. We won a new customer in the commercial real estate sector. They cut the cord with the local cable ISP once they tested our outdoor 5G FWA solutions and experienced upload speeds of 151 Mbps. That's correct, I said upload. Another example of a new customer we recently secured is a well-known car wash chain based in the Midwest. As with all retailers, consistent uptime for video surveillance and payment transactions is paramount. The customer was facing challenges with the satellite communications they were using as it cannot deliver reliable performance in inclement weather, which compromises their uptime.

After successful testing in a number of locations, our 5G FWA solution was selected for primary connectivity, replacing their existing satellite ISP services. On the carrier side, in addition to our Telstra launch in Australia, we expanded our relationship with Drei Austria, part of the Three Group companies. They launched our Wavemaker FG2000 indoor solution for their business customers during the quarter. I also want to address our investments in inventory. These have been a headwind to cash flow generation and are now beginning to moderate, as you can see in our inventory position exiting Q3. Given the challenging supply chain with long lead times of many constrained components over the last couple of years, we increased our inventory position significantly over the past few quarters. This was done to ensure we have adequate supply to meet our customers' needs in this newly developing 5G FWA market.

We believe that build has plateaued, and we will be able to sustain a downward trend and manage new demand without major cash needs. Considering the progress we've made on all fronts, we remain on track to approach cash flow breakeven by year-end. Most importantly, we are poised to generate positive free cash flow in the first quarter of 2023 and expect to remain positive thereafter. I want to thank our employees and customers for their continued support, and I would now like to turn the call over to Bob, who will provide more details on our Q3 results.

Bob Barbieri (CFO)

Thank you, Ashish. Let me now review the results of our third quarter fiscal 2022. Please note that all metrics and comparisons made are non-GAAP on a pro forma basis, adjusting for the divestiture of Ctrack South Africa, which was completed in July 2021. Please refer to our earnings release for additional details on the GAAP to non-GAAP reconciliation. Q3 revenue was $69.2 million, up 9% from the prior year and up 12% on a sequential basis. Our growth reflects higher than anticipated sales of our new MiFi X PRO product, partially offset by anticipated declines in 4G products sold to our carriers.

Next generation solutions, which are comprised of 5G devices and all of our cloud software assets, increased 19% over Q3 fiscal 2021 and represented 70% of total revenue in this quarter as compared to 62% of the revenue in the year ago quarter. Third quarter IoT and mobile solution revenue was $62.6 million, up 10.1% from the same period last year. Our growth was primarily driven by the launch of MiFi X PRO hotspot and further uptake of our solutions by enterprise customers, which Ashish mentioned comprise over 13% of our revenue in Q3. Enterprise SaaS solution revenue was $6.5 million, representing a slight decline on a sequential and year-over-year basis. Consolidated gross margin was 26.3%, down from 29.5% in Q2 and 28.2% in Q3 of last year.

Gross margin for the IoT and mobile business was 23.4%, down from 24.4% in the prior year period and 27.3% in the prior quarter. The lower gross margin on a sequential basis was attributable to a significantly higher mix of hotspot revenue, which had lower contribution margin than we've seen of late due to higher component and distribution costs associated with the initial launch of our MiFi X PRO product. The majority of these costs are not expected to recur in Q4 and beyond, meaning margins on our carrier products should rebound in the coming quarters. Also worth noting, gross margin on our enterprise FWA sales remained robust in Q3, exceeding 40% and leaving us confident that our gross margin has ample room for expansion as we continue to scale our enterprise business.

Gross margin for the enterprise SaaS segment was 54.1%, relatively consistent with the past two quarters. Q3 non-GAAP net loss was $12.4 million or $0.11 per share, compared with a loss of $0.09 per share in the prior quarter and a loss of $0.08 per share in the year ago quarter. We reported an adjusted EBITDA loss of -$2.5 million, which was up from a loss of $1 million in Q2 and a loss of $800,000 in the year ago period.

The change was largely due to the supply chain costs alluded to earlier and higher than anticipated levels of R&D this quarter, which included a one-time non-cash adjustment of $700,000 related to capitalized software expenses that incurred in prior periods and also higher certification costs that will abate as we now have completed a major product launch and obtained key certifications from our carrier partners. For additional details on our non-GAAP and adjusted EBITDA results, please refer to the reconciliation tables in our press release. Cash, cash equivalents, and restricted cash at the end of Q3 was $18.1 million. Our cash usage improved from the prior quarter, but working capital consumed additional cash due to the timing of orders. For the remainder of the year, we expect our quarterly cash usage to trend lower and approach cash flow breakeven.

We believe this will leave us well-positioned to generate positive cash flow on a sustained basis during 2023. We note that our expectation for generating positive cash flow next year is predicated upon a steady ramp in our enterprise fixed wireless revenue and growth in our 5G carrier hotspot sales, offset by the anticipated decline in our 4G product sales. As mentioned previously, we continue to be focused on cost and ensuring we are cash flow positive next year. We continue to prioritize growth in our higher margin enterprise sales, which we believe will have a transformative impact on our business by increasing our mix of recurring revenue, expanding our margins, and ultimately sustaining strong free cash flow over the long term. With that, let me turn it back to Ashish for his closing comments.

Ashish Sharma (CEO)

Thanks, Bob. The key takeaway from our Q3 update is that we saw steady progress against our key initiatives, and we continue to approach an inflection point in our business. As the availability of 5G enterprise FWA offerings become more prevalent, we are well-positioned to benefit from the growing demand for our products. In parallel, our cloud-based software solutions have a high attach rate, providing us with a high margin recurring revenue stream. This enterprise growth, layered on top of our existing cost structure, will ultimately transform Inseego into a high growth company with sustained profitability and positive cash flow. Thank you all for your interest and support. We look forward to taking your questions.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble our roster. Again, if you have a question, please press star then one. Our first question will come from Lance Vitanza with Cowen and Company. Please go ahead.

Lance Vitanza (Managing Director and Senior Analyst)

Hi, guys. Thanks for taking the questions. I have kinda three areas that I was hoping that we could explore. The first on the revenue side, that is, in IoT services. Revenue was up about $5 million-$6 million year-on-year. It's about a 10% increase. I'm just wondering if you could sort of help us break that down between increased hotspots versus software, 5G versus 4G, you know, price versus volume. Any additional color on those categories would be helpful.

Ashish Sharma (CEO)

Hey, Lance. Great talking to you. This is Ashish. Let me take that. First, good question. I would say there are two components of increase year-over-year in that revenue. One is the new hotspot launch we've had with new customer in Telstra in Australia. I would say that's net new revenue. Number two, I would say the continued growth in our enterprise FWA revenue, that's all bucketed in that IoT and mobile revenue. I would say those are the two main components.

Lance Vitanza (Managing Director and Senior Analyst)

I guess the question, are you seeing any change with respect to the unit pricing on either side? Is this, I mean, should we just think of this as being pure increase in units that you're selling, or is there a pricing component as well?

Ashish Sharma (CEO)

Why don't we step back a little bit, right? Lance, you know, since I took over as the CEO earlier in the year, right, we did a comprehensive review of all the businesses. We started to change our focus from chasing every type of revenue growth to more of quality of revenue and cash flow generation, right? In that respect, I would say our highest priority right now is to grow the enterprise FWA business, which was a component of this, you know, increase you're talking about. Yes, the margins there are significantly higher. I mean, out the gate, we're seeing 40%+ margins there. That's embedded in that revenue. Number two, I would say on the hotspot side, we're still focused on taking that revenue from key selected carrier partners.

We're not chasing every carrier, you know, with low margin, you know, business, because hotspot tends to be quite a lower margin business compared to enterprise FWA business. We did see an impact on our hotspot margins while the revenue increased this quarter, but we continued to see higher elevated supply chain costs, particularly given it was a brand-new product in the quarter, you know, from approval to launching it, we had to put everything on air. There are higher costs of shipping, and there continued to be higher component costs. I would say that's the mix you're dealing with. As we generate more and more enterprise FWA revenue, you start to see that margin really, you know, shift towards much more than what we see today.

Lance Vitanza (Managing Director and Senior Analyst)

Great. That actually answers most of my gross margin question. Just to sort of follow up on the gross margin, you know, you did call out the elevated supply chain costs in the quarter, and I'm just wondering, you know, do you have any ability? I would think that you would be able, like a lot of companies that we cover, to go back and pass on some of those increased costs to your customers. I'm wondering if that's the market just too competitive for you to do that? Or is it simply the nature of the one-time nature of the cost increase that really didn't give you the time that you needed to go out and get these costs back? Or how should we think about that going forward? Thanks.

Ashish Sharma (CEO)

Yeah, good question, Lance. On the enterprise product side, we have done all of that, right? We have increased the pricing, but it is still a smaller piece of our revenue, even though it grew to 13% of the quarterly revenue this time. I would say on the hotspot side, it is a very competitive market, even for our carrier customers. They have certain slots out there, and there's pricing and elasticity of volume with pricing on those slots. It is super challenging for us to pass on those costs. Having said that, we've still surgically gone ahead and in some cases, with the customer's consent, increased the pricing.

Still, like I said, there was just too much hotspot revenue this quarter that shifted the margins downwards, given in general, the margins on hotspots are quite lower compared to the FWA enterprise margins.

Lance Vitanza (Managing Director and Senior Analyst)

Okay, understood. Lastly, on the margin. Thank you for the detailed explanation about these, you know, non-recurring cost items that came up, and it seems as though they came up very late in the quarter. I don't recall you know, identifying these when we spoke three months ago on the earnings call. My question is, do you feel confident in your visibility as you sit here today with, you know, with where we are as it relates to the fourth quarter and sort of the turnaround in margin? Or do we have to worry that, well, gee, there could be some other, you know, one-time items that come up, that crop up, you know, over the next 60 days or so?

Ashish Sharma (CEO)

Yeah, Lance, given that the launches of the new product, you know, at least two big ones were executed this quarter, we are fairly confident that we're gonna see improved margins next quarter. I don't see those type of headwinds hitting us again.

Lance Vitanza (Managing Director and Senior Analyst)

Okay. Then just shifting, if I could last, and then I'll wrap up, I promise. On the balance sheet, you know, I would imagine that given your relationship with Foxconn, that your minimum cash balance is quite low. Could you talk about that? I mean, I know you have the revolver, which is great, but, you know, is there sort of a minimum cash balance that we should expect that you will need to stay above just from the standpoint of operating the business? I know it's early, you have a couple of years, but could you talk also about how you anticipate addressing the convertible note maturity in May of 2025, I believe it is. Thanks.

Ashish Sharma (CEO)

Yeah, Lance. Let me, you know, give a high level overview there, and then I'll ask Bob to chime in here. Three things I wanna highlight, right? One, that we took out $20 million in cost this year as a run rate already. That's one. Number two is the inventory, as I mentioned in the script, we were running pretty high on inventory given the long lead times and trying to just really manage the you know, supply chain costs, you know, by you know, by putting stuff on the boat and by trying to pre-buy with long lead items, right? That's moderating now, and that's gonna trend downwards. It relieves pressure on spending more cash there. That's number two.

Number three, and the most important one is we're seeing, you know, lot of traction in our enterprise FWA business with, you know, already this year, we have signed up hundreds of new customers with high margin revenue. Combination of those three, you know, Bob's team has done a very, very detailed modeling. We're fairly confident with the cash and the revolver we've got. We don't plan to use the revolver for cash needs. It's mostly for some working capital changes that in the quarter we go through here and there. But we'll be able to manage the business pretty tightly moving forward with those three different things I talked about. Bob, if you have anything to add.

Bob Barbieri (CFO)

Yeah. Yeah, hello, Lance. I mean, the only things that I would add, and, you know, you've been with us, so you know this. The heavy investment in the two transitions, the transition to fixed wireless and having the correct portfolio position. Then the second transition from, call it, earlier or previous generation 4G and even previous generation 5G to new generation 5G in hotspots, we've already made those investments. First, from the investment need, we feel really good that, of course, we're going to spend some money, but the heavy lift is behind us. Second, we wanted to avoid what some other companies found, and they were stockouts and limited to what they could supply. If anything, we intentionally inventoried up, so to speak, to that.

We now have very, very good optics by SKU or as to what the demand cycle should be, so we'll moderate those down. Then as Ashish also mentioned, the cost. It wasn't, you know. When we talk about cost, it was really, we don't need the same investment. I do want for the audience to kind of focus on. You know, this is not a company full of waste. Instead, it's a company who invested heavily in what they saw as a great 5G opportunity. As such, we now have that behind us, so we can reduce costs, not by cutting bone and muscle, but by just correctly sizing, since we do have all of those investments already in place. Hopefully, that helps, Lance. But, you know, feel free to ask a follow-up.

Lance Vitanza (Managing Director and Senior Analyst)

Thanks, guys. Appreciate it.

Ashish Sharma (CEO)

Thank you, Lance.

Operator (participant)

Again, if you have a question, please press star then one. The next question will come from Mike Latimore with Northland Capital. Please go ahead.

Aditya Dagaonkar (Equity Research Analyst)

Hi, this is Aditya on behalf of Mike Latimore. Could you tell me what was international as a percentage of revenue?

Ashish Sharma (CEO)

Hey, Aditya.

Aditya Dagaonkar (Equity Research Analyst)

Hi.

Ashish Sharma (CEO)

One thing I would say, Aditya, traditionally, we have not broken out our international revenue as a percentage. This quarter, I would say, given the big Telstra launch, that was significant part of the revenue.

Bob Barbieri (CFO)

Yeah.I would say it's, you know, we don't give out that specific granularity, but it was over 10%, so we took advantage of, you know, the good opportunity with Telstra, and we satisfied that.

Aditya Dagaonkar (Equity Research Analyst)

All right. Fine. Could you give some color on if you're seeing any hesitancy among the enterprise buyers given the macroeconomic concerns?

Ashish Sharma (CEO)

Hey, Aditya. A good question. So from our perspective, 5G has quite a bit of momentum in the enterprise and SMB market because if you look back to when the pandemic began, you know, access to broadband and internet became the lifeline for a lot of those businesses and customers. From our perspective, we see this, as I mentioned the previous call, we see this as an essential services that every enterprise, every employee of the enterprise needs to have, and 5G actually gives them a totally untethered capability, you know, based on location, irrespective of the location of where the employees are based. So we're not seeing any slowdown from the enterprises on evaluating and then continuing to deploy 5G.

Aditya Dagaonkar (Equity Research Analyst)

All right. Fine. That's helpful. Thank you.

Ashish Sharma (CEO)

Thank you, Aditya.

Operator (participant)

Again, if you have a question, please press star then one. This concludes our question and answer session. I would like to turn the conference back over to Mr. Ashish Sharma for any closing remarks. Actually, sir, it seems that we actually have another question that just came through, and that will come from Mr. Scott Searle with Roth Capital. Please go ahead.

Scott Searle (Managing Director and Senior Research Analyst)

Hey, good afternoon. Thanks for taking the questions. Ashish, I apologize, you probably covered this earlier in the call. But I just hopped on. Could you take us through the gross margin impact, you know, headwinds on that front, I'm sure from a component availability as well as some of the logistics issues. Can you take us through where we are today and how you see that progressing over the next couple of quarters, and give us a quick update in terms of how the supply chain impact is looking right now?

Ashish Sharma (CEO)

Yeah. Hey, Scott. Nice talking to you. Thanks for the question. On the gross margin front, you know, we had couple of things happening this quarter. You know, one positive that our enterprise FWA business, you know, grew quite a bit this quarter, and it's now 13% of overall revenue. And that's all very high-margin revenue, 40-plus% margins on that. But we also, you know, had significant stocking orders from couple of very big hotspot launches we did this quarter. And that kinda, you know, took the margin down because the hotspots were facing higher supply chain costs given it was new launch in the quarter, we had to put everything on the air.

The lead times were still a little bit long, so we had to, you know, order a bunch of the material well in advance. Those are a couple of things happening in the quarter. I would say moving forward, Scott, irrespective of what you saw in the gross margin, one, we will, you know, definitely improve the gross margin next quarter. We don't see all of those things repeating again. Number two, we're quite a bit focused on free cash flow generation into Q1 and getting very close to cash flow breakeven at this quarter. That's really driven by three things I mentioned earlier. You know, one is the growth in our enterprise FWA revenue, which is a great highlight.

Number two is we did take out over $20 million in cost from the business given our change in focus from chasing more quality revenue versus the quantity of revenue. Then that focus is all about enterprise FWA. Third is that, you know, this new hotspot got launched this quarter, and so, you know, now we're not quite facing the same supply chain pressure that we did in last, you know, this quarter. In Q4, that should come up. That's kind of quick summary of how we're thinking about both, you know, the margin and the cash flow.

Scott Searle (Managing Director and Senior Research Analyst)

Perfect. Ashish, if I could just follow up on fixed wireless access comment. 13% is a big number in the September quarter. Could you calibrate us in terms of what it was in the June quarter? Maybe help us understand the customers and the geographies that are ramping in full volume right now, what we should expect over the next couple quarters for that product line.

Ashish Sharma (CEO)

Yes, Scott. What I would say is that geography is you know, predominantly North America right now because you know, the couple of carriers here are the most aggressive one on enterprise FWA versus, you know, the carriers internationally. So most of it was coming from North America. I would say, just a ballpark, you know, that number is, you know, north of, you know, 50%, what we saw in the previous quarter.

Scott Searle (Managing Director and Senior Research Analyst)

Great. Okay. Thanks so much, guys.

Ashish Sharma (CEO)

Thank you, Scott. I'm gonna just summarize now. Thank you, operator, and thank you everyone for joining us on the call today. We look forward to updating you all next quarter on our continued progress. Thank you again.

Operator (participant)

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