Inseego: Why It Could Be A Sleeper Stock (NASDAQ:INSG)

Inseego Corp. (NASDAQ:INSG) has been in freefall since it had a huge ascent from about $1.50 per share in early 2018, when it had a nice three-year run to over $20 per share, before falling off the cliff since then, trading at $1.55 as I write, almost the same price it was in January 2018.

In order to improve its margins and earnings, the company is transitioning to being a more diversified company by offering connectivity and mobile solutions to businesses.

In this article we’ll look at the potential impact of its new business focus could have on the company, completing the bulk of spending on components, as well it latest earnings report and the market’s response to it.

Latest earnings

In the third quarter INSG generated $69.2 million in revenue, up 9 percent year-over-year, and 12 percent sequentially. The catalyst behind the increase in sales came primarily from its new MiFi X Pro product.

Non-GAAP EPS of -$0.11 missed expectations by $0.03

The company reported an adjusted EBITDA loss of $2.5 million in the reporting period, an increase of $1.5 million from the $1 million loss in the prior quarter, and the $800,000 loss in the same quarter of 2021. That was attributed to a one-time non-cash adjustment of $700,000, an increase in supply chain costs, and a rise in R&D costs that were higher than expected.

In an area that concerned the market, consolidated gross margin dropped to 26.3 percent, down from the 28.2 percent in the same reporting period last year, and the 29.5 percent it had in the previous quarter.

Most of the decline in gross margins came from its carrier business which has lower margins. It’s focus on growing its higher-margin businesses should mitigate that going forward, as well as lower supply chain spend.

Cash, cash equivalents and restricted cash in the quarter was $18.1 million.

Breaking down gross margins

With the market being primarily concerned over the gross margins and earnings of the company, we’ll look at the factors that had a negative impact in Q3, and why it looks like they’ll be mitigated over the next quarter or two.

The major headwind for gross margins in the quarter was two large hotspot launches by the company. With lower margins in that business, it drove margins down.

With long lead times, the company had to order materials ahead of time, resulting in an increase in spend because supply chain costs were higher. This isn’t likely to happen over the next couple of quarters, so gross margins are likely to improve as its FWA (fixed wireless access) business, which accounted for 13 percent of total revenue in Q3, is expected to increase that percentage. The FWA business has margins of over 40 percent.

Changing its strategy from going after carrier revenue to higher quality revenue as reflected in its FWA business – assuming the company executes on its plan – will significantly improve gross margins as early as the next couple of quarters, which has a good chance of bringing the company to cash flow breakeven by the first quarter of 2023, according to company expectations.

If its FWA business does in fact increase as a much larger percentage of sales, and the company is disciplined in its cost management, I think it will achieve cash flow breakeven by early 2023.

The No. 1 priority of INSG is to grow its enterprise FWA business. Successfully executing on that goal will significantly reduce gross margins and improve earnings and cash flow.

Consequently, if that’s how it works out and INSG can continue growth in a sustainable manner, its share price has a very good chance of moving steadily up. Last, with much of the spend on inventory behind the company in response to the demand cycle, much of that can now be moderated down going forward, which will support margins and earnings.

Its enterprise FWA business

With INSG’s FWA business being identified as the priority for the company, it’s important to see how that’s advancing, and how, in part, it works with the company’s customers.

As a reminder, FWA now represents 13 percent of all sales with a margin of over 40 percent.

INSG reported selling 5G products to over 600 businesses in 2022 so far, with its overall enterprise base now surpassing 1,000 customers.

Where the market can miss some of the potential in its customer base is in how they deploy the devices. A lot of the businesses acquire and test anywhere from 20 to 50 devices for the purpose of testing and evaluating them for the purpose of eventually deploying them across the entire footprint of the companies. That includes the software INSG sells. Since this process occurs over multiple quarters, the various stages of adoption result in a consistent boost in revenue that isn’t readily seen at a larger level in a specific quarter because of the stages they are acquired and deployed.

But it’s not hard to see how this would be a strong catalyst for INSG as it continues to win more business in this segment and monthly revenue, along with higher margins improve its top and bottom lines.

Conclusion

I like the clarity and visibility offered by management, and if it’s able to execute on its strategy, I think it could surprise to the upside in the quarters ahead.

As for concerns over economic conditions that may result in businesses cutting spend, I don’t think that will have much, if any impact on the performance of INSG from that point of view. Companies are going to have to adopt these types of devices in order to remain competitive, and I think it’s a priority for them to do so. While companies will cut costs, I don’t think it will in regard to 5G.

A positive about following INSG is it has laid out a very clear path to profitability, and it all centers around the performance of FWA business. All that needs to be done there is to watch its growth as a percentage of overall revenue. Since we already know the margins are over 40 percent, it’s not difficult to see that gross margins, EPS, and cash flow will improve in alignment with revenue growth coming from FWA.

With much of its big inventory spend behind it, if the company can have a better product mix with FWA being an increasing percentage of it, investors could find this being a sleeper company with a lot of growth potential.

As to how to play it, it should still be considered a speculative play in my opinion, until it proves it can execute on its strategy. For that reason, taking a small position with capital set aside for speculation would be a good way play it. For longer term investors, I would wait and see. There’s a chance of missing on a big upward move in the quarters ahead, but there’s also the chance the company fails to increase the FWA segment in any meaningful way, and under that scenario, its share price would experience a lot of downward pressure.

Last, my thought is there’s a better chance the company will be successful in executing its strategy than failing at it. But until that is proven, it’s best to take a wait-and-see attitude. In the case of success, yes, we’d miss a big boost in its share price, but we can, under that circumstance, wait for a dip and buy at a good entry point if we believe the company will produce sustainable growth over a long period of time.