Insignia Systems: The 10-Bagger You've Never Heard Of

Jul.21.06 | About: Insignia Systems, (ISIG)

Insignia Systems (NASDAQ:ISIG) is the 10-bagger nobody's heard of - except for those shareholders who were smart enough to have already bought it near its lows under .30 last fall when things were looking pretty dire for the company. Now that the rear-view mirror clearly displays a big winner, the question is whether ISIG stock has legs from here - or if it's just too late for new investors to get involved. Lets take a closer look.

Insignia Systems, Inc., markets in-store advertising products, programs, and services to retailers and consumer packaged goods manufacturers through the Insignia Point-of-Purchase Services [POPS] in-store advertising program. POPSign is a national, account-specific, shelf-edge advertising program that delivers meaningful sales increases (up to 50% or more per branded product) over a two-week cycle.

Paid for by consumer packaged goods manufacturers, the program allows manufacturers to deliver vital product information to consumers at the retail shelf edge. POPSigns put brand-specific information in front of shoppers when they need it most, while providing retailers with an effective sign that fits their store decor and merchandising theme. For retailers, POPSign is a source of incremental revenue and functions as an in-store advertising program that delivers a complete "call to action" on a product- and store-specific basis. For consumer goods manufacturers, POPSign provides access to a uniquely strategic retail advertising site for their products - the retail shelf.

Insignia is contracted with more than 12,000 chain retial supermarkets and drug stores, including A&P, Kroger, Safeway, Pathmark, and Rite Aid. Through the nationwide POPS network, over 190 major consumer goods manufacturers, including Gerneral Mills, Kellogg, Nestle, and Pfizer, have taken their brand messages to the point-of-purchase.

Insignia turned the corner in Q1, reporting .04 EPS, following three straight years of losses. Significantly, Q1 gross margins were a robust 54.8%, up substantially both sequentially (31.9%) and year-over-year (34.8% in Q1 '05). On the conference call, management indicated they were optimistic this type of gross margin could hold in Q2 and perhaps for the full year. Gross margin expansion is being driven by a lower level of retailer revenue guarantees, as the company has contracts with many retailers that provide for the retailer to be paid on a per sign basis for services rendered to hang POPSigns in their stores.

Some retailer contracts provide for minimum annual payment amounts, and if minimum levels are not met based upon annual activity with those retailers, Insignia is obligated to pay the contractual difference to the retailers. In 2005, Insignia incurred costs of $2.13 million in cost of goods sold related to these minimum guaranteed payments; In 2004 $2.7 million; conversely, in 2006 that number will be drastically reduced - and in Q1 it was actually ZERO.

This savings, which again, is part of cost of goods sold, taken in conjunction with reduced sales force headcount from December (estimated $1.1 million savings annually) has cut Insignia's total cost structure by around $3 million per year. Meantime, POPS revenues returned to health in the quarter ($4.7 mil) following the sharp dropoff in Q4 ($3.2 mil), and bookings for the quarter ending June 30th speak toward a solid first half.

A recent legal development lends intrigue to the story. Back in September 2004, Insignia brought suit angainst News America and Albertson's Inc. in Federal District Court in Minneapolis, Minnesota, for violations of federal and state antitrust and false advertising laws, alleging that News America had acquired and maintained monopoly power through various wrongful acts designed to harm Insignia in the in-store advertising and promotion products and services market. The complaint alleges that News America (wholly owned by News Corp.), entered into exclusive, long-term contracts with retailers, paid large economically unjustified up-front fees and guaranteed payments to retailers to induce them to enter such contracts, insisted on the right of first refusal for any new in-store advertising products, bundled and predatorily priced its products, and unfairly disparaged Insignia's products. In addition, the complaint is based on allegations that News America instigated and conspired with Albertson's and other retailers to boycott Insignia in an effort to exclude them as a principal competitor. The complaint further alleges that Albertson's conspired to assist News America in excluding Insignia by encouraging and accepting unusually high and economically unustified up-front payments in return for agreeing to deal only with News America. The lawsuit seeks injunctive relief sufficient to prevent further antitrust injury and an award of treble damages to be determined at trial for the harm cuased to Insignia.

On June 30th, the United States District Court for Minnesota issued an order denying News America and Albertson's amended motions to dismiss. This decision allows Insignia to proceed with crucial litigation that could have blockbuster outcomes click here to read the release). At the minimum, any ruling in Insignia's behalf based on New America's alleged abuses of monopoly power would lead to a more "level playing field", allowing Insignia to more readily grow its business through an expanded product line and distribution network, while gaining more traction with manufacturers. The wild card here is the jury trial and any favorable award.

Although typically litigation of this type takes about two years to resolve, the company is optimistic it will prevail and recover a significant damage award. How significant? That's the $100 million question - which by the way - is less than the actual reduction to ISIG's market cap from the beginning of 2003 to the end of 2005. A pretty heady concept to ponder, especially when treble damages (less legal fees) are part of the equation. ISIG stock has 15.3 million shares fully diluted outstanding.

There's plenty of uncertainty here. For one, this lawsuit should take years to resolve, and the outcome could prove disappointing. Its possible Insignia doesn't win, or that even if they do prevail, they receive only a minor award. On the operational side, POPS quarterly revenues tend to be a bit erratic, and have topped $5 mil only once out of the last nine quarters. So, while gross margins have spiked and the expense base has been rationalized, in the absence of substantial top-line growth, 2006 earnings would probably have a hard time reaching .20 per share.

There is also significant customer concentration, with Kellogg (17%) and Nestle (16%) leading the way last year; while an un-named customer accounted for a whopping 29% of revenues (and 30% of receivables) in Q1 2006. Cash is down to around $1.72 million, however, with the improvement in business conditions, management does see sufficient resources to make it through the foreseeable future - a vast improvement over where they stood in late October.

A newly formed agreement with Valassis Sales and Marketing Services, a leader in the newspaper free-standing insert industry, can potentially serve as a key revenue driver for Insignia this year and beyond. Valassis, who, incidentally, have also filed an antitrust suit of their own against News Corp., will open up new manufacturer relationships for Insignia through their established insert-business relationships, while also assisting Insignia in selling more to existing customers. The Valassis arrangement, taken in conjunction with Insignia's lower cost structure, could lead to a more interesting earnings picture for ISIG stock than is visible at the present time.

We like the Insignia story, but we think ISIG stock will need a breather soon. The stock is up 900% since late November and over 125% in the past month, and at $3.07 we're not big fans of the current risk/reward. However, ISIG should be on your radar, and we encourage patient investors to consider keeping an eye out for a better entry. The unfolding antitrust case proceedings will continue to invite speculators, and the pospect of improving profitability can make ISIG stock an interesting name at the right time.

Read the 10-Q

Read the 10-K

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