Allen Muhich – CFO
Brian Bronson – President and CEO
James Kisner – Jefferies
RadiSys Corporation (RSYS) Q4 2013 Earnings Conference Call February 11, 2014 5:00 PM ET
Ladies and gentlemen, thank you for standing by and welcome to the Radisys’ Fourth Quarter Earnings Conference Call with Brian Bronson, Radisys’ President and Chief Executive Officer; and Allen Muhich, Radisys’ Chief Financial Officer.
As a reminder, this call is being recorded. Later, we will conduct a question-and-answer session. (Operator Instructions)
Thank you. Mr. Muhich, you may begin.
Good afternoon everyone and thanks for joining us on the call today. We will be providing a strategic update on the company discussing fourth quarter business and financial highlights as well as our expectations for 2014. We will then open up the call for questions.
Before I turn it over to Brian, let me caution you that any statements made regarding future expectations for Radisys constitute forward-looking statements that involve a number of risks and uncertainties. We caution you not to place undue reliance on these statements.
Factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in today’s earnings release and in our SEC filings, most recently in our quarterly report on Form 10-Q for the quarter ended September 30, 2013.
All information provided in this call is as of today. Radisys undertakes no duty to update any forward-looking statement to conform to actual results or changes in the company’s expectations. In addition, during the call, we will discuss some non-GAAP measures. We have provided a GAAP to non-GAAP reconciliation of these measures in today’s earnings release.
With that, I’ll now turn the call over to Brian.
Thanks Allen, and good afternoon, everyone. As we close out 2013 and reflect on our accomplishments over the last year, I believe we’ve made meaningful strategic and operational progress which has positioned us for an expected return to profitability in the second half of 2014.
We have been able to make this progress despite the revenue declines and overall market softness currently affecting many of our current product lines. We have made many difficult but necessary decisions that include eliminating non-strategic products, evaluating potential non-core divestitures, and taking action to right-size our organization with the over-arching objective of focusing and simplifying our business in order to maximize shareholder value.
We have conducted a thorough review of our product portfolio to determine our most differentiated products that provide the greatest long-term competitive advantage. As a result, we are now putting virtually all of the organization’s efforts and investments into the following three areas.
First, is our T-Series systems and network appliance product lines, which include 40-gig carrier grade platforms, network appliances that enable deep packet inspection and other lower end applications as well as our yet to be publicly disclosed next-generation terabit products that fully leverage our switching and load balancing expertise.
Second, is our media processing capabilities, which include our MRF products that enable voice-over-LTE, conferencing, transcoding, and video, and finally, our Trillium LTE protocols and professional service capabilities which include small cells, intelligent gateways, and load balancing. Operationally, we are well underway on our initiatives to materially reduce cost while at the same time improving the entire organization’s efficiency and effectiveness.
The steps we have taken include increasing the span of control across organizational structure, significantly decreasing our executive overhead, and reorganizing into a functional organization bringing a new sales leadership that is already increasing our intensity on delivering against both short and long-term revenue objectives, eliminating two significant sites in Asia enabling the consolidation of all platforms development and support, including both hardware and software in Shenzhen, and embarking on a change to our contract manufacturing partner.
Our team has worked through all of these transitions with little to no impact on our customers or new product roadmap, and in fact our overall quality and on-time delivery measures have meaningfully improved from a year ago, and we are meeting our engineering and customer deliverables.
These combined actions will result in total operating expenses going from a run rate of approximately $100 million back in 2012 to closer to $65 million to $70 million in 2014. We also anticipate realizing an additional $6 million in annualized cost of goods sold savings as we complete our 2014 hardware operations consolidation again into Shenzhen, China.
As I mentioned earlier, these changes help position us for a return to profitability in the back half of 2014. With these decisions behind us and the actions well underway, I’m now turning virtually all of my focus towards our customers and ensuring our sales team has the right product set, features, tools, and resulting actions that are needed to get Radisys back into growth mode.
To that end, I have been on the road with our sales organization since the beginning of the New Year, and I’m hearing first hand from customers how they value the creative new NFV-enabled solutions we have in development. We also continue to see meaningful traction with our MRF and overall media processing capabilities in voice-over-LTE and transcoding applications. Additionally, opportunities for our LTE solutions including small cells continues to grow with many carriers moving from lab to trials and into production.
Let me provide you a few specific examples. In our T-Series Systems and Network Appliances, we are continuing to leverage our longstanding hardware expertise, our software capabilities, and key telecom relationships to develop a next-generation product that has enhanced switching and load balancing capabilities. For competitive reasons, I can’t provide more specific details today. However, the early discussions we are having with large global carriers as well as telecom equipment manufacturers are frankly the most meaningful I have seen in my 14 years at Radisys. These early discussion have the potential to build meaningful shareholder value beginning in 2015 and into 2016 given standard telecom development to deployment cycles.
In Media Processing, trials for our full carrier grade media resource function as well as our virtualized software-only MRF continue to progress very well as we exceeded our 2013 expectations in terms of both customer shipments and design wins. We are now in 21 different trials with carriers around the globe. Our MRF platform delivers the industry’s highest capacity of media processing platform that is essential for the processing of both voice and video heavy content through the LTE wireless networks.
Our intent is to leverage this flexible platform to enable our customers as they deploy a myriad of applications that require media processing. These applications run the gamut from traditional audio conferencing to voice-over-LTE, WebRTC, video, and transcoding to name a few.
Our common MRF is positioned well to meet these market requirements, and we are optimistic about its potential to drive again meaningful shareholder value. In our Trillium LTE protocols and professional service offerings, our pipeline of opportunities remains robust and enabled over 80% second half bookings growth when compared to the first half of 2013.
Not only have we been able to successfully leverage our core technology into small cells, but also into adjacent markets that leverage our broad LTE experience in areas such as aerospace and defense and load balancing.
Again, my recent direct customer interaction has increased my conviction that we are making the right technology investments that will translate into new revenue beginning in the back half of 2014. Unfortunately, prior strategic decisions and resulting revenue dynamics have hidden from you the strategic and operational progress we have been making over the last year.
This is particularly frustrating for our team as they have made meaningful tangible improvements to the company only to have them offset by the current dynamics. That said, I can assure you, we will do whatever it takes to return the company back to profitability regardless of the topline over the next [few] (ph) quarters.
I look forward to communicating to you key customer wins over the next six months that will be evidence of the building momentum necessary for Radisys to turn the corner.
Now let me turn the call over to Allen, who will speak more about our fourth quarter financial results as well as projections for the first quarter and full year 2014.
Fourth quarter revenue was $50.1 million and our non-GAAP loss was $0.21 per share. Revenue was at the high-end of our expectations due primarily the stronger, software solutions revenue combined with higher than expected demand for our Medical Rackmount Server Appliance.
In software solutions, we experienced sequential quarterly revenue growth of 16% to $11.1 million representing over 22% of total revenue. Its highest contribution in our history as both our MRF and Trillium product lines increased sequentially.
Our non-GAAP loss per share of $0.21 was towards the low-end of our expectations and included $2 million non-cash excess inventory charge resulting from a product end of life transition. Excluding this charge, profitability would also have been towards the higher end of our earnings expectations.
Turning to customer mix, fourth quarter top five customers accounted for 48% of total revenue representing a modest reduction in our customer concentration. Top five customers were Arrow, Danaher, NEC, Nokia Solutions and Networks and Philips Healthcare. Two customers Nokia Solutions and Networks and Philips Healthcare each accounted for more than 10% of fourth quarter revenue.
Q4 non-GAAP gross margin was approximately 27% representing about 3 percentage point decrease when compared to the third quarter. The $2 million non-cash excess inventory charge, I mentioned earlier adversely affected our gross margin percentage by approximately 4 percentage points.
Fourth quarter non-GAAP R&D and SG&A expense of $18.7 million represents a nearly $2 million sequential quarterly reduction and is a direct result of the cost reduction initiatives launched earlier in the year.
Additionally, in the fourth quarter, we incurred $3.7 million in restructuring and other charges that are primarily associated with restructuring activities in the United States as well as reserves associated with the closure of our Penang development and operations support facility.
I should also note a couple of additional fourth quarter items that we excluded from our non-GAAP results. First during the fourth quarter, we sold vacant land adjacent to our corporate headquarters in Oregon for $1.4 million in cash which resulted in an $800,000 gain. Second, as a result of operational changes that will reduce our cost structure and simplify customer interaction yet have an adverse effect on expected long-term profitability in certain foreign entities. We recorded a $12.5 million non-cash valuation allowance against foreign deferred tax assets.
Switching over to the balance sheet, fourth quarter accounts receivable decreased $1.1 million from the third quarter to $41.4 million reflecting Q4’s lower revenue levels. Fourth quarter inventory decreased sequentially by nearly $1 million to $25.4 million and remains nearly $4 million lower than levels exiting 2012. The decreased inventory reflects the meaningful improvements being driven by our operations team combined with decreased revenue levels.
Cash decreased $6.1 million during the quarter to end at $25.5 million. Outstanding debt as of December 31st, remained unchanged at $33 million. I should also not that yesterday February 10th, we amended our Silicon Valley bank agreement to provide greater EBITDA covenant flexibility. Our borrowing base at quarter end supported $22.9 million in borrowing leaving $7.9 million of unused and available borrowing capacity.
Moving over to the first quarter outlook, we expect Q1 revenue of between $40 million and $46 million which at the midpoint reflects a decrease in MRF revenue due to the timing of customer deployment and an anticipated reduction in COMe Rackmount Server revenue that results from our strategic decision to manage for cash the value line of our COM Express modules. ATCA revenue will remain relatively flat sequentially.
Q1 non-GAAP gross margin is expected to improve to approximately 33% of sales. We expect to recognize a $2 million one-time credit resulting from a vendor claim on faulty components within cost of goods sold and will benefit our gross margin by approximately 5% points. Q1 non-GAAP R&D and SG&A expenses are expected to decrease by approximately $1 million to $17.5 million as a result of the actions Brian mentioned earlier.
We expect fourth quarter non-GAAP EPS to range from negative $0.06 to negative $0.18 per share. We also anticipate first quarter cash consumption of approximately $4 million to $5 million reflecting our non-GAAP loss as well as an estimated $1 million in additional cash restructuring payments.
Turning to the full year 2014, we expect ATCA products to remain relatively flat to down 5% year-on-year. COMe Rackmount Server revenue is expected to decrease approximately 30% year-on-year as we manage for cash certain product lines. We also expect a 50% annual reduction in low margin other legacy hardware. In software solutions, we anticipate both MRF and Trillium revenue to increase 20% plus or minus when compared to 2013. Taken together overall RadiSys revenue should decline 10% to 15% to between $200 million and $220 million in 2014.
As mentioned previously, we remain on track to reduce operating expenses to between $65 million and $70 million, which represents an approximate 30% reduction from a year-and-a-half ago. That said, we are continuing to invest more than $30 million annually in R&D projects tied to the three focused areas Brian outlined earlier and surely we can successfully realize our growth initiatives.
Between the expected growth and higher margin software solutions revenue and our expense reductions we expect 2014 non-GAAP EPS of between $0.15 and %0.30 per share. Given the timing of the completion of our plant contract manufacturing transition and the expected wrap in our new higher margin MRF revenue much of our expected 2014 earnings will occur in the second quarter of 2014.
Additionally for the full-year 2014, we anticipate generating between $10 million and $15 million in cash reflecting primarily the effects of our cost reduction efforts as well as a meaningful inventory reduction resulting from the term of our new contract manufacturing agreement.
As we exit 2014 given the completion of our cost reduction activities and expected revenue mix shift towards higher margin software solutions products we anticipate our breakeven revenue to come down to approximately $45 million which compares to about $55 million in Q4 of 2013.
With that I will hand the call back over to Brian.
Thanks Allen. Given typical Q4 to Q1 sequential revenue declines and the lumpy nature of our MRF business, our first quarter will remain in a loss position. As I’ve said multiple times, I remain convinced we are taking the necessary actions to return Radisys to profitability in the second half of this year and for whatever reason revenue levels remain depressed beyond our expectations we will do more. We must meet our profit objectives.
Before we open up the call for questions, I want to reiterate a couple of key tenants under which we will operate. First, we will continue to make the necessary investments to drive growth in MRF and as we enable platforms and LTE protocols and solutions. Second we will be driving a streamlined expense base that will result a material improvement and we will continue to refine as the market and our revenue levels dictate.
And finally, we will continue to do whatever it takes to drive shareholder value and I will tell you that there are a number of secondary options on how to accomplish this above and beyond delivering to our organic strategy. I’ve been saying this since I took over as CEO and the reason that there hasn’t been any result has nothing to do with the fact that there haven’t been any options. We have a tremendous amount of unrealized value inside of the company especially within our three core focus areas.
And with that let me open up the line for your questions.
(Operator Instructions) And our first question comes from the line of Mr. James Kisner with Jefferies.
James Kisner – Jefferies
Yes. This is James Kisner.
James Kisner – Jefferies
Thanks for taking my questions. Hi, there. Just want to clarify a couple of things really quick on the gross margin. I think you said there was a 5%, I guess, probably a GAAP benefit in Q1, just clarify that generally quickl,y I’m sorry, this year is going kind of fast.
Yes, I think you got it right James. So we are expecting about $2 million benefit that will be reflected in our gross margin, which will be in that 4% to 5% gross margin uptick in Q1. It is associated with some faulty components that were shipped to us in prior years. Frankly, we’ve been recognizing some expense associated with those products, those faulty products, and so therefore, expect I think a little bit of improvement in Q1 to offset that prior – those prior year losses as well as we’re getting through some of that transition in future quarters.
Yes. It’s, I would just add on to that. It’s been, it’s fortunate for us timing wise too, because as Allen just mentioned really much of the work that Mack and his operations team are doing doesn’t result in a positive impact until the second half of the year. So the $6 million plus a year savings that I keep referencing really don’t get to see much until the second half.
So we do expect gross margins to be in the mid-to-high 30s, no change. I understand that we’ve been below that because revenue has been soft, right, and the actions have yet to take hold, but I don’t expect that be up to the mid-30s and then back down into the low-30s or high-20s as we progress deep into 2014.
James Kisner – Jefferies
Okay. That’s helpful. Again, you said that the business (inaudible) was going to be back end –back-end weighted in the year, I just want to kind of parcel [ph] like how much of that is just the pipeline kind of where the business is expected, and how much of that is kind of a revenue recovery situation ??
Yes. So it’s a really good question. So first and foremost hopefully you heard from my prepared remarks that we acknowledge that, our current situation revenue wise, we also hopefully hear the enthusiasm in my strategic comments. So there is a bit of a hockey stick in the second half, folks can choose to believe it or not, but I think that there are some very, very specific design wins in geographies like China. There are very, very specific deferred revenue items that you will see in our balance sheet, and plus there is cost of goods sold reductions, there is expense reductions that will drive for a much better second half, right. So we can banter on what the hockey stick looks like inside that 200 to 220, but it will be better for the reasons I mentioned.
James Kisner – Jefferies
So when might you see that could benefit revenue, are you expecting you’ll kind of see that at your balance sheet in Q1 or Q2 or kind of build to the quarters or I’m not sure, just help us have some milestones for the future?
Yes. Well, there should be some, Allen, there should be some build already. You’ll see another build in Q1, is that right for a particular operator that I’m referencing. And depending on collections and some other things in timing that will dictate the second half revenue.
Yes. So James as Brian indicated, we have seen some improvements, some nice steady improvements from essentially Q2 of 2013 through Q4 of 2013. And then again, we should see a little bit of a step function up in Q1 of 2014.
James Kisner – Jefferies
Just looking through your balance sheet here to where I might see that, so okay. So what about your components of visibility? I was just wondering coming into the year, looking back at last year, do you feel like you have kind of a higher risk outlook or lower risk outlook over the last year? Do you feel like you are getting some recently good visibility to talk about sort of your components of visibility, is it cheap, you’ve got – certainly got some design wins, but just any kind of texture around your visibility for the year would be helpful?
Well, two things come to mind when I listen to your question. There are more moving pieces than that. But, I think about China in general, I mean, let’s be open, I mean 2013 was a disappointment, we had some assumptions around our platforms business and frankly even our Trillium, our small cell business that now is pushing into 2014. But, good news tangible data points, now Spectrum has been awarded, provinces are starting to get loaded with equipment, and I think that means good news for Radisys as we progress through 2014. Obviously, if that continues to slip to the right for whatever reason beyond what I just mentioned, that’s a risk or on opportunity inside the band of revenue.
The other piece, I would tell you is, voice-over-LTE or MRF in general. You can sense that, I mean and we share with you our trials are growing. We are starting to get tangible revenue, I mean it’s not enough yet to move the needle for our overall MRF product line and largely because its audio conferencing still. But the trials are growing; trials are starting to move into production, and I’m thinking about one particular carrier now with one of our partners. And so, over the next couple of quarters, we should get a better assessment on timing of how impactful voice-over-LTE for example can be to our topline .
James Kisner – Jefferies
Okay. And just sort of a final one, and I will happily pass here. Just thoughts on some sort of your cash outlook, so the first thought was benefit you are getting from gross margin, I assume that’s purely accounting like you are not getting like a check from someone for $2 million and maybe a settlement of some kind, but just your thoughts on additional cash burn before you kind of start generating cash again, do you have kind of a rough idea where that might be?
We do. Thanks James. So first of all, the $2 million it is absolutely a cash payment, we do not expect to get it in the first quarter even though we anticipate recognizing the benefit in the first quarter, we do anticipate receiving that cash in the second quarter. So we outlined in Q1 that we expect cash burn of somewhere between $4 million or $5 million, we do have a little bit of cash restructuring still to go.
As we go throughout the year, you should see us come close to breaking even in relatively cash flow neutral in the second quarter, and then in the back half of the year, generating some nice cash as we indicated for the full-year expect cash to be somewhere between $10 million, $15 million.
One of the elements – well, there is a couple of different components that will help that cash generation. One of the key ones, and we touched on it in the prepared remarks is around inventory and the agreement that we have with our new contract manufacturer that has the opportunity to generate actually some meaningful cash for us that will help bolster that $10 million to $15 million. The other is simply getting through with our cash restructuring actions and realizing a much lower expense base that will ultimately drive increased profitability, increased cash generations and finally, obviously the revenue that Brian touched on earlier.
Those are some of the key components that will enable us to drive incremental cash in the back half of 2014 and ultimately be positive in 2014. So to take that positive cash generation tack on the $25 million – $25.5 million of the cash that we have today and we feel still that we are in reasonably good shape to be able to service the $18 million convertible to debt that’s coming due in early 2015.
James Kisner – Jefferies
And that’s just really a fine point on that. The $4 million or $5 million cash in Q1 and that is net of the $2 million benefit, right?
It excludes it because we will not receive the cash until the second quarter.
James Kisner – Jefferies
Oh, yes. Got it. Okay. That’s perfect. Okay. That answers it. Thank you.
And I just want to punctuate because it’s an important point, right. So what I and we have decided to do, I mean separate out the fact that we are – we taken down operating expenses 34 plus percent in the last year in change. I want to continue to see the momentum build. I want to enable register in the corner. I want us to be able to complete the restructuring actions. I want us to be able to successfully transfer our products to Ennoconn and Foxconn.
All that being said, we will generate cash from the second half, right. So we want to do it the right way but for example, if revenue is soft, we will do what’s necessary to be cash flow positive. But, right now, given that the strategic momentum, giving that the size and the count of deals that we are working on here in the first half particularly, we will know a lot more in the summer as I keep anything at around what we are out as a business.
James Kisner – Jefferies
Okay. Thanks a lot.
(Operator Instructions) And we have no further questions in queue at this time.
Okay. With that thank you again for participating in the call and look forward to providing you another update following our first quarter results. I appreciate all of your support and confidence as we continue to transform Radisys. Have a good rest of the day.
Thank you. This does conclude today’s conference call. And you may now disconnect.
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