RadiSys Corporation Q2 2008 Earnings Call Transcript

RadiSys Corporation (RSYS)

Q2 2008 Earnings Call

July 29, 2008 5:00 pm ET

Executives

Brian Bronson - CFO

Scott Grout - President and CEO

Analysts

Matt Petkun - Davidson & Company

Ted Jackson - Cantor Fitzgerald

Peter Johnson - Nierenberg Investment

Presentation

Operator

Good afternoon. My name is Kristy and I'll be your conference operator today. At this time, I would like to welcome everyone to the RadiSys second quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you, Mr. Grout. You may begin your call.

Scott Grout

Thank you, Kristy. Good afternoon and thank you for participating in our second quarter conference call. In this call, we'll review our financial and strategic results for the second quarter of 2008, as well as our outlook for the third quarter and for the year, and then open the call up for your questions.

Participating on the call today are Brian Bronson, our Chief Financial Officer, and myself, Scott Grout, President and CEO. Before we get started, I would like to turn the call over to Brian for a caution about forward-looking statements.

Brian Bronson

Thanks, Scott. Any statements in this call regarding future expectations for the business of RadiSys constitute forward-looking statements and involve a number of risks and uncertainties. We caution you to not 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 our earnings release today and in our SEC filings.

All information provided in this call is as of today. RadiSys undertakes no duty to update any forward-looking statement to conform the statement to actual results or changes in the company's expectations.

Now, I'll turn the call back over to Scott.

Scott Grout

Thanks, Brian. So, we had a very good quarter from both a strategic and a financial perspective. We grew revenues pretty nicely and per share results nicely over last year, as well as over the prior quarter. Our Q2 revenues were $97.6 million, up 29% over last year. Our GAAP net loss improved by 22 pennies from last year to a $0.12 loss, and our non-GAAP net income was $0.14 for the quarter, which was up $0.14 from the same quarter in '07, as well as up $0.14 over the first quarter.

The growth in revenues and per share results were driven by strong demand in our wireless and media server products in the second quarter. We continue to make meaningful progress in the deployment of our new communications products, with increased shipments of both our higher margin media server and ATCA products. Overall I'm quite pleased with our progress in the quarter, and for the combined first half of the year.

Our media servers were up in the IP conferencing space again this quarter. We are also seeing increased growth opportunities in other applications, such as messaging, call center, voice services and interactive voice recognition. These opportunities are driven by our target markets moving from TDM to packet, where our IP media servers are required.

Our global sales team is also leveraging our successes in North America in applications in Europe and Asia. We had a robust quarter of ATCA shipment, up again over the first quarter, and we expect them to be up again in the third quarter, as some of our customers move into the later stages of development and testing, and some customers begin to deploy.

Our top five customers for the quarter, in alphabetical order, were AT&T, Comverse, Danaher, Nokia Siemens Networks and Philips Healthcare. Collectively, these top five customers represented 63% of our revenue for the quarter. We had a robust demand from Nokia Siemens Networks, and they represented 48% of second quarter revenues. AT&T, who was an end customer of our IP media server products, entered as a top five customer for us in Q2. As we have stated previously, we expect our top five customers to vary from quarter-to-quarter.

I would like to talk a little bit about product highlights and some deployment highlights for the business in the quarter. Overall, deployment and delivery of our new communications products is going well. Our first half 2008 next generation communication revenues came in ahead of plan, and are over prior projections that supported the $80 million full year outlook that we gave you earlier.

And some examples of progress include a new tier I RadiSys's customer completing its development phase and entering into the testing for a wireless networking voice quality enhancement using our ATCA platform. Field deployment for this application is projected to begin in the second half of 2008.

In another case, end customer lab trials started for a new RadiSys customer, who is a leading provider of video networking solutions. As a final example, our ATCA products were recently deployed by a new China customer to support Web Live TV service for the upcoming 2008 Olympic Games in Beijing. While we are still in early ATCA deployment, these are just a few examples of customers' progress against using our ATCA products.

In terms of new design wins, we also had a fairly good quarter. New wins were across a diverse set of applications including packet inspection, medical imaging, RNC, Security Gateway, IP conferencing, test and measurement, Session Border Controller, video-on-demand, patient monitoring, access gateways and in the military. In the quarter, we saw a nice increase of wins in Asia, with over a third of the value of the new product wins coming from that geography.

Within the media server family of products, we announced that we are ranked as the top media server provider for the fourth consecutive year in recent reports by Infonetics and iLocus. Both firms track the Voice over IP and IMS equipment end markets. On our media sever products, we also introduced continuous presence video conferencing capability that support multiple real-time video streams. We also announced automatic speech recognition and text-to-speech in multiple languages for IP contact center applications

Within the Promentum ATCA family of products, we received the 2007 Communication Solutions Product of the Year Award for our two Promentum ATCA blades, including our 7220 with the smart front-end architecture. The Communications Solutions Product of the Year Awards recognizes the most innovative products that facilitate voice, video and data applications.

Within the Procelerant Com E Express family, or COM E family of products, we introduced the new product using Intel's Core 2 Duo processor for high-performance portable applications in medical imaging, test and measurements and communications. This product is early to market and offers low power with increasing processor capability.

Finally in the quarter, we completed the formal integration plan for Intel's MCPD acquisition that we closed late last year. Overall, I'm really happy with how well this integration went, and how effectively the combined team managed a pretty complex program.

With that, I would now like to turn the call over to Brian, who will give you some information about our second quarter results, as well as projections for the third quarter and full year.

Brian Bronson

Thanks, Scott. Scott already mentioned revenue and per share results were up nicely. Our second quarter GAAP gross margin percentage was 25.1, up 4.6 points year-over-year. Our non-GAAP gross margin rate was 29.4, up 4.1% year-over-year, due to a greater mix of higher margin products and operational improvement. Gross margins increased 1.6 points for the first quarter, due to higher media server revenue, Intel MCPD transition costs going away and lower other cost of sales. We currently expect our third quarter gross margin percentage to be similar or slightly up sequentially.

R&D and SG&A expenses totaled $26.1 million in the second quarter. Non-GAAP R&D and SG&A expenses totaled $23.9 million, which was up about $700,000 from the prior quarter. The increase was due to higher sales commissions and incentive compensation expenses driven by higher revenues, profitability levels, and new product wins relative to the prior quarter. We currently expect third quarter total non-GAAP R&D and SG&A expenses to be down sequentially by about $500,000, due to cost savings from our recent restructuring efforts. This projection assumes revenue and earnings level at the mid point of our guidance range.

Stock-based compensation expense was $2.5 million in the second quarter. We expect stock-based compensation expense to be around the same level again in the third quarter. Restructuring charges were approximately $600,000 in the second quarter, related to employee termination expenses.

Our second quarter net non-operating expense, which includes interest income, interest expense and other non-operating items, was $178,000, which is down from income of $877,000 in the first quarter, due to increased interest expense associated with our new convertible notes, in addition to lower yields on our investments, partially offset by positive cash flow in the quarter. We currently expect non-operating expense to be around the same level in the third quarter.

Our second quarter GAAP tax rate was 25% and our non-GAAP tax rate was 18%. Our tax rates were better than we originally expected due to higher earnings. We currently expect our third and fourth quarter GAAP and non-GAAP tax rate to be around 25%. Our basic weighted average shares increased to $22.4 million in the second quarter, from $22.2 million in the first quarter.

Our diluted weighted average shares used for the calculation of our Q2 non-GAAP earnings were $29.1 million, which includes the remaining shares associated with our old converts, and the $4.2 million shares associated with the new converts. So, for Q3, we expect the dilutive threshold to be $1.8 million for the inclusion of both converts, with $423,000 of interest add back and $5.8 million shares. We are projecting Q3 dilutive shares to be $29.2 million with both converts.

In Q4, the net income dilutive threshold is expected to be $2.2 million for both converts, with $391,000 interest add back and $5 million shares. And then, starting in 2009 and thereafter, the net income dilutive threshold are expected to decrease to $1.9 million, with only the new convert left, and $321,000 of interest add back and $4.2 million shares.

Moving to cash and the balance sheet. Cash flow from operating activities was $8.3 million, again, in the second quarter, and we ended the quarter with $115 million of total cash and investments. Based on our current cash on hand, our future cash flow projections and our line of credit, we believe we'll have no obstacles to fund on going operations, and to payoff the remaining $37.5 million of our old converts in November of this year. We currently expect cash flow from operating activities to be $3 to $5 million in the third quarter.

Our receivables were $55.8 million, which is down about $400,000 from our Q1 balance, as DSO improved, which was partially offset by higher revenues. DSO for the second quarter was 52 days, which was down 8 days in the first quarter, mainly due to improved linearity shipments in the second quarter. Net inventory increased $3.4 million to $33.5 million, due to increased raw materials associated with higher bills, or expected increased revenues in the third quarter. Inventory churns for the quarter was 8.3.

CapEx was $1.8 million and depreciation expense was $1.6 million in the second quarter. Our cash cycle time was 35 days in the second quarter, which is down two days from the first quarter. The decrease is mostly attributed to lower DSO, partially offset by lower days to pay. We expect cash cycle time to remain in the 30s in the near future.

Lastly, we repurchased another $10 million of our old converts below par during the second quarter. The remaining balance is $37.5 million, again, and is classified as short-term debt, as it will most likely be put to us in November of this year.

With that, I'll turn the call back over to Scott to talk about the outlook for the third quarter and the full year.

Scott Grout

Thanks, Brian. So, regarding our outlook for the third quarter and for the year, please note that this is our view as of today, and as the forward-looking statement subject to risks and uncertainties, as discussed previously and in our press release made available earlier today.

So, we currently expect third quarter revenues to grow from the second quarter to be between $98 and $103 million, with projected growth in both our ATCA and commercial products over the second quarter. We expect third quarter GAAP results to be between a loss of $0.06 per share and an income of $0.01 per diluted share. We expect non-GAAP net income to also grow to be between $0.16 and $0.22 per diluted share.

We are increasing our full year revenue guidance, and now predict 2008 revenues to grow 14% to 16% over 2007. This is up from our prior projection of low double digit to high single -- I'm sorry, a low single -- I'm sorry, high single digit to low double digit rate. Within this overall growth rate, we are seeing stronger than expected demand in our wireless market, and now predict that wireless revenues will grow year-over-year, versus our prior estimates of flat wireless revenue for the year.

And finally, we expect our next generation communication product revenue to be higher than earlier projections, up to around $90 million for the full year, versus our prior estimate of $80 million for the full year. I'm really pleased with our strategic and operational results in the second quarter and for the first half, as well as our outlook for the third quarter and the full year.

We are seeing good progress on shipment of our new higher value strategic products across a growing base of customers. While it is still earlier in deployment phase, we are happy with our momentum and market position, and believe that we'll exceed our annual objective for new business revenue this year.

Before we close the call and open it up for questions, I would you like to invite you to our Annual Investor Day Event on August 12th from 11:15 in the morning to 1:45 Pacific Time at our company headquarters here in Hillsboro, Oregon. The Event is part of the 2008 AeA Oregon Technology Investor Tour that includes five other local public high-tech companies.

I'll be presenting along with other members of our management team here, and we'll have demonstration of our latest products. You can register by going to our IR website calendar. If you cannot attend in person, we'll also be webcasting the event live on our website.

With that, I would now like to open the call up for questions and pass it back to Kristy. Thanks.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Your first question comes from the line of Matt Petkun from Davidson & Company. Your line is open.

Matt Petkun - Davidson & Company

Hi. Good afternoon.

Scott Grout

Hi, Matt

Matt Petkun - Davidson & Company

First of all nice quarter. Second of all, the guidance Scott that you gave the $90 million for the next-generation comms business, I think you had previously spoken about your expectations are roughly $20 million in the Com E business and the related standard space platforms in the commercial market. Is that estimate still valid for the year?

Scott Grout

What we have said before it was $80 million for next generation comms which is ATCA and media server and then if you include that and add all new products including Com E, all other new products, that estimate was $100 million. And we're doing really well against that.

Matt Petkun - Davidson & Company

So, it would be safe to say $110 million for the total?

Brian Bronson

Well the $80 million turns into north of $90. So, it's up $10 million overall as well.

Matt Petkun - Davidson & Company

Okay.

Scott Grout

And the remaining new product we haven't done the math. But we are well within well above that number.

Matt Petkun - Davidson & Company

Okay. And then when you look at the specific revenue that's coming, you breakout sort of by end market. The comms related business that's not in the IP network and messaging or in the wireless segment, clearly a lot of that's coming from the MCPD business. Can you be a little bit more specific about what types of end applications are being captured in that number, because that's the number that's grown the most in absolute dollar terms?

Brian Bronson

Yeah Matt I'll take a crack at it and then I have Scott follow-up and if you know I have talked about this too. We need to overtime work these submarkets and change them. So, to be clear wireless is mostly our largest customer today and I think that's clear and the IP networking and messaging space probably close to $14 million that we did in the second quarter about and around half of that is our media server business. And so, the rest of it is the old IP networking and messaging, Comverse lives on for us as a strategic customer etc cetera that's the ticking and time there. And the other comm is MCPD and really all of our ATCA business.

Matt Petkun - Davidson & Company

Okay, great. So, to be clear, AT&T is clearly, is there and again are they a customer or they purchasing through TDM?

Scott Grout

So, they will purchase through a TDM but relationship is predominately direct between the organizations.

Matt Petkun - Davidson & Company

And why did, okay. I'm just wondering why in this case, you chose to break them out as the service provider rather than as of Nokia selling into service providers as well?

Brian Bronson

Yeah. I just think to be honest with the size of revenue, highlighting media server growth and just the nature of the uniqueness of the relationship.

Matt Petkun - Davidson & Company

Okay. Because clearly that's wireless related business depending upon how you want to slice it.

Brian Bronson

It is and in addition to that not to pile on Matt, some of our other comms which are strategic forces and wireless as well.

Matt Petkun - Davidson & Company

Right.

Brian Bronson

So, we've got I think this gives you a picture but we still got work to do.

Matt Petkun - Davidson & Company

Right, great.

Brian Bronson

Yep.

Matt Petkun - Davidson & Company

And then the final question this is not a complaint because clearly my numbers need to go up. But the implied guidance for Q4, if we take the mid point of your guidance for Q3, we are looking at the potential for a down year-over-year number in Q4 at the midpoint of your full year guidance. You are just trying to be conservative, what specific buckets do you expect a decline and what do that do to the overall margins and relative profitability year-over-year, as we look to Q4?

Brian Bronson

Yeah. That's a really good question. I'll take it in chunks. So, first and foremost, I still think the comfort level around is guiding one quarter out specifically is there. But what we felt and what we needed to do is we do not see particularly in the high end of the range sort of $103 million. We don't see a Q4 number that looks at or above that.

So, we want to make sure we bound the streets on modeling. That being said and by the way I should say that our wireless business in the first half was very strong. We expect it to continue to be strong in the second half, but remains to be seen what Q4 specifically looks like. And then from a profitability perspective, we did have a strong quarter in Q4 last year, good profitability quarter as well. What I think has changed even if for whatever reason revenues are south of Q4 last year. We have got better margin and what I think to be a better cost structure to at least meet if not beat the earnings number.

Scott Grout

And, add that I would have on that is revenues for new product at this point we continue to expect it to grow.

Matt Petkun - Davidson & Company

Okay. Thanks so much and nice quarter.

Brian Bronson

Thanks, Matt.

Operator

(Operator Instructions) Your next question comes from the line of Ted Jackson with Cantor Fitzgerald. You're line is open.

Ted Jackson - Cantor Fitzgerald

Hey, Scott. Hey Brian. Congratulations on an outstanding quarter.

Scott Grout

Thank you.

Ted Jackson - Cantor Fitzgerald

Then Brian, I want to also thank you for all the tables in the press release.

Brian Bronson

Well, I appreciate that. So, we have taken advice from you guys and our large shareholders and shareholders as well and changed the format of the entire release. But you are right we have added tables in the back not just cash flow but some of the other quarterly metrics that we provide on the script or typically provided on the script

Ted Jackson - Cantor Fitzgerald

I feel like as an analyst I'm going to be coasting downhill.

Brian Bronson

Well, thank you. We tried.

Ted Jackson - Cantor Fitzgerald

So, a couple of questions. One is you had indicated in the last call, not this call, that you were seeing a little economic softening in the medical and testing markets. You had a good quarter commercially and I'm curious for a little color as it relates to those end markets and how you are seeing the current economic conditions impact them? And then I do have a follow-up question.

Scott Grout

So, from a medical perspective, if you look at first half in total and Q2 in particular there definitely is some softening there. So, our customers have seen it and talked about it. We have seen it and talked about it a little bit. One of the drivers is the Deficit Reduction Act in the U.S. that allowed less reimbursement for some of the imaging applications.

Our outlook for the second half, I think it doesn't worsen. We are probably being a little bit conservative. It's probably early to tell whether we'll see a bit of uplift. But I think we have seen the extent of softening. The other thing that you maybe aware of is we are adding a new tier I medical imaging player in the second half that should start shipping in the second half.

So, on top of current revenues I would expect to see that grow a little bit as that customer kicks into deployment. Test and measurement, I think has held in there relatively well. We are not getting any significant signals from customers that there is a turn at all, but just watching general economy that would be one of the earlier areas that might be impacted.

Ted Jackson - Cantor Fitzgerald

Okay, thanks. And then my follow-up question has to go into the media server business. And first of all, I was curious if you could comment in terms of what the specific application, the platforms being deployed for within AT&T? And then secondly, I wondered if you could put some commentary on that business as it relates to China given the movements you have seen there relative to restructuring of the wireless industry and 3G network deployments?

Scott Grout

Yeah. I think so. I would like to be just a little oblique on answering that as it's competitively kind of sensitive. Conferencing is another application. There is another odd number of other applications we do with AT&T as well. In terms of China, we are starting to see some interesting signs of life there probably not yet related to 3G and IMS infrastructure.

But over the last six months, our level of engagement with the number of different TEMs and some new applications has picked up. I think standing out there and looming out there for us still is opportunity as they begin to deploy IMS but it's not something that we are counting in our numbers yet.

The last thing I would point to is Europe has started to pickup really nicely in the last six months to nine months. So, sales team is fully equipped and doing a really nice job finding some new business. We are counting them in our design win process and it's actually been pretty robust. So, North America has always been a strong point. China, starting to pickup a little bit on some new applications and Europe picking up as well.

Ted Jackson - Cantor Fitzgerald

And is the relationship with Huawei is still intact.

Scott Grout

It is.

Ted Jackson - Cantor Fitzgerald

All right. Thanks very much and again superb quarter.

Scott Grout

Thanks so much Ted.

Operator

And your last question comes from the line of Peter Johnson with Nierenberg Investment. You're line is open.

Peter Johnson - Nierenberg Investment

Hi guys. Very good quarter. Well done.

Brian Bronson

Thank you.

Peter Johnson - Nierenberg Investment

That's very good news. Two questions. One small and technical, the other a little broader. Could you just tell us the actual number of shares outstanding as of today's date?

Brian Bronson

$22.6.

Peter Johnson - Nierenberg Investment

Probably more precise Brian, we couldn't get the final digit. So, maybe you could let me know that afterwards.

Brian Bronson

I'll let you know afterward. But I can tell its $22.6 was the ending basic share count. I'll get you fully extended numbers.

Scott Grout

He wants a few more digits.

Brian Bronson

Yes.

Peter Johnson - Nierenberg Investment

Very good. And secondly, I just wondered whether you care to comment a little bit about some of the activity amongst the TEMs. On the one hand, you see some very interesting positive developments in New Zealand? On the other hand, news today of the CEO and the Chairman going at Alcatel-Lucent, just wondered whether you have any perspective and how that may in due course affects your business?

Brian Bronson

So, as you mentioned, we are seeing good strength with Nokia. I think they are doing extremely well in their end markets in a number of different geographies. So, I think their combination, their execution, their value proposition to customers remains pretty strong. With respect to changes about Alcatel-Lucent is my own personal perspective. I think it is a reasonable timeframe to bring in some eyes to work to focus on what's next for the company.

So, Pat and her team had more than their arms full executing the integration. I think that's been reasonably well done and competed and now time to think about how you grow the company. In terms of how it affects our relationship, our expectation is certainly the trends are not to do everything yourself and everything internally and go to the ecosystem for more of your product development process. So, I'm hopeful that this would represent a potential acceleration.

Peter Johnson - Nierenberg Investment

Very good. Thank you for the good quarter.

Brian Bronson

Okay. Thanks Peter.

Scott Grout

Thanks, Peter.

Operator

(Operator Instructions) We do have a follow-up question from Ted Jackson with Cantor Fitzgerald. Your line is open.

Ted Jackson - Cantor Fitzgerald

It's not really a question. I was just wondering Brian, when you went through the part of your presentation with the share count and the convert if you could actually run through that again, I missed a couple of numbers.

Brian Bronson

Yeah. So, and what point are you referencing, it's Q2, Q3 or Q4.

Ted Jackson - Cantor Fitzgerald

Just kind of run through the whole thing. I don't trust what I wrote down.

Brian Bronson

Okay. So, the shares for the quarter were $22.4 basic shares, right. And then on top of that you need to add $4.2 million shares for the new convert, $1.7million shares for the old convert and then about $700,000 shares for normal options/restricted share dilution to get to your $29.1. Hopefully that math works. And then in Q3, expect it to be all in at $29.2. So, slightly up. Really the only difference is as we get about $100,000 shares less of the old convert.

Ted Jackson - Cantor Fitzgerald

Okay. So, what you're saying then is that those are the different elements and if you look at the pro forma your average share count would be $29.1 in the second quarter and $29.2 in the third quarter.

Brian Bronson

Right. And then just a quick follow-up. Q4 everything else constant you got about $800,000 shares left on the old converts and we'll pay it off in the middle of the quarter. So, I think $28.9 and then of course, as we go into 2009 the only thing that's left from the convert is the $4.2. So, share count gets better.

Ted Jackson - Cantor Fitzgerald

Okay. Okay.

Brian Bronson

And then we can follow-up afterwards. I can help you to take a typewriter if we need to.

Ted Jackson - Cantor Fitzgerald

Okay. Thanks very much.

Operator

We have no further questions in queue.

Scott Grout

Okay great. Thank you very much, Kristy. And thanks for all that participated on the call. And again I would encourage you to consider coming out and visiting us on August 12th for the AeA Tech Tour. Thanks much and talk to you soon.

Operator

Thank you so much. This concludes your conference call for today. You may now disconnect your line.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!