Radisys' (RSYS) CEO Brian Bronson on Q4 2016 Results - Earnings Call Transcript

| About: RadiSys Corporation (RSYS)

RadiSys Corporation (NASDAQ:RSYS)

Q4 2016 Earnings Conference Call

February 9, 2017, 05:00 P.M. ET

Executives

Jon Wilson - Chief Financial Officer

Brian Bronson - President and Chief Executive Officer

Analysts

Mike Latimore - North Plains Capital

Brian Alger - ROTH Capital Partners

Jaeson Schmidt - Lake Street

Thomas Diffely - D. A. Davidson & Co.

David Nierenberg - Nierenberg Investment Management Company

Brian Alger - ROTH Capital Partners

Operator

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 Jon Wilson, Radisys' Chief Financial Officer. As a reminder, this call is being recorded. Later, we will conduct a question-and-answer session. [Operator Instructions]

Mr. Wilson, you may begin.

Jon Wilson

Thanks. Good afternoon everyone and thanks for joining us on the call. Today, we will provide an overview of our fourth quarter business and financial highlights, as well as our expectations for the first quarter and full year 2017. We will then open up the call for your questions.

Let me caution you that any forward-looking statements regarding the company made during the call involve a number of risks and uncertainties and therefore, we caution you not to place undue reliance on them.

Factors that may cause actual results to differ materially from those in our forward-looking statements are discussed in today's earnings release and in our SEC filings, most recently in our Form 10-Q for the quarter ended September 30, 2016.

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. During the call, we will discuss certain non-GAAP measures and have provided a GAAP to non-GAAP reconciliation in today's earnings release.

In addition to today’s press release, we have also posted a short supplemental slide presentation in the investor relations section of our website, which we would encourage you to reference as part of our announced results and guidance.

With that, let me turn the call over to Brian, who will provide an update on the business and our fourth quarter results.

Brian Bronson

Thanks Jon and good afternoon everyone. Fourth quarter revenue of $40.6 million was within our expected guidance range for the quarter. Software and systems revenue was particularly strong as we secured expected orders from Reliance Jio deploying MediaEngine in support of their network build-out.

As a result of favorable product mix, we still delivered $0.04 of non-GAAP EPS. For the full year, revenue was $212.4 representing growth of just over 15%. This is a significant step up from the original full year guidance of $180 million to $200 million that we provided at the outset of the year and at the high end of our increased guidance range of $195 million to $215 million. This includes strategic revenue which represents all of Radisys revenue, excluding our legacy embedded hardware products growing by over $68 million or a 120% year-over-year to $125 million.

In addition to our top line growth, we were also able to deliver full year non-GAAP earnings of $0.25 per share consistent with the outlook we outlined at the beginning of 2016 and up from $0.21 per share in 2015. We were able to achieve these results while continuing to accelerate investments across our strategic product lines.

Before we move to talking about 2017, I would like to highlight certain accomplishments that I believe summarize our transformational progress, but also demonstrate what is in store for shareholders over the next couple of years. First, we have grown revenue from our strategic product lines from $40.3 million in 2014 to over $125 million in 2016. We have turned a small professional services engagement with Verizon into over $70 million in sales across DCEngine and FlowEngine.

Revenue what with our largest MediaEngine customer Reliance Jio has grown to over 30 million cumulatively since initial deployments began in 2014. And we now have proof of concept/trials with a number of new and different service providers across all of our strategic product lines, which we expect to result in commercial revenue towards the back end of this year and become the driver for accelerating revenue growth in 2018.

These results lay the foundation as we enter 2017 to drive towards our strategic revenue growth projections of 20%, which will be offset on a consolidated basis in 2017 by increase in pressure on our legacy embedded business. The degree of growth and accelerating engagement with Tier 1 service providers we’ve seen over the past year simply doesn't happen without specific investments and product roadmap, sales, marketing and support personnel along with investing in processes and infrastructure to scale.

Over the last year alone, we’ve hired two new seasoned executives and another 20 or so senior level leadership resources, as well as a number of other key employees to enable our ability to successfully execute on our go forward strategy. We have also increased our direct sales force by over 50% with experienced professionals that have a long history of selling direct to Tier 1 accounts.

As a result, we now have account managers in place to service all of the Tier 1 US service providers, as well as selective Tier 1 and Tier 2 operators across Europe and Southeast Asia. Let me now shift to updates on each of our strategic products and professional services offerings throughout the quarter. Within DCEngine, we made important strategic progress with another new prospect. Specifically, our ongoing trial at a Tier 1 US service provider we described last quarter continues to develop favorably with now three DCEngine systems in the labs running live applications.

Assuming we continue to perform this could lead to initial commercial revenue by the third or fourth quarter of 2017 of this year. Additionally, we initiated a new trial with the large existing embedded customer in the US to migrate them onto DCEngine from our traditional ATCA products. While our objective is to sell direct to service providers, this existing customer has a very strong relationship with a Tier 1 US service provider and thus provides a path to market for us.

In FlowEngine, we booked initial orders for approximately $0.5 million from an existing customer associated with a new used case for packet inspection and their network that we expect to ship in the first quarter or this quarter. We also booked an initial order from a Tier 1 European service provider, which we indicated was expected on our third quarter call tied to a security application. Each of these new opportunities have the potential to be multimillion dollar engagements over time.

Regarding FlowEngine, we remain on track to release our new appliance, which is a highly scalable and programmable SDN enabled data plane platform by the middle of 2017. Our new appliance will fully support programmable data plane capabilities to intelligently classify, load balance, and forward data flows within the network and combined with disruptive pricing, I expect will position us favorably against the competition.

There are many disruptive expects about this new product, but one of the most formidable is the number of used cases for which our customers can deploy the product. Given timing of our new product coming to market, this sets the stage for expected revenue acceleration in the second half of 2017 on the back of successful customer trials.

Within MediaEngine, we finished the year on a strong note achieving record quarterly revenue in the product line as a result of expected orders from Reliance associated with the continued build-out of their LTE network. This new order, which we fulfilled, should satisfy demand tied to media processing and their network for the near term.

However, we are continuing to explore further used cases for MediaEngine within this account that if we are successful have the potential to drive continued need for our product. Specifically, as we have indicated previously, for us to grow materially in this product line over time, we need to nail transcoding use cases with a couple of Tier 1 service providers. These transcoding wins are a primary focus in 2017, as we believe our product will both reduce network complexity and cost relative to existing session border controller and media gateway solutions.

Finally, our professional services offerings continue to drive strong year-on-year revenue growth tied to increasing engagements with tier 1 service providers. Specifically, we have materially expanding ongoing programs with our largest customer tied to various disruptive projects all of which are tied to initiatives to drive operating cost out of their network.

Further, during the fourth quarter, we secured purchase orders from two Tier 1 European service providers for hardware and integration services tied to initial proof of concepts and trials for CORD of which one represented an expansion of an existing trial announced during the third quarter. As I indicated earlier, why still early, we view CODE or central office re-architected as the data center has a tremendous long-term opportunity to monetize our value first as a services play and then more materially as a complete integrator of all components including some of our own hardware and software.

To be more specific, although the initial service engagements we enter in with service providers through CORD, it’s considered part of software and system segment one of the largest early opportunities to expand these relationships to include product revenue is with our own DCEngine. To give you some sense of scale, a single commercial deployment of DCEngine and/or CORD could easily translate into a multimillion dollar plus opportunity over multiple years.

Take one largest service provider for example. Say they have 4,000 central offices, we know certain of the large service providers do by the way, and let’s say 50% of those locations need at least one track. So, even if we were able to win only 25% share, we are looking at 500 racks at close to 200,000 each that’s a $100 million. Conversely, we may be out to just provide the hardened CORD software and services and not the rack and therefore some engagements, while incredibly sticky may result in lower total revenue contribution, but still provide the potential to meaningfully grow our existing revenue streams.

So the bottom line is that not every Tier 1 represents this large of an opportunity, but my point here is that a single service provider can lead to substantial upside, an opportunity over time. As we’ve addressed in many forums, the tremendous opportunities across our business are being driven by a transformational shift in the telecom market as service providers increasingly embrace software defined networking, network function virtualization, and open source software and hardware to evolve their networks.

They have the opportunity to provide new services, while collapsing their CapEx and OpEx by 50% or more. In order to drive this change, service providers are applying immense pressure on traditional vendors to meaningfully evolve their legacy business models. This will acquire tradition and vendors to either one, significantly lower their selling prices impacting gross margins or two, shift to software only models, which results a materially lower total revenue and margin dollars and will require significant reduction in overall operating costs in order to deliver expected bottom-line operating margins.

The reality is that the existing equipment manufacturer simply can't go there. This is where Radisys comes in with our disruptive business model. The shift is still in its early stages of what we believe to be the start of a long-term cataclysmic shift in how networks are built. Think about it. Radisys is at the forefront of redefining how telecom networks are built. The same disruptive trends that are creating increasing momentum for our software and systems and DCEngine product lines are also creating unavoidable headwinds for the remaining legacy embedded product lines beyond what we had previously anticipated.

Service providers continue to transition away faster from older architectures and purpose-built equipment, which are embedded product lines have historically supported and move towards open standards hardware. Although we anticipated this shift several years ago prompting our decision to harvest this portion of the business and redirect resources to our strategic product lines, these headwinds have become more pronounced even over the last few months, and therefore we believe the market contraction for these legacy products will become increasingly acute.

While this is positive news for our go forward business and further validates our strategic thesis, it creates a revenue and an amount of profitability challenge for our legacy embedded product lines going forward as we manage through these declines. Although it’s difficult at this point to predict the potential impact to our business long term, we do anticipate legacy product revenue will decline to approximately $55 million in 2017. This is down from the $75 million for we previously expected and down from the 2016 actuals of $87 million.

So with that, our top priorities will remain on maximizing operating income and cash flow from these products, which is what we’ve done over the last three years and support our long standing customers continue needs, while at the same time maintain our desired business model. So let me gross all this up for you, as we indicated last quarter, I do expect our revenue to remain lumpy over the next few quarters as we both navigate the timing of legacy embedded revenue declines, Verizon order patterns, and on boarding new Tier 1 service provider wins.

That said, I expect our strategic revenue should grow 20% in 2017 to $150 million, which will be offset on a consolidated basis by increasing pressure on our legacy embedded products revenue. On the earnings side of the equation, we will be down year-over-year by about $5 million given the decline in legacy embedded revenue, as well as staying firm and committed to our investments across our strategic product lines required to capture more meaningful levels of long-term growth.

With this understanding in place, we are heads down focused on a very selective list of objectives for 2017. These objectives will directly be linked to all of our compensation programs in 2017. Specifically, securing a minimum of 10 new proof of concepts or trials across our strategic product portfolio, winning a minimum of three new Tier 1 service providers, again across our strategic product lines and generating new revenues and deliver to our state of revenue and earnings expectations with specific focus on the acceleration of revenues and our strategic product lines at 20%, while maximizing their earnings generation of our legacy embedded product lines.

With all of that, let me turn the call over to Jon for more details around our fourth quarter results.

Jon Wilson

Thanks Brian. The fourth quarter represented another strong quarter of execution against our short-term objectives as we delivered both on our expected financial results or at the same time driving continued progress against internal objectives required to secure new customers over time. With that now let me now recap our fourth quarter results.

Revenue was $40.6 million, representing 8% year-on-year decline, largely attributable to DCEngine revenue related to uneven timing of orders from our largest customer, and partially offset by significant growth within software systems. Non-GAAP gross margin was 38.4%, up 900 basis points sequentially as the result of product mix towards our higher margins software systems products and lower revenue from DCEngine.

Fourth quarter non-GAAP R&D and SG&A expenses are $14.4 million versus $13.6 million in the third quarter, reflect ongoing investments in our strategic product lines. Non-GAAP operating income was $1.2 million or 3.1% of revenue and non-GAAP net income was $1.6 million or $0.04 per diluted share, compared to $0.08 in the fourth quarter of 2015 as accelerating investment levels and lower revenue offset margin mix.

Switching over to sequential changes on the balance sheet, gross cash increased by $5.6 million to $33.1 million, principally the result of generating $7.2 million in cash from operations coming of our strong third quarter results. Staying on cash, we also recently announced an amendment to our new syndicated line of credit with Silicon Valley Bank and Square 1.

The amendment provides us with greater access to capital, while lowering near term EBITDA covenants to ensure we have the ability to invest in our strategic product lines, will come in at only a modest increase in our overall borrowing costs. Accounts receivable decreased over $18 million and was a result of timing of DCEngine shipments to our largest customer.

Inventory increased nearly $1 million attributable to advanced bills for first quarter deployments and offset by reductions in inventory associated with our embedded legacy product lines. And accounts payable decreased nearly $12 million and was directly associated with the timing of DCEngine shipments and payments to our suppliers.

Moving over to outlook for the first quarter, before I address our specific guidance range I do want to highlight that both our revenue and earnings range are reflective of the lumpiness we have expected in the business which Brian alluded to earlier and as we highlighted on our third quarter call.

As a result, we expect revenue between $37 million and $41 million representing a year-on-year decline of approximately 30% and the result of a significant reduction in legacy embedded revenue and an expected reduction in software systems revenue given the strong deployments of FlowEngine in the first quarter of 2016 with our largest customer, which we now expect to resume in the second half of 2017 aligned with the launch of our new FlowEngine product.

Non-GAAP gross margin is expected between 24% and 28% of sales, which is a result of product mix relative to the fourth quarter. Non-GAAP R&D and SG&A expenses are expected to approximate $14.5 million, roughly flat with the fourth quarter, and we expect first quarter non-GAAP EPS to range from a loss of $0.16 to $0.10 per share. The non-GAAP EPS to range is based on an estimated 40 million shares outstanding.

Moving over to our annual 2017 guidance, consolidated revenue is expected between $190 million to $220 million. At the midpoint, this includes approximately $55 million in revenue from our legacy embedded product lines and about $150 million from our strategic product lines. Note the range of revenue is largely a reflection of the timing of revenues achieved from the many new opportunities we are engaged in across our strategic product lines and at the midpoint anticipates multi-million dollar revenue contribution from at least a handful of new customers or new opportunities with existing customers.

Non-GAAP gross margins are expected to approximate 32%, representing an increase of nearly 200 basis points year-on-year as a result of lower contribution from legacy embedded products revenue. Non-GAAP R&D and SG&A expenses are expected between $56 million and $62 million, an increase of approximately $2 million from our annualized expense run rate in the fourth quarter of 2016.

The increased operating expenses are associated with a continued resource ramp specifically tied to DCEngine and CORD professional services and offset by further reductions to our legacy embedded product lines as we right size the organization. And finally, non-GAAP earnings per share is expected between $0.07 and $0.17 per diluted share and assumes approximately 40 million diluted shares outstanding.

At the midpoint, this represents a reduction in non-GAAP net income of approximately $5 million year-on-year as we remain committed to investing across our strategic product lines in 2017 in order to bring expected new products to market, fully staff our organizations, and ultimately harden our ability to deliver for Tier 1 service providers. All where navigating the headwinds within our legacy embedded product lines. That said, we expect 2017 will set the stage for a return to consolidated revenue growth in 2018 as our strategic product lines further accelerate on the back of the many existing and future opportunities we expect to engage in.

With that, let me now hand the call back over to Brian for closing remarks.

Brian Bronson

Thanks John. There are tremendous tailwinds for Radisys as the markets we participate in are in the early stages of a transformational disruption. We are at the forefront of playing a leading disruptive role in fundamentally changing the way telecom networks are built. The available telecom equipment market is in the multi-billion no matter how you cut it and it’s now ours to go on when our fair share.

Service providers want to do business with the Radisys, which we have proven [indiscernible] with two of the world's foremost thought leading operators. Frankly Radisys is unique and different. We are not part of the old guard trying to protect the margins of our purpose-built network elements and resisting the transition to software and open standards hardware, rather with our products and capabilities we can see service providers billions and OpEx and CapEx over time by leveraging and implementing Open Source software and hardware solutions leveraging our agnostic telecom expertise.

And all of this adds up to the following long-term business model for Radisys. Revenue from strategic products will grow at least 20% annually. Gross margins of approximately 30%, which is a blend of our lower gross margin percent open standards DCEngine hardware that ultimately pulled through our remaining products and services, which at the high-end derived traditional software gross margins given our IP differentiation and capabilities, and operating margins of 10%, which we expect to achieve as the business gains greater scale over the next few years.

And back on 2017, we remain committed to generating positive cash flow and earnings all while investing to capture our share of this evolving market and when we are successful, I fully expect that we will further accelerate our long-term strategic revenue growth targets of 20% as we will only take a few more meaningful Tier 1 wins for this to become a reality.

With that, we’ll now open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Richard Valera of Needham & Company.

Unidentified Analyst

[Indiscernible] for Rich. My first question is, there is a pause from Verizon and for DCEngine and you guys mentioned rebound in Q1, I just wanted to know what your overall outlook for the year is on that.

Jon Wilson

So our outlook for 2017 is another strong year with Verizon. I'm not going to suggest that we're going to see growth with Verizon year-over-year as you just know and we mentioned $70 million worth of business in 2016 as part to grow off as a base, it’s possible, but we're not planning on it. It’s not part of our guidance, but we should expect revenue from Verizon every quarter. Some will be larger than others and I can give you an update more in April.

Unidentified Analyst

Got it. And then just, what are your overall expectations for software systems to grow in Q1 and throughout the year?

Jon Wilson

Software systems in Q1 specifically will be down sequentially, year-on-year it will be down largely as we indicated in our prepared remarks given the strong FlowEngine deployments in the first quarter of 2016, so software systems likely is somewhere in plus or minus maybe $10 million in the first quarter of 2017.

Unidentified Analyst

Got it. And then, last one from me, do you expect CellEngine to grow in 2017, just given the prospects haven't been so exciting?

Jon Wilson

We do. CellEngine is morphed into professional services tied to enabling all for product lines. So there is some access specific deals and there absolutely is CellEngine centre technology that we are embracing to help operators disrupt what they have in their market, but overall revenue growth. FlowEngine should grow meaningfully CellEngine as you guys think about it will grow meaningfully, DCEngine will grow meaningfully, MediaEngine will grow a little bit and it is going to be tied to winning these transcoding deals that I mentioned in my prepared remarks, CORD will grow meaningfully and then of course the embedded products business would be down substantially.

Unidentified Analyst

Got it. Thanks guys.

Operator

And your next question will come from the line of Mike Latimore of North Plains Capital.

Mike Latimore

On the, Brian I think you said as part of your goal to grow strategic products, 20% this year you expect to have, I think you said three new Tier 1’s goal live [indiscernible] and then second are you talking about DCEngine specifically there or will that be kind of across the product line?

Brian Bronson

Across the product line. So here is what I would say the update is at this point in time. On the 10, we engage with at least 10 service providers/operators and proof of concept or trials we’re ahead of expectations there. And that expectation was set last summer and measured for the next year, which should be this coming summer. And again, we are ahead of expectations and the context of winning at least three which - or are a key driver for hitting the $150 million that I referenced. I think we’re on track. I think we will have more revenue than that from more operators than that, but that’s we've got at least to have three, to have a shot to hit the 150.

Mike Latimore

And of the three, how many would potentially be DCEngine let's say.

Brian Bronson

I think based on the way the strategy is unfolding and the traction of we are getting all three.

Mike Latimore

Okay, I get it.

Brian Bronson

All three. And by the three could be six, it could be - my point is that we have to have, with Verizon being the anchor tenant and Reliance Jio being the anchor tenant, the MediaEngine we need a handful of other accounts to start to deliver seven figure, like run rates in the back end of 2017, and I see why it’s actually more than that, but let’s see how it plays out to the summer.

Mike Latimore

And I think you mentioned this, and now it’s entirely clear on, what was sort of the number one factor and maybe lower legacy embedded product outlook here?

Brian Bronson

There is one customer, particularly in the US and by the way that’s the same customer that I reference that is looking at our DCEngine right now, that really is being forced to move to a software only model, and then embracing open standards hardware and today that’s not us. But we hope it’s us moving forward and so by the way, it is with a large US Tier 1 service provider, as I mentioned in my remarks. So, a little bit of it to transfer revenue from embedded going down to shoring up and still uncomfortable with delivering the 20% in 2017 for DCEngine.

Mike Latimore

Got it. And then just last on Jio, I think going back into, maybe can you just say what - how much revenue they generated in 2017 and then are you expecting Jio to kind of growth this year as well?

Brian Bronson

Mike let me re-characterize it, were you asking how much revenue they generated in 2016?

Mike Latimore

Yes in 2016 and then what …

Brian Bronson

Yes, and I can comment on 2017.

Jon Wilson

So, yes Mike down slightly from 15 levels. It was north of $10 million for the year.

Brian Bronson

And I would say put up this way or any operating plan doesn't have Reliance growing in MediaEngine, it’s about feathering in the other voice over LTE accounts, transcoding is an option for Reliance, but it can come with a couple of accounts that we are working. So, but I don’t expect - but I love to - I mean it is possible to either help short the plan or beat the plan, but the plan of record is down actually year-over-year as they are now filled out, let's call 100 subscribers.

Mike Latimore

Got it. Thank you.

Brian Bronson

Thanks Mike.

Operator

And your next question comes from the line of Brian Alger of ROTH Capital Partners.

Brian Alger

Hi guys, obviously a lot of moving parts here and a lot of transformation going on within the model over the course of the year, can you help us understand how fast the legacy customers in the embedded space is peeling off the business and how fast you think that may or may not transition over to a DCEngine type of win?

Brian Bronson

It’s peeling of fast. The cut over is quick, and so I’m not going to give you specific number but let's just say the embedded number for Q1 is in and around the annual message or number that we have provided on the scripted remarks, so that’s a pretty precipitous drop off. Now, well there still will be some shipments to them, yes. So it will go up or down as we continue to harvest that business and the context of them ramping up, in the next couple of quarters you could see some revenue. And it is not a new, it’s not a new application. So, they’ve won the business or simply not with those operator, and to be more about [indiscernible] Radisys over the competition.

Jon Wilson

Correct.

Brian Alger

Okay. And at that kind of adjusted, I mean it’s a pretty big hit, gone from what we thought previously $75 million to $55 million, do you think you are still going to be able to cash flow positive on the full year at that $55 million run rate?

Jon Wilson

Yes, no question about it. Are you talking about, you know for - I answered emphatically for both RSYS Corp as well as Embedded Products.

Brian Alger

I was thinking more CORD total, just in terms of how it - but in terms of just the - that legacy business if we were to kind of carve out the business associated with it, I guess it’s declining at this rate, kind of brings the question, why do it all in, I guess for cash flow positive the answer would be why not. Is that correct?

Brian Bronson

I mean - we - I am not chucking at you, it is that remaining business reality that, part of the team are navigating, I mean Jio might have took over what was a couple of hundred, $250 million revenue or something, now it is under 55, and we have the opportunity to sell it for shareholders a couple of years ago, but for hardly anything, and it wasn't right.

So, we've ultimately harvested, milked it, provided more than substantial returns and really incubated this business as come from 40 to, you know we’re expecting 150, do I like the fact that it’s down, no, did we think that we could glide into some other hardware-related businesses that would have meant the bottom, the 75 to 100 that we are originally referencing, yes.

Is that actually still happening with this one customer, yes, but they moved away faster. And we are cutting faster and make sure there continues to be profitable. And further Brian, just to go down on the alliance again MediaEngine is profitable CellEngine or Professional Services is profitable, DCEngine is profitable, Embedded Products again is profitable, what we’re funding is Fall Engine and CORD, so there is more than just Embedded that’s making money.

Brian Alger

Of course. And then the strategic areas that are growing, the 150, you guys are basically projecting to be up 20% at least, at the midpoint et cetera year-on-year, how should we think about the software business, I mean last year it was up slightly year-on-year, my math says about 3%, do you expect to see a flat year in software, I mean we are starting at 10 million per quarter, it implied a pretty big ramp if that were the case.

Jon Wilson

So certainly are big ramp Brian, as we go into second half with as you know the timing of the new FlowEngine appliance coming into market, right, big expectations around that product and beginning to enter trials in the first half that set the stage for that second half growth. Frankly MediaEngine, if we think about extra alliance, which is kind of, which is really what Q1 represents, this is actually a pretty typical seasonal quarter for MediaEngine in the first quarter, and then it builds throughout the year. So, certainly sets a stage for software systems ramping throughout the year and does it grow at 20%, I think maybe a little bit less than that is kind of what we see right now, but certainly good growth in software systems year-on-year.

Brian Bronson

And it is because of MediaEngine, right, so FlowEngine absolutely growing in excess of the 20%, same thing with services less Cell Engine, it’s MediaEngine where I think we will probably see slight growth. Here again predicated on transcoding traction, simply because Reliance has been an anchor tenant that will be down a little bit year-over-year. We have to get to a position though to get all these product lines coming and/or Fall Engine offsetting the MediaEngine flatness where every year FlowEngine gets bigger to where we are taking the whole portfolio, but at least 15% to 20% of the year and of course DCEngine is at least 20% as well.

Brian Alger

Right, and just one last one and then I’ll get back in the queue. You talked about DCEngine with some of the new customers perhaps generating new revenues, as early as Q3, does that imply that shipments could be coming in Q2, just understanding there is the sign of phase?

Brian Bronson

Yes it is possible, and by the way shipments meeting, they already have racks, are you talking about POD racks?

Brian Alger

Yes, I am talking about POD racks racks [indiscernible].

Brian Bronson

Yes definitely possible. There aren't going to be again in the multi seven figure you know how the ramp is going for us throughout the year and timing still could change that right, but we absolutely should see some POD’s in Q2.

Brian Alger

Great, thanks.

Brian Bronson

Thanks Brian.

Operator

Your next question comes from the line of James Kisner of Jefferies LLC.

Unidentified Analyst

Hi everybody this is actually [indiscernible] for James. How are you?

Brian Bronson

Great.

Unidentified Analyst

Good. Could you guys talk a little bit more about the mix within software, your revenue is really nice in Q4, but the margin declined, do you know, is there, has there been a structural change going forward because we’re modeling 60% less going forward and is that no longer the case, any comments would be great there?

Jon Wilson

He's talking about the of 58 number Brian.

Brian Bronson

Yes, I was just looking at my numbers, frankly modest decline in the margins I would characterize sequentially and really the results of Q3 well revenue was more modest it was a lot more software only revenue. Q4 our largest customer in MediaEngine, Reliance, those are systems based sales and not commanding as higher gross margins, especially with the larger orders that we have received from that operator. And then as we look into 2017 [indiscernible] I still think that in and around 60% is roughly the right place from a modeling standpoint to be for software systems.

Jon Wilson

Another way to answer the question is to, and this is with Reliance and really how our MediaEngine MPX 12K works is that you ship of the software and the chasse and cards. These cards are albeit software rich they are blades, they are DSP blades, they get populated inside the systems as the densities are required or the subscriber uptake is there. We shipped a lot of additional cards only in Q4 that drove the revenue, which again are nice margins, but not as high as the normal 70 or 80 points you would expect for MediaEngine overall, did that help?

Unidentified Analyst

Okay yes, that’s helpful. And then for Q1, the gross margin 26% I guess I don't know if you could talk about some of the factors behind that and software I’m assuming is going to be pick up a little bit looks like or maybe it is similar, software margin in Q1 2017.

Jon Wilson

[Indiscernible] what I referenced earlier is that in the first quarter software systems revenue will be in and around $10 million and that’s the consolidated gross margins when you gross it all up given the mix with really DCEngine being the largest contributor to the revenue from a product line standpoint in the first quarter, that’s kind of how we net out at 26% midpoint for gross margins in the first quarter.

Brian Bronson

Here is the other thing I would say to, we have, John made this software and systems down a little bit earlier, but we have probably million dollars, million and half dollars in Q1 baked [ph] in for FlowEngine as part of the 10, I mean we talk a lot about the TD 2000 or next-generation product, coming to GA in the second half. So, not to say we couldn’t have another $10 million quarter because of the lumpiness, but I would expect obviously higher levels of software and systems revenue and even when it is down quarter, it should get the overall company gross margins to at least 28, I mean John has been on record many times talking about 28 to 32 or 30 at the midpoint, being in the gross margin range depending on again the mix in the quarter. So, I wouldn't read too much in the Q1, but do expect volatility.

Unidentified Analyst

Okay and I think my last question, so I think in the past you talked about some backend loaded year for 2017, perhaps some more DCEngine revenue in the back end, but is there any types of seasonality or cadence you expect, you’re guiding about $38.5 million and then you are expecting sequential growth every quarter or any other feedback would be useful?

Jon Wilson

Well, I will talk about the revenue again just except the picture for the margin mix and everything else, and go through each product line. So, everybody understands that DCEngine today is materially Verizon and the use cases around Verizon. We do have other customers, but again they are relatively small. We are in multiple proof of concepts and trials right now of which I would expect at least a handful of those to go into more mainland trials and as I referenced my prepared remarks is actually one service provider in the US that I expect could be commercial, actually commercial revenue, and I wanted to draw the stint between proof of concept and trials in commercial revenue. We could ship 10 racks as a proof of concept or trial and it is material revenue for us.

So, we could have revenue that allows us to meet our objectives in 2017 and not even get to commercial deployment. That’s just kind of where we are at in the revolution. So that’s DCEngine. With FlowEngine, our early access units are available at the end of March, our GA is the end of June, our customers are playing with the new appliance now, lot of interest, lot of enthusiasm, can't wait to share more on how this profit of it is relative again to the few competitors and again the competitors through the F5 and the A10s and [indiscernible] and there is a long list of them, but it is going to be backend waited, not a traditional hockey stick, let's hope we get deals, it is just availability of the product. And then CellEngine professional services is a little more linear.

Unidentified Analyst

Okay, great thank you.

Jon Wilson

Thanks.

Operator

Your next question comes from the line of Jaeson Schmidt of Lake Street.

Jaeson Schmidt

Brian, I just wanted to clarify, get clarification on one of your prior comments, I know you said that the goal was to add 4 to 6 new DCEngine customers outside Verizon by kind of one year out, are you still on track for that goal?

Brian Bronson

Yes, I am. We are. What I want to try to do is to bring consistency to our messaging and that’s why I keep referencing the material from last summer the 10, the 3, and the 20 points of growth, but in reality I believe we will have more customers paying customers, by end of this year than we are referencing and again good memory 4 to 6 in DCEngine, but the three is important for me because I want to see revenue beyond proof of concepts and trials. I want to see a commercial win, similar to what we have with Verizon. Commercial win, you’ve been awarded the business for Radisys, no more bake-off, we are into a run rate situation, albeit run rate could be lumpy, but again you’ve been awarded the business.

Jaeson Schmidt

Okay that's helpful. And I know DCEngine products obviously have lower gross margins, but there is some talk that maybe you guys could scale those of up, have you found that to be true or should we still think about high teens gross margin for the DC engine product?

Jon Wilson

Yes absolutely. We are - and it can vary and the grand prize for us is going to take those 15 points, 20 points gross margin, sometimes is 20 points, 19 points, that’s a good number to use to. Along with our professional services revenue and normal professional services gross margins, you obviously know about our various software initiatives that we're undertaking. Core comes with different business model potentials and I don’t really feel comfortable going into now, because it's pretty - it's really disruptive. I can't wait to share more on that. But that will kind of grosses up to 30 points.

And I know I've talked to investors a lot about, wow, I'm super excited and they look at 30 points in gross margin, well, okay, I thought it would be 50, 60, 70, 80. The reality is, this is a combination of CORD’s hardware, professional services, our own software, open source software wrapped together in volume delivering 10 points of operating income.

That that's our game. And it's going to be that expensive all these old [indiscernible] who are 70 points, 80 points of gross margin, go to the operators for services margins, that's done. Those days are done. You guys haven't seen it yet. It's coming with many of the TAMs. It's very, very real, whether Radisys wins or not, it’s very real.

Jaeson Schmidt

Okay. And then the last one for me, Jon, how should we be thinking about CapEx this year?

Jon Wilson

Yes, Jaeson, good question. So CapEx will be in and around similar levels to 2016, I believe, we excited the full-year was about $5 million. That’s about roughly the number we're planning for in 2017. And I would characterize it as much of it is tied to DCEngine and really success-based in some respects when we think about preparing for these proof-of-concepts and trials that we're planning for in 2017.

Jaeson Schmidt

Okay. Thanks a lot.

Jon Wilson

Yep

Operator

Your next question comes from the line of Tom Diffely of D.A. Davidson

Thomas Diffely

Good afternoon. Maybe another question on the software side. Heading into 2016, you had a little higher growth expectations that ended up. Just curious what the difference was between your initial expectations and the actual year?

Brian Bronson

So MediaEngine met my expectations largely, because Reliance delivered in Q4 and I think we said that in the outset of the year. Professional services for us and again the context of CellEngine proper CORD enabling broader product lines again exceeded my expectations.

CellEngine licensing deals go back and this is the model where we try to go off and get $250,000 for a small cell builder and then we put a royalty back onto it disappointed. And I think, I mentioned in my prepared remarks, we've moved that business to a services model and we're seeing success with that. But that disappointed relative to 2016.

And then FlowEngine, we had really nice growth. But we slipped in a $1 million or $2 million and some of its product availability et cetera. But again, no concern, had really nice growth there signing up for another 40 points or 50 points of growth in 2017. But that was the reconciler.

Thomas Diffely

Okay. Do you think the prospects of a new Flow product coming out actually dampened business for this year, or for 2016?

Brian Bronson

Yes, it's a really good question. Not - because of the number of use cases, I would say, no. Did we did focus a little bit too much on the new product versus some of what we had - its part has been fully transparent, it's possible. But again, I'm not too worked up based on the funnel, based on the interest, based on the actual numbers we posted. But the big - I think the big hang up for many of you and even our customers who want it is that, that we're working as hard as we can to get the product out as soon as we can. That's why we’re so explicit with 331 and 630 EA and GA dates, it's not because operationally, I wanted done is, because the customer is ready for it. We’ve got to get it done.

Thomas Diffely

Okay. And then when you look at CORD in the opportunity there, is the most compelling offering from Radisys today based on your services, your hardware, your software, what is the - what is it that drives the customer to come to you?

Brian Bronson

Well, I think, first and foremost it’s our orientation, meaning, we're willing to help them decompose their current vendors…

Thomas Diffely

Okay.

Brian Bronson

…and we're experts of doing that, we understand telecom. So I don't know if you spent much time on beyond that lab or the CORD website. But what they're really trying to do this on Access side, which is our CORD, residential CORD, and M-CORD, which is Mobile CORD essentially leverage as many open source software and hardware pieces as they can, and where they can't, or the technology isn't viable enough, they reach back out to the traditional vendors for just a piece of what they used to deliver for them.

And so for us the tractions become helping them define what our CORD means to them? What M-CORD means for them? We obviously have the capabilities. We’re hardening that open source software to help deliver it to on - for on that lab. So I'm going to say this and we need to prove first something that we'd like to be the red hat here. Telecom, we take these pieces. We harden them. We provide maintenance and patches for them. We also ship them a DCEngine, where it make sense as part of this open source software.

We have our services. Oh, by the way, there's a concept of having FlowEngine be part of the virtual services gateway that’s sitting right on top of this hardened R-CORD or M-CORD solution. So it gives you a little bit of a glimpse into our orientation, our ability to do whatever they want, meaning, in the context of pulverize in their current vendors, and then we need to turnaround and deliver this open source solution for them.

Thomas Diffely

Okay. So I guess on that same topic then, when you look at the DCEngine and your capabilities there, how is the competition evolved over the last few quarters? Do you have more direct competitors with your type of product, or are you still battling against the big guys that don't have a very open architecture, or what is the competitive landscape?

Brian Bronson

The competitive landscape is, there really isn't anything that TAMs can do other than Throw FUD, FUD meaning, this is going to work. These guys won't be able to support you. I mean, what else are they going to say. I mean, their business is going to get killed. In best case scenario, the Nokia's, the Eriksson's, the - I mean, pick your TAM Cisco, Juniper, their top line, best case scenario for them gets cut massively and they retain the business.

And so a lot of it's around this isn't going to work. It's just technology. And so because of them the incumbency for some of these guys and the big operators, that's working to kind of slow the DevOps progress. But you know the pressure the service providers are under. This is going to happen in the end. But that’s largely who you are still competing with.

I still believe that there's this competitor that evolves over time that brings a Tier 1 big incumbent like hardware presence with a telecom software presence, with an integration presence and the services presence like what we do through a series of acquisitions, I still see that coming. This is too big of a market for Radisys just be the only one that's being a leader here, in fact, I want competition, need competition. I don't see it yet from a new player.

Thomas Diffely

Yes.

Brian Bronson

Ciena, Ciena a little bit, I guess. I mean, Ciena and Radisys are both integrators of choice for CORD. Ciena more with Access expertise. Radisys with more core expertise, even though we have Access - expertise on the Access side. So that might be an additional nugget for you of and they're very open. Again, they’re on the Board. I'm on the Board of CORD. Ciena is on the Board of CORD. And so, there will be one company that I think could benefit from this over time.

Thomas Diffely

Okay. But do you think the biggest bigger competition is from newer players coming into the market from below versus the big guys coming down into the market?

Brian Bronson

The big guys are going to try to come down the market. They’re going to sale the right things. But their business models, their financial models, their CFOs, their shareholders, and they will see it long-term. They just won't allow them to go there. I mean, the crushing financial model implications here longer-term or such, where I just don't say, how they can do it.

Thomas Diffely

Yes. Okay, yes.

Brian Bronson

So, I mean, I think folks like - I'm biased, because there are a customer of ours there, but might tell, that soon to be mapping here again. They have a very disruptive - they have a little bit different approach, but they have a disruptive approach, right, which is there taking the virtual versions of SPCs and EPCs and do it something very different in the market. I think that's another good example of the new TAM, or the new world but the same place.

Thomas Diffely

Okay. All right. Move over to the model, it sounds like you're going to basically you’ll be cash flow positive for the year. What is the cash flow metric for the first quarter?

Jon Wilson

What I'll tell you in the first quarter, Tom, is that cash will be down. It will be down through really from a work - from a working capital timing standpoint. So, as Brian alluded to on the call, we've got strong bookings for DCEngine entering the quarter, those will ship in the quarter. We’ll pay obviously for the goods and then we’ll collect in Q2.

So I wouldn't - don't focus on Q1 cash. I’d focus on really first-half cash, given the timing of working capital and as expected maybe through the first-half to be down just a little bit.

Thomas Diffely

Okay. And then finally, when you look at the operating expenses, it looks like that come up a bit here for some of the new programs. Is there much you can cut, or rationalize from the just the older business - the legacy business, or you’ve been pretty well cleaned up over the last few years?

Jon Wilson

So we put - we've put action in place to…

Thomas Diffely

Yes, took another layoff in January your side of this business?

Jon Wilson

Yep, unfortunately. We're continuing to manage it as we need to ensure we maximize the cash flow and - from that product line, so really important there. And as Brian alluded to earlier from an operating expense standpoint, look, across the company in 2017, all of our compensation programs are tied to driving towards these revenue objectives.

Brian Bronson

Yeah, right.

Jon Wilson

So, we’ve got to deliver everybody, always under reported.

Thomas Diffely

Yes, okay thanks for your time today.

Jon Wilson

Yes, thanks Tom.

Operator

[Operator Instructions] Your next question comes from the line of David Nierenberg of Nierenberg Investments.

David Nierenberg

Hey, guys.

Brian Bronson

Hey, David.

Jon Wilson

Hey, David.

David Nierenberg

When I first read the press release and saw the sentence in the bottom of the second long paragraph that talks about increasing headwinds in legacy, without a number it was not possible really for anybody to figure out exactly what you meant by it. After listening to the call, basically what I’m hearing is this, you expect software and services to grow about 20% to $150 million and you expect legacy to shrink from about 75, which is what you thought before to about 55, hence the 205 midpoint.

Brian Bronson

Correct.

David Nierenberg

If I think about that relative to where the Street was expecting your 2017 revenues, it is that shrinkage of very low margin legacy business that accounts for almost all of the lower revenue expectations that you’re giving now for 2017. In other words, if my reading of this is correct, there was not a competitive problem, there was not a customer adoption problem, there was not a product availability or performance problem, which is resulting in the lowered range of growth expectations for 2017, it is more of a flip side of the growth of S&S, in effect accelerating the veining of the legacy business. Am I reading that correctly?

Brian Bronson

Absolutely correct and another way to put it would be, really nothing has changed except for the old embedded business that’s going to - that's been dying and yeah we thought there was a floor as we shifted. Now it's moved faster, which suggests that the market we’re attacking is just that much more right for us to grow, there's been no change. In effect the customer traction is faster than I would have thought, it's getting more and more and I was trying to talk to John Wilson about how I get this across, it’s a little bit counterintuitive.

Many of you guys know my background right, so you should know that and you've seen us over the last couple of years, when I increase expenses that means the deals are getting closer, not further away. So you should take away that not only have we had no change to our strategic revenue guidance, we have accelerating customer traction and we're investing to win.

David Nierenberg

My next question - and thank you for that answer. My next question Brian is that, I assume that none of us who are shareholders are shareholders because of any expectations we ever had about the first quarter of 2017, because back in August you then telegraphed the probability in your opinion then that sometime in the first-half of 2017 you would have an unprofitable quarter.

Brian Bronson

That's right.

David Nierenberg

So when you take that and you subtract that from the midpoint of your revenue and profit guidance for the full-year of 2017, my math tells me that in Q2 through four recognizing it will certainly not be winning, not for your business, not for your company. On average in Q2 through four, we’ll do $54 million a quarter and $0.08 of non-GAAP EPS to get us to what you think the full-year will be?

Brian Bronson

That's right, it sounds right.

Jon Wilson

That’s right. Q2, we’ll need to see, remember with EA and GA at FlowEngine been, 331 and 630 and higher margins. I'd - please don't anybody expect to wake up and see a meaningful EPS number in Q2, it’s possible, but I don't see it right now, but again it's definitely backend weighted for more substantive reasons than normal.

David Nierenberg

But as I said in my first question, you are not attributing this change in combined corporate revenue to competitive customer product or technology challenges associated with the new products and services?

Brian Bronson

Zero, all legacy embedded.

David Nierenberg

Thank you, good luck.

Brian Bronson

Thanks David.

Jon Wilson

Thanks, David.

Operator

And you have a follow-up question with Brian Alger of ROTH Capital Partners.

Brian Alger

Hi, guys thanks for allowing me to come back in here. Maybe in the spirit of consistency in the messaging, Brian, can you maybe give us an update and I know you did this at the Needham Conference against your hope or target of 10.3 % and 20% on that slide, where we stand today in terms of, from last summer, how many various service providers have been engaged? How many are transitioning to customer engagements at this point?

You talked about being on track to meet your goals. So obviously we're not at 10.3% and 20% already. But where are we today relative to where we were at the end of last quarter. And maybe where do you expect to be, it sounds like you expect to be at least there by the middle of the next year, but perhaps ahead of it?

Brian Bronson

Yeah, I and maybe this is the time to calibrate in terms of how we're going to roll this out. If you’re thinking out for Q3, we started talking about count, count for - we talked about two DCEngine, one Flow, one CORD, one MediaEngine announcement that wasn't quite numbers, but I think I made some comments around a big win with the U.S. Tier 1 operator, pretty important.

And then I start to think about, man, every quarter we're making progress here. And I'm going to talk about now we went from two in DCEngine to four and then six and eight, how do I get the streets head around modeling this. And so I'm hoping that we provided enough color here that gave, if you wanted to just still track count, you could. For example in Q4 we talked about what John and two other DCEngine. One was a very large Tier 1 U.S. service provider that could be commercial revenue in the second-half.

Brian Alger

Yes.

Brian Bronson

And the other one being in embedded customers. David referenced again that could embrace our DCEngine that not only would shore up our growth expectations, I just have a better shot of us even beating DCEngine in 2017. And then same thing with CORD, we had a follow on PO from Q3 with a very large European Tier 1 provider. And we actually got a new win as well with another European Tier 1 service provider.

And then FlowEngine, of course there was a European Tier 1 again that we got a PO for. So I’d actually guess maybe do your own math that gives you the color, expect that kind of color moving forward. But you're not going to see charts from us to do a cumulative count on wins over it and it's too hard to model.

Brian Alger

Fair enough, fair enough. Just looking for it, because I've heard people ask the question a couple of different ways and I think you just helped us out right there by walking us through it. I appreciate that. And then just one last follow-up if I might, and this is kind of to David's point, the stock has obviously taken a knee jerk reaction here in the aftermarket, but it appears that from what I'm hearing, the engagement level if anything is accelerating with the large service providers and its diverse, not just for DCEngine, but for the multitude of your products and services. But because the purchase orders haven't been won yet, you're not baking those into the cake, is that fair to say with your guidance?

Jon Wilson

I don't and there’s the guidance that contemplates obviously some of the trend. For us, I think it's more about timing. Brian, I’d really - for us to stick and stay with the 20 points of growth, there's all sorts of ways to beat that number. At the same time, we want to be sensitive to timing. We're trying to give enough color and that we need to say worst case, we'll have to push it from Q2 into Q3 or something, which would be the walk into telecom that we don't find ourselves reconciling with you after the fact.

So I guess where I'd like to stick is, like we've been sticking to on the new business that we put our heads down, make the progress, give you guys updates, have pleasant surprises and we go from there. And one thing I can't reconcile is embedded, all I can do is make money at it on the path to wherever it's going.

Brian Alger

Fair enough. Thanks guys. I appreciate all your time.

Brian Bronson

Thanks, Brian.

Jon Wilson

Thanks, Brian.

Operator

And there are no further questions. I would like now to turn the call back to management for any closing remarks.

Brian Bronson

Thanks Karen. Before closing out today's call, I'd like to briefly mention that we’ll be participating in Mobile World Congress in Barcelona in late February, and then also presenting at the ROTH Annual Conference in Dana Point, California on March 14. We would welcome the opportunity to meet with you at either of these events should you have plans to attend. Thanks again for joining in today's conference call and we look forward to providing further updates on our call in April. Thanks.

Operator

This does conclude today's conference call. Again, thank you for joining us. And all participants may now disconnect.

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