Radisys Warns For The Second Time In 6 Months

Summary

• Company misses Q2 revenue expectations by more than 20% just eight weeks after giving guidance.
• Expect management to reduce Q3 and full year guidance meaningfully on the upcoming Q2 conference call.
• Gross margin, strategic revenue growth and cash flow guidance for the full year all at substantial risk.
• Expect further pressure on the company's shares going into the Q2 earnings release and potentially beyond.
• It will take time and some major business wins to recover some of the credibility lost with the investment community over the past six months.

Thursday after hours, small network solutions provider Radisys (NASDAQ:RSYS) shocked investors with a bold earnings warning:

Radisys Corporation, the services acceleration company, today announced preliminary revenue for the second quarter ended June 30, 2017 of approximately $35 million, compared to the Company’s previously stated guidance range of $41 million to $47 million.

“Delayed buying decisions at two of our largest customers resulted in second quarter revenue below our previously expected range,” stated Brian Bronson, Radisys President and Chief Executive Officer. “Despite these near-term challenges, I remain encouraged by the incremental progress we are continuing to make in proof-of-concepts and trials with tier-one customers across our strategic product lines, including initial engagements for our now commercially available FlowEngine TDE-2000 product. Our highly disruptive products and solutions are actively receiving increased attention from leading service providers, which reinforces my belief that we remain on track to secure new commercial wins in the second half of 2017.

“Additionally, we recently completed an amendment to our existing line of credit with Silicon Valley Bank and Square 1 Bank. The amended agreement provides us with greater financial flexibility by revising our quarterly EBITDA covenants. Importantly, this amendment supports our ability to continue executing toward our long-term strategic objectives.”

Unfortunately, this is already the second time within the last six months the company missed expectations by a wide margin. Back in February, management blamed a stronger than anticipated decline in the company's legacy embedded products business as the reason behind the lower than expected guidance but this time things are different as now "delayed buying decisions" at two of the company's largest customers are cited.

As Radisys is in the midst of transforming to a more software-centered business model, fellow contributors like Gregg Sterling have urged investors to look past the current distractions and instead focus on the company's allegedly bright future.

Obviously, it will take some more time for this thesis to play out as at least two of the company's largest customers clearly hesitate to purchase the company's solutions in the amounts previously expected by management.

Moreover, the severe underperformance required the company to, again, amend the minimum EBITDA covenants governing the company's new credit facility after already having been lowered significantly in January.

The company's largest telecommunication customers over the past year have been Verizon (VZ) and India's Reliance Jio, so I would expect them to be behind the alleged "delayed purchase decisions".

This is particularly troubling as on the recent Q1 conference call just eight weeks ago management was quite optimistic with regard to ongoing Verizon deployments:

Moving into the second quarter, we have visibility to ongoing deployments with this customer, including the opportunity for broader adoption and use cases of our solution across their network.

Management also predicted strong cash generation for the second quarter from payments expected by both Verizon and Reliance Jio, so this will be another important issue to watch in the company's upcoming earnings report.

Moreover, the company did neither reiterate previous gross margin guidance of 30-32% nor its annual strategic revenue growth target of at least 20% or $150 million for the company's newer software and hardware products.

Accordingly, I would expect management to lower both Q3 and full year 2017 revenue and earnings targets meaningfully in the upcoming Q2 conference call. In addition, I would expect cash flows from operations to be negative for the year.

While the stock already sits at 52-week lows, I do expect further downside going into the Q2 earnings release on August 1 and, depending on the magnitude of the anticipated guidance reduction, some more pressure on the shares thereafter.

With $15 million left under the company's credit facility and potentially negative cash flows for the year, Radisys overall financial picture is clearly deteriorating. But with cash on hand of more than $30 million compared to $40 million outstanding under the credit facility and an expected cash inflow for the second quarter, the situation is still far from being dire.

While management, as always, remained optimistic about its ability "to secure new commercial wins in the second half of 2017", these potential orders most likely won't translate into meaningful revenue for the current year. Accordingly, investors should prepare for a disappointing fiscal year 2017.

Going forward, management not only needs to improve its ability to forecast the business in a more accurate way, it would also be well served to better diversify the company's revenue streams to lower the current dependence on just a couple of large customers.

To leave the penalty box, Radisys needs to win major new business fast and more constantly than in recent quarters. Particularly the software business with its superior gross margin contribution should remain management's focus.

Bottom line:

Radisys management, again, fails to deliver on expectations set just a couple of weeks ago. While large orders in the telecommunications space always tend to be somewhat lumpy, a more than 20% forecast miss after having been almost halfway through the quarter at the time of giving guidance looks troublesome, at least to me - particularly after the company already fell short on expectations by a wide margin at the beginning of the year.

Expect management to significantly lower Q3 and full year 2017 guidance on the upcoming Q2 conference call and cash flows from operations now expected to be negative for the year.

Despite the stock already sitting at 52-week-lows, I do expect further downside over the next couple of weeks and will look to take a short position in the shares going into the Q2 earnings release.

After the renewed disappointment, it will take time and some major positive business developments for Radisys to regain credibility with the investment community.

As always, don't bet the farm on short positions and adequately manage your risk.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in RSYS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.