RadiSys Corporation (NASDAQ:RSYS) Q4 2017 Results Earnings Conference Call February 7, 2018 5:00 PM ET
Brian Bronson - President and CEO
Jon Wilson - CFO
Tom Diffely - D.A. Davidson
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. [Operator Instructions]
Mr. Wilson, you may begin.
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 of 2018. 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, 2017.
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.
With that, let me turn the call over to Brian, who will provide an update on the business and our fourth quarter results.
Thank, Jon. And good afternoon everyone.
Our fourth quarter results top to bottom closes out higher than expectations. Revenue was $32.3 million or slightly higher than our preliminary revenue provided on January 4. Gross margins been a strong at over 40% and we drove lower operating expenses linked to our restructuring efforts. This resulted in a non-GAAP loss of a penny per share.
Importantly, our software and systems revenue grew over 30% sequentially which contributed to the strong gross margin performance. The revenue growth was the result of strength in both MediaEngine product sales, as well as professional services offerings. In fact, our professional services business ended up growing 21% for the full year.
Entering 2018, our funnel remained strong across the business and is further supported by the new customer wins we have secured over the past two quarters. This sets the stage for us to continue making incremental progress with both existing and new customers and as a result I expect that this will enable us to deliver annual revenue growth across our software and systems business during 2018.
Within MediaEngine specifically, our top channel partner security total of four new Tier 1 wins in 2017 including a new software only deployment with a Tier 1 service provider in China, as well as expansion orders from a Tier 1 U.S. service provider during the fourth quarter. This new win is expected to drive multiyear revenue contribution including incremental orders for deployments in the first quarter of 2018.
We were also notified that another channel partner was recently awarded a Voice-over-LTE deployment with a Tier 1 U.S. service provider and they expect to begin rolling out during 2018 as well. With the number of Voice-over-LTE subscribers anticipated to grow from 400 million at the end of last year to nearly 2 billion by 2021, I expect both of these partners to enable increasing levels of revenue growth for Radisys.
As expected we also secured a nearly $5 million order from our large Indian customer of which we delivered approximately 3.5 million last quarter and will deliver the balance of the order in the first quarter. This customer remains incredibly strategic to Radisys and the relationship continues to provide opportunities across all of our product lines.
In fact, I just delivered a keynote speech to a packed house on their campus as part of their first annual India Open Telecom Summit. The visibility and relationships we have with this customer will continue to be extremely important.
Lastly on MediaEngine, we're finally seeing increase interest from service providers to leverage our MediaEngine product and transcoding applications. The economics we deliver over incumbent vendors is very compelling given the hardware acceleration our software enables. And while we aren't planning on any material contribution from transcoding in our 2018 plan, I believe this could be future upside for us.
Switching to MobilityEngine, royalty revenues from prior small cell licensing arrangements are beginning to accelerate and contributed approximately 800,000 in the fourth quarter revenue representing our largest quarter of royalties in a number of years. This momentum will continue in 2018 as visibility from our customers and to end-user small cell deployments is improving. Specifically, we have two customers that are seeing material traction in service provider deployments across the U.S., U.K. and India and a number of smaller customers that are beginning to see traction with end customer deployments as well.
During the quarter we also closed our first 5G license deal which is an important milestone for us as we continue to harden our software with further capabilities that we believe are essential in this new standard. Both existing and new customers are increasingly looking to leverage our software to begin development of their 5G mobility solutions, and as a result we expect 5G to be a key growth driver for the business in 2018 and beyond.
And in professional services, we drilled sequential growth of over 20% tied to ongoing programs with multiple strategic accounts that continue to leverage our organization of experts to help them accelerate development of disruptive solutions across various initiatives. Whether leveraging our own intellectual property to advanced development needs or simply leveraging our core telecom expertise for programs like CORD, we continue to see increase interest from service providers and embracing Radisys to help enable disruption which I believe positions us favorably to further accelerate our services revenue.
In FlowEngine we remain focused on expanding the funnel of opportunities for the TDE-2000, while at the same time targeting more selective use cases. We were awarded our second commercial win through a channel partner in Europe that is leveraging our product for network monitoring capabilities for deployment into a specific service provider opportunity. This channel partner selected our TDE-2000 largely due to the high-performance scalable capabilities of our product. Again network monitoring is a key use case for us.
Finally in our legacy hardware business we delivered a strong financial quarter with a modest increase in demand from our largest customer. Entering 2018 we have a backlog of over 25 million largely associated with demand from our top customer, as both existing and new design wins continue to perform well.
Before I turn the call over to Jon, I want to address the closing of our financing last month as well as today's Board of Directors changes. First, the financing enabled us to take the necessary actions across our business to both focus our investments and streamline our infrastructure. It has also helped to provide current and prospective customers additional comfort that Radisys is well-positioned financially to support them.
As it relates to improving our financial profile, substantially all operating expense actions will be implemented by the end of the first quarter. This will allow us to reduce the annual operating expenses by over $14 million or greater than 25% to below $40 million in 2018.
Further, we have taken actions that will enable us to materially lower our internal operations overhead that when combined with a more favorable mix of software and systems revenue as progress throughout the year will drive gross margins above 40% for the full year.
With much of what I just discussed behind us, our top three priorities are to return the company back to quarterly non-GAAP profitability not later than the second half of this year, accelerate the conversion of our growing sales funnel to revenue and grow the funnel of new opportunities both with existing and prospective new customers.
As it relates to the Board of Directors changes, today we announced the appointment of Steve Domenik brings a wealth of public company board experience and a track record of helping management teams create shareholder value. With Steve's appointment, we also announced that Scott Gibson has resigned from the Board effective immediately. I would like to thank Scott for his years of service and specifically his leadership in onboarding multiple new board members including our current Chairman and the recent search for his own replacement that resulted in the appointment of Steve.
Let me now turn the call over Jon for more details around our fourth quarter results and first quarter expectations.
Fourth quarter revenue was $32.3 million representing a 12% sequential increase largely attributable to 31% growth in our software systems business. Non-GAAP gross margin was 40.4% representing an improvement of 650 basis points sequentially given the favorable mix of software systems revenue during the quarter.
Note that the gross margins referenced exclude the impact of inventory charges within a hardware solutions segment during the fourth and third quarters of $9.7 million and $6.6 million respectively.
Non-GAAP R&D and SG&A expenses $12.3 million were down $1.1 million sequentially due to initial savings resulting from our cost reduction actions. Non-GAAP operating income was $0.7 million in the fourth quarter, an improvement of $11 million sequentially or over $4 million when excluding the third quarter hardware solutions inventory charge.
Non-GAAP net loss was $0.3 million or a loss of a penny per share compared to a net loss of $0.28 per share in the third quarter of 2017. And while excluded from our non-GAAP results, we did report a restructuring charge of approximately $3.2 million during the fourth quarter tied to employee severance obligations. Further, we expect to record another $1 million to $2 million of severance charges and pay associated cash obligations during the first half of 2018 tied to our restructuring plan.
Switching over to sequential changes on the balance sheet, net cash decreased by $5.6 million largely tied to our results of operations during the fourth quarter, as well as the payment of nearly $4 million tied to the DCEngine inventory originally purchased during the second quarter of 2017.
Importantly, in early January we announce the closure of a new 17 million senior note financing, as well as a new asset-backed facility associated with our accounts receivable. On a pro forma basis and net of transaction costs, this financing would've taken gross cash to over $23 million as of December 31 assuming similar levels of borrowing under the lines of credit.
Accounts receivable decreased $1 million largely attributable to the increase in revenues and offset by the receipt of $4.7 million of past year receivables from our large MediaEngine customer. At period-end, the past due balance with this customer was approximately $2 million of which we have now received payment for $1.7 million of this balance during the first quarter.
Net inventory decreased $6.8 million largely due to inventory write-downs during the fourth quarter. Additionally part of the inventory charge included a reserve for noncancelable purchase commitments of $1.2 million for inventory to be received in the first half of 2018 for which we do not expect future customer demand.
Accounts payable decreased over $2.3 million. The balance of period-end includes nearly $4 million of payable to our contract manufacturer for previously reserved embedded products inventory which has been paid in the first quarter of 2018.
Finally, while our new financing closed subsequent to period end, I do want to highlight a few details for our investors. Specifically, payments will begin in the third quarter of 2018 and then quarterly thereafter. The notes caring interest rate of prime plus 5.75% and no cash interest will be paid until September 2018.
Further, commensurate with the closing of the financing arrangements we expect to record transaction costs of approximately 2 million which will be amortized in the interest expense over the term of the senior notes. For further details of the transaction, I would encourage investors to reference our 8-K filing on January 4 which contains a comprehensive summary of the terms and conditions of the arrangements.
Moving over to outlook for the first quarter, we expect first quarter revenue between $22 million to $24 million with the mix weighted slightly towards the hardware solutions segment. Note revenues from a hardware solutions segment are expected to include nearly $5 million of lifetime customer builds during the first quarter.
First quarter non-GAAP gross margin is expected between 31% and 33% of sales given expected revenue mix across our segments. Non-GAAP gross margins are expected to expand throughout 2018 as software systems revenue becomes an increasingly larger portion of the company's revenue mix.
Non-GAAP R&D and SG&A expenses are expected to approximate $10 million down more than $2 million from the fourth quarter given expense actions taken across the business. Further we expect operating expenses to drop to a run rate of approximately $9 million per quarter beginning in Q2 which will represent a reduction of over 25% from fourth quarter 2017 levels.
And finally, we expect first quarter non-GAAP loss to be between $0.12 and $0.08 per share. The guidance range incorporates an increase in interest expense of nearly 400,000 over the fourth quarter resulting from the new senior notes and excludes any impact due to changes in the fair value of the associated warrants. Finally, non-GAAP earnings per share is also based on an estimated 40 million shares outstanding.
With that, let me now hand the call back over to Brian for his closing remarks.
I fully expect that our more focused software and services centric strategy will position us to profitably participate in the disruptive initiatives ongoing across the telecommunications industry. The previously discussed market trends will allow us to accelerate our software systems revenue given the differentiation in value-add or products and services capabilities provide.
And as I mentioned earlier, we are fixated on returning the company back to non-GAAP profitability, accelerating the conversion rate of our funnel and creating more customer diversification all of which should return our valuation to more appropriate levels and overtime drive increasing shareholder value.
With that Ryan, we’ll now open up the call to questions.
[Operator Instructions] And we do have a question coming in from the line of Tom Diffely from D.A. Davidson.
So just quick question on the interest expense, did you say it was 400 K for the first quarter that was projection or is that the Delta?
That’s the Delta Tom, yes, so we expect interest expense for the first quarter to be between 700,000 and 800,000.
And then looking at the first 5G license deal could you give a little more color on what that was for and how you expect that to rollout over the next couple of years?
While I would say that the first deal is really to get customers prepare for 5G call a pre-5G licensing technology enablement I can't really say much more than that because it's new and can't disclose customers. But I'm hoping over the next quarter two is - things more officially rollout may be after Mobile World Congress I can share more details.
And then curious on the DCEngine part of the business that you deemphasized, what is the situation now if customer does want to ramp some back up? Do you outsource that completely, is there a third-party.
Yes, so I’ll break it down into a couple of steps. We have inventory that we have written off. Right as we change our strategy and so to the extent that their needs line up with our existing inventory whether it squared sets or maybe there's a few missing pieces and we can deliver that we’ll do that direct.
In the case going forward of larger scale deployments, we will act in a consulting arrangement focusing on our software and services capabilities you can appreciate that our current partners, our large hardware ODM could be one but there's also others that had been asking us to help work with them to deploy. So, think about this as more of a consulted model moving forward and not standing up perhaps and deploying them directly.
And then when you look at the older hardware - traditional hardware business. I think you said that your largest customer is starting to ramp a little bit I’m just curious what’s behind that ramp is it just - units on their side is it more expensive new piece. So what is behind that?
Tom we're actually seeing - we’re in transition from older designs to new designs that we've won and so as a result of that we’re actually seeing strength in their revenue streams and coupled with strength in their end markets. So we expect another strong year from that customer in 2018.
And then we look at to just the growth of the different software pieces over the next year, is it the FlowEngine that you expect to be - to lead the charge out there by the services?
Outside of some revenues highlighted services first that will continue to be the biggest grower for us. FlowEngine would be another and then to the extent that there is any material transcoding when that would drive growth on top of our MediaEngine business. The nice thing now is that our MediaEngine product line is officially transitioned to a software only model, 90% plus of business is software.
So to the extent that there is any material revenue on top of that and transcoding by the way would be most likely software plus hardware given the densities required so you could see upside there as well.
Tom just to be clear though I mean, we haven't put those in our plans that will be more upside folks are wanting to think about that.
And then just one final question on the cash flow, what does it look like if you do get back to 40% plus margins for the full year what kind of cash burns could we expect?
For the full year Tom?
For the full year, yes.
Not in a position to go there. What I will tell you or can tell you now is that we expect to consume cash in the first quarter on the back of the restructuring efforts, as well as finalizing we’re finalizing the working capital, largely associated with the inventory that we had to bring on the books for DCEngine. And then as we get into the second quarter and beyond I’m expect to start seeing positive levels of free cash flow from the business.
[Operator Instructions] And we do have a question coming from Mike Latimore from Northland Marketing.
This is Rashid for Mike. Just a quick couple of questions. So what size of this newer FlowEngine deals is it like six-figure or seven-figure ones?
Well in a yearly basis its six-figure deals, so they can bounce then to sort of 10, 20 box sort of deals. But just like any other network element, there's not any situations where it's a one-off and so - these are multiyear wins but let’s just figure out in the calendar year being six figures.
And how is Nokia channel doing?
Exceeding expectations, really.
Really nice - I mean it's been a long-standing partner with us but you're hinting at when we formalized agreement to officially take over their combined MRF and as Jon mentioned exceed our expectations. And part of that because Nokia has won it, I mean so that that helps all of us.
So you do have a multiyear contract with Nokia?
[Operator Instructions] And there are no more questions in queue at this time. So I will turn the call back to management for any closing remarks.
Thanks Ryan. Before closing out today's call, I want to mention that I and we will be participating like usual Mobile World Congress in Barcelona at the end of the month. It'd exciting for us. And then we'll also be presenting at the ROTH Annual Conference in Dana Point. In the middle of March we will welcome the opportunity to meet with you at either of these events should you have plans to attend.
Thank you again for joining today's conference call. We look forward to providing further updates on the business in about a quarter or so. Thanks.
And this does conclude today's conference. You may all now disconnect.