Radisys's (RSYS) CEO Brian Bronson on Q1 2018 Results - Earnings Call Transcript

Radisys Corporation (NASDAQ:RSYS) Q1 2018 Earnings Conference Call May 1, 2018 5:00 PM ET

Executives

Brian Bronson – President and Chief Executive Officer

Jon Wilson – Chief Financial Officer

Analysts

Tom Diffely – DA Davidson

Scott Searle – Roth Capital

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Radisys Corporation Earnings Conference Call with Brian Bronson, Radisys’s President and Chief Executive Officer; and Jon Wilson, Radisys’s Chief Financial Officer.

As a reminder, this call is being recorded. [Operator Instructions]

Mr. Wilson, you may begin.

Jon Wilson

Good afternoon, everyone, and thanks for joining us on the call. Today, we will provide an overview of our first quarter business and financial highlights as well as our expectations for the second 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-K for the year ended December 31, 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 first quarter results.

Brian Bronson

Thanks, Jon, and good afternoon, everyone. Our first quarter results, top to bottom, finished at or above the high-end of our expectations. Revenue was $26.2 million, which is above our preliminary revenue estimate provided on April 9. This exceeded the high end of our original guidance range of $22 million to $24 million by over $2 million, driven by stronger-than- expected results from our hardware business, while our software and services business performed to expectations.

Even with the larger-than-expected mix of Hardware revenue, gross margins finished at nearly 33% as a result of favorable product mix within our software and system segment. When combined with strong execution during the quarter against our previously announced cost- reduction initiatives, first quarter non-GAAP loss of $0.08 per share was at the favorable end of our guidance range. From a strategic perspective, we secured a number of new program awards with both existing and new customers across our software and services business, which will begin contributing to revenue throughout 2018.

In Professional Services alone, we closed multiple new bookings during the quarter, with the most significant being in over $3 million award from a Tier 1 European service provider, where we are enabling their migration to a CORD architecture over the course of this year. Whether leveraging our own intellectual property to advance development needs or leveraging our core telecom expertise for programs like CORD, we continue to see increased interest from service providers and embracing Radisys to help implement disruptive open-centric solutions.

Before I get into our product line updates, I do want to say a few things about this year’s Mobile World Congress and the collective mood of the industry. Just six to nine months ago, there were still lot of talk and not a lot of commercial action around decomposing network elements and embracing disruptive open source centric solutions. We experienced a fundamental shift during our meetings at Mobile World Congress with operators willing to commit budget towards implementing these solutions into their networks starting in 2019 and on into 2020.

This time line aligns with our business expectations and is further validated by the initial wins we secured during Q1, tied to early proof-of-concepts and trials across 5G, multi-access or mobile edge compute, media processing and decomposing and/or recomposing traditional network elements. Within MediaEngine, we continue to see increase in traction with our top channel partner, as they secure multiple new customer wins during the quarter as well as following orders from existing customers. Just as a reminder, we have an exclusive relationship with this channel partner, who is a leader in providing network equipment for voice-over-LTE deployments.

We also delivered the balance of the fourth quarter order from a large Indian customer, totaling just over $1 million. We see additional opportunities later this year with this customer in support of their ongoing network expansion. Further, during the quarter and in collaboration with Orange, we announced an industry-first integration of a virtualized media processing platform in the Open Network Automation Platform or ONAP release, which I expect will drive further adoption of our product and service providers overtime. This capability is also beneficial when going after broader business opportunities beyond MediaEngine, when the customer wants to embrace ONAP at their orchestration layer.

Lastly, on MediaEngine, we continue to make progress relative to our transcoding initiatives. Specifically, we are in advance discussions with a U.S. Tier 1 service provider to enter into initial lab trials over the next two quarters, and if successful, has the potential to represent significant future upside in this product line.

Switching to MobilityEngine, we are seeing increasing momentum in the market for early 5G licensing opportunities across both our traditional customer base as well as the test and measurement markets, who generally are early adopters of advanced technology required to develop their testing solutions to align with market readiness.

Additionally, we announced partnerships around our 5G solutions with both Qualcomm and Quanta during the first quarter, which I expect we will benefit from financially over time as we see broader adoption of 5G solutions across the market. Visibility from our customers into end-user small cell deployments is also improving; and taken together, this has led to a strong funnel of licensing opportunities, which I expect will drive an increasing conversion rate over the course of 2018.

These licenses continue to range in the hundreds of thousands per customer as an upfront perpetual fee, and generally include royalties over time tied to actual deployments. Additionally, royalty revenues in the first quarter were $500,000, which span multiple customer, supported by continued ramp in 3G and 4G small cell deployments that are expected to continue throughout 2018.

In FlowEngine, we announced another new customer win, Microtel, for our TDE-2000 in the first quarter and have seen sustained engagement with other previously announced customers relative to our product. In each of these opportunities, the funnel for commercial revenue remains largely tied to anticipated second half 2018 deployments, which continue to attract to expectations. These shorter-term used cases are tied to packet inspection, where application providers are embracing the high-performance capabilities of our product.

Finally, in our legacy hardware business, we delivered another strong financial quarter relative to our expectations as demand from ongoing customers was robust. As we previously indicated, our first quarter revenue also included approximately $5 million of last time bills for legacy customers, which was contemplated in our original guidance range. And while we are no longer strategically focused on selling DCEngine hardware directly, our pipeline still includes opportunities that would enable us to confer our previously reserved inventory into sales and recovery of cash. Speaking of that, we did secure an initial DCEngine lab order from a non-telco customer tied to their expected data center build out in South Korea.

Before I turn the call over to Jon, I want to acknowledge the significant achievements across the company made over the past few months. In addition to our growing pipeline and improving customer conversion rate, we’ve made fundamental progress towards transforming our cost structure and balance sheet. Importantly, our first quarter results do not yet fully reflect the significant progress that we’ve made.

Closing our new financing arrangements has enabled us to realign our operating model and reduce anticipated second quarter expenses by over 30% as compared to the third quarter of 2017. Coupled with increased revenue growth in our software and systems business, which will drive gross margin expansion over time, we remain on track to deliver quarterly non-GAAP profitability in the second half of 2018.

Let me now turn the call over to Jon for more details around our first quarter results and second quarter expectations.

Jon Wilson

Thanks, Brian. First quarter revenue was $26.2 million compared to $32.3 million in the fourth quarter. Revenue was above the high end of our initial guidance range resulting from strength in Hardware Solutions revenue and on-plan Software-Systems revenue, which grew over 10% from the first quarter of 2017.

Non-GAAP gross margin was 32.8%, compared to 40.4% in the fourth quarter. Fourth quarter margins benefited from a more favorable product mix given higher Software-Systems’ revenue. Note that first quarter non-GAAP gross margins exclude the reversal of nearly $300,000 in DCEngine inventory charges resulting from an initial lab system sale to a new customer.

Non-GAAP R&D and SG&A expenses of $10.7 million were down $1.6 million sequentially due to initial savings resulting from our cost-reduction actions, which were substantially complete by the end of the first quarter and will drive further benefit into the second quarter. Non-GAAP operating loss was $2.1 million as compared to operating income of $0.7 million in the fourth quarter.

Non-GAAP net loss was $3.3 million or a loss of $0.08 per share as compared to a net loss of $0.3 million, or a loss of a $0.01 per share in the fourth quarter. And while excluded from our non-GAAP results, we did record additional restructuring charges of approximately $1.6 million during the first quarter tied to employee severance obligations and other non-recurring expenses associated with our cost-reduction initiatives.

Switching over to sequential changes on the balance sheet. Gross cash was $11.4 million as compared to $8.1 million at December 31^st. Importantly, we had another $3.6 million remaining available for borrowing under our credit facility at quarter-end. Net cash was in line with our internal expectations, decreasing approximately $6 million from December with the reduction tied predominantly to our cost-reduction actions.

As a reminder in early January, we announced the closure of a new $17 million senior note financing as well as a new asset-backed facility associated with our accounts receivable. Accounts receivable decreased $3.2 million, attributable to the decline in revenue from the fourth quarter and offset by timing of payments from a large Indian customer.

Net inventory increased $300,000 as a result of customer builds in our Hardware Solutions segment for orders that were shipped in early April. And accounts payable decreased $4.4 million, resulting from payables to our contract manufacturer for previously reserved embedded products inventory paid in the first quarter of 2018.

Moving over to our outlook for the second quarter. We expect revenue between $20 million to $22 million, which at the midpoint, is effectively flat sequentially when excluding approximately $5 million of legacy customer last time builds recognized in the first quarter. Non-GAAP gross margin is expected between 37% and 41% of sales, a sequential improvement of over 600 basis points given a more favorable mix of Software-Systems’ revenue.

Non-GAAP R&D and SG&A expenses are expected to approximate $9 million, down nearly $2 from the first quarter. With our expense-reduction actions now substantially complete, our go- forward quarterly operating expense levels will now be down over 30% from the third quarter of 2017 and we expect second quarter non-GAAP loss to be between $0.08 and $0.02 per share. The non-GAAP earnings per share range is based on an estimated 40 million shares outstanding.

Brian, back to you for closing remarks.

Brian Bronson

Thanks, Jon. The implementation of our more focused software and services-centric strategy is off to a strong start, as we begin to see increased conversion of our pipeline of opportunities across these product lines. Radisys continues to deliver disruptive solutions for our customers. And when coupled with our realigned cost structure, this will allow us to properly participate in these disruptive initiatives across the industry.

In closing, I want to reiterate the top three objectives outlined on our February call and the progress towards achieving each. Specifically, we are making tangible progress relative to converting our sales funnel, as evidenced by the multiple new program awards we secured in the first quarter. I’m pleased with the volume of new opportunities emerging across our strategic product lines, specifically as it relates to incremental opportunities with both new and existing customers.

And finally, we remain on track to return to quarterly non-GAAP profitability in the second half of 2018, supported by driving our software and systems business to over 50% of total revenue, which will enable continued gross margin expansion as well as our cost-reduction initiatives, which are now substantially complete. And when taken together, I expect these will collectively return our valuation to more appropriate levels and over time drive increasing shareholder value.

With that, I believe we’re now ready to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from the line of Tom Diffely from DA Davidson.

Tom Diffely

Yes. Good afternoon. First question on the restructuring. Are you guys done with restructuring at this point?

Jon Wilson

Yeah. Substantially, complete, Tom. There’ll be a few lingering charges that come through in the second quarter, but really substantially complete, again.

Tom Diffely

Okay. And then when you look at the $70 million, the new note, are there any meaningful covenants connected with that, that we should worry about?

Jon Wilson

Not that you should worry about, but there are covenants tied largely to liquidity and happy to take that off-line with you later today to walk through the details of those.

Tom Diffely

Okay. And then when you look at the guidance through the current quarter, what do you think the cash from operations cash flow will be?

Jon Wilson

So, we’ll probably consume a little bit of cash, Tom. It will be, to some extent, dependent on timing of payments from our large customer that, to some extent, we highlighted in the prepared remarks. But assuming payments track from them, we’ll probably consume just a little bit of cash this quarter.

Tom Diffely

Okay. So at this point, it looks like kind of in the mid-20s would be your break-even revenue level?

Jon Wilson

Not necessarily. I mean to some extent as…

Brian Bronson

Yeah.

Jon Wilson

to some extent, as you know, low to mid-20s, depending on the mix of Software-Systems’ revenue.

Brian Bronson

Yeah. It actually lowers as it progresses through the year.

Jon Wilson

Yeah.

Tom Diffely

Okay. that makes sense. And then Brian, when you look at the – I guess, the three main engine that you highlight, which of those do you think is the biggest near-term opportunity?

Jon Wilson

Well, it’s definitely MobilityEngine, and I can speak to it from multiple perspectives. One, this is where we’re going to see the largest near-term growth. And if you think about the collection of assets that now makes up MobilityEngine, you see opportunities in 5G and MEC and CORD and open-centric solutions. So when you wrap all those different initiatives together, it’s got the most opportunity for growth. I’m consciously optimistic on MediaEngine, as we have a sensible plan; we’re off to a strong start. At this point in time, we’re planning on it to be 90% plus software-only, now as we transition completely away from hardware. And as we progress through the year and if things go well with transcoding, particularly, I think there is some opportunity there as well, longer-term for sure, but in the 2018 timeframe, give me another quarter or so and there may be some shoots of green.

Tom Diffely

Okay. And then last thing, you mentioned your three objectives. I got your convert to sales funnel, the return to profitability. What was the third one in there?

Brian Bronson

What we want to – so what we want to do, we had plenty in customer engagements. And the customers like what we were doing even just six or nine months ago, but we need the CPOs. So pushing those existing customers into a point where, “Look, if you like us and we’re disruptive for you, you’ll give us a PO.” And then beyond that, I wanted to continue to expand the funnel with new customers. So we’ve done a great job of mining our existing customer set. I want to post new customers. And I, particularly, and my leadership team have specific objectives on count of new customers. I’m talking commercial customers in 2018.

Jon Wilson

Yeah. So, Tom just crisply expanding funnel, converting funnel, returning to non-GAAP profitability.

Tom Diffely

Okay, I got it. All right. Yeah. I like the momentum here. So I look forward to talking to you soon.

Brian Bronson

Thanks, Tom.

Jon Wilson

Thanks, Tom.

Operator

Next question comes from the line of Scott Searle from Roth Capital.

Scott Searle

Hey, good afternoon. Nice quarter guys, especially on the cost front.

Brian Bronson

Thanks, Scott.

Scott Searle

Just real quick clarification from a cash perspective. It sounds like Reliance continues to extend the DSO cycle. So you’re expecting some of that to convert here in the June quarter? Or not clear that may extend a little bit?

Brian Bronson

No, expecting this to convert, Scott.

Jon Wilson

Yeah.

Jon Wilson

To be fair, but given historical patterns, we’re – it’s tracking to plan, but we need to see it in the bank

Scott Searle

Got you. And looking on in term of your guidance for the second quarter, are you assuming that software continues to increase a little bit sequentially? Or is -- are there some other mix issues that are going on within that?

Brian Bronson

No, would expect it to increase sequentially. And really the guidance range is largely contemplates variability with a few larger software and systems deals.

Jon Wilson

Exactly. Exactly.

Scott Searle

Okay. And then to dig in a little bit on the MRF front, it sounds like Reliance is still out there and you are engaged with them. How big a factor are they in this second half of this year? And do you need them to reach profitability? And then with the transcoding expectations, it seems like that’s been building for quite some time. What sort of visibility are you getting on that front? Do you expect some of that to convert this year? And how big is that opportunity, in general?

Brian Bronson

Yes. So a couple of really important points about MediaEngine tied to those. First of all, we’re not expecting any of the revenue from that large customer in the second half, Indian customer. We possibly we could get some revenue, but in the context of our guidance, no. In the case of transcoding, also not included in our current planning and guidance. We haven’t guided crisply out in the second half. So that would be considered upside. So the hint is, we are more diversified MediaEngine than we have ever been. The count of customers has exponentially grown over the last couple of years. We no longer are reliant. Our largest Indian customer, very important to us, but not heavy concentration.

And instead of planning on transcoding happening, transcoding is now upside. And so taken those things together, that’s why I get more and more bullish on MediaEngine as each quarter goes along. In terms of the size of the transcoding opportunity, it depends on whether it is software-only or if it comes in a OCP-based form factor. And I don’t mean to be encrypted, but we’re kind of in that stage now. It’s big. It’s $10 million plus opportunity, regardless of how you cut it. It could be much larger of hardwares included.

Jon Wilson

Yes. And that’s just with when Brian referenced to that -- references that, Scott, excuse me, that is with just that one customer we’re engaged with currently. Certainly, it would be a larger opportunity over time if and when we’re successful with others.

Scott Searle

In terms of what’s built into the expectations for 2018 on the MRF front, do you have pretty good visibility at the current time? It seems like there are a lot of factors in there that could provide some upside, but in terms of that base level of expectation, do you have pretty good visibility?

Brian Bronson

Yes. I would say between -- maintenance is a good chunk of that just for foundational purposes. We have reoccurring revenue streams. I mean, they are not always NCNR, but we’ve got commitments from our largest channel partner, which I’m sure most people know who that is, and so that adds another layer. And so there is some terms business every quarter, but I can feel very good about where we are at, MediaEngine-wise.

Scott Searle

Got you. And lastly, just on the MobilityEngine front, it seems like we’ve got a nice base level of business that’s related to small cell architectures for 3G and 4G. But we’re starting to hear a lot more chatter, not just from an industry standpoint but you’re talking about it as well in terms of 5G and the opportunities that’s out there. Can you provide a little bit more color in terms of the level of engagement, may be the number of engagements that you got? It’s a relatively small world out there. As you look at 5G in the number of vendors that are going to be going in that direction. And when you would expect revenue opportunities to materialize on the 5G front? Thanks nice quarter.

Brian Bronson

Yes, thank you. So in the case of 5G, just for everybody’s calibration, we’re on the leading end, very early in, in the adoption of 5G. So when folks start to develop their own complete products or begin to think about next-generation topology that needs to start with MobilityEngine’s stacks. And so when we talk 5G, we first talk about license deals, and we closed less than half a dozen, but multiple deals so far. We got more in the funnel. And so that’s the leading indicator for us that it’s real, folks are starting to put more work into it. More comprehensively, 5G also includes things like Open RAN and includes like bringing telecom topology towards the edge, that will be a longer cycle. We’re involved in those discussions. We’ll start to get some POs around -- PoC into the trial work, but our 5G declaration is largely tied to license deals.

Scott Searle

Great, thank you.

Brian Bronson

Thanks, Scott.

Operator

Next question comes from the line of Mike Latimore from Northland.

Unidentified Analyst

This is Rasheed [ph] for Mick Latimore. Thanks for taking my call. I’ve a couple of questions here. Can you give me a little more color around opportunities you are seeing with mobile edge computing, like the type of products and the timing?

Brian Bronson

Yes. Well, there’s all sorts of permutations and form factors when folks talk about MEC. But when we’re seeing when we’re being engaged with is around the building blocks, time to make an MEC successful. So if you think about a pod, whether that pod is in a central office, whether it’s close to a base station, maybe it’s even on a lamp pole or whatever over time, it needs to have RAN technology, it needs to have 40 engines, it needs to have an understanding of how to interact with BBUs. It needs a virtualization layer. You think about all those piece parts that are needed to be put together along with a physical form factor that needs to be sitting in a box or a pod, whatever, we understand all those pieces.

So we’re engaged with operators right now on putting PoCs together, which ideally and realistically we get paid for. And that’s where it’s at. To rule out MEC commercially, it’s another year, 1.5 years away, and there’s a debate of what it looks like and where it sits, but it’s very real. In fact, it’s -- to me it’s going to move a lot faster than CORD and CORD-like initiatives. No knock on CORD because that’s important too, but MEC is real, because if you think about what makes 5G different and the last chance for the operators to monetize themselves, it’s to remove latency, it’s to deliver enhanced services, it’s to bring all those IoT devices on their network, again, try to monetize it. Another way they can do that is to bring out the processing towards the edge.

Unidentified Analyst

Okay. And does the Sprint-T-Mobile merger influence opportunities or timing of opportunities for you?

Brian Bronson

Not directly. Not directly. We do a little bit of business indirectly through a channel partner. But -- we’re just actually thinking about that over the weekend. No. Not materially.

Unidentified Analyst

Just one -- Okay, yes. Just one last question. Has the FlowEngine pipeline grown in the -- over the last six months?

Brian Bronson

It has and exponentially has grown. And I have commented on -- I mean, I had some, obviously, prepared remarks. But when folks earlier asked about the most growth and the biggest opportunities, I stayed silent on FlowEngine, not from my lack of enthusiasm but it is going to be a small number this year. I mean, both of our MobilityEngine and MediaEngine businesses are well north of $20 million. And so over the next quarter or so we will see more wins in flow. We’ll start to see some commercial deployments as we roll to the end of the year, but it’s a relatively small number, in the context of our 2018 projections.

Unidentified Analyst

Okay, all right. That’s all from me. Thank you.

Operator

There are no questions at this time. I will now turn the call over to the management for any closing remarks.

Brian Bronson

Well, great. Thank you, again, for joining today’s conference call. We look forward to providing further updates on our quarterly update after the second quarter, sometime either late in July or early August. So talk to most of you then.

Operator

Thank you for your presentation. This concludes today’s conference call. You all may now disconnect.