This article was written by Brandon DaSilva
- Revenue increased by 46% from the previous quarter & 36% YoY
- Markets are worrying about lighter than expected margins; which the company has taken steps to fixing in near term
- Radisys is still trading at depressed levels; 100% immediate upside still present
Software Growth Coming In Above Expectations
Radisys’ software-systems revenue for Q2 2015 came in at $14.2 million, a 46% increase from Q1 2015 and a 36% increase from Q2 2014. The robust software revenue growth, combined with the decline of embedded products revenue, is making software a larger portion of Radisys’ revenue (30% of revenue compared to 20% last year). This is perfectly aligned with management’s strategic goals to transition the company to a software centric business.
Management has projected that the long term growth rate in software will be in the 15-20% range. The company’s reported growth figures have come in at double this guidance, thus indicating impressive initial traction with Radisys’ offering. The market however, is overlooking this in favor of margins, which were slightly under expectations.
The transition to software is allowing Radisys to realize higher margins, with consolidated gross margin for this quarter coming in at 31.2% on a non-GAAP basis, 280 bp higher than the prior year. Though the reported figures came in below what analysts were expecting, management reiterated that software should see margins above 60%. In the hardware segment, Radisys has shifted focus to the most profitable clients; thereby expect margins to be in the mid-20%. As a result, the reported Q2 margins should be immaterial in the grand scheme of things.
Leaner Legacy Segment Funding High Growth Software
Embedded product revenues came in stronger than expected at $32.9 million due to the strength from the core customer base. This is a decline of 15.6% from Q1 2015, and a decline of 16.9% from Q2 2014. Management stated “expect revenue to continue to decline 15% to 20% annually to a base line of between $75 to $100 million”. Based on this guidance, and using an average declining rate of 17.5%, revenues for this segment will reach the midpoint of management’s estimates by 2017. With an operating income in the 8-10% range, Radisys will use hardware profits to fund the faster growing software business. By 2017, expect the software segment to be self-sustaining and be the dominant percentage of Radisys’ revenue.
Channel Partners Keeping Outlook Bright
Radisys’ announced a MediaEngine deal for “$11 million follow on order from a large Asian carrier.” Slightly less than 50% of this revenue was received in this quarter, with the remainder to be collected in Q3 2015. Radisys is confident that their seven channel partners will allow them to continue to grow their revenues. In fact, it was announced this quarter that both Metaswitch and ZTE are new channel partners, with ZTE being the more important one. This is because ZTE can “open up broader market opportunities within both China and Latin America,” allowing for further revenue growth for Radisys.
At the above assumptions, software revenues would grow by 20% over Q2 2015 and about 45% YoY. On the hardware front, we expect revenues to continue declining which is in line with management’s expectations to have Q3 EPS at a midpoint of $0.06. Additionally, Radisys plans to use the flat, but profitable hardware business to fund the growing software arm. For the year, management expects software to lose between $8M and $2 M, but to become profitable in 2016.
Radisys Value Proposition
Markets are still overlooking Radisys’ transition to software and the initial growth shown in this segment. At a current market cap of $105M, Radisys is trading at 7x the estimated 2015 profits of the hardware business alone. Management projects operating income of $13M-$17M from the hardware segment. Margins should see a rise as software becomes a larger part of the overall business and hardware business is focused only on the most profitable clients. At these valuations, investors are essentially getting the fast growing software business for free. Even if software is valued at only 1X 2015 revenue (~$48M), Radisys would be trading 50% higher.