This article was written by Robert Borowski of Last Financier
With the upcoming fourth quarter 2014 earnings just around the corner, RadiSys (RSYS) is expected to see an uptick in trading activity. During the company’s Q3 2013 earnings call , management announced a restructuring plan to reduce operating costs, and transition from telecom hardware to a software provider. Over a year later, the company has finished the restructuring initiative, making way for 2015 to be the turning point in which the company reaps the rewards. With RadiSys stock trading near 52 week lows though, the market is discounting this potential catalyst. Q4 earnings will be end up being the inflection point that starts the upward trajectory.
No Direct Competition in a Niche Market
RadiSys provides wireless infrastructure solutions for the telecom, aerospace and defense markets. The company supplies innovative hardware and software platforms for next generation IP-based wireless, wire line and video networks in media & processing applications. Recently, the focus has been more tailored towards Voice over LTE (VoLTE) & Voice over Wi-Fi (VoWifi) software solutions that provide a favorable shift in the product offering mix from legacy hardware to higher margin software business offerings.
In a nutshell, RadiSys helps customers find ways to solve problems with the recent data explosion by utilizing MRF, SDN/NFC and LTE software rather than conventional voice-only technologies.
Favorable Transition into Higher Margined Software
During the Q3 FY 2013 earnings conference call, the company announced that it will be restructuring its revenue streams by transitioning the focus from its hardware products to innovative software for telecommunications technologies. The hardware revenue stream currently accounts for about 80% of total sales and the remaining 20% from software (below).
Moving forward, the company expects the revenue mix to reverse. This is evident from the recent announcing of a newly obtained contract with a North American wireless provider for its FlowEngine software. More and more revenues are being generated from newer technologies rather than conventional sources like video conferencing and transcoding. These new products and software sales account for over 67% of current sales, and have grown at over 60% annually.
This robust growth, however, is hidden by the declines in two of its older revenue streams, the largest segment having fallen off by 60% in the last year. This glaring sore spot now accounts for only about 16% of new revenues.
Cost Savings Tricking Down to Bottom Line
Like other successful software companies, RadiSys is seeing increased margins and profitability solely resulting from the restructuring efforts. For the past three quarters, the company’s high operating expenses were taking away from the bottom line, leading to inefficiencies and unprofitability. Operating expenses have been in excess of $100M as recent as 2012.
However, the restructuring efforts are expected to reduce operating expenses to approximately an annualized $60M (over 50% reductions). The benefits from these cost cutting efforts were depicted by the positive non-GAAP EPS of $0.02 in Q3 2014. It is expected that the upcoming earnings release will also reflect a positive non-GAAP EPS with 2015 being the year when the company becomes profitable across all accounting measures.
Efficient spending and consolidation of infrastructure are expected to continue the cost cutting efforts in 2015. As a result, management projects that operating expenses will be lower than the ~$60M in 2014. Assuming a constant 2015 operating expenditure figure of $60M operating expenditures and no top-line growth would continue RadiSys’ positive earnings momentum.
An earnings multiple of 20x would yield potential upside greater than 30% current price. Keep in mind; the above figures are conservative when compared to analyst expectations and what management has discussed with regards to the top line traction expected from the shift to software offering.
Revenues are expected to increase from the company’s VoLTE and VoWifi solutions attracting more wireless providers. The company mentioned as many as 30 providers are currently in trials with the MRF technology. This Software & Solutions segment of the portfolio could have long term growth between 10%-20%. Analysts project revenue to grow by 6 to 8% over the next five years as a result of the tailwind the MRF technology and other software products have experienced since restructuring as well as the interest the company generated for these products.
Market Mispricing….. But for How Long?
RadiSys stock is currently reflecting the “old” company that was seeing revenues diminish while costs were soaring. With the restructuring, this is not the case. RadiSys has become a lot leaner, shedding more than 50% of costs in the last two years, while expanding into new avenues of income with the Continuous Computing acquisition. RadiSys’ software portfolio rollout, such as the FlowEngine contract to a large North American carrier, and new low cost manufacturers will result in more income trickling down to the bottom line.
This new, efficient version of RadiSys will benefit with cash flows, as the company expects to be cash flow positive in 2015. Consequently, management alluded to having no issue in repaying the $18M senior note due on Feb 15, 2015.
The company is still faced with risks such as dependence on a few large customers. Nokia represents 17% of revenues and the top 5 customers comprise a total of 57% of generated revenue. This reliance will place a ceiling on margins.
The restructuring plan and transition from hardware to software have progressed well thus far. The company’s financial struggles seem to be in the rear view mirror as 2015 seems like the year in which the prior adjustments payoff. Q4 2014 earnings could be the potential catalyst that represents the inflection point in RadiSys’ turnaround.