LTE network adoption is picking up speed (as explained in this article) and Radcom (RDCM, Financial) is seeing the benefits. According to The Mobile Economy 2014 report by GSMA, networks offering LTE will increase to more than 500 in 128 different countries by 2017. To compare, about 3% of the global mobile users were connected to LTE in 2013. This figure will rise to 25% by 2020. Therefore, it shouldn’t come as a surprise that Radcom stock traded 40% higher after releasing Q3 2014 earnings that showed both top/bottom line coming in above expectations.
Radcom’s new monitoring software, MaveriQ, uses high capacity processing power and support protocol analysis to identify and solve service problems associated with complex LTE networks. Network operators that integrate MaveriQ will be able to maintain a high level of customer experience with subscribers, which in turn will reduce churn (rates at which customers stop subscribing). As LTE becomes the standard in telecommunications, more and more service providers will adopt MaveriQ thereby providing a source of revenue for Radcom. I believe Q3 2014 was just the inflection point for Radcom as greater growth is expected in 2015.
Q3 2014 Metrics
Sales for the quarter were recorded at $6M, proving to grow 26% YoY and 21% QoQ. Keep in mind that only about 30% of these quarterly revenues were due to MaveriQ, which shows the great initial traction of a product released earlier in 2014, but also the immense future growth prospects. The majority of revenue for the quarter consisted of Radcom’s lower margined legacy technology. As we move forward, management expects greater percentage of sales being derived from MaveriQ.
Gross margins for the quarter were 66%, compared to 50% gross margins a year ago. This growth in margins reflects the company’s continued transition to a software driven business model. Management has set a 75% gross margin target for the longer term. For the first 9 months of 2014, Radcom gross margin was 69%.
Gross margins for the quarter (66%) were relatively lower due to selling more of the legacy technology than new technology, which has higher margins. As the sales mix leans towards more software derived revenue (fueled by adoption of MaveriQ and LTE growth), margins will reach the 75% target set by management.
Net Income for the quarter totaled $776K (or $0.10 EPS), which is more than triple the Q2 2014 reported figure. This represents a 13% net profit margin, a new record for Radcom. In addition to Radcom reporting 26% top-line growth, the company managed to lower operating expenses by 17% YoY. This is in line with the cost control that management has alluded to in the past. Operating expenses are expected to remain ~$3.5M/Q for the next several quarters at least.
On the cash flow front, Radcom has reported positive cash flows for a third straight quarter. Transitioning to a software-driven company has improved collections as Radcom’s cash balance was up 17% from the previous quarter. At the end of September, Radcom had $4.5M in cash, nearly 4x the balance at the beginning of the year.
Projecting Q4 2014 & FY 2014
For Q4 2014, I assumed that sales would grow 20% over Q4 2013 (equating to 15% growth over Q3 2014). The growth rate experienced thus far in 2014 and expected adoption of MaveriQ support the assumptions made for Q4 2014.
Gross margin for the last quarter was presumed to be 70% as the sales mix is expected to tailor towards more high-margined software rather than lower-margined hardware. Keeping cost structure at the levels management has guided in the past (~$3.5M/quarter) yields operating income of $1.23M for the quarter. This represents an operating margin of 18%, on par with prior quarters.
Risks
Radcom is headquartered in Israel so the company is exposed to geopolitical issues that have afflicted the region. Nearly all of Radcom’s business is done outside of Israel, with the focus being South America and Asia, two of the fastest-growing regions in regards to telecommunications. So although Radcom’s operations are not correlated with the region’s conflict, resurfacing tensions pose as a “headline risk” to Radcom stock regardless.
Going forward, the company expects MaveriQ to be the basis for the majority of revenues. Above, I have explained the benefits of such a transition to a software business model. However, Radcom poses a risk of becoming a company completely reliant on MaveriQ. If MaveriQ adoption does not gain the expected traction, Radcom could become a company with little value to offer.
Radcom has a relatively small float of trading shares which could be a cause of volatility in the stock. The company has 8.1M shares outstanding, of which 40% are owned by insiders. This leaves an approximate float of 5M shares. Since earnings were reported last week, RDCM stock has seen a spike in daily volume with over 1.5M shares traded cumulatively. As the Radcom story gets out to investors, the stock may see unpredictable swings in the short term.
Conclusion
At current valuations, Radcom is sporting a P/E of 27x, using the projections made above. Investors must keep in mind that this is a growing business (15%+ YoY) with high margins (70% gross and 10% profit) and a stable cost structure.
Management has alluded to costs being constant (roughly 3.5M/quarter) for “the next several quarters at least”. Growing revenues indicate that sales over $5M figure would trickle down to income. The latest quarterly revenue figure was $6M. Management is very optimistic about the growth prospects that 2015 will bring. Seeing quarterly run rates of $8M in revenues during 2015 should not be surprising with MaveriQ adoption picking up. I expect Radcom stock to see double digits by the start of 2015.
