Redknee (RKN.TO) Surprises With Weak Q4.

In its Q4 and Full-Year press release, the company downplayed its weak Q4 and focused on Full-Year profitability, which was strong.

Revenue for the quarter decreased sharply to $10.4 million, a 28% decline from its previous year Q4 revenue reported at $14.7 million.

The weak Q4 also impacted an otherwise stellar performance for FY 2009, which was reported at $53.3 million, an approximately 5% improvement over FY 2008 revenue reported at $50.0 million. Most analysts were probably expecting revenue growth to be nearly double what was reported. Nothwithstanding, the company was able to report EBITDA of $6.5 million versus a previous year loss of $4.2 million. This approximately $10.2 million of imrpovement was largely driven by reductions in expenses over the year as the company reduced its effective breakeven point to $49 million from approximately $58 million during the previous year.

EBITDA of $1.6 million reported for the quarter was an improvement over $0.6 million in EBITDA for the previous year, but that was enhanced by reduced commission payouts, which should not be considered a positive condition by analysts.

Management stated that Q4 performance suffered from delays in deployments and customer buying decisions by some of its client base due to lower subscription growth, compressed ARPU, and general market uncertainties, which led to poor capex spending conditions in the market. Management assured analysts during the conference call earlier today that it was experiencing delays in deployments and buying decisions, and not outright cancellations. The company also recognized $1.8 million in foreign exchange losses, which had an impact on earnings, resulting in a loss of $0.2 million or 0.00 loss per share for the quarter in comparison to net income of $0.9 million, or $0.02 EPS for Q4, 2008.

Although the company has increased its recurring revenue component to 41% of totals, it still depends upon capex budgets for growth. With uncertainty remaining for a return to capex spending by its client base for Q1, investors may see volatility in quarterly performance for H1 FY 2010. Essentially, visibility has been reduced.

Current clients represented 90% of total revenue for Q4, 2008, inferring that there were essentially no new sales for the quarter. However, the company still reported a $25 million backlog, although that was down from the $28 million backlog reported for Q3, 2009.Tellingly, management expressed that for future quarters, it expects current clients to represent 80% of total revenue, which implies that it does expect new client revenue to come back on line during FY 2010.

ARPU contraction worldwide is coming at a time when data requirements are skyrocketing due to more mobile activity. Both Tier 1 and high-growth carriers worldwide will need to adjust billing away from flat-rate "all you can eat" billing to more pay-as-you-go billing, while improving network efficiency. Redknee management believes that these market conditions are positive for future sales as carriers make adjustments to these realities.

The company also suggested that some vendors may not be able to survive the short-term spending freeze currently in the market, and that there may be future distressed assets available for acquisition. The company has $25.8 million in cash, which positions it well not only to weather the current conditions, but to also leverage its balance sheet to make acquisitions.

Analysts are likely to be disappointed in the Q4 performance, and may worry about the near-term outlook for Redknee. Some will ponder: is this a simple quarterly hiccup, or is it something more significant? However, it appears that some of the uncertainty may already be priced into the stock. Currently, the stock is trading at a TTM EV/EBITDA multiple of approximately 5x, which is a low multiple for the sector, where high growth multiples are in the low-teens.The TTM P/E ratio is 16.7, which is not unreasonable at current levels if future earnings growth is modest. Due to near-term uncertainty in outlook, some analysts may choose to adjust their forecasts and targets downward.

Look for RKN to drop out of the RES Free Thinking Top 5 Picks for the new year.

Disclosure: I do not own shares of RKN

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