Ribbon Communications Inc. (NASDAQ:RBBN) Q3 2023 Earnings Call Transcript

Ribbon Communications Inc. (NASDAQ:RBBN) Q3 2023 Earnings Call Transcript October 25, 2023

Ribbon Communications Inc. misses on earnings expectations. Reported EPS is $0.05 EPS, expectations were $0.07.

Operator: Ladies and gentlemen, greetings and welcome to the Ribbon Communications Third Quarter 2023 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joni Roberts, Chief Marketing Officer. Please go ahead.

Joni Roberts: Good afternoon and welcome to Ribbon’s third quarter 2023 financial results conference call. I am Joni Roberts, Chief Marketing Officer at Ribbon Communications. Also on the call today are Bruce McClelland, Ribbon’s Chief Executive Officer; and Mick Lopez, Ribbon’s Chief Financial Officer. Today’s call is being webcast live and will be archived on the Investor Relations section of our website at rbbn.com where both our press release and supplemental slides are currently available. Certain matters we’ll be discussing today, including the business outlook and financial projections for fourth quarter of 2023 and beyond are forward-looking statements. Such statements are subject to the risks and uncertainties that could cause actual results to differ materially from those contained in these forward-looking statements.

These risks and uncertainties are discussed in our documents filed with the SEC, including our most recent Form 10-K and Form 10-Q. I refer you to our Safe Harbor statement included on Slide 2 of the supplemental slides for this conference call. In addition, we’ll present non-GAAP financial information on this call. Reconciliations to the applicable GAAP measure are included in the earnings press release we issued earlier today as well as supplemental slides we prepared for this conference call, which again are both available on our Investor Relations section of our website. And now, I’d like to turn the call over to Bruce. Bruce?

Bruce McClelland: Great. Thanks, Joni and thanks to everyone for joining us today. I am pleased to report solid earnings in the third quarter despite revenue coming in short of expectations. Positive customer and regional mix, lower product cost and strong software sales all contributed to improved gross margins in both of our segments. And as a result of the restructuring plan we implemented earlier this year, our operating expenses continued to improve and were $87 million on an adjusted basis, the lowest point in over 3 years. Combined, this resulted in adjusted EBITDA earnings of $28 million, up 21% year-over-year and near the midpoint of our guidance. This included an EBITDA improvement of $6 million in our IP Optical Networks segment.

Sales in our IP Optical business continued to grow year-over-year for the fifth straight quarter, with sales increasing 6% and up 14% year-to-date. Sales in our Cloud and Edge segment were down 4% year-to-date, with reduced spending from U.S. Tier 1 service providers, offset by growth from other customers. The shortfall in revenue this quarter relative to our guidance was largely due to timing of several IP Optical projects in the EMEA region. Several of the projects are now planned for this quarter and the first quarter of 2024. We also had a large Cloud and Edge enterprise RFP that we expected to close in the third quarter that was paused and is now expected in 2024. Despite the lower revenue, lower product costs and strong software mix resulted in very good gross margins for both businesses this quarter.

Before I go on to the segment results, I’d like to update you on the status of our operation in Israel. As many of you know, we have a substantial presence in Israel with approximately 20% of our employees located in our office near Tel Aviv. The office is primarily focused on our IP Optical business, with the majority of employees in R&D and operations. We also perform a portion of our manufacturing Flex in Israel. Following the attack several weeks ago, approximately 60 people or 10% of our local team in Israel have been called up to the Israeli Defense Force or IDF. We don’t currently expect this to increase significantly. We have planned for this possibility and have a global R&D and operations capability with significant presence in India, Europe and North America.

Our main office in Israel is open and employees are working both in the office as well as remotely. We have an incredibly dedicated team, and it’s really amazing to see them adapt and overcome during this challenging time. We’re in constant communication with our team and our priority is the health and well-being of them and their families. Our manufacturing partner, Flex, is also fully open and operating at normal capacity. We have a global manufacturing capability and have already shifted a portion of our requirements to other locations. While logistics are certainly more challenging, we do not anticipate an impact to our operations at this time. Now on to the segment results. We continue to make good progress towards our goal of achieving profitability in our IP Optical segment, with adjusted EBITDA improving to negative $3.9 million in the quarter, an improvement of $6 million year-over-year and $8 million sequentially.

Sales of our IP Routing Solutions increased 30% year-over-year and up 31% year-to-date, driving top line growth for the segment. From a regional perspective, IP Optical sales to India were once again strong and increased 51% year-over-year this quarter and are up 34% year-to-date. Momentum in the U.S. Rural segment was strong again this quarter, with IP Optical sales in the U.S. increasing 49% year-over-year and overall sales in North America, up 58% year-to-date. The EMEA region was weaker in the third quarter than we had expected, with several projects delayed to Q4 or early 2024. However, we do expect a much stronger fourth quarter from this region. We achieved a very important milestone this quarter. The strategy from the beginning of the merger of Ribbon and ECI was to successfully penetrate U.S. Tier 1 service providers with our IP optical portfolio.

Following 24 months of work and investment to adapt the portfolio to better fit the U.S. market, we finally went live with our Neptune IP Router inside the AT&T network. We have been working with AT&T on a number of use cases that leverage the Neptune platform to replace older routing platforms and to transition TDM and copper networks to modern IP technology. This will enable AT&T to significantly reduce costs and simplify their network, eliminating legacy transport networks and wiring centers over time while maintaining existing residential and business service offerings as well as helping to achieve environmental sustainability goals. The solution leverages products from both our voice and IP portfolios and has undergone extensive certification and system validation testing, including OSMINE certification and live network testing.

The solution can be used across hundreds of switching offices nationwide and even larger number of enterprise locations. It’s very exciting to finally reach this in-service milestone with a major U.S. Tier 1. This multiservice edge routing capability is also being used by several other carriers in the U.S. and is a great entry point for IP routing technology that allows us to land and expand inside a carrier’s network. We also continue to get good feedback on our new Apollo 9400 compact modular optical transport platform, supporting industry-leading 1.2 terabit per second wavelengths. We received first orders for the product in the third quarter and have multiple trials in process in the fourth quarter, including a European Tier 1 service provider customer.

The first variant of the solution is focused on high-performance applications that maximize capacity over long distances. Initial shipments will begin this quarter with the general availability planned for January 2024. A lower power variant on the same platform aimed at supporting metro and regional transport applications is planned for availability in the second quarter of 2024. In our Cloud and Edge segment, despite the lower sales this quarter, we delivered solid earnings with strong gross margins and lower operating expenses. Sales to enterprise customers are up more than 40% year-to-date, and we have growing interest in our new pricing model that emphasizes software term licenses rather than perpetual licenses. While this lowers the initial revenue for the deal, it provides a base of future recurring revenue, which is very important for the business.

In the U.S. federal space, the voice modernization opportunity across multiple federal agencies continues to gain momentum. Following an initial significant win in the second quarter, we shipped additional expansion capacity this quarter as the project progresses, and we expect multiple additional phases over the next 12 months as legacy on-premise TDM infrastructure is replaced with modern cloud-based solutions. We have a great partnership with Dell Technologies that brings us major scale and reach across multiple public sector customers and with highly specialized partners such as VAE that have great technical depth and credibility in this space. We also had an initial shipment to another branch of the Armed Forces for this quarter, which is just the beginning of another significant base deployment.

As I mentioned last quarter, we’ve seen increased activity internationally from service providers, evaluating options to modernize their voice infrastructure. In the third quarter, we were awarded 3 new major international voice core modernization projects that together, we expect to generate more than $25 million over the next 12 months. We had expected to recognize a portion of the deals in the third quarter, but contract discussions extended into the fourth quarter. 2 of the 3 deals are now under contract, and we expect the third to be finalized in the next few months, with revenue recognized over the contract period. Similar to voice modernization projects in the U.S., these projects include the replacement of aging telecom infrastructure with modern software-centric platforms that significantly reduce the operating costs, improve reliability and expand service capability.

As expected, our U.S. Tier 1 service provider spending continues to be lower this year, impacting year-over-year comparisons even as the rest of our customer base continues to grow. However, early planning for 2024 with our key U.S. customers gives me confidence this will recover next year. And in fact, there’s a very good opportunity for growth with projects such as the AT&T multi-service edge IP routing program. From an overall bookings perspective for the company, we’re at 1.0x year-to-date following strong Q1. Cloud and Edge bookings in the third quarter were 1.2x with several multi-quarter voice modernization projects booked that include deployment services. IP Optical bookings were 0.7x in the quarter as we continue to ship against large orders from the first quarter to India and European defense customers.

With that, I’ll turn it over to Mick to provide additional detail on our third quarter results and then come back on to discuss outlook for the fourth quarter. Mick?

Mick Lopez: Thank you very much, Bruce. Good afternoon, everyone. In the third quarter of 2023, we were pleased with our financial performance from a profitability perspective. While revenue was below expectations, we were able to compensate with an improved gross margins and continued expense reductions, leading to non-GAAP adjusted EBITDA around the midpoint of our guidance. Please refer to our Investor Relations page on the Ribbon website for supplemental slides summarizing our third quarter 2023 and historical financial performance. Let’s begin with consolidated corporate financial results. In the third quarter of 2023, Ribbon generated revenues of $203 million, which is a decrease of 2% or $4 million from the prior year as our growth in IP Optical almost compensated for the decrease in Cloud and Edge products.

Non-GAAP gross margin was 54.8%, which is 30 basis points higher than prior year and a 280 basis point improvement from the previous quarter due to a positive mix and lower product royalties and costs. Non-GAAP operating expenses were $87 million, a decrease of $7 million or 7% year-over-year, driven by reductions in R&D and sales expenses. This marks the third consecutive quarter of sequential expense reductions as a result of our restructuring efforts. Non-GAAP net income was $9 million, which is a $5 million increase from the previous year. This generated non-GAAP diluted earnings per share of $0.05, which is an increase of $0.03 versus prior year. Our non-GAAP tax rate year-to-date is 35%. Our interest expense for the quarter was $7.1 million, which is a $2 million increase from the previous year, driven entirely by the increase in interest rates.

Non-GAAP EBITDA was $28 million in the quarter, which is a $5 million or about 20% improvement both year-over-year and quarter-over-quarter. Our basic share count was 171 million shares and our fully diluted share count was 176 million shares for the quarter. Now let’s look at the results of our two business segments. In our Cloud and Edge business, third quarter revenue was $116 million, a decrease of 7% year-over-year, driven by decreases by U.S. Tier 1 service providers. Our services business remained consistent year-on-year, delivering value to our customers and strong profit generation. The Cloud and Edge business had a strong non-GAAP gross margin of 68%, up 240 basis points from the prior year, driven by mix and 130 basis points from the second quarter as a result of higher software revenue percentage.

Adjusted quarterly EBITDA was $32 million, consistent with the previous year, although we had lower revenues this year. Let’s turn to our IP Optical Networks business results. We recorded third quarter revenue of $87 million, which was an increase of $5 million or 6% year-over-year, led by continued growth in India, North America and Japan. Non-GAAP gross margin for IP Optical was 38%, which was in line with the prior year and significantly higher by 680 basis points than the previous quarter. This was driven mostly by a one-time royalty adjustment, better product mix and fixed cost absorption from higher revenues. As we noted in the last quarter, as we continue the revenue growth with improved sales in Europe and Americas, we aim to achieve our target gross margins in the mid- to upper 30% range for the IP Optical Networks segment.

Non-GAAP adjusted EBITDA loss for the quarter was reduced to $4 million, which is an improvement of about 60% or $6 million year-on-year and 68% or $8 million improvement over the previous quarter. We have cut the EBITDA loss in about half for each of the past couple of quarters. As we mentioned in the last earnings call, we expected to have higher working capital requirements in the third quarter as we grow the IP Optical business in the second half. Cash used from operations was $12 million. In addition, we used cash for $3 million in capital expenditures and our quarterly $5 million term loan repayment. Therefore, we ended the quarter with $25 million of cash and cash equivalents which is a decrease of $10 million from the previous quarter.

Our senior term loan balance is $240 million, and we had $10 million drawn on our revolver loan, which has a $75 million capacity. Our preferred stock and warrants are valued at $55 million. For the bank covenant calculations, which include preferred equity and total debt, among other adjustments, we met both of the amended term loan covenant metrics in the quarter. Now I’ll turn the call back to Bruce to provide more comments on our outlook for the fourth quarter. Bruce?

Bruce McClelland: Great. Thanks, Mick. We expect the fourth quarter to be a very important milestone for us with continued sales growth and improved gross margin in our IP Optical business, resulting in the segment reaching profitability on an adjusted EBITDA basis. We project IP Optical sales in the quarter to exceed $100 million for the first time since 2019 and double-digit growth for the full year. We anticipate IP Optical sales in Europe, the Middle East and Africa to contribute the majority of the sequential growth across multiple market verticals. We also anticipate sequentially higher sales in North America with another strong quarter with rural broadband providers and a small amount of revenue associated with the AT&T project.

We expect India to remain one of our strongest markets with consistent IP and Optical shipments to Bharti and Tata Teleservices. We also expect strong IP Optical gross margins in the fourth quarter, benefiting from the higher sales, better regional mix and lower product cost. As we look into 2024, we expect to build on the momentum we have developed and gained share in multiple regions, and we’re very excited about the new AT&T project and several adjacent programs where we will have an opportunity to expand our presence within their network. We’re very focused on building out our portfolio of multi-service edge IP routing solutions, including TDM circuit emulation, 5G cell site routing and IP MPLS aggregation. We have several additional Tier 1 service provider opportunities that we expect will drive additional IP revenue growth in 2024, building on the 30%-plus growth we have accomplished this year.

In our Cloud and Edge segment, the work we have done to transition from perpetual licenses to renewable term licensing for enterprise customers will benefit us in the fourth quarter with a number of annual enterprise license agreements expected to close before the end of the year. We also anticipate another strong quarter for U.S. federal agencies, including new projects as well as expansion for active voice modernization projects, although we have reduced our projections somewhat to account for the length of time it takes to evaluate and award these complex programs. In the U.S., Tier 1 service provider spending is expected to remain constrained and lower than last year, but we do anticipate opportunity for this to rebound in 2024. Internationally, we expect to generate first revenue from the significant voice core modernization projects I mentioned earlier.

Overall, we expect Cloud and Edge sales in the fourth quarter to increase sequentially from the third quarter but to be lower year-over-year. Based on the above backdrop and assumptions for the fourth quarter, we’re projecting revenue in a range of $230 million to $240 million; non-GAAP gross margins of 54.5% to 55.5%, and non-GAAP adjusted EBITDA in a range of $40 million to $46 million for the quarter. Operating expenses continue to exceed the lower spending targets we established for the year. For the full year, our Q3 results, along with the fourth quarter guidance imply a sales range of $830 million to $840 million and adjusted EBITDA of $88 million to $94 million. Our guidance assumes no significant impact from the war Israel or disruptions in U.S. federal spending related to pending approval of the fiscal year 2024 budget.

Let me wrap up by emphasizing the important role our service provider customers play in providing the foundation for highly reliable secure communications. That’s critical to practically all industries and consumers. The demand for bandwidth continues to grow exponentially and the additional traffic that will be generated by new AI and machine learning technologies, particularly at the edge of the network where Ribbon is focused will not be possible without continued investment and adoption of new networking technologies. I believe this is a very attractive market to invest in and provide significant profitable growth opportunities, particularly for new challenges such as Ribbon. The major investments that we’ve made in the development of new products, combined with our broad customer base, puts Ribbon in an excellent position to capitalize on these macro trends.

Operator, that concludes our prepared remarks, and we can now take a few questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Erik Suppiger with JMP Securities. Please go ahead.

Erik Suppiger: Yes. Thanks for taking the question. On the carrier spending in North America, any thoughts in terms of timing, how long this is going to stay kind of in this state? And then also any comments about the contribution level from your new products to the IP optical revenues.

Bruce McClelland: Yes. Hi, Erik. Thanks for the questions. So on the Tier 1 spending environment, I think we’re in a lower environment through the end of the year, obviously. I think budgets are still being set going into next year. So it’s a little early. What is obviously key for us is where do those dollars get spent. And as I mentioned on my remarks, the early planning we had for next year indicates there is opportunities for us to grow from where we’re sitting here today and rebound back to a more normalized level. There are literally thousands of Class 5 wiring centers and switches still that are yet to be modernized. And we’re working on how do we help our customers go faster in enabling that, including the new routing solution I talked about that basically helps eliminate some of the legacy SONET and TDM interfaces.

So I think we will have, obviously, a much better view as we get towards the end of the year here. On the contribution of new products, I’d estimate about 20% of our product sales in the third quarter in IP Optical were from new products that we introduced earlier this year. So these are things like the new long-haul, optical long-haul platform, cell site routers, the next-generation Neptune 2000 Series, all of those have combined to 20% or in that order in the third quarter from a revenue perspective. You still with us, Erik?

Erik Suppiger: That’s all my questions. I’m good. Thank you.

Bruce McClelland: Thank you.

Mick Lopez: Thank you, Erik.

Operator: Thank you. Our next question comes from the line of Greg Mesniaeff with WestPark Capital. Please go ahead.

Greg Mesniaeff: Yes. Thank you for taking my question. Bruce, a two-part question. On the AT&T win that you talked about, is that a multivendor award? Or are you the primary supplier? Are you the sort of the second supplier? How does that shake out? And then I have a follow-on.

Bruce McClelland: Yes. Thanks, Greg. So it’s a fairly unique solution where we combine our routing platform with our voice core, and it basically allows the interconnect for voice traffic as well as functions like circuit emulation allows you to terminate a TDM trunk and run it over top of IP. So the way we’ve architected it and then going through what they call OSMINE certification, which is the back office provision and the management makes it pretty unique. So it’s – I think it’s a unique solution in the market that it’s not just applying to AT&T. It’s really a broad use case for a more rapid replacement of TDM and copper links while still preserving the functionality and the interface into either the consumer or the enterprise. So I think it’s a fairly unique solution that we’ve put together.

Greg Mesniaeff: And as far as – I know last quarter; you had some Tier 3 smaller carrier wins in the U.S. Can you talk about any progress there? And generally speaking, have your recent wins in IP Optical been market share displacements or additional being added to the existing vendor list. Can you just kind of give us some color on that? Thanks.