Ribbon Communications Inc. Q1 FY2023 Earnings Call

Good afternoon, and welcome to Ribbon's First Quarter 2023 Financial Results Conference Call. I am Bita Milanian, SVP of Marketing 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 will be discussing today, including the business outlook and financial projections for the second 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. I refer you to our safe harbor statement included on Slide 2 of the supplemental slides of this conference call. In addition, we will present non-GAAP financial information on this call. Reconciliations to the applicable GAAP measures are included in the earnings press release we issued earlier today as well as in the supplemental slides we prepared for this conference call, which again, are both available on the Investor Relations section of our website. And now I would like to turn the call over to Bruce. Bruce?

Thank you, Bita, and thank you everyone for joining us today. I'm very pleased with our performance to start the year, with financial results slightly above the midpoint of our guidance, building on the momentum from the latter half of 2022. Overall, sales increased 7.5% year-over-year to $186 million, and adjusted EBITDA grew by $6 million to a loss of $2 million in the quarter. Bookings were strong again, with a product and service book-to-revenue ratio of 1.23 for the company, representing a 14% increase compared to the first quarter of 2022. Non-GAAP operating expenses decreased by $4 million or 4% year-over-year, aligning with our strategy to lower operating costs and enhance profitability. Gross margins were at the upper end of our guidance for the quarter, reflecting stable margins in our cloud and edge business and lower margins as anticipated in our IP Optical sector due to customer and regional mix. We concluded the quarter with $46 million in cash, $11 million from operations, and a total reduction of $80 million in our senior secured debt following a successful capital raise, which Mick will elaborate on shortly. The key highlights for the quarter include a 7.5% increase in total revenue year-over-year, a strong IP optical book-to-revenue ratio of 1.6, and a 62% increase in cloud edge sales to enterprise clients. Now, let’s delve a bit more into each of our operating segments. This marks the third consecutive quarter of double-digit year-over-year revenue growth for our IP Optical segment, with a book-to-bill well above 1.0. Sales rose 13% year-over-year, with a book-to-bill of 1.6 for the quarter. The sales growth included a 20% rise in IP routing products, a 14% increase in optical transport products, and an 11% uplift in maintenance and service revenue. This continued sales growth is directly tied to the increased investment we've made in new products. In our IP routing portfolio, we've launched the new XDR 2000 series, which supports various applications, including multi-service edge aggregation and high-performance metro routing. These platforms, based on the latest generation of merchant routing technology, are competitive in terms of cost, density, and power consumption and are designed to capture the substantial telecom IP routing market. The portfolio ranges from 800 gigabit edge aggregation routers to 3 terabit and 8 terabit modular redundant platforms for metro aggregation and IP transport. Our innovative pay-as-you-grow architecture allows additional switching capacity to be added as necessary, enhancing the total cost of ownership. Integrated optical interfaces, such as 400-gig ZR and ZR+ coherent optical pluggables, further integrate the IP and optical layers of the network. We've also expanded our Apollo optical platform to accommodate more long-haul transport capabilities, broadening our market reach and resulting in several recent customer successes. Here are some key highlights from a customer and regional perspective for the first quarter. Our business in India continues to thrive as we execute on earlier wins with Bharti Airtel in optical transport and IP routing, alongside growth with other operators in the region like Tata Teleservices. Sales in India grew 18% year-over-year as we ramp up production of new optical and IP products, and we experienced strong new bookings, primarily for these products. We anticipate this region will keep growing due to substantial investments in deploying 5G technology and ongoing exponential increases in internet traffic. Our expanding presence in India is also benefiting our Cloud Edge business, with several voice infrastructure deals closing in the first quarter and a robust pipeline of enterprise opportunities. As we noted last quarter, we are experiencing success in the EMEA region, with a 10% year-over-year increase in sales across various critical infrastructure, telecom, and defense customers this quarter. Bookings were particularly strong, highlighted by a new 5-year agreement for products and services with our largest defense customer, which included a significant $45 million order, part of which is accounted for in this quarter's bookings and scheduled for delivery in 2023. The rest will be included in future periods as it is scheduled for delivery or completion. This is a strong endorsement from a key customer that prioritizes quality, service, and security. In the U.S. region, investment from regional telecom and broadband providers continues to grow, supported by multiple federal funding programs benefiting the industry. Our IP optical sales in the U.S. rose 78% year-over-year, achieving a new high with shipments to rural telecom providers nearly doubling, a trend we expect to continue throughout the year. From a supply chain standpoint, we are managing several component shortages, particularly as we ramp up new products. This limited shipments by about $10 million in the quarter; however, we have made good progress in addressing other supply-related challenges. As anticipated, IP Optical segment margins fell below our normalized target this quarter due to the ramp-up of several new products and providing the infrastructure for various new DWDM optical projects. We expect modest margin improvements in the second quarter, with more significant margins in the latter half of the year. Now, let’s review some highlights from our Cloud Edge business. Sales in the first quarter increased 4% year-over-year, with sales to enterprise customers rising over 60% and related SBC sales up 24% compared to the first quarter last year. Gross margins were in line with Q1 last year at 61%, despite a higher mix of enterprise edge SBC hardware platforms. Alongside a 6% reduction in operating expenses, adjusted EBITDA for the segment increased by $5 million, or 28% year-over-year, marking a solid start to the year. Product and service bookings were at 0.9x following strong bookings last quarter for professional services that will translate into revenue over several quarters. Regionally, year-over-year growth in cloud edge sales mainly came from the U.S. and European markets, with another strong quarter in Japan. Sales to service providers remained flat year-over-year, with enterprise sales driving the segment's growth. Specifically in the U.S. market, cloud-edge sales to our top Tier 1 service provider accounts increased by 2.5% year-over-year. We anticipate overall sales to U.S. service providers to rise sequentially in the second quarter but to be lower than the strong results from last year. From an enterprise standpoint, we closely partnered with Bank of America this quarter to deliver a major upgrade to their core SBC and policy routing infrastructure. This is a prime customer for us, and we play a vital role in their communications infrastructure. We also continued several major voice modernization and capacity expansion projects with clients such as Qualcomm, Wells Fargo, Citigroup, and ADT. We maintained strong momentum with our service provider channel partners this quarter as we sold a substantial number of enterprise edge SBC servers to mid-sized enterprise customers for various unified communications applications like Microsoft Teams and Zoom, as well as hosted Centrix replacements. Revenue from enterprise edge SBC rose by nearly 60% year-over-year. Empowering our channel partners is a crucial facet of our enterprise strategy, and we're supporting them as they evolve their product offerings. Horizon, AT&T, SHI, and CONVERGE 1 are notable examples of U.S. partnerships where we're enabling managed service offerings using Ribbon products and services. Ultimately, the momentum in enterprise contributed to a very strong quarter for sales of session border controllers and related policy routing and analytics solutions. One key way we distinguish our voice communication products is through our advanced analytics platform, which supports a range of applications, including service assurance and fraud management. We had several expansion deals with both enterprise and service provider clients this last quarter, leading to over 100% year-over-year revenue growth for our suite of application services. Our support services also serve as a significant differentiator, and our Cloud Madge maintenance revenue remained steady, consistent with last year. We currently have nearly 90% of our projected maintenance revenue for the year already in backlog or under contract. With that, I'll turn it over to Mick to provide further insights on our first-quarter results and then return to discuss our outlook for the second quarter. Mick?

Thank you, Bruce. In the first quarter of 2023, our financial results showed good improvement over the prior year, with continued revenue growth for our IP Optical Networks business and sustained profitability from our cloud and edge business. From a financial structure perspective, we were able to improve our capital structure with an $80 million reduction in our term loan funded in part by a $55 million preferred equity raise, led by our major investors and an $18.4 million gain from the sale of our fixed-rate swap hedge instrument. Please refer to our Investor Relations website for supplemental slides summarizing our first quarter 2023 and historical financial performance. Let's start with consolidated corporate financial performance. In the first quarter of 2023, Ribbon generated revenues of $186 million, which is an increase of $13 million or 7.5% from the prior year, driven by a 13% increase in IP Optical Networks and a 4% increase in cloud and edge. Non-GAAP gross margin was 48.1%, reflecting approximately a 200-basis point decrease versus the prior year. Non-GAAP operating expenses were $95 million, a decrease of $4 million or 4% year-over-year. Our non-GAAP net loss was $2.8 million, which generated a non-GAAP diluted loss per share of $0.02. Non-GAAP adjusted EBITDA was a loss of $2 million in the quarter, which is a $6 million improvement year-over-year. Within the quarter, we sold our fixed-rate swap for a cash gain of $18.4 million, a portion of the gain, $7.3 million, was immediately recognized in our income statement and is included as part of our non-GAAP results in other income. The gain is not included in adjusted EBITDA. Non-GAAP tax rate for the quarter was 30%. Our basic share count was 169 million shares. Our fully diluted share count is now 175 million shares for the quarter, which includes 4.9 million warrants we issued in March. Now let's look at the results of our two business segments. In our Cloud & Edge business, first quarter revenue was $114 million, an increase of 4% year-over-year, led by enterprise revenue growth. Software as a percentage of total product revenue was 41%. The Cloud & Edge business had gross margins of 61.1% and operating expenses of $52 million, resulting in an adjusted EBITDA of $21 million or 18% of revenues. Let's now turn to our IP Optical Network business results. We recorded first quarter revenue of $72 million, which was an increase of $8 million or 13% year-over-year. As Bruce mentioned, this is the third straight quarter of double-digit revenue growth, reflecting the momentum from new product introductions. Non-GAAP gross margin for IP Optical was 27.2%, which is about 200 basis points lower than the prior year. The lower gross margin was primarily related to the initial shipments of chassis for several new optical DWDM projects, a higher mix of shipments into India and the ramp of new products. We expect that IP optical gross margins will improve modestly this quarter and more significantly in the second half of the year. Non-GAAP adjusted EBITDA loss for the quarter was $23 million, which is an improvement of $2 million year-on-year. We had significant activity with our cash flows in the quarter. Cash from operations was a positive $11 million, which included $18 million from the sale of our fixed-rate swap. Free cash flow was a positive $9 million, including $2 million in capital expenditures. Our cash flows from financing activities were a negative $30 million, driven by a repayment of $80 million on our senior term loan and mostly offset by our capital raise of preferred equity and warrants for $55 million total or approximately $53 million net of discount. As a consequence, our cash and cash equivalents balance at the end of the quarter was $46 million. We have included a bridge chart in the earnings presentation that provides the summary of cash flows in the quarter. There were other noteworthy changes to the balance sheet. Ribbon's other current assets decreased from $68 million to $53 million, reflecting mostly the $18 million net gain from the sale of the fixed-rate swap. Deferred taxes increased partially to reflect taxable gain on the sale. Our senior term loan debt is now at $250 million, which is a decrease of $80 million from the previous quarter and a decrease of $150 million or 37.5% from the original amount as we continue to. Our revolver loan remained undrawn at quarter end. The $53.5 million preferred equity and warrants are shown as a liability on the balance sheet due to our settlement features. Please note that their value will fluctuate each quarter as we are using the fair value method of accounting, which requires that we perform a quarterly mark-to-market valuation to provide greater clarity and transparency to our accounting for these matters. As part of the term loan debt repayment, we have paid a favorable amendment that allows Ribbon greater flexibility in our leverage and fixed charge coverage ratios. Our maximum leverage ratio increased from 3x to 4.5x for most of 2023, while the minimum FCCR decreased from 1.25x to 1.1x. Per to bank covenant calculations, which include preferred equity and total debt, among other adjustments, we comfortably met both of the amended term loan covenant metrics in the first quarter with a leverage ratio of 3.58x and an FCCR of 1.61x. The other key points of the amendment include a change to our base rate from LIBOR plus a maximum spread of 450 basis points to SOFR plus a fixed spread of 450 basis points as well as a reduction in the size of our revolver from $100 million to $75 million. The sale of the fixed-rate swap hedge that provided a cap on LIBOR at 90 basis points merits some explanation. With the Federal Reserve slowing the pace of interest rate increases and likely pausing in the near future, in consultation with our financial advisers, we felt it was the right time to maximize the value of our interest rate swap. As a result, we sold the fixed-rate swap for an $18 million gain before tax. The accounting treatment required $7 million of the gain to be recognized in other income this quarter, while the remaining $11 million will be amortized through interest expense over the remaining period of the term loan. As discussed in our last earnings calls, we have implemented a number of changes to reduce our expenses. In the first quarter, we reduced our operating expenses year-over-year by $4 million from $99 million to $95 million and expect further efficiencies and lower quarterly operating expenses for the remainder of the year. Coupled with anticipated revenue growth, we are expecting a significant improvement in profitability for the year. Now I'll turn the call back to Bruce to provide more comments on our outlook for the second quarter. Great.

Thanks, Mick. The first quarter was very active with a number of key industry trade shows and meetings with many of our customers across all regions. Mobile World Congress is, of course, the biggest show of the year and a great opportunity to meet with key executives from operators across Europe and Asia Pacific in particular. This was followed by an important optical technology conference called OFC, where we unveiled our next-generation optical platform, which received a lot of attention. It leverages the latest pluggable coherent optics technology, including a new 5-nanometer process node DSP to support the industry's first 1.2 terabit per second wavelengths. So, we're very excited about the introduction of this new product later this year. Our customers' investment priorities that I highlighted on our last earnings call were underscored in practically all of our meetings. 5G mobile deployments, broadband Internet growth, reducing operating costs and total cost of ownership and leveraging cloud technology to accelerate service availability and quality of experience are key focus areas as our customers prioritize their capital spending plans this year. As I mentioned on our last call, the introduction of new products in our IT Optical segment are directly targeted at the 5G and broadband investment priorities and are the catalysts behind growing revenues and bookings. Our expanded Neptune IP routing portfolio, including the XTR2000 series, addresses a wider range of applications, including 5G cell site routing and multiservice edge and aggregation, and enhancements that we've made to our Apollo optical transport portfolio have positioned us to expand our share with wins such as the Bharti long-haul project. As a result, new products accounted for more than 20% of the IP optical bookings in the first quarter. We're still in the early ramp phase on several of these new products and are scaling supply chain and production over the next several months. With the further increased backlog created in the first quarter, we remain on track to meet our target of at least 15% revenue growth in 2023 for the IP Optical segment and once again anticipate year-over-year growth of 25% or more in the second quarter. In addition, we continue to explore partnerships to collaborate in the development of advanced orchestration and automation software for the service provider market segment. As I mentioned in the last call, I'm excited about the potential to leverage our technology with major industry integrators and digital service consultants. From a margin perspective, our Q1 results were impacted by shipments of lower-margin optical transport equipment associated with several new projects, along with a higher mix of shipments in India and the ramp of new products. We're expecting modest improvement in our IP optical margin in the second quarter and gross margins in the mid- to upper 30s range in the second half of the year given the pipeline and projected customer and regional mix. Combined with the projected revenue growth and lower operating expenses, we continue to project profitability on an adjusted EBITDA basis in the second half of the year. From a Tier 1 or major mobile and telecom service provider perspective, we have a lot of focus on building on the wins we've already announced and landing and expanding with operators such as Bharti, Rogers, Singtel, MTN Group, Telecom Italia and others. As mentioned in the last call, we have multiple additional IP and optical opportunities where we're at different stages deep in the evaluation and decision process that have potential for incremental revenue in 2023. Lead applications such as TDM to IP circuit emulation are becoming great entry points and leverage our experience and presence in the carriers voice network to deploy our IP routing and optical transport solutions. In our Cloud & Edge business, growth in the enterprise market segment is a key part of our strategy to maintain overall revenue and profitability. The adoption of cloud-based unified communication solutions such as Microsoft Teams and Zoom to modernize voice infrastructure, replace legacy hosted centric as well as continued growth of contact center capacity, all create significant growth opportunities. We continue to receive very good feedback on the feature richness and flexibility of our secure voice communication solutions and believe we are gaining share, particularly with large enterprise customers. One of the largest enterprise markets we're pursuing encompasses a number of U.S. federal government agencies, both civilian and defense. We've made good progress on several of these large voice modernization projects and anticipate an initial award later this quarter. We're working closely with Dell and other integration partners to provide a comprehensive pre-integrated federal solution. We continue to project significant revenue growth from the U.S. federal market in the second half of the year. As I mentioned earlier, sales of Cloud & Edge products to service providers in the first quarter were consistent with the first quarter of 2022, and we expect sequential growth in the second quarter. However, last year's second quarter was one of the strongest quarters on record with strong voice modernization projects with U.S. service providers, which makes the year-over-year comparison challenging. Based on our current outlook for the timing of service provider related projects, we anticipate Cloud & Edge sales in the second quarter to be lower than last year, partially offset by growth in enterprise. Our current view of the second half of 2023 continues to show modest growth in Cloud & Edge versus 2022, continuing to support an overall stable projection of the business for the full year. From an investment perspective, we've now implemented changes across the company to meet our reduced spending target of $30 million, yielding an in-year savings of $20 million in OpEx and operating costs. This includes a reduction of approximately 200 positions or 6% of headcount. In light of the macro environment and margin pressures, we plan to further exceed this target as the year progresses, resulting in even larger savings on an annualized basis. This will translate into a quarterly OpEx run rate of approximately $90 million in the second half of the year, down from $97 million in the fourth quarter of 2022. With that as the backdrop, for the second quarter, we're projecting revenue in a range of $205 million to $215 million; non-GAAP gross margins of 50.5% to 51.5% and non-GAAP adjusted EBITDA in a range of $17 million to $24 million for the quarter. For the full year, we continue to maintain our previous guidance with revenue growth of 3% to 6% and a greater than 50% improvement in adjusted EBITDA.

Our first question is from Erik Suppiger with JMP Securities.

First off, can you just comment on the health of the service provider market? Cloud & Edge was relatively good. But can you speak to kind of the last 90 days in service provider activity relative to expectations?

Thank you for joining the call, Erik. In the first quarter, our large Tier 1 customers in the U.S. saw a growth of about 2.5% in the cloud and edge business. Additionally, our rural telecom customers experienced significant growth, especially with our IP optical portfolio, which has nearly doubled compared to last year. This segment of the market, bolstered by federal funding initiatives like RUS funding, has performed strongly for us, particularly in the international market. India has shown remarkable demand with solid bookings momentum and a good increase in revenue year-over-year, especially with the major mobile operators in that region. Overall, the beginning of the year has been quite strong. Not only have we seen good revenue results, but bookings have also been even stronger. Things are looking good so far this year.

And then on the new product front, I think you said that reached 20%. Can you talk about that relative to expectations? How did that perform relative to your expectations?

Yes, exactly right. So, this is a combination of several of the new routing platforms, the XTR 2000 series, it includes the new cell site router product we're deploying with Bharti in India and also includes the enhancements that we've made to the optical portfolio around long-haul transport. So those 3 categories contributed over 20% of the bookings in the first quarter, which I think was maybe a little stronger than I expected, but certainly directionally, where we thought it was going to be, obviously, given the investment we've made around enhancing the portfolio.

Our next question is from Tim Savageaux with Northland Capital Markets. Tim, your line...

I wanted to follow up on the rural opportunity. Can you provide any insights on how significant this is becoming in relation to IP optical as a whole or for the company overall?

It's fairly material at this point, Tim. I want to say, in the order of 10% or so of our IP optical sales are in that area. In fact, it was the strongest quarter we've ever had in the U.S. market on the strength of a variety of those customers. So, it's becoming a reasonably significant portion of the business.

Great. And I guess you mentioned, as you look at the 15% plus growth target in IP Optical, it sounds like you expect that kind of rate of growth in rural to continue and then that's sort of built into your expectations. This sort of doubling. I guess beyond that, you mentioned a lot of opportunities out there that could positively impact '23 with additional Tier 1 carriers. What are your kind of expectations built in on that front? Or is your growth outlook here mostly based on kind of expanding with current customers and the order book that you have in funnels there an expectation of meaningful new wins contributing to that growth?

Yes, the majority of the projected year-over-year increases come from customers we are already working with. I feel very positive about the momentum we have, and we are off to a strong start in terms of bookings. Regarding rural growth, I anticipate that it will continue and should likely double or even more than double last year's performance in that segment. We are seeing good momentum in the U.S. market, and likewise internationally in India with our large customers and new products. In Europe, the Middle East, and Africa region remains a very strong market for us, particularly in the critical infrastructure segment, and I noted our new expanded wins with defense customers. Overall, we see a variety of opportunities that indicate a positive outlook for the remainder of the year.

Okay. My final question is about India, which has been described as very active, particularly for the major base station companies. However, I’m not sure if I would describe the 18% year-over-year revenue growth as extremely active. Is this reference related to bookings? Could you provide more specific information on that? Additionally, do you anticipate any of the major Indian carriers will make it onto the 10% customer list this quarter as the year progresses?

Yes. I was considering bookings when I made that comment, Tim. A significant portion of our strong bookings in Q1 comes from that region due to the new wins we've announced and the new products we're introducing there. From the perspective of the 10% customer base, we may fall a bit short for the full year, but we'll have to see how the second half progresses. We certainly hope to achieve that.

And just quickly on that, did you have many 10% customers in the quarter? Just kind of the usual or...

Yes, exactly same as we had on Verizon was our 10%-plus customer in the quarter.

And congrats on the quarter and the outlook.

Our next question is from Dave Kang with B. Riley Securities.

My first question is your book bill for IP Optical 1.6. Just wondering if it was due to any kind of order pull-ins if you can provide additional color on that?

I would characterize it as building backlog not just for this quarter but for future quarters. I mentioned a significant federal defense industry booking that contributes to the backlog we're creating, which will ship over the next 12 months, and there will be additional bookings as we move forward. This is definitely contributing to a solid backlog for the remainder of the year. Similarly, bookings from the India region assist us in building backlog for upcoming quarters. I don't view these as pull-ins; they provide us with clear visibility into demand for the future, making supply chain-related activities more predictable.

Got it. Now I know that you don't quantify backlog, but just wondering if you can provide additional color as far as the mix between IP optical and SBC or CNA.

Yes. So, the bookings or the backlog obviously created in the first quarter were stronger around the IP and optical portion of the portfolio. We have a very strong bookings position obviously around the maintenance portion of our Cloud & Edge business. As I mentioned, more than 90% of the projected revenue this quarter is already covered under backlog or secure contracts. So, we've got a pretty healthy backlog for the next couple of quarters, yes.

Got it. And then you talked about selling more chassis in the first quarter, and that's why your margins were below 50%, but then you're kind of guiding to mid-50s second half as you're going to sell more line cards. Is that one of the drivers for margin expansion?

Yes. I think there's 2 or 3 drivers. So certainly, that's one of them that some of the equipment that we're shipping last quarter and this quarter, as you know, is building out the optical underlay, the optical line for the deployments, and those are always at lower margin. So, as we fill that in with transponders, obviously, that reverses and improves dramatically on the margins. That's a piece of it. The second piece is just regional mix. As we start off the year, obviously, there's always a mix of how much is in Europe, how much North America, how much India, et cetera, with India being stronger, that's pulled margins down somewhat in the first half and the visibility we have to growth in the other regions help improve the gross margin. And then the third factor is always around the volume of business. As you saw in the fourth quarter, I think we did $97 million of IP optical as we get into the higher revenue level, that clearly helps with fixed cost absorption adds another 300 or 400 basis points just from a pure volume perspective.

Got it. My last question is about India. I believe most of the revenues are coming from Airtel. What about the other two companies, and Vodafone? Are there any opportunities, especially considering Huawei's involvement with them?

Yes. So, we do business with all the operators there, Geo, Vodafone, Idea I mentioned TATA Teleservices on the commercial or the enterprise side. They're not at the level of business we're doing with Bharti. And we do a mix of business in the region. Some of it's on our IP optical portfolio, but we also have a very good presence with our Cloud and Edge business as well. It's at a lower level of revenue, but it's a higher margin, higher profitable business. So that blend helps us. And clearly, we have ambitions to grow our share in the region.

If there are no further questions at this time, I'd like to turn the floor back over to Bruce McClelland for any closing comments.

Okay. Great. Well, thanks again for being on the call this afternoon and your interest in Ribbon Communications. We look forward to speaking with many of you in the upcoming investor conferences over the next couple of months. Operator, thank you as well, and that concludes our call.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.