RBBN - NASDAQ

Greetings, and welcome to the Ribbon Communications First Quarter 2023 Financial Results Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host, Bita Milanian, Senior Vice President, Global Marketing. Thank you, Pete. You may begin.

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?

Great. Thanks, Bita, and thanks to everyone for joining us today. I'm very pleased with our performance to start off the year with financial results just above the midpoint of our guidance, building on the momentum from the second half of 2022. Overall, sales grew 7.5% year-over-year to $186 million, and adjusted EBITDA increased $6 million to minus $2 million in the quarter. Bookings were once again very strong with a product and service book to revenue of 1.23x for the company. This represents a 14% increase in bookings generated this quarter versus the first quarter of 2022. Non-GAAP operating expenses were lower by $4 million or 4% year-over-year, in line with our strategy to reduce operating expenses and improve profitability. Gross margins were at the high end of our guidance for the quarter, reflecting consistent margins with our cloud and edge business and lower margins as expected in our IP Optical business from customer and regional mix. We ended the quarter with cash of $46 million with cash from operations of $11 million and a total $80 million reduction in our senior secured debt following a successful capital raise, which Mick will go through in more detail in a minute. The key business highlights for the quarter were a 7.5% year-over-year increase in total revenue, a strong IP optical book to revenue of 1.6x and a 62% growth in cloud edge sales to enterprise customers. Now let me go through a little more detail on each of our operating segments. This was the third quarter in a row that we've had double-digit year-over-year revenue growth for our IP Optical segment and a book-to-bill well above 1.0x. Sales increased 13% year-over-year, and book-to-bill was 1.6x in the quarter. Year-over-year sales growth included a 20% increase in IP routing products, a 14% increase in optical transport products and an 11% increase in maintenance and service revenue. The continued growth in sales is directly related to the increased investment that we've made in new products. In our IP routing portfolio, we've introduced our new XDR 2000 series that supports a variety of applications, including multi-service edge aggregation and high-performance metro routing. Based on the latest generation of merchant routing silicon, these built-for-purpose platforms compare favorably on a cost density and power perspective with a routing feature set to address the large telecom IP routing market. The portfolio scales from 800 gigabit edge aggregation routers through to 3 terabit and 8 terabit modular redundant platforms for metro aggregation and IP transport. Our unique pay-as-you-grow architecture allows additional switching capacity to be added as needed, providing a compelling total cost of ownership. -- integrated optical interfaces, including 400-gig

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. Their 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 2 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 were 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 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, we have also added an explanatory page in our earnings presentation. 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 point 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 drop for $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 cost and total cost of ownership and leveraging cloud technology to accelerate service availability and quality of experience, our 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

[Operator Instructions]. Our first question is from Erik Suppiger with JMP Securities.

First off, can you just comment on the service -- 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.

Erik, thanks for joining the call. I think I commented that in the first quarter, our large Tier 1s in the U.S., we were up about 2.5% in the cloud and Edge business. I also commented on the rural telecom customers that we work with and have seen very strong growth, particularly with our IP optical portfolio year-over-year, almost doubling from what it was a year ago. So that part -- that segment of the market, which obviously is supported by some of the federal funding initiatives, particularly RUS funding, which is really helping with deployments of broadband infrastructure has been really strong for us kind of more broadly in the international market. As I mentioned, India has just been almost on fire for us, very strong demand, good bookings momentum and good revenue increase year-over-year. And that's with the large -- obviously, the very large mobile operators in that region. So, in general, it's been -- the start to the year has been pretty strong, and we not only have had a kind of a good start from a revenue perspective, but the bookings even stronger. So, so far so good this year.

And then on the new product front, I think you said that reached 20%, 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...

It is. Sorry about that. I wanted to follow up on the rural opportunity. And I wonder if you could give us any comments as to how material -- obviously, you're growing really fast, but how material is that becoming either in the context of IP optical in general or the overall company? Follow-up from there.

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. So, the majority -- the vast majority of the projection, the year-over-year projected increases with customers that were already transacting with and doing business. And yes, I feel really good about the momentum we've got here and off to just a really good start from a bookings perspective, obviously. And yes, your comment on the rural matches, I think, what I said that we expect that growth to continue and ultimately from a full year perspective, probably to double or more than double what we did last year in that segment. So good momentum in the U.S. market at that level, obviously, good momentum internationally in India with our large customers there and the new products -- and then I mentioned a little bit about Europe. Again, the Europe, Middle East, Africa region continues to be a very, very strong market for us across that critical infrastructure segment, and I mentioned the new expanded win with defense customers, yes, so a variety of different places that provide a really good outlook for the rest of the year here.

Okay. And I guess my final question is kind of focused on India, which described as almost on fire, and it has been for a lot of the big base station guys as well. Although I don't know if I characterized 18% year-over-year revenue growth is on fire. So, are you kind of -- is that a reference to bookings? Give us any more specific color there? And did? Or do you expect any of the major India carriers can make it on the 10% customer list in the quarter as we move through the year?

Yes. So, I think my comment was -- I had bookings in my head when I made the comment, Tim. So part of the strong bookings in Q1 clearly is out of that region with the new wins we've already announced and the new products we're ramping there. From a 10% customer perspective, we may end up a little short of that on the full year, but we'll have to see how the second half plays out. And certainly, we'd love to see that happen.

And just quickly on that, did you -- how many 10% customers did you have 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?

Well, I guess I'd describe it as building backlog for -- not just for this quarter but for future quarters, Dave. So, I mentioned the one large federal defense industry booking that was certainly part of the backlog that we're building, which will ship over the next 12 months -- and then there's another portion of that, that books as we go forward. So certainly, that's building good backlog for the remainder of the year. Similarly, bookings out of the India region help us build backlog for future quarters. So, I certainly don't think of them as pull-ins. They're simply giving us good visibility into demand in future quarters. And it certainly makes the supply chain-related activities more predictable that way as well.

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 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 the 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. And my last question is on India. I guess most of the revenues are coming from Airtel. What about the other 2 guys [indiscernible] and Vodafone, any opportunities, especially I'm assuming Huawei is in their either geo or [indiscernible]?

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.

Our next question is from Greg Mesniaeff with WestPark Capital.

Yes. Question on the margin guidance you gave for IP Optical and what you just reported. Can you talk a little bit about component pricing and how you're managing those inputs? Is there just an improving component pricing environment that you're dealing with? Or are you attempting to redesign some of your products and design out some of the components that you may not need as much anymore?

Yes. Good question, Greg. So, the last 18 months, we've seen almost no component or cost improvements. Normally, you'll see a 2%, 3%, 4% improvement on an annual basis just through negotiation just through cost improvements, et cetera. We haven't seen that for 18 months. We do anticipate seeing a little bit of that start to happen in the second half of the year. And obviously, you've seen the supply situation shift around pretty dramatically on not only key components, but memory components, connectors, et cetera. So, we do anticipate seeing some improvement in the second half. And again, as volumes just get higher, it gets better as well. So, we'll see how the year progresses. But I think -- the other part of your question around designing out problematic components, that's definitely a part of the agenda that we've been working on half a dozen or so designs that have been re-spinning to remove either short supply components or higher cost components, and we see some of those designs start to kick in early in the third quarter that helps as well.

Got it. Got it. Now turning to Cloud & Edge. It looks like the weakest sort of component of your sales profile there is to the AT&Ts and Verizons of the world. Can you comment on that as far as what you're seeing? I know that business is lumpy and it could turn around and become a major boost as well. So -- if you could just give us some color on that?

Yes, Greg, that's exactly right. These are kind of big projects that go through a 2- or 3-quarter progression to go to completion, where we're helping modernize the voice infrastructure, replacing a lot of legacy equipment, putting in a lot of software. And the timing of those projects can move revenue and profit around quite a bit. As I mentioned, we had a really strong quarter a year ago in the second quarter with that network transformation business, very, very strong quarter. And the timing on that looks a little later this year. It's not as prominent in the second quarter. And so, we've reduced expectations around that for the quarter, but we do expect projects in the second half of the year.

[Operator Instructions]. 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.