Ribbon Communications Inc. (NASDAQ:RBBN) Q4 2022 Earnings Call Transcript February 15, 2023
Operator: Greetings, and welcome to the Ribbon Communications Fourth Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Bita Milanian, Senior Vice President, Global Marketing. Thank you, Bita. You may begin.
Bita Milanian: Good afternoon, and welcome to Ribbon’s Fourth Quarter 2022 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 first 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 for this conference call. In addition, we will 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 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?
Bruce McClelland: Thanks, Bita, and thanks to everyone for joining us today to discuss our fourth quarter results and our outlook for 2023. I’m very pleased to report solid financial results for the fourth quarter, the strongest quarter of the year, with year-over-year growth in revenue and earnings. Overall, sales were above the midpoint of guidance, growing 13% sequentially and 1% year-over-year. Adjusted EBITDA increased 25% versus the third quarter and 11% versus the fourth quarter of 2021. And bookings momentum continued with book-to-revenue of 1.1 times, even with higher sales levels in the quarter. Operating expenses were slightly higher than we projected, primarily related to higher customer-related travel expenses and variable sales compensation.
Continued elevated supply chain costs and component expedite fees, along with customer and product mix resulted in gross margins a little below our initial projections. The highlight of the quarter was the continued improvement in our IP Optical business, with sales improving across all regions and multiple new customer wins. In particular, momentum continued to grow in our IP Routing portfolio, which we believe will only get stronger as additional new products enter the market this year. But we also posted good results in our Cloud and Edge segment, with one of the strongest quarters ever for sales to enterprise customers and a strong quarter for session border controller sales. All of this resulted in $16 million of free cash flow in the quarter and $67 million of cash at year-end.
Overall, it was a very good quarter and sets a great foundation for 2023. Now, a little more detail on each of our operating segments. This was by far the strongest quarter for our IP Optical Networks business since the ECI acquisition in early 2020. Revenue was $97 million, growing 18% quarter-over-quarter following growth of 20% in the third quarter. Sales of Optical Transport Equipment grew 16% versus the third quarter and were up 6% year-over-year. Sales of our IP Routing portfolio grew even faster increasing 21% quarter-over-quarter and 34% versus the fourth quarter of 2021. Production of several of our high-volume access routers continued to be limited by availability of very specific microcontroller parts, which would have further increased our Q4 revenue by approximately $10 million, but which has now moved into backlog for the first half of 2023.
We expect to have a new design in production by the end of the second quarter, as well as additional supply eliminating this bottleneck. The EMEA region was once again the strongest region for IP Optical sales across a broad range of customers in Continental Europe, Africa, the UK, and the Middle East. Highlights include growth with the Israeli Defense Forces, Syserso Networks formerly Corning Services, British Telecom and the Finnish Defense Forces. We also had several new wins in Europe at the end of the quarter, including expansions with the Swiss Army and German railway operator Deutsche Bahn as well as the Czech Republic science and education network operator. We believe these new wins will get us off to a good start in the first half of 2023.
The most significant growth this quarter was in the Asia Pac region, with multiple key wins including Eastern Telecom and InfiniVAN in the Philippines, Viettel in Vietnam, Taiwan Mobile and multiple operators in Africa including MTN, GlobalConnect and BoFiNet. And we were very excited to be awarded for the first time ever a portion of Bharti’s optical transport long haul DWDM network in India. This is a major accomplishment for the team and highlights the completeness of our portfolio in a highly competitive and fast-growing market. These are the exact type of Tier 1 operators we’re targeting to provide additional scale and predictability for the business. We also continue to make progress on our strategic goal of gaining scale in the critical North American region with full year sales increasing more than 30% versus 2021 and exceeding 10% of overall IP Optical sales for the year.
Opportunities with additional major Tier 1 mobile and telecom operators also continue to progress. I count a total of six wins at this stage where we have now received orders and are at various stages of early deployment and at least eight additional highly active engagements that have potential for incremental revenue in 2023, along with a variety of other engagements in early stages. This funnel is, key to our strategy to drive longer-term scale and growth for this business and incremental to the current base. Product and service bookings were strong again this quarter, keeping pace with increased shipments with a 1.05 times book-to-revenue in the quarter. Optical bookings were particularly strong on the back of several new customer wins in Asia Pac.
Now some highlights from our Cloud and Edge business. Sales in the fourth quarter increased 10% versus the third quarter but were down 7% year-over-year. Despite the lower sales, adjusted EBITDA margin for the segment improved 117 basis points versus the fourth quarter of 2021, primarily due to spending improvements implemented throughout the year and continued strong mix of software sales. Product and service bookings were strong at 1.15 times. Our focus on the faster-growing enterprise market segment showed positive results once again this quarter with revenue growing 67% quarter-over-quarter and 7% year-over-year, reaching 37% of Cloud and Edge, product and service sales in the quarter. Sales were distributed across a number of market verticals including customers such as Liberty Mutual in insurance, HCA in healthcare, JPMorgan and Vanguard in financials and Qualcomm in technology.
We believe Ribbon is uniquely positioned to meet the large complex communication needs of these Fortune 500 companies. Our business model in the enterprise market continues to evolve with an increasing mix of annual enterprise-wide license agreements and as a service recurring monthly subscription revenue. Multiple significant opportunities in the Federal Government segment continued to progress in the quarter. We’re working with a number of important channel integration partners including Dell to provide a comprehensive pre-integrated federal solution. I remain very excited about the potential opportunity and expect revenue from these large complex projects to begin to build throughout the year. From a product mix perspective, sales of session border controllers and associated policy routing products were strong in the quarter increasing 59% from the third quarter.
Shipments of both core high-performance SBCs as well as enterprise edge appliances were strong, serving both enterprise and service provider segments. We also had a strong quarter with cloud communication partners such as Bandwidth, SoftBank, Inteliquent and Peerless and contact center providers such as inContact. We also continued the momentum behind our analytics offering. We had new international wins with Optus in Australia and Colt in France for our fraud and robocalling prevention application. By leveraging cloud technologies these customers benefit from a fast and seamless deployment experience, helping them protect customers from a wide variety of annoying and potentially malicious calls. Shipments of our voice network transformation solutions were consistent with the previous quarter with a continued shift towards telco cloud solutions such as our Virtual C20 Call Controller.
We were excited to announce a strategic win with Liberty Latin America as they consolidate multiple legacy platforms across their footprint on to our modern cloud-based architecture while also leveraging our advanced analytics application suite. There remains a strong pipeline of similar network modernization opportunities that will provide a solid underpinning for the business in 2023. Revenue with our largest customer Verizon once again exceeded 10% of our overall sales and was consistent with the third quarter. Finally, fourth quarter is our strongest period for renewing maintenance and support contracts and bookings were even stronger than usual and underpin the profitability and stability for this business. Our focus on securing multiyear agreements is a key part of our strategy.
And we’ve broadened our offering to include a variety of value-added services, including software upgrade assurance to further increase our value and attachment rate. With that, I’ll turn it over to Mick to provide additional detail on our fourth quarter results. And then, come back on to discuss the outlook for the first quarter and 2023, Mick?
Mick Lopez: Thank you, Bruce. In the fourth quarter of 2022, our financial results showed good improvement over the previous quarter and prior year, with revenue growth momentum for our IP Optical Networks business and continued profitability contributions from our Cloud and Edge business. Please refer to our Investor Relations website for supplemental slides, summarizing our fourth quarter 2022 and historical performance. Let’s start with consolidated corporate financial performance. In the fourth quarter of 2022, Ribbon generated revenues of $234 million which is an increase of $3 million or 1.3% from the prior year, driven by a 17% increase in IP Optical Networks that compensated for a 7% decrease in Cloud and Edge. Non-GAAP gross margin was 52.4% which is a 150 basis point decrease from prior year, entirely driven by the increased percentage mix of IP Optical Networks from 36% of total Ribbon revenues in fourth quarter of 2021 to over 41% in fourth quarter of 2022.
Gross margins were unchanged year-over-year for Cloud and Edge at 64% and for IP Optical at 36%. Non-GAAP operating expenses were $97 million, a decrease of $5 million or 5% year-over-year, as we continue to reduce labor costs even in an inflationary environment and look forward to additional efficiencies in 2023. Non-GAAP adjusted EBITDA was $29 million for the quarter which is an increase of $3 million or 11% increase from prior year. Non-GAAP diluted earnings per share, was $0.09 higher than our guidance as a result of improvements in our global tax provision estimates. Our non-GAAP tax rate for the quarter was 3.2%, to reflect the modification of our quarterly tax provision. Our non-GAAP tax rate for the full year, 2022 was approximately 31% which is an 800 basis point reduction from 39% in the prior year in 2021.
Our cash taxes for 2022 were $16 million which were in line with our 2021 cash taxes of $13 million. Our basic share count was 168 million shares and our diluted share count was 172 million shares for the quarter. Now, let’s look at the results of our two business segments. In our Cloud and Edge business fourth quarter revenue was $137 million, down 7% year-over-year and up 10% quarter-over-quarter. Software, as a percentage of total product revenue was 59%. Once again, the Cloud and Edge business contributed robust gross margins of 64%, which led to a $36 million EBITDA or 26% of revenues. For the full year, gross margins were 65% and $128 million of EBITDA or 25% of EBITDA margin showing the resilient profitability and cash contributions from this business.
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Let’s turn to our IP Optical Networks business results. We recorded fourth quarter revenue of $97 million which was an increase of $15 million or 18% quarter-over-quarter and 17% year-over-year. Non-GAAP gross margin for IP Optical was 36% which is 170 basis points lower than the previous quarter, but 20 basis points higher than the fourth quarter of 2021. As Bruce mentioned, gross margins were below our projected level, due to supply chain issues with expedite fees higher than initially projected and lower margins on several new customer projects associated with the initial infrastructure portion of the project. Non-GAAP EBITDA loss for the quarter was $7 million or 8% of revenues. While still negative, our EBITDA improved every single quarter over the previous quarter in 2022.
Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $67 million. This is an increase of $11 million from the end of the third quarter. As expected, we returned to positive cash flow in the quarter, as we had cash from operations of $16 million. Our term loan is currently at $330 million outstanding, as we have paid off $70 million or 17.5% of the original balance. Our $100 million revolver remained undrawn at quarter end. For the fourth quarter of 2022, we met our amended term loan covenant metrics. Given that we revert to the original leverage and fixed charge coverage covenant metrics in 2023, we are exploring alternatives to ensure credit facility compliance, such as paying down debt or raising additional capital.
While we have confidence in executing a plan to ensure term loan covenant compliance, as you may understand, there is always a risk of noncompliance, which would require us to reclassify the long-term debt into current debt for the year-end 2022 balance sheet. Ribbon enjoys the benefit of a fixed rate swap, which is valued at about $25 million on our balance sheet that limits our effective LIBOR rate to only 90 basis points, compared to the current one-month spot rate of about 450 basis points. Please note that we are working with our banking syndicate to change our base rate from LIBOR to SOFR, the secured overnight financing rate. Even though short-term rates were up significantly, we kept our interest rate total charges flat to 2021 through debt repayments and our swap hedge instrument.
Ribbon was also very effective at managing other expenses under our control. In spite of increased inflation, supply chain disruptions and higher labor costs, we were able to contain our 2022 operating expenses to almost the same level as previous year while simultaneously investing more in IP Optical research and development. Finally, we were able to decrease our non-GAAP annual effective tax rate as we said by 800 basis points with changes to our global tax provision. Now I’d like to turn the call back to Bruce to provide more comments on our outlook for 2023.
Bruce McClelland: Great. Thanks, Mick. As we enter 2023, the operating environment for the telecom industry remains healthy despite a variety of macro pressures including higher inflation and operating costs. Consumers continue to rely heavily on the services provided by our customers in order to enable a digital mobile lifestyle and competition for consumer dollars remains fierce. It’s imperative for our customers both service provider and enterprise to invest in their communication infrastructure in order to stay competitive. There are a number of common themes that we hear from our customers on how they are prioritizing their investment in 2023. First and foremost, mobile remains the top priority for the majority of operators.
The adoption of 5G has hit a tipping point with mass market adoption exceeding 50% in many countries. The higher speeds and improved coverage enabled by 5G technology greatly increases the data traffic on the network. This in turn is a major catalyst for the deployment of increased fiber capacity from the radio head to the core network and broader deployment of IP/MPLS to the edge of the network. The next major priority is to increase the capacity and reach of the fixed broadband network. Availability of fiber-to-the-home Internet access for the majority of consumers is an imperative for practically all countries reflecting the adoption of hybrid work and education practices. Significant federal funding is supporting more aggressive business plans and a supercharged investment cycle.
These first two priorities adds an even higher level of attention on total cost of ownership, the third key focus area. Increased competition and impacts from inflation puts a premium on every dollar spent and a spotlight on the cost of maintaining both new platforms and legacy infrastructure. Solutions that lower support costs, reduce power consumption and decreased real estate needs have grown in importance as a result. Finally, there’s a clear recognition that all aspects of business can yield significant benefits from adoption of a digital or a cloud-first approach. Service providers and enterprises are reinventing all aspects of their business, leveraging the power of cloud to reduce cost, accelerate service availability and improve overall quality of experience.
This includes practically all of the traditional voice and data communication functions. We believe the products and solutions provided by Ribbon are extremely well in line with these investment priorities and provide us confidence that we’re in one of the few parts of the economy that will remain robust despite macro environmental pressures. For Ribbon, we’re in a significantly improved position from a year ago. Sales in our IP Optical segment increased 36% in the second half of 2022, compared to the first half. And we anticipate this growth to continue in 2023 on the strength of incremental investment we’ve made in new products and associated new customer wins. In particular, our focus and investment in IP Routing provides us a significant opportunity to realize our strategy of becoming a major supplier of IP Optical solutions.
From a regional perspective, we’ve significantly diversified and strengthened our customer base. In Europe, we have a broad range of customers across multiple market verticals. We have a strong presence with critical infrastructure providers, where there’s a relentless focus on security and reliability. We’re very well positioned to continue to grow and take share in this market. A recent example is, the multiyear extension we have reached with the Israeli Defense Force, to provide critical support and products supporting their unique communication requirements. And the telecom industry is proving very resilient across Europe, and we have significant opportunities with several of the major carriers in the region. There’s a critical focus on supplier diversity, given the shifting political landscape and importance of supply chain assurance.
The presence we have with our Cloud and Edge portfolio in this region, is a major asset as we build confidence in our expanded portfolio. Developing markets such as Africa, also present a major growth opportunity in the region as major carriers such as MTN, Airtel, Etisalat and Orange make significant investments alongside major content providers such as Facebook, Google and Microsoft. Fiber networks, both subsea and terrestrial are the fundamental building blocks for these networks, and we’re very excited by the early success we’ve had in the region in 2022. This will be a major focus for us again this year. And we expect the India market, will also be a major source of growth for us this year, building on the new wins we’ve achieved with Bharti in the last several months.
The investment we’ve made in new products is paying dividends, as we expand our presence and gain market share in both optical and IP networking. In the broader Asia Pacific region, we’ve also gained share with new customers such as SoftBank, Eastern Telecom, InfiniVAN, Viettel, Taiwan Mobile and others. These are all new accounts over the last year and provide us an opportunity for additional extensions, and sales of our entire portfolio. And in North America, we continue to win new regional service providers as they invest in additional network capacity to support broadband and mobile growth. We’ve also identified multiple entry points with the major carriers, and are making good progress towards breakout wins in this critical region. We also believe that we’ve made the right investments in our Cloud and Edge segment, to maintain revenue and profitability and to ensure our portfolio of secure voice communication products are positioned to gain share in both enterprise and telco market segments.
We have a strong recurring revenue base of critical maintenance services, that underpin this part of our business. And the US Federal voice modernization opportunity, is a large multiyear investment cycle where we are very well positioned. We continue to make progress on our core strategy to cross-sell our entire portfolio to existing customers, where we have a track record of success, and have built a strong level of trust. More and more of our customers are purchasing products from both operating segments, and in some cases are being deployed as an integrated solution which is a major differentiator for us. So our primary focus in 2023, is on improving the profitability of the business. Our strategy is focused on four key elements. First, we expect a major improvement in profitability from the IP Optical business’ revenue growth this year.
We expect to be able to continue to grow and gain share in the multibillion dollar optical transport market, and recent wins such as the Bharti Long Haul award highlights, our portfolio competitiveness. We expect this will continue to improve with the launch of a new platform called the 9400 later this year. Even more significantly, we’re very encouraged by the growth we’re seeing in our IP Routing business, on the strength of our new XDR2000 portfolio, and believe this will be a major factor in improving profitability in 2023. Second, we’re focused on several key areas of our Cloud and Edge addressable market to maintain revenue and profitability in this business. This includes continued growth in the enterprise market including, winning a significant share of the large federal voice modernization opportunity.
We’re also encouraged by the pipeline of new telco cloud transformation projects, that directly contribute to lowering operating costs a major priority for our service provider customers. Third, we anticipate the impact from global supply chain challenges to continue to moderate improving product cost and operational flexibility. In addition, we have a number of product redesigns that will further reduce our reliance on problematic components, and technology and eliminate the majority of issues. And finally, we’re targeting a reduction of operating costs of $25 million to $30 million, which will yield approximately $20 million of in-year savings net of inflation and other costs. To help achieve this target, we’ve recently implemented a series of organizational changes under the banner of Ribbon 3.0. Our current business unit structure served us well during the initial integration of Ribbon and ECI, providing separate empowered teams focused on the unique aspects of each portfolio.
But we’re now seeing a growing number of areas where closer collaboration and coordination would be beneficial and have therefore combined leadership of the business units under Sam Bucci as Chief Operating Officer. Similarly, with the recent addition of Dan Redington from Juniper, we have combined our global sales organization under Dan, emphasizing the importance of IP networking to our growth strategy. In many ways, this is the next logical step in the integration of Ribbon and ECI, reflecting the Ribbon 3.0 branding. From a program perspective, after a surge in investment the last 18 months, we’re moderating R&D investment in IP Optical somewhat, as multiple new products reach completion. A part of this is related to a new partnership we’re finalizing with Tech Mahindra.
We’re very excited to be working with Tech M to collaborate in the development and deployment of an advanced cloud-based multi-domain, multi-vendor orchestration and management platform that leverages Ribbon technology and Tech Mahindra’s global market presence. We plan to formally announce our engagement at the upcoming Mobile World Congress in Barcelona later this month. With that backdrop, we expect overall company revenue to grow in 2023, with a range of $840 million to $870 million, with Cloud and Edge revenue relatively flat year-over-year and IP Optical revenue growing greater than 15%. Increased sales, along with modest improvement in gross margin and lower operating costs, combined to significantly improve projected adjusted EBITDA for 2023 in the range of $95 million to $110 million.
Our business has an element of seasonality, with the second half typically much stronger than the first half, as we experienced in 2022. We anticipate a similar pattern in 2023 with the first quarter being the lowest point for the year, but we are in a much better position from a momentum and visibility perspective. As mentioned, we do expect component shortages to limit shipments this quarter by approximately $10 million. So for the first quarter, we’re projecting revenue in the range of $180 million to $190 million, non-GAAP gross margins in the range of 46% to 48% and non-GAAP adjusted EBITDA in the range of minus $6 million to plus $1 million for the quarter. The upper end of our guidance includes several million dollar benefit from the potential Tech Mahindra partnership that we expect to close in the quarter.
I’d like to thank the entire Ribbon team and our partners for a strong finish to 2022 and look forward to our continued progress in 2023. Operator, that concludes our prepared remarks and we can now take a few questions.
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