Ribbon Communications Inc.

Greetings and welcome to the Ribbon Communications third quarter 2021 financial results conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Tom Berry, Investor Relations.

Good afternoon, and welcome to Riven's third quarter 2021 financial results conference call. I'm Tom Berry, investor relations of Riven Communications. Also on the call today will be Bruce McClelland, Riven's chief executive officer, and Mick Lopez, Riven's chief financial officer. Today's call is being webcast live and will be archived on the investor relations section of our website at rivencommunications.com, where both our press release and our supplemental slides are currently available. Certain matters we will be discussing today include business outlook and financial projections for the fourth quarter of 2021 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 the 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 two 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 measures are included in the earnings press release we issued this afternoon, as well as in the supplemental slides for this commerce call, which, again, are both available on the investor relations section of our website. And now, I'd like to turn the call over to Bruce.

Bruce? Great. Thanks, Tom. Good afternoon, everyone, and thank you for joining us today to discuss our third quarter 2021 results and our outlook for the fourth quarter. The third quarter played out almost exactly as we expected, with the exception of increasing supply chain constraints. Revenue in the quarter was $210 million, with approximately $9.5 million moving to the fourth quarter due to supply chain-related constraints. Profitability was very solid, with both adjusted EBITDA, a non-gap earnings per share within our guided range, despite the lower sales and increased costs related to component pricing, transportation, and logistics. Without these issues, we would have been at the midpoint of our guidance on the revenue range, and we would have exceeded our guidance for both adjusted EBITDA and non-GAAP earnings for sharing. In our IP optical network segment, we continue to add new customers with 12 new logos this quarter, and to build our presence in the critical North American market, where sales in this region have increased 270% on a year-to-date basis. We had an exciting new win in the quarter with Viero Wireless and Fiber Networks, a top 10 mobile network operator in the U.S. Viero is deploying our entire IP optical solution set, Apollo for DWDM transport, Neptune for IPM PLS networking, and Muse for domain orchestration and network management. The deployment will support 1 gig and 10 gig client-side aggregation over a 200 gig optical transport network. that easily scales up to 400 gig wavelengths. The converged IP optical network supports both broadband backhaul and 5G X-haul services. We also announced a new win with Dakota Central, a longtime Ribbon Cloud and Edge customer based in North Dakota. They chose our IP optical solution to increase broadband speeds and provide the ability to backhaul 5G mobile traffic. Outside of the U.S., we added a major new customer, Megaphone, the second largest mobile phone operator in Russia. After an extensive RFP and trial process, they selected our Apollo DWDM solution for long-haul transport. We're in the early stages of deployment with this new Tier 1 customer. Similarly, we had a great win with Moritel, the second largest fixed broadband provider in Indonesia. They're adding capacity to their network as well as adding a new sub-C cable and will utilize our Apollo DWDM platform. In Europe, we continue to win new critical infrastructure customers, signing deals with a large Swiss utility company and a major rail operator in Germany. These are all great examples of the strength of our IP optical portfolio and our ability to compete and win against the installed incumbents. Our product bookings to revenue in the quarter was 1.17 times, signaling growing demand into the end of the year. Sales in India continued to be impacted by environmental factors, and while shipments in the quarter were consistent with the second quarter, this is still down approximately 20% from the run rate in the second half of 2020 and well below 2019. While the market is slowly improving, we now only anticipate modest improvements in the fourth quarter. We remain well-positioned to capture significant business once the market rebounds in 2022. In our cloud net business, Sales were down approximately 5% from the third quarter last year, excluding candy. When we benefited from higher session border controller spending from both service providers and large enterprise during the peak of COVID, gross margins in the third quarter were very strong with a high mix of software. And when combined with a 14% reduction in our non-GAAP operating expenses, the adjusted EBITDA in this segment increased 7% compared to the third quarter of 2020. Demand for our voice over IP network transformation solutions was exceptionally strong again this quarter, growing 78% year over year, with higher shipments of our soft switch and media gateway platforms. We have early visibility on several new major projects beginning in 2022 that will continue the momentum in this business, and we see growing interest in the adoption of cloud-centric technologies, what we're calling telco cloud. This trend is definitely breathing new life into this very important product segment. Session border controller sales decreased from the third quarter of last year, primarily due to a very large wireless transcoding deal last year and strong sales in our 5K and 7K products to large enterprise. I'm very encouraged by the growing pipeline of opportunities following the creation of a dedicated enterprise sales team earlier this summer. We have new opportunities across a range of different verticals, healthcare, insurance, industrial, state and local government, financials, and expect meaningful improvement in sales this quarter. Our Ribbon Connect SBC-as-a-Service solution supporting Microsoft Teams continues to gain traction with over 100 distributors and partners now onboarded. We also added a top three US MSO to the platform in the quarter to support their growing business services offering and had several large international carriers evaluating the service. While it's still early, paid subscriptions have more than doubled over the last 90 days and we expect to continue to see sizable growth from this new recurring revenue service offering. And finally, in our reoccurring revenue maintenance business, we had another strong bookings quarter and continue to maintain a very high renewal rate, with bookings for the year now essentially at 100%. I'll now turn it over to Mick to provide additional detail on our results for the quarter, and I'll come back on to review our guidance and provide additional detail on our plans for the remainder of 2021 and comment on 2022.

$2 million in integration expenses, and usual adjustments for amortization of intangible assets and non-cash compensation. On an adjusted non-GAAP basis, third quarter 2021 results were as follows. Total revenue was $210 million, down 7% year-over-year when adjusted for the sale of candy, and negatively impacted by approximately $9.5 million from supply chain constraints with increased travel and marketing expenses. Non-GAAP adjusted EBITDA was $32 million, at the low end of our guidance, but a good result given the supply chain constraints. Non-GAAP diluted earnings per share was $0.11 in the third quarter, within our $0.11 to $0.13 guided range. Our diluted share count was $148 million for GAAP and $154 million for non-GAAP earnings in the quarter. Now, let's turn to the results of our two business segments. In our cloud and edge business, third quarter revenue was $140. was driven by higher software mix, the candy sale, the structuring savings, and discretionary expense savings. Here are a few additional points on the cloud now, turning to our IP optical networks business. We recorded third quarter revenue of $68 million, down slightly from $70 million in the second quarter, due in part to supply constraints and logistic delays. Non-GAAP gross margin was 37% in the third quarter, which showed an 11 percentage point decline as compared to the 48% benefited from a number of one-time items and unusually strong product and customer profitability mix. In the third quarter, these two matters reverted back to normal, and we had a further 3% decrease in margin due to supply chain incremental costs that included higher component prices, expedite fees, and freight costs. Our priority is to continue to deliver high-quality products do expect continued cost pressure from suppliers and transportation over the next several quarters, but are actively working on mitigation. We estimate gross margins at or above 40% for the IP optical segment for the fourth quarter as we increase our revenue volume. Now, here are some consolidated key metrics for the company. Maintenance revenue represented 34% of total revenue to revenue excluding maintenance was 0.98 times for the third quarter. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $104 million, including $3 million in restricted cash. This is a decrease of $11 million from the previous quarter due primarily to a $16 million increase in accounts receivable due to timing of collections at quarter end. Our $100 million revolver still remained undrawn. Once again, we comfortably met our quarterly financial covenants for our term law. Our bank leverage ratio was 2.34 times, well below the 3.5 times maximum. Fixed charge coverage ratio was 3.9 times, more than three times the 1.25 times minimum. Capital expenditures were $4 million for the quarter, We're really proud of the team this quarter for meeting customer demand and achieving our profitability guidance. Now, we'd like to turn the call back to Bruce to discuss the operating environment and our outlook for the quarter. Great.

Thanks, Mick. Before discussing our guidance for the fourth quarter, I'd like to provide a few comments about the progress we're making on our core strategy across selling our IP optical portfolio to the broad base of traditional ribbon customers utilizing our voice over IP solutions. We have very big ambitions for our IP optical business and have a deliberate strategy in each region to gain entry into large service providers that control the majority of the capital spend in the industry. In the last 12 months, we've had a series of material wins with significant operators such as Rogers, Optus, Singtel, Altice, Megaphone, Telecom Italia, Taiwan Mobile, and Sony. The revenue growth results in a material way, but we are investing in both R&D and go-to-market to support these wins. They will be a strong addition to the base of customers currently supporting our business. Beyond that, we have significantly increased the number of Tier 1 customers we're actively engaged with and who are evaluating one or more elements of our portfolio, as highlighted on slide 12 of our third quarter investor presentation. The sales cycle will take time, But we expect many of these customers will be the next wave of wins, further increasing revenue in the second half of 2022 and full year of 2023. And the list of potential additional targets beyond this is even longer and collectively represents an even larger addressable market. All in, we estimate that we can address a $14 billion global market and are investing to capture a much larger share than we have today. Our disruptive approach to enable a more open ecosystem and network architecture, optimizing across both optical and IT layers of the network, and providing a next generation orchestration and automation control system is really resonating with customers and disrupting competitors. Extensive investments will be made in fiber network infrastructure over the next five years, enabling true 5G mobile networks and dramatic improvements in residential, band service. At the same time, the investment in collaborative voice communication is also expected to continue at a robust rate as enterprises adapt to leverage a more mobile workforce and digitize all aspects of their business. Traditional service providers are adapting their business model to embrace cloud technology, modernize their infrastructure, and to leverage public cloud platforms to accelerate new service introduction and lower costs. we're really entering a new phase for the company. We've completed the integration of ECI and Ribbon and have done the hard work of building a new company. We're now in the second phase and beginning to see clear evidence that our strategy is working and will be a significant transformation of Ribbon. We're in a great industry with a favorable competitive environment and super excited about the future of the company. In order to provide more detail on our technology and solutions, we'll be hosting two virtual events on November 18th as part of a series we're calling Ribbon Spotlights. We'll focus on two specific topics that day, beginning with what we're calling IP Wave, how we envision the evolution of IP and optical networks, and our solutions that are leading this network transformation. We'll then discuss the quickly growing trend for carriers to further leverage public cloud platforms and our telco cloud solutions We'll continue this series with additional events in 2022, and we'll keep the investor community posted on the dates and other details as we get closer to the events. So now for guidance. Our sales team is now in front of customers on a regular basis, which is a big benefit as we compete for new business. And personally, I have face-to-face customer meetings across Europe, the UK, India, and North America over the next 45 days. Our Q4 sales pipeline is very robust, and we continue to have line of sight to significant growth in the quarter, with potential to exceed our updated guidance range depending on the end-of-year capital spent. However, it's become more difficult to estimate the exact impact that global supply chain constraints will have on being able to fully meet demand. We also expect continued elevated costs in our IT optical segment this quarter due to higher logistics and expedite fees, but still project gross margins for this business back above 40 percent in the fourth quarter. With these factors in mind, we're broadening our normal guidance range on both revenue and earnings. For the fourth quarter, our expectations are for revenue in a range of $240 to $260 million, non-GAAP gross margins of 58 percent, non-GAAP adjusted EBITDA of $45 to $51 million, and non-GAAP diluted earnings per share of 13 to 17 cents. Just a note on tax rates. As we close on the end of the year, we're adjusting our non-GAAP tax rate assumptions for the fourth quarter to approximately 39 percent, reflecting our projected regional income. This change results in a revised full-year tax rate of about 31 percent versus our previous estimate of 27 percent, affecting the non-GAAP EPS calculation. While this updated guidance will put us short of our $900 million goal for the year, We expect to get very close to the adjusted EBITDA and EPS targets we established at the beginning of the year. As we look into 2022, we have a growing number of tailwinds as we begin to see the results of our significant 2021 customer wins and the benefit of a broader global base. I expect that supply chain constraints will be an ongoing theme for us and others to manage, but the fundamentals behind the business are very solid, and I expect 2022 to be a strong road here. Operator, that concludes our prepared remarks, and we can now take a few questions.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Paul Silverstein with Cullen. Please proceed with your question.

Thanks, guys. First off, Bruce, the $9.5 million of delayed shipments, if you had recognized those in Q3, does it follow that the fourth quarter outlook would be $9.5 million less, or is Is this, you know, as one would think, a ripple through that there's another $9 million or $10 million or some number of revenue that's delayed, that will be delayed from Q4 into Q1 for similar reasons tied to logistics, et cetera?

Yeah, hey, Paul, that's a good question. You know, I would say it's a zero-sum. So if we shifted in Q3, it would be a deduct from Q4. Having said that, you know, as we look at the Q4 guidance, obviously we're trying to take into account any restrictions and whatnot that we see and try to take that into account as we sit here today. So, you know, I think we're going to continue to see a variety of issues and we're, you know, doing the best we can to make sure we estimate them as accurately as we can. But it's a fluid situation.

Bruce, I appreciate the challenges with respect to visibility, et cetera, for you and all of your peers. But I want to keep you honest. When you talk about third quarter would have been $9.5 million better, but for, you know, I just want to make sure. You're clearly saying that, by definition, the fourth quarter outlook would have been $9.5 million worse, but for if that revenue had been recognized. But let me move on. I don't mean to give you a hard time. No, that's correct, Paul. Okay. Mick, can you repeat the impact from supply chain? I heard the 9.5 million, but how much of a hit to margins for total company as well as for, I don't know if you broke it out, I apologize if I missed it, but for IP Optical and for Cloud Match, how much was both the revenue and the margin hit for both of those businesses?

Yes, Paul. So we noted that the impact to revenue was 9.5 million dollars. and it's about half and half related to each of the business segments. In regards to the margin erosion, that was a bigger impact on cost increases, logistic and transportation, expedite costs, and that was about 300 basis points on the IP optical network side.

And was 300 basis points the total impact? So it was all on IP optical, or was there also some on cloud and edge?

There was a little on cloud and edge, Paul, but obviously with the margins where they are, it's not as significant on the cloud and edge side.

Got it. And, Mick, or Bruce, with respect to normalized gross margin on IP optical, I thought you all had been referencing a mid-40s, to your credit, model previously for that business, higher than I would have thought you could do. But can you just refresh my memory? What is the outlook for that business? If we normalize, if you normalize for the impact from supply chain, you know, as a steady state, what are you expecting that business to run at?

Yeah, so we, you know, we were estimating low to mid 40s. So it could be, you know, anywhere from 40 to 45%, depending on mix and volume, etc. And as Mick mentioned, let's call it 300 basis points impact of higher costs right now. We estimate that continuing in the fourth quarter, which is why we're projecting margins in that segment right around 40%.

But long-term, Bruce, do you think it can be a low as much as mid-40s business normalize?

I think you'll see that happen quarter over quarter, Paul. I think if you look over an extended period of time and do an average, you know, it's probably in the 42%, 43% range. It'll just move around a little bit each quarter.

Got it. All right. One more from me before it passes on, which is, Bruce, on these impressive customer wins, at least the names of the customers that you're citing, telecom, et cetera, can you give us a sense for the – I assume the projects vary in nature, but, you know, there's, of course – you becoming the key optical supplier for Metro or other builds, and then they're getting a discrete project. And no shame if it's the latter, but can you give us a sense for what are the nature of those projects across those customers in terms of revenue impact and the nature of the projects? Thank you.

Yeah, that's a great question, Paul. So some of them are, they are project-based. They're more, let's say, enterprise-based. WDM services, so you'll do one project at a time, and you may have more than a quarter or less than a quarter. It can vary. I think the real potential here for us, though, is if we get into the core portion of the transport network, like we talked about with the Rogers opportunity, that ends up being a more consistent multi-year business and really starts to build a stronger foundation for us like we have with our other tier one customers in Russia and India and other areas. And, you know, these are all for us pretty meaningful opportunities, you know, double digit millions annually and really start to, you know, strengthen the business force.

Each opportunity you would size it at least double digits annually.

No, I wouldn't say, I would say some are probably less than that that tend to be more enterprise oriented, but the, you know, the larger ones are in that magnitude.

Bruce, can you give us, I don't know if you want to, but can you give us in the aggregate those larger, the incremental wins from the past quarter or two, what are those worth on an annual basis or quarterly basis?

Well, in a general sense, not to avoid the question, but obviously it's sensitive information, they contribute towards our goal of 10% plus growth on an annual basis. So, you know, that annual growth, 10% on 300 million plus is, you know, annually $30 million worth of growth. You know, that gives you an idea of what we expect out of kind of the aggregate and hopefully more, right? I mean, we're really obviously putting a lot of effort into this space.

Got it. All right. I'll pass it on. I may come back in if no one has questions. Thank you, guys.

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question is from Dave Khan with B O'Reilly. Please proceed with your question.

Thank you. Good afternoon. I guess the first question is regarding a mid-tax use at 39% fourth quarter. Is that just for fourth quarter, or should we use that for next year as well?

Yeah, certainly. This will be only for the fourth quarter. We've had some changes in our regional jurisdictional tax mix. For the full year, it will then average out to be 31%. So effectively, quarters one through three at 27, an adjustment in fourth quarter so that the full year is at 31%.

So how should we think about next year's tax rate, back to 31% or...

I would say that obviously we would like to reduce it back to the 27% with some further improvement, but keeping it in that range would be about right.

Okay. And then I guess I can figure out OPEX for fourth quarter, but how should we think about OPEX fourth quarter and beyond?

Well, you have seen that we have managed OpEx fairly well. We had unusually low OpEx last quarter, about $90 million. That did have some one-time beneficial effects. This quarter, we were in closer to the mid-90s. We do expect the fourth quarter, as usual, to have a lot of variable compensation and other seasonal aspects. in that mid-90 range and certainly continue to drive efficiencies in some aspects in order to continue to drive R&D in our future growth areas.

And, Dave, if I might, I'll just add in a comment on that. Some of the increase is seasonal, if you will, right, variable comp, et cetera. But we are investing more, as I mentioned on the call, around R&D investment and go-to-market investment around IP optical investments. as we win more of these customers, and they all come with some roadmap commitments and things like that, I think we'll continue to invest more. We're really looking at this as a growth area for us and a great place to invest.

Got it. And just a couple of questions regarding the supply chain situation. So, How many chips are fairly tight or giving you problems? Is it like onesies or twosies, which one of your competitors talked about, or is it more broad-based?

The biggest area, I think, where we see pressure is around routing silicon, IP networking silicon. That's probably the area that's most challenging. But we had a variety of smaller things as well, really a handful of things. You know, all it takes is obviously one component to cause an issue. So whether it's a connector or a fan or a PCB, you know, what we're seeing, and it really picked up in the third quarter, is a tightness in a variety of different areas. And so, you know, it puts a lot of focus on making sure we're planning appropriately, we're partnering closely with our manufacturing partners and good visibility from our customers on the demand. And, you know, I commented, you know, we see pretty strong demand here in the fourth quarter. And part of the challenge is just making sure we can supply as much of it as we can.

Okay. And my last question is on back to chips. My understanding is that some of these chips lead times are, you know, like maybe one, one and a half years. Well, one and a half might be a little bit drastic, but maybe, you know, one year. And if prices are going up, won't your gross margin be impacted when these higher chips go into production like one year from now? So like fourth quarter next year, gross margin will be under incremental pressure because of higher chips, higher price chips?

Yeah. Yeah, I do think we'll see cost of goods pressure. You know, we, of course, are attacking that on a daily basis with different programs across the company to continue to evolve the products and reduce cost and substitute less expensive parts, all those types of things, and really be able to try and manage that. You know, you've seen a number of suppliers in the industry look at increasing prices and those sorts of things to also help offset the increased cost. And I think you'll see more of that as the years progress here. You're correct. You know, if you go out and place an unplanned order today in some components, you know, you'll get a one-year lead time on them. And so, you know, having, again, good visibility, good forecast, and long lead time orders on key components, all those kind of regular things are – you know, part of the job these days. And, you know, we've seen this cycle before. You know, the last big supply-demand balance issue was around memory and other components like that. And, you know, it does level out. It takes time to happen. But, you know, it does come back into balance, you know, particularly around core ASICs and core silicon. Of course, the fab houses are oversubscribed these days, and it really starts at that fundamental level but then drives restrictions and cost increases back into the whole supply chain. What I do know is it levels out and it'll happen. Trying to predict exactly when that happens is almost a fool's errand. You really just need to get on it and kind of manage it.

Got it. Actually, let me squeeze in one more. Some of the router companies have raised prices. Do you have that kind of leverage to raise prices on some of your products?

Yeah, I don't think of it so much as leverage as it's really, you know, what's the competitive balance? And, you know, as we're out trying to win new business and position new products, we're looking for ultimately for the best value for our customer, lowest cost, you know, for the best value. And, you know, that's actually something we're really good at. The advanced tools we have for designing the network really allow us to drive to a really, you know, lowest possible bill of material cost. And part of, as we're doing that pricing, is looking at what are the target margins we're trying to generate. And so I do think there's some flexibility. There will be more flexibility as more pressure increases around supply, for sure.

Got it. Thank you.

All right. Thanks, Dave.

Our next question is from Mike Latimore with Northland Capital. Please proceed with your question.

Hi. This is Aditya on behalf of Mike Latimore. Could you tell me how much did top 10 customers contribute to your overall revenue?

Yeah, we'll look that up here for you. It's in the low 50 range, but we'll look it up here in just a sec.

It is about that. The top 20 is usually around 60%.

But Tom will get that for you here in just a minute.

All right.

Yeah, it's 47%. Bruce, it's almost exactly right, 47%. All right, fine. Got it.

And could you give me some color on how the situation is in India? Like, do you guys see a bit of improvement in 3Q compared to the previous quarter or just a little more color on what's happening in India?

Yeah, our third quarter was, I think, slightly better than the second quarter. It was very, very similar. You know, and we saw our deployment rates kind of recover in the July timeframe from earlier in the second quarter. And, you know, we do expect a stronger fourth quarter certainly in India versus the third quarter, just not as strong as I thought maybe, you know, 45 days ago. You know, some interesting changes over the last 30 days in India. You know, the Department of Telecom there has provided some relief to the mobile carriers related to the adjusted gross revenue taxes that are owed over the next 10 years. and have basically pushed out the timing of some of those payments. You know, I think that's going to provide some relief to the overall industry, which is great. The other comment I'll make is that one of our large customers, Vodafone Idea, you know, it's pretty public knowledge that they've been working on trying to recapitalize, you know, a portion of the balance sheet for the company. And, you know, there's been kind of increased level of rumors around getting that done here. Part of it, I think, because of some of the relief that the government's providing. You know, that's an important element to our getting back to normal in the Indian environment. That's one of our, you know, largest historical customers there, and getting them back into investing in the infrastructure is really key for growing our business and accelerating growth for the overall company next year.

All right. All right. Fine. Thank you.

Okay. Thanks very much.

Ladies and gentlemen, we have reached the end of the question and answer session, and I would like to turn the call back over to Brian McCollum for closing remarks.

Yeah, great. Well, thanks very much for everybody joining us today. You know, we're really looking forward to the Ribbon Spotlight events coming up next month and really highlighting some of the differentiation in the portfolio and how Ribbon wins. And so we're really excited about that and As you've seen in our press release, we have a number of investor conferences over the next 45 days, so look forward to connecting with everyone. Thanks very much.

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