Ribbon Communications Inc. (RBBN) CEO Bruce McClelland on Q1 2020 Results - Earnings Call Transcript

Ribbon Communications Inc. (NASDAQ:RBBN) Q1 2020 Results Conference Call May 6, 2020 4:30 PM ET

Company Participants

Monica Gould - IR

Bruce McClelland - CEO

Daryl Raiford - CFO

Conference Call Participants

Paul Silverstein - Cowen

Operator

Greetings. Welcome to the Ribbon Communications First Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note this conference is being recorded.

At this time, I will turn the conference over to Ms. Monica Gould, Investor Relations for Ribbon Communications. Ms. Gould, you may begin.

Monica Gould

Good afternoon and welcome to Ribbon's first quarter 2020 financial results conference call. I am Monica Gould, Investor Relations for Ribbon. And on the call with me today are Bruce McClelland, Ribbon's CEO; and Daryl Raiford, CFO. Today's call is being webcast live and will be archived on the Investor Relations section of our website at ribboncommunications.com, where both our press release and our supplemental data are currently available, including slides detailing our historical financial performance.

I'd like to remind you that during this call, we may make certain forward-looking statements. Such statements are based on current expectations, forecasts and/or assumptions regarding Ribbon's business, financial results, growth, anticipated benefits from acquisitions, restructuring and cost containment activities, global economic and health conditions including the ongoing COVID-19 pandemic and other opportunities in the marketplace that include risks and uncertainties that could cause our actual results to differ materially from the statements discussed today.

Any forward-looking statements are qualified in their entirety by cautionary statements contained in Ribbon's most recent annual report on Form 10-K and the company's other SEC filings. While we may elect to update or revise forward-looking statements at some point, we specifically disclaim any obligation to do so, except as may be required by law.

We utilize various metrics to assess the performance of our business. Not all of these metrics are GAAP metrics. And while our metrics are discussed on a non-GAAP basis, we have provided a reconciliation of GAAP to non-GAAP results in our press release and within the supplemental presentation on the Investor Relations section of our website. Statements about profitability refer to adjusted EBITDA unless otherwise indicated and are on a non-GAAP basis.

Statements about Ribbon’s organic business, organic and Ribbon standalone and organic revenue growth as used in this earnings call, refer to the business continuing operations and/or financial results, as the context dictates, of Ribbon communications on a non GAAP basis, excluding the recently acquired ECI business. When we referred to overall Ribbon results, these are ribbons consolidated results and include the results for both Ribbon standalone and for ECI for the stub period from March 3, 2020 acquisition date through the end of the first quarter 2020.

And now, I would like to turn the call over to Bruce.

Bruce McClelland

Thank you, Monica. I'd like to thank everyone for joining us today during these challenging times and sincerely hope you and your families are safe and healthy. I'm delighted to join you on my first earnings call since becoming Ribbon’s CEO on March 1st. I've spent my entire career in the telecommunications industry working closely with service providers, and more recently, enterprise customers to develop and deliver sophisticated, large scale, complex systems that underpin the voice, video, and data services in many of the networks around the world.

I’ve spent the first 11 years of my career at Nortel Networks and the last 20 years at ARRIS and most recently at CommScope. As the CEO of ARRIS we executed on a strategy to expand our target markets beyond service providers and into the larger, more diverse, enterprise segment. I've known Ribbon and many of the predecessor companies for almost 20 years, and I feel I have a good foundation both from a technology perspective and a commercial perspective. I have a successful history of doing business with the majority of customers Ribbon sells to today, and many others that we hope to work with in the future. I'm very excited to be here and to lead the next phase of innovation and growth for the newly combined Ribbon and ECI team.

I'd like to thank the entire Ribbon team for a great welcome and for coming together to continue to support our customers throughout the COVID-19 pandemic. The energy from the team is invigorating and the response from customers has been very motivational. In my first 60 days, I've been able to meet with many employees and customers and visit many of our locations prior to moving to a work-from-home operating model in late March. I'm happy to report that we've had only a very small number of employees infected by the COVID-19 virus thus far and they're on a path to full recovery.

Overall, our employees are very engaged and productive working from home. We've recently been able to reopen our R&D office in China and we'll be able to leverage the learnings from that process as we start to reopen offices in other regions. The team has done an incredible job supporting our customers and their networks and quickly responding to additional capacity needs and network upgrades.

Data and voice traffic pattern shifted significantly as a result of the increased work-at-home activity and our service provider customers were able to react quickly to address congestion points and add capacity. Similarly, communication needs for critical infrastructure providers such as hospitals and national, state and local governments are vital and under stress and we had several urgent needs that we quickly addressed in the quarter. The traditional standalone Ribbon business has been very resilient as many of the products in our portfolio are fundamental in providing voice and data services.

One of the key things that attracted me to Ribbon was the planned combination with ECI, packet optical networking technology provides the underlying foundation for all forms of communication, both wired and wireless. Continual investment in innovation in this part of the network is crucial to keep pace with the exponential growth in bandwidth consumption and is a great complement to the Ribbon [telephony] portfolio. Our new optical transport and packet processing product portfolio from ECI positions Ribbon more squarely in the growing datacom market and the capital spend of our customers. The additional scale and global presence will make us more relevant and strategic to major carriers and enterprises. In particular, we expect to be able to leverage the excellent relationships and position Ribbon as in the North American market to take share in the large and growing optical networking vertical.

And as 5G mobile networks become more prevalent and the unique features to support private networks such as low latency and network slicing become table stakes. We will be uniquely positioned to capture additional share. The combination of Ribbon and ECI significantly expands our addressable market and target customer base. Together, we're providing solutions to the majority of Tier 1 service providers around the world, with significant growth potential to grow sales by selling the total portfolio to existing customers.

Jointly, we support the communication needs of many of the largest banks, airlines and retailers, as well as a growing list of other enterprise customers. And we have a growing business in the state and local government and defense sectors in North America and in Europe. While it will take time for the strategy to play out, we're on a journey to transform the company over the next several years.

As of the ECI transaction close on March 3rd, we retired the previous Ribbon debt and have a new five year $400 million term loan and $100 million undrawn revolver provided by a top notch bank syndicate led by Citizens Bank and Santander. At transaction close we have $88 million of cash on hand for a net debt to trailing 12 month EBITDA leverage ratio of less than 3. We will be very focused on sales execution, cost management and cash generation over the next 12 months and aim to improve this leverage ratio quickly.

From an organization perspective, we formed two business units reflecting the diversified portfolio and to ensure ownership and accountability. The cloud and edge business unit is comprised of the classic Ribbon product teams, and packet optical networking business unit is comprised of the classic ECI product teams.

Most importantly, we're integrating our go-to-market organizations to create clear focus on the customer and enable selling of the entire portfolio to service provider, enterprise and critical infrastructure customers. The business units will leverage a common operations, supply chain and services organization to achieve scale and efficiency. The remaining G&A functions have all been merged under individual leaders who are working aggressively on optimizing our teams and supporting our customers.

As part of my first 60 days, and as part of the overall integration of Ribbon and ECI, I'm doing a whole portfolio investment review as we align around a new combined strategy for the company. While my review is not yet complete, I expect the outcome to be a leaner organization focused on key growth areas, while leveraging the critical footprint and presence we have with our customers that will enable us to gain share and expand our business. Nothing is off limits. Each program must have a clear ROI and contribution to the long-term success of the company.

With that, I'd like to say a few words about our performance in the first quarter. We reported sales -- total sales of $158 million, a 33% increase versus the same period last year, benefiting from the one month of packet optical sales in March from the ECI acquisition. Excluding ECI sales, the traditional Ribbon business on a standalone basis was very robust, with sales increasing 8% to $128 million. A significant portion of these incremental sales were software based products, increasing 55% year-over-year and having a very positive effect on profitability.

The standalone Ribbon non-GAAP gross margin increased 6 percentage points in the first quarter to 62%. And overall adjusted EBITDA grew $13 million to $10 million in the quarter, a very solid start to the year. While we've only owned the ECI business for less than 30 days in the quarter, the COVID-19 pandemic is definitely having more impact on this business. In Q1, the business experienced some supply chain disruption as well as logistics delays shipping into regions such as India. For the most part, these issues are now behind us.

From a demand perspective the European market continues to perform well but we continue to see purchasing delays in India and Russia. While we expect this to recover and are already seeing signs of improvement, sales of packet optical equipment into these regions is trending lower in the first half of 2020 as compared to the first half of 2019.

I'll now turn the call over to Daryl who will discuss more of the details of the first quarter results and our expectations for the year. Daryl.

Daryl Raiford

Thanks Bruce. For Ribbon, overall, we reported first quarter revenue of $158 million, non-GAAP EPS of $0.01 and non-GAAP adjusted EBITDA of $10 million. These overall results included ECI for the portion of time in March that we owned the business. For that stub period in March, we recognized $30 million revenue from ECI with breakeven non-GAAP adjusted EBITDA. Such ECI revenue was comprised of $22 million of product revenue and $8 million of service revenue.

To help with comparability, I'll take extra time to lay out our results for Ribbon on a standalone basis that exclude the ECI results for the stub period in March. Our Ribbon standalone first quarter 2020 financial results as compared with the first quarter of 2019 were as follows:

Total revenue was $128 million in the current quarter, up 8% from $119 million last year. Non-GAAP gross margin was 62%, up 6% percentage points from 56% a year ago. Non-GAAP operating expenses were in line with last year at $72 million. Non-GAAP diluted earnings per share was $0.02 as compared with the non-GAAP loss per share of $0.08 in the first quarter of 2019 and non-GAAP adjusted EBITDA was $10 million as compared with a negative $3 million in the comparable quarter last year.

In our cloud and edge business, our software sales as a percent of Ribbon standalone product revenue grew to 53% from 39% in first quarter 2019. Software growth came from both network transformation solutions and from our virtualized software for SBCs as service providers could rapidly deploy our suite of virtualized software products into their networks to manage their network demand. In particular, network transformation solutions benefited as expanded call control capacity was in critical need at certain service providers and MSOs to respond to unexpected network demand spikes.

Product revenue from the enterprise vertical grew 5% from the comparable period last year and was 29% of our standalone Ribbon product revenue. Higher software mix drove improving gross margins of 6 percentage points and we did achieve the 62% for the quarter.

In packet optical networking, product revenue from the enterprise vertical was more than half of ECI product revenue in the stub period. As Bruce stated, our recently acquired packet optical products enjoy a solid enterprise presence serving governments, defense, and utilities and critical infrastructures along with large enterprises. Seven of our 10 new customers for these packet and optical products came from the enterprise segment. And going forward, we believe there will continue to be a meaningful opportunity for enterprise deployed optical transport and packet processing platforms.

Also, we saw a significant increase in demand for our 1.2 terabit solution primarily in Europe and the steady ramp of RFP and lab testing related to 5G with service providers.

Turning to profitability, Ribbon’s overall non-GAAP diluted earnings per share was $0.01 and adjusted EBITDA was $10 million in the first quarter of 2020, representing a 6% EBITDA margin. We were pleased with our profitability performance this past quarter compared with the corresponding EBITDA loss of $3 million last year. As I mentioned, improved Ribbon organic profitability came from higher revenue and better margins from higher mix of software sales.

ECI’s adjusted EBITDA contribution for the stub period was breakeven. On the balance sheet, cash and investments were $110 million as of March 31st including restricted cash, of which $8 million will be used later in the second half of 2020 to pay certain taxes associated with the ECI merger. We do likewise expect to use approximately $20 million for remaining transaction and merger related items.

In the first quarter of 2020 the company generated positive cash flow from operations of $40 million, which was double of what we realized in the first quarter of 2019. Our unlevered free cash flow of $38 million in the quarter was more than double the $17 million generated in the first quarter of ‘19. The company refinanced its borrowing this past quarter in order to consummate the ECI merger. Our prior credit facility with borrowings outstanding of approximately $49 million was retired upon closing the ECI transaction. And as Bruce stated, we entered into a new $500 million credit facility comprised of a $400 million five-year term loan and a $100 million revolving credit facility. The term loan balance was $400 million as of March 31st and the revolver was undrawn. Floating LIBOR interest on the term loan was fixed through swap at less than 1%. The spread varies based on leverage ratios with the effective interest rate as of March 31 at 3.9% all in.

Now I'd like to provide a few comments on our outlook. As you may recall, we gave full year 2020 profitability guidance for Ribbon on a standalone basis excluding the ECI acquisition during our fourth quarter earnings call. Based on our first quarter Ribbon standalone results, we're pleased with our progress and continue to have solid visibility into our cloud and edge 2020 pipeline. The service providers and enterprise customers continue to respond to increased network demand from growth in voice and data traffic. But understandably, our earlier guidance was on a standalone basis and the recent merger makes the previous guidance no longer applicable. Therefore, we're withdrawing that standalone guidance.

For Ribbon on a combined basis, as we discussed, our packet optical networking business in the first half of 2020 is being impacted by both the COVID-19 pandemic as well as some other factors in India and Russia creating reduced demand, supply constraints and logistical challenges. We believe these issues are already beginning to improve, and are optimistic about our second half 2020 prospects. However, predicting the near term performance of our recently acquired ECI business, when the restrictions to curb the pandemic will be lifted and how the recovery will look is uncertain.

In summary, due to the uncertain nature of the pandemic, we will not reintroduce formal guidance for Ribbon on a combined basis, including ECI at this time. In the interim we'll aggressively control our costs while supporting our customers during these challenging times.

Now, I'd like to turn the call back to Bruce.

Bruce McClelland

Great. Thanks, Daryl. I'd like to reiterate several key points of our near term strategy as we transform and strengthen the company. First, we will continue to emphasize and invest in the evolution of our cloud and edge products to leverage software, and as a service deployment models. Both our SBC portfolio and our network transformation application servers are available in both software-only and high performance appliance versions, and are complemented by our growing suite of analytics and capabilities in our Ribbon Protect platform.

Second, we are very focused on growing the business we do with enterprise customers; banks, airlines, retailers, critical infrastructure providers, state and local governments and defense sectors. The communication needs for these market verticals continue to grow. And as they mature, the need for robust high performance solutions begin to look very similar to service providers, our sweet spot.

Third, our combined sales team is aggressively pursuing opportunities to sell our total combined portfolio to existing customers to increase our share of total spend and increase our relevance and strategic value to these customers. In turn, we believe over time, this will enable us to win share in the North American packet optical space.

While this won't happen overnight, this is the most strategic objective in the next 12 to 24 months. And I believe several of the capabilities that are designed into our packet optical platforms, such as HART, network slicing and precision timing will be key differentiators and entry points as service providers begin to really use 5G networks to enable new services and expand their business.

And finally, as I mentioned earlier, we're completing a full portfolio review and expect to make adjustments over the short and medium term that will improve the efficiency of the organization and direct investment more squarely on growth areas for the company, reducing operating costs and increasing our competitiveness.

As a result, and as was stated on our fourth quarter 2019 conference call, we expect Ribbon to exit 2020 as a company that is significantly stronger and more growth oriented. I couldn't be more excited.

That concludes our formal remarks. At this time, I'd like to turn the call over to the operator for questions. Operator, we're now ready for our first question.

Question-and-Answer Session

Operator

[Operator Instructions]. The first question is coming from the line of Paul Silverstein with Cowen. Please proceed with your question.

Paul Silverstein

So I appreciate the environment has created a lot of moving pieces, not just for you, but for all of your peers and are recognizing challenge that entails. But a question for you relative to the 12 to 24 months strategic focus, the thought arises that in the current environment for any company trying to break into new enterprise business, whether an optical and unified communications, whatever the product market, there's the challenge of both getting access to staff given that there's reduced IT staff, that those enterprises survive and that have budgets, and that have business models that require either new projects or expanded equipment. And there's also the incremental challenge to begin your equipment in for trials and that probably doesn't go away maybe next year, but it probably persists well past the current quarter for some time to come.

Secondly, some of the verticals you name, some of them should be relatively healthy like government, but others like airlines in particular, ones that you highlighted, there again, given what's going on in the airline industry and I guess things can change, but it's hard to imagine that that industry is going to come back in a robust way in the next six to 12 months, hopefully far robust than it is today, and that’s up another level. I mean the obvious question is, how do you overcome those challenges given the focus on enterprise in particular, understandable in a normalized environment, I get it. But in the current environment, how do you deal with those particular hurdles that are not unique to Ribbon, that any company trying to sell into enterprise and trying to sell into those verticals, those challenges you're going to have?

Bruce McClelland

Hey, Paul, this is Bruce. And I appreciate the question. And, yes, I think you're right. I think there are clearly areas of the economy that are more impacted than others, airlines is a perfect example. And so we're going to go where the money is obviously right? I mean we can't capture share if dollars aren't being spent. And, as you know, our products are fairly well, right? Some of them sit right in kind of the middle of the unified communications flow. And that part of the business I think continues to be fairly robust as more capacity is being added in those areas. I do think you're right, reason we’re trialing equipment, where you're trying to bring product into a new customer, into new network and going through both the RFI process and RFP process and trials. Those are more challenging. And I think that reflects a little bit in what we're seeing in our packet optical business short-term.

I think as you know, as we go to market to address enterprises, for the most part we're working through partners, either service providers or other type of communication service providers. And so we’ll kind of leverage that scale and into kind of the larger scale enterprises. I think you probably saw a recent announcement, our portfolio for working with Microsoft and their direct routing capability. So I think there are a variety of places that will continue to be more robust than others and we need to focus on those for sure.

Paul Silverstein

Just one more if I may for you or Daryl. Can you give us any insight -- and if you have it in the slide deck I apologize, I haven't seen it yet. But can you give us any insight on the revenue mix geographically, both for traditional Ribbon and for ECI? If I go back to the comment ECI made when it was trying to go public, if I recall I think India at the time was 40% and Russia was around another 20%, I may be somewhat off on those numbers, but I assume India and Russia, while you have some understandable challenges there, I assume there's still a big piece today of the puzzle into your statement. I think I heard you say that you're expecting improvement in the second half, albeit visibility is bad. But the improvement that you're expecting, is that based upon what you're currently seeing or just business level is there so low they have to go up?

Bruce McClelland

Yes. So, good question. And then as Daryl is digging out the numbers, I'll give you the first part of the response. So certainly with the ECI business historically, the three regions that are strongest for that packet optical business are Europe, Russia and India. And what we're currently seeing is that European [feeder] is pretty robust, and kind of ongoing deployment of capacity and those sorts of things have been pretty solid. The two markets we mentioned more impactful Russia and India, Russia somewhat related to COVID obviously and somewhat related to devaluation of currency and those sorts of issues given the oil environment. And in India, which is obviously a large and important market for the business, in addition to the COVID impact, just the general environment around the challenges between the wireless carriers and the government around taxation rules and those things have slowed down some of the capital spend short-term, the discussion around adjusted gross revenue and what taxations they owe.

As I think Daryl mentioned in his script, we have already started to see improvements, both related to -- I think plans to get be able get back after COVID as well as I think just in general plans to start moving forward on deployments and purchases. But to your point, it’s going to take some time, and frankly, nobody knows for sure just how quickly that happens. And just in general what sort of impact in the global economy there is in general and unemployment rates and those sorts of things. So we are trying to be conservative in how we frame this for you. Daryl, I think you've probably got the numbers that he was requesting.

Daryl Raiford

Hey Paul, I hope that you and your team and your families are doing well. It's nice to speak with you. Ribbon -- two parts, Ribbon historically has been approximately 60% United States, 40% outside of the United States in terms of the revenue mix. And when we put our 10-Q on file, you'll see that the case. In terms of the $30 million that we recognized in the shorter period in March for ECI, over a third of that is -- which is a pre-customary is -- was sold in the European region. A little -- less than a third of that was sold in the Indian region. And then the other regions fill in around that.

Paul Silverstein

One last quick one if I may. In your optical business and ECI acquired platforms, who are you mostly coming up against in enterprise? I know the landscape in general in terms of major players in optical -- but within the enterprise market where you're selling, who are you most directly competing against?

Bruce McClelland

Yes. So in some parts of that enterprise vertical and of course there's a variety of different types of enterprises, we'll see the normal names you'd expect, Ciena, Infinera, in international markets Huawei, in some cases Nokia, in particular where they’ve got a larger set of products or services that they're bringing into some of those enterprise verticals. So it's a variety of different players. And I think you probably saw in the past that ECI had announced a partnership with Ericsson in some regions going to market and we’re continuing that relationship that will help to accelerate results.

Operator

[Operator Instructions]. The next question is from the line of Mike Latimore with Northland. Please proceed with your question.

Unidentified Analyst

It’s [Stan] on for Mike Latimore. Do you expect stronger second half CapEx from your customers?

Bruce McClelland

Yes, I apologize. You're breaking up a lot. Do you mind repeating that again?

Unidentified Analyst

Do you expect stronger second half CapEx from your customers?

Bruce McClelland

We have a prediction on second half CapEx. I'm sorry, it really breaks up.

Unidentified Analyst

Oh! I'm sorry. I will repeat again. Do you expect stronger second half CapEx from your customer?

Bruce McClelland

I believe what I heard and let me ask, are we seeing what is our projection of CapEx for our customers in the second half and would we believe the CapEx would be stronger?

Yes. Well, in North America, it’s all obviously the carrier CapEx. In some cases, there's obviously an increase in CapEx. Verizon talked about increasing CapEx. And what we've seen is pretty robust spend in those areas. It's a little hard to tell what the second half looks like. I know if you -- you've talked to carriers, they're thinking about what happens with unemployment and disconnects and slow pace and those sorts of things. So I think they will be careful on their CapEx. So far, it's been pretty positive commentary around the CapEx environment, particularly as the traffic patterns have shifted so significantly. And I think expectations are, that continues for quite some time. And so, the kind of the retooling of how the network is performing and where the traffic is coming from et cetera, is certainly a change in the network.

In the international markets, of course, the two that we follow most closely, India and Russia, it's hard to imagine that it doesn't improve in the second half of the year, it's come down. It feels like pretty substantially in the first half. And as things get back a little bit more normal -- I'd be surprised if it doesn't come back a little stronger from the first half, whether it gets back to last year or not, is a little hard to tell.

And Europe, again, has been pretty stable. I think it will depend a little bit on just how significant the overall economy impact is and just how fast some of that comes back. So I don't know if that helps you too much but that's kind of what we're seeing at this stage.

Operator

Thank you. Were there additional questions for Mr. Raiford?

Unidentified Analyst

I think I will may be take them offline, maybe with a better audio.

Operator

Alright. Thank you. And at this time, I'll turn the call back to Bruce McClelland for closing remarks.

Bruce McClelland

Alright, thank you, Rob. It's a busy earning season. So I know everybody is juggling a variety of different calls this evening. But we appreciate those who have joined here tonight, concludes our call and look forward to updating everyone again soon. We'll be participating in a variety of conferences and [Audio Gap] meet with many virtually. Alright, have a good evening. Thanks, Rob.

Operator

You're welcome. Thank you all. And this concludes today's conference. You may disconnect at this time. And thank you for your participation.