Ribbon Communications Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 26, 2023

There are 9 speakers on the call.

Operator

Greetings, and welcome to the Ribbon Communications Second Quarter 2023 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, Joni Roberts, Chief Marketing Officer.

Operator

Thank you, Joni. You may begin.

Speaker 1

Good afternoon, and welcome to Ribbon's I'm Joni Roberts, Chief Marketing Officer at Ribbon Communications. Also on the call today are Bruce McCollan, Ribbon's Chief Executive Officer and Mick Lopez, Ribbon's Chief Financial Sure. Today's call is being webcast live and archived on the Investor Relations section of our website at rbbn.com, for both our press release and supplemental slides are currently available. Certain matters we'll be discussing today, including the business outlook and financial projections for the Q3 of 2023 and beyond are forward looking statements. Such statements these are subject to the risks and uncertainties that could cause actual results to differ materially from those contained in these forward looking statements.

Speaker 1

These risks and uncertainties are discussed in our documents filed with the SEC, including our most recent Form 10 ks and Form 10 Q. I refer you to our Safe Harbor statement included on Slide 2 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 measure 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 Investors section of our website. I'd like to turn the call over to Bruce.

Speaker 1

Bruce?

Speaker 2

Great. Thanks, Joni, and welcome to the Ribbon team, and thanks to everyone for joining us today. I'm pleased to report a very solid quarter with financial results above the midpoint of our guidance. Our focus on growing enterprise and cross selling our IP the portfolio is working with growth in both sales and earnings. For the first half of the year, sales have increased 5% year over year our earnings have improved 66 percent or $8,000,000 on an adjusted EBITDA basis.

Speaker 2

In the 2nd quarter, sales increased 2.3% year over year to $211,000,000 with continued growth in India, resulting in sales in Asia Pacific increasing 21%, while EMEA sales were up 1% and overall North American sales were down 2%. In the Optical segment, we continued our trend of double digit year over year growth for the 4th consecutive quarter with sales increasing 24% year over year. In the Cloud and Edge segment, as expected sales were down approximately 9% year over year, primarily due to lower sales to Verizon as compared to the record sales a year ago. This was offset by continued strength in our enterprise business with product sales increasing 94% year over year, reaching a new high of 44% of overall Cloud and Edge product sales in the quarter. This includes revenue from a very strategic win in the U.

Speaker 2

S. Federal space, the first of what we believe will be many voice modernization projects. Government agencies need to transform their legacy communication infrastructure to modern cloud based unified communication platforms with high levels of security and survivability. This initial project includes product and services exceeding $10,000,000 a substantial portion of which was recognized this quarter. As a result of the overall mix in the quarter, gross margins were strong at 52% and above the high point of our guidance.

Speaker 2

Combined with lower operating expenses, adjusted EBITDA was also towards the high end of guidance at $23,000,000 products and service booking to revenue for the first half of the year was 1.05 times with the 2nd quarter at 0.9 times following strong bookings in the Q1. Now a little more detail on each of the operating segments. Financial performance for the IP Optical segment continued to improve in the 2nd quarter with sales of $85,000,000 and margins increasing quarter over quarter year over year to 31%. This resulted in a $10,000,000 improvement in adjusted EBITDA as compared to last year. The growth in sales is directly related to the investment we have made in developing new products, resulting in a strong funnel of projects and projected continued growth with a target of being breakeven on an adjusted EBITDA basis in the second half of the year.

Speaker 2

Our focus specifically on IP routing continues to show strong results with sales of IP routing products increasing 46% quarter over quarter and 41% year over year. Our expanding portfolio of routing solutions directly addresses a very large addressable market in multi service edge aggregation And Metro Routing for both fixed broadband and mobile networks. Sales of optical transport products increased 21% year over year And maintenance and services revenue increased 1%. India was once again our strongest market with sales of IP optical products increasing 30% year over year, reaching the highest level since the acquisition of ECI in 2020. Shipments included a number of new products, including our 5 gs CellSide Router, Neptune XDR routers and Apollo Long Haul Optical Transport.

Speaker 2

Deployments of the new CSR router more than doubled in the Q2 versus Q1 as we scaled the program. We expect margins in these new products to improve as volumes increase and the mix of infrastructure and capacity cards is more balanced. Our cross selling strategy continues to bear fruit in several regions. IP optical sales in North America reached a new high, increasing 94% year over year and representing more than 15% of overall segment sales in the quarter. Following the trend in the Q1, investment by rural broadband providers, funded in part by federal programs, was very strong with sales more than tripling versus this has become a strategic market segment for us where we're leveraging the great presence and reputation that Ribbon has established.

Speaker 2

Our strong IP routing and optical transport portfolio is very well suited for these growing networks. Federal funding programs will increase dramatically over the next several years as existing programs such as RDOF and Reconnect are augmented by the much larger $45,000,000,000 BEED funding program. Another region where we've successfully implemented our cross selling strategy, leveraging the local presence and relationships established by Ribbon is Japan. Following several strategic wins, sales of IP optical products in Japan exceeded 5% of overall IP optical sales in the 2nd quarter, up from essentially 0 in the first half of twenty twenty two. Finally, in the EMEA region, sales grew 6% in the first half of twenty twenty three across a variety of critical infrastructure, telecom and defense customers.

Speaker 2

We have a strong pipeline of projects planned for the second half across the region. From a supply chain perspective, issues remain localized to particular new high demand products where we're still ramping production. We expect continued improvement in the second half of the year and start to see some benefit from cost improvements and full elimination of remaining expedite fees. As expected, IP Optical segment margins improved from the low point in the Q1, but are still below our normalized target. We expect further improvement in the 3rd Q4 from both fixed cost absorption from higher sales and improving mix.

Speaker 2

Now some highlights from our CloudMedge business. Overall CloudMedge sales increased 9% quarter over quarter, but were down 9% year over year after a record quarter with Verizon a year ago. Excluding Verizon, sales in the quarter actually increased year over year. Margins were very strong at 67% with a favorable mix of software licenses and enterprise sales in the quarter. Product and services book to revenue was 1 times 1.0 times for the quarter.

Speaker 2

As I mentioned, we were very excited we closed a significant voice modernization deal for a major U. S. Department of Defense Agency in the quarter. We anticipate we expect to be one of several projects starting this year as federal agencies transition from legacy on premise TDM PBX or IP Centrix infrastructure to cloud based unified communication solutions. The unique security and survivability requirements and multi site Flexity is very well suited to Ribbon's broad portfolio of session border controllers, telephony application servers, media gateways and advanced analytics.

Speaker 2

Ribbon's expertise and experience is also a key differentiator. The sales process for these projects is certainly lengthy and complex, working with key integration partners such as Dell and multiple managed service partners will allow us to scale and standardize a common solution for the market. The federal project helped contribute to the very strong quarter for sales to enterprise customers. The leading market vertical was once again financials, with multiple projects, including a significant expansion project at JPMorgan and other projects at Goldman, Bank of America and Barclays. This helped to contribute to a solid quarter for SBC sales with shipments of core SBC platforms increasing 25% year over year.

Speaker 2

In addition, the service provider sell through business also remains strong with sales of enterprise edge SVC products up 8% year over year following the almost 60% increase in the Q1. In addition to the high activity level with enterprise customers, we've seen an increased level of engagement with service providers evaluating options to modernize their voice infrastructure. We were recently awarded significant projects totaling more than $10,000,000 with 4 major service providers in multiple regions, including the U. S, Europe, Middle East and we are focused on replacing legacy voice infrastructure with modern software centric platforms that provide immediate operating cost benefit And significant feature advances. In the case of these 4 operators, they have not made significant investments in this part of their network for years, But this is now a key part of their strategy to improve operating efficiency.

Speaker 2

The urgency to replace aging copper TDM networks with modern fiber based IP networks, while minimizing service disruptions continues to grow. With that, I'll turn it over to Mick to provide additional detail we will now turn the call back over to discuss outlook for the second half. Nick?

Speaker 3

Thank you, Bruce. Good afternoon, everyone. The Q2 of 2023, our financial results showed continued improvement over the prior year, bolstered once again by a double digit revenue growth in our IP Optical Networks please refer to our Investor Relations page on the Ribbon website for supplemental slides summarizing our Q2 2023 and historical financial performance. Let's begin with consolidated corporate financial results. In the Q2 of 2023, Ribbon generated revenues of $211,000,000 which is an increase of $5,000,000 or 2% from the prior year and 24 we expect to be approximately $1,000,000 or 13% increase from the Q1.

Speaker 3

Non GAAP gross margin was 52%, which is about 300 basis points lower than prior year, mostly due to the change in business segment revenue mix and a 400 basis point improvement from the previous quarter, Driven by revenue increases and product mix. Non GAAP operating expenses were $90,000,000 a decrease we are pleased to report that we are executing on our financial results of $6,000,000 or 6% year over year and down $5,000,000 from the previous quarter. As announced earlier this year, we implemented a strategic restructuring plan to streamline operations, reduce costs and focus our growth areas. We have optimized real estate, renegotiated supplier terms and driven headcount synergies. We definitely are on track to exceed our operating expense reduction target of $20,000,000 year on year.

Speaker 3

Our non GAAP net income was $8,000,000 we generated a non GAAP diluted earnings per share of $0.04 Our non GAAP tax rate for the quarter was 30%. Our interest expense for the quarter was $6,800,000 which is a $2,000,000 increase from the previous year. Non GAAP EBITDA was $23,000,000 in the quarter, which is a $2,000,000 or 9% improvement year over year And a positive change of $25,000,000 from the previous quarter. Our basic share count was 170,000,000,000 shares And our fully diluted share count was 175,000,000 shares for the quarter. Now let's look at the results of our 2 business segments.

Speaker 3

In our cloud managed business, 2nd quarter revenue was $125,000,000 a decrease from 9% year over year. As you may recall, Q2 of 2022 was the highest revenue for the year for Cloud and Edge, led by strong sales to our largest customer. Software as a percentage of total product revenue was 57%, which is in line with prior year and a 16 percentage point increase we are now ready for the Q1. The Cloud and Edge business had a non GAAP gross margin of 67%, slightly down from 68% in the prior year and up 5.40 basis points from the 1st quarter. Adjusted quarterly EBITDA was $35,000,000 or 28 percent of revenues.

Speaker 3

Let's turn to our IP Optical Networks we recorded 2nd quarter revenue of $85,000,000 which was an increase of $17,000,000 or 24% year over year and $14,000,000 or 19% versus prior quarter, led by growth in North America, India and Japan. Non GAAP gross margin for IP Optical was 31%, which is about 3 50 basis points higher than the previous quarter And 200 basis points higher than the prior year, fixed cost absorption is a key factor in IP optical networks gross margin. At current levels, for every $10,000,000 of incremental revenue, the gross margin improves by about 200 basis points. For example, if revenue grows $10,000,000 from the current level of $85,000,000 to $95,000,000 the current gross margins of 31% will improve by 200 basis points to 33%. With more revenue increases and improvements in product mix, we can achieve our target gross margins in the mid to upper 30% for IPP optical networks.

Speaker 3

Non GAAP adjusted EBITDA loss for the quarter was $12,000,000 which is an improvement of about $10,000,000 year on year and over previous quarter. With revenue growth in the second half, improved mix of products and lower operating expenses, we continue to strive for profitability in this business segment. We ended the quarter with $35,000,000 of cash and cash equivalents, which is a decrease of $11,000,000 from the previous quarter. Our revolver remained undrawn at quarter end. Cash used from operations was $3,000,000 capital expenditures were just $2,000,000 And we made our quarterly $5,000,000 term loan repayment.

Speaker 3

We expect to have higher working capital requirements in the 3rd quarter as we grow the business in the second our senior term loan balance is $245,000,000 and our preferred stock and warrants are valued at $55,000,000 per we completed the bank covenant calculations, which include preferred equity and total debt among other adjustments. We complete both of the amended term loan covenant metrics in the 2nd quarter. Now, I'll turn the call back to Bruce to provide more comments on our outlook for the Q3.

Speaker 2

Great. Thanks, Mick. As I look into the second half of the year, it's clear that our strategy to diversify the company has become increasingly important and is working. From an industry perspective, enterprise has become a significant new growth vector for the company it counterbalances variances in service provider spending. From a portfolio perspective, the addition of IP routing and optical transport has opened major new opportunities such as the U.

Speaker 2

S. World Broadband segment. And from a geography perspective, the company is very well positioned in high growth areas

Operator

we have

Speaker 2

a strong financial performance in the second half of the year benefit from this strategy and are based on 4 key assumptions. 1st, in the North American service provider market, we expect the elevated spending by U. S. Rural broadband providers we expect to continue and likely increase over the next several years as new funding sources become available. Our portfolio is a great fit and we're taking share.

Speaker 2

We expect the rural broadband opportunity to offset more constrained spending by Tier 1 U. S. Service providers in 2023, With increased spending anticipated in 2024 for voice network modernization given the compelling business case to reduce operating costs. As I mentioned earlier, we've also seen increased activity in this area across multiple regions with service providers who have not made this a priority in the past. Second, we will continue to gain share in the enterprise market vertical as investment in communication and collaboration platforms enables companies to improve their efficiency and effectiveness.

Speaker 2

This includes several major U. S. Federal opportunities that we anticipate being awarded in the second half, where we are very well positioned and expect to generate significant revenue. Where it makes sense, we're transitioning the business model with enterprise customers away from perpetual licenses to subscription models that will create a more predictable recurring revenue stream for the business. 3rd, the growth we've experienced in India and several other countries in the Asia region will continue as 5 gs deployments accelerate and the strategic wins we've announced in the region enable us to gain share in both IP routing and optical transport.

Speaker 2

I expect a number of new opportunities to mature and create further growth in 2024 in this region. And finally, in the EMEA region, the second half of the year looks we are confident that we will continue to be strong with increasing investment from critical infrastructure providers in Europe and service providers in Africa and the Middle East. Underpinning our strategy is the investment we've been making to expand our portfolio and introduce new products that enable a more open architecture and ecosystem. As we announced at the OFC Optical Conference earlier this year, we're very excited about the new Apollo 9,400 platform that will be first to market with industry leading 1.2 terabit per second wavelengths, leveraging the latest in 5 nanometer DSP silicon. The 9,400 uses less than half the power per bit of competing solutions with industry leading density in a compact modular pluggable form factor.

Speaker 2

We expect to be in customer testing this quarter and early production in the Q4. In our IP routing portfolio, we continue to expand our Neptune XDR2000 series with new variants that significantly expand our addressable market and the types of networks where we can be deployed. The latest new product that begins to ship this quarter is the Neptune 2,400, which is a perfect fit for metro networks supporting Mobile XOL applications and broadband aggregation. Equally important is the growing set of IP routing protocols supported by the platform, including next generation segment routing capabilities and advanced features such as EVPN. The significant investment we have made in expanding our IP optical product line has resulted in 19% growth in the first half of twenty twenty three.

Speaker 2

We expect to continue that trend in the second half, we are reporting the 15% plus growth target for the year. We also continue to target profitability on an adjusted EBITDA basis for this segment in the second half of twenty twenty three as higher volumes enable improved margins and better regional mix. In our Cloud and Edge segment, the strong growth in enterprise sales in the first half has mostly offset lower U. S. Service provider spending.

Speaker 2

We expect 3rd quarter financial performance to be similar to the 2nd quarter, followed by our typically seasonally strong 4th quarter. For the full year, we expect CloudMedge earnings contributions to be higher than 2022, primarily due to lower operating expenses. Our early view on 2024 indicates a recovery in spend by North American service providers for voice network modernization, which would be additive to the continued growth in enterprise and federal. Based on the above backdrop and assumptions for the Q3, we're projecting revenue in a range of $215,000,000 to $225,000,000 non GAAP gross margins of 51.5 percent to 52.5 percent and non GAAP adjusted EBITDA in a range of we expect to be approximately $6,000,000 to $32,000,000 for the quarter. For the full year, we continue to believe our revenue guidance range of $840,000,000 to $870,000,000 is Achievable.

Speaker 2

Operating expenses are on track to exceed the lower spending targets we established. Due to the overall projected mix, adjusted EBITDA is currently tracking to the lower half of our $95,000,000 to $110,000,000 range, which will be a significant 50% improvement year over year. We have a great pipeline of opportunities and as with most years, we expect the 4th quarter to be the strongest quarter of the year. Operator, that concludes our prepared remarks, and we can now take a few questions.

Operator

Thank you. We will now be conducting a question and answer session. Thank you. Our first question is from Christian Schwab with Craig Hallum Capital Group. Please

Speaker 4

Congratulations on the strong results. So as we move to roll

Speaker 2

Hey, Christian, I apologize, you're breaking up, I think. Try again, Christian.

Speaker 4

I'm sorry about that. I was asking on rural broadband. Could you tell us how big that could be over a multiyear time

Speaker 2

Yes. So, thanks, Christian. Good to connect again. So obviously, we Seeing that grow substantially here this year, I think we're up about 3 times from what we were doing last year. I think there are some upper bounds just from a construction resource perspective in the whole industry.

Speaker 2

It's hard to predict exactly what the growth looks like next year. It's not a lack of funding at this point, particularly as bead funding starts to flow in Into the second half of next year, I think the limitations are going to be more at the pace that they can do construction and drive fiber. But as the Funding envelope increases, the amount of addressable market for us certainly is going to expand. So I expect it to grow pretty well going into next year.

Speaker 4

And then on the IP optical business, can you tell us how many customers You know that you're selling to currently and what we should anticipate that number of customers to expand to say by the end of 'twenty four as

Speaker 2

Yes, that's a good question. I don't have a number off the top of my head. In a particular quarter, the majority of the revenue will come from several dozen customers within the quarter, let's say. And we are definitely adding customers every quarter. A number of our projects are with critical infrastructure projects or operators.

Speaker 2

And so every quarter there's somebody new being added. We do try and kind of keep a good cadence of press releases every quarter on some of the more strategic adds we've had within a quarter. So I think that gives you an indication of kind of the velocity every quarter of new names being added. And of course, some are smaller projects and some can account for much larger revenue stream in the future.

Speaker 4

Great. And then my last question, I know you guys have talked about for some time landing material business Even on the optical side, with the top Tier 1 carriers, do you have any update For us on how that's going or is that something you're enthusiastic for over the next 12 months?

Speaker 2

Yes. So there's definitely a healthy pipeline here in 3 primary regions, North America, Europe and Asia Pac. Obviously, we've announced some already with the expansion with Bardy, with the wins in Africa with MTN, Singtel, Optus in different regions, Rogers in Canada, we're clearly kind of building momentum. In my remarks, I And although we haven't announced any names there, I think those are pretty significant opportunities and wins for us. And I think as I mentioned, it was about 5% of revenue in the 3rd quarter.

Speaker 2

So stay tuned. We're definitely focused on that part in addition to kind of building the momentum With Regional Telecom and with critical infrastructure providers.

Speaker 4

Excellent. Thanks. No other questions. Thank you.

Speaker 2

Yes. Thanks very much, Christian.

Operator

Thank you. Our next question is from Tim Savageaux with Northland Capital Markets. Please proceed with your question.

Speaker 5

Hey, hi, good afternoon. Couple of questions, maybe following on some of that recent discussion. And I think you talked about for IP Optical, U. S. At 15%.

Speaker 5

I assume rural is The vast majority of that, I think you talked about U. S. Rural being 10% of IP optical revenue last quarter. And it's clear you expect that to grow. My question is, how should we and you've talked about Japan, how should we relate that to India?

Speaker 5

And you talked about growth in India. I assume that's your single largest market, e. G. Greater than the U. S.

Speaker 5

From a country standpoint, not a region standpoint, but is there a scenario with this rural broadband growth out a couple of years? Can that become bigger than some of these big markets you're talking about now? Can you just kind of maybe size India where it is right now and what sort of margin implications does that U. S. Rural broadband growth have for the segment?

Speaker 2

Yes, great all good questions, Tim. So the 15% of sales was a North American number And rural broadband, a significant portion of that. As you recall, we've got a number of other customers in North America, including Rogers up in Canada that all to that 15% of sales, but the world broadband portion was more than half of that, certainly in the quarter. As you kind of compare it to India, India is still significantly larger than North America today. I think more than 2 times, Mick, right, in that ballpark.

Speaker 2

So, of course, we have one large customer in India with Barty that we've enjoyed good growth here this year. As I mentioned, getting kind of back to maybe where we were a few years ago it was our strongest quarter we've had since we merged the companies together. So back to your final question on how big can rural be, in some ways, we're just getting started. I mean, we've had some really good success with customers That know us well, that have other products from us deployed today and that's allowed us to start to build a good pipeline with new customers. I don't know if it can be bigger than India.

Speaker 2

I mean India is 1,200,000,000 people, 3 major operators there that I think are going Drive a lot of scale. We're deployed in enterprise markets in India as well with partners like TATA teleservices and folks like that. So I think that's going to remain a really significant market for us.

Speaker 5

Great. And maybe similar question around Japan. I mean, I think you're implying your Fraction there is likely with Tier 1 carriers, but how significant can that get for you over time?

Speaker 2

Again, we're kind of just entering the market. I mean, it was great to see some of the momentum there with several A number of different use cases both in optical as well as in IP. So I'm pretty excited about that market. We've got a great infrastructure in place in Japan. It was one of the kind of strategic elements to the combination several years ago and focused on cross selling, it's taken us a while to go through The vetting process go through the testing process now into commercial service.

Speaker 2

So it will add another plank to the operation here for us For sure.

Speaker 5

Okay. And last question for me. Obviously, after a very strong Q1, IP optical orders came Pretty significantly in Q2, I guess how would you characterize that and what are your expectations for orders in IP optical in the second half?

Speaker 2

Yes. So there were kind of two reasons why the order velocity was lower in the second quarter, all related to the strong first quarter. I'd mentioned previously that part of the bookings in Q1 was a large multiyear agreement with defense operation in Europe, a portion of those orders were for the Q2. So we were shipping those in the Q2. Normally, we would have gotten those bookings in the Q2, but they were all accelerated into Q1.

Speaker 2

And then the other part was around some of the expansion market share expansion in India with Bardi and some of the larger orders that we're shipping against in the second and third quarter. So I'm not although obviously numerically the number is down in the second quarter for the first Half, I think we're at 1.15 for IP optical for the first half or 1.14 some number like that. So I still feel good. Obviously, For the second half of the year, we're still projecting growth going into the second half. I think to achieve our 15% plus Annualized growth number, the second half will grow more than 10% versus last year.

Speaker 2

We're feeling good about the velocity in the second half here.

Speaker 5

Great. Thanks.

Speaker 2

Thank you, Tim.

Speaker 6

Thank you.

Operator

Our next question is from Dave Kang with B. Riley. Please proceed with your question.

Speaker 6

Thank you. Good afternoon. First question is on the IP Optical. Just wondering if you can talk about their EBITDA trajectory in second half and into next year, I mean, will they be positive? And just wondering If it will dip into negative in Q1 next year before becoming positive in Q2, just if you can help us out.

Speaker 2

Yes. So I think if you do the modeling on the business here with assumptions on margin and OpEx and whatnot, The target for the second half is to get to EBITDA breakeven and positive. So that's what the whole team is focused on. That's the reason we've done the acquisition. This business needs to contribute.

Speaker 2

You need to be in the $100,000,000 plus Range per quarter with where margins are projected to be there and that's what the target is for the second half. We do find that the first quarter tends to be a lower quarter every year. So whether we'll be at that level or not in the Q1 is a little too early for me to provide additional commentary on, but the focus here is on the second half and making sure we get to that mark in the 3rd Q4 combined.

Speaker 6

Got it. And then I believe regarding the supply chain situation, I think that impacted your revenue by about $10,000,000 in Q1. Just wondering what that was in Q2?

Speaker 2

Yes, it was very similar, Dave. Really the same sort of issues as we're ramping, in particular our long haul products and our cell site router we could have shipped more in the quarter again, not unlike others, I'm sure, right? So I didn't comment on it this time, but Very, very similar in the Q2. I do think we get more caught up in the Q3 on some of the longer lead time parts on the new products. So as I mentioned, I think that as we get into the second half of the year, the majority of those existing issues are behind us.

Speaker 2

Who knows what new surprises we find in the future?

Speaker 6

So should we expect something like maybe $5,000,000 impact in 3rd quarter or is it going to just Quarter was 0.

Speaker 2

It's in that ballpark probably, Dave. There's always something that ends up Kind of hanging out to the next quarter, so it's probably in that ballpark, yes.

Speaker 6

Got it. And then just wondering what the split is between I know you gave IP routing growth. Just wondering if you can split What IP versus optical is? And what's their margin differential between IP and optical?

Speaker 2

Yes. So I think we've talked historically that the split is in the 35% to 40% range for IP routing. Obviously, that's been increasing over the last several quarters with the growth rate around IP. I think we're I think it's over 40% now from a product revenue perspective, with the recent growth. Now you've seen both businesses grow.

Speaker 2

I think optical grew about 20% and IP grew about 40%. So optical is not standing still either, it's growing. But I think the mix continues to shift more towards IP routing and that's what we expect to see over time as well.

Speaker 6

And what's their margin differential? Is it about 5%, 10% something like that?

Speaker 2

Yes. So we don't break that out. It varies by region and the type of product. If you're if it's a higher volume CellSight router type product, that tends to be a little lower margin. If it's more a high performance 4 terabit routing platform, that's much better margin.

Speaker 2

So it can vary a little bit, Dave, just depending on the mix and the type of products we're shipping in the quarter. In general, the trend is towards higher margin on the IP products.

Speaker 6

Got it. And my last question is actually on clarification. Did you say C and E will be kind of flat ishier or maybe I misheard?

Speaker 2

Yes. So I'd characterize the 3rd quarter is being similar to the 2nd quarter with a stronger 4th quarter. And overall in the second half, earnings contribution will be up from last year. So I've kind of given those two data points.

Speaker 6

Got it. Thank you.

Speaker 2

Okay. Thanks, Dave.

Operator

Thank you. Our next question is from Greg Mezenhof with West Parr Capital. Please proceed with your question.

Speaker 7

Thank you. My question is on the Cloud and Edge segment. You had mentioned in the call that you're in the process of transitioning your revenue model from 1 of a perpetual license to A subscription based model and I totally understand why you're doing that, namely Smooth out the lumpiness that this business has had. Can you kind of give us a little more color as to what the steps are to kind of proceed down that path and where you are in that process? In other words, are you keeping your existing customers on perpetual licenses And starting new ones with the subscription model or are you weaning the older customers off the perpetual license to the subscription model?

Speaker 7

And then I have a quick follow-up. Thanks.

Speaker 2

Yes. Hey, Greg, good question. So most of it's first of all, it's mostly in the enterprise space, not in the service provider or the carrier space, most of the acceptability or interest is in the enterprise side. There's a couple of different models there. There is if you look at our RibbonConnect offer as an example, which is A completely cloud based multi UCaaS platform for Microsoft Teams or Zoom or Cisco WebEx, That's a per subscriber, per seat, per month pricing model.

Speaker 2

And that's a fairly small business today, but that's Obviously, a typical as a service type revenue stream, small but growing. The other Type note kind of approach to subscription licenses is moving from a perpetual license for, let's say, an SBC to a term license and perhaps an enterprise wide type license, an ELA that includes software licenses, it includes maintenance, it includes professional services, and that's a much more kind of significant transition that we're in underway. And it provides the ability to renew those licenses every year or whatever period that you set up the term license for. And that's probably the most significant transition, and it's a combination of both new customers and existing customers. Many of the products like a session border controller or analytics platforms, which are highly software high software content really lend themselves to that model and we're finding a lot of interest in moving in that direction.

Speaker 7

Are customers being receptive to this transition, would you say, especially the legacy larger ones on the carrier side?

Speaker 2

Yes. I wouldn't describe it as we're trying to force it. We'll meet the customer wherever the economics are best to meet their needs. So most of the cases, this is not just a receptive thing, the customer is very interested in that type of approach. Again, it's mostly around enterprise, not so much around the carrier side, although the RibbonConnect platform, as I mentioned, is used by a number of carriers and it supports their managed service offering to enterprises.

Speaker 2

So it fits that

Operator

thank you. Our next question is from Erik Suppiger with JMP. Please proceed with your question.

Speaker 8

Yes, thanks for taking the question. Couple of questions. First off, did you see I believe Verizon was a 10% customer. Did you see some of the adjustments to inventory that were noted by the likes of Ericsson and Nokia In terms of some of these carriers working down some of their inventories or was Verizon in the range that you had been expecting? And then secondly, your guidance implies Q4 gross margins picking up Fair amount.

Speaker 8

Is that just a normal seasonal uptick? Or is there anything in Q4 that's going to be Particularly beneficial to gross margins.

Speaker 2

Yes. Thanks for the questions, Eric. So from a Verizon perspective, we had just a great quarter a year ago in the Q2 of 2022. We had a variety of voice modernization programs with them, all basically going to revenue in the 2nd quarter. So in a lot of ways, it's not a fair comparison.

Speaker 2

It's the best quarter we ever had with Verizon a year ago. And so the step down year over year is pretty substantial. As I mentioned though, if you excluded Verizon from our revenue in both ends, the service provider business was actually up year over year. So it was just it's primarily a phenomenon, it's a strong quarter a year ago. So it wasn't what you're hearing, I don't think from others around inventory story build and those sorts of issues, Eric, it's really just the year over year comparison that's a little tough.

Speaker 2

And It ends up exactly where we predicted it was going to be in the quarter and very consistent to the previous quarter. I think if you see our 10 Q that will come out, you'll be able to see the percentage of revenue that we report for our 10% plus customer there. Yes, from a Q4 margin perspective, yes, so we do expect Q4 margins to be stronger in both businesses, as Mick mentioned, pretty in a lot of detail, the increased margin around IP optical, a lot due to just the increased level of revenue and the fixed cost absorption driving a higher gross margin percentage. In Cloud and Edge, it tends to be the mix. Obviously, the velocity makes a difference as well, the revenue level, but we have a good pipeline of The larger deals both enterprise and service provider in Q4.

Speaker 2

We have, as I mentioned, this Kind of transition on models towards more annual ELAs that benefit us and just the software mix in general stronger in Q4, but your model Sounds correct.

Speaker 8

Okay. And then lastly, last quarter you had discussed new products Contributing about 20% of IP optical revenues. Can you provide any update or any color that you can add to that?

Speaker 2

Yes, I think it's similar, Eric. Unfortunately, I don't have that number in front of me. Tom is going to have to go do some more research on it. I apologize.

Speaker 8

Okay. That's fine. Thank you.

Speaker 2

Thanks, Eric.

Operator

Thank you. Our next question is from Tim Savageaux with Northland Capital Markets. Please proceed with your question.

Speaker 5

Hi, sorry about that. I just wanted to follow-up. And it looks like and the subject is kind of profitability in IP optical. It looks like in Q2, you brought your cost base down pretty significantly in terms of the breakeven revenue run rate in IP optical in particular. I don't know, dollars 5,000,000 $6,000,000 something like that.

Speaker 5

And that's reflected in your overall OpEx performance as well. So

Speaker 6

I guess

Speaker 5

the question is, is that about right? Is that where you expect it to stay? It looks like you're forecasting your EBITDA loss in IP optical to be cut in half or maybe a little more again here in Q3. I'm assuming that's revenues increasing gross margins as Mick described in kind of flattish Sort of OpEx in that kind of high-30s range. Is that a reasonable way to look at things?

Speaker 5

And then obviously another quarter that you're looking to be EBITDA positive in Q4.

Speaker 2

Yes. So, I don't want to parse the Q3 guidance Too much. It's directionally correct. What you said is absolutely directionally correct. In order to get the breakeven in the second half, it's a combination Q3 and Q4 and I think the Q4 volumes are higher, so the profit will be higher.

Speaker 2

The cost improvements, the spending improvements that we've made, we're ahead of plan, we're ahead of what we committed we were going to do for the year, a portion of that's benefiting both of the businesses. If I remember right, in Q2, I think we're about $3,000,000 better on OpEx in IP optical, But there's also some savings above the gross margin line in the cost of service and whatnot as well. We do think that is that plays forward at that level, certainly at the company level. I think, Mick, we were at $90,000,000 of OpEx in Q2, and we expect to be in a similar range, Plus or minus $1,000,000 sort of thing in Q3 and Q4 and that would get us to greater than the $20,000,000 net savings for

Operator

thank you. There are no further questions at this time. I would like to turn the floor back over to Bruce McClellan for any closing comments.

Speaker 2

Okay, great. Well, thanks, Paul. Thanks, everyone, for being on the call here with us again today, your interest in Ribbon Communications. We have a number of upcoming investor conferences, so we look forward to meeting everyone there and continuing the dialogue. Thanks very much, operator.

Speaker 2

Appreciate your help and that concludes our call.

Operator

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

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Earnings Conference Call
Ribbon Communications Q2 2023
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