Ribbon Communications Inc. (RBBN) Q4 2021 Earnings Call Transcript

Ribbon Communications Inc. (RBBN 0.39%)
Q4 2021 Earnings Call
Feb 16, 2022, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to Ribbon Communications' fourth quarter 2021 financial results conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tom Berry, investor relations. Thank you.

You may begin.

Tom Berry -- Investor Relations

Good afternoon, and welcome to Ribbon's fourth quarter and full year 2021 financial results conference call. I'm Tom Berry, investor relations of Ribbon Communications. Also on the call today will be Bruce McClelland, Ribbon's chief executive officer; and Mick Lopez, Ribbon's chief financial officer; and Sam Bucci, general manager of Ribbon's IP Optical Networks business. 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 slides are currently available.

Certain matters we will be discussing today, including the business outlook and financial projections for the first quarter of 2022 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 2 of the supplemental slides for this conference call.

In addition, we will present non-GAAP financial information on this call. Reconciliations to the applicable GAAP measures are included in the earnings press release we issued this afternoon, as well as in the supplemental slides for this conference call, which, again, are both available on the investor relations section of our website. And now I would like to turn the call over to Bruce. Bruce?

Bruce McClelland -- Chief Executive Officer

Thanks, Tom, and thanks to everyone for joining us. I'd like to start the call this evening with a short assessment of our performance in 2021 and the actions we're taking to improve our results going forward. Despite incredible efforts by the employees of Ribbon during a challenging year, we were disappointed with our financial results for 2021. When we started the year, we had expected to achieve growth in both revenue and earnings.

We have just completed a difficult 2020 with the onset of COVID but performed exceptionally well despite this and posted improvements every quarter throughout the year. Of course, there are several reasons we missed our growth goals in 2021. We had extended COVID challenges, supply chain issues, heightened employee attrition and regional headwinds in areas like India, to name a few. But ultimately, our primary challenge has been the length of time it takes to convert our new IP optical customer wins into sustainable revenue, while the investment that's needed to obtain and execute on the wins and develop our road map were immediate investments.

Similar to others in the industry, we've also been impacted by more than we expected by escalating macro supply chain issues from both the cost and predictability perspective. And we were particularly surprised by the increased intensity of issues in the last several weeks of 2021 and the impact it had on shipments and product costs. Costs across many of our products have increased. And as a result, we've adjusted our forward margin projections for fiscal '22.

We've taken a variety of actions to mitigate these issues, and the recent weeks have begun to see stabilization. But we remain cautious and are not assuming any significant improvement in component lead times throughout the remainder of the year and have adjusted our forecasting process to more accurately account for these issues. We have a strong funnel of IP optical opportunities and a growing list of new strategic wins that has significant and long-term growth potential. While conversion of these opportunities into revenue is taking longer than we expected and has been adversely impacted by supply chain issues, we are projecting year-over-year revenue growth of at least 10% for the IP Optical segment in 2022.

In the critical North American region, we grew by 164% last year, and we're targeting greater than 50% growth again in 2022. Other regions such as Japan, India and Australia are also expected to contribute to our projected 2022 growth outlook. As we've discussed previously, our investment in IP Optical Networks spans three product categories: optical transport, IP networking and domain orchestration and element management. We believe there are strong linkages between each of these technologies, and the combination is a powerful differentiator.

As a result, we've been increasing our R&D intensity in the IP optical portfolio, increasing 15% in 2021. And I expect the investment in 2022 to be 25% higher than our 2021 investment rate. I'd ask Sam Bucci, the GM of our IP Optical business unit, to join us this afternoon to provide a little more detail on the key investments we're making and where he is seeing best growth opportunities based on his 20-plus year career at Nokia and Alcatel-Lucent, leading their optical business. Sam?

Sam Bucci -- General Manager, Ribbon's IP Optical Networks Business

Thank you, Bruce. From a macro perspective, demand for bandwidth continues to grow at unprecedented levels as 5G deployments accelerate and adoption of cloud networking and remote work create new traffic patterns and operational complexity. Dealing with these challenges while lowering total cost of ownership requires an IP Optical Network solution with better economics and a stepwise improvement in operational efficiency and simplicity. We are increasing our investment in developing solutions which provide optimized hardware and automation software within an open architecture, all under an umbrella of customer collaboration.

This includes fit-for-purpose IP routing optimized for multiservice access, aggregation and metro networks; 400-gig optical transport everywhere; and practical automation software, which enables service providers to cross the automation divide at their own pace. To be more specific, our portfolio investment strategy revolves around three pillars. First, in our Neptune IP routing portfolio, we are adding several new solutions, notably the introduction of the Neptune 2000 series next generation of IP routers powered by our real-time network operating system. The Neptune 2000 series provides best-in-class economics for IP transport networks with a full range of form factors and payers who use pricing options, up to 16 terabits in capacity.

The platform provides converted support for Ethernet, IP and POS, segment routing, flex Ethernet, TDM to IP, OTN and WDM, all optimized for aggregating, routing and backhauling traffic from the multi-service access edge to the IP core. The Neptune 2000 series routers support WDM interfaces up to and including 400-gig ZR and ZR+ IP over WDM applications. The Neptune 2000 series is built around the Ribbon real-time network operating system, a state-of-the-art telco-grade NOS, which is based on Neptune's widely deployed routing software. The RNOS can be sold and deployed either on our own platforms or on third-party white-box platforms.

The second pillar of the portfolio is the Muse SDN multilayer orchestration. Muse provides advanced network planning, control and automation applications, including analytics, workflow engines and closed-loop processes to deliver practical automation from human-assisted to cognitive software intent-driven under an open and flexible cloud-native software architecture. Muse provides modernized network management for Ribbon's IP optical products, as well as advanced SDN-based capabilities related to service fulfillment and assurance such as multilayer optimization, network slicing and preplanned restoration, among others. The Muse cloud native architecture incorporates low-code techniques to enable DevOps space tailoring to the specific needs of the network operator.

The third pillar of the portfolio is our Apollo optical networking solution, where investments are being made to expand the portfolio to support 400 gig transport everywhere, recognizing that 400 gig is the capacity of choice going forward in Metro, offering the best trade-off between performance and cost. We see significant opportunity for differentiation, particularly around the software aspects of our products and have refined the road map through extensive discussions with both existing and potential new customers. Our strategy is to lower total cost of ownership and reduce operational complexity by enabling practical automation in a more open ecosystem and network architecture with an end-to-end suite of products. This is key to our differentiation and how we win.

We recently received a Lightwave Innovation Award for the multi-layer optimization capabilities of our Muse network planner, which demonstrates industry recognition of our approach to reducing cost and complexity using our multilayer optimization engine. Bruce, I'll turn it back to you.

Bruce McClelland -- Chief Executive Officer

Great. Thanks, Sam. We expect these investments will result in substantial growth and establish Ribbon as a significant player in IP and optical networking. To capture this longer-term growth, we expect 2022 to be an investment year and are projecting negative adjusted EBITDA of approximately $35 million for the IP Optical segment.

In light of our projections, we analyzed the carrying value of our IP optical goodwill and took a noncash accounting charge in the fourth quarter. In our Cloud & Edge segment, the secure voice over IP business continues to be a great foundation for the company, and our visibility into 2022 is solid. We expect continued investment by many of our service provider customers as they modernize their voice networks and address their aging infrastructure, also helping them meet increasing environmental regulatory requirements. The backdrop of accelerating usage of platforms, such as Microsoft Teams and Zoom, provide an excellent opportunity for growth for our Cloud & Edge business.

And the continued investment we are making both in road map and go-to-market support our projections for this business. And as both service providers and enterprises increasingly adopt cloud computing paradigms, our investment to adapt our voice-over-IP portfolio to leverage cloud native technologies provides some additional growth opportunity to the business. We had our first significant Telco Cloud win in Q4 with a major mobile carrier in Japan, who have selected our cloud native session border controller for deployment in their network. In addition, the dedicated go-to-market enterprise sales team we've created in the middle of last year to better address the growing enterprise market opportunity is bearing fruit and we had promising results in the fourth quarter, including new customer wins across the financial, IT and automotive verticals.

As an example, we had a significant win with our partner Infosys to deploy an integrated digital transformation solution with one of the world's largest automobile brands as they transition from a legacy on-premise PBX system to Microsoft Teams. This new collaboration with Infosys offers a pre-integrated solution leveraging our Microsoft-certified core and edge session border controllers and centralized policy manager to simplify and accelerate communications upgrade to large corporations with complex requirements. Overall, we expect the growth from Enterprise and Telco Cloud to mostly offset any decline in traditional service provider spending but are conservatively projecting flat to slightly down overall Cloud & Edge revenue in 2022, with approximately 8% lower opex and a very profitable contribution to the company with adjusted EBITDA projected in excess of $150 million for 2022. To support the investment in critical growth areas, we're implementing a strategic restructuring to streamline operations.

We'll sharpen our focus on the areas where we have the best opportunity to grow and further reduce investment in more mature product areas, while also lowering overall corporate expense overhead. We expect the majority of these changes to be completed in the second quarter and reduce our operating expense run rate from the $100 million level in the first quarter to approximately $95 million per quarter for the rest of the year. Changes include reductions within G&A, R&D and sales and marketing, as well as reduced real estate occupancy as we implement a more flexible work-from-home environment that employees have requested to continue post COVID. In summary, we continue to believe in the strategy behind the business.

We've been able to leverage the traditional Ribbon voice-over-IP business to position our software and hardware portfolio of IP networking and optical transport products. And we continue to win important new customers each quarter. In particular, we're making real progress identifying entry points with a significant number of major Tier 1 operators and are investing heavily to capture this multiyear growth opportunity. The thesis is completely intact, and we believe patience will pay off with higher growth in subsequent years.

There were several great examples accomplished in Q4. We were awarded new business with a major multiservice communications provider in Japan for an important TDM to IP migration project that will begin in the second half of the year. We were also selected as a new provider of optical transport solutions by MTN Group to provide mobile communication services in many African and Asian countries. And we are selected by a leading European railway operator for a major national backbone project, a hard-fought win against all the major competitors in the industry.

We also announced a data center win with Telehouse, an international colocation service provider based in London and owned by KDDI in Japan, along with several other projects, including manpower in Africa and an undersea cable project between Manila, Hong Kong and Singapore with IPS. Even more significantly, we've now started on a major project with a U.S. Tier 1 service provider to modernize their fixed voice infrastructure over the next several years that will significantly reduce the complexity and operating cost of their network. The solution combines our Telco Cloud voice core solution with technology from our IP optical portfolio.

It's a great example of the strength of our combined assets. We expect revenue to start on this project in the second half of the year and stretch over several years. Based on the above set of assumptions and initiatives, we're projecting overall revenue growth for the company of 2% to 4% in 2022, gross margins in the range of 55% to 56% and adjusted EBITDA of $110 million to $120 million. And with that, I'll turn it over to Mick to provide additional detail on our performance in the fourth quarter and first quarter 2022 guidance.

Mick Lopez -- Chief Financial Officer

Thank you, Bruce. Good afternoon, everyone. Beginning with our GAAP results. Our GAAP net loss of $96 million in the fourth quarter includes three significant amounts.

First, we have a goodwill impairment related to the IP Optical Networks segment reflected as a noncash accounting charge of $116 million. In light of lower revenue growth than anticipated last year and of our continued investment, we revised forward projections of the profitability of our IP Optical Networks reporting unit and as a consequence, have lowered its fair value in our books. We remain optimistic in the future growth of IP Optical Networks as we continued to invest in research and development to create truly disruptive technologies. We also had a $7 million loss in our GAAP income statement related to the quarterly mark-to-market of our investment in AVCT.

These two GAAP accounting losses were partially offset by an income tax valuation release of $28 million associated with the company's United States tax position as we have improved profitability expectations there. On an adjusted non-GAAP basis, fourth quarter 2021 results were as follows. Total revenue was $231 million, up 10% sequentially but down 5% organically year over year when adjusted for the sale of Kandy. Sales in the quarter were negatively impacted by approximately $10 million of shipments moving into 2022 due to supply chain-related constraints.

These constraints impacted both segments equally, with shortages of key routing silicon and other components. We continue to face constraints in these areas so far in 2022 and are taking those into account with our first quarter guidance. We also had several high-margin software deals that did not close but moved into 2022. None of these opportunities were lost, but they did impact our results in the fourth quarter.

Our book to revenue excluding maintenance was 1.14 times for the fourth quarter. Non-GAAP gross margin was 54% in fourth quarter '21, below our 58% guidance. The margin was negatively impacted by lower sales than expected, higher component costs and deal mix that we will explain for each segment. Non-GAAP operating expenses were $102 million for the quarter, up from $93 million in the third quarter as we had anticipated more investment in IP optical research and development, incurred more sales commissions and increased travel to customers.

Non-GAAP adjusted EBITDA was $26 million, which was $22 million above the midpoint of our guidance driven by about $12 million of lower revenue and $9 million of lower gross margins than anticipated. Non-GAAP diluted EPS was $0.01 in the fourth quarter. The lower guidance as a result of the lower adjusted EBITDA and a higher tax rate in the quarter. Our share count was 149 million for GAAP earnings 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 & Edge business, fourth quarter revenue was $147 million, down 5% on an organic basis, excluding Kandy. Those sales to enterprise customers nearly doubled compared to both prior quarter and prior year period. Gross margins were 64% in the quarter, but below our expectations due to higher component costs, higher freight and logistics and higher volume mix of hardware such as our session border controller enterprise edge products that carry lower margins.

While we expect first quarter margins will continue at above this level, we expect recovery into the mid- to high 60s in our margins as we improve revenue and expenses throughout the year. Non-GAAP adjusted EBITDA for Cloud & Edge was $37 million or 25% of revenue. After the seasonally slow first quarter, we would expect adjusted EBITDA percentage to revert close to the 30% range for Cloud & Edge. Now turning to our IP Optical Networks business.

We recorded fourth quarter revenue of $83 million, up 22% from $68 million in the third quarter with the majority of the increase coming from Europe and North America. Sales in India were up modestly versus the third quarter. Non-GAAP gross margin was 36% in the fourth quarter, down slightly from 37% in the third quarter. This was below our expectations by about 300 basis points driven by lower volumes, higher material costs and expedite fees, along with unfavorable customer and product mix.

As an example of mix, we had higher start-up costs with a new customer deployment. First quarter margins will likely be in the low 30% range as we continue to be challenged by these factors but are expected to improve as the year progresses and revenue grows. Turning to the balance sheet. We ended the quarter with cash and cash equivalents of $106 million, including $3 million in restricted cash.

This is an increase of $2 million from the previous quarter due to $11 million in cash flow from operations in the quarter. Capital expenditures were $3 million for the quarter. We met our quarterly financial covenants for our term loan. Fixed charge coverage ratio was 3.08 times, above the 1.25 times minimum.

Our bank leverage ratio was 2.79 times, below the 3.5 times maximum for the fourth quarter. This maximum for this covenant metric will decrease to 3.25 times at the end of March 2023. Lastly, we have announced a strategic realignment of our investments toward key areas of growth, which includes some restructuring charges for 2022. As Bruce noted, we anticipate that Ribbon will improve our operating expenses by $5 million per quarter starting in the second quarter.

We anticipate taking a restructuring charge of approximately $6 million from employee separation expenses and about $14 million for real estate optimization. Now let's turn to first quarter guidance. The first quarter is always the seasonally low point for our business. And after considering continued supply chain procurement challenges and costs, we are projecting Q1 revenue to be approximately 10% lower than prior year and in a range of $165 million to $180 million.

In our Cloud & Edge segment, we had a smaller number of network transformation projects completing this quarter, reducing both product and professional service revenue. This has a heightened impact on margins and earnings for the first quarter. We have a good visibility on 2022 projects with many of our core base of customers and expect revenues through the remainder of the year to be at similar levels to 2021, along with potential and additional growth related to the new network modernization project Bruce mentioned earlier. In the IP Optical segment, we have visibility for demand above the guidance range but are adjusting for potential delivery challenges late in the quarter.

We're also cautious about the potential impact to demand in Russia, Ukraine and surrounding areas related to heightened political tensions. We expect IP Optical margins to be lower than normal this quarter due to lower volumes, supply chain cost and customer mix. Overall, we anticipate Ribbon's gross margin in the quarter to be 50% to 51%. We do not expect significant benefits from our restructuring efforts in the first quarter and estimate operating expenses in the $100 million range.

The combined effect is an abnormally low adjusted EBITDA loss outlook of $5 million to $11 million in the first quarter. For the remainder of the year, we anticipate that we will return to adjusted EBITDA positive margins in the mid- to high teens as we experience revenue growth, fewer supply chain disruptions and improved expenses from restructuring. I'll turn it back to Bruce for a few closing remarks before we open it up to Q&A. Bruce?

Bruce McClelland -- Chief Executive Officer

Thanks, Mick. Once again, I'll emphasize that we continue to believe in the strategy behind the business. We have a growing number of proof points and strategic wins and are investing heavily to capture this multiyear growth opportunity. The thesis is completely intact, and we believe patience will pay off with higher growth in subsequent years.

I'd like to thank the employees of Ribbon for their dedication and efforts in 2021. And I know they're committed to executing on our plans in 2022 to realize our growth objectives. Operator, that concludes our prepared remarks, and we can now take a few questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from the line of Tim Savageaux with Northland Capital Markets. Please proceed with your question.

Tim Savageaux -- Northland Capital Markets -- Analyst

Hi. Sorry about that. Can you hear me?

Operator

Yes. Now we can.

Tim Savageaux -- Northland Capital Markets -- Analyst

OK. Great. Sorry. A couple of questions kind of on the demand environment and maybe directed toward Sam since we have him on the call and sort of kind of different aspects of the carriers you might be pursuing.

You mentioned a pretty robust pipeline from a Tier 1 perspective. I wonder what your outlook is for that pipeline moving toward a decision in '22? I imagine there's not a lot included in guidance for any new wins, but more ramping what you've already got, but a review of that on the one hand. And then I want to follow up and talk about kind of U.S. rural broadband-driven type opportunities?

Bruce McClelland -- Chief Executive Officer

Yeah. Hey, Tim, it's Bruce. Thanks for the question. Yeah, I think you're right.

We -- trying to estimate the exact timing of when we start to see revenue from new wins is one of the challenges we've got in predicting the business. The majority of what we've projected for '22 is with the set of customers that we have in the win column already and ramp throughout the year. I think as you know, the regions that are largest for us today is the European region, the India market. And where we're really focused on growing is in North America.

And it was great to see the progress we made last year in North America with the series of customers like Rogers and Viaero Wireless that we've mentioned. And as we talked about in the call, the engagement we have with just a broad set of customers is pretty exciting, but trying to estimate the exact timing is a little trickier. So we've tried to be a little more conservative in the outlook for this year.

Tim Savageaux -- Northland Capital Markets -- Analyst

I guess to follow up on that, you did say you expect maybe 10%-plus growth. I mean, what factors could -- maybe outside of the obvious, which is maybe a better supply environment, could lead to upside to that outlook for IP optical growth?

Bruce McClelland -- Chief Executive Officer

Yeah. So what we're seeing, Tim, right now, is just a really active RFP environment with a whole variety of different customers in different regions, so both North America and Europe and Asia, I mentioned. And so it's a combination of wins with new customers, as well as new product insertions with existing customers. So whether it's a new cell site router opportunity or coming in as a new supplier like MTN Group, I mentioned, in the Africa region, growing the business with some of the new accounts that we announced last year like MegaFon in Russia, Optus and Singtel in the Asia Pac regions, which really haven't started yet from a revenue perspective.

There's been a lot of work going on qualifying the product, going through the network certification process, etc. And all of those contribute to the growth later in the year. And again, some of the new customers that we think we're going to win, again trying to predict the exact timing is more difficult. So we've not tried to factor them into the 10% growth rate, thus the plus on the end of it, basically.

Tim Savageaux -- Northland Capital Markets -- Analyst

OK. Thanks very much.

Bruce McClelland -- Chief Executive Officer

Thank you so much, Tim.

Operator

There are no other questions in the queue. I'd like to hand the call back over to Bruce McClelland for closing remarks.

Bruce McClelland -- Chief Executive Officer

Yeah. Thanks very much for everyone joining here this afternoon. And we're excited about the year ahead, and I really look forward to keeping everyone updated as we go along. So thanks very much.

Operator

[Operator signoff]

Duration: 34 minutes

Call participants:

Tom Berry -- Investor Relations

Bruce McClelland -- Chief Executive Officer

Sam Bucci -- General Manager, Ribbon's IP Optical Networks Business

Mick Lopez -- Chief Financial Officer

Tim Savageaux -- Northland Capital Markets -- Analyst

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