Ribbon Communications Inc. (RBBN) Earnings Call Transcript & Summary

Hi. I'm Samik Chatterjee. I cover the IT hardware and networking equipment names at JPMorgan. The next session we're hosting today, we have the pleasure of hosting Ribbon Communications and we have Bruce McClelland, who is the CEO of Ribbon Communications, for the next fireside chat here. Bruce, thanks a lot for taking the time to attend the conference. What I do want to do is, just maybe if you can start for the new investors in the room with a brief background on kind of what Ribbon Communications is all about, what are the technologies you have in your portfolio, just to give them, the new investor, a bit of background on what we're talking about before we dive into more detailed questions?

Yes. Thanks, Samik, and great to be here. I really appreciate the time from everyone and JPMorgan for hosting the event for us here today. So I started with Ribbon just over 2 months ago actually and just a few weeks before the COVID pandemic situation started to accelerate. So it's been an interesting a couple of months for us and for the company. Most recently, prior to that, I was with CommScope, and right before that, as the CEO of ARRIS. So really excited to join the company. I see a lot of parallels in Ribbon to the journey we had at ARRIS and the transformation we went through over a 20-year period. So hope to repeat some of that success here going forward. Samik, as you know, we -- the portfolio we have today is essentially in real-time software communications, a variety of products that are directly in the processing of telephony command and control capabilities that are deployed directly with service providers and help power the existing PSTN phone network as well as a set of products that really enable the ability for enterprises to grow and scale their telephony needs and transition from kind of a traditional phone technology towards IP-based voice over IP and ultimately unified communications like we're experiencing here today. In addition, we recently closed the acquisition of a company called ECI, which adds a data communications portfolio to the company. It's a little more in the sweet spot of where capital spend is with service providers and a whole variety of other types of companies that build their own [ transports ] and communications networks.

Bruce, so maybe just to start off, you mentioned the disruption that we're seeing from COVID. If you can just kind of start off with what you're seeing maybe more from a supply chain perspective because as we've talked to companies yesterday in our conference, I think one of the underappreciated headwinds for a lot of companies that's still there in the June quarter seems to be the supply chain? So if you can just outline which parts of your business are you seeing those concerns? And then we'll give into the demand side.

Yes. So there's a lot of complexity, as you know, in the global supply chain and a lot of dependencies and linkages around the world. There's a lot of dependency still on technologies and operations in the Asia-Pacific region, in China, Vietnam, et cetera. And in our case, we manufacture in a couple of different locations, including one location in China. And that was impacted early on in the year given that's where the momentum around the virus really started early. But then as you look at the rest of the supply chain, you look at the components and not only where they're manufactured, but where they're packaged and tested and -- regions like Malaysia had significant disruptions that impacted a lot of the components coming out of that region. And then you get into just the logistics, right, on airplane capacity, new rules and regulations on how to import product into different regions of the world, and I think anyone that manufactures at scale has been dealing with a variety of those types of issues. For our perspective, most of that is behind us at this point. Our factories are manufacturing. Most of the components have kind of worked their way through, limited capacity and starting to scale up. And a large portion of our products are software oriented today as well and of course there's been really minimal impact around those types of products and deployments. And in fact, we've seen I think a faster adoption of the software versions of our products in the case of the classic Ribbon portfolio.

So we'll just dive into the demand side here. But let me just stop and kind of remind investors that you do have the option of sending in questions for Bruce. You can put them in the Q&A feature and I'll ask it on your behalf. So feel -- please feel free to do that. Bruce, then to just maybe shift the focus to the demand side. You mentioned seeing some pull through of the communication software that you do deliver in. I think on the last earnings call, you mentioned the disruption that you were seeing on the ECI side of the portfolio. Maybe just help us match that together. Service provider spending, as you mentioned, is kind of where you see some upside. So just help us match that. Is ECI more a supply chain headwind or is it more demand? And how about you kind of seeing upside when it comes to communication software?

Yes. So first of all, the communications portfolio, the software portfolio has been very robust in the first quarter and our visibility continues to be pretty good around that portfolio. These are products that sit kind of in the heart of the PSTN network and provide call capacity, provides protocol translations and the gateway function that goes with the phone network, transcoding, those sorts of capabilities. And of course as traffic has shifted from both the mobile network and the enterprise towards working at home, what I think most service providers are seeing is a jump in call volumes as well as an increase in holding times and those sorts of things. And that goes directly to the types of products that we sell, and so there's been quite a bit of activity to augment the capacity in that portion of the traditional phone network. And this can be done either through kind of hardware-based capacity additions, in a lot of case turning on existing capacity on, on equipment, in parallel with that, again, unified communications type of services like what we're using today. We're seeing quite a jump in demand from enterprises to enable work from home and communications from home. And the product -- the types of products that we sell into that space scale directly, again, with call volume and capacity and hold times and those things. So that portion of our business has been pretty robust and we continue to have really a good visibility. The areas that have been more impacted from a demand perspective are either projects that are more construction oriented that aren't critical that don't go directly to immediate additions in capacity. For places where we're working to win new business and we're going through lab testing and proof of concept and those things tend to be less priority during this phase. Secondly, from a demand perspective, I think there's been different regions that have been impacted in different ways. North American environment has been pretty robust. The European environment has been fairly robust for us. Regions like India and Russia have been more impacted. In particular, India is -- the environment there has been going through a variety of issues with the carriers and how they calculate their adjusted gross revenue and the taxation rules around that, and we expect to see some resolution around that hopefully in the near future and kind of a return to more normal velocity in the business. Russia, similarly with the impact around oil prices, is certainly impacted, the FX rates and the spending power. And so I think we've seen a step down in demand as a result of that. So there are -- I think the big factor, Samik, that we're seeing -- and it causes to step back. And as you look at just the visibility in the second half of the year, try and predict what happens with the increased unemployment rate and those things, it makes it challenging to get a really accurate perspective on the full year.

Got it. Maybe before we dive into kind of some of these -- the segments in more detail -- and this is I think something that will help investors kind of think about the company as well. Because I personally -- kind of when I started looking at the company, kind of had this question is: the strategic priority for the company. You had a position in communication software, which is -- and you had a messaging around improving your focus on increasing software mix and recurring revenues. And then you've more recently done the acquisition of ECI and where you went to the other extreme in terms of optical that remains fairly high reliance on hardware capabilities. So help investors think through what is the strategic priority of the company at this point after the acquisition of ECI because there might be some confusion related to that?

Right. Well, I think the basics of the strategy are still valid and highly intact. We'll continue to focus on building our software portfolio and transitioning existing products to be fully software capable and cloud-native. There's some good data points to point to around the business. More than 50% of our products sales in the classic Ribbon business are now software orientated. And I think that will continue and we'll continue to invest around that. As the industry evolves, I think the way that our customers consume our products will move more towards as a service type models. And we can talk more about that, but I think that's important. We'll continue to invest around those -- such priorities. In addition, we felt like it was important that the company expand its addressable market to be more squarely in the data communications market. And so I think we look at that strategy as being very complimentary to being in the telephony technology, and now we have a portfolio that allows us to grow in a much larger addressable market. So we go from an addressable market in the $2 billion range to something that's over $20 billion. And so there's a real opportunity for us now to grow our revenue and our position and our market share as well as contribute profitably to the bottom line with a mix of products that allow us to do that.

Let me just focus on the ECI segment for a bit here and let's take a closer look at that. I think one of the things that you've mentioned more recently is the opportunity for the ECI product portfolio with enterprise customers or the enterprise vertical. Just help us think about the long term opportunity there and why enterprises would be interested in deploying optical transport or packet processing platforms by themselves and not rely on a service provider to do that? How you're thinking about the addressable revenue opportunity? And we can then kind of maybe follow on with kind of what's the level of engagement you're seeing kind of in the COVID world around this kind of next generation stuff that enterprises -- where -- how much of a priority is this to them right now?

Yes. Maybe it's a little misleading when we say enterprise. These are market verticals like utilities and railways and critical infrastructure providers, oil, gas, power, government and defense. Anything that effectively is not an operator that would buy our equipment and offer services over the top of that infrastructure, we classify as enterprise. So maybe it's not the traditional enterprise you would think of. But there are a lot of companies in that space that build their own networks and provide their own communications infrastructure. And 50% of the ECI product sales have been in that market in Europe and in other regions. So I do think it's a healthy addressable market. It tends to be project based as opposed to kind of ongoing recurring revenue. And so you've got to go find the opportunities and they can be a little bit lumpy. But it's a pretty important portion of the market for us. And of course, the other portion of the strategy here, Samik, as you know, is we really are focused on building our business around that portfolio in North America, and using the relationships, the foundation that we have with our major tier 1 carriers in North America, to begin to insert these products and build the business and take share in the space. And that's not something that happens overnight. It takes some time to build up that portfolio in the region. But I think that would be the thing to look at to gauge our success over the next 12 or 18 months.

Got it. So you mentioned kind of that you want to steadily gain share, and if I am thinking about the competitive landscape here -- and correct me if I'm wrong -- you're kind of probably running into larger incumbents like Sienna, Nokia. How are you looking at kind of differentiating the product against these larger incumbents, which also have a much -- kind of bigger balance sheet to go and kind of deploy in R&D as well as new product development? So how are you looking at the competitive landscape and what makes you feel confident about like running into these large incumbents?

Yes. So I guess what I would point to is the results last year. And as an example, in the fourth quarter, ECI on their own sold about $110 million of product and services, primarily 100% outside of North America and in some of the toughest regions in the world, in India and Russia and Europe. And that was business going head-to-head against the big names that are in this space already today. And so when I look at the success that we've had there with pretty good profitability, that gives me confidence that we can come into the North American market and be a bit of a disrupter and make an impact here. We're not trying to be everything to everyone. We're very focused on the access portion of the network and the metro portion and have designed the product specifically around those opportunities, not necessarily data center, interconnect and those other areas. And some of the capabilities that are in the product like the ability to provide a 1.2 terabit dual transceiver architecture with 2 600 gigabit connections essentially bonded together, those things are getting a lot of interest from customers because it really fits the sweet spot of that market. And as these networks upgrade from 100 gig, 200 gig to 400 to 600, I feel like we've got the right solution in those areas. And as we look a little further out, particularly at the packet processing layer, we've designed a number of capabilities specifically around 5G networks, 5G mobile networks. And as 5G networks become a reality and you really start using them for things like private networks, the ability to -- with quality and with security, cordoned off traffic and do hard network slicing, is really going to be critical. And those are the types of things I think we've built into the product that are getting a lot of mindshare and will allow us to grow the business.

Great. Maybe just before we move off the ECI topic, India, Russia, those are 2 markets you mentioned. And I think everybody knows those will be longer term kind of challenging markets. They will have their kind of ups and downs. But definitely a lot of companies are kind of willing to explore those opportunities because of the long-term growth expectations. So maybe just outline for us what do you think the addressable market opportunity there is? What are you looking for in terms of long-term growth from that market and are those markets easier in some sense from a competitive landscape standpoint?

Well -- so I'm not sure if they're easier. We -- just about every supplier there is -- that's in this space is interested in that market. I do think we have a better position with tier 1 carriers today in those markets, and so we need to delight those customers and serve them very well. And just, obviously, given the population density and the growth in traffic, I believe we will continue to be fairly significant growth in those markets from a demand perspective. It's a matter of what share of that we're able to get. Ultimately, the strategy is to do a good job in those markets and continue to have that as a base for the company. But the real growth opportunity is for us to penetrate the North American market, where we have very little share and the competitive environment is a little bit different. And again, we want to be a little more disruptive coming into the market here and leverage the position we already have to bring in these new products. They don't sell themselves. Obviously, they need to earn -- they have to earn the position. But I think we have an opportunity given the base of business we already have today to become a more strategic supplier to be in kind of the -- right in the sweet spot of where they're investing, the importance of their networks, and just be a more valuable supplier. You mentioned the scale of the environment and the competition, which -- scale is really important in these businesses in order for us to compete. We're working very closely more with commercial silicon photonics companies to kind of leverage the investment going on there and try and stay out in front as opposed to having to do all of the R&D internally ourselves as well.

Moving to the communication software group here. I think generally what we've seen, you kind of break down that business by the network functions like session control, network transformation, applications and security. So maybe if you can just kind of for investors outline what -- how these capabilities kind of value add to customers who are adopting individually? And what's your growth expectation for individually -- these kind of sub segments within your broader communication software portfolio?

Yes. So when we started the year, pre-COVID, what we expected was kind of overall for that portfolio low single digit revenue growth, but continue to improve in profitability. And some of that's due to the continued focus on restructuring and being more efficient across the company, but part of it is this transition to more software-based products. In the network transformation space, we think that's -- it's not a revenue grower, but if there's a kind of a continued investment around transforming and moving these networks from kind of traditional digital switches towards more software-based products, then you get a lot of value from that. They almost pay for themselves in the real estate savings, the power savings and then the flexibility in the network. And while we -- I think we started the year thinking that wasn't going to be a significant growth driver, but a good profitable business. That could be conservative at this point. I think it's become much more apparent how important that portion of the network is as traffic has transitioned to more at home. It doesn't feel like that's going to change anytime soon. I mean, it feels like that, that transition has accelerated and we'll be there kind of long term as companies try and leverage more work at home capabilities. The session management piece of our business kind of is directly aligned with the growth in telephony traffic for enterprises as well as the interconnect traffic between networks. And that overall market, we think is kind of mid-single digits growth, and again, maybe it's a little more than that here in the near term. And an area that while volumes are increasing, obviously, prices come down as the implementation moves to software. But overall the profitability is just growing for us in that space. So I think that's the way we think of those 2 businesses. The third piece that we have that isn't as large from a revenue perspective, but I think is very strategic, is the layer on top, the analytics, the security software, the subscriber identification capabilities. And it creates not only a halo effect for the rest of the portfolio, but it solves point problems like all of the robocalling issues we all deal with every day. And I think you're going to see a big focus around really tamping that down, and there's a new architecture around how to do that and -- an area that we focused investment and that we think would be a good business for us.

Got it. If I can just follow up. I think you mentioned the last portion, where you have some analytics capabilities. I see, in 2019, you acquired a company called Anova Data and just wanted to get your kind of thoughts on kind of what capabilities did it bring in-house? Is this what's kind of helping you differentiate, as you said, like provide some strategic value in terms of the analytics to your customers? And is this kind of -- how much of this is organic versus inorganic in terms of the capabilities here?

Yes. So the Anova acquisition was more focused around mobile networks than fixed networks, and we felt like adding that capability and knowhow to the fixed network analytics packages that we had would round out the portfolio. And I think that's worked fine. Again, it's not a major portion of the revenue inside the company. But instead of talking about speeds and feeds and kind of just comparing numbers like that, we're talking about how do we garner insights from the network, how do we control the network and self-heal issues across the network because of these analytics packages and the visibility we have in the network. And so again, that creates a totally different type of dialog with the customer. And I think ultimately as we bundle these things together, it really strengthens our position in the market.

Got it. One of the opportunities that I think you haven't kind of -- maybe investors haven't focused on as much is the opportunity with some of the public cloud business. You have active instances in different public cloud environments that allows customers to leverage your products. If you can just kind of walk us through how you're thinking about that opportunity? How does it help customers in their cloud migration? And how you are thinking about kind of the long-term growth prospects there?

Yes. So our Kandy business services portfolio really encompasses 3 different verticals or addressable markets. One is unified communications, the ability for a full-fledged unified communications capability. The second around communication platforms as a service or what they call CPaaS, which is different, right? This is the ability to consume network services through a programmatic interface. And then the third is around contact center as a service. And that really -- all 3 of these really build on a common core technology platform and really the set of products that we sell directly to service providers and enterprises. So the thought process around this was "let's build" -- "let's take the capabilities we have as a product and offer it as a service." And so we've stood up a variety of instances of this around the world, serving our customers in one of those 3 kind of market verticals or use cases. And again, as our customers -- as our service provider customers business transitions and they begin to offer and deploy their services differently through more programmatic interfaces, this as a service direction I think is pretty important for the company. Obviously, those 3 spaces are big, large markets with a lot of different players in them, quite a bit of fragmentation still today. In the case of UCaaS, we focused in very directly on kind of the premium service capability that really leverages the full feature set of the call processing capabilities that came out of the different acquisitions over the years and back to the original Nortel platform. And so again, we're not trying to be everything to everyone. We really focused in on those areas where we think we can differentiate. Today, this business for us -- this public cloud business is still an investment business. It has not kind of reached critical mass, where the velocity is at a point where it contributes to the profitability. And so that's how we're thinking of it today. It's really an investment mode and part of a longer term strategy for growth in the company.

Got it. So let me just try and kind of pull all that together into -- trying to quantify something for investors in terms of what to expect on the top line. I know pre kind of the ESI acquisition, you had some revenue growth targets out there which were more in that low single digit growth range. Post the ECI acquisition, you haven't really rolled out a new set of targets yet. But maybe just help investors think about what are they looking for when they're looking at Ribbon? What are they looking for in terms of expectations for top line growth, on a more kind of longer term basis what to expect here?

Yes. So the easy thing to start with is to kind of look backwards, right? So in 2019, the Ribbon business was, call it, $560 million in revenue and the ECI business was a little under $400 million. So combined together, the business is $950 million, 900-plus as a combined company without the short term impact we've been having here around COVID. Again, the way we are looking at it long term, the core telephony portion of our portfolio should be a solid, stable business that generates cash and allows us to invest in other things. And we do expect to see growth as we gain share and scale the packet, optical business. So clearly, the strategy here is to grow both top line and the bottom line, improve the position of the company, become a more strategic supplier to our customers. Over the next 18 months, we're going to be really focused on integration and execution and cash generation, paying down the debt that we took on to do the acquisition, and then find ways to continue to scale the company both organically and inorganically.

Got it. Maybe just moving to -- you talked about the leverage you would get as you scale up. That's kind of very typical for most companies in the space given that the number of customers tend to kind of remain really kind of focused, in that sense, so you don't have to increase a lot of operating expenses. But how should we think about the gross margin trajectory here like once you've now on boarded ECI, which is a much more hardware business? And kind of where do you see the combination kind of cracking in terms of gross margins and what kind of improvement can you drive towards?

Yes. So from a gross margin perspective, the company has done a great job of improving gross margins. The comparison of first quarter of '20 to first quarter of '19 was really impressive. And so we don't want to lose that momentum and I don't think we will given the products are transitioning to more software based in that portion of the portfolio. Obviously, the margin profile around the ECI business is different. I always say you can't virtualize layer 1, so there's a portion of that business which is obviously hardware oriented. And there's a lot of room in the industry for a really good provider of hardware at that layer of the network. Again, if I point you to last year's business, that business at the right level of revenue is 40%-plus non-GAAP gross margin. So what you'll see blended for the company will obviously depend on the mix of sales, right: how much is software and how much of the packet, optical portfolio. What I focus more on is: "What are we generating at the bottom?" Right? "What's the contribution percentage that we can get out of both of those businesses? And are we covering our cost of capital and growing again both top and bottom line and improving the health of the company?" I guess I'm a little more worried about that than I am just necessarily the gross margin percentage.

Got it. Given the current uncertainty, we've seen a lot of companies take either temporary cost actions or exit some of their long-term cost initiatives. So maybe if you can give us an update on what you're doing on that front, because we understand everyone's kind of focused on not only profitability, but to some extent on liquidity as well?

Yes. So I think it's a necessary part of everybody's strategy at this point in making sure companies are healthy. Of course, we just put 2 companies together, so we're already in the phase of driving to get the synergy. That was in the plan originally. The company had talked about a $12 million net synergy target for combining the companies, which feels pretty modest, although it reflects the fact there wasn't a lot of overlap -- direct overlap in the businesses. At this point, I think that number is easily achievable. And internally, we're targeting more significant synergy just partly given the environment we're in and continuing to look at ways to be more efficient and make sure the portfolio is aligned properly. I mentioned on our earnings call last week, I'm doing a full review of all the investments in the entire portfolio. And I expect we'll realign somewhat to make sure we're investing in the places we think we really have a high opportunity for return.

Just on the liquidity front. You recently entered into a $500 million credit facility. You have $110 million of cash on the balance sheet. But how are you generally feeling about the liquidity position and kind of any concerns that you have on what cash flow headwinds would be as you're navigating this demand uncertainty?

Yes. So we entered into the $500 million facility, $400 million 5-year term loan and an undrawn $100 million revolver. At the end of the quarter, we finished with $110 million in cash, although a portion of that I think is kind of reserved, right? We have a number of final transaction fees and taxes and whatnot to pay out of that. So it's not all unrestricted. But I think we start in a pretty good position. We have to be very mind full of cash flow. But the great thing is the majority of our customers are kind of blue chip solid payers, and so we're not seeing collections issues and things like that at this point. So I feel like we're in a pretty decent spot. We'll be careful and manage it appropriately depending on what happens with the overall macro environment. But I think we're in a good position to execute on the plan. In some areas, we're adding staff to increase our -- in particular around the sales function for the packet, optical business in North America. So there's some areas we're actually investing a little more in to make sure we're better positioned.

Yes. Bruce, maybe just kind of as we try and wrap up here, you've done a large acquisition -- or the company has done a large acquisition recently. Now these are not the best times to kind of do another acquisition, but everybody understands the advantage of scale in this business and especially the flow through to the bottom line. So how are you thinking about kind of the appetite to continue to kind of add to the portfolio here? And on the flip side, I know you had mentioned -- just after the ECI acquisition that there has been a mention of some portfolio rationalization as well. So where are you in that process? That would be helpful.

Yes. So I think the next 12 months seem pretty clear to me. We've got a lot of work to do to get the integration completed, prove out the thesis that we have, and really execute well. And I think that's going to be the plan at this point. I'm not of the mind that we're looking at anything else near term. A longer term scale means a lot in this business. And so there's a variety of different potential paths in the longer term that we could think about, whether it's consolidation oriented or growth in immediate adjacent areas. But there's nothing kind of near term at this point, Samik, that we're thinking about. From a rationalization perspective, I don't have a lot to add there at this point. I'm still in the middle of kind of going through that, and we'll see what the outcome of that analysis is.

Great. Bruce, that was an excellent kind of discussion on kind of what the company is working on and the priorities. We definitely want to thank you for coming to the conference and making the virtual conference happen in this format. So thank you. And for those that are listening in, thanks as well.

Thanks very much, Samik.