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

Hi. Good morning. I'm Samik Chatterjee, the networking and hardware analyst at JPMorgan. Welcome to day 2 sessions for the hardware and networking companies. The first one this morning, we have the pleasure of hosting Ribbon Communications. As you can see on your screen, we have Bruce McClelland, who is the CEO. We have Mick Lopez, CFO. We also, I know in the room, have Tom Berry from Investor Relations. He's there somewhere in Bruce's office. So we have the whole group here. Bruce, Mick, thanks for taking the time to participate in the conference, a pleasure to host you. Let's start. I know, Bruce, you wanted to kind of start off with some introductory remarks, but I think for the broader investor group it's definitely good to get a brief overview on the company before we dive into some specific questions. So over to you.

Yes. Great. Well, thanks, Samik, and I really appreciate the opportunity to join the JPMorgan conference here today. As many people probably know, Ribbon is a provider of real-time communications technology serving both the carrier market service provider space as well as the enterprise market. We're a global company headquartered here in Plano, Texas and serve about 140 countries -- business in 140 countries around the world today with about 3,700 employees. In 2020, we recorded revenue just under $850 million and an adjusted EBITDA [ of a little ] over $130 million. We have 2 primary focuses today in the company. We provide industry-leading voice over IP application and security platforms to many carriers and enterprises around the world. And we have a growing presence in IP optical networking, the 2 main focuses for the company. Ultimately, our products provide the foundation for both Internet and voice traffic. We're a very technology-focused company. More than half of our investment goes directly into research and development of new products. A year ago, in March last year, Ribbon merged with a company called ECI Telecom, growing our international presence and significantly increasing the scale of the company. In 2020, about 60% of our business was outside of the U.S. So it's really helped diversify where we do business today. And we have a great balance of customers. About 30% of our business is with enterprise, 70% with service providers. We have a market-leading position in the modernization of the traditional phone network, the traditional PSTN network. And we have a unique position in the session border controller space, serving both, again, service providers as well as this increased adoption of unified communication and collaboration platforms like Microsoft Teams and Zoom, which we're on here today. But I'm probably most excited about the growth potential around our IP optical business. We're seeing real proof points around our strategy to sell that new portfolio into the strong base of customers where Ribbon has traditionally done business. On our last earnings call a few weeks ago, I alluded to this, but I am excited to announce 2 recent wins, one in North America, one in Asia Pacific, both of which are with long-standing Ribbon customers that have now chosen us as a major new supplier in the 400-gig regional optical backbone upgrade. So really exciting to see this momentum. They cover over 25 million broadband and mobile subscribers today. So that's just the beginning. So lots of exciting kind of potential for the company and great to chat more about it here with you, Samik.

Great. Let me dive into some more specific questions. But before I do, for the audience dialed in, you do have the option of sending in questions, and we definitely encourage you to do if you have any questions. [Operator Instructions] Bruce, you alluded to this somewhat in the wins that you're seeing in IP optical, but maybe 2 themes that I want to hit on. Firstly, 5G, and we've seen more recently, the CapEx plans being outlined by the Tier 1s. I'm going to assume, and largely, the expectation would be that Tier 2s, Tier 3s have to follow as well in terms of starting to invest in the metro layer. How is Ribbon positioned to leverage that? What are the -- generally the differentiating capabilities for Ribbon in the -- particularly when it comes to metro layer products, and what generally is the customer base for Ribbon today, who would you benefit most in terms of customers investing in the 5G opportunity?

Yes. So 5G is definitely a catalyst for our business. The reality is most service providers now are both mobile operators and fixed providers. And when they're thinking about their IP optical network and backbone, the capacity that they're investing in, in many cases, are to support both their mobile network and their broadband networks. So really, the growth in residential broadband capacity for all these types of communication platforms and the upgrade cycle around faster brand networks are both drivers around investing in our types of products and I think we're really in the early innings still of the transition from 4G to 5G, so that 5G is really ubiquitous and really becomes the technology connecting most devices. So there's kind of many years ahead around the upgrade cycle. Specifically for us, in the mobile network, I mentioned on our earnings call a couple of weeks ago, we had 2 new products introduced specifically around 5G around optical networking, focused on the 5G cell site router space as they're moving from microwave backhaul to more optical backhaul. There's opportunities for coherent optics products directly in that space, both redundant, nonredundant versions of products and these allow the operators to really rebuild their backhaul networks using pluggable coherent optics, very cost-effective to aggregate traffic. We're introducing a brand-new platform focused on a 400-gig ZR+ pluggable optics we can talk more about, which is really targeted at that space with a brand-new 7-nanometer CFP2 plug-in module, which is really getting a lot of interest. And these are not just simple transponders. I mean, these are pretty sophisticated platforms that using FlexEthernet technology allow operators to do different things with their traffic patterns and strike them over multiple different wavelengths. And it's a real key differentiator in the types of products that we offer into the mobile space. Similarly, in our IP networking platforms, our IP MPLS platforms that are directly targeted at mobile backhaul, the ability to support all the precision timing requirements of the network and be able to support different SLAs for different types of traffics -- traffic and basically be able to slice the network either with hard slicing for dedicated types of traffic or more flexible soft slicing as traffic comes in and out of the network. All of those things are really important as we think about how to position our products for 5G. And as you can tell, there's a growing level of sophistication in the network. So management and orchestration become really key factors and there's really a lot of interest around our Muse platform, which really fills that part of the portfolio. So long story short, I feel from a product perspective, we're really well positioned in this part of the market, and we're seeing quite a bit of validation now as well.

Got it. That's helpful. Bruce, a couple of follow-ups on that. You did mention most of your customers are investing not only towards 5G but also broadband connectivity, which then brings in the question, how are you thinking really about RDOF? And more importantly, as that gets extended into a Biden infrastructure plan, how are you thinking about the leverage that you would have? And maybe as a second part of that, how is the customer exposure today for Ribbon between Tier 1 service providers and Tier 2, Tier 3 because I think that broadly, the expectation at this point is as these investments or the government funding comes through, it benefits more of the Tier 2, Tier 3 service providers to really kind of get more ubiquitous networking out to the rural area, suburban areas, et cetera.

Yes, that's exactly right. And I think there's a list of 300-plus winners of the RDOF funding pool that will get spent over the next 5 to 7 years. And every one of those networks requires backhaul of some sort, aggregation and backhaul, and that's exactly where we're positioned. And we have a whole focus around that part of the market, particularly the Tier 2 and Tier 3s. Could be utility telcos, I mean, there's a variety of different types of companies focused on that business. And it's a little hard to know exactly how much of that funding goes towards our types of products. I think our initial estimate was maybe in the 5% range. So it's a fairly meaningful addressable market over the next several years for IP optical networking. And we've had a number of wins already, and I think they'll continue to build in the second half of the year as project plans turn from paper into reality and construction really starts here.

Moving on a couple of other topics that I wanted to hit on IP optical. More recently, you've talked about the Huawei replacement opportunity. I know there are different estimates out there from other companies in terms of what that opportunity could look like for the industry. Any way you've quantified what that addressable market could look like as Huawei kind of runs is not allowed in some of the bids anymore. Is there a second leg to it in terms of a Ribbon replace opportunity in the international markets for the Huawei equipment. So let's just go through those, and then I wanted to get your thoughts about the opportunities in the different regions as well, but let's first hit those 2.

Yes. It's obviously a big opportunity for the overall networking ecosystem, not just in our space but in a whole variety of different technologies and products. So it's a very unique time. We're focused in a couple of different regions, obviously, with a lot of focus in India where we already have a big presence. And again, I kind of alluded on our last earnings call, but we've been awarded new IP MPLS business with 2 of the largest carriers in India that's directly attached to replacing or -- replacing Huawei as a supplier in those parts of the network. So we're clearly gaining share, have a real positive outlook in that region, in particular, around the Huawei opportunity. And then there's focus in Europe, clearly, around different countries, where, I think they'll be replacing Huawei as a supplier in certain regions. As far as quantifying it, again, I've seen the same numbers you have anywhere from $0.5 billion a year to well over $1 billion spent on this space. We're kind of more of a bottoms-up perspective, looking to incrementally gain share either with existing customers like in India or a new entry point. It really becomes the new decision point to think about the supplier base when you're making a big shift like that. And it's just -- it's perfect for us, right? It's a real disruption for us to come in and have an opportunity to really position the portfolio and as I went through earlier, I think we're really in a good spot with some of the capabilities we've designed into the products here.

That's helpful. Just want to hit -- I know you mentioned Europe in there. I think specifically I wanted to ask you on LATAM. Is there an opportunity to do a Huawei replacement in LATAM? And is that right now taking a backseat just given the macro situation there with COVID?

Yes. So we -- even in our Cloud & Edge business, we've won some Huawei replacement around traditional PSTN networks, voice over IP, call processing, media gateways, et cetera. So clearly, there's an opportunity there. I would characterize it probably as not as large as the opportunity in the other regions. And it is a region that's smaller for us historically as well. So we probably talk less about it, but there's clearly opportunity in that region as well. Again, this has just caused a disruption in the ecosystem. And so I think just about every carrier is taking a step back, thinking about long-term suppliers and who they're going to partner with. And the product mix are an important part of it, but also the trust in being there long-term and delivering and that was the whole strategy behind combining companies a year ago was to really leverage the long relationship, the foundation that Ribbon's established with many of these carriers around the world dating back to even the Nortel carrier business that we acquired back 10 years ago. And again, it's great to see the strategy starting to really play out here.

A follow-up -- just following up on India. You mentioned the wins there. How are deployments looking right now? I know you spoke about it on your earnings call as well. Obviously, there's been probably a couple of weeks since then. But anything changing there? Is business impacted given what's happening? Or are you still managing to get some of the deployments done, maybe not at the same pace but still business activity is generally ongoing?

Yes. The India market for us is about 10% of sales. It can be 8% to 11%. It's kind of averaged in that range over the last 3 quarters. With the recent surge and the stricter lockdown, certainly, the deployments over the last several weeks have been slower. They're still progressing, but they're definitely slower with the -- just the strict measures that have been put in place. It's a little hard to predict how long this latest lockdown will last. Fortunately, the daily infection rate has dropped from, I think, over 400,000 a day to just over 200,000 in the last 2 weeks. Obviously, the death rate remains elevated. So the restrictions will likely continue for some time. But -- so it's definitely slowed down in the last couple of weeks. On a positive note, again, I mentioned some of these recent market share wins that will really be a catalyst in the second half of the year. So we'll see how the next couple of weeks progress. And obviously, by the time we get to the next earnings call, we'll have a better view on what's progressed over the next 2 months here.

Got it. [Operator Instructions] Bruce, before I move to the pluggables, wanted to get your kind of try to put all the market share commentary in terms of share wins that you're seeing. If you can provide any background on what is Ribbon share today in IP optical either on a North America basis or on global basis? And are there any internal targets that you're really trying to achieve then in terms of share gains over the next few years? How -- and particularly, when we start thinking about why customers choose Ribbon, is there a particular differentiation that's able to drive those share gains?

Yes. So I think the optical market, the latest numbers I've seen, including the China market is about a $15 billion market in optical. And then IP networking is a considerable -- in a similar range. So it's a massive market, and we're clearly a small part of that ecosystem today. So I don't know what our share number is, but it's certainly not the top 5 at this point today. As you get into individual regions, we actually do pretty well, and we show up much more significantly on the numbers. But if I think about our strategy and how we're trying to be successful here, we're not trying to serve the entire market. We're very focused on the metro backbone portion of these networks. The aggregation network and then the metro backbone that supports that. So as a smaller company, we really need to focus, and that's where our expertise is around that portion of the network. What really matters in that part of the market is that the products have the scale that's needed for each layer of the network. You can have a product that is way oversized and not cost effective. And so we've really focused on a portfolio of platforms that really fit that portion of the market really well. And our network planning tools, our design tools do a fantastic job of taking a complex network and breaking it down into its different parts, such that by the time we generate a bill of material for an opportunity, I think we're really optimized, we really fit that portion of the network well. The second element we focus on is a much more, I think, open networking approach to how we develop and deploy products. Perfect example is the work we're doing around 400-gig ZR+. We've embraced that quickly. I think we'll be one of the first to market with production-capable products with this CFP2 plug-in form factor. And that allows us to introduce new suppliers quickly as they come to market and be a disruptor, really, I think, economically with this new solution. And unlike some of our competitors, this is not a cannibalization for us. I mean we're embracing this as a part of our portfolio. And I think it allows us to be even more competitive in the market. From a management perspective, we're leveraging completely SDN management interfaces, open interfaces such that a single orchestrator can manage multiple vendors, multiple platforms in a single network. So it's just a different approach as we think about how we position the products and insert into these networks. Ultimately, it does come down to trust. I mean this is a really critical part of the network architecture. And it takes the sales cycle to go in and validate not just the product, but the trust in the supplier relationship is not to be underestimated. And Ribbon has a very successful business with many of these carriers in the region. And so the trust factor, I think, is pretty high. And obviously, we're seeing signs of this starting to work. So yes, really excited about this part of the business.

Got it. No, that's helpful. So moving to -- I know you mentioned pluggables in there, but more specifically on it, the general impression investors have and we have at this point of the pluggables market is, it's a bit more of a crowded competitive landscape relative to the systems market. You mentioned you'll be one of the early ones with the ZR product out in field. But I think investors perceive the space to be filled with a lot more players than you have in the systems market. So how are you thinking about, is the first-mover advantage really substantial? Or how are you thinking about continuing to differentiate yourself in the pluggables market?

Yes. It's a good question, and it's probably important that I really clarify. We're not selling pluggables into the market. We're selling systems that support pluggables, which is quite different. And we've had pluggables, but they're more proprietary pluggables. This is the first time we have metro pluggables that ultimately are interoperable between suppliers. So it is quite different. And so we're taking advantage of this -- the economic scale that a more standardized solution will have in the market. So it is quite different. And these are not just simple products. These are not simple optical transceivers. The platform that we've developed provides a huge amount of flexibility between the line card interfaces and the actual transport interfaces, and being able to take the traffic and spread it across multiple wavelengths to be able to build in different types of redundancy into the solution. But we'll be able to do all that with more disruptive economics using these industry standard pluggables. Yes. So it's quite different, I think, than perception around pluggables in the pluggable market, Samik.

Bruce, the other -- you mentioned the disruptive economics with the products that you're looking to deliver with support pluggable. The other concern in the industry has been around the deflationary impact on revenues when you start selling products that support pluggables versus your standard compact modular boxes today. How should we think about -- like how Ribbon would be positioned in that sense? Is it more of a market share opportunity that offsets any deflationary impact on the revenue? How are you thinking about that?

Yes, it really is. I mean, again, we don't have a big legacy business we're trying to protect here. So I think we're a catalyst for this movement as opposed to trying to protect a proprietary, closed ecosystem, large-scale systems business. Yes. So I think the upside around market share gains more than dwarfs the ASP changes that we'll see from moving to more standard optics here.

Got it. Got it. Okay. [Operator Instructions] And then in the meantime, let me pivot over here to some of the other opportunities on the Cloud & Edge business that you've talked about. So Microsoft connect service, I think you've talked about that in -- on the earnings call and there is a -- can you give us a sense here of how that product offering looks and what that new opportunity for Ribbon could look like?

Yes. So there's a variety of different ways for the Microsoft Teams environment to connect to the traditional PSTN, just like Zoom can here today. Microsoft recently introduced a new mechanism, they call Operator Connect, which is really focused on, I think, reducing the friction of deploying Microsoft Teams, a fully featured voice-enabled platform that's not just used for collaboration but really used as the base phone system for enterprises. And so this new Operator Connect capability basically precertifies and preconnects the Microsoft cloud with the operator cloud. And as an enterprise, wanting to launch Microsoft Teams, it's a much simpler process to pick which operator you'd want to have your phone service supported with. So that's the basic premise behind it. And the SBC platform that secures and manages that SIP trunk interface between those 2 networks is typically still deployed inside the Operator network. And so this new approach really plays our strength. I think we've got a really good foundation of our SBC certified deployed inside of the Operator's networks around the world and already support work this Operator Connect capability. But there's other ways, I mean, this will be complementary to the existing direct routing capability, typically either deployed in partnership with a carrier or with a systems integrator, and we've launched with many partners, a similar sort of SBC as a Service capability such that enterprise doesn't have to worry about all the networking requirements and complexity of an SBC. It really is a cloud-enabled, cloud-deployed type model, which also supports legacy PBX capabilities, interoperability, et cetera. So there's different options just depending on what the requirements are and where customers ultimately trying to translate their or migrate their network over time. But this new Operator Connect capability, I think, will be a really good addition to how things work today.

Great. So Bruce, on that front, though, when I look at the revenue trajectory for this Cloud & Edge business, it's been [indiscernible] either modest growth or modest declines in revenue. It's not really had the same growth as the IP optical business over the past, at least recent history that I can think of. So what gets that to change? What gets -- what needs to change to see more of a substantial amount of growth? And maybe you don't have the same level of growth as IP optical, but more -- stronger growth than you're seeing right now in that business.

Yes. So there's portions of that business, which are more mature. Obviously, the modernization of the phone network, PSTN network, is a pretty mature space. There's other pieces of that business that have actually grown very well. The SBC, that core platform that we sell to both carriers and enterprises was up more than 20% last year. So there's pieces that are growing, pieces that are not growing as much. But overall, the business has really transformed over the last 3 years. It's predominantly a software business as opposed to a proprietary hardware business. So although the top line revenue growth might be lower, the gross margins have dramatically improved, and we've really focused on optimizing the R&D programs as well. And so this business has turned into a really, really strong platform for the company. The Cloud & Edge EBITDA, the earnings generation off of that business year-over-year grew over 200% from the previous year. That just tells you how much that product line, those sets of products have transformed in the last couple of years. We made the decision to sell a small UCaaS business called Kandy last year that continued to help optimize the investment within the portfolio. And ultimately, we think this is a sustainable business at this point. And again, it's a foundation that we can generate good cash flow, allows us to invest in other growth areas. And I think there's growth areas even in Cloud & Edge, particularly around enterprises. We return back into the office and these new collaboration platforms really create the foundation for communication going forward. More and more attach rates are projected for traditional voice into those environments. So -- yes, so I think we can continue to grow that portion of the portfolio, albeit at a smaller growth rate. But more importantly, be a really solid earnings generator for the company to allow us to invest in other areas.

Bruce, that brings me to a more strategic question. I believe I can't remember the date now, but it's been probably about 3, 4 years since you took over as the CEO, I might be getting my years mixed up here. I mean since then, it looks like you've done a -- put a lot of focus in driving growth while balancing that with profit improvement. And if I remember again the numbers right, 1Q, you had a fairly strong increase in EBITDA on much more modest increase in revenue. So as you move forward, how are you really thinking about continuing to balance that? Because as you mentioned, there are investment areas that we can kind of try to pursue to secure future growth, while at the same time, the profitability of the company also has a much more further road map to cruise. How you're really looking to balance that, particularly when it comes to also spending more dollars to secure future growth?

Yes. So I think we can do both. And by the way, it's only been a year, it might feel like 3 years, but I've been -- the 3 years you're thinking about is when Sonus and GENBAND came together to form Ribbon about 3 years ago. So I know that was what you were thinking. So -- but again, the company has transformed a lot, and we have not only that traditional business but now a great growth trajectory for the company. And to me, I think investors reward companies that are able to do both. You've got to be able to grow both top line and be a profitable company. Having said that, I think what we're going to find is more opportunities to grow in IP optical and a need to invest more around that business. Clearly, today, we invest less than some of our larger competitors. And as we're more successful gaining share, we're going to need to invest more around that business. But I think we can do that along with continuing to grow profitability for the company. And I think that will be a good trade off. I think investors will reward a company that can grow revenue and be profitable at the same time.

Let me bring in Mick here. Mick, we've seen a significant moderation in the OpEx trajectory of the company. You continue to kind of work hard on that. As investors look at the opportunity here outside of the top line in terms of optimizing the OpEx further, how do you think about opportunities there? What are your areas of focus where you can optimize the spend further so that you can drive -- allocate more to R&D investments?

Yes, absolutely. The company has done an admirable job in integration so far. And there's still more work to do in that regard. Notably, we have taken out all duplicate costs and positions, but we still have the basic platforms that will leverage us into the future that we can take cost out of. But very notable, though, as a real rationale for the merger is the revenue synergies. And even though we have attained the cost synergies, our expenses are down 10% plus year-on-year. That we can be able to really drive these unique revenue synergies of merger of these 2 companies. So we're driving the platforms that will reduce cost and allow us to go get customers in both of our acquired -- merged companies together. There's plenty of opportunity left, Samik.

Last question from my side, and let me just do a quick check if any other questions came in. No. So I don't see any questions from the audience yet. But last question, and it will probably be wrong to let you go without asking you this one, supply chain constraints. That's kind of top of mind coming out of this earnings season. And I know you buy a lot of components from the supply chain. So which aspects of the -- which -- or which products rather, are you seeing the most impact on? When do you expect these constraints to start easing? And is that primarily leading to a revenue headwind or also leading to a margin headwind?

Yes. So we've been successful so far in managing a tightening supply chain environment. Clearly, we've seen lengthening lead times going from traditional 24, 26 weeks on core silicon to a year plus, basically. It demands good predictability, good visibility. And so far, we've been able to manage that. We don't anticipate any big issues in the second quarter. And obviously, we're planning ahead throughout the rest of the year. The real issue comes down to, do you have a decommit on a particular component even in the week that you're planning production. That sort of thing, just managing on a daily basis to make sure factories continue to run. Of course, we're smaller than some of our larger competitors. So the numbers are smaller to manage, a little more manageable, I think. But it's going to take a lot of attention. And I don't think it gets better this year. It looks like this year is pretty subscribed at this point. And you're likely looking into first and second quarter next year before you start to see any improvements? Mick, I don't know any other thoughts...

Yes. I just wanted to add that for us, given our very strong software base on the cloud and edge side, and in particular, our very big and repetitive and recurring revenue on the services side, it doesn't impact us as much as some of our other competitors. So we do have a more flexible base.

Last pick one. So are suppliers raising prices on you? Is that part of the headwind that you're seeing? Or are you largely going through this, just trying to manage the revenue headwinds at this point?

Yes. So there are a few price increases, certainly. And in fact, the biggest issue is if you have to expedite something, that cost a fortune. So it's really balancing, trying to mitigate any need for expedites and have -- even if that means you carry a little more inventory, it's a much better path than having to expedite anything at this point. So far, again, to Mick's point, we have such a large mix of software. We're able to manage the overall gross margin blends fairly effectively so far.

Great. I think we are fairly close to end time of the session here. Bruce, Mick, thank you for taking the time to attend the conference, and thank you to everyone who dialed in for the session as well.

Yes. Thanks so much, Samik. Really appreciate the time, and JPMorgan for hosting the conference here this week.

Thank you.