Ribbon Communications Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts are in U.S. dollars; financial statement figures are in millions unless noted.
Business context and reporting period
Ribbon provides communications software and networking products and services. Its March 3, 2020 acquisition of ECI expanded the business into optical and packet networking; ECI’s results are included only from the acquisition date. Consequently, reported year-over-year growth is not directly comparable with the prior-year periods. The company also agreed to sell its Kandy cloud-based enterprise services business, subject to closing conditions.
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $231.1 | $137.7 | $599.6 | $402.0 |
| Gross profit | $123.3 | $78.9 | $317.2 | $216.1 |
| Gross margin | 53.4% | 57.3% | 52.9% | 53.8% |
| Operating income (loss) | $11.9 | $2.7 | $(15.2) | $(40.6) |
| Net income (loss) | $6.3 | $1.7 | $(35.2) | $20.3 |
| Diluted EPS | $0.04 | $0.01 | $(0.26) | $0.18 |
Q3 revenue increased 67.9% year over year, including $77.6 million from ECI; product revenue rose 110.8% and service revenue rose 33.6%. For the nine-month period, revenue grew 49.2%, including $171.1 million from ECI. Product and service revenue both increased, while the nine-month net loss compared with prior-year net income, which included substantial other income.
Q3 gross margin declined 3.9 percentage points year over year, chiefly reflecting ECI’s higher-hardware-content product mix and acquired-intangible amortization; organic Ribbon product margins improved. Management expects total gross margin for 2020 to decline versus 2019, mainly due to ECI’s product mix.
- Cash flow: Nine-month operating cash flow was $65.2 million, versus $22.6 million a year earlier. Investing used $322.0 million, primarily for the ECI acquisition, partly offset by $43.5 million in proceeds from a land sale. Financing provided $323.0 million, mainly from debt proceeds.
- Cash and liquidity: September 30 cash and cash equivalents were $103.7 million, plus $7.2 million restricted cash. Current assets were $402.8 million and current liabilities $319.8 million.
- Debt: Term-loan principal was $395.3 million, plus a $0.7 million short-term loan; the $100 million revolving facility was undrawn, with $5.3 million of letters of credit outstanding. Term A averaged 3.4% and Term B 8.4%. The company reported compliance with credit covenants.
- Other balance-sheet items: Goodwill was $416.9 million and net intangible assets $432.9 million at quarter-end. ECI’s purchase-price allocation remained preliminary.
Material changes, outlook and risks
- The ECI merger was funded partly with a new $400 million term loan and 32.5 million Ribbon shares. ECI contributed $11.2 million of net loss in Q3 and $31.9 million since acquisition through September 30.
- The August credit-agreement amendment created a $75 million Term B loan bearing a materially higher rate than Term A and tightened certain limits on additional borrowing. An interest-rate swap hedges $400 million notional through March 2025; its quarter-end fair-value liability was $12.9 million. The company estimated $3.1 million could be reclassified as additional interest expense over the next 12 months.
- Management expects 2020 revenue to exceed 2019 revenue primarily because of ECI, but expects it to be below combined Ribbon and ECI 2019 revenue. Management said the full COVID-19 impact was uncertain and believed cash and available borrowing capacity would cover at least 12 months of anticipated needs; further cost reductions may be considered if conditions worsen.
- COVID-19 risks include delayed customer spending, supply-chain and logistics disruptions, workforce constraints and market volatility. Other material risks include successful ECI integration and realization of expected savings, debt and refinancing requirements, LIBOR transition, customer concentration, and uncertainty in 5G and cloud-market adoption.
- The Kandy sale consideration is 13 million shares of AVCTechnologies, subject to adjustments, and closing depends on shareholder, financing, lender and other approvals. The company also disclosed a securities class action seeking monetary damages; management did not expect routine disputes to materially affect results.
- Q3 included a $4 million tax benefit from releasing part of the Ireland valuation allowance. The company recorded $10.7 million of restructuring expense for the first nine months and expected approximately $6 million of additional expense under its 2020 initiative.
Important facts for investors to verify
- Comparable, acquisition-adjusted performance and the contribution, profitability and integration progress of ECI.
- Whether management’s revenue and gross-margin outlook is achieved, given COVID-19 uncertainty and product mix.
- Debt amortization, Term B borrowing costs, covenant headroom, swap accounting and future refinancing capacity.
- Completion terms and timing of the Kandy sale, including the value and marketability of the share consideration.
- Final ECI purchase-price allocation, including acquired intangible and goodwill valuations, and the status of litigation and IIA royalty contingencies.