Ribbon Communications Inc. — Q2 2019 Form 10-Q
Business context and period. Ribbon provides communications networking software, products and services to telecommunications, cable and wireless providers and enterprises. This unaudited filing covers the three and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $145.4 million | $137.4 million | $264.3 million | $258.5 million |
| Gross profit | $80.7 million | $75.1 million | $137.3 million | $130.4 million |
| Gross margin | 55.5% | 54.7% | 51.9% | 50.4% |
| Operating income (loss) | $(7.1) million | $(16.6) million | $(43.3) million | $(59.0) million |
| Net income (loss) | $49.5 million | $(19.9) million | $18.6 million | $(64.8) million |
| Diluted EPS | $0.45 | $(0.20) | $0.17 | $(0.64) |
| Cash from operating activities | — | $29.1 million | $(22.7) million |
Revenue and margins. Q2 revenue increased 5.9%, led by product revenue up 14.2%; service revenue declined 1.2%. For the first half, revenue increased 2.2%. Q2 product gross margin fell to 49.4% from 52.0%, while service margin rose to 61.4% from 56.9%. Verizon contributed 19% of Q2 revenue and 17% of first-half revenue.
Profit quality. Reported net income was substantially driven by unusual other income: a $63.0 million Metaswitch litigation settlement gain and an $8.1 million reduction in Edgewater deferred purchase consideration (primarily reflected in first-quarter results). The filing reports an operating loss of $7.1 million in Q2 despite the reported net profit.
Balance sheet, debt and liquidity
- At June 30, 2019, cash was $51.2 million and marketable securities were nil. Current assets were $250.6 million and current liabilities $230.4 million, a current ratio of approximately 1.09.
- Debt under the new credit facility totaled $85.0 million at an average interest rate of 4.75%; the facility matures in April 2024. The company had $4.4 million of letters of credit outstanding and was in compliance with its financial covenants.
- The facility is secured by first-priority liens on substantially all company and guarantor assets. Management said cash and available borrowings should cover anticipated needs for at least 12 months, while noting future financing needs could arise.
- Operating cash flow was positive $29.1 million for the first half, versus cash use of $22.7 million a year earlier. Investing activities provided $1.1 million; financing activities used $22.9 million. The cash-flow period included the $37.5 million cash received under the settlement.
Material changes, outlook and risks
- Acquisitions and strategy: Ribbon acquired Anova Data in February for consideration preliminarily valued at $16.9 million, mostly stock, to add analytics and machine-learning capabilities. Edgewater, acquired in 2018, contributed to higher channel and enterprise product sales.
- Restructuring: A June 2019 plan includes workforce reductions and facility consolidation, including a shift toward software virtualization and away from hardware-focused development. Ribbon expects approximately $25 million of annualized cost-footprint savings once complete and approximately $10 million of savings in the remainder of 2019, which it intends to reinvest in software development. Completion is expected by the end of 2020. The company recorded restructuring expense of $9.1 million in Q2, including $5.8 million of severance and $2.9 million of accelerated lease amortization.
- Management outlook: Ribbon expects 2019 revenue to be relatively flat versus 2018 and total gross margin to increase. It expects R&D expense to rise slightly, while sales and marketing and general and administrative expenses are expected to decline. These are directional statements; the filing provides no detailed numerical revenue or earnings guidance.
- Settlement and litigation: Metaswitch agreed to pay $63.0 million in total: $37.5 million received in Q2 and $25.5 million in three annual installments beginning June 2020, bearing 4% interest. The parties also cross-licensed existing patent portfolios and sought dismissal of the lawsuits. A separate shareholder class action remained pending; an amended complaint was filed in July 2019.
- Other risks and items: Industry consolidation and pricing pressure weighed on services revenue. The filing identifies tariffs and trade restrictions affecting components and products sourced or manufactured internationally as a risk. Two customers represented approximately 31% of accounts receivable at quarter-end. Adoption of lease accounting standards added approximately $43.9 million of lease assets and $47.8 million of lease liabilities at January 1, 2019, with no impact on reported earnings or cash flows from adoption.
Investor verification points
- Separate recurring operating performance from the $63.0 million settlement gain and $8.1 million deferred-consideration reduction when assessing profitability.
- Track whether the expected restructuring savings are achieved, their implementation costs, and how much is reinvested in software development.
- Monitor product mix and product gross margin, as well as service revenue trends amid industry pricing pressure.
- Review the timing and collectability of the $25.5 million settlement installments, customer concentration, and working-capital movements affecting operating cash flow.
- Confirm ongoing compliance with secured-credit covenants and assess debt, liquidity and the pace of the authorized $75 million share repurchase program; $70.5 million remained available at June 30.
- Follow developments in the shareholder class action and potential exposure from tariffs, acquisitions and facility restructuring.