Ribbon Communications Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. The company provides network communications products and services to service providers and enterprises. It completed the GENBAND merger in October 2017 and acquired Edgewater Networks on August 3, 2018. Consequently, 2018 results include GENBAND for the full period and Edgewater only after acquisition; the reported 2017 comparisons are not like-for-like.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $152.5m | $74.6m | $411.0m | $183.7m |
| Gross profit | $82.2m | $54.5m | $212.6m | $124.7m |
| Gross margin | 53.9% | 73.1% | 51.7% | 67.9% |
| Operating income (loss) | ($7.6m) | $3.9m | ($66.6m) | ($19.6m) |
| Net income (loss) | ($10.2m) | $3.5m | ($75.0m) | ($19.5m) |
| Diluted earnings (loss) per share | ($0.10) | $0.07 | ($0.73) | ($0.39) |
- Q3 product and service revenue were $77.3m and $75.2m, respectively. Nine-month product and service revenue were $191.9m and $219.1m.
- Operating expenses totaled $89.8m in Q3 and $279.2m for the nine months. These included acquisition/integration costs of $5.6m and $14.3m, and restructuring expense of $2.4m and $15.2m, respectively.
- Cash used in operating activities was $23.5m for the nine months, versus $9.0m provided in the comparable 2017 period. Investing activities used $33.4m, including $46.4m net cash consideration for Edgewater, partly offset by security maturities and sales. Financing activities provided $36.2m.
- Cash and cash equivalents were $36.0m; marketable securities were $7.3m at September 30. Current assets were $235.5m and current liabilities $258.3m.
- Revolving credit borrowings were $58.0m, at an average 5.26% interest rate, with $2.6m of letters of credit outstanding under a $100m facility. Related-party debt was $23.5m, including $1.0m of unpaid interest added to principal. The company reported compliance with credit covenants.
Material changes and drivers
- Reported revenue more than doubled year over year, primarily because GENBAND was included in 2018; Edgewater contributed approximately $10m of revenue after its acquisition. Management also cited product-level growth and increased enterprise contribution in Q3. The filing’s separate illustrative GENBAND pro forma comparison gives 2017 Q3 revenue of $147.6m, underscoring the limitation of comparing reported periods.
- Margins fell substantially. Management attributed product margin pressure to acquired-company costs and acquired-intangible amortization, as well as product/customer mix; service margin was affected by GENBAND costs and higher supply-depot support costs.
- Amortization of acquired intangible assets was $37.7m for the nine months, compared with $6.8m in 2017. Research and development, sales and marketing, and general and administrative expenses also increased, largely reflecting the expanded combined business.
- Revenue recognition standard ASC 606 was adopted January 1, 2018 using the modified retrospective method. Adoption increased opening accumulated deficit by approximately $12m (an increase to opening equity). Under prior revenue rules, revenue would have been approximately $8m lower in Q3 and $9m lower for the nine months.
Outlook, risks and unusual items
- Management expected 2018 total revenue to be significantly above 2017, mainly due to a full year of GENBAND and Edgewater from August 3. It expected lower full-year gross margin, primarily from acquired-intangible amortization, and expected research, sales and marketing, and general and administrative costs to remain higher than 2017 because of the acquisitions, partly offset by restructuring savings.
- Management estimated approximately $3m of additional acquisition/integration expense and approximately $1m of merger-related restructuring expense in Q4 2018. It expected cash, investments and available credit to meet anticipated needs for at least 12 months, including Edgewater deferred consideration.
- Edgewater consideration included $46.4m net cash paid, 4.2m Ribbon shares, and a further $30m cash payment due in installments; the timing of the second installment depends partly on 2018 Edgewater product revenue. Purchase accounting valuations remained preliminary.
- GENBAND purchase accounting reduced acquired deferred revenue by approximately $50m. Management estimated revenue was approximately $4m lower in Q3 and $19m lower for the nine months than GENBAND would have recognized absent the merger, with reductions expected to continue through 2020, primarily affecting service revenue.
- Five Metaswitch lawsuits include company claims and counterclaims. An $8.9m royalty judgment plus $0.4m in costs in one case was appealed; the company had not recorded the award. Management said it could not predict outcomes and did not expect the cases to materially harm the business or financial statements. An SEC inquiry was resolved with a $1.9m civil penalty, previously accrued and paid.
- Other risks include acquisition integration and realization of synergies, customer purchasing and revenue-recognition timing, industry pricing and competition, technology change, customer concentration, restructuring execution, litigation, and foreign-currency exposure. Verizon and AT&T each represented at least 10% of revenue in reported periods.
Important facts for investors to verify
- Assess underlying revenue and margin trends using comparable combined-company periods, separating acquisition contributions, purchase-accounting effects, and ASC 606 impacts.
- Track operating cash flow, working capital, liquidity, and the use and availability of the revolver, especially alongside Edgewater’s remaining $30m consideration.
- Monitor whether management achieves integration savings and its revenue outlook while controlling expenses and acquired-intangible amortization.
- Review the related-party note’s 10% interest rate, repayment timing, and the credit facility’s springing maturity condition tied to that note.
- Follow Edgewater purchase-accounting finalization, Metaswitch litigation and appeal developments, and the company’s future restructuring charges and payments.