Ribbon Communications Inc. (RBBN) Q3 2022 Earnings Report, Transcript and Summary

Greetings, and welcome to Ribbon Communications Third Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Bruce McClelland, CEO. Sir, you may begin.

Good afternoon. And welcome to Ribbon's third quarter 2022 financial results conference call. I'm Bita Milanian, SVP of Marketing at Ribbon Communications. Also on the call today are Bruce McClelland, Ribbon's Chief Executive Officer; and Mick Lopez, Ribbon's Chief Financial Officer. Today's call is being webcast live and will be archived on the Investor Relations section of our Web site at rbbn.com, where both our press release and supplemental slides are currently available. Certain matters we will be discussing today, including the business outlook and financial projections for the fourth quarter of 2022 are forward-looking statements. Such statements are subject to the risks and uncertainties that could cause actual results to differ materially from those contained in these forward-looking statements. These risks and uncertainties are discussed in our documents filed with the SEC, including our most recent Form 10-K. I refer you to our Safe Harbor statement included on Slide 2 of the supplemental slides for this conference call. In addition, we will present non-GAAP financial information on this call. Reconciliations to the applicable GAAP measures are included in the earnings press release we issued earlier today, as well as the supplemental slides we prepared for this conference call, which again, are both available on the Investor Relations section of our Web site. And now, I would like to turn the call over to Bruce. Bruce?

Great. Thanks, Bita, and thanks to everyone for joining us today to discuss our third quarter results and our outlook for the remainder of the year. I'm very excited to report significant improvements in our IP Optical networks business this quarter. Revenues increased significantly to $82 million, up 20% sequentially and year-over-year. Perhaps more importantly, our product and service bookings increased over 90% versus the previous quarter with a book-to-bill of 1.4 times for this segment. Obviously, overall demand was not an issue and we could have easily shipped more product in the quarter. However, availability of a small number of key components and General Logistics challenges continued to limit overall output. The increased IP Optical revenue in the quarter resulted in a dramatic improvement in non-GAAP gross margin, returning to more historical levels at 38%. The 900 basis point improvement is equally partitioned between three factors, higher volume, lower supply chain cost, and overall customer and product mix. From a regional mix perspective, sales in Europe increased by more than 40% versus the second quarter, and North America increased by over 15%. Our IP Optical sales in India were down about 6%, which were limited by the supply of key components. We expect India to be stronger again in the fourth quarter. An extremely important element of our strategy is to focus on the large service provider IP routing market and the investment in an expanded portfolio of IP routing solutions. We've made great progress on this strategy in the third quarter, with bookings of our Neptune IP routing products more than doubling compared to the second quarter and making up more than half of the IP Optical segment product bookings in the quarter. We received a huge validation of the strategy with a major new 5G mobile cell site router win and large booking with Bharti Airtel in India, one of the largest mobile carriers in the world. This new wind builds on the IP MPLS deployments we're already doing with Airtel in the access and aggregation layers of their network, and extends our footprint to include cell site routing. Part of our recently announced XDR family of routing solutions, this flexible 64 gigabit IP MPLS cell site router and includes advanced routing capabilities, and is perfectly suited for aggregation of ever increasing 4G and 5G mobile traffic. More broadly, we continue to make good progress on our pipeline of major Tier 1 mobile and telecom carrier opportunities. Of the 18 RFPs I mentioned last fall, we have wins and initial POs from for them, and decisions are pending on three others and look very positive. And we've been excluded from three of them. Ramping to significant revenue will obviously take time, but I'm pleased with the initial success. The incremental R&D investment we've been making in this segment and particularly in advanced IP routing software and hardware platforms is directly linked to the momentum building with these new major customer opportunities. But ultimately, what really matters is how this translates into a sustainable, profitable business. We have a clear path to profitability with the stronger sales and improved margins and expect to close in on this goal in Q4. We are also planning additional cost improvement actions across the company to accelerate overall profitability in 2023 and increase cash flow. In our Cloud and Edge segment, AT&T was a real bright spot this quarter, and I'm very encouraged by the growing opportunity funnel resulting from their increased focus on network infrastructure and reducing operational costs. The combination of network transformation projects to significantly reduce operational costs along with great sell through enterprise channel partnership resulted in AT&T once again becoming a 10% plus customer in the quarter. In several of the projects, we are now leveraging technology from our IP routing portfolio to enable the migration of TDM voice networks to IP, and other multi-service access integrations. This type of solution synergy is a real bonus on top of the original ECI acquisition strategy and one of the many ways we are finding opportunities to sell the IP Optical portfolio to existing Ribbon voice over IP customers. We were honored to have Scott Mayer, former AT&T Networks Engineering and Operations President, join our Board of Directors last quarter. He is providing great input on strategic direction, both from a technology and a business perspective. Activity with our largest customer Verizon was very strong this last quarter, but many of the projects involved deploying products shipped last quarter, resulting in lower product sales this quarter. Overall engagement with service providers related to network modernization and introduction of new cloud based technologies remains very high across all regions. Sales of our Cloud and Edge solutions to enterprise customers continued to build this quarter, increasing 17% quarter-over-quarter and 26% year-over-year. Once again, we have a very nice distribution of new wins and growth across multiple enterprise market verticals, including Johnson & Johnson in Healthcare, Giant Eagle in Retail, Marathon Petroleum in Energy, the University of Calgary in Higher Education and Accenture in Consulting. But one thing that these companies and institutions all have in common is large complex communication needs and they all selected Ribbon to help solve these challenges. One of the key productivity improvement enablers for enterprises of all sizes continues to be the adoption of unified communication platforms. We are partnering with Microsoft and Poly on a very successful roadshow across North America, Europe and Asia, promoting our solutions and educating hundreds of enterprises on the merits of investing in hybrid work technologies. Service providers continue to be a very large and important channel to market for UCaaS services such as Microsoft Teams and Zoom, and increasingly they are augmenting their on-premise solutions with public cloud managed service platforms for the session border controller and policy management functionality. Our Ribbon Connect service is a perfect fit and we were recently selected by and Cincinnati Bell to support their Microsoft Operator Connect deployment. This complements the highly successful sell through business we have developed partnering with many of the US service providers using our broad enterprise edge on-premise SBC portfolio. As I highlighted last quarter, modernization of the communications infrastructure across US Federal Government agencies is a very large opportunity for us over the next several years. We were awarded an initial defense agency order in Q3, but anticipated several larger deals also closing in the quarter and beginning to ship for revenue. The timing on these projects has proven very difficult to predict. While we fully anticipate they'll be awarded in Q4, we have de-risked our guidance by planning them for revenue in 2023. And finally, our focus on added value applications such as network monitoring, service assurance, mobile, radio network congestion and fraud and robocalling mitigation received a boost this quarter with a significant deal with the US Tier 1 operator and additional wins in France for the STIR/SHAKEN, where we established a very strong market leadership position with three of the largest carriers. Overall application revenue more than doubled this quarter. As we discussed last quarter, we have a great pipeline of new products beginning to come to market. Our new XDR IP routers address a wide variety of applications from multi service edge aggregation through to high performance metro routing for mobile and broadband networks. Based on the latest generation of merchant routing silicon, these built for purpose platforms compare favorably on a cost, density and power perspective. And with a routing feature set to address the large telecom IP routing market. Following the introduction of the XDR 2100, 800 gigabit router last quarter, we expect to begin initial shipments by the end of the year of the XDR 2300, a 3 terabit modular [redundant] platform that significantly expands our addressable market. We already have initial customer orders and expect this to be a strong new market entrant as service providers transform their IP transport networks to leverage hyper scale data center architectures and technologies. The platform also supports a full set of optical interfaces including 400 Gig ZR and ZR Plus coherent optical pluggable, enabling further convergence of the IP and optical layers of the network. In the first half of 2023, the XDR portfolio will expand further with several new variants, including the 2700 and 8 terabit per second high capacity modular platform for metro aggregation and IP transport. The 2700 has a unique Pay As You Grow architecture that allows switching capacity to be added as needed, providing a very compelling total cost of ownership and completes a comprehensive portfolio of 5G optimized IP routing solutions from the very edge of the network to route to the Metro core. With that, I'll turn it over to Mick to provide additional detail on our third quarter results, and then come back on to discuss guidance for the fourth quarter.

Thank you very much, Bruce. Good afternoon to everyone. As always, please refer to our Investor Relations Web site for supplemental slides summarizing our third quarter and historical financial performance. The third quarter of 2022, our financial results showed improvement over the previous quarter and were just slightly below our guidance range. Let's start with consolidated corporate financial performance. Ribbon generated revenues of $207 million, which would have been $2 million higher on a constant currency basis. Non-GAAP gross margin was 54.5% also impacted $2 million negatively by currency changes. Non-GAAP operating expenses were $94 million impacted positively by $2 million from strong US dollar. Therefore, the foreign exchange impact to Ribbon in the third quarter was effectively neutral to profits. Non-GAAP adjusted EBITDA was $23 million in the quarter and non-GAAP diluted earnings per share was $0.02. Our basic share count was 159 million shares and our diluted shared count was 163 million shares. Our non-GAAP tax rate for the quarter was 70%, which as we have stated before, is derived from jurisdictional income taxation. In August, we entered into a settlement agreement with AVCT that granted Ribbon perpetual royalty free rights to Web RTC gateway technology that is integrated into some of our session border controllers and application servers. As consideration, the company paid cash and surrendered our shares and warrants in AVCT. And therefore, the investment in AVCT has been written down to zero in our balance sheet. Now, let's look at the results of our two business segments. In our Cloud and Edge business, third quarter revenue was $125 million, down 12% year-over-year and 9% quarter-over-quarter. Product Revenue contributed $51 million, maintenance revenue was $56 million and professional service revenue was $18 million. Software as a percentage of total product revenue was 61%. Our Cloud and Edge businesses experienced declines in revenue. It was able to maintain its high level of profitability with non-GAAP gross margins up 65% and non-GAAP adjusted EBITDA of $33 million, or an EBITDA margin of 26%. Let's turn to our IP Optical networks business results. We recorded third quarter revenue of $82 million, which was an increase of $14 million or 21% year-over-year and an increase of 20% quarter-over-quarter. Product revenue was up 30% compared to the third quarter of 2021. Non-GAAP gross margin for IP Optical was 38%, a 9 percentage point increase over the previous quarter and a 1 percentage point higher than the third quarter of 2021. As Bruce mentioned, the significant improvement was driven equally by higher volume, lower supply chain costs and overall product mix. Non-GAAP EBITDA loss for the quarter of $10 million was reduced by half from the previous quarter, driven by the increased revenues and margins with stable expense controls. Here are some consolidated key performance indicators for the company in the third quarter. Maintenance revenue was $72 million, which represented 35% of total revenue and was constant year-on-year. Top 10 customers were 46% of revenue and included both Verizon and AT&T as providing over 10% of revenues for the quarter. Service providers accounted for 70% of our product revenue and enterprise customers represented 30%. International customers provided 58% of revenue, which is a higher percentage from previous quarter commensurate with the increase in IP Optical business as a percentage of total Ribbon revenues. We had healthy [booked] revenue, excluding maintenance ratios of approximately 1.28 times for Ribbon, 1.45 times for IP Optical and 1.13 times for Cloud and Edge. Turning to the balance sheet. We ended the quarter with cash and cash equivalents of $56 million. This is an increase of $18 million from the end of the second quarter. The main addition to the cash balance is our successful $50 million capital raise that by some of our major investors including Neuberger Berman, JPMorgan and Swarth Group. Our term loan is currently at $335 million outstanding as we have paid off $65 million or 16% of the original balance. Our $100 million revolver remained undrawn at quarter end. For the third quarter of 2022, we met our term loan covenant metrics as a result of continued profitability, constant level of interest rate hedged by our fixed rate swap and application of the equity tier clause in our loan agreement. During these times of increasing interest rates, Ribbon enjoys the benefits of a fixed rate swap that limits our LIBOR rate to only 90 basis points compared to the current one month spot rate of about 350 basis points. We had use of cash from operations of $18 million, driven mostly by the timing of deferred revenues and contract manufacturer payments. Major cash outlays included $26 million reduction of accounts payable, $7 million increase in inventory for strategic components and to support revenue growth, $7 million in capital expenditures, including $3 million for the WebRTC perpetual license and $5 million for debt paydown. We are expecting a return to positive cash flows in the next couple of quarters. In the third quarter, Ribbon continued to show resiliency in our profitability as we navigated through supply chain disruptions, global inflation, increases in interest rates and US dollar appreciation. With the very positive indicator of revenues and bookings growth in IP Optical, we are beginning to see the benefits of our investments in our strategy. Now, I'd like to turn the call back to Bruce.

Thanks, Mick. As we anticipated, the third quarter was a market improvement in our IP Optical networks business in virtually all key metrics. A significant investment we are making in developing new products is beginning to show results, underlined by the recent 5G cell site router win with Bharti Airtel, and the very strong bookings in the quarter. Supply chain volatility continues to be a background challenge but we mitigated much of the impact with some increase in working inventory, and expect gross margins in the fourth quarter to be consistent with the previous quarter. Overall, we expect further revenue growth in our IP routing and optical transport segment in the fourth quarter across the majority of regions supported by significantly higher backlog entering the quarter and approaching profitability on an adjusted non-GAAP basis. Similarly, we expect the fourth quarter to be a sequentially stronger quarter for our Cloud and Edge business, with good backlog and visibility with our traditional service provider and enterprise customer base. In particular, we anticipate a significant increase in session border controller revenue with increased shipments of high capacity SBC core platforms and capacity licenses to both service providers and enterprise customers, as well as enterprise SBCs sold primarily through our service provider customers and increasing usage of our as a service Ribbon Connect platform. The US Federal network modernization projects remain a large opportunity for us. However, we are taking a more cautious approach assessing the timing of awards and have taken that into account with our revised guidance. As we look into 2023, I remain very positive on the outlook for our diversified business and the momentum we continue to build with our expanded product portfolio. The recent successful equity investment in the company gives us the resources we need to realize our vision, and we are now starting to see results and this is just the beginning. The telecommunications industry tends to weather macroeconomic recessionary effects better than almost all other industries. And it's imperative that service providers continue to invest in new technologies to keep pace with the exponential growth in traffic. However, we remain watchful of any signs of reductions in capital investment and need to be flexible to quickly react to the changing environment. From an operating cost perspective, we are planning to implement additional expense reductions going into 2023 to improve profitability and cash generation. In particular, I see market opportunities that would be more efficiently addressed by further functional integration across the company. And as we focus on the best opportunities for profitable growth, accelerating our path to improve profitability and cash generation. With that backdrop, our expectations for the fourth quarter are as follows: For revenue in a range of $220 million to $240 million; non-GAAP gross margins of 53.5% to 54.5%; and non-GAAP adjusted EBITDA of $30 million to $36 million. I'd like to thank the entire Ribbon team and our partners for navigating in a complex operating environment and look forward to a strong finish to 2022. Operator, that concludes our prepared remarks. And why don't we now open up for a few questions.

Thank you. We will now be conducting a question-and-answer session [Operator Instructions]. Our first question comes from Paul Silverstein with Cowen.

I've got several questions starting with a high level and then building down [Indiscernible] on the call. First off, can you tell us -- I know you give the book to revenue on IP Optical business. But could you give us the book to revenue [Indiscernible], I don't see it in the deck, but is that something you could share with us?

I think it is in the -- while it's somewhere, it's 1.13, Paul, in the quarter.

So for the overall company, what was the book to revenue?

1.28.

And then in terms of trying to decipher demand, secular demand versus macro, I apologize if you've answered this in the prepared remarks, but what are you seeing in terms of demand trends in a macro weakness, especially outside of the US given FX and given Europe's exposure to energy in particular. It certainly doesn't seem to be adversely impacting your IP Optical business. But how much of the Cloud and Edge weakness, or [Indiscernible] your response in terms what you're seeing in both businesses?

I guess, if I break it into two pieces, certainly, the demand perspective, the demand backdrop around IP Optical improved significantly in the third quarter, as we expected and as we have guided, and it's a combination, obviously, of the momentum around the new products we're bringing to market. And in particular, as I mentioned, the bookings in the third quarter increase around IP routing in particular now being more than half the bookings in the quarter for that segment, was really good to see underpinned or underlined by this new deal with Airtel in India. I also, I think, mentioned the demand in Europe and the revenue in Europe, or Europe, Middle East Africa, kind of the whole EMEA region, was up pretty significantly in the quarter as well. Obviously, the Cloud and Edge business was down from previous quarter, down from the previous year. I've mentioned, in particular, we had a great quarter with Verizon in the second quarter, and a lot of the activity in the third quarter was deploying some of those products. So revenue was kind of naturally down there, offset by real strength with AT&T and as I mentioned, now kind of once again becoming a 10% plus customer in the quarter. So those are some of the dynamics I think that affected third quarter. As we look into the fourth quarter, again, as I think about the two segments in the IP Optical business, what we're projecting is really some increases in each of the geographies around the world. For the most part, every one of them, we're expecting some level of increase. We don't think Europe is as strong from an increase perspective is what we saw in the third quarter. And obviously, part of the reduction in guidance here was around being a little more cautious around what happens in Europe, in particular, in the fourth quarter. As I also mentioned, we have some really significant opportunities in the federal space. But just trying to predict the exact timing of when some of the deals go into procurement and when they get closed and as they flow to our partners, it's just been challenging to nail down exactly. So I've tried to be a little more cautious in what we see happen in the fourth quarter.

Bruce, I appreciate that you are not the largest supplier in the world. So it would not be unusual if there was a divorce between these larger trends and what you actually see for better or worse. But relative to your commentary about US Federal, about Europe and even beyond those two. Are there -- is the caution, or the caution note about federal in Europe, is that because either US Federal and/or European carriers or customers have communicated to you and your team that due to macro concern, or in the case of Europe, perhaps FX as well, that they're reevaluating, pausing, slowing, elongating purchasing cycles, any of the traditional warning signs that are not just about rhythm but broader in terms of these broader trends? And again, the question is not just something special in Europe but general Asia-PAC. Any of your service buyers [Indiscernible] extent causing you concern and same thing on US Federal?

Yes, to provide a little more color, in particular, around Europe. Quite a bit of our business in Europe is with critical infrastructure providers. So it's a range of transportation, oil and gas, railways, those types of customers that are investing in programs and projects to build out their own infrastructure. And I think we've got a great pipeline of opportunities and nothing's kind of happened that's caused anything to really disappear. I just think -- I expect that decision making on some of these takes longer given the macro environment. Now, clearly, in Q3, we saw great increase in business in Europe over the previous quarter and we expect Q4 to be a strong quarter. But as I look at individual opportunities and trying to predict exactly when they close and when they go to revenue, I'm trying to be a little more cautious. So it's not so much a macro service provider commentary as it is more specificity around where we're selling in Europe. Federal is somewhat similar. I mean, there's a whole lineup of different programs being contemplated and bid. And as I mentioned on the last earnings call, there's a really significant legacy infrastructure of TDM interfaces and products throughout the federal communication infrastructure. And all of those need to be replaced and moved over to an IP infrastructure over the next couple of years. Anybody that's got experience working with the fed knows the timing on when things go through procurement and get awarded, can be a little unpredictable. So again, it's not a real commentary on something that's changed, just trying to predict the exact timing is really the challenge.

What it shows [indiscernible] questions, if I may. On the IP Optical, it sounds like the strength is broader than Airtel, but let me ask you a question. How much of a significant increase in bookings is a function of Airtel, how much of it goes well beyond your pocket?

Yes. So Airtel has been a significant customer for us for a while. Obviously, they are not a 10% plus customer, or they'd be listed that way. So there were a portion of obviously the strength in the third quarter, but just a piece of it. So it's not like it was the dominant piece or anything like that. I mean, it was a piece of the growth but just seeing the revenue numbers, obviously, how the Europe tells you that there is strength elsewhere as well.

And that's also true to bookings comments, Bruce? You were up, what 90% Q-over-Q in IP Optical on the bookings?

Yes, exactly. Same commentary on bookings, yes.

And again, I appreciate that you are far smaller in size of business relative to [indiscernible] optical, and so you wouldn't necessarily experience the problems [indiscernible] they are. But from a supply standpoint, we’ve just had [Nokia] last week say that demand for optical remains very strong, but supply chain remains very challenged, you said that back in early September, that doesn't seem to be restraining your growth. Again, I appreciate the numbers were smaller and units are far less. Any insight you can share about what you're seeing there?

So if I start with supply, it is still a battle hand-to-hand every day, every week on various issues. And I mentioned -- I called it a background activity, that just meant, I'm a little tired of talking about supply chain frankly. But there are a couple of specific component areas that are still problems for us that limit the amount that we can produce and ship in a particular quarter. I mentioned in my opening that India, in particular, in the third quarter was down or lower than I expected it to be, primarily because of specific component issues around the products we ship into that region. So it's still an issue. We could have obviously given the bookings that we had in the third quarter, we could have shipped a lot more in the third quarter, if we have been able to supply it. So that continues to be an issue. Just general logistics continues to be an issue, getting products around the world. Again, we are -- maybe it's a reflection of where we are doing business and scope and size, et cetera. But as we completed the quarter, we had a number of shipments that ended up in transit, as we were completing and should have had a stronger finish to the third quarter. So all those things kind of contribute. And I can certainly recognize or relate to the commentary that Nokia had more broadly about demand going forward. I mentioned it in my comments. I am watching really carefully to see signs of reductions in capital spend and budget. and I do think we will expect to see just more -- taking more time for decisions to get made on investments and obviously the macro environment is not a plus from an overall capital allocation spend perspective. I know as you have listened to some of the carriers here in the US over the last week, I think both AT&T and Verizon commented on their capital spend plans being unchanged for the rest of this year at least anyway. So we will see what happens in '23. But they have not announced any kind of macro level reductions there that I've seen.

Bruce, just to be clear, the concern you just expressed that is you may appropriately concerned. I mean, just given history, that's not because the carriers of any magnitude or any number, appreciable number have communicated to you that they are currently planning to cut back, that's the question. Is it based on just general appropriate concern or is it actually based on some conversations that you have had with -- and your team have that [indiscernible]?

No, I think what we've heard is what they have said publicly. And again, I haven't seen any public statements around reductions in capital. But I don't think people put out their plans in detail for '23 yet. So that's where my cautiousness, I guess, comes in just trying to look a little further into the future. As far as this year capital spending, this seems to be pretty consistent.

One last question, I promise. On the India opportunity, you've just had announced that Jio had a far key -- I'm not sure about Vodafone, but these are massive 5G buildouts, you are talking about imminently and they may have already started. And over the next 18 months, it's going to be a ton of spend. The last time I checked Huawei, ZTE are out of the picture. And so it's essentially you I think seen in Nokia. What are you seeing in terms of optical in India, has already started? And Bharti Airtel, I trust that IP router your referenced is part of that. But are the funds already starting to flow in this 5G buildouts, what's the outlook for the pipeline there or the opportunity over the next 18 months or so?

This new cell site router, opportunity is directly linked to the investment around the 5G infrastructure buildout. And I think as you know they're just starting. So there's a long runway ahead there. And that architecture in that series of products apply not just to Bharti, but to most of the carriers around the world building out 5G infrastructure. And it's just one product in the portfolio, but it's the reason we've been making the investment we have. We really see a significant opportunity and a spot for us to really grow the company. In addition to the optical business that we're doing, which also grew clearly in the quarter, the growth in IP and kind of the increased balance in the portfolio is really exciting to watch here.

Next question comes from Dave Kang with B. Riley.

My first question is, just wanted to clarify. Did I hear you correctly when you said, when you're talking about margins that one of the reasons margins increase was because your supply chain costs went down. Did I hear that correctly?

So you did and there was essentially three reasons why the IP optical margins improved quarter-over-quarter. One was lower expedite fees that we were paying in the quarter. And of course we just had a good discussion with Paul on supply chain. But in a variety of areas, we've seen improvements. Obviously, we've also invested in incremental inventory and that's allowed us to avoid as much as possible any expedite fees, and that flowed through and was about a third of the improvement in the third quarter. The other two pieces, just overall volume and fixed cost absorption obviously improved the gross margin percentage in the quarter. And then the third was just general mix on what products and what regions we’re shipping into in the quarter.

And regarding expedite fees, is there more room to good decline or like compared to like pre-pandemic situation. Where are we in terms of expedite fees?

So we are still paying some amount of expedite fees each quarter in both businesses. And we make kind of a game time decision on, do we wait and ship a little bit later or do we pull in or accelerate and pay incremental fees. And a lot of it depends on obviously the dialog with the customer and how soon they need the product and those sorts of things. So we are continuing to pay some amount of expedite fees. We anticipate paying some still this quarter around making sure we get products to customers.

And regarding the supply chain situation, it sounds like last quarter, meaning second quarter, I think you quantified that as about $10 million impact, looks like since you missed about $11 million this quarter, it was about $11 million as far as how much you left revenue on the table?

So I would say half of it is directly related to supply chain and logistics right at the end of the quarter, and could have easily gone either way. The other half, we have expected some of these federal deals to start to come to revenue in the third quarter, and that was the other piece of it, Dave. I will add, of course, with the incremental backlog that we've been able to accumulate in the third quarter, we have kind of a growing impact from supply chain. Clearly, we could have shipped a lot more in the third quarter given the bookings, if we've been able to build more. I had not anticipated that in the guidance. So I don't call that a shortage relative to the projection. But we enter the fourth quarter with stronger backlog than we've had probably ever at this point. So a direct reflection on the bookings momentum in the third quarter.

And so just wanted to be clear. It seriously impacted C&E more than IP Optical. Is that correct?

I think the shortfall relative to our guidance was evenly split between the two businesses. Most of the impact on Cloud and Edge was the federal opportunities and most of the impact on IP Optical was simply around components and logistics at the end of the quarter.

And just wondering, what's the rough mix between Optical versus IP? And what are -- I assume their margins are quite different? What's the margin differential between those two?

So just to comment directionally, I guess, because we don't break that out specifically. But in the third quarter, obviously, both IP and Optical grew from a revenue perspective. And I've kind of characterized it as 60/40, traditionally, and third quarter was similar in nature. I also did comment though that from a bookings perspective, IP increased significantly, almost doubled quarter-over-quarter from a bookings perspective, and that they were more than half of the bookings in Q3. And it's what I expect. I mean, given the expanding portfolio around IP routing, that's definitely a stronger growth area going forward. From a margin perspective, it'll be different between IP and Optical. In general, I expect over time the IP margins to be stronger than Optical margins. I will say it depends on the type of product that we're shipping and what region we're shipping it into as well. So it can vary days. But in general, that's a directional comment.

And then obviously, with a 1.45 book-to-bill sounds like you are building backlog. Can you just talk about backlog situation? Albeit talking in a pretty significant increase in backlog like some other NIM companies. Just any color on backlog situation. And do you expect that to increase again in fourth quarter? And if so, when does it peak and when do you start to convert that to revenues?

So with revenue increasing in IP Optical in the third quarter to $82 million and the book-to-bill increasing to 1.45, of course, you can easily do the math on that. That was a pretty big significant increase overall in bookings. And in fact, the way I think of it is, I think about momentum. If I add revenue and bookings together, this was by far the best quarter we have had for IP optical. And obviously a lot of that bookings goes into backlog going into Q4 and I think our -- we don't report our backlog, but our backlog 10% plus up from where it has been entering quarters in the past. So that gives us a little better predictability and outlook going into the fourth quarter. And clearly, the thinking is in the fourth quarter, we are building backlog for 2023 and expect something similar in the fourth quarter. We will see how we do but that's the outlook we have.

Next question comes from Greg Mesniaeff with WestPark Capital.

Bruce, towards the end of your prepared remarks, you said that you are anticipating additional expense reductions in 2023 and further functional integration, if I could pretty much quote you on that. Can you expand on that a little and tell us what you mean by that? Give us some color.

A number of the opportunities that we're seeing now include technologies and products from both portfolios from both the Cloud and Edge, voice, core technology, as well as in particular IP routing technology. And as you see these networks transition from TDM interfaces to over to IP, we are able to leverage the technology coming out the IP optical business. And I think today, we are organized around two business units and global sales teams, et cetera. We are looking at different ways to take advantage of what we are seeing as the market opportunities and bring these organizations more closely together and particularly around how we serve the customer, how we do professional services, how we do maintenance and support. I think there is opportunities to be more efficient and more effective, frankly, as we bring the organization more tightly together. You could think of it as kind of the next phase of integration after we brought the two companies together. And we will have more detail on that obviously as we get into fourth quarter results and outlook for 2023, but that's kind of the color behind the scenes.

And just a quick follow-up to that same topic. As you do that, have you explored any possibilities of strategic partnerships with other vendors that may have complementary product fit and similar sales and marketing organizations?

Yes, that's actually a great question, Greg. There is a number of threads around that. As you think about the broadband access networks and for the most part, we are not in the access portion of the network. There is a number of companies there that I think are good partners for us as we have a complementary set of products. So that's one area that's fairly active. The other is really around kind of the other end of the network as you think about automation and orchestration. Clearly, we are focused on the optical and IT domains that we are operating in, but that fits into a broader automation and orchestration environment that includes the RAN network and the Access network. And I think there's some, some really interesting partnership opportunities to accelerate our vision around products like Muse that are kind of the foundation of orchestration for the entire network. So there's couple of real good examples that we're exploring there, Greg.

Next question comes from Tim Savageaux with Northland Capital Markets.

A couple of questions here, but just wanted to follow-up on something you just commented on, which is when you talk to expecting something similar in Q4 in IP optical is, is that a 1.45 book to bill again or a 10% backlog increase, or what are you referring to there?

Maybe I should have been more clear, Tim. So our outlook for Q4 assumes growth in IP optical revenue, obviously. And I think to do the math, it's 10% plus growth in revenue. And if we think about the bookings target for Q4 from a dollars perspective, obviously something similar to what we've done in Q3 overall for the company, not necessarily a 1.45 bookings ratio.

I’ll try to cut that one little bit later on and move on. In terms of the -- and thanks for the update and the detail on the RFP pipeline. I think, if I recall properly, you had taken that number to 18 Tier 1s and I think you said you won four of them, or at least pieces of 4. A couple questions on that, which is, one, can you give us any metrics around the aggregate value of those wins, either in total or annually? I think we’d characterize this pipeline as multi hundred million in annual revenue in the aggregate. So relative to that, on the one hand, on the other, to what extent were those wins contributors to Q3 revenues, or is that more into backlog and into '23, should we think about that?

The Bharti cell site router is an example that I can talk about. So it's an example of one of those opportunities. And those are significant deals for us. The initial order that kind of takes us through the first part of next year is -- and I don't want to give specific numbers, but it's double digit millions, if you will. So these are all, as you characterized them, these are tens of millions of dollars each and obviously, ramp over time. If you think about Rogers deal that, that we're now in kind of full deployment mode with, it took a while to ramp to that level, but we're at that level of spend on an annual basis and then some. So each one of these are pretty meaningful for increases for where we're starting from.

And so given that's the case, I mean you I expect continued fairly robust bookings in Q4, given the backlog you're going to exit with. I mean, you grew -- with some supply constraints, you're able to grow IP Optical kind of mid single digits this year. I would imagine the expectation might be for a pretty significant acceleration in that growth rate in '23 without getting ahead of ourselves efficiently…

Yes, without getting to the point of providing specific guidance for next year. Obviously, the investment we've made in this product line, we're expecting significant growth going forward. And we've obviously said that for a while, we're now kind of seeing some of that start to come into play. And in particular, the IP routing piece that we're investing in and the momentum there, I think, is a game changer. So we're expecting good growth going into next year. And that obviously, what really matters is how do we get to better profitability and that's part of the whole picture here, as well as we go into next year and help ourselves by lowering the operating costs a little bit and getting the growth and the margin improvement at the same time.

And last one for me, and I think you talked in the past about approaching 40% gross margins in IP Optical through the end of the year. You obviously got pretty darn close in Q3, just given what looks to be a little better than expected performance in Q3. Any update to those targets? And I guess I'll ask the same non-question about next year. I mean, I imagine, given the mix improving on the IP side, do you feel like 40% plus is a pretty reasonable target?

So I think about nearer term, what we expect looking at the mix in the fourth quarter is gross margins on both businesses similar to what we just did in the third quarter. So call it 38% on IP Optical. There was room for improvement -- on those numbers, particularly around the supply chain costs. So if I look at direct margin and kind of exclude the expedite fees and things like that, I like what I've seen. We still need to see better improvement around what we have to be around securing components, and then I think we close in on that target.

Next question comes from Erik Suppiger with JMP Securities.

First off, I'm trying to gauge the incremental change in the supply chain. Did it change from Q2, or how would you -- what would you describe the status relative to the last couple of quarters?

So I would say we have had incremental improvements in the Q3. So it's more positive than it was in Q2. That doesn't mean we don't have issues and shortages and a variety of things. But in Q3, we were able to solve many of them. We had a couple of very specific Intel parts, as an example, that meant we couldn't build to the full level we expected and we ended up having material that at 99% of what you needed to build, but you missed one key component. So there was some of that in the quarter. But as I just commented on expedite fees and whatnot, obviously, they came down in the quarter so incrementally improved from where we were in the second quarter. Mick, what do you think, thoughts on that?

I agree, and I think it has improved. We're still not out of woods yet. In particular, the logistics and transportation costs are more stable and we're able to move things around much better. And the basic parts, which were spiking up and down in the beginning of the year, they're more readily available now. It's those special components that are still very dear and far out.

Erik, I'll just add one more comment to that. Ultimately, and I know some of our peers have commented the same, but we have to look at some design changes in some cases to beyond components that are more readily available, and of course making hardware design changes, getting that cut in, getting approved by customers takes time. So we actually see, as we get into kind of the second quarter next year, another step up in improvement in stability around supply chain, because some of the products that we know we're just going to continue to struggle on some parts will get designed on more readily available components.

So that relates to the next question I had is, how do you see the supply chain getting back towards normal? And it sounds like it's going to be gradual, but Q2 of next year is when you start to see some incremental significant changes?

The couple that are still painful for us, there is not a great line of sight to them improving from a supply availability perspective. We are going to be tight on them through -- until we move on to another component, and we expect that to happen in the second quarter timeframe. So if I said when does this all get a better, and we are not talking about it, it's probably in that timeframe based on what we are currently seeing.

And then what is the pricing environment out there for your product as you are dealing with the component costs moving around? Have you been able to pass much of that on or what is the pricing environment?

We really focus on two areas. One is around the product cost and then the other around the inflationary costs relative to employees and labor and everything that goes into facilities, et cetera. And so we are focused on trying to get prices raised around our maintenance business, which is a key part of obviously our revenue stream. So a lot of focus on as these contracts come up for renewal trend press for higher prices around support. And then obviously we are trying to move the needle on pricing on products. I'd find that harder. We are out competing for new business, trying to get new wins, new insertion and ultimately we have got to be competitive on price, and that we have less pricing control or pricing power I think around that. So that's the way we are really approaching it.

Then last quick question. AT&T, it sounded like it's kind of a short term dip. Would you expect them to return back to 10% contribution as they work through some of the deployments?

I think you probably referred to Verizon. And so Verizon continues to be our largest customer, our top 10, 10% plus customer and expect that to continue for the foreseeable future at this point. The projects I mentioned in Q3, again, there is a lot of activity with them, a lot of professional services, helping them deploy our products. But we’ve shipped a lot in Q2, so we are still kind of absorbing a lot of that as we complete those programs. I think the opportunities with Verizon in addition to the network transformation, upgrades that continue, I'm pretty excited about the work we are doing with them in federal. They are one of our key partners as we address the federal space. And so a big focus around that. And then around enterprise, they're great channel partner for us as well as we help them grow their enterprise business. So I think there's a number of different threads here to pull on to make sure we maintain a strong book of business with Verizon.

There are no further questions at this time. I would like to turn the floor back over to Bruce for closing comments.

Okay, great. Well, thanks, Victoria. And thanks, everyone, for joining our call this afternoon. We look forward to speaking with many of you at upcoming investor conferences and obviously a strong finish to the year. So thanks very much operators. Thank you. That concludes our call.

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