Greetings. Welcome to the Ribbon Communications Second Quarter 2023 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joni Roberts, Chief Marketing Officer. Thank you, Joni. You may begin.
Good afternoon, welcome to Ribbon's Second Quarter 2023 Financial Results conference call. I'm Joni Roberts, Chief Marketing Officer at Ribbon Communications. Also on the call today, Bruce McClelland, Ribbon's Chief Executive Officer, and Mick Lopez, Ribbon's Chief Financial Officer. Today's call is being webcast live and archived on the Investor Relations section of our website at rbbn.com, where both our press release and supplemental slides are currently available. Certain matters we'll be discussing today, including the business outlook and financial projections for the third quarter of 2023 and beyond, 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 and Form 10-Q.
I refer you to our safe harbor statement included on slide two of the supplemental slides for this conference call. In addition, we'll present non-GAAP financial information on this call. Reconciliations to the applicable GAAP measure are included in the earnings press release we issued earlier today, as well as in the supplemental slides we prepared for this conference call, which, again, are both available on the Investors section of our website. Now I'd like to turn the call over to Bruce. Bruce?
Great. Thanks, Joni, welcome to the Ribbon team. Thanks to everyone for joining us today. I'm pleased to report a very solid quarter with financial results above the midpoint of our guidance. Our focus on growing enterprise and cross-selling our IP Optical portfolio is working, with growth in both sales and earnings. For the first half of the year, sales have increased 5% year-over-year, and earnings have improved 66% or $8 million on an Adjusted EBITDA basis. In the second quarter, sales increased 2.3% year-over-year to $211 million, with continued growth in India, resulting in sales in Asia Pacific increasing 21%, while EMEA sales were up 1% and overall North American sales were down 2%.
In the optical segment, we continued our trend of double-digit year-over-year growth for the fourth consecutive quarter, with sales increasing 24% year-over-year. In the Cloud and Edge segment, as expected, sales were down approximately 9% year-over-year, primarily due to lower sales to Verizon as compared to the record sales a year ago. This was offset by continued strength in our enterprise business, with product sales increasing 94% year-over-year, reaching a new high of 44% of overall Cloud and Edge product sales in the quarter. This includes revenue from a very strategic win in the U.S. federal space, the first of what we believe will be many voice modernization projects. Government agencies need to transform their legacy communication infrastructure to modern, cloud-based, unified communication platforms with high levels of security and survivability.
This initial project includes product and services exceeding $10 million, a substantial portion of which was recognized this quarter. As a result of the overall mix in the quarter, gross margins were strong at 52% and above the high point of our guidance. Combined with lower operating expenses, Adjusted EBITDA was also towards the high end of guidance at $23 million. Products and service booking to revenue for the first half of the year was 1.05 times, with the second quarter at 0.9 times, following strong bookings in the first quarter. A little more detail on each of the operating segments. Financial performance for the IP Optical segment continued to improve in the second quarter, with sales of $85 million and margins increasing quarter-over-quarter and year-over-year to 31%.
This resulted in a $10 million improvement in Adjusted EBITDA as compared to last year. The growth in sales is directly related to the investment we have made in developing new products, resulting in a strong funnel of projects and projected continued growth, with a target of being break even on an Adjusted EBITDA basis in the second half of the year. Our focus specifically on IP routing continues to show strong results, with sales of IP routing products increasing 46% quarter-over-quarter and 41% year-over-year. Our expanding portfolio of routing solutions directly addresses a very large addressable market in multi-service edge aggregation and metro routing for both fixed broadband and mobile networks. Sales of optical transport products increased 21% year-over-year, and maintenance and services revenue increased 1%.
India was once again our strongest market, with sales of IP Optical products increasing 30% year-over-year, reaching the highest level since the acquisition of ECI in 2020. Shipments included a number of new products, including our 5G Cell Site Router, Neptune XDR routers, and Apollo long-haul optical transport. Deployments of the new CSR router more than doubled in the second quarter versus Q1 as we scaled the program. We expect margins in these new products to improve as volumes increase and the mix of infrastructure and capacity cards is more balanced. Our cross-selling strategy continues to bear fruit in several regions. IP Optical sales in North America reached a new high, increasing 94% year-over-year, and representing more than 15% of overall segment sales in the quarter.
Following the trend in the first quarter, investment by rural broadband providers, funded in part by federal programs, was very strong, with sales more than tripling versus last year. This has become a strategic market segment for us, where we're leveraging the great presence and reputation that Ribbon has established. Our strong IP routing and optical transport portfolio is very well suited for these growing networks. Federal funding programs will increase dramatically over the next several years, as existing programs such as RDOF and ReConnect are augmented by the much larger $45 billion BEAD funding program. Another region where we've successfully implemented our cross-selling strategy, leveraging the local presence and relationships established by Ribbon, is Japan.
Following several strategic wins, sales of IP optical products in Japan exceeded 5% of overall IP optical sales in the second quarter, up from essentially zero in the first half of 2022. Finally, in the EMEA region, sales grew 6% in the first half of 2023 across a variety of critical infrastructure, telecom, and defense customers. We have a strong pipeline of projects planned for the second half across the region. From a supply chain perspective, issues remain localized to particular new high-demand products where we're still ramping production. We expect continued improvement in the second half of the year and start to see some benefit from cost improvements and full elimination of remaining expedite fees. As expected, IP Optical segment margins improved from the low point in the first quarter, but are still below our normalized target.
We expect further improvement in the third and fourth quarter from both fixed cost absorption from higher sales and improving mix. Some highlights from our Cloud and Edge business. Overall, Cloud and Edge sales increased 9% quarter-over-quarter, but were down 9% year-over-year, after a record quarter with Verizon a year ago. Excluding Verizon, sales in the quarter actually increased year-over-year. Margins were very strong at 67%, with a favorable mix of software licenses and enterprise sales in the quarter. Product and services booked to revenue was one ti mes, 1.0 times, for the quarter. As I mentioned, we were very excited to close a significant voice modernization deal for a major US Department of Defense agency in the quarter.
We anticipate this to be one of several projects starting this year, as federal agencies transition from legacy on-premise TDM, PBX, or IP Centrex infrastructure to cloud-based unified communication solutions. The unique security and survivability requirements and multi-site complexity is very well suited to Ribbon's broad portfolio of Session Border Controllers, telephony application servers, media gateways, and advanced analytics. Ribbon's expertise and experience is also a key differentiator. The sales process for these projects is certainly lengthy and complex, but working with key integration partners such as Dell and multiple managed service partners, will allow us to scale and standardize a common solution for the market. The federal project helped contribute to the very strong quarter for sales to enterprise customers.
The leading market vertical was once again financials, with multiple projects, including a significant expansion project at JP Morgan and other projects at Goldman, Bank of America, and Barclays. This helped to contribute to a solid quarter for SBC sales, with shipments of core SBC platforms increasing 25% year-over-year. In addition, the service provider sell-through business also remained strong, with sales of enterprise edge SBC products up 8% year-over-year, following the almost 60% increase in the first quarter. In addition to the high activity level with enterprise customers, we've seen an increased level of engagement with service providers evaluating options to modernize their voice infrastructure.
We were recently awarded significant projects totaling more than $10 million, with four major service providers in multiple regions, including the U.S., Europe, Middle East, and Africa, that are all focused on replacing legacy voice infrastructure with modern software-centric platforms that provide immediate operating cost benefit and significant feature advances. In the case of these four operators, they have not made significant investments in this part of their network for years, but this is now a key part of their strategy to improve operating efficiency. The urgency to replace aging copper TDM networks with modern fiber-based IP networks while minimizing service disruptions continues to grow. With that, I'll turn it over to Miguel to provide additional detail on our second quarter results and then come back on to discuss outlook for the second half. Mick?
Thank you, Bruce. Good afternoon, everyone. The second quarter of 2023, our financial results showed continued improvement over the prior year, bolstered once again by double-digit revenue growth in our IP Optical Networks business. Please refer to our investor relations page on the Ribbon website for supplemental slides summarizing our second quarter 2023 and historical financial performance. Let's begin with consolidated corporate financial results. In the second quarter of 2023, Ribbon generated revenues of $211 million, which is an increase of $5 million, or 2% from the prior year, and $24 million or 13% increase from the first quarter. Non-GAAP gross margin was 52%....
which is about 300 basis points lower than prior year, mostly due to the change in business segment revenue mix, and a 400 basis point improvement from the previous quarter, driven by revenue increases and product mix. Non-GAAP operating expenses were $90 million, a decrease of $6 million, or 6% year-over-year, and down $5 million from the previous quarter. As announced earlier this year, we implemented a strategic restructuring plan to streamline operations, reduce costs, and focus on growth areas. We have optimized real estate, renegotiated supplier terms, and driven headcount synergies. We definitely are on track to exceed our operating expense reduction target of $20 million year-on-year. Our non-GAAP net income was $8 million, which generated a non-GAAP diluted earnings per share of $0.04. Our non-GAAP tax rate for the quarter was 30%.
Our interest expense for the quarter was $6.8 million, which is a $2 million increase from the previous year. non-GAAP EBITDA was $23 million in the quarter, which is a $2 million or 9% improvement year-over-year, and a positive change of $25 million from the previous quarter. Our basic share count was 170 million shares, and our fully diluted share count was 175 million shares for the quarter. Let's look at the results of our two business segments. In our Cloud and Edge business, second quarter revenue was $125 million, a decrease of 9% year-over-year. As you may recall, second quarter of 2022 was the highest revenue for the year for Cloud and Edge, led by strong sales to our largest customer.
Software as a percentage of total product revenue was 57%, which is in line with prior year, and a 16 percentage point increase from 41% in the first quarter. The Cloud and Edge business had a non-GAAP gross margin of 67%, slightly down from 68% in the prior year, and up 540 basis points from the first quarter. Adjusted quarterly EBITDA was $35 million or 28% of revenues. Let's turn to our IP Optical Networks business results. We recorded second quarter revenue of $85 million, which was an increase of $17 million or 24% year-over-year, and $14 million or 19% versus prior quarter, led by growth in North America, India, and Japan.
Non-GAAP gross margin for IP Optical was 31%, which is about 350 basis points higher than the previous quarter and 200 basis points higher than the prior year. Fixed cost absorption is a key factor in IP Optical Networks gross margin. At current levels, for every $10 million of incremental revenue, the gross margin improves by about 200 basis points. For example, if revenue grows $10 million from the current level of $85 million- $95 million, the current gross margins of 31% will improve by 200 basis points to 33%. With more revenue increases and improvements in product mix, we can achieve our target gross margins in the mid to upper 30% for IP Optical Networks.
Non-GAAP Adjusted EBITDA loss for the quarter was $12 million, which is an improvement of about $10 million year-on-year and over previous quarter. With revenue growth in the second half, improved mix of products, and lower operating expenses, we continue to strive for profitability in this business segment. We ended the quarter with $35 million of cash and cash equivalents, which is a decrease of $11 million from the previous quarter. Our revolver remained undrawn at quarter end. Cash use from operations was $3 million, capital expenditures were just $2 million, and we made our quarterly $5 million term loan repayment. We expect to have higher working capital requirements in the third quarter as we grow the business in the second half.
Our senior-term loan balance is $245 million, and our preferred stock and warrants are valued at $55 million. Per the bank covenant calculations, which include preferred equity and total debt, among other adjustments, we comfortably met both of the amended term loan covenant metrics in the second quarter. Now I'll turn the call back to Bruce to provide more comments on our outlook for the third quarter.
Great. Thanks, Mick. As I look into the second half of the year, it's clear that our strategy to diversify the company has become increasingly important and is working. From an industry perspective, enterprise has become a significant new growth vector for the company that counterbalances variances in service provider spending. From a portfolio perspective, the addition of IP routing and optical transport has opened major new opportunities, such as the U.S. rural broadband segment. From a geography perspective, the company is very well-positioned in high-growth areas such as India and Africa. Our financial projections for the second half of the year benefit from this strategy and are based on four key assumptions. First, in the North American service provider market, we expect the elevated spending by U.S. rural broadband providers to continue and likely increase over the next several years as new funding sources become available.
Our portfolio is a great fit, and we're taking share. We expect the rural broadband opportunity to offset more constrained spending by Tier 1 US service providers in 2023, with increased spending anticipated in 2024 for voice network modernization, given the compelling business case to reduce operating costs. As I mentioned earlier, we've also seen increased activity in this area across multiple regions, with service providers who have not made this a priority in the past. Second, we will continue to gain share in the enterprise market vertical as investment in communication and collaboration platforms enables companies to improve their efficiency and effectiveness. This includes several major US federal opportunities that we anticipate being awarded in the second half, where we are very well positioned and expect to generate significant revenue.
Where it makes sense, we're transitioning the business model with enterprise customers away from perpetual licenses to subscription models that will create a more predictable recurring revenue stream for the business. The growth we've experienced in India and several other countries in the Asia region will continue as 5G deployments accelerate and the strategic wins we've announced in the region enable us to gain share in both IP routing and optical transport. I expect a number of new opportunities to mature and create further growth in 2024 in this region. In the EMEA region, the second half of the year looks strong, with increasing investment from critical infrastructure providers in Europe and service providers in Africa and the Middle East. Underpinning our strategy is the investment we've been making to expand our portfolio and introduce new products that enable a more open architecture and ecosystem.
As we announced at the OFC Optical Conference earlier this year, we're very excited about the new Apollo 9400 platform that will be first to market with industry leading 1.2 terabit per second wavelengths, leveraging the latest in 5 nm DSP silicon. The 9400 uses less than half the power per bit of competing solutions, with industry-leading density in a compact, modular, pluggable form factor. We expect to be in customer testing this quarter and early production in the fourth quarter. In our IP routing portfolio, we continue to expand our Neptune XDR2000 series with new variants that significantly expand our addressable market and the types of networks where we can be deployed. The latest new product that begins to ship this quarter is the Neptune 2400, which is a perfect fit for metro networks, supporting mobile xHaul applications and broadband aggregation.
Equally important is the growing set of IP routing protocols supported by the platform, including next generation Segment Routing capabilities and advanced features such as EVPN. The significant investment we have made in expanding our IP Optical product line has resulted in 19% growth in the first half of 2023. We expect to continue that trend in the second half, supporting the 15%+ growth target for the year. We also continue to target profitability on an Adjusted EBITDA basis for this segment in the second half of 23, as higher volumes enable improved margins and better regional mix. In our Cloud and Edge segment, the strong growth in enterprise sales in the first half has mostly offset lower U.S. service provider spending. We expect third quarter financial performance to be similar to the second quarter, followed by our typically seasonally strong fourth quarter.
For the full year, we expect Cloud and Edge earnings contributions to be higher than 2022, primarily due to lower operating expenses. Our early view on 2024 indicates a recovery in spend by North American service providers for voice network modernization, which would be additive to the continued growth in enterprise and federal. Based on the above backdrop and assumptions, for the third quarter, we're projecting revenue in a range of $215 million-$225 million, non-GAAP gross margins of 51.5%-52.5%, and non-GAAP Adjusted EBITDA in a range of $26 million-$32 million for the quarter. For the full year, we continue to believe our revenue guidance range of $840 million-$870 million is achievable.
Operating expenses are on track to exceed the lower spending targets we established. Due to the overall projected mix, Adjusted EBITDA is currently tracking to the lower half of our $95 million-$110 million range, which will be a significant 50% improvement year-over-year. As with most years, we expect the fourth quarter to be the strongest quarter of the year. Operator, that concludes our prepared remarks, we can now take a few questions.
Thank you. We'll now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Thank you. Our first question is from Christian Schwab with Craig-Hallum Capital Group. Please proceed with your question.
Hey, congratulations on the, on the strong results. As to roll.
Hey, Christian, I apologize. You're breaking up, I think.
Hello?
Yeah, try again, Christian.
I'm sorry about that. I was asking on rural broadband, can you tell us how big that could be over a multiyear time frame?
Yeah. Thanks, Christian. Good to connect again. Obviously we've seen that grow substantially here this year. I think we're up about 3 times from what we were doing last year. You know, I think there are some upper bounds just from a construction resource perspective in the whole industry. I, you know, it's hard to predict exactly what the growth looks like next year. It's not a lack of funding at this point, particularly as BEAD funding starts to flow into the second half of next year. I think the limitations are going to be more at the pace that they can do construction and drive fiber. You know, as the funding envelope increases, you know, the amount of addressable market for it certainly is going to expand.
I expect it to grow, you know, pretty well going into next year.
On the IP Optical business, you know, can you tell us how many customers, you know, that you're selling to currently and what we should anticipate, you know, that number of customers to expand to, say, by the end of 2024 as new introductions come out?
That's a good question. I don't have a number off the top of my head. In a particular quarter, the majority of the revenue will come from several dozen customers within the quarter, let's say. We are definitely adding customers every quarter. A number of our projects are with critical infrastructure, projects or operators. Every quarter, there's somebody new being added. You know, we do try and kind of keep it a good cadence of press releases every quarter on some of the more strategic ads we've had within a quarter. I think that gives you an indication of, you know, kind of the velocity every quarter of new names being added.
Of course, you know, some are smaller projects and some can account for a much larger revenue stream in the future.
Great. My last question, I know you guys have talked about for some time, landing material business in, on the optical side, you know, with the top Tier 1 carriers. Do you have any update for us on how that's going? Or, you know, is that something you're enthusiastic for, you know, over the next 12 months?
Yeah, there's definitely a healthy pipeline here in 3 primary regions, North America, Europe, and Asia Pac. Obviously, we've announced some already with the expansion with Bharti, with the wins in Africa, with MTN, Singtel Optus in different regions, Rogers in Canada. You know, we're clearly kind of building momentum. In my remarks, I talked about Japan as a market that's new for us. You know, again, that's a region where Ribbon had a great presence with our voice infrastructure products. Although we haven't announced any names there, you know, I think those are pretty significant opportunities and wins for us. I think as I mentioned, it was about 5% of revenue in the third quarter. You know, stay tuned.
We're definitely focused on that part in addition to kind of building the momentum, with regional telecom and with critical infrastructure providers.
Excellent. Thanks. No other questions. Thank you.
Yeah, thanks very much, Christian.
Thank you. Our next question is from Tim Savageaux with Northland Capital Markets. Please proceed with your question.
Hey, hi, good afternoon. Couple of questions, maybe following on some of that, recent discussion. I think you talked about, for IP Optical, US at 15%. I assume, you know, rural is, you know, the vast majority of that. I think you talked about US rural being 10% of IP Optical revenue last quarter, and it's clear you expect that to grow. My question is: how should we, and you've talked about Japan, how should we relate that to India? You know, and you talked about growth in India. I assume that's your single largest market, e.g., greater than the US, from a country standpoint, not a region standpoint.
You know, is there a scenario with this rural broadband growth out 2 years, you know, can that become, you know, bigger than some of these big markets you're talking about now? Can you just kind of maybe size India where it is right now, and what sort of margin implications does that U.S. rural broadband growth have for the segment?
Great. All good questions, Tim. The 15% of sales was a North American number, and rural broadband, a significant portion of that. As you recall, we've got, you know, a number of other customers in North America, including Rogers, up in Canada, that all contribute to that 15% of sales. The rural broadband portion was more than half of that, certainly in the quarter. As you kind of compare it to India is still, you know, significantly larger than North America today. You know, I think more than 2 times, Nick, right? In that ballpark.
Yeah.
Of course, we have one large customer in India with Bharti that we've enjoyed a good growth here this year. As I mentioned, getting, you know, kind of back to maybe where we were a few years ago, was our strongest quarter we've had since we merged the companies together. You know, back to your final question on how big can rural be? You know, in some ways, we're just getting started. I mean, we've had some really good success with customers that know us well, that have other products from us deployed today, and that's allowed us to start to build a good pipeline with new customers. I don't know if it can be bigger than India.
I mean, India's, you know, 1.2 billion people, three, you know, major operators there that I think are going to drive a lot of scale. We're deployed in enterprise markets in India as well with partners like Tata Teleservices and folks like that. I think that's going to remain a really significant market for us.
Great. Maybe similar question around Japan. I mean, I think you're implying your, you know, fraction there is likely with Tier 1 carriers, but, you know, how significant can that get for you over time?
Again, we're kind of just entering the market. I mean, it was great to see some of the momentum there with several operators. A number of different use cases, both in optical as well as in IP. I'm pretty excited about that market. You know, we've got a great infrastructure in place in Japan. It was one of the kind of strategic elements to the combination several years ago and focused on cross-selling. It's taken us a while to, you know, to go through the vetting process, go through the testing process now into commercial service. It'll, you know, add another plank to the operation here for us, for sure.
Last question for me. Obviously, after a very strong Q1, IP Optical orders came down, you know, pretty significantly in Q2. I guess, how would you characterize that, and what are your expectations for orders in IP Optical in the second half?
Yeah. There were, you know, kind of two reasons why the order velocity was lower in the second quarter, all related to the strong first quarter. You know, I'd mentioned previously that part of the bookings in Q1 was a large multiyear agreement with defense operation in Europe. You know, a portion of those orders were for the second quarter, so we were shipping those in the second quarter. Normally, we would have gotten those bookings in the second quarter, but they were all accelerated into Q1. Then the other part was around some of the expansion, market share expansion in India with Bharti and some of the larger orders that we're shipping against in the second and third quarter. You know, I'm not...
You know, obviously, numerically, the number's down in the second quarter. For the first half, I think we're at 1.15 for IP optical for the first half, or 1.14, some number like that. You know, I still feel good. Obviously, you know, for the second half of the year, we're still projecting growth going into the second half, I think, to achieve our 15%+ annualized growth number. You know, the second half will grow more than 10% versus last year. You know, we're feeling good about the velocity in the second half here.
Great. Thanks.
Thank you, Tim.
Thank you. Our next question is from Dave Kang with B. Riley. Please proceed with your question.
Thank you. Good afternoon. First question is on the IP Optical. Just wondering if you can talk about their EBITDA trajectory in second half and into next year. I mean, will they be positive? Just wondering if it will dip into negative in first quarter next year before becoming positive in second quarter. Just if you can help us out.
I think if you do the modeling on the business here with assumptions on margin and OpEx and whatnot, the target for the second half is to get to EBITDA breakeven and positive. That's what the whole team's focused on. That's the reason, you know, we've done the acquisition. This business needs to contribute. You need to be in the $100 million plus range per quarter with where margins are projected to be there, and that's what the target is for the second half.
We do find that the first quarter tends to be a lower quarter every year. Whether we'll be at that level or not in the first quarter is a little too early for me to, you know, to provide additional commentary on. You know, the focus here is on the second half and making sure we get to that mark, in the third and fourth quarter combined.
Got it. I believe, regarding the supply chain situation, I think that impacted your revenue by about $10 million in first quarter. Just wondering what that was in second quarter.
Yeah, it was, it was very similar, Dave. Really the same sort of issues as we're ramping in particular, our long-haul products and our Cell Site Router products. We could have shipped more in the quarter again, not unlike others, I'm sure, right? I didn't comment on it this time. Very, very similar in the second quarter. I do think we get more caught up in the third quarter on some of the longer lead time parts on the new products. As I mentioned, I think the, you know, as we get into the second half of the year, the majority of those existing issues are behind us. Who knows what new surprises we find in the future?
Should we expect something like maybe $5 million impact in third quarter, or is it going to just go to zero?
It's in that ballpark probably, Dave. There's always something that ends up kind of hanging out to the next quarter, so it's probably in that ballpark.
Got it. Then, just wondering what the split is between... I know you gave IP routing growth. Just wondering if you can split what IP versus optical is, and what's their, you know, margin differential between IP and optical?
Yeah. I think, you know, we've talked historically that the split is, you know, in the 35%-40% range for IP routing. Obviously, that's been increasing over the last several quarters with the growth rate around IP. I think it's over 40% now from a product revenue perspective, with the recent growth. Now, you've seen both businesses grow. I think Optical grew about 20% and IP grew about 40%. Optical's not standing still either. It's growing, but I think the mix continues to shift more towards IP routing, and that's what we expect to see over time as well.
... what's their margin differential? Is it about 5%, 10%, something like that?
We don't break that out. It varies by region and the type of product. You know, if it's a higher volume Cell Site Router-type product, that tends to be a little lower margin. If it's more a high-performance, you know, 4-terabit routing platform, that's much better margin. It can vary a little bit, Dave, you know, just depending on the mix and the type of products we're shipping in the quarter. In general, the trend is towards higher margin on the IP products.
Got it. My last question is actually a clarification. Did you say CNE will be kind of flat this year, or maybe I misheard?
I'd characterize the third quarter as being similar to the second quarter, with a stronger fourth quarter. Overall, in the second half, the earnings contribution will be up from last year. I've kind of given those two data points.
Got it. Thank you.
Okay. Thanks, Dave.
Thank you. Our next question is from Greg Mesniaeff with WestPark Capital. Please proceed with your question.
Thank you. My question is on the Cloud and Edge segment. You had mentioned in the call that you're in the process of transitioning, your revenue model from one of a perpetual license to a subscription-based model. I totally understand why you're doing that, namely to, you know, smooth out the lumpiness that this business has had. Can you kind of give us a little more color as to what the steps are to kind of proceed down that path and where you are in that process? In other words, are you keeping your existing customers on perpetual licenses and starting new ones with a subscription model, or are you weaning the older customers off the perpetual license to the subscription model? I have a quick follow-up. Thanks.
Yeah. Yeah. Hey, Greg, good question. First of all, it's mostly in the enterprise space, not in the service provider or the carrier space. you know, most of the acceptability or interest is in the enterprise side. There's a couple of different models there. you know, there is, if you look at our Ribbon Connect offer as an example, which is, you know, a completely cloud-based, multi-UCaaS platform for Microsoft Teams, or Zoom, or Cisco Webex, you know, that's a per subscriber, per seat, per month pricing model. you know, that's a fairly small business today, but that's a, you know, obviously a typical as-a-service type revenue stream, small but growing.
The other type, you know, kind of approach to subscription licenses is moving from a perpetual license for, let's say, an SBC to a term license and perhaps an enterprise-wide type license, an ELA that includes software licenses, it includes maintenance, it includes professional services, and that's a much more kind of significant transition that we're in underway. You know, it provides the ability to renew those licenses every year or whatever period that you set up the term license for. You know, that's probably the most significant transition, and it's a combination of both new customers and existing customers.
many of the products, you know, like a Session Border Controller or analytics platforms, which are, you know, highly software, high software content, that really lend themselves to that model. you know, we're finding a lot of interest in moving in that direction.
Are customers being receptive to this transition, would you say, especially the legacy, larger ones on carriers?
I wouldn't describe it as we're trying to force it. You know, we'll meet the customer wherever the economics are best, you know, to meet their needs. Most of the cases, this is not just a receptive thing. The customer is very interested in that type of approach. Again, it's mostly around enterprise, not so much around the carrier side, although the Ribbon Connect platform, as I mentioned, is used by a number of carriers, you know, it supports their managed service offering to enterprises, it fits that model pretty well.
Great. Thank you.
Thanks, Greg.
Thank you. Our next question is from Erik Suppiger with JMP. Please proceed with your question.
Yeah, thanks for taking the question. A couple questions. First off, did you see, I believe Verizon was a 10% customer. Did you see some of the adjustments to inventory that were noted by the likes of Ericsson and Nokia in terms of some of these carriers working down some of their inventories, or was Verizon in the range that you had been expecting? Secondly, your guidance implies Q4 gross margins picking up a fair amount. Is that just a normal seasonal uptick, or is there anything in Q4 that's gonna be particularly beneficial to gross margins?
Yeah. Thanks for the questions, Erik. From a Verizon perspective, you know, we had just a great quarter a year ago in the second quarter of 2022. We had a variety of voice modernization programs with them, all basically going to revenue in the second quarter. In a lot of ways, it's not a fair comparison. It's the best quarter we ever had with Verizon a year ago. The step down year-over-year is pretty substantial. As I mentioned, though, you know, if you excluded Verizon from our revenue in both ends, the service provider business was actually up year-over-year. It was just, it's primarily a phenomenon, as a strong quarter a year ago.
It wasn't what you're hearing, I don't think, from others around inventory build and those sorts of issues, Erik. It's really just the year-over-year comparison that's a little tough. It ended up exactly where we predicted it was gonna be in the quarter and very consistent to the previous quarter. You know, I think if you see our 10-Q that'll come out, you'll be able to see the percentage of revenue that we, you know, we report for our 10% plus customer there.
Okay.
From a Q4 margin perspective, yes, we do expect Q4 margins to be stronger in both businesses. As Nick mentioned, pretty in a lot of detail, you know, the increased margin around IP Optical, a lot due to just the increased level of revenue and the fixed cost absorption driving a higher gross margin percentage. In Cloud and Edge, you know, it tends to be the mix. Obviously, the velocity makes a difference as well, the revenue level. We have, you know, a good pipeline of, you know, larger deals, both enterprise and service provider in Q4. We have, as I mentioned, this kind of transition on models towards more annual ELAs that benefit us and just the software mix in general, stronger in Q4. Your model sounds correct.
Okay, and then lastly, last quarter, you had discussed new products contributing about 20% of IP Optical revenues. Can you provide any update or any color that you can add to that?
Yeah, I think it's similar. Erik, unfortunately, I don't have that number in front of me, I'm gonna have to go.
Okay.
Do some more research on it. I apologize.
Okay, that's fine. Thank you.
Thanks, Erik.
Thank you. Our next question is from Tim Savageaux with Northland Capital Markets. Please proceed with your question.
Hi, sorry about that. I just wanted to follow up, and it looks like the subject is kind of profitability in IP Optical. It looks like in Q2, you brought your cost base down pretty significantly in terms of the break-even revenue run rate in IP Optical, in particular. I don't know, $5 million-$6 million, something like that. That's reflected in your overall OpEx performance as well. I guess the question is: Is that about right? Is that where you expect it to stay? It looks like you're forecasting your EBITDA loss in IP Optical to be cut in half or maybe a little more again here in Q3.
You know, I'm assuming that's, you know, revenues increasing gross margins, as Nick described, in kind of flattish sort of OpEx in that, you know, kind of high thirties range. Is that a reasonable way to look at things? You know, obviously another quarter that you're looking to be EBITDA positive in Q4.
I don't want to parse the Q3 guidance too much. It's directionally correct. What you said is absolutely directionally correct. In order to get the break even in the second half, you know, it's a combination of Q3 and Q4, and I think the Q4 volumes are higher, so the profit will be higher. The cost improvements, the spending improvements that we've made, you know, we're ahead of plan, we're ahead of what we committed we were going to do for the year. A portion of that's benefiting both of the businesses. If I remember right, in Q2, I think we're about $3 million better on OpEx in IP Optical, but there's also some savings above the gross margin line in the cost of service and whatnot as well.
We do think that plays forward at that level, certainly at the company level. I think, Nick, we were at $90 million of OpEx in Q2. We expect to be in a similar range, plus or minus, you know, $1 million sort of thing, in Q3 and Q4. That would get us to, you know, greater than the $20 million net savings for the year in OpEx.
Great. Thanks very much.
All right. Thanks, Tim.
Thank you. There are no further questions at this time. I would like to turn the floor back over to Bruce McClelland for any closing comments.
Okay, great. Well, thanks, Paul. Thanks, everyone, for being on the call here with us again today, your interest in Ribbon Communications. We have a number of upcoming investor conferences, so we look forward to meeting everyone there and continuing the dialogue. Thanks very much, operator. Appreciate your help, and that concludes our call.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.