DZS Inc.
Q4 2009 Earnings Call Transcript

Published: 28 Jan 2010

[Operator:]

Good day and welcome to the fourth quarter 2009 Zhone Technologies, Inc. conference call. I am Izet and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session toward the end of the conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to introduce Mr. Kirk Misaka, Zhone's Chief Financial Officer. Please proceed, sir.

[Kirk Misaka:]

Thank you, operator. Hello and welcome to the Fourth Quarter 2009 Zhone Technologies, Inc. conference call. I'm Kirk Misaka, Zhone's Chief Financial Officer. The purpose of this call is to discuss Zhone's fourth quarter 2009 financial results as reported in our earnings release, which was distributed over Business Wire at the close of market today and has been posted on our web site at www.zhone.com. I am here today with Mory Ejabat, Zhone's Chairman and Chief Executive Officer. Mory will begin by discussing the key financial results and business developments of the fourth quarter. Following Mory's comments, I will discuss Zhone's detailed financial results for the fourth quarter and provide guidance for next quarter. After our prepared remarks, we will conclude with questions and answers. As a reminder, this conference is being recorded for replay purposes, and will be available for approximately one week. The dial-in instructions for the replay are available on our press release issued today. An audio webcast replay will also be available online at www.zhone.com following the call. During the course of the conference call, we will make forward-looking statements, which reflect management's judgment based on factors currently known. However, these statements involve risks and uncertainties, including those related to projections of financial performance; the anticipated growth and trends in our business; the development of new technologies and market acceptance of new products, and statements that express our plans, objectives, and strategies for future operations. We refer you to the risk factors contained in our SEC filings, available at www.sec.gov, including our Annual Report on Form 10-K for the year ended December 31, 2008 and our quarterly reports on Form 10-Q for the quarter ended September 30, 2009. We would like to caution you that actual results could differ materially from those contemplated by the forward-looking statements and you should not place undue reliance on any forward-looking statements. We undertake no obligation to update any forward-looking statements. During the course of this call, we will also make reference to pro forma EBITDA and pro forma operating expenses, non-GAAP measures we believe are appropriate to enhance an overall understanding of past financial performance and prospects for the future. These adjustments to our GAAP results are made with the intent of providing greater transparency to supplemental information used by management in its financial and operational decision making. These non-GAAP results are among the primary indicators that management uses as a basis for making operating decisions, because they provide meaningful supplemental information regarding our operational performance and they facilitate management's internal comparisons to the company's historical operating results and comparison to competitors' operating results. The presentation of this additional information is not meant to be considered in isolation or as a substitute for measures of financial performance prepared in accordance with GAAP. We have provided GAAP reconciliation information for pro forma EBITDA within the press release, which as previously mentioned, has been posted on our web site at www.zhone.com. With those comments in mind, I would now like to introduce Mory Ejabat, Zhone's Chairman and Chief Executive Officer.

[Mory Ejabat:]

Thank you, Kirk. Good afternoon and thank you for joining us today for our fourth quarter 2009 earnings call. The fourth-quarter earnings of was up 16% as compared to the fourth quarter of 2008, and remained basically flat as compared to the third quarter. On another positive, we substantially improved pro forma EBITDA profitability, which was our top priority and were also slightly profitable on a GAAP basis during the fourth quarter. Profitability improved largely as a result of improved margins on our newer products and continued expense control. We expect continued revenue growth in 2010 based on the strong interest in our product solutions, both in the US and abroad. We see the major forces driving revenue growth in 2010 as follows First, our customers have been focused on delivering new services with higher bandwidth due to competitive pressure, requiring network upgrades and transition to IP-based network. Second, we introduced our MXK product line, which provides an interim solution to meet those customer needs. Third, our global reach allows us to focus on providing solutions in emerging growth markets. And finally, the US broadband stimulus package should provide additional domestic financing for broadband network field outs during the second half of 2010. Kirk will give you more details on our financial performance and guidance later. So let me give you a brief update on the status of our NASDAQ listing at this price. On our last earnings call, we had until March 29, 2010 to comply with the $1 minimum bid price required for continued inclusion on the NASDAQ capital market. Accordingly, we have postponed plans to move forward with the reverse stock split approved by our shareholders in October 2008. We continue to evaluate the alternatives to maintain our NASDAQ listing. We will issue a press release prior to taking any action that may be required. Now let me give you an update on our products and customers. As you know, last June, we announced the introduction of our MXK intelligent terabit multi-service access platform that features a two-time bandwidth improvement over the next competitor. Service providers across the globe quickly deployed the MXK in every major market where we do business. Following the introduction of the MXK, we added a powerful suite of optical network terminals that assist carriers in reducing time, cost and complexity of delivering FTTx services. Our ONTs include the following key features

[Kirk Misaka:]

Thanks, Mory. Today, Zhone announced financial results for the fourth quarter of 2009. In our press release, the traditional comparison of financial results for the fourth quarters of 2009 and 2008 is presented alongside a comparison to the third quarter of 2009. As we have done in the past, most of our discussion today will focus on the sequential comparison to third quarter results. As Mory mentioned, the fourth quarter revenue $36 million remained basically flat as compared to the third quarter, but was up 16% as compared to the fourth quarter of 2008. Fourth-quarter revenue fell short of our previous guidance of revenue between $37 million and $38 million, largely due to reduced demand by smaller rural carriers in the US that were waiting for broadband seamless bundling. Looking forward, we are forecasting a normal seasonal slowdown in the first quarter, and expect revenue to be flat or slightly down in the mid-single digit percentage range. After that, we expect revenue to grow sequentially each quarter throughout 2010. We also expect quarter revenue in 2010 to exceed that of the corresponding quarters in 2009. We continue to serve approximately 700 active customers worldwide, with 65% of revenue for the fourth quarter being attributable to international customers. We have experienced more customer concentration over the last two quarters, with one 10% customer each quarter and the top five customers representing approximately 48% of revenue for the fourth quarter, and 42% of revenue for the third quarter. Gross margins increased substantially from 33.5% for the third quarter to 40.1% for the fourth quarter, which exceeded our previous guidance range of margins between 33% and 36%. As mentioned on our last conference call, we expected margins to improve with the introduction of our new technologies that have been designed with maximum cost efficiency in mind. Fourth-quarter results prove those expectations to be somewhat conservative. So for the first quarter of 2010, we are increasing our margin guidance once again to between 36% and 40%, with the potential for additional margin expansion throughout 2010, as the department of our new higher-margin technologies increases and higher volumes allow us to take advantage of manufacturing economies to scale. As we begin this new product cycle however, we will be carefully balancing revenue growth and increase market share with profitability and higher margins. Operating expenses for the fourth quarter came in at $13.7 million versus guidance of between $13 million and $14 million. Operating expenses included depreciation of approximately $400,000 and stock-based compensation of approximately $700,000. With additional sales and marketing activity around our new product launches, we still anticipate total operating expenses for the first quarter of 2010 to increase slightly to between $13.5 million and $14.5 million, including approximately $1 million of expenses for depreciation and stock-based compensation. Finally and most important, pro forma EBITDA for the fourth quarter of 2009 was a $1.9 million profit, and better than the expected profit of approximately $1 million. We also reported net income on a GAAP basis of just over $300,000 for the fourth quarter. As mentioned, substantially stronger margins associated with our new products lead to improved profitability. However, due to normal seasonal weakness in the first quarter and a slight decline in revenue, we anticipate a slight pro forma EBITDA loss for the first quarter of 2010. We expect the first quarter to be a normal and temporary seasonal downturn and thus anticipate returning to profitability in the second quarter as well as improving on that profitability for the remaining quarters of 2010. Now let us take a quick look at the balance sheet. Cash and short-term investments at December 31, 2009 were $21.8 million, which declined only slightly from the $22 million at September 30, 2009. The positive cash flow associated with the $1.9 million pro forma EBITDA was largely offset by working capital changes in the balance sheet, dominantly Accounts Receivable. Accounts Receivable levels continued to increase and grew by $5.1 million to $37.1 million at December 31. Correspondingly, the number of days sales outstanding on accounts receivable for the fourth quarter increased to 93 days as compared to 80 days for the third quarter. The increase in accounts receivable and DSOs is largely attributable to the growth in business with our 10% customer. We anticipate DSO will gradually decline beginning in the first quarter as the payment cycle with this customer begins. With this decline in DSOs, operating cash flow will begin to turn from negative to positive along with pro forma EBITDA. For the year, we anticipate net neutral cash flow from operations, which will help us stabilize our liquidity resources. As for other balance sheet changes, inventory declined slightly to $30.2 million as of December 31 and $30.5 million as of September 30. Our total debt obligations remain basically the same as last quarter at $28.7 million. With that financial overview, I will turn the call back to Mory for a few final comments before we open the call up to questions and answers. Mory?

[Mory Ejabat:]

Thank you, Kirk. We are excited by a stronger-than-expected profitability associated with the beginning of a new major product cycle for the company. The initial positive reaction to our new products is very encouraging and we hope to build on that momentum in 2010. In the fourth quarter, we achieved our primary financial goal of generating positive quarterly pro forma EBITDA and GAAP net income and now focus on improving that profitability for 2010 and beyond. Thank you for joining us today. We will now open the call to questions. Operator, please begin the Q&A portion of the call.

[Operator:]

(Operator instructions) Your first question comes from the line of Greg Mesniaeff from Needham & Company. Please proceed.

[Greg Mesniaeff:]

Yes, thank you. Two quick questions. First, on the gross margin improvement, obviously new product cost profile. Is that product still internally manufactured or is that outsourced?

[Kirk Misaka:]

Yes, it is manufactured in our Largo facility.

[Greg Mesniaeff:]

So that has not changed, it is really a function of just the design, correct?

[Kirk Misaka:]

That is correct.

[Greg Mesniaeff:]

And the other question is one the DSOs. Did I hear you right, there were 93 days in the fourth quarter?

[Kirk Misaka:]

Yes, 93 days for the fourth quarter.

[Greg Mesniaeff:]

And is that attributable to linearity, you know, back-end loaded revenue pattern or is that more just a function of the nature of the customer?

[Kirk Misaka:]

There is some of that that was in the back end of the quarter, but 20-plus days related to the increase in DSOs related to this one 10% customer that we referred to.

[Greg Mesniaeff:]

So what you are saying is this customer tends to pen lay it anyway, but on top of that, a big chunk of business came at the very end, right?

[Kirk Misaka:]

That is right.

[Greg Mesniaeff:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Heidi Heikki [ph] with Vone Technology [ph]. Please proceed.

[Kirk Misaka:]

It is from Buz Heikki maybe?

[Buz Heikki:]

She said Judy, I thought that I – I didn't know whether it was me or not. This is Buz Heikki [ph] with Midsouth Investor Fund. A couple of questions. What is your debt count?

[Kirk Misaka:]

We were on about $300,000 per quarter as our net interest cost.

[Buz Heikki:]

At what rate?

[Kirk Misaka:]

It varies. We have two facilities, one with Silicon Valley Bank and it is at prime plus 2.5%, and we also have a mortgage that runs on a six month LIBOR plus 300 basis points.

[Buz Heikki:]

What about your R&D counter? Are they going to stay where they are?

[Mory Ejabat:]

Yes, we anticipate our R&D to remain the same.

[Buz Heikki:]

Okay. Your inventory went down a lot. Does that have to go back up or what was the reason that is so?

[Mory Ejabat:]

No, we anticipate our inventory to stay at this level or go down.

[Kirk Misaka:]

When you refer to that it down a lot, it went down a lot compared to December of 2008 to now, but from the third quarter to the fourth quarter, it was relatively stable. It went from $30.5 million to $30.2 million and as Mory said, we are anticipating that it will level out somewhere in this range.

[Buz Heikki:]

Okay. And then, this contract Salisbury municipality was that bid on or did they come to you, how did you get that contract?

[Mory Ejabat:]

Well, you know, there was an RFP and we answered the RFP. There were many competitors that were invited to that RFP, and we won that RFP.

[Buz Heikki:]

And why did they select you all?

[Mory Ejabat:]

Because of our product and performance and quality of the product.

[Buz Heikki:]

Okay then. And will you be getting some larger municipalities, do you think, or is that about the average size you will be getting in the future?

[Mory Ejabat:]

We are working on all the fronts, so any RFPs that come onto our desk, we will go after that.

[Buz Heikki:]

Okay, and what would about the approximate dollar size of this one?

[Mory Ejabat:]

We don’t share.

[Buz Heikki:]

Okay, then. And your margins are going to be getting better I guess to the end of the year as your revenues start going up higher.

[Kirk Misaka:]

That is our plan.

[Buz Heikki:]

Okay, then. Thank you very much.

[Kirk Misaka:]

You are welcome.

[Operator:]

Your next question comes from the line of Donna Jaegers with D.A. Davidson. Please proceed.

[Donna Jaegers:]

Hi, thanks for taking my questions. Just two quick questions, I guess on the pipeline. Can you give us a little more color as far as what the – are the number of RFPs out there increasing, any sort of color that you can give on the pipeline.

[Mory Ejabat:]

In respect to our pipeline, what we are seeing is a lot more activities this year from the same quarter last year or actually from the last quarter. We are seeing lots of RFPs and RFIs. And internationally, we are seeing a lot more activity than we are seeing domestically.

[Donna Jaegers:]

Okay. And then, where you respond to RFPs, but you don’t end up winning, is there one specific reason why you don’t win those contracts?

[Mory Ejabat:]

Yes, it is different in the different areas, and some of the areas internationally, we might walk away from the RFP because of the low pricing from Chinese manufacturers, and domestically, we haven't lost any in the RFPs that have come out. I don't know if they come, what we would lose them, I don’t know. We are going forward with a new product as we are.

[Donna Jaegers:]

And obviously, you have leapfrogged your competition with this new product, being able to carry twice the bandwidth. How long of a lead do you think you have versus say ADTRAN and some of your other domestic competition?

[Mory Ejabat:]

Well obviously, we are not going to stop our development. We are going to continue enhancing this platform. Our intention is to stay ahead of competitors for a year. Year-by-year, we are going to enhance this product.

[Donna Jaegers:]

Great. Thanks a lot, Mory.

[Mory Ejabat:]

You are welcome.

[Operator:]

Your next question comes from the line of James Johnson with Comcast. Please proceed.

[James Johnson:]

Hi, just one quick question about the NASDAQ listing. Do you guys – you guys anticipate something happening in the next two months? Is there a plan; is there a potential expanding the deadline, what are you guys – can you guys provide something on that?

[Mory Ejabat:]

Well, right now, the deadline is end of March and we have to comply with that. We are obviously looking at different alternatives onto that. So you should just standby until we come up with a resolution and we will let you know.

[James Johnson:]

So there is a plan.

[Mory Ejabat:]

Well, we are always looking at different plans.

[James Johnson:]

And reverse is out of the question.

[Mory Ejabat:]

I cannot say that it is out of the question. That might be one of the items in the plan, but we are looking at several alternatives.

[James Johnson:]

Okay, thank you for your time.

[Mory Ejabat:]

Sure.

[Operator:]

Your next question comes from the line of Mark Gomes with Pipeline. Please proceed.

[Mark Gomes:]

Hi, folks. I was wondering if you could talk a little bit about any deal slippage that you may have incurred during the quarter as a result of implementation of broadband stimulus funding and along those lines; can you provide some further commentary or updated commentary on how you expect to benefit from the coming broadband stimulus?

[Mory Ejabat:]

Yes, I can say that in the fourth quarter, we saw various slowdowns in our US business because of how our customers were waiting for the stimulus funding or the award on that respect. As I mentioned, there has been two awards that has been published, and some of our customers too have been awarded to this for the funding. But they have to send their project plans and all of that and have to get approved. And I really cannot tell you what the cycle time is for those projects to get approved and the funding to start. So until we get the first indication of how fast the government moves providing this funding, we cannot tell you exactly when this funding is going to be available.

[Mark Gomes:]

Okay. Would it be fair to say that you would have been able to make the published street estimates this quarter if those deal delays did not occur in the fourth quarter?

[Kirk Misaka:]

Most likely, yes.

[Mark Gomes:]

Okay, thank you. And can you name any of the customers that were awarded broadband stimulus funding in the last two rounds?

[Mory Ejabat:]

We cannot do that. And also, there are a lot of customers; they haven't selected anybody that we are targeting as well.

[Mark Gomes:]

Great. Thank you very much.

[Operator:]

Your next question comes from the line of Edward Zabitsky with ACI. Please proceed.

[Edward Zabitsky:]

Ed Zabitsky, ACI Research. I was wondering about the MXK product. Is that – are you bidding larger deals because of the availability of the platform? In other words, are you going after Tier-1 carriers now?

[Mory Ejabat:]

The answer is yes, we are going after Tier-1 carriers. Actually, Etisalat is a Tier-1 carrier. (inaudible), a couple of quarters back, these are Tier-1 carriers. We are going after Tier-1 carriers internationally. Domestically, we haven't seen any RFP from either Verizon or AT&T. They haven't published anything, but we have RFIs from Tier-2s that we are responding to those and I believe we are in a strong position to win some of those.

[Edward Zabitsky:]

That is great. Could you characterize sort of the size, just the rough size of the (inaudible) deals? Are they in the millions; are they above $10 million, what is the scope we are looking at?

[Mory Ejabat:]

I cannot tell you exactly what it is, what I can tell you is we are already in.

[Edward Zabitsky:]

Okay, thanks very much.

[Operator:]

(Operator instructions) Your next question comes from the line of Martin Landry [ph]. Please proceed.

[Martin Landry:]

Good afternoon. I was wondering if you could identify your two 10% customers that you mentioned acquiring in the last two quarters.

[Kirk Misaka:]

It is the same customer and it is our customer in the UAE.

[Martin Landry:]

Thank you.

[Operator:]

You have a follow-up question from the line of Mark Gomes. Please proceed.

[Mark Gomes:]

Do you guys ever comment on backlog at all, qualitatively or quantitatively and can you tell us if your backlog increased or decreased in the quarter eventually.

[Mory Ejabat:]

We had not commented on the backlog in all of our conference calls and we won’t do that. We just give you guidance on the top line and the gross margins.

[Mark Gomes:]

Okay, thanks.

[Operator:]

At this time, you have no further questions.

[Mory Ejabat:]

Thanks again for joining us today. We appreciate your continuous support. I am looking forward to speaking with your on our next earnings conference call. Operator?

[Operator:]

That concludes today’s conference. Thank you for your participation. Have a great day.