DZS Inc.
Q4 2010 Earnings Call Transcript

Published: 27 Jan 2011

[Operator:]

Good day and welcome to the Fourth Quarter 2010 Zhone Technologies Incorporated Conference Call. I am Shenelle and I will be your coordinator for today. At this time, all participants are on a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would like to introduce Kirk Misaka, Zhone's Chief Financial Officer. Please proceed.

[Kirk Misaka:]

Thank you, operator. Hello and welcome to the fourth quarter 2010 Zhone Technologies, Inc. conference call. I am Kirk Misaka, Zhone's Chief Financial Officer. Purpose of this call is to discuss Zhone's fourth quarter 2010 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 website 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 31st, 2009, and our quarterly reports on Form 10-Q for the quarter ended March 31st, 2010, June 30, 2010, and September 30, 2010. We'd 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 also undertake no obligation to update any forward-looking statements. During the course of this call, we will also make reference to adjusted EBITDA and adjusted 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 of 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 comparisons to competitors' operating results. 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 adjusted EBITDA within the press release, which as previously mentioned has been posted on our website 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 2010 earnings call. We continue to see a strong growth attributable to our MXK multi-service solutions, so surpassing a new company affairs [ph], 1000 MXKs shipped in 2010. Additionally, the fourth quarter marked our third consecutive quarter receiving top industry rankings by the leading research analysts, IDC, Infonetics, Dittberner, broadbandtrends, and Ovum. We also continued industry-leading GPON growth globally in the key European, Middle Eastern and Latin American markets. Among other highlights for the fourth quarter, we launched several new products expanding the already aggressive MXK product portfolio. First, as a commitment to the fiber-to-the-node, fiber-to-the-home, and fiber-to-the-building market segments introduced two new high-density VDSL2 cards for the MXK, which is the first in a series of powerful launches that we will continue next month further expanding or FTTx solution. We also announced the first of an entire new zNID 9108 Multiple Dwelling Unit Optical Network Terminal or MDU ONT, available in both outdoor Gigabit Active Ethernet and Gigabit Passive Optical Networking or GPON solutions. This latest addition to the zNID portfolio delivers best-in-class effort for even the most demanding FTTx applications. Lastly we announced that a formidable addition to our management and provisioning capability for MXK, by adding Zhone EZ Touch Provisioning, simplifying initial and ongoing configuration and management of the end-to-end Zhone solutions. Other noteworthy news and a company affairs [ph], Zhone was awarded entry into the famous Gartner Magic Quadrant Report. We are extremely proud to announce that we were recognized and awarded with a visionary ranking which is an outstanding accomplishment for Zhone Technologies and in this new classification and ranking. Now, let me provide a few customer highlights. Further validating the multi-service attribute of MXK, I wanted to profile several very different customers, all deploying MXK in unique, yet powerful deployment scenarios, all expanding fiber triple and quadruple play services to both residential and business end users. First at the TelcoTV Show in Las Vegas, we announced that Greenlight Communications has selected the industry-leading MXK MSAN system as a core enabler of its new Gigabyte Passive Optical Network or GPON network in the city of Dunnellon, Florida. Specifically Zhone’s GPON solution will enable the delivery of cost effective, best-in-class triple-play services to Greenlight customers across the municipality including residence, businesses and facilities like fire departments, city buildings, and police headquarters. This very exciting project demonstrate that the opportunity that exist to apply our FTTx solution to numerous Telco TV-centric broadband projects in addition to operator driven fiber upgrade. Then, in December, we announced our first Russian deployment of the MXK, Telecom TZ, which was previously leveraging a broadband card solution to deliver voice, video and data services with customers in the city. This core anti-migrating tool MXK along with GPON solutions such as Zhone zNID ONTs within the Moscow service footprint. What is important to note is the Russian operator primary serves enterprise customers and has been experiencing an increased amount for faster speeds among its most bandwidth intensive business services, which is what is picking off the need for even more bandwidth and ultimately our MXK functionality. We further demonstrate the global elements of our MXK. I want to note that we use, we have in Asia Pacific and Nordics. In October 2010, Viewqwest began integrating Zhone’s MXK and zNID ONTs into their new GPON network in Singapore in what has amounted through Zhone’s largest GPON deployment in the country to date. In the coming month, our solutions will provide advanced connectivity to Viewqwest’s customers including the small and medium-sized enterprises throughout Singapore. In addition, two more Aegean utilities announced that they have been using the MXK as the core enabler of their fiber upgrades projects. Specifically Tussa IKT AS has leveraged the MXK to bolster its voice, video and high-speed data offering in Sunnmøre region since 2009 and has since recognized the benefit of advanced connectivity, improved network quality and service consistency. And LOS is starting to deploy the MXK in the Kristiansand region to support its fiber build out and triple-play service enhancement with the goal of achieving subscriber services speedup up to 1 gigabyte per second with consistent network reliability and service quality. Lastly, from a customer perspective, we expect to see continued broadband and stimulus contracts from both new prospects and existing customers throughout the remainder of Q1 2011 and beyond. As you can see by the right area of deployments across multiple networks and countries, each highlighted their each multi-service attributes of MXK and the Zhone end-to-end solution. Based on the diversity of deployments from such a wide area of service providers throughout the world, we continue to have tremendous confidence in MXK for 2011 and beyond. Now I will turn the call over to Kirk to provide more details about our financials results for last quarter and to discuss our financial guidance for the next quarter. Kirk?

[Kirk Misaka:]

Thanks Mory. Today, Zhone announced financial results for the fourth quarter of 2010. Fourth quarter revenue of $31 million was in line with our preliminary estimate announced on January 7th, and which declined from third quarter revenue of $33.7 million, due to a variety of factors. These factors included material shortages and long lead times on some of our modems and delays in processing letters of credit for several orders. By resolving these issues, we expect the first quarter which is normally a seasonally weak quarter to be stronger than normal. Therefore, we expect revenue for the first quarter of 2011 to be flat instead of slightly down as compared to the fourth quarter of 2010. Despite the sequential decline in fourth quarter revenue, revenue for the year as a whole increased by 2% from $126.5 million in 2009 to $129 million in 2010. We expect continued revenue growth in 2011. We continue to serve over 750 active customers worldwide, where 61% of revenue year-to-date being attributable to the international customers. We also had two 10% customers but experienced slightly less customer concentration overall this quarter, where the top five customers representing approximately 42% of revenue for the fourth quarter as compared to 45% of revenue for the third quarter. Gross margins were stronger than expected at 39.6% for the fourth quarter of 2010 as compared to our previously provided guidance of between 34% and 36%. With a more normalized mix of OLT and ONT revenue next quarter, we expect margins for the first quarter of 2011 return to between 34% and 36%. Operating expenses of $13.5 million for the fourth quarter was at the low end of our guidance range of $13.5 million to $14.5 million. We expect operating expenses for the first quarter of 2011 to drop slightly to between $13 million and $14 million, mostly due to the additional occupancy cost savings associated with the sale and leaseback of our Oakland Campus that we discussed last quarter. Operating expenses for the fourth quarter included depreciation of approximately $300,000 and stock-based compensation of approximately $200,000. Going forward, we expect approximately the same amount of depreciation and stock-based compensation. Finally, our adjusted EBITDA loss for the fourth quarter of 2010 was approximately $700,000 due to the lower revenue level, partially offset by the higher than expected gross margins. With continued sequential quarterly revenue growth during 2011, we expect to return to profitability on an adjusted EBITDA basis in the second half of 2011. The revenue growth will also allow us to exit 2011 with more cash than we started the year with. And, while we are on that topic, cash and short-term investments at December 31st, 2010 were $21.2 million, which decreased slightly from $21.5 million at September 30, 2010, mainly due to the adjusted EBITDA loss. As for other balance sheet changes, other working capital changes largely netted out with a decrease in accounts receivable being offset by an increase in inventories. But the decrease in accounts receivable, the number of day sales outstanding on accounts receivable for the fourth quarter decreased to 86 days as compared to 91 days for the third quarter. As mentioned on our last few earnings calls, we anticipate DSOs will continue to be affected by the shipment and payment cycle with our largest customer. Our total debt obligations remained at $10 million at December 31st and September 30, 2010, and is associated with our working capital facility with Silicon Valley Bank. As we’ve discussed before, we will renew this facility annually and we anticipate being able to renew it again as we’ve done for many years. Our renewal would occur in the first quarter of 2011. Lastly, the weighted average basic and diluted shares outstanding were $30.5 million for the fourth quarter of 2010. The weighted average basic and diluted shares outstanding for the third quarter of 2010 were $30.4 million and $31.9 million respectively. With that financial overview, I’ll 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 remain part of industry momentum and recognition, MXK’s achieving surpassing over 1000 chassis deployed across a diverse range of broadband and stimulus contracts, new service providers, and markets, instill tremendous confidence that we have developed the right solution at the right time. Thank you for joining us today. We would now like to open up the call to questions. Operator please begin the Q&A portion of the call.

[Operator:]

(Operator Instructions). And your first question comes from the line of Jayakumar [ph] of Mittal Funds [ph].

[Jayakumar:]

Hi guys, a quick question. Did you guys mention that you’re going to turn profitable in the second half of the year?

[Mory Ejabat:]

Yes, we did.

[Jayakumar:]

Okay, so your revenue and expense – your revenue is going to go up and expense is going to go down or how do you see that going to go in terms of –?

[Mory Ejabat:]

We expect the revenues to go up and operating expenses to stay flat.

[Jayakumar:]

Okay. Do you have any margin of how much it might go up in terms of ballpark item on the revenue side?

[Mory Ejabat:]

No, we just give quarterly guidance.

[Jayakumar:]

Who is – which sector is the biggest sector that you guys supply your switches to?

[Mory Ejabat:]

By sector what do you mean? By product or –

[Jayakumar:]

By product, yes.

[Mory Ejabat:]

It’s our MXK product line.

[Jayakumar:]

Is it on the backend of the mobile phones or for the – to mobile operators or I mean who is the biggest –?

[Mory Ejabat:]

We sell through the landline operators and some of them use it for mobile backhaul as well.

[Jayakumar:]

Okay, all right. Thank you, guys.

[Operator:]

Your next question comes from the line of Joseph Beaulieu of Morningstar.

[Joseph Beaulieu:]

Hi guys, thanks for taking my call.

[Mory Ejabat:]

Sure.

[Kirk Misaka:]

Hi, Joe.

[Joseph Beaulieu:]

Hi. I was wondering if you – if you’ve noticed any interesting trends geographically with regard to infrastructure build outs?

[Mory Ejabat:]

We are seeing interest in the South America, mainly Brazil and Argentina as well as Chile and some in Mexico. Middle East is growing rapidly, especially in Saudi and UAE and some of the Gulf countries. And we do see some requirements – and in Russia coming strong as well as some in Nordic countries.

[Joseph Beaulieu:]

Is that really – the Nordic countries – and so nothing else in Western Europe or the UK or you just don’t have enough exposure to talk about that?

[Mory Ejabat:]

No, we do lot’s of business in UK, but it’s mainly on the copper-based networks. We do with our EFM product line. One other area that we are getting lot of attraction is with the broadband and stimulus winners in the US.

[Joseph Beaulieu:]

So you’re seeing an uptick for broadband stimulus?

[Mory Ejabat:]

Yes.

[Joseph Beaulieu:]

Okay, great. That’s a great data point, thank you.

[Mory Ejabat:]

Thank you.

[Operator:]

Your next question comes from the line of Harry Levin [ph].

[Harry Levin:]

Yes, I would like to know what is the current backlog of orders?

[Mory Ejabat:]

We normally don’t mention the backlog in our conference call. And our business is mainly book sheet business.

[Harry Levin:]

And one of things that is in your annual reports relates to products where you actually have deferred revenue, contractual commitments. So my next question would be what is – what would you have to sent out there where revenue is being deferred?

[Mory Ejabat:]

You mean dollar wise or –

[Harry Levin:]

Yes.

[Mory Ejabat:]

That has been a constant for all the quarters in the past. So we normally don’t talk about backlog in that scenario.

[Harry Levin:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Wayne Linman [ph].

[Wayne Linman:]

Good afternoon, gentlemen. The material shortage, does that mean that the orders are in, but the material or equipment has not been produced yet?

[Mory Ejabat:]

That’s correct. We have received the orders and we haven’t been able to ship the product.

[Wayne Linman:]

How do you plan that – correct that next quarter or this quarter?

[Mory Ejabat:]

Well, some of our suppliers are now committed to provide those material, and we believe with the schedules that they’ve given us, they will be able to solve majority of it then.

[Wayne Linman:]

Well, that’s good news that those orders are in, correct?

[Mory Ejabat:]

Yes, yes, that’s a good news.

[Wayne Linman:]

The other question I had asked this third quarter 2010, I saw last year Calix bought out Occam. If a private equity firm approached you guys would you look at selling the company?

[Mory Ejabat:]

We would look at any opportunities. It depends what the dollar amount is and how big the check is.

[Wayne Linman:]

Okay, thank you guys.

[Mory Ejabat:]

Thank you.

[Operator:]

(Operator Instructions). Your next question comes from the line of George Tomsey [ph].

[George Tomsey:]

Can you shed any more light on when you may start to realize on the P&L some of the stimulus revenues?

[Mory Ejabat:]

We would probably start realizing that this quarter as the funds are going to be processed and given to the operators.

[George Tomsey:]

Okay. And will you be making any more announcements of stimulus wins?

[Mory Ejabat:]

Yes we will. We have done several of them so far and we will continue doing so.

[George Tomsey:]

Okay. And then what – what competitive impact do you expect to see if the Calix Occam merger goes through?

[Mory Ejabat:]

Well, there is couple of points into that. One is we have one less competitor which is good. Secondly is, Calix and Occam have been in number one, number two position in some accounts, and that would give us the opportunity to be the second one in their account or to lead one. And also the uncertainty that has caused this transaction to some of the operators we have seen more RFPs coming to the market because of that. So we might take advantage of some of those RFPs and win them.

[George Tomsey:]

Okay, thank you.

[Mory Ejabat:]

Sure.

[Operator:]

Ladies and gentlemen, that concludes the Q&A session. I would now like to turn the call back over to Mr. Mory Ejabat, Chief Executive Officer of Zhone.

[Mory Ejabat:]

Once again, thanks for joining us today and for your continuous support. We are looking forward to speaking with you on our next earnings call – conference call.

[Operator:]

That concludes today’s conference. Thank you for your participation.