DZS Inc (DZSI) 2004 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Zhone Technologies Q2 2004 earnings conference call. My name is Rachel 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 towards the end of today's conference. If at any time during the call you do require assistance, please press star followed by zero and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. And I would now like to turn the presentation over to your host for today's call, Ms. Marianne Lackey [ph], Director of Investor Relations. Please proceed ma'am.

Thank you operator. Good afternoon everyone and thank you for joining us today. The purpose of this call is to discuss Zhone's Q2 2004 financial results and accomplishments. 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 CEO, and Kirk Misaka, Zhone's CFO. Mory will begin by discussing the key events of Q2. Kirk will then discuss Zhone's financial results for Q2 and give some guidance for the next quarter. We will conclude with questions and answers. Before Mory begins I need to advise you that during the course of this call Zhone may make forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities and Exchange Act of 1934. These forward-looking statements we will make include statements regarding the projected financial impact of our merger with Sorrento. These forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties. Actual results could differ materially from those projected in or contemplated by the forward-looking statements. Factors that could cause actual results to differ include the possibility that the intended benefits of the Sorrento acquisition may not be fully realized, the failure of the combined company to retain key employees, the failure of the combined company to manage the cost of merger integration, general economic conditions, the pace of spending and timing of economic recovery in the telecommunications industry, the combined company's inability to sufficiently anticipate market needs, and develop products and product enhancements that achieve market acceptance, and higher than anticipated expenses the combined company may incur in future quarters.

In addition, please refer to the risk factors contained in Zhone's SEC filings available at www.sec.gov for other important factors that could cause actual results to differ materially from those contained in the forward-looking statements.

During the course of this call, we will also make reference to non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles and may be different from non-GAAP financial measures used by other companies. Non-GAAP financial measures should not be considered as a substitute for or superior to measures of financial performance prepared in accordance with GAAP. The company's management refers to non-GAAP financial measures because they provide meaningful supplemental information regarding the company's operational performance. As such these non-GAAP financial measures are used by management in its financial and operating decision-making. I would now like to introduce Mory Ejabat Zhone's Chairman and CEO.

Thank you Marianne. Welcome everyone and thank you for joining us today. During the 2nd quarter we continue to execute our strategy of being a leading provider of the next generation Wirelan solutions allowing carriers and cable operators to deliver voice, data and video services over their existing networks.

The second quarter concluded with stockholders of both companies approving our acquisition of Sorrento Networks which we announced on our last conference call. As you recall, Sorrento is a leading provider of access network optical transport products. We believe this acquisition will complement our existing business by broadening our customer base among cable operators and by adding optical transport technology to our portfolio of carrier access products. Zhone made a number of important product introductions to its flagship SLMS products during the second quarter. These new products will enable carriers to deliver voice, data and video services over existing copper or fiber, while simultaneously providing a migration from circuit to packet networks. These new products, in addition to taking market share from our competitors, contributed to SLMS revenue growth of 17% over last year's second quarter SLMS revenues. Our new 48 port ADSL 2 Plus line card allows carriers to offer IPTV services by providing bandwidth necessary for video delivery of up to 24 megawatts per second while also improving density by 50% over our previous platforms.

We finished the trial with a major IOC customer that will be [rolling out] video services using our SLMS products over the next few months. We are also in trial with our [palm] products at another major IOC. Our new access optimizer technology allows carriers to consolidate voice and data traffic over legacy DSL, DLCs and DSLAMS onto Zhone's mount. This allows carriers to deploy new services and to cap their investment in legacy platforms. Our new line Power Raptor DSLAMs extend reach to 38,000 feet and optional water tight outside plant enclosure allows pole, [inaudible] or underground deployment of our Raptor products.

Zhone now provides the most comprehensive array of access platforms and cabinets available supporting 2,880 ports per enclosure. This deployment flexibility allows carriers to provide universal broadband needed for Triple Play services.

In April, Zhone introduced the new Mac IP access gateway which allows carriers to maintain the existing TDM voice services, while simultaneously retooling for VoIP using [Cep], MGCP or H248 signaling. Software selectable line and trunk interfaces allows carriers to cut over to IP on a circuit by circuit basis through a simple software selection, and without the need for incremental hardware.

Finally Zhone introducing together the Access Plus Transport in the MALC using resilient packet link technology. By introducing a packet based transport solution utilizing RPR over a Gigabit Ethernet, Zhone offers carriers a way to migrate to the next generation IP Ethernet infrastructure while delivering competitive low-cost voice, data and video services. Multi-chat and broadcast video traffic is delivered much more efficiently with the RPR offering carriers bandwidth efficiency and quality of service.

We believe these new products, and product introductions combined with Sorrento's optical transport technology further advances Zhone SLMS products to uniquely allow carriers to manage their migration to cost-effective pure packetry [inaudible] service delivery. We believe that these recent product initiatives position us well for meaningful growth during the 2nd half of 2004.

Before turning the call over to Kirk for discussion of the financial results, I wanted to comment on a few other matters. First, the lockup period related to our Tellium acquisition last November and recent Sorrento Acquisition have ended. Although our major inside investors can now sell under this shelf registration filed in March, no such sales have occurred. One of our major inside investors, New Enterprise Associates, actually purchased an additional 1.5m shares during the quarter. Also Zhone has no present intention of raising any capital from the shelf registration.

Finally, during the quarter we announced several key management additions. In particular, Michael Fischer has joined us from AFC to lead our IOC sales team. Michael brings to us broad contact with most of the major independent carriers in North America, and we expect him to grow the business over the coming quarters. With that I would now like to turn the call over to Zhone's CFO, Kirk Misaka, who will provide you with more detail on our second quarter 2004 financial results. Kirk?

Thanks Mory. First I'll discuss the 2nd quarter financial results and then turn to our financial guidance. As a reminder, throughout my discussion I'll reference both GAAP and non-GAAP proforma financial information. We have provided GAAP reconciliation information within the press release. The 2nd quarter proforma results exclude stock based compensation and amortization of intangibles. Also, since the Sorrento acquisition closed on July 1st 2004, our second quarter results do not include any revenues associated with the Sorrento product.

Today Zhone disclosed financial results for the 2nd quarter. Our revenue was $21.0m as compared to $20.5m for Q2, 2003, and $21.0m for Q1 2004. 2nd quarter revenue was slightly lower than the guidance provided during our 1st quarter conference call, however, bookings were strong at $23.5m. In addition we're encouraged by the addition of 15 new customers during the quarter, of which 10 began deploying our SLMS product. Also during the first half of 2004, over $2m of SLMS equipment was deployed by a large international incumbent carrier. The revenue associated with this contract will be recognized as we meet certain acceptance criteria, under the contract over the next 3-12 months.

Sales by product line for Q2 2004 were as follows. $8.5m for SLMS products, $4.6m for DLC products, and $7.9m for [MALCS] products. As compared to the 2nd quarter of 2003, SLMS revenues increased 17% from $7.3m, while legacy product revenues declined slightly from $4.8m for DLC products and $8.4m for [MALCS] products.

International sales were approximately 19% of revenue for Q2 2004 as compared to 15% of revenue for Q1 2004. For Q2 2004, our top 3 customers were Motorola, Qwest and Bell West, making up approximately 31% of our quarterly revenue. The remaining revenue is attributable to approximately 200 customers. Gross margins were 43.4% in Q2, 2004, within the range of guidance of 43-46% that we provided during our last conference call. Total operating expenses were $16.5m in Q2, 2004, as compared to $21.9m in Q1, 2004, which had included a $6.2m charge for purchased, in process research and development, relating to the Gluon acquisition.

Operating expenses for Q2 '04 exceeded our previous guidance by $1m, which was primarily due to legal expenses for litigation that we inherited through our acquisition of Tellium. During the quarter, one of these legal matters was resolved favorably when through a binding arbitration process, all claims made by Corning against Tellium and its subsidiary were dismissed. The litigation relating to Tellium's shareholder lawsuits continues to be outstanding. Although we expect to continue to incur legal expenses to defend this action, we believe that any potential settlement exposure is adequately covered by insurance.

On a GAAP basis, our net loss for Q2, 2004 was $7.4m compared to $13.4m for Q1, 2004. On a non-GAAP proforma basis, net loss for Q2 2004 was $4.6m compared to $4.5m for Q1, 2004. Now let's turn to the balance sheet for a moment. Cash and short term investments at June 30, 2004, were $79.9m. Accounts receivable DSO were 53 days for Q2, 2004, compared to 58 days for Q1, 2004. Inventory was $31.3m at the end of Q2, 2004, as compared to $28.4m at the end of Q1, 2004. The slight increase in inventory levels relates to new product introductions that Mory previously discussed. Finally our long-term dept balance declined slightly from $31.8m at March 31, 2004, to $31.5m at June 30, 2004.

Basic and diluted EPS shares were 78m for Q2, 2004. As a result of the Sorrento acquisition, we expect those shares to increase to approximately 94m for Q3, 2004. Before I turn the call back to Mory, here is our financial guidance for the next quarter. On the top line we expect Q3, 2004 revenue to range between $27m and $29m. We will also be reclassifying our revenues to reflect the Sorrento acquisition and plan to report revenues segmented into 3 categories, SLMS, Optical Transport, Legacy and Service. As for 3rd quarter margins, we expect them to range between 42% and 44% reflecting the affect of the Sorrento product line.

Excluding any acquisition related charges for the Sorrento acquisition, we expect 2nd quarter 2004 operating expenses to range from $17m-$18m, including stock based compensation expense and amortization of intangibles of approximately $2.5m. As mentioned during our last conference call, the impact of the Sorrento acquisition is expected to be immediately accretive. Over the next quarter we'll continue emphasizing top line growth, cost containment measures to become profitable on a proforma basis as early as the 4th quarter. With that overview I'll now turn the call back to Mory.

Thank you, Kirk. We believe we are on track with our business calls and plans to achieve profitability. Our acquisition of Sorrento demonstrates our commitment to develop and diversify our product portfolio and to expand our reach into emerging growth markets and gain market share. We have proven over the past 4 years our ability to successfully integrate or acquire companies, and we intend to continue to do that with the seamless integration of Sorrento, our 11th acquisition. We believe that Sorrento provides key additions to our product portfolio, and we continue to integrate other acquired technologies into our product offering. We intend to continue this strategy by adding the best available technology to our product portfolio, and the talent to our management team.

Our focus remains on delivering [inaudible] network to telecom and communication carriers and cable operators worldwide. Thank you for joining us today, I would now like to open the call for questions. We will now begin the question and answer portion of the call. Operator?

Ladies and gentlemen, if you wish to ask a question, please key star followed by one on your touchtone telephone. If your question has been answered, or you wish to withdraw your question, please press star followed by 2. Questions will be taken in the order we receive them. Please press star one to begin. Your first question comes from the line of Anton Wallman [ph] of Needham and Company, please proceed, sir.

Hey, can you hear me?

Yes, we can hear you.

Kirk, I've got a numbers question for you. On the Other Income and Expense line-in previous quarters you've had, let's call it ballpark, $0.5m kind of negative item there, in terms of interest expense, I guess, and this quarter it was essentially zero. Could you inform us what's going on there?

There was a one-time benefit related to a settlement that we had, so we expect going forward that that would normalize back around $0.5m.

And could you also remind us in what form that interest expense is, and if there's an offsetting interest income-I mean, is it-what's kind of the gross interest income and the gross interest expense on a normalized, going forward basis, assuming no other major items, acquisitions and so forth.

Right, Anton. Most of that line item is related to interest-the interest income is only about $100,000, so the differential is attributable to the interest expense on the long-term debt.

So the basically $600,000 or so worth of interest on the long-term debt.

That's correct.

Okay, all right. And you have a couple of, you said there were some trials for IPTV video with a major IOC, is that with the new ADSL 2 Plus, or is that with some other physical layer connection?

No, Anton, it's with our ADSL 2 Plus, providing high bandwidth for Triple Play offering. And also we do have another trial going on with the FTTP product line offering Triple Play. But the first one, we did pass the trial and the customer is going to go to the rollout of the service within the next few weeks.

But that was with the ADSL 2 Plus, not with an older ADSL line card that-

No that was with ADSL 2 Plus.

Okay. Also, I think you mentioned, I wasn't sure I heard you exactly right, but did I hear you correctly-you said that you were going to have a [pots] card for your DSLAM?

Well, I didn't mention that but we do have [pots] card for our DSLAM, we had that for a long time. If you recall, our DSLAM is actually, our [inaudible] or Packet [Rise] DLC, can be disabled to be only a DSLAM.

Okay, but this is something that if you were a, sort of an [Unipe] reseller previously, that you could deploy a DSLAM and put in a [pots] line card and then offer service if the [Unipe] sort of goes away or becomes otherwise more or less prohibitively expensive. Is that one use that this solution could have?

Yeah, that's one use, and also with the same platform you have VoIP gateway capabilities so they can take that traffic and convert that to VoIP on a [pots] level circuit by circuit basis.

Okay. Two more questions. First of all, did I hear you correct when you said NEA had purchased 1.5m shares over the last quarter or so. And then I couldn't quite hear what you said right before then. Did you say that a few sales had occurred, or was it a few other purchases had occurred, I wasn't sure what you said there.

No, actually what we said is our lockup, insider's lockup came off from Tellium and Sorrento acquisitions, even though we filed a registration statement, none of the insiders sold or intend to sell.

Okay, so no sales have occurred, but the major purchase was NEA. Okay. Finally for your Kirk, you said Motorola, Qwest and who else did constitute the total of the 31%? You said Bell something, and I didn't quite hear you.

Bell West in Canada.

Bell West in Canada. All right, the three of them combined were 31%. How does that percentage compare to the last quarter? What was the total of the 3 of them last quarter?

I actually, last quarter three companies, and I don't know if Bell West was in there or not, contributed to about forty plus percent.

Okay, but what was Motorola, Qwest and someone else other than Bell West.

I'm not sure if it was Bell West among them or not but-

Actually the three top customers remain the same, and the percentage was slightly higher during the first quarter of '04.

Okay, that makes sense. Thank you very much.

Thank you. Your next question comes from the line of Joanna Maycrest [ph] of Adams Harkness [ph], please proceed.

Good afternoon.

Hi Joanna.

Hi. I'm wondering how much of the sequential decline in SLMS revenue can be attributed to the single international customer that you mentioned, and what is your outlook for SLMS looking out into the September quarter? Could it be more like Q1 levels?

Well, on the SLMS side we had about, as we mentioned, $2m of deferred revenue on an international carrier that we couldn't recognize. If we could have recognized that we would have sequentially, quarter-over-quarter, we had a sequential increase on that product. And we believe in Q3 our SLMS product line is going to grow, probably in double digits.

Okay, great. And then on the [MALC] side of the business, what drove the strong sales you saw this quarter, and would you expect those to be sustainable into the September quarter?

I'm sorry could you repeat that again.

On the [MALCS] product line, what drove that increase that we saw this quarter, and would you expect September quarter levels to look much like the did in Q2 for [MALC].

In the [MALCS] business, there was an international carrier that also, not the same one, that put in some order for the [MALCS] business, and in this quarter we believe the [MALCS] business is going to be comparable to what it was in Q2, in Q3.

Okay, great, thank you.

Thank you. Your next question comes from the line of Hassan Imam [ph] please proceed.

Thank you. I had a couple of questions. First of all, in terms of your $23.5m in bookings that you mentioned, does that include the revenues you had to delay given the revenue recognition issues?

About $1m of that included that.

Okay, thanks. And then, in terms of the guidance, $27m to $20m, how much is expected from Sorrento?

Actually it was $27m - $29m, Hassan, and we are expecting between $4.5m - $6m to be out of Sorrento.

Out of Sorrento. Okay, thanks. And then a question on profitability, you mentioned that you expect to hit profitability by the 4th quarter. I was wondering, is that based mostly on kind of revenue uptick, or do you have to tweak the operating model more, in terms of headcount reduction etc.?

Well, our plan is to focus on revenue growth for the Q4, and also we may be able to reduce some of our costs, because we had to do lots of certification in our product during the Q2, through [Osmo] and others that added cost to our operating expense. That may reduce some of our operating expense.

Thanks. And then last question. Mory, we've heard a significant number of IOC showing, kind of [IFI] RFP activity on video.

Right.

Would you talk about how you're positioned on that front, could we see some revenues out of that by the end of the year?

Well, actually, as we mentioned, as I mentioned, we won a contract on a large IOC for the video deployment, Triple Play deployment. Actively we are working on about 6 or 7 RFP, and we believe we can win a majority of that. And Hassan, in the future, our majority of revenue is going to be based on two applications, VoIP and Triple Play.

So we could potentially see some more wins this year, do you think?

Yes, I believe you are going to see more wins.

Great, thank you.

Thank you. As a reminder ladies and gentlemen, it is start one to ask a question. Your next question comes from the line of Steve Levy [ph] of Lehman Bros.

Thanks, I was just wondering, the $2m international shipment you're talking about, is that showing up in deferred revenue on the balance sheet, or is that just in inventories?

Actually it would be more of an inventory at this point. And also it is a deferred revenue. But mainly it remains under inventories.

So this is deferred-is it showing up-is this $2m of revenues when it finally gets accounted for?

Yes.

So it's less than the inventories right now.

It will be $2m of revenue when it gets accounted for, and also we get the same, whatever our cost was on that $2m, which sits in the inventory, will be reduced-our inventory would be reduced by that amount.

Right. And then would you expect this all to be recognized at one time or is this over-

Steve, the way the contract reads, it has different stages.

Okay.

We believe we are going to pass the first stage within the next few days.

Right. And then on the Fiber to the Premise trial that you refer to, where is that in terms of the status of testing, deployment-and I know you've got this out there, is it rolling out with all services right away, or-

Yeah, it's a limited trial to about 9 or 10 [inaudible] on that trial and it's for a full service of voice, video and data.

Right, thank you.

Thank you. Your next question comes from the line of Don Road [ph] of S2 Technology [ph].

Hi. What's the impact on the balance sheet for the net cash position with the inclusion of Sorrento?

The impact in terms of their net cash balance?

Yeah.

They have closed the quarter with about $5m of cash, but that does not reflect all of the severance and termination payments that will be made, nor does it reflect $11.6m of convertible debt balance.

Okay, thanks.

Thank you. Your next question comes from the line of Irvy Lavin [ph] of Bell Securities [ph] please proceed.

What was the price that NEA paid for the stock and were there any contingencies to that purchase?

Well, let me-there were no contingencies on that purchase, we really don't have any idea what the price was, because they bought it in the open market.

Thank you.

Thank you. Your next question comes from the line of Don Oracle [ph] of Water Island Capital [ph] please proceed.

Hi Gentlemen. I wanted to follow-up with the question regarding Sorrento and the balance sheet items. From what I recall back last call on this particular transaction, they had some real estate they were in the process of liquidating. Can you give us an update on what you expect-have those transactions been completed, or if not what you think the impact will be proforma those transactions? And can you talk at all about Sorrento and how the integration has gone and where you stand as far as headcount and so on, please?

Okay, this is Kirk, I'll address the balance sheet and the real estate. They own their campus, two buildings in San Diego and we're in a dialogue with a broker to sell those buildings. We have gone through an offer and counter-offer process and are optimistic that we can have that transaction move forward in the 3rd or 4th quarter. It will create some additional proceeds above the mortgage financing on the building, the mortgage financing being approximately $3m and I would prefer not to mention the price on the facilities at this point, as we're in negotiations.

In respect to integration of the Sorrento into Zhone, in respect to the headcount, we have reduced the headcount to about 46 people that are going to be in our payroll from 130 people. In respect to the customers, they have 3 major customers, Comcast, [Karks] and Time Warner. And we have spoken to all 3 customers. They are very anxious to go forward with Sorrento products with us, in addition of looking on our products, especially for VoIP capabilities and also for DLC, DSM type of capabilities in the network offering. TDM voice or VoIP.

Great, thank you.

Thank you and at this time you have no further questions. Gentlemen, if you have any closing remarks?

Thank you everyone for joining us today, we appreciate your support and look forward to speaking with you on our next earning call. Operator?

Ladies and gentlemen, thank you for your participation in today's conference, this does conclude the presentation and you may now disconnect your lines.