DZS Inc (DZSI) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Zhone Technologies third-quarter 2004 conference call. My name is Stephen and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session toward the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms. Tiffany Brown.

Thank you, operator. Good afternoon, everyone, and thank you for joining us today. The purpose of this call is to discuss Zhone's third quarter 2004 financial results, as accomplished, as recorded in our earnings release, which was distributed over Business Wire at close of market today, and has been posted to our website at www.Zhone.com.

I'm here today with Mory Ejabat, Zhone's Chairman and Chief Executive Officer and Kirk Misaka, Zhone's Chief Financial Officer. Mory will begin by discussing the key highlights of the third quarter, and then Kirk will discuss Zhone's financial results for the third quarter 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 the call, Zhone may make forward-looking statements within the meaning of Section 27 A of the Securities Act of 1933 and Section 21 E of the Securities Exchange Act of 1934. 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 or contemplated by forward-looking statements. Factors that could cause actual results to differ include general economic conditions; the pace of spending and time of economic recovery in the telecommunications industry; the Company's inability to sufficiently anticipate market needs and develop products and product enhancements that achieve market acceptance; higher than anticipated expenses the Company may incur in future quarters; and the impact of any future acquisitions and any unanticipated charges.

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

During the course of this call, Zhone may make reference to non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles and may differ 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 the financial and operational decision making.

I would now like to introduce Mory Ejabat, Zhone's Chairman and Chief Executive Officer.

Thank you, Tiffany. Welcome everyone and thank you for joining us today. During the last quarter, we had a good revenue of $27 million, with a good growth in the SLMS business line, and also a stable legacy business. Kirk Misaka will take you through that in detail after me.

Some of the highlights here in the quarter could be one, acquisition of Sorrento. That acquisition was completed. The integration as well was completed within engineering, sales and manufacturing. In respect to their facilities, we moved (indiscernible) operation to Oakland and terminated (indiscernible) lease. Also we move San Diego operation to a plant and are in the process of selling the San Diego facility.

In respect to their customers, we had high-level and most of management-level meetings with Comcast, Cox and Time Warner Telecom, and they all see this measure as a positive position for both companies. We also have had a very good positive reaction from Deutsche Telekom in Germany and Meribenni (ph) in Japan. And also we had a solid revenue from (indiscernible) business, which is their legacy business, and Sorrento is worth about $1 million.

We also added some new customers to Sorrento product line last quarter. SANNET and Global Access in Japan, ING Bank and EL (ph) Bank in Germany.

We also did introduce several new products. We introduced a 12-port (ph) (indiscernible) card and also 10-port GigE card. In addition, we have also introduced a 2-port fiber channel that's (indiscernible) filtered and it can exceed 15,000 kilometers.

Now, talking about the SLMS business during the quarter. SLMS business is growing strongly. During the first nine months of business, SLMS revenue grew 36% year-over-year. We added 11 new SLMS customers during the past quarter. And also in the last call, we talked about the international PTT that we deployed some part SMLS product to them. That PTT is (indiscernible), which is the largest in combat in the Middle East. The deployment has been very successful and they are running live traffic. We also passed other product certification during the quarter. We did not recognize any revenue in Q3 from them, but we expect to recognize some revenue in Q4.

Our focus, as usual, has been on broadband, SKTP (ph) and DSL, in addition to IPTP and triple play, VoIP and packet migration with the integrated transporter. With respect to the ADSL, in last quarter, in Q3, we shipped more ports than we shipped during the whole year 2003. And also, in Q3, we increased 50%, quarter-over-quarter, our ADSL shipment and also with the majority being ADSL2+.

With respect to IP TV and triple play, we have six customers begin deploying or in the initial trial. We have one large ROC (ph) that is running live traffic to their customers, doing IP TV. And also we are deploying some IP TV internationally.

With respect to the VoIP, we added four new customers using our CPN Gateway. As a whole, we've seen our products are becoming the platform of choice by carriers offering FTTP, ADSL2+, VoIP, and legacy voice and data services. We're taking market share in these areas from our competitors.

We also announced two new SLMS product lines, ZRG 600 and 800 for indoor and outdoor deployment. These products are CP (ph) for voice, video and data. We've gone IP TV on those, either on coaxial or fiber or copper. And that's the only product that exists in the market that has integrated set-top boxes in addition to running IP over coaxial.

In summary, our business is improving and we see increased order activities in our market. We're taking market share from our competitors. We anticipate double-digit growth in DSLMS and optical product line within the Q4. And we are on our plans for profitability.

With that, I will turn this to Kirk Misaka to take you through financial points of the quarter. Thank you.

Thanks, Mory. In the next few minutes, I'll discuss both our third-quarter financial results, as well as our financial guidance for the fourth quarter. As a reminder, throughout my discussion I will refer to both GAAP and non-GAAP pro forma financial information. We provided GAAP reconciliation information within the press release.

The third quarter 2004 pro forma results exclude purchased in-process research and development, stock base compensation, and amortization and impairment of intangibles. Also, since the Sorrento acquisition closed on July 1st, 2004, our third-quarter results include revenues associated with the Sorrento products for the first time.

Today, Zhone disclosed financial results from the third quarter. Our revenue for the quarter was 27 million, as compared to 22.2 million for the same quarter of last year. The revenue was within the range of guidance that we provided during our second-quarter conference call. Once again, our bookings and shipments exceeded revenue for the quarter, primarily because of a 1.5 million shipment to Etisalat, our PTT customer in the UAE that Mory mentioned.

To-date, our cumulative shipments to Etisalat have been approximately $4 million. As Mory mentioned, different zone products are beginning to meet the performance criteria stipulated in our contract with Etisalat, and we have recently received an acceptance certificates for our mouth product. Accordingly, we anticipate that we will begin to recognize meaningful revenues related to this contract in the fourth quarter of this year. We anticipate double-digit revenue growth for the fourth quarter over the third quarter in both our SLMS and optical transport product, with a model single-digit percentage decline in our legacy and service business. As a result, our revenue for the fourth quarter is expected to be in the range of 28 to 30 million, or about 4 to 11% quarter-over-quarter.

As we mentioned during our last earnings call, we have changed our revenue categories to better reflect the current nature of our business, and are reporting a new optical transport revenue categories to reflect the group of products acquired from Sorrento Networks, excluding their Mera (ph) products, which have classified as legacy products. On this basis, revenues by product lines for the third quarter of 2004 were as follows -- $5.6 million for SLMS products; $17.2 million for legacy products and service; and $4.2 million for optical transport products.

For the nine months ended September 30th, 2004, product line revenues were 19.6 million for SLMS products; 45.3 million for legacy products and service; and 4.2 million for optical transport products. As compared to the nine months of last year, SMLS revenues have increased by 36% while revenues for legacy products and service have remained basically flat. Please note that our SLMS revenues differ from our previously-reported numbers, due to the inclusion of service revenue associated with the SLMS product in the legacy and service category rather than the SLMS category.

Looking at a different cross-section of our revenues, international revenues were approximately 29% of total revenues for the third quarter as compared to 19% of total revenues for the second quarter. This increase reflects the incremental demand for our products overseas, particularly for greenfield deployment where next generation technologies have clear advantages.

Finally, we had one 10% customer for the third quarter, and our top five customers comprised approximately 44% of our quarterly revenues. The remaining revenues were attributable to over 200 customers.

Now, turning to our margins. Gross margins were 42.1% for the third quarter, which was within the 42 to 44% range of guidance that we provided during our last conference call. With continued emphasis on manufacturing cost reductions, particular with regard to the Sorrento product line, we anticipate gross margins for the fourth quarter to range between 42 and 45%.

As for operating expenses, total operating expenses were 21.6 million in the third quarter, which includes $3.4 million of expenses related to the Sorrento acquisition, and a $700,000 expense related to the termination of one of our long-term lease commitments. Without these expenses, total operating expenses would have been $17.5 million, which is within the range of guidance of 17 to $18 million that we previously provided.

Going forward, we anticipate reducing our total operating expenses for the fourth quarter to be between 16 and $17 million, as we continue to emphasize cost containment. Our expense guidance includes approximately $3 million of expenses for amortization of intangibles and stock-based compensation.

On a GAAP basis, our net loss for the third quarter was $11 million compared to $3.5 million for the same quarter of last year. On a non-GAAP pro forma basis, net loss for Q3 of 2004 was 5.3 million compared to a $2 million loss for Q3 of 2003.

Turning to the balance sheet -- our cash and short-term investments at September 30th, 2004 were $68.6 million. Accounts receivable day sales outstanding were 65 days for Q3 2004 compared to 41 days for Q4 2003, attributable to a buildup in accounts receivables from sale occurring near the end of Q3 2004, and receivables related to the Etisalat contract.

Inventory was $37.2 million at the end of Q3 2004 as compared to 24.3 million at the end of Q4 2003. The increase in inventory level relates to the inventory attributable to the Sorrento product and the new product introductions we mentioned during our last conference call.

Our long-term debt balance increased to 46.6 million at September 30th, 2004 from 32 million at September 31st, 2003, primarily due to Sorrento's convertible debt facility of $11.7 million and a mortgage of $3.5 million related to their facility.

Finally, basic and diluted EPS shares were $94 million -- 94 million for the third quarter, which represents an increase from 78 million shares for the second quarter due to the shares issued to acquire Sorrento.

Before I turn the call back to Mory, let me recap our guidance for next quarter. We expect revenues of 28 to $30 million; gross margins between 42 and 45%; and operating expenses of 16 to 17 million, including 3 million of amortization and stock compensation expense. We expect revenues attributable to our SLMS and optical transport products to grow at double-digit percentage rates sequentially, and our legacy and service revenues to decline modestly at a single-digit percentage rate.

With continued emphasis on top line growth and cost containment measures, we believe that we can break even or be slightly profitable on a non-GAAP pro forma basis this quarter. And with that overview, I'll now turn the call back to Mory.

Thank you, Kirk. We believe we are on track with our business goal and plans to achieve profitability. Our acquisition of Sorrento demonstrated our commitment to develop and diversify our product portfolio and expand our research, and reaching to emerging growth market and gain market share. Our focus remains on delivering next generation networks to carriers and cable operators worldwide. Thank you for joining us today. I would now like to open the call to questions and answers. Operator, please begin the question and answer portion of the call.

(OPERATOR INSTRUCTIONS). Our first question comes from Joanna Makris.

I'm wondering if you could comment a little bit about Etisalat. And maybe you could comment a little bit about the size of the deployment and your expectations for them over the next couple of quarters.

Etisalat is the largest incumbent, a state-owned carrier in the Middle East, based in the UAE. They have been deploying our MALC product, mainly for DSL deployment and possibly migration from legacy to packet networks. I cannot comment on the size of our deal with them, because we have to get authorization from them to do that. But so far they have deployed about $4 million worth of our products, and they continue to do deploy more products in the going-forward basis.

Okay, great. I'm wondering also if you can talk a little bit about your existing SLMS revenue, and maybe what portion of that is reoccurring from existing customers that are expanding deployments with you versus new customers?

On the SLMS product line, there are two ways to look at it. There are some recurring customers that they do two things -- one is for their new deployment; another one is for new applications, in such a way that we have some customers that we're deploying our SLMS product for DSL deployment only. Now they are getting to the point that they are offering parts or voice services or DSL with their splitter, and using it as a next generation packet (indiscernible) carrier. So, if you look at it in that scenario, combining application, new application, new customers, I would say 50% of our business comes from new customers and the other 50% comes from recurring customers.

And one last question, maybe this is more for Kirk. What do you see as a more normalized quarterly op-ex level? You commented about Q4, but looking out into the first half of calendar '05, what do you see as normalized op-ex?

Well, our guidance for fourth quarter is 16 to 17 million, which includes some cost reductions from this quarter. Going forward, we are hopeful that we can reduce that by $1 million, maybe, and be into the 15 to $16 million op-ex level.

Thank you.

Hasan Imam.

A couple of questions -- first of all, for Mory -- last quarter, Mory, you mentioned that you're working on 6 to 7 RFPs (ph) on video deployment. And in the call you mentioned some new customers this quarter. I'm wondering were you able to translate some of these RFPs into sales? And do you have additional RSP selling in the pipeline?

Yes, our customers RFPs, I believe we have one or two that have turned into trials now. I mentioned about six customers that are some of them in trial. A couple of them can be from the RFPs. And also we are responding to about -- I would say around 7 to 8 RFPs are active right now in our office.

Okay, great. And so, there are some additional ones in the backlog also?

Yes, the last quarter we got one major RFP from one RBOC. And then we got a couple other ones from a smaller IOC (ph). And also we have one for our optical transport business.

And then also last quarter you mentioned that about 2 million of SLMS equipment was deployed by major international incumbents. I was wondering how much of that sale was recognized in revenue this quarter? And what's the timeline for the remainder?

Okay, I will let Kirk answer that question.

Hasan, that reference in the second quarter was to the Etisalat customer that Mory mentioned in the UAE. Year-to-date, we've shipped $4 million to them. We anticipate that the first real meaningful revenue will be recognized in the fourth quarter of this year.

And just two more questions -- what is the new timeline for profitability now? And what's the (indiscernible) target revenue and expense mix that you would break even at, Kirk?

Our guidance for this quarter actually will get us to a pro forma profitability, depending upon where in the range we are. So, 28 to $30 million revenue level with margins of 42 to 45%, and 16 to 17 million of op-ex can get us to a pro forma break even and slightly profitable position.

And you're expecting that next or so?

This is for the fourth quarter, yes.

So, the cash would then essentially bottom out at above 60 million?

Well, again, we anticipate to either be flat on the cash or slightly up on our cash.

Got it. And the last question -- are all the restructuring costs related to Tellium and Sorrento now behind us?

Yes, as far as we know there is --

All the material cash costs related to both transactions, the financial statements, expenses, have been recognized.

Great. Thank you, guys.

Steve Levy.

Kirk, just if I could follow up on the working capital. Your expectations for the next quarter or so, would you imagine that receivables and inventories would be coming down?

We do anticipate that the receivable level and the inventory level will come down. As we discussed, inventories rose by about 13 million from the end of the year. Approximately half of that relates to the Sorrento acquisition, but half of it related to new products introduction that we discussed. And as we work ourselves further into the life cycle of that product, we can carry lower levels of inventory.

On the accounts receivable side, Etisalat has built up a fairly large balance with us, $4 million now. And we anticipate we'll be able to start collecting and liquidating those kinds of balances.

And that's the second question I had on the receivables. You said Etisalat's in the accounts receivable, but you have not recognized the revenues?

Deferred revenues offsetting that, but on gross receivable basis, Steve, it is. So there will be cash generated from the liquidation of that receivable, and revenue recognized.

So it's basically in deferred revenues now, any you have not collected cash yet?

No.

But you recognized a small amount of revenues overall? Or is it all in deferred revenues?

Almost entirely in deferred revenues. There's a small amount of revenues related to certain pieces of equipment that have already met the acceptance criteria in the contract.

Great, then if I can just switch gears and go to Mory on the video installations. Could you give us an idea -- you talked about, I think -- I got this 4, 6 IP video customers. Can you give us an idea of what the range of deployments are? Are these one central office, 200 lines? Or are we talking about multiple central offices with thousands of lines? Can you give us some framework for that?

Yes, actually, they range, as you know, in different spaces. The largest customer we have has 200,000 lines that is offering IP video in the (indiscernible) least right now, and hoping that this year they will probably announce their service and roll out more products. And they are in several FCOs (ph) and RTs. And also we have a couple of them that are in their small RTs right now, and one that has a couple of central offices.

So, if I go back to that first one, it's a telco that has 200,000 access lines, and they're just offering it in the few spots, basically, to -- as you said, friendlies. When do you think that they start going generally available for --

My anticipation is either at the end of this month or next month. But you never know which customer does that.

(OPERATOR INSTRUCTIONS).

Do we have anyone else, operator?

Yes, we do have a question from Hasman Karim?

I was just wondering if you had your headcount, pre-merger and post-merger, please?

Actually, our headcount has been -- went from pre merger of 252, now to about 300.

And so the operating expense for those incremental 48 employees has not come on? Or have you offset that with some --?

We have offset that, and some of that are in operating expense. As you know, prior to the merger we had about $1 million less in operating expense.

Additional operating expenses were reflected in our third-quarter results. And as we discussed in our guidance for the fourth quarter, we anticipate further reducing some of the headcount to get down to the operating expense guidance that we had of 16 to 17 million.

Anton Wahlman.

A couple of things here -- first of all, did you say -- did we hear correctly when you said that you had shipped in the quarter to UAE about a million and a half, but there was 4 million to date, so we should therefore infer that you shipped -- a majority of what you've shipped to UAE today actually occurred following October first. Is that the correct interpretation?

Anton, 4 million has been shipped year-to-date. 1.5 was shipped this quarter, the third quarter. And the other 2.5 million was shipped in Q1 and Q2.

Okay, so before the third quarter, so it was not a first-quarter issue? I see. So, the other one is -- what's your CapEx for the quarter?

Very minimal. Less than $200,000 a quarter.

And what's your depreciation and amortization, respectively?

Combined -- excluding the amortization of intangibles that I separately carved out, the depreciation is approximately 3 to $400,000.

The two of them combined?

The depreciation. The amortization of intangible is separately included in our pro forma information in the earnings release.

So that was only the ongoing amortization there, is just a minor fraction of that? Or that doesn't reflect an ongoing rate does it?

It does, because Sorrento is included in there for a full quarter. The ongoing amortization is expected -- and stock-based compensation -- is expected to be $3 million.

Upright. So, that's good to know. You've now been shipping, obviously, a lot of DSLs for TV over DSL purposes, and you're now in trials for IP TV. Where do you stand with actual fiber-to-the-home. I know you announced a product a couple of quarters ago. Are you actually shipping fiber-to-the-home products to any customer at this point? Or are those still in trial?

It's still in trial, Anton. We have about two or three of them that are trialing at this point, and none of them have come to the full deployment yet.

And in terms of terminating digital video at the side of the house, is any customer taking that product now? Or is that product also still in trials?

No, they are still in trials. I mentioned we have several large trials going on. Our VR-chip (ph) product that has integrated set-up boxes, Plus voice and data, has been in trial with those customers.

And those are mostly domestic customers?

They are mainly domestic customers. With one exception, that we are beginning a trial in Europe.

There are no further questions at this time, sir.

Thank you all very much for participating in this call. And we will talk to you next quarter. Thanks a lot.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.