DZS Inc (DZSI) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen. We thank you for your patience. Welcome to the Fourth Quarter 2005 Zhones Technologies Incorporated Earnings Conference Call. My name is Bill, and I'll be your conference coordinator for today. At this time, all participants are in a listen-only mode. However, we will be facilitating a question and answer session towards the end of today's conference. [OPERATOR INSTRUCTIONS] Today's conference is being recorded for replay purposes. I would now turn the call over to your host, for today's presentation, Mr. Kirk Misaka , Zhone 's Chief Financial Officer. Please proceed sir.

Thank you operator. Good afternoon, everyone, and thank you for joining us today. The purpose of this call is to discuss Zhone's Fourth Quarter 2005 financial results and accomplishments as reported in our earnings release which was distributed over [inaudible] at the close of market today and that's been posted on our web site at www.ZHONE.com.

I'm here today with Morey Ejabat, Zhone's Chairman and Chief Executive Officer. Morey will begin by discussing the key highlights of the fourth quarter. Then I will discuss Zhone's financial results for the fourth quarter and provide guidance for the next quarter. We will conclude with questions and answers. As you know, during the course of the discussion today, we will make forward-looking statements, including those relating to our future financial performance, such as profitability, positive cash flow, revenue, margins, operating expenses, earnings and cash balances. The anticipated growth and trends in our business, product lines or key markets, plans, objectives, and strategies for future operations, Zhone's market position, and statements that express our expectations, estimates, beliefs, plans, and forecasts. We'd like to caution you that actual results could differ materially from those contemplated by the forward-looking statements. We refer you to the risk factors contained in our SEC filings available at www.SEC.gov. Including without limitation, our annual report on Form 10-K for the year ended December 31, 2004 and our quarterly reports on Form 10-Q for the quarters ended March 31, 2005, June 30, 2005, and September 30, 2005.

We would like to caution you not to place undue reliance on any forward-looking statements which speak only as of the date on which they are made and undertake no obligation to update or revise any forward-looking statements for any reason. During the course of this call, we will also make reference to pro forma EBITDA, an additional non-GAAP measure we believe is important 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 is 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 comparison to the Company's historical operating results in comparison to competitor's 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 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 Morey Ejabat, Zhone's Chairman and Chief Executive Officer.

Thank you Kirk. Good afternoon and thank you for joining us today for our fourth quarter and year end 2005 earnings call. We are pleased with Zhone's execution in the fourth quarter of 2005. Sales of our SLMS and legacy products were a strong, while sales of our optical products did not meet our expectation due to budgetary constraint among some of our larger customers. While we completed the integration of Paradyne, we focused on cost reduction and expense control. As a result, we achieve our profitability goal on an EBITDA basis.

Overall, 2005 was an excellent year for Zhone. We introduce several new products targeted for the IPTV, voice-over IP and broadband markets. During the year Zhone shipped over 675,000 DSL ports, putting Zhone among the top [two] suppliers of the DSL equipment in North America. We maintain a broad customer base of over 600 geographically diversified customers with no single customer representing over 10% of revenue. Financially, we achieve profitability on an EBITDA basis for the last two quarters of the year. We increased our cash balance and reduced our long-term debt. Kirk will provide more detail on our financial data.

During the fourth quarter of 2005, Zhone won significant new business for it's products including shipment to 24 new customers, business from new first-time customers continued to be realized in all of Zhone domestic and international sales regions. Newly announced customers during the quarter include Globility, TSC, Lafourche Telephone and Yipes. Outside of North America, we have new deployment in Argentina, Australia, Camaron, Finland, Germany, Ghana, Italy, and Romania. Zhone, again sustained the number one market share position in the Broadband Loop Carrier , for the fourth quarter, as well as for all of 2005 according to industry analyst firm Broadband Trends. BLCs are defined as access platform that support IPTV, VoIP and broadband services with IP infrastructures. BLCs remain the fastest growing segment of the multibillion dollar broadband market. The success of our MALC product is evident not just by customer wins and market share leadership but also by analyst reviews. In November, independent analyst firm, [Current Analysis], performed a comprehensive product assessment and awarded our MALC the highest ranking of any product in [it's space], edging out offerings from eight competing vendors including Alcatel, Calix, Ciena, Lucent, Occam, Samsung and Tellabs. In October at the USGS show in Las Vegas, we announced our new MALC 100 product. This product allows service providers to deliver IPTV with ample band width to deliver high definition and a standard definition video, traditional voice, as well as VoIP and broadband services. The small footprint of our carriers to deploy closer to their subscribers given in our remote serving areas. Also, during the quarter, we announced our new VDSL2 product line including fully featured CPE and a Line Card for our MALC product family. Zhone is among the first vendors to market this new broadband technology which can deliver speeds of up to 10 times the performance of ADSL.

Looking forward to 2006 with the acquisition and integration of Paradyne complete and behind us, we will continue to enhance our product offering with new products and additional functionality that better allow our customers to offer high bandwidth IPTV, VoIP, broadband and Gigabit Ethernet services. Domestically, we will continue to increase our market share in higher [inaudible] market, with a solution that allow them to deliver greater bandwidth and services at lower cost. Internationally, we will continue our focus on growth areas such as the Middle East, South Asia, Eastern Europe, and the Caribbean. While we focus on alternative carriers in Western Europe, Canada, and South America. Comparatively, we will focus on increasing our lead with the new products, increase functionality and reduce cost. Financially, we will continue to enhance our profitability and generate positive cash flow during each quarter. Now I would like to turn the call to Kirk to take you through our financial performance and guidance. Kirk?

Thanks, Morey. Today Zhone announced financial results for the fourth quarter of 2005. Before discussing these results, please remember that this was the first full quarter reflecting the impact of our Paradyne acquisition that closed on September 1st. It's also the first full quarter excluding the results of certain of our nonstrategic legacy businesses that were divested on September 30th. Therefore the fourth quarter results are not directly comparable to our prior operating results. As I discuss results for the quarter, I will focus on our performance against previously provided financial guidance and use the fourth quarter results as a baseline to describe our anticipated future operating model. With that reminder, let's start with a review of revenue. Our revenue for the fourth quarter was 53.2 million, which was slightly below our previously provided guidance range of 54 to 56 million. As Morey mentioned, our [SMLS] and legacy products continue to show strong demand while our optical products experienced some weakness this quarter because of budgetary constraints by some of our larger customers. In addition the integration of Paradyne and the effect of the divestitures were difficult to predict at the beginning of the quarter. But by mid quarter, we refocused our energy from these activities to our core business and regained momentum by the end of the quarter. We carried that momentum into this quarter and for the first time in Company history we expect to be able to grow revenues from the fourth quarter to the normally seasonally weak first quarter. In the past, our business in the first quarter of the year usually slows down as many of our customers begin their budget cycles and reduce network deployments due to inclement weather. Despite this normal trend, we expect revenues to grow between 2% and 5% quarter-over-quarter to between 54 and 56 million for the first quarter of 2006.

Now let's look at where the fourth quarter 2005 revenue came from. [SLMS] revenue was 29.8 million. Legacy and service revenue was 19.0 million and optical transport revenue was 4.4 million. As mentioned, these results are not directly comparable to prior results because of our acquisition and divestiture activity. However our SMLS revenue now represents 56% of our business which is up from 35% in the same quarter of last year. At the same time, our legacy and service revenue has declined to 36% of our business from 48% in the same quarter of last year. This trend shows a dramatic shift in our reliance on legacy technologies as our rapidly growing SLMS business is over taking it. We expect this trend to continue in 2006 with strong double digit percentage growth in our SLMS business and a flat to slightly declining legacy business. For the second time, we didn't have any 10% customers during the quarter, reflecting an increasingly diversified customer base and a reduced dependence on certain key customers. Also our top five customers represented approximately 21% of our quarterly revenue, declining from 29% in the third quarter. The other 79% of quarterly revenue was attributable to over 600 customers. Most important, we added another 24 new customers during the quarter as market acceptance of our technology continues to accelerate. International revenue was approximately 38% of total revenue in the fourth quarter of 2005 as compared to 35% in the third quarter of 2005. International revenue as a percentage of total revenue has now increased in every quarter during 2005 led by successes in the Middle East, Eastern Europe, and Central and Latin America.

Now let's turn to gross margins. Gross margins were 40.1% for the fourth quarter of 2005 which was within the 39 to 41% range of guidance we previously provided as the product mix, pricing, and manufacturing costs were generally in line with our prior expectations. Going forward, we will continue to focus on manufacturing cost reduction to further improve margins. For now though, we estimate the margins for the first quarter of 2006 will continue to range between 39 and 41%. As for operating expenses, total operating expenses for the fourth quarter of 2005 were 127.8 million, which included an impairment charge of 102.1 million related to goodwill and other acquisition related intangible assets. A recent decline in our market capitalization, most notably since the announcement of the Paradyne acquisition, [lost] a recorded value of certain [aquisitional] related intangibles and goodwill to exceed the implied fair value of those assets. Accordingly, acquisition related intangible assets were written down by 46.9 million and goodwill was written down by 55.2 million. These non cash impairment charges were calculated in accordance with GAAP and are expected to be nonrecurring. Excluding these impairment charges, operating expenses for the fourth quarter were 25.7 million which were slightly better than the previously estimated range of 26 to 28 million. Continued cost containment efforts and accelerated cost reductions related to the acquisition resulted in lower than anticipated operating expenses. Going forward, we anticipate total operating expenses for the first quarter of 2006 to drop even further to between 22.4 and 24.4 million, largely attributable to lower amortization expense. Our expense guidance includes approximately 2.4 million of expenses for depreciation, amortization of intangibles, and stock based compensation. Finally, pro forma EBITDA for the fourth quarter was 1.1 million and still within the anticipated range of one and two million that we previously announced. We expect to report our third consecutive quarter of positive pro forma EBITDA during the first quarter of 2006. Our estimated pro forma EBITDA range for the first quarter is between one and three million. As we move through 2006, our quarterly pro forma EBITDA is expected to grow along with revenues.

Turning to the balance sheet, our cash and short-term investments at December 31, 2005 were 71.1 million, down from 80.9 million at September 30, 2005, largely because we chose to pay down 11.2 million in debt related to the refinancing of our campus loan. As I mentioned on our last conference call, we were looking to reduce the net interest costs of the Company. Excluding this payment, our cash balance has increased during the fourth quarter by 1.4 million. We expect our net cash balances to continue increasing during the first quarter of 2006 resulting from positive cash flow from operations. Our total debt obligation decreased the by 11.7 million from 56 million at September 30, 2005 to 44.3 million at December 31, 2005, largely as a result of the campus refinance. In addition to reducing the net interest costs of the Company, the campus refinancing reduced the interest rate on loan and extended its maturity to April, 2011. More details about the refinancing are contained in our Form 8-K filed with the SEC on December 27, 2005. Finally, the number of day sales outstanding on accounts receivable were 60 days for Q4, 2005 compared to 51 days for Q3, 2005. And the average basic and diluted EPS shares were 147.4 million for the fourth quarter.

Before I turn the call back to Morey, let me summarize the financial results for the fourth quarter and recap our guidance for next quarter. We are pleased with the 53.2 million of total quarterly revenue that was led by our SMLS and legacy products. After putting all the recent acquisition and divestiture activity behind us early in the quarter, we finished the quarter strong and expect to carry that strength into a normally seasonally weak first quarter. Our guidance for the first quarter of 2006 is for 2% to 5% sequential growth or between 54 and 56 million of total revenue for the quarter. Margins, operating expenses, and pro forma EBITDA were all within our prior guidance and led to strong financial performance for the fourth quarter. Also our second consecutive quarter of positive pro forma EBITDA gave us the confidence to reduce our long-term debt as we begin to generate positive cash flow from operations. For the first quarter of 2006, we expect gross margins to range between 39 and 41%, operating expenses to range between 22.4 and 24.4 million, including 2.4 million of expenses for depreciation, amortization of intangibles, and stock based compensation. Each result should drive between one and three million of pro forma EBITDA for the quarter as well as increasing net cash balance. We look forward to building on this momentum throughout 2006 which we expect to be an important turning point for the Company. With that overview, I'll turn the call back to Morey.

Thank you, Kirk. During 2005, we completed integration of Paradyne, introduced market leading products, strengthened our balance sheet, reduced our costs and improved our profitability. We're going into 2006 with a solid foundation, over 600 customers worldwide, balanced distribution channels, great product lines, and growing markets. We are well-positioned to capitalize on our investment. Thank you for joining us today. Now I would like to open the call to questions. Operator please begin the Q&A portion of the call.

Thank you very much, sir.

[OPERATOR INSTRUCTIONS] [ Mike Lee, SW Bach].

How are you, Kirk? Hello?

Yes. Hi, Mike.

Hello?

Yes, Mike?

Yes. This is Kirk? This is Mike Lee from SW Bach. How are you?

I'm fine, thank you.

You gave a range from one to three. Those are EBITDA numbers for the first Q of 2006?

That's correct.

Why such a big range? One to three, I mean, that's pretty big.

Well, if you go through the range of revenue margins and operating expenses, you'll see that the possibilities range from one to three million.

And can you back out numbers? Can you give me the first Q number for 2005? Do you have that on hand?

First quarter of 2005. Which -- what are you looking for?

Yes.

The first quarter of 2005 total revenues was 27 million.

Okay, yes, I just need a ball park. So you guys are looking for 2 to 3% Q to Q. That would put you around what? 54, 56, around there? That's where you guys are looking for?

Right, our guidance said 54 to 56 million in revenues which is 2% to 5% for sequential quarterly growth.

And you guys aren't willing to go out and give guidance for the second Q or for the whole fiscal year. Right? You guys usually just don't do that?

We typically only look one quarter out.

Okay. Alright. Thanks.

Thank you.

[OPERATOR INSTRUCTIONS] Hasan Imam, Thomas Weisel Partners

Morey and Kirk, a question either of you can answer this. I'm just wondering in terms of the guidance for next quarter given that you're going to buck seasonal trend, I mean, what gives you that -- that visibility? Is it strong backlog? And also is some of that deferred revenues from the optical -- delayed revenues from the optical segment? Thanks.

Yes. Hasan, what we are saying, we had -- we had a great January, and we are seeing a good forecast from ourselves and our customers and also looking at the budget and the spending. All of our customers, especially domestically in the SLMS area are forecasting a good growth for this quarter. So we feel very comfortable by looking at our forecast on what they are presenting to us. That -- that number that we forecasted is a fairly good number.

That's interesting. It seems like domestic demand is stronger, at least in the start of the year. Is that going to be the trend you think? And also related to that, Morey, could you give us an update on some of the large customer deployments that are going on -- that have been in the Middle East that you've also been trying to get traction in? Thanks.

Yes. What we can tell you is that domestically is going to be probably over 60% of our revenue is with -- in this quarter as well. So someplace between 60 and 65, and international is going to be the rest. International is coming -- coming on strong especially in the Middle East. We're -- we are going -- we are going to see a good revenue base from our existing customers in Middle East and potentially having some new customers in that area that we are not ready to discuss who they are yet.

Thank you.

Thanks.

[OPERATOR INSTRUCTIONS] Todd Kaufman, Raymond James.

Thank you. If you go back to your June quarter and look at your business and the Paradyne's business separately, the combined Company was doing around 58 million in revenue. If we assume the September quarter is somewhat of a stub period, you're coming in in the December quarter at 53. You're guiding slightly up, 54. My question is, with regard to the SLM products, SLMS products on both Companies, where is the weakness relative to the level of business that the two Companies apart, separately, back in the June period were do -- where doing?

Well, let me -- let me get a stab at it if I don't answer your question, I will ask Kirk to follow that up. If you recall in the end of September, we announced that we diversified -- divested a couple of our businesses. That was counting around four to $6 million a quarter. So if you add those things together, it doesn't really add up. So you have to -- you have to take that number off of -- off of the baseline. And also our SLMS number was -- grew during the year. The area that we were weak, as we mentioned, was our optical -- optical area. In the optical area, we are forecasting around $6.5 million and we came in short by about almost $2 million on that. Did I answer your question?

Yes. Very helpful. Just a further clarification. When I look at the port data, I think in the September quarter, the port data that you provided was 250,000 ports which I believe only reflected one month of Paradyne. And now, if I'm back in the full year number, I'm getting a December port number of 245,000 ports. My first question is, are my numbers right? And then why is that trend looking not terribly impressive?

Todd, the number that you just put on the table, I cannot reconcile with the number that we have set. We'll have to get back to you on that.

Thank you.

Sure.

[Ashima Anand, Canaccord Adams]

Hello, guys. I was wondering if you could break down the revenue for Zhone core and Paradyne for this quarter?

You know, the last quarter that we did the announcement of the Paradyne, and [cost] of the Paradyne, we did the break down of the two. We don't intend to offer that anymore.

Okay. Thank you very much.

Peter Schleider, Peninsula Capital Please proceed.

I wonder if you could give us a sense of who you're seeing most in the SMLS area in both domestically and then separately internationally in terms competitively? And also some insight in terms of what you think is driving demand across the Company. Is it IPTV or Triple Play or is there some other more legacy demand factors?

Competitions are fairly -- fairly simple. Domestically, we have couple of small companies. Occam, which is a small company in Santa -- Santa Barbara and Calix, another company in California that we compete with in the IFC market. In a different market that we are in, we don't have that high of a competition. Internationally, we do compete with Alcatel and [Wawa] in areas that we are penetrating. So those are our comp -- competitors. What we see driving our business really is mainly IPTV, voice-over IP and broadband, and normally you've got to have broadband to have voice-over IP and IPTV [so it's a can't lose combination, that's what's] driving our business.

And did you ship -- Morey, did you ship any BDSL 2 product in the quarter or is that just this quarter that [it's in]?

We are going to ship BDSL 2 this quarter.

And do you have orders for that currently?

Yes, we do. Yes, we do.

Great. And, Kirk, on the expense side, have we gotten all of the kind of legacy or expenses out of the Paradyne merger? Is that behind us or is there still more expenses that will wear off, I guess, to say it that way, over the course of the year? And kind of what are those on a quarterly basis?

We've implemented the cost-cutting synergies that we previously announced, and the Opex guidance for future quarters essentially reflect's what we anticipate going forward. I also should mention that the operating expenses does not consider the impact of the new financial accounting standard 123 R and the impact to stock based compensation.

Right. And then, in your commentary, you said something to the effect that, as we move through the year, quarterly EBITDA will grow with revenue. What -- what kind of growth would you expect to see in the EBITDA contribution as you go through the year maybe on a relevant to sales basis? For a dollar of sales, do you get $0.05, $0.10 or $0.20?

Well, let me just say that our -- our goal is to get to about 10% operating profit, and throughout the year we are going to -- we are going to have this goal in front of us to achieve it. Sometimes maybe later this quarter -- late this year or either next year.

You mean 10% EBITDA profit or 10% operating [margin]?

Operating. Operating margin. Operating profit.

Great. Alright. Thanks very much.

[OPERATOR INSTRUCTIONS] Anton Wahlman, Needham & Co.

Just a quick little petty question on the interest income, slash, expense. I mean, if I understand the notations to your income statement, it suggested that your interest expense was $227,000, quite a bit less than previous quarters. In terms of what we should expect there, obviously you caught some cash from Paradyne that reduced that, but is that the level that we should be looking for for net interest expense going forward?

That's about right, Anton. 200 to 300,000 net interest expense in Q1 is what we're forecasting. Also the fourth quarter included a loss on the sale of the Verilink shares, about 360,000, which we show in the pro forma reconciliation to EBITDA.

And that was part of the 500 and whatever -- $74,000?

That's right.

Okay, and just to be clear, your depreciation is otherwise included in the general core expenses?

Each of the line items, research and develop, sales and marketing, G&A yes.

Okay, so that's 554,000 is otherwise included in those and not -- not -- not in something else?

Yes. Going forward into Q1, we're looking at about 300,000 of depreciation, about 1.9 million of amortization of intangibles, and roughly 200,000 of stock based compensation. Although, as I mentioned, that stock based compensation is not considered the impact of implementing the new FAS 123 R.

And of course then that number would be much higher basically.

Yes.

So just to reconcile the expenses here, basically in this quarter, taking the core expenses, R&D, S&M, and G&A, about two twenty point about eight -- 20.85 million, and it sounds to me that that should be pretty much flat then or up just very, very slightly going into March, those three items. The core, of all core expenses?

That's correct. That's what we expect.

So we should show 21 million or so backing out and adding then subtracting the various non cash charges is roughly where a reasonable number is?

Which is the midpoint of the range of expense guidance that we gave.

Yes. It's -- what? 20.4 to 22.4 basically?

Well, we said 22.4 to 24.4, including non cash of 2.4 million. So that would essentially give you core operating expenses of 20 to 22 million.

So figure 21 million would be the core of the core then. Okay. All right.

To the midpoint of that range.

And share account really nothing going on here. Basic shares really no material movement at this point?

Shouldn't. The ending balance at December 31, 2005 was 147.8 million, an average for the quarter was 147.4. So as you can see, it picked up a little bit through exercises of options.

Okay, simple enough. Thank you.

[OPERATOR INSTRUCTIONS] At this time, we have no further questions. I'd like to turn the call back over to our speakers for any closing remarks they may have.

Thank you. Thank you for joining us today. And we'll talk to you in the next conference call. Thank you.

Thank you very much, sir, and thank you, ladies and gentlemen, for your participation in today's conference call. This concludes the presentation, and you may now disconnect. Have a good day.