DZS Inc (DZSI) 2006 Q1 法說會逐字稿

Good day and welcome to the first quarter 2006 Zhone Technologies Inc. conference call. I'm Cheryl and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question answer session towards 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 call over to your host for today, Mr. Kirk Misaka, Zhone's Chief Financial Officer.

Thank you, operator. Good afternoon everyone and thanks for joining us today. The purpose of this call is to discuss Zhone's first-quarter 2006 financial results and accomplishments as reported in our earnings release which was distributed over business wire at the close of the market today and has been posted on our Web site at www.Zhone.com.

I'm today with Mory Ejabat, Zhone's Chairman and Chief Executive Officer. Mory will begin by discussing the key highlights of the first quarter, after which I will discuss Zhone's financial results for the first quarter and provide guidance for the next quarter. We will conclude with questions and answers.

As you know, during course of this 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 in trends in our business, product lines for key markets; the finance objectives and strategies for future operations; several large orders in Q2 and the strength of our backlog and statements that express our expectations, estimates, beliefs, plans and forecast. We would like to caution you that actual results could differ materially from those contemplated by the forward-looking statements. We will 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, 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. We 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 appropriate to enhance an overall understanding of past financial performance and prospects for the future. These adjustments to our GAAP results are made with the intent of providing greater transparency to supplemental information used by management in its financial and operational decision making. These non-GAAP results are among the primary indicators that management uses as a basis for making operating decisions because they provide meaningful supplemental information regarding our operational performance and they facilitate management's internal comparisons to the Company's historical operating results and comparisons to competitors' operating results.

The presentation of this additional information is not meant to be considered in isolation or as a substitute for measures of financial performance prepared in accordance with GAAP. We've 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 Mory Ejabat, Zhone's Chairman and Chief Executive Officer.

Thank you, Kirk. Good afternoon and thank you for joining us today for our first quarter 2006 earnings call. All the revenues in the first quarter of 2006 were slightly below our original expectations. We saw strong growth in our primary product line of single line multiservice products. The SLMS product line grew sequentially by over 11% quarter-over-quarter, fueled by increased production of IPTV, VoIP and broadband services.

Our optical business group had growth as well due to the deployment of multiple (indiscernible) products. Sales of our legacy products were lower than expected because of the seasonal buying pattern amongst some of our legacy product customers.

Financially, we achieved profitability on a pro forma EBITDA basis for the first quarter of the year. We increased our cash balance and (indiscernible) reduced our long-term debt. We maintain our broad base of service provider customers with sales into each of our worldwide sales regions and with no singular (indiscernible) over 10% of our revenue. Kirk will provide more detail on our financials later.

Service providers are moving to the next generation of IP-based networks, installing BLCs to enhance their services by offering IPTV, VoIP and broadband. As a result, during the first quarter of 2006, (indiscernible) significant new businesses for its products, including shipments from 19 new customers.

Business from new first-time customers continued to be realized in all of Zhone's domestic and international sales regions. Outside of North America, we had new customer deployment in Bolivia, Germany, Indonesia, Sweden, Tunisia and United Kingdom. By focusing on growth vision internationally, we have realized 8% sequential growth in our international business in the first quarter 2006.

During the quarter, Zhone sipped 296,000 DSL ports, our strongest quarter for a DSL shipment to date and a good indicator of growing adoption of our SLMS products. This represents more than 20% increase in the DSL ports for the last quarter which had previously been our biggest quarter for DSL shipments.

Zhone continued the long-standing role as number one worldwide market share leader in the fast-growing broadband (indiscernible) carrier market during 2005 according to industry analysts and broadband trends. BLC has remained the fastest-growing segment of the multibillion dollar broadband market. Zhone was also among the top three leading supplier of DSL equipment in North America for 2005.

Turning to our optical products, this week, we announced that Zhone's GigaMux product has successfully completed interoperability testing with IBM's system and storage products and has been confirmed as IBM system and storage [proven]. This further enhances the value and credibility of Zhone's optical product solution to the end-user customer and demonstrated as Zhone and IBM are each focused on the customer satisfaction by promoting greater interoperability.

We will continue to enhance our product offering with more new products and additional functionality that better allow our customers to offer a higher bandwidth, IPTV, VoIP broadband and gigabit ethernet services.

Domestically, we are capturing market share with the success of new products like our MALC 100 and (indiscernible). MALC 100, which provides the capability our flagship BLC in a smaller size is being widely adopted at both existing and new carrier accounts and is creating an entry for us to sell more of our products in these accounts.

Motorola [Next Level's] recent decision to close its [Roanoke Park] facility [on limited] future development of their access products has expanded the opportunity for Zhone domestically. We have actively engaged with several Next Level customers who are evaluating Zhone to deliver their next generation of advanced IPTV solutions.

Internationally, we will continue our focus on growth markets, such as Middle East, South Asia, Eastern Europe and Caribbean while we focus on alternative carriers in Eastern Europe and South America. Competitively, we will focus on increasing our lead in new product, increase functionality and reduce costs. Now I would like to turn the call to Kirk to take you through our financial performance and guidance. Kirk?

Thanks, Mory. Today, Zhone announced financial results for the first quarter of 2006. In our press release, the traditional comparison of financial results for the first quarters of 2006 and 2005 is presented [alongside] a comparison to the fourth quarter of 2005. As you will recall, the fourth quarter of 2005 was the first full quarter reflecting the impact of our acquisition of Paradyne, which closed on September 1. Since the fourth-quarter results are more comparable to this quarter, we will spend most of our discussion today focusing on this sequential comparison. Although any comparison to the first quarter of 2005 has limited value, we will be glad to answer any specific questions about Q1 2005 results during the Q&A session.

With that background, let's begin with an overview of revenue. Our revenue for the first quarter was 52.7 million, which was slightly below our previously provided guidance range of 54 to 56 million. The shortfall was attributable to normal seasonal weakness in sales of our legacy products as our single line multiservice product line continued to show significant strength, growing from 29.8 million in the fourth quarter of 2005 to 33.2 million in the first quarter of 2006. This 11.4% sequential quarterly growth in our SLMS product revenue puts us on-track to exceed the 30 to 40% annual growth rate that we've experienced over the past two years.

The growth in SLMS revenue was supported by broad-based purchases of our MALC product, further validating last year's industry analyst report that MALC is the best broadband loop carrier in the market. MALC revenue was generated from approximately 55 SLMS customers during the quarter, both domestically and abroad, concluding a $1 million-plus going deployments by [Etiselot] in the United Arab Emirates, Global Village Telecom in Brazil and [Ballard] Communication domestically. We also added 16 new as SLMS customers and 19 total new customers this quarter as more and more carriers are recognizing the benefits of our market-leading technology solution.

By contrast, the legacy products and service revenues experienced normal seasonal weakness during the quarter by declining from 19 million in the fourth quarter of 2005 to 14.7 million in this quarter. Meanwhile, optical transport revenue rebounded to 4.9 million this quarter from 4.4 million in the previous quarter.

Once again, we didn't have any 10% customers during the quarter, reflecting an increasingly diversified customer base and a reduced dependence on certain key customers. Our top five customers represented approximately 26% of our quarterly revenue, increasing from 22% in the fourth quarter. The other 74% of quarterly revenue was attributable to over 620 active customers. As previously mentioned, we added another 19 new customers during the quarter as the market continues to embrace our next generation access solutions.

International revenue was approximately 42% of total revenue in the first quarter of 2006 as compared to 38% in the fourth quarter of 2005. International revenue as a percentage of total revenue has now increased in every quarter for the last five quarters, led by successes in the Middle East, Eastern Europe (indiscernible) [rural] and Latin America. Our success abroad is further validation of diversity of our access technology solutions.

For the first quarter, our SLMS revenue represented 63% of our business, which is up from 56% in the fourth quarter of last year. At the same time, our legacy and service revenue declined to 28% of our business from 36% in the fourth quarter of last year. This trend shows a dramatic shift in our reliance on legacy technologies as our rapidly growing SLMS business continues to overtake it. We expect this trend to continue throughout 2006 with double-digit percentage growth in our SLMS business and a flat to slightly declining legacy business. Overall, we expect revenues to grow between 4 and 8% quarter-over-quarter to between 55 and 57 million for the second quarter of 2006.

Now let's turn to gross margins. Gross margins were 37.7% for the first quarter of 2006, which was slightly below the 39 to 41% range of guidance we previously provided. Margins declined largely as a result of higher prices on certain parts shortages that we experienced during the quarter and additional temporary labor required to meet the spike demands of unusually back-ended quarterly shipments. Going forward, we do not expect these types of shortages and demand flows to continue, and therefore expect margins to rebound next quarter to between 39 and 40%.

As for operating expenses, total operating expenses for the first quarter of 2006 were 23.6 million, which was within our forecasted of range of between 22.4 and 24.4 million. Operating expenses included depreciation of approximately 400,000, amortization of 1.9 million and stock-based compensation of 1.2 million. Overall, OpEx decreased by 2.1 billion, or about 8%, as compared to operating expenses for the fourth quarter which were 25.7 million excluding 102.1 million of impairment charges taken in the fourth quarter. Continued cost containment efforts and accelerated cost reductions related to the Paradyne acquisition resulted in lower operating expenses.

Going forward, we expect total operating expenses for the second quarter of 2006 to continue to range between 22.5 and 24.5 million. Our expense guidance includes approximately 2.5 million of expenses for depreciation, amortization of intangibles and stock-based compensation.

Finally, pro forma EBITDA for the first quarter was slightly positive at 158,000, but below the anticipated range of between 1 and 2 million due to the aforementioned revenue and margin shortfalls. Despite this temporary setback, we expect to report our fifth consecutive quarter of positive pro forma EBITDA during the second quarter of 2006. Our estimated pro forma EBITDA range for the second quarter is between 2 and 4 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 March 31, 2006 were 71.5 million, up from 71.1 million at December 31, 2005. Our total debt obligations decreased by approximately 700,000 from 44.3 million at December 31, 2005, to 43.6 million at March 31, 2006 as a result of additional principal payments during the quarter.

On a combined basis, our net cash balance, or cash net of debt obligations, increased by a total of approximately 1 million during the quarter. So for the second quarter in a row, we generated positive net cash and expect our net cash balances to continue increasing during the second quarter of 2006.

As for other balance sheet changes, accounts receivable levels temporarily increased as a result of the back-ended sales activity which resulted in the number of days sales outstanding on accounts receivable to increase to 64 days for Q1 2006 as compared to 60 days for Q4 2005. Similarly, inventory levels increased during the quarter as we began purchasing material for several large orders that were requested by customers in early Q2. This increase in inventory and the corresponding increase in accounts payable are expected to largely reverse next quarter. Finally, the average basic and diluted EPS shares were 148.1 million for the first quarter.

Before I turn the call back to Mory, let me summarize the financial results for the fourth quarter and recap our guidance for next quarter. SLMS revenue continued to grow at more than a 30% annual growth rate as broad-based deployment of our market-leading BLC products continued. Normal seasonal fluctuations affected revenue from our legacy products while optical transport revenue rebounded to previous levels. We entered the second quarter with a strong backlog and expect 4 to 8% overall sequential quarterly revenue growth to between 55 and 57 million in total revenue. For the second quarter of 2006, we expect gross margins to range between 39 and 40% and operating expenses to range between 22.5 and 24.5 million, including 2.5 million of expenses for depreciation, amortization of intangibles and stock-based compensation. These results should drive between 2 and 4 million of pro forma EBITDA for the quarter as well as further increasing net cash balances. We look forward to building on this momentum throughout 2006 as we turn the corner on profitability.

With that overview, I will turn the call back Mory.

Thank you, Kirk. As I have mentioned before, we believe our ability to continually innovate will be a significant driver for our future success. Our next-generation SLMS architecture is the cornerstone of our product innovation and we intend to continue to develop advanced technologies that provide our customers with seamless migration from legacy circuit-based technology to converged packet-based IP networks, while simultaneously reduce operating costs. Our success is validated not only by customer wins and increased market share, but also by the analyst community.

As we have mentioned before, (indiscernible) which tracks the communication industry awarded our MALC product the highest ranking of any product in the class, edging out offerings from several other competing vendors. These results demonstrate that our substantial investment over the past several years are now paying significant dividends. Since Zhone's inception, we have invested heavily in R&D and have acquired complementary companies and technologies to augment our engineering resources in order to respond to our customers' diversity. During 2006, Zhone is a much larger company with a much broader portfolio of carrier-class product products and (indiscernible) solution to serve needs of our customers. We are confident that we have the right strategy, the right solution and the right leadership to take advantage of tremendous opportunities that lie ahead. We are appreciative of continued support in that effort. Thanks for turning us today and I would like to open the call to questions.

(Operator Instructions). Hasan Iman, Thomas Partners.

Thank you. First question has to do with the legacy product. The trend that legacy was in [secular] decline was always expected, but this quarter it seems particularly steep. So just wondering, is this some customer-specific issue, or an accelerated shift to the next gen? If you could add some color on that?

Yes, there's a couple of those issues. One is that one of our customers went from legacy and move to our MALC product line, replacing our legacy channel banks functionality and using our MALC product for their services. That was one due to that change. But the other thing was obviously Q1 has been for awhile a [rich] quarter for our legacy business. We don't see the legacy business tailing off as much as it did between Q4 and Q1 and we believe we're going to see a stable legacy business in the remainder of the year.

The second question is, can you give more of an update on Paradyne, particularly where you stand with respect to divesting in some of the products, closing down facilities, reducing headcount, et cetera. And related to that, what is the current thinking on time to profitability?

Well, Hasan, as we said in the last earnings call, we did go through all of the manpower reduction, all the facilities closure and all of the adjustments that we had to by the end of last quarter in Q4. We don't anticipate any other reduction in manpower or facility closure. At this point, we are in the optimal operating position. And on an EBITDA basis profitability, we did have profitability this quarter, and [our facilities] (indiscernible) last quarter. So the point is, when we're going to get to GAAP profitability, and our goal is to get there within the next within the second half of this quarter -- I mean this year.

So there are no additional, because at one point you talked about over time finding additional synergies with the Paradyne acquisition and maybe taking some additional steps. In your view, it's all done at this point?

It's all done and we are -- as far as we are concerned, in a very clean operating budget at this point.

One last question. We're seeing a broad based uptick in optical demand. So I was wondering, can you talk about what you are experiencing from your end, both from the Sorrento business as well as some of the IOC builds I think you have been part of?

Yes. We saw the same things as we mentioned, our optical business rebounded during the quarter and we anticipate we see the rebound continues in the optical product. And the same trend is true among all the optical product providers.

Great, thank you.

Peter Schleider, Peninsula Capital.

I'm curious what happened in the sales organization. Did you -- where you ended in terms of number of sales reps out versus the previous quarter.

Our number of sales reps did not decline or increase in respect to the last quarter. We might have one or two people that have been changed, but overall our [schedule] (indiscernible) stayed flat.

What is the aggregate number (MULTIPLE SPEAKERS) sales reps?

The number of sales people we have altogether, about 85 people.

Okay. And is there any area within the legacy products that was particularly weaker than the others?

No, it was all the same, I should say, in the legacy area.

Kirk, you mentioned that you were building inventories for some large orders this quarter. Can you kind of give us a little insight on what those orders are or where they are? What product segments?

There were two large orders placed for delivery in April, and we began purchasing materials towards the end of the quarter, therefore the inventory began to rise as a result of that.

And is that in the legacy products, or in the SLMS or optical?

Those are SLMS orders.

Alright, thanks.

Anton Wahlman, Think Equity.

Two quick things. I understand from your comment on the further acquisition and the further sort of merger synergies with Paradyne, that should we draw the conclusion that you're basically now going to proceed along the lines of utilizing their manufacturing capability and just putting more and more and more product in that in-house? Is that the way that your analysis over the winter came at the end?

No, Anton. We are doing two things in respect to manufacturing. One, we are still continuing outsourcing of our product. We are doing it with a company called ACT and another company called PSR. We will continue our outsourcing in this area. We are shifting some of our short run and also more complex product into Paradyne facility or in [Largo] facility. As you recall, we downsized that to be an operation that would be only focused on that type of manufacturing. Our strategy remains to be outsourcing our product.

Okay, but you are still maintaining the old Paradyne product, plus some of your other lower volume products in there, and then you continue to outsource other (MULTIPLE SPEAKERS)?

Yes, and mainly for new products. When we do a new product (indiscernible) and stuff like that, that gives us the capability to produce faster prototype and get to the market faster.

That makes sense. On your comment on Motorola/NextLevel, I am kind of curious, the fact that [their] (indiscernible) Park original Next Level IPO facility there was shut down, I mean in terms of that, I cannot imagine that being so black and white in the sense that they probably -- aren't they doing anything in this space after that? And, haven't they already some time earlier, many months and quarters before then, started turning down those activities, or was it really -- has it really been like a black and white in the market space?

Anton, when they shut down that organization, that gave an indication that that product, that existing product that the customers have, is not going to be developed or added functionality. I don't know of Motorola's intent, if they're going to come out with a new product platform or not. But the existing product that those customers have, they're an ATM-based product -- all those customers are asking for IP-based product, and our product fits right into their network. So even though if Motorola comes up with a new next generation IP-based product, and still, there's room to go for the IP product and the customers are going to measure one against the other. And our belief is our product is much advanced and much more proven than any product there is, and we have a good chance of taking some of those customers.

Absolutely. A final question on kind of philosophically in terms of the product direction, the kind of products that you make many of them, you already sell to a number of the cable operators, like Cox and Cablevision and so forth. Do you see that there are further possibilities to make sure that your product portfolio in the future is such that you will be able to go after both telcos, local carriers as well as cable TV operators?

Definitely. Our product, it is in that category and we are already in trial with our actually SLMS products with one of the cable companies for providing those.

Just to understand, in terms of how SLMS in this contest fits in with a cable operator, could you elaborate? What kind of application would that be?

It would be sitting behind the CMTS and providing packetized voice to [GR303] switch.

Thank you very much.

[Chet Gloacky], a private investor.

Are you folks still looking at potential acquisition?

No, not at this point. There is nothing in our plans.

And do you know if anybody is looking at Zhone as a possible acquisition?

I have no idea.

Thank you.

You're welcome.

There are no further questions, sir.

Okay. Thanks again for joining us today. We appreciate your support and are looking forward to speaking with you on our next conference call. Operator?

Ladies and gentlemen, this concludes today's conference. Thank you for your participation.