DZS Inc (DZSI) 2007 Q1 法說會逐字稿

Welcome to the first quarter 2007 Zhone Technologies conference call. [OPERATOR INSTRUCTIONS] I would now like to introduce Susie Choy, Director of Investor Relations. Please proceed.

Hello and welcome to the first quarter 2007 Zhone Technologies Incorporated conference call. I am Susie Choy, Zhone's Director of Investor Relations. The purpose of this call is to discuss Zhone's 1st quarter 2007 financial results as reported in our earnings release which was distributed over Business Wire at the close of market today and has been posted at our web site at www.Zhone.com. I'm here today with Mory Ejabat, Zhone's Chairman and Chief Executive Officer, as well as Kirk Misaka, Zhone's Chief Financial Officer. Mory will begin by discussing the results of the first quarter and providing some insights for the future for the Company.

Following Mory's comments, Kirk will discuss Zhone's financial results for the first quarter and provide guidance for the next quarter. After our prepared remarks we will conclude with questions and answers. As a reminder this conference is being recorded for replay purposes and will be available for approximately one week. The dial-in instructions for the replay are available on our press release issued today. An audio web cast replay also will be available online at www.Zhone.com following the call.

As you know, during the course of the discussion today we will make forward-looking statements including those relating to projections of profitability, earnings, revenue, margins, operating expenses or other financial items, the anticipated growth and trends in our business, product lines or key markets, the capital spending environment and the migration of customers to newer technologies,Zhone's market position and focus and statements that express our plans and objectives and strategies for future operations including R&D. We would 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 our annual report on Form 10-K for the year ended December 31st 2006. We would like to caution you not to place undue reliance of any forward-looking statements which speak only as of the date on which they are made and we undertake no obligation to update any forward-looking statements.

During the course of this call, we will also make reference to pro forma EBITDA, a 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 have provided GAAP reconciliation information for pro forma EBITDA 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 you to Mory Ejabat, Zhone's Chairman and Chief Executive Officer. Mory?

Thank you, Susie. Good afternoon and thank you for joining us today for our first quarter 2007 earnings call. We are pleased with the results from our first quarter of 2007. Overall revenues came in at $43.1 million which was above our anticipated range of $40 million to $42 million. The stronger than expected revenue numbers were driven by our SLMS revenue which grew by over 15% over the prior quarter. We added 10 new customers and no customers accounted for over 10% of total revenues. Both margins and operating expenses remain flat compared to the fourth quarter. Our pro forma EBITDA loss of $2.9 million was in the middle of our anticipated range of $2 million to $4 million. Kirk will provide more detail on our financial results later. So let me spend a few minutes discussing the business and our progress during the quarter in executing our strategy.

During the previous earnings call we mentioned that the second half of 2006 was affected by several of our large international customers who delayed orders as they evaluated alternative natural architectures and technology paths. In addition, consolidation among our service provider customers resulted in a pause in CapEx spending. During the first quarter of 2007 we were very encouraged by the accelerating pace of deployment of our next generation technologies in markets across the globe. We anticipate that our customers will increase their spending as they search for ways to increase bandwidth. These customers will also convert their TDM and ATM networks to capitalize on the benefit of the more flexible IP-based architecture. They will also be expanding their networks to provide multi service offering of VOIP high speed internet access and IPTV.

Although much of our growth will come from existing customers, we also expect to grow as other telephone carriers and cable recognize the benefit of our solutions. The introduction of the new category products and enhancement to our existing products will contribute to our growth during 2007. By focusing on our SLMS growth we continue to manage cost and control our expenses with the primary near term goal of achieving quarterly profitability by the end of 2007.

From a customer prospective, we will continue our focus on international emerging markets with an emphasis on [inaudible] and nationwide alternative carriers. Domestically, we will continue to expand our customer base of carriers. From the product perspective, we have concentrated our focus on research and development. This year we will introduce several next generation technologies designed to significantly expand capacity in the access network. We will also launch new releases to keep existing products to increase functionality and to deliver enhanced multiplace services, or fiber, or copper.

In summary, we are focused on delivering best in class access product and best in class customer service. Our products will help providers maximize the value of existing networks while ensuring their agility to deliver IP services on demand. Our single line multi service architecture continues to be derived [inaudible] as carriers migrate from a TDM network to an IP packet based network. As copper lines are replaced by fiber lines and as single service networks are beginning to be replaced by bundled multiple services, We are well positioned to take advantage of the market growth inVOIP and IPTV and broadband. Now, I would like to turn the call to Kirk to take you through our financial performance and guidance.

Thanks, Mory. In today's Zhone announcement of results for the first quarter of 2007, and in our press release, the traditional comparison of financial results for the first quarters of 2007 and 2006 is presented alongside a comparison to the fourth quarter of 2006. As we have done on previous earning calls we will spend most of our discussion today focusing on the sequential comparison. Let's start with an overview of revenue. Our revenue for the first quarter of 2007 was 43.1 million which was above our guidance range of 40 million to 42 million and down 3% sequentially. Our single line multi service product line increased over 15% from 26.2 million in the fourth quarter of 2006 to 30.2 million in the first quarter of 2007. Also as Mory mentioned, we added 10 new customers this quarter validating the continued interest in our product.

By contrast legacy service and other revenue declined by 29% decreasing from 18.1 million in the fourth quarter of 2006, to 12.9 million in this quarter. This expected decline was driven by the impact from the sale of the iMARC product line at the end of 2006 as well as normal seasonality attributable to the legacy business. As we said in the past we expect our overall legacy business to decline by 5% to 10% year-over-year. That overall decline as evidenced by the current quarter will likely be somewhat uneven going forward as that part of our business becomes smaller and therefore more concentrated.

Overall we do not have any customers comprising greater than 10% of our total revenues during the quarter. Our top five customers represented approximately 25% of our quarterly revenue, which is consistent with the fourth quarter of 2006. As previously mentioned, we continued to enjoy a diversified customer base with approximately 600 active customers. International revenue was approximately 47% of total revenue in the first quarter of 2007 as compared to 37% of total revenue for the fourth quarter of 2006. This increase was primarily driven by our focus on emerging global markets and our largest international customers increasing their spending during the quarter. For the first quarter of 2007 our SLMS revenue represented 70% of our business which was up 59% in the fourth quarter of 2006.

At the same time, our legacy and service revenue decreased to 30% of our business from 41% in the prior quarter. Going forward, we expect our SLMS business to continue this trend as legacy customers migrate to next generation solutions. For the second quarter of 2007, we expect our total revenue to increase to between 44 million and 45 million fueled by expected growth in emerging international markets.

Now, let's turn to gross margins. Gross margins were 36% for the first quarter of 2007 which was within the 35% to 37% guidance we previously provided and consistent with the 36% in the prior quarter. We expect our margins for the second quarter of 2007 to remain between 35% and 37%. As for operating expenses, total operating expenses for the first quarter of 2007 were 20.1 million, which was at the low end of our 20 million to 21 million guidance. For the fourth quarter of 2006, total operating expenses were 20.2 million. Operating expenses include depreciation of approximately 500,000 and stock-based compensation of 900,000. Going forward, we anticipate total operating expenses for the second quarter of 2007 to remain at this reduced level between 20 million and 21 million, including approximately 1.1 million of expenses for depreciation and stock-based compensation.

Finally, pro forma EBITDA for the first quarter was a loss of 2.9 million and in the middle of the anticipated range of loss between 2 million and 4 million. Our estimated pro forma EBITDA for the second quarter of 2007 is a loss of between 2 million and 3 million. Nonetheless, as stated previously, our goal is to achieve positive pro forma EBITDA on a quarterly basis by the end of 2007. Turning to the balance sheet, our cash and short term investments at March 31, 2007, were 60.3 million, which is down from 64.3 million at December 31st, 2006. Cash balances declined during the quarter primarily as a result of the pro forma EBITDA loss of 2.9 million.

Our total debt obligations remained flat at 41.5 million at March 31st, 2007, and December 31st, 2006. On a combined basis our net cash balance, or cash net of debt obligations, decreased by approximately 4 million during the quarter. As mentioned, we expect to grow revenues, improve margins, and maintain our operating expenses throughout 2007. The combined effect of those efforts will minimize net cash burn. As for other balance sheet changes inventory levels decreased but accounts receivables levels increased as a result of increased international sales. The number of days sales outstanding on accounts receivable increased to 72 days from Q1 2007 as compared to 65 days for Q4 2006.

Finally, the average basic and diluted EPS shares were 149.3 million, for the first quarter, changing only slightly from the 149.1 million in the fourth quarter, due to stock option exercises by executives and employees. Before I turn the call back to Mory let me summarize the financial results for the first quarter and recap our guidance for next quarter. Revenue for the first quarter of 2007 was 43.1 million, exceeding our previous guidance of 40 million to 42 million, driven by strong demand for our SLMS products which grew 15% sequentially. Gross margins remained flat at 36% as expected and operating expenses were 20.1 million at the low end of our anticipated range of 20 million to 21 million. Our pro forma EBITDA loss of 2.9 million was in the middle of our anticipated range of a $2 million to $4 million EBITDA loss.

Our guidance for the second quarter of 2007 anticipates revenue growth to between 44 million and 45 million as a result of increased deployment of our next generation technology, especially in our emerging international markets. Gross margins should remain between 35% and 37% and operating expenses should remain between 20 million and 21 million including 1.1 million of expenses for depreciation and stock-based compensation. Overall we anticipate a slight reduction in our pro forma EBITDA loss for the second quarter of 2007 expecting an EBITDA loss of between 2 million and 3 million. The pro forma EBITDA losses and negative cash flow should be minimized throughout the year as a result of growing revenues, improving gross margins and consistent operating expenses. These efforts should produce positive EBITDA and cash flow on a quarterly basis by the end of 2007. With that overview, I will turn the call back to Mory.

Thank you, Kirk. We're pleased by the result of our first quarter and excited about the prospect for 2007. The continued customer wins and level of customer interested in our next generation products is encouraging. As I mentioned at the beginning of the call, our primary goal is achieve quarterly pro forma EBITDA profitability by the end of 2007. As always we appreciate your continued support. Thank you for joining us today and I would like to open up the call to the questions. Operator, please begin the Q & A portion of the call.

[OPERATOR INSTRUCTIONS] We'll take our first question from Hasan Imam of Thomas Weisel Partners.

Yes, thank you. I had a couple of questions for Mory and then one for Kirk. In terms of the 10 customers that you talked about, Mory, can you characterize the size and scope of these deployments? Are these small carriers with quarterly deployment or multi quarter deployment.

The majority were small carriers with small deployment with exception of one larger customer which was international.

Okay. And that's essentially new customer win that's multi-quarter deployment?

Correct.

Okay. Mory can you comment on what is going on with the product line with Sorrento? You talked previously about pushing some of those revenues into legacy, but didn't give any kind of clear indication what the overall Sorrento revenues would do in terms of growth or decline.

As I mentioned on the last conference call, we are moving the Sorrento traditional product into the legacy business. We will be announcing some new product that is based on SLMS architecture using some of the Sorrento technology that will be deployed within this year. So we will be announcing that. And that revenue is going to go into SLMS.

Okay. So essentially you're taking some technology and that could drive growth in your existing product lines, but the existing--I mean the non-Sorrento product lines, but your existing Sorrento revenues are on decline. Is that the right way to think about?

Yes, we assume that some of the traditional Sorrento legacy business is going to be declining or has been flat as we saw last year. But that new product is going to be additive to what SLMS has been doing or will be doing. We are in trial with one of the products that we are going to announce; it is the combination of Sorrento technology based on SLMS architecture within the next few weeks.

I got you. And then, Kirk, in terms of the gross margin variability, could you talk a little bit about what's driving that going forward?

Gross margins right now have been fairly steady at 36%. We did mention that we hoped to improve gross margins moving forward. Most of that improvement in gross margins would come through additional volume and fixed manufacturing costs.

So does a product mix have any meaningful impact on the margins since your legacy is declining and the SLMS is growing?

Well as you can see from the activity in the fourth quarter and the first quarter, margins are not significantly impacted by the variations in revenues in our respective product lines.

I got you and one last questions. One of your peer companies had revenue recognition problems related to, as I understand it, the SOP92. Can you comment on Zhone's compliance with that?

Zhone has a small amount of its own management system that is recognized according to provisions of SOP97-2. It is a rather small portion of our total revenues and we're in compliance with those provisions.

Got it. Thank you.

And we'll take our next question from Greg Mesniaeff of Needham & Company.

Yes. Thank you. I was wondering if if you could give us a little bit more color on the breakout of revenues by worldwide regions.

Yes, are you talking about EMEA versus Asia?

Yes, exactly.

We don't have that breakout. Let's see if we do have that. Hang on.

We typically have not provided details by region but I can say that the EMEA region, Europe, Middle East and Africa, makes up the most significant portion of our international revenues. The Central and Latin America being next and Asia bringing up the rear.

Okay. That's kind of what I was looking for. And as far as the issue of gross margins, any chance of improvement from any silicon or component redesign in any products that you have on the drawing boards?

Yes, Greg, we are working with some of our suppliers and chip manufacturers to reduce costs and we are going to see some improvement in that aspect. So hopefully we're going to see our margins increasing. As you see, our SLMS business grew 15% quarter-over-quarter. Our legacy business was [inaudible] so we held on pretty good with our gross margin. So our hope is to see some improvement in our gross margin. We are saying between 35 to 37, but our goal is to be on the higher end of that.

I understand, but is it fair to say that we could see the benefits of that silicon or other component redesign earlier this year, or at the very end of it?

I would suggest it would be at the end, probably later on this year we're going to see some improvement on the silicon chipset cost.

Okay. Thank you.

Sure.

[OPERATOR INSTRUCTIONS] We'll take our next question from Ben Shamsian of Canaccord Adams.

Hi. How are you guys?

Hi, Ben.

Do you guys see any of this Trans 5000 moving into your space sort of via the North America mostly I guess?

Well,a couple of things on the [Attran] 5000 we haven't seen it in any of our customers, but we saw that was in deployed by at Frontier. That was in one of other customers, one of our other competitors. I don't think we have seen it in our customers in here. We don't see them in South America or Europe or Middle East at all. So I think that's a product that is going to go to their existing customers.

Okay. Could you just add some color on your North American business, sort of either with competition or what you're seeing going forward?

Well, competition-wise in North America We don't know how strong Attran is going to come on. But the other competitors that they are in and they are out sometimes. We don't have a true understanding of the revenues of competitors in this field and their technologies behind their technology. They are just one of them is ADSL plus parts suppliers. They don't have other features such as AFM and others or GPON. We don't see them as a competing product, but then we don't know how their financials is.

Great. And just one last question for Kirk. Could you just talk about OpPex and, you know, what level can we see going forward, you know, going out toward the end of the year? You know, we saw the ramp down in Q4 and you guys have maintained that level. How should we think about that going forward?

As we said in the past, Ben, operating expenses are highly leverageable. We continue to grow into the high 40's $50 million range with increases in operating expenses. Our guidance reflects flat operating expenses going into the next quarter despite anticipated revenue growth and we expect that that would continue through the remainder of the year. Mory and I look at opportunities to reduce costs where we can, and we'll continue to look at that, as well.

Okay. Thank you. Congratulations.

There is no questions at this time. We'll turn the call back over to management for closing remarks.

Thank you again for joining us today. We appreciate your support and look forward to speaking with you on our next conference call.

Ladies and gentlemen, thank you for joining us on the call. You may now disconnect.