DZS Inc (DZSI) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen. Thank you, very much, for your patience and welcome to the third quarter 2007 Zhone Technologies Inc. conference call. My name is Bill, and I will be your conference coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of the conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now like to introduce Susie Choy, Director of Investor Relations. Please proceed.

Thank you, operator. Hello and welcome to the third quarter 2007 Zhone Technologies Inc. conference call. I am Susie Choy, Zhone's Director of Investor Relations. The the purpose of this call is discuss Zhone's third 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 on our website at www.zhone.com. I am 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 third quarter and providing some insights into the future for the Company. Following Mory's comments, Kirk will discuss Zhone's financial results for the third 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 webcast replay will also 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, new product introductions and the migration of customers to newer technologies, Zhone's market position and focus and statements that express our plans, objectives and strategies for future operations including restructuring initiatives. 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 31, 2006, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2007, and June 30, 2007. 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're 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 for 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 website at www.zhone.com. With those comments in mind I would now like to introduce Mory Ejabat, Zhone's Chairman and Chief Executive Officer. Mory?

Thank you, Susie. Good afternoon and thank you for joining us today for our third quarter 2007 earnings call. Let me briefly discuss the financial result before giving you an update on the business. As expected, revenues declined due to the divesture of one of our legacy product lines and seasonally slow international market. Despite this decline, we are encouraged by the long-term prospects of our business as evidenced by significant new customer wins continually towards next generation technologies. Revenue for the third quarter of $41.6 million was slightly below our guidance of $42 million to $44 million. However, with new customer wins and introduction of new products, we will drive a strong sequential growth in the fourth quarter of between $44 million and $45 million. The lower revenue level impacted our gross margins while operating expenses improved as we continued to restructure our manufacturing and other operation. This mixed result led to a pro forma EBITDA loss of $4.9 million for the third quarter. However, as Kirk will explain in greater detail later, we are planning to achieve break even or slightly positive pro forma EBITDA in the fourth quarter.

Now let's look to the future. Exciting things are happening in our business that give me confidence that we are on the track for full financial performance for the coming year. I would like to start by talking about Zhone's overall position in the access technology market. Our primary strategy focus has been on the emerging multi-service access product segment. We knew that the competitive forces among service providers would combine with their customer's appetite for new services to create tremendous pressure on their access network's overtime. We knew operators would feel this pressure in two directions. One, to offer an ever-wider and more complex layer of services, from voice to video to an increasing number of sophisticated forms of data connectivity and the other to simultaneously drive down their capital and operating costs. We also knew that an aggressive agenda of product development over a number of years would create a product portfolio uniquely equipped to meet the needs of service providers as well those pressures in their access networks.

We have seen a number of significant events in the third quarter of this year that have validated both our vision and its fulfillment through milestone achievements. First off, one of the industry analysts (inaudible) tracking the access market in detail, Infonetics Research reported early in the quarter that our Q2 portion in the multi-service access platform or MSAP category puts at at number one market share positions throughout Americas by as much as a two to one margin over the best of the competition. This surely is an important acknowledgement of our product (inaudible) execution as we continue to grow our SLMS based revenues. As Jeff Heynen, Directing Analyst at Infonetics put it, the MSAP category is widely acknowledged as the platform of choice over single purpose systems. Further, Teresa Mastrangelo, Principal Analyst for Broadbandtrends.com observed: Zhone's portfolio is one of the broadest and deepest in the industry. Our MSAP surely (inaudible) many new job, new customer wins and conversions of the first generation access networks for our current customer base. The customer success stories we have shared publicly over the past three months include Vodafone Iceland, Enter Net in Italy, On Telecoms in Greece, Taylor Telephone and Cornerstone Communication in the U.S. all testify to the inherent value of multi-service platform as these carriers deploy our [MALC] line for a variety of applications. The most exciting validation of our effort is the recent announcement in Saudi telecom of the world's largest deployment. Over 60,000 lines throughout Saudi Arabia of the internet in the first mile or EFM technology integrated on our [MALC] line. Our EFM technology taps the current (inaudible) industrial standard to deliver from 5 to 45 megabits per second and internal services already have a local copper infrastructure. This (inaudible) telecom deployment is indicative of the growing carrier interest in MSAP enable service expansions we're seeing worldwide, and indicative of the kind of a result our focus on tier 1 PTTs outside the U.S. is delivering.

We mentioned at the end of the last quarter we plan to introduce four new products throughout the balance of the year. In accordance with these plans, activity in the third quarter includes one public launch of a multi-product extension to our EFM line along with finishing touches, development and customer tried work on a number of products we will be rolling out early next year. Our EFM portfolio extensions include new line part for our MALC and the DSLAM (inaudible) platforms. To help our existing as well as new customers leverage their installed assets for new service creation and revenue generation along with premium models of customer premise equipment or CPE, these extensions bring critical business service definition functionality such as [tracking safety] forward to EFM from our previous standard internet over copper solutions, as well as making a wide variety of CPE available to meet diverse operator needs.

In summary, Q3 showed us clearly that carrier preferences of access platforms are moving at increasing rate to the MSAP model. Further, their choice of Zhone products over those from larger competitor is validating our strategy of focusing on innovation in this MSAP category. We're looking forward to making in public over the next couple of months a number of additional customer success stories with similar strategy added. Over the next year we will continue to introduce new and innovative products as well as focusing on improving profit margins and EPS. Now I would like to turn the call to Kirk to take you through our financial performance items. Kirk?

Thanks, Mory. Today Zhone announced financial results for the third quarter of 2007. In our press release, through additional comparison of financial results for the third quarters of 2007 and 2006 is presented alongside a comparison to the second quarter of 2007. As we have done on previous earnings calls, we will spend our discussion today focusing on the sequential comparisons, since the year-over-year comparison distorted by our legacy product line divesture and operational restructuring.

With that in mind, let's begin by looking at the revenue trend. Our revenue for the third quarter of 2007 was $41.6 million which was slightly below our guidance range of $42 million to $44 million. As Mory mentioned, revenue decline is compared to the second quarter due to seasonally slow international market. However, with significant new customer wins and the introduction of new products, we expect strong sequential growth in the fourth quarter of approximately 6 to 8% or between $44 million and $45 million of revenue. International revenue dropped to approximately 44% of total revenue in the third quarter of 2007 as compared to 50% of total revenue for the second quarter of 2007. This decrease was primarily attributable to the seasonally slow international markets that we already talked about. The sequential decline in revenue attributable to our international business is also reflected in revenue from our single line multi-service product line which decreased from $31.7 million in Q2 2007 to $29.2 million in Q3 2007. Accordingly, SLMS revenue declined from representing 72% of our business in the second quarter to being 70% of our business in the third quarter. We expect the SLMS revenue trend to revert to strong growth in the fourth quarter based on the rebound of our international business and improved CapEx spending environment. Also, as Mory mentioned, we announced several new significant new customers this quarter, validating the continued interest in our next generation product, including Saudi Telecom, Vodafone Iceland, Enter Net in Italy, Om Telecom in Greece and Taylor Telephone and Cornerstone Communications in the U.S. By contrast, legacy service and other revenue was essentially flat at $12.4 million while we continue to expect moderate decline in the 5 to 10% on the year-over-year basis. As we mentioned in the past, that overall decline will likely be somewhat uneven going forward as that part of our business becomes smaller and therefore more concentrated. Overall, we continue to enjoy a diversified customer base with approximately 600 active customers. We didn't have any 10% customers during the quarter, and our top five customers represent approximately 27% of our quarterly revenue which is consistent with that of second quarter.

Now let's turn to gross margins. Gross margins were 30% for the third quarter of 2007, which was below the 33 to 35% guidance we previously provided and the 34% in the prior quarter. As Mory mentioned, the effect of fixed manufacturing costs on lower revenue levels affected our margins, but we have taken steps to make the necessary adjustments. As discussed during our last earnings conference call, we restructured and consolidated our manufacturing processes during the third quarter so that we can better leverage manufacturing costs. The expense that was associated with this restructuring also reduced margins during the third quarter. With the new manufacturing model which is aligned to our current sales volume levels, we expect our margins to improve for the fourth quarter of 2007 to be between 33 and 35%.

As for operating expenses, total operating expenses for the third quarter of 2007 was $13.9 million which included a gain on sale of a certain legacy technology patent of $5 million. Otherwise, pro forma operating expenses were $18.9 million which was slightly better than our $19 million to $20 million guidance and approximately $500,000 lower than the $19.4 million of operating expenses for the second quarter. Operating expenses included depreciation of approximately $500,000 and stock-based compensation of $600,000. Going forward, we anticipate total operating expenses for the fourth quarter of 2007 to continue at a reduced level between $17 million and $18 million, including approximately $1.1 million of expenses for depreciation and stock-based compensation. This reduced level of operating expenses is the result of the operational restructuring that we previously talked about and completed during the third quarter.

Finally, pro forma EBITDA for the third quarter was a loss of $4.9 million and higher than the anticipated range of a loss between $3 million and $4 million because of the lower revenue and gross margin previously mentioned. Despite the mixed results of the third quarter, we are optimistic that the fourth quarter will bring a return to revenue growth and improved margins. Coupled with disciplined expense management, we hope to achieve break even or slightly positive pro forma EBITDA in the fourth quarter, which was our goal at the beginning of the year.

As for the balance sheet, cash and short-term investments at September 30, 2007, were $50.4 million which is down from $57.2 million at June 30, 2007. Cash balances declined by $6.8 million during the quarter since we repaid approximately $7 million of our debt. The pro forma EBITDA loss of $4.9 million which otherwise reduced cash was offset by the proceeds from the past [sale] of $5 million. As a result of the debt repayment, our total debt obligation declined from $41.4 million at June 30, 2007, compared to $34.5 million at September 30, 2007. On a combined basis, our net cash balance or cash net of debt obligations was $15.9 million and remained approximately the same as in the prior quarter. With the anticipated break even fourth quarter, we anticipate keeping our net cash balance stable at this level for the remainder of the year.

As for other balance sheet changes, the inventory levels decreased slightly while accounts receivable levels grew slightly as compared to the prior quarter. Accordingly, the number of day sales out standing on accounts receivable increased to 77 days from Q3 2007 as compared to 71 days from Q2 2007, due to slightly higher receivables and lower revenue levels in the third quarter. Finally, the average basic and diluted EPS shares were $149.7 million for the third quarter, changing only slightly from the $149.5 million in the second quarter due to stock option exercises by management and employee.

Before I turn the call back to Mory, let me summarize the financial results for the third quarter and recap our guidance for next quarter. Revenue for the third quarter of 2007 was $41.6 million, slightly below our previous guidance of $42 million to $44 million. Revenue was sequentially lower because of our seasonally slow international markets. Gross margins were 30%, which was below our guidance of 33 to 35% due to lower volume and additional costs associated with restructuring our manufacturing operations. Operating expenses were $18.9 million, excluding the effects of a $5 million sale of legacy patents which was better than our anticipated range of $19 million to $20 million as we continue our cost containment efforts. These mixed results led to a pro forma EBITDA loss of $4.9 million which was higher than our anticipated range of a $3 million to $4 million pro forma EBITDA loss. With significant new customer wins and our restructured manufacturing and operational structure, we hope to deliver strong financial results for the fourth quarter. Our guidance for the the fourth quarter of 2007 anticipates 6 to 8% sequential revenue growth to be between $44 million and $45 million. Gross margins should rebound to be between 33 and 35% and operating expenses should drop to between $17 million and $18 million including $1.1 million of expenses for depreciation and stock-based compensation. Overall, we anticipate break even or slightly positive pro forma EBITDA for the fourth quarter of 2007, which was the primary financial goal we set at the beginning of the year. With that overview, I will turn the call back to Mory.

Thank you, Kirk. Although we would like to deliver better financial results in the short-term, or the long-term, we're excited about the prospect for the future of the company. This quarter we took advantage of the opportunity to streamline our business and maximize our operational efficiency as we prepare for a period of strong growth for the Company led by our carrier class SLMS products. We're encouraged by the continued customer wins and level of customer interest in our next generation products for both copper and fiber-based services, which have already attracted a strong interest, and as always we appreciate your continued support. 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. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Anton Wahlman of ThinkEquity. Please proceed.

Hey, Mory and Kirk, a couple of things here, just primarily the housekeeping side first. Kirk, you said you talked about the international percentage. I am just not sure I heard correctly. Did the international percentage decline from what to what in the quarter?

Hang on, Anton.

International was 44% in the third quarter, Anton, and 50% in the second quarter. Okay. Also you got that tax item, the $125,000. Should we assume that that's some sort of minimums or foreign tax payment going to be nominally steady in coming quarters, or is that -- is the two quarters in a row here you paid $125,000 each. What's likely to happen there when that item?

We expect it to be about the same going forward in the fourth quarter.

And same thing beyond the fourth quarter, like for the longer term as well or for the intermediate term anyway?

There is minimum amounts of taxes we're paying in certain jurisdictions.

Okay. And not sure, did you give the headcount as well?

We did not. I can tell you at the end of September 30 we had a total of 440 employees, of which 165 were in our manufacturing operations.

And how does that compare to three months earlier?

Overall down 12%. We had about 500 employees at June 30. Manufacturing was down 14% quarter over quarter.

Just slightly bigger decline in manufacturing than in the other part of the business?

That's right.

Okay. All right. I will leave it at that for now. Thank you.

Thank you very much, sir. (OPERATOR INSTRUCTIONS) Our next question comes from the line of [Alan Shipry] of New Generation.

Hi, Mory and Kirk, how are you guys doing?

Good, thank you.

Okay. I have a quick question. How is your GPON product doing now that you introduced it -- was it last quarter?

Yes. We introduced the GPON product last quarter. I couldn't hear your detailed question, Alan.

My specific question, Mory, had to do with -- how is it tracking with respect to expectations and how do you see it playing out in fourth quarter and then 2008?

Actually we see lots of attraction based on the RFP that we're seeing. We're seeing major deployment overseas with respect to the GPON as well as we are seeing in the carriers in the U.S., especially on the third and fourth tier carriers in the U.S., so we believe GPON will play a good part of our revenue growth in the next few quarters.

Okay. And are the margins better in that product set compared to the DSL?

The margins on the GPON is better than DSL, of course it is, yes.

And how does it compare with respect to the rest of the industry? Last time we spoke you had indicated it was a standard space product, right?

Alan, I couldn't hear your question. I am sorry.

Mory?

We get lots of static. I couldn't hear your question.

Okay. My question is yours was a standard space product, right, the GPON?

Correct.

Who else is competitive wise, what's happening in the market space from your perspective? Where does it stand?

I see. On the standard based GPON which is the product that we have in the deployment, we see Huawei and Alcatel playing in those areas, and we have seen them in some lab trials and lab tests. We haven't seen many deployment on them in these areas. By far I believe we are the largest deployment of standard base GPON at this point.

Okay. Thank you.

You're welcome.

(OPERATOR INSTRUCTIONS) We do have a follow-up from the line of Anton Wahlman of ThinkEquity. Please proceed.

Yes. Quick follow-up for you, Mory, on the issue of fixed mobile convergence, and what I am referring to specifically are operators that own GSM networks and that are looking to deploy dual mode devices GSM plus Wi-Fi. Have you seen any activity of any meaningful nature, increase of any kind in the last quarter or so with respect to operators coming in and more explicitly sighting deployment of such dual mode handsets as a driver for new service offerings, and have they asked you to optimize or otherwise design products that can operate in that type of an environment in an optimized fashion?

Yes. As you know, Anton, there is lots of dual mode handsets coming into the market that can take advantage of Wi-Fi versus GSM or 3G networks or 4G networks. What we are seeing is that wireless companies that are offering wireless phones are looking at augmenting their wireless towers with the Wi-Fi devices that can offer some of the traffic from the network. That is in the various stage -- earliest stage of study in that respect, and we have a couple of customers that asked us if there is something we can do in that respect, and we are looking at that.

Excellent. Thank you very much.

Thank you very much, sir. Ladies and gentlemen, that concludes our Q&A Session for today. I would like to turn the call back over to the speakers for any closing remarks they may have.

Thanks again for joining us today. We appreciate your continued support and look forward to speaking to on our 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 your presentation for today. You may now disconnect. Have a good day.