DZS Inc (DZSI) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 Zhone Technologies Incorporated conference call. I'm Akia, and I'll be your coordinator for today. At this time, all participants are on a listen-only mode. We will be facilitating a question and answer session toward 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.

(Inaudible - technical difficulties) Investor Relations. The purpose of this call is to discuss Zhone's fourth 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, Chief Executive Officer, as well as Kirk Misaka, Zhone's Chief Financial Officer. Mory will begin by discussing the results of the fourth quarter, the recent divestitures of nonstrategic legacy products and the future focus of the Company and Pure-Play access technologies. Following Mory's comments, Kirk will discuss Zhone's financial results for the fourth quarter, the financial impact of the divestitures, 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. Dial-in instructions for the replay are available on our press release issued today and 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. 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 10K for the year-ended December 31st, 2006, and our quarterly reports on Form 10Q for the quarters ended March 31, 2007, June 30 , 2007, and September 30, 2007. We would like to caution you not the to place undue reliance on 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 nonGAAP 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 nonGAAP 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 companies 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 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.

Thank you, Susie. Good afternoon, and thank you for joining us today for our fourth quarter 2007 earnings call. Let me briefly discuss the financial results before giving you an update on the business. Financial results for the fourth quarter were very strong and were highlighted by 12% revenue growth to $46.6 million, which exceeded our previous guidance of between $44 million and $45 million. The strongest growth came from our international markets, particularly the Middle East and Central and Latin America, but we maintain a leadership position among some of the largest incumbent carriers in the region. The increase in revenue level also help the us improve gross margins by 4.5 percentage points to 34.5%. In addition to high volume, margins improved as a result of the consolidation of our manufacturing operations into single facility that the we discussed last quarter.

Most important, the substantial higher revenue and gross margins, we were able to meet our primary financial goal of slightly positive pro forma EBITDA for the quarter. Due to a strong economic growth within emerging global markets, our focus on these global markets and introduction of new products, we are anticipating sequential growth in our core business for Q1 and for the entire 2008 year. Kirk will elaborate on our financial results and guidance, so let me talk about why our business is well positioned to take advantage of the significant growth opportunities in the access market.

When we spoke to you last quarter we emphasized the theme of fulfillment of our vision for multi-service access technology. Through our leadership in subcategory, a number of noteworthy customer wins and the launch of expansion to our EFM product line, our news in the fourth quarter resonates with the same theme. We have been able to publicize a number of important customer wins in the past three months. Telefnica del Sur or Telsur in Chile is a key victory for us. The telecommunication market is the most dynamic in South America and Telsur is particularly an aggressive player in Chile. Their selection of technology to support their strategically critical IPTV offering is an excellent endorsement of our MSAP value proposition, one we will be able to leverage well throughout the region.

In Europe, we are now supporting triple play services for Blatzheim Networks, an innovative carrier in [Bahn], Germany. As an endorsement of our MSAP integrated EFM products, MC-link in Italy chooses to help expand their value-added business services, demonstrating the power of ethernet solutions and MC-link has now launched the regions first symmetric 25 megawatt per second ethernet services in Rome at a small fraction of the price businesses there have been paying for E3 services on their incumbent.

In the U.S, our announcement with Cavalier Telephone and TV is an indication of the customer partnership we have been building this past year in the select market. Serving 16 states, Cavalier is one of the most successful of the alternative carriers in the U.S., and our marked platforms, versatility is essential to their aggressive triple play strategy. Our research and development team have made great progress this past quarter as well. We launched in December a major software and hardware upgrade for MAP platform that extended its capability to include a number of features requested by our carrier customers, from network timing and EFM cost to advanced QOS control and PSLA support. This (inaudible) boosts the platforms breadth of the capabilities even further out ahead of the competition. We have also been working closely with Nortel, MetaSwitch (inaudible) and UTS Telecom and a number of other vendors to support tight integration between their platforms and ours in the key customer installations.

In December we joined a provider back bone transport ecosystem, an industry coalition driven by British Telecom and a number of other tier one carriers, catalyzed by Nortel on the vendor side to define industry standards for enhanced ethernet, connectivity in the converge access and transport networks environment. We will be working within this group to insure that these effort accommodates the future and performance requirements of carrier class access networks. And we will be involving our MSAP platforms and software to integrate us smoothly into the carrier ethernet ecosystem as it is defined. One very important final note on market and company activity is our recent move to Pure-Play access model. As those of you who have been following us for some time remember, we acquired a number of companies over the years, to extend our customer base and to gain access to critical technologies. Naturally, there comes a time for reshaping ones portfolio and refining focus as the market customers needs and integration of the acquired products and technologies evolve.

As we announced last week, we are choosing to diverse two legacy product lines to increase our focus on our core IP-based multiservice access strategy. The AccessNode product line was sold to Communication Test Design and our GigaMux product Optical Transport products were acquired by the new Sorrento networks. Customers using these products will continue to receive full support from these organizations. And they will be well served by their focused attention they can provide. Our exclusive focus on access will give us greater leverage across the organization from product development to manufacturing to sales and support. The industries reception of this move has been positive, as Teresa Mastrangelo, principal analyst for Broadband Trends puts it, "The sharpening of Zhone's focus on pure IP-based access technologies is timed right and in sync with the evolution of the market at large, particularly in EMEA and emerging markets where Zhone is realizing a strong growth."

We are pleased with the progress we have made as a Company in 2007. We continue to innovate in our core multiservice access space, helping the growing carriers all over the world to improve their own competitive position through innovation access services. We are looking forward to further expansion of our role in the industry as 2008 unfolds. Now I would like to turn the call to Kirk to take you through our financial results for last quarter, and to discuss our financial guidance for next quarter. Kirk?

Thanks, Mory. Today, Zhone announced financial results for the fourth quarter of 2007. In our press release the traditional comparison of financial results for the fourth quarters of 2007 and 2006 is presented alongside comparison to the third quarter of 2007. As we have done on previous earnings calls, most of our discussion today will focus on the sequential comparison to third quarter results since the year-over-year comparison is distorted by our divestiture of the legacy iMark product line in Q1 2007, and other operational restructuring that occurred during 2007. In addition during the course of my comments I will discuss the impact of the divestiture of the AccessNode and GigaMux product lines on fourth quarter results, and explain the anticipated effect on our financial guidance for the first quarter of 2008.

With that in mind let's start with top line revenue. Our revenue for the fourth quarter of 2007 was $46.6 million , which was up 12% over the third quarter and above our guidance range of $44 million to $45 million. Very strong growth in our Middle East and Central and Latin America regions lead to strong performance. As a result international revenue increased to approximately 54% of total revenue in the fourth quarter, as compared to just 44% of total revenue for the third quarter. As has been the annual trend for the past several years, international revenue continues to grow at a faster rate than domestic revenue. Thus, our focus on emerging markets around the world has buffered us against domestic economic weakness and has positioned us to take advantage of the growth of access networks occurring in other parts of the world.

In addition to having the global customer base benefit from having a diversified customer base of approximately 600 active customers and no significant customer concentration. For 2007, we didn't have any 10% customers and our top five customers represented approximately 24% of our annual revenue. Over the past few years we have divested most of our nonstrategic legacy product lines and are almost exclusively focused on next generation multiservice access technologies. In so doing we expect single line multiservice revenue to drive total revenue for 2008, since the revenue from legacy product lines will be negligible. Going forward instead of differentiating revenue as between SLMS and other legacy product verticals, we plan on focusing on the horizontal geographic markets that we serve. That being said the divested legacy product lines will have a short-term effect on the comparability of our quarterly revenue, so I'll provide information as necessary to make the appropriate quarter-to-quarter comparison.

With that in mind, let's discuss the two product lines that were recently divested. The AccessNode transaction closed on December 28th, and the GigaMux transaction closed on January 16th, so the fourth quarter results reflect a full quarter of revenue from these divested product lines, whereas the first quarter will have virtually no revenue from the divested products. For the fourth quarter, revenue attributable to the AccessNode and GigaMux product lines was $7.3 million, for all of 2007 revenue from these product lines averaged about $6.3 million per quarter. Accordingly we expect total revenue for the first quarter to decline by about $6 million to $7 million, attributable to the divested product lines.

Also, the first quarter is seasonally slow quarter and is therefore usually flat to slightly down as compared to the fourth quarter. Despite the normal seasonality, we still expect our core single-line multiservice revenue to grow moderately in the first quarter due to strong momentum and backlog carrying over from the fourth quarter. Factoring in these variables, we expect first quarter revenue to range between $41 million and $42 million, which is based on fourth quarter revenue of $46.6 million, thus approximately $6 million to $7 million of divested revenue and moderate growth in an otherwise seasonally flat quarter for the SLMS product portfolio.

Now, let's turn to gross margins. Gross margins improved to 34.5% for the fourth quarter of 2007, at the top end of our 33% to 35% guidance range. As you will recall we expected margins to improve, and they did, as a result of higher revenue volume and the consolidation of our manufacturing operations into a single facility. Gross margins improved by 4.5 percentage points over the 30% gross margins in the third quarter. For the first quarter of 2008 we expect margins to drop slightly to between 32% and 34% because of the lower forecasted Q1 revenue. For the anticipated quarterly revenue growth throughout 2008, we expect gross margins to rebound to between 33% and 35% by year end as revenue volume increases. We do not expect any margin deterioration as a result of the product divestitures because the margins on the divested product lines were not significantly different from those of other products.

As for operating expenses, total operating expenses for the fourth quarter of 2007 were $17.1 million and within our $17 million to $18 million guidance range. Operating expenses included depreciation of approximately $400,000 and stock-based compensation of approximately $400,000. Going forward, we anticipate total operating expenses for the first quarter of 2008 to continue to range between $17 million and $18 million, including approximately $1.1 million of expenses for depreciation and stock-based compensation. Operating expenses associated with the divested product lines were approximately $1 million in the fourth quarter; however we plan to reinvest most of that reduced spending into additional R&D to expand new technologies that we expect to introduce later this year.

Finally, pro forma EBITDA for the fourth quarter was slightly positive, which was our primary financial goal for the quarter and will continue to be our financial goal for 2008. On a quarterly basis we expect a small pro forma EBITDA loss of $1 million to $2 million during the first quarter, with roughly break-even pro forma EBITDA in the second quarter, and positive pro forma EBITDA in the second half of 2008. As the year develops, we will provide more detail on the level of profitability that can be achieved.

As for the balance sheet, cash and short-term investments at December 31st, 2007, were $50.2 million, which is down slightly from $50.4 million at September 30, 2007. We expect cash balances to increase by about $10 million in the first quarter, attributable to the proceeds from the divestitures, less the anticipated pro forma EBITDA loss and other working capital changes expected in the first quarter. Our total debt obligations declined ever so slightly to $34.4 million at December 31st, 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 $15.8 million and remained approximately the same as in the prior quarter. For the first quarter net cash balances are expected to increase by the $10 million previously mentioned.

As for other balance sheet changes, inventory levels increased by about $2 million to $44.7 million at December 31st, 2007, as we began to bring in material to fulfill the larger backlog of orders that I previously mentioned. Accounts receivable decreased by $2.4 million to $33.3 million at December 31st, 2007, despite higher revenue for the quarter. Accordingly, the number of day sales outstanding on accounts receivable dropped to 64 days for the fourth quarter as compared to 77 days for the third quarter. Finally the average basic and diluted EPS shares were 149.9 million for the fourth quarter, increasing only slightly from the 149.7 million in the third quarter. The slight increase resulted primarily from stock option exercises by management and employees.

Before turning the call back to Mory, let me summarize the financial results for the fourth quarter and recap our guidance for next quarter. Revenue for the fourth quarter grew 12% over the prior quarter and exceeded our previous guidance, lead by strengthen our international markets particularly the Middle East and Central and Latin America. Gross margins improved by 4.5 percentage points due to higher revenue levels and the consolidation of our manufacturing operations, while operating expenses were also in line with our previous guidance. Overall, we are very pleased with these financial results because we met our primary financial objective of achieving slightly positive pro forma EBITDA for the quarter.

With significant new customer wins and a growing backlog, we hope to carry the momentum into 2008. We expect first quarter revenue to range between $41 million and $42 million, which is based on fourth quarter revenue of $46.6 million, thus approximately $6 million to $7 million of it divested revenue and moderate growth in an otherwise seasonally flat quarter for our SLMS product portfolio. Gross margins for the first quarter are expected to drop slightly to between 32% and 34%, as a result of lower volume, but should rebound throughout 2008 as quarterly revenue grows. Operating expenses should remain stable between $17 million and $18 million, including $1.1 million of expenses for depreciation and stock-based compensation. Overall, we anticipate a slight pro forma EBITDA loss of between $1 million to $2 million during the first quarter, with roughly break-even pro forma EBITDA in the second quarter, and positive pro forma EBITDA in the second half of 2008. We'll provide more detail on the level of profitability that can be achieved as the year develops. With that financial overview, I'll turn the call back to Mory for some final comments before we open the call up to questions and answers.

Thank you, Kirk. As a communication organization, Zhone's expertise and energy have always been focused on new technologies that enhances communications and lead to accessing to new levels. With the divestiture of the AccessNode and GigaMux product lines, we are focusing maximum resources on continuing to enhance and extend our unmatched portfolio of integrated multiservice access products, reaching ever greater efficiency of speed and operational agility to the access network. At the same time, we are focusing on emerging markets around the world including Middle East and Central and Latin America, where service providers are rapidly expanding their telecommunications networks. Our fourth quarter results, highlighted by very strong growth in our international markets, confirm that service providers around the world are adopting our market-leading access technologies at increasing rate. We are deriving the majority of our revenue from these growing international markets making us less susceptible to domestic economic downturns. As a global Company focused on Pure-Play access technologies, we are positioned to benefit from the expansion of our access network in emerging markets around the world, and expect 2008 to be a very good year for us. Thank you for joining us today. We will now open the call to questions. Operator? Please begin the Q&A portion of the call.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Greg Mesniaeff of Needham & Company. Please proceed.

Yes, thank you. I was wondering if you guys could tell us whether the very recent divestiture of AccessNode and GigaMux can potentially result in some operating expense leverage, that's not fully baked into your guidance, and kind of a best case scenario in '08?

Well, Greg, as we stated our guidance is the same as it was in the prior quarter at $17 million to $18 million of operating expense, and we had intended to invest $1 million of expense related to the divestitures back into R&D to accelerate some of the development of new technology. What it looks like for the remainder of the year, hopefully we can maintain these expense levels and leverage it from here. As we've told you before, we believe operating expenses can be leveraged significantly, and as revenue grows we do not anticipate any operating expense increases.

So what you're saying is, basically, some of the leverage you might get from SG&A will be plowed into -- plowed back into R&D?

That's correct.

Okay. Thank you.

Your next question comes from the line of Anton Wahlman. Please proceed.

Yes, hey, Kirk and Mory. I have one question on some of the international wins that you referenced in Chile and Germany and so fourth. I mean, generically speaking, I mean it sounds to me the tone this quarter is a little bit different, a little bit more positive than it has been in the last few quarters, and your commentary is almost geared toward the improving economic climate in some of these areas that really is one of the reasons behind more investment in this area. And could you maybe elaborate a little bit on whether the wins in general with many of the international opportunities are displacing an incumbent, or whether these are new investments done where there really weren't any competitors, so you're basically seeing that you're taking maybe let's call it your fair share of an expanding market. How would you characterize, I mean, I know there's got to be examples probably in all of these buckets, but maybe you can characterize maybe an average.

Yes, well, there are two areas, Anton. One area are the incumbents. We are investing in the incumbents in Middle East and South America and some other places in the world, that they are adding more DSL penetration, and also they're moving to fiber rather than copper in their offering, and also they're getting into EFM or ethernet. So the two areas that we are really getting a strong penetration with the incumbent overseas are the [GPON] activities and also EFM activities and also, we are seeing some of the unbundling taking place in several of the European countries that allows the alternative carriers to offer services either to the business customers or residential customers. And that is getting aggressively penetrated by these telephone companies that are using our product, mainly for providing triple play services. In South America, we are working with some of their incumbents that are going to GPON offering and also EFM. So as a whole, we are seeing a strong requirement for our product as they want to offer several services in the same box and be able to have the flexibility to offer either copper-driven services or fiber-driven services.

And in terms of the sort of the progression here, I mean you talked about the DSL and fiber, but within DSL going from ADSL to VDSL, to -- I mean, when are we going -- when are all of these things becoming sort of mature enough whereby the vast majority of these things are going to go to VDSL to -- are we still about a year or so away from that happening or is it coming along pretty strong at this point?

Okay, you expect VDSL to be about a year or so away for two reasons. The chip sets are not mature enough for CP side, but the CO side is working fairly well. We need the CP side to be working as well as the CO side. But some of these areas that we are targeting, the areas of penetration actually is in this single digit at this point. So there is a movement to increase the DSL penetration to at least 80% in the local regions. So as the DSL gets penetrated in the new areas or new Greenfield for DSL, the others that have penetrated DSL, they're moving not to VDSL2, but they're moving right into the fiber areas such as GPON.

Okay, I understand. Well, thank you very much for the commentary, and good to see things turning around a little bit.

Well, we're very excited about what's happening in our area and things are for sure improving.

(OPERATOR INSTRUCTIONS) And please stand by for your next question. Your next question comes from the line of [Shelton Fehter] of [Walter Mitchell] & Company. Please proceed.

Yes, is there any influence of the exchange rate on the numbers?

Of course it is, since our business is mainly international, as the exchange rate, as the dollar weaken, we are being able to compete against some of the major competitors and sell our products.

Thank you. And the second question is, in the inventory number, what portion of that is with -- for the legacy products?

Well, obviously, those legacy areas got to be divested and those inventories have moved with the divestiture to that prior Company. So within the inventories, we don't have any legacy per se -- legacy inventory of those products as we divest it.

Thank you.

Yes.

That is all the questions we have at this time. I would like to turn the call back over to Mr. Mory Ejabat. Please proceed, sir.

Thank you, again, for joining us today. We appreciate your continued support, and looking forward to speaking with you on our next conference call, when we hope to be announcing another good quarter. Operator?

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.