DZS Inc (DZSI) 2008 Q3 法說會逐字稿

Good day and welcome to the third quarter 2008 Zhone Technologies, Incorporation conference call. I'm Lamanual, and I'll be your coordinator for today. At this time, all participates 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 Kirk Misaka, Zhone's Chief Financial Officer. Please proceed.

Hello, and welcome to the third quarter 2008 Zhone Technologies, Inc. conference call. I am Kirk Misaka, Zhone's Chief Financial Officer. The purpose of this call is to discuss Zhone's third quarter 2008 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'm here today with Mory Ejabat, Zhone's Chairman and Chief Executive Officer. Mory will begin by discussing the key financial results and business developments of the third quarter. Following Mory's comments, I will discuss Zhone's detailed 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 this discussion today, we will make forward-looking statements including those related 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 do you the risks factors contained in the SEC filings at www.sec.gov, including our annual report on Form 10-K for the year-ended December 3, 2007, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2008 and June 30, 2008. We would like to caution you not to place undue reliance on any forward-looking statements which speak only of as 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 and pro forma operating expenses, non-GAAP measures we believe are 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 in 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 comparison to the company's historical operating results in 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.

Thank you, Kirk. Good afternoon, and thank you for joining us today for our third quarter 2008 earnings call. Let me briefly discuss the financial results for providing an update on the business.

For the second consecutive quarter, economic conditions prove to be challenging and cause us to miss our revenue and margin guidance. Revenue was $32 million [because] to our recently updated guidance of approximately $32 million but below our earlier financial guidance of between $36 million and $37 million.

Some the revenue shortfall was attributed to the global credit contraction which caused many of our customers to defer or reduce their network expansion plans. With the revenue shortfall, gross margin, pro forma EBITDA, and cash flow were also negatively impacted on a short-term basis. Until the economic environment improves, we will continue to reduce operating expenses and improve gross margin by reducing the costs of our products.

Kirk will give you more details on our financial performance and guidance later.

Before turning to the business side, let me bring you up to date on the status of our NASDAQ listing. As you know, we decided to do a reverse stock split in order to regain compliance with the $1 per minimum per share bet cost required for continued inclusion on NASDAQ global market.

You may recall that NASDAQ has given us until December 8 to regain compliance. Recently, they also temporary suspended the minimum bet price requirement until January 16, 2009.

At our shareholders meeting on October 16, our shareholders approved a reverse stock split of between 1 for 5 and 1 for 10. We plan to proceed with the process to complete the [reverses] stock split and regain compliance well in advance of the deadline.

Now, let me talk about our business. On products and customers, this quarter we announced three new releases targeting the growth areas in the market. For the FTTX application using [immediate] sell [through] in the last few hundred feet, we launched a Bitstorm HP, a 24 port (inaudible) platform that supports the metric 100 megawatt per second services over single copper pairs.

The HP supports triple play services in multi-dueling units and fiber to the node applications. For operators who's plan involve getting triple play leverage out of their copper loops or (inaudible) distances, we also launched a Bitstorm RP, a platform that provides up to 45-megawatt per second of ADSL 2 Plus connectivity over two bonded copper pairs, supporting robust rates of distances of up to 33 [months].

We also released a major upgrade to our unique SLMS access operating system, the common software foundation for our full range of access phone factors and service guides. SLMS version 1.14 includes new capabilities for advanced networking, quality of service control, voice interoperability and circulation. These new software features are critical to addressing their needs of our customers in all regions we serve. As they continue to adopt more sophisticated networking technology such as GPON, EFM, Media Sell Through and ADSL 2 Plus.

This past quarter saw a number of customer wins, and in every case, the selection of Zhone for the next phase of the access network was based on our unmatched single platform support for the full breadth of forward-looking access technologies such as GPON and Active Internet as well as legacy interfaces such as ISDN.

Now I would like to turn the call to Kirk to provide more details about our financial results for the last quarter and to discuss our financial guidance for next quarter. Kirk?

Today Zhone announced financial results for the third quarter of 2008. In our press release, the traditional comparison of financial results for the third quarters of 2008 and 2007 is presented alongside a comparison to the second quarter of 2008. As we have done on previous earnings calls, most of our discussion today will focus on the sequential comparisons to second quarter results.

As Mory mentioned, revenue for the third quarter of 2008 was just over $32 million which met our revised guidance, but fell short of our original financial guidance of between $36 million and $37 million. Global economic weakness affected both our domestic and international businesses.

We continue to serve approximately 700 active customers worldwide and experienced less customer concentration as compared to the past. We didn't have any 10% customers and our top five customers represented approximately 30% of revenue for the third quarter as compared to 37% for the second quarter.

Third quarter revenue of $32 million declined by 20% when compared to second quarter revenue of $40.1 million. Until global economies begin to improve, we don't believe we can sustain consistent revenue growth. Therefore, we are forecasting that fourth quarter revenue will be basically flat at approximately $32 million.

As for gross margins, they improved to 30.1% for the third quarter of 2008 despite the lower revenue level because we anticipated the sales weakness earlier in the quarter and were able to partially, but not fully reduce our manufacturing operations. Going forward we further adjusted our variable manufacturing, labor and other costs at the lower revenue forecast and therefore expect margins to improve to between 31% and 33% for the fourth quarter.

As for operating expenses, total pro forma operating expenses for the third quarter of 2008 were $15.4 million, approximately $2 million less than last quarter, and within our $15 million to $16 million guidance range. Pro forma operating expenses excluded approximately $400,000 of expense related to reducing the work force and operations to match the lower revenue level. Operating expenses included depreciation of approximately $400,000 and stock-based compensation of approximately $600,000.

As Mory mentioned, we will continue to reduce our operating expenses until our revenue outlook improves. We anticipate total operating expenses for the fourth quarter of 2008 to drop to between $14.5 million and $15.5 million including approximately $1 million of expenses for depreciation and stock-based compensation.

Finally, pro forma EBITDA for the third quarter of 2008 was a $4.6 million loss and larger than our estimate of an EBITDA loss of between $2 million and $3 million. We expect the pro forma EBITDA loss for the fourth quarter to range between $3 million and $4 million with the goal of returning to break even quarterly pro forma EBITDA some time in 2009.

As for the balance sheet, cash and short-term investments at September 30, 2008, were $41.3 million, which declined from $50.1 million at June 30, 2008, mostly attributable to the EBITDA loss and other working capital changes occurring during the third quarter. Total debt obligations remain basically flat at $34.2 million. On a combined basis, our net cash balance or cash net of date obligations decreased from $15.8 million at the end of the second quarter to $7.1 million at the end of the third quarter, again, as a result of the EBITDA loss and other working capital changes occurring in the third quarter.

As for other balance sheet changes, inventory levels increased from $37.2 million as of June 30, 2008 to $42.9 million as of September 30, 2008, as we added material for new product introductions and ended up with temporarily excess material related to our higher revenue forecast. Accounts receivable decreased by $3.7 million to $26.6 million at September 30, 2008, with a number of days sales outstanding on accounts receivable for the third quarter coming in 75 days as compared to 68 days for the second quarter.

Finally, the average basic and diluted EPS shares were $150.4 million for the third quarter, increasing only slightly from the $150.3 million in the second quarter. A slight increase resulted primarily from stock option exercises by management and employees.

With that financial overview, I'll turn the call back to Mory for a few final comments before we open the call up to questions and answers. Mory?

Thank you, Kirk. Our new product releases on customer wins were unfortunately overshadowed by weaker than expected financial performance. The third quarter proved to be challenging as the global (inaudible) contraction caused many of our customers to delay or reduce their plans to expand their networks.

Until global economies improve, we do not foresee sustainable revenue growth. However, we hope to be able to return to break-even or positive quarterly performance some time in 2009. Until then, we will continue to work hard and reduce software expenses in order to minimize losses and cash flow. Thank you for joining us today. We will now turn the call to questions. Operator, please begin the Q&A portion of the call.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of [Nyrad Sinia]. Please proceed.

Okay. When you coming to earning call, do you know where some percentage of the new quarter's revenue are coming from? What is the typical level of revenue visibility? And how does that compare to third quarter?

Will you repeat your question and say it a little bit slower, please. Hello?

Hello?

Would you repeat your question again, please.

Sure. When you come in to an earning call, do you know where some percentage of the new quarter's revenue are coming from? What is the typical level of revenue visibility, and how does that compare to third quarter?

Okay. Let when we start the quarter, we really -- our business is booked on ship within the quarter. Whatever we book, we ship. So the visibility is very narrow. Majority of our business happens in our the third month of the quarter, so that's where we have the (inaudible) in the quarter. In comparison to the last quarter, we are seeing the same position. That's why we are forecasting a flat quarter.

Okay. And I have one more question.

Okay.

I would like -- yes. Is there any new tactics that carriers are using to fund their projects?

Are there any new carriers --

Tactics they're using to fund their projects.

Okay. I have to ask this question again. Are there new carrier tactics?

Yes.

Can you explain that, please?

Sure. My question is that -- are there any new tactics carriers are using to fund projects?

Oh, yes. The carriers are funding projects based on their needs today, and normally it is based on the areas that they are trying to offer new services, either IP TV or EFM, or FTTX. These are the new projects that the carrier are looking at. And if there is no requirement for those, they don't deploy anything.

Okay. And I would like to add one more question, and that --

Okay.

Have you seen more constancy from bigger or smaller customers, from any geography, or any other helpful insights into more optimistic or pessimistic market segments?

We see globally a cautious approach to deploying product or services in the region, with the exception of Middle East. We see some improvement over there.

Okay.

All right. Next question?

And your next question will come from the line of Connor [Irvin]. Please proceed.

Hi, there is this Conner Irvin with Needham & Company calling for Greg Mesniaeff.

Sure.

Quick question. Can you give us an update on your SkyZhone product and how that product is ramping in Q3? I think the last call you said that it was really going to pick up in Q4 and in Q1. How is that tracking along as of now?

It is meeting our expectation. This is a wireless service provider off of our [Match] platform and they use it for several different application from Homeland Security to offering internet access. We are seeing some movement, but not as much as we anticipated for Q3.

There is lots of trials. We are having lots of trials in different countries and different regions, but when they materialize it remains to be seen with this economic situation.

Okay, got it. And another question. Some of the weakness that you saw in Q3 with your international sales, was that one geography in particular? Or was it -- I think you said you saw it all over, but was it weighted more towards one than another?

No, it wasn't. As I mentioned, Middle East was doing fairly well.

Fairly well.

In South America and South Asia and European countries, we saw some problems over there. And lots of our customers that we require ERP payment or letter of credit, couldn't get their letter of credit in process or couldn't come up with financing.

Okay, great. Thank you very much.

Sure. Next question?

And your next question will come from the line of Chad Smith, Smith Capital. Please proceed.

Hi, guys. How are you doing? Thanks for taking my call.

Sure.

I have got a couple of questions and really, they have more to do with the big picture and not so much with regard to trends you are seeing in the marketplace or the overall malaise that we're experiencing economically. But with all due respect, obviously, the macroeconomic environment is affecting everybody, and I know that it's affecting you as well. But unfortunately, I'm afraid as we really look at things, if we really were to look at things realistically, I don't know if you have the time at this particular moment to wait out the storm as it were. Kind of waiting for the general global economic environment to pick up.

And as I look at your situation right now with your balance sheet as it is, and you guys have done a great job in trying to be good stewards of everything, considering the situation. But with the net cash position where it is and the burn rate that you guys are experiencing, I'm kind of getting a little bit concerned about what the end game is at this particular moment.

With days sales outstanding getting stretched and if any other further problems come with respect to credit availability with some of your customers and push-outs continue, the trend has been to continue -- I know you're guiding level for this quarter, which is great. But the trend has been for you guys to come in later in the quarter and guide lower even further. And I'm kind of getting a little concerned about the -- a couple of quarters out, we're going to be getting into you guys burning through enough cash to take you down to a negative net cash position.

So my question really is, have you guys been thinking about strategically with the attractive product line that you have, and I want to commend you on all of you have continued to put out there in terms of innovative products, but as a stand-alone entity, as a stand-alone operation, how much longer can you hold out in the financial position that you are in kind of waiting for the overall global economic environment to pick up? And I really want to see you guys make it and turn this thing around, but I'm trying to get a feel for realistically --

Well, you asked lots of questions. So let me try to see if I remember to answer them all.

Okay.

First of all you asked -- you mentioned that we come at the end of the quarter and the guiding is down. That's correct. But if you look at the past several quarter, we have been really the indicator of what is happening in the industry. If we announce a soft quarter, all of our competitors or majority of those competitors would do the same.

You expected today on the sales outstanding, our DSOs, we had one customer that owed us large amount of money in the Middle East, but if -- I don't know if you know or not, at the end of the quarter, it was a holiday in Middle East, and the bank didn't process the payment. We got the payment. We are anticipating our DSOs to go down this quarter by a good magnitude.

Okay. The other thing is as we have mentioned and continue doing so, we improve our operating expenses and gross margins. And we believe we have a good run rate to stay as we look at the industry, to stay in a good cash position until the storms is over.

Did I answer all of your questions?

Yes, but let me just kind of follow up, if you don't mind. Are there any provisions in your current debt instruments that have any kind of kick-in clause, if you guys go into a negative net cash position? If you look at -- I mean, obviously, I know your cash position is okay right now, but if you look at again, as you referenced earlier, your net cash is down to what, $7.5 million? I think is what you said. So if you guys get in to a position where the ratios there are certain to diminish because of a couple of quarters and negative cash burn, does that kick out anything with your loan covenants?

Chad, I'll take that. This is Kirk. The majority of our debt, about $20 million, is mortgage on our campus, and that provision is only secured by the campus and has no cash requirements or liquidity requirement.

Okay.

The line of credit that we have outstanding of $15 million is with the bank that has the liquidity covenant of 1.5 times our cash in accounts receivable. And that liquidity covenant, we're well in compliance with.

Okay.

And if I just have to make a comment, our campus worth more than what our mortgage is.

Right. Okay.

Okay?

And then finally, with respect to the general question I asked about -- when I said the word as an independent growing concern, again -- and I think I talked about with you, another point in the past, Kirk. But with your product line that you have, again, as -- I believe a very enviable product line that you currently have. And you continue to create new products and I commend you on your innovation there. And the diversity of your customer base. All of that is wonderful. But strategically I'm trying to get a feel for if you have begun to think about strategically, does it make more sense for you to look at strategic options maybe again?

We do always look at all of the options and opportunities. And with this environment, I don't know who would be a great strategic partner for us. If you have any crystal ball, I would like to hear that.

Well, that's fine. Let me ask one last question. That is, at this particular point and again, market capitalization being down where it is, obviously this is a little bit of a stretch to look at this now. But what is your annualized, if you could come up with just a rough number, what does it annually cost you guys to continue on as a publicly-traded entity in terms of all of the costs related to, obviously SEC filings and Sarbanes-Oxley compliance, et cetera, et cetera. What is all of the aggregate cost of that on an annualized basis amount to do you think, roughly, Kirk? And the reason I ask is because that number, relative to your market capitalization is probably a pretty ridiculous number right now.

It is a pretty large number. It's just shy of $1 million annually to comply with the internal and external costs.

Okay. So I just throw that out there as a percentage of market capitalization that particular ratio would arguably point to the question of does it make any sense for you guys even to continue to be publicly traded when you are having to deal with all of the headache you have to deal with but yet, you have got potentially a lot of good opportunity ahead of you from a business standpoint.

Chad, we are here for the long run. We are not here for today or tomorrow or take advantage of $1 million saving and do other things. We are here for long term. We know, as you mentioned, we have a great product. We have a great customer set. The customer says they are in a kind of an economic turmoil. I'm sure they are going to come out of it. The housing is going to improve. The small businesses are going to get going again, either domestically or internationally. And it's where our products fit and where the customers are to use our product and deploy it. So we are looking at it in the long term, not in the short-term.

Okay. Well, that's it for me. Thanks a lot for your answers. I appreciate it.

(OPERATOR INSTRUCTIONS). At this time there are no more further questions in queue. I would now like to turn the call back over to Mory Ejabat for closing remarks.

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 announce improved financial performance.