DZS Inc (DZSI) 2009 Q4 法說會逐字稿

Good day and Welcome to the fourth quarter 2009 Zhone Technologies Incorporated conference call. I am Yvette and I will be your coordinator for today. At this time, all participants are in a listen-only mode. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to introduce Mr. Kirk Misaka, Zhone's Chief Financial Officer. Please proceed sir.

Thank you, operator. Hello and welcome to the fourth quarter 2009 Zhone Technologies, Inc. conference call. I am Kirk Misaka, Zhone's Chief Financial Officer. The purpose of this call is to discuss Zhone's fourth quarter 2009 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. Mory will begin by discussing the key financial results and business developments of the fourth quarter, following Mory's comments I will discuss Zhone's detailed financial results for the fourth quarter, and provide guidance for 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.

During the course of the conference call, we will make forward-looking statements which reflect management's judgment based on factors currently known. However, these statements involve risks and uncertainties including those related to projections of financial performance, the anticipated growth and trends in our business, the development of new technologies and market acceptance of new products, and statements that express our plans, objectives, and strategies for future operations.

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, 2008, and our quarterly report on Form 10-Q for the quarter ended September 30, 2009. We would like to caution you that actual results could differ materially from those contemplated by the forward-looking statements, and you should not place undue reliance on any forward-looking statements. 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 by management in its financial and operational decision making.

These non-GAAP results are among the primary indicators that management uses as the basis for making operating decisions, because they provide -- supplemental information regarding our operational performance, and they facilitate management's internal comparisons to the Company's historical operating results, and comparison 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 to 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 fourth quarter 2009 earnings call. The fourth quarter revenue was up 16% as compared to fourth quarter 2008, and remained basically flat as compared to third quarter.

On another positive note, we substantially improved pro forma EBITDA profitability, which was our top priority, and we were also slightly profitable on a GAAP basis during the fourth quarter. Profitability improved largely as a result of the improved margins on our newer products, and continued expense control. We expect continued revenue growth in 2010 based on the strong interests in our product solutions, both in the US and abroad.

We see the major forces driving revenue growth in 2010 as follows. First, our customers have been focused on delivering new services with higher bandwidth, due to competitive pressure, requiring network upgrades and transition to IP-based networks.

Second, we introduced our MXK product line, which provides an interim solution to meet those customer needs.

Third, our global reach allows us to focus on providing solutions in emerging growth markets.

And finally, the US broadband stimulus package should provide additional domestic financing for broadband network buildouts during the second half of year 2010. Kirk will give your more details on our financial performance and guidance later.

So let me give you a brief update on the status of our NASDAQ listing. As discussed on our last earnings call, we have until March 2009-2010 to comply with the $1 minimum bid price required for continued inclusion on the NASDAQ capital market. Accordingly, we have postponed plans to move forward with the reverse stock split approved by our shareholders in October 2008. We continue to evaluate the alternatives to maintain our NASDAQ listing. We will issue a press release prior to taking any action that may be required.

Now let me give you an update on our products and customers. As you know, last year we announced the introduction of our MXK intelligent terabit multi-service access platform, that features a two times banded improvement over the next competitor. Service providers across the globe quickly deployed the MXK in every major market where we do business. Following the introduction of the MXK, we added a powerful suite of Optical Network Terminals that assist carriers in reducing time, cost, and complexity of delivering FTTx services.

Our ONTs include the following key features, the ability to deliver any service over any port, auto provisioning, a smart OMCR, and simplified management to Zhone's SLMS operating system. Because ONTs represent a big part of the cost of any GPON or active Ethernet network design, it is important that ONTs match precisely, and operate to a specific network and service requirement.

Our development and integration efforts on ONTs have created the industry's most comprehensive product portfolio. We now have over 30 different models, covering a wide range of functionality, in both indoor and outdoor applications, from simple low-cost devices for basic residential service, to sophisticated multi-service devices for business applications, and mobile back haul. Our customer base for the new MXK platforms continues to grow. This past quarter we announced a new high profile installation in El Gouna, a larger resort town on the Red Sea, created by property development arm of global telecom operator Orascom.

More importantly, however, we announced that our MXK platform was selected by Etisalat for a major roll out of the next generation GPON service, services throughout the UAE. As you may know, Etisalat has been the primary telecom communications provider in the UAE since 1976, and is known for their technological excellence, innovation and reliability. Being selected by them for this major multi-year deployment is an important acknowledgement that MXK provides a superior innovative carrier class solution.

In making the selection of our FTTx solution they cited MXK's unprecedented scalable bandwidth, robust network control, and the ability to service customers with greater efficiency. We are very excited about being selected by Etisalat for this nationwide GPON deployment, and believe it will be a major catalyst in helping us grow our revenue in 2010 and beyond.

Last quarter we also added the ETHX 3100 Series with Pseudo-wire to our EFM product portfolio, which enables operators to migrate TDM applications on to a converged packet network for simple network management, and immediate OpEx savings in the delivery of voice, video and mobile back haul. Last quarter, Updata in the United Kingdom selected our EFM platform to provide carrier class networks for UK public sector and institutions, including government, healthcare, and education.

Finally, the US market supported a number of our customers and prospective customers in their efforts to obtain a portion of the $7.2 billion broadband stimulus grants. In December 2009, and January 25, 2010, the Government announced a portion of the investment, and awarded some of our customers the funds needed to build out the broadband infrastructure.

We will continue supporting our customers with their projects, and anticipate seeing the effects of the broadband and stimulus grants in the second half of 2010. In the meantime, we continue to have success domestically. This past quarter, Hardy Telecommunications selected our platforms to provide higher-speed data and voice over IP services, with sophisticated call features to their customers over a wide and disparate geographical area. Hardy cited our high value, reliability, and limited maintenance as a reason for continuing to leverage the Zhone's product portfolio.

We also announced today that the City of Salisbury in North Carolina has selected Zhone's MXK and zNID fiber to the home solution, to serve their municipality broadband initiative now underway. Salisbury cited Zhone's FTTx system as the most powerful solution, with twice the capacity over other platforms, resulting in the lower bandwidth costs, while providing the freedom to grow network services to the growth of the city.

As you can see, we finished 2009 with considerable momentum, with an improved profitability and increased gross margin. We also introduced a strong product portfolio for FTTx and EFM, targeting broadband projects for GPON, active Ethernet, and Ethernet over copper, that gives us a strong competitive advantage. The rapid economic recovery in our global emerging markets, and the expansion of the broadband networks in these markets, combined with the US broadband stimulus grants, should translate into continued improvement in our financial performance for 2010.

Now I will turn the call over to Kirk to provide more details about 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 2009. In our press release the traditional comparison of financial results for the fourth quarters of 2009 and 2008 is presented alongside a comparison to the third quarter of 2009. As we have done in the past, most of our discussion today will focus on the sequential comparison to third quarter results.

As Mory mentioned, the fourth quarter revenue of $36 million remained basically flat as compared to the third quarter, but was up 16% as compared to the fourth quarter of 2008. Fourth quarter revenue fell short of our previous guidance of revenue between $37 million and $38 million, largely due to reduced demand by small rural carriers in the US, that were waiting for broadband stimulus funding.

Looking forward, we are forecasting a normal seasonal slowdown in the first quarter, and expect the revenue to be flat or slightly down in the mid-single digit percentage range. After that we expect revenue to grow sequentially each quarter throughout 2010.

We also expect quarterly revenue in 2010 to exceed that of the corresponding quarter in 2009. We continue to serve approximately 700 active customers worldwide, with 65% of revenue for the fourth quarter being attributable to international customers. We have experienced more customer concentration over the last two quarters, with one 10% customer each quarter, and the top five customers representing approximately 48% of revenue for the fourth quarter, and 42% of revenue for the third quarter.

Gross margins increased substantially from 33.5% for the third quarter to 40.1% for the fourth quarter, which exceeded our previous guidance range of margins between 33% and 36%. As mentioned on our last conference call, we expected margins to improve with the introduction of our new technologies that have been designed with maximum cost efficiency per port in mind. Fourth quarter results proved those expectations to be somewhat conservative.

So for the first quarter of 2010, we are increasing our margin guidance once again to between 36% and 40%, with the potential for additional margin expansion throughout 2010, as the deployment of our new higher margin technologies increases, and higher volumes allow us to take advantage of manufacturing economies of scale. As we begin this new product cycle, however, we will be carefully balancing revenue growth and increased market share with profitability and higher margins.

Operating expenses for the fourth quarter came in at $13.7 million, versus guidance of between $13 million and $14 million. Operating expenses included depreciation of approximately $400,000, and stock-based compensation of approximately $700,000. With additional sales and marketing activity around our new product launches, we anticipate total operating expenses for the first quarter of 2010 to increase slightly to between $13.5 million and $14.5 million, including approximately $1 million of expenses for depreciation and stock-based compensation.

Finally and most important, pro forma EBITDA for the fourth quarter of 2009 was a $1.9 million profit, and better than the expected profit of approximately $1 million. We also reported net income on a GAAP basis of just over $300,000 for the fourth quarter.

As mentioned, substantially stronger margins associated with our new products led to improved profitability. However, due to normal seasonal weakness in the first quarter, and a slight decline in revenue, we anticipate a slight pro forma EBITDA loss for the first quarter of 2010. We expect the first quarter to be a normal and temporary seasonal downturn, and thus anticipate returning to profitability in the second quarter, as well as improving on that profitability for the remaining quarters of 2010.

Now let's take a quick look at the balance sheet. Cash and short-term investments at December 31, 2009 were $21.8 million, which declined only slightly from the $22 million at September 30, 2009. The positive cash flow associated with the $1.9 million pro forma EBITDA, was largely offset by working capital changes in the balance sheet, predominantly Accounts Receivable. Accounts Receivable levels continued to increase, and grew by $5.1 million to $37.1 million at December 31.

Correspondingly, the number of days sales outstanding on Accounts Receivable for the fourth quarter increased to 93 days, as compared to 80 days for the third quarter. The increase in Accounts Receivable and DSOs is largely attributable to the growth in business with our 10% customer. We anticipate DSOs will gradually decline beginning in the first quarter as the payment cycle with this customer begins. With this decline in DSOs, operating cash flow will begin to turn from negative to positive, along with pro forma EBITDA.

For the year we anticipate net neutral cash flow from operations, which will help us stabilize our liquidity resources. As for other balance sheet changes, inventory declined slightly to $30.2 million as of December 31, from $30.5 million as of September 30. Our total debt obligations remain basically the same as last quarter at $28.7 million.

With that financial overview, I will 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. We are excited by a stronger than expected profitability associated with the beginning of a new major product cycle for the Company. The initial positive reaction to our new products is very encouraging, and we hope to build on that momentum in 2010. In the fourth quarter we achieved our primary financial goal of generating positive quarterly pro forma EBITDA and GAAP net income, and now focus on improving the profitability for 2010 and beyond.

Thank you for joining us today, and we will now open the call to questions. Operator, please begin the Q&A portion of the call.

(Operator Instructions). Greg Mesniaeff from Needham & Company.

Yes, thank you. Two quick questions. First, on the gross margin improvement, obviously a new product cost profile. Is that product still internally manufactured, or is that outsourced?

Yes. It is manufactured in our Largo facility.

So that has not changed. It is really a function of just the design, correct?

That is correct.

And the other question is on the DSOs. Did I hear you right, there were 93 days in the fourth quarter?

Yes. 93 days for the fourth quarter.

And is that attributable to linearity, a back end loaded revenue pattern? Or is that more just a function of the nature of the customer?

There is some of that, that it was in the back end of the quarter. But 20-plus days related to the increase in DSOs, related to this one 10% customer that we referred to.

So what you are saying is this customer tends to pay late, anyway, but on top of that a big chunk of business came at the very end, right?

That is right.

Okay. Thank you.

[Edi Hecky], Zhone Technologies (sic).

This is for Buzz Heidtke, maybe? Okay. She said Judy. I didn't know whether it was me or not. This is Buzz Heidtke with MidSouth Investor Fund. A couple questions. What is your debt cost?

We run about $300,000 per quarter is our net interest cost.

And what rate?

It varies. We have two facilities, one with Silicon Valley Bank. It is at prime plus 2.5%. We also have a mortgage that runs on a six-month LIBOR plus 300 basis points.

Okay. Let's see. What about your R&D costs? Are they going to stay where they are?

Yes. We anticipate our R&D to remain the same.

Okay. Your inventory went down a lot. Is that apt to go back up? Or what was the reason?

No. We anticipate our inventory to either stay at this level or go down.

When you refer to that it went down a lot, it went down a lot as compared to December of '08 --

Right.

-- to now. But from the third quarter to the fourth quarter, it was relatively stable. It went from $30.5 million to $30.2 million. And as Mory said, we are anticipating that it will level out somewhere in this range.

Okay. And then this contract at Salisbury municipality, was that bid on or did they come to you, how did you get that contract?

There was an RFP. We answered the RFP. There were many competitors who were invited to that RFP, and we won that RFP.

Why did they select you all?

Because our product performance and quality of the product.

Okay then. And will you be getting some larger municipalities, do you think? Or is this about the average size you will be getting in the future?

We are working all the fronts. So any RFPs that come across our desk we will go after that.

Okay. And then what was to be about the approximate dollar size of this one?

We don't publish that.

Okay then. Your margins are going to be getting better I guess at the end of the year, as your revenues start going up higher?

That is our plan.

Okay then, thank you very much.

You are welcome.

Donna Jaegers with D.A. Davidson.

Hi. Thanks for taking my questions. Just two quick questions I guess on the pipeline, can you give us a little more color as far as what's the -- are the number of RFPs out there increasing? Any sort of color that you can give on the pipeline?

In respect to our pipeline, what we are seeing is a lot more activity this year from the same quarter last year, or actually from the last quarter we are seeing lots of RFPs and RFIs. And internationally we are seeing a lot more activity than we are seeing domestically.

Okay. And then where you respond to RFPs but you don't end up winning, is there one specific reason why you don't win those contracts?

Yes. It is different in different areas. In some of the areas internationally we might walk away from the RFP, because of the low pricing from Chinese manufacturers. And domestically we haven't lost any when the RFPs have come up. I don't know if they come what we would lose on I don't know. We are going forward with the new products that we have.

Obviously you have leapfrogged your competition with this new product being able to carry twice the bandwidth. How long of a lead do you think you have, versus say an Adtran and some of your other domestic (multiple speakers)?

Obviously we are not going to stop our development. We are going to continue enhancing this platform. Our intention is to stay ahead of competitors for a year. Year by year we are going to enhance this product.

Great. Thanks a lot, Mory.

James Johnson with Comcast.

Hi. Just one quick question about the NASDAQ listing. You guys anticipate something happening in the next two months? Is there a plan? Is there potential expanding the deadline? What do you guys, can you guys provide something on that?

Well, right now the deadline is the end of March and we have to comply with that. We are obviously looking at different alternatives until then. So you should just stand by until we come up with a resolution. We will let you know.

So there is a plan.

Well, we are always looking at different plans.

And the reverse is out of the question.

I cannot say it is out of the question. That might be one of the items in the plan, but we are looking at several alternatives.

Okay. Thank you for your time.

Sure.

Mark Gomes with Pipeline.

Hi, folks. Wondering if you could talk a little bit about any deal slippage that you may have incurred during the quarter as a result of anticipation of broadband stimulus funding. And along those lines, can you provide some further commentary or updated commentary on how Zhone -- how you expect to benefit from the coming broadband stimulus?

Well, yes, I can say that in the fourth quarter we saw various slowdown in our US business because of some of our customers were waiting for the stimulus funding, or the award on that respect. As I mentioned, there have been two awards that have been published. And some of our customers do have -- been awarded for the funding.

But they have to send their plans, their project plans, and all of that, and have to get that approved. And I really cannot tell you what the cycle time is for those projects to get approved and the funding to start. So until we get the first indication of how fast the government moves, of providing those fundings, we cannot tell you exactly when those fundings are going to be available.

Okay. Would it be fair to say you would have been able to make the published Street estimates this quarter if those deal delays did not occur in the fourth quarter?

Most likely, yes.

Okay. Thank you. And can you name any of the customers that were awarded broadband stimulus funding in the last two rounds?

I cannot do that. And also the result of customers that they haven't selected anybody, that we are targeting as well.

Great. Thank you very much.

Edward Zabitsky with Zhone (sic).

Ed Zabitsky, ACI Research. Wondering about the MXK product. Is that, are you bidding larger deals because of the availability of the platform? In other words, are you going after Tier 1 carriers now (multiple speakers)?

The answer is yes. We are going after Tier 1 carriers. Actually Etisalat is a Tier 1 carrier. [Fujiro] that we announced a couple of quarters back is a Tier 1 carrier. We are going after Tier 1 carriers internationally. Domestically we haven't seen any RFP from either Verizon, Qwest, or AT&T. They haven't published anything. But we have seen some RFPs, or RFIs from Tier 2's that we are responding to those. And I believe we are in a strong position to win some of those.

And that is great. Could you characterize sort of the size, just the rough size of the Orascom and Etisalat deals? Are they in the millions? Are they above $10 million? What is the scope we are looking at?

I cannot tell you exactly what it is. But I can tell you it is over $1 million.

Okay. Okay. Thanks very much.

(Operator Instructions). [Martin Laney].

Good afternoon. I was wondering if you could identify your two 10% customers that you mentioned acquiring in the last two quarters.

It is the same customer, and it is our customer in the UAE.

Thank you.

Mark Gomes.

Do you guys comment on backlog at all qualitatively or quantitatively, and can you tell us if your backlog increased or decreased in the quarter sequentially?

Well, we have not commented on the backlog in all of our conference calls. We won't do that. We just give you guidance on the top line and the gross margins.

Okay. Thanks.

Thanks so much.

At this time you have no further questions.

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

That concludes today's conference. Thank you for your participation. Have a great day.