DZS Inc (DZSI) 2012 Q3 法說會逐字稿

Good day and welcome to the third-quarter 2012 Zhone Technologies, Incorporated, conference call. I'm Regina and I will 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 Kirk Misaka, Zhone's Chief Financial Officer. Please proceed.

Thank you, operator. Hello and welcome to the third-quarter 2012 Zhone Technologies, Inc., conference call. I Kirk Misaka, Zhone's Chief Financial Officer.

The purpose of this call is to discuss Zhone's third-quarter 2012 financial results as reported in our earnings release. This 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 of 2012 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, 2011, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2012, and June 30, 2012.

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 also undertake no obligation to update any forward-looking statements.

During the course of this call we will also make reference to adjusted EBITDA and adjusted 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 a basis for making operating decisions because they provide meaningful supplemental information regarding our operational performance and they facilitate management's internal comparisons to the Company's historical operating results and comparisons to competitors' operating results.

A presentation of this additional information is not meant to be considered in isolation or as a substitute for measures of financial performance compared in accordance with GAAP. We have provided GAAP reconciliation information for adjusted 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 2012 earnings call. This quarter, revenue decreased slightly to $29.2 million due to the difficult economic conditions in our served markets and deferred deployments of a few domestic customers related to the changes in Connect America funding.

Nonetheless, as expected, our MXK continued to derived new organic customer growth, sustaining the industry leadership and a strong customer acceptance. Coupled with the launch of our new FiberLAN product line last quarter, which positioned us in a new market segment that is growing rapidly, we expect to be able to get back to revenue growth in the near future.

During the third quarter, we also restructured the business to only focus on existing and new copper- and fiber-based product lines with a major emphasis on FiberLAN and the next-generation broadband products. As you know, capital spending by telecom companies has been substantially reduced for a prolonged period due to tight budgets and difficult economic conditions. Accordingly, we suspended the product and market development related to non-broadband product line until capital spending in these sectors resumes over the next few years.

Since this new product line is already substantially developed, we anticipate being able to react quickly to any upturn in capital spending by these organizations. In the meantime, we will incur substantially lowering operating expenses, and that will lower our breakeven point for profitability which, as I have said before, remains our primary financial goal.

After my comments, Kirk will give you more details about the impact of this restructuring as well as our financial results for the quarter and guidance for the next quarter.

The last financial matter I'd like to briefly mention is that we continue to evaluate all alternatives to regain compliance with the NASDAQ $1.00 minimum bid price requirement before the December 18 deadline. We are also developing contingency plans in the event that we do not regain compliance by then, and we will announce more detailed information as we move forward.

Now, let me turn your attention to exciting things happening on the business side. As I mentioned last quarter we launched Zhone FiberLAN, an innovative and exciting new product line. We believe FiberLAN represents an exciting new opportunity for Zhone. Thus far the excitement and new customer interest has been exceptional.

After completing a comprehensive analysis comparing FiberLAN Optical LAN service to that of the copper switch Ethernet LAN, the savings are [triple], providing compelling short- and long-term savings for our customers. Initial [analysis reflects] 73% reduction in capital expenditure, 92% savings in operational recurring costs, 84.7% green efficiency.

We are excited to share these new results with our customers. To accompany FiberLAN Optical LAN solution, we launched an impressive new line of zNID 26xx series of indoor [gas copper] ONTs specifically designed for the FiberLAN Optical LAN solution.

Zhone products continue to drive new customer growth while sustaining GPON industry leadership in each of our served markets for a company record 11th consecutive quarter. The analysts report also the fact that Zhone Technologies is the number-one GPON provider in the Middle East.

During the quarter, we won several new customers and expanded our customer base globally into customers such as Pend Oreille County Public Utility, Washington State; iTV-3, Central Illinois; Cherokee Communications, Southeast Oklahoma; York Data Services, United Kingdom; Communication Partner SRL, Argentina; Access Media 3, Chicago, Georgia, Minnesota, Florida, Tennessee, Virginia, and Washington DC.

MXK shipments remain strong. We shipped roughly 350 units in the quarter, bringing the total units shipped to 4,000 units and well over 28.7 million [ports] of MXK GPON subscriber capacity. Additionally, we experienced strong ONT shipments of nearly 100,000 units of the popular zNID 2400 ONT series.

With those brief comments let me turn the call over to Kirk to provide more details about our financial results for last quarter and to discuss our financial guidance for the next quarter. Kirk?

Thanks, Mory. Today, Zhone announced financial results for the third quarter of 2012. Third-quarter revenue at $29.2 million decreased from second-quarter revenue of $30.8 million due to the difficult economic conditions in our international markets and deferred deployments for some of our domestic customers. As Mory mentioned we expect to be able to replace much of the revenue being lost due to the difficult economic conditions and changes caused by Connect America Funding.

Our international markets continued to produce the majority of our business and represented 58% of revenue for the third quarter versus 57% of revenue for the second quarter. We experienced slightly less customer concentration this quarter, with the top five customers representing approximately 38% of revenue for the third quarter as compared to 43% of revenue for the second quarter. We also had only one 10% customer for the third quarter as compared to the two 10% customers in the second quarter.

Gross margins declined to 28% for the third quarter as compared to 30% for the second quarter. Margins continued to be under pressure from aggressive competitive pricing, especially in our international markets.

On the positive side, we see prices beginning to bottom out. When coupled with continued product cost reductions, we believe gross margins will begin to improve next quarter.

Operating expenses at $12.4 million for the third quarter are slightly higher than our previous guidance range of between $11.5 million and $12 million, and the $11.4 million for the second quarter. As Mory mentioned we restructured the business to only focus on existing and new copper- and fiber-based product lines, with a major emphasis on FiberLAN and next-generation broadband products.

As a result of the restructuring, we incurred approximately $700,000 of additional operating expenses this quarter for severance, termination of certain leased office space, and writeoff of certain assets related to that restructuring. In addition, operating expenses for the third quarter included depreciation of approximately $100,000 and stock-based compensation of approximately $800,000. Stock-based compensation included $650,000 related to the accelerating vesting of certain stock options for senior management and employees.

For the fourth quarter, we expect approximately the same amount of depreciation, or about $100,000, and anticipate that stock-based compensation will drop to about $50,000. We expect overall operating expenses for the fourth quarter to drop substantially to between $9.5 million and $10 million, largely as a result of the restructuring. That is over $2 million per quarter lower when compared to the third-quarter operating expenses, and $1.5 million per quarter lower when compared to the second quarter.

Finally, our adjusted EBITDA loss for the third quarter of 2012 was approximately $3.2 million as compared to the $1.7 million adjusted EBITDA loss for the second quarter. However, we expect to generate positive adjusted EBITDA for the fourth quarter with approximately the same amount of revenue, because margins should improve and operating expenses will be substantially lower.

Now turning to the balance sheet, cash and short-term investments at September 30, 2012, declined to $10.3 million from $13.1 million at June 30, 2012, primarily due to the adjusted EBITDA loss. The net effect of other balance sheet changes had a positive effect of about $500,000.

Accounts receivable grew to $26.1 million at September 30, 2012, from $25.5 million at June 30, 2012, increasing the number of days sales outstanding on accounts receivable for the third quarter to 80 days as compared to 74 days for the second quarter. The growth in receivables and DSO was largely attributable to our largest customers. As we have stated before, the shipment and payment cycle with our largest customers continue to create these large fluctuations.

Our total debt obligations associated with our working capital facility with Wells Fargo remained at $10 million at September 30, 2012, and June 30, 2012. You may recall that we entered into this new working capital facility during the first quarter of this year and anticipate that it will provide adequate liquidity to continue to run the business during its entire two-year term.

Lastly, the weighted average basic and diluted shares outstanding were 31.1 million for the third quarter of 2012 and 31 million for the second quarter of 2012.

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. In summary, we believe that we can return to profitability in Q4 through better gross margins and substantially lower OpEx. That profitability should also continue for 2013 as a whole and generate positive free cash flow from operations.

Thank you for joining us today. We would now like to open up the call to questions. Operator, please began the Q&A portion of the call.

(Operator Instructions) [Lalat Munah]

Hello. Yes, hi, guys. You know, you guys are not a Chinese company; and considering that, I think this was a pretty decent quarter, because I have seen some of your competitors having pretty bad quarters recently. I am also encouraged by the fact that you have done some restructuring and hopefully that will bear some fruit in the next quarter and for the next year.

Can you please describe in a little more detail your restructuring effort in Q3? What I want to know is how much of the Q3 losses that were attributable to the restructuring costs. You mentioned I think $700,000; was that the total expense of the cost of restructuring?

Yes, that's right. The $700,000 was incurred for severance, the termination of the leased office that we had, and also the writeoff of various equipment related to that portion of our operations.

Okay. Now, I assumed you have completed the renegotiation of your Largo facility lease agreement. A, is it fair to assume that you have gotten rid of the excess space you used to have?

Yes, we extended the term through June of 2013 and are currently in negotiations to extend that again. The other space that we had prior to that time has been turned back to the landlord and we are not paying for it.

So, your operating expense estimate you have provided earlier, does that get full benefit of this renegotiation of your lease? Or you have maybe some more savings coming down the line?

No, that has already been reflected in our operating expenses; and there aren't any future savings on the Largo lease.

Oh, okay. Now, during the last conference call you had mentioned that you are going to focus on improving gross margins. And looking at all the various competitors, Zhone's gross margins are probably one of the lowest.

Also, we note that all the other competitors have their manufacturing outside US. Are you getting to a point where you may consider doing the manufacturing outside US to become competitive as far as the gross margins are concerned?

Lalat, first of all, this is Mory Ejabat; thank you for your earlier compliment. And let me tell you about our gross margin. Actually our gross margin is better than some of our competitors.

A couple of domestic competitors that we have, actually they only sell domestically and with a small amount of revenue coming from international market, which they have a better gross margin as a result. Even though a couple of them have acquired companies in -- can do international business actually, we have seen some erosion on the gross margin as well.

Now, if you compare our gross margin with ZTE and Huawei and any other international companies, actually -- Alcatel-Lucent, actually we are high in the gross margin. Given that, we are continuously trying to improve our gross margin by focusing on cost reduction of our product and actually our efficiencies in manufacturing.

We have done several studies of manufacturing in the US versus manufacturing overseas. Considering the fuel costs and the transportation costs of the product shipping from overseas to different areas in the world, we feel our manufacturing is very competitive, and it might be in some instances better efficiency than other companies.

Thanks. That's helpful. Another question I had, because of the losses, your cash level is declining. And one question I have is, you have this revolving credit line with Wells Fargo. Are you getting close to where you may be in trouble with their covenants for the credit line?

We looked forward through the term of the credit line and believe we will be in compliance. We did the restructuring in order to continue to be in compliance, so that that would provide adequate liquidity to continue to run our business through the term, which ends in the beginning of 2014.

Oh, okay. Well, thank you. I have a few more questions, but I think I probably would give other people a chance to ask questions and go back in line and if I get a chance ask a few more questions later on. Thanks.

You can always send us an e-mail if you wish to do so.

Thank you.

(Operator Instructions) All right, with that we will go ahead and conclude our question-and-answer portion of today's event. I would like to turn the call back over to Mory for some closing remarks.

Once again, thanks for joining us today and for your continued support. We are looking forward to speaking with you on our next earnings, and we hope to discuss a return to profitability then. Thank you very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. All lines may disconnect at this time.