DZS Inc (DZSI) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2014 Zhone Technologies Incorporated conference call. My name is Chris and I will be your conference moderator for today.

At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session toward the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

And now I would like to turn the conference over and introduce Mr. Kirk Misaka, Zhone's Chief Financial Officer. Please proceed.

Thank you, operator. Hello and welcome to the fourth-quarter 2014 Zhone Technologies, Inc. conference call. I'm Kirk Masako, Zhone's Chief Financial Officer.

The purpose of this call is to discuss Zhone's fourth-quarter 2014 financial results as reported in our earnings release that 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 Jim Norrod, Zhone's Chief Executive Officer. Jim will begin by discussing the key financial results and business developments of the fourth quarter. Following Jim's comments, I will discuss Zhone's detailed financial results for the fourth quarter of 2014 and provide guidance for next quarter. After our prepared remarks, we will conclude with questions and answers.

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, 2013, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2014, June 30, 2014, and September 30, 2014.

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 supplement the 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 comparison to the Company's historical operating results and comparisons to competitors' operating results.

The presentation of this additional information is not meant to be considered in isolation or as a substitute for measures of financial performance prepared in accordance with GAAP. We have provided GAAP reconciliation information for 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 Jim Norrod, Zhone's Chief Executive Officer.

Thank you, Kirk. Good afternoon and thank you for joining us today for our fourth-quarter 2014 earnings call. During the fourth quarter, we began regaining the momentum lost in the transition and restructuring that we did in the third quarter. We carry that momentum into the new year with renewed optimism that our Company is positioned for exciting growth and profitability.

This quarter's modest revenue growth is just the beginning. We see continued revenue growth in 2015 that will get us back to profitability for the year as a whole.

In the first quarter, we will take another step forward and we fully expect to see improving financial results as the year progresses, driven by the changes and investments that we have made these past two quarters. Kirk will talk more about how that translates into financial results throughout the year, so let me talk about the growth opportunities that position us for success in 2015 and beyond.

In 2015, we see three primary growth catalysts. First, the launch of our new industry-leading MXK-F platform will provide significant network improvements for existing customers and will attract new customers to upgrade to our industry-leading access technologies.

Second, the execution of our focused sales and marketing strategy for FiberLAN will lead to continued growth multiples in our nascent enterprise business. And third, our largest service provider customers plan significant incremental network expansion in 2015. Now let me elaborate on each of these exciting growth opportunities.

In the fourth quarter, we made our first revenue shipment of our next-generation MXK-F platform. The MXK-F is the fiber-only evolution of our MXK product line, offering 10 times the switching capacity and 2 times the port capacity, while giving our customers a migration to new high-speed fiber services and access to network functions, like software-defined networks, deep packet inspection, and other network virtualization functions.

Zhone will continue to support and enhance our MXK classic platforms for copper and fiber access deployment. Our customers have been anxiously awaiting for the release of the MXK-F and the enormous demand has already exceeded our expectations. We are certain that this industry-leading platform will soon catch the attention of other service providers around the world, creating an opportunity for us to develop a substantial new customer base.

The second growth catalyst is one I talked about extensively during our last conference call. We remain as confident as before that FiberLAN, our optical LAN solution for the enterprise, can be a $100 million annual revenue business in 5 years. A growth rate which exceeds doubling on an annual basis is just one indicator of the potential. An 80% success rate in closing sales opportunities is another.

But perhaps the best indicator is the complete satisfaction of customers that have deployed our FiberLAN solution, satisfaction resulting from lower capital costs, lower operational maintenance and IT expenditures, better performance, increased security -- and, as we know, this is on everyone's radar -- a green solution that reduces carbon footprint through lower power utilization and cooling requirements.

We continue our business development efforts with several large strategic partners who share our belief in the significant potential of the optical LAN market and who share our commitment to make it a reality. They see the same powerful value proposition for FiberLAN as we do.

This quarter, we announced a nonexclusive agreement with Corning to co-market an all-fiber network solution capable of deploying passive optical local area network and cellular distributed antenna systems on a common infrastructure. The result will be quicker installation, a smaller equipment footprint, and lower cost for enterprise companies.

We also announced a new FiberLAN distribution agreement with Temple, a distribution company headquartered in Dublin, that provides connectivity solutions to enterprise companies throughout Europe, Middle East, and Africa. Temple is a leading advocate for passive optical LAN and is dedicated to communicating its value within the region.

The company knew its enterprise customers would benefit from the partnership, because Zhone's FiberLAN enable enterprises to improve energy efficiency and reduce operating costs and infrastructure complexity. Meanwhile, FiberLAN deployments continue to expand and more than doubled from 2013 to 2014. I expect the same for 2015.

Last quarter, we announced a new FiberLAN deployment with Beanfield Metroconnect, a Toronto-based telecom company, an official supplier of the Toronto 2015 Pan Am/Parapan Am Games. They will be providing state-of-the-art network infrastructure for game venues in the CIBC Pan Am/Parapan Am Athlete's Village.

This quarter, we announced a new FiberLAN deployment with Washington State University. The deployment was made possible through working with Leidos Engineering. WSU, a public research university located in Pullman, Washington, needed a flexible and future-looking solution to upgrade the broadband infrastructure for its on-campus housing.

With a student body of nearly 28,000, WSU selected Zhone's passive optical LAN solution, FiberLAN, to improve bandwidth availability and reliability for students living on campus. WSU is continuing to integrate POL into its own information technology building and other campus administrative and housing facilities.

The last growth catalyst comes from our existing customer base. During my first six months at Zhone, I traveled the globe to meet with our largest customers, to listen to their strategies for success in 2015 and beyond and to find out how we could help them achieve their objectives.

Resoundingly, our customers told me that we provide the most innovative cutting-edge technologies available today and that they need us to continue that leadership role. They were uniformly excited about the launch of our new MXK-F, citing it as another game changer that they want to get into their networks as soon as possible.

In addition, many of our top 10 customers talked to me about their growth plans for 2015 and beyond. Those plans represent significant incremental expenditures over the next few years. Since our top customers generate nearly two-thirds of our total revenue, I am very encouraged that those customers have aggressive growth plans that include our technologies.

To summarize, we see 2015 as a strong growth year for Zhone, stemming from the first shipment of our highly anticipated MXK-F, the execution of our sales and marketing strategy for FiberLAN, and incremental network expansion by our largest customers. We are very excited about the opportunity, because we know that revenue growth, coupled with operating expense leverage, leads to improving profitability.

Now let me turn the call back to Kirk to provide more details about returning to profitability, our financial results for last quarter, and to discuss our financial guidance for the next quarter. Kirk?

Thanks, Jim. Today, Zhone announced financial results for the fourth quarter of 2014. Fourth-quarter revenue of $30.1 million grew 2.3% sequentially from third-quarter revenue of $29.4 million and generally met our expectations of mid single-digit percentage growth.

As Jim mentioned, we expect revenue growth in 2015 to be driven by the launch of our MXK-F, continued strong growth in FiberLAN, and strength in our international markets due to incremental network expansion plans by our largest customers. Due to normal seasonal patterns, we expect first-quarter revenue will decline by about 10% from the fourth quarter before growing sequentially throughout 2015.

We experienced slightly more customer concentration this quarter, with the top 5 customers representing approximately 51% of revenue for the fourth quarter as compared to 44% for the third quarter. We also had three 10% customers in the fourth quarter as compared to two 10% customers in the third quarter.

Since all of our 10% customers were international, our international markets continue to produce the vast majority of our business and represented 71% of revenue for the fourth quarter as compared to 61% of revenue for the third quarter.

Gross margins of 30.6% was below our guidance range of 33% to 35%, largely due to increased labor costs on the initial shipments of our MXK-F and a large low margin upgrade at one of our 10% customers. Since the manufacturing process for our MXK-F will become more efficient with time and a customer upgrade was completed in the fourth quarter, we expect gross margins to rebound in the first quarter to more normal levels estimated at between 34% and 36%.

Operating expenses of $11.3 million for the fourth quarter were approximately $2 million lower than the third quarter, which included the nonrecurring CEO transition and business restructuring costs that we talked about last quarter. We anticipate that operating expenses will continue to range between $11 million and $11.5 million for the first quarter of 2015 before dropping by about $1 million in the second quarter of 2015 as a result of the business restructuring.

Operating expenses for the fourth quarter included depreciation of approximately $100,000 and stock-based compensation of approximately $250,000, both of which we expect to continue at about the same level into the first quarter of 2015. Finally, our adjusted EBITDA loss for the fourth quarter of 2014 was $1.7 million and net loss on a GAAP basis was $2.1 million or $0.06 per basic and fully diluted share.

For 2015 we are looking forward to returning to profitability. That profitability will be driven by revenue growth, a rebound to historical gross margin levels, and lower operating expenses resulting from restructuring the business. We expect that profitability to begin in the second quarter and accelerate through the end of the year.

Now let's look at the balance sheet. Cash and short-term investments at December 31, 2014, declined to $11.5 million from $13.5 million at September 30, 2014, primarily due to the adjusted EBITDA loss. The net effect of other balance sheet changes was very minor, although specific balance sheet accounts fluctuated to a larger extent.

Accounts receivable decreased to $29.9 million at December 31, 2014, from $34.2 million at September 30, 2014, improving the number of days sales outstanding on accounts receivable to 89 days as compared to 104 days for the third quarter. Offsetting that improvement was an increase in our net inventories from $17.7 million to $20 million that we expect to reverse next quarter.

Our total debt obligations associated with our working capital facility with Wells Fargo remained at $10 million at both September 30 and December 31, 2014. Lastly, the weighted average basic and diluted shares outstanding were 32.5 million for the fourth quarter of 2014.

And with that financial overview, let me turn the call back to Jim for a few final comments before we open the call to questions and answers.

Thank you, Kirk. We enter 2015 with a renewed level of confidence that we will grow revenue in both our service provider and our enterprise businesses. We are equally confident that our focused business structure and decisive business restructuring will lead to profitability, which remains our primary financial objective. Our MXK and zNID solutions continue to be deployed by service providers and enterprises globally by the most dynamic companies across the globe.

Now I would like to open up the call to questions. Operator, please begin the Q&A portion of the call.

(Operator Instructions) Alan Davis, LA Davis.

Just a couple quick questions here. First of all, in the service provider business, curious if some of the weakness -- just topline weakness in the third quarter and early fourth quarter was due to the pending release of the MXK-F platform. And then secondarily, do you guys still project that business as kind of a low to single digit growth business?

Yes. Good question. We see the service provider business -- because we do more than two-thirds of our business outside the US, the service provider business outside the US is still a growing, thriving business. We see excellent growth.

The MXK-F that we talked about, we actually shipped the first one of those in December to one of our large service providers in the Middle East. So again, we continue to see excellent growth opportunities, both Middle East, Europe, and Central America -- Latin America.

The US service provider business will be somewhat more flat going into 2015. We continue to see a flattening of that business. I think that is going to continue in the year coming up -- 2015 -- as I mentioned. But we do see -- because we are so heavily weighted to international, the whole service provider business in total will grow. But again led by international customers.

Okay. Thanks. And the $1 million drop in OpEx starting in 2Q, just give us a sense for kind of where those cuts are coming from.

Hey, Alan. This is Kirk. A significant portion comes from the R&D group, given that as we prepared for the launch of the MXK, much of the increase in expenditures related to that. But also as a result of our business restructuring, we are seeing cuts across the board. So you will see some reductions in G&A and sales as well.

Okay. And then last two questions. One regarding gross margins. I guess given your comments and the guidance next year as a pair to expect, it sounds like you expect for the year increased gross margins over 2014.

And then lastly, I guess on FiberLAN, you guys get this question every quarter, but do you guys want to provide any guidance, either quantitative or qualitative, in terms of your expectations on that for the year -- 2015?

Okay. Let me start with gross margins. For the year as a whole, 2014 gross margins were at 34.7%. Our guidance for the first quarter was 34% to 36%, so that is pretty close to being in the middle of that bandwidth.

We do hope, though, that we would see some margin expansion in 2014. I don't know whether it is going to push us to the top end of that range or whether we will get back to the historical range, which was 35% to 37%. So it is going to be close, but the midpoint of that range is probably about right.

In 2015, you mean.

In 2015. Yes.

And then on the second part of the FiberLAN question, I think everyone knows that in the last quarter, I really ramped up a sales organization to focus on this opportunity by bringing in a dedicated vice president of FiberLAN enterprise sales, with several salespeople and support people per.

That business, as we mentioned, has double from 2013 to 2014. I expect again it will double in 2015. The guidance that we have given to the analysts has been pretty consistent that we thought that that would be a $100 million business in 5 years. And I am still holding to that, that number.

We have not disclosed the actual numbers on that. We said we wouldn't do that until it became at least 10% of our total revenue, which obviously it is not there yet.

All right. Good. Thanks, gentlemen.

(Operator Instructions) Bill Morrison, Oppenheimer and Company.

Couple of questions. First on the DPI, how much do you expect for that to contribute to the gross margin in sales? I mean, do you expect it to be over 10% in 2015 or beyond?

And then secondly, for the carrier business, do you expect that to grow a bit faster than the low to single digit level that it was in 2014 or is it the same?

Hi, Bill. The DPI capability that we talked about in the earnings release or in the statements we made is a new network function that we will be adding to our MXK-F platform. There are several functions that we are working on, such as deep packet inspection or DPI, other network virtualization features, and SDN, which is software-defined networks.

Our engineering team is rapidly working on these to include these in later releases of the MXK-F. We have not shipped those yet. But they will be added to our MXKF- platforms in the future. So we are not giving guidance on any specific revenue related to DPI yet. So we haven't done that.

On the carrier business, low to single digit improvements -- again, the service provider business, we are comfortable with that moving forward. And that is, as I said, total. That includes domestic and international.

But again, I want to repeat that over 70% of our business today is in international, so you could just imagine that the international will be the growth engine in the service provider area. And as I mentioned, domestically will be somewhat flat.

Okay. Just a couple of follow-ups on that. On the domestic business, why wouldn't there be any boost from CAF or government stimulus?

Well, there very well could be, but we are not counting on it. Government stimulus has always been important to our revenue growth when we have seen it. So yes, I mean, we're going to need it all to make domestic be flat. I think there is no question that the domestic service provider business has been a challenge for us as well as several of our competitors.

So again, our goal is to, Corporation-wise, to be single-digit improvement on that business, led by international. Domestic will still -- it'll still be a fight, no question. And I don't want you to think it is going to be a simple task. But yes, I think government stimulus could help there.

Good. Okay. And then on the DPI and SDN, I mean, is that later in 2015 or beyond or --?

Yes. Later in 2015 and beyond, both.

Okay. I mean --

There's several things we are doing. And I want to point out that the MXK-F is a fiber-only OLT. It is a fiber-only product and that gives us the ability to do these different advanced technologies on that product. And again, we are working on all these as we speak. And we have not announced when it will be released yet, but it will be -- some will be this year and some will be next year.

Okay. Good. And then the technology underlying both of these, are they homegrown or do you license them?

Yes. Yes. They are homegrown. Our engineering team -- as you know, we have been in the MXK business for a long time. And so our team, of course, has brought this new platform out -- the fiber-only platform, as I mentioned, that has got 10 times the switching capacity and over 2 times the port capacity.

So we did all that ourselves, all homegrown. The software that we are working on on these new features will be homegrown. So yes, it all belongs to us.

Okay. And the SDN controller, is it based on OpenDaylight or something else or you haven't said that yet?

No. We haven't talked about that yet.

Okay, great. Thanks a lot. Appreciate it.

Barry Bergman, Barry Bergman Management.

I would like to know does Zhone have an IR firm representing it?

No, we do not.

So who handles investor relations?

We have an internal person that takes the call and then forwards them appropriately to Jim and myself.

All right. Because I have called numerous times -- a couple of times, I have called Kirk. And I have never gotten a call back from anyone.

Barry, this is Jim Norrod. I think, if I am not mistaken, you got a call back from me.

No, I didn't.

You didn't. Okay. I'm sorry. I will give you a call back then.

Appreciate it.

All right? I got your number. I will call you.

Thank you.

All right.

(Operator Instructions) And we have no further questions at this time, sir.

All right. Well, again -- once again, thank you for joining us and your continued support. We certainly look forward to talking to you in the next quarter's earnings conference call and talk about our progress on achieving sustainable revenue growth and profitability.

We are excited about moving forward here and, again, we'll look forward to communicating that to you. And Barry, you will be hearing from me today.

Ladies gentlemen, that concludes today's conference. Thank you so much for your participation. You may now disconnect. Have a great day.