DZS Inc (DZSI) 2015 Q3 法說會逐字稿

Good day and welcome to the third-quarter 2015 Zhone Technologies, Incorporated, conference call. I'm Alex and I will be your operator for today. (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 2015 Zhone Technologies, Inc., conference call. I'm Kirk Misaka, Zhone's Chief Financial Officer.

The purpose of this call is to discuss Zhone's third-quarter 2015 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'm here today with Jim Norrod, Zhone's Chief Executive Officer.

Jim will begin by discussing the key financial results and business developments of the third quarter. Following Jim's comments, I will discuss Zhone's detailed financial results for the third quarter 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, 2014, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2015, and June 30, 2015.

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.

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.

Thanks, Kirk. Good afternoon and thanks for joining us today for our third-quarter 2015 earnings call. As I discussed last quarter, we have transformed our business over the last year to focus on our two key businesses: being a global leader in fiber access transformation for service providers, and providing the most cost-effective, efficient, and environmentally friendly alternative to existing copper-based ethernet LAN infrastructure to businesses and other enterprises, using our industry-leading FiberLAN technology.

We have a strong and well-established service provider business serving the most innovative carriers around the world. Despite the drop in revenue for the third quarter, we continue to be encouraged by the interest in our industry-leading products and believe that, when global economic conditions improve, so will demand for our products.

In order to continue being a global leader in that business, we maintained the course of investing heavily in R&D to continue providing the cutting-edge technologies that our customers expect and demand. At the same time, we quickly reduced discretionary spending in other areas to adjust to the temporary lower revenue in the third quarter.

As global economic conditions improve, both our service providers and enterprise businesses are positioned for growth. As you know, growth leads to increasing profitability for us, because we can leverage our operating expenses and our manufacturing capacity. Profitability continues to be our number-one financial goal, and we fully expect to return to profitability in 2016.

Revenues are already rebounding. Gross margins continue to surprise to the upside. And as I said, operating expenses have been trimmed to match our current revenue level so that we can get to breakeven EBITDA in the fourth quarter. Kirk will talk more about those specifics, so let me provide a few comments about our two businesses.

As I've said before, our service provider business continues to anchor our Company, so we are encouraged that our largest service provider customers continue to test the MXK-F in their labs, and we expect them to begin operationalizing the MXK-F in their networks soon. They are uniformly excited about the game-changing nature of this platform, and we look forward to helping them migrate to it as soon as possible.

We are certain that this industry-leading platform will also catch the attention of other new service providers around the world, creating an opportunity for us to develop an expanded customer base. We expect to begin a formal product launch later this quarter or even early next year after some of these initial lab tests are completed.

Meanwhile, we continue to support and enhance our MXK classic platforms for copper and fiber access deployments for those service providers on a slower migration path or with different network requirements.

As for our enterprise business, revenue for the first three quarters of 2015 more than doubled over the same time frame of last year, continuing to demonstrate that FiberLAN can be a $100 million annual revenue business in another five years. In addition to growing at a rate which exceeds doubling on an annual basis, we are seeing the total pipeline of opportunities grow even faster than that as the market learns about the FiberLAN value proposition. Also, we are just beginning to tap the international markets, where our world-class sales team and partners have driven our Company's greatest growth.

Our strategic partnerships with other players in this market are also key catalysts to the accelerating momentum in our enterprise business. We previously announced a nonexclusive agreement with Corning to co-market an all-fiber network solution capable of deploying passive optical local area networks and cellular distributed antenna systems on a common infrastructure. Last quarter, we announced another partnership with TE Connectivity to co-market passive optical LAN solutions to customers in a wide variety of sectors including government, healthcare, hospitality, education, and finance.

In this quarter we announced yet another agreement, with Clearfield, the specialist and fiber management and connectivity platforms for communications providers, to co-market GPON solutions for enterprise customers and develop integrated hardware/software solutions that optimize the implementation of Clearfield's fiber optic products with Zhone's fiber access solutions. Clearfield manufactures and distributes fiber optic management products, helping service providers reduce the high costs associated with deploying, managing, protecting, and scaling of fiber optic network to deliver mobile, residential, and business services.

With the popularity of fiber-based local area networks and GPON networks increasing, Clearfield is aggressively expanding, which led it to lease a new 70,000 square foot space for its company headquarters in Minneapolis, Minnesota, earlier this year. And of course, Clearfield chose to deploy Zhone's FiberLAN solution as its broadband network for this new facility that contains both manufacturing space and an office environment.

The space houses up to 100 employees at any given time, so the network had to support approximately 500 devices, including 150 PC workstations and voice-over-IP phones, peripheral devices such as wireless printers, and mobile devices dependent on WiFi connections. This is just one example of the many successful FiberLAN solutions.

With that brief overview of our business, 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 next quarter. Kirk?

Thanks, Jim. Today, Zhone announced financial results for the third quarter of 2015. Third-quarter revenue of $22.1 million declined 19.5% sequentially from second-quarter revenue of $27.5 million. As we discussed last quarter, global economic uncertainties are causing many service providers to cautiously approach new network investments, and as a result many of our international customers have reduced their network expansion.

Although we expect our customers to begin increasing their network investments during the fourth quarter, we do not anticipate that revenue will return to prior levels until these uncertainties are resolved and economic conditions improve. Even FiberLAN revenue growth stalled somewhat this quarter, as some business enterprises postponed discretionary IT spending. Despite that slowing, FiberLAN revenue remains on track to double year-over-year, and we expect that revenue growth to continue into 2016.

Since the global economic slowdown impacted many of our international markets, revenue from our international customers, which typically produce the vast majority of our business, represented just 58% of revenue for the third quarter as compared to 67% of revenue for the second quarter. We also experienced slightly more customer concentration this quarter, with the top five customers representing approximately 42% of revenue for the third quarter as compared to 38% for the second quarter; and we had two 10% customers in the third quarter as compared to no 10% customers in the second quarter.

Despite the decline in revenue, gross margins of 39.6% exceeded our guidance range of 34% to 36%, largely due to stronger domestic margins and continued manufacturing efficiencies. Since the growth in revenue next quarter is expected to be driven by a partial rebound in our international markets, our gross margin mix should normalize and gross margins for the fourth quarter should return to historical levels, estimated at between 34% and 36%.

Total operating expenses of $10.2 million for the third quarter were below our guidance expectations of between $10.5 million and $11 million since we began the process of reducing expenses during the quarter. With the completion of that restructuring process, operating expenses are now completely aligned with the lower revenue level.

We anticipate that adjusted operating expenses, excluding depreciation and stock-based compensation, will drop by approximately $1 million in the fourth quarter, bringing adjusted operating expenses to between $8.5 million and $9 million. Total operating expenses for the quarter included depreciation of approximately $200,000 and stock-based compensation of approximately $400,000.

Finally, our adjusted EBITDA loss for the third quarter of 2015 was $829,000 as compared to an adjusted EBITDA profit of $148,000 for the second quarter. Our net loss on a GAAP basis increased to $1,452,000 and $0.04 per basic and diluted share in the third quarter of 2015, from $366,000 and $0.01 per basic and diluted share in the second quarter. As Jim mentioned, our revised goal is to break even on an EBITDA basis in the fourth quarter and return to profitability next year.

Now let's take a look at the balance sheet. Cash and short-term investments at September 30, 2015, declined to $9 million from $11.1 million at June 30, 2015. Although cash declined by $2.1 million, cash net of debt obligations actually increased by $2.8 million due to the improvement in the net working capital balances, cash generated by employee stock option exercises, offset by the adjusted EBITDA loss.

Accounts receivable decreased slightly to $30.9 million at September 30, 2015, from $31.6 million at June 30, 2015. But the number of days sales outstanding on accounts receivable increased to 126 days as compared to 103 days for the second quarter, and it was impacted by the lower revenue level.

DSOs have been elevated over the past few quarters largely due to the pattern of shipments to and collections from our largest customers. We expect those patterns to normalize and DSOs to substantially improve during the fourth quarter.

We continue to focus on reducing net inventories, which were $15.4 million at September 30, 2015, as compared to $20 million at December 31, 2014. We also reduced our total debt obligations associated with our Wells Fargo working capital facility by $4.9 million, from $10 million at June 30, 2015, to $5.1 million at September 30, 2015.

Lastly, the weighted average basic and diluted shares outstanding were 32.9 million for the third quarter of 2015. With that financial overview, let me turn the call back to Jim for a few final comments before we open the call up to questions and answers.

Thank you, Kirk. We fully expect to regain most of the revenue that we lost last quarter. In the meantime, we reduced our expenses to eliminate the additional cash burn, and yet we continue to make the necessary investments in new technologies in markets that will lead to the greatest growth for the Company. We believe that our focused investments will soon lead to revenue growth; and that, coupled with operating expense discipline, will lead to profitability next year.

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, L. A. Davis.

Thank you. Hey, guys, I had one quick numbers question; I missed one number. Where do you expect your non-cash expenses in the fourth quarter, D&A, and stock comp to come in at?

Excluding depreciation and stock comp, $8.5 million to $9 million.

Okay. Did you say that you expect stock comp and D&A to be similar next quarter, to this quarter?

It was about $600,000 combined this quarter. Next quarter, unless some options are issued or canceled, it should be approximately the same.

Okay, okay. Then in terms of the service provider business, obviously you mentioned the weakness was international. I wonder if you can talk a little bit about any changes, good or bad, in terms of demand, what you're seeing domestically.

And is the new MXK platform being on the horizon, is that pushing out any business?

Yes, I think going forward -- domestic has been somewhat flat here for a while, domestic service provider business. The growth has been in our service -- our enterprise FiberLAN business. But service provider side has been relatively flat, and I see that continuing for a bit until we start getting some leverage with the MXK-F that you mentioned.

We literally just showed that product to our domestic service providers in St. Louis about three weeks ago. They saw it for the very first time, and we're starting to get orders from that now. So I think we'll start to see some increase in revenue on that product here in the next quarter or two.

Okay. Then just lastly on FiberLAN, just looking throughout to the end of the year in terms of your tactical goals with that product, anything we should be looking for over the next few months in terms of either ramping up in certain markets or the same markets? Or is there any kind of acceleration expected? Any milestones you can talk about in that regard?

No, we've been pretty consistent on our doubling of the business this year versus last, which as I mentioned we're better off -- we're even greater than double this year versus last. We expect that's going to continue in both the US markets and the international markets.

My upward surprise on that has been internationally. I see some really good opportunities with the FiberLAN product line internationally, and I think that's going to be hopefully the positive surprise next year to us as we continue to grow that business.

So again, we're pushing hard. We've got, I think, a couple more strategic partnerships to talk about in the next couple quarters on FiberLAN. As you know, we've announced three so far.

We're continuing to push partnerships, which I expect will be -- will have positive impact on the business. Stay tuned for some other announcements on that.

Okay, and are you seeing any changes in the time it's taking to close deals on FiberLAN? Anything there?

No, that hasn't changed dramatically. It's -- the one thing -- we're still trying to figure out how to shorten the sell cycle. We've talked about that several times.

In that, I'm continuing to see it's a tougher sell cycle. It takes longer than normal in the enterprise. But we're sharpening our pencils to try to find out ways to improve it; but I haven't found the magic bullet on that yet.

Okay. All right. Thank you, guys.

Christian Schwab, Craig-Hallum Capital Group.

Hi, great. When, Jim, is FiberLAN -- as we double sales every year, when is it actually going to be big enough that you actually break it out and tell us exactly what we're doing there?

Yes, (multiple speakers) Kirk --

I know the old saying is when it's 10% of revenues and that type of thing. But -- so is that three years from now, is that next year? What's your thought there?

Christian, based on the rate of growth right now, sometime next year, one of the quarters, we expect to be 10% of revenue.

Yes.

Okay. That's very helpful. Great. I don't have any other questions. Thanks, guys.

(Operator Instructions) At this time I show no additional questions in queue. I'd like to hand the call back over to you for closing remarks.

All right, thanks, operator. As always, we thank you for joining us today and for your continued support. We are continuing to be optimistic that we are positioned for tremendous growth opportunities that will lead to success in 2016 and beyond.

We also remain committed to converting that success into profitability and shareholder value, and we look forward to speaking to you again on next quarter's earnings conference call to talk about our progress on achieving sustainable revenue growth and profitability, which are our goals. So again, thanks, folks; and we'll talk to you soon.

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