DZS Inc (DZSI) 2016 Q2 法說會逐字稿

Good day and welcome to the second-quarter 2016 Zhone Technologies, Inc. conference call. My name is Karen and I will be your coordinator 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 second-quarter 2016 Zhone Technologies, Inc. conference call. I am Kirk Misaka, Zhone's Chief Financial Officer.

The purpose of this call is to discuss Zhone's second-quarter 2016 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 in the second quarter. Following Jim's comments, I will discuss Zhone's detailed financial results for the second 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 made 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; statements that express our plans, objectives, and strategies for future operations; the completion and timing of the closing of the merger with Dasan Network Solutions; and the timing and amount of financial benefits that may be achieved in connection with the merger.

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, 2015, and our quarterly report on Form 10-Q for the quarter ended March 31, 2016. 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 second-quarter 2016 earnings call. As you know, on April 12, we announced signing an agreement to merge with Dasan Network Solutions.

Since that time, we've been working to complete the transaction while remaining focused on improving our stand-alone financial performance so that we can carry those successful practices to the combined Company. So before talking about the merger, let me spend a few minutes to reflect on our stand-alone financial performance for the second quarter.

Revenue grew by nearly 10% over the first quarter from normal seasonal strengthening and focus by our sales team to avoid the possible business distractions that can accompany a merger announcement. Gross margins also continued showing strength at nearly 39%, while adjusted operating expenses, excluding transaction costs associated with the merger, were also better than expected.

The net result of revenue growth, continued strong gross margins, and lower operating expenses reduced the adjusted EBITDA loss by nearly $600,000. And we nearly finished the quarter at breakeven, which was our goal.

Meanwhile, our balance sheet continues to be strong and we have adequate liquidity with our Wells Fargo debt facility to adequately manage the business. So while the second quarter had significant challenges, especially with the merger announcement, we performed well. And I am proud of the effort of our team and the progress that we are making toward becoming a growing, profitable company.

As I have mentioned before, we have four growth catalysts. First, the official launch of our MXK-F is being deployed by our largest customers. Second, the global economic conditions that caused the downturn in 2015 are stabilizing enough to create an improved spending environment for our international service provider customers. And we are seeing more business from those customers in our third- and fourth-quarter forecasts.

Third, the second round of Connect America funding should begin to provide some stimulus for our US service provider customers in the second half of the year. Fourth, our enterprise business continues to grow rapidly. Kirk will provide more financial details of the second quarter later, so let me say a few words about our two businesses.

First and foremost, we continue to support our strong and well-established service provider business, serving the most innovative carriers around the world. In order to continue being a global leader in that business, we will maintain the course of investing heavily in R&D to provide the cutting-edge technologies that our customers expect and demand.

In the fourth quarter of 2015, we officially launched the MXK-F, a new aggregation platform that can support fiber-based triple-play service from one chassis for a large city of up to 250 million users. Innovations like the MXK-F are what made us a global leader in fiber access transformation.

As I have 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. 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, it continues to grow rapidly because of the compelling value proposition of our FiberLAN product. As I have said many times, it is easily the most cost-effective energy-efficient and secure alternative to traditional copper LAN infrastructure. Although FiberLAN revenue is still relatively small, 2015 FiberLAN revenue more than doubled over 2014 and we saw the same growth rate in the first half of 2016.

In addition to growing at a rate which exceeds doubling on an annual basis, we continue to see the total pipeline of opportunities filling up, leading to continued strong growth in the enterprise business as key reference wins in numerous market verticals are leading to follow-through successes in those markets.

As you can see, our two businesses continue to thrive as we approach the merger with Dasan Network Solutions, so let's talk about what we believe will be an exciting opportunity for Zhone. As previously announced, the current stockholders of Zhone will own 42% of the combined Company's outstanding shares and 58% will be held by Dasan Networks. Upon completion of the merger, the combined Company will be named Dasan Zhone Solutions, and we expect trade under the symbol DZSI on the NASDAQ capital market.

After the acquisition, Dasan Zhone Solutions will have two co-CEOs, as I will run sales, marketing and G&A, and Yung Kim will manage engineering, support, and operations. Yung has over 30 years of experience in telecommunications and has held executive positions at British Telecom and Korea Telecom. His background and wealth of experience will help lead our combined Company's product strategy.

Both Zhone and Dasan Network Solutions are market leaders in the broadband access sector with strong and loyal customers around the world. The combination of Dasan Network Solutions and Zhone will enhance this leadership position in both carrier and enterprise solutions for the broadband market.

As I've stated before, there are three compelling reasons for this merger, and we continue to be excited about the benefits of the combination. The first reason is a near-perfect complementary product line. Zhone is world class in broadband access and passive optical LAN, and Dasan Network Solutions is world class in mobile backhaul and Ethernet switching. We believe that combining the products and talents of Dasan Network Solutions and Zhone, we will deliver the most complete competitive solution in the market.

The second reason is near-perfect complementary markets and marketing teams. Our customers just do not overlap. Where we are strong, Dasan is not active, and where Dasan is strong, Zhone has not been active. Jointly, we will have a stronger sales and support organization.

This transaction also expands our customer base worldwide. The combined Company will have a strong presence in every geographic region in the world for growth of sales, service, and support. This complementary customer base and market opportunity will also create operational efficiencies which will flow to improved financial results.

The third compelling reason is financial strength. The merger will more than double revenue, strengthen the balance sheet, and provide the scale to become profitable. In addition, the combined Company will have access to significant lines of credit and/or committed loans.

The merger will also facilitate operational efficiencies which are expected to significantly improve adjusted EBITDA and GAAP net income performance. The transaction will be immediately accretive.

To summarize the three compelling reasons for the merger are: complementary products, complementary markets, and financial strength. The combination will expand the product portfolios of both companies and grow our substantial carrier and enterprise customer base.

We will have a strong position as a leading provider in four key areas: broadband access, mobile backhaul, Ethernet switching, and passive optical LAN. We will provide customers, both enterprise and service providers, with the best solutions for converged packet-based voice data and video services.

This transaction will bring cost savings from reduction of operating expenses and will be immediately accretive, excluding acquisition- and integration-related charges, providing a stronger balance sheet with better liquidity.

We are working diligently to complete the transaction and currently expect to hold our shareholder vote in September, with a close shortly thereafter. The distribution of our shareholder proxy statement will contain much more information about the transaction and will proceed the shareholder vote by about one month, so please stay tuned.

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 second quarter of 2016. Second-quarter revenue of $22.6 million grew 10% sequentially from first-quarter revenue of $20.6 million, and slightly more than the normal seasonal improvement that we expected.

In particular, our domestic business outperformed with 18% sequential revenue growth, while our international business grew by just 3%, since global economic uncertainties are having a greater impact on our international service provider customers, making them cautiously approach new network investments.

As a result, revenue from our international customers, who typically produce the vast majority of our business, represented just 51% of revenue for the second quarter as compared to 62% of revenue for 2015 as a whole and 68% for 2014. With the revenue growth, we also experienced slightly less customer concentration this quarter, with the top 5 customers representing approximately 42% of revenue for the second quarter as compared to 46% of revenue for the first quarter. And we had two 10% customers in the second quarter as compared to 3 in the first quarter.

As for next quarter, we expect normal seasonal improvement, which should result in slight sequential revenue growth into the third quarter on a stand-alone basis. However, if the merger with Dasan Network Solutions is approved by shareholders and the transaction closes in the third quarter, then all of our forward-looking guidance will not be reflective of the actual results of the combined Company, which as Jim mentioned will be named Dasan Zhone Solutions.

Instead, the financial results of the combined Company will reflect those of Dasan Network Solutions for the entire quarter combined with the financial results of Zhone just for the step-period following the close going forward. The reason for this treatment is that Dasan Network Solutions will be treated as the acquirer for accounting purposes, even though Zhone is the legal acquirer. For more details, please read the forthcoming proxy statement which as Jim mentioned will hopefully be distributed sometime in August.

Gross margins of 38.8% exceeded our guidance range of between 36% and 38% due to stronger domestic margins, stronger enterprise margins, and continued manufacturing efficiencies. We expect our domestic international mix to begin normalizing next quarter.

As a result, we expect gross margins for the third quarter of 2016 to return to historical norms of between 36% and 38% on a stand-alone basis. But as just mentioned, will not be reflective of the combined Company's gross margin percentages.

Total operating expenses of $10.4 million for the second quarter included merger-transaction-related costs of $1.2 million. Adjusted operating expenses, excluding these transaction costs, were approximately $9.2 million and below our original guidance expectations of between $9.5 million and $10 million, excluding merger transaction costs. Total operating expenses for the second quarter also included depreciation of $145,000 and stock-based compensation of approximately $100,000.

For the third quarter, we expect total operating expenses on a stand-alone basis to range between $9.5 million and $10 million, excluding expenses related to the potential merger, which will be expensed when incurred.

Finally, our adjusted EBITDA loss for the second quarter of 2016 was $85,000 as compared to an adjusted EBITDA loss of $668,000 for the first quarter. Our net loss on a GAAP basis was $1.6 million and $0.05 per basic and diluted share in the second quarter of 2016 as compared to the net loss of $3.4 million and $0.10 per basic and diluted share in the first quarter.

Our goal for the third quarter is to be slightly profitable on an adjusted EBITDA basis, excluding any expenses related to the potential merger. And as mentioned, actual results of the combined Company will be different if the merger closes.

Now let's take a look at the balance sheet. Cash and short-term investments at June 30, 2016, decreased $8.3 million from $9.3 million at March 31, 2016, largely due to the adjusted EBITDA loss and merger transaction expenses, offset by a slight improvement in our net working capital balances.

Accounts receivable increased to $26.5 million at June 30, 2016, from $24.8 million at March 31, 2016, while the number of days sales outstanding on accounts receivable improved slightly to 106 days as compared to 108 days for the first quarter. DSOs have been elevated over the past few quarters, largely due to the patterns of shipments to and collections from our largest customers. We expect those patterns to normalize and DSOs to continue improving in 2016.

Net inventories remained relatively flat at $14.4 million as of June 30, 2016, as compared to $14.6 million as of March 31, 2016. And our total debt obligations associated with our Wells Fargo working capital facility remained at $2 million at June 30, 2016, and March 31, 2016.

Net property and equipment increased to $4.4 million at June 30, 2016, from $2.2 million at March 31, 2016, largely due to the leasehold improvements made to relocate our Florida manufacturing and engineering facility. Lastly, the weighted average basic and diluted shares outstanding remained at 33.8 million for the second quarter of 2016.

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

Thank you, Kirk. The changes we made over the past two years are beginning to bear fruit in 2016 and will create sustainable revenue growth and profitability for the future. Despite the impending transaction, we continue to maintain focus on our stand-alone financial performance and are driving the initiatives that will create revenue growth and margin expansion while maintaining cost efficiencies.

As for our merger with Dasan Network Solutions, the combination will expand the product portfolios of both companies and grow our substantial carrier and enterprise customer base. A complementary product portfolio and complementary customer base will lead to revenue growth.

We will have a strong position as a leading provider in the four key areas of broadband access, mobile backhaul, Ethernet switching, and passive optical LAN. We will provide customers, both enterprise and service providers, with the most and the best solutions for converged packet-based voice, data, and video services.

The transaction will bring cost savings from the elimination of duplicate operating expenses and will be immediately accretive excluding acquisition- and integration-related charges, providing a stronger balance sheet with better liquidity.

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 off, I wondered on FiberLAN, could you give us a little more granularity on that in terms of momentum first quarter to second quarter? Any change in momentum in sales or in the pipeline?

Yes, Alan, the momentum has continued to advance and grow. We got a couple fairly large deals, which we are very pleased to have gotten, and the size of the deals were pretty substantial. So yes, the momentum is continuing. And again, our goal is to double again this year over last year, and I think we are right on track to do that or beat it. So yes, I think the momentum is continuing.

Okay. Okay, great. And then just one on your service provider market. As you look out to the second half of the year, just trying to get a sense for your expectations here. As you look at the three factors you mentioned -- the stabilizing economic conditions, the new MXK platform, and then the Connect America funding -- if you were to rank those in terms of importance to your top line or the effect it will have on your top line, how would you do that?

I think the stabilizing environment is probably number one of that. I think we -- and that is kind of translating into some additional international opportunities. So the stabilization, we are really talking more international there than domestic.

So I think that that, because of the stabilization, we are seeing some of the customers that we haven't seen business from for a year or so internationally are now starting to come forward and buy. So I clearly put that as number one, and then number two would be the MXK-F and then followed by the connectivity, the third one.

Okay, okay. And then last thing here. If the deal does close in the third quarter, do you guys do a call to discuss it or just wait until the third-quarter results call?

We have not made a decision with regard to that. It really kind of depends on how close it is to the quarter end.

Okay.

And whether we will be reporting third quarter in any event.

Okay, fair enough. Thank you.

Bill Morrison, National Securities.

Just a couple of quick questions. First of all, do you see any RFPs or any trial activity on NGPON2?

Yes. We are seeing some RFPs on NGPON2. They are longer-term RFPs, but yes, we are seeing some.

Okay, good. So when would you expect that to start to contribute?

Next year, Bill. 2017.

Good. Also with Dasan, you are looking for immediately accretive, so you must have done some work on a model. Is it going to be accretive to the gross margin? What kind of model would we be looking at?

Bill, we have not provided any information to the markets, and don't plan on doing that until a transaction is approved by shareholders. What we will do is as soon as we have formulated an operating plan of the combined Company, and it is approved, we will try to get that information out as soon as possible.

Okay, good. And then looking at Dasan's pipeline, how is that shaping up here domestically? Has there been any movement and any wins, losses, that kind of thing?

Domestic defined as US?

Right. Here.

Well, we haven't really disclosed any of that information yet, Bill. I know everyone on the phone is interested in getting more details on this and we just haven't published any information on it specific to their pipeline or their customers or -- we just haven't disclosed it.

All right, all right, great. Thanks.

Thank you. That concludes our question-and-answer session for today. I would like to turn the conference back over to Jim Norrod for any closing comments.

As always, we thank you and appreciate you joining us today and especially for your continued support. We continue to be very optimistic that we are positioned for strong growth opportunities that will lead to success in 2016 and beyond. We also remain committed to converting that success into profitability and shareholder value, especially as it relates to the merger.

We look forward to speaking with you all again on the next quarter's earnings conference call to talk about our progress on the merger and achieving sustainable revenue growth and profitability. So again, thank you and we appreciate your time.

Thank you. That concludes today's conference. Thank you for your participation and you may now disconnect.