DZS Inc (DZSI) 2020 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the DZS Q4 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker for today, Ted Moreau, Vice President, Investor Relations. Sir, you may begin.

Thank you, Towanda. Welcome to DZS's Fourth Quarter 2020 Earnings Conference Call. This is an incredibly exciting time at DZS, as our newly assembled senior management team implements a strategic vision for the accelerating broadband access and mobile transport markets. This vision and the strategic milestones necessary to achieve it, along with guidance and context for the quarter and 2021, are all outlined in our Q4 2020 and full year 2020 stockholder report published this morning in the Investor Relations section of our website at dzsi.com. I look forward to interacting with our analysts, shareholders and prospective shareholders.

Joining me today are President and CEO, Charlie Vogt; CFO, Tom Cancro; and CTO, Andrew Bender.

I would now like to provide the DZS safe harbor statement. During this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. The company cautions you that such statements are only current expectations and actual events or results may differ materially. Please refer to documents that the company files with the SEC, including its most recent 10-Q and 10-K reports in the forward-looking statements section of the stock -- of the letter to stockholders that was filed on a Form 8-K as well as being available on our Investor Relations section of our website.

These documents identify important risk factors that could cause actual results to differ materially from those contained in the company's projections or forward-looking statements. Please note that unless otherwise indicated, the financial metrics being provided to you on this call are determined on a non-GAAP basis. These items, together with corresponding GAAP numbers and a reconciliation to GAAP are contained in the letter to stockholders.

With that, I will now turn the call over to Charlie.

Thank you, Ted, and welcome, investors and guests. Prior to the market opening today, DZS released our quarterly stockholder report, providing a market business and financial update for the fourth quarter and full year 2020. Specifically, our stockholder report provides an in-depth insight, milestones and performance achieved during the fourth quarter and full year 2020, such as the numerous technology, supply chain and growth initiatives that are underway.

Our mobile transport milestone, eclipsing 1.5 million ports shipped, our exceptional second half and full year revenue growth across our mobile transport customer sector, our acquisition of Coherent Optics technology innovator, Optelian, complementing our and expanding our mobile transport portfolio, Omdia's market outlook for Open RAN and fiber-based passive optical Networking, and the introduction of Velocity and Chronos, our new portfolio brands for our market-leading broadband and mobile transport solutions.

Also included in our stockholder report are timely business governance and financial updates, such as the addition of 2 new Board members: Matt Bross, who was formerly the CTO of Williams Communications, the former CTO of British Telecom and the former CTO of Huawei; and Barbara Carbone, a former KPMG partner with 4 decades of experience working with public Fortune 1000 companies and subject matter expertise in the areas of mergers and acquisitions, business transformation and workforce management. And our execution of a $64 million follow-on equity raise, which was led by Stifel, Needham and B. Riley and comanaged by Craig-Hallum and Northland Securities with Advisory Services provided by Woodruff & Company.

And finally, our Q1 2021 and full year 2021 guidance. As Ted mentioned, our stockholder report can be viewed and downloaded by visiting the DZS website. Over the past 6 months, management has been diligently transforming and investing in our future. For our employees, our customer-first culture is comprised of a faster pace, higher expectations, a relentless pursuit of operational excellence, unification across our global R&D, supply chain and customer support teams and a higher level of accountability. For our customers, partners and suppliers, our improved communications, attention to detail, sponsored technology workshops and results have fostered better alignment and trust. And while we have much more to accomplish, measurable progress has been achieved. We anticipate that over the course of 2021 and into 2022, our vision, strategy, financial discipline and our pursuit of operational excellence will translate into a better experience for customers, market-first innovation and geographic and margin expansion.

Briefly, regarding our financial performance, we are pleased to report fourth quarter revenue of $88.7 million, representing a 14% year-over-year increase compared with the fourth quarter of 2019 and exceeding our $75 million to $80 million guidance. When combined with our third quarter revenue, our second half revenue resulted in the 2 best consecutive revenue quarters in the company's history and a 22% increase compared to the same period in 2019.

In addition to our record-setting second half revenue, we achieved mobile revenue of $77.6 million for the full year, representing a year-over-year increase of 150% and a fourth quarter increase of 250% compared to the same period in 2019. Our mobile transport growth continues to be fueled by the emergence of 5G and Open RAN and design wins with marquee operators. Recognizing 10 of the top 25 wireline and wireless service providers as customers and with customers spanning more than 100 countries, we remain laser-focused on innovation, exceeding customer expectations and market share growth.

With the health care of the COVID-19 pandemic improving, our primary risk, as we enter 2021, is supply chain and component availability. Many of our products rely on semiconductor chips that require fabrication of silicon wafers, which are experiencing extraordinary long lead times due to the impacts of the pandemic and the global demands for such chips from the communications, consumer electronics, smartphone and the automobile sectors.

With that as a backdrop and a summary, I'll now turn the call back over to the moderator to facilitate questions that you might have.

(Operator Instructions)

Our first question comes from the line of Christian Schwab with Craig-Hallum.

Great. Just as far as the market share gains, can you walk through whether you think that's an improved spending environment, coupled with share of wallet gains? Or should -- or do you anticipate adding any meaningful customers in the 20-or-so largest spenders?

Christian, it's Charlie. Thank you. Well, as it specifically relates to the mobile transport portfolio, I mean, obviously, most of the market share gains really has a lot to do with just the emergence of 5G and Open RAN, specifically with 6 of the largest mobile operators in Asia. And so we're certainly seeing the emergence of 5G and Open RAN starting in Asia. There's certainly a lot of activity underway in North America, CALA and Europe. But as it relates really to the second half of last year, that's where we saw most of the growth that we experienced.

Okay. Great. And then I guess my second question, as it relates to RDOF, can you give us an update on where customer dialogue is going? Where -- and you may be able to begin to see potentially meaningful revenue from that?

Yes. So I think we have been on point as it relates to the timing of RDOF, and I think it aligns with what you probably heard from Calix and ADTRAN and Nokia. But the first phase of RDOF has occurred, I think, $9.2 billion has been approved to, I think, close to 200 RDOF award winners. And so we certainly are anticipating that the second half of this year is when we're going to begin to see that ramp up.

Obviously, we have a significant number of existing customers who were award winners, and we're working very closely with those customers. And there's a lot of new customers that aren't your traditional regional communication service providers that have made their way into the new awards. So that's when -- that's where most of our focus has been.

Our next question comes from the line of Dave Kang with B. Riley.

I have some questions regarding your 2021 revenue outlook of $310 million to $330 million. Just wondering your mobile, in second half, was about 31% of revenue. How should we expect that number to change for the year -- this year?

Well, we haven't provided any specific guidance as it relates to the breakout of our fixed broadband and mobile revenue. We did, for the first time, begin to break out revenue by customer sector. So I think as we continue to move forward, we'll continue to look at certain metrics that we feel like will be beneficial for analysts and shareholders to begin to evaluate. But the first step forward is to begin to break out revenue beyond just regional revenue, and we did, as you could see, in the Q4 letter to shareholders.

So we haven't provided that level of guidance, but certainly, we continue to see strong demand for our mobile transport products. With the acquisition of Optelian, we certainly have additional opportunities that we will be aggressively pursuing around the world. So there's certainly some upside as it relates to what we're going into the year with, as it relates to mobile transport.

Sure. And speaking of Optelian, can you provide any more information on them such as who their customers are? What kind of margins they have? Anything will be helpful.

Yes. So I mean, one of the exciting things -- I mean, there's several things that got us excited about Optelian. One was just the complementary nature of their products and our existing mobile transport products. The second is, they have been doing business and have been a key supplier to the world's largest service provider in the world for a number of years, and they are in 4 of the top 35 global service providers in the world. So they certainly give us an opportunity to expand into North America. I mean, they have been primarily focused in North America, so that is where most of their customer traction and revenue has traditionally come from. As it relates to margins, their margins today are higher than ours. I mean, looking at our historical margins, their margins are significantly higher. So we certainly hope that as the revenue ramps over the next year or 2 that, that blended margin and blended revenue will translate into higher margins for the company.

Got it. And then speaking of margins, you're guiding about 34%-ish for this year. In the presentation a few weeks ago, you talked about several pillars. To get to 34%, how many -- which pillars are you kind of baking in? And then how many pillars are left to get you to even higher gross margin next year?

Yes. So there are several work streams underway, Dave, because -- look, obviously, we're not happy with our margins, and we're laser-focused on getting that up in 2021. So things that are available to us right now that are underway, things like merger synergies and integrating the former DASAN and Zhone and KEYMILE purchasing functions into one unified global supply chain, product rationalization, things like that. And then maybe looking at your manufacturing and your ODMs and optimizing that. Those are all underway, and that's what gets you towards the higher margins in the second half of the year.

And geographic mix. I mean, certainly, we're seeing a pretty significant pipeline that's emerging in North America, CALA and across Europe, Middle East. And those margins in those countries are higher than they are in Asia, and that will certainly have an impact.

So right now, Asia is roughly 60% and then EMEA and America is about 20% each. So for gross margins to be higher, you need what, Americas revenue to be higher than 20% this year. Is that the target?

Yes. I mean I think the way you guys should look at it is -- look, there's a number of work streams that are underway. I mean, one of the initial work streams that began months ago was just rationalizing the entire portfolio. And getting to a place where we're streamlining where there was product duplication or overlap, reducing the number of suppliers that we're doing business with today, that is going to allow us to increase the amount of revenue that we're giving to certain ODMs and CMs, which in return, gives us a better [bomb] and a better cost base that ultimately translates into higher product margins.

We've got a pretty significant initiative underway with regards to just service expansion. And as we launch new products, especially in the mobile transport area, some of the new next-generation fixed wireline broadband access technologies, we're launching -- I think you saw in the report that we're launching our any-PORT / any-PON platform or module, and that certainly is going to give us an opportunity to expand margins as well.

Our next question comes from the line of Tim Savageaux with Northland.

Appreciate the incremental reporting and transparency around the mobile revenue where, obviously, you saw a pretty significant growth in calendar '20, offset to some degree by pretty healthy declines. And I guess we'd characterize the remaining revenue as fixed. And my question is, with some of the upgrades to 10-gig PON, kind of the general momentum around the fiber-to-the-home and PON space we see kind of heading into '21, do you expect that trend to reverse? Can you grow your fixed broadband revenue in calendar '20? Or is that what you're assuming? And I'll follow-up from there.

I'll start and, Tom, you can certainly chime in. First, I would tell you that, really, the first 5 -- 4 to 5 months of 2020 was severely impacted by the pandemic. And we had a $47 million quarter in Q1, $70 million quarter in Q2, and much of that was our fixed broadband access portfolios. We also saw the beginnings of a pretty significant transition from copper to fiber this year, which I think is a really good thing as we enter 2021 and beyond. Most of our customers in Europe and even places in North America were beginning to make that transition. So there was a bit of a revenue lag as those customers evaluate, a lot of the newer fiber-based technologies.

We also had a contract manufacturing partnership in Germany that we transitioned away from. And it was a lower margin, manufacturing-only relationship that we didn't seem -- that we didn't deem to be strategically important going forward. So it did have some revenue associated with it in the second half of the year, and it certainly will not be part of our revenue profile going forward, and that was roughly $15 million.

And so if you look at that $15 million on an annual basis and you look at our growth trajectory in 2021, backing out that $15 million from 2020, you can get a better appreciation for -- from a revenue growth, both on the fixed wireline side as well as on the mobile side.

Our next question comes from the line of John Marchetti with Stifel.

I was wondering if you could talk for a moment again about some of the issues that you're talking around the supply chain and maybe indicative that really -- if you've had to be a little bit more conservative maybe with the 1Q or full year outlook as a result of that? And how maybe we should think about that playing out, both over the near-term and through the course of the year?

Yes. I mean, in all of my years I don't know that I've ever seen the sourcing of components in semiconductors as challenged as they are right now. I mean I think we've done a really good job, John, of navigating through 2020. And I think we've got pretty good line of sight into the first 2 or 3 quarters. But look, it is challenging, and I think that we are being -- I don't want to say we're being conservative, but I think that we're being cautious as it relates to where we entered the quarter and where we had fulfillment against backlog that was already aligned with Q1 versus what our go-get revenue was profiled for Q1.

As it relates to the outlying quarters throughout the year, there's a lot of time and effort that's going into working with our semiconductor chip suppliers, like Broadcom and others. So it's a real challenge. I mean I think everyone in our space, including other sectors, are seeing the long lead times, especially from the silicon fabricators of wafers. I think that's part of the bottleneck right now. And I think that stemmed primarily going back to the first half of 2020. And everything that we're hearing from our strategic semiconductor chip partners is that by Q3, they feel like they will be in a much better place than where they are in the first 3 quarters.

The good news for us is we got ahead of it, and we were forecasting and ordering back in the second half of 2020, and that has given us, I think, a much better position to de-risk the first half of this year.

Got it. And maybe just as a follow-up to that. I mean does that change conversations with, say, new customers, who may be a little bit more reluctant to move to a new platform or a new solution rather than stay with somebody where maybe they do feel like they've got a little bit more history, they have a little bit more confidence in that supply. Or particularly, you mentioned bringing Optelian in and given their exposure to North American Tier 1s. Does it change the tenor of those conversations at all? Or do you still see a pretty open willingness to work with new partners who have the right solutions?

Well, I mean, I think there's 3 pieces to that. One is, I think that there is an availability challenge for certain suppliers. And where suppliers have challenges in the supply chain, I certainly think it's going to open the door for others. And we see that as an opportunity. Two, I think it's given us a great opportunity to sit down with our larger customers and be able to secure larger orders, and in fact, even full year orders, giving us a lot more visibility. So I think that at the customer level, they really understand what's going on in the semiconductor and the overall sourcing of components, and they want to make sure that their deployments aren't delayed.

So in our particular case, we got pretty significant jump-start on this really in the second half of the year last year when I joined, and we sat down with our largest customers, began to have these dialogues, which have really helped. And so getting that alignment with your core customers, getting those customers to give you firm orders in the first half of 2021, for the full year, is certainly helping us significantly. But I mean -- for us, I mean, we see it as an opportunity, and we're going to leverage it the best we can to be able to take share at a time when we feel like the sourcing is a bit more favorable for us than maybe for others.

We have a follow-up question from the line of Tim Savageaux.

Sorry about that. I was on mute there. And I do want to follow-up on that fixed versus mobile discussion. And Charlie, I think I heard a couple of your comments there on the CM front. And also note that you're -- I guess you're in a run rate for the second half of the year, at least that would imply growth for '21, even if just staying at that run rate. When you add to that, I'd just like to get a sense of what, if anything, you've built into your assumptions in terms of any material Optelian contribution or anything meaningful on the enterprise side as you look at your kind of initial calendar '21 guidance?

Yes. So we've been pretty conservative with Optelian in our 2021 forecast, and we've been pretty conservative in our FiberLAN enterprise outlook for this year. So 2 good questions, and they are fair questions. But we have -- it is a global product. I mean, we're excited about the ability most likely in the second half of the year. I mean the first half of the year, most of the European, Latin America and Asia teams, which just got trained up on the entire product line will be spending a lot of their energy introducing that portfolio into customers in the first half and getting it into the labs. And so it's most likely a second half of the year uptick for regions outside of North America.

In North America, there's a lot of traction. And we certainly are optimistic about the year for that particular portfolio. And FiberLAN, look, I mean FiberLAN, as I've said many times, I think it's our wildcard as a company. I mean we've got the technology. It's really about the go-to-market strategy. And I think as the overall market reopens here, over the next several months, in talking with a lot of our larger systems integrated partners, who are serving some of the verticals like the hospitality industry, like the educational market, like the health care industry, will be -- I think, a second half of the year 2021 and into 2022 sort of growth opportunity for us.

Got it. And last question for me...

I think it's also -- I'd say one other thing that I didn't get a chance to add earlier. I mean, there's some recent data out that is aligning with a lot of what we're hearing from a lot of our fixed wireline customers, and that is that the service providers are anticipating and building their network capacities to support about a 30% capacity increase over 2020. And that's just due to the forecast that I think a lot of operators are getting as it relates to more employees having more flexibility to work from home, and they've got to keep the network up as if those employees were there Monday through Friday. So I think that's going to continue to fuel a lot of growth for us over the next several years.

And certainly, PON, in general, is -- I mean, the evolution from sub-1 gig to 10-gig is something we're seeing everywhere. I mean, even our smaller customers are pushing 10-gig PON on us -- in almost every one of their markets. So that's also an exciting opportunity for us this year.

And that's pretty related to where I was going to head there although may be focused on larger versus -- or larger potential customers. If you can give us an update, I don't know qualitatively perhaps, on what you're seeing from an overall pipeline or RFP-, RFQ-type perspective as you survey the carrier landscape globally, kind of -- you would assume there's an element of just adding capacity to current networks that relates to what you were talking about with these capacity demands, but also larger upgrades and maybe more formal processes. I wonder what you're seeing out there.

Well, I'll tell you a couple things. One, as we entered January, our sales pipeline was about 3.5x our forecast or our guidance, which is a good trend. And two, we have -- and it's just because of the changes that I think we've made across the globe with regards to our sales focus and just go-to-market strategy. But we have responded to the largest RFPs this company has ever participated in, in the company's history, I think, over the last 6 months. And whether or not we'll win some part or all of those is to be determined. But it's pretty exciting to, one, now be in a position where we're beginning to participate in some of these large, very strategic Tier 1 RFPs and our ability to really transform the company over the next several years.

Our next question comes from the line of Jon Gruber with McBaine.

This is Jon Gruber. Two related questions. One, with this phenomenal shortage in components, how are you able to exceed fourth quarter revenue by so much? And then I have a related question after that.

Well, as I think I've shared in the past, Jon, I mean, the cadence and the governance by which we're managing the forecasting process has significantly changed over the last 6 months. And we have daily revenue calls, daily forecast calls with sales, our key customers and supply chain. And I think the team did a fantastic job in the second half of last year, just aligning with our customer demands and getting ahead of the supply chain shortage. And so I would tell you, it wasn't easy to navigate through the second half of the year and even into Q4. But I attribute a lot of the success that we had to just the micro managed and discipline that came with our sales operations team and the sales team with supply chain.

As it relates to this year, as I said earlier, we really got on this supply chain forecasting endeavor back in like August, September. And I think we put ourselves in as good of a position as we can as we entered this year aligning with as much detail as you can, as it relates to just the backlog that we entered the year with as well as the high degree of confidence that we had with forecasting from a lot of our key customers. So my hat goes off to the supply chain team and our forecasting team that really delivered strong alignment with the requirements that we had.

Well, given that and given the first quarter revenue bump from the depressed level of last year's first quarter, the yearly forecast assumes no growth in the 9 months after the first quarter. Is that conservative like you've been so far to us? Or is that realistic now that you had the one piece of new information on the $15 million business that you didn't -- you either divested or sold or just stopped, but...

Yes. I think the best way for shareholders and analysts to look at the year-over-year is to compare a $285 million year to our guidance of $310 million to $330 million. Just because we -- that was a strategic decision we made. It was the right decision for us to make. And so when you look at that sort of year-over-year growth, I mean, we're in the double-digit growth range for 2021. And we -- you're backing us into a quarter as it relates to the level of confidence and the level of conservatism that we have in the year. I mean, I think the guidance that we've provided of $310 million and $330 million is in line with our level of confidence at this point.

Our next question comes from the line of a Chad Tevebaugh with Needham & Company.

It's Chad on for Rich Valera. We are wondering if you could provide any additional information on pipeline for Open RAN opportunities, and then second, on the NCTC partnership?

Yes. The NCTC partnership is exciting. We've been working on that for most of 2020, and it certainly opens up a broader opportunity for us to align and partner with the U.S. regional service providers. And so it's certainly an exciting opportunity that we feel like provide some upside for us in 2021.

As it relates to Open RAN, I would maybe change the question to what our outlook is for 5G, in general, and virtual RAN, in general. I personally believe, and it was noted in the stockholder report, in just every conversation we're having with traditional mobile operators as well as emerging mobile operators, I think Open RAN is something that will be embraced over time. Certainly, the emerging mobile operators like a Rakuten, which we're obviously a big part of that network deployment and the dishes of the world, geo, are certainly starting from a different place than AT&T or Verizon or T-Mobile.

And that said, I think that they've made comments, and I think other mobile operators have made comments that Open RAN is something that you're going to see this industry continue to adopt and embrace, and it's the right thing to do. And we feel like the ecosystem that we are part of today and that we are creating will position us well for the future. And I think if you look at some of the data that's out there from Omdia, I think they're expecting O-RAN to grow by 10x by 2025. So it's certainly where the industry, I think, ends up going over time.

Towanda, are there any questions left in the queue?

I am showing no further questions in the queue. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.

Thank you.

Thank you.