DZS Inc (DZSI) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the DZS Third Quarter 2020 Earnings Conference call. (Operator Instructions) Please be advised that today's conference may be recorded.

I'd now like to hand the conference over to your host today, Mr. Ted Moreau, Vice President, Investor Relations. Please go ahead.

Thank you, Liz. Welcome to DZS Third Quarter 2020 Earnings Conference Call. Before beginning, I would like to comment that DASAN fun working with the management team, since I joined DZS 2 months ago. This is an exciting time for the company as we position the business to take advantage of a number of growth opportunities we see in the coming years. This is all outlined in our stockholder letter published last night to 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, Thomas 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 results or 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 and the forward-looking statements section of the letter to ship stockholders that was filed on a Form 8-K as well as being available on the 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 the reconciliation to GAAP are contained in the letter to stockholders.

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

Thanks, Ted, and welcome investors and guest and especially our West Coast attendees were getting up early with us this morning.

Following the market close yesterday, we released our inaugural quarterly stockholder letter highlighting our performance for the quarter ending September 30. Our quarterly stockholder letter providing an overview of our alignment with today's market trends as well as our regional expansion plans, government sponsored programs such, as the United States Secure Trusted Communications Act in the Rural Digital Opportunity Fund. We also profile, the enhancements we have made regarding our new leadership team as well as a broader overview of where our products and solutions are being deployed within fixed mobile, and enterprise networks.

As Ted mentioned, our Chief Financial Officer, Ted Cancro, and our Chief Technology Officer, Andrew Bender, who recently joined DZS for VMware are here today with me to expand on topics of interest as well as answer any questions you may have, that was represented in our stockholder letter.

Closing out my first quarter, I'm thrilled report all time record revenue for the quarter, which was led by growing demand for our next generation mobile transport solutions as well as continued demand for our fiber-based broadband access and customer premise solutions. We had an exceptional top line quarter, delivering 33% revenue growth when compared to Q2, and 31% compared to the same period a year ago. I want to recognize and applaud our employees and partners for achieving this outstanding milestone, especially in light of the ongoing global pandemic, which has impacted component shortages, customer evaluation trials and deployments.

Before, I open the call to questions, I want to amplify 3 key themes represented in the shareholder letter. First is our expansion in North America and Latin America, me in India, leveraging our fiber rich portfolio of broadband access solutions and next generation mobile network transport solutions, which are being deployed in volume, in the world's first open grand network.

Second is our skilled and agile research and development team that spans both fixed and mobile domains in our follow the sun geographic capabilities across the United States, Germany, South Korea, Vietnam, and India.

And finally, the more than 30 new employees including executive management team members as well as key leaders spanning product engineering supply chain, sales, marketing, and finance that have joined DZS, since my appointment in early August. Over the past 3 months, we have made significant progress integrating former DASAN Zhone in key mile, creating a one DZS brand and culture. We have rationalized and accelerate our commitment towards unified technology road maps in aligned our employees and partners with the vision and strategy to capture market share in the burgeoning 5G, fiber to the premise in connected home and enterprise market segments.

With that, I'll turn things back over to the moderator for questions.

(Operator Instructions) Our first question comes from the line of Dave Kang with B. Riley.

First of all, regarding on gross margin, can you just provide more color on the gross margin decline, and how should we think about gross margin going forward?

Sure. Margins in this quarter were impacted by some significant orders for fiber access infrastructure. Certain customers where we have won the business a few quarters ago competing against Huawei, and just delivered now. And largest it sometimes to capture share spend footprint, and particularly when you're taking it from an incumbent that can be competitive, and been hard one. So it impacts our gross margins, but and it was a contributor to gross profit dollars overall right helping to drive up EBITDA. The point is, going forward as we globalize these products we sell into less price-driven markets were well it doesn't compete also as products further, and a life cycle margin improves.

Got it. And then you talked about some demand that was pulled it from fourth quarter. Can you kind of quantify how much, how much of that was pulled it?

Well, we're not going to, we're not going to quantify. I think as you may recall on our Q2 earnings call, I had mentioned that we started the quarter out with about $50 million of scheduled backlog. And based on the guidance that we had provided we had somewhere in the $35 million will get for the quarter, and we were able to one pull some things, and do I think demand for our mobile products as well as our fixed line products exceeding our expectations that we had in our original outlook.

Got it. And then regarding our fourth quarter outlook, clearly there was some pull it in the third quarter. But what about rising COVID cases and increasing restrictions or what are your assumptions on that regarding the outlook?

Well, I think you're exactly correct. And I think that's part of the reason why we guided, the way we guided. We certainly see the new cases not only across the EMEA region, but also in Asia and you look at not only the customers are potentially affected. But you look at supply chain and components, and we feel like the guidance that we have provided aligns with that. I think, I think the reality is that when you still take a look at Q3's actual of nearly $94 million in the mid-range at what we're guiding of 77, the second half of this year represents the best sequential combined half that company's ever had. So we're not in or necessarily looking at our revenue on a quarter-by-quarter basis. But looking at it more on a longer-term totality basis.

Got it. And my last question is on, can you grow will go over the 5G pipeline previous management, they talked about 2 Korean, and 2 Japanese customers. And are there any opportunities outside of Asian countries?

Well, look, I mean I would tell you and Andrew can certainly chime in, it's probably one of the most exciting segments within the company right now. I mean in our base business has been traditionally our fixed wire line, cord as well as connected premises products, but with the introduction of our really first market a product into the end of the mobile space with rocket and a couple of other customers in Asia, it certainly gives us a tremendous opportunity in other markets. And there's a lot of sales activity underway. We have, we certainly aren't going to represent our pipeline in any of the segments, but I can tell you that there is a lot of excitement on both the customers as well as the sales side.

Our next question comes from Christian Schwab with Craig-Hallum.

Hey, congratulations on a strong second half of the year. As we look forward a couple of different questions about the different growth drivers and how they may play out in the future. Can you give us some idea of how much you think you'll be shipping roughly to wrap it, And how much you could be selling to them next year, and if you don't want to talk about that, maybe just incrementally how much better their customer could be in one than 21 and 20?

Yes, I mean, obviously, we're not going to share that data, but certainly we expect Rakuten to continue to have a strong 2021 with us as they continue to deploy their 5G network, they certainly been a great advocate for DZS and in a champion for us, helping us as a reference with other key accounts that we've been marketing to around the globe. So our outlook for Rakuten in 2021 is, is strong.

Okay. Great. And when you guys think about the Rural Digital Opportunity Fund. Did you expect that to drive meaningful revenue in 21, or would you expect that to be more 22 event. Typically, there has been a lag between awards, and real true aggregate spending. Just wondering in these government programs, just wondering how you guys are thinking about that over the next few years?

Yes, no, I mean that the auction began yesterday, I think there was approximately 400 of the 500 recipients that were awarded some, some element of the program yesterday, the reality is, and I think you said it very well. We anticipate that a lot of the RFI, RFP activity will happen during the first half of next year. We certainly are cautiously optimistic second half of next year, we'll certainly provide an uptick for us, especially since that's a market that we haven't, as a, we have aggressively pursue that market is we are today, but I think it's more of a 2022 acceleration than it is in 2021.

Okay. Great. And then, and Just trying to better understand your highlight in the stockholder letter of opportunities versus Nokia and Huawei, and certainly I think I understand that the political environment and the opportunities and Huawei way. But is there any geographies where you think people might be more receptive to hearing from DZS then it may have over the last few years ago?

Well, I think one of the things that we get excited about and certainly investors should get excited about with DZS is especially when you compare us to others. Most network most large scale even medium to large scale network providers are selecting at least 2 suppliers and one of the things that we have found across all of the EMEA, obviously a lot of the APAC regions Latin America over the last 10 years, while we have made significant inroads into those markets. And just the calls that I've had with dozens and dozens of customers since I joined the company.

There is certainly an appetite to look at someone like DZS that has the resources, the products and the scale in those particular regions to augment as they reemphasize Huawei, in those particular networks and even here in the United States. I think a lot of people are appreciate there is $2 billion worth of rip and replace of Huawei, that the US government is sponsoring that we're certainly involved with. So I see I certainly see us as an ideal suiter to be able to participate alongside Nokia. I mean Nokia's with the combination of Lucent-Alcatel and NSN there in a lot of accounts. Just because of the combined nature of those 3 companies. But when you look at, where in a few years, and you look where Huawei was, we certainly see DZS as a natural company to be able to participate and a lot of the markets, included in the US, but certainly where, where they were strong outside of the US.

Great. And then my last question has to do with the FiberLAN, previous management teams have significantly talked up the opportunity of that as a new product category. And now that you've been there for a while, Charlie. I'm just wondering what is your thoughts on that product line and its potential over the next few years. Is it realistically have an opportunity to be a material contributor to the top line of DZS?

So first of all, FiberLAN is a solution brand. And the way, I want you guys to look at this is FiberLAN represents existing products that we fell into the core as well as Customer Premise Network Solutions in the traditional service providers. But is intended for the enterprise verticals. And I think the reality is, is that the products and solutions have always been there. It's really been the focus, and the go-to-market and systems integrator alignment that was required, and I can tell you that I'm very passionate about this market. I think it's a significant opportunity for us.

We've recently hired several enterprise lead sales people to help us accelerate the pace, but I think it's a great question because when you look at the market, we think it's a $10 billion market, that the copper in traditional COEX infrastructure with a lot of the enterprise verticals is going to be completely transformed. And I think it's a significant opportunity for us. So we're aggressively planning on going after that market, and we will do it through the service provider channel as well as through a lot of systems integrators who are focused on that market.

Andrew, did you want to comment on anything?

Yes, a quick comment about FiberLAN. I think one of the exciting things that we see with that solution set is also the adjacencies to the licensed and unlicensed mobile market as Charlie correctly said, we've seen networks transforming and that includes in the premises in enterprise customers. So as they embrace more wireless technologies in building, and across campus FiberLAN is well-positioned to enable that transformation. And it's a natural for us to extend into the fixed wire line part of the market as well. Right. That's right.

Our next question comes from Tim Savageaux with Northland.

Congrats on the strong Q3 results, obviously, it looks like Asia Pacific. From a geographic standpoint was a big driver there. I wonder if you could speak to any more specific color around geographic markets perhaps in Korea and Japan and also any 10% customer concentration in the quarter. And then, should we assume that to the extent you saw some of this business come sooner than expected is that the Asia-Pacific region, and the deployment patterns of specific carriers or what's, what's driving that pull in from Q3 to Q4? And then I'll follow up.

Well, first of all, Tim, I appreciate the congrats. As I think you probably saw in the cycle letter, Asia represented 60% of the revenue. Yes, North America was also up, and I think what we get excited about going forward, and I'll talk about Q3. But as we think about our business going forward. There's just a tremendous amount of focus, and effort that's being place right now on expanding into North America, EMEA, Latin America, India, and I think these are markets that traditionally have been underserved and under-focused few appreciated the new sales talent that we brought into the company, especially around these regions.

We certainly are optimistic about the prospects for these regions in 2021, as it relates to third quarter you can appreciate the fact that our core customers in Korea, and Japan, and continue to deliver strong results both on the mobile side as well as on the fixed wire line side, Rakuten continues to accelerate their deployment, which is very exciting. And we got to be careful about who we represent, and in the region. Just based on our confidentiality with those customers, but you can imagine the Tier 1 in both Japan and Korea that make up the lion's share of that 60% of the revenue.

Got it. And last quarter you'd referenced some comments on backlog and shippable backlog and as you look into, you're Q4 guide here, I mean it, I don't know whether it's accurate to say you've haircut the members based on from risk factors from potential pandemic impact or whether that's really kind of a pull forward dynamic. But to the extent you have kind of taken some conservatism with regard to uncertainties around pandemic. And could you possibly quantify that? And is there any, are there any similar metrics that you can offer relative to last quarter you had indicated that you had 3 quarters of your plan, and in backlog or something like that. Any comments around visibility heading into Q4?

Yes, so, as we entered Q3, as I articulated last quarter we entered Q3 was about $50 million and scheduled backlog and so we had a go get based on our guidance of as you mentioned 25% of our original $74 million to $79 million in Q3. We entered in Q4 with $45 million of scheduled backlog. And so when you look at the current guidance that we have, we have got similar metrics. And so are we being cautiously optimistic maybe, i think we are, we are guiding what we think is aligned with where we see that the pipeline and go get, and other dynamics as i think we've all talked about as it relates to just like in COVID. There is a pretty significant component shortage out there, we did a great job navigating through that Q3, i expect that we will do a good job navigating through Q4, but it’s there, it’s real, and the risk that we all need to be aware of. But there is some upside in Q4 as well

Got it. Appreciate that color, and looking into next year, you mention North America which relatively small market for you, but it, at this point would it be too much say that you expect that perhaps your fastest growing segment for the company in 21 given the opportunities and obviously we have seen a lot of strength in that rural broadband area even prior to our taking off. When you consider that market backdrop and your increased sales efforts, what are you think about growth in North America in 21?

I think there is 2 very significant growth opportunities for us next year. One, and i think, we are find the best job we can to really articulate just how significant the mobile segment opportunity as far, it’s a brand new market segment for us. If you look at the historical revenue profile the company going back a decade, it’s been almost a 100% fixed wireline. And so now you open up a brand and new market segment that has probably more investment focus in any segment that is in the mobile space, and when you look at the front-haul. You look at front, I'll all back haul front-haul as a magnitude difference in the number of education devices that will be, will be deploy. And so that alone, I think I talked to the sales team and management team all the time that, if we can just secured 5 more Rakuten you can only imagine the size and scale that it has a multiplication effect for the company.

But to your point, we certainly think that North America represents the single biggest growth opportunity for us over the next several years, we've invested significantly in a very senior sales organization over the last several months in. It's not just about art off. I think it's about the overall dynamics, the focus, the alignment of our products, and I think the consolidation that that's certainly continued to occur here has helping us. So I think your assumption is right.

Great. And your last question for me. And when we consider you mentioned kind of the Huawei rip and replace program and also just Nokia been pretty concentrated everywhere, at least that first one with Huawei, you would think that's focused on a large number of small carriers, but maybe a different opportunity relative to Nokia, it maybe not.

I guess when you talk about opportunities to displace larger vendors, either because of political pressure or carriers looking to diversify vendors, Should we think of that is mostly kind of a Tier 2 Tier 3 carrier focused opportunity for DZS or other larger Tier 1 opportunities out there that kind of have the same profile?

So Tim, it's Andrew Bender here. I guess one of the things that we have seen in the market dynamics surrounding this, this this regime that you mentioned is not just the geopolitical aspects. But the changing landscape of the network, the concept of open the concept of standardized interfaces. In fact, there are some legislation in the US supporting that. And I think we talked about in in our letter to stockholders. So part of our success factors in addressing incumbents, large, and small is our ability to be agile to bring new products to market, and to embrace the open network standards like the open alliance family of standards and similar, similar initiatives in the wireline, I network, we are seeing that being a big reality for us in the product space.

Well, and the other thing I would comment Andrew is to Tim's point. Most of the success that Huawei, has had around the world with the Tier ones, And so even when you look at North America, which includes Canada, which is where they've had some success, there is significant Tier ones that there'll be replacing and a lot of wireless infrastructure. As you would appreciate it and a lot of, to your point, Andrew, a lot of close and proprietary networks that, obviously with the momentum that we have, and in the architecture that Rakuten and ourselves in the ecosystem that we're forming right now is promoting is really an open RAN network architecture, which really fosters an opportunity, a unique opportunity for us.

Our next question comes from George Iwanyc with Oppenheimer.

Charlie, with all the additions that you've made. Can you give us a sense the go-to-market changes you're making at the same time with the new sales leadership?

No, I appreciate it. I mean I wish everybody could be a fly on the wall over the last 90 days, because really accomplished a lot and first and foremost, we're a technology company. And so what we have spent a lot of time over the last 3 months, focusing on is really rationalizing the product portfolio, and aligning the product portfolio with our resources around the world, and how that aligns with where we believe we have the best chance of winning. Looking at the geopolitical landscape as well as the competitive landscape and we've just calling it like it is, I mean we put together a very significant Huawei playbook. We've looked at every single Huawei account there is and we're engaged in all those accounts. As it relates to how we might be able to participate either at the edge are in the core and then here end here in North America, we certainly are competing heavily with ADTRAN and of new PNK links and we certainly think there is a growing opportunity for us, especially with the fact that both ADTRAN, links don't really participate on the mobile side like we do. I don't think neither of them have the same size and scale of portfolio on the enterprise side and CPE side. And so there is certainly an opportunity for us to continue to grow there, but our focus is really been where we feel like we have the best chance of winning based on our product alignment and the overall competitive landscape. And so thank you for that perspective. And as you look at expanding regionally as well as looking at the product synergies. Can you give us a sense of how long the customer engagements are probably likely to take and the timing of ramps in the newer regions in the newer areas? While on the enterprise side, on the FiberLAN Solution portfolio side. The sales cycle can be relatively short in fact we and I'll just add a very large recent project that came and the opportunity came very quickly. And the opportunity to be able to engage in deploy that was within 90 days. If you look at participating in the core, especially if you're dealing with a Tier 1 or Tier 2 the sales cycle been last anywhere from 6 to 6 months to a year.

Having said that, I think that the enterprise or the CPE in home, our enterprise CPE portfolio seems to be an opportunity that we can get into relatively quickly. We've got a new line of Wi-Fi 6 in, products that are being very well received around the world. And so our sort of strategy and game plan is especially on the Huawei side is for us to be able. I mean, one thing we don't talk enough about that. The company has done a phenomenal job of in and that is just having to compete in Asia, we've had to Interop with just about everyone. So we've Interop in our CPE products in our core products of Interop with Huawei and GTE and fiber home ADTRAN, Calix and so we sort of look at ourselves as a pretty nimble and agile company to where we can deploy our products anywhere in the network and we comparable and complement the existing infrastructure.

It's there and there is several very large customers in EMEA that have entertained the idea of bringing us in on the, on the in-home and enterprise side with our CB portfolio and then giving us an opportunity to then we've our way back into the core of the network over time.

All right. And just last question is to make, maybe this one for Tom. Can you give us a sense of as you do more on the CPE side and focused with some of those opportunities. How the product margins look across the portfolio?

Yes, I mean, I'm not going to get into some detail on it, but it's pretty much as US expect and as we seen throughout the industry CPE never is the highest margin product that you have certainly some of what we're doing on the mobile transport side is some of the higher margin products in our portfolio, and you're seeing a greater growth there, but as much of it has to do with geography as product mix, right. And as you start to they've seen with a little bit in R&D this quarter as we sort of globalize some of these products. So that you can sell them into markets that are less price focused, that will impact our margins going forward as well.

Yes, I would just. I would just echo the fact that there are several dynamics on the margin mix. One is just what cycle you are in, selling chassis based core systems versus the service module. So the chassis tend to come with large less margins than the service module. So as we deploy a new corps chassis into a central office, and we start deploying service modules as more subscribers come online, the margin profile of that is much higher. And then as Tom said, where we have an opportunity to truly differentiate, especially with newer disruptive technology of the margin profile is much greater.

Our next question comes from Jon Gruber with Gruber & McBaine.

Liz, maybe move on to the next question then.

Our next question comes from Bill Woodruff with William K. Woodruff & Company.

How does what you're doing in 5G and open RAN complement or compare with Mavenir’s open RAN product offerings?

So thanks for the question. Bill, Andrew Bender here. What we are engaged with Mavenir as with a lot of the ecosystem vendors, as Charlie mentioned here, we're not today an end-to-end provider of the radio access network in 5G, but we are providing some key enabling technology with unique products and that's what's led to our early wins in the in the any haul or the front in the back haul space.

So that's, I guess, that's probably the best answer I can give about where we're complementary there that we're providing unique networking and transport capabilities in the rand that are complementary to the BBU functions. The centralized unit distributed unit that you would see in in the open architectures there.

Yes, we're certainly fostering relationships with the overall mobile ecosystem that complements an open RAN architecture, as Andrew said. I think Mavenir who’s down the street here in Dallas is certainly an ideal ecosystem partner that complements us and where they're participating in the core versus where we're participating in that, okay. Let me election results if there's a change in administration. Do you think will be a change in policy regarding Huawei? We've actually been pretty engaged with the White House over the last few months, and what I would tell you is we can in fact, we were on a call with, with very large team last week, and asked the same question to the group. And I think the feeling of the current administration is that the current policies as well as some of the programs that have already been approved. Like for example, if you look at the, that this, the secure trusted communications act. It has a $2 billion rip and replace of Huawei that program has already been approved. It's just waiting for funding. So I think the question I had so damaged with. Is there any risk in that program going away in the answer was no as it relates to things like we will digital opportunity fund. Is there anything that would impact that particular program? And the answer was no. And so we don't see they a change in administration have a change and use as it relates to Huawei. Go ahead, Andrew. Anything you want to add?

Yes, sure. One thing I would quickly add there, Bill, is that if you look at some other legislation in this area, particularly the U.S. fed, USAA, or the Utilizing Strategic Allied Telecommunications Act, that is bipartisan legislation or proposals that support the adoption of open standards to enable the creation of the ecosystem that we've been talking about on this call, so one suspect that, that will be enduring.

That concludes today's question-and-answer session. I'd like to turn the call back to Charlie Vogt for closing remarks.

Well, I'd just like to thank everyone for joining our earnings call and especially our analysts for their questions. Our industry has experienced transformational change, which is resulting from disruptive technology shifts accelerate network upgrades fueled by today's work and learn from home dynamics and certainly the geopolitical security concerns that we were just talking about we think DZS is well positioned to capitalize on these opportunities with a clear vision and strategy and with a committed and experienced employees systems integrator distributor and technology partner base. So with that, we like to say thank you, and have a great weekend.

Ladies and gentlemen, thank you for your participation in today's conference. Everyone have a great day.