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Zhone Technologies, Inc. (NASDAQ:ZHNE)

Q4 2012 Earnings Call

January 23, 2013, 05:00 pm ET

Executives

Kirk Misaka - CFO

Mory Ejabat - Chairman, President & CEO

Analysts

Operator

Good day and welcome to the Fourth Quarter 2012 Zhone Technologies, Inc. Conference Call. I am Keith and I'll be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, today's conference is being recorded for replay purposes.

And I would now like to introduce Kirk Misaka, Zhone’s Chief Financial Officer. Please proceed.

Kirk Misaka

Thank you, operator. Hello and welcome to the fourth quarter 2012 Zhone Technologies, Inc. conference call. I am Kirk Misaka Zhone’s Chief Financial Officer. The purpose of this call is to discuss Zhone’s fourth quarter 2012 financial results as reported in our earnings release which was distributed over Businesswire at the close of market today and has been posted on our website at www.zhone.com.

I am here today with Mory Ejabat, Zhone’s Chairman and Chief Executive Officer. Mory will begin by discussing the key financial results and business developments of the fourth quarter. Following Mory’s comments, I will discuss Zhone’s detailed financial results for the fourth quarter of 2012 and provide guidance for next quarter. After our prepared remarks, we will conclude with questions and answers.

As a reminder, the 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 will 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, 2011 and our quarterly reports on Form 10-Q when the quarter’s ended March 31, 2012, June 30, 2012 and September 30, 2012.

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 with the company's historical operating results and comparisons to competitor’s 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 Mory Ejabat, Zhone’s Chairman and Chief Executive Officer.

Mory Ejabat

Thank you, Kirk. Good afternoon and thank you for joining us today for our fourth quarter 2012 earnings call. We are pleased to announce that we met our primary financial goal for the Q4 2012 of achieving positive quarterly adjusted EBITDA and at the same time generated positive quarterly GAAP net income. For the quarter, we achieved or exceeded our revenue, gross margin and expense targets and also generated positive free cash flow for operations which improved our liquidity.

Fourth quarter revenue of $28.3 million was driven by new MXK customer to over 277 FTTx customers globally. The continued acceptance of our MXK chassis and volume based GPON solutions was demonstrated by the shipment of over 400 MXK units for the quarter.

Gross margins improved substantially as we walked away from unprofitable commodity pricing in one of our international markets. The result was a slightly lower revenue as compared to the third quarter, but a significantly improved margins.

Finally, OpEx was reduced substantially by various actions that we undertook in the third quarter to focus on new and existing copper and fiber-based product lines with a strong emphasis on FiberLAN and the next-generation broadband products.

Our fourth quarter result indicate that our strategy paid off and led to profitability as well as positive cash flow from operations. Going forward, we substantially reduced the breakeven point for profitability and continue to remain focused on maintaining profitability. After my comments, Kirk will give you more details about our financial results for the fourth quarter and guidance for next quarter.

The last financial matter I would like to briefly discuss is that we continue to evaluate all alternatives to regain compliance with the NASDAQ’s $1 minimum bid price requirement before the June 17, 2013 deadline. In order to maintain our NASDAQ listing, first and foremost, we hope that our financial performance last quarter and in the upcoming quarter we need to improve the Zhone’s past performance.

Nevertheless, we are developing contingency plans in the event that if we do not regain compliance by June 17 and we will announce more details and information as we move forward.

Now let me turn your attention to the exciting things happening on the business side. Although FiberLAN Optical LAN Solution is a new product we remain very optimistic about this market opportunity based on enthusiastic response from potential customers and channel partners.

The initial feedback about our FiberLAN Solution has been very strong because the new optical LAN solution delivers compelling fiber based solutions to multiple enterprise verticals while offering a growing alternative to traditional [copper] solutions at a fraction of the deployment cost.

Some of the verticals that have indicated interest and that we plan to target are the following, military and federal government, hospital and hotels, new building and Greenfield deployments, universities and colleges, medical and hospitals. For the 2013, we have already initiated an aggressive sales and marketing campaign targeting new FiberLAN prospects. We expect our FiberLAN Optical LAN Solution will begin creating a new avenue in the second half of 2013.

In the meantime, we continue to see a strong interest in our core MXK product line, especially in Europe and Russia. Last quarter, we won 21 new customers expanding our rapidly growing customer base. Let me share a few of the examples, first, through an expanded partnership with Connect Plus, Sitronics Information Technologies has deployed the Zhone MXK in the six Siberia Federal District delivering telephone, internet access and digital coverage and services to businesses and residence in the onset region of Russia.

We also announced that Zhone was selected by MLL telecom to help deliver high speed broadband services to more than 600 public sector facilities in the County of Suffolk, England; using Zhone MXK to deliver reliable high speed internet services to schools, libraries and county buildings within the United Kingdom.

As for (inaudible) mentioned, shipments picked up once again in Q4, Zhone shipped more than 400 units in the quarter bringing total unit shipments to 4,409 units and well over a 30.7 million ports of MXK GPON service (inaudible) capacity. With those few comments, let me turn the call back to Kirk to provide more details about our financial results for the last quarter and to discuss our financial guidance for the next quarter. Kirk?

Kirk Misaka

Thanks, Mory. Today, I am going to announce financial results for the fourth quarter of 2012. Fourth quarter of $28.3 million decreased slightly from third quarter revenue of $29.2 million because as Mory previously mentioned, we turned down commodity price business in one of our international markets.

As a result, we experienced a shift in the mix of business being generated by international versus domestic customers. Although our international markets continue to produce the majority of our business, they represented only 51% of revenue for the fourth quarter as compared to 58% of revenue for the third quarter.

We experienced the same amount of customer concentration this quarter with the top five customers representing approximately 38% of revenue for the third and fourth quarter with only one 10% customer in each quarter. By the first quarter of 2013, we expect the revenue to be consistent with the fourth quarter of 2012 despite the normal seasonal weakness we typically experienced in the first quarter of New Year.

We are more optimistic this year because of the strong product demand for our MXK and the larger than usual pipeline of business. As Mory mentioned, gross margins improved substantially as a result of locking away from the commodity price business in one of our international markets.

Gross margins improved to 36.8% for the fourth quarter as compared to 28.2% for the third quarter. Going forward, we believe gross margins will range between 34% and 36% which is consistent with margins before the aggressive commodity pricing of the past few quarters.

Operating expenses of $9.6 million for the fourth quarter was substantially lower than the $12.4 million for the third quarter. As previously discussed, we restructured the business in the third quarter to only focus on existing and new copper and fiber based product lines with a major emphasis on FiberLAN and next generation broadband products.

For 2013, we expect operating expenses to continue at this lower level of about $10 million per quarter. In addition, operating expenses for the fourth quarter included depreciation of approximately $100,000 and stock-based compensation of approximately $50,000 which we expect to continue into the first quarter of 2013.

Finally, our adjusted EBITDA profit for the fourth quarter of 2012 was $900,000 as compared to $3.2 million adjusted EBITDA loss for the third quarter. As discussed, the dramatic shift in profitability can be attributed to stronger margins without commodity price business and substantially lower OpEx after the restructuring.

As Mory mentioned, we also generate positive quarterly net income on a GAAP basis. Our primary financial goal for 2013 is to generate profitability for the year as a whole, not just on a quarterly basis.

Now turning to the balance sheet, cash and short-term investments at December 31, 2012 increased to $11.1 million from $10.3 million at September 30, 2012; primarily due to the adjusted EBITDA profit. A net effect of other balance sheet changes was minor despite some large cost effects.

Accounts receivables declined to $25.8 million at December 31, 2012 from $26.1 million at September 30, 2012; while the number of day sales outstanding on accounts receivables for the fourth quarter increased to 82 days as compared to 80 days for the third quarter.

Our total debt obligations associated with our working capital facility with Wells Fargo remained at $10 million at December 31, 2012 and September 30, 2012. You may recall that this working capital facility extends through the first quarter of 2014 and we expect that it will continue to provide adequate liquidity to run the business through the anticipated renewals.

Lastly, weighted average basic and diluted shares outstanding remained at 31.1 million for the first quarter of 2012.

And with that financial overview, I will turn the call back to Mory for a few final comments before we open the call up to questions and answers. Mory?

Mory Ejabat

Thank you, Kirk. We're very pleased that we met our primary financial goal for 2012 of achieving positive quarterly adjusted EBITDA and at the same time, generated positive quarterly GAAP net income. For 2013, our primarily financial goal will be maintaining that profitability through revenue growth in the second half of the year based on the continuous success of our industry leading MXK and the generation of new revenue from our recently launched FiberLAN Optical LAN Solution.

We're also anticipating their gross margin and substantially lower OpEx as compared to last year. The combined results should generate positive free cash flow from operations for 2013 as a whole which will improve our liquidity even further. We would now like to open up the call for questions.

Operator, please begin the Q&A portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question is from the line of [Al Kamuna], Private Investor. Please go ahead.

Unidentified Analyst

Hi guys. First of all congratulations on meeting the guidance and producing the solid numbers. Special thanks to Mory for making sacrifice of foregoing the salary to materially contribute to this solid performance. I have a couple of questions, with due respect or consideration to quarterly ups and down that happens, is this the type of performance we can count on going forward, what I mean is a profitability or at least a breakeven on quarter-to-quarter basis?

Mory Ejabat

Yeah, thank you very much. I got to tell you that is our plan and our goal to manage the business in such a way that we either breakeven at or provide profitability on the quarterly basis and as a whole for 2013 to generate free cash flow, that’s our plan and that’s our goal. And today we see the economy turning in some of our regions that is certainly doable and [down long-term] deals that we have seen a pipeline that’s very encouraging.

Unidentified Analyst

Great, it appears that Wall Street has essentially stopped following Zhone for some time now and to ensure that the stock price of the Company reflects the performance you have reported today. Are you going to make any deliberate effort to invite the Street to rediscover the Company once again?

Kirk Misaka

Well that is something that we are internally discussing and we may for sure do that and follow with some plans.

Unidentified Analyst

Okay, great. Well once again. Congratulations as a shareholder, I am very happy very pleased and thanks for great effort. I will get back in the queue and let other people ask the question, thanks again.

Kirk Misaka

Thank you.

Operator

Your next question is from the line of [Kenneth Spear with NewCap Associates]. Please go ahead. Mr. Spear your line is open. You may be muted.

Unidentified Analyst

Yeah, I am sorry, I was on mute. Thank you, great quarter gentlemen. I have two questions. One regarding Axtel, you presented a cost [menu] in 2011, and is the MXK rollout in Axtel for mobile backhaul only or is it for also mobile backhaul and GPON residential?

Mory Ejabat

Kenneth this is Mory. Majority of the Axtel deployment is for residential services that includes voice, television and internet access, and they do use some of it not majority of it for mobile backlog, but they are in three major cities and they are expanding to the other cities in Mexico.

Unidentified Analyst

All right, great, thank you. And then the second question. The chassis that were shipped this quarter, I assume that those chassis are shipped practically [MT] one possibly two cards?

Mory Ejabat

They are more than the one or two cards, probably maybe three cards to a [house], if you look at the total population.

Unidentified Analyst

Okay, great. All right, again, great quarter thank you.

Kirk Misaka

Thank you.

Operator

(Operator Instructions) We got a follow-up from the line of [Al Kamuna] the Private Investor. Please go ahead.

Unidentified Analyst

Hello, one more question, the number of customer I guess existing who are now switching to MXK or the new customer, the number of announcement that company makes about the new wins or new customers appears to be a very small percentage of the actual customer numbers that you have, can you give a sense of approximately what percentage of those customers you are able to make an announcement for?

Mory Ejabat

As you saw last quarter we said that we had 21 new customers and we did only two or three announcement on the customers. So obviously we – we're making announcements for about only 10% to 15% of the new customers we get and eventually some of those will turn into a press release.

Unidentified Analyst

And then you mentioned that you are optimistic about the growth in business and revenue for the 2013. You know between these categories that I see one is your customers who had originally installed MALC chassis and are now switching to MXK and then those who are new customers for MXK. And then the third category being the people who already have MXK chassis and are going to be buying cards as they get more customers and or need more bandwidth. The growth that you are anticipating, can you just provide some sense as to how much from each of these categories you are expecting to get your potential growth?

Mory Ejabat

We haven't done analysis like that but we do know that some of the existing customers that have deployed the MXK in their very initial phases are going to get [into a] major deployment. That is one of the area that we see in growth. The other one we see that European demand has increased as well as in Russia that we are seeing some growth happening there that would be majority of them would be new customers with some existing customers coming up.

And in the meantime we have seen lots of RFPs coming in Middle East that is giving us some confidence that we have a good chance of winning those RFPs.

Unidentified Analyst

Okay, well great. Thanks again and congratulations again. Great quarter and look forward to similar result down the line in 2013.

Operator

Mory Ejabat

We'll do that, and thank you.

Operator

And sir no other questions at this time.

Mory Ejabat

Once again thanks for joining us today and for your continuous support. We are looking forward to speaking with you on the next quarter's earnings conference call when we hope to discuss our continued profitability and improving fundamentals. Operator?

Operator

That will conclude today's conference. Thank you for your participation.

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