Zhone Technologies, Inc. Q4 2008 Earnings Call Transcript

Jan.28.09 | About: DASAN Zhone (DZSI)

Zhone Technologies, Inc. (ZHNE) Q4 2008 Earnings Call January 28, 2009 5:00 PM ET


Morteza Ejabat - Chairman of the Board, President, Chief Executive Officer

Kirk Misaka - Chief Financial Officer


Greg Mesniaeff - Needham & Company, LLC

Chad Smith - Smith Capital, LLC


Good day, and welcome to the fourth quarter 2008 Zhone Technologies Incorporated conference call. I am Melanie, and I will 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 at the end of the conference. (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.

Kirk Misaka

Thank you, operator. Hello and welcome to the fourth quarter 2008 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 2008 financial results as reported in our earnings release, which was distributed over Business Wire 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 and provide guidance for the next quarter.

After our prepared remarks, we will conclude with questions and answers. As a reminder this conference is being recorded for replay purposes and will be available for approximately one week. The dial-in instructions for the replay are available on our press release issued today. An audio webcast replay will also be available online at www.zhone.com following the call.

As you know, during the course of the discussion today we will make forward-looking statements including those relating to projections of profitability, earnings, revenue, margins, operating expenses or other financial items. The anticipated growth and trends in our business, product lines or key markets, new product introductions and the migration of customers to newer technologies, Zhone’s market position and focus and statements that express our plans, objectives and strategies for future operations.

We would like to caution you that actual results could differ materially from those contemplated by the forward-looking statements. We refer you to the risk factors contained in our SEC filings at www.sec.gov, including our annual report on Form 10-K for the year ended December 31st, 2007, and our quarterly reports on Form 10-Q for the quarters ended March 31st, 2008, June 30, 2008 and September 30, 2008.

We would like to caution you not to place undue reliance on any forward-looking statements which speak only as of the date on which they are made and we undertake no obligation to update any forward-looking statements.

During the course of this call, we will also make reference to pro forma EBITDA and pro forma operating expenses. Non-GAAP measures, we believe, are appropriate to enhance an overall understanding the 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 pro forma 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.

Morteza Ejabat

Thank you, Kirk. Good afternoon, and thank you for joining us today for our fourth quarter 2008 earnings call. Let me briefly discuss the financial result before providing an update on the business.

Economic condition has continued to be challenging and caused our revenues to decline slightly to $31 million. At the lower revenue level, pro forma EBITDA and cash flow were also negatively impacted but we were able to meet our gross margin and operating expenses guidance by continuing to control expenses and improving gross margins by reducing the cost of our products. Kirk will give you more details on our financial performance and guidance later.

Before turning to the business side, let me update you on the status of our NASDAQ listing. As you know, we decided to seek shareholder approval of a reverse stock split between 1.5 and 1.10 in order to gain complete compliance with $1 minimum per share bet price required for continued inclusion on NASDAQ global market.

You may recall that the NASDAQ originally gave us until December 8, 2008 to regain compliance and then temporarily suspended the minimum bet price requirement until January 16, 2009. Recently, they suspended the requirement again and the enforcement of these rules is now scheduled to resume on April 20, 2009, due to the dramatic deterioration of valuation in the public equity market, and the challenging nature of the NASDAQ’s reaction to them. We will continue to monitor the situation to determine whether a reverse stock split does still makes sense for Zhone.

If we decide to proceed with the process to complete the reverse split, we will make a future announcement well in advance of the deadline to regain compliance with the NASDAQ’s requirements.

Now let me talk about our business. On products and customers, this quarter we were excited to receive certification of our MALC GPON solution from the USDA Rollout Utility Service. Adding to the MALC’s original certification from 2003, this extension to cover GPON is a prerequisite to delivering FTTx solutions to the smaller, independent telephone companies throughout the US. These also position us well to participate in the universal broadband initiatives that appear likely to be part of the US governments economic stimulus plan in the balance of 2009.

We were able to announce the number of new customer wins this past quarter, which have been showed the value of our consistent strategy of providing the most efficient solution for offering multiple services on a converged access network. Cruz Telephone Company, one of the most innovative operators in Philippines, choose our platform for a strong cyclical to support of people place services throughout Manila and surrounding markets, as they responded to over 200% annual growth in broadband demand there.

In the US, the efficiency of our platform continues to attract the alternative carrier segment. Birch Communications, one of the largest competitive local exchange carriers in the US, chose Zhone to support their transition to our packet network throughout the 31 state operations and Excella Communications, a Nevada-based, selected Zhone to deliver EFM and DSL services in their market.

Now, let me turn the call 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, Zhone announced financial results for the fourth quarter of 2008. In our press release, the traditional comparison of financial results for the fourth quarters of 2008 and 2007 is presented alongside the comparison to the third quarter of 2008. As we have done on previous earnings calls, most of our discussion today will focus on a sequential comparison to third quarter results.

As Mory mentioned, revenue for the fourth quarter of 2008 was just over $31 million, which was slightly below our financial guidance of being flat to third quarter revenue of approximately $32 million. Global economic weakness continued to affect both our domestic and international businesses, but business from our US customers was particularly weak this quarter.

We continue to serve approximately 700 active customers worldwide and experience minimal customer concentration. We had only one 10% customer and our top five customers represented approximately 33% of revenue for the fourth quarter as compared to 30% for the third quarter.

Fourth quarter' revenue of $31 million declined by 3% when compared to third quarter revenue of $32 million. Until global economies begin to improve, we will continue to have limited visibility. In addition, the first quarter is typically seasonally weaker than the fourth quarter. Therefore, we are forecasting our revenue for the first quarter of 2009 will be flat and slightly down as compared to the fourth quarter.

As for gross margins, they improved to 32% for the fourth quarter despite the lower revenue level because we anticipated the sales weakness earlier in the quarter and we are able to partially, but not fully, reduce our manufacturing operations. Going forward, we will continue to adjust our variable manufacturing labor and other costs to the revenue forecast and therefore expect margins to continue ranging between 31% and 33% for the first quarter of 2009.

As for operating expenses, total pro forma operating expenses for the fourth quarter of 2008 were $15.4 million which excludes the $1.1 million gain on the sale of some of our non-strategic patents and within our $14.5 million to $15.5 million guidance range. Pro forma operating expenses included depreciation of approximately $400,000 and stock-based compensation of approximately $500,000.

As Mory mentioned, we will continue to reduce our operating expenses until our revenue outlook improves. Beginning in the first quarter, we reduced Mory’s compensation by 20%, reduced the compensation of his management team by 15%, and reduced other salaried employee compensation by 5%. With these salary reductions, we anticipate total operating expenses for the first quarter of 2009 to drop by about $500,000 to between $14 million and $15 million including approximately $1 million of expenses for depreciation and stock-based compensation.

Finally, pro forma EBITDA for the fourth quarter of 2008 was a $4.5 million loss and larger than our estimate of an EBITDA loss of between $3 million and $4 million. We expect the pro forma EBITDA loss for the first quarter to range between $3 million and $4 million and hope to return to breakeven quarterly pro forma EBITDA by the end of 2009 assuming economic conditions begin to improve.

As for the balance sheet, cash and short-term investments at December 31st, 2008 were $36.2 million which declined from $41.3 million at September 30, 2008, mostly attributable to the EBITDA loss and other working capital changes occurring during the fourth quarter. Our total debt obligations remained basically flat at $34.1 million. On a combined basis, our net cash balance or cash net of debt obligations decreased from $7.1 million at the end of the third quarter to $2.2 million at the end of the fourth quarter, again as a result of the EBITDA loss and other working capital changes occurring in the fourth quarter.

As for other balance sheet changes, inventory levels decreased from $42.9 million as of September 30, 2008 to $40.7 million as of September 31st, 2008. Also accounts receivable levels decreased by nearly $3 million to $23.7 million at December 31st, 2008 but the number of day sales outstanding on accounts receivable for the fourth quarter improving to 69 days as compared to 75 days for the third quarter.

Finally, the average basic and diluted EPS shares were $150.6 million for the fourth quarter, increasing only slightly from the $150.4 million in the third quarter. Slight increase resulted primarily from stock option exercises by management and employees.

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?

Morteza Ejabat

Thank you, Kirk.

Our customer wins and loss certification of our MALC-GPON solutions were unfortunately overshadowed by continued difficult business condition. The fourth quarter proved to be challenging as the global credit contraction caused many of our customers to delay or reduce their plans to expand their networks. Until global economies improve, we do not foresee sustainable revenue growth. However, we hope to be able to return to breakeven or positive quarterly pro forma EBITDA by end of the 2009. Until then, we will continue to work hard and reduce operating expenses in order to minimize losses and cash burn.

Thank you for joining us today. We will now open the call to questions. Operator, please begin the Q&A portion of the call.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Greg Mesniaeff -Needham & Company.

Greg Mesniaeff - Needham & Company, LLC

Good evening, just a couple of quick housekeeping questions, you mentioned two US [z-line] customers in the quarter, one being Excella. I did not hear the other one, if you could re-say that.

Morteza Ejabat

One is Excella and the other one is Birch, Greg.

Greg Mesniaeff - Needham & Company, LCC

Got it, okay. And you mentioned that there was one 10% customer in the quarter. Can you tell us who that is?

Morteza Ejabat

Greg, we typically do not disclose the 10% customers.

Greg Mesniaeff - Needham & Company, LCC


Morteza Ejabat

For the full year, they were not a 10% customer.

Greg Mesniaeff - Needham & Company, LCC

Okay, got you. And then, if you could just, looking at sort of your worldwide segmentation of sales by region, could you give us a little bit of color where you where you saw perhaps packets of strengths and packet of weakness?

Morteza Ejabat

We saw strength in Caribbean and in Latin America. We are seeing still a strong demand in the Middle East. We saw volume weakness in the United States. United States this year was the last quarter was the biggest region that we had. Asia typically is steady and Europe was steady. The main area of weakness was US but the other areas were strong.

Greg Mesniaeff - Needham & Company, LLC

Okay and just as a follow up, with the softer revenues what kind of, and your attempts to maintain your gross margins at current levels, have you undertaken any changes to your manufacturing or supply chain management practices?

Morteza Ejabat

No, we have not but we have got into a major discussion with our suppliers to reduce costs and reduce expenses. As Kirk mentioned, we have already reduced our manufacturing expenses so we believe we are very competitive in the manufacturing sector and we should be able to maintain or increase our gross margin at this point.


(Operator instruction) Your next question comes from the line of Chad Smith - Smith Capital, LLC.

Chad Smith - Smith Capital, LLC

I just want to get a little bit more clarification on a couple of things in the balance sheet. Kirk, can you give me a bit more color on characteristics of you debt right now? I know your line of credit is kind of run at $15 million, I guess breakeven. Can you give me some color on that and then also on your long-term debt, just some of the various covenants that you got there. My question is direct to that kind of getting a feel for, if you have another cash burn quarter in Q1 and then maybe we will see how things go in Q2, you are going to get down to potentially at negative net cash position. Are there any concerns or issues there with such covenants on any of your debt?

Kirk Misaka

Okay. Let us start with the components of debt. We have two major lenders. One is with Silicon Valley Bank, the $15 million line of credit. It is a $25 million revolving line and it comes due in March of 2009. We are currently in discussions with them about renewal of that line and we have consistently renewed over the past few years. The primary financial covenant that exists in that line with Silicon Valley Bank is liquidity covenant in which we need to keep 1.5 cash in accounts receivable to one part of debt. We are in no jeopardy of being in violation of that liquidity covenant.

The other major loan is the $19.1 million dollar loan on our campus. As we talked about this before, it is due in April of 2011. It is originally was a $20 million loan in kind of 25-year amortization. Our campus has been recently appraised. It is valued significantly in excess of this loan and we do not anticipate any problems of either renewing that line or finding additional financing to replace that line in 2011.

I think I had answered most of your questions with regards to the financial covenant there are in our loans. The ongoing discussions that we have with Silicon Valley Bank will hopefully result in the renewal of that facility in a manner similar to what it currently is.

Chad Smith - Smith Capital, LLC

Okay. That is helpful. So, as I said I remember that your long-term debt that you are holding on to is primarily the mortgage. So, that is fine. I just want to get some feel for, if you do have a couple more quarters of cash burn if you are going to get in to any kind of problems with that particular covenant, with that debt. So at this point right now not an issue, would you projects based on what you guys are seeing unless there is some kind of renegotiations you can get into with Silicon Valley Bank, any potential problems down the road if the cash burn rate continued at the rate that it is right now?

Kirk Misaka

Well, as we said we have typically normal cash including the $15 million debt to Silicon Valley Bank. If that had to be paid, we still have $2 million of net cash. The growth cash is obviously increased by the line of $15 million and the $19 million on the campus loan. So, the next major liquidity event would come in April 2011 when we need to refinance the campus loan.

Chad Smith - Smith Capital, LLC

Right, okay. That is helpful. Second question, with respect to wins that you announced this quarter, and congratulations on some of you guys were able to announce. That is great. Could you just give me a feel if there were additional customer wins and I know some of those you can not announce but in terms of the number of new customer wins that you had in the quarter that you were not able to announce, are there any of those that you had?

Morteza Ejabat

Yes, so there are several others that we have won that we have not announced and we will probably announce some of them in this quarter. There had been a group reception in our GPON product line. We are doing very well on the GPON as well as active internet and EFM product line. Those three product line has been very attractive to our customers and many customers are deciding to build their infrastructure on those products.

Chad Smith - Smith Capital, LLC

Okay and then finally I will let you go, with respect to the buzz right now regarding the stimulus package and some of the potential elements and that being directed at broadband adoption and expansion, etc, and obviously you guys keep doing what you do and blocking and tackling, getting business all over the world but is there any potential that you guys have looked at or targeting where you can weasel your way in to some of those potential opportunities in the US or that..?

Morteza Ejabat

Definitely. That is the brightest spot for our US business. As you know, we worked with tier two to tier five carriers and [z-lines] and the broadband has not been the main distributor in those areas and we are working with some of them to put in the broadband infrastructure in place and one of the thing that we did in the past quarter, we got the Ross approval which requires IOCs or telephone company to go to government for the funding and that approval will help us a lot especially on GPON and active internet product line.


Ladies and gentlemen, I see no further questions at this time. We will turn the call back over to management for any closing remarks.

Morteza Ejabat

Thank you again for joining us today. We appreciate your continued support and look forward to speaking with you on our next conference call when we hope to announce the improved financial performance. Thank you.


That concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.

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