Zhone Technologies Inc. Q1 2009 Earnings Call Transcript

| About: DASAN Zhone (DZSI)

Zhone Technologies Inc. (ZHNE) Q1 2009 Earnings Call Transcript April 23, 2009 5:00 PM ET


Mory Ejabat - Chairman and Chief Executive Officer

Kirk Misaka - Chief Financial Officer


Karl Laconte - Private Investor

George Tamacy - Scott-Macon


Good day, and welcome to the first quarter 2009 Zhone Technologies Incorporated conference call. 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)

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 first quarter 2009 Zhone Technologies Inc. conference call. I am Kirk Misaka, Zhone’s Chief Financial Officer. The purpose of this call is to discuss Zhone’s first quarter 2009 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 first quarter. Following Mory’s comments, I will discuss Zhone’s detailed financial results for the first 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 available at www.sec.gov, including our annual report on Form 10-K for the year ended December 31st, 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 that 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 the primary indicators that management uses as the 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 in 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.

Mory Ejabat

Thank you, Kirk. Good afternoon and thank you for joining us today for our first quarter 2009 earnings call. Let me briefly discuss the financial results before providing an update on the business.

As we’ve talked about on the last call, the first quarter is normally a seasonally weak quarter but proved to be even more challenging with global economic difficulties. As a result our revenue declined to $24.1 million. However, we are beginning to see signs of an improving environment and we are encouraged by growing backlog and prospects for revenue growing throughout the remainder of the year.

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 expense guidance by reducing the cost of our products and continue to control expenses. Kirk will give you more details on our financial performance and guidance later.

Before turning to the business side, let me give you a brief update on the status of NASDAQ listings. As you know we received shareholder approval to do a reverse stock split of between one 1.5 and 1.10 in order to regain compliance with the $1 minimum per share bet price required for continued inclusion on the NASDAQ global market.

You may also 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 and again until April 20, 2009.

Recently they suspended the requirement once again and enforcement of these rules is now scheduled to resume on July 20, 2009. Due to that deterioration of valuation in the public equity markets and the changing nature of the NASDAQ’s reaction to them, we will continue to monitor the situation to determine whether a reverse stock split 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 NASDAQ’s requirements.

Now let me talk about our business. On product and customers, this quarter we added two new extensions to our product portfolio. To a partnership with update, we have added a technology called RF over glass, or RFoG to our GPON solution. This allows telephone companies the legacy analog cable television operations to support video over GPON without costly replacement of their head-end equipment. This opens up an important segment for us in the US market.

We have also added a new small form-factor platform for EFM services, the XP 170, an ideal entry point for operators interested in serving a smaller number of business subscriber from a given central office location.

We also marked the 5 Million Port Milestone for our multiservice access platform with a release subversion 1.15 or SLMS Access Operating System Software. This release includes a number of new capabilities and service enablement and security that help us continue to set new industry benchmarks for access future support.

On the customer side, in February we announced WorldNet Telecommunications in Puerto Rico who has been using our MALC platform throughout their network for over four years, has extended their service offering to include EFM supported by our EFM cards for the MALC and our EtherXtend CPE.

Behind the scene, we continue to gain encouraging customer trend and momentum with new products that are now nearing formal release. In particular tapping larger opportunities in Middle East and Latin America where FTTx scores remains strong as well as US service providers enhancing their fiber access infrastructure.

Despite the tough economic environment, we have seen increased interest among service providers in Middle East, South Asia and all our telephone companies in the US. The increased interest in our products can potentially result in a stronger revenue growth in the seconds half of the year.

As a final note, many of our US customers have become very active in developing concepts that could take advantage of broadband stimulus fund. We are providing close support for their efforts. We are also actively involved in the process of influencing them and how their stimulus program will be implemented and are hopeful that the stimulus funds will provide a necessary input as to increase broadband deployment in rural areas through the use of our equipment.

As one of the few American manufacturers of broadband access equipment we hope to catch a significant portion of this market.

Now let me turn the call to Kirk to provide more details about our financial results for last quarter and discuss our financial guidance for the next quarter. Kirk?

Kirk Misaka

Thanks, Mory. Today’s Zhone announced financial results for the first quarter of 2009. In our press release the traditional comparison of financial results for the first quarters of 2009 and 2008 is presented alongside the comparison to the fourth quarter 2008. As we have done in the past, most of our discussion today will focus on the sequential comparison to fourth quarter results.

As Mory mentioned revenue for the first quarter of 2009 was just over $24 million which was below our original financial guidance of being flat to slightly down from the fourth quarter revenue of approximately $31 million, but met our revised financial guidance from earlier this month.

Global economic weakness continued to affect both our domestic and international businesses. Despite past results we are starting to see some signs giving us hope that revenue levels may have hit bottom. Those factors include sales backlog that increased for the first time in several quarters, increased trial activity, more request for information about our new products and product enhancements and greater visibility into this quarters pipeline of orders.

Based on these factors, we are forecasting a strong revenue growth for the second quarter of 12% to 16%, reaching a revenue level of between $27 million and $28 million. We hope that our second quarter will mark a turning point in which we break the secular trends of declining revenue.

We continue to serve approximately 700 active customers worldwide and experience minimal customer concentration. We didn’t have any 10% customers and our top five customers represented approximately 26 percent of revenue for the first quarter as compared to 33% for the fourth quarter.

As for gross margins, they improved slightly to 32.4% for the first quarter despite the lower revenue level because of the anticipation to sales weakness earlier in the quarter, and were able to reduce our manufacturing operations accordingly.

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 second quarter.

As for operating expenses total operating expenses for the first quarter of 2009 were $14.4 million within our $14 million to $15 million guidance range.

Operating expenses included depreciation of approximately $500,000 and stock-based compensation of approximately $500,000.

As discussed on our last earnings call, we plan to continue reducing operating expenses until we see improvement in our revenue levels. We reduced pro forma operating expenses in the first quarter by approximately $1 million as compared to the fourth quarter and expect to further reduce operating expenses in the second quarter by another $500,000.

We anticipate total operating expenses for the second quarter of 2009 to drop to between $13.5 million and $14.5 million, including approximately $1 million of expenses for depreciation and stock-based compensation.

Finally, pro forma EBITDA for the first quarter of 2009 was a $5.5 million loss and larger than our estimates of an EBITDA loss of between $3 million and $4 million.

With strong revenue growth and lower operating expense level, we expect the pro forma EBITDA loss for the second quarter to decline to between $3 million and $4 million and hope to return to breakeven quarterly pro forma EBITDA by the end of 2009, assuming revenue continues to grow.

As for the balance sheet, cash and short-term investments at March 31, 2009, were $28.9 million which declined from $36.2 million at December 31, 2008, largely due to a $5 million reduction in debt owing to Silicon Valley Bank and the $5.5 million EBITDA loss offset by positive other working capital changes occurring during the first quarter.

As announced in our press release in March, we renewed our credit facility with Silicon Valley Bank that provides working capital financing of up to $20 million to support borrowings and letters of credit. We renewed this facility every year since 2003 on substantially similar terms and are pleased to have the short-term liquidity it provides.

In the first quarter, we’ve reduced the amount of borrowings on this facility from $15 million at December 31, 2008, to $10 million at March 31, 2009. Thus reducing our total debt obligations from $34 million to $29 million in that same period. As for other balance sheet changes, inventory levels decreased again from $40.7 million as of December 31st, 2008 to $39.8 million as of March 31st, 2009.

Also accounts receivable levels decreased by $5 million to $18.6 million at March 31st, 2009, with a number of days sales outstanding on accounts receivable for the first quarter increasing slightly to 70 days as compared to 69 days for the fourth quarter.

Finally, the average basic and diluted EPS shares were $150.7 million for the first quarter increasing only slightly from the $150.6 million in the fourth quarter. Once again the 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.

Mory Ejabat

Thank you, Kirk. For the first time in a long time, we see signs of an improving environment and we are encouraged by growing backlog and increased interest in our products. With prospects for revenue growth throughout the remainder or the year, we’re optimistic that we are return to generating positive quarterly pro forma EBITDA by the ends of 2009 which remains our primary goal.

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

Question-and-Answer Session

(Operator Instructions) Your first question comes from the line of [Karl Laconte] - Private Investor.

Karl Laconte – Private Investor

Actually I have three questions, should I ask all three now or ask one and then wait?

Mory Ejabat

Ask all three questions now.

Karl Laconte – Private Investor

At your last quarterly teleconference, you mentioned you were expecting some new deals early in Q1 and then indeed there were some announcements, shortly thereafter but there haven’t been any announcements of new sales recently. Are there any deals you expect to close here in the near term and are they of substance?

Mory Ejabat

Yeah, we have also got several deals during Q1 and recently but as the customer would allow us to make the press releases or announcement, we do so. So, so far we are working on several press releases that’s going to hit in the next few weeks.

Karl Laconte – Private Investor

Question two is, on the 16th and 17th of this month, there was about a 50% run up in your price of the stock. Can you comment on what you might attribute that to?

Mory Ejabat

I would not have any idea. I cannot comment on that.

Karl Laconte – Private Investor

And then third question is, could you comment or maybe Kirk could comment, there’s a recent rating from audit integrity that says that your accounting and governance risk was higher than most of the other companies they had audited. Can you comment on that?

Kirk Misaka

I’m sure that that was prepared in preparation for our annual shareholders meeting in May. I’m not aware of the reasons for an increased risk rate.

Karl Laconte – Private Investor

But you expect then that would be discussed in May?

Kirk Misaka

It won’t be discussed in our May meeting but normally the governance ratings come out prior to the shareholder meetings, that’s all I was saying.


(Operator Instructions) Your next question comes from Karl Laconte – Private Investor.

Karl Laconte – Private Investor

Actually you triggered this thought in your discussions. Do you see any specific value or progress that may occur due to the Federal Government stimulus package in terms of your business in both the near term and maybe over the next few years?

Mory Ejabat

As we said in this meeting, we are hopeful that the stimulus package will be a positive initiative for us and for the broadband initiatives. So, we are hopeful that will increase our revenue in the next few quarters.


Our next question comes from the line of George Tamacy - Scott-Macon. You may proceed.

George Tamacy - Scott-Macon

My question was just answered. Thank you.


Sir, it appears there are no additional questions at this time.

Mory Ejabat

Okay. 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. Operator.


This concludes today’s presentation. You may now disconnect. Good day.

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