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Zhone Technologies, Inc. (NASDAQ:ZHNE)

Q1 2013 Earnings Call

April 17, 2013 5:00 pm ET

Executives

Kirk Misaka – Chief Financial Officer, Corporate Treasurer and Secretary

Mory Ejabat – Chairman, President and Chief Executive Officer

Operator

Good day, and welcome to the First Quarter 2013 Zhone Technologies, Inc.'s conference call. I am Darcelle, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards 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 first quarter 2013 Zhone Technologies, Inc. conference call.

I’m Kirk Misaka, Zhone’s Chief Financial Officer. The purpose of this call is to discuss Zhone’s first quarter 2013 financial results as reported in our earnings release that was distributed over Business Wire at the close of market today, and it has been posted on our website at www.zhone.com.

I’m 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 of 2013, and provide guidance for next quarter.

After our prepared remarks we will conclude with questions and answers. 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.

During the course of the conference call we will make forward looking statements which will 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, 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 to 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 of mine 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 2013 earnings call.

We are very pleased to announce that we achieved or exceeded our revenue, gross margin and expense targets thereby generating positive free cash flow from operations and further improving our liquidity. First quarter revenue of $28.4 million was driven by new MXK customer growth globally. The continued acceptance of our MXK chassis and 1U-based GPON solutions was demonstrated by the shipment of 268 MXK units for the quarter.

Gross margins continued to exceed historical levels as we have consciously walked away from commodity pricing in some of our international markets. We have said we anticipate more moderate revenue growth going forward, but at greater profitability. Finally, OpEx has now stabilized at much lower level thereby lowering our breakeven point. You may recall that we substantially reduced OpEx in the third quarter of 2012 by focusing only on new and existing copper and fiber based product lines, with a strong emphasis on FiberLAN and next generation broadband products.

Our first quarter results indicate that our strategy is paying off, and that we are able to consistently generate profitability as well as positive cash flow from operations. Going forward, we continue to remain focused on improving that profitability, and expect to be even more profitable next quarter on moderate revenue growth.

In a few minutes Kirk will give you more detail about our financial results for the first quarter and guidance for next quarter, so let me address one last one financial matter, that is our NASDAQ listing.

As we have discussed before, we must regain the compliance with the NASDAQ’s $1 minimum bid price requirement before June 17, 2013 in order to maintain our NASDAQ listing.

First and foremost we hope that our strong financial performance over the past two quarters will lead to improve a stock performance that, we will be sufficient to regain compliance with the NASDAQ’s requirement. Regardless, we continue to develop contingency plans in the event that we do not regain compliance by June 17, and we will announce more detailed information if we need to move forward with any of those plans.

Now, let me turn your attention to the exciting things happening on the business side. Although our FiberLAN Optical LAN Solution is still a very new product, our optimism continues to grow. We are shipping FiberLAN Optical LAN Solution in each of our served markets. We are in certification labs at some of the world’s leading hotel brands and the U.S. government for FiberLAN.

Zhone was awarded multiple new hotel, enterprise, and university contracts. The more we learn about FiberLAN, the more applications we see for this powerful solution. At this point we see endless new applications for FiberLAN solution across multiple-deployment verticals, hotel room or college or university dorm rooms, multi-building businesses, single or multi-floor businesses, hospital building, multi-building hospitals, multi-dwelling apartment buildings or businesses, multi-tenant office buildings, temporary housing and disaster recovery, manufacturing facilities.

I mentioned last quarter that Zhone initiated an aggressive sales and marketing campaign targeting new FiberLAN prospects. We plan to continue these efforts to drive new FiberLAN revenue. We also launched several new products in the quarter as well. While we see fiber optic connectivity is the ultimate form of broadband communications and connectivity, many of our customers they still have copper in their networks. And it’s our goal to ensure they maximize the performance of their copper loops, so we introduced a high-density VDSL2 vectoring card for the MXK platform.

This new card helps customers to achieve a speed of as high as 200 megabit per second over traditional copper telephone lines. We also launched zNID ONT, it is the smallest GPON ONT in our product line up-to-date. The zNID 2301 is ideal for customers looking for a small form factor at an affordable price point.

During the quarter, we once again were awarded multiple new customer contracts. Let me share a few examples. First, Cooperativa Electrica de Lujan selected Zhone for a new GPON deployment in the city of Lujan through a strategic partner with Trans Industrias Electronicas S.A. Zhone's MXK 319 and zNID 2402 GPON ONTs were selected for the network to increase the cooperative's bandwidth offering to its customers.

Next, VOLstate.net, an ISP providing voice and data services to business customers in Dayton, Tennessee is deploying MXK. VOLstate.net built a new gigabit passive optical network to support high-speed Internet, hosted PBX, and VoIP services to its current footprint of business subscribers. We also announced through a partnership with our reseller Digistar that the Brazilian company Klisa Telecom has deployed the Zhone MSK solution to support advanced broadband services in the city of Montes Claros, Brazil. The Company also selected the platform for 10 additional cities in the state of Minas Gerais, Brazil. Klisa Telecom plans to offer high speed voice and data services to their customers using the MXK 819 with a mix of GPON ADSL+POTS and VDSL2+POTS, combo cards for new FTTx and broadband services.

The MXK has been deployed as the core enabler for Ligue Telecom’s new GPON solution also in Brazil, a combination of MXK and Zhone’s zNID ONTs were used to support customers across their service footprint. Back in the States, will be launching new ADSL service deployment with Farmers Telephone Cooperative, a South Carolina based triple-play service provider that has served Clarendon, Florence, Lee, Sumter, and Williamsburg counties for more than 60 years. Farmers Telephone will deploy Zhone’s 6519 ADSL residential gateway products to deliver IPTV services to business and residential customers.

Lastly, I am very proud to mention that our zNID ONTs were deployed by North State Telecom a leading broadband and entertainment provider based in High Point, North Carolina to deliver IPTV and video services via fiber to the home as one of the largest independent communication and home entertainment provider in North Carolina. North State maintains a robust network comprising more than 68,000 miles of high capacity fiber delivering voice, video, broadband internet for residential services and networking, IP services and critical backhaul and disaster recovery solutions for businesses.

As mentioned previously, MXK shipments were strong once again in the Q1. Zhone shipped 268 units in the quarter bringing in the total unit shipments to 4,676 units and well over 32.5 million plus of MXK GPON subscriber capacity.

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

Kirk Misaka

Thanks, Mory. Today, Zhone announced financial results for the first quarter of 2013. First quarter revenue of $28.4 million increased slightly from the fourth quarter revenue of $28.3 million, despite being a seasonally weak quarter. As compared to the same quarter of last year revenue increased by 5% growing from $27.1 million in the first quarter of 2012. Going forward, we expect sequential revenue growth for the second quarter of 2013 somewhere in the mid-single-digit percentage range. Compared to the last quarter, the strong product demand for our MXK in the larger than usual pipeline of business gives us confidence that we can achieve that revenue growth.

Our international markets continued to produce the majority of our business and represented 65% of revenue for the first quarter as compared to just 51% of revenue for the fourth quarter. We experienced more customer concentration in this quarter with the top five customers representing approximately 53% of revenue for the first quarter as compared to 38% for the fourth quarter. We also had two 10% customers in the first quarter versus just one 10% customer in the fourth quarter. As Mory mentioned gross margins exceeded our anticipated range of 34% to 36% and improved to 37% for the first quarter.

Going forward, we believe gross margins will range between 34% and 36%, which is consistent with the margins prior to the aggressive competitive pricing that we experienced in 2012. Operating expenses of $10.2 million for the first quarter was consistent with the fourth quarter and our previous guidance. As we move forward, we anticipated operating expenses we will continue at this level and can be levered to support the anticipated revenue growth, thereby leading to improve profitability.

In addition, operating expenses for the first quarter included depreciation of approximately $100,000 and stock-based compensation of approximately $200,000, both of which we expect to continue into the second quarter of 2013. Finally, our adjusted EBITDA profit for the first quarter of 2013 was $561,000 and net income on a GAAP basis was $230,000. As previously discussed, the dramatic shift in profitability can be attributed to stronger margins and substantially lower OpEx.

With revenue growth for the remaining quarters of the year, and an operating model that can be leveraged we anticipate improving profitability each quarter. Now, turning to the balance sheet, cash and short-term investments at March 31, 2013 increased to $11.7 million from $11.1 million at December 31, 2012, primarily due to the adjusted EBITDA profit. The net effect of other balance sheet changes was minor.

Accounts receivable declined to $24.2 million at March 31, 2013 from $25.8 million at December 31, 2012, while the number of day’s sales outstanding on accounts receivable for the first quarter improved to 77 days as compared to 82 days for the fourth quarter. Our total debt obligations associated with our working capital facility with Wells Fargo remained at $10 million at March 31, 2013 and December 31, 2012.

As we discussed on previous calls, 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 renewal, especially in light of the additional operating liquidity being generated by the business.

Lastly, the weighted average basic shares outstanding remained at $31.1 million and the diluted shares outstanding was $31.8 million for the first quarter of 2013. And, with that financial overview I’ll 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. Going into the year, our primary financial goal was to generate profitability for the year and as a whole. With the objective clear in sight, we are now focused on generating more profitability in each consecutive quarter. We believe we can achieve that new goal through moderate revenue growth based on the continued success of our industry-leading MXK, and the generation of new revenue from our recently launched FiberLAN Optical LAN Solution. We also anticipate that a stronger gross margins and substantially lower OpEx will continue. The combined results should lead to improved profitability and positive free cash flow from operations each quarter. We plan to use the enhanced cash flow to further strengthen our balance sheet.

One last comment before we open for questions. Yesterday, we announced our long-time relationship with AXTEL and its successful launch of AXTEL TV in five major cities Mexico City, Guadalajara, Monterrey, Queretaro, and San Luis Potosi. With over 16,000 customers since service was launched IPTV is already proving to be a winning a strategy for AXTEL. This service is offered over AXTEL's fiber-based GPON network utilizing Zhone MXK and zNID ONTs. Over the last year AXTEL's customer base for voice and data services more than doubled and we are extremely proud to have them as a customer in this rapidly growing market.

We would now like to open up the call for questions. Operator, please begin Q&A portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the name of [Alaca Muna]. Please proceed.

Unidentified Analyst

Hi there, great quarter, gentlemen. Congratulations.

Kirk Misaka

Thank you.

Mory Ejabat

Thank you.

Unidentified Analyst

Just a few questions, you mentioned you shipped 268 MXK in the first quarter. If I remember, this number was somewhere around 400 in the fourth quarter, but in the meantime, your revenue are essentially same, actually slightly improved. So, what changed in the mix of products shipped? Did you ship more cards this quarter or more ONTs and so forth?

Mory Ejabat

Hi [Alaca], we did ship more ONTs this quarter and also more line card to the existing chassis, that’s why the revenue went up. The number of chassis were deployed they are not fully loaded, so some of the cards were given there.

Unidentified Analyst

Okay, thank you. And, great news that you provided yesterday about Zhone’s relationship with AXTEL. How much more revenue do you expect to get from this relationship in the future?

Mory Ejabat

Unfortunately, I cannot tell you about the revenue, but I can tell you that they were in three cities, and now they are going to five cities, and the three cities they are not fully distributed yet, so there is a good potential of revenue with AXTEL?

Unidentified Analyst

Okay. And, is Global Village Telecom in Brazil is still your customer on an ongoing basis?

Mory Ejabat

Yes, they are still our customer. And, several weeks ago they announced themselves that they are going to get in FTTH and most likely we will be a part of their FTTH deployment.

Unidentified Analyst

Okay, great. And, this is second quarter in a row where you guys provided solid financial results. Do you think that these results will in turn give more confidence to your existing customers and the potential customers in the Zhone’s future, and hopefully generate more revenue from these customers and potential customers?

Mory Ejabat

Well, that is our plan and our goal, so we have not lost many customers because of our balance sheet, but having a stronger balance sheet will always work to our benefit. So yes we will definitely hope that happens.

Unidentified Analyst

Okay. And then, the last question. You have substantially reduced your OpEx in last quarter, and you are maintaining that, and you have the same guidance for future quarter. Do you think this lower OpEx is sustainable on a long-term basis?

Mory Ejabat

Yes, it is sustainable. We have positioned the company to grow based on this OpEx. The only variable in this OpEx would be sales commissions. So, if we get more revenue we have to pay more commission. So, other than that the base will stay the same and we are confident. We can manage the business with that.

Unidentified Analyst

Okay. Thank you for great performance. And, once again, congratulation and keep doing what you guys are doing. Thank you.

Mory Ejabat

Thank you, very much.

Operator

(Operator Instruction) There are no further questions at this time.

Mory Ejabat

Once again, thank you for joining us today and for your continued 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. Thank you. Operator?

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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