Zhone Technologies Inc (ZHNE) Q2 2013 Earnings Conference Call July 17, 2013 5:00 PM ET
Mory Ejabat - Chairman, President and Chief Executive Officer
Kirk Misaka – Chief Financial Officer
Alan Davis - LA Davis and Associates
Kenneth Speer - Nupath Associates
Good day and welcome to the Second Quarter 2013 Zhone Technologies Incorporated Conference Call. I’m Jason and I will be your coordinator for today. At this time all participants are on a listen-only mode. We’ll be facilitating a question and answer session towards the end of the conference. (Operator Instructions).
I would now like to introduce Kirk Misaka, Zhone’s Chief Financial Officer. Please proceed.
Thank you operator. Hello and welcome to the second 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 second 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 second quarter. Following Mory’s comments, I will discuss Zhone’s detailed financial results for the second 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 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 and our quarterly report on Form 10-Q for the quarter ended March 31, 2013.
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.
Thank you Kirk. Good afternoon and thank you for joining us today for our second quarter 2013 earnings call. Once again we’re pleased to announce that we achieved or exceeded our revenue, gross margin and expense target for the quarter thereby generating positive free cash flow from operations. For the third quarter in a row we have generated positive net income and cash flow from operations further strengthening our financial position. We continue to focus on profitability as our number one financial objective and expect to improve the profitability in the second half of 2013.
Second quarter revenue of $30 million increased by 6% over the first quarter and was driven by new MXK customer growth globally and a continued acceptance of our MXK chassis and 1U-based GPON solutions.
As demonstrated were the shipment of 320 MXK systems for the quarter. Gross margins continue to exceed historical levels due to an improved pricing environment and concentrated efforts on reducing the cost of our products. We’re encouraged by the initial signs of long term margin expansion that would have a significant positive impact on future profitability.
Finally OpEx remained low through continued cost containment efforts which allows us to generate profitability at substantially lower breakeven point. We continue to believe that we can leverage OpEx to support revenue growth for the next year without substantially changing the cost structure.
In a few minutes Kirk will give you more details about the financial results for the second quarter and guidance for the next quarter, so let me discuss our NASDAQ listings. As you know we were unable to regain compliance with NASDAQ’s $1 minimum bid price requirement before the June 17, 2013 deadline and requested a hearing before the NASDAQ Listing Qualifications Panel. First and foremost we hope that our strong financial performance for the past three quarters will lead to improve our stock performance which will be sufficient to regain compliance with the NASDAQ’s requirement. Regardless we continue to assess contingency plans in the event that NASDAQ does not grant a short exception within which for evidence, compliance and if necessary to execute the reverse stock split approved by stockholders at our Annual Meeting on May 2nd, 2013.
Our hearing with the NASDAQ panel has been scheduled for July 25, 2013 and we plan to announce more detailed information shortly thereafter.
Let’s now turn to the exciting things happening on the business side that are driving our sound financial performance. Enthusiasm continues to grow with the FiberLAN Optical LAN Solution; given that solution is still very new to the market we continue to ship FiberLAN Optical LAN Solution in each of our served markets. We acquired new sales staff specifically targeting FiberLAN.
Our reference include 12 major hotel chains, office buildings and business parks, university and our ongoing certification process with the [JTAG] [ph] continues to proceed on plan and as expected for military and several government contracts. We’re also in the discussion and negotiation with some of the largest integrators in the world for partnership to deploy FiberLAN. We expect that FiberLAN will be a very big part of our future in 2014.
We also launched several new products in the quarter, we’re very excited to introduce an all-new unified provisioning solution providing service providers with a holistic and simplified approach to multi-service and multi-function access management which integrates a cloud based provisioning solution providing a single point from which to manage and configure the entire network. This solution reduces network and management complexity and also reduced OpEx and CapEx.
Furthermore we also introduce the newest version of MXK high performance Uplink card with new innovation in hardware architecture that essentially doubles the network facing uplink capacity.
The new Uplink card was designed to enable operators to offer superior high bandwidth services in a variety of different networks by offering a wide range of available service types and features. This card kicks off a series of a new enhancement to the already improved impressive MXK.
During the quarter once again we’re awarded multiple new customer contracts; let me share a few examples. First we announced a VDSL2 deployment with Northern Michigan University, located in Marquette, Michigan. Designed as a cost effective way for the University to provide residents in the nearby off campus apartment with exceptionally fast and reliable wireless Internet. VDSL2 is an access technologies that uses the existing copper infrastructure originally designed for the traditional telephone services to deliver high speed Internet.
Next we announced a full fiber deployment with SuperOnda Telecom, located in the city of Volta Redonda, Rio de Janeiro in Brazil. SuperOnda Telecom will use Zhone’s MXK solution and 24xx zNIDs to provide service to 3,000 homes in Volta Redonda. The telecom company is currently building fiber OSP to expand service to an additional 5,000 subscribers in 2014, and 7,000 subscribers in 2015.
We announced a strategic partnership to integrate Tilgin's TR-069 management suite with Zhone’s indoor GPON ONT product line – providing operators with a robust plug-and-play network management solution for triple-play offerings.
We were pleased to announce a new 4 million British Pound expansions of Ethernet in the First Mile deployment with Zen Internet, made possible through a strategic partnership with Imtech Telecom. Zhone’s EFM solution will allow Zen Internet to expand its service offerings in the United Kingdom, enabling the independent ISP to provide high quality and affordable Ethernet access to businesses of all sizes across the U.K.
We released news that Zhone will assist with iTV-3’s the new network expansion in Central Illinois building off of the two previous network expansions that used Zhone’s equipment. Zhone’s MXK, GPON and zNID products will enable iTV-3 to expand its high speed Internet and triple-play services to an additional 10,000 subscribers in the region.
Lastly, after years of work and partnership, we were very proud to publically announce longtime customer AXTEL for its successful launch of AXTEL TV in five major cities, Mexico City, Guadalajara, Monterrey, Querétaro and San Luis Potosí. With more than 16,000 customers signed up since service was launched in February, IPTV is already proving to be a winning strategy for AXTEL in the residential and small and medium businesses. This service is offered over AXTEL's fiber-based GPON utilizing Zhone's MXK and zNID.
Over the last year, AXTEL's customer base for voice and data services more than doubled to 130,000 subscribers, due to its superior quality, reliability and feature capabilities.
As mentioned previously MXK shipments were very strong in Q2 surpassing Q1 shipment. Zhone shipment - shipped 320 units in the quarter bringing the total unit shipment to 4996 units and well over 34.2 million [inaudible] of MXK GPON subscriber capacity.
Now let me turn the call back to Kirk to provide more details about the financial results for last quarter and discuss our financial guidance for next quarter. Kirk?
Thanks Mory. Today, Zhone announced financial results for the second quarter of 2013. Second quarter revenue of just over $30 million grew 6% from first quarter revenue of $28.1 million. Going forward, we expect some of the sequential revenue growth for the third quarter of 2013 somewhere in the mid-single-digit percentage range driven by strong product demand to our MXK larger than usual pipeline of business.
Our international markets continued to produce the majority of our business and represented 63% of revenue for the second quarter as compared to 65% of revenue for the first quarter. We experienced lower customer concentration this quarter with the top five customers representing approximately 39% of revenue for the second quarter as compared to 53% of revenue for the first quarter. We also had two 10% customers in the second quarter similar to the first quarter. As Mory mentioned gross margins exceeded our anticipated range of 34% to 36% and improved to 37% for the first quarter and 38.6% for the second quarter.
The improving trend is certainly encouraging. We believe gross margins are at the beginning of a long term expansion period resulting from improved pricing and product cost reductions. For the third quarter we’re cautiously increasing our gross margin forecast to between 35% and 37%.
Operating expenses of $10.5 million for the second quarter was consistent with the first quarter and our previous guidance. As we move forward, we anticipate that operating expenses will continue at this level and can be leveraged to support the anticipated revenue growth, thereby leading to improved profitability.
In addition, operating expenses for the second quarter included depreciation of approximately $100,000 and stock-based compensation of approximately $100,000, both of which we expect to continue at the same level into the third quarter of 2013. Finally, our adjusted EBITDA profit for the second quarter of 2013 was $1.3 million and net income on a GAAP basis was $1.1 million. As previously discussed, the dramatic shift in profitability can be attributed to stronger margins and substantially lower OpEx.
[With revenue growth] [ph] for the remaining quarters of the year, and an operating model that can be leveraged, we anticipate improved profitability for the second half of the year.
Now, turning to the balance sheet, cash and short-term investments at June 30, 2013 increased to $12.7 million from $11.7 million at March 31, 2013, primarily due to net income. The net effect of other balance sheet changes was very minor.
Accounts receivable increased to $27.8 million at June 30, 2013 from $24.2 million at March 31, 2013, causing an increase in the number of day’s sales outstanding on accounts receivable for the second quarter to 83 days as compared to 77 days for the first quarter. Our total debt obligations associated with our working capital facility with Wells Fargo was $10 million at June 30, 2013 and March 31, 2013.
As you may recall our 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 was 31.2 million and the diluted shares outstanding was 32.7 million for the second 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?
Thank you, Kirk. Going into the year, our primary financial goal was to generate profitability for the year as a whole. Last quarter we added the objective of achieving greater profitability in each consecutive quarter. Now that both of these financial objectives are clearly [inside] [ph] we hope that improved stock price performance will follow
After generating three consecutive quarters of profitability and free cash flow from operations we’re confident that our strategy is working and that we’re on the road to success. Our industry-leading MXK and new FiberLAN Optical LAN Solution make us optimistic that we can continue on the path of adding momentum as we move into Q3, 2013 and the remainder of the year.
We would now like to open up the call to questions. Operator please begin the Q&A portion of the call.
(Operator Instructions). The first question comes from the line of Alan Davis with LA Davis and Associates. Please proceed.
Alan Davis - LA Davis and Associates
Hi guys just have three quick questions for you. First off on revenues, in the quarter anything meaningful from FiberLAN and then also going forward can you give us an insight into your expectations for the impact of FiberLAN in the second half of the year and 2014.
First of all revenue from the FiberLAN was very minimal at this point. As I have mentioned in the past at this point we’re doing lots of education and training of the sales force as well as our customers. Given that we have signed up about 12 hotel chains right now even though a couple of them have been - are treated with FiberLAN. Also we have some office building and business parks. Our expectation is that we’re going to do a small revenue generation throughout the year but majority of that is going to happen in 2014, that’s where we’re going to see FiberLAN taking off and being a major part of our revenue.
Alan Davis - LA Davis and Associates
Okay, and then on gross margins you mentioned obviously production cost improvements and also the pricing environment. I guess couple of questions there, is it kind of the improvement in gross margins has been kind of equally weighted towards your own internal cost savings and the markets pricing and then can you give us an insight into FiberLAN’s impact on margins in 2014 and beyond.
Definitely we continuously look at our cost reduction of our product and we try to take any advantage of a new technology that we can, we can incorporate in our product to reduce cost. That’s one thing. The other thing is we have seen lots of price stabilization especially in our ONTs or CPEs at this time and we don’t see Chinese manufacturers dropping their prices heavily anymore. So that has stabilized. Our FiberLAN business has a bigger gross margin than our carrier product so we believe when the FiberLAN gets going we will have a better gross margin overall in our business.
Alan Davis - LA Davis and Associates
One last one here just on your working capital facility and can you give us an update on those discussions and any expectations you have for changes in the structure of that debt facility.
As I mentioned the debt facility extends through the first quarter of 2014 but we have already discussed at initial discussions with Wells about the renewal. They have been an excellent partner and has been staying in touch with us on a regular basis and has been adapting to the changing needs and situation that exist at Zhone. Their renewal proposal reflects that interaction and at this point it looks as if we will complete the renewal well before the end of the year and that will be on terms substantially similar to the existing facility. The renewal will likely extend through 2016 and contain an accordion feature similar to the one that currently exists that will allow us to expand the facility by $5 million depending upon our needs and subject to other requirements. We will obviously make an announcement when that renewal process is complete.
Your next question comes from the line of [Alaka Munna] [ph]. Please proceed.
Congratulations gentlemen, absolutely solid quarter; as an investor I’m thrilled with your success. Thank you for your work and effort. Few question, what is your expectation of growth based on the plans of your current and potential customers that you’re talking to? That is for the next two quarters as well as long term, maybe next two, three years.
Thanks for the kind words, but in respect to growth as we mentioned during the call we’re expecting a single digit growth this quarter and most likely we will guide the same in the next quarter. Now in the next 2014 it might be higher than that based on the success of FiberLAN. So I’m not going to speculate why that could be but our goal is to be higher than what we have during this year.
Okay, great. Can you give if possible some sense of magnitude as to what is the size of the opportunity in FiberLAN that is realistically achievable by Zhone?
FiberLAN as you know is a replacement for existing LAN infrastructure. Now given that market is huge but what it can be is - what it can be for our size and our product line is that the FiberLAN requires any new building and any restoration of the existing building. So it can be dependent on what the new infrastructure is where the new buildings are and what is the retrofit on those, and we see that lots of hotels and government facilities are retrofitting to the fiber at this point. So it can be anywhere from $20 million to $40 million next year for us.
Well that is impressive. Now would you consider reporting growth in FiberLAN as a separate line item at some point because I guess market loves growth and if you’re going to see that level of growth it will be really helpful if that is separately reported so people can get a sense of what’s happening.
Honestly we haven't even thought about that but that’s something that we can consider in our future conference call if we see a good trend on that going forward.
Okay, now based on your current cost structure what part of each additional revenue dollar will go to bottom-line as you have some incremental growth?
As I said we anticipate being able to leverage operating expenses significantly to support the growth through 2014. Obviously there will be increase in sales commissions which will grow with revenue growth and we anticipate that that would be about 3% of each revenue dollar, so for each revenue dollar growth we would anticipate a 3% increase and so to specifically answer your question 97% of that would drop to the bottom-line.
Okay. Thank you, and finally now with three solid profitable quarter achieved did you have any plan to go to the Wall-Street and invite them to come and look Zhone again and benefit from the potential that it offers?
Definitely, we’ve been talking to some investors and we will continue to do so and we have seen a report that came out about our company and that was very positive and we plan to continue following that through and discuss with several different investors as time allows.
Well, thank you again, and congratulation again, great quarter, great progress. Appreciate that.
(Operator Instructions). Our next question comes from the line of Kenneth Speer with Nupath Associates. Please proceed.
Kenneth Speer - Nupath Associates
Can you provide any color on VDSL2 vectoring in Europe? Are you seeing activity there?
Yes, we do see some of our customers requesting VDSL vectoring, as you know there are two kind of vectoring available, one is port vectoring and some are unit based vectoring. We offer port vectoring and many of our customers are taking advantage of that vectoring solution.
Kenneth Speer - Nupath Associates
Okay, and the FiberLAN questions were mostly answered from the first caller but one question on that, in North America, is there any focus on an American made product or is that not an issue?
Actually we’re in a process of getting some certification from military for our product and the built in America has lots of advantage in that.
Kenneth Speer - Nupath Associates
All right, again thanks, great quarter, thank you.
At this time we have no more questions.
Once again thank you for joining us today and for your continued support. We’re looking forward to speaking with you on the next quarter’s earnings conference call when we hope to discuss even greater profitability and continued success of our products in the marketplace. Operator?
Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.
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