Zhone Technologies' CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.17.13 | About: Zhone Technologies, (ZHNE)

Zhone Technologies, Inc. (NASDAQ:ZHNE)

Q3 2013 Earnings Conference Call

October 17, 2013 17:00 ET

Executives

Mory Ejabat - Chairman, President and Chief Executive Officer

Kirk Misaka - Chief Financial Officer

Analysts

Alan Davis - L.A. Davis & Associates

Orin Hirschman - AIGH Investment Partners

Operator

Good day, and welcome to the Third Quarter 2013 Zhone Technologies Incorporated Conference Call. I am Esteban and I will be your coordinator for today. At this time, all participants are on a 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 third quarter 2013 Zhone Technologies, Inc. conference call. I am Kirk Misaka, Zhone’s Chief Financial Officer. The purpose of this call is to discuss Zhone’s third quarter 2013 financial results as reported in our earnings release that 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 third quarter. Following Mory’s comments, I will discuss Zhone’s detailed financial results for the third 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 quarters ended March 31, 2013 and June 30, 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.

Mory Ejabat

Thank you, Kirk. Good afternoon and thank you for joining us today for our third quarter 2013 earnings call. For the fourth quarter in a row, we are pleased to announce that we achieved or exceeded our revenue, gross margin and expense targets thereby generating positive net income and free cash flow from operations, all of which further strengthens our financial position. We expect that our fourth quarter will be profitable quarter and will close out 2013 with a record profitability and financial performance.

Third quarter revenue of $31.5 million, increased by 5% quarter-over-quarter and 8% year-over-year driven by the shipment of 377 new MXK systems for the quarter and demonstrating broad-based acceptance of our MXK chassis and 1U-based GPON solutions.

Gross margins continued to exceed historical level due to an improved pricing environment and concerted efforts on reducing the cost of our products. At the same time OpEx remained low through continued cost containment efforts allowing us to generate maximum profitability from our revenue book. Mostly importantly, net income improved to $1.6 million or $0.05 a share. Our strong financial performance for the quarter also helped us to strengthen the balance sheet as we increased our cash flow balance to $14.3 million. Coupled with the renewal of our debt facility, we maintain a comfortable cushion of liquidity to effectively run the business.

Kirk will give you more details on the financial side. So let me talk about the things happening on the business side that are driving this strong financial performance. Enthusiasm continues to grow with FiberLAN Passive Optical LAN. This solution is still new to the market. However, our optimism continues to grow. We continued to ship FiberLAN Optical LAN Solutions in each of our served markets and we continue to see broad acceptance of GPON deployed in the LAN. [JTAG][ph] anticipated certification will be completed this quarter enabling Zhone to pursue military and federal government contracts around the world. Furthermore, we were extremely excited with the experience with FiberLAN at Crowne Plaza hotels delivering clear benefits for the hotel while increasing occupancy.

As mentioned on our last earnings call, we continued to see tremendous traction in the hospitality market.

Additionally, we joined two very important industry driving associations. The first directly linked to FiberLAN, the new association for Passive Optical LAN, Zhone is a co-founding member working in conjunction with IBM, 3M, Corning, SAIC, TE [Data] [ph] and others. This new association comprises of members involved in providing infrastructure, electronics, integration, distribution and consulting services while supporting the growth of Passive Optical LAN industry.

We also announced membership in the Open Networking Foundation. ONF is a user-driven organization dedicated to accelerating the adoption of open Software-Defined Networking. Zhone will work alongside 90 plus member companies including global giants and a startup with a variety of expertise, bringing together diverse perspectives from silicon to systems and software to computing for a variety of users. We are very optimistic about participating in both of these new organizations.

We launched our new products in the quarter. We were really excited to introduce our new Zhone FiberBuilder, the newest addition to our already robust MXK product. Zhone’s FiberBuilder provides high-density LTE mobile backhaul, MXK Global IntraLink switch-to-switch trunking and 1GE to 10GE Access Aggregation. Furthermore, we also introduced general availability of the Zhone Unified Provisioning software for our zNID product line. Integration of Zhone’s cloud-based provisioning solution provides a single point from which to manage and configure an entire network while also reducing networking management complexity. During the quarter, we were awarded multiple new customer contracts.

Let me share a few examples. First, we announced a new deployment on Clarksville Department of Electricity for expansion of their [lifetime] [ph] network deploying our zNID ONTs to offer 1 gigabyte service to their growing customer base. Next, we announced a new GPON-based MXK and zNID deployment with NineStar Connect in Indiana. We also announced Telecom Namibia, which will deploy Zhone’s MXK and zNID in multi-year deployment in effort to support their 145,000 customers. As mentioned previously, we were thrilled to announce Zhone FiberLAN at Crowne Plaza in the Midwestern region.

Lastly and we were excited to announce that TVFuego in Argentina selected Zhone for a new GPON network deployment that will enable greater bandwidth support for its customers versus its previous DOCSIS cable solution. This new network will be the largest GPON deployment in the country.

As mentioned previously, MXK shipments were very strong in Q3. Zhone shipped 377 MXK units in the quarter bringing the total shipments to 5,372 units and well over 36 million ports of MXK GPON subscriber capacity.

Now, 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, Zhone announced financial results for the third quarter of 2013. Third quarter revenue of $31.5 million grew 5% sequentially from second quarter revenue of just over $30 million and grew 8% year-over-year from third quarter revenue of 2012 revenue of $29.2 million. Going forward, we expect similar sequential revenue growth for the fourth quarter of 2013 somewhere in the mid single-digit percentage range driven by a larger than usual pipeline of business and continued customer demand for our products.

Our international markets continued to produce the majority of our business and represented 66% of revenue for the third quarter as compared to 63% of revenue for the second quarter. We experienced slightly higher customer concentration this quarter with the top five customers representing approximately 42% of revenue for the third quarter as compared to 39% for the second quarter. We also had two 10% customers in the third quarter similar to the second quarter.

Gross margins of 37.8% exceeded our guidance range of 35% to 37% and continued the trend of higher gross margins when compared to historical norms. As Mory mentioned, we believe gross margins are at the beginning of a long-term expansion period resulting from improved pricing and product cost reductions. For the fourth quarter, we are leaving our gross margin guidance between 35% and 37%. We are hopeful that gross margins can continue to surprise to the upside.

Operating expenses of $10.3 million for the third quarter was slightly lower than the second quarter and our previous guidance of about $10.5 million. As we have mentioned before, 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 third 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 fourth quarter of 2013.

Finally, our adjusted EBITDA profit for the third quarter of 2013 was $1.8 million and net income on a GAAP basis was $1.6 million, which represents a nearly 50% improvement over second quarter net income of $1.1 million. Earnings per share increased dramatically from $0.03 per share in the second quarter to $0.05 per share in the third quarter. As previously discussed, the significant shift in profitability can be attributed to stronger margins and substantially lower OpEx. With revenue growth for the final quarter of the year and an operating model that can be leveraged, we also anticipate improved profitability for the fourth quarter of 2013.

Now, turning to the balance sheet, cash and short-term investments at September 30, 2013 increased to $14.3 million from $12.7 million at June 30, 2013, primarily due to net income. The net effect of other balance sheet changes was very minor, although specific balance sheet accounts fluctuated to a larger extent. Accounts receivable increased to $29.4 million at September 30, 2013 from $27.8 million at June 30, 2013 causing a slight increase in the number of days sales outstanding on accounts receivable for the third quarter to 84 days as compared to 83 days for the second quarter. Our total debt obligations associated with our working capital facility with Wells Fargo was $10 million at September 30, 2013 and June 30, 2013.

As previously announced, we extended the maturity date of the facility from March 13, 2014 to March 31, 2016. In addition, the amendment amends the letter of credit sublimits in the facility and reduces the interest rate margin from 3.5% to 3.0% with a provision for further decreases in the event that Zhone attains specified performance metrics. The extension of our credit facility ensures our ability to develop leading technologies for our customers. Wells Fargo Capital Finance continues to be an excellent partner in developing a financing solution that supports our continued growth and enables us to meet the changing needs of our business.

Lastly, the weighted average basic shares outstanding was $31.5 million and the diluted shares outstanding was $33.3 million for the third quarter of 2013. Now with that financial overview, let me 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. When we entered 2013, our primary financial goal was to generate profitability for the year as a whole. During the year, we added the objective of achieving greater profitability in each consecutive quarter. As we begin the final quarter of 2013, both of these financial objectives are clearly insight and we are confident that our strategy is working. Our industry-leading MXK and the new FiberLAN Optical LAN Solution make us optimistic that we can continue on the path adding momentum as we move forward.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Alan Davis with L.A. Davis & Associates.

Alan Davis - L.A. Davis & Associates

You gave us the geographic breakdown, I am just wondering in terms of obviously the competitive environment, and pricing looks pretty good given the margins, but just wondering if there was any – give us any update or insight into any competitive changes you saw in the [inaudible] markets whether any shifts there from your competitors that you noticed?

Mory Ejabat

Well, Alan, this is Mory. In reality, the only shift we have seen in our competitors is from our Chinese manufacturers who we are competing with. And they have stopped dropping the prices and have worked on the stability on the pricing scheme in the global terms.

Alan Davis - L.A. Davis & Associates

Okay. And going into the fourth quarter, do you expect similar product mix and geographic mix in that quarter as well?

Mory Ejabat

We do see the same thing as we had in Q3. We might see a little more FiberLAN in our mix than we had in the past.

Alan Davis - L.A. Davis & Associates

Okay. And in regards to the new debt facility, will there be anything noticeable in the income statement going forward or is it just a matter of you have got the flexibility now for the next couple of years that you need?

Kirk Misaka

Alan, this is Kirk. It really just increased the flexibility. As you know, we do not have significant borrowing costs and those borrowing costs although they go down won’t have a significant impact on the income statement.

Alan Davis - L.A. Davis & Associates

Okay. And last question here obviously on FiberLAN, in terms of as you look out to next year, would you say your outlook on that product and its impacts both in revenue and margins is unchanged from the last two or three months ago or any updates there in terms of your expectations for FiberLAN and its impact on the income statement?

Mory Ejabat

I believe we are on our plan for FiberLAN as we had outlined that before and we are working towards that. We see lots of interest lately in the hospitality area. We have announced one hotel chain and we are in the course of getting some other contracts with some other hotel chains. And we are feeling optimistic about FiberLAN. FiberLANs affecting our product would be really an increase in the gross margin and revenue.

Alan Davis - L.A. Davis & Associates

Okay, great. Thank you, guys.

Mory Ejabat

Thank you, Alan.

Operator

Our next question comes from the line of Orin Hirschman with AIGH Investment Partners.

Orin Hirschman - AIGH Investment Partners

Hi, AIGH Investment Partners. Congratulations on the progress.

Mory Ejabat

Thank you.

Orin Hirschman - AIGH Investment Partners

In terms of the seasonality from Q4 to Q1, can you just review with us and is FiberLAN going to temper that more, just give us your thoughts on seasonality in general? And I have two follow-ups.

Mory Ejabat

Yes. First of all, Q4 normally is a strong quarter for us and it has been in the past. In respect to FiberLAN, FiberLAN sales cycle is large and we may get some of those orders during the quarter, but we may get some of them during the year in 2014. So we are in the beginning phase of FiberLAN and we believe FiberLAN is going to be an exciting product for us and it’s going to have some effect in our bottom line, but the timing of FiberLAN is really unknown because of the long sales cycle.

Orin Hirschman - AIGH Investment Partners

So just following up again and then one question more on FiberLAN, just in terms of seasonality, can Q1 be up over Q4 or could it be up just significantly Q1 over last year Q1, what should we hope for or what’s the possibility?

Mory Ejabat

Our goal is our year-over-year quarters are exceeding our last quarter. So let me keep it like that.

Orin Hirschman - AIGH Investment Partners

Okay. Now, in terms of FiberLAN, the last question that was asked before me that indicated whether you are reiterating your guidance of FiberLAN for what you had mentioned on the previous last conference call. So if I remember correctly from that call, it was $20 million to $40 million for a wide range for next year 2014. Is that still the range that’s a comfortable range?

Mory Ejabat

That’s the plan we have and that’s what we are executing too.

Orin Hirschman - AIGH Investment Partners

Okay. Any thoughts as to whether you are more comfortable with the middle of the range to higher end, the lower end, anything like that?

Mory Ejabat

Let’s put it this way. I am always more comfortable with the lower range than the upper range.

Orin Hirschman - AIGH Investment Partners

Okay. Anything competitive more in terms of competition creeping up from FiberLAN besides many of the stuff that’s already out there like a Cisco style solution and anymore pickups of customers from [what are] [ph] all the dropping out and update on Tellabs?

Mory Ejabat

Well, right now we have Tellabs as only competitor in the FiberLAN arena. We haven’t seen them coming with any new products or any new solution. I believe we are going to come up with some new product that enhances our position in the FiberLAN arena. And also we haven’t seen any changes in the direction that Cisco and any traditional Ethernet switches are going. So we see our position in the FiberLAN area to be very strong at this point.

Orin Hirschman - AIGH Investment Partners

And you mentioned some new add-ons to the FiberLAN family that will help you continue to gain a leap over Tellabs, when can we hope to see something like that?

Mory Ejabat

You may probably see some announcement from us this quarter.

Orin Hirschman - AIGH Investment Partners

Okay, great. And just last question in terms of Tellabs, I haven’t really followed them in terms of their specific product lines, have they announced any major hospitality wins, where are they in terms of – I know we were out there first, but where are they in terms of getting customers and particularly on the government side?

Mory Ejabat

Well, the only place we see Tellabs is on the government side and that’s because they have the [JTAG] [ph] approval. We are in the process of getting the [JTAG] [ph] approval and hopefully this government shutdown didn’t affect our progress and we are hoping to have that this quarter.

Orin Hirschman - AIGH Investment Partners

Great, thank you and congratulations on the progress.

Mory Ejabat

Thank you, Orin.

Operator

Our next question comes from [Alaca Muna] [ph] with Zhone Technologies.

Unidentified Analyst

Congratulations gentlemen, great quarter.

Mory Ejabat

Thank you.

Unidentified Analyst

In particular, the 50% earning increase over the last quarter was very impressive. Thanks for hard work the Zhone team is putting in. I guess some of my questions are already answered. Did you guys provide any revenue guidance for the next quarter?

Kirk Misaka

Yes, we said mid single-digit percentage sequential revenue growth.

Unidentified Analyst

Okay, thank you. And what level of revenue can be supported by your current cost structure, hopefully the revenue growth continues, at what point you may have to increase, I mean, current year cost structure?

Mory Ejabat

Okay. Let me make a clarification. First of all, [Alaca Muna] [ph] is not with Zhone Technologies. So, I want to clarify that in this call and also make sure that we say understand your question that is how much headroom do we have with the existing OpEx, before we have to increase the OpEx in our balance sheet or income statement? We are for foreseeable future, for the next few quarters, I believe we are fine with the level of OpEx that we have.

Unidentified Analyst

Okay. My understanding is that Zhone was going – was involved in some discussions with some major integrators for Motorola business, because Motorola is apparently abandoning optical LAN business, is there any progress to report on that front?

Mory Ejabat

Yes, definitely. We are working with the integrators and we are getting close to winning couple of deals with them and we are hopeful that, that will happen soon. As you know, Motorola business is not supported anymore. So we are seeing a good market opportunity in that area.

Unidentified Analyst

Okay. And finally, there was the announcement earlier this year by CenturyLink, they won a very large defense department project, I think it was like $750 million worth. Is Zhone by any chance involved in that deal?

Mory Ejabat

No, we are not and actually I wasn’t aware of that deal, so no.

Unidentified Analyst

Okay. Well, thank you. Great quarter. Very impressive. Good luck for the next one.

Mory Ejabat

Thank you very much.

Operator

There are no more questions at this time.

Mory Ejabat

Thank you. 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 expect to announce closing our 2013 with a record profitability. Operator?

Operator

That concludes today’s conference. Thank you for your participation.

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