Zhone Technologies' CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.22.14 | About: Zhone Technologies, (ZHNE)

Zhone Technologies, Inc. (NASDAQ:ZHNE)

Q1 2014 Earnings Conference Call

April 22, 2014 17:00 ET

Executives

Kirk Misaka - Chief Financial Officer

Mory Ejabat - Chairman and CEO

Analysts

Alan Davis - L.A. Davis & Associates

Christian Schwab - Craig-Hallum Capital Group

Michael Conti - Sidoti & Company, LLC

Operator

Good day, ladies and gentlemen and welcome to the First Quarter 2014 Zhone Technologies Inc. Conference Call. I am Webley 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 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 2014 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 2014 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 first quarter. Following Mory's comments, I will discuss Zhone's detailed financial results for the first quarter of 2014 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, 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 the 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 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 2014 earnings call. We are pleased to announce that we generated positive net income for the six quarter in a row and continue to strengthen our financial position. In 2014, we expect to continue to be profitable each and every quarter adding to that strength. First quarter revenue of $28.6 million increases slightly year-over-year and decline quarter-over-quarter due to known off seasonal weakness. Meanwhile gross margin continue to exceed historical level due to an improved pricing environment and concentrated efforts on reducing the cost of our products. Most importantly, net income of $300,000 or a $0.01 per share continued our streak of six consecutive quarters of profitability and strengthening the balance sheet. Kirk will give you more details on the financial side, so let me talk about some improving business fundamental that we expect will lead to a good profitability for Zhone in 2014.

We continue to harness momentum with our FiberLAN Passive Optical LAN solution. We are working with a growing number of new enterprise opportunities. While we continue to ship our solutions in each of our served markets and we are experiencing broad acceptance of GPON as the new choice for enterprise deployments. Our main objective now is to increase awareness about FiberLAN and hence educate our customers and targets about the performance characteristics and cost savings of our Passive Optical LAN solution.

Accordingly, we are aggressively marketing to several FiberLAN target markets primarily in hospitability and military government. In the second quarter, we plan to continue our existing awareness program while adding education as another target market specifically targeting college and universities as a part of our FiberLAN awareness program.

We made several significant announcements this quarter. First, we announced the launch of our new Zhone Optical Connect Partner Program in conjunction with our FiberLAN Partner Training Program. We also completed several new product launches. First, we announced the release of through Small-Form-Factor MX 180 products, enabling operators to deliver advanced triple play services to their customers from a more compact footprint while moving even closer to the hand customer. In addition, we made significant advances with the MXK while announcing the introduction of the XG-PON1 Line Card for MXK. This card delivers up to 10 Gbps downstream and 2.5 Gbps upstream over a passive optical network, enabling service provider to deliver sophisticated application and video services.

We also announced several customer wins including Swedish service provider Gavlenet who choose to upgrade its network through installation of Zhone's MXK for VDSL2. Further, we have announced joining forces with FONEX Data System Inc., a leading telecom equipment supplier to bring high speed bandwidth to their East Central Vermont Community Fiber Network. ECFiber is a group of 24 local municipalities that in partnership with ValleyNet, a Vermont based non profit organization is building a fiber optic network capable of delivering high speed internet and telephone services to homes and businesses in participating town. Lastly, we announced that new FiberLAN deployment with IP UtiliNET helping the Atlanta, Georgia based firm enhance campus security offerings for its customers, Club Entrepreneurs, Atlanta. In addition to enabling more security for Club E, Zhone's MXK -194 and zNID -2600 series warranty help reduce ongoing operational cost.

As expected MHK shipments were very strong in the first quarter. Zhone shipped 535 MHK units in the quarter bringing their total shipment to 6,307 units and approximately 41 million ports of MHK GPON subscriber capacity.

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

Kirk Misaka

Thanks, Mory. Today, Zhone announced financial result for the first quarter of 2014. First quarter revenue up $28.6 million grew 1% year-over-year from 2013 first quarter revenue up $28.4 million. And as expected declined sequentially due to normal seasonal patterns. Backlog also increased significantly during the quarter so we expect stronger sequential revenue growth for the second quarter of 2014, somewhere in the mid to upper single digit percentage range. Our international market continue to produce the majority of our business and represented 65% of revenue for the first quarter as compared to 69% of revenue for the fourth quarter and consistent with the first quarter of 2013.

We experienced slightly higher customer concentration this quarter for the top five customers representing approximately 46% of revenue for the first quarter as compared to 42% of revenue for the fourth quarter. We've also had only one 10% customer in the first quarter as above in the fourth quarter. Gross margin was 38% exceeded our guidance range of 35% to 37% and continued the trend higher gross margin when compared to historical norms. As Mory mentioned the gross margin expense is a result of an improved pricing environment and product cost reductions.

However, we are expecting our gross margin to return to historical norms of between 35% and 37% for the second quarter of 2014. As expected operating expenses were $10.5 million for the first quarter and were slightly lower than at $10.7 million for the fourth quarter. We anticipate that for the second quarter of 2014, operating expenses will increase only slightly due to the sales commission on the additional revenue that we are forecasting. Operating expenses for the first quarter including depreciation of approximately $80,000 and stock based compensation of approximately $60,000, both of which we expect to continue at about same level into the second quarter of 2014.

Finally, our adjusted EBITDA profit for the first quarter of 2014 was $500,000 and net income on a GAAP basis was $300,000 or $0.01 per fully diluted share.

Now let's look at the balance sheet. Cash and short-term investments at March 31, 2014 were basically flat at $15.6 million and as an effect of other balance sheet changes was very minor although specific balance sheet account fluctuated to a larger extent. Accounts receivable decreased to $30.6 million at March 31, 2014 from $33.3 million at December 31, 2013. Although the number of days sales outstanding on account receivable increased slightly for the first quarter to 96 days as compared to 93 days for the fourth quarter. Our total debt obligations associated with our working capital facility with Wells Fargo remained $10 million at both March 31, 2014 and December 31, 2013.

Lastly, the weighted average basic shares outstanding were $32.3 million and the diluted shares outstanding were $34.8 million for the first quarter of 2014.

And 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 2014, confident that we can deliver on our primary financial goal which is to generate greater profitability for the year as a whole. Having achieved both top line growth and profitability for all of 2013, we entered 2014 remaining focus on our two primary financial objectives. Generating continued revenue growth and improving profitability. MHK continues to pay dividend for Zhone resulting in outstanding quarterly shipments. While our FiberLAN Optical LAN solution continues to outpace our expectations and our strength or optimism.

We will now like to open 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 the line of Alan Davis with L.A. Davis. Please proceed

Alan Davis - L.A. Davis & Associates

Hi, guys. Solid quarter, good margin, just curious if you could breakout and talk about strong pricing environment. Could you give us a little bit information on that kind of breaking out where are you seeing domestically in your China international markets?

Mory Ejabat

Okay, Alan, on the pricing side we have seen pricing is stabilizing mainly on the ONT or CPE product line. It has been like this for several quarters. We believe that it is very sustainable and it has hit bottom at this time. So we don't see very comparative pricing actually or we see that our Chinese manufacturer have stabilized the pricing now actually they are demanding higher price for their warranties. That is everywhere in the international market. And their parking, it has been very stable in the United States as well.

Alan Davis - L.A. Davis & Associates

Okay and the guidance for the next quarter at -- so the margins coming down to the debt, is that product mix, geographic mix shifting or conservatism or kind of all the above?

Mory Ejabat

I think you would see that as more of higher product mix because we shipped a little more OLT last quarter than normally we do. But these OLTs need some warranty so we are -- that's what we are projecting for gross margin. But our goal is to actually smash the gross margin for year, for this quarter.

Kirk Misaka

The other thing is that the international percentage of the total declined from 69% in the fourth quarter to 65% in the first quarter, and we are expecting perhaps the larger percentage of international business which is slightly lower margin as well.

Alan Davis - L.A. Davis & Associates

Okay, great, thank you. And one last one, I know if you don't provide any specific FiberLAN and may be give us a sense for kind of your -- how your view has changed or not changed in terms of the timing of that product line becoming significant in terms of kind of -- how it has been received in the market?

Mory Ejabat

Alan, you know we are still very much in favor of FiberLAN, it has picked some momentum as we have seen in the last quarter comparing to 2012, we see more request and more RSP in that respect especially in the hospitality arena. As you know this market is competing against their traditional switch market which is almost $ 20 billion market. We are very enthusiastic about where this product is going. And a type of acceptance we are seeing in this market.

Operator

Your next question comes from the line of Christian Schwab, Craig-Hallum. Please proceed.

Christian Schwab - Craig-Hallum Capital Group

Great, thank you. Sorry guys I got disconnected from the conference call, I apologize. I missed what you guided the top line to do with Q2 on a sequential basis.

Kirk Misaka

We said that it would be in the mid to upper single digit percentage range, stronger than what we expected this quarter.

Christian Schwab - Craig-Hallum Capital Group

Okay, perfect. And then on the FiberLAN initiative, have you quantified your pipeline of activities for this year at all?

Mory Ejabat

No, I can tell you we are quantify our Q2 plan, Q3 and Q4 we have not see the pipeline but how to quantify that is remained to be seen. But we are very optimistic about what we are seeing in the market.

Christian Schwab - Craig-Hallum Capital Group

Can you give us idea of how big the potential pipeline is? Can we do $10 million revenue in FiberLAN this year, $ 5 million - $20 million, what is a realistic number for us to start thinking about now?

Mory Ejabat

The numbers that we have said you mentioned $10 million or flat but we are still looking forward to those kind of number and what we have seen in Q1 has given us some confidence that yes that number is doable.

Christian Schwab - Craig-Hallum Capital Group

Was the FiberLAN revenue in Q1 greater than Q4?

Mory Ejabat

No, it wasn't but definitely it was much greater than Q1 of 2012

Christian Schwab - Craig-Hallum Capital Group

Great and then are you guys in a position to quantify what that revenue number is on quarterly basis yet? Or are you still not going to break that out yet?

Mory Ejabat

It is too early, Christian, we love to do that but we think it is too early to do that.

Christian Schwab - Craig-Hallum Capital Group

Okay, great. No other questions, thanks guys.

Operator

(Operator Instructions)

Our next question comes from the line of Michael Conti with Sidoti.

Michael Conti - Sidoti & Company, LLC

Hey, guys. Just a few questions. Just regarding with the U.S. spending, can you just throw some color on what you are seeing out there in terms of stimulus funding? It looks the domestic revenue increased as a portion of total revenue from the fourth quarter?

Mory Ejabat

No, Michael, as you know Q1 is normally slow quarter for our industry and is very seasonal. Obviously, it was less than last quarter but we have seen spending in carrier space but our FiberLAN has been pretty strong domestically in the Q1.

Michael Conti - Sidoti & Company, LLC

Okay. Then I guess can you just talk about I guess the pace of U.S. revenue over the first quarter from January to March? I guess that you exit the quarter on a strong note as compared to last year. Any color on that?

Mory Ejabat

We exited the quarter with a stronger backlog going to Q2 than we had previously that we did at Q4 to Q1. So we have build up a good backlog going to Q2.

Michael Conti - Sidoti & Company, LLC

Okay, great. And I think I missed it. How many are the MXK shipments that you guys have at this quarter?

Mory Ejabat

It was around 535 I believe in last quarter.

Michael Conti - Sidoti & Company, LLC

Okay, that was -- that significantly higher than the first quarter of March -- the first quarter of 2013 rather so I guess what's the revenue mix in that number?

Mory Ejabat

No, we don't give revenue mix on that but one of the reason we shipped more MXK that we normally do is some of that went to our FiberLAN customers.

Michael Conti - Sidoti & Company, LLC

Okay, so I can assume that a majority of it was related to FiberLAN then?

Mory Ejabat

No, no. It wasn't majority of them, majority of them went to our core business customer what we had MXK FiberLAN who are enterprise customers.

Michael Conti - Sidoti & Company, LLC

Got it, perfect, okay, that's all I have. Thanks.

Operator

We have no further questions. Now, I would like to turn the conference back over to Mory. Please proceed.

Mory Ejabat

Once again thanks for joining us today. Thanks for continued support. We are looking forward to speaking with you on the next quarter's earnings conference call. And we expect to announce continued profitability and improving fundamentals. Operator?

Operator

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

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Zhone Technologies (ZHNE): Q1 EPS of $0.01. Revenue of $28.6M misses by $0.65M.