Zhone Technologies, Inc. (ZHNE) Q3 2010 Earnings Call October 20, 2010 5:00 PM ET
Kirk Misaka - CFO
Mory Ejabat - Chairman and CEO
Good day and welcome to the third quarter 2010 Zhone Technologies Incorporated conference call. (Operator Instructions) I would like to introduce Kirk Misaka, Zhone's Chief Financial Officer.
Hello and welcome to the third quarter 2010 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 2010 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 third quarter. Following Mory's comments, I will discuss Zhone's detailed financial results for the third 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.
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 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, 2009, and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, and June 30, 2010. We'd 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 of 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 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 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.
Thank you, Kirk. Good afternoon and thank you for joining us today for our third quarter 2010 earnings call. We are pleased that we have exceeded our profit guidance and generated positive cash flow from operations for the third quarter of 2010 based on the double-digit growth in our Latin America, European and Middle East regions and continued revenue growth attributable to our MXK OLT and zNID ONT.
We continue to remain confident about generating positive adjusted EBITDA and a cash flow for the fourth quarter of 2010 as well. The fourth quarter should bring even stronger revenue growth as we work to adjust material and long lead times from suppliers that limited our third quarter revenue growth.
The other important financial accomplishment for the third quarter was the sale and leaseback of our Oakland Campus. The transaction allowed us to substantially strengthen our balance sheet and reduce occupancy costs going forward. Kirk would give you more details about this transaction in a minute.
In the meantime, let me spend a few minutes talking about the improving state of our business. First, growing service provider demand for our GPON solutions vide MXK has become the product to beat. Second, new customer growth, expanding over 20 new MXK customers in Q3 2010 alone.
Third, growing interest in our solution from broadband stimulus recipient in the U.S. who are beginning to receive funding and are choosing the MXK for deployment. Fourth, MXK recognition by the leading research analyst firms like Infonetics, broadbrandtrends and Dittberner, recognized as a clear leader in GPON globally, recognized as the leader in GPON in Latin America, recognized as the number two in GPON in Europe and Middle East.
Moreover, we are well on our way to achieve three consecutive quarters as a clear leader in GPON rating among industry giants, Huawei and Alcatel. And finally, with over 700 MXK systems deployed globally supporting a total system capacity of over 7 million subscribers we expect GPN expansion at both the Central Office and Customer Premises locations in the future.
Now let me provide a few highlights from the past quarter. As anticipated, the combined strength of the colorful MXK and zNID solution continues to gain market share and recognition. As mentioned previously, MXK is clearly recognized as a market leader in GPON and selected as the product of choice by more than 20 service providers globally in Q3 2010.
Additionally, in Q3, we announced several of many new North American broadband stimulus winners, including Yadkin Telephone Membership Corporation. Yadkin will use Zhone's MXK intelligent Gigabit Passive Optical Network, or GPON solution, as well as the zNID ONT to extend high speed fiber optic connectivity to homes, businesses and schools in the rural North Carolina.
We also announced broadband stimulus award winner Shawnee Telephone Co., who selected our multi-service access node for support of the Southern Illinois Sustainable Broadband Transformation project.
Shawnee was awarded $8.5 million in federal and state funds to connect households, businesses, and public schools, libraries, law enforcement offices, and medical facilities in one of the nation’s most remote and underserved regions. Shawnee is one of the largest and most remote contiguous service areas in Southern Illinois.
We continue to recognize worldwide market gain for GPON solution in the third quarter of 2010. The impact of Zhone's GPON market growth and overall industry leadership is substantiated by Zhone's recent ranking status with leading market analyst firms, broadbandtrends, Infonetics Research and Dittberner Associates.
As of Q3 2010, Zhone was recognized as the #3 vendor worldwide for GPON revenue for rolling four quarters, 3Q 2009 to 2Q 2010, source, broadbandtrends, the #1 vendor in CALA region for GPON ports for 2Q 2010, source, Dittberner Associates, the #2 vendor in EMEA region for GPON ports for 2Q 2010, source, Infonetics Research.
We announced our new brand strategy and Website as part of a nonstop global awareness campaign. The company's rebrand strategy is centered on two core elements: Building the network of the future... Today!. Building the fastest, highest quality all-IP multi-service networks in the world!
The positioning concept drives our new corporate tagline, "Bandwidth Changes Everything!" As mentioned previously, we remain confident about the fourth quarter and highly optimistic about 2011 as we see considerable momentum from many new and existing customers, and enthusiasm for the highly successful MXK and our powerful Voice with ONT solutions.
Now I will turn the call over to Kirk to provide more details about our financial results for the last quarter, and to discuss our financial guidance for the next quarter.
Today, Zhone announced financial results for the third quarter of 2010. Third quarter revenue of $33.7 million grew slightly by 1% as compared to the second quarter revenue of $3.3 million. As Mory mentioned, growth was limited due to material shortages and long lead times from suppliers. By resolving these issues, we expect stronger single digit percent of sequential revenue growth for the fourth quarter. That growth will be driven by and increased stimulus funding for domestic customers and network expansion in emerging international markets.
We continue to serve of 750 active customers worldwide with 62% of revenue year-to-date being attributable to international customers. We also continue to have just one 10% customer that experienced slightly more customer concentration this quarter with the top five customers representing approximately 45% of revenue for the third quarter as compared to 42% of revenue for the second quarter.
Gross margins of 40.3% for the third quarter of 2010 were better than expected due to the large percentage of OLT revenue during the quarter. With a more normalized mix of OLT and ONT revenue next quarter, we expect margins for the fourth quarter to return to between 34% and 36% which would be consistent with second quarter gross margins of 36.1%.
Operating expenses for the third quarter included the $2 million gain on the sale of our well planned campus which I’ll discuss in greater detail in a moment. Otherwise, operating expenses of $13.6 million excluding the gain was at the low end of our guidance range of $13.5 million to $14.5 million. We expect operating expenses for the fourth quarter to continue to be within this range.
Operating expenses for the third quarter included depreciation of approximately $400,000 and stock based compensation of approximately $200,000. Going forward, we expect approximately the same amount of depreciation and stock based compensation. Finally, and most important, our adjusted EBITDA profit for the third quarter of 2010 was approximately $600,000 which beat our break even guidance and improved upon the adjusted EBITDA loss of approximately $800,000 in the second quarter.
For the fourth quarter, we expect to continue to generate positive adjusted EBITDA. If we accomplish this goal, we should exit 2010 with more cash than we started the year with. And while we’re on that topic, we substantially strengthened our balance sheet this quarter by generating positive adjusted EBITDA and selling our open campus. Cash and short term investments of September 30, 2010 were $21.5 million which increased from $20.3 million at June 30.
Also, nearly all of the proceeds from the sale of campus were used to pay the outstanding mortgage debt. Accordingly, net cash or cash net of debt obligations improved by $19.7 million to $11.5 million at September 30, from a negative $8.2 million at June 30.
Now let me say a few things about the sale and lease back of our campus. As mentioned on our last earnings call, we initiated conversation with our mortgage lender to restructure the mortgage debt that was coming due in April 2011. As part of that process, we began evaluating other alternatives to monetize the value of the excess space associated with our campus. Ultimately, the buyer and landlord approached us with a superior opportunity to sell the campus, and retain the space that we needed to run our business including space to accommodate growth over the next few years.
In the meantime, the sale lease back will also reduce our future operating costs by approximately $1.5 million per year. We anticipate completing the transition and consolidation into the single building by the end of the year, at which point we will begin realizing the benefits of the reduced occupancy costs.
As for other balance sheet changes, other working capital changes largely netted out, but an increase in accounts receivable being offset by a decrease in inventory and an increase in accounts payable. With the increase in accounts receivable, the number of days sales outstanding on accounts receivable for the third quarter increased to 91 days, as compared to 75 days for the second quarter.
As mentioned on our last few earnings calls, we anticipate DSOs to continue to be effected by the shipment and payment cycle with our 10% customer. Our total debt obligations declined from $28.5 million at June 30 to $10 million at September 30, due to the payment of the campus mortgage debt. The remaining debt is associated with our working capital facility of the Silicon Valley Bank.
As we’ve discussed before, we will renew this facility annually, and we anticipate being able to renew it again as we’ve done for many years. That renewal would occur in the first quarter of 2011.
Lastly, the weighted average basic and diluted shares outstanding were $30.4 million and $31.9 million respectively for the third quarter of 2010. The weighted average basic and diluted shares outstanding for the second quarter of 2010 were $30.3 million, as reflected on our post reverse split basis.
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. The positive feedback we have received from customers and industry analysts shows that our MXK solution is gaining momentum in the marketplace, as we are moving to the fourth quarter and 2011. With this momentum, we hope to improve on our revenue growth and EBITDA profitability for the fourth quarter.
Thank you for joining us today. We would now like to open up the call to the questions.
(Operator Instructions) And our first question comes from the line of (Martin Laney with Blue Inc).
Just two brief questions. What were the DSOs again, Kirk?
DSO was 91 for the third quarter and 75 for the second quarter.
And other than Yadkin, did you release the names of the other 19 customers you got in the quarter?
Yes, it was Shawnee Tel.
You mentioned 20 total I thought.
20 new customers we got, we didn’t announce those names. The two that we named were the stimulus accounts.
(Operator Instructions) And I am showing no further questions at this time. I'd like to turn the call over to Mr. Ejabat for the closing remarks.
Once again, thanks for joining us today and for your continued support. We are looking forward to speaking with you on our next earnings conference call.
Thank you. That concludes today’s conference. Thank you for your participation. You may now disconnect.
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