Zhone Technologies' (ZHNE) CEO Mory Ejabat on Q2 2014 Results - Earnings Call Transcript

Jul.17.14 | About: Zhone Technologies, (ZHNE)

Zhone Technologies Inc (NASDAQ:ZHNE)

Q2 2014 Earnings Conference Call

July 17, 2014 05:00 pm ET

Executives

Kirk Misaka - Chief Financial Officer, Corporate Treasurer, Secretary

Mory Ejabat - Executive Chairman

Jim Norrod - President and Chief Executive Officer

Analysts

Christian Schwab - Craig-Hallum Capital Group

Alan Davis - L.A. Davis

Michael Conti - Sidoti

Orin Hirschman - AIGH Investments

Marty Albam - Verizon Network

Operator

Good day. Welcome to the Second Quarter 2014 Zhone Technologies, Inc. Conference Call. I am [Whitley], 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 second 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 second 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 Executive Chairman. 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 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, 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, 2013, our quarterly report on Form 10-Q for the quarter ended March 31, 2014. 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 in mind, I would now like to introduce Mory Ejabat, Zhone's Executive Chairman.

Mory Ejabat

Thank you, Kirk. Good afternoon and thank you for joining us today for our second quarter 2014 earnings call. We are pleased to announce that we generated positive net income for the second quarter in a row and continue to strengthen our financial position.

Second quarter revenue of $32.4 million increased 8% year-over-year and increased 13% quarter-over-quarter, meanwhile gross margin declined slightly to 34%, mainly due to product mix. Net income of $369,000, or $0.01 per share continued a streak of seven consecutive quarters of profitability and strength in the balance sheet.

Kirk will give you more details on the financial side, so let me talk about some important changes to Zhone.

Effective immediately, the board has named James Norrod as this company's new CEO. I will remain as an Executive Chairman, providing a seamless transition while delivering a strategic guidance as it relates to the carrier access business and future product development. Jim Norrod will join the Board effective immediately.

With 25 years of experience as Chairman and CEO and a proven track record of consistently meeting or exceeding goals, Jim has extensive enterprise experience relevant to taking advantage of the FiberLAN value proposition and direct experience in the service provider and telecommunication industries.

Jim's refined expertise includes development of domestic and international operations, establishment of new sales distribution channels, hiring and developing world-class teams while developing and implementing business strategies. We are very excited that Jim has decided to join Zhone as CEO and the member of the board. With his experience, we believe, he can guide the company to take advantage of the exciting opportunity with FiberLAN.

Now, let me turn the call over to Jim to introduce himself and say a few words. Jim?

Jim Norrod

Thanks, Mory. It is with great pleasure that I accept my new position as CEO and board member at Zhone Technologies. I am thrilled to be part of this exciting forward-looking company with seven consecutive quarters of profitability and growth, an exciting new enterprise technology market with FiberLAN and a strong suite of products.

I can't imagine a better place to be right now. I look forward to working with the rest of the board and management team at Zhone as we prepare to take Zhone to the next level on this exciting new journey.

Now, let me turn the call back over to Mory, so that he can provide more details from the past quarter. I look forward to speaking with all of you at the end of Q3.

Mory Ejabat

Thanks, Jim. With regard to our business, we continue to gain momentum with our FiberLAN passive optical LAN solution, a number of new enterprise opportunities continue to grow each quarter as we expand our FiberLAN customer reference list.

Our main objective now is to guide awareness about FiberLAN, hence educating industry about this exciting new technology and the performance characteristics and cost savings of FiberLAN. Accordingly, as mentioned last quarter, we continue to aggressively market important FiberLAN target markets, primarily hospitability, military, government and education.

In the second quarter, we plan to continue our existing awareness program while adding a new vertical each quarter moving forward. We made several significant announcements this quarter, many of which were related to FiberLAN deployment.

Fuller Apartment Homes, Inc. deployed FiberLAN for it's for its 224 unit Park Square at Seven Oaks upscale apartment community currently under construction in Bakersfield, California. We also announced an earlier new FiberLAN deployment with Aljabr Group at its Alfarouq Residential Compound, located in Jubail Industrial City, Saudi Arabia.

We announced seven ways fiber-based passive optical LAN solutions can improve enterprise communications with and aggressive FiberLAN awareness campaign. We announced that Finnish service provider, JNT selected Zhone's MXK, replacing AXE traditional telephony features. Headquartered in Finland, JNT provides broadband, voice-over-IP, television and IT solutions to consumers, enterprises, communities and other telecom operators in both, Finland and Scandinavia.

Finally, we announced a new deployment ESCO Technologies, LLC, that provides senior living facility with a state-of-the-art technology to enable better care and more independence for residents. ESCO is using Zhone's MXP-150, MXP-160 and MXK Platform to provide a unique level of advanced broadband services to these communities.

As expected MXK shipments were strong in the second quarter. Zhone shipped 469 MXK units in the quarter bringing total units shipments to 6,776 units and approximately 43.8 million MHK GPON subscriber capacities.

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

Kirk Misaka

Today Zhone announced financial results for the second quarter of 2014. Second quarter revenue of $32.4 million totaled 8% year-over-year from 2013 second quarter revenue of $30 million and increased 13% quarter-over-quarter from first quarter revenue of $28.6 million.

Going forward, we expect sequential revenue growth for the third quarter of 2014, in the low single digit percentage range, driven by strong product demand for our MXK and FiberLAN products and larger than usual pipeline of business.

Our international markets continue to produce the majority of our business and represented 73% of revenue for the second quarter as compared to 65% of revenue for the first quarter. We experienced slightly higher customer concentration this quarter, with the top-five customers representing approximately 51% in revenue for the second quarter as compared to 46% for the first quarter. We also had two 10% customers in the second quarter compared to one in the first quarter.

Gross margins of 34% was below our guidance range of 35% to 37%, due to high [zNID] and ONT shipments, however we are expecting our gross margins to return to historical norms of between 35% and 37% for the third quarter of 2014.

As expected, operating expenses of $10.6 million for the second quarter was slightly higher than the first quarter of $10.5 million, due to the sales commissions on the additional revenue.

We anticipate that for the third quarter of 2014, adjusted operating expenses will be approximately $11 million. Operating expenses for the second quarter included depreciation of approximately $90,000 and stock-based compensation of $100,000. Finally, our adjusted EBITDA profit for the second quarter of 2014 was $600,000 and net income on a GAAP basis was $400,000 or $0.01 per fully diluted share.

Now, let's turn to the balance sheet. Cash and cash equivalents at June 30, 2014 were basically flat at $15.6 million. 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 $35.4 million at June 30, 2014, from $33.3 million at December 31% 2013, and a number of day sales outstanding on accounts receivable increased slightly for the second quarter to 98 days as compared to 96 days for the first quarter.

Our total debt obligations associated with our working capital facility with Wells Fargo remained $10 million at both, June 3, 2014 and March 31, 2014. Lastly, the weighted average basic shares outstanding were $32.4 million and diluted shares outstanding were $34.4 million for the second quarter 2014.

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. We enter Q3 of 2014 with confidence. The outlook for the remainder of the year is optimistic. I am confident that Jim's refined leadership and enterprise expertise can exceed our objectives while increasing FiberLAN sales.

Achieving seven consecutive quarters of growth and profitability gives us more confidence than ever. Our MXK and zNID solution continued to pay dividend for Zhone resulting in an outstanding quarter of shipment while our FiberLAN optical LAN solution continues to outpace our expectation quarter-after-quarter.

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 the line of Christian Schwab. Please proceed.

Christian Schwab - Craig-Hallum Capital Group

Congratulations on becoming the new CEO. Mory, I guess congratulations on taking the less active role in running the day-to-day in operations. Kirk, I think I missed it. What specifically drove the better than expected revenue?

Kirk Misaka

Significant ONT and CPE sales being itself.

Christian Schwab - Craig-Hallum Capital Group

Okay, and that was it driven predominantly in the international market or was that just broad-based both?

Kirk Misaka

Predominantly in the international market, that's why the percentage of revenue from international increased to 73%.

Christian Schwab - Craig-Hallum Capital Group

Okay.

Kirk Misaka

Also, our top two 10% customers were international customers.

Christian Schwab - Craig-Hallum Capital Group

Yes. I think, I got that. Okay. Perfect. Then as we look to the FiberLAN sales, can you give us an idea of what type of revenue you guys did in the first half of the year and what you expect to be doing in the second half of the year?

Mory Ejabat

Okay. Christian, let me answer that. We were on our plan in the first half. This year, we are not going to increase that much. I mean, we are not going to tell what it is, but the numbers that we discussed last quarter with the pipeline that we have and the backlog that we have, we feel fairly comfortable. Of course, we have to close some of these deals in this quarter and next quarter, but we feel comfortable with that number that we discussed in the past.

Christian Schwab - Craig-Hallum Capital Group

As a reminder, you thought you would be able to approach kind of that $8 million to 10 million range this year, right?

Kirk Misaka

Correct.

Christian Schwab - Craig-Hallum Capital Group

Great. Then if that ends up being close to 10% of the mix in the back half of the year that that we would expect to hear from you guys breaking out or quantifying FiberLAN on a quarterly basis, is that still the plan Mory?

Mory Ejabat

Yes. That is the plan. Obviously, I would let Jim to decide on that, but that was the plan that we mentioned before.

Christian Schwab - Craig-Hallum Capital Group

Great. Can you quantify your pipeline, your backlog, so we can get an idea of what your success or closure rate has to be? I would assume that your backlog is bigger than the numbers that you would hope to ship in the back half of the year given the sales cycle, but maybe if you can offer any color there that would be helpful.

Mory Ejabat

Christian, I really don't feel comfortable to put numbers, but what I can tell you is, when we get cost back to a customer, - prospect or customer, our hit ratio is over 90%.

Christian Schwab - Craig-Hallum Capital Group

Great. Then my last question as it relates to FiberLAN, I know the product is manufactured with a gross margin above the corporate average. As you are beginning to close more of these deals, are you using some of that to give some pricing allowance, if you will, to close these deals or as that becomes a bigger part of the mix, do you believe that your gross margins can improve from the 35% to 37% range? How should we be thinking about that?

Mory Ejabat

You know, our tradition has been 35% to 37%, where last few quarters we were about 38% this quarter, due to warranty shipment we were about 34%. As a whole, our FiberLAN gross margins are higher than our normal corporate deal, but remember this is a new product in the new market. If we have to give some price concession to get the deal, we will do that.

Christian Schwab - Craig-Hallum Capital Group

Okay, but we wouldn't go below the corporate average to do a deal, right?

Mory Ejabat

No. Our corporate average is pretty low.

Christian Schwab - Craig-Hallum Capital Group

Yes. All right. Perfect. No other questions. Again, congratulations to Jim and Mory likely to you as well Mory. Thanks guys.

Jim Norrod

Thanks, Christian.

Mory Ejabat

Thanks, Christian.

Operator

Your next question comes from the line of Alan Davis with L.A. Davis. Please proceed.

Alan Davis - L.A. Davis

Hi, guys. Just I wanted to follow-up on FiberLAN. Without quantifying things, I know you don't want to do that, but in terms of your backlog and your expectations for the second half of the year, can you give us a feeling for how revenues from your various verticals there might come in if you breakout hospitality, government, military and education, I guess, are three major ones there. How significant are each of those in your current backlog and what you expect for the second half of the year in terms of revenues, FiberLAN?

Mory Ejabat

Yes. Alan, all I can tell you, majority of them are in the hospitality. The government follows and then the education. If I guess, and I'm not sure I know, because I don't have information in front of me. It would be 60% hospitality and 35% government and the rest education.

Alan Davis - L.A. Davis

Great. Thanks. Then one other, I may have missed this, but what was your revenue guidance for the third quarter?

Kirk Misaka

Revenue guidance was to be up in the low single-digit percentage and margin guidance was 35% to 37%.

Alan Davis - L.A. Davis

Great. Thanks, guys. That's all for me.

Mory Ejabat

Thanks, Alan.

Operator

Your next question comes from the line of Michael Conti with Sidoti. Please proceed.

Michael Conti - Sidoti

Hey, guys. Good afternoon. Just a question on the FiberLAN initiative, I guess, what vertical markets do you plan on targeting for the second half?

Mory Ejabat

You know, our target initially has been hospitality, government and education. Now, we see some interest in medical industry, especially hospitals, so we are talking to some of those. If that becomes more concrete, we will add that to one of our targets.

Michael Conti - Sidoti

Okay. Great. I know you don't quantifying specifically the revenue, but can you more or less give us a sense whether or not second quarter FiberLAN revenue was larger than the first quarter?

Mory Ejabat

Definitely it was.

Michael Conti - Sidoti

It's definitely above?

Mory Ejabat

Yes. It was higher than the first quarter.

Michael Conti - Sidoti

Okay. Great. That's all I have.

Mory Ejabat

Thank you.

Operator

Your next question comes from the line of Orin Hirschman with AIGH Investments. Please proceed.

Orin Hirschman - AIGH Investments

Hi. How are you? Just in terms of the better base business that you are seeing, what you attribute that to? Any macro trend or specific to large customers that are driving more of that?

Mory Ejabat

Orin, I am sorry. We cannot hear you. Can you speak louder?

Orin Hirschman - AIGH Investments

Sure. In terms of the base business being rejuvenated now and coming back to life, what is driving it on a macro level. Is it a macro trend? Is it specific customers that are just adding more ads right now?

Mory Ejabat

Actually, it's both. Especially, in the international, we are gaining some new customer and customers in [North] and in Middle East that has helped fuel our growth in the base business.

Orin Hirschman - AIGH Investments

In terms of visibility, last quarter you entered the quarter with backlog. Is the backlog ratio for the coming quarter, is it less, is it meaningful metric or not really?

Mory Ejabat

Well, as you know, we don't talk about backlog, but what I can tell you is, we went to Q3 with a larger backlog that we went to Q2.

Orin Hirschman - AIGH Investments

Okay. Then finally on FiberLAN, can you talk a little bit about what the partners are doing in terms of trying to push you forward on field more?

Mory Ejabat

As far as we can see, they are very high achiever partners, especially TE Data and Corning, they are fairly active pushing the FiberLAN as well as IBM. We have some deals with three of them in our forecast, so hopefully they will final us.

Orin Hirschman - AIGH Investments

Just to repeat, you feel comfortable with $8 million number you put out there for the year?

Mory Ejabat

What I said is that, what we see in the pipeline as cost back and backlog and other potential customers, we feel comfortable with that number.

Orin Hirschman - AIGH Investments

Is there upside to that number or that's a big enough number that, that's what you would hope for?

Mory Ejabat

As I mentioned to the other gentlemen, we see something between $8 million and $10 million right now.

Orin Hirschman - AIGH Investments

Okay. Great. Thanks a lot.

Operator

(Operator Instructions)

Your next question comes from the line of Marty Albam with Verizon Network. Please proceed.

Marty Albam - Verizon Network

Hello.

Mory Ejabat

Yes.

Marty Albam - Verizon Network

Hi, Mory.

Mory Ejabat

Hi, Marty. Yes. Hi. How are you? Congratulations to Jim and to yourself. Mory, I am curious how many shares of stock you used own in the company now?

Mory Ejabat

You know, Marty, I have no idea, but I own a lot.

Marty Albam - Verizon Network

What is a lot?

Mory Ejabat

I still 4% to 5%.

Kirk Misaka

Mory, 1.3 million, a little over 1.3 million shares.

Marty Albam - Verizon Network

Okay. Now, also as far as Jim, I am excited to hear more about Jim. What was his last job, because you didn't really.

Mory Ejabat

I am going to ask Jim to answer the question, but I got to tell you. We were really lucky to get Jim, because he has a good, solid experience in both, enterprise and telecom and his enterprise can really fuel the FiberLAN that we are working with. We see a huge opportunity and Jim is a very good asset to have in our team. Jim?

Jim Norrod

Hi, folks. Good question. I will try to do this in a brief fashion, but I have been running companies for over 25 years, and I actually run public companies and private companies. Most recently I was a CEO of a battery company in Denver, Colorado that was acquired by largest handheld manufacturer the world. That was done about a year-and-a-half ago.

After that as Executive Chairman in a company in Rhode Island, company called GreenBytes. It's just been recently acquired by Oracle, about two months ago. Prior to those private companies, I ran a company you may have heard of Segway, which is a privately held company that that Kleiner Perkins was a major investor in and I did the turnaround of that business and sold that company.

The public companies that have been involved in the space, in the enterprise space was I ran was a company Telebit Corporation right here in California, which I ran for several years and it was acquired by Cisco, so I have had a lot of experience in the enterprise space, and believe me one of the reasons I came here was I looked at the FiberLAN product strategy and I'm a true believer that that can make a significant impact on our business in the future. In fact, I mean, if look at what we did last year versus this year, we are already up 700%, 800% over last year's revenue on, in that product line.

I think there is a chance that we can really take that forward next couple of years and do something with it, so I have been involved in publics, privates and several M&A activities, so glad to be with this team. I have known Mory for over 15 years probably closer to 20 if I had to count, back in his [days] and know some of the lead investors in this company and so excited to be here and happy to talk to you more about it later on if you want to call.

Marty Albam - Verizon Network

Great. Thank you so much. Very exciting.

Mory Ejabat

Thank you.

Operator

There are no further questions in the queue.

Kirk Misaka

Once again thank you for joining us today and for your continued support. Thank you.

Operator

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

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