Zhone Technologies Achieves Profitability Ahead Of A Pivotal 2012

| About: DASAN Zhone (DZSI)

Wednesday evening, Zhone Technologies (ZHNE) announced Q4 revenue of $33.4M, representing solid year over year and sequential growth versus $30.2M in the third quarter of 2011 and $31.0M in the fourth quarter of 2010. More importantly, the company delivered against its promise to generate positive EBITDA in the quarter.

CEO Mory Ejabat was visibly ebullient, "We're pleased to announce strong revenue growth across all regions during the quarter. Fourth-quarter revenue grew 11% sequentially over third-quarter revenue and 8% year over year as compared with last year's fourth-quarter revenue. With this strong top-line growth, we also achieved our other major financial objective for the quarter and generated positive adjusted EBITDA."

On the earnings call he stated that he expects the momentum to continue into 2012. CFO Kirk Misaka concurred, stating that investors can expect normal seasonality, but continued growth for 2012. He went on to provide guidance, which calls for positive EBITDA for the full year of 2012.

Gross margins were among the highlights, coming in at high end of guidance range (36%). The company expects that to moderate seasonally to 34%-36% in Q1 before improve for the reminder of the year. Its emphasis on U.S. manufacturing was cited as a catalyst for the improved results and profit margins.

On the flip side, ZHNE impaired some long-lived assets, based on the company's decreased market capitalization. It should be noted that the last time this happened was in the middle of 2008. The shares then traded at $1.65 and were pulled down further by the financial crisis. By the beginning of December however, the shares decoupled from the broader market and rose by 200% from that point. Even as the market made its final lows in March of 2009, ZHNE continued upward. At its peak, the shares hit $8.20, nearly 1,800% above its late-2008 lows.


A repeat of that performance is unlikely, but it's not unreasonable to continue thinking that the shares are poised to triple from here.

As we enter 2012, ZHNE is valued at just over $30M. However, its book value is nearly $40M and the company has guided to EBIDTA profitability for 2012. Both factors will cushion investors from significant losses. Meanwhile, its valuation makes the company a prime candidate for share-price appreciation and/or acquisition. To go along with its $40M balance sheet, ZHNE generates over $120M in revenue and invests over $20M into R&D annually. When combined with EBITDA profitability, both of these measures beg for a minimum valuation of $2 (0.5x revenue and 3x R&D).

All the company needs is a catalyst to spark investor interest. Such catalysts should be in ample supply this year. 2011 was marred by a fiber cable shortage, which put numerous projects on hold. The year was also characterized by delays in U.S. Government Broadband Stimulus funding, which also delayed broadband deployments.

Going into 2012, a simple Google search shows that both issues are now reversing. As such, a significant headwind should become a major tailwind. Management confirmed this view on its earning conference call.

In addition to the above, the FCC's Universal Service Fund (USF) promises to be the greatest catalyst of all. The USF has traditionally focused on making sure all Americans have access to telephone service. However, its mandate was recently shifted to enabling Broadband access.

This mandate was unanimously approved by the FCC on October 30, and will funnel $4.5 billion toward the development of rural Broadband access annually through 2017 ($22.5 billion total). This compares with the Broadband Stimulus program, which totals a "mere" $7 billion. The program is expected to kick off in 2012 and will run in parallel to the U.S. Broadband Stimulus program.

With EBITDA profitability attained, major write-offs out of the way, fiber shortages alleviated, and stimulus funding set to flow, it appears that ZHNE is finally cleared for takeoff.

Disclosure: I am long ZHNE.