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Zhone Technologies, Inc. (NASDAQ:ZHNE)

Q1 2012 Earnings Call

April 19, 2012 5:00 p.m. EDT

Executives

Kirk Misaka – CFO

Mory Ejabat – Chairman and CEO

Analysts

Wayne Lindemann – Lindemann

Larry Levin – ATT

Operator

Good day and welcome to the first quarter 2012 Zhone Technologies, Incorporated conference call. I'm [Regina] and I will be your coordinator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Kirk Misaka, Zhone’s Chief Financial Officer. Please proceed.

Kirk Misaka

Thank you, operator. Hello and welcome to the first quarter 2012 Zhone Technologies, Inc. conference call. I'm Kirk Misaka, Zhone’s Chief Financial Officer.

The purpose of this call is to discuss Zhone’s first quarter 2012 financial results as reported in our earnings release which was distributed over BusinessWire at the close of market today and has been posted on our website at www.zhone.com.

I'm 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 2012 and provide guidance for next quarter. After our prepared remarks, we’ll 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, 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, 2011.

We’d like to caution you that actual results could differ materially from those contemplated by the forward-looking statements and should not place undue reliance on any forward-looking statements. We also undertake no obligations to update any forward-looking statements.

During the course of this call, we’ll also make reference to adjusted EBITDA and adjusted operating expenses, non-GAAP measures we believe are appropriate to enhance an overall understanding of the 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 management uses as the basis for making operating decisions because they provide meaningful supplemental information regarding our operational performance and they facilitate management’s internal comparisons with 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.

Mory Ejabat

Thanks, Kirk. Good afternoon and thank you for joining us for our first quarter 2012 earnings call.

Revenue for the first quarter of 2012 was $27.1 million, which was lower than the fourth quarter of 2011 due to the seasonality of our business as anticipated and mentioned on our previous earnings call. During the quarter we experienced some weakness in our domestic and Western European businesses and also had some purchase orders that could not be shipped because of unavailability of long lead time components. Despite these conditions, we experienced a strong increase in orders during March, and as a result, we exited the first quarter with better-than-expected backlog, driving opportunities for 2012 and a much stronger second quarter.

In the first quarter we also announced that Zhone entered into a new credit facility arrangement with Wells Fargo Capital Finance, part of Wells Fargo & Co. This facility provides multi-capital financing of up to $25 million to support borrowings and letters of credit. The terms of facility extended for two years through March 2014. Kirk will give you more details on our financials later on.

Now focusing on market opportunities. The MXK continues to drive new customer growth while sustaining industry leadership and a strong consumer acceptance throughout our served markets. As you might recall, several quarters back we launched the new Zhone FiberHome line. In Q1 we started to experience growth of these new products, helping our customers deploy new fiber-to-the-home curb and building solutions. Overall, the new FiberHome growth was led primarily by increasing in the number of VDSL2 deployments. We expect to sustain this momentum throughout 2012. We noted a respectable increase in the number of MXK voice deployments, most commonly in combination with GPON.

As indicated by a number of new customers announcement, we continue to experience good momentum in our international markets where we also launched our new zNID 2400 series ONT line to the European community in February. We announced an immediate availability of the new zNID 2400 gigawatt ethernet ONT to the European market at the annual FTTH Conference in Munich, Germany. The new active ethernet indoor ONTs, part of the zNID 2400 xx series indoor ONTs, provide a cost-effective, high-performance solution for delivering high-bandwidth services. The new zNID 2400 series has become very popular with our customers around the globe.

Now I would like to share a few examples of wins announced throughout the quarter. We announced a new multiple access line concentrator deployment with Convergence SpA, the leading regional operator in southern Italy. Convergence is offering affordable and reliable VoIP and high-speed internet access services to its customers in southern Italy. By utilizing Zhone’s market-leading product, Convergence has been able to increase network bandwidth and reach, lower service delivery costs and provide utmost services to its customers. Further, we announced that our MXK would serve as the core enabler of the CEdiS deployment of GPON solutions in Italy. Through the channel partner Dimension Data, the combination of MXKs and ONTs will be deployed to support customers across the service footprint.

We also announced a new MXK deployment with Palm Hills Developments, a leading real estate company in Egyptian market, to provide the first fiber-to-the-home community in the region. The new real estate complex consisting of more than 1,000 residents will provide access to the state-of-the-art [entertainment] services and high-speed bandwidth connectivity to every home within the deployment.

Last week we announced the expansion of one of our largest US-based clients with the new MXK development at Consolidated Communications, an advanced telecommunications provider serving businesses and residential customers in Illinois, Texas and Pennsylvania. Together, the companies have built a fiber network to support fast delivery of more affordable and reliable high-speed internet access, voice-over-IP, and video services to subscribers.

In general, MXK shipments remained strong, shipping well over 400 units in the first quarter, bringing the total unit shipments to over 3,400 and over 24 million [ports] of GPON subscriber capacity.

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 next quarter. Kirk?

Kirk Misaka

Thanks, Mory. Today we announced the financial results for the first quarter of 2012.

As expected, first quarter revenue of $27.1 million declined from fourth quarter revenue of $33.4 million due to the normal seasonal slowdown in our business and orders that could not be shipped prior to the end of the quarter as a result of the extended lead times for a certain material. Bookings for new orders were actually stronger than expected during the latter half of the quarter, which led to a substantial increase in backlog going into the second quarter. As a result, we should see strong sequential revenue growth of greater than 10% for the second quarter of 2012. We also still expect revenue for 2012 as a whole to grow over that of 2011.

For the first quarter, 57% of revenue was generated from our international customers as compared to 60% for the fourth quarter of 2011. We had one 10% customer and experienced less customer concentration this quarter, with the top five customers representing approximately 39% of revenue for the first quarter of 2012 as compared to 46% of revenue for the fourth quarter of 2011.

Gross margins at 31% for the first quarter were below our previously provided guidance range of between 34% and 36%, primarily as a result of the lower volume. As we’ve discussed before, we expect margin expansion in our long-term model associated with the benefits of the extensive hardware reengineering we’ve undertaken to cost-reduce our products, and from additional manufacturing cost leverage at higher future anticipated revenue levels.

For the second quarter of 2012, we expect gross margins to rebound to around 34% before improving even more later in the year. Operating expenses of $11.7 million for the first quarter was lower than our previous guidance of approximately $12.5 million, primarily due to lower sales commissions and other expenses incurred on lower revenue. We expect operating expenses for the second quarter of 2012 to increase with the higher anticipated revenue to between approximately $12 million and $12.5 million.

Operating expenses for the first quarter included depreciation of approximately $100,000 and stock-based compensation of approximately $200,000. Going forward, we expect approximately the same amount of depreciation in stock-based compensation for the second quarter.

Finally, our adjusted EBITDA loss for the first quarter of 2012 was approximately $3.1 million due to the lower revenue level and gross margins, partially offset by lower operating expenses. With sequential quarterly revenue growth during 2012, we expect to return to profitability on an adjusted EBITDA basis in the second half of 2012. The revenue growth should also allow us to exit 2012 with more cash than we started the year with.

While we’re on that topic, cash and short-term investments at March 31, 2012 were $15 million, which decreased from $18.2 million at December 31, 2011, or roughly equal to the adjusted EBITDA loss for the quarter.

As for other significant balance sheet changes, the days sales outstanding on accounts receivable improved substantially, allowing us to reduce our working capital debt back to previous levels. Accounts receivable decreased to $23.7 million at March 31, 2012 from $31.6 million at December 31, 2011, dropping DSOs to 79 days for the first quarter as compared to 85 days for the fourth quarter.

DSOs continued to be affected by the shipment in payment cycle with our largest customer which for this quarter had a positive effect. With the substantial improvement in DSOs this quarter, we were able to reduce our total debt obligations to $10 million at March 31, 2012 from $15 million at December 31, 2011.

As previously announced and as Mory mentioned, we also entered into a new credit facility with Wells Fargo Capital Finance during the quarter. This new credit facility allows us to continue investing in the development of leading technology for our customers. We’re pleased to work with the business credit team at Wells Fargo Capital Finance who is providing us with the flexible financing to meet the changing needs of our business. The quick and smooth transition to this credit facility during the quarter makes us optimistic that this new banking relationship will continue for many years.

Lastly, the weighted average basic and diluted shares outstanding were 30.9 million for the first quarter of 2012 and 30.8 million for the fourth quarter of 2011.

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?

Mory Ejabat

Thank you, Kirk.

Reflecting on Q1 2012, MXK continues to be the most successful product for our company and our customers. Although this quarter certainly was seasonally weak, there are several reasons for enthusiasm as we focus on our efforts on 2012.

We are successfully expanding our market share and footprint globally. We launched our popular new zNID 2400 series ONT to the European market, we experienced new growth with our Zhone FiberHome VDSL2 products, and experienced new growth of MXK voice services over GPON, proving that MXK is not only an access solution, moreover, a multi-service solution for the future. During 2012, we will continue announcing new products and customer wins, expanding our international and domestic footprint.

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

Question-and-Answer Session

Operator

(Operator Instructions).

Your first question today comes from the line of [Wayne Lindemann] with [Lindemann].

Wayne Lindemann – Lindemann

Hi, Kirk, Mory. I have a question. Have you guys given any thought to selling the company to a private investor or group or publicly-traded company?

Mory Ejabat

We look at all strategic alternatives that are available to us. We haven’t done anything that jeopardize our relationship with our customers or shareholders and our employees.

Wayne Lindemann – Lindemann

And do you see profitability for next quarter or by the end of the year?

Mory Ejabat

We mentioned in the second half of this year.

Wayne Lindemann – Lindemann

Thank you.

Operator

Your next question comes from the line of [Larry Levin] with [ATT].

Larry Levin – ATT

Yes, hi. Where it’s common for any company introducing a new product line to provide substantial support, my question is, it seems like every single press release I see released from Zhone shows that the products have already started being shipped and we’re involved in the implementation and installation of the network prior to any press releases, contracts or the same being released. So my question is, why?

Mory Ejabat

I really don’t understand your question.

Larry Levin – ATT

Okay. A company goes and comes out with a new product. Now, prior to -- you need to go and establish a certain amount of customer base for that product line to really go and push your sales, correct?

Mory Ejabat

Right.

Larry Levin – ATT

So my question is, every press release that I’ve seen basically shows that Zhone is involved in the implementation, installation of our systems before contracts are signed, or I'm going to also assume, any revenue is being generated.

Mory Ejabat

That’s not correct.

Larry Levin – ATT

Okay.

Mory Ejabat

That’s a wrong assumption.

Larry Levin – ATT

I mean, if I go and I look at some of the most recent press releases, you’ll see that -- the press releases will show that a company started installing the system six months ago. So this is going on before a press release is actually initiated. So, why is that?

Mory Ejabat

Well, because the customers, they want it installed and make sure the product works to their satisfaction before they allow us to release the press release.

Larry Levin – ATT

And is Zhone --

Mory Ejabat

And that is not a one-time deal with that certain customers. They do install that, they allow us to publish press release, then becomes a customer and [annuity] for us that we will sell to that customer.

Larry Levin – ATT

Well, I guess it’s very common for any company that comes out with a new product to provide a lot of assistance until they’ve established that certain customer base. Now, the MXK Unc now for two years, and yet we still seem to be providing an awful lot of additional assistance prior to actually getting the sale.

Mory Ejabat

That is not correct.

Larry Levin – ATT

No?

Mory Ejabat

No. We don’t sell -- we don’t give products for free Unc we don’t install any product unless we have a purchase order, and we don’t announce any product or any press release that we have a purchase order with that customer. Either we fulfill the first portion of the order or some of that. We don’t announced based on our feeling, let’s say.

Larry Levin – ATT

Okay. Thank you.

Operator

(Operator Instructions).

And it doesn’t look like we have any further questions at this time, so I’ll turn the call back over to Mory for some closing remarks.

Mory Ejabat

Once again, thank you for joining us today and for the continued support. We are looking forward to speaking with you on our next earnings conference call.

Operator?

Operator

Ladies and gentlemen, thank you so much for your participation today. This does conclude the presentation and you may now disconnect. Have a wonderful day.

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