Zhone's Q1: Seasonality Offset By Strong Order Flow

Apr.20.12 | About: Zhone Technologies, (ZHNE)

Thursday evening, Zhone Technologies (NASDAQ:ZHNE) reported revenue of $27.1 million, down from the $29.6 million reported in the year-ago period. Longer lead times for components were fingered for delayed shipments (and therefore revenue recognition). CEO, Mory Ejabat stated,

Although this quarter's revenue was seasonally weak, there are several reasons for enthusiasm as we focus our efforts on 2012. We experienced a strong increase in orders during March and as a result, we exited the first quarter with better than expected backlog driving optimism for 2012 and a much stronger second quarter.

Indeed, the company maintained its asserted goals for 2012 - rising gross margins, growth over 2011, and profitability. The company also stated that Q2 revenue will be up at least 10% over Q1's levels. This is substantially ahead of the company's typical Q1 to Q2 performance. Most importantly, ZHNE stated that it plans to exit 2012 with more cash than it entered. Accordingly, the company's book value should rise, providing a floor under the shares (which are already priced below book value).

ZHNE's higher backlog provides further cause for optimism. In addition, its accounts receivable fell dramatically, from $31.6 million in Q4 to $23.7 million in Q1. Last year, A/R barely budged sequentially. This is a sign that the company didn't push for any last-minute shipments, which would have increased revenue, but also A/R (since customers generally take 90 days to process invoices).

Thus, the company enters Q2 with a stronger pipeline and over $15 million in cash. Meanwhile, it is trading below its book value of $36.3 million with the company guiding to EBIDTA profitability for 2012. Both factors continue to serve as a cushion against significant losses. Meanwhile, its valuation continues to make the company a prime candidate for share-price appreciation and/or acquisition. The company generates about $120M in annual revenue and invests about $20M into R&D annually.

For many potential acquirers, these metrics make for an intuitive (and accretive) acquisition. The company carries a high expense structure, which easily be could be pared by a larger entity. In an average selling environment, a mere halving of operating expenses would generate well over $10 million in free cash flow annually.

When combined with EBITDA profitability, ZHNE's financial measures point to a fair valuation of at least $2.00 (0.5x revenue or 3x R&D). 4x R&D + Cash would equate to over $3.00 per share. 1x revenue + cash would get the stock over $4.00.

When compared to its low price to book ratio, shares of ZHNE continue to represent a superior risk to reward opportunity for patient investors.

Disclosure: I am long ZHNE.