DASAN Zhone Solutions Inc. (DZSI) CEO Yung Kim on Q2 2018 Results - Earnings Call Transcript

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About: DASAN Zhone Solutions, Inc. (DZSI)
by: SA Transcripts

DASAN Zhone Solutions, Inc. (NASDAQ:DZSI) Q2 2018 Earnings Conference Call August 9, 2018 5:00 PM ET

Executives

Pei Hung - VP, Investor Relations

Yung Kim - CEO

Michael Golomb - CFO, Corporate Treasurer and Secretary

Analysts

Christian Schwab - Craig-Hallum Capital

Dave King - B. Riley FBR

Operator

Good day, ladies and gentlemen and welcome to the DASAN Zhone Solutions Inc. Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to hand the call over to Ms. Pei Hung, Vice President of Investor Relations. Ma'am you may begin.

Pei Hung

Thank you, operator and good afternoon. And thank you for joining us on our Q2 2018 earnings call. Joining me on the call today are the Chief Executive Officer of DASAN Zhone Solutions, Yung Kim as well as Chief Financial Officer, Michael Golomb.

This afternoon DASAN Zhone Solutions issued a press release announcing the results for its second quarter 2018. If you like a copy of the press release, you can access it online in the Investor Relations section of our company website www.dasanzhone.com.

During the course of this call, we will refer to forward-looking statements regarding our future financial and operating performance and our growth strategy. Listeners are cautioned that actual results could differ materially from those expressed in or contemplated by the forward-looking statements.

Factors that could cause actual results to differ are detailed in today's earnings press release, in our annual and quarterly reports filed with the SEC. The Company undertakes no obligation to update or reverse any forward-looking statements. Please also note that certain financial measures we use on this call are expressed on a non-GAAP basis. We have provided reconciliations of these non-GAAP financials measures to GAAP financials measures in our earnings press release. Finally note that, our Q2 2018 results and forward-looking guidance are provided under ASC 606 which we adopted on January 1, 2018 on a modified retrospective basis.

With those comments in mind, I'd now like to introduce Yung Kim, CEO of DASAN Zhone Solutions. Yung?

Yung Kim

Thank you, Pei, good afternoon everyone. I'd like to begin by discussing our second quarter results. As I look at our performance in Q2, 2018 and through the first half of 2018. I'm pleased by our progress on many fronts. On the revenue side, we continue to see the global Fiber-to-the-Home opportunity in our core Broadband Access business as we grew our total revenue in Q2 to $76.3 million which represents a 27.2% year-over-year growth and reflects the higher end of our guidance.

For the first half of 2018, our revenue totaled $135.8 million which was up 21.2% year-over-year. Our Q2 growth was driven by a sizable contract with the Indian state government of Andhra Pradesh to build out their next generation high speed optical fiber network infrastructure across 13 districts within the state. While the Indian market is an exciting one for us given the significant Greenfield opportunities across all 29 states. I would characterize the India opportunity as additive to our existing core business that is already strong globally diverse and the one that benefits from broad based opportunities across our 1,000 plus customers.

To that end, we continue to see the acceleration of fiber based GPON as one of the fastest growing Broadband Access technologies across global market as the confluence of factors has made the supply side and demand side economics work very well in our favor. On the supply side, the fiber economics compare extremely favorably first is, XDSL [ph] speed upgrade cost. Particularly in cases where there are additional incurred costs in moving street cabinets closer to homes.

The fiber OpEx savings have been demonstratively superior than copper OpEx, but now the CapEx savings are starting to make essential difference given the unlimited bandwidth capacity from fiber deployment. I believe that this CapEx pricing phenomenon is driven in large part by large scale GPON deployments in global markets especially in China and the increasing economic development advantages of a connected Fiber Access network.

On the demand side, Over the Top providers such as Netflix, Amazon, YouTube and others are driving bandwidth consumption like never before. As they're increasingly recording and delivering ultra high definition video contents in 4K and 8K which requires 16 times more bandwidth for 4K and 64 times more bandwidth for 8K than high definition 1K video. As important, ultra high definition displays are more ubiquitous than ever before further driving higher bandwidth requirements. This is where the bandwidth limitations of copper access are quickly becoming apparent resulting in an increasing number of carriers bypassing copper upgrades in favor of new fiber optic deployments.

The confluence of these factors make me very confident that we are in the midst of a robust $10 billion plus multi-year investment cycle for Fiber-to-the-Home which I believe is the most future proof technology option available. I believe we're uniquely able to capitalize on the markets tailwind given our scale, our diverse geographic footprints and our comprehensive and innovative product portfolio serving Tier 1 carriers in Asia and the Middle East. As well as Tier 2 and Tier 3 carriers and alternative providers in North America, Latin America and Europe.

Besides Fiber-to-the-Home momentum, we also see other growth green shoots in our business. As an example, we are working with a Tier 1 carriers primarily in Asia to help them build out their 5G infrastructure including providing our ultra low latency switches. Although not in our public forecast, this can translate into what I would consider a tens of millions type of revenue opportunities for a single Tier 1 carrier. I believe this is a tangible opportunity that can cross-sold to a broader set of our customers in other regions.

We are also working with the Tier 1 carriers primarily in Asia and the Middle East on NGPON2 relative technology and product testing. But I believe this is a market that will take time to materialize given the high costs of the optical transceivers today. Finally, as we previously mentioned we're on track for the launch of our fiber LAN 2.0 offering into the enterprise market in the latter half of this year that would be plug and play and would be purpose built to meet enterprise requirements. I'm very excited by these growth levers which are currently not in our public guidance that will be additive to our core growing Broadband Access business.

Now turning back to our financial results, on the margin front our gross margin was 30.4% for the June quarter which met the mid-range of guidance and reflects the impact of the geographic mix in the quarter which was in large parts driven by the large contract in India. Equally important, we continue to deliver profitability across our operating income, net income and adjusted EBITDA. We generated GAAP earnings per diluted share of $0.08 in the quarter due to a strong focus on cost containment initiatives we successfully bid our adjusted operating expenses in the quarter which were $19.8 million against the prior guidance range of $20.7 million to $21.5 million.

As a result, we generated $3.2 million of adjusted EBITDA which greatly exceeded the guidance range of $1 million to $2.5 million. With this overview, let me turn the call to Michael who will discuss our quarterly financial results in more detail. Michael?

Michael Golomb

Thank you Yung and good afternoon. Today I will speak about our second quarter 2018 results and discuss what we're seeing for the third quarter 2018 as well provide a revised outlook for the full year 2018 revenue. We last provided you with a guidance regarding the Q2, 2018 quarter on May 10 in that guidance we called for Q2, 2018 revenue to be between $72 million and $78 million, a gap gross margin of between 30% and 31%. Adjusted operating expenses, which exclude depreciation and amortization, stock-based compensation expenses to be between $20.7 million and $21.5 million for an implied adjusted EBITDA range between $1 million and $2.5 million.

Relative to the guidance, I'm happy to report that our actual revenue for the second quarter came in at a higher and [indiscernible] guidance at $76.3 million which is up 27.2% year-over-year compared to $59.9 million reported in Q2, 2017. Overall the revenue strength in Q2 was broad based with year-over-year growth across almost all geographies. With particular strength in our Asia Pacific market, overall North American market grew 12% year-over-year to approximately $50 million of revenue and international markets grew 32% year-over-year to approximately $61 million of revenue.

In our Q2, we generated approximately 80% of our revenue outside of North America. Across international markets, Asia Pac contributed 58% in Q2. We are also seeing strong customer traction in our Europe and Middle East markets which collectively accounted for approximately 12% of our Q2, 2018 revenue. From a customer perspective we had a sizable contract from Andhra Pradesh State Fiber Limited or APSFL which is the wholly owned subsidiary of the Indian State of Andhra Pradesh that is deploying a state wide next generation high speed optical fiber network infrastructure.

As such APSFL become a sizable customer in the second quarter and contributed approximately 22% of the quarter revenue. As Yung discussed there are tangible opportunities to grow the APSFL relationship and we would categorize the Indian opportunity to be additive and not captured in our public revenue guidance. In the coming quarters, we expect to see continued customer in geographic diversification as we've seen in prior quarters without the onetime impact of the large India contract.

Now let me turn to the gross margin. Gross margin of 30.4% came in line with our original gross margin guidance of 30% and 31%. Primarily driven by the APSFL contract in India which while profitable was below our typical customer margin profile. The good news in that, we do see gross margins normalized with APSFL as we continue to broaden our product mix include to higher margin add on devices. I would not be surprised to see additive revenue from APSFL another neighboring state in India at higher margins due to more favorable product mix, as well as leveling out initial ramp us cost.

Let me spend some time addressing our operating expenses now. Where I believe we have made meaningful strides since last quarter due to continued cost containment initiatives. In Q2, our total GAAP operating expenses were $20.6 million, an increase of only $0.3 million [ph] compared to $20.2 million for the second quarter in 2017, even with our revenue growing of more than $16 million in the year-over-year basis.

On a quarter-over-quarter basis our total GAAP operating expenses in Q2 reflect the reduction of approximately $49 million from $21.5 million in Q1, 2018. Our non-GAAP adjusted operating expenses for the quarter were $19.8 million which came in significantly below the guidance of $20.7 million, $21.5 million the difference between GAAP versus non-GAAP operating expenses in Q2 was due to the depreciation and amortization expenses and stock-based compensation expenses.

On a non-GAAP basis our adjusted EBITDA for the second quarter 2018 was $3.2 million reflecting a margin of 4.2%. Our adjusted EBITDA exceeded our previously provided guidance range of between $1 million and $2.5 million benefiting from strong revenue growth and decrease in operating expenses from prior quarters. In the second quarter 2018, we continue to be profitable in GAAP basis posting next income attributed to DASAN Zhone Solutions of $1.4 million or $0.08 per diluted share as compare to net loss of approximately $0.08 million or loss of $0.05 per diluted share for second quarter of 2017.

Now turning to another topic at hand. I would like to pre-emptively address potential tax if tariffs materialize between the United States and China. Put simply, we're able to leverage flexible production out of our own in-house manufacturing facility in Florida and from our Korean contract manufacturers. Also our revenue base is very geographically diverse as already discussed. Depending on the quarter, we generate approximately 70% to 80% of our revenue outside of United States.

Even this, we're relatively shielded from potential tariff risks. Now I would like to turn to discussion to our revenue outlook for the third quarter, 2018 and provide the revised full year 2018 revenue guidance. For the third quarter, 2018 we expect revenue to be in the range of $70 million to $74 million over approximately 5% to 11% year-over-year increase from the prior year quarter of $66 million. This reflects continued solid growth in run rate business without the benefits of large one-time opportunities.

We expect our Q3, 2018 GAAP gross margins to be approximately 32% which does reflect impact of increased revenue from our Asia Pacific region. We expect Q3, 2018 non-GAAP adjusted operating expenses to be approximately $20 million which is modestly higher than Q2 levels to reflect ongoing initiative to build out our R&D capabilities in regions like Vietnam. For the full year 2018, we are revising revenue to be in the range of approximately $280 million to $285 million of approximate 13% to 15% year-over-year growth as compared to prior guidance provided on May 30 in the range of $272 million to $280 million or approximate 10% to 13% year-over-year growth.

While we believe there is a continued and significant growth opportunities in the markets like India which is further bolstered by our greenshot growth opportunities including our enterprise focused fiber LAN 2.0 product launch we did not consider in our full year 2018 top line outlook. At this point, let me turn the call back to Yung. Thank you.

Yung Kim

Thank you Michael. To wrap up, we are proud of our progress, we made in the first half of 2018. Where we grew our revenue close to 21.2% year-over-year and grew our adjusted EBITDA to $4.7 million from an adjusted EBITDA loss of $500,000 in the first half of 2017. We are excited for our long-term revenue growth and the profitability prospect and continue to believe that the market opportunities is ours to seize.

Operator, we're now ready to open up for any questions that our listeners might have.

Question-and-Answer Session

Operator

[Operator Instructions] and our first question comes from the line of Christian Schwab of Craig-Hallum Capital. Your line is open.

Christian Schwab

As you guys look to fiber LAN and the initiatives, can you kind of give us an update on kind of multi-year outlook and opportunity from that yet?

Yung Kim

I think it is too early for me to give you guidance because we barely finished the development and we're entering into a distributed trial and we're gauging the potentials with global distributors around the world. So maybe probably next year I may be able to give you some better, but until then I think is something that I have something dear to my heart. That what's happening in the first of all Fiber-to-the-Home in the Broadband Access market will inevitably play out in the enterprise market that delivering gigabit to the [indiscernible] and the GPON technology is the best technology to tackle that. And that is my belief and that's why I'm staying in this company to run that, but sorry that I can't give you a number today.

Christian Schwab

No problem, given the strong revenue growth year-over-year in 2017 to 2018 different opportunities for growth whether it be Fiber LAN or opportunities in India etc. as you look at the opportunities in front of you over the next three to five years, what type of growth do you think you guys are capable of driving on the top line?

Yung Kim

I think as I said my earnings call, that it's really we have this Netflix, YouTube and Amazon. Even now Walmart is coming to the streaming business and also the locals have displayed. It's literally there is no other sensible solution long-term other than the Fiber-to-the-Home and therefore, we see some market reports of 15% plus compound growth for the next 10 years. And I think it is us to see that, rather than tailing off from that. So I see continuously that I like to grow this business, but I don't want to be bullish too much because there are always competitors, people try to have a better solutions, better product. So I have to be cautious and pull out my part and Michael.

Michael Golomb

And plus if we're geographically diversified also gives us an appetite for more than others.

Christian Schwab

Okay, that makes perfect sense. Great I don't have any other questions. Thank you.

Operator

[Operator Instructions] our next question is from the line of Dave King of B. Riley FBR. Your line is open.

Dave King

Just wanted to focus more on this Indian market, so first of all just wanted to get your third quarter outlook assumption of this particular Indian customer.

Yung Kim

I think we may have an opportunity which we are working on is very much the essential office equipment which call it OLT. Because they fill the OLT many years ago from approach called telecom which - a system integrated by Cisco. Now that we have provided a large number of OLTs. I'm sure that there are opportunities are there for us to provide OLT. But because it's not OLT the numbers could be significantly smaller than the Q2, but it will give us opportunity to grow again in the future and we are also working the neighboring state, who are trying to try similar kind of rollout. Whole of India is trying to rollout Fiber-To-the-Home and the PVVNL which is a government agency is rushed with money to dish out.

Dave King

Right. Let's see if I heard you correctly, I believe you said this customer was supply 20% of revenue which is well like mid-teens like $15 million, $16 million. Last quarter and then you, that's dropping off and yet your sales will be just down modestly, so what's making that up from second to third quarter.

Yung Kim

We generally have Asian strength coming and South American strength coming. We have opportunities building up again in Middle East. So as Michael said we have a very robust sort of diverse customers. So we're not affected by single or big customer.

Michael Golomb

I can actually add to that. If you take this customer out in one-time month or this one quarter. All of our other nine customers they don't even come close and actually they go between the nine and 7%, 6% or so. And it took six months also, we don't have any single over 7%, only this Indian customer comes little bit over 10%, and a good level. So that's actually not bad and they're all of those customers are geographically spread across the whole world, which is exciting.

Dave King

Got it. Is your - I assume your - I guess what's your typical lead time, is it like maybe a few weeks or is it the few months, can you characterize what your typical lead time is?

Yung Kim

I mean lead time from the customer engagement to the order.

Dave King

No actually orders to ship.

Yung Kim

Order to ship. It's very much between about six weeks onwards. We don't build a lot of things as inventory and ship. Mostly we stock small amount and the big orders are once orders take and we give a delivery time, so it's about two months, usually and six weeks. So we don't take any risk of building inventory and expecting customers and ship it. So that is one of our strength and operational I would say excellence, our flexible manufacturing which is different from our competitors. We do not outsource completely to manufacturer, what we have, our own production engineers and we go and borrow people in the floor space of factory. We set it up the production line and then, run the factory with our test equipment and all that. So because of that flexibility we don't have to give them a long-term orders which normal outsourcing companies for example like Foxconn they will ask you forecast of a year and orders of maybe six months advance orders, but we don't do that kind of thing.

Dave King

Actually I was thinking more like, is your business more backlog or turns business, that's what I was after?

Yung Kim

We have a sizable backlog. So any fluctuation that comes in our production can be smoothed out by our backlog. So that's one thing that since I joined this company we changed our compensation to our sales in such a way that the whole cycle of order taking and the delivery to the cash collection is incentivized by that process. Therefore, they have incentives to actually take orders early on, so that we can smooth our production and the delivery. So we have some unusual orders goes up to a year, but usually we get something like three months to six months that kind of time.

Michael Golomb

Dave to answer a couple - to relate, so in Q2, 18% of our revenue came from United States and 2% from Canada. So 20% from North America and then we had 10% from Latin America and then about half came from Asia Pac, just to give you a flavor. Year-to-date, we're 24% from North America of which 22% from United States. Again to give you flavor and then about 50% including that bump, right from Asia Pac just to give you a flavor. So you can see that, that's not that big of deal. We're very diversified. Yes.

Dave King

The reason I was asking is because looking at your annual guidance and it's like only $5 million window typically, I mean the company that I follow they give much wider window and that's just for the quarter. So just wondering what kind of visibility you have for multi quarters out. It seems like you have a pretty good idea, how things are going to develop, this year.

Yung Kim

I usually have a pretty good window up to about two quarters.

Dave King

I see.

Michael Golomb

We meet our numbers.

Dave King

Got it. And just couple more, if I could. Now the ZTE is back, was there are a lot of overlap between you and ZTE?

Yung Kim

Not a lot at all because we've been invited where ZTE [indiscernible]. We're doing some work to help operators in some Asian countries and we're getting into some - South America, but not in Europe. We compete in Asia, we used to compete quite favorably in Asia because of that, we have a reputation. We heavily compete with Huawei and ZTE and Nokia. It was a very severe, a battle ground.

Michael Golomb

And Dave just to add to that point, even with you heard me just telling you about the breakdown of our revenue, right?

Dave King

Right.

Michael Golomb

Even with competing with all, competing heavily against Huawei, ZTE. We were able to lower DSOs below 80 when you compete on that ground, they give sometimes a year payment term, so we were able to competing with on those grounds lower DSOs below to 79.

Dave King

Got it.

Michael Golomb

[Indiscernible].

Dave King

Yes. And then Michael, I think you talked about potential impact on your business from this US tariffs, but can you just talk about how that will impact the overall industry and whether can you summarize whether it's net positive or negative for year?

Michael Golomb

Okay, so yes we believe it's going to be probably positive for us especially because of the revenue breakdown for our company, we are very global, very diversified. So we don't think it's going to be, there is going to be any impact for us. As we discussed, we have a manufacturing location in Florida and we're proud to produce products at United States. We also have as Yung just discussed we have a flexible manufacturing location in Korea. We also have production close to [indiscernible] and also in Vietnam and also we have some work in China. So we're very diversified depending, we listen to our customer, we produce what customer wants. Now some of our COGS [ph] in the market, they're very focused to cost effect and they don't, sometimes don't care of our diversifying risk. So the market will show it happens.

Yung Kim

Actually the way I expect it for us, as I mentioned earlier how manufacturing technique, we can actually shift manufacturing fairly quickly. However, I think big plus side is our we are shipping to North America at China dependency or to US is very small.

Dave King

Right, but then and some of your major domestic competitors - and also their products made in China. How quickly do you think they can shift out of China into other regions.

Yung Kim

I think [indiscernible].

Dave King

Could that open up an opportunity for you to kind of get into the US market?

Yung Kim

It's really how well they do it, it's their - kind of realm. And for me I know how quickly I can move.

Michael Golomb

Dave, what's important is that - the company has been competing all the time big companies like Huawei, ZTE and been waiting this projects and competing in a global scale and those margins and bring money to - bottom line to investors. That would be a good test right now for the other companies. Now that they have to compete in a global basis to, let's see what happens.

Dave King

Got it. Thank you very much.

Operator

Thank you. And with that, that does conclude our call for today. Ladies and gentlemen, thank you for your participation. You may now disconnect.