DZS, Inc. (DZSI) CEO Charles Vogt on Q1 2021 Results - Earnings Call Transcript

DZS, Inc. (NASDAQ:DZSI) Q1 2021 Earnings Conference Call May 3, 2021 4:15 PM ET

Company Participants

Ted Moreau - VP, IR

Charles Vogt - President, CEO & Director

Conference Call Participants

John Marchetti - Stifel, Nicolaus & Company

Dave Kang - B. Riley Securities

Christian Schwab - Craig-Hallum

Timothy Savageaux - Northland Capital Markets

Ryan Koontz - Needham & Company

Operator

Good day and welcome to DZS First Quarter 2021 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Ted Moreau, Head of Investor Relations at DZS. Sir, the floor is yours.

Ted Moreau

Thank you, Laura, and welcome to the DZS First Quarter 2021 Earnings Conference Call. Joining us today are DZS President and CEO, Charlie Vogt; and CFO, Tom Cancro. We are pleased to discuss our first quarter financial results as well as insights and performances in our global business, trends driving our market, transformative initiatives and our outlook for the remainder of 2021.

As we've done for the past 3 quarters, this morning, DZS published our shareholder report for the first quarter of 2021 on the Investor Relations section of our website at dzsi.com. I'd also like to remind you that we will host our virtual Horizons21 Investor and Analyst Day on Thursday, May 13. And we plan to participate in the Needham, Craig-Hallum and Stifel investor conferences during Q2.

During this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the company. The company cautions you that such statements are only current expectations, and actual events or results may differ materially. Please refer to documents that the company files with the SEC, including its most recent 10-Q and 10-K reports in the Forward-looking Statements section of the shareholder report that was filed on a Form 8-K as well as being available on our Investor Relations section of our website. These documents identify important risk factors that could cause actual results to differ materially from those contained in the company's projections or forward-looking statements.

Please note that unless otherwise indicated, The financial metrics being provided to you on this call are determined on a non-GAAP basis. These items, together with corresponding GAAP numbers and other reconciliation to GAAP, are contained in the letter to stockholders. I will now turn the call over to Charlie.

Charles Vogt

Thank you, Ted, and welcome, investors, analysts and guests. As Ted mentioned, prior to the open, DZS released our quarterly shareholder report, providing market business and financial update for the first quarter of 2021. Our report is designed to provide shareholders, prospective shareholders and analysts with market insights, product and business updates and our financial performance.

The management changes and transformational enhancements executed during the second half of 2020 are delivering encouraging results. And we've become -- and become the foundation to delivering long-term sustainable shareholder value. With that as the backdrop, the first quarter of 2021 was a strong start to the year, with record orders, record backlog, better-than-expected revenue and gross margin and positive adjusted EBITDA.

Orders increased 163% year-over-year, yielding $106 million of backlog, our highest ever, and a sequential increase of 49%. Growth in our mobile revenue was exponentially strong, increasing 635%. During the quarter, we added 24 new customers, with North America and EMEA experiencing the strongest customer growth. Revenue of $81 million exceeded guidance for the third consecutive quarter compared with our $70 million to $75 million guidance, representing a 71% year-over-year increase. Better-than-expected revenue, favorable geographic mix and strong operational execution enabled us to deliver favorable gross margins of 35%, resulting in a positive adjusted EBITDA of $3.6 million, which was also above guidance. These results follow a strong second half of 2020 and support an optimistic view of the remainder of 2021 and into 2022.

The unexpected global health pandemic, coupled with a surge in demand for networking and communication services, has challenged the global supply chain. To date, our forecasting process, customer relationships and our robust supply chain ecosystem have limited our exposure to price increases, component availability as well as manufacturing, logistics and delivery delays. With that said, we are not ruling out deviations to the previous statement as the current environment is fluid.

Offsetting the supply chain challenges, the pandemic has forever transformed how people rely on high-speed wireless and wireline connectivity for business, education, health care, e-sports and entertainment. Aligned with these technology requirements and the emerging lifestyle and workplace trends, DZS is well positioned with its innovative lineup of mobile edge transport, broadband connectivity and now, software-defined networking solutions.

In February, we acquired Optelian and in March, we acquired RIFT. These two acquisitions have strategically enhanced our mobile edge and global -- and broadband connectivity portfolios. Optelian provides our customers with a temperature-hardened high-capacity, long-reach mobile transport portfolio that complements our fast-growing mobile edge transport solutions. And our RIFT acquisition accelerates and enhances our software portfolio for mobile and broadband connectivity networks. Following our RIFT acquisition, we announced TELUS, one of Canada's premier communication service providers as a new DZS cloud customer. TELUS will be deploying DZS Cloud for network orchestration, application management and software automation. As of this earnings call, the integration of both of Optelian and RIFT are nearly complete. In addition to TELUS, these 2 new acquisitions add AT&T and LUMEN to our lineup of marquee customers.

Also in the quarter, we executed a $64 million gross proceeds follow-on equity offering, eliminating debt and strengthening our balance sheet. During the quarter, we began the consolidation of our high-cost manufacturing facility in Germany, which we anticipate will deliver favorable margins and earnings in 2022 and beyond.

As Ted stated on April 8, we announced our inaugural Horizons Investor and Analyst Day, which is scheduled for Thursday, May 13. I, along with Andrew Bender, our Chief Technology Officer; Miguel Alonso, our Product Line Manager; Tom Cancro, our Chief Financial Officer; and several marquee customers will be presenting as part of this virtual event. To learn more and to register, please visit our Investor Relations page. Thank you for joining the call, and with that, I'll now turn the call back over to the moderator to facilitate any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question will come from the line of John Marchetti from Stifel.

John Marchetti

Charlie, I was wondering if you could spend a minute on some of these software efforts. Given the acquisition of RIFT, where the -- I guess, the overall software portfolio stands now. I know that accelerated some of the efforts and certainly some of the time to market. But where that portfolio stands, what we should still look for there? And maybe how much of that is really contributing. I know you highlighted TELUS, but I'm just curious if there's others already in that software portfolio now.

Charles Vogt

Yes. Well, first of all, thank you, John. What I would tell you is, prior to RIFT, there certainly was a pretty significant software development effort that was underway that was really focused on primarily our fixed wireline network and the products within that portfolio. What RIFT really did was helped us accelerate our play in the broader network orchestration, the software automation, lifestyle -- life cycle management as well as data analytics.

And if you dive into the TELUS opportunity, it really opened up a great opportunity for us to participate in their wireless network. And most of the sales projections and this year's pipeline are really focused around the wireless part of our business.

That said, I will tell you that a big part of the investment thesis around RIFT was really the opportunity to unlock the value that we have with the 20 million products that we have deployed around the world, especially on the fixed wireline side. So look, we've got a pretty substantial R&D team that's in Bangalore as a result of it. And it certainly is giving us an opportunity to deliver a stronger presence in the network and to attract a lot more value with our existing customers.

John Marchetti

Great. And maybe if I could just follow up there for either you or for Tom. Given the little bit of the raise in the full year outlook, I'm just curious how much of that bump has to do with what we're getting here from Optelian and RIFT versus maybe what you're seeing in the stand-alone business.

Charles Vogt

Are you talking about from a revenue standpoint?

John Marchetti

Yes. I'm sorry, yes.

Charles Vogt

Yes. I mean I think the way analysts and shareholders should think of RIFT and Optelian is we -- well, first of all, we've added an additional $4 million of OpEx spend to this year's incremental forecast as a result of both of the transactions. And we're not -- we didn't have anything baked into this year from a RIFT perspective, and we still don't. So anything that we see from revenue that's recognized from TELUS as well as other customers in the pipeline, we would see as upside.

From an Optelian perspective, we did have a modest amount of revenue that we had plugged into this year's plan. So we're cautiously optimistic, and we hope that both of these transactions provide some upside that we didn't have baked into our plan early in the year.

John Marchetti

And if maybe I could just ask one more, and then I'll turn it over. You mentioned in the shareholder letter about some of the momentum that you're starting to see on the RDOF side, particularly in North America. Has that -- have you gotten, I guess, real RDOF-based orders from customers? Can you track it in that way? I'm just curious if there's a metric that you can share along those lines that just helps us sort of measure overall success in North America against maybe what's specifically tied to that program.

Charles Vogt

I think what analysts need to think about as it relates to DZS, especially as you guys compare us to ADTRAN and Calix, which have spent a lot of the last 15 to 20 years focused on the rural markets in the U.S., I mean, DZS is a global player. And much of our revenue, as you all know, comes from a lot of Tier 1s around the world. That said, a big initiative that I took on when I joined the company last year was to revamp our sales efforts, our support and service efforts, our innovation alignment with North America and specifically the U.S.

And if you look at Q1, we grew Q1 orders by nearly 85% sequentially and 138% year-over-year. That was a record for North America. I mean we've got a small amount of RDOF customers. I think we have close to 40 RDOF customers that are active. But I would suggest that you look at the participation of RDOF customers as it relates to the size and scale of those RDOF customers and their spending pattern.

There's also another important area that I think is worth noting, and that is, we estimate that about 30% of all the RDOF funds were awarded to nontraditional or rural ILECs, meaning that these were not traditional customers of ours, Nokia, Calix or ADTRAN. And certainly, our customers or at least prospective service providers, these are fiber builders, the utility operators and others that are new fertile ground for us. So that's where we're spending a lot of our time as well as spending much of our time with the Tier 1s in North America.

Operator

Your next question will come from the line of Dave Kang from B. Riley.

Dave Kang

My first question is regarding your second quarter outlook. Despite your commentaries about strong visibility and debt lock, you're guiding kind of flat to down a little bit. So I was wondering if that's based on conservatism, which wouldn't be too surprising or perhaps other factors such as chip situation?

Charles Vogt

I don't know if we're forecasting decline. I think that we've kept our Q2 outlook somewhat consistent with where we were prior to our Q1 shareholder report. But look, I mean, I think that we continue to remain, as I shared earlier, optimistic about the year and into next year. But we are certainly taking a cautious approach to the unknown. And what gives us confidence in our ability to deliver Q2 is we go into -- we entered the quarter with our strongest backlog ever and it's -- but as you get closer into the quarter, you certainly have shorter cycles to be able to deliver stronger upside. So I think the forecast that we provided is a forecast that the analysts should align to.

Dave Kang

Got it. Can you just talk about the chip situation? Because some of the other comm equipment companies, they are feeling some pinch as far as availability is concerned as well as prices going up that's impacting their margins.

Charles Vogt

Yes. I mean prices certainly have unexpectedly gone up. I mean prices went up in Q1, and we were still able to navigate around some of those increases, delivering a higher-than-expected margin profile for Q1. But it is real. I mean for us, our largest semiconductor partner is Broadcom. And we've got a great relationship with them, which certainly helps. But it's -- we used to look at all the factors. I mean everything that our semiconductor ecosystem continues to articulate to us is they're 6 months behind from the impacts of COVID. And then you had a surge in demand from both the communications sector as well as the networking and consumer-related markets that have them stacked out at least through 2021.

Now I would tell you that mix has a lot to do with where the impacts are and how well and aggressive you were in forecasting back in August, September of last year. I would tell you that we got ahead of the curve, I feel like. When I first joined back in August, we sat down with our ecosystem supply chain partners, and I think we did a really good job of forecasting what we thought 2021 was going to require, and that has so far helped us. And we're right now not expecting that there's going to be an impairment or impacts on what we're forecasting for the rest of the year due to supply chain.

Dave Kang

Got it. And my follow-up question is regarding your backlog, $106 million. Can you just provide some color as far as how the mix looks like between broadband versus mobile?

Charles Vogt

I don't have that right off the top of my head. I would say it's roughly -- Eric, do you have -- do you know what that is, roughly speaking?

Unidentified Company Representative

It would be about 60-40, broadband.

Charles Vogt

60-40 -- 46 versus mobile. We expect -- and we expect most of that to ship this year.

Dave Kang

Got it. And then my last question is regarding Asia, specifically on India. I guess that was a pretty big market for you a couple of years ago, has gone down. And would you expect India to recover this year? And if so, what's the current status, I guess, with their -- in situation with COVID cases?

Charles Vogt

Well, we have increased our sales personnel in India. And just for the record, I mean, we have one really large project in India back in the 2016 to 2018 time frame, the large FTTx project, with one of the government entities in India, which really did give us a notable footprint. We have since then engaged with the 4 Tier 1s in India. We are not forecasting anything significant from India despite the fact that our pipeline has increased. And I think you guys are probably seeing that, especially with India, like the United States, becoming very anti-China. And so we are getting pulled into a lot of new opportunities for projects that we weren't part of a year ago.

Operator

Your next question will come from the line of Christian Schwab from Craig-Hallum.

Christian Schwab

Congrats on solid results. Can you just update, Charlie, just what we just talked about there? Can you tell us or quantify potentially the positive impact of new opportunities because of Chinese vendors?

Charles Vogt

Well, I would tell you, and I think I spoke a bit of this the last time we were on the call, that our sales pipeline, specifically across the EMEA region and the APAC region, and I'm speaking outside of Korea and Japan, has more than doubled. And so we are seeing a lot of opportunities across Europe, across India. Those are probably the 2 regions, the European -- Central Europe and India regions are probably driving the most near-term activity, with real projects that we are, from a product alignment perspective, best suited to be able to participate.

Christian Schwab

Okay. That's fair. Is any of the new customers on the list due to that? Or is it just a share of wallet potential as existing customers?

Charles Vogt

Are you talking about the 24 new customers we announced?

Christian Schwab

Yes. Are any of those have to do with the China marketplace opportunities as you just elaborated on and discussed at first -- last quarter? Is some of that new customer opportunities? Or is -- or are the opportunities really more with existing customers?

Charles Vogt

Well, the 24 new customers that we announced were primarily in North America and Europe and Middle East. I mean those were the 3 regions that we saw most of those -- these customers come in and not really any notable customers that we can represent as a new design win relative to share from Huawei. I mean most of the Huawei customers, I think, people have to understand, are large Tier 1 fixed and mobile operators. And the process that we are embarking on right now, it just takes some time. I mean I can tell you that there's a pretty significant log of activity across EMEA, especially in India, where Huawei had a pretty strong presence, but we haven't gotten to the stage where we can credibly announce any design wins.

Christian Schwab

Okay. That's fair. My last question has to do with analytics and cloud. Can you help us quantify how big that opportunity will be for you guys this year and what type of growth rates you would expect there going forward?

Charles Vogt

I think the opportunity this year should be tempered, just based on the longer sales cycle that comes along with at least the mobile side of the network orchestration and the software automation and 5G slicing. As it relates to our plans to embed the software attributes into our fixed wireline portfolio, I think that there's a meaningful opportunity for us in 2022 and beyond.

Operator

Your next question will come from the line of Tim Savageaux from Northland Capital.

Timothy Savageaux

Congrats on the results as well. You made a couple of references to Tier 1 opportunities, one earlier in the call with regard to spending time. Focusing there in the U.S. and then with -- in reference to Huawei opportunities, maybe principally in EMEA, and realizing there is a sales cycle here, but I wonder if you can give us your best update on when you think decisions might be made there or you might be in a position to talk about something with more specificity. And of course, any color on the size of those opportunities, either individually or in the aggregate, if there's any update there, would be interested in that as well.

Charles Vogt

Yes. I would say that the projects that we're currently involved in, as it relates to being able to cap and grow a Huawei network, is most likely in the Q3 to Q4 time frame, just based on where that cycle is. And I would tell you that all of the projects that we're working on are what we would consider as Tier 1 operators. So the opportunity for those projects could be sizable over a period of years.

Timothy Savageaux

Right. And obviously, Huawei not operating in the U.S. previously, those -- we have different drivers for those opportunities. So both of the -- or several of the big carriers in the U.S. seem to have gotten off to a pretty strong start in terms of investments in access, in particular. I wonder, given that it appears that your sales efforts among smaller carriers in North America have borne fruit, I guess, a bit quicker than you may have expected, any comments on that would be interesting. Is -- how are you feeling about that same dynamic with regard to U.S. Tier 1?

Charles Vogt

Yes. I mean we're pretty encouraged with what's going on right now in the U.S. and Canada. And that's coming from a technology company that arguably was lagging, Nokia, Calix and ADTRAN from a footprint perspective. But I would tell you that we're making great progress. And to your point, I think the relationships that we've fostered have helped us better align on a more robust forecast for this year and next year with those operators.

And several of the regional operators are pretty significant. I mean you've got some really small Tier 3 operators that have thousands of subscribers, and you've got some of the Tier 3s that have millions of subscribers. And I would tell you that we're fortunate, have several of the ILECs in the U.S. that are relatively sizable, and they're expanding their networks. And we feel like we're getting a larger portion of the network split than we have historically. And I think that's attributed to where we are on the technology curve and where we are and just our focus on these customers from a sales and service perspective.

Operator

[Operator Instructions]. Your next question will come from the line of Ryan Koontz from Needham & Company.

Ryan Koontz

Charlie, trying to slice it maybe a different way and trying to understand the dynamics a little bit. Can you maybe give us some qualitative insights as to -- if you look at your revenue mix today how much of it is roughly longtime DASAN Zhone customers versus newer customers in the last 18, 24 months?

Charles Vogt

I would say that most of the revenue globally is sustainable historical revenue that we've been able to capture a larger portion of their network. I mean as you can probably appreciate, there's a lot to be said about being an incumbent because it could -- certainly gives you the opportunity to participate in other adjacent projects that you're much more easily able to show your value than being someone -- being a supplier that's trying to wedge their way in.

So I would tell you that the bulk of our revenue continues to come from existing customers that we've been able to go in and represent our newer product. I mean we've introduced a lot of new products over the last year. And if you look at what we're doing with some of the large scale mobile operators like Rakuten and Softbank and LGU, a lot of the revenue there is attributed to some evolving network projects that have given us more upside than I think we were expecting. And I think that when you think about the overall mix, I would say it's probably 90-10, 10% of our revenue is coming from new customers and 90% is coming from existing customers.

Ryan Koontz

That's great. So you've seen a pretty good dollar expansion rate with a lot of your current customers.

Charles Vogt

Yes. I mean I continue to highlight the success that we had in Q1. I mean we don't profile orders, but you can probably back into a rough estimate of what our order profile was in Q1, especially when you factor in that we ended December at $71 million of backlog and we ended March at $106 million. So we had a pretty significant bookings ratio in Q1. Still exceeded the top line range of our revenue for the quarter.

Ryan Koontz

Yes. You bet. And just another quick follow-up on your strength in Middle East. I typically think of that as a region that's dominated by the Chinese and the big multinationals and -- have you seen shifts in the competitive landscape there? Or do you have longtime customer relationships in that area?

Charles Vogt

So [indiscernible] has been a longtime customer, 20 years. And they continue to grow as does Mobilia and STC. So it's a really strong region for us, and it's a meaningful region for us, and they continue to throw new projects at us. So I am seeing Huawei being deemphasized in the Middle East. So for what you may have recalled, I mean, those three customers especially are -- we're seeing more deemphasizing the Chinese suppliers, at least with those customers and -- than maybe what you might have thought.

Operator

And I am showing no further questions at this time. I would like to hand the conference back to Mr. Charlie Vogt for the closing remarks.

Charles Vogt

Well, I guess, I just want to say thanks to the DZS team for delivering an outstanding quarter. We continue to navigate what I think is a fantastic opportunity for the company, and as I said earlier, we're very optimistic about the remainder of this year and into 2022. And when I think about the 2 technology acquisitions that we acquired with RIFT and Optelian, they were great fits into an existing portfolio of products that helps us to accelerate what we're doing within those particular technology areas that I think gives us a lot of upside, especially as we go into 2022. So I just want to thank the employees of DZS, and I appreciate the interest that the analysts, the shareholders have.

And remember that we've got our Investor Day on May 13, I think. It's -- it'll be 3 hours of time well spent if you can afford it, but we're going to go into a lot more detail as it relates to our product portfolio, why we believe we will continue to succeed and win against our competitive landscape. We'll talk a lot more detail about the various opportunities. We've got a number of our marquee customers that are going to participate, and we've got a Board member that's also participating. So we're excited about that as well. So I guess with that, I'd just say thanks for the time this afternoon.

Operator

Thank you, sir. Thank you so much, presenters. And again, thank you, everyone, for participating. This concludes today's conference. You may now disconnect. Stay safe and have a lovely day.