Kirk Misaka - CFO Jim Norrod - CEO.

Christian Schwab - Craig Hallum Capital Group Alan Davis - L.A. Davis.

Good day, and welcome to the First Quarter 2015 Zhone Technologies Incorporated Conference Call. I'm Denise and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference.

[Operator instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to introduce Kirk Misaka, Zhone’s Chief Financial Officer. Please proceed sir..

Thank you, operator. Hello, and welcome to the first quarter 2015 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 2015 financial results as reported in our earnings release that was distributed over Business Wire at the close of market today and has been posted on our website at www.zhone.com. I'm here today with Jim Norrod, Zhone’s Chief Executive Officer.

Jim will begin by discussing the key financial results and business developments of the first quarter. Following Jim’s comments, I will discuss Zhone’s detailed financial results for the first quarter and provide guidance for next quarter. After our prepared remarks, we will conclude with questions and answers.

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, the 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 31st, 2014.

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

During the course of this call, we will also make reference to adjusted EBITDA and adjusted operating expenses, non-GAAP measures we believe are appropriate to enhance an overall understanding of 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 that 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 to 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 Jim Norrod, Zhone’s Chief Executive Officer..

Thank you, Kirk. Good afternoon, and thanks for joining us today for our first quarter 2015 earnings call. We are excited to that we met or exceeded all of our financial goals for the quarter, completed the transformation of our business and position ourselves for substantial growth and profitability in the years ahead.

When I joined Zhone in the third quarter of last year, we began focusing our efforts on our two key businesses.

Being a global leader in fiber access transformation for service providers and providing the most cost effective efficient and environmentally-friendly alternative to existing copper-based Ethernet LAN infrastructure to businesses in other enterprises using our industry-leading FiberLAN technology.

We have a strong and well-established service provider business serving the most innovative carriers around the world. In order to continue being a global leader in that business, we maintain the course of investing heavily in R&D to continue providing the cutting edge technologies that our customers expect and demand.

This included the launch of our new MXKF last quarter, which is fiber-only evolution of our current MCK product line offering 10 times the switching capacity and two times the port capacity while giving our customers a migration to new high-speed fiber services and access to network functions like software-defined networks, deep packet inspection and other network virtualization functions.

At the same time, we began building the sales and marketing infrastructure to develop the passive optical land market for the enterprise.

We embarked on an intensive campaign to educate businesses in other enterprises about the tremendous value proposition associated with our FiberLAN solution, a solution that helped businesses increase revenue through increased occupancy, decrease power consumption, increase security, increase life span, reduce CapEx, improve space utilization, and of course most of all lower overall expenses.

Those efforts included a non-exclusive agreement with Corning to co-market an all-fiber network solution capable of deploying passive optical local area network and cellular distributed antenna systems on a common infrastructure. Today both our service providers and our enterprise businesses are positioned for growth and gaining momentum.

As you know, growth leads to increased profitability because we can leverage our operating expense and our manufacturing capacity. Profitability remains our number one financial goal as we fully expect to return to profitability in the second quarter in this year. Revenues have already rebounded from our management and product transition.

Gross margins had similarly rebounded and operating expenses are back at levels of a year ago. So, we're confident that we will achieve that objective this quarter and that the momentum of our business will get us back to profitability for the remainder of the year and for the year as a whole.

Kirk will talk more about those specifics, so let me provide a few final comments of our two businesses.

Obviously, our service provider business continues to anchor our company, so we're encouraged that our largest service provider customers had started testing the new MXKF in their labs and we expect them to begin operationalizing MXKF in their networks later this year.

They are uniformly excited about the game changing nature of this platform and we look forward to helping them migrate to it as soon as possible. We're certain that this industry leading platform will also catch the attention of other new service providers around the world, creating an opportunity for us to develop an expanded customer base.

Meanwhile we continue to support and enhance our MXK classic platforms for copper and fiber access deployment for those service providers on a slower migration path or with different network requirements. Finally, as I mentioned last quarter many of our largest service provider customers had their own aggressive growth plans for 2015 and beyond.

Those plans represent significant incremental expenditures over the next few years. Since our top 10 customers generate nearly two-thirds of our total revenue, we're also encouraged that those customers had growth plans that include our technologies. As an example, one of our largest Canadian customers recently began a major MXK deployment.

Saskatchewan Telecommunications Holding Corporation or SaskTel is the Tier-1 service provider of business and residential customers in the province of Saskatchewan.

SaskTel is replacing and modernizing that SaskTel legacy voice network with next-generation voice over IP technologies with the ability of leveraging the MXK technology to triple play services in real areas in the future.

To-date Zhone has deployed over 3,000 of its fully redundant carrier-grade all IP MXK platforms over more than 150 service providers similar to SaskTel and total subscriber capacity supported by these deployment now exceed over 20 million.

As for our enterprise businesses, revenue for the first quarter more than doubled in the first quarter of last year. It also grew sequentially from last quarter, where normally we would expect a contraction from the fourth quarter due to normal business seasonality.

These are more signs that our sales and marketing strategy are yielding results which increase our confidence that FiberLAN can be $100 million annual revenue business in five years. In addition to growing at a rate which exceeds doubling on an annual basis, we're seeing the total pipeline of opportunities growing even faster than that.

Also we're just beginning to tap the international market to our world-class sales team and partners that driven our company's great growth.

Meanwhile, we continue our business development efforts with several large strategic partners who share our belief in a significant potential of the obstacle LAN market and who share our commitment to make it a reality. They see the same powerful value proportion for FiberLAN as we do.

Last quarter we announced a new FiberLAN deployment with SouthEast Bank located near Nashville, Tennessee.

Through strategic partnerships with TE Connectivity and tailored telecom solutions, Zhone's equipment will enable SouthEast Bank's customers to access its services over a super-fast fiber optic internet through a secure cost efficient and greener alternative FiberLAN technology.

SouthEast Bank looks to Zhone and TE Connectivity to help them build an advance network at an affordable cost. One of the bank's biggest concerns was saving space. Zhone's FiberLAN was the perfect solution to fulfil their needs since it provides them to a 90% reduction in floor and rack space.

Zhone partnered with TE Connectivity and Qypsys in working with SouthEast Bank to identify the best solutions to improve their network capabilities for banking customers and prepare for future adaptation. This is just one example of the many success stories that we are experiencing in our enterprise business.

Now, let me turn the call back to Kirk to provide some more details about returning to profitability, our financial results for the last quarter, and to discuss our financial guidance for the next quarter.

Kirk?.

Thanks, Jim. Today, Zhone announced financial results for the first quarter of 2015. First quarter revenue of $27.1 million met our revenue guidance of being down 10% sequentially from fourth quarter revenue of $30.1 million due to normal seasonality.

As Jim mentioned, we expect revenue growth in 2015 to be driven by the launch of our MXKF, continued strong growth in FiberLAN, and strength in our international markets due to incremental network expansion plans by our largest customers.

Accordingly we expect second quarter revenue to grow in the mid-single-digit percentage range from the first quarter and continue to grow sequentially for the remainder of the year.

We experienced slightly less customer concentration this quarter with the top five customers representing approximately 42% of revenue for the first quarter as compared to 51% for the fourth quarter. We also had just one 10% customer in the first quarter as compared to three 10% customers in the fourth quarter.

Since all of our 10% customers were international, our international markets continued to produce the vast majority of our business and represented 63% of revenue for the first quarter, as compared to 71% of revenue for the fourth quarter.

Gross margin of 37.5% exceeded our guidance range of 34% to 36%, largely due to a higher percentage of domestic revenue which tends to have stronger margins and better manufacturing efficiencies at fine volume level for the quarter. We expect gross margins for the second quarter to return to more normal levels estimated at between 34% and 36%.

Operating expenses of $10.7 million for the first quarter were better than the guidance expectations of $11 million, $11.5 million, largely due to executing the remainder of our business restructuring earlier in the quarter.

With the completion of our restructuring, we anticipate that operating expenses will continue to range between $10.5 million and $11 million for the second quarter of 2015 and only increase slightly for the remainder of the year due to additional sales commissions on the anticipated revenue growth.

Operating expenses for the first quarter included depreciation of approximately $200,000 and stock based compensation of approximately $200,000, both of which we expect to continue at about the same level into the second quarter of 2015.

Finally, our adjusted EBITDA loss for the first quarter of 2015 was only $142,000 and net loss on a GAAP basis was only $602,000 or $0.02 per basis and fully diluted share. Anticipated losses were much lower than expected due to the improved gross margins and expense reductions that I mentioned.

For 2015 we are looking forward to returning to profitability. That profitability will be driven by revenue growth, a rebound to historical gross margin levels and lower operating expense resulting from restructuring the business. We expect that profitability to begin in the second quarter and accelerate through the end of the year.

Now let’s take a look at the balance sheet. Cash and short term investments at March 31, 2015 declined to $11.3 million from $11.5 million at December 31, 2014, primarily due to the adjusted EBITDA loss. The net effect of other balance sheet changes was very minor, although specific balance sheet accounts fluctuated to a larger extent.

Accounts receivable increased to a $31.9 million at March 31, 2015 from $29.9 million at December 31, 2014. Increase in number of days sales outstanding on accounts receivable to 106 days as compared to the 89 days for the fourth quarter. The increase in DSOs is largely due to the pattern of shipments to and collections from on our largest customers.

We expect those patterns to normalize and DSOs will decline over the coming quarters. Offsetting that increase was a reduction in our net inventories to $17.3 million at March 31, 2015 from $20 million at December 31, 2014.

Our total debt obligations associated with our working capital facility with Wells Fargo remained $10 million at March 31, 2015 and December 31, 2014. Lastly, the weighted average basic and diluted shares outstanding were 32.6 million for the first quarter of 2015.

With that financial overview let met turn the call back to Jim for a few final comments before we open the call to questions and answers..

Thank you, Kirk. We entered 2015 with a renewed level of confidence that we will grow revenue in both our service provider and our enterprise businesses.

As I mentioned the growth drivers stemmed from the launch of our highly anticipated MXKF incremental network expansion by our largest customers and the execution of our sales and marketing strategy for FiberLAN.

Our first quarter results demonstrate that we are back on track and that our focused business structure will lead to profitability which remains our primary financial objective. We are very excited about the opportunity, because we know that revenue growth coupled with operating expense leverage leads to improved profitability.

Now, I would like to open up the call to questions.

Operator can you please begin the Q&A portion of the call?.

[Operator Instructions] Our first question comes from Christian Schwab with Craig Hallum Capital Group. Please proceed..

Hey congratulations on a great start to the year. As we look to....

Thanks Chris..

Yeah, you’re welcome.

Can you quantify the revenue that you are kind of expecting from the MXKF platform in 2015 and then what that type of growth should accelerate to 2016?.

Let me try. It’s good to talk to you Christian. We haven’t announced the MXKF formally to all of our customers. We've done it on a controlled release and so we chose two of our largest service providers in the Middle East to take their early installations.

We've got I think about half a dozen other of our largest service providers who have requested deliver which we are planning to do this quarter. So we are really still doing it on a controlled release basis to make sure we get lots of input on the product before we do a full release.

I expect that right now it looks like it will be more like Q3 before I will do a general release of the product. So it’s still controlled, as I said probably Q3. Once we do that I think it can grow pretty rapidly. I don’t have a specific forecast on numbers on it yet for the end of the year.

But again, let me also point out Christian that it is a separate product from the MXK product line as I made very clear. This is a fiber only implementation, so its four our largest service providers that only want to do very large fiber roll outs.

And so if you are still in the copper fiber combination for transition purposes you will use the MXK product. So this is a fiber only product. As I said, we are really anxious to get it on a general release. We haven’t announced the GA yet, general release of it. But as I said, I expected sometime in Q3..

Great. And then as you guys -- as you are talking to your largest service provider customers, as you talked about the top 10 begin two-thirds of your revenue.

And as they look at the products that they would purchase from you, not necessarily their aggregate CapEx, is that kind of looking to be low to mid-single digit growth year-over-year or higher than that or how should we be thinking about that? Can you quantify that at all?.

Christian, I think the service provider business is stable, but it’s not significant incremental growth. It would be low single-digit percentages, what we've thinking about. .

Right. Could you guys have talked about your customers are planning significant incremental network expansion and I guess I just don’t know what that means? That means kind of….

Yeah, in total is what Kirk said on the growth of it. And I think we are going to see growth for the rest of this year in that year.

I do want to remind, as you know that, we -- I have said in the past and I will say today and I will say in the future, I think the growth -- the true growth engine of our company is in the FiberLAN area, that's where we will see, as I said, the greater growth in the company will be in the enterprise FiberLAN.

But all in all the single-digit growth on the service provider business is what Kirk mentioned and he is right on, on that..

So we are thinking, so our math is right that when did we start the clock ticking on the 100 annual revenue business in five years, so that starts this year. So we are thinking 2020 to that start previous when we started telling.

When should we start to clock on our annual revenue goal of five years?.

Well, I think I mentioned that in the last meeting, if I'm not mistaken, in the last quarterly update for shareholders that I had committed that we would see $100 million year business in five years. So I would say the clock started last quarter because that's when I mentioned that. And I think clock is ticking.

We will -- as I said, we are on track this from a year-over-year basis, from Q1 to Q1 we more than doubled in the FiberLAN and we are on track for this year 2015 to more than double over 2014. So the clock is ticking and I would say it’s started here in the last one to two quarters..

Okay, great. Thank you..

All right. .

[Operator Instructions] Our next question comes from Alan Davis with L.A. Davis. Please proceed..

All right. Nice quarter. Just a couple quick questions here. Has FiberLAN started to impact margins yet, or still chose to small as you kind of look out over the next few quarters.

Should we expect that to more significantly affect margins as you get later in the year?.

Alan this is Kirk. Thanks. As you know we've said that we will start disclosing FiberLAN revenues when its 10% of the quarter and so it obviously has not reached that and therefore is not impacting margins significantly.

What we are experiencing though is about 10 point higher gross margin on FiberLAN revenue as compared to our service provider margins.

Okay.

And geographically -- in your main geographies anything change from the prior quarter in terms of customer demand or competitive positioning anything of that nature that’s of no worth mentioning?.

For FiberLAN or in total?.

Just in total..

Yeah, I think the distribution is basically the same. We’re still little over two-thirds of our business is outside the United States. I expect that numbers are going to remain pretty well the same. On the FiberLAN side, as I mentioned in the last call, we did the focus -- sales marketing focus team in the United States initially.

So I have dedicated sales Vice President dedicated sales team in the U.S. on FiberLAN. Some of the pleasant surprises to me this last quarter is that we have had a pretty interesting buildup of opportunities in FiberLAN outside the U.S. without having a dedicated sales team.

It’s been really done by our general sales team that’s been focused on service providers. So that’s been pleasant surprise because I look at the follow and the amount of deals that coming into funnel specifically from international is a very positive surprise to me from a FiberLAN perspective. That’s without the focus effort.

So I’m very pleased about that..

Allan, let me add a point.

As we noted, during the quarter international mix of business decline somewhat from 71% to 63% and that maybe what was driving your question because if there is any major shifts I don’t think that that points to any trend, just happens to be the large customers that we have domestically and internationally just a change in the amount that they had purchase this quarter.

I wouldn’t read anything into that shift..

Okay. Alright, thank you..

Thank you..

We have no remaining questions. I will now turn the call back over to management for any closing remark. Please proceed..

Thank you, Operator. Once again, I want to thank all of you for joining us and for your continued support. As I said before, we’re extremely excited about the growth opportunities that position us for success this year and beyond. We are very committed to converting that success and their profitability.

We look forward to speaking with you on next quarter’s earnings conference call to talk about our progress on achieving sustainable revenue growth in profitability and our commitment to that is just the strong as ever. So again, thanks for your support. We look forward to talking to you soon..

This concludes today's conference. Thank you for your participation. Have a great day, everyone..