Kirk Misaka - CFO Jim Norrod - CEO.

Christian Schwab - Craig-Hallum Capital Group.

Welcome to the Fourth Quarter 2015 Zhone Technologies' Incorporated Conference Call. My name is Karen and I'll be your coordinator for today. [Operator Instructions]. I would now like to introduce Kirk Misaka, Zhone's Chief Financial Officer. Please proceed..

Thank you, Operator. Hello and welcome to the fourth 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 fourth 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 fourth quarter. Following Jim's comments, I will discuss Zhone's detailed financial results for the fourth 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 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 will 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, 2014, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2015, June 30, 2015 and September 30, 2015.

We would 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'll 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 a basis for making operating decisions because they provide meaningful supplemental information regarding our operational performance and they facilitate management's internal comparison to the company's historical operating results and comparisons to competitor's 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..

Thanks, Kirk. Good afternoon and thanks for joining us today for our fourth quarter 2015 earnings call. As you know, 2015 was a year of change for us as we position ourselves to be successful in our two key businesses.

Being a global leader in fiber access transformation for communication service providers and providing the most cost effective, energy efficient and secure alternative to existing copper based Ethernet LAN infrastructure to businesses and other enterprises.

We fully expect that the changes we made in 2015 will begin to bear fruit in 2016 and will create sustainable revenue growth and profitability for the future. We began to see some of those benefits in the fourth quarter with nearly 9% sequential revenue growth and gap profitability.

Our fourth quarter results demonstrate that we can grow revenue profitably even in very tough global economic conditions. For 2016 we see four growth catalysts. First, the official launch of our MXK-F should begin to be deployed by our largest customers.

Second, the global economic conditions that caused the downturn in 2015 should improve or at least stabilize enough to create an improved spending environment for our international service provider customers. Third, the second round of Connect America funding should provide some stimulus for our U.S.

service provider customers although the impact of the CAF-2 funding will not be felt until the latter part of the year. Fourth, our enterprise business continues to grow rapidly which I will discuss in greater detail in a moment. Kirk will also provide more financial details later so let me say a few words about our two businesses.

First and foremost we continue to support our 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 will maintain the course of investing heavily in R&D to provide the cutting edge technologies that our customers expect and demand.

In the fourth quarter, we officially launched the MXK-F, a new aggregation platform that can support fiber based Triple Play service from one chassis for a large city of up to a quarter million users. Innovations like the MXK-F are what made us a global leader in fiber access transformation.

As I've said before our service provider business continues to anchor our company so we're encouraged that our largest service provider customers continue to test the MXK-F in their labs and we expect them to begin operationalizing MXK-F in their network soon.

They're uniformly excited about the game changing nature of this platform and we look forward to helping them migrate to it just as soon as possible. We are certain that the 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 [Technical Difficulty] call last quarter. We quickly reduced discretionary spending in other areas to be able to continue making those R&D investments in our service provider business and to create profitability.

Our service provider business is thus positioned for profitable growth as global economic conditions improve. As we've discussed before growth also leads to increased profitability because we can leverage our operating expenses and our manufacturing capacity.

Profitability continues to be our number one financial goal and we fully expect to return to profitability in 2016. As for our enterprise business it is growing rapidly due to the compelling value proposition of our FiberLAN product.

It is easily the most cost effective energy efficient and secure alternative to traditional copper LAN infrastructure, although FiberLAN revenue is relatively small, 2015 FiberLAN revenue more than doubled over 2014 demonstrating that FiberLAN can be a $100 million annual revenue business in another 4 to 5 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 as the market learns about the FiberLAN value proposition. As I've said in the past, success breeds success.

So key reference wins and numerous market vertical should lead to follow through success in those verticals. Also we are just beginning to tap the international markets where our world class sales team and partners have historically driven our company’s greatest growth.

I have now assigned our VP of Enterprise Sales to focus on the international market in addition to the existing U.S. to market sales team. Our strategic partnerships with other players in this market are also key catalyst to the accelerating momentum in our enterprise business.

We previously announced a non-exclusive agreement with Corning to co-market in all fiber network solution capable of deploying passive optical local area networks and cellular distributed antenna systems on a common infrastructure.

In the second quarter of 2015 we announced another partnership with TE Connectivity to co-market passive optical LAN solutions to customers in a wide variety of sectors including government, health care, hospitality, education and finance.

In the third quarter of 2015 we announced yet another agreement with Clearfield, the specialist in fiber management and connectivity platforms for communication providers to co-market GPON solutions for enterprise customers and develop integrated hardware software solutions that optimize the implementation of Clearfield's fiber optic products with Zhone's fiber access solutions.

In the fourth quarter of 2015 IBM launched a global consortium to modernize sports venues and to enhance fan experience. We were part of that announcement as we were named a passive optical LAN strategic partner in that effort. We also released case studies involving two applications of our FiberLAN solution.

First, the deployment of FiberLAN at Grace Christian School demonstrates how the technology can foster digital learning and support connected devices as well as other cloud based applications. Secondly, the deployment of FiberLAN at Woodland's Retirement Community provides the most reliable and secure access to a multi-use network.

With that brief overview of our business let me turn the call back to Kirk to provide more details about returning to profitability. Our financial results for last quarter and to discuss our financial guidance for next quarter.

Kirk?.

Thanks, Jim. Today Zhone announced financial results for the fourth quarter of 2015. Fourth quarter revenue of $24 million grew 8.5% sequentially from third quarter revenue of $22.1 million.

As we discussed last quarter global economic uncertainties continue to cause many service providers to cautiously approach new network investments and as a result many of our international customers have reduced their network expansion.

Although, the fourth quarter sequential growth is encouraging we do not expect continued growth into the first quarter. Instead we are anticipating normal seasonal weakness in the first quarter and slightly lower revenue. After the first quarter, we would expect normal seasonal growth for the remainder of the year.

For 2016 as a whole we expect mid-single digit percentage revenue growth over 2015 driven by the four growth catalysts that Jim mentioned namely the official launch and deployment of our MXK-F platform by our large service providers and improved spending environment for our international service providers.

Some CAF-2 stimulus in the latter half of the year for our U.S. service providers and continued strength in our FiberLAN business.

Since the global economic slowdown impacted many of our international markets revenue from our international customers which typically produced the vast majority of our business represented just 58% and 57% of revenue for the third and fourth quarters respectively. As compared to 63% and 67% of revenue for the first and second quarters respectively.

We also experience less customer concentration this quarter with the top five customers representing approximately 31% of revenue for the fourth quarter as compared to 42% of revenue for the third quarter. And we didn't have any 10% customers in the fourth quarter as compared to two 10% customers in the third quarter.

Gross margins of 40% exceeded our guidance range of 34% to 36% due to stronger domestic margins, stronger enterprise margins and continued manufacturing efficiencies. We expect our domestic international mix to normalize next quarter but our better enterprise margins and manufacturing efficiencies should continue.

As a result we expect gross margins for the first quarter of 2016 to range between 36% and 38%. Total operating expenses of $9.1 million for the fourth quarter were at the low end of our guidance expectations of between $9 million and $9.5 million but we expect operating expenses next quarter to be closer to the high end of that range.

Total operating expenses for the fourth quarter included depreciation of approximately $200,000 and stock based compensation of approximately $300,000. Finally, our adjusted EBITDA profit for the fourth quarter of 2015 was $990,000 as compared to an adjusted EBITDA loss of $829,000 for the third quarter.

Our net income on a GAAP basis was $403,000 and $0.01 per basic and diluted share in the fourth quarter of 2015 as compared to the net loss of $1.452 million and $0.04 per basic and diluted share in the third quarter.

Our goal was to breakeven on an adjusted even dubbed basis in first quarter of 2016 and return to profitability in subsequent quarters. Now let's take a look at the balance sheet.

Cash and short term investments at December 31, 2015 increased to $10.1 million from $9 million at September 30, 2015 largely due to our adjusted EBITDA profit accompanied by minor changes in our networking capital balances.

Accounts receivable decreased to $28.2 at December 31, 2015 from $30.9 million at September 30, 2015 reducing the number of days sales outstanding on accounts receivable to 106 days as compared to 126 days for the third quarter.

DSOs have been elevated over the past few quarters largely due to the pattern of shipments to and collections from our largest customers. We expect those patterns to normalize and DSOs to continue improving in 2016.

We also continue to focus on reducing net inventories which were $14.8 million at December 31, 2015 as compared to over $19.9 million at December 31, 2014. Our total debt obligations associated with our Wells Fargo Working Capital facility declined slightly from $5.1 million at September 30, 2015 to $5 million at December 31, 2015.

Lastly, the weighted average basic and diluted shares outstanding were $33.5 million and $34 million respectively for the fourth quarter of 2015. And with that financial overview let me turn the call back to Jim for a few final comments before we open the call up to questions and answers..

Thank you, Kirk. As I said we fully expect that the changes made in 2015 will begin to bear fruit in 2016 and will create sustainable revenue growth and profitability for the future. Our fourth quarter results with nearly 9% sequential revenue growth and GAAP profitability demonstrate that we are on track. Now I'd like to open up the call to questions.

Operator, please begin the Q&A portion of the call..

[Operator Instructions]. Our first question comes from the line of Christian Schwab from the Craig-Hallum Group..

Congratulations on a solid quarter.

When FiberLAN next year, do you think that has the opportunity to become 10% of quarterly revenue at any time during next year?.

2017 Christian?.

2016 or do you think that’s more of a 2017 event?.

Yes, I would say 2017 that had been an easier answer to say yes, 2016 I'm just not sure yet. Again we have more than doubled in 2015 over 2014 and I expect we will more than double again this year. So it certainly could be close but no guarantees but I will tell you 2017 should not be a problem disclosing those numbers..

And when will we have announcements of greater scale of some of these partners pulling deals through you. Well, as the pipeline that you talked about is that what they are helping you build and what is the length of the sales process so we can get an idea of that..

And there are other partners that we haven't mentioned in this press release as well that are doing a really bang up job, doing a great job building the sales funnel and closing business. But you take as an example IBM, they've dedicated a complete group into this new sports arena fan experience business that they've announced.

They see this as a long term business opportunity for them and they have won several large deals but they've not announced the names of those deals yet. So I cannot announce them until they do because they're in charge and I can't you know jump in front of them on these announcements.

But they have won several big sports deals and I think that as they announce those you'll see that we’re participants in those announcements.

But IBM -- I want to reiterate they're making a major worldwide commitment to this whole area and this is not just major league professional sports, we're talking college sports as well as internationally in the soccer area. So this is a big deal.

And it's significant to them and certainly to us and I wouldn’t doubt if they become our number one partner here in the future..

When you guys talked about -- I think I heard you say mid-single digit year over year revenue growth or mid to high single digit year-over-year revenue growth, if that's the case then should we assume that the lion’s share of the incremental growth on a year-over-year basis is really coming from FiberLAN and CAF-2 spending [Technical Difficulty] and do product platform family allows that modest growth or if we’re going to grow [Technical Difficulty] I guess is what I'm asking is what is the rank in order of importance of your growth drivers?.

Christian, on the service provider side as a whole we’re thinking that it would be low single digit percentage growth over 2015.

FiberLAN clearly and on the enterprise side is expected to more than double again but the impact of that on total revenues is not nearly as significant but it does drive the percentage up to mid-single digit percentage overall for the business..

Okay. And then as far as CAF-2, you're hopeful for some revenue in the second half but should we be thinking of that as if that goes really well that's more upside and or use.

Are you seeing any initial signs you know, you’re not as strong in United States as say ADTRAN is or Calix is who you would obviously be competing with for that, Alcatel Lucent, isn't going to come down and compete with you for these small little deals.

So are you seeing any initial signs of success where you think you're going to win some business competitively versus the two people you would obviously run into?.

As we know that’s – CAF-2 is a U.S. program, we're not going see internationally any impact. And we are not in Tier 1s in the United States as everyone knows.

We have a couple of Tier 2s and then Tier 3s through 5s, so we'll see some of our Tier 2s pick up some of that money and they have already told us that they think it will have a positive impact toward the latter part of the year. So as you know we’re not competing with ADTRAN and Calix on the Tier 1 business, that’s beyond where we're focusing.

We're not going to spend the money to go after that business. But you drop down to the Tier 2 and 3 through 5 we’re highly competitive there. We expect to possibly see some new customers come into the U.S. with that CAF-2 funding and we expect to see some positive impact there.

But again we don't really compete with ADTRAN and Calix specifically in the Tier 1 space, because we're not going after those companies..

Right, but CAF-2 is more of a rural phenomenon anyway even though AT&T and CenturyLink a little bit couple bigger customers have taken the lion’s share of the [money] [ph], [indiscernible] little bit later about what's going on there. I don’t have any other questions. Thank you..

[Operator Instructions]. And that concludes our question and answer session for today. I would like to turn the conference back over to Jim Norrod for any closing comments..

Thank you, operator.

As always we do appreciate you folks joining us today and your continued support because I know many shareholders are on this phone call and want you to know we’re continuing to be optimistic that we're positioned for strong growth opportunities that will lead to success in 2016 and beyond and we’re also committed to converting that success into profitability and shareholder value because as we speak to you that I want you to know that that this will remain sustainable, the revenue growth and profitability remain our key goals and key objectives for 2016.

We remain focused on that and again thank you for your support. We look forward to talking to you again at next quarter's conference call..

Thanks everyone..

Thank you. Ladies and gentlemen thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day..