Good afternoon. Welcome to DASAN Zhone Solutions Third Quarter 2019 Earnings Conference Call. My name is Latif and I will be your operator for today's call. Joining us for today's presentation are the Company's CEO, Yung Kim; Vice President Finance, Blair King; Philip Yim the Company's COO; and Corporate Controller Jerry Borja.

Following their remarks, we will open up the call for questions from DASAN Zhone’s institutional analysts and investors. Now, I would like to turn the call over to Blair King. Sir, please proceed..

Okay. Thank you, Latif. Before we begin, I'd like to point out that during this call, we will provide projections and other forward-looking statements regarding future events or the future financial performance of the Company. We caution you that such statements are only current expectations and actual events or results may differ materially.

We refer you to documents DZS files with the SEC including our most recent 10-Q and 10-K reports and the forward-looking statement section of today's preliminary results press release.

These documents identify important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Please note that unless otherwise indicated, the financial metrics we provide on this call are determined on a non-GAAP basis.

These items together with corresponding GAAP numbers and a reconciliation to GAAP are contained in today's press release that we have posted on our website and filed with the SEC on Form 8-K. We will also discuss historical financial and other statistical information regarding our business and operations.

Some of this information is included in the press release and the remainder of the information will be available on a recorded version of this call. So with that, I'll turn the call over to our CEO, Yung Kim.

Yung?.

Thank you, Blair. Good afternoon, everyone. Our preliminary results for the third quarter reflect a disappointing setback to our near-term financial growth agenda, with the revenue of $71.5 million, well below our expected range of $88 million to $94 million.

We believe a large portion of the softness in Q3 is a precursor to the move to the next-generation broadband access technology we have targeted for growth. That is the move to 5G network where our deal pipeline has grown much faster than expected, and the upgrade of access network to support new copper and fiber-based technologies.

Most specifically, as the quarter progressed, we were surprised to see more customers actively engage in the planning process to deploy new 5G services. Coincidentally, our deal pipeline for the ultra-low latency mobile transport switches is running significantly above where we expected it to be. That's the good news.

The bad news is that for a service provider, transitioning to 5G is a mega trend [ph] requiring extensive planning and preparation, which has stalled investment for our equipment elsewhere in the network.

Similarly, during the quarter, we saw customers in Europe increasingly commence plans [indiscernible] to next generation [indiscernible] as a fiber-to-the-home technology. In summary, these technology trends have created more turbulence in our business than we anticipated just a few months ago.

Some of our largest and most important [ph] customers are really setting back to actively consider new approaches to the delivery of innovative new services and associated operational complexities.

So, while on one hand we are pleased with the activity and are encouraged by the trend; on the other, we will see a near-term transition through in the business as this is an area we really need to sharpen our execution to navigate through.

Now, quite separately at the same time, secondary challenge during the quarter was an unforeseen global slowdown in carrier spending. Specifically, we saw several anticipated deals postponed in the final few weeks of the quarter.

And while we’ve seen some recent improvement, this change in business conditions certainly heightened our level of caution in the current quarter.

Finally, as it relates to execution, we recognized during the quarter that the breadth and the complexity of our Americas [ph] business across developed and emerging markets warranted structural changes to enable better coverage, visibility and growth. Consequently, last month, we reorganized our Americas sales organization.

And after some strategic action, we expect improved visibility to be better positioned to drive, outperform in the region. In addition, we implemented several cost measures to optimize our business. This included personnel reductions across business as well as focused menu [ph] to reduce manufacturing overhead.

These measures account for $4 million of annual cost savings for the Company, and when paired with anticipated the contribution from our 5G deployment, we at anticipate continued growth expanding adjusted EBITDA margin in 2020. Blair will provide more color on our Q4 outlook shortly.

But before I turn the call over, I would like to update all of you on our CFO search. I’m encouraged to report that we have identified a new CFO and an individual appointment is pending Board resolution.

This individual will bring a wealth of global finance experience to our Company, having served in senior finance roles for two Fortune 10 companies, previously a controller of GE Research, General Electric multidisciplinary technology research and IT licensing business.

Prior to that, this individual served as a business unit controller and divisional CFO at both GE and Verizon, as well as Chief Accounting Officer for two publicly traded companies including Fortune 500 company Mastech, [ph] and American multinational infrastructure engineering and construction company.

We look forward for making a formal announcement in the coming weeks. With that, Blair will walk you through the financials for the third quarter of 2019.

Blair?.

Thank you, Yung. And now turning to our financial results for the third quarter ended September 30, 2019. Net revenue was $71.5 million, which is in line with the preliminary revenue range we provided in early October and as Yung just mentioned, well below our original guidance of $88 million to $94 million.

On a comparable basis, the $71.5 million of net revenue in Q3 was down 15% from the prior quarter and down 1% from Q3 of last year. Year-over-year decline was primarily due to a decrease in revenue from the APAC region, and to a lesser extent the Americas. This decline was somewhat offset by growth in the EMEA.

From a customer standpoint, LG U+ represented 11% of total revenue on the quarter, the top 10 customers in Q3 represented 60% of our total revenue, which was up from 57% in the same period of last year. The increase was led primarily through continued customer momentum in both Japan and South Korea.

From a market segmentation standpoint, revenue from our international market accounted for 85% in the third quarter with the remaining 15% coming from North America. Within the international market, Korea accounted for 29%, other APAC was 25%, EMEA was 22% and Latin America was 9% of total revenue in the third quarter.

From a gross margin standpoint, GAAP gross margin in the third quarter was 31%, which was down from 32.6% in Q3 of last year. The lower margin in the quarter reflects a less favorable customer and product mix than we experienced in the year-ago period.

And when compared to guidance of 32.5% to 33.5%, the decline is largely attributable to lower volumes, which of course resulted in less than expected overhead absorption. Now, as Yung touched on earlier, we've taken steps to improve our efficiency going forward.

And while we anticipate realizing some of the benefits through Q4, we anticipate to see the full impact of the restructuring as we exit the year. So, looking at our expenses. GAAP operating expenses in the third quarter of 2019 were $26.1 million or 36.5% of total revenue, compared to $19.9 million or 27.7% of total revenue in Q3 of last year.

The increase in GAAP operating expenses was primarily due to the inclusion of expenses from KEYMILE, which were not included in the year-ago period. And, we also incurred over 1 million of nonrecurring expenses in the quarter, as well as the severance and early lease terminations, relocation and other professional service fees.

Non-GAAP operating expenses, which exclude depreciation and amortization, as well as stock-based compensation were $24.1 million, or 33.6% of total revenue, and this compare to $18.7 million or 26% of total revenue in Q3 of 2018.

The cost optimization measures we implemented at the start of the quarter should reduce our operating expenses by approximately $4 million annually. Adjusted EBITDA in the third quarter of 2019 totaled the loss of $257,000 compared to $4.4 million gain in Q3 of 2018.

Our GAAP net loss attributable to DZSI for the third quarter of 2019 was $4 million or $0.19 per diluted share. This compares to GAAP net income attributable to DZSI of $1.8 million or $0.11 per diluted share. Cash position at quarter end was $47.9 million.

Days sales outstanding increased to 127 days from 97s in Q2 of 2019 with AR increasing approximately $101 million from $88 million in Q2 of 2019. The increase in accounts receivable was largely due to approximately $7.7 million moving from contract assets to receivables compared of course to less favorable payment terms awarded to some customers.

The lower than expected sales added approximately 18 days to our DSO calculation. Here, given the lower than expected revenue in the quarter, we’d be remiss not to mention that during the quarter we did break the maximum leverage ratio covenant and our credit agreement for the bank P&C.

[Ph] It is also worth noting [indiscernible] So, let's now turn to our financial outlook.

For the fourth quarter of 2019 we expect net revenue of $80 million to $86 million, GAAP gross margin of 31% to 32%, and non-GAAP gross margin of 31.6% to 32.6%, operating expenses of $27.5 million to $28.5 million and adjusted operating expenses at $21 million to $22 million, EBITDA loss of $2.2 million to a gain of $1.4 million and adjusted EBITDA of $3.4 million to $7.2 million.

For the full year of 2019, we expect net revenue of $309 million to $315 million, GAAP gross margin of 32.2% to 32.5% million, and non-GAAP gross margin of 32.5% to 33.3%, operating expenses of $104.1 million to $105.1 million and adjusted operating expense of $91.9 million to $92.9 million, EBITDA of $2.5 million to $6.3 million, and adjusted EBITDA of $11.7 million to $15.5 million.

As a reminder this guidance reflects lower than anticipated customer spending levels for the balance of 2019 including certain customer orders shifting from the fourth quarter of 2019 to the first quarter of 2020. And with that, I’ll turn the call back to Yung before we move to Q&A.

Yung?.

Thank you. Despite the near-term turbulence in our business, we're seeing some market appeal and we are in the very early innings of a multiyear investment cycle in 5G, and the fiber broadband access solution. The investments we have made in these technologies are solid.

Our customer base is actively engaged, our pipeline is being built faster than we anticipated. As it relates to customer planning cycle that incorporates our new technologies, our visibility will be impacted. However, as history has demonstrated in the past, we are ensuing success with the strong demand trend ahead.

So, while we are not pleased by our Q3 results and the outlook for Q4, our strategic direction remains focused and firmly intact.

We are well armed with a competitively differentiated and the largely refreshed product offering paired with a growing pipeline of exciting new business opportunities and a strong leadership position in the markets we serve. As such, we are increasingly confident in the future top and bottom-line growth of our business.

Operator, we are ready for Q&A..

Thank you, sir. [Operator Instructions] Our first question comes from Tyler Burmeister of Craig-Hallum. Your line is open..

Hi, guys. Thanks for letting me ask question. So, as we look into 2020, I understand the visibility might be limited.

But, it sounds like with some orders pushed out into Q1, you'd expect another quarter of sequential growth in the Q1, if that's correct? And then, how we should think about the trend of revenue through the year, if there is anything we should be thinking about?.

I think, in 2020, even though some of the products that is moved to the Q1 from Q4, we also see some of the delay in the [indiscernible] from our supplier and which subsequently delays some of the 5G deployment.

One is customer in Japan is experiencing [indiscernible] delay while the other customer, the rollout is delayed by months also pushes our general 2021 slightly. But I don't think that we will have a big impact from that overall for the year. So, we still see growth in 2020..

Okay. That's great. And then, just a little bit clarification I guess.

You mentioned $4 million of OpEx savings, is that off of the reported Q3 levels we should think about?.

No. Oh, go ahead, Yung..

Yes. So, the savings, the $4 million will start from exiting the Q4. So, I think, there is a little bit of savings which will be in Q4. But that is not -- it offset by the expenses that is incurred with the restructuring. So, you should not be able to see any improvement.

So, I think -- so, I will not take into account any savings in Q4 because of expenses required to do the restructuring. So, $4 million let's say the beginning of 2020, every quarter about $1 million..

Tyler, does that answer your question?.

That makes perfect sense. Thank you. That's all for me, guys. I appreciate it..

Thank you. Our next question comes from Dave Kang of B. Riley FBR..

Thank you. Good afternoon. Just wondering regarding your fourth quarter outlook $10 million to $15 million sequential growth.

Can you just go over some of your assumptions; specifically, how much of that is from 5G contracts?.

I think, [indiscernible] continue. I think, the reason they became the top customer is their strength in 5G. And also, we start a small amount of 5G for Korea Telecom. That number is not significant.

I would say, maybe a couple of hundred thousand, but Korea Telecom was that more honestly from next year because we are part of the second [indiscernible] supplies to Korea telecom from 5G. But real 5G in Japan, will now be more like Q2 to Q3 into Q4 will be the biggest amount. And obviously, Korea Telecom [indiscernible] next year as well..

Got it.

And then, regarding fiber LAN, besides Lagrange any other partners that you want to share with us?.

We are just starting to -- big structure [indiscernible] company in France. Because we have all that agreement from them yes, I can’t reveal, but that those conditions are. And there is another company in the U.S. that we are discussing similar kind of deal.

So, I think for the -- most of the efforts is [indiscernible] our products and get into their system integrated into the [indiscernible] training [indiscernible]. So, I would say that there are big ones that we have targeted and one already announced and there are two more, one in Europe and one in North America..

Got it. And then just in terms of next year’s gross margins. My understanding is that fiber LAN and 5G, their margins are up at corporate average.

So, how should we think about next year as gross margin target with these two ramping?.

I think I will be cautious because last year I said with the 5G coming in Korea and mostly in Japan, we saw predefined with the plan. But I think the portion of 5G was not as much to impact our margins. And in fact, we were very much attacked by Chinese companies Latin America, South America and Asia Pac.

So, our overall margin hasn’t increased much from last year to 2019. But, I think [indiscernible] coming, I mean probably the biggest market next year with high margin, we expect margins will improve, my aim is to improve between 1 and 2 points..

[Operator Instructions] Our next question comes from the line of Timothy Savageaux of Northland Capital Management. Your line is open..

Hi. This is actually Steven on the phone for Tim. I was wondering if you guys could give us a breakout of the APAC region. I know you mentioned that it was 25% of revenue, see if you could give like -- how much of that was Japan, India, et cetera..

For you mean Q3 or you were talking about year-to-date?.

Q3 and year-to-date, if you wouldn’t mind. .

Okay. So, Q3, APAC with nearly $40 million, which is way down from our usual run rate. And excluding Korea, I think we've been impacted by all over APAC, India was very small. Japan was reasonably strong but it was not enough to offset business including Taiwan and Thailand.

So, does that answer your question?.

Yes. I think, I can get some there..

And also overall year-to-date apart from Korea and Japan, the APAC has been underperforming. .

Okay. And then, I know you guys mentioned another contract win here in September.

Can we get any like more color on that like size, ramp?.

Which portion are you referring to?.

I believe it was the GTB [ph] Group event in early September..

[Indiscernible] that’s in Egypt [ph], our distributor in Egypt [ph] a big fiber LAN deployment. Other than that the significance win was 5G ultra-low latency switches for Korea Telecom that we've been qualified, we have orders to supply in Q4. That's the beginning of the cycle….

Okay. I think that's it for me. Thanks..

[Operator Instructions] Next question comes from the line of Jon Gruber of Gruber McBaine. Your line is open..

Good afternoon. Could you give us an update on the 5G Japan potential orders and potential orders, and when do they positively impact the Company's revenue picture? Soft in Q, I believe you announced already the Elephant. You haven't announced when does that get announced..

Okay. So, actually we were working until last night to get in time. But, the reason why it was delayed is our potential customer, our [indiscernible] customer in other areas, for 5G. They changed their procurement and asset management system, which actually whatever they order and deliver [indiscernible] asset management tool is also relative one.

And they’re having some issues with that integration into their business. And that has delayed actually the orders coming. But, I think we're looking at immediately that the system has been now going through and we’ve seen the [indiscernible] going through their hierarchy. So, I would say that the press release, it’s going between the two companies.

So, as soon as those processes [indiscernible] I think we will announce. I’m sorry that we thought we could well be announcing it in October or before but I think this is something that they haven’t [indiscernible]. .

And when we start shipping on that contract, when do you actually start on that?.

[Indiscernible]..

I’m sorry when?.

Q2 next year. We're actually developing the system because of the letter of intent we received. So, it's not that the work has stopped, it just formal order has not arrived officially. But, the development…..

Thank you very much. Thank you..

At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Kim for his closing remarks..

Thanks, Latif. Thank you for joining us today. I would like to thank our global employees, customers, partners and shareholders for their continued support. We look forward to updating you on our next call. Thank you..

Thank you for joining us today for the DASAN Zhone Solutions third quarter 2019 conference call. You may now disconnect..