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Technology - Communication Equipment - NASDAQ - US
$ 0.66
10 %
$ 25.1 M
Market Cap
-0.25
P/E
EARNINGS CALL TRANSCRIPT
EARNINGS CALL TRANSCRIPT 2020 - Q1
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Operator

Good afternoon. Welcome to DASAN Zhone Solutions First Quarter 2020 Conference Call. Joining us today are the company's CEO, Yung Kim; and CFO, Tom Cancro. Before we begin, I would like to provide DASAN Zhone Solutions' safe harbor statement.

During this call, management 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 and the forward-looking statements section of today's press release.

These documents identify important risk factors that include -- 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 materials being provided to you 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, which has been posted on DASAN Zhone Solutions website and filed with the SEC on Form 8-K. Management will now -- will also discuss historical financial and other statistical information regarding its business and operations.

Such of this information is included in the press release. And the remainder of the information will be available in a record version of this call on our website. With that, I'll now turn the call over to the company's CEO, Yung Kim. Sir, please proceed..

Yung Kim

Thank you, operator, and welcome, everyone, to our first quarter call. Before heading into our recent business results and outlook, I'd like to briefly address the extraordinary situation we all find ourselves in.

On behalf of all of us at DZS, we are deeply grateful for the support our employees and their families have received from essential service providers and local governments around the globe. And our hearts go out to everyone who has been impacted by this terrible disease. We are proud of the role we play in enabling vital broadband services worldwide.

And we appreciate the continued strong partnerships with our customers and suppliers and particularly thankful for the extraordinary efforts being made by our employees to continue to support our customers and drive our business forward.

Although we have real near-term challenges to overcome, our customers are fundamentally healthy, and we expect to emerge from this crisis as an even stronger company. COVID-19 impacted our business in APAC throughout the entire quarter and impacted the rest of our global business in the final weeks of March.

At the same time, our sales cycle has already elongated as customers evaluate how best to transition from 4G to 5G and from copper to fiber broadband access networks.

While our first quarter results were generally in line with or better than guidance, our visibility into the timing of the conversion of our project to revenue has certainly become less clear than it was just a couple of months ago.

We are seeing several deployments ports, restarts and then proceed at a slow pace as carriers around the world adopt and implement appropriate safety precautions. In some cases, customers' warehouses has been closed, preventing shipments from taking place. And in parallel, these times on critical components have extended four to eight weeks.

Taken in combination, it is increasingly difficult to predict the timing of our project completion beyond the current quarter. So until the impact of the health pandemic becomes more predictable and known, it is not prudent to provide annual guidance.

That said, while COVID-19 has created several unexpected and near-term tactical challenges in our business, it is also shining a light on the need for enhanced broadband service capacity in general and the 5G and next-generation fiber access solutions, in particular.

Nearly overnight, most of the world switch to working remotely, while classrooms transitioned to online learning. The lack of travel and impediment to mobility has led to a massive increase in video conferencing. Business meetings and personal, social gatherings are now being conducted online. Streaming entertainment has never been so more prolific.

In short, the networks are running at near peak levels of capacity.

While we remain in the early innings of demonstrating the true potential of our next-generation 5G architecture, it is increasingly clear that DZS mobile any haul platform has the potential to be a significant revenue driver for the company while expanding our total annual addressable market by nearly $7 billion.

Despite depressed level of on-site integration activities at the customer site, I'm pleased to say that we have recently commenced shipments of our commercially available total products to Rakuten.

During COVID-19, apart from the tremendous increase in the downstream traffic, the more important part is the significantly increased levels of upstream traffic driven through the accelerated use of interactive video applications.

The internet and cable association reports cable upstream traffic is up 35% since early March, nearly doubled the downstream peak growth of 19%. In this context, it was particularly encouraging to see new and existing customers accelerate to a pace of XGS-PON adoption to enable symmetrical 10 gigabit services on a single wavelength.

Looking ahead, this is strategically important as many of our customers are preparing networks for the next wave of broadband stimulus funding through the $20 billion rural digital opportunity fund. Following several years of focused investment, DZS has established itself as a trusted global leader in fiber-based broadband access solutions.

According to recently published data by Omdia, formerly known as Ovum, over the last 9 quarters, we have shipped more next-generation optical line terminals than any other vendor outside China and 8x more than any of our North American competitors. And in 2019, DZS was a leading vendor in 10-gig optical terminal -- optical network terminal shipments.

Although we remain in the early days of adoption here, DZS is clearly demonstrating a solid early leader in the market amidst a noticeable increase in customer activity levels. Let's now pivot to an update on how our business trend at the regional level.

And I'll provide a bit more color on how we see our business evolving in the coming months and quarters. In Asia, we are seeing business starts to pick up. While Korea was kicked hard in Q1, we see a growing pipeline of new business opportunity.

We are fortunate to have a strong customer base in Korea with the key Tier 1 carriers such as Great Telecom, SK Telecom and LG Uplus.

Following the initial reaction by carriers to COVID-19, these customers are now all armed with the ability to manage operational challenges of the virus while also executing on their respective strategic broadband and 5G initiatives. Japan was our largest revenue geography in the quarter.

And as I mentioned in our prior call with you, we anticipate Japan to remain our largest target market opportunity in 2020. The growth we expect from Japan is led by new 5G deployments by both Rakuten and SoftBank.

Although on-site integration activities have broadly slowed the pace of deployment activity, it is good to see facility lock down conditions loosen. We continue to anticipate sequential growth in Q2 and the stronger second half to the year. North America performed in line with expectations.

Although the final few weeks of the quarter were challenged and the customers' warehouses closed, preventing shipments from occurring. We will further be able to complete some field deployment activities and customer facilities closed.

In Latin America, we continue to experience the impact of customer consolidation and heightened competition from Chinese vendors. Although we are seeing some modest sign of improvement with the new orders for our wireless niche product from a Tier 1 carrier in Chile and our recent introduction of lower-cost ONTs and OLTs into the region.

In Europe, the same dynamics we experienced in Asia and North America also impacted our business through the final weeks of March. While spending has generally softened in front of the new investments in fiber access technologies, we do expect a sequential improvement in Q2.

The Middle East continues to be the upright spot in our business, but it is also impacted by material shortages and the project delays as some customers pulled back on the number of people assigned to new product qualification activity.

Putting this all together, based on extensive customer and channel partner conversations, we expect the second quarter planned sales activity will slowly improve and begin to reaccelerate through the second half of the year, driven in part by more focused investment strategy in next-generation market solutions.

Many of our flagship initiatives remain on schedule. Our manufacturing capabilities in the U.S. and Germany have continued to function throughout this crisis. And our OEM partners in Asia are getting back to work. Sourcing components is still a challenge and will take a bit more time to recover.

So while we don't have projects visibility into when the world returns to normal or perhaps evolves to a new normal, we do believe the broadband access market is healthy, and there is a good reason to remain optimistic about our mid- to long-term business, and in the meantime, our ability to execute against our strategic initiatives.

In summary, let me be clear, we do not believe we are losing anticipated business for competitive reasons, nor do we believe business opportunity will permanently disappear. While COVID-19 created a near-term headwind and risk, the fundamental mid- to long-term outlook for our business remains positive.

I'll now turn the call over to our CFO, Tom Cancro, who will provide further details on the quarter.

Tom?.

Thomas Cancro

Thank you, Yung. It's a pleasure to speak with all of you today. Turning to our financial results for the quarter ended March 31, 2020. Net revenue for the first quarter was $47.5 million, which compares to $77.6 million of net revenue in Q4 of 2019 and $74.1 million in Q1 of 2019.

First quarter 2020 revenue was down 39% from fourth quarter of '19 and down 36% from Q1 of last year. The decline in net revenue was primarily due to the impact of COVID-19. As Yung mentioned a moment ago, COVID-19 impacted our business in APAC throughout the entire quarter and the rest of our global business in the final weeks of March.

From a customer standpoint, Oke Denki and LG Uplus [ph] were the only customers that represented more than 10% of our revenue in the quarter. Combined, they were 25% of net revenue. Our top 10 customers in the first quarter represented 55% of our net revenue, which was up from 49% in the same period last year.

Looking at geographies for the first quarter of 2020, Korea accounted for 20% of net revenue. Other Asia Pacific was 31%; Europe, Middle East and Africa was 26%; North America accounted for 18%; and Latin America was 5%.

GAAP gross margin in the first quarter was 33.7%, 110 basis points better than the fourth quarter of 2019 and 10 basis points better than what we achieved in the first quarter of last year.

Adjusted gross margin, which excludes amortization and depreciation as well as stock-based compensation, was 34.7% in Q1 of 2020 compared to 33.1% in Q4 of '19 from 34.6% in the year ago period. The higher gross margin relative to both prior periods reflects geographic and product mix changes.

Turning to our expenses; GAAP operating expenses in the first quarter were down to $23.6 million compared to $30.5 million in Q4 of '19 and $25.7 million in Q1 of '19.

Adjusted operating expense, which excludes depreciation and amortization and stock-based compensation, was $22 million in the first quarter compared to $23.3 million in Q4 of '19 and $23.6 million in Q1 of 2019.

Sequential and year-over-year reduction in both GAAP and non-GAAP operating expenses was primarily due to good cost control in the quarter and the benefit of restructuring activities taken in Q4 of last year.

A decline in our first quarter revenue resulted in a negative adjusted EBITDA of $4.8 million in the quarter compared to adjusted EBITDA of $1 million in Q4 of '19 and $1.8 million in Q1 2019. Our GAAP net loss for the first quarter was $8.8 million or $0.41 per diluted share.

This compares to a GAAP net loss attributable to DZS of $10.2 million or $0.48 per diluted share in Q4 of '19 and a loss of $1.6 million or $0.10 per diluted share in the year ago period. During the quarter, we executed an agreement on a new term loan with DASAN Networks Inc., a 44% shareholder of the company.

This 2-year term loan with DNI is in the amount of KRW 22.4 billion or approximately USD 18.5 million and carries a 4.6% fixed interest rate. The proceeds were used to terminate our credit facility with PNC and Citi, which carry significantly higher interest cost of fees and to cash collateralize our outstanding undrawn loans of credit.

As a result of the new financing, we will achieve interest savings in 2020 at an annualized rate of approximately $500,000. At March 31, 2020, cash and cash equivalents were $26.4 million compared to $28.7 million at the end of Q4 2019 and $20.9 million in Q1 of '19.

A decline from the prior quarter was largely associated with the increase in restricted cash used to cash collateralize our outstanding undrawn letters of credit following the refinancing of our credit facility.

$2 million is a relatively slow cash burn rate in a COVID-19-depressed quarter and further suggest that our cost optimization efforts are having a positive effect. Our day sales outstanding at the end of Q1 were 169 days compared to 132 days in Q4 2019 and 105 days in the year ago period.

It's important for me to note that we have changed our methodology to calculate DSOs by including contract assets, which represent unbilled AR. The significant sequential increase in DSOs reflects the low revenue quarter since DSO was a backward-looking calculation. We expect this metric to improve as revenue returns to normal.

Backlog as of March 31, 2020, increased slightly to $82.6 million from $81.1 million at December 31, 2019. Moving on to our financial outlook. On our last call, we discussed the healthy backlog and good customer momentum we built up, leading into this year as well as the expected ramp of 5G in the latter half of 2020.

While our backlog remains strong, and we remain optimistic about our long-term opportunities, we do anticipate the impact of COVID-19 will continue to be felt throughout the second quarter. Based on this assumption, we are providing the following guidance.

For the second quarter of 2020, we expect net revenue of $57 million to $65 million, adjusted gross margin of 32.5% to 33.5%, adjusted operating expenses of $23 million to $24 million, and adjusted EBITDA of negative $5.5 million to negative $1 million.

As Yung discussed, our mid- to long-term business drivers remain intact, and we believe we are both strategically and competitively well positioned in the markets we address. However, due to the near-term economic uncertainty arising from the COVID-19 crisis, we're withdrawing our previously issued full year 2020 guidance.

We'll reassess our ability to provide annual guidance at the end of second quarter. With that, I'll turn the call back over to our CEO.

Yung?.

Yung Kim

Thank you, Tom. We are ready to open the call for questions.

Operator?.

Operator

[Operator Instructions] And your first question comes from the line of Christian Schwab..

Christian Schwab

Personally, on the backlog, last quarter, you talked about $80 million backlog in hand. Has there been any change to those order patterns? Any push-outs or cancellations? Or is the second half kind of withdraw of outlook really critical components, and obviously, the COVID-19 crisis and movement controls that are going on.

Is the withdrawing the guidance more about that? And that backlog number hasn't changed? Just any color around that would be great..

Yung Kim

Yes. I think one of the things -- there are two things happened is we could not take bookings or the orders in Q1. As you can see massive activities, like, for example, in Korea, that's gone down. Even though we have two Top 10 customers in Japan and Korea, but this time, we have about 51% of our revenue coming from Korea and Asia Pac.

But traditionally, it is between 60% to 65%. And that's -- so coming back to your question is, yes, we have more or less the same slightly increased backlog, but we could not put newer orders into that. So I think it remains a delivery issue that is impacted by COVID. And that moves on to Q2, Q3 and Q4 is -- certainly, we have a backlog to catch up..

Christian Schwab

Okay, great. And I know we're not giving top line guidance for the things we've already discussed.

But Tom, are we still expecting to spend $90 million to $94 million this year?.

Thomas Cancro

We retrieved guidance for a reason, and I don't want to undo that. I will say, if you look at our cost control this quarter, I think we did a reasonably good job with it. And some of these were things we started in previous quarters, and some of them were cash containment exercises we initiated in this quarter.

So I think we're on track to continue to perform on or better than planned. But I don't want to -- none of us knows what the next page is going to be in this global pandemic. So I think we're going to sit without giving guidance for second quarter for right now..

Christian Schwab

Okay, that's fine.

And then the better-than-expected gross margins in the quarter, was that due to some sort of mix change that was unanticipated?.

Thomas Cancro

Yes. I mean it's always mixed change when your gross margin changes in this business. It's a number of factors, right? North America, which is a high-margin region for us, represented a larger percent of sales, and that's just because of the way the virus played out.

So it impacted Asia for nearly the entire quarter, but only impacted that North America mostly in the last month of the quarter. So you had a higher shipment -- higher percent of sales, even though sales were down in total, they were down much less in the Americas. Looking ahead, we expect APAC to rebound from a very unusual low watermark in Q1.

That's also a high-margin region. As Yung mentioned previously, we expect Japan to become our largest target market, surpassing Korea this year in an expected ramp in 5G. So those have been the recent and expected near-term impacts to our gross margin..

Christian Schwab

Great.

And could you give us an idea of the revenue opportunity between Rakuten and SoftBank, the 5G opportunity in Japan over a multiyear basis? Is there -- have you guys have a range of potential outcomes on the top line from that?.

Yung Kim

Tom, I'll answer that. I think with the Rakuten, the ramp-up starts in Q2. And then it goes to the October. But we are already talking about the follow-on order. SoftBank 5G is ramping up in Q3. We are going through the technical integration activity at the moment. So the systems are delivered.

We're going through the integration activity, and the production will start in Q3 in numbers. And that's a multiyear contract base with the orders. So when we say orders, we don't calculate the contract. We only calculate the orders that we have received in hand. And that's why I say the second half is much bigger.

Now we can't reveal the exact size, but it's a good double-digit millions we need to deliver for Rakuten. It's a midrange of the two digits. And SoftBank is less than that, but not far off from that. So if you put two together, I think your eye will say those two opportunities will represent about 60% of the Japanese revenue this year.

And the rest comes from our relationship with the KDDI and CTC and all that. So that's the sort of color. And then also, there are other opportunities within Rakuten and also SoftBank which are not the 60% I mentioned..

Christian Schwab

Yes.

And is there any opportunities for new customer expansion here in North America now that Sprint and T-Mobile have finally been able to merge?.

Yung Kim

I think we are asking about the three proposals. And that's the stage for -- based on our activities in Rakuten. And I can't sort of reveal the customer name, but we are keeping 43 quotations of cellular front wall to Europe Tier 1 and North American Tier 1.

So it's backstage, the initial discussion and then predictory sort of the numbers are going across..

Thomas Cancro

I know some folks have trouble dialing in. So I'm going to suggest we wait a moment or two and see if anyone else can get their question across..

Operator

[Operator Instructions] At this time, I'd like to turn the call back over to Mr. Yung Kim for his closing remarks..

Yung Kim

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

Operator?.

Operator

Yes, Mr.

Kim?.

Yung Kim

Yes. Okay, so I think we're going to close. Thank you very much..

Operator

Thank you for joining us today for our presentation. You may now disconnect..

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