Good day, and thank you for standing by. Welcome to the DZS Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I'd now like to hand the conference over to your speaker today, Ted Moreau, Vice President of Investor Relations. Please go ahead..

Thank you, Shannon. Good morning and welcome to the DZS second quarter 2022 earnings conference call. Joining us today are DZS President and CEO, Charlie Vogt, and CFO, Misty Kawecki.

Yesterday after market close, we published to the Investor Relations section of the DZS website, our shareholder report for the second quarter of 2022 to provide shareholders, prospective shareholders, and analysts with market insights, product, business, and financial updates as well as forward-looking information.

On 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, 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 part that was filed on a Form 8-K, as well as being available on the Investor Relations section of our website.

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 the reconciliation to GAAP are contained in the shareholder report referenced earlier.

During the third quarter, we will be participating in investor conferences hosted by Three Part Advisors, Rosenblatt, and Jefferies, and Charlie will also be participating in a panel session at Cowen Conference next week. I now have the pleasure to turn the call over to Charlie..

Thank you, Ted, and welcome investors, analysts, and guests. As Ted shared yesterday after the market closed, we posted our second quarter shareholder report, which provides an update on our business, financial results, market trends, and 2022 outlook.

We are encouraged that demand environment has remained robust and resilient in the face of increasing economic uncertainty. Service providers are laser-focused on modernizing and upgrading their fixed and mobile networks to effectively compete lower operating cost, reduce customer churn, and increase revenue.

With the new hybrid work-from-home environment in place, service providers understand that to compete and win in the respective markets they must deliver smarter, faster, and more cost-effective broadband Internet services. They are increasingly leaning into the home as consumers design and build smart homes and intelligent Wi-Fi networks.

As such, service providers are offering more advanced technologies and intelligent software solutions than ever before. Our access and solutions enable service providers to deliver hyper fast multi-gigabit broadband services.

Our subscriber edge solutions extends the multi-gigabit broadband connectivity throughout the home and office and to the specific devices connected to the Wi-Fi network. Our Optical Edge Solutions enables service providers to cost-effectively aggregate and transport last mile and mobile traffic.

TCS's new cloud software solutions empower service providers to automate, orchestrate, and optimize their network performance and leverage advanced data analytics to improve customer satisfaction, increased revenue, and build customer loyalty. With over $120 billion of global government broadband infrastructure initiatives.

the numerous Chinese vendor replacement opportunity spanning the United States, Canada, Europe, and Pan-Asia, we remain confident that the investment cycle for our cloud solutions as well as our Access Subscriber and Optical Edge Solutions will remain strong and provide DZS with revenue and margin expansion growth prospects for the foreseeable future.

The second quarter represented our sixth consecutive quarter with orders in excess of $100 million. Q2 bookings of $123 million increased our total backlog to $293 million, an increase of 83% year-over-year, combined with $28 million of deferred software and service revenue, our total backlog and deferred revenue is now $321 million.

Our first half bookings performance of $224 million inclusive of 54 new and acquired customers and numerous new project wins highlights strong demand and momentum for our cloud software and our Access Subscriber and Optical Edge Infrastructure Solutions.

The second quarter of 2022 reflected continued supply chain challenges for semiconductors and subcomponents as manufacturing and shipping port closures in China that began in March extended well into May.

Second quarter revenue of $91 million represented an increase of 18% sequentially and 10% year-over-year and was unfavorably impacted by approximately $5 million due to unforeseen foreign exchange rate fluctuations during the quarter, spanning the Euro, Korean Won, and Japanese Yen.

Without these foreign exchange fluctuations revenue for the quarter would have been $96 million, which would have been closer to the top end of our Q2 guidance range.

Likewise, gross margin and earnings were also unfavorably impacted by foreign exchange fluctuations as well as the incremental expedited airfreight logistics cost to satisfy customer deployment schedules.

As I reflect on the past eight quarters since I joined DZS, we are pleased with the results we have delivered, 187 new customers, $903 million of new orders, numerous next-generation product innovations, and two cloud software acquisitions. In addition, we have completed our people, product and brand transformation initiatives.

The only outstanding infrastructure initiative that is still ongoing is our One DZS ERP systems project, which we expect to be completed in Q1 of 2023. In just two short years, DZS has built an enviable cloud software portfolio that complements our Access, Subscriber and Optical Edge Infrastructure Solutions.

During this time, we have been strategically focused on alignment with our marquee customers around the world and transforming our portfolio with differentiated high margin software subscription solutions.

In Q1 of 2021, we acquired RIFT, a disruptive cloud software innovator that developed a vendor neutral Tier-1 focused orchestration and software automation platform, which form the foundation of DZS Cloud.

During the second quarter of 2022, we accelerated our vision for DZS Cloud with the acquisition of ASSIA's Service Assurance and Wi-Fi management software portfolio.

The transaction which included ASSIA's award-winning express service assurance and cloud check Wi-Fi experience management software solutions provided DZS with valuable intellectual property, 31 marquee service provider customers and an elite team of cloud and artificial intelligence software engineers.

We expect pro forma annualized revenue to be approximately $25 million in gross margins to be approximately 80%. The all-cash purchase was equivalent to one times revenue.

Our newly acquired marquee customer spanning primarily North America and EMEA represent a significant cross-selling and market expansion opportunity for our Access Subscriber and Optical Edge Solutions. Shifting to our progress with Open RAN.

During the second quarter, we began shipping our market defining front-haul gateway platform to a new marquee mobile operator in Europe, aligned with Rakuten Symphony's Open RAN 5G reference architecture. Additionally, we unveiled our next-generation environmentally hardened 400-gigabit coherent optical aggregation router platform, Sabre.

Sabre redefines the Optical Edge category significantly improving deployment flexibility, application optionality in the economics of middle mile transport.

We demonstrated Sabre at the Fiber Connect 2022 Conference in Nashville in June to an audience of service providers poised to leverage the $1 billion middle mile grant program and aligned with a $10 billion capital projects funds as well as the $42 billion of broadband equity, access, and deployment program.

The highly scalable Sabre 4400 delivers multi-terabit bandwidth in a compact modular platform spanning distances of up to 100 kilometers. The environmentally hardened platform is perfectly suited for bridging the digital divide allowing deployments virtually anywhere in the network at a fraction of the cost of traditional solutions.

Sabre is an elite design for mobile edge transport applications aligned with 5G cell sites for aggregating last mile fiber deployments within the broader $17 billion mobile and Optical Edge transported addressable market. Our innovation and culture set the tone at DZS. We are thrilled with the new talent that continues to join the company.

As we look to the remainder of 2022 and into 2023, we plan to accelerate our go-to-market strategy and playbook designed to capture new customers and better position DZS with our existing customers.

In closing, despite supply chain headwinds and wide fluctuations with foreign exchange, during the second quarter DZS delivered $123 million in new orders and added 38 new customers including our newly acquired ASSIA customers.

Our $91 million in revenue was within our guidance range, though if not for the unforeseen foreign exchange fluctuations revenue would have topped $96 million.

We remain disciplined in our execution and confident in our ability to gain market share in North America and Europe, while delivering our margin expansion plans, especially as foreign exchange and today's supply chain dynamics stabilize in 2023.

With that, I'd like to turn the call over to Misty to walk through our Q2 financial highlights and our Q3 2022 outlook.

Misty?.

revenue of $380 million to $410 million; gross margin in a range from 32.5% to 34.5%; operating expenses in a range from $118 million to $122 million, and our full year EBITDA guidance is between $7 million and $17 million.

Looking to our third quarter, we are guiding revenue to a range of $100 million to $110 million, gross margins of 33% to 35%, and operating expenses of $31 million to $34 million. As a result, we expect EBITDA between $2 million and $7 million.

We anticipate our cash balance to be relatively flat sequentially at the end of the third quarter and look to improve our cash balance by Q1 of 2023 as we convert working capital to cash.

In order to provide greater transparency into the evolution of our business, we intend to break revenue out by two new product technology categories when we report Q3 results in approximately 90 days.

The first new category will be software and services, which will be an ever-increasing portion of our revenue mix as software grows in importance to our business. In the second quarter of 2022, this category represented approximately 9% of total revenue.

The second category will be the Access Networking, which will consist of our historic broadband connectivity and mobile transport product areas. We feel this breakout will provide a more useful reflection of our business in directional strategy going forward.

That completes our prepared remarks, I'd now like to hand the call over to the operator to facilitate the Q&A session..

Thank you. [Operator Instructions] Our first question comes from Paul Essi with William K. Woodruff. Your line is now open..

Thank you for taking my call. It looks like you guys hit your numbers if you exclude China, the expediting charges and the currency, can you maybe, Charlie, talk a little bit about how this is going to affect the third and fourth quarters and also maybe your assessment overall in the supply chain going forward? And then I have another question..

Yeah. I mean, it's hard for us to be disappointed when the team certainly executed to the top end of the revenue guidance that we provided as you pointed out, $96 million would have been our second best revenue quarter ever, so it's frustrating with the foreign exchange that hit us.

I mean, if you look at just what happened within Q2, the Yen was up 12%, the Won was up 6%, the Euro was up 6%, and so with this much exposure that we have to Asia and Europe, we certainly we're dealing with some things that obviously as we were going into Q2 didn't see and certainly didn't see.

As it relates to the second half of the year, we've been working very closely with our global banking partner JPMorgan and looking at what the anticipated foreign exchange fluctuations are likely to be in the second half and the outlook that Misty had provided, and she can comment on it, incorporates what JP Morgan and other key banking partners have provided us with.

So, the outlook that we have assumes that foreign exchange doesn't change much in the second half of the year. What we are hearing from our banking partners is, as we exit this year and enter 2023, that we believe that foreign exchange will return to normal levels, which will certainly be beneficial for the company.

Misty, I don't know if you want to comment on any of that..

Yeah. As it relates to foreign currency, we certainly had to project a bit of what we expect given some of the significant variances that occurred in the second quarter of 2022 and so we took some of those forecast views and incorporated that into the second half to have a better view of how we will perform in the second half..

I think the other thing that's important to appreciate from a margin perspective is, if you look at the $321 million of total backlog and deferred, more than 50% of that is North America and Europe, and so as we unlock more and more of our backlog into North America and Europe, the margin profiles we expect to be much better..

Okay. Thank you. My second question, maybe a little bit shifting gears, I noticed that you have contract liabilities now on your balance sheet and about three quarters of them are current, and I assume these are from the ASSIA acquisition.

This would imply that good portion, maybe three quarters a year, contracts have been renewed each year, which provides a nice opportunity to increase revenues.

Two questions, first, can you give us a little color on maybe what your game plan is in the next 12 months or so? And secondly, how do you expect it to take to fully integrate the ASSIA into your cloud offering and that where you have a good value, where you can get a bit more aggressive on the pricing, and will this be done in phases or all at once?.

Yeah. I mean, the Express and CloudJack software portfolios are already fully integrated into DZS Clouds, so there is really no gap in the integration because it really filled a void.

If you think about where we were prior to the ASSIA transaction, RIFT was really all about network orchestration for mobile which over the last year, we've tilted that to be able to provide fixed access orchestration, which we think is a game-changing software platform somewhat -- something that nobody is doing in this space.

And what ASSIA gave us was really the service assurance and network aware software attributes from the OLT to the ONT to where fiber and DSL is terminated at the house, and then the Wi-Fi experience management software is really all about software management inside the home in the Wi-Fi part of the network.

So, all of that is net new and that's all been fully integrated. The employees have been fully integrated, even the systems have been fully integrated into the way DZS is managing that business.

You said something that's pretty important and it was obviously something that was really important to us as we were assessing the transaction through due diligence.

It's just the timing of when some of these contracts renew and we certainly have an opportunity as some of these contracts renew in 2023 to provide more value, which we expect that will translate into an overall better ARPU for customers and better margin and revenue profile for us..

Well, thank you. I'll pass it on..

Thank you. Our next question comes from Dave Kang with B. Riley. Your line is now open..

Yes. Good morning.

Just wondering how big is India right now and how big can it get next year, I'm hearing some major upgrades coming over the next couple of years?.

Well, as I think, you all are aware, we did announce, I think two quarters ago that we were awarded at least Phase 1 of a pretty significant Tier 1 in India.

We see that opportunity expanding for us and there is obviously different parts of the network that we participate in, from the Optical Transport side to the OLT to the ONT to the in-home Wi-Fi and Phase 1 of that was with the ONTs, the second Phase of that is OLTs, which comes with a much higher profile and margin profile.

So, we certainly are being really thoughtful about the opportunity in India. I mean, it clearly is a country that has opened up for companies like DZS to be able to participate in their aggressive capital replacement of China -- the former China vendors in that particular region.

I think it's important also for investors and shareholders to appreciate we are being thoughtful about it, we're not rushing into India to go chase low-margin deals, but there are different bookends that come with different margin profiles, obviously, the ONTs are much lower margin profile and to be able to complement that with the OLTs in the software attributed to the OLTs is what is in Phase 2.

So, Phase 1 for us was the ONTs, Phase 2 is the OLTs in middle mile transport and that's something that we expect that we will book in the second half of this year and begin shipping in early 2023..

Got it.

My next question is, your APAC was fairly strong, but your mobile transport continues to be weak, I thought significant portion of that was mobile, so can you kind of go over that and what will get the mobile transport get going in second half and beyond?.

Well, in my comments, I did share with you that we did -- we did win a large mobile operator in Europe in Q2. We will begin shipping on that project, which is a high-margin project in Q3 and Q4.

We did see -- SoftBank drove a lot of our revenue over the last, let's call it five, six, seven years, and in the first half of this year, they're going through a reevaluation of their next-generation PON-based mobile transport platform that we're working on with them and so the pause that I think you're seeing in some of the mobile transport revenue has to do with where SoftBank is in sort of their Phase 4 of their 5G Mobile Transport Architecture with DZS, something that we anticipate we will contract on in the second half of this year and begin to ship the next phase of that which is a multi-year phase starting in ‘23..

Got it.

And my last question is regarding U.S., various government funds such as RDOF have they been released yet?.

Yeah, sure. I mean, we've got a lot of customers that are participating, I mean, I think what we've been articulating and I think it's fair to assess with our three peers in North America. I think for the most part, outside of what we would refer to as sort of new entrants into the traditional regional ILECs.

Most of those funds are flowing to service providers and through to the equipment supplier partners that they have historically been using.

Where we've been seeing a lot of excitement frankly is a lot of the new fiber overbuilders and some of the utility co-ops, who are entering into the market that gives DZS frankly an opportunity to participate where we weren't historically incumbent..

Got it, actually one -- one more question, because I get this question a lot, is that how solid is your backlog, maybe can you go over like your contract policies, how much can be cancellable after so many months?.

Well, ironically, we were just talking about this before the call and I think it speaks volumes of the technology and the relationship and the dependency on our technology, I mean in the two years I've been here, we haven't had a D Book, so when we look at the historical backlog over the last two years and including the $293 million, which would have been $298 million if not for some of the foreign exchange impacts, we haven't seen any D books, and so, look, I mean, customers can do whatever they want, I mean, independent of contracts.

I mean, I don't know, in 30 years I've been here, Dave, that I've ever pulled out of contract and fought with a customer on it.

We're trying to do the right thing for customers, but I think customers have been very supportive and they've been very patient with the extended and any long-dated lead times and we've been very fortunate that we've not seen any customers derail from the committed orders that they have..

I think to add to that, Dave, I think Paul mentioned it earlier, but on the contract liabilities, which we have most commonly referred to as deferred revenue, those are projects that have -- we've build, but we haven't recognized the revenue, for example, a maintenance contract, right, and that can vary in terms from one month to three years, and so deferred revenues are already build and solid backlog if you want..

Thank you..

Thank you. Our next question comes from Tore Svanberg with Stifel. Your line is open..

Yes. Thank you, and congratulations on the continuous transformation here and certainly the record backlog.

It sounds like you have a handle on the ForEx now, but I was just wondering on the backlog conversion, Charlie, how is that trending, especially in light of the component shortages and things like that, is that really starting to ease and you're starting to see that backlog conversion now moving in the right direction?.

Yeah, I mean one of the things, I mean, we certainly are trying to align with this sort of first-in-first-out mindset. I mean, we are trying to do everything we possibly can to meet customer deployment schedules and so we're trying to adhere to the best we can to this sort of first-in-first-out from a backlog perspective.

And we're in August of 2022 and sometimes we forget that there were significant price increases that all of the equipment suppliers in this industry incurred starting in the second half of last year.

So, we're trying to aggressively flush out a lot of the backlog that was impacted by the price increases, but not yet favorably impacted by price increases that we pass along to customers and so some of that you're seeing in what we delivered in Q2, I think you'll see some of it in Q3, but as we've been sort of articulating this whole year, we had sort of expected that by the end of Q3 most all of the backlog that was attributed to the higher price and not attributed to price increases passed along to our customers will have flushed out.

So, we look at some low-margin projects that we have on the books that will flush out in Q3 and a little bit left in Q4, and then most everything is frankly based on new pricing and the current cost structure that we have, I mean with the only real variable being the foreign exchange fluctuations, which let's hope that that stabilizes and we're seeing less and less, I mean there was, the other thing that's important to appreciate is, the way expedite fees work, I mean, at least with DZS and I speak to a lot of my peers.

The way the expedite charges were implemented is, if you agreed to and expedite six months ago for something that you were pulling in to this quarter, you were paying for it and it was on the books six months ago as a reserve, but you are paying for it six months ago, so it wasn't like you get an expedite, you agree to an expedite today, it's going to ship in six months and that cash in that and that expense follows it, you're paying for it now and the impact from a margin perspective happens when it ships.

So, there's some of that is lingering from, we saw some of it Q1, we saw some of it Q2, we'll see some of it in Q3, but I will tell you that we are seeing much more cooperative ecosystem of subcomponent and semiconductors and years covering that space, so you know it probably better than anyone on the call, that we are seeing a bit of a shift as consumers and a lot of consumer electronics technologies sort of pumps the brakes and lot of the -- those wafers and chips are finding their way to ease into our space.

I'm hoping that the second half of this year we're seeing a lot less need for expedite fees, and also remember, we've got an aggressive plan to exit China.

We're still incurring some tariffs with some of the existing backlog into the U.S., which we expect a lot of that will go away in 2023 just based on some of the consolidation decisions that we're making on the CM side.

So, there is a lot of multifaceted margin enhancement elements that will attribute to a much different business profile in ‘23 as we flush out some of the old backlog as we move out of China and not incur some of the tariffs and we certainly hopefully are seeing a more stabilized FX and less expedite charges that we're incurring in ‘22..

That's great perspective, thank you.

And my next question is, and by the way I really appreciate you're going to start sort of reporting revenues by software versus product and related to that, I assume that the sort of mix trajection of software and the move towards 40% gross margin that -- all of that is still on track, it's just -- basically just been delayed by a couple of quarters because of the ForEx issue?.

That's exactly right. That's exactly right..

And Tore, when you look at our normalized, right, if you added back the 750 basis points, right, you get to this quarter around 35% on a year-to-date basis we're around 36%, if you again add our ASSIA contribution to that of 250 to 350 basis points, so we are getting really close to the 40%..

Very good.

And then just one last question on inventory, should we assume that the inventory will be back to sort of the normalized range by Q1 of 2023, is that the target?.

Well, as we define a new normal and we're growing our business, we will get back to normalized ranges for a stronger built bigger company..

Okay, perfect. Great answers. Thank you..

Thank you. Our next question comes from Christian Schwab with Craig-Hallum. Your line is now open..

Hey, guys, just, unfortunately just unprecedented currency swings on such a short timeframe that everyone is facing, but, Charlie, your aggregate topline growth rate for the company either on a go-forward basis, that hasn't changed, has it?.

It has, and in fact, the guidance that we provided for the year really was just hair-cutted by the foreign exchange impacts that we anticipate for taking into consideration Q2 and the rest of the year.

So, if you back out the foreign exchange fluctuations, we didn't change our guidance for the year, all we did was incorporate what we believe to be the impacts of foreign exchange in the second half, obviously, if that changes and it becomes favorable then our ability to deliver on the higher end of the range is still there, I mean, we've got a range of $110 million in Q3, and we continue to struggle because the majority of our backlog is still with customer request ship dates of as soon as possible.

So, I think if we can continue to unlock some of the backlog and access to subcomponents, we certainly have an opportunity to exceed that, and we need to do that first and foremost to just satisfy customer requirements and customer deployment schedules, so that's been our number one priority and I hope you guys appreciate that, where we're being thoughtful and spending money and expedites, which is a frustrating situation for all of us we're doing because we want to make sure that we're doing everything we can to keep customers happy..

Great.

And then just on the commentary on inventory and increased raw materials and working capital, can you tell us why you would be putting on raw materials on your own balance sheet instead of your contract manufacturing partners securing that for you?.

Yeah. So, one of the things that is -- this is -- nobody has asked me this question quite the way you did, I'm glad you asked it. Remember, that when I got here two years ago, we didn't have one, but we had two manufacturing facilities, so we had one in Hanover, Germany, and we still have one in Tampa, Florida.

So, we're building -- today we're vertically integrated with a portion of our business, where we're manufacturing in Tampa.

In Korea, we still buy and manage a lot of the semiconductors and so the philosophy that the company had before I got here was to do everything we could to manage the cost and manage the accessibility of those chips and then provide those chips to the downstream CMs to build the product.

Now I will tell you that we have a very aggressive plan as we exit this year and into 2023 to consolidate our CMs, one to be more meaningful with them, obviously, the lower our cost and to free up a ton of cash, and so there is a great opportunity and significant upside for us we believe in 2023 as we execute our CM consolidation strategy that I'm not prepared to give you the details on today for obvious reasons, but I will share more details as we get closer to our final execution on that, which we believe has upside that's not baked into the outlook that we're providing today..

Yeah. I would think that that would be very wise, leading contract manufacturers have hundreds if not thousands of people working on supply chain..

We're not -- we're not a manufacturing company, we are a technology company and as we ship more and more of our emphasis towards software, obviously, software needs to reside on infrastructure, and so we're going to be on the -- in the Access Infrastructure business for a very, very long time, but as we -- as we're able to participate more in the intelligence side of the way these networks are being built, managed, and orchestrated, there's a great opportunity there, but we don't want to be in the manufacturing business long term to your point, there is large multi-billion dollar companies that should be doing that, and that means that they'll be buying, inventorying, and managing the cash differently and that to me frees up a lot of working capital for us in 2023 and it certainly we believe will help our margins as well..

Perfect. And then just one quick follow-up question on supply chain and expedited fees.

The majority of all the networking chip companies have sent letters out, I don't know if you've received one, talking about price increases that are going to begin to happen this fall and we'll certainly start on January 1, is that kind of incorporated, I assume into your outlook, and do you believe there will be an opportunity to pass those costs on again with price increases at some point to take effect in 2023?.

Yeah. So the answer is, we like everyone else have been sort of communicated that there is an anticipated price increase coming.

I would tell you, we haven't accepted that and we certainly are in dialog with the key downstream semiconductor companies who are speaking to those price increases, but yes, I mean we have baked in our margin profile for the second half. There is nothing that is taken a hold in the second half, right now.

They're communicating, they're telegraphing that the prices would be effective January 1, assuming that they take hold, but the answer is yes. I mean, we're certainly taking the price increases under consideration.

I think we've done a really good job of partnering with our end user customers on the necessary price increases, but it becomes a very delicate process and it's something that I'm not prepared to talk about in granular detail, but I will acknowledge that we did receive communication that there is potential price increases that are at least desired to be increased in January of ‘23..

Great, thanks guys. No other questions..

Thank you. Our next question comes from Tim Savageaux with Northland Capital Markets. Your line is now open..

Hi. Good morning. Couple of questions on the demand side, and while you're seeing these FX headwinds even on an organic basis, looks like you're looking for a pretty good ramp in the second half from a revenue standpoint.

I wonder if you could and I think you mentioned the backlog being significantly or at least reasonably biased towards Europe and North America, but as you look at that ramp in the second half, are there any kind of particular drivers that stand out, I assume you have good visibility based on backlog either in North America or Europe, and as you contemplate that, I guess there's been a lot going on with one of your Tier 2 customers, consolidated communications sector, being pretty aggressive in terms of fiber and we're going to get more so, is that -- can something like that move the needle for you guys as you think about your business in North America?.

Yeah. So, we don't talk about it enough, but your points are very fair, Tim, 75% of our business is with 20 of the top 30 telecommunication service providers around the world.

So, we continue to drive a lot of new business and certainly much of our backlog is tied to a lot of large, what we would refer to as Tier 1 and Tier 2s, consolidated at two million subscribers, excuse me, is sort of tiering on that Tier 3, Tier 2, but they are meaningful. I mean, they are very significant customers for us.

They're very, I think, they are one of the best customers that we have just from a technology partnership perspective. They've been very loyal to our entire portfolio and they also represent today a significant amount of our backlog that we intend to unlock in the second half of the year, so I think your comments are spot on..

Okay.

Then maybe shifting back to that Tier 1 area of focus, I think you mentioned a win with a large European mobile operator, but I wonder if you could step back and review and I think you made reference to this in your letter that the pipeline of opportunities that you're seeing develop whether they are fixed or mobile while a replacement and whether we can count that win that you mentioned is one of those and what the go-forward pipeline looks like for you guys?.

Yeah, I would say that the, I mean we've got a very strong loyal run rate business in Korea and Japan. Pan-Asia, which has been a very exciting new market for us. We've been investing in that particular region.

It's a region that I think, Dave, mentioned India, but if you think about even Vietnam and Taiwan and Singapore and Australia, there is a lot of countries there that are aggressively capping and moving away from some of the Chinese suppliers and we've got a large base there, we've got close to 100 engineers in Vietnam and Hanoi, and so it's certainly giving us an opportunity to participate in expanding our sort of two pillars in Korea and Japan and that Pan-Asia market, but where I would tell you the most exciting future opportunity for us is the pipeline that we have in North America and Europe.

It's by far the most trial activity, I mean, we've moved from sort of that proposal Phase to the proof of value to physical trials and as we close out on the future gaps and closing out on those trials, you're moving into that contract and then order and eventually deployment phase.

So, I'm cautiously optimistic that some of that activity will close in the second half of this year and convert into revenue opportunity for us in 2023. It certainly has been a lot of our focus. And if you look at the ASSIA customers, they're all Tier 1s that came over.

I mean all -- I mean, virtually all of the 30 marquee operators that we talk about for the most part are Tier 1 operators and they've given us a great opportunity to really invoke a cross-sell opportunity.

I mean, if you think about the Express product that sits between the OLT and the ONT and the CloudCheck that sits inside the home, I mean, it's very complementary to our OLTs to our ONTs, and our Wi-Fi products and we're in deep discussions already with a lot of those customers as to how we might be able to help them better manage their network and be able to participate in some of those broadband network projects that maybe historically we hadn't been involved in..

Great. And last question for me.

Going back to the kind of fixed versus mobile broadband and I certainly understand the drivers for the pause and mobile side, what I wanted more color on was, obviously, you are strong in Asia, so what's kind of filling the gap there? I'm guessing that might be more fixed fiber, the home business in Korea and elsewhere, but any more color on that would be appreciated.

Thanks..

Yeah. It's all fixed broadband that's filling the gap right now. I mean, obviously, Japan and SoftBank has historically been a 10% customer, Rakuten, Mobile, their core network in Japan has historically been a 10% customer.

With Rakuten Symphony being very successful out in the market deploying their IP and Software into a lot of these third-party service provider networks we are today, their exclusive front-haul gateway reference platform and as they have success, we're seeing success, and one of the new mobile operators in Europe, which I had mentioned, which is pretty significant, will be utilizing our front-haul gateway for their next-generation 5G rollout with Rakuten Symphony Software.

So, we're seeing a pipeline mature there. We're excited about the evolution of the 5G and eventually 6G network with SoftBank, and I think we're in a very good position to participate in that as that rolls out in ‘23. And with our new optical transport platform, Sabre, that we rolled out, we think that's a huge opportunity for the company.

We're filling a pretty huge void. At The Investor Day, we sort of did a soft launch and shared some of the details at the Nashville Fiber Connect Show, we actually demonstrated it.

We had a lot of interest in that product and with the middle mile Optical Transport funds that are now being deployed, we see that as something that could provide some upside with decent margins into 2023 as well.

So, we're still very optimistic and are very aggressive on what we're doing on the mobile side, it's just for us we need Open RAN to continue to take hold and we are seeing Open RAN gain a lot of momentum around the world, it is new, and for our analyst partners and for shareholders, who are looking at DZS, I think everyone has to just appreciate the timeline around Open RAN and as that mobile network becomes much more open, it allows for us to participate differently than historically where you've got closed mobile networks, but we are seeing a lot of activity.

There is a lot of trials going on right now, it's just -- it's just going to take some time to unlock a lot of that..

Okay. Thanks very much..

Thanks, Tim..

Thank you. Our next question comes from Ryan Koontz with Needham and Company. Your line is open..

Right. Thanks for the question. Most of mine have been answered, but I wanted to, see if I could ask about the gross margin outlook and the supply chain impacts there in a different way. What's changed in the last 60 days since you guided there, it sounds like several hundred basis points hit kind of for the rest of the year there.

Is most of this freight that was already in inventory or is it new cost increases or maybe you're seeing more of a revenue mix shift toward APAC as you saw in the quarter? Thanks..

So, Ryan, great question. So on the supply chain side, we've certainly seen some of the new cost increases come through, right, as we've moved through the year, what we're seeing are new cost increases more recently..

And you got the FX piece that was....

Right..

The most significant piece, Ryan.

I mean, as I sort of was saying earlier, I mean, just in Q2 alone, you have the Yen, it was -- it was weakened 12%, the Won that was weakened 6%, the Euro weakened, and that was more than 50% of our revenue in Q2, and so the regional mix associated with those currencies was a surprise, obviously, we didn't see that coming into Q2..

Okay. Right.

So the strength in APAC on fixed in APAC that we saw in 2Q that you don't expect that to necessarily continue into the second half and be much of a headwind to margins?.

Well, we factored in what we have been educated by JPMorgan and other banks, based on what they anticipate the foreign currency to fluctuate within Q3 and Q4, so we've done the best we can to hedge and to incorporate their outlook for what we had in backlog and what we expect to ship in Q3 and Q4 to the best that we can..

Okay. Thanks, Charlie. Thanks, Misty..

Thanks, Ryan..

Thank you. And I'm currently showing no further questions at this time. This does conclude today's conference call. Thank you for participating. You may now disconnect..