DZS Inc. (NASDAQ:DZSI) Q3 2024 Earnings Call Transcript

DZS Inc. (NASDAQ:DZSI) Q3 2024 Earnings Call Transcript November 6, 2024

Operator: Good day, ladies and gentlemen. Thank you for standing by. My name is John, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the DZS Third Quarter 2024 Financial Results Conference Call. [Operator Instructions]. I would now like to turn the call over to Mr. Geoff Burke, SVP, Marketing and Investor Relations. Please go ahead.

Geoff Burke : Thank you, John, and welcome to the DZS conference call to discuss Q3 2024 financial results. Joining me today are DZS President and CEO, Charlie Vogt; and Interim CFO, Brian Chesnut. During our call, we will provide projections and other forward-looking statements based on our current expectations regarding future events or future financial performance of the company. Such statements are subject to risks and uncertainties, 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 DZS’ Wednesday, November 6 press release. These documents identify important risk factors, which can 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 to you on this call include those determined on a non-GAAP basis. These metrics, together with corresponding GAAP numbers and a reconciliation GAAP were contained in the press release issued on Wednesday, November 6 which we have posted to 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 and some of this information is included in the press release. I will now turn the call over to Charlie.

Charles Vogt: Thank you, Geoff. It was a long night for Americans. So good morning, and thank you for joining. We are pleased to report that our third quarter financial results delivered $38.1 million in revenue, representing an increase of 23% quarter-over-quarter. Our non-GAAP adjusted gross margin was 36.7%, representing an increase of 6.5% quarter-over-quarter. Our operating expense increased during the quarter primarily due to the incremental costs associated with our NetComm acquisition and our final restatement-related costs. Our adjusted EBITDA was unfavorable by $2 million compared to Q2 2024 due to our inability to convert backlog shipments by quarter end, revenue recognition timing and various cost savings initiatives that are planned and committed though not realized during the quarter.

Despite a challenging market environment across the broader industry, resulting from an over rotation of inventory, higher cost of capital and delays with numerous government stimulus programs, we have delivered sequential revenue growth on a continuing operating basis over the last 4 quarters. With our restatement behind us, our filings current, the sale of our network assurance and in-home WiFi management portfolio closed and optimism with a growing sales pipeline and robust backlog, we believe our best days are ahead of us. We chose to divest our network assurance and in-home WiFi management portfolio for 3 reasons: the first was to create software independence and reduce the competitive friction we were experiencing with our WiFi connectivity and WiFi software management peers.

The second was to improve our balance sheet, which we accomplished by securing $34 million in an all-cash transaction. And third, was to recalibrate our technology and go-to-market focus centered on our core broadband access and connectivity systems and Cloud Edge software solutions. The third quarter — during the third quarter, we made meaningful progress across several tactical and strategic initiatives. As we enter the fourth quarter, we established 4 key performance initiatives that will anchor us in and into 2025. Our first KPI is centered around growth, profitability and improving our balance sheet. The recent $34 million sale of our network assurance and WiFi management portfolio reduced our debt by $50 million and added $15 million of cash to our balance sheet.

The strategic divestiture combined with Q3 shipments, inclusive of paid inventory have improved our balance sheet as of the end of October. Based on a growing sales pipeline, scheduled backlog and interaction with customers and channel partners, we anticipate Q4 revenue and profitability to improve compared to Q3 2024. As we look ahead to 2025, we anticipate service providers will return to pre-COVID spend levels and normalized deployment patterns. We also anticipate the various government stimulus programs around the world, including the United States broadband equity access and deployment program will begin to accelerate funding during the second half of 2025. Our second KPI is focused on completing our cost savings initiatives, including the cost synergies associated with our recent acquisition of NetComm.

These cost savings initiatives began in the first half of 2024, and we expect the total savings to be completed by year-end 2024 and reflected in Q1 2025. Our cost optimization programs are inclusive of the divestiture of our former Asia business unit as well as the divestiture of our network assurance and in-home WiFi management portfolio. Our third KPI is executing the sales synergies resulting from the acquisition of NetComm, which adds market-leading fiber extension, home broadband and fixed wireless access technology to our market-leading broadband access and connectivity portfolio. We are encouraged with the growing sales pipeline and the revenue conversion and backlog created in just 120 days since acquiring NetComm. During the past 4 months, we have begun to validate the cross-selling synergies for our existing customers and likewise, the prospective synergies with our core broadband portfolio with the former NetComm customers established as part of our acquisition thesis.

Our fourth KPI is focused on monetizing $79 million of inventory, which is aligned with our sales pipeline, scheduled backlog and projects in flight. While progress was made in Q3 relative to sales and shipments of paid inventory, a revitalized and growing sales pipeline and improved visibility with our scheduled backlog gives us better line of sight to inventory conversion to cash over the next 4 to 5 quarters. Our vision and strategy established over the past several years has been centered around the introduction of open standards-based next-generation broadband access and network systems and cloud orchestration and software automation solutions aligned with the large-scale incumbent service providers and emerging fiber overbuilders as well as utility providers.

Announced a few weeks ago, our broadband access portfolio was formally certified as Build America, Buy America compliant aligned with the $42 billion broadband equity access and deployment program. While the USB program has been front and center in the United States and has garnered much of the excitement across our industry, other countries such as Germany aim to make available billions of euros for the incumbent broadband service providers, emerging alternative fiber providers, utility operators as well as other types of ISPs. We expect that the decisions and investments that we’ve made over the past few years, which includes more than $100 million of invested technology will result in the continued growth and ultimately sustained profitability and positive cash flow.

As many of you are aware, we appointed Brian Chesnut as our Interim CFO in September following 5 months as Chief Accounting Officer, leading and managing the final phase of our restatement process. Prior to DZS, Brian was the Vice President and Corporate Controller; of Continental Battery Systems, a $1 billion U.S. distribution company, where he oversaw global accounting operations across the United States and Canada. Additionally, Brian held senior finance management positions at Jacobs Engineering and OneMain Financial and he began his career at PricewaterhouseCoopers. Brian, I want to thank you for the comprehensive and diligent work you and the team accomplished over the past 7 months. The results have improved our internal controls, corporate governance and overall close process.

With that as a brief introduction, I’ll now turn the call over to you to share more on our financial results.

Brian Chesnut: Thank you, Charlie, and good morning, everyone. As Charlie mentioned, I’ve been with DZS for 7 months with the first 5 months focused on completing our restatement. I appreciate the opportunity to lead finance as the interim CFO as we look forward, focused on sustainable growth and profitability. Over the past year, the company has made improvements across the business, including internal controls, corporate governance, cyber security, supply chain management and quote to cash. While we delivered favorable revenue and gross margin growth during the third quarter, our expectations and work streams underway are designed to deliver better overall results in Q4 and across 2025. The leadership team is focused on balancing and encouraging sales pipeline with profitable growth and free cash flow.

Revenue from continuing operations during the third quarter was $38.1 million compared to $31.1 million in the second quarter, an increase of 23% quarter-over-quarter and an increase of 67.8% year-over-year. Adjusted gross margin from continuing operations for the third quarter was 36.7% compared to 34.5% in Q2 and 17.4% compared to the same period a year ago. Adjusted operating expenses increased incrementally by $1.9 million or 8.9% during the third quarter compared to the same period in 2023, primarily driven by the additional operational costs associated with our NetComm acquisition. Year-over-year and on a continuing operations basis, adjusted operating expenses decreased by $12 million or 17.2% from $69.8 million in the first 9 months of 2023 to $57.8 million in the first 9 months of 2024 as various operational cost reduction initiatives taken by management through 2024 have been implemented.

Adjusted EBITDA for the third quarter was a loss of $9.3 million compared to a loss of $17.5 million in Q3 2023, an improvement of $8.2 million or 46.8%. While our balance sheet ended the quarter with $5.7 million of cash and cash equivalents, our in-home WiFi management network assurance divestiture closed on October 25, generating $30 million of cash, which reduced our debt by $15 million and increased our cash balance by $15 million. During the quarter, our DSO significantly improved from 120 days to 83 days as a result of favorable collections. Our DPO at 242 days continued to lag during the third quarter though with the combination of our network assurance and in-home WiFi management sale plus favorable sales during the third quarter, we expect to improve our DPO during the fourth quarter and into the first quarter of 2025.

At the end of the third quarter, inventory was valued at $79 million, working capital was $24 million and quarterly interest expense was $2.2 million, which includes interest and debt discount amortization. With the SEC restatement behind us and our public filings current, we are turning the page to more favorable outcomes. We are lowering our working capital by executing our scheduled backlog, converting inventory to cash, and micro managing our operating expenses. Current KPIs and work streams underway, we expect to achieve breakeven on an adjusted EBITDA basis and positive cash results in 2025. Our acquisition of NetComm has resulted in accretive results to date. The acquisition enhanced our broadband connectivity portfolio with market-leading fiber extension, home broadband and fixed wireless access solutions as well as 8 marquee service providers spend in the United States, Europe and Australia.

As we enter the fourth quarter and as we prepare for 2025, Charlie highlighted our 4 key performance indicators, which are focused on growth, profitability, balance sheet improvements, cost savings and business optimization and synergies from our NetComm acquisition and converting the $79 million of inventory to cash. With that, I’ll hand the call back to Charlie for his final comments.

Charles Vogt: As we look ahead to the immediate and medium-term future, many of our projects in flight and active technology trials are expected to convert to design wins into revenue in 2025. Our interactions with customers, prospective customers and channel partners indicate an improvement across the overall sector is underway and a resounding commitment to fiber and fixed wireless deployments over the coming years. We also expect excess inventory caused by abnormal lead times among service providers and distributors to continue to normalize over the course of 2025. With an encouraging sales pipeline, $90 million of backlog, $79 million of inventory and with annual operating expenses lower by more than $20 million, we anticipate our financial performance will improve in Q4 and throughout 2025.

We also expect favorable sales synergies from the NetComm acquisition, and we remain focused on converting technology trials to design wins and inventory into cash. In closing, I want to thank our employees and Board of Directors who continue to relentlessly and effectively support the company. Furthermore, I want to thank our loyal and committed customers who continue to benefit from our technology differentiation in our customer-first culture. Finally, I want to thank our technology, manufacturing and broader supplier ecosystem who remained aligned and committed to our next chapter together. Looking ahead, we plan to share our Q4 business and financial results in early March. Until then, thank you for your time and attention today. I’ll now turn the call back to you, operator, assuming there’s any questions for Brian and I.

Thank you.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Ryan Koontz with Needham.

Ryan Koontz: Great. A couple of questions for you, Charlie. What’s your current visibility look like into the first half of ’25 in the U.S. market? Are you seeing any signs in the kind of frozen climate we’ve had in the last year plus?

Charles Vogt: Yes. I mean we just finished our preliminary 2025 AOP last week, which really encompasses 3 buckets. The first is just our scheduled backlog for next year. The second is our pipeline in the way we slice and dice our pipeline. And then it’s just the overall synergies from the NetComm acquisition, which are actually validating, I think a lot of the thesis that we had going into it. There’s a lot of synergies that we’re beginning to validate. So that, coupled with the fact that the company has certainly been under a cloud due to the restatement over the last year. And I think if you lift all of that, and you see that at least we’re seeing that a lot of our customers are working through a lot of excess inventory that they took on in 2023 and certainly this year.

And so we’re cautiously optimistic about the first half of next year. And so — and that’s primarily built on the U.S. market, Europe and Middle East. I mean, obviously, with NetComm, we do bring on a new region in Australia and New Zealand, which will begin to be a reporting region in 2025, but those are the 3 core markets that we’re seeing more visibility, certainly.

Ryan Koontz: Okay. And then kind of double-clicking on the European opportunities in Middle East. Any particular large opportunities that you’re competing for? You point out you don’t have to list customer names, but can you maybe characterize some of the larger opportunities, international.

Charles Vogt: Well, as I think most people who’ve been following the company know we’re doing business today with the 3 incumbent operators in the Middle East. And in Europe, we did announce a large design win last year that we expect that to begin deployments in the first half of 2025. So we’ve worked hard on that. And that will certainly generate, we believe, significant revenue for us in ’25 and over the next 5 to 7 years. Across markets like France and Spain, we’re certainly very involved with the 2 large incumbents there, and there are certainly projects that we’re hoping that will evolve in 2025. And so as I know you know and others that are following us, we’ve been very, very focused on the larger scale service providers since I joined 4 years ago.

That’s where a lot of our innovation efforts and sales and marketing efforts have gone into. And while last year, I think, was challenging for the whole industry, I think we’ve quietly made some progress on a lot of these trials, and we’re expecting those design wins to convert into revenue next year.

Ryan Koontz: Great. And 1 last one. What’s your competitive landscape look like in fixed wireless for the NetComm products? Is that going up against the big historical incumbents, the Nokia, Ericssons and Samsungs or is it more the smaller wispy types like the Taranas and Cambiums and the like?

Charles Vogt: Yes, not so much with Cambium. I think from Cambium’s perspective, is probably more complementary aspects because I think they’re more focused on the unlicensed spectrum. Our fixed wireless portfolio is more focused on the license spectrum. So to your point, Tarana is certainly emerging. They have a proprietary platform from the core to the home, and we’re certainly seeing them emerge into the market. I think it’s just a different proprietary and cost structure that they have that, I think, the larger Tier 1s, which even in that market, we’re focused on is a bit more challenging. So to answer your question, with our fixed wireless portfolio, we’re seeing more of the traditional Nokias as our competitive peers than anyone else.

Ryan Koontz: Got it. And on the gross margin front, any commentary there in terms of how you feel about that trajectory going forward?

Charles Vogt: Well, I mean, look, it wasn’t in the commentary, margins would have been in the 40s. We did take some inventory reserves during the quarter. So our margin profile was actually close to 650 basis points higher had we had not chosen to take some inventory reserves in the quarter. So I’d say that our margins are actually returning to where we expected them to be. And as I know you know and your peers know when you look at our core broadband access portfolio, which represents our optical transport and OLTs compared to our connectivity products, which now includes a much broader portfolio from NetComm, which has lower margins. . The timing of when the deployments are in this fiber cycle and fixed wireless cycle from quarter-to-quarter has a lot to do with the mix and the margin profile from quarter-to-quarter.

So we’re obviously hoping that we can get to a more balanced and blended margin profile as we go forward. But as we divested Asia, which certainly was much more challenged from a margin perspective. We think there’s a path to sustaining margins even without the former ASSIA software business to get us close to 40%. So that’s our goal. And I think we’re proving that out at least this year.

Operator: [Operator Instructions] There are no further questions at this time, that concludes the Q&A session and today’s conference call. Thank you, everyone, for participating. Have a pleasant day.