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spk01: Ladies and gentlemen, thank you for standing by, and welcome to the DCS Third Quarter 2020 Earnings Conference Call. At this time, all participant lines are in listen-only mode, so if you require operator assistance, please press star, then zero. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star, then one. Please be advised that today's conference may be recorded. I'd now like to hand the conference over to your host today, Mr. Ted Moreau, Vice President, Investor Relations. Please go ahead.
spk04: Thank you, Liz. Welcome to DZS's third quarter 2020 earnings conference call. Before beginning, I would like to comment it has been fun working with the management team since I joined DZS two months ago. This is an exciting time for the company as we position the business to take advantage of a number of growth opportunities we see in the coming years. This is all outlined in our stockholder letter published last night to the investor relations section of our website at DZSI.com. I look forward to interacting with our analysts shareholders, and prospective shareholders. Joining me today are President and CEO Charlie Vogt, CFO Tom Cancro, and CTO Andrew Bender. I would now like to provide the DZS Safe Harbor Statement. During 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 and actual results or actual events or results may differ materially. Please refer to documents that the company files with the SEC, including its most recent 10Q and 10K reports and the forward-looking statement section of the letter to stockholders that was filed on a form 8K, as well as being available on the investor relations section of our website. These 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 letter to stockholders. So with that, I will now turn the call over to Charlie.
spk07: Thanks, Ted, and welcome, investors and guests. and especially our West Coast attendees for getting up early with us this morning. Following the market closed yesterday, we released our inaugural quarterly stockholder letter highlighting our performance for the quarter ending September 30th. Our quarterly stockholder letter provided an overview of our alignment with today's market trends, as well as our regional expansion plans, government-sponsored programs such as the United States Secure Trusted Communications Act, and the Rural Digital Opportunity Fund. We also profiled the enhancements we have made regarding our new leadership team, as well as a broader overview of where our products and solutions are being deployed within fixed mobile and enterprise networks. As Ted mentioned, our Chief Financial Officer, Ted Cancro, and our Chief Technology Officer, Andrew Bender, who recently joined DZS from VMware, are here today with me to expand on topics of interest, as well as answer any questions you may have that was represented in our stockholder letter. Closing out my first quarter, I'm thrilled to report all-time record revenue for the quarter, which was led by growing demand for our next-generation mobile transport solutions, as well as continued demand for our fiber-based broadband access and customer premise solutions. We had an exceptional top-line quarter, delivering 33% revenue growth when compared to Q2 and 31% compared to the same period a year ago. I want to recognize and applaud our employees and partners for achieving this outstanding milestone, especially in light of the ongoing global pandemic, which has impacted component shortages, customer evaluation, trials, and deployments. Before I open the call to questions, I want to amplify three key themes represented in the stockholder letter. First is our expansion into North America, Latin America, and India, leveraging our fiber-rich portfolio of broadband access solutions and next-generation mobile network transport solutions, which are being deployed in volume in the world's first open RAN network. Second is our skilled and agile research and development team that spans both fixed and mobile domains and our follow the sun geographic capabilities across the United States, Germany, South Korea, Vietnam, and India. And finally, the more than 30 new employees, including executive management team members, as well as key leaders spanning product, engineering, supply chain, sales, marketing, and finance, that have joined DZS since my appointment in early August. Over the past three months, we have made significant progress integrating former DAZN, Zone, and KeyMile, creating a one DZS brand and culture. We have rationalized and accelerated our commitment towards unified technology roadmaps and aligned our employees and partners with a vision and strategy to capture market share in the burgeoning 5G, fiber to the premise, and connected home and enterprise market segments. With that, I'll turn things back over to the moderator for questions.
spk01: Ladies and gentlemen, if you'd like to ask a question at this time, please press the star, then the number one key on your touch-tone telephone. To withdraw your question, press the pound key. Again, that is star, then one, if you'd like to ask a question. Our first question comes from the line of Dave Kang with B. Reilly. Your line is now open.
spk10: Yeah, good morning. First of all, regarding gross margin, can you just provide more color on the gross margin decline and how should we think about gross margin going forward?
spk09: Sure. You know, margins in this quarter were impacted by some significant orders for fiber access infrastructure. Certain customers where we had won the business a few quarters ago competing against Huawei and just delivered now. The margins take a hit sometimes to capture share and expand footprint, particularly when you're taking it from an incumbent. That can be competitive and a hard one. So it impacts our gross margins, but it was a contributor to gross profit dollars overall, right? Helping to drive up EBITDA. The point is, going forward, as we globalize these products, we sell into less price-driven markets and markets where Huawei doesn't compete. Also, as products get further along in their life cycle, you know, margin improves.
spk10: Got it. And then you talked about some demand that was pulled in from fourth quarter. Can you kind of quantify how much of that was pulled in?
spk07: Well, we're not going to quantify. I think, as you may recall, on our Q2 earnings call, I had mentioned that we started the quarter out with about $50 million of schedule backlog. And based on the guidance that we had provided, we had somewhere in the $35 million go-get for the quarter, and we were able to, one, pull some things in, two, I think the demand for our mobile products as well as our fixed wireline products exceeded our expectations that we had in our original outlook.
spk10: Got it. And then regarding our fourth quarter outlook, clearly there was some pull in the third quarter. But what about, you know, rising COVID cases and increasing restrictions? What are your assumptions on that regarding the outlook?
spk07: Well, I think you're exactly correct, and I think that's part of the reason why we guided the way we guided. We certainly see the new cases not only across the EMEA region but also in Asia, and you look at not only the customers that are potentially affected, but you look at supply chain and components, and we feel like the guidance that we have provided aligns with that. I think the reality is that when you still take a look at Q3's actual of nearly $94 million and the mid-range of what we're guiding of 77, the second half of this year represents the best sequential combined half that companies ever had. So we're not necessarily looking at our revenue on a quarter-by-quarter basis, but looking at it more on a longer-term totality basis.
spk10: Got it. And my last question is, can you go over the 5G pipeline? The previous management, they talked about to Korean and to Japanese customers. And are there any opportunities outside of Asian countries?
spk07: Well, look, I mean, I would tell you, and Andrew can certainly chime in, it's probably one of the most exciting segments within the company right now. I mean, you know, our base business has been traditionally our fixed wireline core as well as connected premises products. But With the introduction of our really first market product into the mobile space with Rakuten and a couple of other customers in Asia, it certainly gives us a tremendous opportunity in other markets, and there's a lot of sales activity underway. We certainly aren't going to represent our pipeline in any of the segments, but I can tell you that there's a lot of excitement on both the customer as well as the sales side.
spk10: Got it. That was it for me. Thank you.
spk01: Our next question comes from Christian Schwab with Craig Hallam. Your line is now open.
spk06: Hey, congratulations on a strong second half of the year. As we look forward, a couple different questions about the different growth drivers and how they may play out in the future. Can you give us you know, some idea of, you know, how much you think you'll be shipping, you know, roughly to Rakuten and how much you could be selling to them next year. And if you don't want to talk about that, maybe just incrementally how much better that customer could be in 21 than 20.
spk07: Yeah, I mean, obviously, you know, we're not going to share that data, but, you know, certainly we expect Rakuten to continue to have a strong 2021 with us as they continue to deploy their 5G network. They've certainly been a great advocate for DZS and a champion for us, helping us as a reference with other key accounts that we've been marketing to around the globe. So our outlook for Rakuten in 2021 is strong.
spk06: Okay, great. And when you guys think about the Rural Digital Opportunity Fund, do you expect that to drive meaningful revenue in 21, or would you expect that to be more a 22 event? Typically, there's been a lag between awards and real true aggregate spending. Just wondering, in these government programs, just wondering how you guys are thinking about that over the next few years.
spk07: Yeah, no, I mean, you know that the auction began yesterday. I think there was approximately 400 of the 500 recipients that, you know, were awarded some element of the program yesterday. You know, the reality is, and I think you said it very well, you know, we anticipate that a lot of the RFI, RFP activity will happen during the first half of next year. You know, we certainly are cautiously optimistic second half of next year will certainly provide an uptick for us, especially since that's a market that we haven't, you know, we haven't aggressively pursued that market as we are today. But I think it's more of a 2022 acceleration than it is in 2021.
spk06: Okay, great. And then just trying to better understand your highlight in the stockholder letter of opportunities versus Nokia and Huawei. I certainly, I think, understand the political environment and opportunities in Huawei, but is there any geographies where you think people might be more receptive to hearing from DZS than may have over the last few years ago?
spk07: I think one of the things that we get excited about, and certainly investors should get excited about with DZS is, you know, especially when you compare us to others, you know, most network, most large-scale, even medium to large-scale network providers are, you know, selecting at least two suppliers. And one of the things that You know, we have found, you know, across all of EMEA, obviously a lot of the APAC regions, Latin America, you know, over the last, you know, 10 years Huawei has made significant inroads into those markets. And just, you know, the calls that I've had with dozens and dozens of customers since I've joined, you know, the company, you know, there's certainly an appetite to look at someone like DCS that has the resources, the products, and the scale in those particular regions to, you augment as they de-emphasize Huawei in those particular, you know, networks. And, you know, even here in the United States, I think a lot of people don't appreciate that there's, you know, $2 billion worth of rip and replace of Huawei that the U.S. government is sponsoring that we're certainly involved with. So I certainly see us as an ideal company. to be able to participate alongside Nokia. I mean, Nokia is, you know, with the combination of Luce and Alcatel and NSN, you know, they're in a lot of accounts just because of the combined nature of those three companies. But when you look at where Nokia is and you look where Huawei was, we certainly see DZS as a natural company to be able to participate in a lot of the markets, including the U.S., but certainly where they were strong outside of the U.S.,
spk06: Great, thank you. And then my last question has to do with eFiberland. Previous management teams have significantly talked up the opportunity of that as a new product category. And now that you've been there for a while, Charlie, I'm just wondering, what is your thoughts on that product line and its potential over the next few years? you know, is it realistically have an opportunity to be a material contributor to the top line of DZS?
spk07: So first of all, Fiberland is a solution brand. And the way I want you guys to look at this is Fiberland represents existing products that we sell into the core as well as customer premise network solutions, you know, in the traditional service providers. but is intended for the enterprise verticals. And I think the reality is that the products and solutions have always been there. It's really been the focus and the go-to-market and systems integrator alignment that was required. And I can tell you that I'm very passionate about this market. I think it's a significant opportunity for us. We've recently hired several enterprise lead salespeople to help us accelerate the pace. But I think I think it's a great question because, you know, when you look at the market, we think it's a $10 billion market. You know, the copper and traditional coax infrastructure with a lot of the enterprise verticals is going to be completely transformed, and I think it's a significant opportunity for us. So we're aggressively planning on going after that market, and we'll do it through the service provider channel as well as through a lot of systems integrators who are focused on that market.
spk06: Okay, great. No other questions. Thank you, guys. Andrew, did you want to comment on anything?
spk03: Yeah, a quick comment about Fiberland. I think one of the exciting things that we see with that solution set is also the adjacencies to the licensed and unlicensed mobile market. As Charlie correctly said, we see networks transforming, and that includes in the premises and enterprise customers. So as they embrace more wireless technologies in building and across campus, Fiberland is well positioned to enable that transformation.
spk07: And it's natural for us to extend into the fixed wire line part of the market as well, right? That's right. Fantastic. Thanks.
spk01: Our next question comes from Tim Savageau with Northland. Your line is now open.
spk08: Hi. Good morning. And congrats on the strong Q3 results. Obviously, it looks like Asia-Pacific, from a geographic standpoint, was a big driver there. I wonder if you could speak to any more specific color around geographic markets, perhaps in Korea and Japan, and also any 10% customer concentration in the quarter. And then should we assume that to the extent that You saw some of this business come sooner that expected that that's, you know, the Asia-Pacific region and the deployment patterns of specific carriers are what's driving that pull in from Q3 to Q4, and then I'll follow up.
spk07: Well, first of all, Tim, I appreciate the congrats. As I think you probably saw in the stockholder letter, Asia represented 60% of the revenue. North America was also up, and I think what we get excited about going forward, and I'll talk about Q3, but as we think about our business going forward, there's just a tremendous amount of focus and effort that's being placed right now on expanding into North America and Latin America and India, and I think these are markets that traditionally have been underserved and under-focused. If you appreciated the new sales talent that we brought into the company, especially around these regions, we certainly are optimistic about the prospects for these regions in 2021. You know, as it relates to, you know, third quarter, you know, you can appreciate the fact that, you know, our core customers in Korea and Japan, you know, continue to deliver strong results both on the mobile side as well as on the fixed wireline side. And, you know, Rocket Time continues to accelerate their deployment, which is very exciting. And, you know, we, you know, We've got to be careful about who we represent in the region just based on our confidentiality with those customers, but you can imagine the tier ones in both Japan and Korea that make up the lion's share of that 60% of the revenue.
spk08: Got it. Last quarter, you referenced some comments on backlog and shippable backlog, and As you look into your Q4 guide here, I don't know whether it's accurate to say you've haircut the numbers based on some risk factors from potential pandemic impact or whether that's really kind of a pull-forward dynamic. But to the extent you have kind of taken some conservatism with regard to uncertainties around pandemics and Could you possibly quantify that? And are there any similar metrics that you can offer relative to last quarter? You'd indicated that you had three-quarters of your plan in backlog or something like that. Any comments around visibility heading into Q4?
spk07: Yeah, so as we entered Q3, as I articulated last quarter, we entered Q3 with about $50 million in schedule backlog. And so we had a go-get based on our guidance of, as you mentioned, 25% of our original $74 to $79 million guidance in Q3. We entered Q4 with $45 million of schedule backlog. And so when you look at the current guidance that we have, we've got similar metrics. And so are we being cautiously optimistic? Maybe. But I think we're guiding what we think is aligned with where we see the pipeline and the go-get and other dynamics, as I think we've all talked about as it relates to just the spike in COVID. You know, there's a pretty significant component shortage out there. We did a great job of navigating through that in Q3. I expect that we'll do a good job of navigating through it in Q4, but it's there and it's real, and there are risks that, you know, we all need to be aware of. But there is some upside in Q4 as well.
spk08: Got it. Appreciate that, Culler. And, you know, looking into next year, you mentioned – uh, North America, which is, you know, relatively small market for you now, but it, you know, at this point, would, would it be too much to say that you expect North America to perhaps be your fastest growing segment, uh, for the company in 21, given the opportunities. And obviously we've seen a lot of strength in that rural broadband area, even prior, um, to, to our top taking off. Um, when you consider that market backdrop and, um, and your increased sales efforts, you know, what are you thinking about growth in North America in 21?
spk07: I think there's two very significant growth opportunities for us next year. One, and I think, you know, we're trying to do the best job that we can to really articulate just how significant the mobile segment opportunity is for us, because it's a brand-new market segment for us. You know, if you look at the historical growth revenue profile of the company going back a decade, it's been almost 100% fixed waterline. And so now you open up a brand new market segment that has probably more investment focus than any segment that is in the mobile space. And, you know, when you look at the front haul, you know, you look at front haul, mid haul, back haul, front haul has a magnitude difference in the number of aggregation devices that will be deployed. And so that alone I talk to the sales team and management team all the time that if we can just secure five more Rocketons, you can only imagine the size and scale that it has as a multiplication effect for the company. But to your point, we certainly think that North America represents the single biggest growth opportunity for us over the next several years. We've invested significantly in a very senior sales organization over the last several months, And it's not just about RDOF. I think it's about the overall dynamics, the focus, the alignment of our products. And I think the consolidation that's certainly continued to occur here has helped us. So I think your assumption is right.
spk08: Great. And your last question for me. And when you consider, you mentioned kind of the Huawei rip and replace program. and also just Nokia being pretty concentrated everywhere. At least that first one with Huawei, you would think that's focused on a large number of small carriers. But maybe a different opportunity relative to Nokia, maybe not. I guess when you talk about opportunities to displace larger vendors, either because of political pressure or carriers looking to diversify vendors. Should we think of that as mostly kind of a tier two, tier three carrier focused opportunity for DZS or are there larger tier one opportunities out there that kind of have the same profile?
spk03: Tim, it's Andrew Bender here. I guess one of the things that we have seen in the market dynamics surrounding this this regime that you mentioned is not just the geopolitical aspects, but the changing landscape of the network, the concept of open, the concept of standardized interfaces. In fact, there's some legislation in the US supporting that. I think we talked about in our letter to stockholders. So part of our success factors in addressing incumbents large and small is our ability to be agile, to bring new products to market, and to embrace the open network standards like the Open RAN Alliance family of standards and similar initiatives in the wireline network. We see that being a big reality for us in the product space.
spk07: Well, and the other thing I would comment, Andrew, is to Tim's point, most of the success that Huawei has had around the world has been with the Tier 1s. And so even when you look at North America, which includes Canada, which is where they've had some success, there's significant Tier 1s that they'll be replacing. And a lot of wireless infrastructures you would appreciate, and a lot of, to your point, Andrew, a lot of close and proprietary networks that You know, obviously with the momentum that we have and the architecture that Rakuten and ourselves and the ecosystem that we're forming right now is promoting is really an open RAN network architecture, which really fosters an opportunity, a unique opportunity for us.
spk08: Okay, thanks very much.
spk01: Our next question comes from George Iwanek with Oppenheimer. Your line is now open.
spk05: Good morning, and thank you for taking my questions. Charlie, with all the additions that you've made, can you give us a sense of the go-to-market changes you're making at the same time with the new sales leadership?
spk07: No, I appreciate it. I wish everybody could be a fly on the wall over the last 90 days because we've really accomplished a lot. First and foremost, we're a technology company, and so what we have spent a lot of time over the last three months focusing on is really rationalizing the product portfolio and aligning the product portfolio with our resources around the world and how that aligns with where we believe we have the best chance of winning looking at the geopolitical landscape as well as the competitive landscape. And, you know, we've, you know, just calling it like it is. I mean, we've put together a very significant Huawei playbook. You know, we've looked at every single Huawei account there is, and, you know, we're engaged in all those accounts as it relates to how we might be able to participate either at you know, at the edge, are in the core. And then, you know, here in North America, you know, we certainly are competing, you know, heavily with Atran and Nokia and Calix. And, you know, we certainly think there's a growing opportunity for us, you know, especially with the fact that, you know, both Atran and Calix don't really participate on the mobile side like we do. I don't think neither of them have the same size and scale of portfolio on the enterprise side and CPE side. And so there's certainly an opportunity for us to continue to grow there. But our focus has really been where we feel like we have the best chance of winning based on our product alignment and the overall competitive landscape.
spk05: All right. Thank you for that perspective. As you look at expanding regionally as well as looking at the product synergies, can you give us a sense of how long the customer engagements are probably likely to take and the timing of ramps in the newer regions and the newer areas?
spk07: On the enterprise side, on the Fiberland solution portfolio side, the sales cycle can be relatively short. In fact, we You know, just had a very large recent project that, you know, came, you know, and the opportunity came pretty quickly. And the opportunity to be able to engage and deploy that, you know, was, you know, within 90 days. If you look at, you know, participating in the core, you know, especially if you're dealing with, you know, a tier one or tier two, the sales cycle, you know, can last anywhere from six months to a year. Having said that, I think that the enterprise or the CPE in-home or enterprise CPE portfolio seems to be an opportunity that we can get into relatively quickly. We've got a new line of Wi-Fi 6 and mesh products that are being very well received around the world. Our strategy and game plan is especially on the Huawei side, is for us to be able, I mean, the one thing we don't talk enough about that the company's done a phenomenal job of, and that is just having to compete in Asia. We've had to interrupt with just about everyone. So we've interrupted, you know, our CPE products and our core products have interrupted with Huawei and GT and Fiber Home, AdTran, Calix. And so, you know, we sort of look at ourselves as a pretty nimble and agile company to where, you know, we can deploy our products anywhere in the network and be, you know, comparable and complement the existing infrastructure that's there. And, there's several very large customers in EMEA that have entertained the idea of bringing us in on the in-home and enterprise side with our CPE portfolio and then, you know, giving us an opportunity to then, you know, weave our way back into the core of the network over time.
spk05: All right. And just last question for me. Maybe this one's for Tom. Can you give us a sense of, you know, as you do more on the CPE side and focus with some of those opportunities, how the product margins look across the portfolio?
spk09: Yeah, I mean, I'm not going to get into, you know, extreme detail on it, but it's pretty much as you expect and as, you know, you see throughout the industry, right? CPE never is the highest margin product that you have. Certainly some of what we're doing on the mobile transport side is some of the higher margin products in our portfolio. And you're seeing, you know, greater growth there. But as much of it has to do with geography as product mix, right? And as you start to, I've seen you invest a little bit in R&D this quarter as we start to globalize some of these products so that you can sell them into markets that are less price focused. That'll impact our margins going forward as well.
spk07: Yeah, I would just echo the fact that there's several dynamics on the margin mix. One, is just what cycle you're in in selling chassis-based core systems versus the service module. So the chassis tend to come with less margins than the service module. So as we deploy a new core chassis into a central office and we start deploying service modules as more subscribers come online, the margin profile with that is much higher. And then, as Tom said, where we have an opportunity to truly differentiate, especially with newer disruptive technology, the margin profile is much greater.
spk05: Thank you.
spk01: Our next question comes from John Gruber with Gruber & McBain. Your line is now open. John? Mr. Gruber, your line may be on mute.
spk04: John? Liz, maybe move on to the next question then.
spk01: Our next question comes from Bill Woodruff with William K. Woodruff & Company. Your line is now open.
spk02: Morning. How does what you're doing in 5G and Open RAN complement or compare with Navineer's Open RAN product offerings?
spk03: So thanks for the question, Bill. Andrew Bender here. We are engaged with Maveneer as with a lot of the ecosystem vendors, as Charlie mentioned here. We're not today an end-to-end provider of the radio access network in 5G, but we are providing some key enabling technology with unique products, and that's what's led to our early wins. in the ME hall or the front and the back hall space. So I guess that's probably the best answer I can give about where we're complementary there, that we're providing unique networking and transport capabilities in the RAND that are complementary to the BBU functions, the centralized unit, distributed unit that you would see in the open RAND architectures there.
spk07: Yeah, we're certainly, you know, fostering relationships with the, you know, overall mobile ecosystem that complements an open-ramp architecture, as Andrew said, and Mavonier, you know, who's down the street here in Dallas, is certainly an ideal ecosystem partner that complements us in where they're participating in the core versus where we're participating at the mobile edge.
spk02: Okay. Okay. Let me ask, the election results, if there's a change in administration, do you think there'll be a change in policy regarding Huawei?
spk07: You know, we've actually been pretty engaged with the White House over the last few months, and what I would tell you, you know, is, you know, in fact, we were on a call with a pretty large team last week, and I asked the same question to the group, and I think that The feeling of the current administration is that the current policies as well as some of the programs that have already been approved, like, for example, if you look at the Secure Trusted Communications Act, it's a $2 billion rip and replace of Huawei. That program has already been approved. it's just waiting for funding. So the question I had for them is, is there any risk in that program going away? And the answer was no. As it relates to things like Rural Digital Opportunity Fund, you know, is there anything that would impact, you know, that particular program? The answer was no. And so we don't see the, you know, a change in administration having a change in views as it relates to Huawei. Go ahead, Andrew. Thank you.
spk03: Yeah, sure. One thing I would quickly add there, Bill, is that if you look at some other legislation in this area, particularly the USADA or the Utilizing Strategic Allied Telecommunications Act, that is bipartisan legislation or proposals that support the adoption of open standards to enable the creation of the ecosystem that we've been talking about on this call. one would suspect that that will be enduring. Thank you.
spk07: Thanks, Bill.
spk01: That concludes today's question and answer session. I'd like to turn the call back to Charlie Vogt for closing remarks.
spk07: Well, I'd just like to thank everyone for joining in our earnings call and especially our analysts for their questions. Our industry has experienced transformational change, which is resulting from disruptive technology shifts. accelerate network upgrades fueled by today's work and learn-from-home dynamics, and certainly the geopolitical security concerns that we were just talking about. We think DCS is well-positioned to capitalize on these opportunities with a clear vision and strategy and with a committed and experienced employee, systems integrator, distributor, and technology partner base. So with that, we'd much like to say thank you and have a great weekend.
spk01: Ladies and gentlemen, Thank you for your participation in today's conference. Everyone, have a great day.
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