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spk11: Ladies and gentlemen, thank you for standing by and welcome to the DZS Quarter 3 2021 Earnings Conference call. 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 1 on the screen. The conference is being recorded. If you require any further assistance, please press star 0. I would now like to turn the call over to one of the students of Investor Relations. You may begin.
spk02: Thank you, Marjorie, and welcome to the DZS Third Quarter 2021 Earnings Conference. I'm your host, DZS CEO, Charlie Vogt, and CFO, Misty Kowicki. Yesterday, after market closed, we published to the Investor Relations section of the DZS website to provide shareholders, prospective shareholders, and analysts with market insights, product, business, and financial updates, as well as forward-looking statements. 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 because the results may differ materially. Please refer to documents that the company files with the SEC, including its most recent 10Q statement section of the shareholder report that was filed on a Form 8K, as well as being available on the Investor Relations section of our website these documents results to differ materially from those contained in the company's projections or forward-looking statements please note that unless otherwise indicated a financial and gap basis these items together with correspondent corresponding gap numbers and the reconciliation gap are contained in the shareholder During the fourth quarter, we will plan to participate in investor conferences hosted by Stiefel, Needham, Craig Hallam, and Oppenheim.
spk14: Thank you. Thank you, Ted, and welcome investors, analysts, and guests. I am pleased to share that for the fifth consecutive quarter, we delivered strong sales momentum with quarterly revenue above the midpoint of our guidance and gross margin and adjusted EBITDA that exceeded the high end of our guidance. Q3 2021 marked our third consecutive quarter with orders exceeding $100 million, resulting in backlog of approximately $200 million, nearly three times higher than a year ago. Even though we were challenged by supply chain availability, price increases, and foreign exchange variations, we delivered revenue of $88.4 million, which was above the midpoint of our guidance, and our 36.8% adjusted gross margin and $5.1 million of adjusted EBITDA were well above the high end of our guidance. With the current supply chain challenges during the third quarter, without the current supply chain challenges during the third quarter, we estimate our gross margin performance would have been approximately 39%, illustrating the effectiveness of our product rationalization, alignment with component and contract manufacturing partners, and a more balanced North America, EMEA, and Asia geographic mix. During the first half of 2021, we outlined to industry and financial analysts and shareholders the market opportunity and company-related transformational themes that we anticipated would lead to long-term sustainable growth and profitability. As we expand, we have been laser-focused on the following four themes. First, market share gains and growth within North America and European regions. While we're in the early stages of an aggressive playbook, Early results have led to a North America order increase of 125% year-to-date compared to the same period in 2020. Second is the technology shifts and investment cycle that is underway evolving from legacy copper and sub-1 gigabit technology to next-generation multi-gigabit broadband connectivity solutions, which are delivering growth across North America and EMEA and with higher margins. This shift to multi-gigabit architecture has also enabled DZS to introduce high-value network and subscriber-based software platforms. Third is a transformational wireless technology shift in industry momentum towards a next-generation 5G architecture fueled by emerging service providers such as our leading Open RAN customer, Rakuten, who surpassed 5 million subscribers during the third quarter. Rakuten has successfully launched Rakuten Symphony, which is designed to accelerate the deployment of Open RAN networks around the world, and with our mobile XR solutions playing a key part of the reference design. And finally, our strategic pursuit to cap and eventually replace Chinese equipment suppliers that are being de-emphasized in the United States and many European and Pan-Asian countries, including India. Our sales pipeline RFP and trial activity during the first nine months of 2021 has been encouraging, And during the third quarter, we secured a large scale broadband connectivity project with a tier one service provider in India. Our product rationalization, next generation 10 gigabit class PON technology and strategic investments in software orchestration, automation, service assurance and subscriber experience solutions are designed to differentiate and enhance our more than 20 million platforms deployed around the world. Our multi gigabit PON and subscriber influence software strategy is on display and our newly launched Accelerate and DZS Experience solutions, both of which are complemented by DZS Cloud, which was launched in March of this year with TELUS as an anchor customer. Our cloud-native network and subscriber software portfolio will provide communication service providers with the applications, automation, and intelligence to more effectively manage the residential and business subscribers, creating new revenue opportunities and operational savings. Our product rationalization workstreams have yielded reductions in SKUs by nearly 60%. While there are many valuable sales, service, and resource alignment benefits, the reduction in SKUs is also reducing supply chain risk. Furthermore, we improved our manufacturing and supply chain efficiency across our global infrastructure as we consolidated our manufacturing operations and enhanced our supply chain partnerships to continue to successfully navigate through a difficult supply chain environment. Looking ahead, We anticipate the trends experienced throughout 2021 will continue in Q4 and into 2022. Specifically, demand for next generation fiber-based broadband connectivity solutions fueled by consumer demand and accelerated by an estimated $100 billion in government stimulus. Demand for network and subscriber-influenced software solutions that will provide operators with differentiated service offerings. The emergence and adoption of Open RAN 5G networks. Chinese equipment supplier cap and replacement opportunities, and persistent supply chain challenges. As it relates to the fourth quarter, we are guiding to a wider than usual revenue range of $80 to $100 million due to the current supply chain environment. We have the backlog to deliver to the high end of the range, assuming our component and contract manufacturing partners are not hindered during the quarter. We anticipate a gross margin range of 32 to 34 percent, reflecting near-term supply chain cost increases, expedite fees, and foreign exchange variations, specifically with the Japanese yen. As we overcome the current supply chain headwinds, we believe the operational efficiencies underway and our new commercial strategies will deliver the long-term growth and margin expansion outlined in our Q2 shareholder report. I would now like to turn the call back over to the operator to begin our Q&A session.
spk11: As a reminder, to ask a question, you will need to press star 1 on your telephone. To answer a question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Ryan Kuntz from Needham and Company.
spk06: Good morning, Charlie. I wonder if you could walk us through the price increase opportunity here and kind of Is there a shot clock here that you have to give them time to place orders to the old price? Is this a temporary change related to freight, or are you implementing it on a permanent basis? Any little clarity like that would be helpful. Thank you.
spk14: Well, the price increases that we've received from many of our component supplier ecosystem group has not been something that has been deemed to be permanent, although I think we are assuming that the price increases that our entire industry is seeing is likely to be elongated. Those price increases really began in the May, June, July time frame. Some of them came as late as September, some of which were already experiencing price increases, some of which we won't see the price increase until the first part of next year. I think what's important for everybody to appreciate and I think it's frankly consistent across everyone in the entire sector is some of the price increases affect current backlog depending on when raw materials were pulled in either to one of our contract manufacturers or in our case to our Florida manufacturing facility. And other components and raw material are scheduled to be delivered in 2022. What we decided to do, and we put a lot of time and energy into this, we spent a lot of time with a lot of our tier one customers and channel partners, was we began increasing prices October 1st. And we're using this term commercial strategies because that's really what it is. I mean, we're being very thoughtful about the various price increases across the various portfolios, but we believe that the price increases that we've implemented will more than offset the price increases that we've been navigating and will navigate over the course of next year.
spk06: So it sounds like it's a multi-quarter implementation. Is that how we should think about it? I mean,
spk14: Well, if you look at the margins that we were able to deliver in Q3, I think from our perspective, if you pull out some of the expedite fees, and that's a new term for our industry. We've really never seen this category that we're referring to as expedite fees. You know, normal lead times are, you know, depending on the component and the supplier, could be as long as 52 weeks. We got ahead of things, I think, better than most, and I talked about this over the last two quarters late last year in the September-October timeframe. You know, just because we had a lot of visibility with a lot of our tier ones, we were able to get ahead of a lot of the forecasting requirements at the raw and systems level. And I think that has really helped us, especially with our Q3 margins. But I think that, you know, what we're expecting to see in the very near term, and I'm saying Q4, maybe Q1, is, you know, some expedite fees that will have some margin impact. But I think that investors and shareholders, excuse me, should think about the longer-term aspects of new orders that we're booking at the margin profile that I think aligns with our long-term margin expansion profile. That, and we certainly expect, you know, our DZS Cloud and our new DZS Experience software portfolio to begin to deliver higher margin in, you know, in the second half of next year.
spk06: Okay, and... On the timing on the mobile side, so like mobile was a little weak in the quarter, so like timing of some of the deployments, is that mix change going to shift in Q4 a bit there, and that's another headwind in Q4 on margins, I assume?
spk14: You know, look, I mean, on the wireless side, you know, and I think we're not the only ones, but I certainly think that the catalyst for DCS and others in our ecosystem is really the adoption and the acceleration of Open RAN, which, you know, in the activity and, you know, specifically in what's going on from an RFP and from a trial perspective, launching, you know, RocketCon Symphony, which is leveraging a lot of their own intellectual property that they've garnered, and DCS. as they have success with their own Open RAN network architecture, we aim to be able to participate in the adoption to Open RAN, and we certainly see that accelerating in 2022. Okay, great.
spk06: And just one last one, if I could, on... On the Huawei replacement opportunity timing, you're starting to see some decisions now there, and when should we think about that starting to impact revenues for you?
spk14: Well, the large-scale project that I just referred to during my opening remarks was a Huawei replacement project in India, and I know The general market gets nervous about large-scale projects in India from a margin perspective, but I do think that India as a country and at least the four large-scale service providers there realize that in order for them to adopt technology from North American, European-based companies, the pricing and margins kind of change. So that's an exciting win for us. There are several large companies tier ones that we are aggressively pursuing in Western Europe, and a lot of those decisions we expect to be made between now and the end of the year. And I think there's certainly a great opportunity for DZS, especially with most of those companies already having Nokia in their network, and they're looking to replace Huawei with at least one or maybe even two additional technology suppliers.
spk05: Great. Super helpful, Charlie. Thank you.
spk14: Thank you.
spk11: Our next question comes from the line of Dave Gann from Beer Riley.
spk08: Yeah, good morning. My first question is maybe if I could get a mix between broadband and mobile for your backlog of $200 million.
spk14: I don't have that off the top of my head, Dave. I can research that before the end of the call to make sure I give you an accurate mix. I don't know that we've ever given that number, so I don't know that we want to start issuing a percentage of our backlog as it relates to the mix of both.
spk15: Got it. I think we could assume that it's
spk14: what you've seen throughout, you know, this year, uh, from a percentage of fixed and mobile.
spk16: I mean, there is, there's some soft bankers.
spk08: Got it. And then, um, regarding that, that, uh, major, uh, tier one Indian contract that, that you replay, I mean, India was fairly big a few years ago. Can you get back to that level and how long, I mean, can you talk about sustainability?
spk14: Well, we're certainly encouraged. I mean, you know, it's not just with the operator that we're, you know, participating in here initially. I mean, all four of the operators have pretty significant work streams underway. You know, look, I mean, you know, I've always been cautious about India, but I would tell you that we're more – we're more positive on India today, I think, than I've ever been just because of the dynamics. You don't have the Chinese suppliers that are putting a lot of margin pressure and pricing pressure on the competitive nature of it. And frankly, we're able to pick and choose. I think we've tried to make it very clear to analysts and shareholders that where things are strategic, we may be a little bit more aggressive from a pricing and margin perspective, but we're committed to getting to that 40% gross margin level. And I think that we're going to make sure that, you know, all the projects that we participate in, including the large tier ones, will enable us to get, you know, to the margin profile that, you know, we've laid out for ourselves and shareholders. So we're encouraged, frankly, with the opportunity in India. We're very encouraged with the opportunities we're seeing in Western Europe. And look, I mean, North America has been You know, just, I mean, it's exceeded all of our expectations this year. I mean, we were obviously very focused on North America. We've got a lot of great relationships that go back 20 years. But the fact of the matter is, you know, year-to-date orders are up 125% compared to the same period last year. And the momentum that we're seeing in North America, which obviously garners the highest margins, is pretty exciting and encouraging for us.
spk08: Got it. And speaking of Americas, it was 31% trending up nicely. At this rate, I mean, can we expect maybe 40% by maybe second half next year? Is that a realistic goal?
spk14: I won't comment on it. It certainly is in line with a lot of our expectations.
spk08: Got it. And my last question is just wanted to – Yeah, clarification on the gross margin. So it's going to be approximately, what, 33% fourth quarter. It sounds like this is going to be about maybe first quarter, kind of maybe flat to up a little bit. But then, you know, going back to your target of 40%, I mean, with 33% as the starting point, I mean, Is 40% maybe by late next year, is that still achievable? And if so, can you kind of walk us through the steps of how you're going to get there?
spk14: Again, I think what shareholders and analysts ought to be looking at across our entire sector, especially where there's a lot of systems and hardware content, even with some of the software elements, Everyone's backlog is being impacted by the price increases. The way most of the price increases have been implemented by the broader ecosystem is such that regardless of whether or not there were orders in the system or not, when they began shipping to you based on whatever active date it is, that was the effective price increase. That's why I think we're going to see a slightly lower margin profile in Q4 and probably Q1 as we flush out the backlog. All the new orders that we're bringing in that began in Q1 will be at the new margin profile, which aligns with our target margin for 2022. And I think we had sort of outlined in our Q2 shareholder letter that we thought we could get to a margin profile in that 37% range next year and 40% in 2023, and that still holds true for the model that we have internally.
spk08: I guess expedite fees, I guess that's a big component of elevated supply chain costs. Has that kind of stabilized? And is that why we're thinking, you know, right now we are kind of bottoming here?
spk14: I know a lot of people keep saying we're bottoming. You know, I think that the expedite fees, like I said, it's sort of a new phenomena. I don't, you know, from our perspective, we're not modeling in a lot of expedite fees in 2022. There certainly has been expedite fees that we've navigated in Q2, Q3, and we will see some in Q4. with a couple of large projects that we need to deliver on. And I think that's really the way everyone should look at it. I mean, if in a perfect world you're forecasting perfectly and you're receiving orders aligned with that forecast, there's no expedite fee. It's when you have an unexpected project or you're pulling in a project that you need for a customer that you're trying to pull forward the delivery dates from some of the component suppliers that's when they're charging you a quote unquote expedite fee. We, as I said, we saw some in Q2 and Q3. I think we did a great job navigating the expedite fees in Q3. We haven't really talked about the foreign exchange impacts that we saw this year, especially with the large amount of business we do in Japan. But, you know, when you look at dollar against the yen, it's certainly been something that surprised us this year. I think we'll do a much better job managing that next year. But I think to your question, Dave, we don't expect to see the same amount of expedite fees next year just based on the alignment of our backlog and the alignment with the forecast plan that we have next year. So I think the price increases that, you know, in the commercial strategies that we'll be implementing will certainly offset the price increases that we're seeing at least you know, in the near-term from our ecosystem.
spk09: Got it. Thank you.
spk11: Again, if you would like to ask a question, please press star, then to number one on your telephone keypad. Our next question comes from the line of Tim Savageau.
spk18: Hi, good morning. Question more around the kind of top-line outlook, and I know you've been, you know, targeting companies kind of an eight to 10% sort of growth range. And I'm not sure whether you've quantified the impact on revenue from supply issues this year, but obviously you're building backlog. Significantly, you've mentioned this order in India, which I guess is looking to ramp sometime in calendar 22. I mean, given the combination of maybe backlog increase and supply issues pushed into 22, overall kind of market growth in the U.S. and some of these new projects. Is it fair to expect above-trend growth in calendar 22 driven by all those factors? Thanks.
spk15: Yeah, thanks, Jim.
spk14: You know, look, we haven't, you know, we've spent, as most companies do this time of the year, we've spent a lot of time analyzing 2022 already. You know, we're not prepared to talk about 2022 on this call, but I would say that the 8% to 10% that we had profiled last quarter, we still feel very confident that that's achievable. As with almost every year I've participated in over the last 25, 30 years, there's the known and the unknown. And when we enter 2022, we're excited about the known, But there's always, you know, upside and there's also risk that you got to balance. But, you know, if I look at the amount of RFP and trial activity that at least we're involved with today, you know, we certainly, you know, are entering 2022 with a lot more enthusiasm and a lot more excitement than I think we did in 2021. And we entered 2021 not seeing, you know, the supply chain challenges hitting this entire segment as it has. And I think we've actually done an extremely good job navigating the supply chain challenges. I mean, we've got a very unique sales and sales finance and supply chain interlock process that we have implemented when I got here. I think that has really helped us. But to answer your question, I think we feel very optimistic about 2022 despite the supply chain headwinds. And I think as you think about revenue, if we're successful with our commercial strategies and price increases, that certainly is going to have a positive impact on top line revenue.
spk17: Great. Thanks very much.
spk11: Our next question comes from the line of Christian Swath from Cape Holland.
spk07: Great. Thanks, guys, for taking my question. I just have a quick question on clarity on backlog. With the price increases taking effect on October 1st and the significant backlog increase in September, was that telegraphed? Was some of that business pulled in? Or should we think about that as true backlog strength that was going to occur you know, just due to end market demand and the four big growth drivers that you outlined earlier in the call. I'm just wondering if you could clarify that for me, please.
spk14: It's a great question, and I'll give you a straight answer. You know, we haven't pulled forward anything. I mean, everything, you know, I'd like to think that we could pull forward more than what we have. You know, we're certainly – rolling up our sleeves with our large tier one customers to make sure that they're well educated about the supply chain environment and making sure that we're not hindering their deployment strategy. But the backlog that we've created in 21 has really been all demand related. In fact, for the most part, I would say 75% to 80% of our $200 million backlog, if we have all of the components, we can ship it tomorrow. We don't have any backlog that's sort of, we're not piling up backlog for 23. We're facilitating a backlog for immediate projects today. And that's why we've got a wide range for Q4 revenue. I mean, if we're successful in aligning the components to the requested chip dates, we've got an opportunity to have a really strong Q4 revenue. But I think we're still in this sort of period, Christian, where all it takes is one component to cause us to not build a lot of systems. And so we're being, I think, fairly conservative and relatively cautious just because we don't want to mislead and misguide. But the backlog that we have today is backlog that we can ship as soon as we have the parts, which, by the way, We're trying to balance. I mean, if we pull everything forward from an expedite fee, you know, you're going to have a margin impact. And so we're trying to balance that the best we possibly can. And I think, you know, for the most part, you should look at the $200 million worth of backlog as backlog that, you know, will likely flush out in Q4 and mostly in Q1.
spk07: Great. Thanks for that clarity. That was my only question. Thank you.
spk11: Our next question comes from the line of Paul Essie.
spk04: Thanks for taking my question. Wanted to get a little bit more color on this Plume partnership. How does it work? What are the service providers? What are their benefits from this? What do you guys benefit? And how quickly can you expect me to penetrate the 20 million subscribers you've got out there that are in place?
spk14: No, I appreciate the question. Yeah, as I think most people know, we announced a strategic partnership with Plume during the quarter. It's a relationship that we've been fostering throughout 2021. And I think as we successfully rolled out DZS Cloud, which is really a network as a service software platform. So DZS Cloud is really designed to deliver orchestration, automation, service assurance, application management type services that will come in the form of either enterprise licenses or subscriber based licenses, or I'm sorry, application licenses. What Flume does is it really complements what we're doing with DCS Cloud and it allows us to participate inside the home It allows us to differentiate our next generation Wi-Fi 6 CPE portfolio with embedded on-sync software from Plume that allows service providers to have a much different experience as it relates to Wi-Fi performance enhancement capabilities, more data analytics capabilities that ultimately are going to you know, allow service providers to think about new revenue opportunities. It's going to allow them to reduce the amount of truck rolls. And when you combine DZS Cloud and Flume, I think we're the only company in the broadband industry that has a complete end-to-end software portfolio from what's going on at the core all the way inside the home or small business.
spk04: Okay. How quickly are you going to roll that out in the first quarter?
spk14: Yeah, well, I mean, we've been forecasting. I mean, we were very thoughtful about this because, you know, what we're doing at Plume really aligns with Wi-Fi 6. And our Wi-Fi 6 portfolio is launching from a product availability perspective in Q1. And so we wanted to make sure that, you know, we didn't launch something that, you know, customers didn't didn't have access to. And so we'll have products available for shipment towards the end of Q1 and into Q2. And so right now, we're focusing on booking orders for our cloud-based portfolio that we expect that the bundle of the software solution with our CPE products will ship towards the end of Q1 and into Q2. So we certainly got a pretty ambitious appetite for the second half of 2022. And by the way, we've got a whole series of what we call DCS experience webinars that will launch this month in the month of November.
spk04: Okay. A couple questions on some of the subsidies the U.S. government is putting through, like RDOF. We're hearing it's just been kind of trickling in. What's your assessment of that? And also in Europe, you said a lot of the money is poised to be let go soon. Can you update us on both of those situations?
spk14: Yeah, so I mean, you know, if you go back 18 months, everyone's been talking about the, you know, the infamous $20 billion of hard-off funds, which is a, as I know everyone knows, is a multi-year deployment. Up until really Q3, there was only about $300 million of that, you know, of the initial phase one $9 billion that got deployed. As of Right now, there's a billion dollars that's been released. So that's good. So we're starting to finally see a lot of the RDoF dollars, you know, that are impacting some of our large customers like Consolidated Communications and others that are beginning to see some of those dollars go to work. We don't talk enough about what's going on in Europe, but there is a number of countries that have significant multi-billion dollar stimulus funds that are coming out of their, you know, government institutions that are also fueling a lot of broadband initiatives across, you know, many countries around the world. And then, you know, assuming that the infrastructure bill gets passed and, you know, we're still assuming that, you know, the broadband element of that is still about $42 billion, you know, that certainly is going to have an impact, I think, more in the 2023 timeframe. just because by the time it gets implemented in Q1 of this year, it'll be something that, you know, begins to roll out towards the very far end of 2022 and into 2023. But, you know, UK's got their Freedom Fiber. You know, Germany's got their utilities in Bulgaria. And so I think that, you know, between just the UK and Germany, there's close to $20 billion of funding
spk04: One last question. You mentioned in your letter that there's a lot of open RAN or more open RAN opportunities in Asia. Can you discuss them outside of Rakuten and who else you're talking to, if you can, or what types of projects you're running into there?
spk14: Yeah, I mean, just from a competitive standpoint, I'm not going to share the projects and the companies that we're engaged with, but I would tell you that there's a tremendous amount of momentum across Europe, Middle East. There's a lot of activity across the Pan-Asian markets for ORAN. And I think even here in the U.S. and Canada, there's a significant amount of activity that's underway for ORAN. So I think ORAN is here to stay. I think it's something that You know, carriers that had already begun to roll out their 5G networks are sticking with that initial deployment. But I think phase two of their 5G deployment will lean in towards more open RAN architectures. And I think that certainly opens the opportunity for companies like us to participate in a more meaningful way.
spk04: Okay. Do you have a sense of timing when that could be?
spk14: You know, we keep, you know, I mean, what we're seeing on our, you know, I mean, we've got, I mean, if you just look at Rocketown alone, which I think what they've done is pretty unique. I mean, they've gone to market themselves going from zero to five million subscribers in Japan. We're, today, you know, we're exclusively providing, you know, their front hall gateway solution for their growth. They have, I think, 16 trials underway with customers that are leveraging their architecture many of those will have a need to leverage their platform reference design, which we're a big part of. There is some meaningful business there that we're not, unfortunately, in a position to disclose right now that we think closes in Q4 and begins to roll out in the first half of next year, which could be very exciting for us. And separate and apart from that, I mean, you know, we continue to be very – pursuant with the Tier 1s, both on the fixed wireline side as well as on the mobile side.
spk03: Okay. Thank you very much.
spk13: Well, thanks for the questions.
spk11: There are no further questions at this time. Ladies and gentlemen, this concludes today's conference call. Thank you, everyone, for participating. You may now disconnect. Music Music Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Ladies and gentlemen, thank you for standing by, and welcome to the DZS Quarter 3 2021 Earnings Conference call. 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 1. The conference is being recorded. If you require any further assistance, please press star 0. I would now like to turn the call over to Student of Investor Relations, you may begin.
spk02: Thank you, Marjorie, and welcome to the DZS Third Quarter 2021 Earnings. CEO, Charlie Vogt, and CFO, Misty Kowicki. Yesterday, after market closed, we published to the Investor Relations section of the DZS to provide shareholders, prospective shareholders, and analysts with market insights, product, business, and financial updates, as well as forward-looking statements. and other forward-looking statements regarding future events or the future financial performance of the company. The company cautions you that such statements or results may differ materially. Please refer to documents that the company files with the SEC, including its most recent 10Q statement section of the shareholder report that was filed on a Form 8K, as well as being available on the Investor Relations section of our website. results to differ materially from those contained in the company's projections or forward-looking statements. Please note that unless otherwise indicated on GAAP basis, these items together with corresponding GAAP numbers and the reconciliations to GAAP are contained in the. During the fourth quarter, we will plan to participate in investor conferences hosted by Stiefel, Needham, Craig Hallam, and
spk14: Thank you, Ted, and welcome investors, analysts, and guests. I'm pleased to share that for the fifth consecutive quarter, we delivered strong sales momentum with quarterly revenue above the midpoint of our guidance and gross margin and adjusted EBITDA that exceeded the high end of our guidance. Q3 2021 marked our third consecutive quarter with orders exceeding $100 million, resulting in backlog of approximately $200 million, nearly three times higher than a year ago. Even though we were challenged by supply chain availability, price increases, and foreign exchange variations, we delivered revenue of $88.4 million, which was above the midpoint of our guidance, and our 36.8% adjusted gross margin and $5.1 million of adjusted EBITDA were well above the high end of our guidance. With the current supply chain challenges during the third quarter, Without the current supply chain challenges during the third quarter, we estimate our gross margin performance would have been approximately 39%, illustrating the effectiveness of our product rationalization, alignment with component and contract manufacturing partners, and a more balanced North America, EMEA, and Asia geographic mix. During the first half of 2021, we outlined to industry and financial analysts and shareholders the market opportunity and company-related transformational themes that we anticipated would lead to long-term sustainable growth and profitability. As we expand, we have been laser-focused on the following four themes. First, market share gains and growth within North America and European regions. While we're in the early stages of an aggressive playbook, early results have led to a North America order increase of 125 percent year-to-date compared to the same period in 2020. Second is that technology shifts and investment cycle that is underway evolving from legacy copper and sub-1 gigabit technology to next-generation multi-gigabit broadband connectivity solutions, which are delivering growth across North America and EMEA and with higher margins. This shift to multi-gigabit architecture has also enabled DZS to introduce high-value network and subscriber-based software platforms. Third is a transformational wireless technology shift in industry momentum towards a next-generation 5G architecture fueled by emerging service providers, such as our leading Open RAN customer, Rakuten, who surpassed 5 million subscribers during the third quarter. Rakuten has successfully launched Rakuten Symphony, which is designed to accelerate the deployment of Open RAN networks around the world, and with our mobile XL solutions playing a key part of the reference design. And finally, our strategic pursuit to cap and eventually replace Chinese equipment suppliers that are being de-emphasized in the United States and many European and Pan-Asian countries, including India. Our sales pipeline RFP and trial activity during the first nine months of 2021 has been encouraging. And during the third quarter, we secured a large scale broadband connectivity project with a tier one service provider in India. Our product rationalization, next generation 10 gigabit class PON technology and strategic investments in software orchestration, automation, service assurance, and subscriber experience solutions are designed to differentiate and enhance our more than 20 million platforms deployed around the world. Our multi-gigabit PON and subscriber-influenced software strategy is on display in our newly launched Accelerate and DZS experience solutions, both of which are complemented by DZS Cloud, which was launched in March of this year with TELUS as an anchor customer. Our cloud-native network and subscriber software portfolio will provide communication service providers with the applications, automation, and intelligence to more effectively manage their residential and business subscribers, creating new revenue opportunities and operational savings. Our product rationalization workstreams have yielded reductions in SKUs by nearly 60%. While there are many valuable sales, service, and resource alignment benefits, the reduction in SKUs is also reducing supply chain risk. Furthermore, we improved our manufacturing and supply chain efficiency across our global infrastructure as we consolidated our manufacturing operations and enhanced our supply chain partnerships to continue to successfully navigate through a difficult supply chain environment. Looking ahead, we anticipate the trends experienced throughout 2021 will continue in Q4 and into 2022. Specifically, demand for next-generation fiber-based broadband connectivity solutions fueled by consumer demand and accelerated by an estimated $100 billion in government stimulus, demand for network and subscriber-influenced software solutions that will provide operators with differentiated service offerings, the emergence and adoption of Open RAN 5G networks, Chinese equipment supplier cap and replacement opportunities, and persistent supply chain challenges. As it relates to the fourth quarter, we are guiding to a wider than usual revenue range of $80 to $100 million to the current supply chain environment. We have the backlog to deliver to the high end of the range, assuming our component and contract manufacturing partners are not hindered during the quarter. We anticipate a gross margin range of 32 to 34 percent, reflecting near-term supply chain cost increases, expedite fees, and foreign exchange variations, specifically with the Japanese yen. As we overcome the current supply chain headwinds, we believe the operational efficiencies underway and our new commercial strategies will deliver the long-term growth and margin expansion outlined in our Q2 shareholder report. I would now like to turn the call back over to the operator to begin our Q&A session.
spk11: As a reminder, to ask a question, you will need to press star 1 on your telephone. To answer a question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Ryan Kuntz from Needham & Company.
spk06: Good morning, Charlie. I wonder if you could walk us through the price increase opportunity here and kind of Is there a shot clock here that you have to give them time to place orders to the old price? Is this a temporary change related to freight, or are you implementing it on a permanent basis? Any little clarity like that would be helpful. Thank you.
spk14: Well, the price increases that we've received from many of our component supplier ecosystem group has not been something that has been deemed to be permanent, although I think we are assuming that the price increases that our entire industry is seeing is likely to be elongated. Those price increases really began in the May, June, July timeframe. Some of them came as late as September, some of which were already experiencing price increases, some of which we won't see the price increase until the first part of next year. I think what's important for everybody to appreciate, and I think it's frankly consistent across everyone in the entire sector, is some of the price increases affect current backlog, depending on when raw materials were pulled in, either to one of our contract manufacturers, or in our case, to our Florida manufacturing facility. And other components and raw material are scheduled to be delivered in 2022. What we decided to do, and we put a lot of time and energy into this, we spent a lot of time with a lot of our Tier 1 customers and channel partners, was we began increasing prices October 1st. And we're using this term commercial strategies because that's really what it is. I mean, we're being very thoughtful about the various price increases across the various portfolios, but we believe that the price increases that we've implemented will more than offset the price increases that we've been navigating and will navigate over the course of next year.
spk06: So it sounds like it's a multi-quarter implementation. Is that how we should think about it? I mean,
spk14: Well, if you look at the margins that we were able to deliver in Q3, I think from our perspective, if you pull out some of the expedite fees, and that's a new term for our industry. We've really never seen this category that we're referring to as expedite fees. You know, normal lead times are, you know, depending on the component and the supplier, could be as long as 52 weeks. Now, we got ahead of things, I think, better than most. And I talked about this over the last two quarters late last year in the September-October timeframe. You know, just because we had a lot of visibility with a lot of our tier ones, we were able to get ahead of a lot of the forecasting requirements at the raw and systems level. And I think that has really helped us, especially with our Q3 margins. But I think that, you know, what we're expecting to see in the very near term, and I'm saying Q4, maybe Q1, is, you know, some expedite fees that will have some margin impact. But I think that investors and shareholders, excuse me, should think about the longer-term aspects of new orders that we're booking at the margin profile that I think aligns with our long-term margin expansion profile. That and we certainly expect, you know, our DZS cloud and our new DZS experience software portfolio to begin to deliver higher margin in, you know, in the second half of next year.
spk06: Okay. And On the timing on the mobile side, so like mobile was a little weak in the quarter, so like timing of some of the deployments, is that mix change going to shift in Q4 a bit there, and that's another headwind in Q4 on margins, I assume?
spk14: You know, look, I mean, on the wireless side, you know, and I think we're not the only ones, but I certainly think that the catalyst for DCS and others in our ecosystem is really the adoption and the acceleration of Open RAN, which, you know, in the activity and, you know, specifically in what's going on from an RFP and from a trial perspective, launching, you know, RocketCon Symphony, which is leveraging a lot of their own intellectual property that they've garnered. And DCS, as they... you know, have success with their own Open RAN network architecture, we aim to be able to participate in the adoption to Open RAN, and we certainly see that accelerating in 2022. Okay, great.
spk06: And just one last one, if I could, on... On the Huawei replacement opportunity timing, are you starting to see some decisions now there? And when should we think about that starting to impact revenues for you?
spk14: Well, the large scale project that I just referred to during my opening remarks was a Huawei replacement project in India. I mean, and I know The general market gets nervous about large-scale projects in India from a margin perspective, but I do think that India as a country and at least the four large-scale service providers there realize that in order for them to adopt technology from North American, European-based companies, the pricing and margins kind of change. So that's an exciting win for us. There are several large companies tier ones that we are aggressively pursuing in Western Europe. And a lot of those decisions we expect to be made between now and the end of the year. And I think there's certainly a great opportunity for DZS, especially with most of those companies already having Nokia in their network and they're looking to replace Huawei with at least one or maybe even two additional technology suppliers.
spk05: Great. Super helpful, Charlie. Thank you.
spk14: Thank you.
spk11: Our next question comes from the line of Dave Gann from Beer Riley.
spk08: Yeah, good morning. My first question is maybe if I could get a mix between broadband and mobile for your backlog of $200 million.
spk14: I don't have that off the top of my head, Dave. I can research that before the end of the call to make sure I give you an accurate mix. I don't know that we've ever given that number, so I don't know that we want to start issuing a percentage of our backlog as a mix of both.
spk15: Got it. I think we could assume that it's of what you've seen throughout
spk14: you know, this year, uh, from a percentage of fixed and mobile.
spk16: I mean, there is, there's.
spk08: Got it. And then, um, regarding that, that, uh, major, uh, tier one Indian contract that, that you, I mean, India was fairly big a few years ago. Can you get back to that level and how long, I mean, can you talk about, talk about sustainability?
spk14: Well, we're certainly encouraged. I mean, you know, it's not just with the operator that we're, you know, participating in here initially. I mean, all four of the operators have pretty significant work streams underway. You know, look, I mean, you know, I've always been cautious about India, but I would tell you that we're more – we're more positive on India today, I think, than I've ever been just because of the dynamics. You don't have the Chinese suppliers that are putting a lot of margin pressure and pricing pressure on the competitive nature of it. And frankly, we're able to pick and choose. I think we've tried to make it very clear to analysts and shareholders that where things are strategic, we may be a little bit more aggressive from a pricing and margin perspective, but we're committed to getting to that 40% gross margin level. And I think that we're going to make sure that, you know, all the projects that we participate in, including the large tier ones, will enable us to get, you know, to the margin profile that, you know, we've laid out for ourselves and shareholders. So we're encouraged, frankly, with the opportunity in India. We're very encouraged with the opportunities we're seeing in Western Europe. And look, I mean, North America has been you know, just, I mean, it's exceeded all of our expectations this year. I mean, we were obviously very focused on North America. We've got a lot of great relationships that go back 20 years, but the fact of the matter is, you know, year-to-date orders are up 125% compared to the same period last year, and the momentum that we're seeing in North America, which obviously garners the highest margins, is pretty exciting and encouraging for us.
spk08: Got it. And speaking of Americas, it was 31% trending up nicely last At this rate, I mean, can we expect maybe 40% by maybe second half next year? Is that a realistic goal?
spk14: I won't comment on it. It certainly is in line with a lot of our expectations.
spk08: Got it. And my last question is just wanted to... clarification on the gross margin. It's going to be approximately 33% fourth quarter. It sounds like this is going to be the bottom, maybe first quarter, maybe flat to up a little bit. But then going back to your target of 40%, with 33% as the starting point, I mean,
spk14: uh is 40 maybe by late next year is it still achievable and if so can you kind of walk us through the steps of how you're going to get there again i think what what shareholders and analysts ought to be looking at you know across our entire sector especially where there's a lot of systems and hardware content um you know even even with some of the software elements um Everyone's backlog is being impacted by the price increases. The way most of the price increases have been implemented by the broader ecosystem is such that regardless of whether or not there were orders in the system or not, when they began shipping to you based on whatever active date it is, that was the effective price increase. That's why I think we're going to see a slightly lower margin profile in Q4 and probably Q1 as we flush out the backlog. All the new orders that we're bringing in that began in Q1 will be at the new margin profile, which aligns with our target margin for 2022. And I think we had sort of outlined in our Q2 shareholder letter that we thought we could get to a margin profile in that, you know, 37% range next year and 40% in 2023. And that still holds true for the model that we have internally.
spk08: I guess expedite fees, I guess that's a big component of elevated supply chain costs. Has that kind of stabilized? And is that why we're thinking, you know, right now we are kind of bottoming here?
spk14: I know a lot of people keep saying we're bottoming. You know, I think that I think that the expedite fees, like I said, it's sort of a new phenomena. From our perspective, we're not modeling in a lot of expedite fees in 2022. There certainly has been expedite fees that we've navigated in Q2, Q3, and we will see some in Q4 with a couple of large projects that we need to deliver on, and I think that's really you know, the way everyone should look at it. I mean, you know, if in a perfect world you're forecasting perfectly and you're receiving orders aligned with that forecast, there's no expedite fee. It's when you have an unexpected project or you're pulling in a project that you need for a customer that you're trying to pull forward the delivery dates from some of the component suppliers. That's when they're charging you a quote-unquote expedite fee. As I said, we saw some in Q2 and Q3. I think we did a great job navigating the expedite fees in Q3. We haven't really talked about the foreign exchange impacts that we saw this year, especially with the large amount of business we do in Japan. But when you look at dollar against the yen, it's certainly been something that surprised us this year. I think we'll do a much better job managing that next year. But I think to your question, Dave, We don't expect to see the same amount of expedite fees next year just based on the alignment of our backlog and the alignment with the forecast plan that we have next year. So I think the price increases that, you know, and the commercial strategies that we'll be implementing will certainly offset the price increases that we're seeing, at least, you know, in the near term from our ecosystem.
spk09: Got it. Thank you.
spk11: Again, if you would like to ask a question, please press star then to number one on your telephone keypad. Our next question comes from the line of Tim Savageau.
spk18: Hi, good morning. Question more around the kind of top line outlook, and I know you've been targeting kind of an eight to 10% sort of growth range. And I'm not sure whether you've quantified the impact on revenue from supply issues this year, but obviously you're building backlog. Significantly, you've mentioned this order in India, which I guess is looking to ramp sometime in calendar 22. I mean, given the combination of maybe backlog increase and supply issues pushed into 22, overall kind of market growth in the U.S. and some of these new projects. Is it fair to expect above-trend growth in calendar 22 driven by all those factors? Thanks.
spk14: Yeah, thanks, Tim. You know, look, we haven't, you know, we've spent, as most companies do this time of the year, we've spent a lot of time analyzing 2022 already. You know, we're not prepared to talk about 2022 on this call, but I would say that the 8% to 10% that we had profiled last quarter, we still feel very confident that that's achievable. As with almost every year I've participated in over the last 25, 30 years, there's the known and the unknown. And when we enter 2022, we're excited about the known, But there's always, you know, upside and there's also risk that you got to balance. But, you know, if I look at the amount of RFP and trial activity that at least we're involved with today, you know, we certainly, you know, are entering 2022 with a lot more enthusiasm and a lot more excitement than I think we did in 2021. And we entered 2021 not seeing, you know, the supply chain challenges hitting this entire segment as it has. And I think we've actually done an extremely good job navigating the supply chain challenges. I mean, we've got a very unique sales and sales finance and supply chain interlock process that we have implemented when I got here. I think that has really helped us. But to answer your question, I think we feel very optimistic about 2022 despite the supply chain headwinds. And I think as you think about revenue, if we're successful with our commercial strategies and price increases, that certainly is going to have a positive impact on top line revenue.
spk17: Great. Thanks very much.
spk11: Our next question comes from the line of Christian Swath from Cape Holland.
spk07: Great. Thanks, guys, for taking my question. I just have a quick question on clarity on backlog. With the price increases taking effect on October 1st and the significant backlog increase in September, was that telegraphed? Was some of that business pulled in? Or should we think about that as true backlog strength that was going to occur
spk14: um you know just due to end market demand and the in the four big growth drivers that you had that you that you outlined earlier in the call i'm just wondering if you could clarify that for me please no it's a great question and um i'll give you a straight answer you know we haven't pulled forward anything uh i mean everything i you know i'd like to think that we could pull forward more than what we have you know we're certainly you know, rolling up our sleeves with our large tier one customers to make sure that they're well educated about the supply chain environment and making sure that we're not hindering their deployment strategy. But, you know, the backlog that we've created in 21 has really been all demand related. In fact, you know, for the most part, I would say 75 to 80% of our $200 million backlog, if we had all of the components, we could ship it tomorrow. So We don't have any backlog that's sort of, we're not piling up backlog for 23. We're facilitating a backlog for immediate projects today. And that's why we've got a wide range for Q4 revenue. I mean, if we're successful in aligning the components to the requested chip dates, we've got an opportunity to have a really strong Q4. But I think we're still in this sort of period, Christian, where, you know, all it takes is one component to cause us to not build, you know, a lot of systems. And so, you know, we're being, I think, you know, fairly conservative and relatively cautious just because we don't want to mislead and misguide. But the backlog that we have today is backlog that, you know, we can ship as soon as we have the parts, which, by the way, we're trying to balance. I mean, if we pull everything forward from an expedite fee, you know, you're going to have a margin impact. And so we're trying to balance that the best we possibly can. And I think, you know, for the most part, you should look at the $200 million worth of backlog as backlog that, you know, will likely flush out in Q4 and mostly in Q1.
spk07: Great. Thanks for that clarity. That was my only question. Thank you.
spk11: Our next question comes from the line of Paul Essie.
spk04: Thanks for taking my question. Wanted to get a little bit more color on this Plume partnership. How does it work? What are the service providers? What are their benefits from this? What do you guys benefit? And how quickly Can you expect me to penetrate the 20 million subscribers you've got out there that are in place?
spk14: No, I appreciate the question. Yes. As I think most people know, we, we announced a strategic partnership with plume, you know, during the quarter, it's a relationship that we've been fostering throughout 2021. And, and I think as you know, we, as we successfully rolled out DZS cloud, which. is really a network as a service software platform. So DCS Cloud is really designed to deliver orchestration, automation, service assurance, application management type services that will come in the form of either enterprise licenses or subscriber based licenses, or I'm sorry, application licenses. What Flume does is it really complements what we're doing with VCS Cloud, and it allows us to participate inside the home. It allows us to differentiate our next-generation Wi-Fi 6 CPE portfolio with embedded on-sync software from Flume that allows service providers to have a much different experience as it relates to Wi-Fi performance enhancement capabilities, more data analytics capabilities. capabilities that ultimately are going to allow service providers to think about new revenue opportunities. It's going to allow them to reduce the amount of truck rolls. And when you combine DZS Cloud and Plume, I think we're the only company in the broadband industry that has a complete end-to-end software portfolio from what's going on at the core all the way inside the home or small business.
spk04: Okay. How quickly are you going to roll that out in the first quarter?
spk14: Yeah, well, I mean, we've been forecasting. I mean, we were very thoughtful about this because, you know, what we're doing at Plume really aligns with Wi-Fi 6. And our Wi-Fi 6 portfolio is launching from a product availability perspective in Q1. And so we wanted to make sure that, you know, we didn't launch something that, you know, customers didn't didn't have access to. And so we'll have products available for shipment towards the end of Q1 and into Q2. And so right now, we're focusing on booking orders for our cloud-based portfolio that we expect that the bundle of the software solution with our CPE products will ship towards the end of Q1 and into Q2. So we certainly got a pretty ambitious appetite for the second half of 2022. And by the way, we've got a whole series of what we call DCS experience webinars that will launch this month in the month of November.
spk04: Okay. A couple questions on some of the subsidies the U.S. government is putting through. Like RDOF, we're hearing it's just been kind of trickling in. What's your assessment of that? And also in Europe, you said a lot of the money is poised to be let go soon. Can you update us on both of those situations?
spk14: Yeah, so I mean, you know, if you go back 18 months, everyone's been talking about the, you know, the infamous $20 billion of RDOF funds, which is a, as I know everyone knows, is a multi-year deployment. Up until really Q3, there was only about $300 million of that, you know, of the initial phase one $9 billion that got deployed. As of Right now, there's a billion dollars that's been released. So that's good. So we're starting to finally see a lot of the RDoF dollars, you know, that are impacting some of our large customers like Consolidated Communications and others that are beginning to see some of those dollars go to work. We don't talk enough about what's going on in Europe, but there is a number of countries that have significant multi-billion dollar stimulus funds that are coming out of their, you know, government institutions that are also fueling a lot of broadband initiatives across, you know, many countries around the world. And then, you know, assuming that the infrastructure bill gets passed and, you know, we're still assuming that, you know, the broadband element of that is still about $42 billion, you know, that certainly is going to have an impact, I think, more in the 2023 timeframe. just because by the time it gets implemented in Q1 of this year, it'll be something that, you know, begins to roll out towards the very far end of 2022 and into 2023. But, you know, UK's got their Freedom Fiber. You know, Germany's got their utilities in Bulgaria. And so I think that, you know, between just the UK and Germany, there's close to $20 billion of funding.
spk04: One last question. You mentioned in your letter that there's a lot of open RAN or more open RAN opportunities in Asia. Can you discuss them outside of Rakuten? Who else you're talking to, if you can, or what types of projects you're running into there?
spk14: Yeah, I mean, just from a competitive standpoint, I'm not going to share, you know, the projects and the companies that we're engaged with, but I would tell you that there's a tremendous amount of momentum across Europe, Middle East, There's a lot of activity across the Pan-Asian markets for O-RAN. And I think even here in the U.S. and Canada, there's a significant amount of activity that's underway for O-RAN. So I think O-RAN is here to stay. I think it's something that carriers that had already begun to roll out their 5G networks are sticking with that initial deployment. But I think phase two of their 5G deployment will lean in towards more open RAN architectures. And I think that certainly opens the opportunity for companies like us to participate in a more meaningful way.
spk04: Okay. Do you have a sense of timing when that could be?
spk14: You know, we keep, you know, I mean, what we're seeing on our, you know, I mean, we've got, I mean, if you just look at Rocket Town alone, which I think what they've done is pretty unique. I mean, they've gone to market themselves. going from zero to five million subscribers in Japan. Today, we're exclusively providing their front-haul gateway solution for their growth. They have, I think, 16 trials underway with customers that are leveraging their architecture. Many of those will have a need to leverage their platform reference design, which we're a big part of. There is some meaningful business there that we're not, unfortunately, in a position to disclose right now that we think closes in Q4 and begins to roll out in the first half of next year, which could be very exciting for us. And separate and apart from that, I mean, you know, we continue to be very pursuant with the Tier 1s, both on the fixed wireline side as well as on the mobile side.
spk03: Okay. Thank you very much.
spk13: Well, thanks for the questions.
spk11: There are no further questions at this time. Ladies and gentlemen, this concludes today's conference call. Thank you everyone for participating. You may now disconnect.
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