DZS Inc.

Hello, my name is Jean-Louis. Welcome to the DZS Q1 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After this remark, there will be a question and answer session. If you would like to ask a question during this time, simply press star 1 on your telephone keypad. If you would like to withdraw your question again, please press star 1. I will now turn the conference over to Mr. Ted Moreau, Head of Investor Relations. Please go ahead.

Thank you, Jean-Louis, and welcome to the DZS first quarter 2023 earnings conference call. Joining me today to discuss our results are DZS President and CEO, Charlie Boat, and CFO, Misty Kweki. Chief Product Officer, Miguel Alonso, is also on the call to participate in the Q&A session. After market closed today, we published our first quarter earnings release along with an updated investor presentation, which will be referenced throughout today's earnings call. And you can follow along with Charlie and Misty's commentary. Our discussion today will contain forward-looking statements based on our current expectations regarding future events or the future financial performance of the company. These statements are subject to risks and uncertainties, and actual events or results may differ materially. Please refer to documents that the company files with the SEC, including its most recent 10Q and 10K reports, as well as being available on the Investor Relations section of our website. 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 today's earnings press release. During the second quarter, we will be attending investor conferences hosted by Needham, B. Reilly, Craig Hallam, Cowan, and Stiefel. Additionally, this Wednesday, May 10th, we will look forward to hosting investors and analysts at an exciting investor day that we have planned at our headquarters in Dallas. I will now turn the call over to Charley.

Thank you, Ted, and welcome to our first quarter earnings call. As reflected in our first quarter 2023 operating results, and despite a robust backdrop for smart, secure, and high-speed broadband solutions, certain customer deployments and certain customer inventory levels hindered our ability to maximize revenue at the high end of our revenue guidance. Beneath the headline numbers, we continue to make encouraging progress in positioning the company to benefit from what will be a favorable long-term secular growth trend. I'm referring to both revenue growth and improved gross margin expansion, which combined will deliver favorable financial results measured by earnings and cash flow. Aside from our relentless focus on customers, revenue and margin growth have been our two primary areas of focus. As it relates to gross margins, we anticipate that 1Q 2023 will mark the low point for gross margin. Furthermore, we expect to deliver gross margin and earnings improvement throughout the balance of 2023 aligned with our backlog and anticipated in-year revenue conversion. While segments of the broadband market have been impacted by the current macroeconomic environment, slower than expected approvals and disbursements of government stimulus funds as well as inventory management challenges, the secular demand drivers for broadband everywhere remains robust and unchanged. While we expect market trends to favorably benefit our revenue and margin growth outlook over the long term, the investments we are making in technology, our IT infrastructure, and with marquee service providers are designed to expand our reach, improve our revenue growth, and expand our margins in order to deliver meaningful improvement to earnings and cash flow. Our recent design wins with Tier 1 service providers and numerous category-defining product launches are validation that our vision, strategy, and playbook are aligned with what service providers around the world are seeking to deploy. While it will take time for these design wins to translate into deployments and revenue, we believe our momentum ultimately translates into meaningful revenue growth and will validate our competitive position across the fiber to the premises and mobile broadband markets. Our new products are differentiating and improving our competitive position within these two markets. With the introduction of our Sabre 4400, we are creating a new access optical edge category aligned with mid-mile transport, which is being fueled by last mile fiber and 5G broadband deployments. As we will share in more detail, we are accelerating in-year cost savings to deliver favorable impacts on earnings and cash flow during the second half of 23 and into 2024. During the first quarter, we delivered $91 million of revenue, 33% non-GAAP gross margin, and a non-GAAP earnings per share loss of $0.06. While our revenue was at the low end of our $90 to $100 million revenue guidance, revenue for the quarter represented an increase of 18% year over year and 23% on a constant currency basis. On a regional basis, America's revenue increased 9%, EMEA was relatively flat, and our Asia region increased 32%. Within our Asia regional performance, our Pan-Asian sub-region, which includes India, increased 260% over the year. On a product segment basis, our software and service revenue contributed approximately 13% of revenue, representing an increase of 148% year-over-year. Notably, for the first time in nearly two years, supply chain sourcing and component availability, as well as elevated supply chain costs, did not significantly surprise or impact our results. While our 33% non-GAAP gross margin was within our guidance range, our adjusted EBITDA was at negative $4 million, due to the timing of higher investment levels that were required to support and deliver on recent and forthcoming design wins. Along with numerous other companies throughout our industry, we are increasingly confident that supply chain will continue to improve throughout the year and into 2024. Strategically, we remain laser focused on positioning the company to capture market share in the fiber to the premise and mobile broadband market, ultimately improving on long-term earnings and cash flow sustainability. With an expected improvement to gross margins, we expect favorable impact to our operating leverage and earnings. As mentioned earlier, we expect sequential improvements in gross margin every quarter throughout the year. Several factors underpin our confidence to deliver higher gross margins and improved earnings over the long term. Sales growth in North America and EMEA, growth with recurring software, higher margins associated with new product introductions, and operational efficiencies aligned with third party contract manufacturing partners. While many government broadband subsidy disbursements have been slower than expected to convert, the bulk of the disbursements remain ahead of us over the next several years. Our current pipeline, trial activity, and project visibility remain robust. and we believe the current deployment schedule timing and inventory management related challenges are transitory in nature. As the fixed and mobile broadband markets adjust to post-COVID environments and supply chain challenges improve, we believe our competitive position with our differentiated infrastructure and software solutions will enable us to secure meaningful new design wins spanning the globe. Our new products and roadmap, which we will cover in more detail Wednesday during our investor day, include our recently announced Access Edge Velocity V6, our new Metro Optical Edge Sabre 4400, our new mobile cell site router M4000, and our new Xtreme network and service automation and orchestration platform. We also expect these products to, in aggregate, to have a favorable impact on our gross margins over time. While we remain focused on positioning the company to capture market share in what we anticipate Being a robust five to 10-year fiber of the premise and mobile broadband investment cycle, investors should appreciate that the past two years represented an unprecedented industry-wide set of challenges, from component availability to cost increases to foreign exchange fluctuations and inclusive of our manufacturing transition and a global ERP conversion. As such, providing revenue margins and earnings guidance has been challenging. Looking forward, as the broader market dynamics stabilize and with manufacturing transition and IT systems integrations complete, we now have the scale and real-time visibility to forecast with better predictability. Our first quarter earnings shortfall was a result of revenue and gross margins converting at the lower end of our guidance range and slightly higher operating expenses. We ended March with $31 million in cash and with inventory lower at $70 million. Sequentially, our cash balance was lowered by $7 million due to the timing of collections and inventory required with investments. Our accounts receivable of $141 million at the end of March provides for a favorable opportunity to improve our cash balance and working capital in the coming quarters. First quarter bookings of $80 million was balanced between our Americas and EMEA region at 51% and Asia at 49% and reflects an expected rebalancing alignment with existing backlog, improved lead times, seasonality, and customer deployment schedules. While our pipeline, trial activity, and project visibility remains robust, our customers are shifting lead time delivery expectations from 12 to 15 months to an expected 3 to 6 months. While we expect Asia to continue to grow and led by South Korea's leadership position in 10 gigabit PON and 5G broadband, Vietnam and India are expected to grow at above market growth rates. We further expect product evaluations and trials currently underway in the United States and Europe to convert to design wins and ultimately deliver favorable orders and revenue growth as well as gross margin expansion. Of our $304 million of RPOs, we anticipate that we will convert $190 million to revenue this year. As a reminder, we have historically converted approximately 70% of our in-year revenue from orders booked during the same period. Compared to the previous 10 years, our backlog aligned with expected revenue is significantly higher, providing us with more visibility than in previous years. As we assess the remainder of 2023 and considering today's recessionary concerns, inventory levels with certain customers, and the timing of government stimulus disbursements, we are revising our full-year revenue outlook to approximately $400 million. As a result of the successful completion of numerous product, IT, and manufacturing work streams, we are accelerating approximately $12 to $13 million of cost savings that we expect to realize this year. Our cost savings are anticipated to offset most of the adjustments to revenue, resulting in an adjusted EBITDA range of between $22 and $27 million. We expect to deliver significant adjusted EBITDA growth and positive operating cash flow during the second half of 2023, and we anticipate ending the year with approximately $40 million of cash. and with our only debt consisting of our five-year term note associated with our ASEA software asset acquisition. Upside to our revenue and EBITDA guidance would come from government stimulus disbursements occurring sooner than anticipated, a stabilizing of the financial markets, the timing of completing product trials currently underway, and the pace of adoption of our new product launches. Reinforcing our optimism, I recently returned from weeks of travel visiting with numerous service provider executives across the United States and Europe and received resounding feedback that DCS remains well positioned and on track to secure new design wins that will further enhance our long-term growth outlook. While there is heightened enthusiasm regarding the fixed and mobile broadband investments countries around the world will be making over the coming years, We expect a similar amount of private equity investment and service providers' self-funding of broadband build-outs. I am more and more convinced that service providers have the unwavering commitment to deploy fiber of the home in 5G broadband services, architected and managed by software-defined networking tools and automation platforms. Service providers are embracing open platforms and implementing solutions at the network edge. and they are moving differentiated features closer to the subscriber to maximize performance, responsiveness, and personalization. The technology shifts to the network edge are creating new opportunities for DZS and are fueled by the accelerating demands of emerging applications and the competitive need to deliver enhanced subscriber experiences. Service providers understand the stakes are high and that to retain and grow their market share, they need to invest and advance in their networks. Appreciate that countries such as the United Kingdom, Germany, Italy, and India have deployed less than 15% fiber of the home and are at various phases with their 5G broadband build-out. Thus, a significant investment over the next several years is expected. Our investments, acquisitions, and innovation executed over the past few years are being validated by service providers around the world and are aligned with the global market evolution towards hyper-fast, low-latency broadband networks. Our investments are enabling DZS to differentiate itself and enable service providers to become experienced providers with a focus on agility, automation, security, and operational efficiency, resulting in market share gains, reduced customer churn, and ultimately, improving on customer satisfaction. We are currently active in many service provider trials with our access optical and cloud connected software solutions, which we expect to evolve to production deployments during the second half of 2023 and into 2024. Not including our technology alignment with mobile operators, Our current fixed wireline customers, including trials that are underway with new prospective service providers, represents approximately 300 million subscribers in aggregate. Over the next several years, market research firms expect the cloud-connected software market over the next several years to grow at an 18% CAGR, the optical edge market to grow at 10%, and the fiber-of-the-home market to grow at 19%. If these growth assumptions are correct, and assuming a 10 to 12 percent blended growth rate across the markets we address, the data suggests that our core business can grow to approximately $500 million in revenue by 2025. Assuming we execute and expand our gross margins and we moderate our operating expenses, we anticipate we can deliver adjusted EBITDA of between $40 and $50 million in 2024 and $60 to $70 million and 2025, with upside achieved by gaining share aligned with our five stated growth pillars. Our journey over the past two and a half years has been an all-encompassing transformation of the business, with our focus being innovation and customer alignment. As our recently announced customer wins validate, our innovation and differentiated access optical and cloud-connected software solutions are well positioned to secure additional marquee service rider wins during the second half of this year and into 2024. In closing, I would like to summarize the progress we are making with our five growth pillars, the first being the fiber broadband upgrade cycle, driven by the evolution to GPON and now XGSPON that is currently underway. We expect this upgrade cycle to continue for at least the next five to ten years, with the investment and pace of deployment varying by country and the size and scale of the service provider. The second growth pillar is our ability to gain market share in North America and EMEA. Over the past two years, we have experienced a 44 percent compounded annual growth rate in North America and 10 percent in EMEA. We expect these two regions to experience favorable growth in 2024 and 2025 due to the traction and progress we are making with many super regionals and multinational service providers across these two regions. The third growth pillar relates to the security concerns resulting in a de-emphasizing of certain technology suppliers. We are very active with numerous service providers around the world and expect incremental design wins to be awarded over the next 12 months. Our fourth pillar is the opportunity to leverage our existing install base of valuable customers to cross-sell. Our differentiated product portfolio enables service providers to design and deliver fixed and mobile broadband services based on category-defining open and standard-based solutions. Our fifth growth pillar and maybe best described as a call option for investors is Open RAN. While we have been instrumental in the technology and the evolution of O-RAN over the past several years, Open RAN is at a very early phase. We have been strategically aligned with Open RAN pioneers such as Rakuten Mobile, Rakuten Symphony, and other large-scale technology leaders. Multinational mobile operators, private and government sectors are keen to adopt and implement Open RAN due to the underlying benefits of opening the mobile network up to standards and broad-scale interoperability. There are numerous benefits for mobile operators to transition to Open RAN, including increased technology choices, reducing their exposure to vendor lock-in, and certainly to lower network costs. We remain bullish and confident in our long-term growth and financial outlook. We will continue to balance our investments with market timing such that we can optimize our long-term growth objectives while achieving our near-term profitability objectives. As service providers continue to invest in the network edge, we believe we are well-positioned to capitalize on the opportunity in front of us. During our upcoming Investor Day on Wednesday, we will provide insights regarding the fixed and mobile broadband market, a real-time status update with the various government stimulus programs around the world, and a more fulsome update regarding our product portfolio, trial activity, backlog, gross margin, and profitability targets. For those of you who are attending in person, I look forward to seeing you Wednesday at our headquarters facility in Plano, Texas. With that, I'll turn the call over to you, Misty.