DZS Inc.

Good day, ladies and gentlemen. Thank you for standing by. My name is John, and I'll be your conference operator for today. At this time, I would like to welcome everyone to the DZS Third Quarter 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. Thank you. I would now like to turn the call over to Mr. Jeff Burke, SVP, Marketing and Investor Relations. Please go ahead.

Thank you, John, and welcome to the DZS conference call to discuss Q3 2024 financial results. Joining me today are DZS President and CEO Charlie Vogt and Interim CFO Brian Chestnut. During our call, we will provide projections and other forward-looking statements based on our current expectations regarding future events or future financial performance of the company. Such statements are subject to risks and uncertainties, and actual events or results may differ materially. Please refer to documents that the company files with the SEC, including its most recent 10Q and 10K reports, and the forward-looking statements section of DZS's Wednesday, November 6th press release. These documents identify important risk factors which can cause actual results to differ materially from those contained in our projections or forward-looking statements. Please note that unless otherwise indicated, the financial metrics we provide to you on this call include those determined on a non-GAAP basis. These metrics, together with corresponding GAAP numbers and a reconciliation GAAP, were contained in the press release issued on Wednesday, November 6th, which we have posted to our website and filed with the SEC on Form 8K. We will also discuss historical, financial, and other statistical information regarding our business and operation, and some of this information is included in the press release. I will now turn the call over to Charlie.

Thank you, Jeff. It was a long night for Americans, so good morning and thank you for joining. We are pleased to report that our third quarter financial results delivered $38.1 million in revenue, representing an increase of 23 percent quarter-over-quarter. Our non-GAAP-adjusted gross margin was 36.7 percent, representing an increase of 6.5 percent quarter-over-quarter. Our operating expense increased during the quarter primarily due to the incremental cost associated with our netcom acquisition and our final restatement-related cost. Our adjusted EBITDA was unfavorable by $2 million compared to Q2 2024 due to our inability to convert backlog shipments by quarter end, revenue recognition timing, and various cost savings initiatives that are planned and committed, though not realized during the quarter. Despite a challenging marketing environment across the broader industry resulting from an over-rotation of inventory, higher cost of capital, and delays with numerous government stimulus programs, we have delivered sequential revenue growth on a continuing operating basis over the last four quarters. With our restatement behind us, our filings current, the sale of our network assurance and in-home Wi-Fi management portfolio closed, and optimism with a growing sales pipeline and robust backlog, we believe our best days are ahead of us. We chose to divest our network assurance and in-home Wi-Fi management portfolio for three reasons. The first was to create software independence and reduce the competitive friction we were experiencing with our Wi-Fi connectivity and Wi-Fi software management peers. The second was to improve our balance sheet, which we accomplished by securing $34 million in an all-cash transaction. And third was to recalibrate our technology and go-to-market focus centered on our core broadband access and connectivity systems and cloud-edge software solutions. During the third quarter, we made meaningful progress across several tactical and strategic initiatives. As we enter the fourth quarter, we established four key performance initiatives that will anchor us in Q4 and into 2025. Our first KPI is centered around growth, profitability, and improving our balance sheet. The recent $34 million sale of our network assurance and Wi-Fi management portfolio is reduced our debt by $15 million, and added $15 million of cash to our balance sheet. The strategic divestiture combined with Q3 shipments, inclusive of paid inventory, have improved our balance sheet as of the end of October. Based on a growing sales pipeline, schedule backlog, and interaction with customers and channel partners, we anticipate Q4 revenue and profitability to improve compared to Q3 2024. As we look ahead to 2025, we anticipate service providers will return to pre-COVID spend levels and normalize deployment patterns. We also anticipate the various government stimulus programs around the world, including the United States Broadband Equity Access and Deployment Program, will begin to accelerate funding during the second half of 2025. Our second KPI is focused on completing our cost savings initiatives, including the cost synergies associated with our recent acquisition of NetCom. These cost savings initiatives began in the first half of 2024, and we expect the total savings to be completed by year end 2024 and reflected in Q1 2025. Our cost optimization programs are inclusive of the divestiture of our former Asia business unit, as well as the divestiture of our network assurance and in-home Wi-Fi management portfolio. Our third KPI is executing the sales synergies resulting from the acquisition of Netcom, which adds market-leading fiber extension, home broadband, and fixed wireless access technology to our market-leading broadband access and connectivity portfolio. We are encouraged with a growing sales pipeline and the revenue conversion and backlog created in just 120 days since acquiring Netcom. During the past four months, we have begun to validate the cross-selling synergies with our existing customers and, likewise, the prospective synergies with our core broadband portfolio with the former Netcom customers established as part of our acquisition thesis. Our fourth KPI is focused on monetizing $79 million of inventory, which is aligned with our sales pipeline, schedule backlog, and projects in flight. While progress was made in Q3 relative to sales and shipments of paid inventory, a revitalized and growing sales pipeline and improved visibility with our scheduled backlog gives us better line of sight to inventory conversion to cash over the next four to five quarters. Our vision and strategy established over the past several years has been centered around the introduction of open, standards-based, next-generation broadband access and network systems and cloud orchestration and software automation solutions aligned with the large-scale incumbent service providers and emerging five-roller builders as well as utility providers. Announced a few weeks ago, our broadband access portfolio was formally certified as Build America, Buy America compliant, aligned with the $42 billion broadband equity access and deployment program. While the U.S. BEAD program has been front and center in the United States and has garnered much of the excitement across our industry, other countries, such as Germany, aim to make available billions of euros for the incumbent broadband service providers, emerging alternative fiber providers, utility operators, as well as other types of ISPs. We expect that the decisions and investments that we've made over the past few years, which includes more than $100 million of invested technology, will result in the continued growth and ultimately sustained profitability and positive cash flow. As many of you are aware, we appointed Brian Chestnut as our interim CFO in September following five months as Chief Accounting Officer, leading and managing the final phase of our restatement process. Prior to DZS, Brian was the Vice President and Corporate Controller of Continental Battery Systems, a billion-dollar U.S. distribution company, where he oversaw global accounting operations across the United States and Canada. Additionally, Brian held senior finance management positions at Jacobs Engineering and one main financial position and he began his career at PricewaterhouseCoopers. Brian, I want to thank you for the comprehensive and diligent work you and the team accomplished over the past seven months. The results have improved our internal controls, corporate governance, and overall close process. With that as a brief introduction, I'll now turn the call over to you to share more on our financial results.

Thank you, Charlie, and good morning, everyone. As Charlie mentioned, I've been with DZS for seven months, with the first five months focused on completing our restatement. I appreciate the opportunity to lead finance of the interim CFO as we look forward, focused on sustainable growth and profitability. Over the past year, the company has made improvements across the business, including internal controls, corporate governance, cybersecurity, supply chain management, and quote to cash. While we delivered favorable revenue and gross margin growth during the third quarter, Our expectations and work streams underway are designed to deliver better overall results in Q4 and across 2025. The leadership team is focused on balancing an encouraging sales pipeline with profitable growth and free cash flow. Revenue from continuing operations during the third quarter was $38.1 million compared to $31.1 million in the second quarter, an increase of 23% quarter over quarter, and an increase of 67.8% year over year. Adjusted gross margin from continuing operations for the third quarter was 36.7% compared to 34.5% in Q2 and 17.4% compared to the same period a year ago. Adjusted operating expenses increased incrementally by $1.9 million, or 8.9%, during the third quarter compared to the same period in 2023, primarily driven by the additional operational costs associated with our netcom acquisition. Year over year, and on a continuing operations basis, adjusted operating expenses decreased by $12 million, or 17.2%, from $69.8 million in the first nine months of 2023 to $57.8 million in the first nine months of 2024, as various operational cost reduction initiatives taken by management through 2024 have been implemented. Adjusted EBITDA for the third quarter was a loss of $9.3 million compared to a loss of $17.5 million in Q3 2023, an improvement of $8.2 million, or 46.8%. While our balance sheet ended the quarter with $5.7 million of cash and cash equivalents, our in-home Wi-Fi management and network assurance divestiture closed on October 25th generating $30 million of cash, which reduced our debt by $15 million and increased our cash balance by $15 million. During the quarter, our DSO significantly improved from 120 days to 83 days as a result of favorable collections. Our DPO at 242 days continued to lag during the third quarter, though with a combination of our network assurance and in-home Wi-Fi management sale, plus favorable sales during the third quarter, We expect to improve our DPO during the fourth quarter and into the first quarter of 2025. At the end of the third quarter, inventory was valued at $79 million, working capital was $24 million, and quarterly interest expense was $2.2 million, which includes interest and debt discount amortization. With the SEC restatement behind us and our public filings current, we are turning the page to more favorable outcomes. We are lowering our working capital by executing our scheduled backlog, converting inventory to cash, and micromanaging our operating expenses. With current KPIs and workstreams underway, we expect to achieve break-even on an adjusted EBITDA basis and positive cash results in 2025. Our acquisition of Netcom has resulted in accretive results to date. The acquisition enhanced our broadband connectivity portfolio with market-leading fiber extension, home broadband, and fixed wireless access solutions, as well as eight marquee service providers spanning the United States, Europe, and Australia. As we enter the fourth quarter, and as we prepare for 2025, Charlie highlighted our four key performance indicators, which are focused on growth, profitability, balance sheet improvements, cost savings, and business optimization, and synergies from our NetCom acquisition and converting the $79 million of inventory to cash. With that, I'll hand the call back to Charlie for his final comments.

As we look ahead to the immediate and medium-term future, many of our projects in flight and active technology trials are expected to convert to design wins and to revenue in 2025. Our interactions with customers, prospective customers, and channel partners indicate an improvement across the overall sector is underway and a resounding commitment to fiber and fixed wireless deployments over the coming years. We also expect excess inventory caused by abnormal lead times among service providers and distributors to continue to normalize over the course of 2025. With an encouraging sales pipeline, $90 million of backlog, $79 million of inventory, and with annual operating expenses lower by more than $20 million, we anticipate our financial performance will improve in Q4 and throughout 2025. We also expect favorable sales synergies from the NetCom acquisition, and we remain focused on converting technology trials to design wins and inventory into cash. In closing, I want to thank our employees and board of directors who continue to relentlessly and effectively support the company. Furthermore, I want to thank our loyal and committed customers who continue to benefit from our technology differentiation and our customer-first culture. Finally, I want to thank our technology, manufacturing, and broader supplier ecosystem who remained aligned and committed to our next chapter together. Looking ahead, we plan to share our Q4 business and financial results in early March. Until then, thank you for your time and attention today. I'll now turn the call back to you, operator, assuming there's any questions for Brian and I. Thank you.

Thank you. Ladies and gentlemen, we will now begin our question and answer session. If you are dialed in and would like to ask a question, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, simply press star one again. Thank you. We'll pause for a moment to compile the Q&A roster. Our first question comes from the line of Ryan Kuntz with Needham. Please go ahead.

Great. A couple questions for you, Charlie. What's your current visibility look like into the first half of 2025 in the U.S. market? Are you seeing any thawing in the kind of frozen climate we've had in the last year plus?

Yeah, I mean, we just finished our preliminary 2025 AOP last week, which really encompasses three buckets. The first is just our schedule backlog for next year. The second is, you know, our pipeline and the way we slice and dice our pipeline. And then it's just, you know, the overall synergies from the NetCom acquisition, which, you know, are actually validating, I think, a lot of the, you know, the thesis that we had going into it. There's a lot of synergies that we're beginning to validate. So, That, coupled with the fact that the company has certainly been under a cloud due to the restatement over the last year, and I think if you lift all of that and you see that at least we're seeing that a lot of our customers are working through a lot of excess inventory that they took on in 2023 and certainly this year. And so we're cautiously optimistic about the first half of next year, And so, you know, and that's primarily, you know, built on the U.S. market, Europe, and the Middle East. I mean, you know, obviously with NETCOM, we do bring on a new region in Australia and New Zealand, which, you know, will begin to be a reporting region in 2025. But, you know, those are the three core markets that we're seeing more visibility, certainly.

Okay, and then kind of double-clicking on the European opportunities and Middle East, any particular large opportunities that you're competing for? You'd point out, you don't have to list customer names, but can you maybe characterize some of the larger opportunities internationally?

Well, as I think most people who've been following the company know, we're doing business today with the three incumbent operators in the Middle East, And in Europe, we did announce a large design win last year that we expect that to begin deployments in the first half of 2025. So we've worked hard on that. And, you know, that'll certainly generate, we believe, significant revenue for us in 2025 and over the next, you know, five to seven years. You know, across markets like France and Spain, we're certainly very involved with the two large incumbents there, and they're certainly projects that we're hoping that will evolve in 2025. And so, you know, as I know you know and others that are following us, we've been very, very focused on the larger scale service providers since I joined four years ago. That's where a lot of our innovation efforts and sales and marketing efforts have gone into. And While last year, I think, was challenging for the whole industry, I think we've quietly made some progress on a lot of these trials, and we're expecting those design wins to convert into revenue next year.

Great. And one last one. What's your competitive landscape look like in fixed wireless for the NetCom products? Is that going up against... the big historical incumbents, you know, the Nokia Ericssons and Samsungs, or more the smaller wispy types like the Taranas and Cambiums and the like?

Yeah, not so much with Cambium. You know, I think, you know, from Cambium's perspective, there's probably more complementary aspects because I think they're more focused on the unlicensed spectrum. Our fixed wireless portfolio is more focused on the license spectrum. So to your point, you know, Toronto is, you know, certainly emerging. They have a proprietary platform from the core to the home, and we're certainly seeing them emerge into the market. I think, you know, it's just a different proprietary and cost structure that they have that I think the larger tier ones, which even in that market we're focused on, is a bit more challenging. So to answer your question, with our fixed wireless portfolio, we're seeing more of the traditional Nokia's as our competitive peers than anyone else.

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

Well, I mean, look, it wasn't in the commentary. Margins would have been in the 40s. We did take some inventory reserves during the quarter. So our margin profile was actually close to 650 basis points higher had we had not chosen to take some inventory reserves in the quarter. So I'd say that our margins are actually returning to where we expected them to be. And You know, as I know you know and your peers know, you know, when you look at our core broadband access portfolio, which represents our optical transport and OLTs, compared to our connectivity products, which now includes a much broader portfolio from NetCom, which has lower margins, The timing of when the deployments are in this fiber cycle and fixed wireless cycle from quarter to quarter has a lot to do with the mix and the margin profile from quarter to quarter. We're obviously hoping that we can get to a more balanced and blended margin profile as we go forward, but You know, as we divested Asia, which certainly was much more challenged from a margin perspective, you know, we think there's a path to sustaining margins even without the former Asia software business to get us close to 40%. So that's our goal, and I think we're proving that out at least this year.

Great, Charlie. Thanks a lot. That's all I've got.

Yeah, thank you. Again, if you are dialed in and would like to ask a question, please press star 1. As there are no further questions at this time, that concludes the Q&A session in today's conference call. Thank you everyone for participating. Have a pleasant day.