Q3 2022 DZS Inc Earnings Call
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
[music].
Yeah.
Good day and thank you for standing by welcome to the D. C. S third quarter 2022 earnings conference call. At this time all participants are in a listen only mode. 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 one on your telephone you will then hear a message that your hand is Reyes. Please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today, Ted Moreau head of Investor Relations. Please go ahead.
Thank you Carmen and welcome to the <unk> third quarter 2022 earnings Conference call.
Joining us today are <unk>, president and CEO , Charlie Robb CFO , Mr. <unk>, <unk> and Chief product Officer Mario Alonso.
After market closed today, we published to the Investor Relations section of the Dcs website, our shareholder report and a new investor presentation for the third quarter of 2022 to provide shareholders prospective shareholders and analysts with market insights.
Product business and financial updates as well as forward looking information.
Our third quarter Investor presentation will be referenced throughout todays earnings call.
We recommend you download that to follow along with Charlie Mcgough and Miss Steve's commentary.
On this call, we will provide projections and other forward looking statements regarding future events or the future financial performance of the company.
The company cautions you that such statements are only current expectations and actual events or results may differ materially.
Please refer to documents that the company files with the SEC, including in its most recent 10-Q and 10-K reports and the forward looking statements section of the shareholder report.
That was filed on a form 8-K as well as being available on the Investor Relations section of our website.
These documents identify important risk factors that could cause actual results to differ materially from those contained in the company's projections or forward looking statements.
Please note that unless otherwise indicated the financial metrics being provided to you on this call are determined on a non-GAAP basis.
These items together with corresponding GAAP numbers and a reconciliation to GAAP are contained in the shareholder report shareholder report referenced earlier.
During the fourth quarter, we will be participating in investor conferences hosted by Stifel Needham and Craig Hallum.
I'd now have the pleasure to turn the call over to Charlie.
Thank you Ted and welcome investors analyst and guests.
Ted shared today after the market closed we posted our third quarter shareholder report and an updated investor presentation, which provides an update on our business financial results market trends in 2022 outlook.
We continue to make significant progress with our four state of growth pillars. During the third quarter for the first time in company history, we delivered revenue in excess of $100 million.
Reflecting market share momentum robust software and service growth and with our core customers, who continue to accelerate their fiber and <unk> deployments.
$107 million of revenue during the quarter amplified our execution navigating a challenging supply chain environment and despite continued foreign currency volatility, resulting from a strong U S dollar.
$207 million of revenue represented an increase of 21% year over year and on a constant currency basis, an increase of 35% year over year.
We remain committed to capturing market share in North America, Europe , the middle East with approximately 70% of third quarter orders align with these regions and we now have surpassed $100 million in bookings for the seventh consecutive quarter.
Our go to market strategy over the past two years has been laser focused on large and medium service providers inclusive of emerging fiber over builders utility cooperatives and wireless Internet service providers, noting that wireless Internet service providers continue to augment their fixed wireless business with fiber based services.
Our strategic alignment with our customers and prospects have led to numerous product innovations accretive acquisitions in high margin software solutions.
Our fixed and mobile broadband portfolio offer service providers and open standards based next generation access optical subscriber in cloud edge software and system solutions designed to disrupt the status quo and enable our service provider partners to differentiate in the markets. They serve.
During the quarter Dcs was awarded two cloud software wins, both with large scale tier one service providers the.
The first to profile was a marquee service provider in Western Europe , and the second with a large scale national service provider in Asia.
The two cloud software wins represent continued momentum and adoption with our Dcs cloud platform. The Western European Ward was for our Dcs extreme orchestration and automation software solution. The service provider will be leveraging our entire Dcs cloud platform, enabling orchestration of revenue generating application.
Automation of services network assurance and in home Wi Fi experience management.
This award represents a significant opportunity Dcs has to bundle and cross sell leveraging our differentiated access and optical infrastructure systems and our cloud software platforms, which has been designed for large scale networks.
The second cloud software win was with our cloud check in home Wi Fi management solution, which enables AI driven network optimization automation real time data analytics and consumer experience management.
Complementing the timing of these two software wins last week Dcs Rajeev that 2022 excellent award from Cloud Computing magazine.
We remain optimistic that we can achieve our stated run rate goal of 40% adjusted gross margins as we exit 2023, and 45% adjusted gross margins by 2025.
It's worth noting that on a on a normalized basis accounting for foreign exchange and supply chain impacts our adjusted gross margins during the third quarter would have been 40%.
We continue to invest in advanced and highly differentiated access and optical edge solutions during the quarter, we unveiled the Dcs velocity V. Six.
I think the industry's most advanced next generation optical line termination system.
<unk> uniquely positions <unk> to capture new opportunities with service providers, including networks that are transitioning due to Chinese vendor security concerns the VCX mirrors the form factor of Huawei as first generation six argue all T. Though delivers an estimated 10 X performance improvement featuring a non <unk>.
<unk> architecture with a market, leading 800 gigabytes of capacity per slot.
<unk> and the Dcs lineup of next generation <unk> offer service providers, what we believe to be the only true seamless upgrade path to 50 gigabit access technology.
The sex innovative second innovative milestone introduced during the quarter was the sabre 4400, and environmentally hardened coherent optic rotem transport platform designed to address last mile broadband access aggregation at the network edge.
Sabre 4400 deliver significant deployment and operational cost savings as it eliminates the need for climate controlled environments.
Additionally, during the quarter, we announced the newly established strategic partnership with fabricate one of the world's leading contract manufacturers and our specialist and access and optical technologies.
As we transition internal manufacturers manufacturing to fabricate it will allow us to free up resources that have been dedicated to supply chain management and manufacturing.
Allowing us to shift our focus to more strategic growth initiatives.
We expect this partnership and the shift to a contract manufacturing model to deliver enhanced margins in 2023, resulting from improved product and lower cost operating.
Following my opening remarks, Magellan lines, our Chief product Officer joins me as we review several product and growth themes from our investor presentation for.
For those of you have downloaded the investor presentation. Please turn to page eight.
Align with Dcs growth aspiration slide eight highlights anticipated growth associated with the broad with the broadband upgrades Super cycle currently underway.
The chart represents a nearly 20% compounded annual growth rate aligned with our access and subscriber edge <unk> illustrated through 2027.
The source of the data is omnia, a highly regarded global market research firm.
Turning to slide nine you will see the current global government subsidies fueling the fiber and fiber broadband market totaling more than $100 billion.
The United States is leading the way with more than $70 billion.
It's worth noting that award winning service providers are likely to contribute 50% or more of the required capital investments.
Slide 10 represents the emerging applications that will continue to drive hyper fast low latency bandwidth requirements for home office and mobile devices.
To amplify the expected decade long investment cycle, we expect 50 gigabit last mile access to shift from roadmap discussions to reality by 2024.
Our lineup of royalties ranging from our <unk>, which includes our <unk> <unk> <unk> thousand 14, and newly allowance newly allowance B six give service providers favorable deployment flexibility and optionality in a seamless upgrade path to 50 gigabit PON to beyond.
Miguel will now speak to the next several slides starting with slide 11 Mcgill.
Thank you Charlie Slide 11 provides a visual representation of the excess network highlighting the areas, where <unk> systems and software are deployed by service providers today.
Adopt our cloud each product portfolio is made up of cloud software that interacts with the physical network to simplify service creation and lifecycle management.
Automated network operations functions and leverage AI to continuously optimize the performance of the <unk> network from the Central office to the subscriber devices in the home.
From left to right. The optical edge is defined by adapting optical technologies traditionally associated with the optical transport network to meet the bandwidth environmental and space constrained demand for what is often referred to as the middle mile which connects the access and transport networks.
<unk> is represented by fiber based optical line termination systems built to deliver today's multi gig services in any network environment and Architected to support 50, and 100 gig access services in the future.
The subscriber edge consists of the network termination devices and Wi Fi service distribution systems that extend the performance of the fiber network and the subscriber premises.
Yes.
Charlie highlighted earlier and turning to slide 12, our most immediate near term growth pillar is the <unk> to <unk> upgrade cycle underway as you can see we have the industry's broadest and most versatile loyalty portfolio.
Our royalties are built on a common hardware and software platform, which provides uniform operations for our customers.
Streamline product development process to introduce new services and applications.
Common to all of our royalty systems are attributes of flexibility like traditional and disaggregated deployment models architectural headroom such as corny as not only a scalable switching an in place upgrade to 50 and 100 gig PON.
Low latency non blocking deployments at any service feed today and in the future.
Furthermore, the physical characteristics of our <unk> are such that any of them can be deployed in data centers traditional central offices or even in the most demanding outdoor cabinet locations.
Slide 13 gives you a view of our recently announced <unk> <unk> system.
<unk> provides industry, leading performance and service density in our <unk> unit high environmentally hardened form factor, which redefines how service providers deployed passive optical networking in high density locations.
This extraordinary performance is best represented by service interface capacity more than 24000 subscribers in our use of rack space near Terabits non blocking switching capacity and the ability to deliver low latency non blocking 10 gig PON class access services.
Additionally, it has the architectural headroom so forth in place upgrades to the 50 and 100 gig PON access technologies of the future, while maintaining low latency non blocking performance for all service types. These compares with complete system repair replacement proposed by other vendors to.
<unk> the same goals.
Last but not least the systems open design facilitates simple insertion into current network environments as well as SDN based control of the <unk> network to accelerate automated operations.
Slide 14 provides a high level overview of our <unk> and next year's bond Oilseed combo cards, which best represents the velocity hardware architecture with flexible onboard access interfaces G bond <unk> combo, one and 10 gig active Ethernet.
High capacity distributed switch fabric, and then an onboard network and back plain non blocking interfaces.
These line card is powered by our modular containerized <unk> embedded operating system that enables software defined networking new application deployment agility and increased system reliability and availability.
Yeah.
Slide 15 represented our newly released <unk> 4400 optical platform. The Sabre 4400 delivers optical transport technologies like 104 hundred gig coherent optics transponders, MX funders amplifiers and grow them functions, one argue telco depth invite.
Mentally harden package.
Personality module based architecture give service providers never before seen optical optionality and flexibility to address the optical transport challenges of the middle mile and the multi gig service era.
This industry first attributes to deliver extremely high value to service providers. Since they are now able to deploy 100 400 gig coherent coherent optical transport technologies anywhere in the network, including outdoor remote governance without incurring the high cost of constructing and operating.
Dr cohorts or control environmental boats.
To close the product section of this presentation I will briefly talk about the <unk> thousand which can be found on slide 16.
<unk> 4000 is an SDN controlled next generation transport and aggregation switch with delayed two and three functionality timing synchronization and low latency packet processing capabilities necessary to uniquely address the needs of a broad set of packet transport and aggregation use cases, such as cell.
Routing for backhaul and mid haul front haul transporting overrun networks and packet aggregation for the access and optical edge.
In summary, our recently announced products across our access and optical edge portfolio exemplify our thought leadership and innovation in support of our growth pillars, and our aim to help our customers successfully deploy their next generation access networks.
Charlie I will now turn things back to you.
Thank you Mikael.
Slide 17 through 27 capture our remaining three growth pillars, which I highlighted in my opening remarks, and slide 21 introduces our fifth growth pillar Dcs cloud.
As we look ahead to 2023, we will focus on smart profitable growth.
Over the past two years <unk> has successfully top graded leadership team upgraded and expanding our sales marketing and customer success resources aligned with a growing sales pipeline and a backlog that has increased more than four times since 2020.
We integrated three disparate ERP systems into one we.
We also exited two high cost manufacturing facilities and shifting to a low cost and a highly flexible contract manufacturing model.
We have added more than 200, new customers most of which are North America and European service providers.
And we acquired two cloud software companies and in optical transport innovator.
We are encouraged with our global sales pipeline.
Our current active fiber broadband <unk> T mobile and optical transport and cloud software trials.
And our now $329 million of remaining performance obligations, specifically, our product and software backlog, including deferred revenue.
As we enter 2023, we expect supply chain to improve in the current purchase price variations inclusive of sub component logistics and expedite costs to improve.
We also anticipate foreign exchange adjusted gross margin and profitability to improve in 2023.
With that I'd like to turn the call over to Mr. <unk> to walk through our Q3 financial highlights and our Q4 and 2022 outlook mistakes. Thank.
Thank you Charlie and good afternoon, everyone. If you are following along on the Investor deck I will start on slide 29.
With strong execution across all of our growth pillars. During the third quarter, we continued to navigate foreign currency headwinds primarily tied to the Japanese yen and Korean won.
Turning to slide 30 orders remained strong at 125 million, surpassing 100 million for the seventh consecutive quarter on a constant currency basis orders grew 8%.
We reported record quarterly revenue of $107 million, an increase of 21% year over year and above the midpoint of guidance revenue growth would have increased 35% on a constant currency basis.
Now that the new express and cloud check software products have been with UBS for a full quarter. We are reporting our revenue mix by product type, including access and optical networking, which was 85% of total revenue and software and services at 15% of revenue.
Our unique end to end software portfolio is resonating with customers and prospects as demonstrated by our Q cloud software wins with tier one service providers.
Turning to geographic mix during the third quarter revenue from the Americas region increased slightly year over year to $28 million.
Customer capture in the region to just indexed to benefit from government stimulus programs that we expect to materialize in 2023 and beyond.
Revenue from EMEA increased 29% year over year to $27 million.
Recent tier one win in the region, along with a full quarter of cloud check in express revenue contributed to the growth.
Revenue from Asia increased 31% year over year to $53 million revenue.
Revenue growth was driven by a more diversified customer base, adopting our subscriber and optical edge products.
Our Q3 adjusted gross margin of 35% was impacted year over year by foreign currency headwinds and elevated supply chain costs. Excluding these headwinds in costs. Our adjusted gross margin would have been 40% in line with our target gross margin Wilhelm.
We'd like to point out that sequentially, we improved gross margins by 670 basis points as we benefited from a higher mix of revenue from North America, and EMEA incurred fewer expedite fees and had greater software and services as a percentage of total revenue.
At the end of the quarter, we entered into an outsourced manufacturing partnership with Fabry net to manage the manufacturing of our of our products shipped to the North America and EMEA regions. The expected savings from this initial scope with the <unk> falls within the operational execution margin improvement category.
Of our target gross margin model that we shared during our Q2 2021 earnings report.
This category is expected to provide 450 to 600 basis points improvement.
In the third quarter, adjusted operating expenses were $33 million compared with $27 million in Q3 of 2021.
The year over year increase reflects our recently acquired assets from Austria and continued investments in sales and marketing to fuel growth.
Our adjusted EBITDA was $4 million during Q3 of 2022 compared to $5 million in Q3 2021.
And our non-GAAP EPS was <unk> <unk> compared to <unk> 16 in Q3 2021 with the year over year decline. The result of lower gross margin related to foreign currency headwinds supply chain costs and sales and marketing investment.
Excluding the supply chain headwinds in foreign currency fluctuations, our non-GAAP EPS would have been 30 higher or <unk> 35 per share in Q3.
We ended the quarter with $21 million in cash and $7 million drawn on our revolving credit facility with $24 million of debt as part of the five year term loan to fund the Asti acquisition.
Days sales outstanding were 106 days in Q3, compared with 90 days in the year ago period.
Growth in tier one accounts contributed to the increase in Dsos in Q3.
Inventory increased $26 million year over year to $85 million to meet growing customer demand annualized inventory turns were three five times during the third quarter compared with four times a year ago.
Our Q4 guidance reflects the continued strengthening of the U S dollar relative to the Euro one <unk> over the past 90 days for.
For the fourth quarter, we are guiding revenue to a range of $110 million to $120 million.
Gross margin in a range from 33% to 35%.
Operating expenses between 32 and $34 million.
And our EBITDA between 4 million and $8 million.
As a result, our full year guidance for 2022 is revenue narrowed to a range of $386 million to $396 million.
Gross margins of 32, 5% to 34%.
Operating expenses between 121 and $123 million.
And EBITDA between $4 million and $8 million.
That completes our prepared remarks, I'd now like to hand, the call over to Carmen to facilitate the Q&A session.
Thank you so much and as a reminder to ask a question you will need to press star one one on your telephone please standby, while we compile the Q&A roster.
One moment for our first question.
Our first question is from Mr. Svanberg with Stifel. Please go ahead.
Yes, thank you very much.
Great relations with a record quarter could.
Could you just talk a little bit more about velocity of east <unk> as far as timing.
When do you expect some some.
More material revenues.
And also perhaps what reason do you expect that.
<unk> products to ramp first.
Yes, we are we will be I guess investors and analysts should expect.
Announcement soon on customer adoption.
As it relates to product availability, we plan to start shipping that product in the first quarter of next year.
Very good and as my follow up Charlie I was also hoping you could elaborate that would be more on the <unk> partnership.
Especially as far as you know when when you expect to see some accretion.
It sounded like Youre already expecting.
Next year, but also wasn't sure. If this was sort of already incorporate into the gross margin thinking so anything else you can add on that that'd be great.
Yes, Theres no gross margin improvement this year I mean, we are if you can appreciate it we almost have a dual sourced manufacturing.
Capacity in Q4, because we have our existing team that is transitioning and handing over while at the same time, we have the new fabric that team that's coming up to speed and so we're I think we've done a really good job accelerating the timeline.
Cooperation and collaboration with our team and seminar has been.
Very impressive and our goal is to completely hand, everything off to <unk> by the end of this year.
And so we expect to see the margin improvements with a lower bom cost as well as just a lower labor cost.
Starting in Q1 of next year.
Great just one last question for misdeeds, so when I look at your gross margin guidance is.
Is it safe to say that all of these headwinds that that's pretty much it.
Second half of the calendar year does this fit as part of headwinds both from currency and also from the supply chain.
Wishes.
So yes, so our guidance for Q4 is certainly reflects the additional headwind that we've experienced in Q3 and expect to incur in Q4 as well as just the timing and flushing out the remaining backlog associated with our higher product cost.
Okay. I guess my question was obviously that would be the second half comment that between this quarter and next quarter.
Move into 2023.
What's your view on especially on some of the currency headwinds I know, it's hard to predict but any visibility that you have would be really helpful.
Tory I would be paid big box, if I had my Golden.
Crystal ball for 2023, but we do expect.
One.
Foreign currency to stabilize at a minimum and possibly produce tailwind in the latter half of 2023.
But based on the <unk> that we're receiving from various sources I think there's three main drivers.
For gross margin improving next year, obviously, the shift from an in source or outsource manufacturing, specifically with our Americas and European remember, we're still doing some of our own.
Handholding with with our CMS in Asia.
Kind of phase III, and how we increase margins.
So there is certainly the improvement that we will see in our product costs and our labor cost in 'twenty three with fabric.
We also as I think everyone appreciates.
I think our entire sector incurred significant price increases that began last year and that affected a lot of our backlog that we werent able to from a timing perspective.
Increase the prices appropriately and so we will see that improve in 2023.
And then you have.
A significant contribution from software and services that we didn't have this year that we'll have next year. So when you layer those three things in.
We feel pretty confident that we can get to an exit velocity on a run rate of 40% margins as I highlighted had we not had the.
The foreign exchange and supply chain headwinds that werent expected in Q3, we would've been at 40% gross margins this quarter.
Great perspective, and congrats again, thank you.
Thank you. Thank you one moment for our first for our next question. Please.
Our next question comes from Ryan Koontz with Needham and company. Please go ahead.
Alright, Thanks for the question and congrats on the quarter there.
With your two software wins, you mentioned there it sounds like in the letter they contributed to revenue and three Q like how should we think about the.
The opportunity for those customers is this just initial deployments I assume this is a.
License and maintenance pricing model for.
Cloud check in your orchestration platform, maybe just walk us through a little more.
There would be helpful. Thank you.
No. Thanks, Ryan No. These are obviously is just an initial deployment. These are designed to be long term.
Contracts and long term software contributing clients I mean, theyre, both large tier ones and so we're not going to speak specifically to our commercial structure.
But certainly we expect the contribution from both of these two and others to continue to contribute well into 'twenty three and beyond.
And sort of highlighted.
And I also highlighted the one large tier one western European win.
Has it really exciting and unique attribute to it in the sense that they're now going to be utilizing the entire Dcs cloud platform. So it will be using extreme which is R.
Access and <unk> orchestration platform. They will also be using express and <unk>.
Cloud check for in home Wi Fi. So that's that's really where we're trying to take our entire customer base. There is a great and software value proposition. There. There is also a very interesting and unique ability for us to begin to bundle, our orchestration and service assurance software with our <unk> to really.
Help differentiate the deployment and the Onboarding of new services and the management of new services for our fiber based customers as well.
I don't know Miguel if you want to you want to add.
Well I think you covered it very well Hello, Ryan This is Miguel.
Maybe to add to that Ryan I think what we're seeing is our customers realizing the.
The synergy that occurs when they have these end to end software that is not just affecting.
The accident, and where overall, including the orchestration evolving services right. So thats a validation of that at all.
Also a validation of our thesis is that.
In history, which is we.
We have build these products to be deployed at scale by national large tier one service providers globally.
That's great great accomplishment guys.
If I could shift gears real quick and talk about the middle mile opportunities certainly sounds promising as you look at kind of the bigger optical players trying to push their way into the access edge, where they don't have the experience.
But for for Dcs, selling standalone optical platforms into the western wireless and wireline operators, that's a new endeavor for you and how should we think about the sales cycles, there and customer adoption opportunity for you in this new market opportunity.
Yes.
Yes.
We have no plans to go upstream and compete in the high density DW DM market. Our strategy has always been when we acquired <unk>. The game plan all along was as more and more capacity is being deployed in last mile.
There's a big gap from high density ODM platforms to last mile aggregation.
So are the introduction of <unk> or the.
4400 is really uniquely designed Ryan to really couple what.
What we're doing with a very flexible 100 to 400 gigabit Rotem based coherent optics platform with our <unk> and so we don't see it.
As it relates to last mile access, we actually don't see it.
As a standalone sale opportunity is certainly there is an opportunity for us to go into networks, where our peers are deploying <unk> and be able to elegantly provide that platform, but think about the unique ability. We're gonna have now to bundle. The sabre 4400, with our <unk> doing something very unique in the way, we're going to aggregate last mile.
<unk> and last mile aggregation separate and apart from that there is a huge opportunity for us too.
Enter the data center market in the Hyperscale or market with a very cost effective platform and <unk> and again remember we believe this is the first of its kind in that its environmentally hardened and the modular design of it and the cost structure of it we think hits a sweet spot and as you said, there's just here in the United States there's over five.
$5 billion of middle mile.
Requirements, and we think that the.
235 applications that have already been filed that we're in a really good place to begin to participate there.
Miguel if you want to touch on anything.
So while it's early days.
The question about.
How do we compete in the transport space as you said this is our vision all along has been.
The fact that there.
There is a gap that exists today between the traditional transport network and <unk> were both fixed and wireless.
Is producing.
A critical amount of bandwidth from subscribers.
Now.
To fill that gap.
Bandwidth capacity of the traditional transport network, but you need the physical attributes of the access network in terms of size environmental heightening et cetera, and thats, how we have uniquely build our products when uniquely because nobody else in the industry.
<unk> got state rings, you've got electric co ops that are ideal.
Customers.
This platform and when you just look at the.
The ROI that we've mapped out I mean, there is and this has been with engineering firms. This is Ben with customers, we're saving somewhere between 20000 and 200000 per deployment.
Based on.
Yeah.
The.
The <unk> on the Sabre 4400.
That's great guys I appreciate the insight I'll pass it on.
Thanks, Brian .
One moment for our next question please.
Our next question comes from the line of Paul <unk> with William K Withdrawals <unk> Company. Please go ahead.
Thanks for taking my question and congrats on a good quarter I wanted to follow on a little more on what Ryan just talked about.
The going into the <unk>, the <unk> is a little bit different than selling your traditional products and I was wondering what steps you were taking what resources with training.
Additional.
Steps have you been taking to.
To try to get your sales force up and running.
Area, and then secondly, I noticed that the head of sales is no longer on your website and I was wondering if you can give.
A little color on the transition as if this was part of this.
This change in strategy.
Well first of all the <unk>.
Thanks, Paul I mean, the V six as an extension to our existing <unk> portfolio. So there is there is nothing new from a product our sales training its really an extension to the portfolio, we have and it really.
It really introduces a completely new type of platform into the market not only designed to to try to form fit a lot of the deployments that Huawei has historically deployed with their six lot platform across.
Western Europe Middle East and.
India and Canada.
But it provides a new architecture from a non blocking and capacity that we haven't seen in the industry. So we've been working on that platform, we're quite a long time.
The attributes of that platform span across the rest of the portfolio. So.
As I think Miguel did a good job highlighting in his.
In his commentary that it is a common architecture from hardware to software to the service modules that were utilizing across all the different chassis sizes and scales and appreciate it if youre going into medium and large size.
<unk> with large and medium sized service providers I mean, it's a density requirements is a big deal and our concept is if you think about a seven foot rack and you've got a <unk>.
Huawei six are you chassis thats in that rack I mean, we're now able to take that out and replace it with the exact form factor.
But with Tenex that capacity so lots of lots of improvements there. We think it's significantly differentiates us from anyone else in the industry.
From a sales and training perspective, there's really very little on the V. Six I mean, the sales team knows how to sell <unk> very well.
You mentioned the Sabre 4400, we acquired Upselling almost two years ago. There is a lot of DNA inside the company the sales team has been.
Coming up to speed here over the last year really.
<unk> for the 4400 to be announced I mean, it's something that we've been.
Training the sales team on for six nine months, knowing that this was coming so I think it's a natural extension to the <unk> portfolio and will be relatively easy for the team to position.
I think Alan I don't know if you want to.
Touch on anything.
As you said, Brian Charles I'll touch on Jay and the change with Jay in a second.
So as you said right.
We see and our customers see the savings 4400, as the necessary extension of the <unk> network.
So from that perspective, the sales teams as Charlie said as part of our new product introduction and product launch.
We prepare our teams and our product specialists to be able to articulate the value proposition to our customers.
And help them realize the value that the product brings to them.
Yeah as it relates to Jay.
As you mentioned I mean, Jay was running.
The Americas and EMEA and.
I've known <unk> for 25 years, he's done a great job, helping us get to this place but over the last 18 months, we've actually done a really good job, bringing on some fantastic sales leadership talent.
And it really gave me an opportunity here to flatten the organization allow me to get closer to sales. So we've basically gone from two regional sales leaders to three so under the new sales organization I have drew Finkelstein, who is running the Americas reporting to me Vincent de.
Who is running EMEA, who joined us from Austria, and Daniel Wong continues to manage Asia. So.
From our standpoint, there's really nothing that we've we've done other than streamlined the sales organization and created three regions, where before we had to.
Okay great.
Another question or.
You know everybody got really excited about it back in May and we haven't heard a lot about it.
Some of your releases you did say in the letter that overtime Youre expecting some growth can you give us a flavor for what we might see the next 12 months as far as what youre going to roll here and what it might mean for revenues.
Well, we did highlight two we did highlight two tier one wins in the call and in the shareholder report one of which was cloud check which came from <unk>.
We certainly didn't go into details of any other.
Let's call it smaller and mid size wins, we were highlighting the two tier one specifically.
We did book $125 million, we didnt split out the bookings.
Between software and.
In access and optical and we're not going to but you should assume that there were software wins within the $125 million quarter that we've posted so if we didn't do a very good job there.
I apologize, but we're.
No.
The software and services revenue as a percentage was 15% of the quarter, which we think was pretty significant and on a full year basis going into 2023 as I've said going back when we acquired Ico, We expect software and service revenue to to increase at least 25% a year and we're sticking to that theme.
For 2023, so if you kind of if you kind of.
Schedule out a run rate.
Okay.
Three you should be expecting.
Our software and services revenue to be in.
To be in that $50 million range next year.
Okay. Good.
Thank you.
Is it on.
Thank you one moment for our next question. Please.
Our next question comes from the line of Tim <unk> with Northland Capital markets. Please proceed.
Hi, there good afternoon.
Question here on some of the customer engagement you discussed some of the wins.
A couple of names up there some of them look like current customers some of them look new.
Interested in what Youre doing with Airtel in particular.
<unk> India.
It'd be something else.
It had been.
A lot of guys getting contracts from those guys. So they're obviously, India is getting underway with a big <unk> build I wonder if you could maybe it's related to that and secondly kind of on the tier one front I understand the.
Software wins, so do we assume at this point that's with third.
RT vendor hardware or do you have any.
Kind of anything on the tier one front in Europe talk about from our access infrastructure perspective. In addition to the software wins.
Yeah. Thanks, Tim Airtel I think we did mentioned was one of our early Huawei replacement opportunity. So you should assume that it's within our access and subscriber edge portfolio and we did begin shipping to.
<unk>.
During the second half of this year and we've got a pretty significant scheduled to ship to them in 2023.
As it relates to.
Our tier one or tier two activity with our access and subscriber edge portfolio in Europe , we didn't specifically highlight anything and I don't think we have any prepared remarks to do that I can tell you that.
If if analysts and shareholders should take anything away from this call I don't think that we would have invested millions of dollars. We did in the <unk> six which was designed to be a huawei replacement platform from a form factor perspective, if we weren't highly confident in our ability to participate in the markets, where they were at and Thats considerably.
Western Europe Middle East.
India parts of Pan Asia, and Canada, I mean, those are certainly the target markets Theres a lot of activity that we've been working on for the last six to nine months and we expect some of that to continue to convert as we as we enter next year.
Yes, let me follow up on that kind of pipeline discussion, there, which we've talked about a number of opportunities out there it sounds like.
Some decisions are starting to get made I mean, I don't know if you can quantify anything in terms of what youre pursuing or award.
How many of those decisions, we might see but.
Have you seen those opportunities expand remained stable or.
Or are we just getting closer to the normal cycle of decision making here.
Yes, I think the opportunities for Dcs on the medium and large scale operators.
In North America and Canada.
In Europe Middle East Pan Asia has continued to increase.
And I think it is increasing because of the things that Magellan I highlighted one of the reasons why we wanted to take some time out of this call and highlight what we're doing on the product side is to amplify where we see a lot of the differentiation that a lot of prospective customers are also seeing from a from a density perspective in <unk>.
This next generation technology.
I apologize Sam I'm, not going to get into the details of where we're at in the cycle of decisions only from a competitive standpoint, I mean, there is only a few of us that are competing in these markets and.
We are.
Sure.
We're very confident in where we're at with a number of medium and large scale tier ones around the world.
With our <unk> portfolio.
Sure.
Great.
And if I could just follow up and maybe touch on the fabric <unk> deal.
A little bit.
Which looks very promising.
I don't know that <unk> necessarily quantified any incremental impact.
But more just said that.
I guess supports the path to 40, and then 45% but.
To the extent that you think you might have been around 40.
Items.
This quarter and are looking to exit the year, they're assuming.
In large part I guess, because a lot of those items.
Moderate or maybe even turnaround.
In that context, where do we see the impact of the <unk> deal.
Or where are we taking kind of a conservative approach to any upside from a gross margin standpoint.
Well go ahead Mr <unk>.
Tim I think one of the important things to know about Fibernet is it will take some time to transition we're rolling it out first and our U S manufacturing facilities that support North America, and EMEA and we will have the ability to expand that.
2023 to other region, we did call out that it was within the.
The category in our target margin model that would provide 450 to 600 basis points improvement.
<unk>.
We do believe it's within that bucket. We do believe there is several things in that bucket right and so we're not ready to call out anything that's incremental to the target margin model.
So we see some course correction in some of the headwinds that we've experienced with foreign currencies and supply chain. So we did mention that in our long range model, we're driving towards 45% and I would say we are still consistent.
Just consistently driving towards that path I think the other thing that's worth noting is when I when I joined the company two five years ago gross margin was around 33% and if we can get to.
240% sustainable margins.
With a three year period, especially in light of everything that we've all had done door 700 basis points improvements pretty significant our goal is to get to a place where we can be.
And in all three regions with a sustainable 40% gross margin exiting next year to your point Tim.
We certainly would like to to meet that goal ahead of ending next year I think if we can continue to make progress on the <unk> side with our optical transport side high margin products. If we can continue to have success with our software and services high margin products, we can certainly get there sooner.
But.
We are trying to be as prudent as we possibly can to provide the best guidance, we possibly can with the most assurance, we possibly can but is there a path to get there sooner there is.
But at this point, we're not prepared to commit to that until we have proof points that we can sustain ourselves at that level, which all the things that we're doing from product innovation to software and services to the outsource contract manufacturing all lends itself to a path to be able to do that.
Got it thanks, thanks very much.
Thank you one moment for our next question. Please.
Our next question comes from the line of Dave Kang with B Riley. Please go ahead.
Hi. Thank you. Good afternoon first question is regarding supply chain. So I just wanted to be clear regarding the impact.
It sounds like its really impacting your margins, but not revenue.
By that is that higher expedite fee definitely impacting your margin but.
Giving any revenue on the table because.
Chip or component shortages.
Just can you provide additional color on my comments.
Yeah.
I would say you are partially correct.
I would tell you and I've said this I think on the last three calls that if we had all of the components that we needed we would be shipping more than what we are I mean.
More than $300 million in product backlog.
And with most of our customer requested ship dates as.
But as soon as possible, we certainly would be generating and converting more revenue. If we got access to more components. So I would tell you that we're by no means.
Through the chute of solving the supply chain challenges.
Is it getting better it's getting better, but it's not where we want it to be it's certainly not where it was pre pandemic. So there is certainly revenue impacting but youre right from.
From a margin perspective, the expedite fees and logistics costs, they're all getting better we certainly saw logistic costs coming down we certainly saw.
Fewer.
Purchase price variances within the quarter associated with the gouging expedite fees and everything else that we've been dealing with for 18 months those were positive signs, but it certainly isn't at a normalized.
In a normalized state it was really FX that impacted order value revenue value in gross margin and <unk>.
Just want to remind everyone that if you go back 10 years.
And this is a company that's been selling into Europe .
ARIA in Japan for more than a decade.
The Korean won and Japanese yen, even the euro have been favorable to where significantly favorable to where the US Dollar is today. So if we can get anywhere back to some state of normalcy.
As Mr. Yu said be a tailwind for us in 2023 and beyond compared to what we're dealing with today.
Got it.
So.
Uh huh.
Your revenue is still constrained by supply chain and it sounds like it.
Better so how should we think about that.
Seasonality for first quarter I mean.
Should we still model typical sequential decline meaningfully meaningful decline or how should we think about first quarter.
Assuming supply chain continues to get better and you got over 300 million.
Or is it an IPO.
Yes, I don't I don't think that Theres any traditional seasonality right now with many of US just because of the.
The backlog that has stair stepped up over the over the class over the last three or four quarters. So I mean.
You certainly can make the comment about quarter flow.
Thank you.
It'll be interesting see how service providers continue to support.
No.
The.
The timing of shipments based on what I hope to be improved.
Delivery times from our key sub component and chip manufacturers in 'twenty three.
I think that Q Q.
Q1 can continue to be.
<unk> can be a stronger than normal Q1.
If we can if we can convert a lot of the backlog in Q4 and Q1 like we are anticipating.
Okay.
If you go back and you go back if you go back if you go back three years.
To a traditional eight to 12 week lead time.
You've got from for most of US in this industry, including some of the large scale systems companies I mean, your <unk> more than 50% of in quarter revenue, meaning your booking and shipping in converting revenue more than 50 to more than 50% in quarter I mean.
Over the course of this year most of us have been up in <unk>.
80% in quarter I mean, we're fortunate we can be a SAR, 10%, so backlog and the timing of our ability to convert it.
Has a lot do with just our alignment to components and the ship schedule that we have so.
If we can if we can continue to have a strong.
Coming off of Q3, we're going to have a strong Q4, and we can and we can deliver the remaining.
Backlog in Q1 and Q2.
May not be as traditionally seasonal as you may you may think.
Got it and my last question is regarding your fourth quarter gross margin outlook.
It looks like it's going to be kind of flat to down.
Is there any reason for gross margin.
Could decline sequentially.
<unk> is improving.
Yes, I mean as Mr. <unk> said, it's really three things.
What we anticipate to be a steady state on FX I mean, if it remains what it is then we're on track if the U S. Dollar weakens in those markets then it could provide upside for us we do anticipate.
More and more participation from from Asia.
And.
<unk> sales in Q4, which puts a little bit more pressure on margin. So you have got anticipated product and regional mix and then as we said just to have the timing of some of the remaining backlog that we had that was associated with higher prices. So remember that we've all been dealing with.
Our backlog that incurred higher prices that didn't reflect our ability to change the sale price and so we flushed most of that out in the first three quarters of this year. We saw him a remainder of that that will flush out in Q4 and I think those are the contributing factors that are our profiling the margin where we have.
In Q4 and by higher prices, you mean cost cost, where we haven't been able to adjust the sales price, yes, that's right.
Okay.
Got it thank you.
Thank you and one moment for our last question.
Our last question comes from the line of Christian Schwab with Craig Hallum. Please proceed.
Hey, good afternoon, guys, Hey, just.
Two quick questions, maybe the first one on the widely replacement if we could figure that product.
In a way that that it could be in line with product.
Product gross margins or when that ramp should we assume.
Thanks.
The customers that chose Huawei in the first place we're extremely price sensitive I assume they still will be how should we think about product gross margins there.
Sure.
Well I think Christmas as Miguel I think you should.
Think of product gross margins in line with our target margins for oil piece.
As we move forward when service providers are replacing Huawei equipment.
Doing so to deploy new technologies in this case, we're taking advantage of that situation too.
<unk> towards 10 gig glass surfaces.
That makes a significant difference and I wouldn't say that.
Every service providers deploy Huawei was you did that because of price sensitivity.
The product that was available in the market and compete with the other one so so that's how we look at it.
Also consider that it's not just the product for a while we have replacement. It's just a phenomenal oil P for the appointment of Pone in high density anywhere in the world right.
That combination should give you a good sense for where its going the other thing I'd just like to add is I appreciate that.
These <unk> have a significant amount of embedded software and there are software licenses associated with the <unk>, it's not just a.
Ah.
Hey, transport classroom access platforming Theres a lot of software there.
Introducing our next generation software defined network operating system, which will add a software contribution element that will add to margin enhancements and if you look at just what happened from GE PON to X gene is PON I think im speaking for the entire sector that we did see an uptick in.
Revenue and margins that were commensurate with what our service providers, we're going to be able to charge their customers downstream and so I believe that that the.
The V. Six is significant because it's the first platform in this industry that you can safely assume as a service provider that it can stay in the network for 15 to 20 years, because we've designed it in such a way that it can support not just X gene is PON, but the evolution of 50 gig and eventually 100 gig.
So we think that that has a significant value.
Service providers, and we think that they'll pay more for a platform that they don't have to do a forklift upgrade which most of our peers will have to do to support the higher speeds.
Okay.
Excellent and then my.
Quick zoom.
My last question just you know.
The five pillars of growth that you outlined.
<unk>.
Seem to suggest that growth could be much more robust than greater than 10%.
Is that conservatism.
On your part given some of the unexpected.
Unexpected currency, but if we just think about it.
Constant currency.
Am I thinking about that right, there's a lot of potential for.
Success from that that outlook.
Yes, I mean, we think so.
If you look at.
I mean look I think omni does a really good job. They spent a lot of time across the globe with obviously large scale in medium sized service providers.
Which is where most of the dollars are and if there are anywhere close to that and we can participate and convert some of the trials and pipeline to revenue sure. There is a lot more upside than what we're probably.
Profiling.
It's hard for us to do that when Youre not already an incumbent it's easy for us easier for us to forecast anticipated orders and revenue with our existing customer base, but when you're in a trial phase or you're in a take share phase, it's hard to be too overly ambitious.
<unk>.
The swings are significant.
<unk> closed a new tier one.
Our tier two four for <unk>, our optical transport I mean, you're talking tens of millions of dollars and it's just hard.
For us to be in a position to where we can feel confident that we're going to we're going to lean in there I think the other thing that we haven't talked a lot about that we will talk a lot more about is the evolution of our mobile orchestration software automation platform.
What we believe to be the industry's most comprehensive access orchestration software automation for fixed wireline networks. We don't think anyone is doing this especially not what we're doing and as we begin to bundle extreme with our <unk>.
That's going to give us a significant differentiation is certainly going to give us an opportunity to enhance margins with our <unk>. So there is there is there is a recipe there that we are we're laser focused on I'm not going to share all of our competitive.
Secrets on an analyst call, but appreciate there is margin opportunity and margin expansion opportunity and compete.
And Pete.
Some of the more challenging as you pointed out.
Christian on the more challenging while were replacement opportunities, where maybe some of the larger tier one or tier twos have a pricing expectations that they got from Huawei I think theyre looking at a completely different today than they did when they originally brought huawei and to compete with for.
For the most part at the time Nokia.
Excellent no other questions. Thanks, guys.
Thank you.
And with that ladies and gentlemen, we conclude our Q&A session and conference for today. Thank you for participating you may now disconnect. The conference will begin shortly to raise Johan during Q&A you can dial one one.
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