Zhone writes off legacy gear

Declining sales of legacy equipment caused Zhone Technologies to miss its revenue expectations for the second quarter in a row this year. The equipment vendor has now written off about 80% of its inventory of legacy products, taking a $7.2-million charge in the second quarter.

Zhone reported $54.2 million in total revenue for the second quarter, missing the range of $55 million to $57 million it expected in April. Its net loss for the quarter was $13.1 million, or $0.09 per share, much wider than the $3.9-million ($0.03 per share) net loss it reported in the first quarter and the $3.4-million ($0.04 per share) net loss it reported a year earlier.

The declining sales of Zhone’s legacy business has been a thorn in the company’s side for at least the last two quarters. It caused Zhone to miss its earnings expectations for the first quarter.

Zhone expects its legacy business to continue to erode as carriers continue migrating toward packet-based networks, causing the vendor’s third-quarter revenue to be sequentially flat. But the legacy business should cease to be a meaningful drag on Zhone’s earnings by either the end of this year or the first quarter of 2007, Ejabat said.

“We took [legacy inventory] down to a level we thought could be sold or liquidated in the next year,” he said.

Although Zhone vowed its earnings before interest, taxes depreciation and amortization will break even in the third quarter, some investors on the company’s earnings conference call late Thursday grew impatient with its lack of profitability.

“You can’t continue to bounce around break-even and have that be an acceptable outcome for shareholders,” one analyst said, accusing management of showing no sense of urgency on the matter. “This is not six or seven years ago. You’ve got to get to profitability.”

Another analyst questioned the size of the bonus awarded to chief executive officer Mory Ejabat this year. In addition to Ejabat’s base salary of $508,333, he was given a cash bonus of $250,000 and options to purchase 850,000 shares of Zhone stock. Zhone’s chief financial officer Kirk Misaka responded by pointing out that Ejabat has performed well and helped aggressively acquire new customers.

Ejabat admitted to spending more in research and development and sales in the second quarter in an effort to try to win some large carrier customers. “That’s a risk we take to make the move to large carriers,” he said. Zhone is tailoring a product for one large potential customer in particular while competing with two or three other vendors for the account. But Zhone is also investing R&D in a new product to be unveiled sometime in the next six weeks.