UTStarcom Holdings Corp (UTSI) 2004 Q4 法說會逐字稿

Good afternoon. My name is Kristen and I will be your conference facilitator. At this time, I would like to welcome everyone to the UTStarcom fourth-quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS). Thank you. Mr. Sophie, you may begin.

Thank you. Good afternoon and thank you for joining UTStarcom's fourth-quarter and full-year 2004 earnings conference call. I'm Mike Sophie, UTStarcom's CFO, and I'm pleased to host today's call with our CEO, Hong Lu. Hong will begin the call by talking about his vision and strategy for UTStarcom and providing an update on our achievements and challenges in 2004. Then he will turn the call over to me for a detailed financial review of the fourth quarter and full year 2004 and guidance for Q1, 2005. Afterwards, we'll open up the call for Q&A.

I would like to remind everyone that some of the information we will discuss today constitutes forward-looking statements. Actual results could differ materially from our current expectations. To understand the risks that would cause results to differ, please refer to the risk factors identified in our latest annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, which are filed with the Securities and Exchange Commission.

Before we begin, you may have noticed that our earnings release does not include net income or EPS for Q4 and full year 2004. With the unanticipated change in operating results we experienced in the fourth quarter, we are now looking at a tax benefit for both Q4 and full year 2004 that should result in a much more favorable EPS number than that which we provided on January 6. We're still doing the work on the tax effect and should have it finalized in the next few weeks. We do not anticipate any issues with timely filing of our 10-K. The filing of the 10-K will include the tax benefit, net income, EPS and our complete 404 assessment. We will publish the net income and tax benefit as soon as we complete and finalize the numbers.

With that, I will now turn the call over to Hong. Hong?

Thanks, Mike, and thank you, everyone, for joining us this afternoon.

Several years ago, I laid out my vision for UTStarcom as a leading global provider of telecommunication solutions. The strategy to achieve this vision was straightforward and has allowed us to grow the Company over 15 times in the past 5 years, even as many of our competitors were facing substantial challenges and declining. The key elements of this strategy involved, one, bringing affordable telecom infrastructure to the areas of the world that have not historically that access to such technology. This was our vision while the majority of equipment vendors were focused on already-developed markets.

Two, developing a suite of destructive (ph) entry end users solutions around the core IP-based SoftSwitch and differentiating our solutions from both a technology and a cost perspective. We chose to capitalize on those three major areas of growing in the telecom sectors, broadband, wireless and IP, and chose not to offer products that were already readily available in the market.

Three, focusing on the success of our customers and providing them with the solutions that would generate revenue and fast return on their investment. Though this idea sounds simple, it was not a common practice in the market. For UTStarcom, however, this was an integral part of this strategy. We knew the customer who could make money on the product would provide them -- would continue to buy from us.

This strategy became a foundation of our tremendous success in China with PAS, which has driven so much of our growth historically. But to maintain a growth and continue building shareholders' value, we added another crucial element to our core strategy, diversities, both in our customer base and our product portfolio.

In 2004, we focused our effort on aggressive implementation of the diversification and globalization strategy. We also took major steps towards enhancing our internal infrastructure to ensure that it can successfully support an increasing global demand for UTStarcom's solution.

I would like to share some of the success and the challenges we experienced in 2004. Key achievements in 2004 include the strong revenue growth to 2.7 billion, representing an increase of approximately 38 percent over revenue of 1.96 billion in 2003; solid backlog of approximately 1.2 billion that positions the Company well for growth in 2005; we also dramatically expanded our international customer base and global footprint, as evidenced by announcing contracts and now strategic partnerships.

Some of our new customers and key contract wins includes Chunghwa Telecom in Taiwan and China Mobile, China Unicom in China for our MSTP optical transport solutions, Sprint in the U.S., who is using our IP-based CDMA2000 solution for their key enterprise customers, Telmex, head of Brazil Telecom in Latin America, both deploying our very successful IP DSLAM products. We also are currently working on several other broadband and wireless projects in Latin America in 2005; PCCW in the UK, the first customer to deploy our 3G TD CDMA wireless broadband solution commercially. We've also announced a TD CDMA trial with Optus, the second-largest GSM operator in Australia, and are launching our several more TD CDMA trials worldwide in the first half of 2005; and DSSI in the U.S., the first U.S. customer to deploy our industry-leading mSwitch and gigabit EPON products, they are also one of the first customers worldwide to deploy our mVision TV-over-IP solutions.

In addition to those new customers announcements, we strengthened many of our incumbent relationships. We received follow-on contracts for existing product and introduced new products to many of these incumbent accounts. For example, in China, despite the fact that PAS market is maturing, both China Netcom and China Telecom continue placing orders for PAS infrastructure throughout the year of expanding their existing networks. We announced contracts totaling over 160 million with these 2 carriers in early January and are encouraged by the increase in handset shipment in the first quarter.

Based on estimates provided by China Telecom, China Netcom, the MII and looking at current subscriber run rates, we continue to believe that there will be 20 to 25 million net PAS subscriber additions in 2005. Initial PAS CapEx estimates from the carriers totaling 1.7 billion, where the factors all of this (ph) into our assumption for PAS revenue in 2005.

At the same time, UTStarcom is working closely with both China Telecom and China Netcom for their next generation wireless and the broadband planning in 2005. Both operators have placed a high priority on the development of IP TV series in 2005. We were currently trailing our mVision solutions in several spots of the carrier's network.

In India, Reliance Infocom is using UTStarcom's broadband products in the roll-out of its broadband access network -- networks across 190 ASICs, in addition. Reliance is also now planning deployment of our IP-based CDMA2000 infrastructures products.

(indiscernible) broadband and Japan Telecom are customers for our IP DSLAM, iAN-8000, our multi-service access platform, NetRing, our Next Generation optical transport product, and gigabit EPON solutions and continue to be aggressively in their planning building out of a Next Generation IP-based services in Japan. There are approximately 13 million broadband users in Japan out of approximately 45 million households. The government of Japan has launched an e-Japan program in which they wanted to have a fiber extended to 50 percent of its households by 2010. This translates into continuing significant demand for fiber-based products in Japan.

Our Personal Communications division shipped 1.5 million handsets in November and December, an increase of 50 percent over the same period in 2003. Demand for our handsets in both U.S. and Latin America is strong, and we recently launched a CDMA, CDM 8940, our first 3G EV-DO handset, into U.S. market with Verizon, our largest U.S. market. We also launched the smallest smart phone in the market with Cingular, which was recently called a nearly perfect device in a review by MSNBC. We continue to be on track on the delivery of our first UTStarcom manufactured CDMA handsets in the U.S. market in the first half of 2005.

In addition to landmark contracts announced and customer wins, we significantly strengthened our technology development, leadership and market position. For example, in China, despite intense competition, we maintain our market share leadership in both infrastructure and handsets for PAS. We hold approximately 60 percent of the infrastructure share and approximately 55 percent handset shares. We also maintain number one worldwide market share in the SoftSwitch and media gateway shipments according to Infomatic (ph) Research and Synergy (ph) Research Group. We successfully compete with China's 3G WCDMA field trial with very high marks. We believe this positions us extremely well to be a key 3G vendor and China. Early last year, we announced our (indiscernible) wireless strategy. Since then, we have demonstrated successful execution by building a full suite of IP-based CDMA infrastructure and handsets solutions.

We also introduced a number of leading-edge products in 2004. The first IP-based infrastructure solution in the world for CDMA2000 and TD CDMA, our first commercialized available 3G wireless broadband solutions -- gigabit EPON, the world's first large-scale gigabit passive optical network product, NetRing, our Next Generation optical transport product and mVision, a comprehensive TV-over-IP solutions (sic). In addition, at the CS (ph) show in January, UTStarcom launched F1000, our first consumer WiFi handset for the U.S. market with Vonage.

These new product introductions are so important for UTStarcom, as they represent new opportunities, drive growth going forward. Our R&D team has developed the Company's product life cycle to map directly to the technology and spending trends in the industry.

In looking at our product life cycle, as mature products such as PAS decline, we also have a tremendous number of new products that build on past successes and further our heritage as an innovator of destructive (ph) technologies. So far, we have seen a tremendous amount of interest for our new products. For example, our F1000 handsets capitalize on the growth of both WiFi and Voice-over-IP and is indicative of the forward-looking nature of our R&D development and planning.

Finally, we made a number of internal infrastructure improvements in 2004. We implemented Oracle on a company-wide basis; we began and have achieved significant progress in a system-wide supply-chain improvement program; we increased the depth of our management team by adding chief quality officers and chief accounting officer. We enhanced our Board of Directors with the addition of Jeff Clarke, who is currently the Chief Operating Officer of the Computer Associates. All of these achievements strengthen UTStarcom and positions us for the continued growth.

We also encountered a number of challenges in 2004, many of which were associated with the faster growth of our company, specifically expanding our product and customer base. Some of these challenges include a maturation of the PAS market in China. Though we anticipated a slowdown, it happened sooner than we expected. As you know, this affected our fourth-quarter 2004's revenues. In addition, we experienced a significant gross margin decline, due primarily to 2 factors, the increasing competitive landscape in the PAS handsets market in China and costs associated with the ramping of our new products for international customers.

We also experienced a change in the business dynamics as well as growing pains associated with undergoing dramatic globalization and product diversifications. These include deploying brand new products and ensuring these products met our quality standards and working with the brand new customers. This creates a lumpiness in the revenue recognition and reduced short-term visibilities.

Our business has become less backlog driven due to an increasing contribution of handsets to total revenues following with the Audiovox acquisition. In addition, certain customers made changes to contract forms and scope during the year, which also had an effect on the timing of the revenue recognition. We also experienced some constraints with the capacities of our internal infrastructures, which limited our ability to meet our increasing customer demand. Finally, we had to allocate a substantial amount of time, managerial resources and money to several large initiatives, which includes the worldwide implementation of Oracle, our supply-chain improvement projects, 404 compliance, and the integration of Audiovox business. In total, we spent approximately 15 million on those initiatives in 2004.

Our success and challenges in 2004 gave us a better understanding of the strength that could be leveraged, going forward, as well as in areas that require improvement. We took this into consideration when we were planning our strategy and objectives for 2005. UTStarcom's primary focus in 2005 is on execution and returning to profitabilities and predictability. Key areas of execution include completing the transformation we undertook in 2004 aimed at diversifying the business and making internal improvements, including overall quality, NPR, DPR (ph) systems, supply-chain and 404 compliance, leveraging our incumbent status in installed base in China and Japan to expand globally and build strategic relationships across the product groups and geographies; adjusting to the changing dynamics in China, which includes the declining PAS spending, changes in the decision-making structure of our key customers in anticipation of 3G licenses; focusing on the quality and delivery of the new products to our customers and converting international contracts into revenues. The ultimate goal of this execution is returning to the strong profitabilities, the improved gross margin, and positive free cash flow.

The value proposition we offer to customers and investment (indiscernible) is based on our core strength. Our primary core strength is the leadership in the destructive (ph) technologies. UTStarcom has an exclusive focus on IP across all of our product lines. This allows us to leverage our R&D resources across the Company and derive innovation services such as TV-over-IP. IP also allows for greater bandwidth speed, service offerings, and operation costs. We have a history of deploying the market-defining solutions, such as PAS, IP DSLAM, gigabit EPON, IP-based 3G solutions, which includes WCDMA, TD CDMA and CDMA2000, MSTP, our Next Generation optical products and mVision, our TV-over-IP solutions. These products created success for UTStarcom by allowing our customers to deliver a continuous stream of a different shade of services and to serve a greater number of end-users.

Our second core strength is our China leverage. China is the largest and one of the fastest-growing telecommunications markets in the world and currently our largest market. The China market has allowed us to deploy the latest technologies at the massive scale. It also provides us an installed base to which we can sell additional products. Our strength in China allows us to be successful on a global basis. Finally, China gives us significant operation leverage. We currently have the lowest OpEx in our industries streaming from our high-volume, low-cost manufacturing operation and low-cost engineering in China.

The combination of these core strengths and the strong Company-wide focus on execution position us well to achieve our 2005 goal. Despite the fact that 2004 was a challenging year for UTStarcom, I am optimistic about our prospects in 2005 and beyond. My primary goal as CEO of UTStarcom in 2005 is focus on execution, predictability, and profitability. This year, we will complete our transformation by diversifying our business and optimizing our internal process and deliver high-quality innovative products that will lead to profitable growth and shareholder value.

With that, I will turn the call over to Mike to discuss the financials.

Thank you, Hong.

First, let me provide some detail on our fourth-quarter and full-year results, and then I will discuss our updated guidance for the first quarter of 2005.

We closed the fourth quarter with sales of 742 million and a loss before taxes, minority interest and extraordinary loss of 66.4 million, which is consistent with the preliminary results given on January 6.

Total sales for the quarter grew 15 percent, both sequentially and year-over-year. These results include 277 million in sales from our recent acquisition of the Audiovox communication business, which we now refer to as our Personal Communications division. As we discussed on the call on January 6, sales were approximately 135 million lower than our original guidance for the quarter. Our China market experienced a primary shortfall, driven by 3 main factors, a push-out in revenue recognition of some past infrastructure sales, lower volumes and continued pricing pressure on PAS handsets, as well as the general slowdown in capital expenditures for PAS infrastructure. Full-year 2004 total sales were approximately 2.7 billion, compared to approximately 2 billion in 2003, an increase of 38 percent.

By product category, handsets represented the largest portion of Q4 revenue at 57 percent, driven by strong sales in the Personal Communications division. This compares to 25 percent in the third quarter of 2004 and 48 percent in the fourth quarter of 2003.

Broadband revenues were approximately 16 percent of sales in the fourth quarter, driven by strong growth in Japan. This compares to 9 percent in the third quarter of 2004 and 10 percent and the second quarter of 2004.

Wireless infrastructure sales were approximately 27 percent of revenues in the fourth quarter. This compares to approximately 66 percent in the third quarter of 2004 and 38 percent in the fourth quarter of 2003. Lower wireless infrastructure revenues are primarily attributed to a delay of revenue recognition on some PAS infrastructure contracts, lower-than-expected subscriber levels, which led to a decline of PAS handset sales, as well as an overall decline in PAS capital expenditures.

By geography, sales outside of China represented approximately 53 percent of total sales in the fourth quarter, a reflection of the growth of our international revenue and the revenues from Personal Communications division. This compares with about 13 percent of revenues outside of China in the fourth quarter of 2003.

Our overall gross margin dollars for the fourth quarter were 105.2 million, or 14.2 percent of sales. Gross margins for the Company, not including the Personal Communications division, were approximately 20.1 percent. Gross margins for the Personal Communications division were approximately 4.3 percent of sales. The primary factors influencing this quarter's poor Company gross margin results include substantial improvement in our wireless infrastructure margins, which were 33.1 percent, driven by improvements in PAS infrastructure margins in China, as we had predicted.

Broadband margins were 8.5 percent, which were driven by 3 primary factors -- one, considerable pricing pressure for DSLAM products in China as well as demos deliveries of new products. For example, in the second half of 2004, Alcatel undercut all its competitors by nearly 30 percent when bidding DSLAM products.

Two was mix. We had a significant ramp in initial shipments of new broadband products, which typically carry initial start-up costs. We discussed this on the third-quarter conference call, in which our initial gig EPON gross margins were 7 percent. They have since improved in the fourth quarter to 15 percent.

Three, customer premise equipment that is sold in conjunction with the central office equipment carry significantly lower margin and is actually a slight loss and therefore brings down the total gross margin percentage. We expect to see improvements to broadband margins through 2005, as I will discuss in the guidance section of the call.

PAS handset margins in China continue to experience downward pressure as we liquidated some low-margin handsets in the quarter and ended the quarter at 12 percent compared to third-quarter margins of 14 percent.

Total operating expenses for the fourth quarter were 173 million, or 23 percent of sales, compared to 21 percent for the third quarter. Although we continue to generate (indiscernible) our operating expenses in line with sales, we experienced several unusual items in the fourth quarter worth noting. First, as a result of the review of our intangible assets, we incurred a one-time asset impairment charge of 10.8 million for the restructuring of our Korea operations. In addition, the Company continued to incur significant external consulting costs to support our Sarbanes-Oxley 404 efforts as well as our supply chain and Oracle conversion projects, which were approximately 5 million in the fourth quarter. Finally, the Company spent over 5 million for non-recurring engineering costs related to our recent acquisition of CDMA handset designer, Pika (ph) Telecom in Korea.

Income taxes -- when we announced our preliminary results on January 6, we had anticipated an income tax benefit of approximately 15 to 17 million for the fourth quarter and an income tax expense of 5 to 7 million for the full year 2004.

We now anticipate an additional income tax benefit for the fourth quarter as well as a benefit for the full year, 2004. While the 2003 correction was primarily due to an error made in the tax provision, the current-year benefit, while counterintuitive-sounding, is primarily driven by the sources of profits in various tax jurisdictions in which we operate. For 2004, we had losses in high-tax jurisdictions and profits in low-tax jurisdictions, the net of which is now a benefit for the quarter and a benefit for the full year. Additionally, we experienced increases in our expected effective tax rates in certain jurisdictions in which we operate. As a result, our deferred tax assets in these jurisdictions have increased, resulting in additional benefit. We are still in the process of determining the extent of the expected income tax benefit and the resulting net income and earnings per share calculation.

Net interest and other expense for the fourth quarter of 2004 ended as net income of approximately 1.4 million.

Now, let me transition from the review of the income statement to highlights of our balance sheet and cash flows.

Our cash and short-term investment balance at December 31 was approximately 698 million, compared to 796 million at September 30. Cash collections from customers were approximately 890 million in the quarter. The primary uses of cash during the quarter included approximately 175 million for the Audiovox acquisition and 116 million to fund initial Accounts Receivable working capital requirements for that business. Total cash flow from operations, inclusive of the Audiovox working capital, was a -76 million.

A question we received on the January 6 call had to do with collections from Japan Telecom. We had expected to collect approximately 190 million in additional cash in the quarter related to our Japan Telecom contract. However, this cash will now be collected in the first quarter of 2005.

Our Accounts Receivable balance increased to 806 million, 69 million over the third-quarter balance. Our DSOs total, including the UTPC business, was 98 days for the fourth quarter. Cast cycles continued to lengthen in China due to competitive conditions. This, however, is being partially offset by a growth outside of China and the Personal Communications division. Our targets for DSOs are to move them back below 90 in the first half of 2005.

As of the end of December, our total inventory and deferred cost balance increased by 195 million to a total of 803 million. 156 million of the increase is related to the Personal Communications division, and our inventory turns for Q4 were 3.6 on a consolidated basis.

By December 31, customer advances were 332 million, which represents an increase of 49 million compared to September 30. The increase relates to cash received from our customers against contracts in China.

We incurred short-term borrowings during the quarter of 175 million, which was primarily used to fund the acquisition of the Personal Communications division. Total short-term debt at the end of the fourth quarter was 351 million.

Guidance going forward -- as we discussed on the January 6 conference call, the visibility of our financial results has been impacted by the changing nature of UTStarcom's business. While we maintain our internal target of 4 billion in revenues for full year 2005, we will be focusing our guidance to the Street on 1 quarter out and will no longer provide full-year guidance. There are several reasons for this. First, we are undergoing a significant shift in our revenue mix, which includes the decline of the PAS business in China, the increase of our international business and the introduction of the Audiovox Personal Communications business. This shift in our revenue mix introduces a different set of business dynamics, including less backlog-driven revenue associated with the handset business. This makes it difficult to give precise revenue and EPS guidance three to four quarters out.

At the same time, we've said that we would provide enhanced reporting along 3 strategic business units, broadband, wireless and handsets/CPE. These business align with the high-growth trends we have identified in the Telecom space.

Broadband -- our broadband business is experiencing very strong growth. According to such sources as Gartner, IDC and Inphonetics (ph), Wall Street Research and our own internal analysis, we believe that global broadband will have a compound annual growth rate of approximately 28 percent from 2004 through 2008. In 2005, we believe our broadband business will be approximately 20 to 25 percent of revenues, up from approximately 11 percent in 2004. The broadband business typically carries gross margins of approximately 35 percent for central office equipment. This is on a blended basis, as margins for equipment sales in China are generally 5 to 10 points below those in our international markets.

Product included in our broadband business are our iAN-8000 multi-service access solution, our AN-2000 IB IP_DSLAM products, our fiber-based Gig EPON access, NetRing multi-service transport, and mVision, our TV-over-IP solution.

Wireless -- our wireless business is going through a transition in 2005. While we are seeing a decline in the PAS market, we are seeing growth in our CDMA and TD CDMA markets. We also anticipate sales from our WCDMA product line to begin in 2006, further offsetting declines in PAS. The wireless business should contribute between 20 and 25 percent of revenues in 2005, compared to 51 percent in 2004. As noted, we will see declines in PAS revenues this year but at the same time, gross margins for PAS infrastructure have now improved to above 30 percent. The decline in PAS will be partially offset by growth in other wireless infrastructure business, such as CDMA and TD CDMA. Beginning in 2006, we believe the PAS declines will be further offset by 3G revenues in China. Wireless gross margins are expected to be approximately 35 percent on a blended basis. Again, margins outside of China tend to be 5 to 10 points better.

Handsets and CPE -- we believe the handsets and CPU business is an integral part to our success. It enables us to provide our operators and customers with a complete end-to-end solution offering differentiated, sciated (ph) features to the end user. In addition, the handset business creates a recurring revenue stream as the replacement cycle is much faster than that of the central office equipment. Handsets also increase UTStarcom's brand awareness and provide entry positions with carriers that can be leveraged for infrastructure sales. Our handsets and CPE business should contribute approximately 50 to 55 percent of revenue in 2005, compared to 30 percent in 2004, and is driven by strong sales of our Personal Communications division and other non-(indiscernible) handset sales globally.

Blended gross margins for our handset business should be approximately 10 percent in 2005. This represents approximately 4 percent margins for our Personal Communications division, excluding internally-designed handsets, and 20 percent margins for our other handset sales.

Similar to our wireless and infrastructure business, handset business is characterized by declines in PAS handset revenues, which are offset by growth in CDMA and other handset products. Our target for own internally-designed and manufactured handsets sold through the Personal Communications division channel is 20 percent of the volume for 2005 and increasing in future years. Gross margins for these handsets are reflected in the non-PCB (ph) numbers.

Geographical breakdowns -- another important way to look at our business is by geography. Let me highlight 3 key markets for UTStarcom. The first market is China. In 2005, we expect that our China business will contribute approximately 40 to 45 percent of total revenues and will be down approximately 20 to 25 percent from 2004 levels, reflecting declines in the PAS business, which are partially offset by growth in other areas. Despite this decline in 2005, China is still our single largest market and we're still often optimistic about the long-term growth in the market. Catalysts for growth in China going toward include IP DSLAM as operators continue to add more subscribers and migrate to an all-IP network, MSTP optical transport which is now deployed in all 4 operators' networks in China, Gig EPON, as fira (ph) becomes increasingly affordable and the demand for higher bandwidth services grows, IP TV as a way for operators to expand and differentiate services and add additional revenue streams going forward, and finally 3G into which our incumbent position with PAS and excellent trial results position us very well for China's 3G market.

Our second largest market is North America. North America should contribute approximately 35 percent to total revenues, driven primarily by the Personal Communications division handset business. Additional sales in North America come from CDMA infrastructure, which we have announced our first customer win with Sprint and already have ongoing PDS hand (ph) sales to many CDMA providers, CPE and WiFi handset sales and services, which is a small but growing piece of our business.

Our third largest market is Japan. Japan should contribute approximately 15 percent of total revenues and will be up approximately 5 percent over 2004. The Japan market is being driven by strength across the broadband product lines, including our iAN-8000, Next Generation DLCs, Gig EPON and NetRing optical transport. We see additional growth opportunities in Japan for IP TV and possibly wireless in the future.

In other key markets, including Latin America, Europe, India and Southeast Asia, we continue to make significant progress and are very encouraged by initial contract wins and ongoing demands. These markets combined will contribute between 5 to 10 percent to overall revenues in 2005 with increased potential in the coming years.

Q1 2005 guidance -- revenue -- for the first quarter of 2005, revenue should be approximately 810 million. We continue to see declines in the PAS business in China while our international and Personal Communications businesses are growing. Handsets and CP revenues should be approximately 440 million of which approximately 300 million will be from our Personal Communications division, and wireless infrastructure revenues should be approximate 70 million, driven by declines in the PAS market in China and slowdowns in the final acceptances due to the Chinese New year. broadband revenues should be approximately 300 million in Q1. Included in the broadband revenue will be approximately 260 million in revenues from the Japan Telecom contract we announced last September. While we anticipate being able to recognize this revenue ahead of our initial Q2 target, the profits will be less than anticipated as we will record little if any revenue for the service element of the contract. Based on discussions with Japan Telecom, we've decided to exit the promotional services element of this contract, as it continued to provide uncertainty as to the revenue recognition on the contract, and we want to focus on our core competency, which is providing telecom equipment. Promotional services had been transitioned to a third party for this any future contracts with Japan Telecom involving a service element. All costs associated with exiting this business are included in our Q1 guidance and we continue to believe that Japan Telecom will be an important customer for UTStarcom. I do not believe this will have a negative effect on the relationship.

In Q1, gross margins should be approximately 23 to 25 percent on a consolidated basis. SG&A in Q1 should be approximately 11 percent of sales for the quarter. R&D should be approximately 9 percent of sales for the first quarter, and intangible amortization should be approximately 7 million in Q1. Other income and Expense should be an expense of about 5 million in the first quarter. This figure reflects interest income and expense, tax refunds and the potential foreign exchange and impairment charges. Joint venture equity income and loss should be a loss of approximately 3 million, and our effective tax rate for 2005 should be approximately 25 percent. (indiscernible) EPS guidance for Q1 is approximately 20 cents. We expect cash collections in Q1 to range between 750 and 800 million, including the 190 million cash collection that was pushed out into January from the fourth quarter. Directionally, we expect Q2 results to be slightly better than Q1. This should aid in modeling, as we transition from full-year guidance to only one quarter out.

Now, I would like to address some recent investment inquiries. Sarbanes-Oxley Act Section 404 -- the Company continues to evaluate the effectiveness of internal controls over its financial reporting -- is required under the provisions of the Section 404 of the Sarbanes-Oxley Act of 2002. During the course of this review, management has made certain preliminary conclusions and accordingly has advised the Company's audit committee and its independent registered accounting firm that, in addition to a deficiency noted above, there may be other additional significant deficiencies which may individually or in aggregate constitute material weaknesses in internal control. These potential material witnesses include ensuring the Company employs sufficient finance personnel with the necessary experience and technical accounting expertise, including knowledge of U.S. Generally Accepted Principles relative to their assigned level of responsibility; two, ensuring adequate processes in personnel (indiscernible) supervise and then monitor locations outside of the United States; three, controls related to the existence and evaluation of inventory deferred costs and related costs of sales; and four, controls related to the financial close (ph) and reporting process.

Management continues to assess the effectiveness of the Company's internal controls, including whether any of the significant deficiencies (ph) individually or in aggregate constitute material witnesses. In addition, the Company's independent register accounting firm (inaudible) evaluation of management's assessment on the effectiveness of internal controls will continue through the filing of the Company's annual report on Form 10-K. The Company has an independent registered public accounting firm (inaudible) report their respected final findings in its Form 10-K, which must be filed in March of 2005. We intend to continue to devote substantial management and financial resources to implement remedial measures to address these internal control matters and we are fully committed to the 404 process as well as the continued upgrades to our Oracle ERP and continued supply chain improvements.

Most of you are probably aware of the revised statement FAS 123 that requires companies to expense their value of their employee stock options. Companies have to implement this new treatment for reporting periods beginning after June 15, 2005. Therefore, UTStarcom will expense its employee options in the third and fourth quarter of 2005 going forward. We're still doing the work to determine the impact of this to earnings per share and will give you an update on the Q1 earnings call.

2003 restatement -- finally, as noted in today's press release, on February 7, 2005, the audit committee of the Board of Directors of UTStarcom concluded in consultation with and upon the recommendation of UTStarcom's management that UTStarcom's previously issued financial statements for the fiscal year ended December 31, 2003 should be restated to correct certain errors contained therein. Accordingly, such financial statements should no longer be relied upon. Now, specifically during the course of our 2004 year-end close process, errors were identified related to the Company's income tax provision calculation for 2003. The impact of this error was an overstatement of the 2003 income tax expense by approximately 5 to $15 million. This will result in an understatement of earnings per share of approximately 4 to 12 cents. As a result, our full-year GAAP earnings per share for 2003 is now anticipated to range between $1.68 and $1.76, as compared to the $1.64 that was recently recorded. This restatement has no bearing on the Company's revenue, cash flow or pretax income in 2003. In addition, the Company does not expect this correction to have any impact on its anticipated 2004 tax expense. The audit committee and management have discussed these matters with UTStarcom's independent registered public accounting firm.

As a result of these corrections, the management has recommended and the Company's audit committee has approved the restatement of its 2003 financial statements to the (indiscernible) filing (indiscernible) annual report on Form 10-K of for the 2003 fiscal year. The Company expects to file a January report on Form 10-K for the 2004 fiscal year on a timely basis as well. As a result of these income tax errors in 2003, the Company has determined that it may have an internal control deficiency that constitutes a material weakness in the Company's internal controls over financial reporting as defined by the Public Company Accounting Oversight Board's auditing standard Number 2.

With that, I would like to open the call for questions and answers.

(OPERATOR INSTRUCTIONS). Jeff Kvaal with Lehman Brothers.

Thanks for taking the question. If I may focus on the Audiovox business just for second, could you give us a bit of detail on how the revenues in that business in particular are trending and in particular how your phones are progressing through the certification at Verizon? They also themselves had some sort of accounting change for the 2002 results. I am wondering if that carries over to you folks as well.

The second question I will ask Mike to answer. I will give you our prospects on our current -- our Personal Communications division. It's the old Audiovox. The product that we're very pleased to see that Audiovox has continued to progress in terms of our partnership that we are introducing the first EV-DO type of products as well as the smart phone has been very, very successful. We are getting -- continuously to getting a lot of confidence from our customers that we are providing a good solution to them.

As far as our own product going through the U.S. carriers, we are expecting, in the first half of the year, that we will be having our own product released to the market and we will be coming out with the first product, as I said, expected to be before the Q2 and hopefully sooner. The first product line will be a relatively low-end product that will be coming out, and we are going through our test process and we're very pleased with the first results.

So the more product is on planning (ph) and not only in the North American market but we also are looking at the entire South America, and Asia market has also shown a great deal of progress on our own designed CDMA handsets. Again, we are coming out with our own product, which is a low-end side, and we want to differentiate from our current, existing -- our strategic partners that we are getting the handsets from. I think that has been working out quite well. (multiple speakers).

Yes, if I could just clarify, you had talked about 3 phones in the past and so you are expecting one of them at the beginning of the second quarter and the remainder by the end of the second quarter?

Well, we're really very close right now. We're definitely before the first half, and we may, if we are lucky enough, that we may be able to coming out (sic) before the end of the Q1, but it is very, very close so I think this is some of the product that we definitely wanted to still working on (sic) -- and another 2 products we are not too sure if we will be coming out in the first half, but definitely in the Q3.

Perfect. Thanks.

Jeff, your second question had to do with accounting issues. We did an asset acquisition on this business, so there's no carry-over from an accounting point of view. The integration has gone extremely well and I can tell you, there's a mutual excitement with the people here as well as, I believe, with the team out there in Long Island, so it has gone extremely well. Now, what we do need to do on a go-forward basis is that, for '05, they've got to be fully integrated and 404 compliant as we go through that process, so that is something will have to work on during the calendar year here.

Great. Thank you both.

Mike Ounjian with CSFB.

I was hoping to get a little more clarity on sort of what the product mix and the geographic mix was within that $1.2 billion of backlog. Second of all, I just wanted to make sure I understood sort what to expect on the Japan Telecom side. I think, Mike, you mentioned 260 million expected to be recognized in Q1. I think you talked about a number of 290 before. Is the difference of 30 something that's going to be reflected later or recognized later, or is that just the services piece that you're exiting from? I guess what can we expect sort of beyond Q1 from Japan Telecom based on some of the comments you made about the full year?

The first thing is on the backlog. You asked for some clarity on the 2.2. What I would tell you is over half that -- I'm sorry, the 1.2 backlog -- over half that backlog is international, non-China, non-Audiovox backlog. It's primarily oriented towards our broadband products, and it's also got some flavors of wireless in there as well.

I would tell you that China is probably in the neighborhood of 25 percent of the backlog, and that's oriented again towards PAS infrastructure. The handsets have already moved towards a book-and-ship type business. Then we've got some additional a little bit of backlog on the Audiovox, which is now our Personal Communications division, for handset shipments in Q1.

Regarding the 30 million that you described, that's an approximate number. That is actually -- the contract is lower now. As I said, we've exited the entire service portion of that contract, so the profit that we will be recording is less than we had originally anticipated. The margins on that though are still above 40 percent. On a go-forward basis, Japan will be our third-largest market in calendar year 2005. Again, I don't want to use specific numbers but Japan's market looks very strong for us and continue (indiscernible) broadband products as well as, in the future, we hope to do some additional things.

Great. Just one last clarification on the backlog -- within that half that's non-China, non-Audiovox, does that include the 260 for this quarter from Japan Telecom?

Yes, it does.

Tim Long with Banc of America Securities.

This is (indiscernible) here for Tim Long. My question is, I see your guidance; you've guided by 22 to 25 percent, right, and I believe this quarter is 14.2 (ph) percent. Can you just give me more clarity in terms of how you can achieve -- jump from 14.2 to 23, 25 percent?

Yes, it really is primarily driven by mix. Again, I think if as we go forward, we've already said the non-China, the international growth would have margins substantially higher than China, so that's continuing to ramp as we've predicted. It's heavily oriented towards our broadband business, specifically Japan in Q1. At the same time, I did highlight that our PAS infrastructure margins have improved substantially, as we had predicted. In fact, we had margins above 30 percent on the PAS infrastructure in the fourth quarter and we expect those margins to stay quite strong throughout 2005. Then the last element is really on the handset business. We do see those margins increasing as we work through 2005.

When you say the handset business, right now I think it's 4.2 percent, right?

That is just the -- that 4.2 percent is strictly the Audiovox/Personal Communications division -- business. We also then have the handsets that are sold in China, and we are working on -- our internally designed handsets will be sold to various markets such as South America, India, etc.

Okay, so you're talking about (indiscernible) PAS handsets, right?

PAS as well as CDMA and some kind of GSM type flavors.

Hasan Imam with Thomas Weisel Partners.

Hi. This is Rock Ash (ph) on behalf of Hasan Imam. Actually first a quick clarification question -- regarding the 2000 -- well, there would be some restatements of the 2003 numbers. Are there any restatements occurring for the first 3 quarters of '04?

We're not anticipating any restatement on the first 3 quarters of 2004.

Okay. Just a bit more clarification on your gross margin outlook for the year -- can you give a bit more color, if you could, by individual segments like how much your gross margin outlook looks like for CDMA infrastructure and PAS infrastructure? You guided to like greater than or close to 30 percent, but if you could give any color on the CDMA infrastructure side and even PAS handsets.

Again, I think what we've tried to really want to do is we are giving specific guidance only one quarter out. I did try to give some general gross margins by our segments of business, where we record by, as I mentioned, wireless infrastructure, broadband, which we think will both run in the neighborhood of 35 percent. Then on our handsets, I broke into 2 distinct pieces, the internally built and manufactured handsets of about 20 percent and then the Audiovox channel, which is running a little above 4 percent. For us to cut our margins any finer is just something that we're not doing. We're going to move towards enhanced reporting along these businesses. We will try to give you guys, you know, if there's specific contracts or there are circumstances that have unusual margins in either direction, we will try to get that guidance to go forward, but at this point, we don't have any more details to share.

Okay. I just have one final question. There's, like, talk about carrier consolidation in China. Can you discuss any impact on 3G spending, especially if like China Netcom or Telecom end up splitting China Unicom?

Now, regarding that rumor that we've been hearing many times that is China Unicom may be splitting up and the China Telecom and China Unicom are in the (ph) China Netcom and China Telecom may be buying some part of China Unicom portion. That type of rumor has been going out and has been officially from MII as well as China Unicom had openly stated that is not happening. Let's assume, if they if they have -- happen, I also wanted to point out first of all that the cellular infrastructure has always had a more cost -- cost-wise, it's more expensive than our PAS, so we don't believe the impact on the user from a habit of using it, will shift everything into cellular phones. So I really think as long as the China Telecom and China Netcom has a fixed-line operator license, they will continue to have expanded their past subscribers, which we have also witnessing in Q1, that we have very encouraged that subscriber (sic) has continued to be strengthened as we have anticipated in Q1 so far.

Assuming that is the case, that if a China Telecom and China Netcom become 3G operators, and they will still have to target those lower-income areas and in the meantime, we will be able to start selling some of our 3G product lines. So we will actually increase our opportunity and so we will welcome the 3G license to be issued to the operators as well.

Great. Thank you so much.

Daryl Armstrong with Smith Barney.

A couple of questions -- now that you are withdrawing in terms of the services component of the Japan Telecom transaction, could you give us some color in terms of how we should think about future services, not necessarily promotional services, but integration services opportunities, and how you guys would recognize revenue on that piece that you expand internationally into other service providers? That's the first question.

The second question is you guys talked a little bit about where you guys are in the Sarbanes-Oxley process. Could you talk a little bit about what you are doing to maybe flush out some of your financial and accounting and control capabilities?

Lastly, if you could give any incremental color, relative to the sensitivity of your results to movements in the iAN, that would definitely be helpful as well.

Hong, maybe if you took the first one on what types of services and I will take the others for Daryl.

All right. The services aside, we are, from case to case is that we are very open to really study what is the requirement from operators, that they will require us to help them to handle this service portion. When we have evaluated and we're requested by the customer on our Japan Telecoms case, we had actually took the challenge and while we are doing a service contract, we had realized that we're not really doing as good of a job that we had actually anticipated and that we didn't really add a lot of value to that. So we have discussed with our customers and have told them that we would prefer, in the future, to not really to participate in the services portion.

Now, in other parts of the market, we have also looking into IP TV areas and so forth -- that we maybe able to add a little more value in terms of providing some of added value in services portion that we are aggressively to discuss about how we're going to be able to get more content side and help our operator and that kind of services that we are working with our operator. So I think it's really based on case-by-cases that we really see what kind of value that we will be able to add to our operator before we make our decisions.

Now Daryl, with regards to how you recognize revenue, this gets very complicated and there's a term, you know, (inaudible) accounting ledger called VSOE, vendor specific objective evidence. What that really gets into is do you have a fair basis for valuing that service. So if you've got a contract that has a service element as well as equipment, can you separate the 2 and recognize the revenue individually? Given we are approaching a lot of new customers in the world and we don't have a history with those customers and we are also continuing to add more product and more services, we don't have an established track record. So there's things we can do such as catalog pricing. You know, as we continue to gain experience and sign multiple contracts, we will have a larger and larger database. As we capture that experience, it will make it much easier to establish that VSOE. So as we establish that track record and can individually value these service elements around the world with the various customers, it will be very easy to separate the 2. If we aren't able to do that, then we will have a contract. If it's combined, we will recognize revenue and complete both the equipment and the service element.

So I know that's a little bit lengthy and complicated but it is a complicated topic and you know, I think we've got our arms around it.

The second question you asked is regarding Sarbanes-Oxley and, moving forward, what we're doing. Clearly, we are continuing to hire very aggressively as a company. I think it's no secret the growth rate; this company has had over 15 times growth in the last 5 years, moving from being very China-centric to a global basis. So we need to continue to add staff on a global basis.

The second thing clearly is continuing to improve our business systems, so we've committed to Oracle, started that process a couple of years ago. I think, as we get more and more of the Company onto Oracle and utilize it to a higher and higher extent, that is only going to help us. Clearly, with the work we're doing with Accenture and supply-chain, I think that is going to add predictability and process in our whole supply chain, which translates obviously to enhanced controls within the Company. So we are entirely committed to this process, Hong and I are actively involved, and you know, I think the Company is really behind it as well.

The third thing is you had asked a question on the sensitivity to the yen. That also can be a complicated answer but I think we've seen some pretty big movements in the yen over the last year. I think, if you look at any particular quarter, we've never seen an impact more than a $5 million, so I think plus or minus $5 million on a quarterly basis, based on historical movement.

That's very helpful. Thank you.

We've gone a little over an hour so maybe we could take 2 more questions.

Joe Noel with Pacific Growth.

Thanks for taking the question. A couple of quick questions here -- Mike, did you say 70 million for PAS infrastructure in China? Is that the number that you gave?

Fort Q1?

For Q1?

I said 70 million, yes, in wireless infrastructure.

It's a little bit lighter than I thought. I was anticipating a number right around there. Are you seeing maybe a little more seasonal weakness in the Q1 there?

Well, I think we're trying to be conservative with the guidance and two, we do have the Chinese new year to contend with and that's usually a very difficult quarter. Not only do you have a winter environment in the northern part of China from an outdoor point of view, but you've also got the Chinese new year that shuts down the country substantially. So historically, we've been conservative in the Q1 and I think it's the right way to guide. You did see some infrastructure contracts that we announced in early January. You know, so again, as Hong said, we are looking at 20 to 25 million subs for the year and we're looking at a nice mix of infrastructure and handsets but it will be down substantially from last year.

The revenue that you're going to recognize from Japan -- that is not GEPON? Is that correct?

The specific contract we're referring to is our iAN-8000. This is the multi-service platform.

Yes. What can you tell us about how the installation of that platform went at Japan Telecom, and what can you tell us about the actual inflation of GEPON in Japan? How are those going?

Well, I don't know if I can say how, too specifically, but typically, it would take about -- from a customer applied for installation -- normally it takes about 2 weeks -- I mean 2 months to be installed, and they only have about a limited number of people. Right now, it is an installation had delayed (sic) a lot of the movement in our units installed to the house right now. So there's a certain restraining from an installation side.

But do you see any delay in the GEPON section of that, or does that appear to be generally on track?

I think it is a little bit slower than we had anticipated, just as I said, due to the installation speed.

David Fondrie with Heartland Funds.

Good afternoon. Could you help me understand the increase in SG&A? Maybe it was partly covered but it looks to me like SG&A went up by about 25 million. The write-off of the intangible amortization, or the intangibles, I think that was about 10 million. Is that included in SG&A?

Yes, it is. There's also roughly a significant increase in commission charges in the quarter. We also had the Audiovox acquisition, which is all in the SG&A line.

(indiscernible).

And Giga (ph) Telecom. Those (indiscernible) charges were actually in the R&D line. But yes, the intangible amortization charge as well as the Audiovox acquisition -- and then the third element in the quarter was obviously significant continued charges on our outside consulting on supply-chain and 404.

Okay, that helps. Previously, or maybe you can describe what happened at the payments relative to the Japan contract were delayed. I mean originally you were expecting to collect I guess maybe 190 million in the fourth quarter, and now it was pushed out into the first quarter. Was that at all related to you exiting the service contracts, or what -- (multiple speakers)?

No, it actually depends on how we are going to be able to complete our shipment. After the shipment that is 37 days, after they've received the shipment, then we will be able to get our payments. Some of the shipment that -- we've made a partial shipment; we did not complete all the entire shipment in time in Q4. That's why I think in time for us to be able to get all of those payments (sic).

Okay, thank you very much.

This has been a long call but we appreciate you for listing. We had a lot of information to cover and we really wanted to highlight the transformation that the Company has gone through in the last couple of quarters as well as the first objective we had had, as it was the globalization. Now, as Hong mentioned, we're focusing on execution and a return to profitability and predictability. So again, thank you all for listing to today's call. Operator?

Thank you for participating in today's UTStarcom conference call. This conference call will be available for replay beginning at 730 PM Eastern time today through 1159 PM Eastern standard time on Tuesday, February 15. The conference ID number for the replay is 300-7591. (Operator repeats numbers). The number to dial for the replay is 1-800-642-1687 or 706-645-9291. Thank you.