UTStarcom Holdings Corp (UTSI) 2005 Q2 法說會逐字稿

At this time I would like to welcome everyone to the UTStarcom second quarter earnings conference call. [OPERATOR INSTRUCTIONS] Mr. Sophie, you may begin your conference.

Thank you. Good afternoon and thank you for joining UTStarcom's second quarter 2005 earnings conference call. I'm Mike Sophie, UTStarcom's COO and I'm proud to host today's call with our CEO, Hong Lu In this call, we'll address five key points: The stabilization of the PAS market in China;Two, progress we're making on our diversification efforts; Three, progress in our restructuring initiatives; And four, gross margin improvements; and five, balance sheet improvements.

I would like to remind everyone that some of the information we'll discuss today constitutes forward-looking statements. Actual results could differ materially from our current expectations. To understand the risks that could 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.

With that, I'll turn the call over to Hong. Hong?

Thank you, Mike. And thank you, everyone for joining us this afternoon. Q2 was a constructive quarter for UTStarcom. We made progress in several important areas. We saw initial results from our restructuring program and we also continued to execute on our diversification strategy. We know that these initiatives do not happen overnight. We believe steady progress each quarter is the way to be successful.

Let me begin by providing the brief summary of our financial results. In the second quarter, UTStarcom generated 723 million in revenue and had a net loss of a $0.65 per share. Booking were good in the quarter and we had a very good visibility into the second half of 2005, with a backlog of approximately 915 million at the end of the quarter. Finally, as targeted, we generated approximately 44 million of positive cash-flow from the operation and made improvement to the balance sheet. Mike will discuss our financial results in greater detail.

Now, I will address our current view of the China PAS market . We maintain our expectation of approximately 50% declines in PAS spending in 2005. At the same time, it is clear that PAS will remain an important technology in China for at least next seven to ten years. PAS is still the fastest and the most cost-effective way to extend the basic phone services to the vast majority of the Chinese consumers. In fact, the chief engineer of China Netcom stated in June that PAS would not only continue to thrive when 3G is deployed, but it is also be an important transition service for customer to migrate over time to 3G. Tentelecom Motion had an activity promoting our Q box solution as an advance solution for PAS consumers. For the consumers, the price differences between the traditional mobile services and PAS continue to be approximately $0.04 to $0.05 per minute for mobile services versus $0.01 per minute for PAS. This is very compelling, as the average annual income in China is approximately $3,000 U.S. per year.

Over the next ten years, China expects to -- approximately 400 million to people to migrate from the farm -- farming community into the metropolitan China. This means the target market of a PAS continue to increase. Statistics also confirm that long-term view of the PAS market. In the second quarter, subscriber addition will continue at the robust pace. With approximately 6.5 million net subscriber additions, it is tracking to a high end of our expectation for the year, and bringing the total number of a PAS subscriber in China to 75 million at the end of Q2. PAS networks in China are currently operating on an average utilization rate of approximately 75%. We expect that both China Telecom and China Netcom will continue to expand and upgrade their networks over the next several years to meet subscriber demand.

UTStarcom maintained leading market share for the both the PAS infrastructure and handsets market, with approximately 60% share of the infrastructure market and 53% to 55% share of the handsets market. In the second quarter, we announced approximately 250 million in PAS infrastructure and handset orders with the China Telecom and China Netcom. We shipped approximately 3.4 million PAS handsets in Q2, with an average selling price of approximately $44. We launched four new PAS model in the second quarter and had 11 of the top 15 selling models in the quarter. UTStarcom is one of the only four vendors today that has passed the necessary test requirement to sell handsets, PIN -- PIN-based, which is a personal identification modules that allows subscriber information to be portable from phone to phone. We currently sell four out of seven PIN-based PAS handset modules available in the market place today.

Beginning of this fall, no models that are not PIN-based were not allowed to be introduced in China. We were also awarded a license to manufacture and sell both GSM and CDMA handsets in China, and won our first CDMA handset contract with the China Unicom for an initial 250,000 units worth. This also means that we can sell our dual-mode PAS GSM handsets into the market in the future.

With respect to 3G, many recent reports indicated that 3G licensing awards may move into two -- 2006. While there has been no official word on timing from the Chinese government, we view this delay as probable, given the continuing mid -- immaturity of the 3G-CDMA technology. Also the decision to grant license must be agreed upon by several government entities, including the MII, the State Asset Supervision and Administration Commissions, and the National Commission of the Reform and Development, which will take some time to coordinate. Despite the uncertainty of the timing of the 3G licenses, we feel we had a very competitive 3G product portfolio and is well positioned to capture market share when 3G spending begin in China. In fact, UTStarcom is the first and only vendor so far to pass the WCDMA Release 4 standard, which is a total IP solution performance test in China Netcom. We're excited about our prospects of the 3G in China and see it as an opportunity for the growth beginning in 2006.

Another area of a growth of a UTStarcom in China is broadband. In the second quarter, we signed contract with the China Telecom and China Netcom and essentially double our deployment over 2004. We also won a contract with the China Telecom and deploy our MSTP optical transport solution in the three cities in HangZhou. We successfully passed the MII test and are commercially shipping of our Gigabit EPON private-to-the-home solution to Chinese Telecom to Shijiazhuang, the capital of HeBei Province. We're the first vendor to be awarded a license in China for this technology. In addition, IP TV is gaining traction in China. As discussed in -- on our analyst day, we currently have over 40 trial of IP TV underway and have seen very good responses. For example, we have a trial with China Netcom in HaErBin City . HaErBin City has a population of around three million people with one million TV subscribers and 300,000 broadband users. The trial begun on May 17 and today has over 20,000 subscribers with the plans to have 100,000 subscribers by the end of the year.

We're providing our complete end-to-end solution, which allows subscribers to enjoy such services as video-on-demand and time-shift TV. Though IP TV licensing is still an open issue for the operators, we're confident that license will be awarded and believe IP TV will be the large growth opportunity for us. There are over 350 million household in China with a television penetration rate of 97%. Diversification isite -- outside of the China is also very important to the future of a UTStarcom. Our new products are been well received by carriers globally. We have a deploy our mVision IP TV platform with a soft bank broadband in Japan to support their new BBTV service, which long-term July 1, the BBTV service will initially offer subscriber 28 channels of the live broadcast television and more than 5,000 movie on demand. Since the launch of the service, more than 12,000 people have subscribed for BBTV. Our IP TV deployments with the soft bank BB demonstrate that success of UTStarcom's strategy of the working with our customer to build the comprehensive platform of a scalable solution to ensure their long-term growth.

Over the last three years, Softbank has deployed a broad range of our solutions including our IP Dslam, IM 8000, MSTP Gigabit EPON, and the most recently mVision IP TV solution. In that same time, Softbank has become one of the fastest growing, most comprehensive and most successful broadband services provider in the world. They are the model for every fixed-line operator looking at providing triple play services. This [indiscernible] shows the strength of our technology and the commitment we have to our customers. Following Softbank's footsteps, DSSI, a CLEC serving communities in the southern, eastern United States is scheduled to the launch the commercial IP TV and triple play services later this summer. They're using our mVision IP TV platform supported by our M Switch IP-based soft switch and our gigabit fiber solution.

In Latin America, we announced a strategic partner with a Cisco to focus on IP TV demand in Brazil. We see additional IP TV opportunity in Latin America, India and Europe, and we're working on expanding the footprint of our IP TV solution this year. Also in Latin America, we announce a contract to deliver our IP Dslam solutions for COTEL in Bolivia. We continue to ship our IP Dslam products to Telmex in Mexico and Brazil Telecom, and are building a strong relationship with them.

In Europe, we sign agreement with Isically (ph) for 150,000 lines of our IP Dslam solutions to expand their broadband network in Italy. It is an expansion on initial contract we announce in June, 2004. UTStarcom IP Dslam is the platform for fiscally growing networks, delivering voice, video and high-speed data services.

We also see strong demand for our optical broadband products globally. In the second quarter, we sign a new contract for [indiscernible] In Japan, Korea, the Philippines and Taiwan. In India, we sign a contract with the BSNL for our NetRing optical transport solutions. Our IP Dslam and Total Control 1000 solutions are already deployed in the BSNL network. Our relationship with the BSNL expands our presence and revenue opportunity in India, one of the fastest growing telecom market in the world. On the wireless side, we're seeing significant interest in our end-to-end IP-based CDMA2000 solutions. During the quarter, we continue to shift our CDMA solution to Reliance in India. We're also in the process to sign a contract for an CDMA2000 infrastructure in North America and in CALA region. Additionally, we believe that Softbank will be awarded the wireless license in Japan in the late 2005, and feel UTStarcom is well-positioned with the right technology to expand our relationship into the wireless base, as well.

Finally, with the respect to the handsets, we have strengthened our relationship with the leading wireless carrier in North America and in CALA through our Personal Communication Division, PCD. In Q2, PCD continue it's a momentum selling 1.75 million handsets. The average selling price of the handsets was $180, which is nearly $50 over industry average. [indiscernible] of our data products to Tier 1 carrier were strong, and included in the lau -- relaunch of our MAT 5600 to Cingular. Our first [indiscernible] handset, the CDMA 8940 was introduced through Verizon Wireless.

Highlighting the quarter was the sale of our first [indiscernible] manufactured handset, the CDM 7000 to Elusa Sale in Mexico. In the U.S., we continue to work with the Tijuana and Tier 2 to introduce the 7000 series this year. This quarter's contract win are evident to continue traction of the several major carriers outside of China. Having said that, we know that building a substantial and consistent international presence in revenue stream takes time. While I believe it is prudent to be cautious about our near-term expectation, I'm optimistic about the long-term growth for UTStarcom.

Now, also challenges we must overcome. One of our primary challenges is to continue to improve [indiscernible] handsets gross margin. To that end, in the third quarter we'll launch three handsets with the new low cast basics. Some of these will be our own internally-developed basics and some will be from [indiscernible]. We believe the new ASICS can take approximately 10% out of our cost of handsets and will bring our [indiscernible] gross margin back into the high teen in the next several quarters. We will integrate them into additional handset models over the next several quarters.

Now, let me provide you with an update on restructuring. We announced a restructuring program on the first quarter earning call and share the additional detail during our analyst day held on May 18. Our primary goal is to reduce the breakeven revenue for each product line, realign our investment with the key growth opportunity, and achieve consistent and substantial level of a profitability, as we exit 2005. I'm happy with the progress we have made today, which includes saving of approximately 24 million in operation expense on the ongoing basis, a reduction of the working capital of 82 million, and the reduction of our long-term debt of a 78 million. We expect to complete the balance of the restructuring the third quarter. Mike will give more detail later on the call.

We also know that in order to have our diversification and restructuring initiatives to be truly successful, we need to have the right management team in place. UTStarcom has evolving to the much more complex and diversified organization we are adding to our executive team to reflect this changes. In the second quarter, we took several steps to broaden our executive team and provide a better fit between the current needs of our organization and background of our personnels. First, we announced the promotion of a Mike Sophie to Executive Vice President and COO. Mike's focus on global operations will include the supply chain optimization, oracle implementation and restructuring efforts. We'll promote the success of our return to profitability. Mike has the experience and understanding of our Company and our industry to greatly enhance UTStarcom separational effectiveness.

In addition today, we announce appointment of a Fran Barton as our new Chief Financial Officer. Fran has an excellent track record of a leading multi-billion dollar financial organization, at such company as AMD, Atmel and Amdahl. We are very pleased to have him on board, as he will add to the depth and experience to our management team, and will lead the financial organization to meet our long-term objectives. We also expect to hire a new global sales executive in third quarter.

As you can see, Q2 was a constructive quarter for UTStarcom, with a significant progress. But there is still work to be done in order to bring UTStarcom back to consistent growth and profitabilities. In Q3, we plan to build on our accomplishment and continue penetrating Tier 1 accounts in our target market and expand relationship with our existing customers. As we process, we will see our effort becoming increasingly focused. We plan to leverage our initial success in a new market and narrowing our efforts to renew strategic product areas. I believe that areas with the biggest revenue potential area where we can best differentiate ourself are in core network con -- IP core network concept, fixed-to-mobile conversions, soft switching, and broadband solutions. We also expect to complete our restructuring plans in the third quarter and are committed to making continue improvement to our cost structure to optimizing our operational efficiency and profitabilities. I'm confident that UTStarcom will be successful in executing on these goals and look forward to providing with you an update at the next earning calls.

And now I will turn to the call over to Mike.

Thank you, Hong. First, let me provide some detail on our second quarter results and give a status on our restructuring initiative. Then I'll give guidance for the third quarter of 2005. We closed the second quarter with sales of 723 million. Sales for the quarter grew approximately 5% year-over-year and were down sequentially approximately 20%, as anticipated. By product category, handsets and CPE revenues were 490.7 million, revenues from our Personal Communications Division were $342.3 million, and broadband revenues were approximately 74.2 million in the quarter, which was slightly below expectations due to some lumpiness in revenue recognition. Wireless infrastructure sales were slightly above expectations and were 158.1 million in the second quarter and by geography, sales in China represented approximately 40% of total sales in the second quarter, which compares to approximately 90% in the second quarter of 2004.

Our overall gross margin dollars for the second quarter were $109.4 million or 15.1% of sales. Gross margins reflect approximately 5.5 million in inventory write-downs associated with our restructuring initiatives. Overall gross margins, not including the restructuring charges, were approximately 16%. Gross profit margin, excluding the Personal Communications Division, was approximately 24.5% of sales and margins for the Personal Communications Division were 4.7%. Broadband gross margins came in at 33.5% of sales, which reflects some lower margin revenues in India. We expect broadband margins will move back into the 40% range in Q3.

Wireless infrastructure margins came in at 29% of sales in the quarter and include the $5.5 million [indiscernible] inventory write-down associated with the restructuring. Without the write-downs, wireless gross margins would have been 32.5% of sales. PAS handset margins came in at 15.7%, which represents a good improvement over the margins of 11.5% in Q1. We are pleased with the PAS handset margin improvement, as it reflects the beginning of our cost-reduction efforts. Total operating expenses for the second quarter were 191 million or 26% of sales. As discussed in the Q1 call, operating expense also include approximately 15 million of restructuring charges, of which $6.3 million was in cash.

We had an income tax benefit in the second quarter of 1.5 million. In addition, as discussed on the Q1 call, we took a non-cash tax charge of approximately $13.5 million in the second quarter, related to the assignment of a more favorable tax rate in China and the subsequent revaluation of a deferred tax asset. If you recall, we had initially anticipated taking a charge of approximately $20 million the second quarter, as we expected to receive high-tech zone designation in two jurisdictions in China. In fact, we only received the status in one jurisdiction during the second quarter and expect to receive the status in the other jurisdiction in Q3. Our effective tax rate has now changed to 9%, as compared to 28% as we had guided on the Q1 call, due to fluctuating profitablility, cost geographies and tax jurisdictions.

Net interest and other expense for the second quarter of 2005 was net income of approximately $5.6 million, primarily driven by the $11.1 million gain we recognized on extinguishment of 38 million of our convertible notes during the quarter. As announced in our 8-K filing for the end of June, we entered into two separate debt extinguishment transactions during the quarter, in which we exchanged a total of 32.8 million in cash and approximately three million shares of common stock for our convertible notes, with a face value of 78 million. Since the value of the cash and shares we exchanged were less than the face value of the notes, we recorded gains of 11.1 million and 10.8 million on the first and second transactions, respectively. The second transaction settled in July and as a result, we reported in Q3.

Net loss for the second quarter was 74.7 million or $0.65 per share, which includes charges of approximately 20.7 million or $0.16 per share associated with restructuring plan, 13.5 million or $0.12 per share associated with a non-cash tax charge and a gain of approximately 11.1 million or $0.08 earnings per share associated with the extinguishment of debt in the quarter.

Moving from the income statement, I believe we achieved meaningful improvement to our balance sheet during the second quarter,which included positive cash-flow from operations and reductions in receivables, inventories and both short-term and long-term debt. Our cash, cash equivalence, short-term investments totaled 381.7 million at June 30, as compared to 388.9 million at March 31. The 7.2 million decline in cash and investments was more than offset by a reduction to both short-term and long-term debt during the quarter so, actually, we're cash-flow positive from the quarter on a net basis, as well as from operations. Cash collections from customers remain strong and were approximately 819 million during this quarter. And as discussed on the Q1 earnings call, we targeted and achieved approximately 44 million of positive cash-flow from operations. We explect -- we expect to collect in excess of 700 million from our customers in the third quarter.

Additionally, we continue to have various credit lines in China that totalled in excess of 900 million at June 30, at which less than a third were utilized at quarter end. We will continue to use our lines of credit, both borrowing against and repaying as needed, to modulate working capital requirements. Also to ensure the liquidity and fundability across geographies will not be an issue, we added a U.S. facility. On August 1, we entered into a one-year $100 million commit receivables purchase agreement with Citibank North America, under which we are permitted, subject to the terms of the agreement, to sell specified U.S. accounts receivables to the bank if, and as needed, for additional liquidity. The agreement will be disclosed on form 8K and our quarterly filing 10Q.

On working capital, as we targeted, we reduced the working capital by 82 million in the prior quarter towards our stated goal of 200 million by year-end. Our accounts receivable balance was 851.3 million, which represents reduction of approximately 55.8 million from the Q1 levels. Our DSO total, including the Personal Communications Division, was 106 days for the second quarter, which reflects the lower quarter -- a lower revenue in quarter two compared to quarter one. We will continue to make reductions in accounts receivable and expect DSO improvement, as we achieve our working capital targets.

As of the end of June, our total inventory and deferred cost balance decreased by 34 million to 750 million. Inventory turns for Q2 also came in at 3.2. We have targeted an additional 10% reduction in inventories in Q3. Our total short-term debt balance at the end of the second quarter was 265.2 million and during the quarter, we repaid approximately 10.2 million in short-term debt. As discussed in the first quarter call, our focus this year is to realign the Company internally and to be able to deliver consistent profitability and predictability, as we complete 2005 and enter 2006.

As Hong mentioned earlier in the call, we feel that we've made a good deal of progress on the restructuring initiative. Specifics include, to date, we've reduced head count by approximately 960 employees. We also made cuts that will reduce operating expenses by approximately 24 million per quarter, beginning in the third quarter of 2005. We continue to expect that we will achieve a op-ex reduction of approximately 40 million per quarter, with the full effect realized by the fourth quarter of 2005. We also reduced working capital by approximately 82 million during the quarter, and the Company continues to expect that it will achieve working capital reductions in excess of 200 million by the end of 2005. We plan to complete restructuring activities in the third quarter and expect to take a charge of approximately five to ten million related to the restructuring.

Guidance going forward. For the third quarter of 2005, revenue should be approximately $60 to $80 million. Revenues from our PCD division should contribute approximately 55% of total revenues. Other handsets and CPE revenues should be approximately 20% of revenues. Wireless infrastructure should be approximately 15%. Broadband revenues should be approximately 10% in Q3, and will include the $30 million in IP TV revenues from SBD we mentioned on the Q1 call.. Backlog as of June 30 was approximately 915 million. f our backlog, broadband is approximately 30%, wireless infrastructure is 45%, and handsets is approximately 25%. We expect the vast majority of the backlog will be converted to revenue by year-end, as final acceptances are obtained.

In Q3, gross margins should be approximately 15% to 18%, on a consolidated basis. Gross margins, not including the PCD division, should be approximately 30% to 32%. Trends we are seeing for our gross margins include the following: PCD will be in the 4.5% to 5%; China handsets -- China handsets went from 11% to 15%, and will continue to rise into the high-teens in the balance of this year; Wireless will move from the low-30s to the high-30s; and broadband will return above 40%. Total operating expenses should be approximately 25% of sales, and will include an additional five to ten million in charges associated with our restructuring. We expect our 2005 annual effective tax rate to be approximately 9% on a go-forward basis. GAAP EPS guidance for Q3 is a loss of approximately $0.35 to $0.40, which is inclusive of the additional restructuring and non-cash tax charges. We expect to be slightly cash-flow positive from operations in the third quarter.

We believe we have made important progress in the second quarter against our five key areas of focus. We have seen stabilization of the PAS market in China, continued momentum in our international markets. At the same time, we made meaningful improvements to our gross margins, balance sheet and cash-flows. And, finally, we made significant progress in our restructuring plans. We look forward to the continued improvements against these bench marks in the remainder of 200,5 and a return to consistent levels of profitability as we enter 2006.

Finally, before I turn the call over to the operator, I would also like to add how pleased we are that Fran Barton will be joining UTStarcom as Chief Financial Officer. As Hong mentioned, Fran has a very strong background of finance and operations, and he and I will be working closely together to ensure the successful transition of the financial organization and achieving the operational goals of the Company.

With that you, I would now like to turn the call over for Q&A. Ronny?

[OPERATOR INSTRUCTIONS] Your first question comes from Mike Ounjian of Credit Suisse First Boston.

Great. Thank you very much. Mike, could you talk a little more, you mentioned from the backlog of 115 million, that all of that would be recognized by year-end. And, you know, of the -- with 75% of that coming from broadband and wireless infrastructure, it sounds like not a lot of that's coming in Q3, most of it, therefore, coming from Q4. Could you talk about what regions and what product the backlog is, and just what the -- sort of what the delays are? Is it just -- is it just customer acceptance of the product or there -- are there any issues related to finding revenues on these?

Yes, with the backlog, the vast majority of the wireless backlog is clearly PAS. I think you saw the announcement at the end of the June, where we announced on the PAS infrastructure orders in China. And, again, just the timing of deployment and achieving final acceptance. We've also got some CDMA, to a lesser extent, in the backlog, and we also have some of the -- you know, the TDCDMA in there, as well as well, in Europe.

With the broadband, it's IP TV oriented. We mentioned the $30 million that'll be recognized this quarter. And then, we just have to continue to play out IP D -- you know, our big EPON and the ST products throughout the balance of the year. But Q3 clearly is a little more handset oriented than we would typically run.

Great, thanks. The other question just related to the Q3 guidance on the Personal Communications Division. How much of that business would you estimate being year-around designs as opposed to resell?

Go ahead.

Mike, this is Hong. We have, for the rest of the balance of the year, we are expected to have half a million handsets. And out of that, we are, probably for the second half the year, from a run-rate wise, we expect to ship that a little bit more than three million handsets. So, I'll probably say a percentage of the number of handsets we should be able to get some meaningful numbers. From a dollar amount are still going to be a relatively small, because our handsets will be selling less than one-half of what normal ASP vendor is selling.

Right, thank you.

Your next question is from Jeff Kvaal of Lehman Brothers.

Thanks very much. Mike, I'm wondering if you could give us an update on when you think breakeven might be feasible and at what revenue level, if that's possible? It sounded like early 2006 was the time frame?

No. We're -- specifically we're still targeting to -- to achieve breakeven or slight profits in the fourth quarter. But as you know, we're only giving guidance one quarter out at this point in time. And, you know, we're still working very hard to achie -- achieve that objective.

Jeff, typically, the Q3 is -- historically that we see it's a -- normally it's a slower quarters for us. So, if our cost reduction and our revenue increases and we also see a -- a fairly positive momentum that we have been shown some our margins and we -- we're getting a fairly encouraged by the recent development that we have. So, we need to be able to get back to that breakeven, hopefully short of what you had expected.

Oh, okay, good. Then, also, on-- on the PHS, with the 3G delays, does that mean that PAS may have a bit of a -- a bit of a longer -- bit of a resurgence in demand over the next two or three quarters?

Yes, definitely if they're slowing down, it's a less opportunity for anyone to make future investment, therefore there will be a -- a better position. But, I also wanted to just share some of recent development that we have been witnessed in Japan, for instance. After they had introduced the fixed cost for -- for the monthly basis, in other words, they can have -- that about $28 a month services and you can call as many call as you can and then after that, their PAS is searched in Japan, and about 60,000 to 80,000 new subscribers per month. And, you -- if you can imagine Japan has been very, very high penetration and still for the cost differential, even in Japan, it is a very, very significant.

Now, in time one, we have a -- selling the PAS product for last four years but this year, again, we've been seeing a much faster growth that we haven't seen compared to the many other years, due to -- there's a more handsets available, as well as the [indiscernible] handsets for the GSM PAS is available to the market so, therefore, there is a lot more new subscriber. Again, that's only 35% differences in price. Look at the China, with a very low penetration and very cost-sensitive area, much so than Japan and Taiwan.

We have actually have a one-to-fourth or one-to-fifth, so that -- that means that there's a 75% to 80% discount on our fixed-land tariff versus the mobile tariffs. And I think that's just significant in the differentiation. And now in the past, a lot of our customer were buying the mobile services due to in one places that they cannot use their phone, because they -- they will not be able to use the same number. And now we're making PIN card and that personal identification module will be able to give them another alternative to go to another cities to use. so given more flexibilities. So, we are very much looking forward to have flexibility to have the more people to come. And as long as there is arbitrage between the mobile and the fixed line, I will probably say even 3G comes in or not coming in, it will be a significant of that business to grow in the future.

Oh, wonderful. Thanks. And, Mike, if you had a brief comment on the deferred tax cash generation and how we should think about that? We -- I would appreciate it.

Yes, what really you saw there is that we had the -- the TSM business in Japan. As we exited that business, we had -- last quarter had set-up a tax payable, as well as deferred tax asset. So, the two basically, as we close that out, they clear. We only had, basically, about a $10 million outflow of taxes, and that's all wrapped up now.

Thanks very much.

Your next question comes from Tim Long of Banc of America Securities.

Hi, this is Chen-Ley Ong-Verkouille for the Tim Long. Actually, I have two questions I'd like to ask. The first question regarding the liquidity question. I know that you're talking about the 4Q being the breakeven. but my question to you is, you know, when you talk about breakeven, are you you talking about working capital? I mean, [indiscernible] working capital requirement, but when you think that you're going to be in a truly to operating cash-flow positive? Which quarter do you think about? Is it going to be early 2006 or --

Well, I th -- I already answered that question as we were operating cash-flow positive in Q2, as we said we would be, and we believe that we'll be operating cash-flow positive in Q3, as well. When we're talking about breakeven, we're referring specifically to the income statement and we'd like to achieve breakeven to slight profits in the fourth quarter and be able to deliver consistent profits on a go-forward basis as we enter 2006.

Okay. The second question regarding the business, when you're talking about -- just a few -- a few questions regarding the gross margin. The first question I have regarding the handsets right, you're talking about in to 3Q, you're going to introduce the three handset, which will have lower cost of ASICS. So, my question to you is when you going to see the meaningful improvement of -- for the PAS handset going forward? It's going to be the 4Q os still going to be the first quarter of 2006?

The -- Chen, I'd like to point out is that we actually had meaningful improvement in the gross margins realized here in Q2. The gross margins had been running about 11% in Q1 for the PAS handsets, and they were about that range for the fourth quarter last year, as well. We actually moved those up to 15% in Q2, realized that in the second quarter. And now, with the ASICS insertions, we think that they'll be seeking -- see continued margin improvement on a go-forward basis. I'll let Hong comment specifically on -- on what we're doing ing with the ASICS.

Well, we are now currently, actually, introducing around three to four handsets per quarter, and we are now going to start using some of our -- the new ASICS.. And, of course, we're still selling a lot of handse -- handsets today in the market with a traditional chip sets or the -- before the cost reduction handsets. And so, therefore, it will be taking some time for us to really ramp it up, and I would say in Q1 next year, we'll have a more than half of handsets by then, it will be hopefully by low-cost ASICS. And before then, it would be sliding in Q3, would be probably very small amount, maybe 10%, 15%. And Q4 would be increasing, that up to, maybe, up to 25 to 40% range, and in Q1, we'll have hopefully more than 50%.

Okay, great. The one more question for the, also, gross margin. I know this quarter, the [indiscernible] was about -- roughly about 32% or 33% of gross margin. And then you're talking about you're going to reach to the 40%. So my question is how are you going to achieve 40%?

And then similar to [indiscernible] question is the currently you are running about, probably, 17 million per quarter for broadband. What you think about -- you know, when you think is going to be meaningful growth? Meaning, it's supposed to be at 100 million per quarter. Last quarter, I know that it's gone 17 million, I mean in the first quarter for the Japan Telecom. But if you exclude Japan Telecom, it's about 17 million per quarter. So my question to you is then why you think of when it's going to be, you know, bo beyond 100 million and the consistent growth?

Okay, you have asked a lot of questions. Let me -- probably first question's about how can we, from low 30% to 40%.

Right.

One of the major reasons is that we still have a lot of inventory in the past that we have finally digested. So, we have taken away a lot of those expensive parts. And second is that we have a lot of the repeat order coming in. In China, a first most expensive part is that to trying to put the system into the sys -- into China Telecom and China Netcom. Now, once you put it in, the repeat order of our -- the boards are much higher margin. And also in Q2, we have opened up our market in India, typically that also has take down some of our margins to just understand and get used to the margin in India. And I think in the future, again, expansion of the business in India after we taking off, it will be a much more higher margin than will be anticipated.

Now, as far as the revenue goes, you know, we have a doubling our -- our shipment compared to the first half of the year and versus it this year and the last year. So, we have again a very, very high number of shipment and also we have been getting into a newer account in the Brazil Telecom and also a Mexico in the Telmex and Tuscale and Japan is continued to coming in. So -- so the broadband business, we have been seeing a very, very more robust. Now, at the same time, if a triple play, everybody needs to have IP Dslam and [indiscernible] on positioning extremely well, because we're number two in the world for as far as the IP Dslam shipment, and so forth.

Now, with the triple play, we're also positioning well, and we're getting a lot of not only the commercial in -- in Japan, but we're getting a very high number of trial in China and we're getting into a trial in both Europe and India. That's going to -- getting in a position ourself into the very good position in 2006. I would say, you know, we're very high on IP TV and MSTP. MSTP and gigabit EPON and all of them are very, very new to -- to the operators. And fortunately, that is something a lot of people are looking into for the IP solutions. So, I will probably say we have -- we had just started getting into a lot of a new accounts with those product lines and, therefore, we see for us to achieve over 100 million is very obtainable.

Yes, Chen, we need to let some other people get a chance to ask us some questions. If you also remember the backlog as I mentioned about 30% of our backlog is broadband.

Thank you.

Next question comes from Darrell Armstrong of Smith Barney.

Thank you very much. Want to clarify at one point and then ask two questions. First of all, you guys did say that you would be running at a three million run-rate for your own design, if you made phones by the end of this calendar year?

No, I didn't say that. We said currently we're running three million is our -- including everyone else's ASICS. Maybe I misunderstand your question. Is this a past question?

No, no, no. What I'm trying to do is get a better sense in terms of the PCD-made products that you guys have designed for yourself. Not the Curatel phones --

I said three million is the entire shipment that expected from -- from -- from our PCDs and our own design would be half a million.

Okay, ab-- about half a million. And so, for your own design, how many units do you have to ship on a quarterly basis so that you absorb the fixed costs associated with -- with manufacturing those phones? The past you guys have talked about the much better margin profile for your own design phones. But I just wanted to get a sense in terms of what type of -- of shipment numbers we have to see in order to really start to see that benefit.

It's a -- at the beginning of our shipment to North America at this time, we are -- we are trying to get into the market and we are still learning the process. So, it will probably -- it's not -- not very relevant numbers for us. We're just trying to get into and trying to learn the processes. We made a lot of mistakes that we shouldn't have made in the future. So, if -- normalizing the situation that if we can be able to do say 300,000 handsets or so, we should be able to breakeven and even making more.

Okay, that's helpful. Then then,, in terms of WCDMA, if -- if the licenses are issued in 2006, and you guys are awarded a contract, how should we think about the qualification time for the equipment associated with -- with those build-outs? You know, are we talking about two to three quarters? So let's say, hypothetically, if we saw licenses issue in the -- in the first quarter of next year, you guys would actually be able to recognize revenue around the, you know, late third to the fourth quarter of '06? How should we just think about the timing from when the licenses would be issued to the timing that you would actually be able to show some revenue from -- from that event?

Yes, the moment the license was issue, they will allow the -- the operator to start negotiating with the contracts and start penetrating it. So, I will probably say they're not going to be in services until -- if they have a license given at the beginning of the 2006, they're not going to be in the service until the latter part of 2006 and the operator typically do not want to give any fina -- final acceptance until they know the system is stabilized. And, potentially in Japan, we will be seeing that the license were given in by year 2005 and they will be probably -- I would still say both cases, maybe slightly earlier in Japan than in China, but I would say in 2006 in Q4 or beginning of a Q1 in 2007.

Okay. That's extremely helpful. Thanks.

Sure.

Your next question comes from Hasan Imam of Thomas Wiesel Partners.

This is Cynthia Mumm asking on behalf of Hasan Imam. Couple of questions. First, a -- there are a number of 3G and reorganization scenarios floating around in China, including Netcom or China Telecom having access to 2D networks of Unicom. If such an event transpires, what would that mean for PAS? At this point, carriers would have cheaper 2D alternatives. We're interested in your view on this.

Okay.

Now, as I said, as long as the tariff is going to be submain and no matter what, I don't think any operator can reduce their tariff by half. I don't think that would be a very viable solution for them. And as long as they also have the license, they wanted to separating between the limitation on the PAS services versus the mobile services. That's why you're seeing, even in the Q2, we have receiving a fairly significant new build-out in the infrastructures and as we speak, we still carry on in the Q3, that we are shipping our bay stations to those that require area. So I will probably say as long as that we ill have arbitrage between the fixed line and the mobile, more than 50%, it will be a significant difference enough for a user to -- to be sensitive.

And I said it in Taiwan, there is only 35% differences. The penetration in Chi -- Taiwan is over 100%. And so, that means everybody has one phone already, and even in that environment, we're seeing a significant growth in Taiwan. Japan, as well. So, China is a very, very low penetration. I would say even below 50%. Arbitrage will be still be significant.

Great, thank you. Second question. Can you shed some light on the Yahoo broadband build-out? Is it mostly completed in 2005 in terms of CapEx?

You know, it is very, very difficult for us to really expect at what Yahoo's BB is going to do. And one thing we know is that they are slowing down their CapEx spending for the second half of this year. But they are, in certain areas such as DV TV, this is extremely important strategic. . Their RPU is going to be $40 per user expecting and so it's very high RPU gain for them. And so, in this particular case, they are gro -- I mean, they are aggressively expanding on this side of the business. But on other part -- portion, you know, I heard that they have been slowing down and not only affect us but affect other companies. But in IP TV section, in the -- from a -- from a one-month time, they have already have 12,000 subscribers and that gave them a lot of confidence.

Great. Third question, what is the impact of the significant head count reduction on Company morale?

Yes, I think you know, clearly, it is very worrisome to the employees, you know, when we announced the restructuring and everybody clearly -- clearly gets worried about do they have a job. Clearly, you know we lost a lot of focus in Q2 but I think, given what the Company's been through, I think most employees have got the right perspective. They've seen the historical growth, the success. You know, they understand we need to get the Company back to profitability. I think we've tried to communicate it very honestly and straightforward what we're trying to accomplish. And I think, you know, given everything that's gone through, the morale actually remarkably well.

We're putting a lot of focus as we enter Q3 into not only completing the restructuring activities, but we're -- we're really implementing a retention program for our employees. I think it's important that we not only work through this, but the employees understand where we're going, that there's a reason to stay. And I think as soon as we can get this Company back to profitability, you know, everybody's going to feel a lot better.

Great. Thank you very much.

your next question comes from William Bean of Deutsche Bank.

Hey, guys, sorry I missed it but could you give the sales breakdown again?

Yeah, hold -- one second, I'll pull it back out. You're talking about for -- for Q2?

Yes.

Okay. Yes, for Q2, the handsets and CP revenues were 490.7 million, Personal Communications Division was 342.3 million of -- that's inside the 490, and the broadband was 74.2, and wireless was 158.1.

Okay. Can you talk a little bit about the licensing requirements as far as for Telecom and Netcom for IP TV and how you think that will [indiscernible] ?

You're asking what's going to be the licensing process in China for IP TV and what will China Telecom and China Net -- Netcom need to do?

Yes and how do you expect that to roll out or --

Well, they will -- they will likely to given the IP TV license to the content providers. And also, China Telecom and China Netcom will be -- they don't have the broadcasting license, so they'll have to work with the company who owns a broadcasting and a content license with them. So, it is a more of a joint effort and China Telecom and China Netcom will not be able to get the license by themselves.

Okay. And right now, there's only one license. I believe the license holder is partnered with a competitor of yours? Are you looking at forming similar partnerships?

What did you say, William? Did you say we have a competitor has a license?

There's only one --

I think one of your competitors is partnered with a license holder. And I was just wondering whether you ha -- you were going to work with all license holders or --

Oh, well, I think you have information the other way around.

Okay.

Well, we have team up with a licensed holder.

Oh. Have you announced who or --?

We have -- we have been working very closely with them.

Okay. Okay. And then lastly, are you thinking about doing any restructurings or about spinning-off a product group for cost going forward?

Yes, we're looking at every possibility to see how we going to be able to benefit our Company of future growth and including some of our outsourcing methodologies and -- and if there's a better way to do our own ACICS design, et cetera, et cetera. All of those are very, very -- ongoing part of our restructuring study for us to continue to make moving forward. So, we have studied every single part of it. And we have not make it our decision how we going to do that yet, but we actively studying all those situations.

Okay, just last -- quickly, can you just touch on -- give us an update on India? You talked about the BSNL alliance. I mean -- I mean, going forward, what do you expect to happen there?

Well, we are very, very excited about the India's opportunity. And just simply because we have seen the growth, that experience in China, they're just about ready to do the similar things and they're very well-educated work forces. And we are not -- only with the BSNL and Reliance we're working with the [indiscernible] and MGNL and so forth. So -- so we are working with all of the major operators there. And I think we have a -- still so far, one of the leading suppliers to -- to the broadband solution in India today. And also, wireless site. We -- we are very, very excited with the delivery to Reliance. They -- we have already deploying in the three regions with them and, so far, they're very pleased with our installation.

Okay. Thanks, guys.

Your next question comes from Larry Harris of Oppenheimer.

Yes, thank you. First, congratulations on a cash-flow performance in the quarter. I was wondering if there had been any change in terms of your relationship with Curatel, any indication of Curatel's interest in directly selling handsets to Verizon or other North American carriers?

Hey, Larry. This is Mike. I'll take that one. I think -- I think we've been trying to communicate for some time that Curatel does have a -- a desire to go want to go direct in the U.S., and I think they've expressed. I think they found it to be a little bit more difficult than they originally had -- had intended but clearly, they want to still go direct in time. We're still continuing to have a strong relationship with them, you know, selling their product into the U.S. On a go-forward basis, what we've been is we've been working on bringing on additional suppliers,you know, such as Hitachi, Casio, KFT, HSI, Sharpe, Hiten. We have got our own design center now that's producing handsets. So what we're doing is we're continuing to diversify our sources of supply and at the same time, offering the option to continue to work with Curatel. So, I think we're in really good shape. through the balance of the year, and we'll just have to see what transforms next year.

So, your contract with them runs, I guess you're saying, through the end of this year?

Some of them carry-over into the next year, as long as the life cycles -- life cycles of the product works and we will continue to do the shipping.

Understood. All right, thank you.

Ronnie, we've gone about an hour, so we can take one more caller.

[OPERATOR INSTRUCTIONS] Your next question comes from Jonie Jensen of McMahon securities.

Hi. I just wanted to discuss a couple of balance sheet liquidity issues. You discussed your new accounts receivable facility with Citi, and of your 851 million in accounts receivable, how many of those -- what percentage of those are domiciled in the U.S.?

About half of our receivables in domiciled in the U.S. Again, I just want to -- want to emphasize that we think our liquidity is in really good shape.

Right.

What we want to do is have an insurance policy.

Okay. And then, as far as just your strategy with respect to both your short-term debt and your converts, you know, I know both of them were down quarter-over-quarter. Do you see, in general, just continuing to roll-over the short-term lines, as needed? And then secondly, with respect to the convert, are you interested in continuing to do these partial debt equity exchanges or do you see, ultimately potentially, taking that one out at maturity in cash?

Actually, several of the banks in China are actively negotiating new lines with us. So the intent would be, as lines expire, just then go and put lines in place to answer your first question. Let me apologize. On the question before, when I talked about the receivables, about a third of our receivables are in the U.S.

Okay.

About half our cash is in Japan and the U.S., outside of China. So, I misspoke, I apologize. With regards to debt reduction, you know, I think, as I said on the revolving lines of credit, those are going to go up and down, based on needs. And, you know, I think with the long-term bonds, we've had a very, very opportunistic carry there. We felt the bonds were significantly trading at a low -- a low point and so we took advantage of that and retired those. I think we'll just have to look at market conditions on a go-forward basis, with no commitments one way or another.

Okay. Thank you very much.

Okay. I want to thank you all for joining our -- our call. That concludes our call. If there's any other -- any follow-up questions, we're happy to take those on a one-on-one basis. Thank you.

This concludes today's conference. You may now disconnect.