UTStarcom Holdings Corp (UTSI) 2006 Q2 法說會逐字稿

At this time I would like to welcome everyone to the UTStarcom second quarter 2006 earnings release conference call. [OPERATOR INSTRUCTIONS] Thank you. Mr. Barton you may begin your conference.

Thank you. Good afternoon and thank you for joining UTStarcom's second quarter 2006 earnings conference call. I 'm Fran Barton, UTStarcom's CFO, and I 'm pleased to host the call with our CEO Hong Lu. 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 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 will turn the call over to Hong. Hong?

Thank you, Fran. And thank you everyone for joining us this afternoon. Let me begin by providing a brief summary of our second quarter financial results. Second quarter revenues were 549 million, which is within our guidance range. Gross margins exceeded our expectations for the quarter and came in at 19.9%. Gross margin upside combined with the lower than anticipated operating expenses allow us to report net loss that compared favorably to guidance. The second quarter net loss was $0.18 per share versus the guidance range of loss of $0.45 to $0.55 per share.

I'm also pleased to report that Q2 was the fifth consecutive quarter in which we generated positive cash flow from operations. Fran will provide detailed financial results later in the call. From an operation perspective I am also pleased with our progress in the second quarter. We remain focused in our efforts concentrating on the product areas where we can leverage our advantages at an added value. I'm encouraged by continuing traction we demonstrate in a key target market such as IPTV, next generation broadband and wireless networks and handsets in the multiple geographies during the quarter.

With that I would like to cover four key areas focus for the Company. One, core networks. In terms of technology trend we continue to see operators desire to migrate and in some cases replace their existing circuitswitch infrastructure to next generation IP based networks. But doing so, they are able to offer multiple IP based services and significantly reduce the amount of space and energy needs to run their networks. This creates significant operational cost savings. UTStarcom has been the leader in the deployment of next generation network technologies and currently has the largest soft switch deployment in the world supporting over 50 million subscribers. In the second quarter we were awarded a contract with a tier 1 operator in the Philippines to build out their next generation broadband network. Handsets allows them to reduce the number of central offices by factor of 10.

Two, IPTV. In the field of IPTV we believe that UTStarcom has demonstrated a distinctive advantage over competitors with our softswitch based RollingStream system, which provides the better capability and scalabilities. As the revenue from traditional voice services continues to decline from the fixed-line operators around the world, we believe that we will focus on IPTV as their most important growth catalyst going forward. Our technology is validated by successful commercial deployment in such a major markets as Japan and China. Today, we have won over 50% of all government licensed IPTV deployments in China and currently have over 90% of the commercial subscribers on our networks.

In Q2 we signed a follow -on deal with a China telecom to expand IPTV coverage in Shanghai, which has a population of nearly 18 million people and 2 million broadband subscribers. We expect to scale our IPTV revenues in China as carriers expand their commercial IPTV deployments. According to IDC, China IPTV subscribers are expected to reach 4 million in 2007 and double to 8 million by 2008. Outside of China we are about to launch a commercial IPTV deployment with Brasil Telecom, a leading carrier in Brazil with a nearly 1 million broadband subscribers. This is the first commercial IPTV launch in Brazil and an important step to building our presence in Latin America. We also continue pay IPTV trial with the priority in India a leading operator with over 1.5 million broadband customers currently. India and Latin America are highly strategic markets where we expect to see significant IPTV deployments over the next 48 months.

The third area of the focus is a wireless infrastructure. I will begin by discussing the past market. While we continue to believe that the past market will decline over time, PAS remains an essential source of revenue for fixed line telecom operators in China. We see the conversions between PAS and fixed-line services as an important trend in the China telecom industries and one that holds good prospects for UTStarcom. China telecom and China Netcom continue investing in expansion contracts and we expect to use cash flow generated by past product lines to fund the expansion in our strategic growth markets and products. We are also using our strong foothold in China to pursue new revenue streams. Our relationship with a key Chinese carrier gives us advantage when establishing presence in new area such as IPTV.

In other wireless infrastructure we focus on niche markets which allow us to take advantage of our unique technology and avoid direct competition. We pursued application for ruler localization locations and unique deployment such as disaster recovery, military, cruise ship, and airlines, as well as enterprise solutions. In the second quarter UTStarcom enter into partnership with a qualcomm which they will resell our emergency response to the government supporting application in North America.

In the CDMA handset area our success is evident. Just a few quarters ago UTStarcom was a new entrant into a highly competitive North American handsets market dominated by several large players. Today we are firmly established as a supplier to tier one carriers selling both the internally designed cell phones as well as some of the most popular models from major suppliers worldwide. The PCD division currently has number 4 CDMA market share position in the United States. We are gaining traction with the key U.S. carriers by offering unique design such as our waterproof and ultra-thin models that were shipped in the second half of 2006.

Fran will talk more about the specific deployments in our product groups. But I wanted to highlight some of our recent achievement and stress that we see multiple growth catalysts in our strategic markets. As we pursue multiple growth opportunities our focus remains on financial discipline and balance sheet management. We are also very conscious about our gross margin and are committed to managing cost by improving supply chain management and pursuing initiatives that are attractive from our margin perspectives. This quarter we reported improved gross margin versus our guidance which serves as a good example of how our quality supply chain and cost reduction initiatives are starting to pay off.

Finally, as I discussed on our last earnings call, infrastructure enhancement is a priority for us on the operational side. For a truly diversified company solid, flexible, infrastructure is a must. I'm also pleased to mention we have extended an offer for a global Chief Operating Officer and we hope to make an announcement by the end of third quarter. This position will spearhead all of the global infrastructure effort going forward. We also expect to finalize our search for a global supply chain executive in the third quarter. These two additions to the management team will conclude our executive level hiring. Now I will turn the call over to Fran who will provide more details on our operational and financial performance in Q2.

Thank you Hong. Now, let me go over the performance of our business units in greater detail, PCD. The personal communications division generated $266 million in revenues just below our guidance range. Total PCD shipments for the quarter were 1.7 million units with an ASP of $142. Going into Q2 we anticipated the sequential decline in PCD revenues partially due to a difficult comparison with a strong Q1, but also reflecting the short term impact of Curetail's departure as well as shipment delays for some of our newer products and the overall competitive environment for the quarter. Overall, our PCD unit is definitely on the right track.

In the second quarter despite the delays, we shipped record 750,000 units of our internally designed handsets. This compares to 250,000 units sold in the first quarter of 2006 and only 200,000 units for all of 2005. The fact that every CDMA carrier in North America added our CDMA 7025 and/or our CDM A 7075 to their product road map also demonstrates the success of our models. In addition, we signed an agreement with Sharp making us their exclusive distributor for their popular Sidekick 3 which began shipping in the third quarter into North America and Latin America. We expect PCD will have a stronger third quarter benefiting from Sidekick shipments, continuing demand for our high end PDA phones, as well as further growth in sales of the internally designed handsets.

Now, let me give a quick update on our PAS business. In the first half of 2006 the total number of PAS subscribers in China increased by approximately 6 million subscribers to a total of approximately 92 million subscribers. The cumulative number of PAS subscribers on UTStarcom's network reached more than 51 million at the end of the second quarter. Chinese fixed-line carriers continue investing in PAS expansion contracts and we secured several capacity expansion and upgrade wins during the quarter. In addition, we signed a contract with a China telecom for 300,000 Q box terminals to support this carrier's fixed-line PAS convergence services. During the quarter, UTStarcom shipped 2 million PAS handsets with an ASP of $47. Our PAS handset market share remains stable at approximately 50%. Another important milestone for us was securing a contract with China Unicom to supply them with our T 66 dual mode CDMA GS handset. The T 66 is the first dual mode CDMA GS handset in China and will support China Unicom's whirlwind dual phone service.

Looking at the broadband business. In the second quarter UTStarcom continuing growing its present in the IPTV market. As Hong discussed early other on the call, we announced a follow on contract with China Telecom to expand commercial IPTV coverage in Shanghai to approximately 51,000 subscribers from our initial 5,000 subscriber trial. Total subscribers on our commercial network in NanNing [ph] reached 66,000 in the end of the quarter, an additional 16,000 during the quarter. We believe that the China IPTV market is in its early stages and will grow substantially over the next several years. Right now is a crucial time for providers to secure market share in preparation for large scale deployments later. We believe that to date UTStarcom has won greater than 50% of all government licensed commercial IPTV deployments in China with over 90% of total commercial subscribers. This clearly puts us in the number one market share position in China.

Now, let me turn to our financials. As Hong mentioned sales for the second quarter were $549 million which were at the low end of our guidance reflecting weakness in our PCD segment for the quarter. By business segment PCD sales were $266 million for the quarter. Sales for the non-PCD handset business were approximately 107 million, which was in line with expectations for the quarter. Wireless infrastructure sales were approximately 114 million, which was in line with the guidance given for the quarter. Sales for the broadband business were approximately $45 million in the quarter, which was slightly below guidance for the quarter. Finally, our services revenues were approximately 17 million in the quarter, slightly below guidance for the quarter.

By geography, sales in China represented approximately 37% of total sales in the second quarter. Gross margins exceeded expectations in the second quarter with total gross margins of 19.9% of sales. This compares favorably to margin guidance of 15% to 17% and reflects improvements across several product segments. By product segment gross margins for the second quarter came in as follows: Gross margins for the personal communications division was 4.6% of sales, which is comparable to first quarter margins. Wireless infrastructure margin was 47.7% of sales, which was better than our expectations for the quarter, and continues to reflect pricing and supply chain improvements. Broadband infrastructure margins were at 10.9% of sales which was better than our expectations for the quarter due again to supply chain improvements. PAS handset margins also remained high and came in at 30.7% of sales, which is due to the new A6 [ph] and improved inventory management and also reflects higher margins dual mode products. Service margins were approximately 28.5% in the quarter.

Total operating expenses for the second quarter were $134 million. SG&A expenses inclusive of stock compensation were approximately 87 million or 16% of sales in the quarter. R&D expenses were approximately 47 million or 9% of sales in the quarter. Net interest and other income for the second quarter was income of approximately $7.7 million primarily reflecting a gain of approximately 2.9 million on FX as well as a $2.5 million gain on an asset divestiture. Total income tax expense was 4.7 million for the second quarter, which reflects our taxable profits in certain jurisdictions. Our total net loss for the second quarter was $21.4 million or $0.18 loss per share as compared to a guidance of a loss of $0.45 to $0.55 per share.

Transitioning discussion to the balance sheet now, i'M once again pleased with our balance sheet performance as we showed continued improvement to such items as cash, accounts receivable and short-term debt. As of June 30th our cash and short term investments totaled $658 million reflecting strong cash collections as well as pay down of short term debt. Our accounts receivable balance at the end of June was approximately $425 million, which represents a reduction of approximately $70 million from Q1. This is the result of continued strong collections of over $665 million during the quarter. Our DSO was 70 days which compares favorably to 75 days in the first quarter. Our inventory levels increased to approximately $712 million, primarily a reflection of inventory build up in PCD in anticipation of higher revenues in the third quarter. Given our strong collections and the reduction in receivables, we generated approximately $25 million of positive cash flow from operations in the second quarter. This exceeded our expectation of break even cash flow for the quarter and marked the fifth quarter in the row we generated positive cash flow operations.

We will continue to focus on reductions in over all A &R and inventory levels over the coming quarters. Our total short term debt balance at the end of the second quarter was approximately $123 million. During the quarter we repaid approximately $50 million in short-term debt. We continue to have lines of credit in China in excess of $700 million with various maturity dates over the next 12 months. As these lines become due we expect to renew them as we have done historically. In addition, we have an unutilized $100 million receivables purchase if facility in available in the U.S.

Now, on to guidance. I would like to begin by giving you my thoughts on the full year 2006. As discussed on the Q1 call, we continue to expect the 2006 will be a year of transition for UTStarcom. We believe that revenues in 2006 will decline approximately 15% from 2005 levels. In addition, we believe that we will have a net loss for the year. We expect to demonstrate positive cash flows from operations for both the first half and full year 2006. But this obviously could fluctuate on any individual quarterly basis. From a quarterly perspective we believe that Q3 and Q4 will show revenue growth, and we continue to work towards returning to profitability which we expect to happen by the first half of 2007.

Let me give the guidance for the third quarter. For the third quarter of 2006, revenues should be approximately $590 million to $625 million, which is consistent with current Wall Street estimates. By segment revenues should be as follows: Revenues from our PCD division should contribute approximately 55% of revenues. In the PAS handset segment revenues should be approximately 12% of total revenues. Wireless infrastructure revenues should be approximately 18%. Broadband revenues should be approximately 10%, and services revenues should be approximately 5%.

Moving on to back log. In the second quarter our book to bill ratio was approximately one which respects a back log of just over $1 billion at the end of the second quarter. In Q 3 consolidated gross margins should be approximately 16.5% to 18.5%. By business units our gross margins should be as follows. Broadband margins should be approximately 17% to 19%. Wireless infrastructure margins should be approximately 45% to 47%. Handset margins should be approximately 23% to 25%, and PCD margins should come in a little over 5%. Operating expenses should be approximately $135 million to $140 million and will include approximately $4 million in expense associated with stock compensation. This increase in spending from Q2 levels reflects additional spending associated with higher future international revenues as well as the implementation of some additional IT infrastructure projects.

Our Q3 tax expense should be approximately $3 million. Therefore, the GAAP EPS guidance for Q3 is a loss of approximately $0.23 to $0.33 per share, which is slightly favorable to current Wall Street expectations. There is a possibility of a one time event that would favorably impact the P& L and cash in either the third or fourth quarter of this year. We are targeting cash flows from operations excluding one-time events to be break even to slightly negative in the third quarter.

So, let me summarize what I see as our situation right now. We were again able to beat our expectations for financial performance for the quarter. It's important to give some comfort that we are being realistic in our assessments. We seem to be at the bottom of our revenue curve and have reasonable expectations for sustained revenue growth from here. This growth will be led initially by PCD handsets with eventual geographic expansion in India, Latin America, Asia, and EMEA for infrastructure products.

The exciting IPTV market is a future opportunity. The fact that customers like our ready now end to end solution is proven by number one position in both Japan and China as well as top positions with Bharti in India and Brasil Telecom. Our gross margins have been moving in the right direction for the past two quarters and operating expenses have been under control as well. Finally, we've taken our net cash position from a deficit of $248 million to a surplus of $260 million over the past four quarters, a swing of over $500 million in our net cash position in that timeframe. So, while we're not out of the woods yet, I am beginning to see more daylight than I've seen in some time previously. So, with that, I will thank you and take any questions you have. So, Janet, if you could get our first question please?

Certainly, sir. [OPERATOR INSTRUCTIONS] Your first response comes from Michael Wayne.

Hi. It's actually Jake [inaudible] for Mike Ounjian.

Sorry. Who? It's Jake [inaudible] for Mike Ounjian. Could you give me a mix of your current back log and maybe expectations for past subscriber for the second half of this year? Let's see. So in terms of back log, something on the order of 40% of it is PCD. This probably almost is similar amount for past infrastructure. The rest are smaller -- smaller amounts. So, I can -- yeah, we usually don't go into too much detail on that breakout. But that just gives you a rough -- a rough mix. Predominant PAS wireless and PCD in other words.

That's helpful. Can you give us what your expectations are for past subscribers for the second half of this year?

We have seen the Q1 has been a faster growth and the second quarter seems to be a little slower than Q1. And Q3 usually is the slowest quarter in the year. And Q4 will be picking up. So, I will probably say with the first half of the year we have 6 million. And if we go for the normal pace, we should be able to do maybe a little short of 6 million, maybe closer to 5-ish in the second half. Jake, is that enough?

That's good. Thank you.

Thanks.

Your next question comes from Tim Long.

Thank you. Just a few questions on the margin front. It seems you had a good bump in the internally produced handsets that expect better gross margin on the PCD side. Could you talk a little bit about the margin development in that division with moving to internal? Secondly on the PAS handset side, could you talk about -- obviously the new chip set is having a benefit there? Could you talk about sustainability of gross margins in that business? That would be great.

Yeah. So, Tim, with regard to the individual gross margins, the PAS terminals are certainly continuing to do well, hitting it at around 30% or so. In addition to that we have even higher margins on the dual mode. The average of that business unit is really doing well. The PCD is highly -- margins are highly dependent on the various mix of products there. We have got our products ramping up which have better than average gross margins. We have traditional Curatel products which are kind of less than average gross margins. So a lot depends on the mix of high end, low end special products there. In terms of just trends, we -- it is -- the margin is up a little bit from Q1, not much.

But we expect going into the next quarter margins to be up over 5%. And we have broken out a bunch of information in our 10 Q so you can kind of sort through that. I realize it just came out today. We can take you off line a little bit. There's just a couple of things. In terms of the chip set within PAS, again, we've had some very good cost reductions there. I don't think we will see any incremental further reductions. In other words, we've got the full benefit by now. Any benefits that come there will be basically on pricing. And that will be somewhat dependent on the competition, of course.

Okay. So, Fran, nothing even though the internally developed units went up a lot there was nothing inherent in the margin on those products where it was not giving you the type of gross margin improvement you would have expected? It's just --

Yeah. Without getting into too much detail, those margins are doing really well, Tim. I think because of the inventory we put in place for future quarter's growth I think you will see somewhat the margins are a little bit depressed as we are making sure that we have adequate reserves and so forth for our inventory that we have there. So a little bit -- let's say the margins are masked by short term inventory.

Tim, this is Hong. I just wanted to say that our own design seems to be -- we are very pleased with some of our progress in margin. And so it is unfortunately not really reflecting it to the overall. So the more we start making it, we see the progress that has been making.

Okay, just a follow up on that. With Nokia's decision to exit, can you talk about opportunity -- I think you mentioned some opportunities to more broadly get some of the CDM A phones out there. Could you talk about if that's something already started to show up on your radar screen and how you may take advantage of the changing environment?

Well, Nokia has actually not decided to really getting out of CDMA North America market. They pretty much decided to getting out of other Asian markets such as China or India, or, for that matter, Taiwan and several other places. But North America, they haven't really decided yet and they have been still working with some of the OEM suppliers. So we haven't really seen a lot of the changes in North America. And saying that, actually Nokia was not a very active player in CDMA neither in the United States either. So we really didn't really get that full benefit of them getting out or of potentially getting out at this moment.

Okay. That wouldn't influence the decision to be more aggressive in the markets where they were doing well where you are entering?

I think North America is something they are really contemplating to keep staying and rest of the areas that they think they are not making any progress so they decide pretty much not to stay in those areas.

Okay. Thank you.

Okay, thanks Tim.

Your next question comes from Larry Harris.

Hi. Thanks for taking the question. This is actually David Friedman [ph] for Larry Harris.

Yep.

Just a few quick questions on the handsets here. I was wondering how the 7075 is doing and if it's been accepted at Verizon or Sprint yet?

7025 has been pretty much accepted by all the carriers. We have shipped to predominantly to Sprint at this stage.

Okay.

And we also are going to start shipping to other carriers. We also got accepted by other major carriers such as Verizon. But we haven't started to ship to them yet. But it has been accepted. Now, 7075, we have been still in the middle of finalization of being formally accepted but so far we have seeing very good progress. Other than those two we also have a few other models that we will be seeing coming into Q3 as well.

Okay. I was also wondering how the Sidekick 3 is doing at T Mobile and if Sharp plans to manufacture any more than the original projection of 100,000 units per month?

Well, actually it is doing quite well. And we have seen the acceptance is quite good. We just wish they came in earlier or as they plan. So so far we are keeping up with the pace of a 100,000 a month.

And just one more question. I was wondering on Verizon how the XV 6700 is doing in the face of the Motorola Q. And if you were concerned for the PPC 6700 at Sprint when the Q is being launched there in Q4?

I think we see some of -- has some effect. But we also getting a fairly good sign that we are going to do the promotion with our carriers . So I still see they will be fairly well accepted in Q3 and Q4. And we are at least in our plan are very hopeful about those units going to move. And we will keep very close eyes on their -- Motorola's Q.

Thanks. All right. Thank you very much.

Thanks David.

Your next question comes from Jeff Kvaal.

Thanks very much for taking the question. I have two lines of question. First is, Fran, on your revenue outlook looks like you are shading things toward the low end of your prior guidance range. It sounds it may be just on the PHS net adds? Is that a fair characterization? Or are there other elements to the story there?

Jeff, are you referring to full year now?

Yes. I'm sorry.

I think all we are really doing is rolling through the Q2 actuals and then sort of resetting the bar a little bit. So the single thing is some of the PCD things that didn't happen this quarter basically aren't recoverable. So we are just adjusting the year for that. That's pretty much it.

Okay. When you say revenue growth through the balance of the year, does that mean you're looking for 2Q 2H '06 to be higher than 1H or 3Q over 2Q and 4Q over 3Q?

Actually both. 3Q will be above 2Q. And Q4 will be above that. I haven't added that together but I have to believe that the second half is above the first half as well.

That sounds about right. And then secondly, I believe last quarter you had issued fairly cautious gross margin guidance, which you of course ended up beating. But I think you had suggested that some of the -- the margin benefit of the chip set outsourcing would ease. Is that how you were thinking about margins for the third quarter as well?

Yeah. Good question. So in terms of specifically PAS terminals, we were able to have no erosion in the second quarter that just ended. So basically we're flat with the first quarter. We are signalling with our guidance of 23% to 25% for a reduction from the 30% we ran for the last two quarters. So, there's always the we can continue maybe somewhere in between. So for right now we want to be careful that market is a very volatile market so that's why we've given guidance for that product line that way.

Jeff, I think regarding the margin for PAS, typically we see they are coming down margin by average of about 6% per quarter. And we have been strategically holding it by focusing more on higher end product. But on the other hand, let some of the lower end with the higher volume not to persuade them, and we also need to make a conscious decision to say how much market do we want to capture those. And if we have to capture that then we need to suffer some of the margin to getting more bigger market share. So, we're contemplating on that end and, therefore, we have seen the Q3 -- we should be a little bit more aggressive to pursue some of those lower end market as well.

Okay. Makes sense. Thank you Hong. Thanks Fran.

Okay, Jeff. Thank you.

Your next question comes from Tienyu Sieh.

Hi. This is Tienyu Sieh from Merrill Lynch. Just a question on IPTV. You mentioned the projections for 4 million subs in '07 doubling to 8 million subs in '08. Can you help us get a sense as to what that would translate in revenue in terms of set top boxes, in terms of net interest and give us pricing trends in terms of ASP, the rate of deflation over that between now and, say, 2008? What do you expect to be the rate of deflation to be over the next two couple of years?

Okay. Obviously you've asked a very, very fair question. There's -- there's multiple numerous forecasts what the market will be. And then given that, it's virtually an unknown what pricing competition is going to be. In our assumptions, we are assuming kind of some business as usual as we look at margins on our infrastructure products. The set top boxes we think are going to be extremely competitive. I think some people will either give them away or sell them below cost. So I 'm dancing around your question because we don't have a very specific model out that far. We are kind of at the front end. We are okay at extrapolating for the next quarter and maybe the one after that. But getting into '08 is really tough right now.

Tienyu, I wanted to say that's a 4 million or 8 million subscribers doesn't really mean that's all from the equipment vendor to provide the capacity. Capacity is usually higher than that.

Okay.

So you have to build that into your model. And predominantly the revenue will be coming in from set top boxes because each set top box is anywhere -- the range I will probably say today around $70 to $100 range. And that depends on the functionality that each operator will require. Either they will require HR 264 or they want to require the MPEG-4 or they want to have a hard disk or not. If you have a hard disk and whatnot, that they will be actually exceeding $100. So really depends on their requirement. I believe that based on the different market they will probably have a big varieties of set top boxes to make it available to end users. That will probably vary the forecast a bit more.

Fine. Maybe another way to ask the question would be what are your expectations in terms of the split between infrastructure revenue and say set top box revenue? For every $1 spent $0.50 goes into infrastructure and $0.50 goes into set top box? So what kind of split should we be looking at?

Somewhere between 50/50 and 60/40 on the set top box side, with 60, infrastructure 40. Something like that. I think a third way to think about it is what -- what I would do if you I I were out there and you were sitting in here, what I would watch over the next two quarters is for every government-approved trial or commercial sale keep track of who's locking up each city as they roll out. And who are the players. I think you will find the answer will be is a small number of players and I think you will find as it rolls out as people take control of one city at a time there will be small number of players. People will be able to announce that I just had a paying customer on a government-approved network.

A lot of people are now saying free trials some people are now saying, you know, try it but they are not on government approved networks and so forth. We feel very comfortable that we are far and away the leading provider of government approved paying customers in China. I would be watching that kind of metric. You can extrapolate it to wherever you want to extrapolate it to. That's a key factor.

We are going to try to do better in helping with the metrics to get people to understand that but there's so many people reported in the paper they have this trial or that trial all of which by the way they are not government approved. There is no license. They are not authorized. The great majority of those are not paying. They are just out there. We're talking about paying customers on government approved networks which we feel very comfortable we are in excess of 50%. And that's what I would be watching in the short term. 2008, 2009, 2010, who knows where that's going to end up. Is that helpful at all?

Your final question comes from Evan Erlanson.

Hi guys. Evan Erlanson here from Bear, Stearns. My first question --

Hi Evan.

Hi. My first question is on the agreement with Marvell. I believe that you referred to some potential one off income that could come in Q3 or Q4. And I think that there's also the possibility of another $16 million coming in from Marvell providing that certain milestones are met by September 30th. Could you actually tell us -- this is on the PAS handset front obviously. Could you tell us what the milestones on PAS subscribers would be for that agreement?

In a simple term, Evan, it's just a volume commitment that when X volumes are hit this trigger is in effect. So we are anticipating that we should at some point this year hit that trigger which as you suggested would cause us to be able to receive a $16 million cash payment. The P&L impact would be less than that, something in the maybe a little over 10 million or something. So we don't know whether that's Q3 or Q4. But that is something that we are aiming for. We are nearly there. We would hope that we would continue on track and hit that milestone.

Okay. Thank you. And on the subject, just looking at the PAS subscribers, the trend and also last year's trend and what the fixed-line operators are actually seeing, we had about 6.7 million net additions on the PAS networks in the first half of the year. You sold about 4.4 million handsets. I think that your competitors are also shipping probably in excess of 3 million handsets the first PAS. So last year we saw about 70% of the net additions in the year being added in the first half. So, if one were looking at how many handsets are actually going out there in the market, are you concerned about inventory buildup given that you had a fairly strong first half relative to the actual subscriber trend?

We actually keep a very close look at inventory at this moment. And we have -- I think our inventories are very manageable right now. We actually last year we had a very bad experience of not having enough handsets on our hand. We were in short supply until the end of the Q1 this year. We had a really bad experience. So we need to balance those experiences versus what's likely going to happen. So, we need to see what is the trend in Q3. So far we see Q3 is expected to be a very, very slow quarter. But we are getting a good number of shares from those markets. So we will be continuing to monitor it and I don't think inventory will be an issue.

Yep.

There are no further questions at this time, sir. Are there any closing remarks?

No. Janet. I thank everybody for tuning in today and look forward to talking to you next quarter. Thank you.

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