UTStarcom Holdings Corp (UTSI) 2007 Q2 法說會逐字稿

Good afternoon. My name is Nicole, and I will be your conference operator today. At this time, I would like to welcome everyone to the UTStarcom First and Second quarter 2007 Earnings 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 session. (OPERATOR INSTRUCTIONS)

Thank you. Mr. Barton, you may begin your conference.

Thank you, Nicole. Good afternoon and thank you for joining us today. I am Fran Barton, UTStarcom's Chief Financial Officer. And I am pleased to host today's call with Peter Blackmore, our Chief operating Officer. Hong Lu, our CEO is in China this week. So, he will not be on the call. However, he will be on our third quarter call in November. The agenda of today's call is as follows; one, I will provide financial results for the first and second quarters of 2007; two, I will give a quick update on liquidity; and finally, I will discuss my thoughts on Q3 of 2007. I will then turn the call over to Peter to give a quick operations update and then, we will turn the call over to Q&A.

So, before I begin my formal remarks, 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, and in our quarterly reports on Form 10-Q, and current reports on Form 8-K, all of which are filled with the Securities and Exchange Commission.

Now, let me begin by discussing our Q1, Q2 2007 financial results. Revenue for the first quarter of 2007 was $475.9 million. Revenue declines in the quarter are attributed to two items. First, seasonality experienced by the PCD business. Q1 of '07, PCD sales were $288.3 million as compared to $422 million in the seasonally strong fourth quarter, a decline of 32% sequentially. Two, continued declines in the past business. Wireless revenues were $69 million in Q1 of '07 compared to $95 million in Q4 of '06, a decline of 27%. On a positive note, our overall book to bill ratio in Q1 was 1.2.

Second quarter, revenue was $538.2 million, up to approximately $62 million from Q1. The sequential increase in revenue from Q1 can be attributed to an increase in PCD sales. The PCD sales in the quarter were $358 million, up approximately $70 million or 24% from Q1. Also, a slight increase in broadband sales and these were partially offset by a slight decrease of $7 million in cellular sales. Our overall book to bill ratio in Q2 was 1.0. PCD revenues represented approximately 61% of total sales in the first quarter and 67% of total sales in the second quarter.

On geography, sales in China represented approximately 29% of total sales in the first quarter, and 24% in the second quarter. Gross margins were approximately 15.8% of sales in the first quarter of 2007. Gross margin percentage increased sequentially due to the fact that we had a lost contract provision of $32 million in Q4 of '06 related to a large broadband contract in India. Secondly, higher margins in the PCD business of approximately 5.8%, compared to 5.2% in the prior quarter due in part to a $2.3 million inventory reserve reversal in Q1, as compared to a write-off of $4 million in Q4 2006. This overall margin improvement was somewhat offset by lower margins in the wireless business, which were approximately 35% for the quarter. This was primarily due to the recognition of some lower margin TD-CDMA revenues in the quarter as well as some past pricing pressure. In the second quarter of 2007, gross margins were approximately 14.8% of sales. While the margins for our wireless business were back up to approximately 46%, we experienced an overall sequential decline in margins, which are primarily attributable to a higher percentage of PCD sales in the quarter at a lower gross margin percentage. With that I mean, 4.4% in Q2 as compared to 5.8% in Q1.

As part of the China sales restatement, there was a positive impact of approximately $9 million of revenue and $3 million in gross margins for each of the first and second quarters of 2007. Since these numbers will be ongoing and we have spoken of them on each of our most recent calls, we won't be highlighting these numbers in future calls. They will however be disclosed in our quarterly and annual fillings.

SG&A expenses, inclusive of stock compensation, were approximately $80 million or 17% of sales in the first quarter, and $89 million or 16.5% of sales in the second quarter of 2006. In the second quarter, we experienced higher legal and investigative fees. R&D expenses were approximately $43.7 million of 9% of sales in the first quarter, and approximately $42.2 million or 8% sales in the second quarter. R&D spending levels have been declining slightly over the last three quarters.

Net interest and other income was income of approximately $2.2 million in the first quarter 2007, and an expense of approximately $3.7 million in the second quarter. The expense in the second quarter can be primarily attributed to additional interest expense. We are now paying on our convertible bonds related to the covenant labor we obtained in January.

Total income tax was $4.3 million for the first quarter of 2007, and $3.3 million for the second quarter. As you know, income taxes are paid in jurisdictions where we have profits.

Our total net loss in the first quarter was $54 million or $0.45 per share, and our net loss in the second quarter was $62 million or $0.51 per share. Our net losses in the first half of 2007 are primarily attributed to more revenues and margins in our non-PCD businesses, coupled with higher levels of expense related to the stock option in China revenue investigations.

Now, moving on to the balance sheet. Our cash and short-term investments totaled $573 million at March 31, 2007, and $528 million at June 30, 2007. Clearly, the losses experienced in first and second quarters were the largest uses of cash. In addition, we did pay down our accounts payable balance by approximately $90 million in the first half of the year.

Our total short-term debt balance was approximately $378 million at March 31, 2007 and $380 million at June 31, 2007. The short-term balances now include the $275 million of convertible bonds due in March, 2008.

Our accounts receivables balance was approximately $353 million for Q1 and $323 million for Q2 for a combined decrease of approximately $85 million in the first half of 2007.

Our DSO was 67 days and 54 days in the first and second quarter respectively. This was similar to the 64 days and 52 days in the last two quarters of 2006.

Our inventory level was approximately $655 million for Q1 and $653 million for Q2. We used a $149 million of cash in operating activities through June 30, 2007. $85 million of which came from our operating losses during the six-month period, offset by non-cash depreciation and amortization charges, the remaining $64 million was primarily attributable to the previously mentioned reduction in our accounts payable as well as increases in our prepaid materials during the period, which were in part necessitated to stem vendor concerns related to our delays in getting our financials filed, and in part to avail ourselves of early payment discounts.

Now, before I discuss Q3, I would like to give a quick update on liquidity. As discussed in our conference call a few weeks ago, we recently made a transfer of funds out of China totaling a $150 million. In addition, we believe that it is possible to repatriate additional funds from China if needed. We also continue to have two equity investments with a current market value totaling over $100 million that may provide additional liquidity if needed.

As we begin our Q3 decision, I just want to remind you again that these are forward-looking statements, which are subject to change. We have spent most of our time finalizing Q1 and Q2. So, therefore our Q3 picture should be considered a work in process.

In the third quarter, we expect that driven by growth in the PCD business, our overall sequential revenue growth should be in the mid-teens. Because that revenue growth is primarily by the PCD business, our corresponding gross margins for the quarter should decline by a few points. Finally, with respect to cash, we expect that the overall cash balance will roughly be flat in Q3 with Q2, which represents approximately $35 million in cash used in operations, which is offset by increases of nearly the same amount in short term debt in China.

With that I would like to turn the call over to Peter to give a quick update on operations. Peter?

Thank you, Fran and hello everybody. Over the course of our most recent conference calls, I have highlighted a number of initiatives paying debt, returning the Company to long-term profitable growth. These initiatives are all consistent with our new strategic direction, which focuses on select broadband and multimedia communications. They do include our restructuring, which we addressed in our last call. This and other cost cutting measures are designed to ensure that each of our business units and the support functions meet benchmark cost goals.

For today's call, I would like to highlight another important area we are actively working on and that is with supply chain, and this will have benefits in both liquidity and margin improvement. Within the supply chain initiative, there are three areas underway. The first is inventory reduction; the second is outsourcing, manufacturing and logistics; and the third is a much improved organizational structure that will drive better operational performance. Inventory reduction is focused on a 10% reduction in physical inventory terms from those levels in the first half of 2007, not including inventory we have at customers' sites pending revenue recognition. For the outsourcing, we have separated it into two studies, the first is focused on handsets and second on infrastructure as these are clearly distinct supply chain processes. The handset study is nearing completion and has included negotiation with potential vendors and we will be in a position to implement by January. This can have cash savings of greater than $50 million and also improve the materials by mid-single digit savings going forward. The second study, the infrastructure will be competed by the end of Quarter 4.

Also, taking the opportunity to reorganize our global supply chain and put in a strong worldwide procurement function, which we really haven't had before, plus drive interim forecasting and much better order of fulfillment process, all of which will improve our competitive delivery performance. As I have observed before, there are many areas of operational improvement be made in UTStarcom, as well as driving the bookings and the topline revenue growth in our operations. We have a full series of actions underway as part of our business transformation and the supply chain initiative is an important with simply one clear example of the actions being taken. We look forward to giving a more extensive update in our next call with you in November.

With that back to Fran.

Thanks, Peter. So now, we filed our first quarter 10-Q earlier this week and we intend to file our second quarter 10-Q for 2007 in the next few days. This will bring us current with all of our financial filings with NASDAQ and our bondholders. Our intention is to file Q3 on a timely basis at which time, we will host another conference call and give guidance for Q4 as well as some thoughts on 2008.

As we put this phase behind us, it might be useful to stand back to reflect on the issues UTStarcom has been working on. Let me give you my perspective anyhow. As you know, in its early years, UTStarcom grew very fast and was very profitable. As is typical, the infrastructure did not keep pace with that fast growth. With the arrival of a slowdown in revenue two years ago, and a more experienced management team, a number of control issues came to light. The current management team has dealt with these issues in a professional and expeditious manner. I think you will find that resolving these types of issues takes any company a considerable amount of time.

It was important that we fulfilled our obligations and responsibilities thoroughly. We now look forward to focusing on returning value to our shareholders, many of whom have stuck with us during this difficult time. For those, I would like to say right now, thank you. I can assure you that we are now looking forward and focused on improving our financial performance as quickly as possible.

With that, I would now like to turn it over to Q&A. So, Nicole, if you could organize Q&A session for us, I would appreciate it.

Yes sir. (OPERATOR INSTRUCTIONS) And your first question comes from Larry Harris with Oppenheimer.

I know you haven't released the third quarter results, but assuming that the gross margins declined by several percentage points and the revenues were up in the mid-teens, and if operating expenses in the third quarter were similar to the second quarter numbers, I get an operating loss in a roughly the same level, perhaps even larger than we saw in first and second quarter. Am I in the ballpark on that?

Your arithmetic is, but the answer isn't. So, we have to wait till we get those results out, Larry. I think we are going to find that OpEx has some items in it that will reduce that loss that you are looking at.

So, did we start to see the benefits of some of the restructuring activity here in the third quarter?

I would like to hold that, Larry. We are going do that third quarter call very, very shortly just of couple of weeks. So, we are trying to pretty much get Q1 and Q2 out of the way here before dissecting Q3, which we are in the process of closing. So, I was hoping to give you just a little broad brush parts on it, which I did and I -- what I am also hoping to avoid is doing a deep dive on that right now. So, I would you ask to bear with me. We will sort of go through that very shortly.

Thank you.

If you'll just have some patience.

Let me try one business related question. There have been a number of HTC, high-tech computer models announced recently at Sprint and today at Verizon, at least two, noticed that Verizon you have the MoGo, you have the Touch. Are you acting as a distributor for those products to Verizon and Sprint?

Well, I am not knowing which particular ad or newspaper article you saw. Let me say, more general answer to your question, we have substantial amount of business right now with HTC and we are playing in that space. But, I don't know which particular model you are referring to. So, I don't know want to give too definitive of an answer but we do -- we are largely in that business as HTC's distributor.

Understood. Okay, thank you.

Okay. Thanks, Larry.

You next question comes from Mike Ounjian from Credit Suisse.

Great, thanks. Fran, can we get some color on the mix of revenues in Q2? Just to clarify, is it -- about two-thirds of the revenues from PCD, with wireless infrastructure was that $7 million sequentially?

That's correct.

And broadband up slightly sequentially.

Yes.

Was there anything in services or handsets in terms of change much in the mix or --?

Not materially, Mike. Let's -- sorry.

Okay. And how should we think about -- you gave us some color on infrastructure and PCD. How should we think about gross margin trends in the other businesses for Q2?

Let's see. We will have all those in our segment report in a day or two, whenever it turns out to be, very quickly. I don't have in front of me all the pieces here. Let me just take a quick look here. I don't have the broadband -- looks like broadband is up and I think I have mentioned that wireless was definitely up from its low, so wireless back up to the mid 40s; broadband is up a little and as we said, PCD was actually down in that particular Q1 to Q2.

And as far as PCD --

Terminals (inaudible) were about flat.

Okay. Great, thank you.

Yes.

Now, as far as PCD, was that just a function of a mix shift between your own handset designs and more distribution side of the business, or is there something else going on there?

Yes, I think it may have been a small inventory adjustment on top of that.

Okay.

But, basically, the rest of it is mix.

Okay, that's helpful. I guess on Q3, I know you will come to us with more detail but the one question. Can you give us any color what book-to-bill looked like in the quarter?

I don't have it but my recollections was that it was [1] again.

Okay.

Yes. Well, (inaudible) it is over one.

Okay.

More than 1.0.

Okay. And then lastly, I know you want to wait till the quarter to give us sort of more specifics by business within Q3 but, how should we think about the general trends aside from the PCD business in the second half here? I mean are we seeing -- I mean is the pace of decline in the pass business similar and sort of what are the trends are you seeing on the broadband side in general?

Yes. We are hoping toward -- over the second half, some starting to lift off a little bit on broadband, probably nothing substantial in the short term. And in a similar way, some combination of pass and other wireless products also trying to lean up. So, I characterize it that way at this point.

Okay. Great, thank you very much.

Okay, Mike. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from [Adam Rosenberg with Femar].

Fran, I was just wondering -- maybe I can ask the expense question a different way but, you mentioned the $88 million for SG&A for Q2. Some of that was legal and [seasonal] accounting. How much of that was related to that and is the regular run rate more of $80 million-ish?

Let me see if I can answer that another way. I think as we think about SG&A, it's a number that will from this point forward be declining and from time to time, there were different issues in there, sometimes some one-time events. But, I think you are going to see a measurable decline, Adam, going forward starting in Q4 and through the early quarters of next year. If I were able to correct for a number of one-time events, you would actually have seen that start two quarters ago, so that we are on a, if you want to thing of it as a normalized run rate, several quarters of decline already, although modest declines, I think you will see increased declines as we get into Q4 and beyond.

Okay. So, the $10 million to $15 million that you mentioned earlier in the year that was -- is that that coming off of a normalized run rate? I am assuming the $10 million to $15 million reduction.

Okay, you are talking about the -- our targeted OpEx reduction of $15 million per quarter?

Yes, I'm trying to figure out where that --

A good piece of that is going to come in SG&A. There will be some in R&D, but predominantly it will in SG&A. I don't know; two-thirds, three-fourths, some large fraction of that will be in SG&A.

Okay, let me guess looking just at the overall mix shift, things like overall gross margin will continue to decline as PCD continues to kind of make up a larger percentage of overall revenue. How much longer do you think that will -- or is there any way to think about when maybe broadband can make up some of the difference in the overall gross margin?

Yes, without getting into specific projections, we would hope that as the core businesses launched next year, that they would certainly be outstripping the PCD growth and secondly, we also look for gross margin improvements in those businesses, particularly broadband. So, the combination of margin improvements -- the margin improvements there should be faster than the margin improvements in PCD, but they should both have margin improvements. But then, the growth rate, and I do not know whether that is going to take a quarter or two or whatever. But, in '08, we expect to see that lift off certainly in the second half, much, much faster than PCD growth.

That's why I made the comment -- Adam, it's Peter here -- on the supply chain because that will drive the gross margin improvements, plus also the mix of business within the broadband as well. We are looking for the higher margin opportunities.

Is that -- looking at the book-to-bill, is most of the book-to-bill, I don't think you mentioned whether a lot of that was made up from the broadband business being at 1.0 for Q2 and Q3, or a little over 1 because of more PCD and more broadband I guess as far the mix goes?

Well, as we said in the growth in Q2 and again Q3, we've got a fairly substantial PCDs, so the single largest line item with the PCD. Having said that, we do hope for over the second half to see growth in the other business too. But, I guess, if you want me to rank them, PCD would be first and the rest of the business would be second.

Okay, that's helpful. And then lastly, Fran, looking at the first Q -- first quarter Q, I get 16% gross margin on broadband -- on the broadband equipment segment. Is that continuing to trend upwards as we move throughout the rest of this year?

Well, yes and no. So, the long-term trend on broadband will certainly be up. We have several unique -- over time, business in Japan some times is 40% plus margins and some times government business in India is single-digit margins, but the private -- the public business in India might be 35% margin. So, a lot will depend in any given quarter on where did we get the order and what was the product. But, the trend is up and to the right, when you weight all of it. But, I don't think you should expect to see sequential rigid increases. I think you will see it going up a bit and it might drop down some, sort of two steps forward one step back kind of progression, as we have had by the way for the last eight quarters.

Okay.

Sorry for the complex answer, but I think that's the accurate answer.

That's fair enough, Fran. That's helpful. Thanks for taking my questions.

Okay, Adam. You're welcome.

And your last question comes from [Shaw at Crawshaw Capital].

Fran, a few questions over here. Why not monetizing your investment in China in that real estate?

(inaudible) Shu is that you?

Yes, right. How are you doing?

Very well. Okay, I think we've talked before both on the calls and otherwise that we try to keep our -- a portion of our strategy from being public to give ourselves the best opportunities to do the things we need to do. So, I am for the benefit of the shareholders, I am trying not to announce what and when we buy and sell and when and where and so forth without giving visibility to what our choices are. So, I think you can appreciate that we will -- I guarantee that we will do the right thing at the right time and we will let you know right after we have done it.

Are you guys seeing any incremental CapEx from China Telecom and Netcom for the wireless data through pass?

I don't know that information in front of me, but the answer is no. I am not aware of any incremental CapEx. It's sort of business as usual there to the best of my knowledge.

And lastly Peter, with the restructuring that you guys have done and you are doing, what is the probability that you would assign for the profitability at UTStarcom in 2008?

What was the last part of the question again?

What is the probability that you would assign that UTStarcom will be profitable in calendar 2008?

What I would like to do?

It is something that you have been talking about and you are implementing.

What I would like to do is comment on that when we have our next call because I don't particularly want to get into 2008 on this call. Obviously, we are driving very hard to aim for profitability towards the end of the year. But, let's leave that to the next call.

Sure. We are going to try to dedicate a portion of the call next time to going through our business units and giving you some margin appreciation and at least the short term view of the directions, and I don't think we will get into guidance for '08, but we can have some discussions on '08 about trends and that sort of thing. So, that is the intent of our -- the focus of our next conference call.

Good Luck.

Okay, thank you. I think, Nicole, you said that was the last call. So then, is that correct?

Yes, sir.

Okay, then I think then we will just thank every body for tuning in. It's been a long hard haul and we are technically not done yet until that Q is filed here and we are just about done. There's some (inaudible) details that have to get, takes an extra day or so. But we will get that done. That will have completed our historic backward looking part of our program. And from now on, we will talking about our current operation more often more fully, some of our expectations, our programs, our products, our product lines, our margins, our spending trends, restructuring plans, all of that kind of stuff and we really do appreciate everybody sort of hanging in there with us. This hasn't been fun for you and we recognize that and I think you probably also appreciate that it hasn't been fun for us either. We have done the things we think we needed to do. We wish we could have done them quicker, but they are done, we are caught up, and we thank you all for sticking with us. So, we look forward to our call in November. We intend to file in our appropriate time in November and to continue to be current with our filings thereafter. So, thanks so much. We will talk to you all soon. Bye now.

Thank you.

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