UTStarcom Holdings Corp (UTSI) 2010 Q4 法說會逐字稿

Greetings and thank you for standing by for the UTStarcom's fourth quarter and full year 2010 earnings conference call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. (Operator Instructions) As a reminder this conference call is being recorded.

It is now my pleasure to introduce your host, Ms. Jing Ou-Yang, Investor Relations for UTStarcom. You may begin.

Hello, everyone. Welcome to UTStarcom's fourth quarter 2010 earnings conference call. We distributed our earnings press release earlier today and you can find a copy on newswire services or on our website at www.utstar.com. In addition we have posted a presentation on our website which you can download to use to follow along on today's call. On today's call we have Mr. Jack Lu, our President and CEO, and Mr. Edmond Cheng, our CFO.

Before we get started I will read the Company's advisory and forward-looking statements. This call will include forward-looking statements on topics that include, but may not be limited to, the Company's restructuring initiatives, IPTV revenues, profit margins and projected business model. Forward-looking statements are generally indicated by such words as will, expects, estimates, goes, plans, or similar words. These statements are forward-looking in nature and subject to risk and uncertainties that may cause actual results to differ materially. This includes risks and uncertainties regarding the ability of the Company io realize anticipated results of operational improvements. The Company's ability to successfully compete to supply GE broadband products. The Company's ability to successfully integrate recent acquisitions, execute on its business plan, and manage regulatory matters. As well as risk factors identified in its latest annual report on Form 10-K, quarterly reports on Form 10-Q, and the current report on Form 8-K as filed with the Securities and Exchange Commission. The Company assumes no obligation to update any forward-looking statements.

In addition, today's call will include certain non-GAAP financial measures. The most directly comparable GAAP information and a reconciliation between the non-GAAP and GAAP figures is attached to the earnings press release, issued earlier today and are filed on our Form 8-K with the Securities and Exchange Commission.

I will now turn the call over to our President and CEO, Mr. Jack Lu.

Thank you, Jing, and hello to everyone on today's call. As Jing mentioned, you can follow along on today's call by downloading the presentation from our website at www.utstar.com.

Please move with me to slide 4. As I mentioned in the press release, I am pleased with our adjusted revenue targets for the year and had a positive operational cash flow in the fourth quarter of 2010. The changes and the restructuring of the last year are beginning to pay off and we expect this to enable UTStarcom's return to profitability. Last quarter, I talked about our top level management transition. I am pleased that we continue to gain momentum as a team in refining our focus and strategy. At the end of the year, we announced a new corporate structure combining the two existing business units to better support our strategy and align the Company for sales and marketing performance. Our three new strategies have already opened opportunities for us with China's cable and telecom network operators in the active TV, and we expect this strategy to bear fruit in the year ahead. As a reminder, the new strategy has three main points. First, return to China. Second, targeting telecom and the cable operators in parallel. And third, providing equipment and services.

Turning to slide 5 and looking at our major demand drivers. As I mentioned on the last call, the three network convergence related market is projected to reach RMB688 billion in the coming three years. According to a report released in January by Chinese government regulator, the State Administration Of Radio, Film And Television, or we call it SARFT, by the end of the year 2010, in China there were 187 million households with cable TV, an increase of 6.9% from 2009. There are 88 million were digital cable TV, a 39% increase from the previous year. Nearly half of this group, or 43.5 million, have completed the two-way digital migration. Finally, there were 4.1 million interactive digital cable TV household subscribers and 6.7 million IPTV subscribers. This elicited the large potential demand from the cable TV networks operators in China for our multimedia communications and the broadband products.

While China's cable operators are relatively less technologically capable than their cousins on the telecom side, they are more eager to find the new high growth opportunity for their business such as interactive TV. Because of this, our expertise in building and supporting the operations for interactive TV platforms are able to help them to build the technology platforms that allow them to offer interactive TV services to their subscribers. We are leveraging this expertise to target the more than 2,000 cable TV network operators in China now. On the telecom side, all the major Chinese telecom operators are conducting tenders to expand their fiber optical broadband networks, some of which we are participating in.

Moving on to slide 6, I want to take this opportunity to highlight our third strategy of equipment and services, which consist of our new operation support service business. Our existing telecommunication equipment products and the technology, especially our roaming screen platform, allows our clients to provide end-to-end solutions, including video counting service and our value-added services like online gaming, online shopping, and the video phone service through their networks. In addition, the cable network operators need partners that can provide continued technological and operational support service for these platforms. This value we provide allows us to contract for a share of the higher margin recurring revenue generated from subscriptions, advertising and value-added service.

A similar dynamic also applies to internet TV. This is where the Stage Smart acquisition which forecast on providing internet TV service fits in. Our rolling stream system will be the technological and operational backbone to this business which will generate a service revenue through subscription fees, advertising and value-added services. Because the business is at an early stage in a competitive sector, we are not in a position to share more this quarter now. We believe the new service business will allow us to capture a significant opportunity through revenue sharing and strategic partnership agreements with the operators in this space. We therefore expect effects and our goal is to generate 10% of this year's revenue from this new line of business. We anticipate at some point in the future this will surpass our equipment based business altogether. Starting in Q1, 2011, we are working on aligning our reporting segments to give you better visibility into how we are executing on this strategy.

Please move ahead to slide 7.There are other highlights from Q4 in China which we would like to share. We won contracts from Sichuan Province for the deployment of a packet transit network to enable the Province's rollout of its next generation broadcasting network, demonstrating good traction with the Chinese cable operators. This is exciting because it is the first ever commercial deployment of PDN technology in the Chinese cable operator. We also won contracts from both cable and the telecom operators in Zhejiang, Fujian, Anhui and Guangdong provinces to expand the capacity of their existing IPTV or IDTV forecasting control platforms. The six IPTV broadcasting control platforms we built in Sichuan, Shenzhen, Beijing, Hubei, Hunan and Shandong were successfully connected with the central level platform which demonstrated our technology advantage and capability.

We won our first contract to supply our EPON product to the provincial electricity grid company in Ningxa. This is a good start in our effort to secure business in the smart grid sector. Further, we have been participating in some of the bidding to provide our GEPON and EPON broadband product to Chinese telecom operators. The competition of this contract is fierce but we are working hard to incrementally establish a presence with China's telcos.

Finally, in the fourth quarter we closed the acquisition of Stage Smart which will enable us to launch an internet TV platform in the second quarter of this year.

Moving from our business in China to other Asia Pacific markets on slide number 8. In Japan, we got preferred supplier status of PGN Equipment to Soft Bank BB. This designation will allow us to secure additional market share in the future. Our [nagreen] product went through a successful field trial in 2010 and as a result, we expect a sizeable increase in 2011 in this area. In Thailand, we received our first purchase order of IPTV systems from TOT, Thailand's largest telecom company.

Finally, in India, we received a purchase order from the Bharti to expand the existing IPTV system we already installed. But the situation with the BSNL phase III has not developed further since our last call. Strategically speaking, we have a good position in India, as a leading supplier of broadband and IPTV equipment. However, we are carefully examining a range of options that would allow us to proceed in a more meaningful and profitable way in this country. Top on the list of our visions of options is a joint venture with a local partner who has a deeper understanding of the Indian market. We will share more of this as we make progress.

With this, I would now like to hand the call over to our CFO, Edmond to share our fourth quarter and full year 2010 financial results before I come back with our outlook for 2011. Edmond, please.

Thank you, Jack. Hello, everyone. Before discussing the key business units performance, I will start by highlighting the Company-wide numbers presented on both a GAAP and a non-GAAP basis.

Now please turn to slide number 9. In the fourth quarter of 2010, GAAP revenues were $76.1 million compared with $116.3 million for the same period a year ago. The year-over-year decrease was primarily due to the wind down of our handset business. Full year net sales exceeded the adjusted guidance we issued several months ago to reach $291.5 million. This was mainly due to an increase in the multimedia product related revenue, as telco operators strove to improve their infrastructure and completed large contracts earlier than expected.

On slide number 10, you can see, therefore, the fourth quarter of 2010, we had a gross profit of $8.1 million, or 11% of total, which was 8.7% more sequentially and refactored the impact of the following significant items. A $3.3 million in lost contract reserve and a $9.9 million in inventory writedowns. Without these items, gross margin would have been 28.8%. Gross profit for the year 2010 was $70.2 million, or 24%, which included the following significant items. A [$15.1] million (Sic-see press release) inventory writedown and a $6 million decrease in the cost of sales resulting from the reversal of an accrual third party commission liability as a result of the expiration of statute of limitation. A $2.6 million in lost contract reserve includes adjustments from the actualization of estimated costs related to certain fixed price contracts. Without these items, gross margin would have been at 28.6%. Gross margin has increased for four consecutive years from year 2007 to 2010. This is mainly due to product mix improvement and better control over inventory levels. In year 2011, we are expecting to further improve our profitability by generating higher margin revenue from the operational services support business. In addition, the new and streamlined corporate structure would also improve our internal efficiency and provide controls over costs and risks.

Moving on to slide number 11. Our GAAP operating expenses in the fourth quarter were $34.7 million, a decrease of $40.9 million from the same period a year ago. GAAP operating expenses for the full year 2010 were $144 million, a decrease of $139.7 million in year 2009. These are results of restructuring and other cost reduction initiatives. With all of the changes that we have made, we are solidly on track to achieve our target of operating expenses for 2011, lower than $100 million.

On slide number 12, you can see that the GAAP operating loss in fourth quarter and full year 2010 was $26.6 million and $73.7 million, respectively, an improvement from operating loss of $40.6 million in Q4 2009 and $218.7 million for the year 2009, which shows how the changes we have made so far are gaining traction. Our fourth quarter 2010 net loss was $23 million, or a loss of $0.15 per share. Year 2010 net loss was $65.1 million or a loss of $0.48 per share, both improved from quarterly net loss of $39.4 million or a loss of $0.31 per share, and an annual net loss of $225.7 million or a loss of $1.77 per share in 2009.

Next, let's look at our segment financial results on slide number 13. And remember that we will be changing our reporting segments in the next quarter. In year 2010, our multimedia communications segment had revenues and gross margin of $175 million and 28% comparing to year 2009 results of $177 million and 39%. As a reminder, we are amortizing the deferred revenue related to PAS through the end of 2011 at a rate of $23 million per quarter. Gross margin associated with the PAS deferred revenue was approximately 35%. Without PAS deferred revenue, gross margin of our multimedia communication segment was 21.6%. For broadband infrastructure, our revenue for year 2010 was $110 million which increased from $107.3 million in the previous year. The gross margin of broadband products were 14%, up from 13% a year ago. In year 2010, the handset business yearly recorded $6.5 million in sales at 82% gross margin from our own inventory. This compares with $102 million, a gross margin of negative 19% for 2009.

On slide 14, I want to talk about bookings and to share the book-to-bill ratio as a metric for measuring the equipment based business. In the fourth quarter of 2010, our bookings reached a high for the year. Without the PAS deferred revenue, our book-to-bill ratio for the fourth quarter was 0.98. With the PAS deferred revenue, our book-to-bill ratio is 0.68.

Now, let us turn to slide number 15 for the balance sheet and cash flow statement. We ended the quarter with a strong balance of $352 million in cash, cash equivalents and short-term investments, and zero debt. This cash balance is an increase of $14 million from the prior quarter. More importantly, we had positive operational cash flow in the fourth quarter which is a significant milestone. Operational cash flow for the quarter was a positive $5.2 million on GAAP basis. Q4 operational cash flow is an improvement from Q3 of negative $12.4 million. While we are pleased to have turned cash flow positive last quarter, improving this metric in the near future will be more challenging. Going forward, we'll be looking at additional options such as additional vendor financing, customer financing arrangements. But the gains will be incremental rather than what they have been over the last three quarters.

I will now hand back over to Jack.

Thank you, Edmond. As you can see, we have clearly made significant progress in the fourth quarter and year 2010, and I am excited about the road ahead. As promised last quarter, here is our guidance for 2011. Please follow along with me on slide number 16. First, while aiming to achieve total revenue for the year in the range of $300 million to $320 million. Second, we target to generate 10% of total sales in 2011 from our new service business. Three, our aim is to have annualized operating expenses of less than $100 million. And finally, our goal is to breakeven in 2011 on a full year basis.

One more important change which will take place next quarter, we will be changing how we report on our business. Going forward, you will see two line items. The first for our existing equipment based business, and the second for the new service business that I described earlier. While it will be comparatively small in the early quarters, I believe and I hope to see this grow significantly in the new year ahead .

At this point, I'd like to ask the Operator to open this for the Q&A.

Thank you. (Operator Instructions) Your first question comes from the line of Jie Liu with UTStarcom.

Hi, good morning. This is Jie Liu from Auriga USA. So, Jack and Edmond, congratulations on the good numbers. I think you guys did pretty good in the fourth quarter. A few questions here. First of all, I'm wondering how the book-to-bill ratio was calculated for the fourth quarter. As Edmond said earlier, the book-to-bill ratio, including the past revenue, is 0.98, but your revenue in the fourth quarter basically significantly beat my estimate. So, let's assume that your revenue was actually within your original guidance. Would the book-to-bill ratio be higher than 1 in that case?

Hi, Jack, this is Edmond. Let me take this question. In Q4, including PHS restatement, the book-to-bill ratio is 0.68 and if you take out the PHS restatement is excluded, then that means that book-to-bill ratio is 0.98. So, what we are looking at it is the revenue for Q4 is approximately more than $10 million above our guidance. So, if you'd follow in line with the Q4 revenue with the guidance, then the book-to-bill ratio will be above 1. That's exactly what it is.

Okay, understood. That's good. That's good. Also, Jack mentioned that you guys are making good progress in Japan with SoftBank. Could you maybe elaborate a little bit on the size of the opportunities there in 2011?

As I mentioned, so, we successfully passed the trial run last year and we are in a position to have sizeable orders almost every quarter, because of our requirement from our customer, I can't give exact amount each quarter, but I would like to say it's sizeable.

Okay, understood. So, next question is on the cash flow, while obviously you guys did very good with the operating cash flow in the fourth quarter, and Edmond also mentioned that in the next couple of quarters the operating cash flow may not be as good as the fourth quarter number. So, how should we think about the operating cash flow, say, on the full year basis on 2011? So, Jack earlier mentioned that you guys are trying to achieve GAAP breakeven in 2011. So, what about operating cash flow?

On operation cash flow, as well we have reported, for the last two quarters you have seen this trend that we have been basically is improving what I call picking order low hanging fruit, and we're able to basically improve our working capital management from that sense, and hence we have a significant improvement in Q4. Going forward, those low hanging fruits has already been picked. So, we have to basically looking at further changing our way of doing our supply chain and basically our way of funding or financing our accounts receivable. And that's something that we need to look at from that perspective. So, the anticipation of going forward is you will not see the improvement trend. Nothing goes up in one straight line. So, you will see Q1 will not be the same trend as what you have seen in Q3 and Q4, but we are also aiming at having operation cash flow as part of our goal, maybe probably starting in Q3. So, that's something that we are working on internally. At this point in time, we would not make any guidance at this point.

Okay, so -- okay, understood. All right. So, next question is on the gross margin. So, I backed out your special charges for the quarter and your gross margin dipped a little bit a quarter-over-quarter. So, how should we think about your gross margin going forward in 2011? In particular, what is the gross margin associated with your new service revenue?

If you are looking at our gross margin trend, I think there's a few things that we'll be looking at. First of all, we've been able to demonstrate a year-over-year improvement in gross margin, and arriving at 24% for year 2010. So, that's number one that you look at it. And secondly, we have still on 2011, we have about close to $92 million in PAS deferred revenue which is at 35% gross margin. And third, our new operation support services business gross margin will be at or higher than our PAS deferred revenue gross margin from that sense. So, if you are looking at the product mix and looking at our improvement in operational controls, and especially in containing the inventory risks on going forward basis, we have confidence that we will do a full year breakeven with an operating expenses of at or below $100 million. So, you can do a reverse calculation on that part. That means that we are looking at a gross margin at the high end of the 20%.

Okay, understood. So, regarding your service revenue, do you need to incur any cash outlay to jumpstart the service business? Like a -- in other words, does the service revenue take any cash expenditure from you guys in 2011?

Depending on what we are looking at it, of course we have cash of $352 million at the end of the year. We are looking at very carefully on using this cash to basically pursue some of our growth initiatives. We will be using some of this cash to pursue if they're right opportunity on the operational services support business, growing that business from that sense. So, obviously there could be some use of cash in that area.

Okay, understood. Maybe just one more question from me. Could you guys talk a little bit more about your EPON related opportunities in 2011? How much -- how should we think about the opportunities from the cable guys, the state power grid as well as the telecom carriers?

Yes, I think -- this is Jack. I think I can take this question. As you can see from the media, because of the three network coverages, both the telcos and the cable operators start to increase their investments and the deployments of broadband access. GPON and the G-EPON is the actual -- the major access solution for both of them. In addition, in China, the state grids also want to implement they call the smart grid projects for the national-wise power supply grid. So, which means three areas all has very big opportunity for that broadband, but given our position in the telcos, cables, and power grids, we will do our best to just achieve a good position in market share for all three of them.

Okay, understood. Thank you.

Yes.

(Operator Instructions) Your next question comes from the line of [Al Toba] with Fidus.

Yes. Hi. I had a question about cash flow and cash as you're looking at things strategically. You've maintained a healthy cash balance and done a very good job of protecting cash. As you move to being a cash flow positive company later in the year and an earnings positive company, how much cash do you feel like you need to keep on the balance sheet in order to keep your customers comfortable with your company? So, how much cash is strategic versus operational?

This is a very good question. I enjoy your question on that part. What I'm looking at it is, if you are looking at our working capital needs from that perspective, looking at our OpEx of $100 million, so, you're looking at it, how much is for operational and how much is for strategic? What we are looking at it is, internally I'm looking at a goal of hoping that we can internally can, for the existing business, we can turn maybe slightly cash flow breakeven from that sense. That means that we can use our operational cash flow to fund the business. So, that's something that, first of all, that's the base assumption from there. And secondly, cash is always not enough for me, and I like cash. I like a business that will generate positive cash flow. So, that's my nature, but on the other hand, we also need to look for growth initiatives. And if the right strategic opportunity comes along that actually fits into the criteria that we are looking at, and with the right valuation, we would look into that, we would actively pursue that, from that sense. So, I don't know if I have answered your question.

I'll just try more specifically. So, your carrier customers, how much cash do you feel like you need to have on your balance sheet in order for you to be able to compete with the big companies you compete with. So, they're not saying, well UT is -- only has X amount of cash?If you have $100 million of cash on the balance sheet, is that a comfortable number? Is $50 million? What's the amount? And then is the rest of the cash going to be earmarked for strategic acquisition opportunities?

Our telco operators is not specifically actually looking at our cash balance as a way of working with them and participating in the projects, first of all. It is important for us to demonstrate that we become a profitable company again and a viable company going forward. That is a more important indicator to them. So, this is important that we would achieve a 2011 full year of profitability come from that sense, and that would speak louder to the telco operators. We will become a viable company again for UTStarcom and cash will be just a caveat over that.

Okay. And then just two questions related. The first question is very specific. Regarding cash flow and earnings, should they be approximately the same level? So meaning, when you turn earnings positive you should be cash flow positive, aside from a little change in working capital? Or will cash flow precede or lag earnings?

In this business, this is a very different type of business than other like consumer electronic type of business which the cash flow will time very similar to the operating profit, from that sense. In our business, because of the way the complicated accounting rules on the revenue recognition side, usually in our business, cash flow actually precedes a little bit ahead of the revenue and the profitability, from that sense. So, that's to the extent that I can tell you.

Great. And then can you share with us your criteria for making a strategic acquisition? And my assumption is that you'll be looking at things that will support your OSS directives, but maybe talk about what kind of criteria you have when you look at acquisitions in terms of contribution to earnings, tolerance for dilution, things like that.

Okay, thank you. This is Jack. So, actually, I set three criterias. Number one, the business must be aligned with our strategic direction which is OSS business. Number two, the targets must have both healthy top line and bottom line. So, that means we only look at profitable companies, and also generate cash from their services. And number three, their business must demonstrate a very strong growing trend.

Good.

Okay.

Thank you very much.

You're welcome.

(Operator Instructions) And you have no further questions. I'll now turn the call back over to management for closing remarks. I'm sorry, we do have a question that just came in from Richard Greensburg with Donald Smith & Company.

Yes, thank you. Just to follow-up on that last question and your points about the type of companies you'd be looking for, it strikes me that the description of those companies are very profitable, strongly growing, cash generating, et cetera. That all sounds good, but it could be very expensive proposition, particularly relative to your own stock which arguably is selling below cash might be a better deal. How can you assure us that you're really not going to overpay for companies and add a lot of intangibles and goodwill? The type of companies you're looking to acquire, typically, you'd have to pay a big premium for and would be very costly to shareholders. So what kind of assurance can you give us that that's not going to happen?

Actually, the management team is very cautious in making this kind of a strategic decision. So, this is why we will not add to anything except that for only one really smart deal. I think we are not going to buy big ones, because of the size and also the price. So, we are going to buy smaller entities that present very good potential in China providing OSS kind of business. And also, from our actual job, we can see some of the entities, they have investors eager to take exits either due to the time of their investment or the entrepreneur, they want to focus their investments. So, this is the case. It is not an easy job to do to drive down and back to the reasonable price, but management, for sure, we'll be very careful about that. And also, in addition, I want to share that personally, I just care a lot about our cash. So, very conservative on that.

Okay, thank you.

Thank you.

And you have no further questions.

Okay. Thank you for joining us on our fourth quarter 2010 earnings conference call. We look forward to updating you on our first quarter 2011 results in a few months time. Feel free to get in touch with us any time you have further questions, concerns, or comments. Thank you, everyone.

Thank you.

Goodnight. Good morning.

Ladies and gentlemen, this concludes today's call. You may now disconnect.