UTStarcom Holdings Corp (UTSI) 2011 Q2 法說會逐字稿

Good morning. Thank you for standing by for UTStarcom's second-quarter 2011 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 is being recorded.

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

The UTStarcom second-quarter 2011 earnings conference call. We distributed our earnings press release earlier today and you can find a copy on news wire services or on our website at www.UTStar.com. In addition, we have posted a presentation on our website which you can download and use to follow along with 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 margin, and projected business model. Forward-looking statements are generally indicated by such words as will, expect, estimate, 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. These include risk and uncertainties regarding the ability of the Company to realize anticipated results of operational improvements, the Company's ability to successfully launch Internet TV platform, continue to integrate recent acquisitions, successful operate new service, execute on business plan and manage regulatory matters, as well as risk factors identified in its latest annual report on Form 10-K, Form 10-K/A, quarterly reports on Form 10-Q, and current reports on Form 6-K as filed with the Securities and Exchange Commission. The Company assures no obligation to update any forward-looking statements.

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

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

Let's start with slide four of our second-quarter highlights. We are expected and excited to report UTStarcom's first profitable quarter after 24 consecutive quarters of losses.

In the quarter we had a significant boost from the equipment business which helped us achieve a net income of $11.6 million or basic earnings per share of the $0.07. Our revenues were $92.5 million, a 26.4% or $19.3 million increase, compared to the same period of 2010.

Gross profit margin was 37.6% compared to 31.3% in the same period of 2010 and 31.1% in Q1 2011. Our operating income was $9.7 million and we had a positive operational cash flow for the quarter. We ended the quarter with $316.4 million in cash and cash equivalents and the short-term investments.

This quarter is a very important milestone for the new management team after a long process of restructuring and reorganization. While I am happy that our effort has started gaining some traction, achieving sustainable long-term profitability will require even more discipline and more meaningful growth on the top line.

Next let's move to operational developments in our various targeted markets. On slide five, in China we successfully launched an end-to-end integrated TV solution and won our first commercial contract for Internet TV in northern China. We also secured a leading market position in [Hebei] province through a contract with local cable operators to build their bidirectional networks.

Finally, in Guangzhou we started to move into the new office facility by the end of June, which is more appropriate for our needs and provides a dramatic reduction of rental costs.

Moving to slide six, Japan continues to show momentum in our PTN orders, as demonstrated in this quarter's positive results. In India we also see encouraging signs as the new DOT regulations promote a level playing field and facilitate fair competition for all companies. Last week we announced our successful participation in BSNL's fiber to home services, which demonstrated our well-established relationship with this leading telecom company.

Though we retain our presence there, we plan to streamline our operations in media to improve our profitability there. Moreover, as mentioned in the last quarter, we will continue to look for local partners with strong market presence for cooperation.

Next, on slide seven I would like to update you on our progress with our (inaudible), which you will recall is the new name for Stage Smart. This platform, soon to be widely accessible through the website, www.itv.cn, will provide Chinese language content to overseas Chinese. We successfully launched non-commercial trials across 300 of North America's households in the second quarter and our rollout of the full subscription-based service is planned in the rest of the year.

As I mentioned on our last call, [iTV dark bill] revenues will be generated through either (inaudible), subscriptions, and software license fees.

Before I hand the call over to Edmond I wanted to touch on the Company's recent achievement for foreign private issuer status. Our disclosure policy and the corporate governance practiced will have committed going forward. This change is part of our reorganization of UTStarcom's corporate structure. It is a natural progression as presently the majority of our assets are located outside of the United States and our major business are managed in Asia.

Administratively, we expect the conversion to result in the reduction in operational, administrative, legal, and (inaudible) costs over a long term and also provide us with a legal structure flexibility to pursue listing on international stock exchange. We continue to be subject to the mandate of the Sarbanes-Oxley Act and the disclosure rules of NASDAQ stock exchange.

As for corporate governance, the Company is making the following commitment, which you can see on slide number eight. We will keep a majority of Board of Directors comprised of independent directors. Exactly the composition will be determined by independent directors or a committee of independent directors.

Director nominees will be sourced through independent directors or a committee of independent directors. The audit committee will be comprised of at least three members, each independent, and at least one will be a financial expert. We will require that any related party transactions be reviewed by the audit committee or another independent committee within the Board of Directors. We will conduct advisory, non-binding vote on exact compensation in year 2014.

With this I hand over to Edmond to share the details of our financial performance in the second quarter. Edmond, please?

Thank you, Jack. Hello, everyone. Our Q2 results showed the new UT management team's ability to execute. We have successfully increased our gross margin, enhanced profitability while simultaneously addressing cost structure issues. We will continue to work on strengthening our discipline in working capital management to achieve sustainable results in both cash flow and profitability.

Please turn to slide number nine. We have $92.5 million in quarter two revenues. This was a 26.4% or $19.3 million increase compared to $73.2 million in Q2 of 2010, and a 50.9% or $31.2 million increase when compared to quarter one 2011.

Significant items included the following -- $11.3 million of revenue recognized on the Jersey Telecom contract upon the receipt of final acceptance certificate in the second quarter, an increased sales of PTN products in Japan. In the first half of 2011 revenue was $153.8 million. This was a 0.1% or $200,000 decrease compared to first half of 2010. Handset sales were $5.5 million in the first half of 2010 while there was no handset sales in the first half of 2011.

On slide 10, let's look at the booking trend for the equipment sales and services business. This is our first time of disclosing our bookings trend. Our book-to-bill ratio was 0.85 without the PAS deferred revenue or 0.64 with the deferred revenue.

I want to point out that, although book-to-bill ratio decreased compared to quarter one 2011, our actual bookings amount has been trending higher since Q4 of 2010 when comparing to the first three quarters of 2010. The fall in the ratio is due to the exceptionally high revenue achieved in Q2 which I have detailed earlier.

On slide 11 you can see that gross profit margin was 37.6%. This favorably compares to the 31% gross profit margin for both quarter one 2011 and quarter two 2010. Part of this improvement is achievable through increased sales of PTN products and the Jersey Telecom final acceptance certificate. Gross profit was $34.8 million in the second quarter of 2011, compared to $22.9 million in the corresponding period of 2010 in absolute dollar terms.

Slide 12 shows that our operating expenses continued to decrease, both year over year and sequentially. Quarter two OpEx $25.1 million, which compares positively to $28 million in quarter two 2010 and $30.2 million in quarter one 2011. Instead, when compared to quarter one 2010 OpEx $46 million, quarter two 2011 OpEx showed a reduction of 45.4%.

We continue to make meaningful progress in Q2 towards our guidance of lower than $100 million in OpEx for the full year of 2011. One new data point that I think is valuable is OpEx as a percentage of sales, which is represented by the red line on slide 12. This is down to about 27.1%. This demonstrates the leverage we have accomplished because of our recent COGS reduction.

Moving to slide 13, it shows our swing to profitability. Operating income for the quarter was $9.7 million while net income hit $11.6 million. Although the performance was positively impact by some significant items in this quarter, we are glad to have reached this major milestone and we will continue to march on in delivering our commitment for breaking even on a full-year basis in 2011.

Earnings per share for the second quarter and first half of 2011 amount to $0.07 and $0.01, respectively. The weighted average number of shares for this calculation was 155 million for Q2 of 2011.

On slide 14, let's look at our statement of financial results and remember that we changed how we statement our revenues last quarter in order to better reflect our operating structure and allow our investors to track our progress in the new OSS business. It is probably worth reminding everyone that the two main reporting segments are Equipment Sales and Service Sales.

The Equipment Sales statement tracks our equipment sales, including network infrastructure and application products. The Service Sales statement tracks the services and support we provide to customers related to the equipment they purchase and our new operational support services that we provide through long-term revenue sharing arrangements with the cable and telecom operators and our Internet TV platform established by our ITV.CN subsidiary.

In the second quarter of 2011 the Equipment Sales statement generated $81.3 million in revenue and a gross margin of 38.9%. This compared with Q2 2010 revenue of $62.6 million and 30.5% gross margin areas. In the first half of 2011 the Equipment Sales segment generated $134.2 million in revenue at a gross margin of 36.2%. This compares with first half of 2010 revenue of $131.8 million at 31.9% gross margin.

As a reminder, we amortized the deferred revenue related to PAS through the end of 2011 at the rate of $23 million per quarter. Gross margin associated with the PAS deferred revenue is approximately 35%. PAS revenue is recorded under the Equipment Sales segment.

Our Services segment generated $11.1 million at 38.7% gross margin in the second quarter of 2011. This compares to $10.6 million at 35.8% gross margin in Q2 of 2010. First half of 2011 Service Sales were $19.4 million at 33.5% gross margin, compared to 2010 first-half Service Sales of $22.2 million at 36.5% gross margin.

As you can see on the slide, we have broken this down further to provide additional details. We expect to see the OSS segment will start making contribution to the overall result in the second half of 2011.

Now let us turn to slide 15 for the balance sheet and overview of the geography and currency of cash deposits. We ended the quarter with a balance of $316.4 million in cash, cash equivalents, and short-term investments and zero debt. This is a $6 million increase from last quarter.

I am comfortable with this balance as it provides assurance to our vendors and customers while retaining a reasonable reserve for both organic and organic growth initiatives.

The (inaudible) pie chart on this slide provides detail on our cash deposits. As you can see, 52% of our total cash is held in China and of the remaining 48% cash is held outside of China. Also, 41% of our total cash is deposited in renminbi or yuan and 31% is deposited in US dollars and 18% in Japanese yen.

Total inventory, including raw materials, work in progress, and finished goods in Q2 2011 decreased 5% or $2.4 million compared to year-end of 2010. Quarter two raw material balance stood at $12.5 dollars or 27.2% of total inventory, compared to $6.7 million or 13.8% of total inventory as of December 31, 2010. This increase was mainly due to increase in bookings in quarter four of 2010.

Q2 finished goods balance was $29.2 million or 63.4% of total inventory compared to $34.9 million or 72.1% of total inventory as of December 31, 2010. The decrease in finished goods was mainly due to the conversion of inventory to sales.

Finally, on slide 16, here is our cash flow analysis. In Q2 of 2011 we have achieved a positive quarterly operational cash flow of $12 million compared to a negative cash flow of nearly $39.4 million in the first quarter of 2011.

The improved results were primarily driven by the following efforts. First of all, we had better collections in Q2 because we have improved our collection efforts and caught up collections which were delayed in Q1 due to the disruption caused by headcount reduction in quarter one.

Secondly, we have improved our cash management system and implemented strict control over inventory procurement. Going forward we envision cash collections to go back to a normal level, while inventory purchases will increase as a result of increased bookings in Q2.

Before I hand the call back to Jack I also want to announce that, for personal reasons, I will be stepping down as CFO. Ms. (inaudible), our Vice President of Finance and Corporate Controller, will be succeeding me as the Company's CFO. I will remain at the Company until August 31 to assist in the transition, but given (inaudible) familiarity with the company and her abilities, I expect the transition to be very smooth.

I will now hand the call back over to Jack.

Thank you, Edmond. The Company is very grateful for the guidance Edmond has provided during his tenure and the role he played in attaining our Q2 results. As Edmond mentioned, Ms. (inaudible) has been promoted to be the CFO of the Company effective September 1 and will work with Edmond during the transition period.

For our year 2011 goals, first of all, our original outlook on total revenue, OpEx, and the annual breakeven remain unchanged. On the other hand, we have experienced delays in growing our new OSS business and, therefore, we may not reach our original target in this area. Because the OSS business is a key focus for the management it is important that the acquisition to be done at the right valuation with targets that also contribute positively to the revenue, profit, and the cash flow. These criteria mean that we have to be especially careful in due diligence and the negotiations so that we deploy shareholders' resources in the best manner possibly.

As a result, due diligence and/or negotiations with acquisition targets and revenue sharing partners have been delayed and this may impact our ability to reach our target to generate 10% of total sales in 2011 from OSS. Equally important, please keep in mind that our commitment to 2011 breakeven with a less than $100 million OpEx and $300 million to $320 million in total will not be affected by this change.

Now I would like to use the rest of the time to take any questions out there. Thank you all for listening in. Operator, please open the line for Q&A please. Thank you.

(Operator Instructions) Jun Zhang, Wedge Partners.

Thanks for taking my call. Congrats on the great quarter. So my first question is, looking at second half, what we should expect in terms of the cash burn and the gross margin? And second, I think right now what would we expect from India and Japan in the second half? Could you give us a little bit more details? Thanks.

For the second half, we are looking in terms of gross margin. If you are looking at our Q2 gross margin it was exceptionally higher than expected because of a one-time effect on Jersey Telecom's contract and [FAC]. So without this I would say that we are comfortable that the gross margin will be at the lower end of 30%. This is something that we are comfortable on a going-forward basis.

As far as for the cash burn, I just want to caution that the Q2 results actually was boost by -- caught up in our Q1 collection. And also, in Q3 we are expecting that we will have -- because of the bookings in Q2 and Q1, we are expecting that our procurement for inventory will start to increase and because of that we will have slightly negative cash flow for Q3 onward from that perspective.

But it is our desire and our target to basically looking at this current business model on our existing business. On a longer-term perspective, our target is to turn this business model from a cash burn to a slightly cash positive business model. That is what we are looking at in 2012 onward.

And your second question is?

So as for the business in Japan and India in the second half, so we can foresee the business from Japan will continue to be strong. And because of the change and the improved DOT regulations and our streamline of our India operations, I believe our Indian performance will be improved as well.

Okay, thanks. Also, could you talk a little bit about the China cable spending and what we should expect from this cable spending trend in the second half? Thanks.

So as you know, each of the provinces their integration of cable operators from the city or county level to a private level developed and balanced. Some provinces are moving fast and some are slow, but for those already integrated we can see the trend that as more strong purchase orders for the cable operators, especially for the bi-directional network improvement, will increase in the second half of this year.

Okay, that is helpful. Thanks, that is all of my questions.

Al Tobia, Sidus.

Just a question on the guidance for breakeven for the year, just so I know what we are talking about. Is that meaning breakeven for the year? Is that using the $0.01 figure for the six months? I am just trying to reconcile GAAP versus non-GAAP.

The $0.01 that we have achieved in the first half of 2011 is on a GAAP basis so all our reporting is on a GAAP basis. So first of all you have to look at that. Our guidance for the full year is to return to profitability and that is something that we will still want to maintain that guidance.

Right. So that would imply basically base worse case for the next six months would be breakeven, which gets you to $0.01 for the year. I just want to make sure there is not an extra item in there I am missing. So the $0.01 in this fixed month number you are looking at for guidance?

You can deduce it this way.

Okay. And then one other question. Looking forward, the OSS revenue I know is a component of the Company's future model, but given the equipment -- orders restrict that you have to see in the equipment orders and your book-to-bill running reasonably good year over year, would you be able to breakeven without making acquisitions in the OSS space? Meaning as the PAS business runs off, do you feel like with your costs coming down and the rest of your business doing reasonably well, would you be able to run at positive operating results without making acquisitions in the OSS space?

Given the current run rate of gross margin and revenue and also looking at our continued efforts on the OpEx side and containing that, we are very comfortable therefore this year, on a full year basis, we will maintain our guidance of return to profitability. As for next year, when the PAS deferred revenue will start to decline and basically we will not be benefited by this $23 million a quarter or 35% percent in terms of gross margin, obviously we need to have additional revenue growth in order to maintain that profitability.

And this the management chain, with guidance from Jack, we are very actively in looking at pursuing both organic and organic growth in terms of covering for this so-called shuffle for 2012.

As for this year, as I just mentioned, because our very careful mandate in (inaudible) those possible acquisitions with strategic partners, I don't think the OSS revenue or [private] will [consequence] any significantly in this year's number.

Without making acquisitions will you have a significant contribution from OSS next year? What I am trying to look at is, if I take this quarter's results, you basically -- even at the gross profit level, if I ex out PAS, were basically breakeven at the gross profit level on this quarter.

Now I know you had some business that will trend down because you have some equipment contracts coming to an end. But as I look at next year, if you have incremental contribution from OSS from organic sources that should generate some level of gross profit, costs on the operating side keep coming down and if you get any level of revenue growth on your non-OSS, non-PAS business it looks to me like you should be able to, without making acquisitions, approximate breakeven.

But I am not sure that that is -- I am not sure that that is not being too aggressive, so that is what I wanted to know. You understand what I am saying? Without making an acquisition but if your OSS business grows, the PAS business declines, is next year a year where you breakeven so the cash is the cash. And then if you spend money on acquisitions it generates incremental earnings?

For 2011 that is correct. We can reconfirm that.

Okay.

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

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

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.