TranSwitch Corporation Q3 2009 Earnings Call Transcript

| About: TranSwitch Corp. (TXCCQ)

TranSwitch Corporation (TXCC) Q3 2009 Earnings Call October 28, 2009 5:30 PM ET


Santanu Das – President & CEO

Bob Bosi – VP & CFO

Ted Chung – VP Business Development


William Harrison – Signal Hill Capital

Quinn Bolton – Needham & Company

Mark Christopher – Unspecified Company

Kevin Cassidy – Thomas Weisel Partners


Good day ladies and gentlemen and welcome to the TranSwitch third quarter 2009 earnings release conference. (Operator Instructions) At this time for opening remarks and introductions, I’ll turn the call over to TranSwitch VP of Business Development, Ted Chung.

Ted Chung

With me today are Dr. Santanu Das, our President and Chief Executive Officer and Mr. Bob Bosi our CFO.

Before we begin I need to remind listeners that forward-looking statements made during this call, including statements regarding management's expectations for future financial results and the markets for TranSwitch’s products are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Investors are cautioned that these forward-looking statements regarding TranSwitch, its operations, and its financial results involve risks and uncertainties, including risks associated with TranSwitch's businesses, including without limitation, risks associated with downturns in economic conditions generally, and in our markets specifically; risks in product development; risks in market acceptance and demand for TranSwitch's products, as well as product developed by TranSwitch customers; risks relating to TranSwitch's indebtedness; risks of failing to attract and retain key managerial and technical personnel; risks associated with foreign sales and high customer concentration; risks associated with competition and competitive pricing pressures; risks associated with investing in new businesses; risks of dependence on third-party VLSI fabrication facilities; risks associated with acquiring new businesses; risks related to intellectual property rights and litigation; risks in technology development and commercialization; and all other risks detailed in TranSwitch's filings with the Securities and Exchange Commission.

With that out of the way, I will hand it over to Dr. Das for some initial comments.

Santanu Das

Thank you Ted, good afternoon everybody. The highlights of the third quarter are as follows, for the second consecutive quarter TranSwitch achieved profitability from its operations on a non-GAAP basis.

In the third quarter of 2009 our non-GAAP operating profit was $200,000 [inaudible] our guidance which was operating profit of roughly $500,000 in the second quarter. These [inaudible] for the quarter [inaudible] $15.2 million, a roughly 5% increase sequentially and slightly ahead of our guidance.

One thing to consider is that we have already exceeded our revenue level of 2008, something that none of our peers have yet to accomplish and we believe that we can continue to increase our business and profitability.

Our non-GAAP operating expenses for the quarter were roughly $8.1 million which was better then our guidance. Going forward we expect our operating expenses to continue to be roughly at this level. Bob will provide additional details on the expense guidance later.

We see continued improving [inaudible] as we move into the future on the basis of stable operating expenses and higher revenue. In Q3 we also secured a number of design wins. The design wins were won across all of our businesses and product lines with [inaudible] in our key areas of Access and CPE and from our high growth [Asian] market.

Last week we also announced both the [inaudible] of our 2010 debt obligation with the filing of the [inaudible] to strengthen our financial position. With respect to the fourth quarter we feel our industry is showing signs of improvement and we currently anticipate a top line growth in the fourth quarter.

I’ll now hand it back to Ted so that he may provide some details for the past quarter as well as discuss the bond restructuring and the [inaudible].

Ted Chung

Thank you Santanu, with respect to business trends by geography, our business resumed its growth both in Asia and North America in the third quarter continuing trends that we saw earlier in the year. I will now review our Asian business by country.

In Japan as mentioned on previous calls, our market share in gigabit EPON has been growing as our primary customer continues to improve its market share. In addition to our EPON business we are also supporting the carrier adoption of voice over IP solutions driven by our Entropia products.

We expect to see revenue contribution from the VoIP rollout in Japan as we move into next year. In Korea our business was helped by the return of some of our customers who are engaged in the Korea Telecom infrastructure upgrade.

Our business involving SK Broadband VoIP rollout remained steady relative to the second quarter. We recently announced that our Atlanta 100 product family has gained additional momentum in Korea as well as other Asian countries where it has been selected for a broad range of customer premises products, such as media terminal adapters, and 3G wireless home gateways.

In China while we continue to be encouraged by the demand trend, much of the anticipated growth relating to the infrastructure upgrade is yet to come. Our third quarter results saw some decline in China versus earlier forecasts particularly with respect to one customer.

That said as we look beyond this year to 2010 the trend of higher CapEx spending for both wire line and wireless systems should greatly benefit customers such as ZTE, Datang, Fiberhome, and Alcatel Shanghai Bell. All of this should ultimately benefit TranSwitch.

Positive developments are also underway in India in the CPE segment. While the revenue has not yet materialized to a substantial degree, one of the fastest growing broadband network operators in India is planning to roll out voice and data services using a range of CPE equipment based on our Atlanta 100 processor.

These new and follow-on design wins demonstrate the versatility, performance and quality of our products. We believe the Atlanta family of CPE processors provide the best cost of performance ratio of any products in the industry.

Next I will talk about North America and Europe, in North America during the third quarter we were able to again exceed our revenue targets as our business continues to be bolstered by the ongoing deployment of 3G infrastructure by both AT&T and Sprint in the United States.

Outside of this 3G rollout business remained stable. As an aside, the same platform being deployed by AT&T and Sprint is also being rolled out by Reliance in India, and is being considered by other worldwide carriers.

While we saw continued strength in Asia and North America, our sales in Europe were weak in the third quarter. As discussed previously our revenues from key platforms at customers such as Alcatel, KEYMILE, Nokia Siemens, Ericsson, Portugal Telecom, and other OEMs in Europe should begin to recover as we move forward.

On the positive side both of our Israel based businesses improved in the quarter as we saw increased activity from our primary ASIC customer as well as from customers seeking licenses to some of our interface offerings.

Before we discuss our fourth quarter outlook we want to update you on the supply chain constraints that were mentioned on the last call. Fortunately due to a lot of hard work by our team we were able to successfully deal with these issues and procure enough material to supply our customers in the quarter.

All in all the third quarter went as we had expected from a business standpoint. Our weaker China business was offset by our being able to [cure] the supply chain constraints discussed on our prior call.

I will now address our fourth quarter outlook. In Asia we expect our business in Korea and Japan to remain stable relative to the third quarter. We expect our Chinese business to improve modestly and India should remain stable as well.

In North America our business should continue at roughly the same level that we’ve seen in recent quarters. In Europe we believe we will see improvement and we should also see some continued improvement in our Israeli businesses.

Overall we expect our fourth quarter revenue to be modestly higher then the third quarter. Based on a current backlog and visibility our revenue in the fourth quarter should be around $15.5 million. Next I would like to address some of the steps we have taken to bolster our balance sheet.

Last week we announced both the closing of a debt restructuring as well as the filing of a universal shelf registration statement. With respect to the debt restructuring we exchanged all of our 2010 notes with an equivalent amount of new 2011 notes.

In addition to the extension of maturity we agreed to begin paying down principal on a monthly basis. Bob will discuss this in more detail. In addition to the note restructuring we filed a universal shelf which will be effective for three years.

This will allow the company to seek additional financing at an opportune time if it is required. Bob will again discuss this in more detail. In summary we believe that the third quarter was a good quarter for TranSwitch.

With Q3 we have now achieved two consecutive quarters of operating profitability. In spite of worldwide economic turmoil over the last year our business has been stable and has shown steady improvement. We have managed our expenses in line with our guidance and we will continue on this track.

We have also taken significant steps to bolster our balance sheet by restructuring our debt obligations. With the shelf filing announced last week we are also in a position to raise further capital if and when required.

I will now hand you over to Bob Bosi for the financial details of the third quarter and he will provide our complete financial guidance for the fourth quarter.

Bob Bosi

Thank you Ted, good evening to everyone on the call. I will review the third quarter results, provide guidance for the fourth quarter of 2009 and discuss the achievements that we recently made in improving our financial position.

Net revenues for the third quarter of 2009 were approximately $15.2 million as compared to net revenues of $14.5 million in the second quarter of 2009 and $10.5 million in the third quarter of 2008. The GAAP net loss for the third quarter of 2009 was $1.5 million or $0.01 per basic and diluted common shares as compared to a net loss of $1.3 million or $0.01 per basic and diluted common shares during the second quarter of 2009 and a net loss of $3 million or $0.02 per basic and diluted common shares during the third quarter of 2008.

Net product revenues in the quarter were approximately $13.5 million compared to product revenue in the second quarter of $13.7 million. Net service revenue for the quarter was $1.7 million compared to Q2 service revenue of $0.8 million.

Our service revenue includes NRE relating to activities for some telecom customers as well as revenue related to royalties, intellectual property licenses, licensing of our HDMI technology. The geographic breakdown of our third quarter total revenues was as follows.

Asia Pacific 61%, Americas 29%, and Europe 10%. The top countries for our third quarter revenues were Japan, Korea, China, and the United States. We had three end customers in the quarter that represented revenues of 10% or greater.

These customers were Acatel-Lucent, [Oki] in Japan, and [Imbrix] which is a contract manufacturer for SK Telesys in South Korea. The GAAP gross margin for the third quarter was 54%. This is compared to the company’s GAAP gross margin of 59% for the second quarter of 2009 and 57% for the third quarter of 2008.

The reduction in gross margin was mostly attributable to unfavorable product mix and higher inventory write-off provisions then the previous quarters. The non-GAAP gross margin was not materially different.

Research and development expenses were $4.3 million for the quarter. Excluding stock based compensation expense and amortization of purchased intangibles, R&D expenses on a non-GAAP basis were $4.1 million.

Sales, general and administrative expenses were roughly $4.3 million. Excluding stock based compensation expense and amortization for purchased intangibles, SG&A on a non-GAAP basis was $3.9 million.

The total operating expenses for the third quarter were $8.8 million. Non-GAAP operating expenses in Q3 were $8.0 million compared to our guidance for the quarter of $8.4 million, $8.1 million in Q2 2009 and $8.4 million in Q3 2008 which is prior to the acquisition of Centillium.

Non-GAAP operating income for the third quarter of fiscal 2009 was approximately $0.2 million which was in line with our guidance and compares to non-GAAP operating income of $0.5 million for the second quarter of fiscal 2009 and non-GAAP operating loss of $2.4 million in the third quarter of 2008.

On a GAAP basis the operating loss for the third quarter of fiscal 2009 was $0.6 million compared to an operating loss of $0.3 million in the second quarter of fiscal 2009 and an operating loss of $2.7 million in the third quarter of 2008.

The GAAP net loss of $1.5 million for the third quarter includes a $0.5 million non-cash foreign exchange translation loss. Our earnings per share amounted to a basic and diluted loss per share of $0.01. Excluding the items I mentioned which are detailed on the last page of our press release non-GAAP net loss of $0.7 million rounds to zero or break-even on a per share basis.

There was approximately 159 million basic and diluted average shares outstanding for the quarter. Our balance sheet shows cash and cash equivalents and restricted cash position of $7.3 million which was in line with our expectations.

Our accounts receivable at September 30 was $13.5 million which is down from the June 30 accounts receivable of $14 million. Inventory at September 30 was $5 million which is up from our June 30 inventory of $4.1 million.

The increase was due to a build up of product for anticipated sales that did not materialize. We anticipate that this increased inventory will be sold in the fourth quarter and our inventory will return to the $4 million range which will imply an inventory turnover ratio of approximately five.

I would now like to discuss the fourth quarter of 2009, it has now been one year since the acquisition of Centillium and the beginning of our implementation of our company wide restructuring plan aimed at achieving sustained growth profitability.

And as planned in the third quarter of 2009 we achieved our second quarter of profitability on a non-GAAP basis. Per our news release we are guiding fourth quarter revenues to be around $15.5 million, a 2% increase from the third quarter.

As of the end of September our backlog for Q4 was approximately $8.3 million. Through today our current billed and backlog is approximately $9.6 million. Based on the current revenue outlook, our product mix, our blended gross margin guidance is approximately $8.7 million or 56%.

Our fourth quarter guidance is for non-GAAP R&D expenses to be roughly $4.3 million which is consistent with our guidance for Q3. Our fourth quarter guidance for non-GAAP sales, general and administrative expenses are roughly $4.1 million which is also consistent with our guidance for Q3.

In the fourth quarter we expect our non-GAAP operating income to be approximately $300,000. Now with respect to cash and liquidity, as I mentioned, as Ted mentioned, we are entering Q4 with approximately $7.3 million in cash and marketable securities.

In the last quarter we discussed our strategy to deal with our $10 million of convertible notes coming due in September 2010. With the improved operating performance and improvements in the financial markets, we concluded the best course of action was to refinance the remaining long-term debt with similar terms with extended maturity while providing flexibility and paying down the principal.

We entered into a transaction in which we exchanged all of our $10 million of outstanding 5.45% convertible notes due September 30, 2010 for an equivalent principal amount of a new series of 5.4% convertible notes due in September 2011.

The new notes provide for payments of principal on a monthly basis such that principal amounts of debt service will be paid down in monthly installments with interest through September 2011 as compared to the balloon payment of the entire principal at September 30, 2010.

The conversion price for the new notes was reduced to $0.90 per share of common stock as compared to 1.83 per share for the old notes. Payment of principal for the new notes may be made in cash or at the company’s option, in shares of our common stock upon satisfaction of certain conditions with regard to our trading volume and stock price.

In addition to the note exchange we concurrently announced that we have filed a universal shelf registration statement which will enable us to raise capital when and if required for the next three years.

We believe these actions put the company in a much stronger financial position. I would like to again conclude by saying that the management team, our Board of Directors and all of our employees worldwide are focused on achieving our goal of sustained profitability and growth and we thank you for your support and we will now take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of William Harrison – Signal Hill Capital

William Harrison – Signal Hill Capital

Quick question on the prepared remarks you had on China talking about some of the, your customer, some of the infrastructure there that was a little weak this quarter, could you elaborate a little further on that. Was that more of sort of second half slower then first half or is there some deployment plans that they have been slower to move to or so forth.

Ted Chung

Yes, I think the answer to that question I think the first comment you made about first half versus second half, I think at least so far from what we’ve seen in the second half there’s been a bit of a slowdown in material purchasing by some of our major Chinese customers.

We do not believe that that’s related to the deployment themselves but rather fits and starts relating to how those deployments are proceeding and we fully expect that moving forward if you look at a longer time frame that there should be significant growth from China based teleco deployment as we move forward.

William Harrison – Signal Hill Capital

And as we anniversary the acquisition that you are talking about, starting to see in this last quarter the cost synergies, if you could maybe take a look back and say, hey a year from now I think this is going to be where I think we’ll be, or this is what I’d like to be, kind of give us a little bit of a grade on where you think you turned out and your thoughts on what you could have done better or what you think you’ve done well on.

Santanu Das

If we look at this acquisition, we believe because in a [inaudible] opportunity for TranSwitch, because of Centillium today we have access to [inaudible] VoIP technology. We have access to EPON technology. We have access to [PE] technology and products which we did not have. Before this acquisition we were TranSwitch mostly in Access and in mostly the DSL area, and in [metro] and [cord].

And with Centillium we acquired the other technologies as well as we have a broader product portfolio. The other advantages that, with the Centillium acquisition when we sell and Access product like EPON, we can bundle the [inaudible] CPE products etc., which we believe none of our competitors can do.

Any transformation which we have an advantage, [inaudible] on the fact that the streamlining process which we undertook whereby we have preserved the best elements of each company and at the same time eliminated [$34] million of expenses. This savings coupled with the fact that we have been able to retain a world class team in that combined company and have access to Centillium’s [cord plus] technology we believe that positions the combined company very, very well.

So in terms of what we did very well, I think what we did very well was that we are able to take [$34] million out of expenses on the combined companies and we are still able to retain the talent and the technologies without any hiccup. And I’m sure there are areas which we could have done better but we as a team feel we have done a tremendous job and have demonstrated very well that we can [inaudible] simulate a company of our size without losing any talent.

And at the same time effectuate excellent reduction of $34 million.


Your next question comes from the line of Quinn Bolton – Needham & Company

Quinn Bolton – Needham & Company

I just want to follow up on William’s question related to China, it sounded like if I heard you right you said China should grow a little bit in the fourth quarter, wondering if that’s just the fits and starts, working their selves through the order chain or are you starting to see more activity on the fiber side or the wireless 3G side in China and then I think you also said that Europe was growing. Is that just increased confidence that the worst of the downturn is behind us. Is there something specific in Europe that’s driving your more favorable outlook or at least an outlook for growth in the quarter.

Ted Chung

First with respect to China, in terms of Q4, yes we do expect a snap back from what we saw in Q3. Its not, we saw pretty good growth between Q1 and Q2 in China. I think we’ll see some maybe some modest growth between Q3 and Q4. What our customers have been telling us is to expect a real ramp up in orders as we get into the latter part of the first quarter of 2010 and Q2 of 2010.

And we’ve heard that sort of universally across pretty much every Chinese OEM that we’ve spoken to so that seems to be a universal theme of 2010 being a real build out year. With respect to Europe I think part of it is the fact that the worst of the downturn is now behind us.

I think the other part is frankly the confidence that we have relating to the design wins we’ve been able to procure with some of these guys like the Alcatel-Lucents and Nokia Siemens of the world that we can actually point to and there’s some of the products that are being deployed in Asia and North America so it just seems very likely that a lot of those same products will go into production in Europe in the near future.

Quinn Bolton – Needham & Company

And just a follow up on that China ramp, is that both for some of the fiber deployments that are going on with some of the relation VoIP equipment or is that wireless 3G or is that a combination of both starting to come back first half of 2010 in terms of the infrastructure build.

Ted Chung

It’s a combination of both. With respect to the fiber, to the premises build out, we’ve heard from one customer that the second half of 2010 should, expect it to be material in terms of the rate of that deployment into China. With respect to wireless 3G, we see sort of an ongoing and that’s some of the fits and starts that we noticed here in the third quarter but overall that’s a three year deployment that I think we’re really just in the early stages of.


Your next question comes from the line of Mark Christopher – Unspecified Company

Mark Christopher – Unspecified Company

You’ve spoken a little bit about a transformation the company has been through and undergone, can you summarize everything that’s been done and why.

Ted Chung

I think Santanu talked a little bit about it in his answer to one of William’s questions, but really before the Centillium acquisition if you look at where TranSwitch was focused it was primarily on metro core and Access portions of the network. I think with the Centillium acquisition we’ve now really broadened our offering to include VoIP, Ethernet PON and technologies that really enable a world class customer premises product portfolio.

So the Centillium acquisition actually broadened us out, allowed us to play in CPE, Access and core in a more unified or effective manner. One example I would say is that we can now bundle our Access and CPE products when we go to major accounts. We recently had some meetings with a major Japanese OEM where they expressed a high degree of interest in our product and frankly kicking out another vendor because we could offer the full end to end solution.

That’s not something we could do prior to the Centillium acquisition. And by the way, none of our competitors today can bundle for instance and EPON Mac DSL controller and CPE processor which can all work together seamlessly.

We certainly consider that transformational. I’d say the second transformational part and Santanu hit upon this as well is that we really went through a streamlining process and the methodology that we used was one where we tried to preserve the best elements of each company. At the same time we were able to eliminate again roughly $34 million of annual expenses.

These savings coupled with the fact that we’ve been able to retain in our view a world class team second to none, as well as broadening our technology portfolio, we think really positions us well for the future.

Mark Christopher – Unspecified Company

I’ve got to admit that 90% of [the factor] that we thought partially of the progress that you’ve made in moving into the Access and the Edge markets, I’m certainly impressed with your [inaudible] IP, [inaudible] 3G network for the iPhone, but there are other companies [inaudible] so I was wondering who you see as the competition and what is your competitive advantage.

Santanu Das

We really don’t like to talk specifically about companies. But having said that in order to be effective and dominant in the wireless area, we believe a company needs to have access to VoIP technology, [inaudible] technology, and also technology for [clock] synchronization. To our knowledge, TranSwitch combined with Centillium is the only organization having access to all of this IT and we believe the [inaudible] products.

Now why are these technologies important, the reason the access to this technology is necessary is that if we look at that infrastructure which links wireless base stations to the rest of the network, either the mix of DDM over [inaudible], it also has [inaudible] over [inaudible], and it also has [inaudible].

That means the back haul equipment must deal with a number of different physical interfaces and a number of different protocols and some of them are very old legacy protocols. And we believe TranSwitch combined with Centillium is the only organization which has all the necessary intellectual property and associated products to deal with this situation and to be effective.


Your next question comes from the line of Kevin Cassidy – Thomas Weisel Partners

Kevin Cassidy – Thomas Weisel Partners

On the gross margin line I was just wondering if is product mix improving a little bit next quarter and is there a chance of getting back up into the 60% range and how does that happen.

Ted Chung

I think Bob in his prepared remarks guided to a blended gross margin in the fourth quarter of 56% that actually is better then what we achieved this quarter. As far as getting back to 60% I think depending on the revenue mix in any particular quarter, it should sort of remain in the mid to high 50% area.

It certainly could in any given quarter get up to 60% but I think for modeling purposes and we’ve said this on prior calls I think, sort of 56% to 58% gross margin range is what you’ll see from us on average as we move forward.

Kevin Cassidy – Thomas Weisel Partners

And if we could, on the services line can you break that up any more between NRE and royalties and licensing or at least maybe directionally what do you expect going forward.

Bob Bosi

More of it is IT and licensing then NRE, but that mix changes from quarter to quarter.

Ted Chung

In a lot of quarters we don’t have NRE at all so much of it is actually the licensing of intellectual property and largely specifically related to our interface businesses. This particular quarter we had some NRE, its certainly possible that next quarter we don’t have as much NRE.


There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Santanu Das

In conclusion for the second consecutive quarter TranSwitch has achieved profitability from its operation. Our business has been steadily in the [inaudible] and North America. Our Israeli business also experienced growth in the past quarter. In this [inaudible] we have had a number of design wins with our Atlanta family of products in Korea, China and other countries.

And we believe we are now a significant player in the CPE area in addition to being an established player in Access. Based on our current backlog and visibility we believe that Q4 will again be a growth quarter for us. Thank you all for joining our call today and we’ll visit with you again in a few months.

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