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UTStarcom, Inc. (NASDAQ:UTSI)

Q3 2009 Earnings Call Transcript

November 5, 2009 5:00 pm ET

Executives

Barry Hutton – Senior Director, IR

Peter Blackmore – CEO and President

Viraj Patel – VP, Interim CFO, Corporate Controller and CAO

Operator

Good afternoon. My name is Laurie, and I will be your conference operator. At this time, I would like to welcome everyone to the UTStarcom third quarter 2009 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. I will turn the call over to Barry Hutton, Senior Director, Investor Relations. Please go ahead, sir.

Barry Hutton

Good afternoon and thank you for joining our call today. Earlier this afternoon, we announced our financial results for the third quarter 2009. That press release is available on the company Web site.

And today Peter Blackmore, our Chief Executive Officer will start the call by discussing certain business unit highlights including a new product launch and key customer wins. Peter will then give an update on our progress on the restructuring initiatives announced in June. Viraj Patel, our interim Chief Financial Officer, will then review the third quarter financial results and certain non-GAAP metrics. And then Peter will close the conference call with some comments about our expectations for next year.

I remind you that this call will include forward-looking statements relating to among other things the Company's restructuring initiatives and projected business model. Forward-looking statements are generally indicated by such words as “will,” “expects,” “estimates,” “goals,” “plans” or similar words. These statements are forward-looking in nature and subject to risks and uncertainties that may cause actual results to differ materially.

These risks include the ability of the company to realize anticipated results from operational improvements and execute on its business plan as well as risk factors identified in its annual report on Form 10-K, quarterly report on Form 10-Q and current reports on Form 8-K as filed with the Securities and Exchange Commission.

The company assumes no obligation to update any forward-looking statements. And in addition, today's call will include certain pro forma non-GAAP financial measures. The most directly comparable direct GAAP information and a reconciliation between the pro forma non-GAAP and GAAP figures is attached to the earnings release issued earlier today and filed on a Form 8-K. The reconciliation is also available on our Web site in the Investor Relation section. And now I will turn the call over to Peter.

Peter Blackmore

Thanks, Barry. Good afternoon, everyone, and thank you very much for joining our call today. Earlier today we issued the press release that outlined our financial results quarter-after-quarter. As you saw the Q3 results include total revenues of $71 million, this is driven primarily by our IP-based products and services. This quarterly revenue also reflects our decision to minimize our Handset operations globally. During this has helped to improve our gross margins and reduce the working capital needs.

Q3 gross margins were 34%, which included some benefits specific to the period that it also reflects that our margins improve as we focus on our IP infrastructure business.

The operating expenses were 58 million. That includes 11 million in one-time charges related to our restructuring activities and a small loss from the divestiture of our career-based handset operation. The reduction in our run rate expenses is on track to hit our 2010 targets. Importantly, we ended the third quarter with 241 million in cash and short-term investments and we continue to manage cash well and manage it tightly.

As always, the financial results are clearly important, but as you all know Q3 is a time of transition for the company. So, equally important to the results as the progress towards repositioning the Company for 2010 and beyond.

During the second half of this year our management team has been very focused on three objectives, which I will discuss in some more detail.

First, we continue to build the product portfolio and the customer pipeline to drive 2010 revenues we need. Second, we are aggressively executing the restructuring and this will streamline the business and reduce the OpEx flow 100 million for 2010 and whilst we're doing this we will maintain the Company's financial R&D and operation resources required to prosper in 2010 and beyond.

Let me now look at some highlights regarding key developments relating to our product portfolio and sales pipeline that will support our 2010 revenues. I'd like to start with the Broadband business unit.

On October 30th our Broadband business unit formally announced the launch of our transport network product family, which refer to as TN product. Already, we have secured two separate commercial contracts that will utilize the TN product solution. The first contract is with SOFTBANK based in Japan. This is a very important contract. And the second contract is with Shandong Power based in China, which is an enterprise win. It's not to a carrier, it is to a utility. And on Tuesday we issued the press releases which discuss both projects and you can find each of those on our web page

We are all very excited about TN product launch and the related growth opportunities. As I think you know the product is designed to help carrier networks managed traffic growth by increased bandwidth and generate high offerings for the carriers.

We believe we have a leadership product and the wins demonstrate a good start and you can find the technological details about the TN product on the Company web page under the “Products” section.

We are bidding this product actively in a number of current RFPs. Most notably, we are pursuing the China Mobile tender, which is already gone out to RFP stage, and we are doing this through a joint partnership with a new partner we have in China, Nokia-Siemens.

Over the next six months we plan to launch a number of launch activities which together will maximize the opportunity and give good coverage of this exciting new product to potential clients and technology groups.

Separate from the TN prospects we continue to move forward with additional Broadband business. Earlier in the year, we spoke about our plan to leverage sales channel relationships in certain markets; one of them is South America. And we're pleased to announce recently new sales alliance relationship with Logicals, an international provider of information and communications technology through many countries in Latin America. The sales relationship has already secured projects in Argentina, Chile, Paraguay and Peru.

These projects utilize cross section of our broadband products including IPDSLAM, MSAN and the GEPON Solutions. And importantly I would like to just reiterate one significant item. As we mentioned last quarter we do expect to take a significant order in India for Phase III of the BSNL contract in Q4.

Let's move to the multimedia communications business. In this business we continue to have the leading market share in IPTV in both China and India. As we look towards 2010 growth opportunities in the China IPTV market, as we've had explained before a meaningful proportion of the industry's 2009 investment has been dedicated to 3G, the indications are that 2010 will see a return to significant IPTV investment by the industry. And in the recent months this quarter we won a number of new contracts that are clearly a positive indication towards our prospects next year.

Also this week on Wednesday we announced a new relationship with a Beijing-based government agency named State Administration of Radio, Film and Television or SARFT. Beginning in November, SARFT will start deploying our IPTV software platform and other solutions throughout Sichuan province and this was the province that you remember was damaged by last year's earthquake.

The project goal is to ensure that the province has access to TV and radio channels to receive important information from media and other content. Specifically, the province residences will have simultaneous access to 7,000 new video streams through the system. We do expect this relationship with SARFT to be a long-term strategic opportunity for us. The SARFT agency is active in a number of provinces and this additional contract will create a benchmark for interactive multimedia contract providers to develop future operations.

Also in China CCTV and Hunan television station jointly established a new IPTV corporation model and UTStarcom was appointed as the solution provider in four cities. Importantly, China Telecom has named us as one of the preferred vendors to roll out the new set-top box standard, which is standard 2.0. This is an open standard for set-top boxes, which will enable us to compete more effectively for set-top box sales, but only for our own systems, but also for competitive systems.

And in Guangzhou, the capital of Guangzhou province recently launched the IDTV service, SMIC, the Southern Media Group and this is the revenue sharing model, we share in the appetizing revenues, and we are expected to expand the service to other cities throughout the province.

And in India, we continue to move forward with multiple deployment projects that we have won and many of the systems going live in Q4 and in 2010.

Let me now switch to an update on restructure and the progress towards our 2010 model. Obviously, it’s a major effort we've continued to execute our restructuring plan, which you remember we announced in June of this year. Plan was carefully put together to target profitability in 2010 without sacrificing our long-term strategic focus on key IP products and to make sure that we were successful particularly in the selected target markets, which are primarily, China, India and Japan.

This restructuring will achieve three goals. It will streamline our competitive focus on these key regions of China and Japan. It has focused our product portfolio to concentrate on opportunities that are very likely to drive growth and attractive gross margins, such as the opportunities I've just mentioned in both Broadband and MCBU.

And third, very importantly, it will reduce our operating expenses so that our 2010 OpEx will be less than 100 million. We have made good progress in Q3 and are on track to complete all of the restructuring actions.

To give it a little bit color on the restructuring process, we have reduced our support for certain legacy businesses. And as we made clear, our business will be almost entirely focused in 2010 on the IP-base system products in the related professional services. We will continue to make R&D investments in products, most likely to generate growth in 2010 and beyond, and the example we gave in this call of the TN product, the new product is a perfect example.

Regarding our sales strategy, our lead markets of China, India and Japan are around primarily dedicated direct sales team focused on Broadband and IPTV products. But you will also note in China we've extended our coverage by working with Nokia-Siemens to penetrate China Mobile which will be a new account for UT, if we win this contract we're currently bidding for.

Across the rest of Asia, Latin America and Europe, we have a combined approach that although it has some direct sales teams to support current high potential clients it will focus increasingly on channel and OEM relationships. And we continue to build up these partnerships in carriers, such as the new relationship in Latin America I just mentioned

Next, on plan and anticipated we recently selected a vendor to outsource our manufacturing operations. This vendor has been selected. We will not announce the name today. There will be a press release coming out shortly.

Obviously completing the manufacturing change requires us to manage a very, very good transition as we move to the outsourced manufacturer. We are beginning the transition, planning, and beginning to move into operations during Q4. However, because we expect a large order from BSNL Q4 plus orders we're going to receive from SOFTBANK and others, we expect very large shipments in Q1 so we are planning to manage the transition carefully in Q1 so that we really execute superbly well on these important shipments as well as handling over to our new outsourced product.

We announced in December last year the plan to consolidate our back office functions into China and at the same time simplifying our operation, rationalize some facilities and obviously reducing costs. Many of our functions have moved to China making UT stock common increasingly Asia-focused operations.

The concentration of employees and functions in one location we'll be able to consolidate a number of our facilities. Currently, our headquarters continue to be –in Alameda, but it is now a much smaller office. In fact, those of you who have visited us will know we had three buildings; we're now down to one building and just a small number of people as we moved or eliminated functions and transferred them. This is a new comment. We were looking at the potential advantages formally moving the company headquarters to China. I will talk more about that as our plans unfold.

All of these changes clearly we plan to have the senior management team which is being based partly in Alameda, partly in China, will be moving the senior management team to China, obviously, supported by very good people in the region, such as India and Japan and other regions so we continue to have a strong international presence.

But in terms of moving the senior management team, we are on track to do that and to make sure we have the appropriate capacity and bench strength. We have already been recruiting people and aligning various functions to senior managers that are joining us already based in China.

As we mentioned on last call we are also looking to expanding our board of directors who are very active in this. And the aim is to add board members with much more familiarity with the China market. We're talking to a number of potential candidates and will advise you as soon as we have firm news on recruits.

In terms of head count, the employee head count at the end of October was under 2,700 people and this is down from about 4,300 in June of this year. Obviously, we're on track to have further reductions in Q4 and some reductions in Q1 as we complete the outsourcing of our manufacturing operations.

But I want to emphasize collectively we're well on our way to bringing the head count for the employees below the 2,000 base that we announced when we talked about the restructuring in June and we will complete that on time.

Let me also give you a quick update on the sale of our Hangzhou facility. We've worked with the local government to ensure that a building sale will be supported by them and it will be. We had made a contract with a realtor to market the building and that is active and ongoing. There is genuine interest in the building already, but I want to remind you that timing of the transaction obviously is still uncertain. We want to maximize the value of this building. It’s a very unique building, very special building and we want to take the time to find the right partner as we go through this transaction.

At this point I will hand over to Viraj to give more detail of our Q3 results.

Viraj Patel

Thanks, Peter. Good afternoon, everyone. I will start by highlighting the company-wide numbers presented both on GAAP and non-GAAP basis. In the third quarter 2009 we had GAAP revenue of 71 million versus 181 million a year ago. It's very important to recognize that the vast majority of the year-over-year differences was anticipated and it is directly attributable to lower revenues from past business.

As you know, use of the PAS technology has been winding down for some time. And earlier in 2009, the China government formally reallocated the spectrum from PAS to 3G users. And such we had anticipated this decline in PAS revenues.

The GAAP gross profit in Q3 was 24 million or 34% of revenues. This compares to gross profit of 57 million or 32% in the third quarter of 2008. As outlined in our press release the Q3 gross profit did benefit from the reversal of 6.5 million inventory charge. You recall that in prior periods, we wrote down certain handset inventory.

Our GAAP operating expenses were 58 million and we're also impacted by certain significant one-time items totaling 10.6 million. First, in June, we had announced a significant restructuring charge and we took some related charges in Q2. As we continue to execute our plans we require an additional 8.9 million restructuring charge in Q3.

We do expect to take an additional restructuring charge in Q4 as rest of the workforce reduction and is finalized. All of these charges are primarily related to one-time severance payment to identified employees.

Second, we recognize 1.7 million non-cash loss related to divestiture of Korea handset operations. Even with these special charges we have been able to achieve 37% reduction in OpEx year-over-year. The reduction comes from a broad range of items across the SG&A category. We also lowered our R&D expenses by streamlining a strategic focus and exiting non-core areas. The GAAP operating loss came in at 34 million. Third quarter 2009 net loss was 35 million, a $0.20 per share

Let me briefly touch on the non-GAAP results. At this point I want to make a moment to discuss the non-GAAP pro forma numbers that were issued in the press release and posted to our web page this afternoon.

Over the past 18 months we have taken actions to narrow our focus towards IP-based products and services. Our actions include exiting a number of non-core businesses, namely the divestiture of PCD in July of 2008 and wind down off a Korea-based handset business.

I remind you these non-GAAP results do not adjust for restructuring charges, any other special charges on non-cash items. These results only adjust for our exit from PCD and the Korea handset operations.

Non-GAAP revenues and gross margins for the third quarter 2009 were 63 million and 35% respectively. This compares to third quarter 2008 non-GAAP revenue and gross margins of 146 million and 35%. Both 2009 metrics reflect the anticipated decline in our PAS business as I had mentioned earlier.

Our non-GAAP OpEx was 57 million in the third quarter. Even including special items from the period these results compare favorably to the 82 million in non-GAAP OpEx a year ago to the company's broad strategic and cost-cutting initiatives. We are clearly making progress towards reducing our cost structure. The non-GAAP operating loss was 35 million versus a loss of 31 million a year ago.

Let me now turn to the segment results. Multimedia Communications. In Q2, our Multimedia Communications segment had revenues and gross margins of 22 million and 46% respectively. This compares to Q3 results of 58 million and 53% for prior comparable quarter.

The Multimedia segment revenues were negatively impacted by the wind down of PAS business in China. The PAS business decline was partially offset by an increase in sales of our IPTV systems.

On Broadband revenue for the quarter was 16 million, which is down from 31 million a year ago. This decline comes from our actions to exit certain low margin Broadband products.

Gross margins of Q3 were.22%, a significant improvement from 10% a year ago as we've managed well, the Phase II, part of the BSNL multiplay deployment.

For the Services segment, the revenue for the quarter was 17 million, which compares to 14 million in the same quarter a year ago. This continues to be a high margin business for us as reflect in the third quarter gross margins of 44%.

For Handsets, in the third quarter the total revenue recorded were 16 million, compared to 72 million a year ago. Last year's handset business recorded 35 million from selling equipment in North America. That is a business we've exited.

And as stated earlier we also had a significant decline in revenue from China PAS handset activity. The gross margin of 21% benefit includes 6.5 million benefits as we had worked with PCD to sell through some handsets which were previously written down

Cash flow. Our cash balance we ended the quarter with a strong balance of 241 million, which includes, cash, equivalents and short-term investments as of September 30, 2009.

During Q4 and Q1, we expect to make cash payment related to the restructuring charges that we've taken. Ultimately, we reiterate our expectation to end the year with sufficient cash liquidity to support our working capital needs for 2010.

At this point I would like to give the call back to Peter.

Peter

Thanks, Viraj. Let me just talk briefly about year-end guidance and the target business model. I'm sure you understand that for the rest of this year, our focus will continue to be on completing the execution of the major restructuring plan we announced in June. At the same time we want to try a very healthy sales pipeline, which will help our business, not only in Q4, but make sure we have a strong 2010. And we want to maintain a strong cash position. (inaudible) this aligns the company to achieve profitability in 2010.

Consistent with last quarter, we'll not be providing specific guidance for the fourth quarter given the significant changes we're currently undergoing to our operating model. However, I do want to reiterate and emphasize our 2010 target financial model. We do expect annualized revenues greater than $350 million. These 2010 revenues will be driven by bookings in 2009 and early 2010.

In addition, we also have the benefit of over $100 million of deferred revenues, which will recognize in 2010 as we get the final customer acceptance.

Let’s move to gross margins. We expect gross margins in the high-20s. We changed our product mix. We now minimize the CDMA handset operations, which tends to have both low margins and high working capital requirements. So as a result we're now almost entirely weighted towards IP-based systems.

In 2010, we'll also see the revenue and gross margin benefits from the new products such as TN which have good gross margins.

Let's move to operating expenses. We do expect annual operating expenses to be less than 100 million excluding any unreceived one-time items. And the restructuring progress continues to make us confident in our ability to achieve this.

Relation to cash levels and cash flow our anticipated December cash levels and the anticipated 2010 cash flows indicate we will maintain not only the financial resources and flexibility, but we will be able to make any desired investments in our customers products and employees to be successful.

At this point, I would like the operator to prepare for the question-and-answer session.

Question-and-Answer Session

Operator

(Operator instructions) At this time, there are no questions. I will return the call to management for any closing remarks.

Peter Blackmore

Well, thank you, operator. I know we've got calls later today and tomorrow with many of the investors so I'm sure we will have most of the questions there. I would like to thank you all very much for listening and look forward to talking to you. Thank you very much.

Operator

Thank you. That does conclude today's UTStarcom third quarter 2009 earnings conference call. You may now disconnect.

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