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UTStarcom Holdings Corporation (NASDAQ:UTSI)

Q3 2013 Earnings Call

November 14, 2013 7:00 AM ET

Executives

Jane Zuo – Senior Manager, IR

William Wong – CEO

Robert Pu – CFO

Operator

Ladies and gentlemen, thank you for standing by for UTStarcom’s Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder this conference is being recorded. If you have any objections you may disconnect at this time.

It is now my pleasure to introduce your host, Ms. Jane Zuo, Investor Relations Senior Manager of UTStarcom. You may begin.

Jane Zuo

Hello everyone and welcome to UTStarcom’s third quarter 2013 earnings conference call. Earlier today, we distributed our earnings press release and you can find a copy on our website at www.utstar.com. In addition, we have posted a slide show presentation on our website, which you can download and use to follow along with today’s call. On today’s call we have Mr. William Wong, our CEO, and our Mr. Robert Pu, our CFO.

Before we get started I will read the company’s advisory on forward-looking statements. This call will include forward-looking statements relating to the company’s business, strategic initiatives and the performance in the third quarter of 2013. These statements are forward-looking in nature and subject to risks and uncertainties that may cause actual results to differ materially and adversely from the company’s current expectations.

This include risks and uncertainties related to among other things, changes in the financial conditions and cash position of the company, changes in the composition of the company’s management and their effect on the company; the company’s ability to realize anticipated results of operational improvements and benefit of the divestiture transactions, the ability to successfully identify and acquire appropriate technologies and businesses for inorganic growth and to integrate such acquisitions, the ability to internally innovate and develop new products, assumptions the company makes regarding the growth of the markets and the success of the company’s offerings in the market and the company’s ability to execute its business plans and manage regulatory matters.

The risks and uncertainties also includes the risk factors identified in the company’s latest annual report on Form 20-F, and current reports on Form 6-K as filed with the Securities and Exchange Commission. The company is in a period of strategic transition and the conduct of its business is exposed to additional risks as a result. All forward-looking statements included in this conference call are based upon information available to the company as of the date of this conference call which may change and the company assumes no obligation to update any such forward-looking statements.

I will now turn the call over to our CEO, Mr. William Wong.

William Wong

Thank you, Jane and hello to everyone. As Jane mentioned, you can follow along with today’s call by downloading the presentation from our website at www.utstar.com. Also unless otherwise stated, all figures mentioned during the call are in U.S. dollars.

I know that many of you have questions about the withdrawal of the proposal that UTStarcom received in March to acquire outstanding shares and take the company private. As it’s customary we have dedicated a portion of our quarterly review comments to address this proposal. We have more than usual to state about it but first let’s proceed with the recap of the quarter as there are lot to discuss.

Let me begin by saying that the third quarter was another period in which we make significant progress. We continued to turn the business around both financially and operationally by building on our core strengths, maintaining our focus in controlling cost and pursuing a strategy that will give us new and more profitable sources of revenue in the future. The results of our efforts are increasingly evident in our quarterly financial results. Robert will delve into the details in a few moments. But let me touch on some highlights.

Revenue growth was healthy again. We saw a another significant drop in operating expenditures [coming] in large parts from savings we achieved by rationalizing our business in recent quarters and divesting non-core product lines. We generated positive operating cash flow for the quarter and we are operating cash flow positive year-to-date. In addition, we generated positive operating income for the quarter, a sharp reversal from a loss in the previous quarter and slowed us in the same quarter last year.

And finally our gross margin came back a bit on a sequential basis as we have fully [recognized] from one-time cost. It is too below our target which we have highlighted at the possibility and Robert will discuss it momentarily. This financial results show that we are moving in a right direction at the business both from an operational standpoint as well as the strategic standpoint, that’s the result of many factors but certainly a key has been our focus on lowering our cost structure and operating the business more efficiently. Also, our results reflect new strategic plan that we put into place last year to accelerate UTStarcom’s transition to a higher growth and more profitable business. That trend centers on divesting non-core business lines, redeploying capital to support high return opportunities and establishing a base of subscribers to value-added services that can generate more predictable recurring revenue.

Now, please turn to Slide 7 to discuss some specific operating achievements from the second quarter that support our strategies and highlight the ongoing progress we are making in many areas. An important part of our strategic plan is to develop our broadband business into a provider of specialized niche products. As part of that plan, we launched a selection of new and innovative broadband products that extended our portfolio of market leading Network Management Solutions. This new products our cable and broadband service providers expand the (inaudible) of the networks and operate them more efficiently. This demonstrates a simple network, simple operation philosophy that underlines our product development strategy to ensure that we more directly target the need for our core customers.

In addition, we continue to grow and diversify the customer base for our broadband business, launching new customer wins with large local incumbent service providers in Taiwan, Indonesia and Brazil. These are important relationships that would solidify our role as preeminent telecommunications network infrastructure provider and it give us the platform on which to build new business lines.

It is important to emphasize that this new customer relations center on our market leading PTN product lines. It is an extremely important business for us. As we have said in the past we expect PTN to be the driver of our broadband business as it gives us the platform to enter the next generation market into Software Defined Networking or SDN. SDN has vast applications for both telecommunication networks as well as cloud-based computing, storage and other services driving growth in our industry. Therefore, the positive market reception of our PTN products is a very promising sign for the future of our broadband business and for the future of UTStarcom overall.

Alongside the growth in our broadband business, the development of our media operational support services business is expecting strides. It is another crucial plant of our overall strategy and it centers on developing a TV over IP business that will give our cable and broadband service provider customers the ability to provide more customized viewing features to their end-user customers. In the third quarter our strategic partner iTV Media continue to flourish in the first commercial launch of its flagship product. As we have mentioned iTV Media has launched a nationwide media service products in Thailand through the countries incumbent telecom and broadband service provider TOT. The number of subscribers through iTV’s flagship product rose by a dramatic 50% in the quarter reaching 90,000 that’s a remarkable growth for product that has been in the market for less than a year.

iTV’s success underscores the potential that we see across Asia and globally for a new range of media entertainment options and features that give consumers on-demand access to premium and internet base content from any location and on any device. These are trends that our new strategy is designed to capitalize on and that we think will result in a subscriber base that provides high growth, more profitable revenue streams that are recurring in nature. It also exemplifies our ability to turn broadband customers like TOT into customers of our media support services. These are very encouraging trends that we believe validate the direction in which we are taking UTStarcom and our ability to capitalize on some of the most promising opportunities in the market.

Now let’s turn to the going private proposal that UTStarcom received in March. As you may have seen the consortium that submitted the proposal has decided not to pursue its intention to take UTStarcom private and has delivered notice to these facts to the special committee of the Board of Directors. As we have said from the beginning there was no assurance that an agreement would be consummated and is important to emphasize that this was the decision that the buyer consortium took on its own and in consultation with its own advisors. As we understand it, the consortium took this decision because it could not secure financing for the proposed transaction for a combination of reasons.

One, our business is in a turnaround. Also the consortium has limits on the amount of additional collateral it was (inaudible). Management cooperated with all requests for information to ensure that the consortium can conduct a sale of due diligence process. That process was run very effectively and was not a factor in a consortium’s decision to withdraw its proposal. Hence, it is our view that this outcome should not be seen as a reflection on the prospects for UTStarcom or the strategy that we are pursuing. One of the members of the buyer consortium Mr. Himanshu H. Shah is one of our largest shareholders and as such his interests are directly aligned with those of our broader shareholder base.

Over time we can share ideas with the management on how to improve shareholder value. He clearly shares the same enthusiasm for the company at the management team and the rest of the Board of Directors. Because of this the company’s Board of Directors has appointed Mr. Shah as a new Director and this was effective November 1, 2015. And at his own request he will not receive any compensation for his service on the board. We welcome his input and our board looks forward to working closely together to drive our business forward and explore many of the strategic initiatives that we’ve discussed in the past.

Now that the outcome of the going private proposal is clear we will consider a broad range of options for capital allocation and strategic investments to increase the shareholder value. We have a healthy capital structure with significant cash and no debt, strong governance mechanisms and full access to the public capital markets. We are confident that we can continue to pursue our business plan and strategy as a publicly listed company. Hopefully, our results demonstrate the efforts we are making to maintain our competitive advantage by investing in new product development and strategic partnerships to increase share value over time.

Lastly, it is important to note that neither the buyer proposal nor the decision to withdraw it, has affected our operations or relationship with our major customers. Our employees have remained motivated and focused on advancing our product lines as it’s evident through the recent launches of new products and our relationships with customers are strong and growing. Our sales results from the quarter and the addition of new customers in Taiwan, Indonesia and Brazil show that we have not had any impact from the going private proposal on our ability to market our products to existing as well as new customers.

Now let me turn the call over to Mr. Robert Pu, our CFO.

Robert Pu

Thank you, William, and hello everyone. Starting from Slide 11, I will discuss our third quarter and the first nine months 2013 financial results in more detail. Before I begin let me remind everyone that in the third quarter of 2012 we divested the IPTV business for better comparison of financial performance on a year-over-year basis. We have prepared non-GAAP financial results which focus on our remaining broadband business. For today’s purposes I will focus on our broadband business and exclude the already divested businesses from our discussion.

Please turn to Slide 12, before I walk through the specific numbers let me highlight a few key [things] of the third quarter and the first nine months of 2013. We managed to do well in several important areas. First, revenue for growth in the third quarter and the first nine months increased incrementally on a year-over-year basis as we continue to experience stable demand for our broadband equipment products from our customers. Second, we continue to benefit from aggressive and focused cost reduction efforts as demonstrated by the significant decrease in operating expenses year-to-date.

Moving forward, we will continue to monitor our OpEx and find ways to further improve our cost structure. Third, we generated positive operating cash flow and the improvement on the bottom line in the third quarter and year-to-date reflecting the positive performance on the top-line coupled with lower cost. Lastly, we ended the quarter in a strong financial position with no debt and approximately $120.4 million in cash on balance sheet. As we had said before we will continue to invest in our growth plan and other initiatives designed to enhance shareholder value.

Moving to one of the challenges we had faced in 2013 gross profit and gross margin decreased from 2012 levels, which we had stressed in the last few quarters. The decrease is largely due to the Japanese yen depreciation versus the U.S. dollars. We had taken certain measures to mitigate the impact. For example converting our Japanese yen denominated assets to U.S. dollar denominated assets regularly. However, by doing business in international markets we are inherently exposed to such risks. Furthermore Japan is perhaps our most important market commercially at this point so this is a market we are committed to.

Now I’ll turn to the specific results. Please turn to slide 13 for revenues. In the third quarter, revenue was $40.9 million compared to $37 million in the prior year period. In the first nine months, revenue was $125 million compared to $160.3 million in the prior year period. Both the quarter and year-to-date revenues increased slightly from the prior year period as we experienced stable demand for our broadband equipment products from our key customers.

Please turn to slide 14 and 15 for gross profit and gross margin. In the third quarter, gross profit was $11.8 million compared to $12.7 million in the prior year period. Gross margin was 28.9% compared to 34.4% in the prior year period. In the first nine months gross profit was $33.1 million compared to $40.7 million in the prior year period gross margin was 26.4% compared to 35% in the prior year period.

I mentioned a moment ago the year-over-year growth profits and gross margin decrease was mainly due to the depreciation of the Japanese yen this year. As a reminder a major portion of our revenue is denominated in Japanese yen most of our cost is denominated in R&D and our reporting currencies the U.S. dollar. In U.S. dollar terms the depreciation of the Japanese yen and the diverse strength of R&D throughout this year were losses in the year-over-year gross profit and gross margin decrease.

Also during our last quarterly conference call we let everyone know that we [booked] an additional loss provision in our India business P&L in the second quarter of this year which massively impacted our year-to-date gross margin results. This was due to an increase in the estimated cost complete a project in India resulting from a cost increase our service provider in conjunction with their final contract renewal. We will continue to monitor the Japanese yen situation and other factors impacting our income statement and update our investors accordingly in the future.

Please turn to slide 15 for operating expenses. In the third quarter, operating expense were $11.6 million compared to $18.9 million in the prior year period. In the first nine months operating expenses were $37.9 million compared to $61.9 million in the prior year period. In the past several quarters we have worked very diligently to reduce OpEx we right sized the business by divesting non-core products, reduced redundancies in our work force and promoted accountability and productivity among our staffs. We also reduced people related overhead expense and outsource service expenses.

Starting from the first quarter of this year we have clarity target benefits from our cost reduction efforts that we initiated in the second half of 2012. In the end of second quarter and the third quarter of this year we managed to maintain [low rate] CapEx with $12 million for the quarter. And year-to-date our [low rate] CapEx was significantly lower compared to 2012. Moving forward we will continue to monitor our OpEx and translate to further improve our cost structure.

Please turn to slide 17 and 18 for operating income and net income. In the third quarter operating income was $0.2 million compared to operating loss of $6.1 million in the prior year period. In the first nine months operating loss was $4.8 million compared to operating loss of $11.2 million in the prior year period. In the third quarter net income was $0.4 million compared to a net loss of $0.2 million in the prior year period. In Q3, we picked up $2.3 million of net loss from iTV Media our invested media operation entity we have the equity method of accounting.

In the first nine months net loss was $6.7 million compared to net loss of $9.6 million in the prior year period. Net loss in the first nine months of 2013 included $6.7 million of net loss being picked up from iTV Media. We have the equity method of accounting. Adjusting for this item net income from our core operation is close to breakeven for the nine months of 2013.

As discussed earlier for the third quarter and first nine months operating performance has improved on a year-over-year basis. This is mainly a function of the slight increase in revenue and significantly reduced operating expenses. Very importantly, we achieved this improvement while facing pressure on the gross profit and the gross margin.

Please turn to slide 19 for cash balance and cash flow. We have approximately $120.4 million in cash we have no debt at the end of Q3. In the third quarter, we generated positive operating cash flow of $3.7 million. Cash used by investing activities was $2.3 million mainly due to investment in PP&E and NGN divestiture payment. Cash used by financing activities was $2.7 million which is mainly due to a $2.7 million collection and payment timing of the AR factoring facility with bank.

In the first nine months, we generated positive operating cash flow of $1.9 million, we have worked hard to do this as we understand that to create value for shareholders and the need to generate cash from operations which we did in both Q3 and year-to-date. Year-to-date, we have made good progress executing our turnaround strategy as demonstrated in our P&L and cash flow measurements.

However, we are still in the early days of our turnaround plan. Looking ahead we will keep our focus on vigilant cost control, cash generation and executing our new strategic initiatives. We will continue to use our strong cash position to invest in our growth plan designed to increase shareholder value and we’ll also continue to monitor our progress and update our investors in the future.

This concludes my third quarter 2013 financial review session. Now I will turn the call back to William to discuss our business outlook.

William Wong

Thank you Robert. If you would, please turn to slide 20 as we enter the last quarter of the year we are well along the path of transitioning our business. We continue to see healthy and improving trends in our financial and operating performance. These results from investments we have made divestiture of unprofitable and non-core businesses and (inaudible) to align our business with long term shifts in the market.

Indeed, overheads in the third quarter was substantial as we increased our sales footprint with new customer wins we continue to develop a portfolio of market leading broadband products and to invest in a development of new services that will enable us (inaudible) our cable and broadband service customers to participate in the dynamic changes to shaping our industry such as cloud computing, mobility and on-demand delivery of which entertainment content. At the same time we are developing a base of subscribers that they can become customers for future value added services and most importantly we achieved ongoing financial improvement with generation of positive operating cash flow on net income, healthy top line growth and strengthening gross margin.

Looking ahead to the balance of 2013 as we have said in the past the changes we are making will take time to complete and fully stabilize the business. Our gross margin may continue to experience headwinds from the depreciation on the Japanese yen against U.S. dollars. As sales in Japan account for a large portion of the company’s total revenues, but if the Japanese yen exchange rate remains stable and we maintained our progress on generating efficiencies from operations, we expect incremental improvement from 2012 in overall financial performance as we said at the end of the second quarter.

Over the long term we expect that our balanced focus on strategic initiatives and continuing investment in our value added broadband business will result in a more profitable and comparative business model. We continue to expect profits from the new TV over IP services to become the majority contributor for UTStarcom by 2015, with gross margin in that part of the business exceeding 50%.

In closing, we believe we have the right leadership. The operational and financial discipline and the right strategy to achieve our goals and move in sync with the market and customer’s demands.

Indeed, we believe the results we are announcing today are a validation of our efforts and the strategy we are pursuing. And now that the outcome of the Going Private Proposal is determined, we can move forward with greater certainty to implement many of the plans that we have in progress.

That concludes our remarks and now we would like to take any questions you have. Operator, please open the line for Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instruction). Our first question is from [Jim Bartolomeo], a Private Investor.

Unidentified Analyst

Good morning, good evening. I’m pleased with management’s decision to maintain UTStarcom as a public company. Assuming the financial numbers and business model have been honorably presented the actions taken should benefit all parties UTStarcom shareholders, UTStarcom employees and UTStarcom management and Mr. Shah. I believe these actions are also in line with President, Xi Jinping’s vision for Great China and will also be looked upon favorably by the National Development and Reforming Commission, the NDRC.

For myself and other investors we will expect positive results from our company and its management. Future plans to make additional investments in UTStarcom or investments in other Great China companies will be subject to positive results. As for the $120 million in cash reserves, the only used for this money is to purchase other companies or parts of other companies that will complement UTStarcom’s business model and be, as a growth company and be accretive to sales and earnings. I am looking forward to your comments respectfully. Thank you.

William Wong

I think as we said earlier, now that the Going Private Proposal cleared, we are certainly considering a very broad range of options including different capital allocation and strategic investments to further increase the shareholder value. And from the business perspective, we are spending a lot of effort in developing a new line of business – excuse me, a new line of products along the PTN area we have embarked on the development on the next-generation SDN products which is going to be a key element driving the future growth for the company. So, we are indeed going to continue on the various different directions to utilize the very valuable assets that we have in the company.

Unidentified Analyst

Thank you.

William Wong

You’re welcome.

Operator

(Operator Instructions) Thank you, there are no further questions at this time. I would turn the conference back over to management for closing remarks.

Jane Zuo

Thank you for joining us on our third quarter earnings conference call. We look forward to updating you on our fourth quarter 2013 conference call in a few months. Feel free to get in touch with us anytime if you have further questions, concerns or comments. Thank you everyone.

Operator

The conference has now concluded. Thank you for attending today’s presentation. Please disconnect your lines.

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