TranSwitch CEO Discusses Q3 2010 Results - Earnings Call Transcript

Oct.31.10 | About: TranSwitch Corp. (TXCCQ)

TranSwitch Corporation (TXCC) Q3 2010 Earnings Call October 28, 2010 5:30 PM ET

Executives

Ted Chung - Vice President of Business Development

Ali Khatibzadeh - President and CEO

Bob Bosi - CFO

Analysts

Kevin Cassidy - Stifel Nicolaus

Richard Shannon - Northland Capital

Melay Nata - Stifel Nicolaus

Operator

Good day, everyone, and welcome to the TranSwitch third quarter 2010 earnings release conference. Today’s conference call is being recorded. At this time, for opening remarks and introductions, I will turn the call over to TranSwitch Vice President of Business Development, Mr. Ted Chung. Please go ahead, Mr. Chung.

Ted Chung

Great, thank you. With me here today are Dr. Ali Khatibzadeh, our President and CEO, and Mr. Bob Bosi, our CFO.

Before I begin, I want 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.

These risks are detailed in TranSwitch’s filings with the Securities and Exchange Commission. With that out of the way, I will provide some highlights for the quarter and then hand it over to Ali for some more details.

For the fiscal third quarter of 2010 net revenues for the quarter were approximately $12.8 million meeting the revised guidance provided at the end of September. Gross margins in the quarter improved to roughly 56%, up from roughly 53% in the June quarter. We see continued margin improvement due to operational improvements as well as mix change to higher margin products.

Our non-GAAP operating expenses for the quarter were roughly $6.6 million, lower than our guidance. As a result of the lower operating expense and higher gross margin, the company achieved operating income of roughly $600,000 on a non-GAAP basis. Bob will provide some additional details later.

The combination of our increasing gross margins and lower operating expense levels effectively lowered the level of revenue required for the company to achieve profitability. I will at this time now hand it over to Ali so that he can share with you his thoughts on the third quarter and some of our opportunities going forward.

Ali Khatibzadeh

Thank you, Ted, and good afternoon, ladies and gentlemen. Before I discuss the current business I would like to highlight that we continue to make progress on our strategy to shift new product development focus to voice and video over IP market with stronger emphasis on consumer segment.

We are on plan to introduce new-generation products in 2011 which we expect to provide additional growth drivers as we move into the second half of 2011 and beyond. At the same time we are seeing improved traction with our latest Entropia and Atlanta processors for voice over IP market with new customer ramp expected to begin in Q1 2011.

On the operational front, as Ted mentioned, our gross margin improved in the quarter and we expect to see continued improvement in our overall gross margin as we move into the fourth quarter.

Additionally, the cost control measures that we put in place are having an impact on our financials. We increased our cash and cash equivalents for the third quarter in a row and as we ramp our new products [and revenue] in 2011 we expect to do even better from an operating standpoint. Bob will discuss the financials in more detail later.

Now let me switch gears to the businesses in the quarter to our current business. On the customer premises side, we've seen during the year increasing demand for our high-speed interface technology resulting in increased sales of our video IP course. While we're primarily licensing the technology today we are looking forward to introducing exciting new IP products in this area in 2011.

In terms of our overall CPE business, revenue came in just over $5.1 million in the quarter, down from roughly $5.3 million in the June quarter. As we move forward, we expect to see continued softness in this segment as we await the ramp up of our new customer products in the first half of 2011.

More specifically, we're seeing increasing interest in the Atlanta 1000 and Atlanta 2000 products that we introduced earlier this year for enterprise and consumer voice over IP applications. Just as a reminder, the Atlanta 1000 processor that we introduced in Q2 expands our addressable market beyond home gateway into voice over IP enabled Wi-Fi routers.

It delivers industry-leading performance in terms of data throughput at the lowest power consumption in the industry. In fact, it is one of the few processors on the market today that is capable of being powered over Ethernet, which is a key requirement for green compliance going forward.

Some of our customers in Asia are planning certification testing of solutions based on Atlanta processors. These tests should be completed before the end of this year in time for deployments to start in 2011.

In China, the customer that we announced in Q2, which is shipping a 4G access product, has moved into volume production with sales growing sequentially as we move into Q4. Now let me switch over to the infrastructure side of the business.

Revenue for the third quarter came in at roughly $7.8 million, down from $8.8 million in the June quarter. During the quarter we started to see softening of demand, which was fairly broad based as many of our telecomm OEM customers began to work through their excess inventory.

We expect this softness to continue into the next quarter materially affecting our fourth quarter revenue. Now, that said, we anticipate this business will return once the excess inventory in the channel has been consumed.

In Japan, OEMs continue to await NTP's decision regarding voice over IP deployment and their migration plans for legacy [PST] and network. The word is that we are expecting an impending announcement in Q4 regarding NTP's [voice] plan.

On the positive side, we anticipate production shipments for Entropia to commence in Q1 for voice deployments by other operators in Japan. We're also seeing ramp up in Entropia sales for voice over IP infrastructure build-outs in Brazil and other Latin-American countries.

Notwithstanding the current inventory situation, we believe the long-term growth prospects for broadband infrastructure equipment supporting video and voice over IP remains sound.

So, in summary, while there are some near-term, broad-based challenges in the telecomm sector, we are on track relative to our plans to reposition the company in new high-growth consumer markets as we move into 2011. On the operation side, we continue to work on improving the profitability of our businesses.

As we discussed, our gross margin improvement plans are ahead of schedule. We reported a three percentage point improvement in Q3 and anticipate further improvement in Q4. I believe the steps we have taken to sharpen our focus over the course of this year toward broadband, voice and video products with emphasis on consumer market will create value for our shareholders.

Now I'll hand it over to Bob to present our third quarter financials and provide our complete guidance for the fourth quarter. Bob?

Bob Bosi

Thanks, Ali, and good evening and good afternoon to everyone on the call. TranSwitch's Q3 revenue was $12.8 million compared to Q2 revenue of $14.1 million and our initial expectations of $13.5 million to $14.5 million.

The geographic breakdown of the third quarter revenue was as follows: Asia Pacific 63%; Americas 23%; and Europe 14%. The top countries for our third quarter revenues were China, Korea, Japan and the United States. In Q3 we had four customers which includes one distributor which had greater than 10% of our revenue.

On a positive note, gross margin in the third quarter of 56% was three points higher than our margin last quarter and our guidance that we provided of 53%. This increase is attributable to operating improvements and sales of higher margin, infrastructural products and higher margin IP sales.

On a non-GAAP basis, operating expenses were $6.6 million in Q3 compared to $6.6 million in Q2 and to $7.1 million guidance that we provided in the quarter. Q3 expenses were reduced by a reversal of a $400,000 accrual for a long outstanding sales tax issue.

We had asserted that we were exempt from this tax liability by claiming a manufacturing exception and this issue was recently adjudicated in our favor. Accordingly, excluding this unusual item our expenses were in line with our guidance.

Non-GAAP operating results in Q3 was income of approximately $0.6 million compared to our initial guidance of income of between $1 million and $600,000. For Q2 we had non-GAAP operating income of $0.9 million and we had income of $0.2 million for Q3 2009.

Other income and expense for the quarter was a loss of $0.9 million, which was primarily due to unrealized exchange rate losses which were recorded in the translation of our intercompany loan balances for our foreign subsidiaries, which offset the $0.8 million gain that we recognized for the same item in Q2.

Non-GAAP net income for Q3 was a loss of $0.8 million of $0.04 per share on a basic and diluted basis as compared to our non-GAAP net income of $0.5 million in Q2 and a $0.7 million loss in Q3 of 2009.

In Q3 2010, GAAP diluted net loss of $0.08 per share versus net income per share of $0.02 in Q2 and a loss of $0.08 in Q3 of 2009. The comparable GAAP measures were gross margin, operating expenses, operating income and net income are reconciled to our related non-GAAP amounts in the [reconcile] of GAAP to non-GAAP measures included in our press release today.

Reconciling items for Q3 are as follows: $0.4 million in the amortization of purchased intangibles and $0.6 million in stock-based compensation expense as described in the press release.

Turning to the balance sheet, we ended the quarter with $12.3 million of cash, cash equivalents and restricted cash and short-term investments as compared to $8.7 million at the end of the quarter and $5.1 million at the beginning of the year. Our accounts receivable at the end of Q3 was $7.8 million, down from $12.6 million, which we reported last quarter. This was due primarily to a more linear pattern of shipments in the quarter.

Inventory at the end of Q3 was $2.7 million, which was the same as we reported last quarter and substantially lower than the year end balance of $4.2 million. We made our scheduled convertible note payments of $1.2 million and our convertible note balance is now just $5 million and is scheduled to be paid within the next year.

I'll now provide information about our Q4 outlook. As Ali discussed, we have experienced a broad-based slowdown in demand of our telecomm products in Q3. In addition, as we mentioned in our earnings call last quarter, we expected some of our lower margin legacy products to be ramping down.

Considering levels of demand and our expectation of booking rates throughout the balance of the quarter, we estimate the potential revenue for TranSwitch in Q4 is between the range of $10 million to $11 million.

Our ship and shippable backlog as of today is approximately $8.1 million, which is approximately 81% of the low end of our guidance. On a positive note, we expect our overall gross margin percentage in Q4 to increase to around 60% due to the operational improvements and the mix change as I mentioned.

Non-GAAP operating expenses in Q4 are expected to be around $7.1 million, increased from our lowest quarter of non-GAAP operating expenses that we achieved in Q2 and Q3 of $6.6 million. This is primarily due to our increased R&D investments in our high speed interface product line.

At this level of operating expenses and increased gross margin, we expect our non-GAAP breakeven revenue to be about $11.8 million. In Q4 we expect non-GAAP operating loss to be between $1.1 million and $0.5 million.

In summary, while the slowdown in telecommunications equipment spending has adversely affected our top line in the short term, we have taken steps to bolster our balance sheet and improve our operations. We remain very excited about our new product initiatives that should position the company for growth in the second half of 2011.

With that said, we thank you for your support and we will now take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from the line of Kevin Cassidy - Stifel Nicolaus.

Kevin Cassidy - Stifel Nicolaus

On the gross margin and maybe understanding the legacy business, is that going away and always out the lower gross margin legacy business that's a discontinued product?

Ali Khatibzadeh

As we said, we did anticipate ramp down of a lower margin legacy product. The margin for that business was around, I would say, in the high 30s, close to 40%. We expect that to be replaced with newer product ramps in Q1 and most of that business will have higher gross margin.

In general, of course, the CPE products will not have as high a margin as our infrastructure products, some of our infrastructure products. So as they ramp we may see some pressure on the gross margin. But we believe we can hold around 60% as we go forward.

Kevin Cassidy - Stifel Nicolaus

That'll include the other telecomm business after the inventory gets worked down?

Ali Khatibzadeh

That's right.

Operator

(Operator Instructions). Your next question comes from the line of Richard Shannon - Northland Capital.

Richard Shannon - Northland Capital

I jumped on a little bit late and I just wanted to maybe clarify what I heard in terms of trends here fourth quarter and beyond. So do I understand correctly you expect this inventory issue to be mostly resolved in this quarter and then would expect first quarter to move up directionally based on that as well as ramp-ups of new products, I think you mentioned the Atlanta 1000 for instance? Did I catch that correctly?

Ali Khatibzadeh

Our visibility to Q1 at the moment is limited, so we obviously provide one quarter guidance at a time. We believe this slowdown in the telecomm sector is going to continue throughout Q4 to the extent that it may or may not continue to Q1. At this point, we're not able to comment on that. But we do expect ramp-up of new products starting in Q1 that should offset even if the slowdown continues into Q1.

At this point, we'll continue to monitor the inventory situation of our customers and we expect that this inventory -- historically, traditionally, these kind of inventory situations tend to correct themselves in the quarter but we'll have to see.

Richard Shannon - Northland Capital

Maybe a couple of numbers-oriented questions -- in Bob's outlook for the fourth quarter you talked about OpEx and I think you said non-GAAP in the $7.1 million range.

Bob Bosi

Correct.

Richard Shannon - Northland Capital

Obviously a little bit higher. You talked about some high R&D in your high speed interface business. Is this kind of a go-forward level here or is this some tape outs that is a one-time issue?

Bob Bosi

No, this is a concerted effort to invest [a grade three] in this area.

Ali Khatibzadeh

In terms of the run rate, we're expecting it to be around there plus or minus depending on in one quarter if we have additional tape outs it may go a little bit higher than that or a lower than that. So on an average basis we think that's a good estimate.

Operator

Your next question comes from the line of Melay Nata - Stifel Nicolaus.

Melay Nata - Stifel Nicolaus

I've just got a quick question. Your backlog coverage looks like it's about 80%, you said, of your sort of midpoint on next quarter's guidance.

Bob Bosi

81%.

Melay Nata - Stifel Nicolaus

81%. What's the normal? What's your typical backlog coverage?

Ted Chung

It varies. I mean, 70%, 80% is not atypical of what we've done in the past. We've got some pretty good sense of some expected turns in the quarter. So I think we're pretty comfortable with that level of backlog.

Melay Nata - Stifel Nicolaus

Then I think you mentioned obviously the weakness on the broadband side, as you said, broad-based. Are there any particular geographies you can point to that you're seeing that? Is that maybe coming from Asia?

Ali Khatibzadeh

The information we're getting is there may be some slowdown in CapEx spending in China and North America by the major operators and that's what's behind it. That's the information we have. We have not validated that.

Operator

(Operator Instructions). At this time, there are no further questions, sir.

Ali Khatibzadeh

Thank you, again. I want to thank everyone for participating in our earnings call and just to summarize again though we are seeing a short-term slowdown in our telecomm business due to inventories in the channel, we remain confident on our plans to reposition the company for growth in 2011 and we are on target with our new product development and we remain very optimistic and excited about the prospects of these products in 2011 and we'll communicated as we go forward as we achieve our milestones. As we introduce the new products we will make further announcements. Thank you.

Operator

That does conclude today's conference. Thank you for your participation today.

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