China TechFaith Wireless Communication Technology Q2 2007 Earnings Call Transcript

Aug.14.07 | About: China TechFaith (CNTF)
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China TechFaith Wireless Communication Technology Ltd. (NASDAQ:CNTF)

Q2 2007 Earnings Call

August 13, 2007 7:00 pm ET

Executives

David Pasquale - EVP, The Ruth Group

Defu Dong - Chairman & CEO

Gilbert Lee - President & COO

Christopher P. Holbert - CFO

Bob Huo - Deputy CEO

Analysts

Brian White - Jefferies & Co.

Adele Mao - Susquehanna International Group

Jason Tsai - Montgomery & Company

Presentation

Operator

Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions)

A replay will be available approximately one hour after the call today through midnight Eastern Daylight Time on August 20, 2007. The replay dial-in number is 888-286-8010 and 1-617-801-6888, with passcode 26444655. The replay will also be accessible at www.TechFaithwireless.com.

I would now like to turn the conference over to David Pasquale. Please go ahead.

David Pasquale

Thank you operator, and thank you everyone for joining China TechFaith second quarter 2007 earnings call. The company’s attorneys advise that this call will contain forward-looking statements. These statements are made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995.

These forward-looking statements can be identified by terminology such as "will," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates" and similar statements. Among other things, the business outlook and the quotations from management in this call, as well as TechFaith's strategic and operational plans, contain forward-looking statements.

TechFaith may also make written or oral forward-looking statements in its periodic reports to the U.S. Securities and Exchange Commission on Forms 20-F and 6-K, etcetera, in its annual report to shareholders, in press releases and other written materials and in oral statements made by its officers, directors or employees to third parties.

Statements that are not historical facts, including statements about TechFaith's beliefs and expectations, are forward-looking statements. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statements.

Potential risks and uncertainties include, but are not limited to, TechFaith's limited operating history, mobile handset brand owners' discontinuation or reduction of the use of independent design houses, TechFaith's ability to retain existing or attract additional international customers, TechFaith's earnings or margin declines, failure of competing against new and existing competitors, and other risks outlined in TechFaith's filings with the U.S. Securities and Exchange Commission, in its annual report on Form 20-F.

TechFaith does not undertake any obligation to update any forward-looking statement, except as required under applicable law. All information provided on today’s conference call is as of today’s date. China TechFaith again does not have any obligation to update any forward-looking statement, except as required under applicable law.

With us today for the call are Mr. Dong, Chairman and CEO; Mr. Bob Huo the Company’s Deputy CEO; and Dr. Gilbert Lee, President and COO, along with CFO, Christopher Holbert.

Please note that Chief Executive Officer, Mr. Defu Dong is on business travel, so the quality of the phone may fluctuate back and forth, if so, we’ll be able to take any follow-up questions afterwards if he gets cut-off.

Finally, if you’ve not received a copy of today’s results release, please call The Ruth Group at 646-536-7003 or you can get a copy of the release off of TechFaith's website.

I would like to now turn the call over to Mr. Bob Huo. Please go ahead, sir.

Bob Huo

Thank you David. I have met many of our investors over the years. For those I have not talked with, I have been with TechFaith from the start. I was a former President of TechFaith and then resumed CEO of TechFaith’s handset design unit in early 2006. I'm more and more involved in the ODM business with the development of the company. I understand the dynamic of the marketplace and understand TechFaith’s strength and challenges.

In my role as Deputy CEO, I will be able to take on much of the operating issues that have consumed Mr. Dong and Gilbert's time. I am excited about our prospect and long-term plan.

With that introduction, I will turn the call over to Gilbert. I will provide product updates after Gilbert’s comment. Gilbert, please go ahead.

Gilbert Lee

Thank you, Bob. Good morning and good evening all the investors. We are encouraged by our progress in the second quarter. We think the transition period is behind us and we expect to see significant gains in the coming quarters. We have a full solution now to our customers through our differentiated ODM model. Our design strength continues to set us apart from our competitors, and we are delivering on more contract than anytime in our history.

Revenue growth in Q2, net total of $32 million compared with $21.8 million in the same period of last year. The business mix has changed significantly, and we expect that it will continue to change. When TechFaith was started five years ago, it was all about handset design and thus the market has evolved, customers now want more of a full service.

Our choice was single, either to ignore the market reality and continue to pursue just design business or change our business model. We decided a year ago to change our business model and continue to pursue revenue growth and profitability. This has not been easy, since we had been in constant change. We understand for our investors, it has also been frustrating. We certainly understand your frustration.

As Bob mentioned at the start though, the transition is over. Bob is a plus to the management team. His previous experience in handset design unit, gave him a deep understanding of the worldwide technology development. His expertise in hardware design and a rich experience at Foxconn and Motorola is very helpful to the company's transition. From a pure independent design house to a new modeled ODM.

If you look at where we are now, we think the company can start performing again and move to the levels it was at before, and hit the growth target, which we know internally, the company is capable of doing. As part of our efforts, we have gone through the business top down and back up again. We’ve now downsized in the quarter. This workforce reduction combined with the several hundred employees we transferred to our joint venture with our manufacturing partner.

We will reduce our operating expenses by $3 million per quarter. This is a big number and a necessary action we need to take to regain profitability. We have around 1,300 employees now; 90% are engineers; 65% of the engineers are focused on R&D; 25% are project material and manufacturers support; the other 10% are marketing, sales and administration staff. We will maintain the staff level in 2007.

We have transformed to an ODM now. However, we are different from most of the traditional ODMs, whose competitiveness are hardware design and manufacturing efficiency. We are an ODM focusing on one-stop handset solutions. We are very serious about this transition, and we are fully aware that without strong R&D capability and a sustainable profitability, we will become just another ordinary ODM player.

Bob will give you a run down of our customer activity in a minute. In general, we are more active now than we have been at anytime in our history. As we enter Q3, we are confident in our outlook. We expect continued progress in our business and the momentum in our results.

As Mr. Dong mentioned in the earnings release, we are confident that the transition period is behind us. In the third quarter, we will strive to achieve breakeven and a sequential revenue growth of at least 10% over the second quarter.

Now let me turn the call back over to our Deputy CEO, Mr. Bob Huo. Bob, please go ahead.

Bob Huo

Thank you, Gilbert. After future updates, we can take your questions. First point; feature phone started to ramp up in the second quarter, during the second quarter of 2007, our feature phones were delivered to customers as planned. New orders have been received from distributors and operators worldwide.

In Q2, feature phones shipments are around 48,500 units with ASP around US$109. In Q3, shipments are expected to be around 100,000 units with ASP around $100. At this time, our feature phone customers are mainly in emerging markets, such as Southeast Asia, Africa, Latin America. We also have customers in some European countries. According to the orders accretion, market response is active. By Q2, we have launched 2.5G and the dual mode feature phone. 3G and 3.5G phones will be launched in the second half in 2007. We expect continued growth for feature phone business.

In terms of models, we launched six models in the first half of 2007. We expect to launch another 15 new models in the second half. They are first GSM/WCDMA phone to HSDPA phone, for CDMA1X/EVDO phone. In Q3, two new models of music phone, with high-end MP3 player sound quality are expected to be delivered and two models of our ultra-low cost 3G WCDMA phones will be launched.

The second point; sales of smartphone will continue to grow in the coming quarters. Total smartphone shipments in Q2 were around 30,000 units. The low volume is mainly because most of our customers were waiting for the smartphone shipped with Windows Mobile version six. Average ASP were around US$210. Due to the low season in European market, shipments expectation in Q3 is about 60,000 units, with ASP around US$200.

We launched three smartphone models in Q2. One is the CDMA for our Chinese mobile operator; the other two are HSDPA for overseas markets. We now have about 30 customers, 60% are international and 40% are domestic.

In the second half of this year, we plan to launch seven new models. They are; one GSM/GSM; two SIM card smartphone; one GSM with GPRS smartphone; one HSDPA smartphone; one HSDPA with GPRS; one super thin music smartphone; one CDMA smartphone; one GSM/CDMA dual-mode; dual-SIM card smartphone.

The third point; for our data card and our wireless module business, we achieved a high growth in Q2 and we expect this growth will continue. A contract of 100,000 units is filtering emerging market country has been signed, for which we start partial shipments in Q2. HSDPA, TD-SCDMA and the EVDO cards are also scheduled to be launched in Q3.

The fourth point; we remain positive on the developments in TD-SCDMA. Apart from already signed contracts with Tier-1 customers, another two TD-SCDMA contracts were signed with two local customers in Q2. The fourth contract with a local customer will be signed in Q3. We expect that the TD-SCDMA project will start generating revenue in Q3.

We will serve our TD-SCDMA customers either in the form of design plus royalty or we provide finished products. We believe the transition is behind us and we are on the right track. We are confident of our Q3 results and are confident of our company’s future developments.

Operator, that concludes our formal comments. We are now ready to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Brian White with Jefferies. Please proceed.

Brian White – Jefferies & Co.

Yes, good morning. I’m wondering if you could talk a little bit about smartphone units and feature phone units, what you’re expecting for 2007. I think you previously had targets of 250,000 for smartphones, 400,000 for feature phones.

Gilbert Lee

Yes, Brian. This is Gilbert. As Bob just mentioned, we have a series of smartphones roll out in all are high-tier, high-end and seven models, all are different technology. And currently, we saw a very strong demand in second half of ’07. So, at this time, we still say, for smartphone, we are targeting 250,000 for complete year.

And for the feature phone, the growth is even faster. So, the complete year, according to the current plan, is 400,000 units, and we are still waiting for more orders. But at this time, we put a little bit conservative number; total year is 400,000.

Brian White – Jefferies & Co.

Okay. And Gilbert, maybe if you could talk a little bit about SG&A in the quarter, I know you had some restructuring in there. But it seems like you did some restructuring in the quarter, which should help out, maybe R&D, SG&A. But it came in a lot higher than, I think, I was modeling in others. Could you talk a little bit about SG&A and maybe, inventories? What’s going on with inventories?

Gilbert Lee

Okay. SG&A in second quarter, I think, we still maintain this number and we layout people at end of April and mid-May. So, the cost will not drop down immediately, plus we have -- there was a compensation package so, that’s why you see in the second quarter SG&A will be -- are still high, its around $14 million now. But in the third quarter to the rebating probably we will reduce by $3 million in the OpEx line. So we are targeting in third quarter, the expense is maintained about $11 million. And that’s why we are so confident we will be breakeven in Q3.

Brian White – Jefferies & Co.

Okay. And maybe talk about just inventory, Gilbert, big uptake sequentially, what was driving that?

Gilbert Lee

The inventory, we migrate to ODM models. And the business model change, we are now which is a design house not only for simple mobile. So the inventory will be proportional to our volume. But in a mean time we have several model in a smartphone. We have a fixed -- we overbook a component and we did take a little bit of price adjustment, and we think this inventory will go -- going down or maintain this level for next two quarters.

Brian White – Jefferies & Co.

Okay. Thank you.

Operator

Your next question comes from the line of Adele Mao with Susquehanna International Group. Please proceed.

Adele Mao - Susquehanna International Group

Good morning. I got cut off of in middle of the call, so I apologize in advance for my asking questions that you already covered. My first question is, based on your conversation last quarter is that, your 2Q ‘07 smartphone unit expectation was around a 100,000 units with a $100 ASP, and for the whole year its 400K. Am I mistaken, because you've mentioned earlier that your unit shipment’s is 48.5,000 for the quarter? Did I go below your expectation?

Christopher Holbert

Yeah. The second quarter has come out of 48.7, but even going to the third quarter, we see that number going more than double. And with even stronger demand -- we are in Q3 now. So we know this number, its more than double. And Q4, the demand search even stronger, that’s why we still maintain 400,000 units for complete year.

Adele Mao - Susquehanna International Group

Okay. So the guidance you gave out on feature phone and smartphone. How much of it is already in the bag, as of mid of August now?

Christopher Holbert

Okay. For Q3 it's about 100%, that’s delivery, order is 100%. For Q4, it's about to 50%, orders on hand.

Adele Mao - Susquehanna International Group

Okay. Q4, it's about 50%. In terms of gross margin, could you comment on gross margin for different segments?

Christopher Holbert

The gross margin, we still maintain prehistoric number. Like smartphone, which built rate its about 25% was smartphone. And therefore, data card and the wireless module is 15%, and the handset design is 50%. Okay. And I think, we still have a great confidence on that number. And in Q2, overall number is still in line.

Adele Mao - Susquehanna International Group

Okay. Do you see any room for margin expansion in the next couple of quarters?

Christopher Holbert

I think it would be fine, it will maintain at 50%. And for smartphone and feature phone, because our uniqueness and our higher influence, it’s possible we can expand the margin a little bit.

Adele Mao - Susquehanna International Group

Okay. Great. We heard that CNTF’s JV with BYD recently, won a TD-SCDMA order from Nokia. Could you confirm that?

Christopher Holbert

We cannot disclose the specific contact with our customer.

Gilbert Lee

Yeah. We just kind of see -- we just win a Tier-1 customer from our joint venture.

Christopher Holbert

Right.

Bob Huo

Yeah. We cannot say the customer name.

Adele Mao - Susquehanna International Group

Okay. Then could you say is this order for -- is for the trial testing for 2007, or it actually goes beyond that?

Christopher Holbert

It’s -- okay, lesser MP is contract -- our JV has a secured contract with a Tier-1 customer, the second Tier-1 customer, and it’s a full commercial product.

Adele Mao - Susquehanna International Group

Okay. Great. Thanks, very much.

Operator

(Operator Instructions) Your next question comes from the line of Jason Tsai with Montgomery & Company. Please proceed.

Jason Tsai - Montgomery & Company

Hi, guys. A couple of questions, here. The guidance you're giving for the 10% growth, what are you expecting out of the design business? Are you expecting that to grow in the third quarter or you’re expecting that to decline once again?

Bob Huo

Okay. I’ll give you -- Jason, good evening. I’ll give you a couple of numbers. The bottom line is, it will be flat. We’ve finished nine projects in the first half of this year, and we have the ten projects on hand now. The design revenue will maintain -- the dollar value will maintain this level. We expect, for full year, the design revenue will be 15% to 18% of our total revenue.

Jason Tsai - Montgomery & Company

Okay. For 2007?

Bob Huo

Yes.

Jason Tsai - Montgomery & Company

Okay. Great. And then, last quarter you had a issue with some returns on the smartphones. Is that behind you guys, now? Did you have to take that product back? Is there any other issues with that customer? And can you elaborate a little bit more about that?

Bob Huo

Yeah. We have to get those units back and we secure our order and then sell those things. So, the inventory issue is out. I want to add a little bit. We have a material issue for that customer, but we already taken reevaluation, and everything has picked it up.

Jason Tsai - Montgomery & Company

So, there a customer still and there’s no lingering issues there?

Bob Huo

No lingering issues there.

Jason Tsai - Montgomery & Company

Okay. Great. And then, your number for 250,000 smartphones, is that include any 3G products yet or are you still not really looking for 3G products in 2007?

Bob Huo

We do. We say we have seven models in the second half. So inside there, we have the 2G, 3.5G model with a one is smartphone for HSDPA and one is HSDPA with GPS. So we do have a two smartphone in three 3.5G area.

Jason Tsai - Montgomery & Company

Okay. And that’s probably going to be what, fourth quarter before launches?

Bob Huo

In Q4.

Jason Tsai - Montgomery & Company

Q4. Okay. All right. Great. Thank you very much.

Bob Huo

Yeah.

Operator

There are no further questions at this time. I will now like to turn the call back over to Mr. Gilbert Lee.

Gilbert Lee

Okay. Thank you for all joining us today. And thank you for your long-term support to TechFaith. We will deliver the result in the coming quarter to reward investors and I hope all the investor you will stay with us and with this the strong compact in the coming quarters. Thank you again. Good night and very good day for the friends in the Asia.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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