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UTStarcom Holdings Corp (NASDAQ:UTSI)

Q1 2012 Earnings Call

May 16, 2012 8:00 am ET

Executives

Jing Ou Yang – Investor Relations Director

Ying (Jack) Lu – Chief Executive Officer and President

Jin Jiang – Chief Financial Officer

Analysts

Lily Wu – TGRA Capital Management LLC

Louis Lubrano – BMI Capital LLC

Himanshu Harshad Shah – Shah Capital Management, Inc.

Operator

Thank you for standing by for UTStarcom’s first quarter 2012 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. Jing Ou Yang, Investor Relations Director for UTStarcom. You may begin.

Jing Ou Yang

Hello everyone and welcome to UTStarcom’s first quarter 2012 earnings conference call. We distributed our earnings press release earlier today and you can find a copy on Newswire Services or 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. Jack Lu, our President and CEO; and Ms. Jin Jiang, our CFO.

Before we get started, I will read the company’s advisory on forward-looking statements. This call will include forward-looking statements on topics that include, but may not be limited to the company’s, IPTV revenues progressed in the video service cloud platform, profit margins and business model.

Forward-looking statements are generally indicated by such words as will, expects, estimate, goals, plans or similar words. These statements are forward-looking in nature and subject to risk and uncertainties that may cause actual result to differ materially.

This include risk and uncertainties regarding the ability of the company to realize anticipated result of operational improvements, and the company’s ability to successfully launch its Internet TV platform, continue to integrate recent acquisition, successfully operate its new Service business, execute on its business plan and manage regulatory matters, as well as risk factors identified in the company’s latest Annual Report on Form 20-F, previous annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and 6-K as filed with the Security and Exchange Commission. The company assumes no obligation to update any forward-looking statements.

I will now turn the call over to our President and CEO, Mr. Jack Lu.

Ying (Jack) Lu

Thank you, Jing, and hello to everyone on the call. As Jing 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.

As you may recall, deferred revenue amortization related to PHS was included in 2011 results at a rate of approximately $23.8 million per quarter. Specifically, for the first quarter 2011, PHS deferred revenue was $23.6 million, PHS deferred revenue amortization ended in the fourth quarter 2011 and starting in the first quarter 2012, were no longer impact our results.

In order to provide a true apple-to-apple comparison, throughout this call first quarter 2012 revenues, gross profits, and the gross-margin, year-over-year comparison will exclude PHS deferred revenue amortization, recorded in our first quarter 2011.

Let us start with the Slide 4 and I’ll talk briefly our first quarter highlights. For the first quarter 2012, total revenues increased 23.8% year over year to $46.7 million, compared to sales of $37.7 million if we exclude $23.6 million amortization of PHS deferred revenue in the first quarter 2011.

Gross profit increased 69.6% year-over-year to $18.4 million compared to $10.9 million if we exclude gross profit related to amortization of PHS deferred revenue in our first quarter 2011. Gross profit as a percentage of net sales or gross margin, was 39.5% compared to 31.1% in our first quarter of 2011. First quarter 2011 gross-margin excluding PHS deferred revenue amortization was 28.8%.

Operating expenses decreased 26.5%, year-over-year to $22.2 million, compared to operating expenses of $30.2 million for the corresponding period of 2011.

Let’s move to Slide 5, and take a look at our equipment business in China. On our last earnings call, we mentioned that the government has identified 42 new trial cities for the second phase of China’s three network convergence. Also we announced that we had won the tender to build an IPTV broadcasting controlling platform in Chongqing City. Chongqing was the first of the 42 new trial cities to award an IPTV contract to a solution provider.

In addition to Chongqing, we have recently won another IPTV tender with Hainan TV station. The new platform will support the content management and the distribution needs of IPTV, Internet TV and the Mobile TV. The platform will cover entire province of Hainan and provide approximately 100,000 household subscribers with digital high definition and bidirectional IPTV.

Out of the 42 new trial cities, 20 are provincial level and will require a solution provider to build an integrated IPTV broadcasting platform. We are targeting to win approximately 15 of these contracts. I am very pleased to share with you that, we have recently won our first IPTV broadcasting control platform expansion contract from Beijing TV Station.

This is a sizable contract with solid gross margin. It demonstrates that some of the trial cities have started to accelerate the capacity expansion progress. That initial IBCP contracts will pay the tax for additional business opportunities from a national rollout of the three networks convergence expected to take place from 2013 to 2015. Our expectation is that most of the IBCP platforms will result in future expansion contracts.

Turning to slide 6, I’d like to share some information with everyone on the continuing investments from China's cable industry in the year 2012. As you can see from the chart, at the end of 2011, they were $202 million basic TV subscribers, but only 6.5 million cable subscribers using interactive services. We anticipate the number of subscribers using interactive TV to increase 20% this year, which will lead to increase demand of our iDTV and IPTV solutions.

We are witnessing a trend of cable operators increasing their investments in order to improve network infrastructure and the service offering. Investments by cable operators is increasing demand for our broadband products especially our EPON EOC product, which enable cable to provide by directional and high-quality video, voice, and data services through end users.

Starting from slide 7, we will be focusing our newly introduced Video Service Cloud platform or VSC platform to provide some updates on this growth initiative. The VSC platform will play an important part in building out of our service business, or more specifically, our Media Operational Support Services, which will be a priority for us in 2012. We officially launched the platform at the China Broadcasting Network expansion in late March. The VSC platform leverages UTStarcom’s RollingStream technology, optical network infrastructure, and the advanced technology of video exchange cloud to support exchange and distribute video and audio content through telecom, cable, and Internet networks.

The infrastructure has advantage of aggregating audio and video content, which enables media operators to rapidly launch their IP video services and offer customers a high quality and highly interactive experience through multiple video devices, such as TVs, PCs, Tablets, and the mobile phones.

The main services includes the Video Distribution Network or VDN services, cloud-based B2B application services and video content exchange services. The VDN is focusing on digitalization, distribution, storage, and acceleration of audio and the video content with significant broadband cost savings.

The Cloud-based B2B video services have a wide range of value added services such as video conferencing, online education, online office and Cloud-based storage and computing for video content for enterprise customers.

Moving to slide eight. Initially, our focus will be on the VDN and certain B2B Cloud-based services such as Video Conferencing Service to generate a steady stream of revenue. We have already established internet nodes in five major cities in China, Beijing, Shanghai, Maoming, Lanzhou and Hong Kong. Also our video system has been deployed and is ready for commercial use. At this time, we have four trial internet TV customers using our video distribution network and expect a number of them to become commercial revenue generating clients in the second quarter of 2012.

Regarding our B2B Cloud-based services, our video conferencing system is online and we currently have five trial customers that we expect some of them to become commercial revenue generating clients in the second quarter of 2012. Besides providing secure high-quality video services, our Video Conferencing Service can be packaged as a comprehensive enterprise’s management solution while combined with wireless applications such as our Online Office service and Wi-Fi Enterprises application.

It enables order and participants to download, share, revise, and the safe working documents from multiple terminals while active in the conference call. For the second quarter 2012, we expect solid progress from the VSC business.

On slide 9, we highlighted some of our operational targets for our VSC business in the coming quarters. First, as we just mentioned, we expect some of the VDN and video conferencing trial customers to become commercial client and start to bring in the VSC related revenues.

For the VDN services our target of commercial customers are Internet iTV operators and the provincial and the CT level cable operators. For video conferencing services, we expect our commercial contact to come from real asset enterprises, education enterprises, as well as provincial and CT level cable operators.

For all commercial contracts, we will charge monthly subscription or service fees with a potential for more added-value revenue. Additionally, we expect to finalize our JV agreements with a key strategic partner, which will enable us to take advantage of these national-wide cable backbone infrastructure.

This will permit us to provide our IP video conference exchange and distribution services at a very competitive price. Whilst this business contract has been finalized, we will be able to provide investors with more details. On a system roll off side, we expect to add approximately 10 more VDN nodes to bring our national-wide node counts to around 15 and which will enhance our core network infrastructure.

Moving now to Slide 10. We summarize the key competitive advantage of our VSC platform, which will positioning us favorably to accelerate the growth of our media operational support service business. First of all, this platform will be built on our strategical partners’ nationwide broadband backbone infrastructure. It will allow us to provide leading services to any users at a very competitive price.

Secondly, this platform will leverage UTStarcom’s RollingStream Technology, optical network infrastructure and the advanced technology of video exchange Cloud to save on CapEx cost to build out the entire network.

Last but not least. We will continue to take advantage of the deep relationship we have built with the TV, Media and the Cable industries in China in the past few years. We expect operators in this industry to become future targeted customers of our video distribution network and the video content exchange services.

Our existing client will benefit from the developments of our VSC business as the Internet TV and the cable TV operators look to improve the quality of their services.

Lastly, before I hand the call over to our CFO, Jin Jiang, I want to highlight some of the initiatives. The management team has both completed and are going to strength UTStarcom’s commitment to high standard of corporate governance. We successfully completed the 404 Internal Control audit and the successfully removed all material weaknesses that we’re including in our 2010 annual reports.

In 2010, we had a material weakness related to the period and the financial reporting process, since that time, we have implemented split processes to improve our reporting process including hiring key individuals in corporate finance and accounting. We’ve increased the knowledge of U.S. GAAP and SEC requirements.

With our restructuring efforts to move the headquarters to China, we consolidated and streamlined our global processes, while maintaining an appropriated level of control points. The other material weakness that we were able to remedy was related to our treasury process. To remediate this issue, we designed and implemented controls to separate closely related functions and cash management and that reduced the risk of this a proper of assets, but also institutive streak through approval requirements for certain actions related to cash management and conducting theoretical reviews to ensure effectiveness.

The remediation of the material weakness is the reflection of the current management's commitment to maintain high standard of corporate governance. Upholding such a high standard of corporate governance would continue to be a priority of the company.

Now I’ll hand the call over to our CFO, Jin Jiang to review our financial performance in the first quarter 2012.

Jin Jiang

Thank you, Jack and hello everyone. Please turn to slide 12 and I will discuss our first quarter 2012 financial results in more detail. I would like to remind everyone again that there was $23.6 million of PHS related amortization of deferred revenue with 34.8% gross margin included in the first quarter, 2011 GAAP financial results. In our comparison analysis below, we will exclude amortization of PHS deferred revenue from first quarter 2011.

In the first quarter 2012, we recorded $46.7 million in revenues, this was a 23.8% increase compared to the corresponding period of 2011, if we exclude amortization of PHS deferred revenue. The increase was primarily the result of increased sale of our MSTP products in Taiwan and MSAN products in Japan. Our quarter one book-to-bill ratio was 0.81.

On slide 13, you can see the gross profit margin was 39.5% for the first quarter, 2012 compared to 28.8% in the first quarter of 2011 if we exclude $23.6 million of PHS deferred revenue amortization, with a 34.8% gross margin in the first quarter 2011. The improvement in gross profit margin was driven by increased sales of higher gross margin MSTP and MSAN products in the first quarter 2012. Gross margin for the equipment sales in China, also improved in the first quarter 2012 compared to the corresponding period of 2011 as a result of our efforts to focus on gross margin, rather than pure revenue growth.

In the first quarter 2012, we also have reversals of third party commission reserve and purchase order liability accrual and sale of previously reserved inventory totaling $1.3 million these items positively impacted our gross margin in the first quarter 2012. For the full year 2012, we anticipate our overall gross margin to remain in the mid 30% range.

Moving to slide 14, Q1 2012 OpEx was $22.2 million, a decrease of 26.5% year-over-year from $30.2 million in the corresponding period in 2011. The year-over-year decrease was mainly the result of our restructuring and cost cutting efforts.

Moving to slide 15, operating loss for the quarter was $3.8 million, while net loss attributable to UTStarcom was $4.2 million compared to operating loss of $19.3 million and net loss attributable to UTStarcom of $18.5 million for the first quarter 2011 if we exclude PHS-related amortization of deferred revenue.

On slide 16, let’s take a look at our segmented financial results. As a reminder, the two main reporting segments are Equipment Sales and Service Sales. The Equipment Sales segment tracks our Equipment Sales, including network infrastructure and application products. The Service Sales segment is split between services and support we provide to customers related to the equipment they purchase. And secondly, our New Service business, which include long-term revenue sharing arrangements with the cable and telecom operators, iTV.cn related sales and media operational support services from our video service cloud platform.

In the first quarter of 2012, the Equipment Sales segment generated $38.7 million in revenue compared to $29.2 million in the corresponding period of 2011 if we exclude PHS-related amortization of deferred revenue. The increase was primarily driven by increased sales of MSTP and MSAN products in Taiwan and Japan.

Our Equipment based service sales segment generated $7.8 million in first quarter 2012, this compares to $8.3 million in Q1 of 2011. The decrease was primarily due to fewer NGN service contracts in China this year, slightly offset by increased service revenue in our international business.

Total New Service revenue for the first quarter 2012 was approximately $0.2 million. This is a result of an IP signage revenue sharing project and technology service revenue generated by our iTV.cn subsidiary.

As Jack mentioned earlier, we are expecting to generate new media operational support service revenue contract from both video distribution and video conference services in the second quarter of 2012.

Now let us turn to Slide 17 for the balance sheet, and overview of our cash by region and currency of cash deposits. We ended the quarter with a balance of $285.4 million in cash, cash equivalents and short-term investments with zero debt. The two pie charts on this slide provide details on our cash deposits. As you can see 41% of our total cash is held within China, 48% of our total cash is deposited in R&D, 32% is deposited in U.S. dollars and 16% in Japanese yen.

Finally on Slide 18, we like to talk about our cash flow. We experience normal seasonal delays in the first quarter related to the Chinese New Year, which traditionally causes weaker collection in Q1, compared to other quarters in the year.

Operational cash flow was negative $14.7 million compared to a negative operational cash flow of $39.4 million in the same period last year. We will continue to focus on improving operational processes to drive us toward operational cash flow breakeven in 2012.

We announced a $20 million corporate share repurchase program in August 2011 and started this program in September of last year. As of today, we have repurchased approximately $7.2 million worth of the company’s shares. At the same time, our management team has collectively and with their personal fund, fully executed the $0.5 million management share repurchase program that was also announced in August 2011. We will more aggressively execute the remaining corporate share buyback plan in the second quarter of 2012.

This concludes our first quarter 2012 financial review section. Now we will like to take any questions you may have. Operator please open the line for Q&A.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen we will be conducting a question-and-answer session. (Operator Instructions). One moment please while we poll for questions. The first question comes from Lilly Wu of TGRA Capital. Please go ahead.

Lily Wu – TGRA Capital Management LLC

Yes hi. Thanks for taking my call. I was wondering the equipment sales $38.7 million, what proportion of that was related to the cable business versus telecom?

Jin Jiang

Hi Lily, thank you for your question. Now if we look at the equipment sales about approximately 20% of that is generated from our network application products. So the cable and telecom segments will fall into the IPTV segment. So if we look at the revenue contribution from the cable market, it is more, can be more easily seen from the bookings side, because at the end of the year we saw cable markets to have to consists about 40% of our total bookings. So I think in the next few quarters we will see increases in the cable operator’s contribution to our revenue.

Lily Wu – TGRA Capital Management LLC

Okay.

Ying (Jack) Lu

This is Jack, also commentary to Jin’s answer. So most ever since the last year was geographically increased the booking from the cable market in China that due to engineering and the contact in limitation cycle most of the were start to turn into revenue from this year.

Lily Wu – TGRA Capital Management LLC

Okay, from subsequent quarters.

Ying (Jack) Lu

Yes, yes.

Lily Wu – TGRA Capital Management LLC

Okay. And so just to be clear in first quarter itself, the revenue contribution from cable related. Could you repeat that, I didn’t quite get it in the first quarter itself.

Jin Jiang

Combining both telecom and cable, they’ve contributed around, they consist about 20%.

Lily Wu – TGRA Capital Management LLC

I see. Okay, okay. And there was a reference on the call that the book-to-bill ratio in the first quarter were 0.81 was that the ratio entering the quarter or exiting the quarter.

Jin Jiang

This is exiting the quarter.

Lily Wu – TGRA Capital Management LLC

Okay, and that just on the Equipment Sales side.

Jin Jiang

Correct. It’s all my traditional Equipment Sales.

Lily Wu – TGRA Capital Management LLC

Okay.

Jin Jiang

Because our new, yeah, our New Service Business, it’s the booking and the revenue will be recognized in the same quarter.

Lily Wu – TGRA Capital Management LLC

Okay. All right, and on the operating cash flow, could you go over again, looking at the press release, other liabilities was a negative $9 million, what exactly was that?

Jin Jiang

Our other liabilities normally consist of other growth that we have on our books which our liabilities to our vendors or they are for example, salary payables or bonus payables that have been accrued on our books. So our other liabilities lines consistent of changes in those balances in Q1 which we have paid down those liabilities.

Lily Wu – TGRA Capital Management LLC

Okay. And so you’re still giving guidance of cash flow breakeven for the year, you think that’s realistic.

Jin Jiang

We are. Our outlook is that we will be operational cash flow breakeven in 2012.

Lily Wu – TGRA Capital Management LLC

Okay. All right, thank you very much.

Jin Jiang

Thank you so much Lilly.

Operator

(Operator Instructions). The next question comes from Louis Lubrano of BMI Capital. Please go ahead.

Louis Lubrano – BMI Capital LLC

Thank you for taking my call. Congratulations on a very encouraging quarter. In your news release statement you talk about for 2012. You anticipate a healthy revenue growth rate, stable gross margin and improvement in operational cash flow. My question is how do we translate that into net profits? What is the gap between all those good things and a good healthy net profit? Thank you.

Jin Jiang

Thank you so much for your question, and thank you for your words of encouragement. So as we take a look at what we have mentioned in terms of our revenue growth, we are expecting a healthy revenue growth and we’ve also mentioned that, we expect our total operating expenses to be less than 2011 annual operating expenses. And we also are expecting our margins to be in the mid 30s, so given those metrics, if you model it out in the financial model, even though, we’re not giving exact financial guidance. But if you use those outlook and if you model it out, we are looking at overall P&L break-even.

Louis Lubrano – BMI Capital LLC

That’s very good. Thank you very much.

Ying (Jack) Lu

Thank you.

Louis Lubrano – BMI Capital LLC

We shy to say it.

Ying (Jack) Lu

Say it again, please?

Jin Jiang

Sorry, could you please repeat that?

Louis Lubrano – BMI Capital LLC

You shouldn’t be shy to say that in your new release. Thank you very much.

Ying (Jack) Lu

This year, so we just want to emphasize our strategic initiatives to develop service, especially media, operational supporting service business such as our VSC business. So all the surprise will be lead our company to totally new directional while maintain sales growth of traditional business. So this is the way we want to exercise more to our matters how we pay more attention to the new directions.

Louis Lubrano – BMI Capital LLC

Thank you, sir.

Ying (Jack) Lu

Thank you.

Operator

The next question comes from Himanshu Shah of Shah Capital. Please go ahead.

Himanshu Harshad Shah – Shah Capital Management, Inc.

Hello, everyone, two questions. Jack, can you talk about the legal funding that has been done and also the strategies that you’re pursuing to monetize your carry forward type losses, which I assume is around a $1 billion, but you can also give me the exact amount, as of March 31? And the second question is on iTV.cn, what is existing sub both in the U.S. and also in the other markets in Asia that you are pursuing? Thank you.

Ying (Jack) Lu

Okay. So, could you please clarify a little bit about your first question?

Himanshu Harshad Shah – Shah Capital Management, Inc.

I just wanted to find out because you have a lot of carry forward losses and so what have you done in terms of separating subsidiaries and what not? And what kind of thought process that you have to monetize those carry forward losses, which could be quite material to shareholders?

Jin Jiang

So, thank you for your question. So this is Jin. If we’re looking at our total loss carry forward, we do have a significant amount on our book. However, once we start to utilize these losses, we will have to do a detail 382 study to analyze to make sure that these losses will not be limited in the utilization. So, the company is currently in the process of performing such of a 382 study to analyze our losses.

Himanshu Harshad Shah – Shah Capital Management, Inc.

And what is the exact amount of losses that you’ve had as of March 31?

Jin Jiang

Sorry, Himanshu I don’t have the exact amount for the end of the year and I will need time to, may be I can get back to you as to what we have as the balance at the end of 12/31, so I don’t have the balance as of 3/31.

Himanshu Harshad Shah – Shah Capital Management, Inc.

Okay. What is your balance at the end of December 31st, say?

Jin Jiang

If you give me a few minutes, let me look that up for you.

Himanshu Harshad Shah – Shah Capital Management, Inc.

Sure, as you can get back to me on that, that’s fine. What about iTV.cn, Jack on both the existing subscribers in U.S. and also some of the markets that you have talked about in the past that you’re pursuing in Asia?

Ying (Jack) Lu

Okay. So our iTV.cn subsidiary is focused on providing China-related TV contents to overseas of Chinese through Internet TV or iDTV solution. We launched our service in October last year in the U.S and the later on, we start working on the joint effort to provide a similar services, plus TV program from U.S. and other countries in Thailand. Now, currently our strategies, given the limited resources and we are also extremely high subscriber acquisition cost in the U.S. So iTV.cn focus more on the strategy and the resources on Asian Pacific market now.

So in the U.S. market, we’re still running at a low profile backing approach, while we just focus on Asia Pacific market. So currently up to now the number of subscribers in U.S. own a lot, iTV.cn service is not very significant. So according to our current plan, we are about to have commercial launch in Asia Pacific, in Asia Pacific country very soon.

Himanshu Harshad Shah – Shah Capital Management, Inc.

Thank you.

Operator

(Operator Instructions). Thank you. There are no further questions at this time. I will turn the conference back to management for closing comments.

Jin Jiang

Thank you for joining us on our first quarter 2012 earnings conference call. We look forward to updating you on our second quarter results in a few months time. Feel free to get in touch with us anytime if you have further questions, concerns or comments. Thank you everyone.

Operator

Thank you. The conference has concluded. You may disconnect your line. Thank you once again.

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