UTStarcom's (UTSI) representatives invited me to do an interview with its CEO, Jack Lu, and CFO, Jin Jiang, because they liked my other Chinese articles. They especially liked my article on its auditor, PWC Zhong Tian.
UTStarcom is a wireless communications company based in China and has a wide array of products and services.
The Company didn't pay me anything to do the interview and I wrote the questions. The Company transcribed the interview, and I edited it.
The interview oscillates between discussions on the Company's Products, Accounting Controls, and Financials. I put in bold letters which section of the interview it is.
Since I'm a finance guy, I questioned Jack and Jin pretty extensively about the Company's finances and accounting controls. We talk about the products quite a bit in the Finance sections when discussing where the revenues and expenses come from.
In the Accounting Controls section, the Company has its auditor do quarterly reports (and pays extra for it), even though it's only required to have its annual reports audited. I was impressed by this as most companies, in the US or China, don't do this. As you'll see in the Accounting Controls section, UTStarcom is extremely thorough with its accounting.
The people in the interview are:
Jack Lu - CEO of UTStarcom
Jin Jiang - CFO of UTStarcom
Adam: Which of your products do you feel are growing the fastest? And what products are you looking to push the most? And where do you see the whole overall industry moving?
Jack: Recently we focus on some of the cutting edge technology and the solutions for both our broadband and multimedia solutions. In both broadband sides we developed our PTN technology. That is the Packet Transmission Network solution, which is the most advanced new technology to serve the demand from telco operators' problems for the convergence network. Before that we only had voice network and later on we had broadband access for the Internet and so on, and later on we had mobile, so different transmission and access networks with different protocols that are costing a huge amount of maintenance cost and resources for the operators. So the PTN technology can just provide a convergence solution that serves both voice, data and mobile with one single transmission network. So that can just save just a huge amount on the operation and maintenance cost to operators.
Also we developed the most advanced technology we called DOCSIS-EoC. That is a combination technology between the EPON technology and also the previous MSTP technology that can provide low cost but a high broadband access service over the cable network. That is very important for the China markets because of the recent drive by the country for three network convergence.
And also on the multimedia side, we pushed pretty hard on the continuous technology development, with cutting edge solutions for IP-based TV services and video services from the traditional IPTV, and then to the recent OTT solutions. So you know, UTStarcom provides a full solution from the broadcasting and controlling platform, also to CDN and VDN-and CDN stands for content delivery network, VDN stands for video delivery network-and to the user end, such as set top box, smart TV and also solutions on the phone and the pad. So we provide a total solution for that. So the recent drive-You know, UTStarcom is already one of the major players in telecom IPTV services, and now we just drive very hard on the cable side for interactive DTV and also OTT services as well.
Adam: People are very distrustful of Chinese reverse mergers, but the market seems to be worried that your company won't remain profitable. Is there any merit to this fear? What are the advantages of your competitors that could possibly put your company out of business? Is there any risks there? What kind of risk would an investor have with your company?
Jack: Yes, so as you know, we just achieved the first profitable year in year 2012, after 24 consecutive quarters of loss. And now we've got three profitable quarters and the whole year became profitable, so yeah-Before that we suffered 24 consecutive quarters of loss. And this year is more challenging, of course, because we have no more deferred revenue, which means everything comes from so called "real" things. But we still want to maintain healthy growth of our traditional business, and we are track to achieve operational cash flow break even. We are fighting a very competitive industry for telecom solutions and equipment, that's for sure, but as we discussed before, we have our focused product line and focused markets and we just leverage our advantage in those focused areas and product and moving fast. Of course there is always a risk or a threat from our competitors drive us out, but the management team and myself feel very confident that we will make it to reach our target this year.
Adam: Okay. Okay, good. So now, let's get more into the annual report, internal controls over financial reporting. I was reading the annual report. It says your internal controls over financial reporting, you know, weren't effective in 2010, however the material weaknesses have been successfully remediated in 2011, and now additional material weaknesses were identified as of 12/31/2011. Now what were these 'material weaknesses' in 2010 that were fixed in 2011? And how are you able to maintain effective internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act?
Jack: Yeah, so first, if we look back to the history of UTStarcom, this company did have some compliance and internal control issues before, but since year 2011, we just spent many attention and also related resources to mediate these issues. We have two major issues. One is related to the period and reporting finding and also internal control, especially with the treasurer management. So the first one we just hired more talent with skill sets related to SOX and also to SEC regulations from the financial and also accounting side.
Adam: Now what sort of new talent have you hired?
Jack: Accountants. Also financial experts. For example, Jin, our CFO joined the company in October 2010. She is a very skillful person with full qualification related to financial control and also accounting. She is from the U.S. and Canada, and she also hired more people, such internal controller, financial analysts. We also hired more people such as revenue recognition, accounting side, so this is how we report this process. On the other hand, we also tightened the internal control and isolated the related departments in the approval process related to treasurer factors. So after that, and according to PWC, Price Waterhouse, our auditors' review, they just confirmed that we just effectively removed these two major weaknesses. This is a very significant achievement for our financial side. As you know last year some of the Chinese based companies suffered with financial or accounting scandals, while we are working very hard to eliminate the problems in financial reporting and internal control. And also in Q4 we released our cash verification report that's attesting that we have everything real in terms of our cash reserve. So you mentioned that our stock price-of course, our company policy is not to discuss the stock price-but the overall situation for China-related listed companies is not that good because of a few bad companies, a bad image for that. But the real thing is UTStarcom is actually among some of the high tiers of well managed companies from China. Yeah.
Jin: And also Adam-this is Jin from UTStarcom-and I would also like to add to what Jack has been saying, that this has been a key focus for the company. And our FCPA compliance procedures actually are embedded in most of our processes, ranging from our vendor selection process, our government and non-government related identification of expenses, and our tracking of time and material, T&E, entertainment and also meals and marketing expenditures. For all of these, our FCPA related compliance are embedded in the company's current internal controls and also our processes. And on a quarterly and also annual basis, like Jack mentioned, all of our employees go through an annual certification and training on FCPA related issues. And in the past year we received 100% completion from all of our employees.
Adam: Okay, so you make sure that your vendors have good internal controls in place so that they are not in violation of the FCPA?
Jin: Hm-hmm (affirmative). Correct.
Adam: Okay, yeah, because actually one thing I did want to connect this to, well, I guess you guys saw my article about PWC Zhong Tian? You know, they are a very good auditor. They have a very good track record. They've never been proven to have signed off on an incorrect annual report. If they see anything shady or anything not right with the accounting, then they won't sign off on the report for a Chinese company. So with PWC Zhong Tian, how long have you had them as your auditor? And are you working closely with them? Because I know they gave a clean report for the 404 internal audit. Did they recommend anything about the way you guys do your processes and making sure that you're following the FCPA? Are you working with them closely? How does that work?
Jack: I think that Jin is the one to answer the question, because Jin works very closely with PWC. Please.
Jin: Yes. Yes, thanks Jack. And yes, we have been using Price Waterhouse since our initial IPO, and we have maintained to use Price Waterhouse. We have not had any changes. And you are definitely correct in terms of Price Waterhouse as-they are very careful and they have a very stringent audit process and procedure. And our team works very closely with Price Waterhouse. And Price Waterhouse actually audits UT on a quarterly basis, not just on an annual basis, so-
Adam: Oh, okay.
Jin: --prior to any earnings release, Price Waterhouse has reviewed our quarterly results and in addition to auditing our financial numbers, of course Price Waterhouse also goes through the 404 certification process.
Adam: Okay, great. Now what you said about the quarterly, how they look at your quarterly reports-that's definitely not required. I mean, they're required to look at the annual reports only for most companies. I mean, are you guys different from most other Chinese companies, that you use them quarterly? Do you pay them extra to do that?
Jin: Of course it is extra for the company. It's additional cost for the company. And the reason we do it quarterly is because, when we do report our results, we want to ensure the accuracy of those numbers when we do report them.
Adam: Okay. Could you give a ballpark number, how much extra you pay Price Waterhouse Cooper to do the quarterlies, compared to if you didn't?
Jin: I think if you have to ask me to guess how much additional cost it would be, I would say it would be an additional 20%-30%.
Adam: Okay. That's good.
Jack: And of course, PWC on an overall basis is the most expensive auditor, but we are still willing to spend the money and maintain a higher standard of financial reporting.
Adam: I see, okay. Okay, good. All right. So now, let's go over the history of your company. I haven't researched the history, but I'm looking at the chart back to the year 2000 on Yahoo Finance.
Jack: Yeah, of course. The company had its IPO in year 2000. At that time UTStarcom was a rising star because of their very good performance financially and also on the marketing side related to PHS business. And due to the technology change, developments, and also the government policies, the PHS gradually going down. And at that time UTStarcom was looking for different strategic directions, and diversified their business coverage. How do you say, to a certain degree, unfortunately, those changes did not result in a successful outlook or result. So then the company just experienced a long time of restructuring and changes. Between 2002-2003, the Company had a very good performance financially, and also business was growing. At that time UTStarcom was a very hot stock in China and also in Wall Street. I believe that was at the peak of PHS market development.
Adam: Okay, so now, let's talk a little about the financials. Like I said-maybe Jin could help with this a little, and you of course. But it's interesting, looking at this-I'm just going to pull it up here on Yahoo! Finance. It lists it pretty well here. For the last three years, 2011, 2010, and 2009. I'd like to get a sense of what is this, because it seems like it's sort of a different company-the numbers are so much different. For example, why did the revenue change those three years?
Jack: Okay, so Jin can just say more if I miss something. In 2009 the revenues were high but there was a huge amount of loss. That is because the terminals, the specialty handset was still there, but in fact that margin was terrible in 2009, especially related to handsets, the mobile handset business. And at the beginning of 2010, the company decided to cut off the handset business, so this is why the revenue just decreased quite a lot, but the losses also decreased as well. But we still suffered loss.
Adam: Okay, so you guys don't sell handsets anymore?
Jack: Yes, we don't sell handsets anymore. Since the second half of 2010. Is that correct Jin?
Jin: Yes, Jack, you're definitely correct. We divested or terminated our handset business, and we had some remaining sales in the early part of 2010. You're correct. That's definitely correct.
Jack: The costs related to the handset business were also high, also the SG&A. But after the new management team formed, we further cut down the cost for the SG&A part. We decreased the excess laborers in human resources as well. And because we just reorganized the company, including moving our headquarters to China, that further drives down the SG&A costs as well.
Adam: And when did you move the headquarters to China?
Jack: That is by Q4? Jin? When did we do that? Q4 2010.
Jin: Yeah, we completed it in 2010.
Jack: Yeah, 2010, Q4.
Jin: And then also, Adam, I'd also like to add that since Jack joined the company, he's also streamlined the operation and really focused our product lines, and that's why you currently see that we are focused on our broadband solutions and also our IPTV solutions. And because of that product line focus, that also helped to streamline our operating expenses and the corresponding costs.
Adam: The non-recurring, those are basically the restructuring, correct?
Adam: Okay, and then the research and development has also gone down a little bit as well. Will that go down more or is that going to be about the same? It looks like $30 million?
Jack: Yeah. So we still want to maintain a reasonable level of investment on the R&D side, because we still need to catch up with the customer demands on our focused area and product line, that's for sure.
Adam: Now why do you usually have a loss in the first quarter, even though revenues were very good?
Jack: Yeah, you know this is very typical, seasonal factors, especially when we just refocused on China, even for Asia Pacific countries, because of the big holidays, the Chinese New Year, so our customers generally slow down their job because of long time vacation, holidays, so we usually have a flat, weaker quarter in the first quarter. That's for years, in general. Of course if we just compare the same period from last year or before, the numbers and the results are still improved a lot. So we are happy to see we continue to have the right direction, the trend for that.
Adam: Okay, I see. Is it because you need to spend more on SG&A expense or something?
Jack: We generally just-for example, most companies, including UTStarcom, we release an annual bonus to our employees if they meet target, of course if the company meets target, and because of the holidays, there are some benefits to release around the holidays as well, so the expenses are a little bit higher. And there are also some customer relations activities. You need to visit your customers before the holidays. And we also have annual parties for our employees. That is, as you guessed, is true.
Adam: What percentage of your revenues are to the government? And are from the government?
Jack: You know, most of the telecom operators-of course now we have more and more private owned telecom operators, also cable operators as well, but you know, in China most of the telcos and also cable companies, broadcasters, are state-owned enterprises. They are not government, but they are state owned.
Adam: Okay. So most of your business is from state-owned enterprises?
Jack: Yes. Yes.
Adam: Okay, I see. Do you forecast for the year 2012 revenue will continue its growth of about 24% above 2011 revenues, and will gross margin remain at about 35.5%?
Jin: So PHS what UTStarcom had as part of their handset business, and that was terminated in 2009, however we had a significant amount of deferred revenue that will be amortized over the remaining two years, up to the end of 2011. So in the revenue numbers you see for 2011, there is approximately $23 million per quarter of PHS amortized deferred revenue. And that ended at the end of 2011. Therefore, in 2012 we will not have any additional $23 million of amortized revenue in the 2012 numbers.
Adam: Okay, so, do you foresee-basically, are you on the path to have continued performance like you did in the first quarter?
Jin: Yeah, sorry, I was going to say, what we have mentioned in terms of our full year outlook is that we are looking at our traditional equipment business, including both broadband business and also IPTV business to grow at around 10%-15% compared to 2011. We don't give up guidance, nor do we give out annual guidance, but this is just an outlook that we have for 2012. And more importantly, we are looking at margins to remain in the mid-30's.
Adam: Okay. Okay, good. Okay, so now let's talk about the ways that the company can do to increase the value of the share price, of the stock price. I know your company is currently engaged in a share buyback. You repurchased $6.3 million worth of shares in 2011. Then in Quarter1 2012, you only repurchased $378,000 worth of stock. Considering your high cash balance-and you expect to have operational cash flow-that's a pretty small amount. You know, only $378,000 is not very much in Quarter 1 2012. How much in share buybacks do you plan on doing in the future?
Jack: We started to more aggressively buy back the stock since Q2 now, because that is related to market price, so I'm not sure about the absolute numbers or shares that we are going to buy. But we will continue to execute the total plan for the $20 million stock buyback.
Jack: The $20 million would end September 2012. So the end of this September.
Adam: Okay, so by the end of Quarter 1 2012, you guys repurchased a little under $7 million, so that means from Quarter 2 until September, you'll buy back roughly $13 million worth of shares?
Jin: Yeah, there is about $13 million remaining that is available in the share buyback program.
Adam: Okay.. Have you discussed increasing that amount? Or maybe even having a dividend in the future?
Jack: So far, the board of directors has decided to maintain the existing stock buyback plan. We did not discuss or come to a decision to give out dividend, because our strategy is to maintain relatively high cash reserve to support our daily operational cash demands, and prepare a portion of that to be used for potential strategic merger and acquisition.
Adam: Okay. All right. Okay, for now, those are all the questions I have. Did you want to say something that I didn't include in the questions, or expand on anything?
Jack: I just want to emphasize that we are not only focused on the traditional business, which is broadband access and transmission, as well as the IPTV-related multimedia solutions, so our basic strategy is, we just maintain healthy growth on those businesses we call the traditional business, while we focus on cultivating our new business we call the VSC business. That is the service-based recurring revenue model. So we wanted to set our strategic direction to catch up the most profitable portion on the market so that to improve UTStarcom's future. So that is what I wanted to emphasize.
Adam: Ok, that concludes the interview. Thank you very much.
Jack: Thank you.
Jin: Thank you. Bye.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in UTSI over the next 72 hours.