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Executives

Mary Lombardo - IR

Ali Khatibzadeh - President and CEO

Robert Bosi - VP and CFO

Analysts

Quinn Bolton - Needham & Company

Richard Shannon - Craig-Hallum Capital

Walter Schenker - MAZ Partners

Paul Berghaus - Cornerstone Asset Management

TranSwitch Corporation (TXCC) Q2 2012 Earnings Conference Call August 8, 2012 5:30 PM ET

Operator

Good day everyone and welcome to the TranSwitch Second Quarter 2012 Earnings Release Conference. As a reminder today’s presentation is being recorded. At this time for opening remarks and introduction I will turn the call over to Mary Lombardo, Investor Relations. Please go ahead.

Mary Lombardo

Thank you. Good afternoon. With me today is Dr. Ali Khatibzadeh, our President and CEO; and Robert Bosi, our CFO.

This call will include forward-looking statements that involve risks and uncertainties that could cause TranSwitch’s results to differ materially from management’s current expectation. We encourage you to review the Safe Harbor statements contained in the earnings release published today as well as TranSwitch’s most recent SEC filings for a more complete discussion.

With that said, I will turn it over to Ali for his thoughts on the quarter and Bob will discuss our financial results. Thank you.

Ali Khatibzadeh

Thank you, Mary, and good afternoon ladies and gentlemen. Over the last three months we continue to make significant progress in expanding customer opportunities for our HDplay product while at the same time we have taken a number of important strategic actions to better position us for growth in our video connectivity business.

Before I talk about our strategic actions and our progress on the new revenue, let me give you a brief top line overview as I currently see it. Then Bob will cover second quarter results in more detail shortly.

Revenue came in at $3.8 million flat with the first quarter while gross margin improved to 67%. This revenue results primarily from our legacy product and we have no expectation that this level is going to grow in any significant way. However, we do see signs of stabilization in our legacy business through the remainder of this year. Additionally, we have greater IP licensing opportunities in the third and fourth quarter of this year. We also anticipate our first HDplay customers to start production in this quarter with a few more customers launching products in the fourth quarter. I will give you more color on the new business later.

While the strategically direction of the company remains on-track, the key challenge for the company has been to maintain an effective balance sheet, in spite of the unexpected rapid decline in our legacy telecom business. This has been a source of investors concern and during the quarter we spent a great of time addressing this matter.

We ended the quarter with about $3.2 million of cash down from [$5.0] million at the end of Q1. Borrowing on our receivable base credit facility which is our only debt we are about $713,000 down about $630,000 from the previous quarter.

During the quarter we raised about $2.7 million through direct placement of shares. On an all-in basis we used about $3.6 million cash during the quarter which essentially went to fund operations. Now clearly this level of cash burn was unacceptable. To address this we have taken three important strategic actions.

First, we reduced our operating expenses by approximately $8 million annually and we expect the full impact of the savings to be again to be reflected in our financials for the third quarter. The bulk of reductions are coming in our telecom business on both R&D and SG&A. As a result of this restructuring, we estimate the average total quarterly operating expenses to be in the range of 5 to $5.5 million including one-time charges.

Based on this level of operating expenses and the anticipated gross margin level, the quarterly revenue for non-GAAP income breakeven is now reduced to about $8 million per quarter. We will continue to look for and take actions on further expense reduction opportunities to further include this breakeven point.

Second, we have been pursuing the sale of non-strategic assets in particularly our legacy telecom patents. TranSwitch had a rich history of innovation in telecom and as a consequence has evolved to strong and valuable patent portfolio. As the company shifts its focus to high definition video market these patents no longer serve our long-term business strategy. Yet they are very valuable and they are very marketable asset.

Patents are very popular subject today and in patent market it's quite strong making a good sign to be (inaudible). And last week we announced that we have retained Drakes Bay, LLC, a leading patent broker to help sell selected telecom patent family in the near future. Drakes Bay has an extensive track record in multi-million dollar patent transaction and has done a detailed study on the potential value of our legacy patent portfolio and determined that we have both strong priority date and a large number of forward citations.

This means that many later patents have cited on ours, and is the marker of the second launch [irrelevance] of our patents. While I do not want to disclose the valuation of this patents so as to not compromise a bidding process, I can say that their estimated value is very meaningful and significant to us. I’d also like to point out that while we are pursuing the sale of our legacy telecom patents we continue to hold a strong portfolio of intellectual property related to our strategic video connectivity business. In fact, we believe these are most valuable IPs. We expect that this portfolio will continue to grow and put us in an excellent position relative to our competitors in our new business.

Third, we recently signed a three year agreement with Aspire Capital Fund to raise up to $11 million though the periodic sale of the stock based on the prevailing market choice and subject to the terms and conditions of the agreement. We chose Aspire because they have a track record of maintaining a significant investment in the company they help to finance. Pursuant to our agreement we sold them an initial trance of $1 million of stock and a slight discount to the market. Any further sale of the stock are entirely at our discretion. We believe this is a good facility to have in place as it gives us a great deal of flexibility at a modest price, but frankly we don’t like selling shares at these prices and our goal is to minimize the use of the facility and raise most if not all of our cash needs through the sale of legacy patents.

Now let me turn to our progress in our new video connectivity business. First of all I’d like to welcome Tim Blanke, as a new VP of Worldwide Sales to our team. Tim brings a wealth of experience in sales of electronic products to consumer electronics, OEMs particularly in the Asia-Pacific region where the bulk of our design activity takes place. Tim has already hit the ground running and I’m confident he can help us convert our sales opportunities into revenue going forward.

In what I think you should read into this announcement is that we have reached the point in our transition with the intense focus on product development, now turns to intense focus on closing the sales opportunities we have identified.

Over the last quarter we have significantly expanded the list of potential customers for HDplay products to over 50 specific opportunity. While we certainly do not expect to win all of these opportunities, we believe we are in a good position to convert a significant number of them to meaningful revenue in 2013.

Consistent with that we have said previously, we still anticipate our first customer to launch their product in the current quarter with a few more foreigners launching products in the fourth quarter of this year. If our customers follow through on their time line and this is a key step through revenue at this point. We will expect HDplay revenue in the fourth quarter to be meaningful relative to the total company revenue.

In June Texas Instruments launched its new DLP projection system platform and we are pleased that HDplay is qualified on their platform. We see this as a significant catalyst for our growth and as market analyst put TI share at above 55% of the estimated 14 million unit projector market next year.

In addition to working with TI under VLC Solution, we have made good progress working with other projection solution providers that use competing technology such as LCD and LCOS which stands for liquid crystal on silicon.

Another important segment of the projector market is a very rapidly growing PICO projector market, PICO projector is our small portable handheld projectors that can even be embedded into smartphones. This is a right opportunity for HDplay and we are pursuing this market segment vigorously.

Currently, we are working on reference designs with three key providers of PICO projector platforms for 2013 launch. We also continue to see excellent traction in other segments of the video connectivity markets such as switches, active cables, AVR equipment, computer monitors, and TVs. Given the unexpectedly rapid decline of our telecom business and its associated implications for revenue and cash flow, we recently undertook another serious reexamination of our revenue targets for HDplay another video product relative to our opportunity.

Our goal was to look at the business with a more conservative deal of our opportunities and having done that, I’m pleased to tell you that we reiterate our 2013 revenue target for HDplay product at $21 million as well as another $10 million in combined revenue target for HDmobile and IP licensing opportunities including HDwire. This makes for a total of $31 million in video connectivity target revenues in 2013. As always these numbers represents our best estimate at this time and are fully subject to the risk outlined in the Safe Harbor statement at the beginning of this presentation.

In summary, we see telecom revenue stabilization in the second quarter with increased IP licensing opportunities and ramp up of HDplay products in the second half of this year. Through strategic actions we have significantly reduced our cash burn and the cash required to reach breakeven. We are hopeful of garnering meaningful proceeds from the sale of non-strategic patents and as a backup we have reached an agreement with Aspire Capital to provide access to capital as required. I believe through these actions we can address our capital requirements and focus 100% of our attention on the growth of the video connectivity business.

I’ll now turn it over to Bob to present our second quarter financials.

Robert Bosi

Thank you, Ali, and good evening to everyone. Our Q2 revenue was 3.8 million as compared to our Q1 2012 revenue of 3.7 and our Q2 2011 revenue of 7.1.

Net product revenue for the quarter was approximately 2.4 million compared to product revenue in Q1 2012 of 3.2 million and 4.0 million in Q2 2011. Net service revenue for the quarter was 1.5 million compared to net service revenue in Q1 2012 of 0.5 million and 3 million in Q2 2011. Our net service revenue includes revenue relating to actual property licensing of our HDMI DisplayPort, HCP technologies and associated royalty revenue.

By product line our CPE revenue for the quarter was 0.7 million compared to CPE revenue in Q1 2012 of 0.7 million and 3 million in Q2 2011. Our infrastructure revenue for the quarter was 3.1 million compared to infrastructure revenue in Q1 of 3 million and 4.1 million in Q2 2011. The geographic breakdown of our second quarter revenue was as follows. Asia-Pacific 35%, Europe, Middle East and Africa 44% and the Americas 21%.

Our gross margin was 67% in the second quarter compared to 59% last quarter and 67% in the second quarter of 2011. On a non-GAAP basis operating expenses was 7.4 million on a comparable basis product core operating expenses were 7.5 million and product core prior years’ operating expenses were 7.4 million.

We recently announced the substantial restructuring eliminating 64 positions which should save us about $2 million per quarter. We booked $1 million restructuring reserve for severance and other related costs. Non-GAAP operating results for Q2 was a loss of 4.9 million on a comparable basis prior quarter’s operating loss was 5.3 million. We had a non-GAAP operating loss of 2.7 million for Q2 2011. Non-GAAP operating loss for Q2 was a loss of 5.0 million was $0.16 per basic and diluted share compared to a net loss of 5.5 million in Q1 2012 and $2.8 million net loss for Q2 2011. Q2 2012 GAAP diluted net loss per share was $0.19 as compared to a net loss per share of $0.20 in Q1 2012 and net loss of $0.11 per share in Q2 2011.

The comparable GAAP measures for gross margin operating expense, operating income, net income are reconciled to the related non-GAAP amount in our reconciliation of GAAP to non-GAAP measures included in our press release today. The reconciling items for Q2 were as follows. Expense of 0.1 million in amortization of purchase intangible assets, expense of 24 million in stock based compensation expense, expense of $1 million for restructuring and a bad debt of 0.4 million for the reversal of accrued royalties. These items are described in our press release.

Let me conclude, Ali talked a little bit on cash position and our financial efforts. I’d like to add that we did raise 2.7 million in the quarter in a direct placement and subsequently in July we raised an additional 1.5 million, by $400,000 with the market facility before we closed it. And 1.1 million in the sale of stock under our equity line agreement with Aspire Capital.

I’d like to conclude to reiterate Ali’s comments that we are all 100% focused on the launch of our video connectivity business and making sure that we have enough capital to execute our business plan.

That said I’ll open the call up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Quinn Bolton with Needham & Company.

Quinn Bolton - Needham & Company

Quick question just on the startup, Ali in your prepared comment you talked about seeing some increased opportunities for IP licensing in the second half of the year, I just want to make sure that IP licensing is not related to this patent sale that you would discuss. Just confirming that these are separate event?

Ali Khatibzadeh

Yes, so that is correct. We do have significant IP licensing opportunities aside from the patent sale that we specifically referred.

Quinn Bolton - Needham & Company

And is this around some of the HDwire and some of the other technologies you are developing or can you expand on where you are seeing these opportunities?

Ali Khatibzadeh

It's a combination of both IP opportunities for high speed interconnect business as well as telecom software licensing opportunities.

Quinn Bolton - Needham & Company

And then on the timing of patent sales, you announced sort of the engagement to begin that process, what in terms of timing, how quickly do you think this process goes. I mean is this something that likely takes six months to engage interested parties and negotiate an agreement but it happens faster. Any sense of timing as to when you think patent sales could become a source of capital rather than equity issuances or other types of financing.

Ali Khatibzadeh

Obviously, it's difficult to predict exactly, this is going through a bidding process. We anticipate we will have this process concluded in the next four months. It could be earlier, it could be sometime between now and end of the year.

Quinn Bolton - Needham & Company

And then just looking at the guidance, good to hear that you are reiterating guidance for the video side of the business. I think on the last call you talked about the telecom business, perhaps stabilizing in the $4-ish million range and potentially generating 16 million of revenue next year. It sounds like that may not be the case anymore, I know you stabilized here in Q2 it was about 3.8, what’s your sense for the telecom revenue you comment of 2013?

Ali Khatibzadeh

We have really no new update in terms of our telecom forecast for next year. We do have obviously some opportunities with regard to the products that we have out there that we anticipate going to production. And so at this point we have no update really relative to what we presented last quarter.

Quinn Bolton - Needham & Company

It sounds like that most of the revenue at least through the second quarter was still sort of the telecom of 3.8, that stabilizing if that kind of level in the 2013 is still your best estimate?

Ali Khatibzadeh

The comments that I have made, we believe the telecom portion of it we see stabilizing on top of that we see additional IP licensing opportunities. So, we anticipate as we go into Q3 and Q4, our revenue will grow where we are in Q2. That’s our anticipation based on what we see in front of us.

Quinn Bolton - Needham & Company

And that’s specifically (inaudible) I know you said you start to get the initial HDplay revenue in 3Q and it could be meaningful in 4Q, that comment. You think you might see a little bit of recovery in telecom in the second half on top of the video ramp?

Ali Khatibzadeh

That’s correct. We see recovery in our legacy business which is telecom plus IP licensing opportunities that we have in addition to that we anticipate ramp up of the HDplay business starting in the third quarter but as we get into Q4 in a more meaningful way.

Quinn Bolton - Needham & Company

And just two quick clarification for Bob. Bob with the financing where do you see that the share count for the third quarter on the diluted basis.

Robert Bosi

It's 33 million right now. That’s where we are.

Quinn Bolton - Needham & Company

And you think that’s a good number then for the third quarter, it sounds like you have done another placement.

Robert Bosi

It's 34 million that’s where we are right now. Again we hope not to use and we put this deal with Aspire as Ali mentioned we really want to minimize the solution to our shareholders. So, at this point I’m not going to forecast, we are going to use the Aspire, hopefully we will get patent sales and other associated IP revenue coming in here shortly.

Quinn Bolton - Needham & Company

And then just OpEx post restructuring you said it was 5 to 5.25 million on a quarterly basis and that includes take back expense?

Robert Bosi

Yes, that includes one-time charge on an average basis.

Operator

(Operator Instructions) And we will go next to Richard Shannon with Craig-Hallum.

Richard Shannon - Craig-Hallum Capital

I love to understand little bit more about your near-term HDplay opportunity that you summarized in your prepared remarks. I guess the first question is when you are talking about the customer that’s going to ramp this quarter and/or the I think you mentioned three customers potentially ramping in the fourth quarter, are these all projector designs or are there any TV related designs in there?

Ali Khatibzadeh

Initial customers will be customers that are in the projector market or switch market or audio visual type equivalent. As we said before our opportunities in the TV space are for 2013, and we remain on-track for those opportunities in 2013.

Richard Shannon - Craig-Hallum Capital

And these projector designs are they related to the TI reference design or they in other technology areas.

Ali Khatibzadeh

The opportunity we have for revenue in the second half of this year are not related to the reference design from TI. We believe revenue from TI reference designs will start sometime in early 2013.

Richard Shannon - Craig-Hallum Capital

Any sense of what kind of design share you are getting with the reference design, I think there is other possibilities of doing what you are doing although probably not as elegant as what you have or not using both HDMI and display port on a projector, any sense of what that pull through is on those event.

Ali Khatibzadeh

We are in discussion with TI platform customers and w are I think we believe we have a good chance of getting decent share of that business. At this point maybe it's too early to quantify it, but our target is to get a significant share of that market and as I said also in the comments I made, we are also making good progress with other projection solutions providers in the market. So, our goal is to address the entirety of that market and in addition to DLP projectors that are designed with LCD or other technology.

Richard Shannon - Craig-Hallum Capital

Would you consider any of these customers ramping on the second half of this year to be tier 1 OEMs?

Ali Khatibzadeh

Yes, our first customer is a tier OEM in that space, a leading provider of projectors, provide on different brands where you are seeing on their different brands and they are major provider of projectors in that space.

Richard Shannon - Craig-Hallum Capital

Do, you anticipate being able to announce them at any point?

Ali Khatibzadeh

We hope so, again that’s our goal as we obviously that’s requires permission from customers and our goal is to be able to do that.

Richard Shannon - Craig-Hallum Capital

Maybe a couple other question on different topic related to the Drakes Bay retention, I think you mentioned in response to previous question about timeframe of roughly four months. Is there a high probability of finishing in that timeframe?

Ali Khatibzadeh

I said it could take up to four months. It could happen earlier, and it may happen in tranches, just want to be. It's obviously difficult to project exactly when that bidding process. The process is under way and we do see as I mentioned significant valuation and to the point that I believe that would either meaningful and certainly enable us to fund ourselves without having to resort to diluted means to our shareholders. So, we are very hopeful and based on the valuation of the detailed study that Drakes made it and look that it from different perspectives, different metrics and they had a very good analysis of the market, and they had a track record of multi-million dollar patent deals. And so we trust their judgment.

Richard Shannon - Craig-Hallum Capital

I guess one last question from me guys, in regards to your confirming in 2013 video sales outlook of I think 31 million is the number. How are your expectations of moving parts within that changed in the three months, first put that out there, I guess specifically by the three main video products that (inaudible).

Ali Khatibzadeh

It's really not changed us in any significant way. I think as we said the breakdown was of $21 million for HDplay and we reconfirmed that. In fact our opportunity list has grown since the last earnings call, I think last earnings call we were 35 specific opportunities, we are over 50 now. And with regard to HDwire we do see licensing opportunities and we are working on those, obviously we expect revenue from that in 2013 as we have said before. And we are still on the same track on that. Of course, the balance of it is the HDmobile product that we expect, I think last time we said we anticipate second half of 2013 basically one quarter of production to reach the number that we put out there. I mean if you look out in terms of the $10 million combined for HDmobile and all of our IP licensing including HDwire and you look at it this year we are probably going to do about $10 million of IP licensing just IP licensing alone. So, for us to reach that it's not a stretch at all by any means.

Operator

(Operator Instructions) And we go next to Walter Schenker with MAZ Partners.

Walter Schenker - MAZ Partners

Can you walk me through the process that after multiple years of defining revenues and many cost cuttings rounds that we now have found that we can touch 64 positions which is a very large amount and take an additional $8 million of cost cut as appose to having done it six, nine months ago or when you came in early.

Ali Khatibzadeh

Yes, obviously as I joined the company since then we have taken steps to reduce our operating expenses. We clearly saw opportunities in the telecom space at the time warranted further R&D and investment, but as we progressed obviously the telecommunication market has taken different outlook not just for us for all the vendors in the space. And we have relooked at and given our certainty our capital structure and given the opportunities we now see in the video connectivity business. We feel that for us and it's best to focus on the video connectivity business. And the result of that we have reduced not just R&D but also SG&A in our telecom business. So, it's somewhat reaffirmation that we feel confident about our prospects in the video connectivity business. And certainly there are opportunities in the telecom space that could be pursued but we believe of course for trends which at this point, it's best to focus our capital and maximizing our opportunities in the video connectivity business.

Operator

And we will go next to (inaudible) Private Investor.

Unidentified Analyst

My question here would go with HDmobile and perhaps your potential average selling prices as compared to HDplay. I believe Ali, in the last call you mentioned that you are with the opportunities going from Texas Instruments, just looking at the numbers you were giving. It seem to be a pretty reasonable average selling price. And Silicon Image in their last call gave a generic average selling price of little over a $1 each for their mobile devices, and were you looking at something similar for that for any potential HDmobile selling or are you expecting hopefully to get a little more than that?

Ali Khatibzadeh

Certainly the mobile space is characterized by much larger volumes talking about hundreds of millions of unit. And by virtue of that some more price sensitive market and we believe that time and number that Silicon Image is talking about are reasonable, obviously it depends on the functionality we put in the product. I think so I don’t want to comment on what Silicon Image quoting relative to their product, it seems to be a reasonable number to the extent that we believe our HDmobile has additional functionality, we may be able to get somewhat better pricing, but it's going to be in that range, I think that’s about the range, $1 to $1.50 in that range that market can support.

Unidentified Analyst

And then I guess my other question would be for the legacy business even though it's the past, previously there were some hopes for ramps in Japan there, because of their tsunami and stuff had, obviously not happened. And then you were hoping they would happen. Did all of that stuff just kind of fade away or did they go into different customers you had going to different areas.

Ali Khatibzadeh

That’s part of our business going forward and in fact that’s we see that business contributing to the stabilization of our Silicon revenue in the second half of this year. And potentially some growth in that segment of it, at least for next year. So, that’s happening, our customer we have mentioned NEC has basically launched their platform in Japan, and I think at the beginning of deployment which is expected to last several years with their customers.

Operator

And we will go next to (inaudible).

Unidentified Analyst

August 8 your company and every company has completed five weeks into the September quarter, so my two part question is, at this point is your revenues in this quarter running at a higher rate than they were in a period ending June 30, and higher incoming orders or actual book-to-bill running higher than it were in the period ending June 30.

Ali Khatibzadeh

As I mentioned we do have more IP licensing opportunities, they tend to come in large months of contracts. So, based on what we see we believe that we are in a process to have better quarter in Q3 and Q4 than Q2. But in terms of I’d say backlog or book-to-bill ratio, it's about the same. We expect that near-term IP licensing opportunities that we will do better.

Unidentified Analyst

So, at what portion during this quarter August, September whatever would that one customer opportunity in HD occur another quarter, what month might it occur?

Ali Khatibzadeh

I want to be cautious in that, because we don’t control the timing that the product line signing of our customers, certainly they have number of factors that determine their launch. But at this point again we expect that to happen I will say in the month of September as far latest information.

Operator

(Operator Instructions) And we will go next to Paul Berghaus with Cornerstone Asset Management.

Paul Berghaus - Cornerstone Asset Management

Just one question, can you comment or give us little color in terms of what the status of your anticipation in the HDMI form is. And do you expect that you are going to be able to influence the new standards and will they be favorable to the company and your new product line?

Ali Khatibzadeh

We are certainly an active member of HDMI forum and we are participating in the current rounds of HDMI 2.0 which is a new generation of HDMI standard definition. And we are certainly contributing to it, obviously it's a large organization with many participants, and we have a confidentiality agreement also with HDMI that (inaudible) talking about specific details, but I can say that we are contributing and influencing and that process in ongoing and I think expectation that there will be a new such case and for HDMI 2.0 release as we go forward in the second half of this year.

Paul Berghaus - Cornerstone Asset Management

I can Silicon Images announced they got 100 million devices out on MHL, is that a threat that technology to your product line and your game plan?

Ali Khatibzadeh

First of all I think the numbers you are seeing from Silicon Image reaffirm that that is a great market opportunity and mobile connectivity is definitely an area we want to be present in. MHL is the first technology, first solution that’s optimized for the mobile video connectivity. And I think Silicon has done a very good job and that product is out in the market and getting traction. Our strategy has always been that we are not going to create a new standard. Our goal is to work with existing standards that are on the market and to the extent that MHL is good traction in the market, our strategy is to support that. So, if you go to MHL website you will notice that TranSwitch is a licensee of MHL and we plan to put products that we introduced in 2013 to support MHL. MHL has is designed with certain feature and application in mind, we believe the next generation of mobile devices require additional features on top of MHLs offering and that’s how we are positioning our product.

Operator

And at this time there are no further questions. I will turn the call back to our speakers.

Ali Khatibzadeh

So, thank you. In summary I realized that it has been a difficult quarter for our shareholders and I want to emphasize that our strategic redirection remains on-track. I’m as optimistic as other about our potential prospects in that business, about our product advantages of other market traction and our customer expansion. And we have been working very hard and I believe we have the path to finance our growth needs without significant dilution to our shareholders. I know that’s probably four months on the minds on many of our shareholders. And I think through the process that we have outlined through the sale of legacy patents, I believe that’s going to put a lot of questions to bed and mind that is that we will have the cash needed to operate and fund our growth as we forward. If you look at the numbers that we discussed with the reduction in operating expenses, the decline of revenues that we see going forward, it doesn’t take a lot of work to see that we really minimized the cash we need to get to breakeven. And with the valuation that we see with our legacy patent portfolio, I think we have a great opportunity to put this issue to rest and clearly focus on creating value for our shareholders. But we will take all of the certainly one-time every avenue possible, create to value for your shareholders and (inaudible). Thank you very much.

Operator

Ladies and gentlemen that does conclude today’s presentation; we thank you for your participation.

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