Ying (Jack) Lu - CEO and President
William Wong - COO
Jin Jiang - CFO
Jing Ou Yang - Investor Relations Director
UTStarcom, Inc. (UTSI) Q2 2012 Earnings Results Conference August 13, 2012 8:00 AM ET
Ladies and gentlemen, thank you for standing by for UTStarcom’s Second 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 of UTStarcom. You may begin.
Jing Ou Yang
Hello everyone and welcome to UTStarcom’s second 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; Ms. Jin Jiang, our CFO and Mr. William Wong, our COO.
Before we get started, I will read the Company’s advisory on forward-looking statements. This call will include forward-looking statements relating to the Company’s operational support services business, the divestiture of its IPTV equipment business and the Company’s performance in 2012. These statements are forward-looking in nature and subject to risk and uncertainties that may cause actual results to differ materially.
This include risk and uncertainties related to other things, changes in the financial condition and cash position of the Company, changes in the compensation of the management and their impact on the Company. The Company’s ability to realize anticipated result of operational improvements and the benefits of the divestiture transaction, successfully operate its 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, and current reports on Form 6-K as filed with the Securities and Exchange Commission. The Company is in a period of transition and the conduct of its business is exposed to additional risks as a result.
All forward-looking statements included in this release are based upon information available to the Company as of the date of this release, which may change and UTStarcom assumes no obligation to update any such 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. 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.
Let me start by saying that, the Company is pleased with its performance for the quarter, which was inline with prior expectations and demonstrated a strong improvement across nearly every metric relative to the first quarter 2012. We are pleased with the overall second quarter results. While year-over-year comparisons were impacted by significant one-time sales contract in the second quarter of 2011. The Company’s has improved performance versus the first quarter of 2012 is indicative of the healthy growth in overall business.
We realized strong sequential gains in net sales and the effort we have made to significantly improve gross margin and reduce costs, result in substantial increase in operating income and a positive operating cash flow in the quarter. As I mentioned, I will like to remind everyone that our 2011 second quarter results included revenue amortization related to PHS of $23.8 million, which generated gross margin of 34.8%. PHS deferred revenue amortization ended in the first quarter – the fourth quarter of 2011 and has not in our results, starting the first quarter of 2012. Therefore, in order provide a true apples-to-apples comparison or discussions in financial results of this call will exclude PHS deferred revenue, unless otherwise specified.
Let us start with slide 4, and talk briefly about our second quarter highlights. For the second quarter of 2012, total revenues decreased 17.9% year-over-year to $56.5 million compared to the second quarter of 2011 relative to the 2012 first quarter, revenue increased to 21% showing the fundamental stability in demand for our products and services.
Gross profit decreased 18.1% year-over-year to $21.7 million compared to $26.5 million in the second quarter of 2011. Sequentially, gross profit increased a 17.9% from the first quarter of 2012. It is important to note that Q2 gross profit margins were strong and are relatively flat compared with the 38.6% reported a year-ago, despite the lower sales levels and decreased slightly from 39.5% in the first quarter of 2012.
The benefits of our restructuring efforts on our expense structure continued to be substantial. As operating expenses decreased to 21.9% year-over-year to $19.6 million compared to $25.1 million for the corresponding period of 2011. Operating expenses also decreased 11.7% compared to $22.2 million in the first quarter of 2012. Be above resulted in income from operations for the second quarter of $2.1 million compared to adjusted operating income of $1.4 million in the second quarter of 2011, exclude PHS deferred revenue amortization.
Operating income also improved significantly from an operating loss of $3.8 million in the first quarter of 2012. Our positive operational cash flow of $2.9 million this quarter also increased dramatically from negative operating cash flow of $14.7 million in the first quarter of 2012.
Now let’s move to slide 5, to provide a bit more detail on the recent roll out of the video service cloud platform, which continued to gain momentum. We currently have fully deployed nodes in 12 cities in China, up from five at the end of the first quarter. We have five trial internet TV customers used our Video Distribution Network regarding our B2B Cloud Based Services, we have a total four customers in China.
Some of these VDN and B2B service trial customers will convert into revenue generating clients and the Company expects additional trials and conversions going forward. Also we continue to negotiate the key terms of our strategic agreements for the broadband resources. As you know, the Company recently announced a number of significant and strategic initiatives including the divesture of the IPTV business. Once that deal closes I will step down as CEO of UTStarcom in order to become CEO of that business. I wanted to thank everyone that I have worked with during my time at UTStarcom for their hard work and dedication to the Company, and I look forward to my new role and to lead the IPTV business as it continues to evolve.
Now I would like to introduce Mr. William Wong who joined UTStarcom as Chief Operating Officer on July 27, 2012 and who will be CEO of UTStarcom once the transaction closes. Mr. Wong and I are working together to ensure a smooth completion of the direct divesture. William, I will turn the call to you now.
Thank you, Jack for welcoming me on to the call today. And on behalf of the Board and the employees, I would like to thank you for your contribution to UTStarcom. You are leaving us with a Company that is much stronger than it was when you joined two and half years ago. It was under your leadership that UTStarcom turned around after six years of consecutive losses and began its transition from being purely an equipment provider and begin charting a path into operation support services.
Let me say that I am thrilled to be part of UTStarcom. I look forward to working with the Board and the rest of the management team on the initiatives that we have recently announced. I firmly believe that UTStarcom has a great future and I am confident that we can work together to transform the business and generate value for our shareholders. Let’s begin with what we recently announced.
Please turn to slide number 6. On July 27, 2012 the Company following the recommendations of a specialist Strategy Committee of the Board of Directors announced that it will seek to focus on and accelerate the development of the media operations support services and broadband businesses, and as a part of this strategy divest the IPTV equipment business which will become a standalone entity.
It is important for our customers, employees and investors to understand the importance of these initiatives. They stem from an extensive Board review of options to accelerate revenue growth, achieve long-term sustainable profitability and increase the shareholder value. After a robust analysis in consultation with our outside advisors a decision was made to divest the IPTV business.
While this business has won several new contracts recently, we estimate it will take 18 to 24 months to fully capitalize on this business wins and competition from local Chinese players will grow more intense in the meantime. In making this decision the Company believes that the divestiture of IPTV was an important step in its transition and will create value on several levels.
First, it will allow us to accelerate the Company’s transition by focusing our time and resources on building out our value added services, mainly our Media Operation Support Services as well as to grow our broadband business. We will have greater flexibility to orient the Company around its higher gross, higher return opportunities and to pursue other opportunities that support our growth objectives.
Second, given ITPVs significantly lower profit margins, the divestiture of IPTV will result in increasing the overall margin and returns for the remaining business. In addition, it strengthens our balance sheet reducing our exposure to risk and liabilities that will not commensurate with the returns being generated. As to the structure of the transaction, it was determined by the Strategy Committee after an extensive review process with independent financial advisors that the transaction represented the most efficient and effective means of separating the businesses and with the least impact on our customers. Our $20 million convertible bond investment in the IPTV business would generate interest income over the course of its five-year period, while also providing us with the option upticking an equity stake in the business should it become successful.
The Board and I have strong confidence in Jack’s ability to make the IPTV business a success, with the additional operational flexibility that they will have, as a privately held independent company. Meanwhile, I am working with the Board to lay our long-term strategic plan, define our investment priorities and best position the Company for growth in the future. I commit to articulating our strategy and vision to transform the company as soon as we conclude a strategy review process. So please stay tuned.
Let me just say it again that I am thrilled to be joining UTStarcom at such an exciting time in the Company’s development, and that I look forward to have frequent dialogue with our investors while working with our employees, customers, management and the Board to implement our new strategy.
With that, let me turn it over to our CFO, Jin Jiang, who will walk you through our Q2 financial results in more detail.
Thank you, William, and hello, everyone. Please turn to slide 7, and I will discuss our second quarter 2012 financial results in more detail. As Jack mentioned at the beginning of the call, unless otherwise noticed the discussion that follows will exclude amortization of PHS deferred revenue from the Company’s second quarter 2011 results.
In the second quarter 2012, we recorded $56.5 million in sales representing a 17.9% decrease year-over-year, a 21% increase sequentially. The year-over-year decrease was primarily the results of fewer next generation network service contracts in EMEA and decreased sales of PTN products in Japan partially offset by an increase in sales of RollingStream and GEPON products in China. Compared to the first quarter of 2012, the sequential increase in the second quarter was mainly driven by higher sales of PTN products in Japan. Our second quarter book-to-bill ratio was 0.62.
Let me comment for a moment on our book-to-bill ratio and its significance going forward. This number will be less representative of our underlying business trends and outlook as we transition into a service business. With our services model, it does not have an associated booking number and for those sales that do have a booking number we anticipate a faster order cycle that will allow us to convert more bookings into revenue within the same quarter which will also make the book-to-bill ratio thus meaningful.
On slide 8, you can see the gross profit margin was 38.5% for the second quarter 2012 compared to 38.6% for the second quarter of 2011 and 39.5% for the first quarter of 2012. As Jack mentioned, we were able to maintain growth margins at a year-ago level excluding PHS sales. We are very pleased with this performance, which was the result of our continued focus on preserving growth margins on contracts instead of pursuing pure bookings.
Moving to slide 9, second quarter 2012 operating expenses were $19.6 million down 21.9% year-over-year from $25.1 million in the corresponding period in 2011. The year-over-year decrease was primarily due to a decrease in bad debt expense, a decrease in personnel costs as a result of continued restructuring efforts in 2011, a reduction in rental cost after relocating the Company’s Hangzhou and Beijing offices to new sites in the second quarter 2011.
Also OpEx decreased 11.8% sequentially from $22.2 million in the first quarter of 2012, which include a one-time cost related to stock turnover of $1.2 million in the first quarter. Our goal of year 2012 is getting operating expenses to be less than 2011 and our current run rate is well below that target.
Moving to slide 10, operating income for the quarter was $2.1 million while net loss attributable to UTStarcom was $1.8 million compared to adjusted operating income of $1.4 million excluded PHS deferred revenue and net income attributable to UTStarcom of $11.6 million for the second quarter 2011.
For the first quarter 2012, we reported an operating loss of $3.8 million and net loss attributable to UTStarcom of $4.2 million. When discussing net loss of $1.8 million for this quarter, it is important to note that we recorded $6.7 million foreign currency exchange loss compared to a foreign currency exchange income of $3 million in the second quarter 2011.
On slide 11, 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 track our Equipment Sales, including network infrastructure and applications product. 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 includes long-term revenue sharing arrangements with cable and telecom operators, iTV.cn related sales and media operational support services from our Video Service Cloud platform.
In the second quarter of 2012, the Equipment Sales segment generated $49.9 million in sales compared to $57.6 million in the corresponding period of 2011 and $38.7 million in the first quarter of 2012. The year-over-year decrease was primarily driven by decreased sales of PTN products in Japan partially offset by increased sales of RollingStream and GEPON products in China. The sequential increase in Equipment segment sales relatively to the first quarter 2012 was mainly due to higher sales of PTN products in Japan in the second quarter 2012.
Our Equipment based service segments generated sales of $6.5 million in the second quarter 2012, this compares to $11.1 million in the second quarter of 2011 and $7.8 million in the first quarter of 2012. The year-over-year decrease was primarily due to onetime net sales from Equipment based services of $3.9 million of revenue recognized on the Jersey Telecom Limited contracts in second quarter of 2011 as well as fewer NGN service contracts in EMEA. Compared to Q1, 2012 the sequential decrease was due to less period service revenue in China in the second quarter 2012. Total New Service sales for the second quarter of 2012 was approximately $0.02 million, this consists of IP signage revenue sharing project.
On slide 12, you can see that we continue to operate from a position of financial strength that will provide us with opportunities to invest in the growth of our core business. We ended the quarter with a cash balance of $277.7 million in cash, cash equivalents and short-term investments and no debt. The two pie charts on this slide provide details on our cash deposits. As you can see 39% of our total cash is held within China, 50% of our total cash is deposited in R&D, 32% is deposited in U.S. dollars and 15% in Japanese yen.
Finally on Slide 13, we like to talk about our cash flow. During the quarter we generated positive operational cash flow of $2.9 million compared to $12 million in the same period last year and a negative $14.7 million in the first quarter of 2012. We have utilized our cash to generate value for shareholders and continue to execute against our $20 million share repurchase program in the period, reducing diluted shares outstanding by 3.6% compared to a year-ago and we continue to be active in the market.
During the second quarter the Company repurchased $2.8 million in ordinary shares bringing the cumulative buyback total to $9.6 million. The Company has $10.4 million left under the current program. We will continue to execute against our buyback trends. To support this goal, the Board has approved a six months extension to the original term of the repurchase program through February 2013.
Net cash used by investing activities for the second quarter of 2012 was $5.3 million. In the second quarter we made the decision to reduce our ownership stake in iTV.cn, our internet TV subsidiary. We did so, in order to better focus on services and technology that we’re developing in-house.
In the repurchase, the Company exchanged iTV.cn ordinary shares for UT shares held by Smart Frontier. As a result of the repurchase, UT’s ownership in iTV.cn decreased from 75% down to 49%. Therefore deconsolidated iTV.cn financials from our consolidated financial statements in June 2012 with a net cash impact of $6.8 million. Going forward, iTV.cn will be presented as a cost basis investment on our balance sheet, which is subject to theoretic impairment assessment.
Let me talk briefly about the IPTV divestiture. I would like to remind everyone that the IPTV business represents about 30% of our total sales, but at a margin lower than our broadband business. It also encumbered $17 million in annual operating expenses, which we will not have to bear after the divestiture.
Upon completion of the transaction, IPTV business will be presented as a discontinued operation for reporting purposes. Due to the complexity of the transaction, we continue to assess the final accounting treatment of this divestiture. With this in mind and based on current market conditions and assuming the IPTV divestiture transaction closes at the end of August as expected, we anticipate continued healthy revenue growth within our remaining businesses with average growth margins expanding to over 35% and operational cash flow break even in 2012.
As highlighted, when the divestiture transaction was announced, the Board of Directors and management will work together to build on initial steps taken with the divestiture to begin to truly transform the business. We will stay true to a set of core priorities and expect to create an effective trend to grow the business and deliver enhanced shareholder value. The Company plans to provide updates on how the evolving strategy will impact the overall future outlook.
This concludes our second quarter 2012 financial review section. Now, we will like to take any questions you may have. Operator, please open the line for Q&A.
We will now begin the question-and-answer session. (Operator Instructions) At this time, we will pause momentarily to assemble our roster. Thank you. There are no questions at this time. I will turn the conference back to management for closing remarks.
Thank you for joining us on our second quarter 2012 earnings conference call. We look forward to updating you on our third quarter 2012 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.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
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