Q1 2008 results/cc

The call started with Hong Lu discussing the CEO transition to Peter Blackmore is as scheduled on July 1, 2008. The transition has been going well with the China sales and marketing unit yet to be handed over.

The call then continued with Peter Blackmore discussing the current state of the turnaround and the individual business unit performance. This was followed by Hong Lu discussing China activities and then Fran Barton talking about the quarter's numbers, liquidity, and Q2 guidance. The call ends with Q&A.

The quarter was highlighted by strong upside in revenue and gross margins with an increase in expenses. Net cash improvements of $90m was primarily through one-time gains (investment sales of Gemdale/infinera, favorable tax provision, delayed payments to vendors, and supply chain improvements). The supply chain improvements amounted to $6.4m, ahead of company's internal projections. Headcount was further reduced from the previous announced restructuring of 11% by another 125 people to total 16% or 946 people.

The company has been adamant about protecting R&D and so this stayed consistent but SG&A stayed particularly high this quarter. Blackmore highlighted a few items why this was the case. First, sales efforts were increased to drive sales/bookings and finance/accounting are still way too high. Continued implementation of their ERP system will extend to the 2nd half and other "legacy" legal costs continue. In reading the 10Q, there are still 3 material weaknesses and many items they may implement to resolve these weaknesses. There was an SEC settlement but the DOJ investigation still continues. Costs will come down as these issues are resolved. There were also "external professional fees" that boosted expenses this quarter and next by $5m each. Some people have speculated these fees are for the divestiture of none-core assets, which the company has said is in active discussions. Peter in the beginning reiterated again the focus is on the core operations. Since the 9-week strategic study and categorizing business units to core/none-core, it is clear they intend to sell these units. Its been 3 cc but no definitive sale as of now but do believe it will happen (or else, what is the point?)

Peter discussed the macro economic environment. He mentioned that UT operates in markets with huge populations and high growth rates, which works towards UTs advantage. Really? I wonder if this is why most investors bought shares in the company in the first place :-)

The next item was India. Peter wanted to discuss India as this supposedely had a lot of investor concerns. There has been a lot of writedowns but Peter wanted to point out this was due to one large contract in 2006 that has to be recognized over a number of years. The company is doing much better now and is reflected in higher GMs (24% this quarter in the broadband unit) without the impact of this initial contract, which did lead to UT being the largest broadband provider in India. The company has 5 different Tier 1 customers in India and a few Tier 2/3 customers. From the four iptv contracts signed in India, bookings totaled $46m. The company was selected as most respected BB provider in India for the 2nd year in a row.

Overall iptv in UT networks worldwide reached 850k by the end of April, up 100k in 3 months. Other new iptv related businesses emerging are ip surveilance and digital advertising. The company is also competitve and Peter noted the Jersey NGN contract win over Sonus and Huawei. The services division will gain traction in the future due to the iptv, ngn, and broadband wins. Peter highlighted PCD's huge quarter ($431m) and reiterated guidance for 2009 profitability. He ended by saying that he and management are very aware that there is still a lot to do, are actively engaged (I hope so) and there is a lot of upside.

Hong Lu was up next and started with the impact of the earthquake to UT and UTs role. There was no impact on UT operations or employees that were hurt. GSM/CDMA networks went down during the earthquake but PAS networks stayed up. The company donated 1m RMB, 2000 PAS handsets, and had service engineers on call. UT employees dontaed another 250k RMB. Overall, good work by the company in this regard and even a good PR for PAS.

Hong discussed UTs 3 strategies in China. The first was growing iptv. Currently, there are 583k users in China, up from about 500k in 3 months. Therefore, most iptv users added were in China as expected. The company maintained 60% market share. As an example of progress in iptv, Lu cited a $7m contract signed in Shanghai and another soon to be signed $3.7m contract also in Shanghai. They also had their first win in Hunan province and are in negotiations in 4 other provinces. They also signed a contract for interactive advertising in Guangdong. There was also a growing ip surveilance business opportunity with 250k retailers in China (must be a lot of theft there :-)

The second China initiative is jump starting the broadband business. Lu talked about breakthrough in GEPON working with CT/CN on 3 to 4 different province each. There was also a key win with SARFT.

The third China initiative is managing PAS decline. Aside from the good PCD numbers, PAS news was surprisingly good. PAS handsets declined from 1.3m to 1.1m but market share moved back above 30%. There was also higher bookings in Q1 and expected in Q2. They had a 50k handset order for Beijing in advance of the olympics. Lu talked extensively about Packet data saying UT was working in several cities and had 100k data cards on order. During the Q&A, Lu mentioned how the PAS packet mode delivered the best current solution over edge/cdma 1x with data rates from 80-110 kbps compared to 65 kbps. The company is having good success in Beijing and are trying to get wins in Shanghai as well where they are still in the slower circuit mode. From an infrastructure standpoint, revenues in the MCBU declined from $73m to $67m but this had very little iptv revenue, mostly PAS and NGN. From a regulatory standpoint, the reorganization of companies are also delayed and not expected until Q4 at the earliest. As we've seen with earlier regulatory issues in China, this takes time. This definitely helps out PAS infra/handset sales as the company tries to slow down the decline and eliminate a lot of talk about PAS going to zero.

Fran Barton discussed the raw numbers for the quarter. Gross margins in MCBU shot up to 49% from 31%. From the 10Q, this was due to the low GMs in 2007 where the company exited 3G but the 49% was still very good. There was hardly any iptv revenues so this bodes well for revenue recognition in the 2nd half of 2008 and beyond. The BBBU was flat from $27m to $26m. Here, the discussion was primarily base on the India contract in 2006. Without this, margins would have been 24% (instead of the 9% reported). Services rev were $11m instead of $13m but gross margins improved to 21% from 5%. TBU was $44m from $70m due to PAS handset decline and lower prices. Gross margins was up 1% to 37%. The "others" division had revs of $7m from $6m and margins declining from 93% to 75%.

Book to Bill - This came in at 1.2, which was the same as last year but revs were particularly strong in Q1 so this was a good sign. Non-PCD business had a book to bill of 1 while the PCD had a 1.3 book to bill (that division is really doing well). Non-PCD bookings totaled $150m and expected to increase 25% next quarter.

I discussed OPEX earlier but basically the focus was on the 2nd half of the year, where the company is still targeting below $110m for each of the 2nd half quarters.

Cash flow- This was particulary strong at $97m, but will be given back in Q2. The company raised a lot of cash through 1-time gains and even chose not to pay some payables and receive discounts. I think the company was really concern about having enough liquidity for the convertible bond payment and hence all the cash generated. Overall, the company is still sticking with overall neutral cash flow for the year.

Cash - Out of the $305m in cash, $174m is in China. From the 10Q, the company has credit facilities of about $150m in China of which $140m or so is still available (and there are no material covenants). Interest on these credit lines are from 6.3% to 7%. The company's cash is making around 1.7 to 1.8%. While not great, most is in China and the Yuan will probably appreciate. As Peter mentioned at the beginning of the call, even without any divestitures, the company can fund their operations. The balance sheet does look fairly good at this time.

DSO and inventory has been going down as well showing some progress in that regard.

Q2 guidance - $580m-$610m in revenue and 14% GMs (36% non-PCD; 6.5% PCD). OPEX will be $118m-123m, which includes more external professional service expenses. Non-PCD revs will be $120-130m. In the first quarter, non-PCD revs were ($586m-431m) $155m. So, the first half will have non-PCD revs in the $285m range. Based on initial guidance for full year 2008, I calculated $833m in non-PCD revenue so the second half of the year is setting up to be huge.

IP Assets/patents - The company anticipates $2m in revenue for licensing/sale of their ip assets/patents. We will need to get clarification if this is projected to be ongoing or one-time events (or probably mixed) but its something to look for.

There will be an analyst day on June 10, 2008 ahead of the shareholder meeting and other road shows planned. Barton mentioned the big distractions (SEC settlement, CB payment) are out of the way and can focus on operations. He re-emphasized profitability in 2009.

Q&A - There were discussions on divestitures and exceeding overall 2008 "guidance" but the company could not give out information at this juncture. The second analyst subbing for Bill Choi asked some relatively poor questions that didn't really add anything. My favorite part of the conference call is the Q&A from Himanshu and Fran Barton. When Himanshu asked about plans for the cash when divestitures were made, Barton answered they didn't have any sale as of yet but were thinking about "clever" ways to use the excess cash (something about checking with the investment bankers and lawyers - maybe thats why it costs so much to do anything! Anyway, Barton did add some informative numbers on opex for the none-core businesses such as PCD, mostly SG&A of $10m/quarter, ipcdma $6m/quarter, Customs solutions business unit $10m/quarter). So, for you home gamers, you can start estimating numbers without those units :-)

I'll add my overall thoughts on the quarter/earnings call on the weekly recap tomorrow.