Sunday, May 11, 2008

UT capital expenditures and working capital requirements

Recently, I have been posting about a stock buyback and have gotten some comments on the working capital needs of the company. From the company proxy statement discussing the repricing of employee stock options and why the stock has gone down,

"Prior to 2005, over 90% of the Company's revenues and profits were derived from sales in China of a second generation (" 2G ") wireless technology system. In the latter half of 2004, it was widely believed by companies engaged in the Chinese telecommunications market that the Chinese government would begin issuing licenses for the sale of third generation (" 3G ") wireless technologies in early 2005. In anticipation of such action by the Chinese government, our operator customers dramatically reduced their 2G capital expenditures. At the same time, with the intention of replacing our 2G revenues, we developed a full suite of 3G products to sell in China and also initiated a capital intensive strategy of global diversification. The Chinese government, however, never issued the expected 3G licenses, thus preventing us from selling any of our 3G products, and our global diversification has yet to yield results sizeable enough to offset the decline in China. We believe our stock price, which has fallen significantly over the past few years, reflects, among other things, the dramatic reduction in our China sales."

Due to the unforseen windfall in gemdale (mostly) and infinera and the initial progress in the company's "cash generation plans", the company has a net cash position of $269m by the end of Q1, 2008. Aside from the net cash position at the end of 2006 where it hit $300m, it has not been that high since the initial ipo. The difference between the end of 2006 and now is that the company faced another 5 quarters or so of burning $40-50 million of their cash while the company now is close to breaking even by the end of the year and getting their cost basis right (we hope). I always have some doubts due to the history but most people will look at the last 8 months and say this time, its more conceivable that the company is conservative and will reach breakeven/profitability at their forecasted timeframe. Peter Blackmore's statement on the state of the turnaround and preliminary Q1 numbers are very encouraging.

Now, lets get back to the capital expenditure and capital requirements. Quarterly expenditures previously had been as high as $185m+ and the company took the steps to write down their 3G businesses. The other major "reason" for their massive cash expenditures is the global expansion, specifically in India. The difference now is that gross margins are not 3% (in 2007) but over 20% in India and multiple wins in triple play business in India show the company is on the uptrend and actually setting the pace there.

During the March 17 meeting, one major focus was capital expenditures and most of the R&D now is focused towards NGN/iptv (some broadband/pcd). The company is forecasting expenses to go from the $120m level to under $110m by the end of the year. This should coincide with PAS slowdown. As PAS slows down, the SG&A portion should decline at similar rates.

Over the years, the company spent $100m for the Commworks division of 3com and $165m (plus debt) for the PCD of Audiovoxx. The commworks division will be profitable and is designated as none-core so it could actually be sold and bring in substantial cash (and reduce expenses to boot). We've talked about the PCD doing well. Other initiatives such as wimax, fixed mobile convergence, etc are on close watch where Blackmore is being careful on weighing the benefits/risk/rewards to continuing or pursuing deals.

In short, I don't see any major capital expenditures on the horizon and see gradual decline of OPEX. Cash generation from leasing the buildings, using OEMs (inventory reduction/efficiencies), licening of patents, AND the lack of massive costs for interest payments, options/China investigations, quarterly filings (as Barton mentioned, how many times have they redone the 2002 quarterly reports?). Add the fact that their accounting systems may be close to being completely installed/functional (thus providing more savings in head count) and you see that OPEX should be declining, cash should be building.

Rather than expecting an "acquisition", we have been anxiously waiting for divestitures. The company can only invest so much in iptv/NGN that is prudent and at a certain point the markets have to open up for them to consider putting MORE money (they are already putting in a lot for their "mature" systems).

Anyway, unless they are planning on a massive expense cycle in the upcoming year (which is unknown to us that follow the company closely), I don't see "liquidity" issues or even need to build massively on working capital. Shareholders are not asking to buy 50% of the float here but enough to make a material statement and reduction in the current float.

In summary, a stock buyback should be announced and implemented while the stock is "low".

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