Saturday, July 5, 2008

Life without the PCD - Focus on Growth

Immediately after the PCD divestiture, discussion turned to the core businesses and profitability. There were two posts by fellow shareholders that summarizes the situation.

"So, excluding numbers from the distribution part of PCD which is what UTSI just got rid of, UTSI will have an annual run rate of $282m in gross profit and $380m in OPEX. Thus to break even on operating income going forward, excluding any unforseen one-time charges, UTSI will have to boost high margin core revenue by $330m (at 30% GM), while keeping OPEX flat." writes Curious_Tigre.

The other post by Shadowdoc99 outlines delayed revenue recognition and strong bookings to make a case for profitability in 2009 despite the several hundred in revenues that need to be added (including effect of additional PAS decline).

Interestingly enough during the Q&A portion of the shareholder meeting, one of the questions I asked was the discrepancy of management's stance of getting the cost base right by early 2009 (or late 2008) and the revenue ramp that is needed to get the expense ratios low enough. To recap, management has targetted OPEX to be about 25% of core revenues (w/out the distribution part of the PCD). These metrics have not been met since 2004. Since then, the expense ratio has been way up and will actually peak this quarter (Q2 2008) at about 67%! See the table on expense ratios I have prepared on the side of the blog.

OPEX - Management's stance is that R&D has to be protected. In fact, they claim this is close to benchmark. While this is the case, much of the expense is actually in SG&A, where it is nowhere close to benchmark yet. Management has acknowledged this and it will drop significantly in the 2nd half of the year. They cite legacy finance, accounting, and legal costs to be reduced, adding that even the remaining Justice Department investigation will be resolved in the months to come (that was in the last earnings cc). Despite the OPEX cuts through the end of the year and continuing in 2009, it will not be enough to get to profitability.

Revenue Growth - Management is focusing on revenue growth to get the cost base right and return the company to profitability. Core revenue has been declining for years and even in 2008, will decline about 4-6%. So, why is management going on road shows, not cutting expenses more, and confident about the revenue growth? Confident enough to sell the PCD. I will point out some information (some facts, some anecdotal, some personal views, etc) that support the revenue growth.

  • Management's committment to the core businesses - Now that the management is divesting non-core businesses, there is no reason to believe they would not sell/divest of the remaining businesses if they don't believe they can be profitable and that the markets are huge. When the company looked at strategic options in 2006/2007, they had offers for parts of the company but presumably those were only for the valuable parts that currently make up the iptv, ngn, and broadband business.
  • Bookings - 50% growth on the non-pas; non-pcd business. Blackmore adds, “Our view is that these two product areas, NGN and IPTV are at the beginning of their life cycles and bookings can ramp fast. We are very pleased with the momentum they are gaining in their respective markets and believe the revenue for each of these product lines can grow in excess of 80% in 2008.”
  • Synergies - Selling iptv, ngn, and broadband are complementary. The strategic wins in 2007/2008 will lead to more wins/higher GMs and repeat customers. David King during the shareholder meeting discussed nurturing the 20 or so larger carriers/customers that they currently have.
  • New technologies - Blackmore has compared UT to a large startup. While a lot of the technologies were built over the last 5-7 years, a lot of the strategic/contract wins have only happened starting in 2007. The NGN wins in particular have come in bunches. From the latest IPTV news magazine ( ), FastWeb of Italy is spending 2 Billion Euros over the next 4 years to complete its NGN to deliver voice, data, and video over IP. We don’t know the size of the contract win with Tiscali (smaller than FastWeb and Telecom Italia) but the multiple wins (Philippines, Italy, Taiwan, Brasil, Thailand, and Argentina) does show significant activity in a very short time frame. (BTW from the shareholder meeting, the Tiscali wins were in the range of $10m and $15m for the two contracts last year)
  • Emering markets - It would be hard to see revenue growth in North America or some of the mature technology markets. Technology spending in those markets are going to be tough but not in the high growth markets UT is in. During the shareholder meeting, David King provided some color in Russia, discussing potential multiple wins by the end of the year. As I posted before, There was also the hiring of former Alcatel-Lucent executive Diego Martinez. "Based in UTStarcom's regional headquarters in Sunrise, Florida, Martinez will lead the company's sales efforts in Central America, Latin America (CALA) and North America while overseeing an extensive team of sales, engineering and support professionals in more than 30 countries."
  • Revenue recognition - As I mentioned in my post yesterday, there is a discrepancy of $83m in non-pcd revenues at the beginning of the year and the one presented by Barton during the Analyst Day Meeting. Barton explained the decline by saying PAS is declining 16% from last year. However, I think this was already built-in. More than likely, Barton is being conservative on the numbers and revenue recognition (as they have been for the last 6 months or so).
  • Confidence - So, when I asked about the several hundred in revenue that is needed to bridge the gap to profitability, Blackmore replied confidently that several hundred million was not that much and they will update the investment community in future earnings calls.
  • Focus - During the shareholder meeting, there were also discussions on various technologies and countries. David King admitted there was a lack of focus and "too much" technologies previously. Too much that even the marketing people didn't effectively capitalize on. The technology was just ahead of the sales/marketing. King discussed slashing certin divisions (one from 49 to 17 people for example).

Doubling their bets - The company is focused on iptv, ngn, and broadband. So much so that they are doubling their investments in these technologies. The question of profitability is far from settled and the cost base is still too high. I discussed with another shareholder whether doubling their bets at this stage was the right thing in today's markets. Basically, we came to the same conclussion. During good times, its better to be diversified. In uncertain times, its better to be focused. Just like in the stock markets, you don't want to be in UT when they were struggling during the bull market. But in a bear market, you want to be concentrated in good performers, avoiding bad performers or company's where the turnaround is far away or too uncertain. Just like UT doubling their bets on their core businesses, I have decided to double my position in UT. I have not bought all as the markets can be volatile (as we've seen last week, UT is not immune). However, I have seen enough during the last 4 years that UT strategy now is correct, they have enough wins to convince me it is working and will work in the future, and finally the strong balance sheet/asset base puts a floor and future exit point should the "growth" not materialize. The stock price at these levels still present one of the best (if not the best) risk/reward ratios for the company at any time of its history.

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