Saturday, July 12, 2008

Weekly recap - stock rebound

The stock closed at $5.57, up 97 cents or 21% for the week, recouping all of last week's 95 cent loss and adding 2 cents for good measure. On the other hand, the markets continued to make new lows (S&P officially in a bear market) as oil's early week pullback was shortlived and new concerns in the financial markets (Fannie/Freddie) and technology (Cisco warning tech spending will comeback in 2009 instead of 2nd half 2008). All of this further highlights UTs outperformance. Aside from the closing of the PCD sale, there was no other UT official news release so I will discuss various pillars of strength for UTs stock outperformance.

Strong asset/balance sheet - Last weekend, I highlighted the cash and assets and it is around $5-6/share (taking into account the rest of the year's cash flows).

Execution - Primarily, this has been tied more to resolving past issues, strengthening the balance sheet (with asset sales) rather than operational turnaround to profitability. These included paying off the CB, settling SEC investigations, finishing internal investigations, catching up on the quarterly/yearly filings, etc.

Turnaround expectations - With most of the previous issues resolved and the balance sheet very strong, the company can now focus on its turnaround. Compared to other companies that have to worry about loans coming due (or raising funds/diluting shares), deteriorating macro environments (slowing economy, high oil prices, real estate falling, etc), UT can focus on its operations. The company is also one year into the tenure of Peter Blackmore (as opposed to other companies that are just switching - See Wachovia and others). The "turnaround" for UT has actually been going on for years (except that progress has been slow). At the "core" of this turnaround has been reducing expenses at the same time growing the core businesses significantly while offsetting the declines in PAS. Since Blackmore arrived a year ago, much work has been done to put the company in position for a return to profitability. With the asset sales, the company has put itself in position (and scrutiny) for this expected significant growth with Peter targetting growth of the core businesses by several hundred million dollars. Let us review the history and in essense the entire strategy that the new CEO has laid out for shareholders and to which he will be held responsible for.

This is what Peter mentioned last November at the Q3 2007 earnings call.

"We have cut the cost base in the functions against a benchmark goal measured by best in class in our industry and we did this against revenue reflecting our core technologies only. Not all the functions get to benchmark immediately as we do have internal controls to improve, new IT systems to implement and some legal costs as we close out this years investigations. They will all get to benchmark by end of 2008.

Although both our Research and Development, and SG&A percentages are currently too high, we believe we can do much better. The model for our R&D is between 10-11% of our revenue, excluding PCD. We believe this is a reasonable ratio for an infrastructure business. The SG&A model is between 13-14%, excluding PCD. Excluding PCD revenues is the right way of looking at our cost base, as PCD is a stand alone business. The SG&A is still too high, but there are a number of costs driving that, including, improving financial controls and implementing a new ERP system. We can get to the ratio as I stated by late 2008 and 2009. The revenues of the early part of 2008 are still ramping."

He added: “We shall see progress in 2008, but I want to make it clear that the revenue ramp in many of these contracts is deferred until implementation is complete, so the way to measure progress will be by bookings, plus a gradual growth in revenue and with it profitability.”

During all these times, Peter has not wavered on this repeating it time after time. The expense ratio goal is 25% of revenue and the overall GM target is around 30% for a net 5% profit.

Commentary (based on last weekend's assumptions of CSBU OPEX): If they sell CSBU, opex will be down to about $85m or $340m/year. If I use Peter's numbers of 25% of the revenue, then the revenue should be $1.36B. On my last blog post, I used the 30% (gross profit) to figure breakeven revenue, which would be $1.133B. Even the $1.133B would be about a 17% increase (plus the offset of PAS decline) so even that would be a $170m+ improvement over 2008 revenues. I suspect that not only is the backlog for the rest of 2008 heavy. The numbers in the Analyst Day meeting are very conservative and Q3/Q4 will be very good. However, for sustaining the metrics, 2009 should have a good ramp as well so that bookings for Q3, Q4 should also be very good. Q2 will only have $120-130m of non-pcd revenue (although with a 25% increase in Q1 bookings of 150m, that would already be a book to bill of 1.5+ although off a very low base).

Discussion with IR: I sent Barry Hutton, UTs new senior director of IR, an email to clarify the CSBU opex that Barton mentioned in the last earnings call and the discrepancy in the guidance. Rather than getting a quick email response, he asked me to call him and we ended up talking for 45 minutes. I don't know if other people have this experience but I just cannot get a quick straight answer from Barry. Its like talking to one of my new engineers right out of college that either doesn't know the answer, doesn't understand the question, is afraid to say he doesn't know, or acknowledge anything wrong or what. The guy kept on repeating that the current end of the year quarterly target is $95m and mentioning that the 10% discrepancy in the simple math guidance was not a concern (to him maybe). Anyway, the talk reminded me of having my teeth pulled. So, after wasting 45 minutes (I do enjoy talking about UT but that was like trying to get my 2.5 year old to do something!), we "agreed" that the opex would be $95m/quarter and he didn't want to get hopes up for anything lower. I tried to explain that the revenue target would be more aggressive with $95m/quarter! Anyway, we went through the math at $95m/quarter (just to see if he got what I was saying), and came to $380m for the yearly run rate. At 25% of revenue, the revenue back calculated would be $1.520B. Management definitely realizes the significant ramp that is needed in core revenues to hit Peter's target metrics.

As a shareholder, I am not worried about the current valuation (based on the assets, and recent execution performances) but still wonder about the aggressive revenue ramp target. If they get close to that in 2009 (sustainable), I am going to have to increase my stock price targets :-)

Personal trading - As stated last weekend, I had accumulated UT shares when the stock was collapsing the previous week. I did not get to my stated goal of doubling my holdings as it did not go lower. I did manage to buy all the way down from $5.5 (high) to $4.55 (my lowest). I did sell most of it at prices above $5 all the way to $5.6 (mainly because of this market). Let me clarify that I am keeping the core (obviously) but no reason not to add when the stock slides down or sell when you have a decent profit. I also bought a bunch of Nortel last week as the market is getting oversold. By the way, there were a bunch of posts discussing possible sale of UT due to its more streamlined company, better balance sheet, and most of the issues resolved. I definitely think it is much more desirable now than back in late 2006 (considering all the issues and lack of traction in their core markets). The potential suitors only wanted the core part and the fact that the company is pouring the majority of their resources into it (and selling the rest) leads me to believe that the core is worth something (amazing, huh ;-) Anyway, if a sale were to happen, it better have a huge premium or else it is so much better to see the company in the revenue ramp phase for once and see how high the stock can go.

Have a good rest of the weekend to everyone!

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