Saturday, August 9, 2008

Post "Earnings Recap"

Based on the severe stock price decline on Thursday alone (27%) and the huge cash flow losses in Q3 and Q4, I decided to contact management to get some clarification and check if the long term thesis regarding the company is still intact. As you can imagine, the company would get a lot of calls from institutional investors/shareholders/analysts. The company scheduled 30 minute time blocks so that Peter Blackmore, Fran Barton, and Barry Hutton (individually or together) could respond to the interested parties. I got my share of phone calls Thursday morning as well and did not get back to Barry quickly enough so I was scheduled for Friday noontime. That worked out well as I was able to get feedback from other shareholders that had already talked with management and the digest the information. During my time block on Friday, I talked with all three (didn't expect Fran but having the CEO/CFO explaining/listening to your banter is always a treat for me). Anyway, here is what we (including other shareholders) found out.

2008 Revenue Shortfall - The 2008 projected earnings for the company (not including the PCD portion that they sold) was $1.035B ($755m core + $280m internal handset part of the PCD). This was reported in the June Analyst Day Meeting. Due to a loss contract in the internal part of the PCD, weakness in the PAS handset market and a little associated on the infrastructure side (due to the China telecomunications restructuring), 2008 company revenues will be around $900m instead of the $1.035B, or $130m less than expected. Because of this, all of my projections for Q4 breakeven to slightly profitable is out the window and instead of around $420m or so will come in at $290m-$300m. Note that analysts are even more bearish at consensus of around $240m-250m.

Impact of China Telecom Restructuring and PAS - I asked Peter if this was a two quarter or longer event and he responded that it should not be. Fran wanted to add that we should not extrapolate the sharp PAS handset declines (aside from normal declines) into 2009. On the earnings conference call, Barton made it a point to highlight PAS infrastructure has a longer contract period and subject to less fluctuations. For 2008, Barton mentioned PAS infrastructure is about $210m and handsets at $155m (about $20m or so of CDMA/GSM handsets sold in China are also lumped in this figure). For historical context and thinking about PAS impact in the future, those numbers are signficantly lower than the peak number of over $2b a few years ago but still represent about 1/3 the total company revenues for 2008.

Strong bookings growth in 2009 - Management will give more information on the 2009 financial model in the Q3 earnings call but did say that bookings growth for 2009 will be a very healthy 25 to 50%. I suggested that it might boost investor confidence to give more information on backlog/deferred revenue. While some of the contracts are multi-year, it would be nice to get information like when they reported having only booked $60m out of the $240m in iptv contracts a few quarters ago. Fran mentioned they will try to work on that part.

2009 Revenues - As mentioned, management will give more details about this in the Q3 call but other shareholders got indications the company is comfortable with high double digit revenue growth and one of the two analysts who downgraded UT has a $1.2B revenue target (per yahoo). That would indicate potential 2009 revenues in the $1.1 to $1.2B range. While not great considering that 2008 was projected to have $1.035B already, it is very healthy considering 2008 is down to $900m and factoring in PAS declines. Keep in mind though that these are only estimates and we know what can happen to those. Also, one analyst only has a $947m revenue target.

Phase II of BSNL (India) Broadband contract - This contract will be in excess of $80m+ but will not have the 30% GMs that Barton discussed other India contracts yielded this year. Peter mentioned that the company "had" to take this contract after Phase I. He did indicate it will still be profitable. The company will use up around $60m to purchase hardware for this contract in Q3 since they want to execute this without a glitch. One my questions was regarding potential cash burn to build a facility in India (we had heard something related to this in 2007 when they were ramping India contracts). This was a concern I had but Peter mentioned that they already had a logistics center that would assemble the products shipped from China.

China building lease - While at it, I asked about any updates on leasing space in the China building. They are looking to sublease currently to smaller tenants to establish price but nothing material.

Q3 book to bill - Q3 revenue will be around $180m but the company already mentioned that the Phase II India BSNL broadband contract will be booked in Q3. The number will definitely be higher than 1.0 but now that the recognized revenue will be low (compared to Q2), it should be. More importantly, the Q3 and Q4 bookings should be very strong to show good growth for 2009 and beyond.

Share buy back/strategic options - With the frustrations of shareholders, you can imagine this was discussed a lot. Other shareholders who brought up the share buy back got the indication that management will look into it but they are more focused on building the business for the growth phase. I myself did not bring this up anymore but did bring up the strategic options. I generally feel the stock price is ridiculously low anyway. With all the issues the company had back in 2006, the company felt the stock ($6-7) was undervalued and decided to try to sell the company. At the peak of that study, the stock hit almost $11, with an enterprise value closer to $1b. Now that they have resolved most legacy issues, streamlined operations, built up cash, and won significant strateigc contracts, the enterprise value is around $100m+ or so (even adjusting for the cash flow losses in the 2nd half). Anyway, I just wanted to point that out since Blackmore and Barton are also board members. Other shareholders have indicated that management response has been it would not make sense to do it when the price is at $5, let alone $3+. For the record, I believe in much higher valuations myself but the board/management (which has more information than we do) has to continuously think about shareholder value/share price and what the market is saying to them. My conspiracy theory is that management wants a lower stock price just to price the employee options and after that, we are really all in the same boat.

CSBU - Blackmore mentioned this in the earnings conference call that parts or all can be monetized and other parts that don't will be rolled over to MMCBU and broadband. Some shareholders also verified the $30-40m in expense savings if this was sold and got more confidence it will be sold in the near term as the company is bent on driving expenses lower. In the Analyst day meeting, Peter also mentioned all the none-core businesses will be resolved by the end of the year. Also, they are winding down their expenses for legal costs and reorganization so my spider senses tell me it will be sold fairly quickly (before the end of Q3).

Credibility - No doubt the management team took a major hit on this one and shareholders suffered. You can either give in and say this is the same UTStarcom and ignore all the progress that has been made or say this is one mis-step out of 20 good (and some very good) things that have happened (remember the non-dilutive resolution of the convertible bond, all the filings, sale of investements/assets, all contract wins, cost cuts, communication with the investing community, etc). I for one think that management is doing a fairly good job and have been defending the company/stock this last couple of days.

Cash flow for 2008 - The major bear point has been the company cannot make a profit and burns a lot of cash. The company got lucky with some investments and now have sold PCD to fund more cash burning. This is the same company that will push shareholders to their knees and shorts are right on the mark. One large institutional shareholder asked me on Thursday morning why I was not livid and that the company should be sold, blah blah blah. The way I look at the situation is based on the following. In 2006, the company actually generated $60m or so in positive cash flow while losing $1/share in the bottom line. In 2008, the company operations will lose $139m (without PCD, based on the Analyst day numbers) but guided to neutral cash flows for 2008 at the start of the year. Now that the cash flow loss is at $100m, every body is upset. Is this reasonable? Lets take a closer look. With part of the gemdale/infinera gains coming in Q1, the company was projecting neutral cash flows despite the operational losses. Out of the $100m in cash flow loss, $60m can be directly attributed to the hardware buildup for the Phase II BSNL contract. Part of it will be the loss of PCD gross profits for the 2nd half of the year (normally the strongest part of the year), and finally part of it is due to the 2008 revenue shortfall. After receiving all $240m from the PCD sale, the company should have about $465m. The $160m or so in cash flow losses will result in the company ending the year with about $305m. My previous projections taking into account PCD sale loss and positives from having the PCD cash was $386m. That is a difference of about $81m. $60m was for the buildup for the BSNL contract so essentially about $21m was due to the revenue shortfall. Is that commensurate with the recent price drop from the mid $5s less than a month ago? In the large scheme of things, is the short fall in the core businesses or will impact 2009 and beyond? Are people buying the stock based on the cash?

2009 cash flows - Currently, one of the analysts has a 47 cent operational loss in 2009 or say $58m. Cash flow can fluctuate a lot from the P/L but as we've seen in 2006, it could be positive despite operational losses. In Q3 2008 alone, the company will spend $60m that will become receivables in 2009. In Q4 2008, the company will have smaller losses (due to higher revenue and lower expenses than in Q3) so part of the $50m cash flow losses will be a benefit to the payables/receivables category. So, for those trying to extrapolate major cash flow losses into 2009, I just do not see it. With a potential sale of the CSBU and its corresponding expense reduction, that would further bolster the $305m in cash on hand. Add to that minimal interest payments, increased interest on their cash, continued benefit of yuan rising, and cash should be very solid. They SHOULD generate cash in 2009.

2010 and assets - With bookings growth in 2009 in the order of 25-50%, margin improvements, ramp of iptv in China/worldwide and further expense cuts, 2010 should be solidly in the black operationally. Cash position that could grow in 2009 (due to sale of CSBU and other things I just highlighted could also be boosted by up to $50m by the end of 2010). Add in the $30m in restricted funds, $25m in other long term investments, and their buildings $180-220m), and... This really reminds me of the situation with Apple computer where it went down from $60 in 2000 to $12 in 2002 (trading at cash/assets) and now at $340 (split adjusted).

Summary - As a long term shareholder with this company (I am a trader on other companies), I have to look at the entire situation. Everyone has their own position and if they want to sell, I tell them to go ahead. I personally have added and built my position (not all the way yet to what I want but over 70k now) and am hurting looking at the paper losses. The way I look at it, the stock will be much higher in a year or two and that anything in the $5 level is a no brainer.

I will still post a weekly recap but felt I needed to do a post "earnings recap" because of the additional information the last couple of days. Its really brutal right now but am even more confident that this has a bright future for shareholders. Have a great weekend. (BTW, there were over 350 hits in the blog on Thursday alone, it was down to about 20-30 recently - lots of interest with this company :-)

1 comment:

tim_94305 said...

Forgot to add that the up to $50m the company could get by the end of 2010 was for the PCD sale 3-year performance provision.