Saturday, August 16, 2008

Quantifying the shortfall

Fellow shareholder Shadow tried to quantify the $100m cash flow shortfall for 2008. Normally, I would just reply on the yahoo board but this is a good discussion so I will post my reply on the blog. Based on $60m in cash usage used in preparation of the phase II BSNL broadband contract, Shadow focused on the $40m cash shortfall as follows:

"I gathered some numbers together from UTSI's 10Q and Tim's blog with the following results. Handset sales (PAS plus China CDMA/GSM) in H1 2008 were around $93M and for year are expected to be $155M indicating H2 sales of only $62M or $31M per quarter. I previously estimated that H2 resulted in an unexpected cash loss of an additional $40M to Analyst Day estimates by management and a loss of $135M in sales (initial sales were to be $1.035B and were revised per Tim's Blog now down to $900M). If you assume H2 handset sales were to match H1 sales then lost sales of $31M are now predicted. At 36% gross margin this would account for gross profit loss of $11.2M in gross profit from this division. If you estimate PAS infrastructure sales loss/delayed recognition of $30M with margin of 45%, you get a loss of another $13.5M. Using the sales constraint above, $135M total sales lost in H2 - $31M (handset division) - $30M (PAS infrastructure) = $74M of lost sales of CDMA handsets due to lost PCD contract. This results in loss of $11.1M in gross profit since gross margins for this product were given to us at 15%. So, total lost gross profit with above assumtions would be $35.8M which is close enough to the $40M in lost cash to be an acceptable solution."

I had commented previously that I was surprised with the $755m in non-PCD revenue expected for 2008 that was in the Analyst Day meeting. Using the mid-range values given late last year, I had come up with $833m. The initial company target for 2008 for the terminals business unit was $210m with a 22% gross margin so the $155m number that Barton mentioned to me a week ago was responsible for the bulk of that. The increase in PCD revenue noted in the Analyst Day meeting made up for the lost TBU revenue but it was also a bad sign already that I should have pursued more. The second item was during the cc to discuss the PCD sale. We learned that the internal handset part of the PCD would have $280m in revenue as noted in the Analyst Day slides. However, Barton was hesitant in backing this number during the CC and only mentioned that it was in the $200m something range. Again, this was something that could have helped in identifying the revenue shortfall.

Anyway, back to Shadow's calculations. I think the PAS handset contribution revenue wise is a good estimate but the gross margin of 36% is on the high side as the company knew even at the beginning of the year that margins would be lower (hence overall 22% GMs). This may lead you to increase the PAS infrastructure contribution of the loss but a large part of the shortfall in cash flow stems from the PCD distribution sale. Also, the $60m+ in TBU sales left might even be less than what you are estimating. The company did not specifically mention PAS infra regarding the cash flow delta in the earning call except in the conversation I had and that was described as "some" so the $30m you estimated is probably on the high side. This is a good discussion because of the importance still of PAS as it still generates about $210m + $155m or $365m in revenue for the company (assuming those numbers are still correct for 2008). I am a little reassured during the conversation that Barton emphasized not to extrapolate the PAS handset declines into the future and that Barton spent time in emphasizing that the PAS infra have much longer time horizons. Blackmore added that the telecom merger impact should help past this short term pain.

MCBU insight - I was going to post on iptv subscribers/revenues and the above discussion is a good backdrop to the MCBUs revenue stream. At the start of the year, the estimate for the MCBU was $315m. Since PAS infra was at $210m, only $115m or so is left for iptv and NGN. This might be more if the PAS infra number that Barton gave me did not include the expected shortfall. I'll continue this on the next post.

In summary, management lost credibility in not identifying the shortfalls in the Analyst Day meeting/slides. Maybe they thought no one followed the company anyway. Maybe they got complacent since they were going to sell the PCD and generate a lot of cash. The 27% one day drop after the earnings call only emphasized that the company has to communicate guidance and manage expectations much better. I had already emphasized my frustration for the discussion I had with Barry Hutton when we were discussing the guidance given in the Q1 earnings call for Q2. I want to point out that our conversation was when the stock was well above $5. While most shareholders will agree with the company's focus on the long term, the company cannot dismiss a drop from almost $6 to $3.5. Can you imagine the uproar of Apple shareholders if the stock drop to $90 in the next two weeks due to some short term issues?

1 comment:

Great Idea said...


What is your 6-18 month biew of this company and stock....could it become a "takeover" candidate for someone like "Cisco"?


I own this stock.