Saturday, March 22, 2008

Recap of Exploratory group meeting with management/BOD (2)

Sale of Non-Core Assets - During the last earnings call, management mentioned they were in active discussions to sell none-core assets. Merrill Lynch is assisting in the asset sales. Peter mentioned he was spending signficant time on the divestitures. The potential business units to be sold are the PCD, customs solutions BU, and the mobile solutions BU. Indications are that two of the business units will be sold. At UTs current valuation ANY sale would really jump start the stock price. A share buyback would almost be guaranteed. This is definitely something to look for in the near term.

PCD - How much can the company get for the PCD? This division is set to have revenues of $1.7b in 2008. During the meeting, management indicated that 35% of the revenues will be from internally made designs and that quarterly expenses are about $10m (or $40m/year). Based on 6% gross margins, the expected gross profits will be around $104m for 2008. So, net profit will be around $64m. Motorola's handset division has revenues of $19b but lost $1.2b last year. There is no way they will get 1x revenues for it at this time as Icahn would like. Motorola's entire market cap right now is around $21b. So, how much is UTs PCD worth? Based on the revenue growth, the profit margins, and the steady improvements in UTs own internally made handsets, I would value it much higher than the $200-250m that has previously been discussed. At 7x multiple of earnings, it would be over $400m. At 5x earnings, it would be $320m. The internally designed phones make up about $600m of revenue already. My best guestimate would be $350-400m and it could be conservative. If this were to be sold, then obviously, 2009 profitability will not happen but I think we can all live with having that kind of cash/liquidity right now. There was a recent article (link posted by kr_khous about Dell and handsets (http://blogs.barrons.com/techtraderdaily/2008/03/20/dell-entering-the-mobile-phone-market-in-2009/?mod=yahoobarrons). It seems like other companies may be able to extract more value from the PCD than UT can and drive valuations even higher. The sale of assets specially the PCD would make the stock explode.

Communication - Management mentioned that since their products are relatively new (iptv/ngn for example), customers are hesitant to put out PRs and thus the company cannot disclose contracts until much later or at all. In some cases, just getting the release paper work is a chore and takes a long time. They did feel that things can be improved. Contract amounts could also be added in the future. Some items that could be disclosed simply happen at the last minute. For example, the cash used to repay the CB fully literally came in the last week so a PR could not be issued. Even the intent of paying the CB in full could not be made earlier or last year because they simply did not have the cash in the US at the time and would have had to say they did not have the cash at the time. I think the information provided in the earnings call have been generally good. However, there may simply be not enough time to address each item in extensive detail in the call. For example, the ongoing concern statement. Barton could have tried to work on removing the statement (5% chance of success according to Barton) but they would have had to file the report 30 days late or just take the hit (have the ongoing concern statement) and get it filed. So, they just got it filed, which everyone agreed was better. There are other items that could be tied to communication. Guidances can be refined so its not too conservative and lead to confusion on business perormance or suspicion of lack of control. I guess with the stock at this level, it is very fragile and the company has to be careful in what they say and don't say. That also became an issue with filing the 10K a day late (or even a couple of weeks late). A shareholder even commented on the announcement when earnings will be released. It seems that other companies can announce the date of earnings much earlier than UT can. Barton replied to the effect that they did not want to close the books to early or too late. This may still be part of the accounting switch to the new system but I got the indication that the earnings date announcement will continue to be last minute. There was also no announcement of the OEM that they have already signed and the ones they are still working on. Communication is very important since it is tied to confidence. If communication is poor, confidence is poor and also reflected in the stock price. Management also mentioned that they have spent most of the time in running the company rather than doing roadshows with the investment community.

Overall CEO position and China CEO situation - Peter is set to assume the CEO post on July 1 and will be more active with the investment community (Peter mentioned that hopefully, there would be more good news to announce as well). I had thought that this (CEO spot) was not assured and that if not offered the CEO title, his contract would stipulate some other arrangement. But, it seemed it was already "known". I think this is clearly another communication issue and it would have been great to have a PR on this. There was no update on the China CEO position. Many new managers were hired in China and they are rebuilding since Wu left.

IPTV Strategy in US and around the world - If UT's iptv system is one of the best, then they should be able to penetrate different markets around the world. Blackmore mentioned that they hired Mckinsey a while back to determine which areas they should focus on. Mckinsey mentioned to "double down" in Asia, stay away first from the US/Western Europe, and try to penetrate the peripheral of Eastern Europe and other areas. A shareholder asked about Mexico and iptv. Management also mentioned Mexico as a possibility. Peter also mentioned that they carefully weigh the risk/rewards (expenses/potential profits) on each area as we would hope for. There is also a lengthy qualification period for a lot of the providers so it is not as easy to break in to new customers.

IPTV competition in China/optical/gepon/broadband situation - The recent news in Shanghai of Huawei giving their iptv equipment basically for free and UT having to share the rest with ZTE drew some concerns. Management clarified that Huawei system is so bad they have to give it away and they know UT's system is excellent and there is no need for major price cuts. Huawei and ZTE are very good in other products but they know customers know UT has the best product in iptv. So, those were normal discounts not expected to impact margins. Even if UTs customer gives away the iptv system for free for promotion, they obviously still get paid. The Shanghai news of expansion to 800k users should have been VERY good news but instead got twisted into a concern. As far as the other news of UT being shut out or not in the top suppliers for a recent gepon contract in China, management mentioned UT working to be a 3rd or 4th supplier. These are not big contracts and are usually divided among about four suppliers.

IPTV regulatory issue in India (MTNL) - No problems according to Blackmore.

It should only take one more post to wrap up the meeting recap.

Recap of Exploratory group meeting with management/BOD

On Monday, March 17, 2008, seven shareholders from the group met with Chesha kamieniecki, Peter Blackmore, Fran Barton, and Thomas Toy at UTStarcom HQ in Alameda. It was a productive meeting that lasted over 3 hours. Prior to the meeting, Chesha had asked if we wanted management to give us a presentation or just Q&A. Since we just wanted to go straight to the main topics, just Q&A was preferable.

Fran Barton started with the forward looking statements and to remind us that no material information would be released to the shareholders at this meeting. Peter Blackmore welecomed the group and introduced the management team and the director present at the meeting. He then turned it over to us.

I gave the introduction for the group going over the previous frustration/confusion of shareholders. As people know, the company had a lot of success with PAS but knew that the company plan was to diversify away from China and PAS. As background, the company had a $2 profit/$4 billion estimate for 2005. Anyway, I started my historical reference after quarterly losses have built up in 2005 leading to the hiring of Fran Barton in Aug. 2005 and the massive writedowns in Q4 2005. As an investor, we were hoping for the iptv ramp and return to profitability in early 2007 (as the company had guided). In the early part of 2006, the share price was around $6 when Hong Lu announced he was stepping down and Ying Wu would take over as overall company CEO starting in 2007. Towards late 2006, the stock started moving up to the $10 range. It could be that the market was anticipating profitability but we learned about the strategic alternative study in October 2006. At that time, the stock stayed in the $9-10 range and we learned that Ying Wu would not take over as CEO, Wu would lead the strategic alternative study, and Lu would stay on as CEO. I asked Director Toy what prompted the strategic alternative study and he responded by saying there was conern regarding PAS decline and at the time felt the share price was undervalued. During this time, we had more delays of the filings as well so did not know whether they would achieve profitability in early 2007 as guided.

The first half of 2007 was basically waiting for the quarterly filings, results of the strategic alternative study, and dealing with options investigations, Nasdaq notices of potential delisting, and negotiating with bond holders regarding additional interest payments so that the company would not be in default on the convertible bonds. The stock steadily dropped to the $7 level as we waited for news. At the end of May, we found out nothing happened with the strategic study, Ying Wu was leaving the company, and Lu was moving to China to stabilize the China operations due to Wu's departure. The stock dropped from the $7 to the $5+ level. At this time, there was still no financials out. At the end of June, the company hired Peter Blackmore to be COO and eventual CEO to replace Lu.

The first hard operational data we received from the company in about a year came on July 24, 2007 when the company released a liquidity update. Based on the last balance sheet, the company had NET $260m in cash. However, the liquidiy update showed net cash falling from $300m at the end of 2006 to $150m at the end of Q2 2007. What happened to the profitability guidance and why was there significant burn rate? Add to this a NEW China investigations and further delay (no timeframe) to the financials. The stock dropped from the high $4s to the $3s. As the stock threatened to break $3 to the downside, the company finally had a cc (Interestingly enough I had posted the company NEEDED to have a cc about 10 minutes before the PR came out). Anyway, a new guidance was issued that the company will get back to profitability and be cash flow positive in EARLY 2008 (As Barton explained at the time, Cash flow positive/GAAP profitability were pretty close).

The reason I had to go over (painfully) the past was to find out if the company really had clear direction this time. During the Q&A on the last November shareholder meeting, management basically said you can trust us or you can sell out. I wanted to let management/BOD know that frankly those are not acceptable options to shareholders. I asked them if they truly feel they can turn this around or are we headed for more frustrations/disappointments. After all, they do know the operations more than shareholders and Blackmore has had some time to look at the various operations and can assess the situation. I mentioned that if this cannot be turned around, then it would be better to go into a new strategic study and just sell the company. Blackmore mentioned that they do feel they can turn this around and it would be a mistake to sell now. Great, but they CANNOT just continue doing business as usual. I think Blackmore did comment that he would be careful with "sense of urgency" comments becuase as I had mentioned, there is a difference with the sense of urgency that management/BOD feels and the way the street/shareholders feel. I wish I can say I just bought recently or even a few months ago and can wait patiently but this turnaround and promises/guidances have been going on for a very long time. Anyway, if they are going to try to turn this around, some things simply have to change and thats why the group brought some proposals and questions. With this setting, we proceeded with the various issues the group has outlined. The format would be to go down the list of issues with me giving a brief intro and other shareholders chiming in with management responding. I have to credit management for addressing each point for the three hours. While there were some overlapping topics, we tried to keep to the list. Here are the details on each topic.

Share-price/Stock buyback - During the last cc, the company announced payment of the CB and other short term debt. This was definitely positive but with the all-time low shareprice, investors were asking for a stock buyback. Even way back last year, shareholders already wanted the company to defend the stock price. Director Toy's position is that data they have from previous stock buybacks showed that limited buybacks were not effective. I made it a point on disagreeing with Thomas Toy on this issue. Shareholders went through all the reasons for a stock buyback such as taking advantage of the all-time low price, best return of investment, reduce share count, defense of the fragile stock price, show much needed confidence, etc. How low does the stock price have to go? Management also mentioned that even if they were to do a buyback, they are also in active discussions to sell none-core assets and there are complications with announcing a buyback at the same time. Based on material information disclosures, we obviously were not going to get a buyback announcement but felt they are more likely to do it after an asset sale. Barton already mentioned no stock buyback on the last call but atleast they are thinking about it.

Compensation - I told Fran Barton I have to pick on him because, well, he is a big target. I was surprise to see that Chesha and Toy were eager to "defend" Fran. I know Fran is well-liked but didn't know how well-liked he really is. A little background on compensation. Fran joined the company in August 2005 and took over for Mike Sophie. We learned in this meeting that they did not have the systems he was expecting back then. Fran's salary was $500k and was increased to $750k partially because of this. I was surprised to learn from recent filings he has amassed 1.3 million shares as well. After the last shareholder meeting in November, Fran also was given a retention bonus contract of $2m/year for the next 5 years to stay on. This is on top of yearly bonuses he may earn. My compensation question was general but wanted to focus more on Fran's compensation. Anyway, Thomas Toy is part of the comensation committee and addressed the compensation issue. He explained that salary is based on data from comparable companies with similar market caps and revenues. I would have argued about the revenue part but base salary was secondary to the bonuses and shares issued. He explained that Lu being the founder and having to uproot his family to China deserved the compensation and that he has not had a salary increase in a while. Blackmore is compensated accordingly based on the current situation of the company and demand for quality executives. I think most shareholders would not question the compensation except for the stock performance and inequalities that they see between what management is getting and what they have to risk (and that they know so much less than the insiders). Anyway, getting back to the $2m/year retention bonus. Toy basically said they had to pay Barton for the sake of continuity during the turnaround phase and that good CFOs were hard to find. I think most shareholders are also for continuity. My response to all of this is that Fran Barton really HURT shareholders will all the poor guidance (see intro above). Being an investor, I base a lot of my decisions on the CFO's guidance. Barton's 2007 profitability guidance (that turned into a $1.62 loss!) and the lack of preliminary numbers during the lack of filings really hurt investors. Barton responded by saying they exceeded early 2006 guidance. Yes, they did but even those guidances were WAY off. Being an engineer or any technical person, we cannot be WAY off. Are they just throwing darts here? What good are numbers if they are way off? Some other information. Morningstar mentioned the $1.4m in bonuses paid in 2006 to Wu, Lu, and Barton were excessive. We did learn that there was no bonus paid in 2007 and that 2008 bonuses are tied to a more diverse set of performance metrics. I could probably spend more time discussing this but lets move on. Towards the end, I said "so the BOD approved all the compensation"? Barton was quick to reply that he wished he was able to approve his own compensation and Toy mentioned that obviously the compensation committiee would approve the compensations. Sadly, I think it did not dawn on them that I was hinting at "accountability." Here is the take away on compensation. There may be very good reasons for the enahanced compensation but like a lot of the reasons I heard that day, the end result is bad for shareholders. The fact that the company was driven to this situation actually now makes these guys more VALUABLE? When Fran came in, even Chesha had to help out a lot on the CC. Now, that they have things more in place, they are indespensable. That is just bad math for the shareholders. I believe the compensation topic ended with me saying somethiing about the 11% they let go and that I just hope Fran Barton is worth it or something like that.

OPEX- The company has announced that they believe expenses are still way too high and are looking to cut more. Why can't they cut right away? Some business units that are not profitable cannot simply be shut down because of the impact it would have on customers, who are also buying other products from the company. So, that part is not as simple to do. It would be better to divest those units rather than simply closing it down. Management is still on track to reaching the expense metrics they have guided by 2009 or late 2008. The "core" revenue will include the internal design handsets part of the PCD. They are about to move to a new Oracle accounting system next month (seems like the accounting software may finally be resolved, that also has taken a while because Chesha mentioned they just grew too fast) and are reducing headcount by about a 100. One other shareholder asked if there were other low hanging fruits to pare off and Barton answered positively. He definitely says more can be done. Barton mentioned that it seems they have been revising 2002 financials forever and that accountants are charging a LOT. R&D funds are concentrated mainly on iptv/NGN now, very little on PAS. As PAS continues to decline, SG&A related to PAS will also come down. Another shareholder discussed expenses and that it really should come down much faster. Barton seems to have things in control with the projections for 2009 profitability as he mentioned and pointed to his master plan folder (if someone can steal that folder, maybe we can lay Fran off. he he). Seriously, I think Peter/Fran ARE looking at all expense cuts/efficiency measures but it is just taking some time. Management seems fairly confident regarding getting back to profitability. I think the street is underestimating profitability in 2009 and thinks it will be later. I think most shareholders believe that R&D can be impoved a bit but it is the future of the company. SG&A has to come down much more.

NOTE: Over two hours ago, I had reached this point of writing and was in the process of posting when I found out the internet had been down all along. Normally, there is an automatic draft save by this web hosting site but since the internet connection was down, it wasn't saving! So, I lost everything (exept the first 3 lines) when I tried to post and had to start over. If the writing is a bit "rushed", I have an excuse :-) I'll continue after a late late lunch. Make sure you SAVE your documents.