Friday, July 4, 2008

Metrics after the PCD sale

The initial guidance for overall 2008 revenues was for an increase of 4.5% from 2.467b to 2.577b. From the Analyst Day slides, 2008 revenues are projected at 2.580b. No problem there or is there? Barton gave a business unit breakdown of expected revenues (I'm using midpt range values) and gross margins as follows:

MCBU $315m 37%
BBBU $180m 24%
TBU $210m 22%
CSBU $40m 70%
PCD $1739m 6.2%
Services $60m 35%
MSBU $33m 70% (The last one Barton forgot to mention in the target but consistent with overall guidance)
That adds up to $2.577b and 15% GMs total, which is the same as the overall numbers of a 4.5% growth in revenue and 15% GMs. In the Analyst Day slides, the numbers were for a 4.6% growth and 15% GMs).

Here is the discrepancy. Because of the strong performance by PCD, the figure in the Analyst Day slides show PCD at $1825m or a 9.7% gain rather than a 4.5% gain. Great, right? Maybe. Non-PCD revenue was projected at $755m ($1035m - $280m internal design) for a decrease of 4.3% from 2007 (thats according to the slide note). However, in 2007, I calculated Non-PCD revenue of $803m ($2.467b-1.664b). Based on the business unit target breakdown, I calculated a 2008 Non-PCD revenue of $838m! If we go with the 4.3% decrease in Non-PCD revenue (as noted in the slide), then the Non-PCD revenue should be $768m and not $755m.

IF somebody made a mistake on the slides and instead of a decrease of 4.3%, it was an increase of 4.3%, then it would be $837.5m ($803m * 1.043) or in line with the Non-PCD guidance from Barton when he discussed the individual business units. If Non-PCD revenue is $755m, then that would be a decrease of almost 6% and not 4.3%.

Q2 guidance - Revenue of $580-610m and overall GMs of 14% were provided for a gross profit of $83.3m. PCD revenue of $460-480m and PCD GMs of 6.5% were provided for a gross profit of $30.5m. Non-PCD revenue of $120-130m and GMs of 36% were provided for a gross profit of $45m. Does $30.5m + 45m add up to $83.3m? I don't know about UT's accounting systems but it sure does not look encouraging.

Q3 & Q4 2008 - Q1 Non-PCD booked was $155.3m ($586m total rev - $430.7m PCD rev). Q2 projection is for $120-130m (say $125m). So, the first half will have Non-PCD rev of only $280.3m. Nothing wrong with that and Barton could be very low balling Q2. IF 2008 Non-PCD rev is $755m, then the 2nd half should still have $474.7m of Non-PCD rev (I really need to have an accronym like NP for Non-PCD :-). Anyway, at 33% GMs, that would yield $156.6 in gross profits for the 2nd half or $78m/quarter. If the 2008 NP rev was $838m, then there would still be $557m. At 33% GMs, that would yield $184m in gross profits or $92m/quarter. Of course, I still need to back out MSBU but say quarterly OPEX was still $100m/quarter for comparisson. Then, you still have to add the gross profits from the internal part of the PCD. This gets a little complicated because if it is only $280m of the $1.825b, then its 15.5% of the total but 25% of the PCD revenue in Q1 was internal UT made. So, if 25% of the $430.7m (or $107m) is gone, there is only $172m ($280m-$107m) left or $57m/quarter. At 12% GMs, that is still $7m in quarterly gross profits.

Ok, back to the 2nd half quarters, IF NP was only $755m for the year (still including MSBU here), Q3 & Q4 would have gross profits of $78m+7m = $85m with a $100m expense or loss of $15m. If yearly NP was indeed $838m, then Q3 & Q4 would average $92m+7m = $99m or close to the $100m expense. In either case, you can see that the second half should have strong NP revenues and hence the neutral cash flows for the year.

Now, I was going to do a 2009 evaluation using $755m NP as a base case and add revenue increases to see how much cash burn the company would have in various scenarios but I'll pause for now (the discrepancy is huge on whether the slide note and numbers were a mistake!). Something to think about......

Cash and Asset Position

After the PCD sale and subsequent 17% drop in the stock this week, investors are understandably not happy. Because the operations are not going to be profitable anytime soon, it is now prudent to look (again) at the (1) company cash/assets and (2) growth prospects of the core businesses and timing of profitability. I will discuss the first part in this post and the second part in another post.

At the end of 2007, the company had $503m in cash and short term investments. It also had $323m in short term debt for a net cash position of $180m. During the Q4 2007 call, Barton updated the cash at $220m and the debt at $40m (net cash of $180m with half of the cash in China and half in the US). The full year forecast prior to the divestitures of the PCD and MSBU was for neutral cash flows. The almost $100m net cash gain after Q1 2008 will be reversed in Q2. So, I will use the net $180m cash as basis for my year end cash/asset balance. Here are my estimates.

$230m (sale of PCD including $216m upfront and $14m in escrow to be received soon)
-$30m The PCD had operating profits of $86m. Lets assume this is all cash flow to the company. For the 2nd half of the year, I am assuming they will lose $30m more in cash flow. This assumes 12% gross margins for the internal handset and 6% for the distribution part of the PCD (also using 6.9% overall GMs, $280m in internal PCD and the rest about $1.545b for distribution part).
+0m (With the same argument, the sale of money losing MSBU should benefit cash flows - unless revenue recognition in the 2nd half is much stronger, but I will assign zero for now)
+6m (With $230m in cash, the company should make 5% in half a year or atleast save in short term interest payments/borrowings)

So, at the end of the year, the company should have about $386m in net cash. Now, lets look at other potential cash/assets.

$10-15m? (Sale of MSBU. This division had sales of about $30m and potentially more from a source that contacted me. I didn't want to add any cash from this sale to the above figure just to be conservative).
$40-50m? (The other non-core asset is CSBU, which includes the 3com Commworks division it bought for $100m a few years ago. This division will be profitable this year, have revenues in the 40m (double from last year), and gross margins above 50%.
$15m (Long term investments)
$6m (2% remaining interest in PCD assuming $300m valuation)
$6m (Bank notes)
$30m (Restricted cash)
$10m (Remaining receivables from PCD sale in escrow due in 12 months)
$50m (Due 2.5 years from now if cummulative earnings from 2008-2010 are met, looking good so far)

Thats about $175m more in assets that could potentialy be realized.

Plant, property, and equipment are valued at about $210m (with the Hangzhou property/building alone assessed at $180m last year).

There are obviously other factors such as receivables, payables, inventory, intangibles, etc but the above adds to about $771m (or $200m more than the current market cap). Shareholder equity based on the last 10Q prior to the two divestitures was $661m (or about $90m higher than the current market cap).

The cash/asset part as detailed above is relatively straightforward. We have been doing these analyses for a while now. The more important analysis is the cash flow/profitability of the core businesses in 2009 and going forward. For a while now, the stock has been discounting the underlying assets due to losses and other issues. The stock has increased due to the elimination of certain issues and the divestiture of some assets but operational profitability is still far off. Barton was correct that it provides the company with more transparency and they can really focus on the core businesses. The outlook will change from the bookings they receive from quarter to quarter but I'll take a closer look at the situation in the next post.