Sunday, May 17, 2009

Company info and future steps

At the end of the month, the company will provide information regarding "accelerating" the timeline to profitability which the company has recently stated to be "sometime" in 2010. The current opex target is for around $60m/quarter by the end of 2009. Presumably, this information might involve cost cuts, restructuring, outsourcing and maybe closing certain operations. I wanted to check some figures in the 2008 yearly 10-K and gain some additional insights into the company. There is only one official analyst following the company now and little institutional interest in the company. The operational performance has (not surprisingly) depressed the stock but even with the latest "surge" and decrease in tangible book value, the shares still only trade for half book.

1. Cash in China - "At December 31, 2008 we had cash and cash equivalents of $309.6 million, of which $200.8 million was held by our subsidiaries in China. The amount of cash available for transfer from the China subsidiaries for use by our non-China subsidiaries is limited both by the liquidity needs of the subsidiaries in China and by Chinese-government mandated limitations including currency exchange controls on transfers of funds outside of China." "As a result of these and other restrictions under PRC laws and regulations, our China subsidiaries are restricted in their ability to transfer a portion of their net assets to the U.S. parent; such restricted portion amounted to approximately $186.1 million, or 40% of our total consolidated net assets as of December 31, 2008. We believe we have sufficient non-cash assets available to meet the above reserved net assets in China restriction; such that none of our cash balances are legally restricted from transfer."

The restrictions in transferring cash out of China has always been a point of contention but it is clear that they have enough non-cash assets that pulling cash out of China is not a major issue. Moving part of their US operations back to China will reduce capital needs outside of China as well.

2. Credit Lines - At December 31, 2008, we had approximately $219.0 million available for future borrowings on this China credit facility, of which an aggregate of $146.6 million remained available for general working capital purposes and $72.4 million remained available in support of letters of credit and corporate guarantees. This China line of credit expires in the third quarter of 2009. In January 2009, we entered into a second credit facility in China for an additional $58.5 million of available credit which expires in December 2009.

The credit facility in China is supported partially by the Hangzhou facility but its also clear they have a good chunk of credit facility within China.

3. China Piggy Bank - Our China subsidiaries paid an aggregate $150 million in dividends to our U.S. parent company during the year ended December 31, 2007 and another $100 million in February 2008. While these cash transfers are offset and eliminated in preparing our consolidated cash flow statements, they have been a principal source of funding of our non-China operations during the periods in which they were made. In February 2009, our China subsidiaries paid an additional $50 million in dividends to our U.S. parent company, and additional cash dividends from our China based subsidiaries to the U.S. parent company may be necessary to fund our non-China cash requirements in 2009.

Pulling an additional $50m in February seems like a lot. Cash usage in Q1 was only $12m.

4. Global Footprint - The headquarters for our China operations are located in Hangzhou. In 2001, we purchased the rights to use 49 acres of land located in Zhejiang Science and Technology Industry Garden of Hangzhou Hi-tech Industry Development Zone and have built a 2.7 million square foot facility on this site. The facility was occupied in October 2004 and is used for manufacturing operations, research and development and administrative offices. At the end of 2008, approximately two-thirds of the facility was being utilized.
We lease approximately 0.8 million square feet of property, of which 0.4 million square feet are properties in China and 0.2 million square feet are properties in North America. We maintain 31 sales and customer support offices in 21 countries covering the United States, Canada, Latin America, the Caribbean, Europe, the Middle East, India, and the Asia-Pacific region. We lease sales offices in 28 locations in China.

The global expansion and operations in the US has been a cash drain to the company and has not produced the desired revenue ramp. The company may announce further reductions in the US and other countries outside of China.

5. Japan Revenues/Non-China/US Revenues - Japan revenues were down again in 2008 from 70+m to $40.6m. The non-China/non-US/non-Japan revenues is $160.9m.

Japan has been a major disappointment, specially with Softbank as a major shareholder. From $400m+ in revenue to $40.6m ($38.3m from Softbank). The $160.9m revenue in other countries does not justify the investments there and the lost focus in China. The company has had enough time to decide which countries they will continue to invest in and which to abandon. Blackmore from the start talked about each business unit being profitable and/or cash flow positive. He needs to make additional tough choices when things don't pan out.

6. Carry Loss - As of December 31, 2008, the Company's U.S. federal net operating loss carryforwards were $213.8 million and expire in varying amounts between 2025 and 2028. As of December 31, 2008, state net operating loss carryforwards were $138.0 million and expire in varying amounts between 2010 and 2028. As of December 31, 2008, the Company also had net operating loss carryforwards ("NOLs") in China of approximately $217.2 million. The China net operating loss carryforwards will expire in varying amounts between 2010 and 2013. As of December 31, 2008, the Company had NOLs in countries other than the U.S. and China. These NOLs are approximately $87.2 million. The majority of the NOLs do not expire and can be carried forward indefinitely.

Even in China, the loss is significant. Depending on a particular country's tax laws, acquiring UT could provide some tax incentive but not as significant as had been discussed because of the breakdown in each country.

7. Hanghzhou Facility Valuation - Using the income capitalization approach, we determined the estimated fair value of the facility and related improvements at December 31, 2008 to be approximately $183.2 million, which exceeded its net book value by approximately $15.8 million. As a result, we concluded the headquarters for our China operations was not impaired.

The company has used the facility for its credit lines but this is still a huge asset to hold considering its value compared to the current market cap of the company.

8. Leased Space - Total (in millions) $ 19,245; Less than 1 year $ 10,854; 1-3 years $ 6,422; 3-5 years $ 1,969.

Moving operations fully to China will further reduce the expenses.

9. Accounts Receivable - 39% of receivable was from PCD at the end of the year.

This has come down since they took in about $40m from Q1. As they wind down operations in Q2, this will further simplify the balance sheet. Writing down assets and simplifying operations increases the odds of an outright sale of the company.

10. Accounting Firm Yearly Cost - $11.5m for the last couple of years.

I voted against renewing the accounting firm. At the very least, they should negotiate a lower price for fees. Spending $11.5m/year for the last two years is significant specially with the much lower revenue base and market cap. This is another reason why UTs expenses are out of line with revenues compared to other companies. The company has mentioned legal expenses, accounting expenses, etc as areas where they can further reduce cost but it this is a yearly event for the last 4 years. As a shareholder, I am blown away with their expenses compared to the performance. Being a US investor, I am used to high compensation for executives and general costs but I would also like to see performance.

Overall Commentary:

The information above shows the massive resources the company had/has. It definitely is not a startup and shows the company never really developed a sustainable/profitable business plan. The company was given a huge windfall with PAS success and early capital from US markets but has squandered a lot of it. From the above, it seems clear they have much more costs they can cut but have ample liquidity to execute it (scary in itself). The company definitely has positives (or else none of us would still be interested in it) and is in a "unique" position as Blackmore puts it. While it seems long overdue that the company get ahead of the curve, their resources show why there is no sense of urgency. The sense of urgency has to come from investors fed up with the performance of the stock. Lu has basically led the company in the good times but clearly cannot lead the turnaround. Blackmore is a competent executive but may not be a good fit for the long term. The board ....well..

I voted against Hong Lu/Jeff Clarke. Your broker should send you information via mail/email to vote. Shareholders have until June 25, the day of the shareholder meeting (or a day before to be exact). I continue to believe in the valuation being that it is half book. The company hopefully will be serious in getting to profitability but we never know. The revenues for PAS/Japan are low but still material so there is possible further downside. Expense cuts clearly need to be lowered and maybe an outright move to China will be announced. Sale of certain technology/businesses need to be considered although it seems a lot is inter-related. Also, the market cap is low so the acquirer will probably want the entire company at this stage and it makes sense now that the balance sheet/operations are much cleaner.

The above points are good to keep in mind as things are announced and there is further discussion in the message boards.

Have a good week everyone.

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