Sunday, November 22, 2009

Q3 2009 CC Recap

The transcript from the Q3 2009 call can be found in the following link:

The live broadcast and SEC filings can be found in the company website. I have talked to some institutional investors that communicated with management and will add some "color" to the information provided in the call.

Q3 Results - Revenue came in at $71m with 34% gross margins. The GMs included a $6.5m benefit from reversing some handset writeoffs for PCD. Factoring that, GMs were in the mid 20s. The expenses were $58m (with $8.9 restructuring charge and $1.7m non-cash charge for divestiture of Korea based handset operations). I'll have much more on the expenses and restructuring later.

Business Units - MMCBU had revenue of $22m and 46% GMs; Broadband BU had $16m revenue and 22% GMs. Services had $17m in rev and 44% GMs; Handsets had $16m revenue and 21% GMs. The overall revenues ($71m) is still lighter than the $85m needed for breakeven but the margins are close to their target of high 20s. The margins for the MMCBU was lower than last year(with PAS) but seems higher than what I expect with iptv STB. The mix this quarter probably had more software/infra component than subscribers, which support the lowered expansion in subscriber count for 2009. The highlight of the quarter was the 22% GMs for the broadband unit as they managed the BSNL phase II contract well and gives added confidence that the Phase III contract will have decent margins (as long as they execute well). The services actually increased revenue (from $14m to $17m) and had very good margins. Handsets were down significantly from last year (that included much more PAS/PCD). The GMs of 21% benefitted from the $6.5m reverse of writeoff. The company is de-emphasizing this lower margin business unit except for handsets specifically sold with their mobile iptv system.

Broadband - Peter Blackmore expects the company to take in a significant order for the Phase III BSNL multi-play project this quarter. Part of the order will be this quarter and the 2nd part around April 2010. Peter mentioned on the call that execution of this contract is a key focus and this will affect the outsourcing transition and result in significant shipments in Q1 2010. Additional shipments in Q1 2010 will be driven by the Transport Network (TN) win with Softbank. Together with better execution of the BSNL project, the higher margins with the TN product will drive the margins for the broadband unit going forward. Peter mentioned the TN product as having good growth opportunity and a leadership product (also "exciting"). There was mention that they are actively bidding this product on a number of RFPs, notably China Mobile, where they are partnering with Nokia Siemens (NSN). The margins with Nokia Siemens will be lower but give them a better chance of winning part of the China Mobile tender and break in with China Mobile. NSN has been a major supplier to China Mobile but they don't have the TN product. Other partners of NSN such as Juniper do not have a competitive product as well.

Additional specifications/marketting materials on the TN product can be found in the UT website (this is additional items from what I linked to previously).

Aside from the TN 703, 705, and 725 products, there is a 735 product with 240GB/s switching capacity not formally announced yet. IR has mentioned providing access to UT engineers for technical questions from the industry on the TN product.

In South America, Peter discussed the recently announced Logicalis sales agreement leading to projects in Argentina, Paraguay, Peru, and Chile for their IPDSLAM, MSAN, and GEPON products.

IPTV - Due to spending focus by Chinese carriers on 3G, iptv momentum in 2008 did not carry forward to 2009 although Peter believes there will be a return to significant iptv investment in 2010. There was a recent win with the Beijing SARFT and chosen as solution provider in 4 cities with (CCTV/Hunan). They were selected as a preferred vendor by China Telecom to deploy the new STB Standard 2.0 (this would allow them to compete for STB business with other iptv systems). Also, "And in Guangzhou, the capital of Guangzhou province recently launched the IDTV service, SMIC, the Southern Media Group and this is the revenue sharing model, we share in the advertising revenues, and we are expected to expand the service to other cities throughout the province."

Restructuring - The employee count is down to below 2700 by the end of October from around 4300 in June. The company will continue to reduce headcount in Q4 and Q1 2010 (probably 500 in Q4 and another 300 in Q1). SG&A for Q3 stood at $33m and R&D at $14m. The target model is around $11m SG&A and $14m R&D. Based on the 10Q, $35.143m of the announced "2009 restructuring" has been recorded but there is still $19.8m balance (cash to be paid out). For the 2008 restructuring, there is still a balance as well. So, for modeling cash and book value going forward, there is still $24m in cash to be spent on restructuring that have been charged to book value and another $5m to 10m in charges/cash to be added (to get to the $40-45m they announced back in June). The company is down to 1 building from 3 in Alameda and will probably maintain 30-40 employees in Alameda. The company "formally" announced in the call that they are looking into moving the HQ to China.

As a side comment, Barry Hutton, UT IR left the company (last day was Friday). They still have offices in Rolling Meadows and in Miami for the Latin America/International sales force team.

An outsourcing vendor has been selected and a PR on it is coming.

Other items - Peter talked about adding new board members and the potential sale of their building in China but no new information on that front.

Company Credibility/always LATE - For years, I have been against the poor BOD and management. Unfortunately, this has continued during Peter Blackmore's tenure. Lets look at just some items that have been executed poorly or "late".

Divestitures of holdings such as Infinera, Gemdale, and even PCD.
Filings and accounting issues that added tens of millions in interest costs.
Last minute transfer of funds from China.
Restructuring and expense cuts time and again.

There is just a corporate culture of being behind the curve and acceptance of poor performance and no accountability. Up to now, I still cannot believe that Lu/Toy and the rest of the BOD are still there with no major changes.

Peter has done things that shareholders want such as the restructuring/focus on core products but he has been late again. I believe he is on the right track and will eventually get there but in the meantime, the company has racked up over $1B in negative retained earnings and the book value has plummeted from the $700m+ level to less than $300m in 3 years (despite the investment gains).

Book Value/Cash flows - Despite the above issues with the BOD/management, the company is incredibly cheap. As of Q3, the company had cash/short term investments of $241m and $296m in stockholder equity. For the next two quarters where losses are still projected and the restructuring is to be completed, lets evaluate the book value/cash. Cash usage for the restructuring will be $24m + $5-10m (for 2008/2009 restructuring). Cash usage for the losses in Q4 and Q1 (say $30m - just a guess). They will bring in $3.5m for the Starent settlement. So, by end of Q1 2010, cash can be down to the $180m level. Because $35m of the $40-45m has already been charged, shareholder equity will decrease by only $10m (upper range of restructuring remaining) - $3.5m (Starent gain) + $30m (Q4/Q1 loss). That will leave shareholder equity at $260m. For 2010, there will be over $100m deferred revenue to be recognized + cash generated from BSNL Phase III so both tangible book value and cash should not be reduced and may start turning upward. Again, this is just my evaluation of where the bottom in cash and shareholder equity will be ($180m and $260m). That compares to the $245m market cap the shares are trading at. So, they are trading above cash based on Q4/Q1 losses and restructuring cash expenditures. But the shares are trading lower than book value even incorporating the Q1/Q4 losses/restructuring charges.

The negatives offsetting the valuation is the BOD/management and their culture of underperforming. Have they done "good things"? Absolutely, such as selling investments, non-core businesses, cutting expenses massively, refocusing on China but they have ALWAYS been late and lateness comes with a price that shareholders have taken the bulk of the brunt.

Company status - There is a powerpoint presentation on the company website on a Sept 30 2009 roadshow.

95% of the material is what has been posted/discussed in the past. However, it does show major operational differences from the years past and the current situation. The customer list is still broad and targetted at the high growth markets. The product line-up is sensible and there is a renewed focus in China (broadband and overall company basis). The company is emphasizing China, India, AND Japan again so there is a renewed traction in Japan with the TN product (margins emphasized). There are still major questions on whether the upside can justify the expenses of the last few years or even now (given their company culture). It is easy in the past to cite a lot of links to technology or worldwide growth in related sectors/products but for UT, it comes to are they in position with their current customers and products (and can they execute). I am not in this investment for the current management/BOD but for traction in their products with their current customers/geographic markets. I am also not for a quick sale based on declining cash/book value because as the above indicates, this is near the bottom (for now). In the next year or two, the company has to either show progress in adding to the tangible book value or there is no turnaround hope anymore.

A lot of the sentiments (above) are what shareholders have discussed but hopefully, it has been quantified a little bit more and provide some metrics to track for the next few quarters.

Have a good rest of the weekend.

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