Q4 2010 Recap

The Q4 2010 Conference call had an interesting format with a powerpoint presentation slide to go along with the recap of the quarterly/yearly performance as well as some historical improvements, and guidance for the year.

The company's PR touted the exceedence of guidance on the top line for Q4 (which had been reduced) and the operating positive cash flow in the quarter. As a long time suffering shareholder, my main focus is on the turnaround and numbers going forward and to see this new CEO (management) performance to gauge whether there is tangible progress. I did not particularly care for all the slides touting the potential at this stage (since that has been provided before and the important thing is whether UT can actually participate in it). I also didn't care for all the comparissons with improving losses, margins, etc that were simply well below normal/industry performance. No, I was looking for data points that would indicate (1) stabilization of the business (are the revenues/bookings still going down for ex.) and (2) whether there is improvements/growth opportunities to the business. The first point is critical in keeping the current shareholder base and determining if the business is still spiraling down and out of control. The second point is there a reason for new shareholders to look at this company as a real turnaround (in the near future) and what value it can get to in the coming years.

So, instead of the usual point by point recap of the call, I will group the overall discussion based on those two general points. As a shareholder point one is important for holding on to shares at the current valuation and point two is important as the stakes are higher after all of these years to see if there is value creation and point one is not enough to keep shares. You can categorize point one as the "downside risk" and point two as "potential for appreciation". Ok, lets dive into the tangible information provided in the report and the call.

CASH - The major holding point for longs is the CASH. Downside investment protection for a small/Chinese company is the net cash it holds. The company reported a loss of 15 cents/share but generated $14m (or around 10 cents/share) in cash. The company now has $352m in cash/short term securities/investments (or about $2.35/share). The cash was a main theme in the Q/A portion as three analysts (yes, there were actually three that asked a lot of good questions) discussed how cash flow was going to be like for the rest of the year, how it relates to the revenue reported, what potential acquisitions it may make). Jack Lu mentioned that they picked low hanging fruit in the quarter and that cash flow won't be positive in Q1/Q2 but will be back in the black by Q3. In their business cash flow is slightly ahead of the revenue recognition. An interesting thing about UTs balance sheet is that while other newly minted Chinese companies performing "very well" are questioned, its been amazing how bad UTs balance sheet with all the writedowns have decimated its book value down to $1.68 at the end of Q3. At the end of Q4, it is down to about $1.66 even after the 15 cent loss and the cash actually going up by 10 cents. The tone of management has been clearly protecting/managing the cash very well.

OPEX - SG&A was $19.3m and R&D was $9m so w/out other one time items, its down to $28.3m. The target OPEX of under $25m/quarter has not been reached but the CFO mentioned it was solidly on track for it to be. The Q4 PR regarding management alignment (to be concluded in Q4) showed that they were still working hard to pare bloated expenses, which is obviously still high for the current revenues/bookings and even for longterm sustainability. I'll discuss OPEX more a little bit later.

Potential Acquisitions - Because of the poor operating performance year after year, the street mainly looks at the cash in valuing the company so the analysts wanted to ask what is their mindset on acquisitions. The management gave good generic response to what they would like to acquire.....(1) something aligned with their current goals/businesses, (2) top line growth and, (3) add to earnings. The analyst fired back that those would be very expensive specially when UT itself is trading UNDER cash. Mangement's response was atleast realistic.....that they are not looking at anything significant and only for the growth of the new Operational Support Services group and would focus more on internral growth via vendor financing.

So, to conclude this first part, I believe the cash is going to be managed very well going forward and provides substantial downward protection to the stock price (even more so before this call). Going on to the second part. The most important part looking ahead for small tech companies are the growth prospects. The street will reward growth (and not the cash or the book value). Q3 2010 could be the most dismal point in the company's history in terms of revenue/bookings as it was down to $60m (with the deferred PAS revenue) and only $36m in new bookings. This was just a continuation of a company losing revenue and could not get new business.

Bookings - Q4 had bookings of around $52m (0.68 book to bill x $76m reported revenues). This is a good size increase from $36m in Q3. Just on a percentage basis, this was very good but more of a relief as even this number is nowhere near enough to make up for the PAS deferred revenue that will be gone by 2012. I look at this as fairly positive due to the nature of the bookings. These are not low margin broadband revenues from India (BSNL phase III is still in limbo but don't think anyone is looking at that at this stage) or handsets or due to a major contract (we didn't really get much PRs in Q4). So, this was a grind it out $52m revenue that was the highest for 2010 (as they reported) but really didn't include much of the growth drivers that I will list.

Growth Drivers -

1. Softbank - Management mentioned a couple of times that the trials for the TN product was completed last year and they expect to generate significant orders early this year. Now, the Japan earthquake may slow that down but essentially this is on track.

2. IPTV growth - New win in Thaliand with TOT (Thailand's leading provider) was encouraging as this is a new country. Additional win/expansion with Bharti was also reported. The macro growth in China has also been very good to further UTs internal growth. As we've seen over a year ago, software upgrades could be nice revenue/profit generators and will increase as their # of users grow. Then, there is the potential in the mobile handset space (whether they make their own iptv handsets or license their software).

3. New platforms/Operational Service Support (OSS)- The deal with StageSmart will yield additional internet TV platforms to drive growth. The new OSS is expected to deliver 10% or around $30m in revenues. This will be reported as a new segment starting Q1 and be a high margin/growth for the rest of 2011 and beyond.

4. India- BSNL Phase III is still in limbo and could add tens of millions (if not more) in revenue but lower margin. The company did mention it was still working on getting local partnerships/JVs to help them maintain/extend their positions in India. The growth in OSS (new platforms developed for the network convergence in China will also carry over in India in the future). We still have not heard anything in the use of TN for India but their mobile/fix line customers there makes it a potential growth driver.

5. Broadband in China -Company mentioned partiicipating in trials for GEPON/EPON (fiber) but did not highlight this as a main priority although revenue wise, it would be a driver (just for the higher equipment sales).

6. Vendor Financing - In terms of cash usage, this is where the company mentions it will spend. Jack Lu, the CEO, made it a point about being stingy with the cash but this is where they will spend some money to driver growth, which makes definite sense and is a highlight of their growth strategy in higher margin/sustainable revenues.

7. Internal growth of the $52m base - These bookings are made up of small value trials/deployments/existing maintenance etc. that should increase as trends in broadband/network convergence continues.

As a side note, lets look at discussion on margins/opex. The company margins w/out PAS/one time items was around 28.6-28.8 (quarter/year). The guidance of 2011 for 300-320m and under 100m (say 100m) would imply 32.2% margins but in the Q/A, Lu mentioned high 20s. So, backing out OPEX at 29% GMs and 310m in revs would yield about 22.5m in quarterly opex at break even, which they seem fairly confident they can achieve.

So, going forward, we need to look at the growth drivers to determine how they can replace the PAS deferred revenue. There are still a lot of work but having $52m in bookings was a nice start in Q4 (basically the first full quarter of the new management/board and the 2nd quarter of network convergence trials).

The ultimate goal is still to get to a profiable/growing company that adds value more than the current cash position. As they solidify/stabilize the company from point (1), we can now focus on point (2). As we've seen with companies that are in the process/turning around, the payoff can be huge. There is still hope for this old dog :-)

Have a good weekend.

Stakes are high

The stakes have always been high for the company getting to profiability and raising revenue. Unfortunately, the management/company has not been able to do it after 7 years.

Another company Sonus just reported a blowout quarter beating analyst estimates by 27% on the top line. Sonus did $227.5m in revenue in 2009 and just did $249m for 2010. It then gave guidance for revenue in the $265m-285m for 2011. Sonus has 60% GM so its not comparable to UT but it did have to get to profitability and increase revenue. By doing so in the last year, the company has now been rewarded with an enterprise value of around $800m compared to negative for UT.

UT's "core revenue" dipped to about $36m in the 3rd quarter and projected to do no better than that in the 4th quarter. OPEX is still in the $30m range and GMs are still in the 20s (I think its even lower than that when taking out the deferred PAS revenue margins and additional writeoffs).

Jack Lu has been with the company almost a year now and officially the CEO for over 6 months so he's had time to evaluate the company and laydown a pathforward. With still around 2k employees and $30m in quarterly expenses, that is way too much for this company. As a longtime shareholder, it is quite baffling to see how incompetent and poorly managed this company is. The stakes are still high and the market will reward performance but it has to start at some point.

I am looking for material booking increases way above $36m, GMs to be in the mid 30s, expenses to come down closer to $20m. Jack Lu doesn't have to be a genuis. He doesn't have to be very knowledgable in business or even in the technology. He just has to look at the bottom line and make the most fundamental changes in running a company (or any budget for that matter). I don't expect the company to reach 60% GMs but revenue growth of 10% like Sonus in China is laughable.

Here's an article on China Telecom on their fiber buildout...

http://www.cn-c114.net/583/a584981.html

"China Telecom plans to cover every city in China with the fiber broadband service in three years and convert all copper lines to fiber, China Daily reported. Under the Five-Year Plan, the Chinese government will focus on developing the telecommunications infrastructure, with total investments reaching 2 trillion yuan. Broadband development would account for 80 percent.

This plan will provide broadband access, high-definition IPTV, 3D and rich media services that require bandwidth of about 10 megabytes and above."

Like I said, the stakes are high.......does this management have any sense of urgency?

Basic business cycle

UT had sold some significant assets from Gemdale to PCD to the building over the last few years . The problem has been the high expenses, and later the costs of unwinding these bloated infrastructre. Coupled with the collapse of PAS and slow adoption of iptv and even lack of traction in India/Japan, and you have a company on the defense and caught in a downward spiral.

The question now is will UT be able to use the accumulated funds to grow revenue going forward. It has NOT done so up to now (Q3 report) but lets look at some items that prevented it from happening or new developments that can make it doable now.

1. Japan/Softbank - Revenues for Japan had gone as low as $6m/quarters. TN revenue have started to come in last year and revenues have gone up to the $10m/quarter range. Full deployments (after the initial trials/equipment testing) are projected to occur this year.

2. India - The India market's security concern primarily targetting Chinese companies hit UT particularly hard. Additional writedowns had to be taken. The company talked about hiring Indian director(s), manufacturing in India, etc but so far nothing. All we know is that UT is still the iptv leader in India and that broadband needs are significant.

3. China - The network convergence trials for the Tier 1 cities just started mid last year. At the same time, UT has "moved" to China, finalized the investment deal from the local Beijing government and added Chinses board members familiar in the industry/regulatory framework.

4. Expenses - Target of under $100m/year has not been achieved...its about $30+m/quarter still. Recent PR from the company discuss additional reorganization of groups and the CEO taking on certain businesses directly. Full outsourcing has not been completed so further cost cuts should continue to lower expenses.

The above lead us to CASH. They have spent $10m on the StageSmart acquisition and put some $20m more in working capital into the acquisition. Providing telecom/communications equipment (everywhere) and the new platforms for network convergence is going to take some significant working capital and this is a UT advantage. While technology (or adoption) or management might not have been in place previously, this is not the case anymore. The world markets have rebounded but capital is still tight. This gives UT an edge over smaller companies or even larger comapnies that are spread too thin across product cycles or different markets.

At this stage, there has been little change in UT price the last couple of years and operating performance has not improved but with significant liquidity, adoption of UT technology now (TN/iptv), new manaegment/focus, the scenario might just be favoring a real turnaround.

Technicals

(Click figure for more clarity)

How are technicals looking for UT stock? It felt "terrible" in December and suddenly "feels" good after an almost 20% move up from the recent bottom. Seems obvious but its good to know why that is and more importantly what to do at that moment (if any).

So, I did some TA on the stock and found some interesting points. Since the stock topped at $3.26 in April and the low in June ($1.65) it has been consolidating for some period. A symmetric triangle has now been formed by the events of the last few months. I have drawn a lower/rising support line from the lows in September and a resistance/falling line at the peak in October highs. This support line basically held throughout the October-November period after the revenue shortfall announcement but broke down in December. Volume actually picked up during this time which was worrisome but not really huge volume (only over 1m on a couple of days). It stopped going down in the $1.9s range (which is the lows in Sept). This was actually a critical hold for the stock as it was a FAKE breakdown, which is what we want to see in a symmetric triangle. Now, after a 20% rally, it is coming towards the resistance line.

While a major breakout is possible, it has to do it soon and it will take some huge volume. Barring that, it will continue to complete the triangle and trade in the $2-2.2 range and then its 50-50. Re-drawing the bottom support line shows it should have very good support and it may NOT ever see the $1s again for a long time and if we do, it is not a good sign.

Upside Target: The peak range is ($3.26-1.65) = $1.61. If it breaks out, it could hit $4 as an initial target. Breaking down in the $2 range would bring the stock to 35 cents.

Here is a definition of a symmetric triangle with some of my side comments in italics:

Most consolidation patterns are about indecision -- traders are uncertain about the near term direction of the stock so they do nothing. Symmetrical triangles are different because when a stock falls into one of these patterns, traders actually behave as though they have reached a consensus regarding price (Easy to dismiss the $2 level as a consensus like one poster Tigre has). We know this because there is a uniform narrowing of price over time. Symmetrical triangles usually develop after a stock has had a spectacular move (Feb - April 2010 when it moved from $1.8s to $3.2s). After reaching a relative new high price momentum may begin to fade modestly and the stock works lower. Because the fundamental news is so strong, Wall Street analysts will often dismiss this weakness as mere profit taking following a lengthy advance (UT didn't actually have strong fundamental news at the time but you may say the Roth conference put some fundamental news into new investors that made them act). The stock slips back to an intermediate term support level and price stabilizes ($1.8-2.2 range). At this point it is common for the stock to begin moving higher on a positive fundamental development (Closing of China investors/Network Convergence starting up). Perhaps the firm has raised guidance, announced a stock split or unveiled a new product but price slowly begins to move higher (Several Chinese contracts announce after Chinese investors close deal and Jack Lu gets appointed CEO). There is one problem, volume is noticeably lighter than previous rallies. The price rally continues but falls short of the recent new high ($2.5s in October). This secondary high will be an important point later in the formation of the pattern. After several days of strength, momentum once again fades and price begins to falter. Slowly the stock moves lower on no specific news and extremely light volume ($2.15 level to $1.9s). Sensing that sellers may not have an appetite to continue selling buyers reappear and the stock stops short of the intermediate term support level ($1.9s in late December). This secondary low completes the bottom parameter of a uniform or symmetrical triangle. Over time the stock begins to trade in an increasingly narrow range characterized by a series of lower highs and higher lows. As time passes traders grow to believe that the current stock price accurately reflects the true value of the stock. Volatility and volume slow dramatically as the stock approaches the apex of the triangle (We'll see how the stock reacts as it approaches the apex but there definitely is a lack of interest and consensus that it is not going anywhere). Then, abruptly there is a fundamental development that leads to a dramatic upside breakout. Volume swells and Wall Street analysts begin making new "buy" recommendations and raising their price targets. As prices moves beyond the upper parameter created by joining the recent new high and secondary high some investors that had felt the stock was fairly priced at lower levels begin selling but their shares are quickly absorbed by buyers. In fact, the demand for the stock becomes so intense that price very quickly surges beyond the recent new high. Weeks later the stock moves significantly higher.

The last part is the longs "hope" but as for the price remaining in this range, something has to give.........I just "hope" its not 35 cents.

BTW, I don't do much of TA on the blog but here's the last one I believe, on Sept 14, 2009

http://utstarcom-stocknews.blogspot.com/search?updated-min=2009-09-01T00%3A00%3A00-07%3A00&updated-max=2009-10-01T00%3A00%3A00-07%3A00&max-results=3

That was posted when the stock traded between $1.94-2.09 with 379,400 shares. My upside target was $3 in 20 days. On Sept 17, 2009, it traded up to $2.54 with 3.3m shares. Not exactly $3 but a nice jump nonetheless :-)

Have a good weekend everyone.

2010 Chinese International Exhibition

This article came out in early October that talked about UTs new logo and products/focus in the Chinese market. It might also be the reason the stock rallied to the mid $2s at the time prior to the revenue fall announcement.

http://www.c114.net/news/128/a549170.html

Heres part of the article translated (poorly):

IPTV and new media as a pioneer in interactive video, UT Starcom, the torrents use their own research and development (RollingStream) IPTV system, launched the world's leading creative, and meet the needs of the real operators may be operational, management, flexible fit the three-screen integration of carrier-class end to end broadband TV solution for triple play help meet the needs of operators to build comprehensive business solutions. Through years of research and development in the area of the accumulation of interactive video, rushing (RollingStream) system has become the industry's leading open, multi-service, multi-service broadband terminal multimedia service platform, and with large-scale commercial world. Data show that the end of 2009, UT Starcom's IPTV system has become China Telecom , Shanghai, Shaanxi, Fujian, Zhejiang, Anhui, Hainan, Yunnan, Ningxia, Jiangxi and other branches of the IPTV system, the main partner in China Continental-scale deployment of IPTV commercial system has more than 200 million.

- the last statement I take as over 2m subscribers under UT.

It does have a nice picture of the UT booth and hopefully, that will increase awareness and drum up some Chinese business. Bookings in China which are probably in the $20m/qtr level need to go significantly higher.

Partnerships, Joint Ventures, and Acquisitions

From the proxy materials (under related party transactions),

http://www.sec.gov/Archives/edgar/data/1030471/000104746910008922/a2200593zdef14a.htm

Yellowstone: In addition, as of the date of printing of this Proxy Statement, we are considering an engagement letter with Yellowstone pursuant to which Yellowstone will act as a strategic consultant to the Company and any of its subsidiaries, divisions or legal/organizational units to assist the Company in establishing or expanding strategic partnerships, joint ventures, acquisitions and the Company's business in Asia consistent with the Company's goals. The terms of the engagement letter and the fees payable thereunder are currently being negotiated; however, it is contemplated that we will pay Yellowstone a monthly fee of US$20,000 and certain success fees upon the successful completion of a specific transaction as proposed by Yellowstone and approved by the Company generally based upon a varying percentage of the transaction deal size, with certain exceptions. We will also reimburse Yellowstone's reasonable expenses incurred in connection with the services.

Softbank: Softbank Corp. is an affiliate of Softbank America, Inc., which holds approximately 9.7% of our common stock. During 2009, we recognized aggregate revenue of $28 million (includes $5 million in sales to NEC Networks & System Integration Corp., Japan Electronic Computer Co. Ltd., Nippon Telecom Sales KK and Oki Electric Industry Co., Ltd. for which Softbank Corp. was the ultimate customer) with respect to sales to affiliates of Softbank Corp., including (i) sales of telecommunications equipment to Softbank BB, (ii) sales of equipment and services to Softbank Telecom Co., Ltd, a wholly owned subsidiary of Softbank Corp. and (iii) sales of equipment to BB Cable, an affiliate of Softbank Corp. Our Audit Committee has reviewed and approved the transaction with Softbank Corp.

In addition, as of the date of printing of this Proxy Statement, we, through a wholly owned subsidiary, are finalizing an agreement with ZTE (H.K) Limited ("ZTE"), a company incorporated in Hong Kong (the "ZTE Agreement"). Pursuant to the ZTE Agreement, we will agree to form a special purpose company incorporated in Hong Kong with ZTE (the "HK SPV") for the purpose of making and holding an investment in a high speed mobile data communication service business affiliated with Softbank Corp. (the "Softbank Affiliate"). We will agree to pay 176,000,000 Japanese yen (approximately US$2.17 million) for 35% of the equity of the HK SPV and provide a loan of 595,000,000 Japanese yen (approximately US$ 7.32 million) to the HK SPV. ZTE will agree to pay 327,000,000 Japanese yen (approximately US$4.03 million) for 65% of the equity of the HK SPV and provide a loan of 1,105,000,000 Japanese yen (approximately US$13.60 million) to the HK SPV. The
U.S dollar equivalents are based on the exchange rate of 81.105 Japanese yen per U.S. dollar. The HK SPV plans to use the paid-in capital and shareholder loans to invest in the Softbank Affiliate. Our Audit Committee has reviewed and approved the transaction.

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Depending on the side of spending you are on, the above is either going to be positive or negative on paper. This is a company that has cash as its strongest asset. If it can use it well to transform the company, then I am all for it as a transformation and turnaround is what we are looking for. The Yellowstone fee is minimal to what they have been paying their managers and resulting performance. On the flip side, spending for the sake of spending would obviously be negative.

The joint venture with ZTE (which ZTE is this?) seems interesting and could contribute right away to the relationship with Softbank and potentially boost company revenue in Japan much faster.

The amount of revenue and bookings are not enough at this stage to support their expenses so the company has to decide how long to keep up that expense base or act more aggressively to generate more revenue. For them to a player in the iptv/telecom-cable infra in 3 major countries no less, I would think they have to generate significantly more revenue and be aggressive for growth (and thus my vote for continued investments).

Random info on UT and industry related news

Value of Network convergence infra spending:

"A report by the iChina Research Center, says that the Three Network Convergence related market will reach RMB 688 billion over the next three years, of which, RMB 249 billion will be spent on migration and construction of infrastructure for both telecom and cable networks, set-top boxes and content management and media service platforms, with the remaining RMB 439 billion generated through content demand and media consumption."

http://finance.yahoo.com/news/UTStarcom-Announces-Strategic-prnews-4271381014.html?x=0&.v=1

So, about $30B over 3 years will be spent. From the same UT PR,

"IPTV subscribers in China will be about 7 million by the end of this year and 10 million by the end of 2011."

"According to Lmtw.com, China Telecom had 5.36 mln IPTV subscribers as of August 2010, accounting for over 82% of national IPTV users."

http://www.cn-c114.net/576/a553725.html

According to recent Chinese articles, UTs share is over 2m subscribers and 33%, which is consistent with the overall numbers so by end of 2011, it could be 3m+ users.

From same article above, Shanghai has another tender and results should have just come out.....

National IPTV network status:

"According to the statement, the platform network has already joined with sub-networks of radio and television organizations in five pilot regions in Sichuan, Hubei, Beijing, Shenzhen and Shandong."

http://www.cn-c114.net/583/a565282.html

Key statement there was Radio as UT acquired Stagesmart and deal with Cristar. Also, UT has already mentioned winning some cities in the pilot.

China Telecom investing CNY15B ($2B) in EPON in 2011.....whats UT share?

http://www.cn-c114.net/576/a566980.html

In Japan with Softbank, see this interesting article...

Softbank Proposes Fiber Broadband Highway for Japan
http://www.cn-c114.net/576/a555240.html

Statement of Jack Lu in the earnings CC,

"Finally, for our broadband business in Japan as we shared on the last call that we passed all of soft SOFTBANK BB’s quality control test. We have already started to receive purchase orders from the clients for our key end technology in Tokyo, Osaka and Nagoya. As a result, we expect a sizable increase in 2011 once this initial rollout proves themselves."

http://seekingalpha.com/article/234469-utstarcom-ceo-discusses-q3-2010-results-earnings-call-transcript?source=yahoo

SIZABLE increase???

-----------------------------------------------------------------
Jack Lu:

"So, while we continue to cultivate the telecom space with pure equipment based sales, you can see that the opportunity in China in with three network convergence is significant, and I see it as my job to ensure UTStarcom and its investors win a significant portion of the upside."

UT PR on Q3 accomplishments:

"the Company won a project with Jinan City's Cable Network as the exclusive broadband solution provider"

"the Company won IPTV projects with operators in Sichuan (already announced), Hubei (new), Henan (new) and Shenzhen (new)"

(Good wins that are the same cities to the pilot cities of the National network cities)

"the Company expanded a previously established revenue sharing relationship with South Media Interactive Co., Ltd, the interactive business unit of South Media Group, to add HDTV options to their IDTV offering, be responsible for the development of interactive products and provide operational support services to the platform "

"the Company announced a strategic partnership with a company controlled by a national level broadcaster to provide technology and operational support for Internet TV service in China and abroad"

--------------------------------------------------------------------------

Unfortunate to see the stock doing so poorly in light of the bull market and year-end rally....The street (or atleast some investors) may finally be giving up on the company/stock as it pushed the price below the investor buy in price and way below cash ($338m + $34m more in restricted cash = $372m or about $2.4 in total cash).

Anyway, the above shows the market for their products are healthy and growing. The key as always is the amount of share they can win and how fast.

If you are a bagholder like myself, atleast you should know what you've got and what the "hope" is.....