Wednesday, December 31, 2008

Improving Technicals

First of all, Happy New Year to everyone. I think its fair to say, it was a very tough year for the market and another disappointing year for UT. In the next couple of days, I will post on the negative and positive events for UT and recap some of the predictions/expectations shareholders had at the start of the year. For the last few weeks/months, I've been looking at UTs chart and tracking the 50 day SMA. The stock had been under the 50-day for months now but is showing some flattening out pattern and "threatening" to break above the 50-day:-)

If you pull a 2-year chart, the stock was under the 50-day from the start of 2007 all the way to September 2007 until it broke above the 50-day and had a brief spike to $5 in late 2007. Around May of this year, the stock made its major move for the year doubling from under $3 to just under $6 staying above the 50-day. Once it broke down, however, it has been all downhill. Several attempts at crossing above the 50-day at the $3.5 and $2.5 level failed. If the stock can closed above the 50-day for a few days, that may be a good sign that it can move to the 200-day average in the $3-3.5 level in early 2009. And IF it breaks the 200 day to the upside, .......(ok I'm getting a little ahead of myself :-)

Have a good year everyone!

Sunday, December 21, 2008

Corporate Restructuring and 2009 Cash Flow Impact

"UTStarcom, Inc. (Nasdaq: UTSI - News) today announced a series of corporate initiatives that are expected to reduce its annualized operating expenses by more than 25% or greater than $100 million. The majority of these measures will have been initiated by the end of January 2009 and a significant portion of the savings will be recognized in the first half of 2009."

The above link provides a detailed PR/info on the restructuring. Listening to the call, there were some additional info so I will just summarize the Four point savings initiative.

Non-core businesses - The Korean based handset manufacturing that supplies handsets to PCD in non-Chinese (mainly North American) markets will be closed down by June 2009. The company will take a $6m cash charge and write off $4m in assets. This is expected to save the company $40m/year in OPEX. Two thirds of the workforce is already gone at this time and enable this division to be cash flow positive in Q1/Q2 (last two quarters). The Customs Solutions Business will be disbanded by end of Q1 2009 and result in savings of $10m/year. Certain parts of the operation will be merged with the Multimedia Communications Business Unit.
Commentary: At the beginning of the year, the CSBU was supposed to be a high margin business that was supposed to show strong revenue growth. I had high hopes for a sale but this was not to be. Also, the opex for the business unit was supposed to be around $10m/quarter (according to Barton during one of the previous quarter earnings call). So, it looks like the majority of the business is still intact. The Korea handset manufacturing business turned out to be a major disappointment the last two years. Not only did revenues go down steadily (as we recently just found out) but gross profits were very small. It makes you wonder (again) why they carried this business for so long.

Global 10% Reduction in Workforce - The company ended the quarter with a little over 5000 employees. The company plans to reduce an additional 465 employees on top of the employees let go as part of the non-core business wind downs/merge. Overall, about 15% or 750 employees will be reduced by mid 2009. The reduction in US employees will be completed this week while the Chinese employee reduction to be completed in January. This will result in yearly savings of $30-35m and cost the company $8m in cash charges to be taken in Q4.

Streamline of Backoffice Operations - Details and charges for consolidating operations into China are not yet finalized. The timing will be the during the first three quarters of 2009. This will result in the rest of the savings.

One-time savings, bonuses, and salary structure - The company will shutdown operations for a week during the year end. Non-executive BOD will not take their cash retainers for 2008, executives (VP level/up) will not take cash bonuses for 2008, and certain salary througout the company will be frozen (no increases).

Impact on cash balance and cash flows for 2009 - After announcing the 15-20% opex target reduction during the last earnings call, I estimated some numbers based on previous bookings, gross margins, etc. Here is an exerpt of what I estimated:

2009 projections - It will be imprecise to estimate 2009 revenues based on bookings because of the timing issues but that is all we can go on at this stage. I will use the book to bill ratios for the core portion and estimate around $140m for the handset division. That yields (0.8*246m + 155m + 184m + 1.2*146m) + $140m = $711m in core bookings + $140m in handsets for around $850m. Again, each quarter could yield new contracts and ramping of iptv but this is my best guestimate for now. 2008 revenues (using the midpt of Q4 2008 guidance) will come in around $836m so 2009 will see little if any revenue growth. At 25% GMs, gross profits will only be $213m. This quarter's GMs of 32% was due to NGN performance and projections for Q4 are down to low 20s. The revenue for 2009 could be higher if internal handsets does better but then GMs will be lower so for now, I will go with $213m in gross profits and OPEX of $320m. That scenario could be highly optimistic if OPEX is higher or revenue lower due to CSBU divestiture. So, that is an loss of $107m. Add in $20m for taxes/options and another $23m for contingencies (higher opex/lower revenue/margins) and it can add up quickly to a $150m cash burn for 2009 (ouch!).

The company will end 2008 with about $291m + $24m in escrow in cash/short term securities. At the end of 2009, that could easily be down to $165m in net cash heading into 2010 (or about $1.32/share).

In light of new information, here is my current best guesstimate: My overall revenue estimate for the company (not including the Korean handset business) was $711m. Half a year of handset sales is around $70m (since the division will be shut down by mid 2009). I will assign 27% GMs to the core business and 5% GMs to the handset part. That will yield gross profits of $711m*.27 + $70m*.05 = $195m. Expenses for the 2nd half of 2009 will be down to $70m/quarter. However, expenses in Q1/Q2 may still be around $80m and $75m respectively. So, opex for 2009 could still be $295m for a loss of $100m (not including taxes and the usual other GAAP charges). Of course, this may be conservative since the handset sales may be larger since it is being wound down and I didn't add sales in the 2nd half of the year for the Chinese market.

Based on previous Q4 cash burn, we expected the company to have $291m+24m in net cash reamining ($315m). There is a $14m cash charge in Q4 so net cash will be around $301m by the end of 2008. If we subtract $100m in losses for 2009 + $20m taxes/options + $20m (China consolidation charges), the company will be left with $161m by the end of 2009. That is $4m less than what I estimated previously.

After reading the PR and listening to the call, my initial reaction is slightly positive. By the end of 2009, the quarterly opex will be less than $70m/quarter (compared to the initial 15-20% cuts announced). However, the positives were outweighed by the fact there is still no signs of revenue ramp that will close the gap to profitability. I'm hoping this time, my guesstimates are conservative and that there is material revenue ramp and margin improvements. Some people are more positive thinking profitability may be in Q2/Q3 of 2009 and cash flows much better than I have laid out. However, after four years in the stock and watching the company be behind the curve and throwing out bad surprises very often, I'd like to see good results and trends before getting even slightly optimistic.

Here is a quick note from BWS:

UTStarcom (UTSI- Buy Rating) provided details on the restructuring plan that the Company has already started to implement. The Company will discontinue manufacturing handsets out of South Korea for the North American market, which will lead to closing the operations by the middle of 2009. UTSI would also reduce their headcount throughout the Company and start to relocate some jobs from their headquarters in California to their operations in China. The process will cost UTSI $18 million, $14 million of which is in cash, but would allow the Company to save approximately $100 million annually in operating expense. The removal of the handset business from the income statement would reduce revenues by approximately $160 million annually, but the revenues were being generated at an operating loss. Our new model continues to reflect UTSI achieving profitability in second quarter 2009, but the losses until that time would be significantly smaller. Cash preservation could provide a lift to UTSI shares after the Company announces fourth quarter results in February. The restructuring makes UTSI a simple story to understand: a company providing equipment for IPTV, broadband, and next generation networks. The Company did not provide an update to guidance. We are keeping our revenue assumptions for the rest of the Company unchanged by only removing the revenues associated to South Korea’s operations.

Meeting with management - I am hoping to schedule a meeting with management next year to discuss outlooks and just do a general Q&A like the one we had in March. I am still very much invested in the company as are a lot of fund managers I have talked to recently. So, I am hoping the recent opex cuts will lead to the elusive sustainable profitability that we have been waiting for although there are a lot of questions that I have (as you can imagine).

I am off for the rest of the year (its been a good work year but terrible year in the markets and UT) and off to Disneyland next week! Hoping that everyone can take some time off and enjoy the holidays safely.

Sunday, December 7, 2008

Weekly Recap - Near Lows

The stock closed at $1.46, off 44 cents or 23% for the week. The markets recovered from the last week's early 7-9% drubbing to end the week down 2-3%. However, UT set a new all-time weekly low. The volume last week was above 1m shares every day so the stock clearly underperformed despite the announcement of the OPEX reduction conference call (on Dec. 18). Specific news was light so the big news was again the shareprice. The main discussion on the message boards was what is UT really worth and can management turn this around.

With morale already low for over a year (when the stock dropped below $5 and then $3), things turned even worse the last few months as the stock is now under $1.5. While the recent credit crunch is deeper than most could have forseen, UT's poor operational performance has been going on for years. The company has been targetting "near term profitability" for atleast 4 years with every management change and company strategic decision.

During the last year, there were glimmers of hope as the "new" management team cut expenses, disposed of none-core assets, paid the convertible, filed all the late financials, raised cash, and laid out the future technology/path of the company. Lets take a look at the balance sheet and see the tangible impact of those actions and see if the company can survive (at $1.46 share price, lower than even the car makers and other "insolvent" companies, its constructive to look at the numbers for survivability).

Balance Sheet - Net cash increased to $331m this quarter due to the sale of the PCD. Inventory was reduced from $570m to just $195m. Other current liabilities was reduced from $440m to around $290m. Inventory plus accounts receivables is close to payables. Tangible assets went down $50m from last quarter to $534m.

As noted in the past, the sale of the PCD brought liquidity, reduced inventory risk, and improve focus to the company. The inventory level is down to under $200m (and this includes the build up for the Phase II India contract). With the current market environment, the importance of being lean is even more important and I have to give management credit for executing the sale. There is a lot of work in the OPEX side that hopefully will be addressed in the December 18 call. Management underestimated the urgency of additional expense cuts even during the last year expecting revenue growth to get to their expense metrics targets (which I haven't heard anymore about). The market doesn't seem to be confident that the company can cut expenses enough and after years, its not surprising. However, the company is getting leaner (based on inventory/cash levels/expenses) and bookings for core businesses and target markets still provide plenty of hope/upside.

Have a good week to everyone.