Thursday, June 11, 2009

Company Initiatives

Peter started the call discussing some background information:

1. Positive momentum in bookings growth
2. Improvements to their CRM, sales, and operations management
3. Moving back office operations to China
4. $301m in cash @ the end of Q1
5. Focus on accelerated profits and having the same basic strategy
6. Highlighted IPTV leadership in China/India and broadband leadership in India
7. Anticipates double digit growth in 2009 bookings for infrastructure products

The call was mainly about the opex cuts to less than $100m/year and a reduction in work force by 2300. Some of the cuts have already started with the majority being done in Q3 and completed by Q4. The company will maintain essential capabilities in sales/R&D and outsource manufacturing. The focus will be on the higher revenue growth/margin products.

Handsets - The company will target the higher end China handset market focusing on specialized handsets that incorporate their iptv system (for ex) as oppose to the entire CDMA market. This will reduce inventory risk, reduce working capital, and improve handset margins.

The opex reductions have various components:
1. Having a direct sales model in China/India and an account based approach for the rest of Asia.
2. Working with OEMs
3. Reduce SG&A (consolidate back office operations into China)

The company will take a $40-45m charge in Q2 with the cash loss in Q3/Q4.

Targetted Business Model to profitability - With a yearly opex of less than $100m, and GMs in the high 20s, the company will need $350m in revenues to break even. Peter mentioned he was confident that they can achieve and exceed this level. He expanded later during the Q&A regarding bookings turning into revenue about 9 months later. Bookings for Q2 in China is as projected and bookings for outside China is above expectations.

Cash - No further information but by the end of the year, the company should have more than sufficient cash to support the business and its improved financial model.

Handset windown - The Korean designed handset business is almost wound down and the China handset operations is also reduced.

Hangzhou building - The company hired a realtor to sell the building but the size and amount will make this a difficult sale.

The company has a "margin improvement" plan regarding the Indian broadband (outsourcing manufacturing). They see continued significant growth in India broadband. They will be leaner/more flexible with less than 2000 employees and confident in returning to profitability.

Info. from the Q&A

1. Virtually no PAS infra in Q1, very little PAS handsets.
2. They have the confidence even with reduced R&D due to looking at the growth with their primary customers. They have 20 major customers making up 80% of the revenue.
3. They are focusing their R&D in the newer products (Transport Network and GEPON). Other products (iptv/softswitch) are more mature and need less development. Most of the huge work has been completed in those two areas as iptv customers don't need more functionality and with their stable product. Regarding their softswitch, most of the code has been written for the Class 5 legacy switches. Peter talked with their leading product managers and were cutting costs because they were spending too much money for the return.
4. A lot of savings on SG&A because of their move back to China. SG&A will be about 10% and R&D in the "teens". If I interpret this correctly, R&D may be about $65m and SG&A at $35m for a target of $100m. They are keeping the infra sales and reducing significantly the handset sales team.
5. Bookings for outside China ahead of projections and not only in India but also in Taiwan, Korea, and the Philippines.
6. Rupee strength - Will help some in the current quarter
7. Transport Network product being trialed with China Mobile and Softbank as the two most notable (any bookings will be revenue in 2010).
8. New Partners - Will be announced in the Q2 call but they picked up one in the US.
9. Workforce in U.S @ the end of the year will consist of a small support staff, legal, and some due to its corporate office.

Let me comment on various issues.

1. Cost cuts - Ever since the end of Feb Q4 earnings call, the management has been baraged by investors and the company has mentioned taking significant actions to accelerate profitability. The $60m target opex for Q4 2009 was clearly too high specially in light of the Q1 company estimates and little ramp through the year. There have been some investors that mentioned it can't be reduced much more without hurting their competitive positions. That the company knew more than investors. Well, it turns out that the majority of the shareholders/the market that have been pushing for much lower expenses were right and finally the company has deviated from their usual year end announcements for cuts and waiting another year. It says a lot about the management and their projections that it has taken them so long to even project a realistic business model. Its not easy to cut 2300 people but if the realistic revenues cannot support more, then that is what has to be done.

2. Rumored Investor - No one knows if there was even an investor and a deal could not be hashed out but this would be inconsistent with the company diluting the shareholders at these levels. They didn't do it when paying the CB when the stock was higher and now with more cash, it didn't make sense (as I thought about it). I still think a local Chinese handset maker could partner and make use of UTs technology/equipment/license/building space.

3. Future Revenues - Q1 revenue was $119m with about $40m in handsets. PAS was very little so the core revenues was about $80m. Book to bill was above 1 (and didn't include BSNL Phase 2 revs) so a little growth and some handset sales in the future could lead to the breakeven revenue and above.

4. Expectations - Some shareholders were expecting an outright sale or an investor. The stock price movement did not support an outright sale. The investor scenario was plausible but the shareholders would have been diluted at these stock levels. Some were expecting a huge contract. That would be odd when they are reducing 2300 people. Can you imagine Peter announcing a major contract and then saying by the way, we are letting half the people go?

5. Valuations - We have discussed cash/tangible book value. The stock was discounting these levels due to the continued losses. More losses this year plust the restructuring costs will lower the cash/tangible book value levels. However, if the company is at breakeven or profitable in 2010, then instead of a discount to book value (let alone cash), it will be greater than those levels. This is not scientific but an approach could be estimating the end of the year book value and then looking at other small cap/technology comanies with around breakeven P/L and what their market cap to tangible book value is. Then, discount or add a premium based on what you feel the growth rates/bookings/margins/technology of UT compared to the other company.

6. Board member re-election - There is no question the company has been way behind their cost cuts and have not developed a profitable business model. While it is more probable now with the additional cuts, shareholder value has been lost. For this reason alone (do you need more?), shareholders must vote out Lu/Clarke and send a message that the performance over the last 5 years have been disastrous. The announcements today just re-affirms the failure of the board and their lack of urgency the last 5 years.

7. Blackmore's credibility/company projections - Blackmore discussed ramping revenue during last year's shareholder and Analyst Day's meetings by hundreds of millions. In March last year, Barton talked about his 2009 business plan that incorporated PAS. Last September, Peter said the company did not feel the recession yet. The cost cuts at the end of last year that would chop $100m/year were clearly not enough. Is it any wonder why investors don't have any confidence/trust with the company/management.

I have been waiting for a long time for profitability and for revenue to ramp. The additional cost cuts and the corresponding revenue breakeven point of around $350m are finally realistic and doesn't require a tremendous revenue ramp. Today was a good start and obviously the company has to execute. The management/board should cut some more of their compensation and consider buying some shares. The news is out so there are no excuses. Overall, Peter went into a lot of details during the call and address a lot of investor concerns regarding the cuts/revenues going forward. I think this was a very good call that addressed a lot of investor concerns. Some may have higher expectations but again I have to remind people this is a $2 stock and the main goal was to operationally break even first and stop the bleeding. The moves today signify their seriousness to get to a profitable business model and made them more attractive to a potential buyer going forward. We'll continue to debate whether the cost cuts will impact them in the future but when you don't have the existing revenue and the returns are not justifiable for the expenses, then you have to cut. I'm positive on the current valuation but I'm biased and always like the valuation :-)