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Vitesse Q107 Conference Call Notes

My only hope for this call was that I would not be surprised. In the absence of any information from the company since November 6 2006, I discovered my mind is capable of generating some frightening scenarios. The last thing I wanted to see was one of those scenarios realized. None were.

Quantitative Data

  • Consumption was 60-62M. Historically I take the midpoint number for all calculations, yielding the following product line growth.
  • Opex cut radically from 33M to 28M. If I had realized the magnitude of the cut during the call I would have asked what projects were rationalized to make this happen. Opex was $42.7M 12 months ago, a reduction of 34%
  • Capex was $2.6M, $1.4M for lease and $1.2M for masks (low)
  • Cash at 16M, down 9.6M. Cash burn of 4M due to expanding inventory, 4.8M professional fees. Payables grew 1.4M too, so actual burn was around 11M.
  • I have questions into the company about interest payments.

Qualitative & Colorful Analysis (because investing in Vitesse will drive you insane without it):

  • Increased ‘consumption’ (Vitesse speak for revenue until an auditor is hired and they can remove their financial training wheels) was the best news of the call. While the growth rate was not as good as last quarter, considering the struggles of others in the industry, this was a good result.
  • As before, no margin guidance was given. The company indicated distribution inventory with channel partners like Nu Horizons (NUHC) was drawn down substantially. As readers of this blog know, nothing kills margins faster than greedy use of distribution. A reduction of channel inventory will impact cash in the short term, but long term will enhance margins by at least 3-4 pts. I will wager their gross margins are in the 58-59% range. As stated in the past, Nu Horizons is facing a big headwind as Vitesse rationalizes it’s business.
  • If my margin assumptions are correct, the company is break even excluding professional extortion expenses.
  • Please, not another quarter of multimillion dollar professional expenses. Just think of how those expenditures are viewed by employees on the inside; Cash controls must be tight to the point where you can’t get paper for the laser printer, but $5M gets paid to guys who are 10 IQ points away from “Would you like Fries with That”.
  • The best thing I heard was the imminent board changes. Mayor McCheese would be an improvement.
  • Cash is tight but company indicated inventory growth is over, and professional extortion expenses are rapidly declining. If revenue stays flat, and the company can hit these two targets, they should be cash flow neutral. Executing this plan should be the most important goal for the company and I wish I heard that on the call.
  • Brief but significant mention of additional financing. I don’t know what to make of this other than their customers are not comfortable with a razor thin cash margin. My guess is they are looking to open a line of credit. This is fine by me so long as no temptation exists to spend it.  If Nu Horizons can finance inventory at LIBOR +1-2% I see no reason why Vitesse cannot. I hope that this is what the company does, and I sure hope they don’t use it.

Summary

In an environment where comm semi companies briefly emerge from the surf before being pummeled along the post-bubble reef of telecom wreckage, Vitesse appears to be treading water against tough odds. I’m much more positive today about the company than I was last August at a lower market price.

Key Priorities for FQ207 (Unfortunately, two weeks from closing)

  1. Reduce cash burn by eliminating professional waste fees and burning off inventory.
  2. Aggressive pursuit of M&A of valuable units such as Ethernet in order to catalyze industry consolidation. Placing the assets of this group in a larger, better funded existing operator would be a win for everyone.
  3. Hire an auditor. Get audited results. Plead for mercy from NASDAQ.

Original Post Published at 10:40AM.
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Author is long Vitesse and short Nu Horizons

Discussion

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  1. Good summary. One question remains open. Why does Tomasetta remain on the board? I know our system is ‘ innocent until proven guilty’, but the man must be smart enough to understand that he is currently a huge liability to the company, and to it’s ability to regain some credibility in the investment community.

    Posted by P Johnson (stockholder) | March 15, 2007, 10:52 AM
  2. They mentioned that they had a $25M line of credit from Tannenbaum. Any understanding of what the terms are if they draw that down? Or would another financing option offer better terms? What is the worse case financing option in your opinion?

    It surprises me why they need to give a range for consumption. I know semi companies 5X VTSS size that know exactly what sales-out are on a daily basis – so why doesn’t VTSS know 2 months after quarter close. It surprises me that a 20 yr company does not have these systems in place already.

    I agree that the professional service fees are criminal. If I were being paid that sum, I certainly would take my time. The problem is that if they reduce those fees and hire an auditor, I can image that the audit fees will be equally criminal.

    Finally, I don’t share your optimism on a flat quarter. It seemed that they mentioned SAS products would be down as well as core networking – unless I heard something wrong.

    Thanks for the good analysis and look forward to your responses.

    Posted by punci | March 15, 2007, 11:39 AM
  3. They have a ‘carve out’ with Tennebaum. This is not a loan or line of credit. This allows them to solicit funding up to $25M from another source without changing the T-Baum loan terms.

    The Yakuza would offer better terms at this point than the existing T-Baum loan.

    Posted by Andrew Schmitt | March 15, 2007, 12:28 PM
  4. the cash situation seems really scary even if they can reduce the majority of the 5m spent last quarter on profs. they could be under 10m by this point in the quarter. any guess how low that 16m will get during the quarter as the cash ebbs and flows?

    also seems like crg is really playing up selling ethernet to the telcos. at the end of the day, can they rationalize the ethernet business without winning more sockets at csco?

    at any rate, it was good to hear that things were picking up and hitachi and hp.

    Posted by m@ | March 15, 2007, 7:21 PM
  5. Andrew, I really appreciate your insights into the Vitesse situation.

    Regarding your comment “Opex cut radically from 33M to 28M.” The actual statement on the call was “Operating expenses which are net of professional fees and depreciation stayed flat at approximately 28 million dollars.” I think Vitesse management misreported their Op Ex number on the November call and the $33M number they quoted in Nov. included the professional fees, I don’t know why else they’d refer to their December quarter Op Ex figure as remaining flat at $28M.

    Given it’s half their business, how concerned are you about the comment Chris made in the last call regarding the softness they are now seeing in the networking segment? I believe his comment was “Consistent with our competitors, we have seen a softening in the end market here (networking) and we do expect this softness to continue somewhat into future quarters.”

    Posted by Brent | April 17, 2007, 1:38 PM
  6. I am not too concerned about it. As I have written before, my interest in the company is based on the value of the underlying assets. Vitesse networking products are an annuity that will pay dividends for many years. I prefer not to drive myself crazy worrying about next quarters revenue.

    I am more concerned about inventory management. If networking revenue was down 10% but they burned off $5M of inventory (and gained cash) in the process it would be a net win. If the softness in networking grows inventory then I am very worried.

    The metrics by which I think Vitesse should be judged are cash management, protecting the integrity of the existing business, and exploring strategic divestitures/combinations that would extract more value from them. I am not concerned about fluctuations in their end markets.

    The fact that we see volatility now is a good sign that distribution is no longer buffering results.

    Posted by Andrew Schmitt | April 17, 2007, 2:23 PM