Aspect Communications ASPT
February 24, 2003 - 1:18pm EST by
ladera838
2003 2004
Price: 3.61 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 285 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

All analysis is proforma for the issuance of a $50 million PIPE in 1/03, which results in a complete paydown of debt, and a net cash balance of $23 million, and 79 million FD shares outstanding.

Thesis. Cheap valuation now, with free option on growth. Low valuation (<4.5x EV/(EBITDA-capex))with homerun potential if economic conditions improve and the company begins to grow again. Leading provider of software systems for incoming call centers. Business has stabilized on the top line. Costs have been cut to reach >16% EBITDA profitability. Debt free. Competition is limited. Non-taxable due to NOLs. PIPE has stock price oriented 28% shareholder in place.

Opportunity. ASPT lost money in several previous quarters, but costs cut to turn significantly profitable in 4Q02. ASPT was faced with need to refinance $125 million convertible debt in August 2003, which was resolved by $50 million PIPE issued to Vista Equity Partners II on January 21, 2003. Covered by only two analysts. Turnaround due to cost-cutting, apparent from earnings announced on January 23, 2002, not generally realized by public.

Business. Aspect is a leading provider of business communications solutions that help companies improve customer satisfaction, reduce operating costs, gather market intelligence and increase revenue. Aspect claims to be the only company that provides the mission- critical software platform, development environment and applications that seamlessly integrate voice-over-IP, traditional telephony, e-mail, voicemail, Web, fax and wireless business communications, while guaranteeing investment protection in a company's front-office, back-office, Internet and telephony infrastructures. Aspect has more than 17 years of experience and over 8,000 implementations deployed worldwide. The company is headquartered in San Jose, Calif., with offices around the world and a global network of systems integrators, independent software vendors and distribution partners.

Markets and Customers. The Company markets and sells its products and services primarily to large organizations in diversified industries worldwide. Aspect markets its products in the United States largely through its direct sales force and internationally has a direct sales force supplemented through distribution partners and value-added resellers in various countries. The Company anticipates that an increased portion of sales will need to be generated through third party resellers to achieve targeted market share goals.

A key part of Aspect’s overall strategy is to increase sales through indirect channels including Value Added Resellers (VARs), Technology Alliances (TAs), and System Integrators (SIs). The Company plans to continue to develop alliances with key technology players who integrate their products or services with Aspect products or services thereby enabling the customer to purchase a complete solution.


Strengths.

Large, diversified customer base. Aspect has customers in over two-thirds of the Fortune 50, with 8,000 installations, and daily managing more than 3 million customer sales and service professionals worldwide.

Significant recurring revenue. 62% of 2002 revenue was generated from services (maintenance and consulting), providing a strong base of recurring revenues.

No customer concentration; significant new business generated from existing customers. In 2002, ASPT had 21 customers in its “Million Dollar Customer Club”, each generating more than $1 million in product revenue, for a total of $56 million, or 38% of 2002 product revenue.

Existing customers, including Hong Kong Shanghai Bank, Green Flag Group, Verizon, Comcast Cablevision, US Internal Revenue Service, Washington Mutual, Cox Communications, DaimlerChrysler, Royal Bank of Scotland, Countrywide, Delta Airlines, and AOL, generated $39 million of 2002 product revenues (70% of the Million Dollar Customer revenue and 27% of total 2002 product revenues).

New customers, including Hutchison 3G, Southwest Airlines, and RCN Corporation, generated $17 million of 2002 new product revenues.

Business from the current customer base is estimated by ASPT at 80%.

ASPT has cut costs to reach profitability.
Employee Headcount____
12/31/2001 12/31/2002 %
Sales and customer operations 320 240 -25%
Marketing 100 80 -20%
G&A (including manufacturing) 280 210 -25%
Support 770 600 -22%
Product development 270 240 -11%
Total 1,740 1,370 -21%

Strong competitive position. Aspect’s principal competitors currently include companies in the CRM contact center market and companies that market traditional telephony products and services. Current and potential competitors include Avaya Inc., Nortel Networks Corporation, Rockwell International Corporation, Alcatel SA, Siemens AG, Cisco Systems Inc., Siebel Systems Inc., and Oracle Corporation.

While the industry has many nominal competitors, ASPT is the market leader, and faces one significant competitor in its legacy (PSTN) business in Avaya and one significant competitor in its newer (VoIP/software) business in Genesys, S.A., owned by Alcatel. Apparently, Avaya is having difficulty transitioning from its hardware history to becoming a software company.

VoIP companies like Cisco could move into call center software business (and it has acquired two companies in this area), but reports from within Cisco suggest that Cisco’s “Contact Center” business is not flourishing.

Avaya - http://www1.avaya.com/enterprise/solutions/crm/products.html
Genesys - http://www.genesyslab.com/contact_center/solutions/ipcc.html
Cisco - http://www.cisco.com/en/US/products/sw/custcosw/

Intellectual Property and Related Matters. The Company currently holds approximately 104 issued United States patents and a lesser number of issued foreign patents and has pending approximately 65 United States patent applications and a lesser number of corresponding foreign patent applications that cover various components of its technology. The Company’s issued United States patents expire on dates ranging from 2004 through at least 2017.

Strong balance sheet. In addition to $25 million in net cash, ASPT owns two of the three corporate headquarters buildings on 10 acres acquired in 1996, one of which is approximately 104,000 square feet, with the other being a newly constructed building of approximately 105,000 square feet. Aspect’s headquarters currently occupies three office buildings, totaling approximately 285,000 square feet, in San Jose, California.

Risks.

Vertical end market concentration. While the information is not readily available from ASPT, it is worth noting that certain large customer vertical segments could be particularly vulnerable to macroeconomic trends in 2003 and beyond. In particular, financial services companies could see a sharp drop-off in refinancing activity, and airlines could continue to suffer, reducing costs through migration to the internet and alternative modes of customer interaction.

Outsourcing of call centers to India. This is a major emerging trend among many customer categories. ASPT does not currently have a channel selling to call centers located in India, but is searching for the right distribution relationship.

Migration to the internet. In order to cut costs, some customer categories are migrating customer interaction (e.g. airline reservations) to the internet , potentially reducing demand for ASPT products over time.

Macroeconomic weakness. ASPT’s products typically represent substantial capital commitments by customers, involving a potentially long sales cycle. As a result, customer purchase decisions may be significantly affected by a variety of factors including trends in capital spending for telecommunications, enterprise software, market competition, and the availability or announcement of alternative technologies. Continued recent weakness in global economic conditions has resulted in many of ASPT’s customers delaying and/or reducing their capital spending related to information systems. If the economy continues to be weak, demand for the Company’s products could decrease resulting in lower revenues and a decline in the overall rate of the Company’s revenue levels.

Shift from Hardware to Software Model. Historically, ASPT has supplied the hardware, software, and associated support services for implementing call center solutions. ASPT’s shift to an enterprise software business model has required and will continue to require substantial change, including:

• Changes in management and technical personnel;
• Modifications to the pricing and positioning of products which could impact revenues and operating results;

• Expanded or differing competition resulting from entry into the enterprise software market;
• More revenues being deferred to future periods under software revenue recognition rules; and/or
• An increased reliance on systems integrators to develop, deploy, and/or manage our applications.
Product Concentration. Historically, sales and installations of a small number of ASPT’s products accounted for a substantial portion of net revenues. Demand for products could be adversely affected by not meeting customer specifications and/or by problems with system performance, system availability, installation or service delivery commitments, or market acceptance.

Litigation. In ASPT’s industry, there has been extensive litigation regarding patents and other intellectual property rights, and ASPT is periodically notified of such claims by third parties. In the past, ASPT has been sued for alleged patent infringement.

Global Risks. The financial resources required to enter, establish, and grow new and existing international markets may be substantial, and international operations are subject to additional risks including government approval, currency risks, etc.

Technology Risks. ASPT’s intellectual property may be copied, obtained, or developed independently by third parties.

The market for ASPT’s products and services is subject to rapid technological change and new product introductions. Current competitors or new market entrants may develop new, proprietary products with features that could adversely affect the competitive position of ASPT’s products.

The convergence of voice and data networks, and wired and wireless communications could require substantial modification and customization of ASPT’s current products and business models, as well as the introduction of new products. In addition, Aspect’s products must readily integrate with major third-party security, telephony, front-office, and back-office systems. Any changes to these third-party systems could require ASPT to redesign its products.

Geographic Concentration of Operations. Significant elements of product development, manufacturing, information technology systems, corporate offices, and support functions are concentrated at a single location in the Silicon Valley area of California. Sales, administrative, and support functions and related infrastructure to support our international operations are concentrated at ASPT’s U.K. offices. In the event of a disaster, ASPT could experience a significant business interruption.



Financials.

Market Value $285,190 79,000 shares @ $3.61
PV of Restructuring
Reserve 21,969
Less: Cash 22,688

Enterprise Value 284,471

EV/(EBITDA - capex) 4.5x


Note that the PV of the $40 million restructuring reserve on 9/30/02 is approximately $22 million (From the Sep 02 10Q, $37 million for real estate to be paid over 14 years - say $2.64 million per year for 14 years discounted at 10% plus $2.5 million of severance to be paid immediately)

2003 Projections.

2003 4Q03 3Q03 2Q03 1Q03
31-Dec 30-Sep 30-Jun 31-Mar
Net revenues:
License $81.6 $21.6 $20.5 $20.0 $19.6
Services 247.3 64.3 62.4 60.6 60.0
Other 53.9 13.1 13.3 13.6 13.9
Total net
revenues 382.9 98.9 96.3 94.2 93.5

Cost of revenues:
Cost of license
revenues 10.4 2.8 2.6 2.5 2.5
Cost of services
revenues 116.0 29.0 29.0 29.0 29.0
Cost of other
revenues 40.6 9.8 10.0 10.2 10.5
Intangibles
Amortization 5.0 1.3 1.3 1.3 1.3
Total cost of
revenues 172.0 42.8 42.9 43.0 43.2
Gross margin 210.9 56.1 53.4 51.1 50.3
Operating expenses:
Research and
development 48.0 12.0 12.0 12.0 12.0
Selling, general and
administrative 124.0 31.0 31.0 31.0 31.0
Total operating
expenses 172.0 43.0 43.0 43.0 43.0

Income from
operations 38.9 13.1 10.4 8.1 7.3
Interest and other income (expense), net
Pretax income 38.9 13.1 10.4 8.1 7.3
Provision (benefit) for
income taxes (5.0) (1.3) (1.3) (1.3) (1.3)
Net income 33.9 11.8 9.1 6.9 6.0
Cash Net Income 38.9 13.1 10.4 8.1 7.3

EPS $0.43 $0.15 $0.12 $0.09 $0.08
Cash EPS $0.49 $0.17 $0.13 $0.10 $0.09
Basic and diluted weighted average shares
outstanding 79.0 79.0 79.0 79.0 79.0

Depreciation 28.7 7.2 7.2 7.2 7.2
Intangibles
Amortization 5.0 1.3 1.3 1.3 1.3
Capex (4.9) (1.2) (1.2) (1.2) (1.2)
28.8 7.2 7.2 7.2 7.2


FCF 62.7 19.1 16.4 14.1 13.2

FCF/share $0.79 $0.24 $0.21 $0.18 $0.17

EBITDA 67.6 20.3 17.6 15.3 14.4


Historical Quarterly. Quarterly performance shows turnaround taking hold.


2002 4Q02 3Q02 2Q02 1Q02
31-Dec 30-Sep 30-Jun 31-Mar
Net revenues:
License $82.8 $20.6 $21.5 $17.8 $22.9
Services 247.4 62.2 58.9 62.5 63.8
Other 65.8 14.2 16.0 17.8 17.7
Total net
revenues 396.1 96.9 96.5 98.1 104.5

Cost of revenues:
Cost of license
revenues 8.3 2.6 2.1 1.9 1.6
Cost of services
revenues 132.6 29.0 29.8 37.1 36.7
Cost of other
revenues 55.9 10.7 12.7 14.0 18.5
Intangibles
Amortization 6.7 1.3 2.9 1.3 1.2
Total cost of
revenues 203.5 43.6 47.5 54.2 58.1
Gross margin 192.6 53.4 49.0 43.9 46.4
Operating expenses: - - - - -
Research and
development 56.2 12.6 13.4 14.7 15.4
Selling, general and
administrative 149.9 32.0 35.0 40.3 42.7
Amortization 1.7 0.1 0.4 0.6 0.6
Total operating
expenses 207.8 44.7 48.8 55.6 58.7

Income from
operations (15.2) 8.6 0.2 (11.7) (12.3)
Interest and other income (expense),
net (11.6) (1.7) 1.6 (9.3) (2.1)
Pretax income (26.8) 6.9 1.7 (21.0) (14.4)
Provision (benefit) for
income taxes 27.4 (0.6) (0.4) 5.5 22.9
Net income 0.6 6.4 1.4 (15.6) 8.5
Cash Net Income 9.0 7.8 4.7 (13.8) 10.3

EPS $0.01 $0.12 $0.03 $(0.30) $0.16
Cash EPS $0.17 $0.15 $0.09 $(0.26) $0.20
Basic and diluted weighted average shares
outstanding 52.5 52.9 52.7 52.4 52.1

Depreciation 34.0 7.2 8.9 8.9 8.9
Intangibles
Amortization 8.3 1.4 3.3 1.8 1.8
Capex (10.7) (1.2) (3.2) (3.2) (3.2)
31.6 7.3 9.1 7.6 7.6


FCF 32.3 13.7 10.5 (8.0) 16.1

FCF/share $0.61 $0.26 $0.20 $(0.15) $0.31

EBITDA 18.8 15.8 9.1 (2.8) (3.3)
% of revenues 4.7% 16.3% 9.4% -2.9% -3.2%




Historical Annual. Long term perspective shows that potetial for growth exists.

2003E 2002 2001 2000 1999

Net
revenues $382.9 $396.1 $445.8 $589.3 $488.3
Gross margin 209.5 192.6 207.1 305.1 245.1
(% of net
revenues) 55% 49% 46% 52% 50%
Research and
development 48.0 56.2 96.0 109.4 86.9
(% of net
revenues) 13% 14% 22% 19% 18%
Selling, general and
administrative 124.0 149.9 224.5 235.5 199.1
(% of net
revenues) 32% 38% 50% 40% 41%
Income (loss) from
operations 37.5 (15.2) (157.4) (44.8) (40.8)
(% of net
revenues) 10% -4% -35% -8% -8%
Net income
(loss) 32.5 0.6 (156.3) (37.3) (29.9)
(% of net
revenues) 8% 0% -35% -6% -6%
EPS $0.41 $0.01 -$3.03 -$0.73 -$0.62

Shares
outstanding 79.0 52.5 51.9 51.1 49.5
Capital
spending 4.9 10.7 50.0 66.1 33.3
Regular full-time
employees 1,370 1,740 1,842 2,740 2,360

Catalyst

More public awareness that ASPT has already turned around (eg the next earnings call in April) - time is the company's friend here, with the strong balance sheet, free cash flow generation and market leadership position - with home run potential if ASPT begins to show any growth.
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