INFS -- “Final Thoughts”

In the previous 5 posts I talked at length about the problems faced by INFS as well as the attractive aspects of an investment in the company.

INFS continues to see prices for its products drop by double digit rates due to roughly 30-40 competing projector manufacturers as well as the ascent of LCD/Plasma televisions.

However, INFS is now controlled by a hedge fund which is the firm’s largest shareholder and will be picking the new management team and setting the new policies, the company has a fortress balance sheet, and it appears that the stock is trading at a discount to the combination of tangible liquidation value + non-tangible assets that certainly posses value for an acquirer.

If there is value for the shareholder, why didn’t anyone purchase INFS when it effectively put itself up for sale a few months ago?

I don’t have a definitive answer to this question but my feeling is that it would be hard for any CEO to justify buying a money losing operation even if he/she feels there is value to be added. Also, since Caxton is actively involved it’s highly likely that they would be looking for a very high premium – again, something most CEO’s could not justify to their boards, shareholders, or analysts.

There will be more key data points coming from the company within the next 6 months. The biggest in my opinion will be hiring of the new CEO and CFO by Caxton and the plan that will be outlined to other shareholders to turn the company around. There will also be a new proxy filled and it will be key to see how the two top people at the firm will be incentivised. Will their biggest gains come only if shareholders benefit (mostly long term restricted stock based compensation plan) or will they be awarded with mostly cash salaries and large parachutes?

Another two key data points in the next few quarters will be the trend in Gross Margins and G&A expense. Obviously these are key metrics for any company any time, but in the case of INFS the trends in Gross Margins and G&A expense will make the difference between survival and bankruptcy.

On the last quarterly call the recently departed CFO stated that gross margins took a 360bps SEQUENTIAL hit due to the company clearing out inventory of IN72 projectors and selling a lot more of the lower price point IN24 and IN26 projectors causing sequential volumes to go up 15% while revenue was down 7%. The CFO stated that they “aggressively sold these products” which of course in the real world means: “CRAZY EDDIE HERE, AND EVERYTHING MUST GO. SALE, SALE, SALE!!!!!!!” While aggressive discounting of course kills margins, the positive is that it clears the deck of old products and turns inventory into cash which the company needs right now. While not as clearly, that much was stated by management on the last call.

The company also needs to cut G&A expense immediately. While there is always a degree of uncertainty around new product introductions which management has no control over, expenses are completely under management’s control. The company needs to cut expenses and needs to do it immediately – this is where a new CEO/CFO team can make an immediate impact. Again, on the last conference call guidance was for $14.5M - $15.5M in quarterly G&A as the goal by year end from the current level of $19.2M in Q1:2007. It will be up to new management to cut expenses without cutting R&D. Cutting costs is great, but where to cut with manufacturing and call centers already outsourced?

One place where I think some cuts can be made is in the development/support of the dealer network as well as some general “home office” jobs. As I understand the business model, the company spends a lot of time training and supporting dealers that sell their product. This is a key function of course, but there maybe room to trim the least profitable dealers (which will mean giving up sales) and the people employed to support them (more profits from fewer dealers). This is by no means a given and in my experience the odds are against any new management team faced with this task.

So is INFS going to be added to the Watch List or the Best Ideas portfolio?

Based on my previous post, I think INFS is trading at a substantial discount to what an acquirer would be willing to pay for the company. The company is now run by the largest shareholders and it the company has the balance sheet needed for such a massive turnaround. Therefore I have added a 1% position in INFS to the Best Ideas portfolio. You will recall that my target for this portfolio is to have 10 full positions at roughly 8% each and 10 smaller positions that will hopefully be increased to full positions eventually.

What will I be watching for in the next few quarters?

I will be looking for a sequential bounce in Gross Margins as the company has apparently moved out the old discounted inventory and should see an increase as it starts selling more higher priced products. I don’t think the company is close to hitting the long term targeted GM of 16% to 18%, but not seeing an immediate increase would be a very bad sign.

After new management is hired I will be looking for declining G&A – are they heading towards previously guided $14.5M to $15.5M? What is management doing to cut expenses immediately?

Details of new CEO’s and CFO’s long term compensation – is it long term stock based or mostly cash?

I will also be looking for trends in revenue and average prices in Q3 and especially Q4. The projector industry is seasonal with most of the sales done in Q3 and Q4, with Q4 being by far the most important. Right now the stated plan is to migrate customers to higher margin IN24+ and IN26+ as well as new product launches like the IN10 ultra mobile projector. If after clearing out inventory the company can’t increase Gross Margins and show at least some initial increase in sales, there is no reason to own this stock.



* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.