Yucheng Technologies Limited (YTEC)

motleysmart (69.34) Submitted: 5/20/08 2:00 PM

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To be more exact in the case of YTEC, it expects $1.5 million extra spending on POS throughout 2008, of which more than $.5 million is frontloaded in Q1, which also happens to be the quarter that has the lowest earnings (a known pattern for YTEC) . Therefore, it's a coincidental double whammy on the net earnings. Analysts had considered the $1.5 million expenses to be spread over the year, factored that into the total earnings of about $15 million, giving approximately a 10% downward adjustment on the EPS for 2008. This is all fine, and was in the pre-Q1 knowledge. Then everybody was surprised by the 33% difference for Q1. But the real reason that caused the surprise is that people don't have a good sense of math. Nothing should be surprising if you look at the above math. At the time of this writing, the stock price of YTEC is $11.90, nearly a 40% drop from its recent peak at $19.60, all caused by a "disappointing" Q1 report, or a gross misunderstanding thereof.

The company has just reassured that its outlook is in line with the pre-Q1 expectations. The company expects a GAAP EPS $0.75 (or pro forma EPS $.83). As the Q1 EPS was a measly $0.08, what does that tell you for the rest of the quarters? By the end of 2008, YTEC will have an net GAAP EPS $.75 (or adjusted EPS over $1.00), with an expected 30%-70% growth of net earnings in 2009. With its massive POS deployment, future earnings will only accelerate. By that time, it is easy to make the case for $22 for the stock (which happens to be the present 12 month target price). I'd say $18-$20 by the end of 2008, $30 by the end of 2009.

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motleysmart (69.34) Submitted: 5/21/08 11:55 AM

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Well, I think this stock just touched the bottom at 11.10 this morning and is leaving now to go back to it's previous highs ($19). Present average target price by analysts is $22.50, but some analysts are raising it. Every once a while, one sees a solid stock driven to such unthinkable lows by mysterious forces (institutional investor's greed assisted by retail investors stupidity). I thought I was cold-hearted cynical when I believed it would go down to as low as $12 as I was determined not to underestimate the stupidity of retail investors this time. Still I was wrong. It went down to 11.10. The great wealth redistribution, from the poor to the rich. Sigh.

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motleysmart (69.34) Submitted: 7/17/08 4:24 PM

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08Q2 (August 08) will be an interesting quarter. What is going to be
important is not only the actual earnings, but also their guidance for
the fiscal year. Suppose they meet the current expectation of $.13,
AND continue to confirm the previous outlook of $.80-$.85 of year 08,
that would mean the earnings for the Q3 and Q4 will need to be in the
range of $.58 - $.63 ($.80-$.09-$.13 = $.58), significantly higher than
the $.43 of 07Q3 and 07Q4 total. If this is the case, the price will
move significantly higher from the current price ($10.7) upon 08Q2
earnings (August 2008).

After 08Q2, if the actual earnings of Q3 comes out to again meeting
the expectation, the stock will move beyond $20 a share. By then, the
burdens of the frontloading expenses of POS is behind, and the future
will look even brighter.

To put this into some perspective, last year at this time, when the
stock price was $8, the company barely had a profitable history and
the investors were pricing it based on the extrapolated annual
earnings of 4 x $0.09 (07Q1) <$.40. When the 07Q2 earnings of $0.15
came out, the stock price jumped as high as $18 within a month. It
then fluctuated from there but was still close to $18 before 08Q1.

We all know now how the earnings of 08Q1 brought the stock down.
Although it is clear that the only thing that is depressing the
earnings is the temporary POS expenses, the stock price went down
nonetheless based on the near-term earnings. The market is
nearsighted, and that is not a secret. But there are strong reasons,
all factors considered including the historical data, to believe that
we have seen the bottom.

Both banking IT and POS are sunrise industries in China. Yucheng
presently has relatively little competition. It's hard to imagine the
company to lose its steam. Even if it does not become a dominating
player among providers of banking IT and POS, the company will still
see explosive growth in the next decade. The market is so huge that it
will easily accommodate the coexistence of several multibillion dollar
companies in the same sector. Yucheng is presently under $200M.
That should give you an idea of its future growth.

It's true that the present cash flow situation has not been great. But
the situation in China is different from that in the US. In the case
of Yucheng, the biggest reason why the company suffers from cash flow
problems from time to time in the past is because its customers don't
have a great tradition to pay bills timely. Chinese banks. You have to
be familiar with the situation there in order to understand this. But
these customs do pay eventually.

Dilution. It will occur. But there are two things need to be taken
into consideration. First, the current price per share already takes
into consideration of the dilution that has occurred. Although the EPS
seems flat compared to 07, the total earnings are significant higher.
Had it not been the temporary expenses of POS, the EPS would have
been significantly higher than that of 07 even after the dilution.

Second, further dilution may still happen, but it will not happen
because of any cash flow problem, but because of the company's
internal compensation schemes. A significant part of its stock-based
compensation is conditioned on the stock prices. If the company does
well as expected, the stock price goes up despite the dilution. A
slower-growing stock price triggers less dilution, vice versa. So
there is an inherent balance factor.

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motleysmart (69.34) Submitted: 8/01/08 12:32 PM

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One thing I hate to see is this stock runs up based on unreasonable expectations before Q2, then does an emotional selloff due to childish disappointment. That will again force me to trade the stock.

Some factors to be considered:

In the first quarter, the POS expense contributed -.04 while the non-POS business contributed a +.01 beat to estimate. As a result, the EPS missed the estimate by 0.03 (which comes from -.04 + .01). The market considered that the big deal, because it was a 30% miss. I wrote about the mathematical blindness of the market because it fails to realize that the ostensible high percentage miss was caused by the seasonal low earnings as a percentage basis in the first quarter.

In the upcoming second quarter, the POS expense is expected to contribute another -.04, but the current estimates took that into consideration (this in contrast to a total surprise of that expense in Q1). The current estimates started with the original estimate of .16, did a -.04 (for POS) then a + .01 (as an upward adjustment for non-POS income based on the Q1 performance), to arrive at the current estimate of .13. I believe this is reasonable. I think the worst scenario could be that the POS contributes -.05 (25% more than estimated), and the non-POS earnings miss another .01 from the current estimate. That will give us an EPS of .11 for Q2, a 15% miss. Although this would be far better than the 30% miss of Q1, another childish emotional selloff is virtually guaranteed.

However, I am optimistic that the above scenario will not occur. First, although it is very likely that the POS expenses in Q2 will increase over Q1, that expense will be at least partially offset by the income generated from the previously installed POS. Because the company expects a breakeven point by the end of 2008, it appears that these POS generate income as soon as they are installed.

Second, at least one analyst believes that the revenue for Q2 is going to be significantly higher than the original expectation, due to fast ramp up by the banks in preparation for Olympics. A Roth Capital Partners analyst on June 30 raised the second-quarter sales forecast by $8.5 million to $24.5 million. That would be a quarterly sequential increase of 53% over Q1, and more than doubles the Q2 of 2007. If that turns out to be true, the EPS for Q2 will beat the current estimate by a large margin.

Based on the announcement on July 23 of the $13.7 million project for China Construction Bank, this is not implausible. The strange thing about that announcement was that it said the majority of the system integration portion is realized in the second quarter, while the majority of the solution and implementation services will be recognized in the third quarter. Don't know how much goes to the second-quarter, but this announcement of the "past news" sounded almost like an intentional giveaway of a positive surprise for Q2.

Cash flow isn't something this company can be proud of. But as I said before, this is mainly caused by the unpredictable payments by its customers (Chinese banks). But these customers do pay. Also, the cash flow situation for Q2 is going to be particularly favorable because in the beginning of this quarter, the company recovered a large amount of cash (something like $15 million), which presumably are delayed payments.

Well, I don't claim that I know something that others don't. I just know that I don't like surprises. I would like to see steady growth of this company, and its stock price, not a roller coaster ride.

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