Shooting Starcom?

Capping off an already bad week for the Nasdaq, telecommunications company UTStarcom (Nasdaq: UTSI) preannounced a disappointing fourth quarter on Thursday evening. Instead of the expected $875-$885 million in revenue, the company said that the figure would come in between $740 and $745 million. Reaction Friday was swift and brutally predictable as owners went supernova, and the stock was hammered nearly 20%.

Management blamed a slowdown in China (which supplies roughly half of the company's revenue) for the miss but also said that increased centralization of decision making on the part of its customers contributed to slower product acceptance. In English, this means that customers delayed completion of their purchases of UTStarcom's gear, and the company couldn't book about $100 million in revenues for the quarter.

Although management characterized this as delayed revenue (as opposed to outright cancellation), if the economic situation in China is truly softening, there is no guarantee that those delayed orders will ever be accepted and booked as revenue. What's more, management also lowered revenue guidance for the March quarter -- not exactly a strong suggestion that this quarter (and the September quarter before it) were complete aberrations.

While the severity of the sell-off suggests a lot of people were caught off-guard, that needn't have been the case. If the miss back in September wasn't a sufficient warning, investors may have had additional clues in the financial statements. Ever since the December 2003 quarter there have been sequential declines in gross margin, operating margin, inventory turnover, and receivables turnover. While one or two of those isn't a crisis, all four together should be seen as a big red flag.

For those who held on through the carnage, there are a few bright spots. Back in September, several company executives loaded up on shares -- usually not a sign that a company is headed for ultimate disaster. Then again, this quarter's miss does go to show that not all insider buys are signs for Fools to do likewise.

Also positive is the fact that the company is working hard to diversify away from China, and valuation is certainly not extreme. While free cash flow is still negative, the company is trading at below sales. That said, Foolish investors might do well to observe this star through a telescope until the company gets through at least one quarter without a warning. While the stock may appear value-priced, true value requires free cash flow and a somewhat stable business outlook. After all, shooting stars look pretty, but they almost always burn up on reentry.

Fool contributor Stephen Simpson is a CFA and has no financial interest in UTStarcom.