With
Anthony Muller, JDS Uniphase's chief financial officer and senior vice president, spoke with The Motley Fool about the fiber optic industry, JDS Uniphase's recently announced $15 billion merger with E-Tek Dynamics (Nasdaq: ETEK), and about the growth potential for bandwidth demand.
TMF: I'm not sure if you're aware, but we had [JDS Uniphase CEO] Kevin Kalkhoven come on to this same feature in May of last year, back before the merger between Uniphase and JDS Fitel.
Muller: So you had the "A-Team" then?
TMF: That's right. Well, I think we still got the A-team. I just wanted to know in the interim, what are some of the elements that have changed about the merged company, the industry you're in, and the technology?
"Every time an institutional investor in particular asks me this I question, I say do you own any service provider companies in your portfolio and the answers yes and I say what's happening in their capital budgets. They're going up. Next question."
Muller: Well everything is moving faster. It's bigger and moving faster. As you know, we closed the merger with JDS Fitel on the sixth of July. And the integration is going well. It's wonderful to have partners and colleagues as talented as they are. The business has continued to grow very rapidly and we continue to be unable to keep up with demand. We have had a rather eventful six months subsequent to the merger, and in the intervening time we have announced seven acquisitions and three stock splits.
I think what has really happened is not only have we gotten larger but the fiber optic business has become much more widely known and much better understood in part because it's a lot larger and still has, we believe, substantial growth potential. And this is becoming a mainstream industry whereas a year or two ago, only those of us close to the business were really familiar with what was happening.
And now, in part because of The Motley Fool, the awareness of fiber optics in telecommunications is becoming much more widespread.
TMF: Well, I think you are giving us credit where credit may not entirely be due, but I will take that as a compliment.
Muller: You guys have been very kind to us.
TMF: Well, we do like companies that we consider to be excellent for investors, so we Fools will take some credit there, but you all deserve credit for looking after the individual investor.
Your comments bring up two questions: The first of which is something that you could probably address best, being the CFO, with all the merger and acquisition activity that your company has had over the past year, and particularly in the last six months, how would you suggest investors go about comparing JDS Uniphase's current performance with past quarters?
Muller: Well, if an investor was to cover our company very closely and they could provide some very good historical information, we of course provide an enormous amount of detail on our acquisitions and our securities filings and that information, of course, is available to everybody on Edgar. And read our security filings carefully. That's the best way to analyze this company, or any other company in terms of its historical performance.
TMF: So you feel that what you have in the securities filings is a pretty accurate representation?
Muller: Well, there's no question that everything we put in our securities filings is very accurate. The real question is whether or not it's adequate to meet the needs of someone who wants to try and reconstruct that past and it's not a complete road map, but it gives a pretty good idea. Another thing is we have started Web casting all of our conference calls. All of our earnings conference calls, and, for example, if you were to go to our website today, there is a link to the conference call we had last week on the merger.
Fortunately technology has made it feasible for us to make this kind of information widely available and for investors to hear it in our own words. And the conference call will also be Web casted.
TMF: I also wanted to ask you, and you mentioned about how fiber optics have gone from being a technical specialty to be something that is really in the broad commercial market and it's also in the common person's parlance. They're aware of what it is, or at least they have a good idea of how fiber optics matter to them.
"I think what has really happened is not only have we gotten larger but, the fiber optic business has become much more widely known and much better understood in part because it's a lot larger and still has, we believe, substantial growth potential."
Muller: Although I'm not sure that the day traders that trade our shares know what fiber optics is all about.
TMF: Nor would they probably care, which is unfortunate.
Muller: Exactly. They should spend their time reading The Motley Fool instead of doing what they're doing.
TMF: We have heard a good deal about a so-called fiber bandwidth glut due to overbuilding and also due to the improvements on the terminating technology. What is your take on the future need for bandwidth?
Muller: We see the capital spending plans of the telecommunications service providers and that's really the ultimate source of our demand. Every time an institutional investor in particular asks me this I question, I say, "Do you own any service provider companies in your portfolio?" And the answer's, "Yes," and I say, "What's happening in their capital budgets?" They're going up. Next question.
I can really personalize my answer, Bill, by asking you if you're happy with your Internet access.
TMF: I would say not particularly.
Muller: And you're really not doing a lot with the Internet yet, because all you're doing over the Internet is you're retrieving text. You're perhaps retrieving some photographs or you might be downloading some voice files such as our conference call. You're not doing full motion video. You're not sending digital video tapes of the grandchildren to the grandparents. You're not doing voice over [Internet Protocol]. You're not doing video over IP, which is video conferencing. You're not doing video on demand. You're not doing any of the things that the venture capitalists conjure for high-speed, abundant bandwidth.
TMF: I would certainly agree with you. When you see a company like Qwest (NYSE: Q), which is lighting fiber all over the place, there still is some question and from the standpoint that it is fairly staggering for the individual to try and consider what corporations are doing with this capacity.
Muller: Well, there will be times when one or another of the service providers hasn't been able to sell all of his bandwidth. And those things will happen, but don't confuse the possibility of those kind of situations with an aggregate.
Let me just give you a little bit of history. If you were looking at a voice circuit five, 10 years ago, or a voice infrastructure, your nightmare if you were a network engineer would be running out of space, giving people a busy signal. But you knew there was a pretty well understood relationship between average use and peak use of your capacity. Nobody other than a stock trader can speak on more than one phone at a time. And even the stock traders are limited to three or four.
Let's go into the data world. With a stroke of a key, you can bring a system to its knees. By just deciding that I want to see this really big, super-high resolution, two-hour streaming video file. The amount of surge or burst capacity that the service provider needs to meet your needs or my needs is almost indeterminate. Because in the data world, we can generate huge amounts of data. In the voice world, we can only talk so much. The amount of extra capacity that's required to do fall back and recovery, in other words error correction. And I could just go on and on with the litany. There is a long way to go in data width.
TMF: You say then the amount in existence today and most of the technological improvements that continue on the equipment to be really the beginning of the spectrum.
Muller: Absolutely. People say what inning are we in. And I say well we're not on the on-deck circle, because we've hit a few home runs. We are still in the first third of the game.
TMF: Why don't we talk a little bit about the E-Tek acquisition? I've looked over a lot of past information about JDS and one of the things that fascinated me was the amount of R&D that you all were able to acquire for a small amount of money. At one point it was about a billion dollars for about $64 million in cash, plus the portion of stock that you gave to Phillips.
This has turned out to be about a $15 billion deal. How do you believe that is going to be accretive to shareholders?
Muller: First, we did extensive analysis just using projections of financial performance. And that deal we project to be slightly accretive to our stockholders. A lot of things that we can do in combination that we couldn't do separately, and please look at this as a merger or combination among three companies, not two companies, with the third being OCLI.
Number one is we think we can increase capacity. In other words, increase more rapidly the total amount of product built by JDS Uniphase and ETEK. With the availability of manufacturing capacity at OCLI and their Asian-Pacific manufacturing sites.
Second, we think that by combining E-Tek with JDS Uniphase and OCLI we can reduce time to the market. By taking certain projects in Ottawa and certain projects in San Jose and Asia and concentrating more people on the projects in the two places, we'll be able to take a scarce quantity of technical talent we have and apply it in a more concentrated manner, and we think get products to market more quickly.
The combination, we think, can help us improve long-term price performance through low-cost manufacturing, having the scale to do automation and tooling for our people, Asian-Pacific manufacturing. So there are many ways in which we think we can provide more benefits to customers from this combination.
TMF: Your gross margins were at about a 51% level from the last quarter. If the prices come down for the products that you're offering, how do you plan on keeping your gross margins at that level?
Muller: We expect our cost to come down with volume, with growth, with improved technology, and we want prices and cost to come down because those forces tend to expand markets. That's good.
TMF: So what's important to you is expansion of the market?
Muller: Well, I'd say we do have to maintain our profit margins, we do have to return a good profit for our stockholders, but the stockholders benefit when our markets continue to grow fast.
TMF: What are your expectations for growth for the next few years, for the market in general?
Muller: The fiber optic market is about $5.5 billion in 1999. We'll grow to $21.3 billion in the year 2003.
TMF: So that's about 60%-per-year growth, if my math doesn't fail me, or 400% over four. Do you expect to have a static percentage, or a growing portion of that?
Muller: Well, we think that the merchant segment of the business is growing somewhat faster than the internal segment. Meaning the systems suppliers are making components for themselves. So if we can continue to serve our customers and make it worth their while to buy from us, I think we can continue to have a reasonable share of the market.
TMF: What other trends in your industry do you think that investors should be paying attention to besides, obviously, that fantastic growth?
Muller: In terms of understanding our business, understand our customers' business and the business of our customers' customers. In other words, the telecommunication systems providers and the telecommunication service providers because we're here to serve them. And if their businesses are healthy and growing and our products continue to be competitive, I think we will be able to continue to grow in the market. But that's a challenge.
And to understand our business, don't just focus on us, focus on our customers and our customers' customers.
TMF: Certainly. I think that it's sometimes lost that every business has certain amounts of organic things that they can do to help themselves, but the health of your customer base also needs to be taken into account. That makes a lot of sense.
I did have one other question for you. I'm not sure if you are familiar with some of the things we do on our site, but we have some real-money portfolios including one that's called the Rule Maker, which made up of companies that we consider to be, if you will, the gorillas of their business, and JDS Uniphase recently was brought up by some of our readers and some of our writers here for potential inclusion as a Rule Maker. My question to you is, Do you think that JDS Uniphase is a Rule Maker in your business?
Muller: Well, Bill, I can explain what is going on in our markets and what our company is doing. I think when it comes to categorizations like this or questions of other things relating to the markets, I'd leave it to the people of the financial community and the press who are much smarter about these things than I am.
But we're always flattered to be given any kind of recognition. We hope we earn it. More importantly, I hope we continue to earn it.
For people who have trouble understanding our company, I refer to our company as a pants company. Here's how I get to that very unlikely conclusion: In 1849, we had a gold rush in California, and of course there are all kinds of business that came out of the gold rush, but a business that has certainly stood the test of time was Levi Strauss. The guy who made the pants for the miners. So if you advance forward 150 years to the Internet gold rush, somebody has to make the pants for the Internet. And that's our job.
TMF: Excellent. Well, Tony, I really do appreciate your spending some time with us and giving me some of your thoughts on your company. It's really been a pleasure speaking with you.
Muller: Bill, my pleasure.
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