RULE MAKER PORTFOLIO
Analyzing JDS Uniphase

Last week JDS Uniphase released its first-quarter results. Wall Street analysts wanted to know if demand is weakening, and management answered with a resounding "No." A Rule Maker's look at the balance sheet, however, did turn up some issues to keep an eye on, such as declining accounts payable and the lack of free cash flow due to factory expansion.

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By Phil Weiss (TMF Grape)
November 1, 2000

Welcome to November. I hope all of you took time away from investing yesterday to share in the fun of Halloween. In our house, we enjoyed watching our three-year-old son in a Halloween parade, taking him trick-or-treating, and sharing treats with costumed kids who came to our door. It's a good time of year to be a kid.

Last week, JDS Uniphase (Nasdaq: JDSU) released earnings for the first quarter of its fiscal year.

For starters, you should take the time to listen to JDS Uniphase's conference call. It will help you gain insight into the company's perception of its results and what's going on in the market. It seemed to me that management was a bit frustrated with all the questions about its business prospects after the Nortel Networks (NYSE: NT) dustup last week.

It's rare that I've listened to any conference call in which I've heard so many comments from management about how good things went in the past quarter and how good they expect business to be in the future. Here are a few tidbits:

Co-Chairman and CEO, Jozef Straus:

  • "Demand in optical networking was strong and will continue to grow."

  • "Recent concerns regarding spending at the carrier level do not affect growth in optical networking equipment because fiber optics provides overriding benefits in terms of declining traffic costs."

  • "There is now more opportunity than ever before for JDSU and suppliers to the optical industry."
President and COO, "Jay" Abbe:
  • "Do not see indications of systematic, across-the-board component or modular inventory builds, either at customers or in our own shops."

  • "Do not see double bookings."

  • There is "no stretch-out of delivery dates for orders already placed."
There's no reason to believe these are empty words from management to get the Wise off its back. During the call, JDS Uniphase substantially increased its performance outlook for the rest of the year. Full-year earnings per share estimates were increased from $0.70 to $0.80. In July, JDSU indicated that it expected revenues to increase by 80% to 90%. Now this figure is 115% to 120%.

During my time as a shareholder of JDS Uniphase, I've found its management team generally conservative in terms of guidance. There's no real reason for me to believe that isn't the case this time. This is particularly true now, as any failure on the part of JDSU to at least meet expectations will be sorely punished.

Rule Maker investors are interested in more than just earnings, though. We like to see strong cash flow, little in the way of debt, and good working-capital management. As shown in the table that follows, JDSU's results for the quarter were fairly solid, but there were a couple of warts.
($ in millions)

                       Q1 '01   Q4 '00  Change
Sales Growth            $787     $524    50%
Cost of Sales           $385     $261    48%
Gross Margin           51.0%    50.2%     2%
Net Income              $177     $114    55%
Net Margin            $22.5%    21.8%     3%
Flow Ratio              1.73     1.33    30%
Cash-to-Debt*          27.92    27.18     3%
Cash King Margin (Est)  -20%      -2%    NMF

Accts Rec.             $494     $382     29%
Inventory              $395     $375      5%
Accts Payable          $161     $195    -17%

*estimated
I compared numbers for the last consecutive quarters rather than taking a look at the year-over-year results. The reason is that all of JDSU's acquisitions are accounted for using the purchase rather than the pooling method of accounting. While I can make arguments in favor of or against both methods, one big disadvantage of the purchase method is that prior quarters do not have to be restated. While JDS Uniphase does a better job than most of presenting income statement data for the combined entity for the prior period, it's still difficult to compare year-over-year performance. So, in this case, I like to look at the sequential results.

Two figures jump out. The first is a substantial increase in the Foolish Flow Ratio. You'll notice that, to examine why the Flow Ratio increased, I looked at accounts receivable, inventory, and accounts payable -- the three primary components of the Flow Ratio. What's most important to me about these numbers is that JDSU's accounts receivable and inventory both grew much more slowly than revenues. This is something I like to see, as it decreases the likelihood that JDS Uniphase is managing earnings through its accounts receivable or inventory balances.

The big culprit in terms of the increase in JDSU's Flow Ratio is the decrease in its accounts payable balance. It looks to me like either some of JDSU's suppliers might be experiencing a bit of a cash crunch, or else JDSU is paying more quickly to retain preferential treatment in having its orders filled.

Fortunately, JDS Uniphase made such an improvement in its current assets management that, even though its accounts payable balance decreased over the quarter, it actually improved its cash conversion cycle -- the time it takes to purchase $1 of raw material, turn it into a finished good, sell that finished good, and collect from its customers -- by 17 days over the third quarter result. (If you're not sure how to calculate this figure, you can check out this column.) Based on my analysis, I'm not overly concerned at this time about the higher Flow Ratio.

You'll also note that, based on information from the conference call, JDSU's operations did not generate enough cash to fund the expansion of its business this quarter. The company currently has an initiative to quadruple its manufacturing capacity every 18 months. It's still on track to meet this goal, and this investment in its future is the reason behind the negative Cash King Margin.

This result does bother me a little bit. While I have no objection to a company with the types of opportunities JDS Uniphase has investing in its future, I don't want to find it having difficulty funding its expansion from its own operations on a regular basis, as this would ultimately lead to it having to borrow money to fund its growth.

Phil Weiss, TMF Grape on the Discussion Boards

 

Rule Maker Portfolio


11/1/00 as of ~8:30:00 PM EST

Ticker Company Price
Change
Daily Price
% Change
Price
AXPAMER EXPRESS(1.63)(2.71%)58.38
CSCOCISCO SYSTEMS(1.75)(3.25%)52.13
INTCINTEL CORP(0.13)(0.28%)44.88
JDSUJDS UNIPHASE CORP(2.88)(3.53%)78.56
KOCOCA-COLA CO0.500.83%60.88
MSFTMICROSOFT CORP0.751.09%69.63
NOKNOKIA CORP ADS0.942.19%43.69
PFEPFIZER, INC0.310.72%43.50
SGPSCHERING-PLOUGH0.561.09%52.06
TROWT.ROWE PRICE ASSOC(0.56)(1.20%)46.25
YHOOYAHOO INC5.729.75%64.34

  Day Week Month Year
To Date
Since
1/6/1998
Annualized
Rule Maker(0.06%)3.85%(0.06%)(18.09%)35.08%11.24%
Comparable S&P 500n/an/an/an/a30.73%9.96%
S&P 500(0.57%)3.02%(0.57%)(3.27%)45.46%14.20%
S&P 500 (DA)(0.57%)2.98%(0.57%)(3.23%)47.23%14.69%
NASDAQ(1.08%)1.68%(1.08%)(18.08%)109.11%29.87%

Trade Date # Shares Ticker Cost/Share Price Total % Ret
6/23/98182CSCO24.7252.13110.24%
2/13/98130INTC26.8844.8866.94%
5/26/9866AXP36.0058.3862.16%
2/3/9866PFE27.4343.5058.57%
2/3/9859MSFT49.3569.6341.08%
2/3/9856TROW33.6746.2537.35%
8/21/9844SGP47.9952.068.48%
2/15/00102NOK42.1043.693.76%
2/27/9827KO69.1160.88(11.91%)
2/17/9961YHOO74.9864.34(14.18%)
2/15/0032JDSU100.7578.56(22.02%)

Trade Date # Shares Ticker Total Cost Current Value Total Gain
6/23/98182CSCO4,498.759,486.754,991.03
2/13/98130INTC3,494.555,833.752,339.20
5/26/9866AXP2,375.953,852.751,476.80
2/3/9859MSFT2,911.794,107.881,196.09
2/3/9866PFE1,810.572,871.001,060.43
2/3/9856TROW1,885.702,590.00704.30
8/21/9844SGP2,111.702,290.75179.05
2/15/00102NOK4,294.544,456.13161.59
2/27/9827KO1,865.891,643.63(222.26)
2/17/9961YHOO4,573.603,924.97(648.63)
2/15/0032JDSU3,224.002,514.00(710.00)
 
Cash: 
Total: 
28.42
43,600.02
 


Notes
The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.