Last night, JDS Uniphase (Nasdaq: JDSU) reported third-quarter earnings, so today I'll conduct our usual quarterly due diligence to make sure our company is still running its business in Rule Maker style. But before diving in, I ought to warn you about something: It's almost too easy for me to say great things about the growth opportunities for this company. If you don't think that JDSU's management team is poised to capture its future opportunities then you might find it helpful to listen to the replay of last night's conference call (linked at bottom). Listening to the call reinforced the confidence I've had in JDSU's management team ever since I performed my own due diligence on JDSU before adding it to my portfolio.
From a Rule Maker perspective, the quarter was pretty much more of the same. As shown in the updated Rule Maker Ranker I prepared last night, it remains a solid second-tier Rule Maker with its score of 46. In addition to the other notes I made in that post, you should be aware that I used the June 1999 balance sheet data (rather than March 1999) for comparative purposes, as the earlier balance sheets have not been restated to reflect Uniphase's combination with JDS Fitel. This problem will go away next quarter, as we'll finally have comparable results for both JDS Fitel and Uniphase.
Let's take JDSU through the quantitative elements of our Rule Maker Criteria and see how things shake out.
- Sales Growth of 10% or More -- Forget looking at things on a year-over-year basis, as that's not even a challenge for a company like JDSU. Revenues grew by 40% just since last quarter (growth exclusive of acquisitions was 22%). On a comparable-quarter basis, revenues grew at an incredible 155% rate.
In the past, JDSU's guidance has normally been for sequential revenue growth of 15%. This time it raised the bar to 20%. That would give it sales next quarter of $480 million. Its guidance for the upcoming fiscal year (FY 01), starting on July 1, 2000, is for sales to grow by 75%, which implies full-year FY 01 sales of $2.4 billion. JDSU continues to grow at industry-leading rates off a much higher sales base than its competition. At this point, the expansion of its business is limited much more by capacity constraints and manufacturing efficiencies than by demand.
It should also be noted that during the quarter, 22% of JDSU's sales were to Lucent (NYSE: LU), which was unchanged from last quarter, and 16% were to Nortel (NYSE: NT), up 2% from last quarter. Due to Lucent's recent announcement that it will be outsourcing more of its manufacturing activities, I wouldn't be surprised to see its reliance on JDSU to actually increase in the future. However, due to the overall growth of JDSU's business, this may not lead to Lucent becoming a bigger portion of JDSU's overall sales base.
- Gross Margins of 50% or More -- JDSU's gross margin for the quarter improved slightly to 51.9% from 51.3% a year ago. The acquisition of OCLI, which closed during the quarter, had a beneficial impact on gross margins. One of the challenges for JDSU is to make its products in large quantities, while also driving down its unit costs by a 15-20% rate.
In order to stay ahead of its competition, Kalkhoven said that JDSU must do three things: 1) have the right products and technology, 2) make these products in large quantities, and 3) use the silicon model (e.g., the model used by Intel) of continuing to increase the price-per-performance of its products. And, it must do these things over and over again.
- Net Margins of at Least 7% -- On a pro form basis (i.e., excluding acquisition-related charges such as amortization of purchased intangibles and acquired in-process R&D), JDSU improved its net margin fractionally from 21.4% to 21.7%.
- Cash-to-Debt Ratio of 1.5 or Greater -- On the surface, JDSU's balance sheet looks to be debt-free. However, on the call, there was a comment that there is some debt in the Other Non-Current Liabilities account on the balance sheet. When I prepared my RM Ranker, I assumed that half of this amount was debt for both quarters. The company's goal is to be able to finance growth through cash provided by operations, but they said that clearing out this debt was too costly, so it sits on the balance sheet for now. I'll look for the exact figures once the more detailed 10-Q balance sheet is released, but if there is any debt, it's minimal.
- Flow Ratio of 1.25 or Less -- This is an area that JDSU falls a bit short of our expectations. Its Flow Ratio for the current quarter was 1.63, which was a 5% increase from the 1.54 of both last quarter and the end of fiscal 1999 (June). Normally we like to look at year-over-year figures instead of sequential ones. However, one of the difficulties with evaluating this number for JDSU is the massive number of acquisitions that it has completed over the last year, highlighted by last June's combination of Uniphase with JDS Fitel.
Due to the substantial changes to JDSU over the last year, and the lack of availability of pro forma balance sheet information for the merged entity, right now I believe that it is better to look at quarter-to-quarter movements on the balance sheet instead of year-over-year. The mid-quarter acquisitions that JDSU has made also are likely to have had an impact on JDSU's balance sheet. It should also be noted that JDSU's Flow Ratio remained lower than that of all its competitors.
There are a couple elements of JDSU's balance sheet that we plan to keep an eye on in the future. The first is its management of accounts receivable. Days sales outstanding (DSO) -- accounts receivable / (sales / 90) -- increased by one day to 60 from last quarter. JDSU has also been building its inventory for certain product categories, which resulted in an increase in its days inventory outstanding (DIO) -- inventory / (cost of sales / 90) -- from 87 days to 94. Most of the inventory buildup relates to work-in-process. This is a natural outgrowth of the dynamic growth of JDSU's industry. The company can essentially sell all that it can make, so as it grows its manufacturing capabilities, its inventory can increase as well.
In the first three quarters of this fiscal year, JDSU's manufacturing capacity has increased from 1.2 million to 3.0 million square feet. Our company also has a number of initiatives directed toward increasing its manufacturing efficiency. Days payable outstanding (DPO) -- accounts payable / (cost of sales / 90) -- decreased from 48 to 38 days. This resulted in an increase in JDSU's cash conversion cycle (DSO + DIO - DPO) from 99 to 116 days.
JDSU is implementing an Oracle supply chain management system that should result in improvements to both its balance sheet and income statement. We fully expect that JDSU's Flowie will come down in the future as it improves the quality of its balance sheet and its operations while also extending its dominant position in the marketplace.
- Cash King Margin (CKM) of at Least 10% -- JDSU is one of the few companies that I've seen that provides information that allows us to calculate the CKM at the time of its earnings release. During the quarter, JDSU realized cash flow from operations of $92.1 million and its capital expenditures were $77.4 million. The significant increase in capital expenditures caused JDSU's CKM to fall from 7% last quarter to 4% this quarter. However, JDSU has tremendous growth opportunities. I certainly don't want to see it pass on opportunities to improve its position for the future. I'm happy that it's able to invest in capital expenditures without having to go into debt to do so. The fact that JDSU's cash flow from operations is significantly higher than its pro forma net income of $23.3 million also bodes well for the future.
These are clearly exciting times for JDSU, a company that is certainly growing quite rapidly at present. As a user of the Internet that eagerly awaits the availability of either DSL or cable in his neighborhood, I find myself aligned with something that Kalkhoven said on the conference call: "More bandwidth to the people."
On a final note, I'd like to direct you to an excellent discussion board post from the recent Rule Breaker Seminar, in which Fool community contributor BitGeek offers up a five-second explanation of fiber.
Phil Weiss (TMFGrape on the boards)