For followers of JDS Uniphase (Nasdaq: JDSU), it really shouldn't be much of a surprise that fourth-quarter results once again showed superlative growth. After all, the company manufactures components for optical network equipment makers, a sector of the market that's shown explosive growth over the last few years. However, when I judge JDSU's results, I want to know about more than its earnings. I want to see how its financial statements fare when held under the Rule Maker spotlight.
Be forewarned: JDSU remains one of the more difficult Rule Makers to analyze. The company's many mergers and acquisitions over the last year have led to a rather confusing presentation of its financial results. I actually expected this problem to get better this quarter, now that it's been a year since the combination of Uniphase and JDS Fitel. But, no such luck. The Q4 earnings release contains no less than six versions of the income statement! This situation probably won't change anytime soon, now that JDSU's acquisition of E-TEK has closed. Plus, it has also agreed to merge with SDL Inc. (Nasdaq: SDLI), a deal that still must be approved by the U.S. Department of Justice.
So, bewildering financials and all, let's take JDSU through the quantitative elements of our Rule Maker criteria and see how things shake out.
Sales Growth > 10% -- This one is not even remotely an issue for JDSU. Quarterly revenue of $524 million marked 173% growth over the year-ago result. Sales even grew by 33% over last quarter's result -- that is, on a "sequential basis."
In addition, during the conference call JDSU upped its revenue growth guidance from 15% sequentially to the high teens. The company also said that it expects sales for the coming year to grow 90%.
Let's talk about the company's book-to-bill ratio. This is an indicator of future product demand. It's the amount of revenue "booked" (i.e., orders taken) versus the amount of revenue "billed" (i.e., product delivered and revenue recorded on the income statement). JDSU's book-to-bill ratio is running above 2.0 -- a phenomenal number -- meaning product orders are running at twice the rate of product deliveries. Both the book-to-bill ratio and the order backlog ($931 million) are at all-time highs.
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. JDSU is working hard to alleviate this situation, but demand is so strong that it's not an easy thing to accomplish. The company's goal is to increase its production capacity by four times over any 18-month period, while at the same time decreasing its unit cost of production. It aims to achieve this goal by:
- Capacity expansion
- Continued improvements in manufacturing, layout, and design
One risk factor to note is JDSU's high percentage of sales to certain clients. During the fourth quarter, 20% of JDSU's sales were to Lucent Technologies (NYSE: LU) (21% for the year) and 15% of its sales were to Nortel (NYSE: NT), up 2% from last quarter. Nortel is also a significant E-TEK customer (13% of sales). Alcatel (NYSE: ALA) is E-TEK's biggest customer, responsible for 30% of its revenues. This is a risky situation because if any one of these clients cuts back purchases, then the impact would almost certainly be felt in JDSU's financials. That said, demand is robust, so it's unlikely that it poses a strong risk right now. But, the situation bears watching.
Gross Margins > 50% -- JDSU's gross margin of 50.3% for the quarter was down slightly from last year's 50.9%, but in line with the company's guidance of 50-51%. Unfortunately, JDSU's manufacturing processes require significant manual labor and also result in non-saleable byproducts. One of the company's challenges is to make its products in large quantities, while also driving down unit costs by 15-20%.
Net Margins > 7% -- On a pro forma basis (i.e., excluding non-cash and acquisition-related charges), JDSU improved its net margin fractionally from 21.6% to 21.8%.
Cash-to-Debt > 1.5 -- JDSU continues to carry no debt on its balance sheet, while the cash war chest is now filled with $1.1 billion.
Foolish Flow Ratio < 1.25 -- While JDSU's Flow Ratio of 1.33 missed our target of 1.25, this quarter's performance was a big improvement over the 1.54 it recorded in the fourth quarter of last year. It was also much better than last quarter's 1.63. This improvement is an encouraging sign that we would definitely like to see continue. Another positive sign is that JDSU's days sales outstanding (DSO) -- a measure of uncollected revenues -- decreased by 2 days to 54 from 56 last quarter. We love to see our companies cutting down on those interest-free loans to customers.
Cash King Margin (CKM) > 10% -- JDSU once again showed its investor friendliness by providing the cash flow information needed to calculate the CKM. For the year, JDSU generated $281 million of cash flow from operations and incurred capital expenditures of $280 million. Take the first minus the second, and that's free cash flow of $1 million. Divide that $1 million in free cash flow by the $1,430 million in sales, and we get a CKM for the year of about 0.0007% -- or essentially zero.
JDSU's CKM is significantly less than its net margin because the company is funding its tremendous growth opportunities. I have no objection to seeing JDSU close to cash flow neutral. This is a company with tremendous opportunities. The fact that it's able to fund these opportunities from operating results indicates fiscal responsibility, and I certainly want to see it take advantage of as many of these opportunities as it can manage.
This was another solid quarter for JDSU. These continue to be exciting times for our company -- one of the fastest-growing companies of its size that you'll find. I look forward to continuing to follow and learn more about this business in the future.
Phil Weiss (TMFGrape on the boards)