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Large top and bottom-line upside to our already upwardly adjusted estimates; gross margin expanding, balance sheet solid: SDL reported $111M/0.33 for Q2:00 (pro forma, excluding merger related charges), well ahead of our already upwardly revised $104M revenue estimate and our (and the consensus) $0.300 EPS estimate. Gross margin expanded 470 bps A/Q to 52.6%, well ahead of our 50.2% estimate. 57% of the sequential gross margin improvement was due to improved manufacturing efficiencies, yields, and product mix, with the 43% balance attributable to the PIRI and Veritech acquisitions, which closed during the quarter. Revenue from the acquired companies was in line with the management's guidance at the time of the May 26th preannouncement but profitability was far ahead. Operating margin increased from 30.2% to 34.4% sequentially, and the company generated $77.4M in cash from operations. The balance sheet improved markedly. Inventory turns rose from 4.4 to 5.0. DSOs dropped from 63 to 55 Q/Q and would have been below 50 were it not for the acquisition of PIRI, which necessitated the addition of its entire receivables balance versus only four weeks of sales.
Strength across product lines; particularly strong upside in terrestrial pumps; acquisitions drive meaningful product diversity. Revenue jumped 53.1% sequentially. Organically, SDL grew 31% sequentially, up from last quarter's 23% rate. Telecom business accounted for 86% of revenue, up from 83% last quarter. Terrestrial business grew 81% Q/Q and 214% Y/Y as 980 nm pump demand continues to soar. Submarine business was also very strong, growing 30% sequentially, a slight discount to organic business as a whole. Raman grew 40% Q/Q with sales to over 13 customers. Production volumes for this product line remain solely in submarine, though we expect meaningful terrestrial Raman contribution in 1H:01. Including four-weeks of PIRI and an entire quarter of Queensgate and Veritech, the recently acquired companies contributed 14.5% of revenue. Including IOC, we believe business from acquired companies generated revenues of 20% to 25% of the total. Additionally, given that all of the acquired companies increased design win activity during the quarter, customer penetration appears to be increasing broadly across product lines.
Ten percent plus customers this quarter were Alcatel, Corning, and JDS Uniphase. Customer diversification continued as SDL had nine customers contributing >$4M, up from four last quarter and three in Q4:99. International revenue increased 59% Q/Q and accounted for 56% of the total, up from 54% last quarter.
Growth constrained only by capacity: Capacity constraints remain at Veritech, PIRI, and most significantly, for 980nm pumps. In fact, we believe organic growth could have been over 20% higher on 980nm pumps alone. 980nm pumps are sold out through year-end and, given long-term contracts, we believe turns business is almost nonexistent. SDL recently announced capacity expansions for Raman and transmitter and receiver products from Veritech. The Company will add a total of 183K sq. feet between the New Jersey Veritech facilities and the Santa Clara Raman facilities. In total, management plans to add more than 60% more floor space by the end of 2000.
Estimates and recommendation: we are raising our estimates from $0.28 to $0.38 for Q3, from $1.06 to $1.41 for FY:00, and from $1.43 to $2.02 for FY:01, inclusive of a slightly higher tax rate going forward. Business fundamentals continue to improve, and there still exists a merger arbitrage opportunity. While JDS may have difficulty gaining HSR approval, we do believe the merger will eventually go through. Additionally, the Lucent ME spinoff announced yesterday further bolsters JDSU's argument. We rate SDLI shares BUY. |
