Scrapps --
I have the H&Q 1-page report dated Oct. 27, 1998.
Recommendation: Buy
* SDL yesterday reported $25.6/9.16 (fully taxed and diluted) versus our $27.0M/0.16 and the $0.16 concensus estimates. Telecom revenue exceeded our expectations but was more than offset by softness in government (research and Satcom) and other (e.g., semiconductor manufacturing) revenue. Despite the revenue shortfall, the Company was able to meet our EPS estimate due to gross margin upside. Gross margin was 36.1% (up 160 basis points sequentially and 80 basis points above our estimate) due in equal parts to improved 980 nm pump laser manufacturing costs, product mix, and higher margin on research contract sales. North America, Europe, and Asia accounted for about 73%, 18%, and 9% of revenue, respectively. On the balance sheet, DSOs remained essentially flat but inventory turns declined from 4.3 to 3.8 as SDL ramped pump laser capacity to meet strong demand.
* 980 nm pump lasers, a critical element of fiber amplifiers for DWDM systems, continue to drive telecom growth and the outlook for this market remains extremely strong. 980 nm pump revenue grew 23% sequentially and 72% Y/Y, and management expects this growth rate (for pump lasers) to continue through Q4. Lucent remains the Company's largest terrestrial pump laser customer, and SDL has three other $1 million plus DWDM customers. In the important and high margin undersea market, SDL this quarter received its first pump laser production order (we believe from Alcatel) and two new qualification orders.
* To meet strong demand for both terrestrial and undersea ppump laser products, SDL is expanding manufacturing capacity, which should have a substantial positive impact on revenue and gross margins. The Company plans to expand undersea pump laser and Bragg grating capacity 300% in Q1'99. Fab capacity is now about 100k chips per year and should approximately double over the next year. Additionally, the Company has begun to build a new pump laser packaging facility in British Columbia, which should expand packaging capacity to about 5X current levels. Overall, with new capacity on-line, we estimate terrestrial and undersea pump lasers will account for 45% and 7% of FY '99 revenue, respectively.
* In businesses other than DWDM, government research and Satcom revenue declined in total about 24% Q/Q. Research revenue was down about 17% Q/Q, as part of an expected on-going trend. Satcom revenue was soft due to 1) delays on the part of a subcontractor and 2) a product development contract that was stretched out. Additionally, sales of equipment sold into the semiconductor industry remained weak.
* Recommendation: We believe SDL is well positioned to capitalize on the telecom market opportunity with its intensified focus and strong technological capabilities. Going forward, we have lowered our estimate for non-telecom business but increased telecom contribution. Overall, our estimates remain unchanged at $28.4M/0.20 for Q4'98 and $134.9M/1.17 for FY'99. At current levels, we view SDLI share as an attractive investment and reiterate our BUY. |
