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I. OPERATOR
Ladies and gentlemen, thank you for standing by. Welcome to the SDL,
Incorporated second quarter earnings release conference call. At this time, all
participants are in a listen-only mode. Later we will conduct a question and
answer session. At that time, if you have a question, you will need to press the
"1" followed by the "4" on your push button phone. And, as a reminder, this
conference is being recorded. I would now like to introduce your host for
today's conference, Ms. Marcia Nakamura of the Financial Relations Board. Please
go ahead, ma'am.
II. DISCLAIMER - MARCIA NAKAMURA
Good afternoon, and thank you for joining us to discuss SDL's second
quarter results. You should have received a copy of the earnings release
already. If not, please call us at the Financial Relations Board at (415) 986
1591 and we will fax a copy of the release to you right away.
Before we begin, I'd like to point out that certain statements made in
the course of this conference call that state SDL's or management's intentions,
hopes, goals, beliefs, expectations, projections, plans, anticipation, outlook
or predictions of the future are forward looking statements. Such statements
include projected sequential quarterly revenue and operating margin growth, the
positioning of the company's products, customer diversity being good for SDL's
business, expected capacity increases, improved labor efficiency of product
designs, the creation of module level products in silicon wafers, the advantages
of the JDS Uniphase merger to SDL's customers, employees and shareholders, the
anticipated completion date for the merger, the company's belief that SDL's and
JDSU's products are complementary, that both companies have vigorous competition
for their products and that new developments, new entrants and new technologies
will spur competition. All forward-looking statements are made as of today, and
SDL disclaims any duty to update such statements. It is important to note that
the company's actual results could differ materially from those projected in
such forward-looking statements. Factors that could cause the anticipated
results not to occur are set forth in our Form 10-K for the year ended December
31, 1999 and in our Form 10-Q for the quarters ended March 31, 2000, as
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well as differences in customer perceptions of the JDS Uniphase merger,
unexpected HSR issues and unexpected technical challenges in producing module
level products on silicon wafers. Copies of these filings may be obtained by
contacting SDL or the SEC.
With us today are SDL's Chief Executive Officer, Don Scifres, Chief
Financial Officer, Mike Foster, and Greg Dougherty, our Chief Operating Officer.
I'd like to now turn the call over to Don Scifres to provide an overview of the
results of the business.
III. CEO INTRODUCTION
Thank you, Marcia. Good afternoon ladies and gentlemen, and thank you
for joining us today for a discussion of our results for the second quarter of
2000.
As I'm sure you can tell from our press release, we're thrilled with
our second quarter performance. We achieved sequential revenue and earnings
growth of 50% or better which is far higher than most companies achieve in a
year. Our year over year results are also noteworthy with fiber optic revenue
growth of 242%, or over three times that of 12 months ago.
Fiber optics products continued to be in high demand as we booked
orders at record levels. Our customer base became more diverse as our
acquisitions broadened our product lines and a number of newer customers ramped
their volumes. Our gross margins improved by 4.7 points sequentially as our
manufacturing teams produced record unit volumes in virtually every division.
Our new acquisitions performed well and helped to generate this improvement in
gross margins. At the bottom line, we had record results with proforma operating
income up 72% sequentially. In short, Q2 was an outstanding quarter in virtually
all respects.
I will discuss our prospects for continued growth and the pending
merger with JDS Uniphase in a few minutes but first let me turn the call over to
Mike to give you more detail on the Q2 financials.
IV. CFO REVIEW OF SECOND QUARTER FINANCIAL PERFORMANCE
Thank you, Don, and good afternoon. As Don just said, SDL's financial
performance continued to improve markedly in the second quarter. The company far
exceeded the recently
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revised consensus estimates in revenue, margins and earnings per share. It was
another great quarter.
Continuing the change to cash earnings as our principal measure of
financial performance, begun last quarter, our earnings are presented excluding
non-cash charges for in-process R&D, amortization of intangible assets and stock
compensation.
Total revenue for the June quarter was a record $110.5 million. This is
a 156% increase compared to $43.2 million for the corresponding 1999 quarter.
Sequentially, total revenue increased 53% from the $72.2 million reported for
the March 2000 quarter. Sales of fiber optic communications products for DWDM
systems were up 60% sequentially, and up by a factor of 3.4 or 242% over the
prior year quarter. Fiber optic communications products represented a record 86%
of total revenue in the quarter.
Results of the second quarter include three full months of results from
the Queensgate and Veritech acquisitions and four weeks of results from PIRI.
Excluding these three acquired businesses, total revenue increased by 31%
sequentially and by 116% over the prior year quarter, and base fiber optic
communications revenue grew by 36% sequentially and by 189% over the prior year
quarter.
Sequential growth remained strong in both terrestrial and undersea
sectors of our DWDM business. Terrestrial revenue, driven by demand for
equipment for higher channel count and faster data rate systems, was up 81%
sequentially and up 214% over the prior year quarter. Undersea revenue was up
29% sequentially, and represented 26% of total SDL revenue. Undersea revenue is
up over five times that of the prior year quarter.
By geographic sector, international revenue increased by 58%
sequentially, was up 291% over the prior year quarter, and represented a record
56% of total revenue.
In the second quarter, we had three 10% customers: Alcatel, Corning and
JDS Uniphase. The overall customer base broadened significantly, with nine
customers over $4 million in quarter revenue, compared to four in the March
quarter and three such customers one year ago.
Gross margin was a record 52.6% in the quarter, up 4.7 points from the
previous quarter and up 10.5 points from one year ago. 57% of this sequential
increase was due to continued mix,
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volume, yield and efficiency improvements in our base business, with the balance
of the gain resulting from the strong margins at Veritech and PIRI.
Research and development expense was 6.9% of revenue in Q2. R&D
spending was up 28% from the March quarter and up 77% from the prior year
quarter.
Excluding non-cash stock compensation charges, selling, general and
administrative expense was 11.4% of revenue in Q2, up from 9.2% in Q1. Adjusted
SG&A spending was up 89% from the March quarter and up 98% from the prior year
quarter. The increase in SG&A expense relative to revenue was due to three
principal factors: significantly higher payroll taxes on stock option exercises,
larger incentive plan accruals and higher external sales commissions. Total
payroll taxes on stock option exercises were approximately $5.6 million in Q2,
including $1.6 million in the U.K. This was up about $2.7 million over Q1.
Pro forma operating income was a record $38.0 million for the quarter
and a record 34.4% of revenue. Pro forma operating income increased by 72%, or
3.9 percentage points over the March quarter, and by 402%, or 16.9 percentage
points over the prior year quarter.
With the substantial increase in profitability, we needed to increase
the effective tax rate for 2000 to 36.5%. In order to bring the cumulative rate
to this level, a 36.8% tax rate was used in Q2.
Pro forma net income for the June quarter was a record $27.2 million,
or 24.6% of revenue, and 33 cents a share, on a diluted basis. This represents a
267% increase over diluted earnings per share in Q2 of 1999.
Weighted average diluted shares were 83.5 million compared to 65.9
million for the prior year quarter.
Turning to the balance sheet, we have $379 million of cash and cash
investments, with working capital of $413 million. Q2 cash flow from operations
was a record $77.4 million. Capital expenditures totaled $10.1 million. Days
sales outstanding in receivables decreased substantially to 55 days from 63 days
at March. Inventory turns also improved significantly to 5.0 from 4.4 in Q1.
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To summarize, the Q2 highlights were the continued strong revenue
growth in both the terrestrial and undersea fiber optic market sectors, markedly
higher margins due to operating efficiencies, improved product mix and higher
yields, and a major improvement in cash flow.
For Q3, we are projecting sequential revenue growth of greater than 25%
with proforma operating margins equivalent to Q2 or higher.
This completes my review of our financial results. I will now turn the
call back to Don to give you an update on further developments at the company
during the second quarter.
V. CEO REPORT
Thank you Mike.
I'm sure you'll agree that the results Mike just presented are
exceptionally good. In the next few minutes, I'll present a few of the
highlights, which led to achieving these results and their future implications.
I'll also discuss our proposed merger with JDS Uniphase and the exciting
advantages the merger offers to our customers, shareholders and employees.
Let's begin with our quarterly highlights. First, our fiber optics
product lines continue to expand, both through internal development and through
strategic acquisitions. Today we offer 980 nm pump lasers and modules, Raman and
erbium doped fiber amplifiers, light modulators and drivers, multiplexers and
demultiplexers, variable optical attenuators, optical receiver modules, network
monitors, tunable filters, fiber gratings and many other products to serve our
customers. Many of these products lead the industry in technical capability and
present a springboard for design into the next generation of optical network
equipment. We continue to design in anticipation of the major fiber optic
industry trends of higher channel count wavelength division multiplexing
systems, higher data rates, all optical networks and longer distances before
optical to electrical conversion. As such, we believe our products are well
positioned to continue our future growth.
Our strategy has been to create customer friendly modules. These are
module level products which can be used by our customers without extensive
customer engineering time put into their design. These modules again represented
over 50% of our fiber optic revenue in Q2. Module level revenue was up 50%
sequentially in Q2 and up 244% over the prior year quarter. This leading-edge
module strategy has led to a broadening of our customer base. During the
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quarter, we had nine customers with revenue of over $4 million, up from four in
the prior quarter and three in Q2 1999. Our modules are allowing a new type of
customer to utilize our products. These are new or emerging players in the fiber
optics industry. They are a diverse group and service markets including
undersea, ultra long haul, long haul terrestrial and metro installations. They
include start-ups as well as major players who formerly were not involved in a
major way in fiber optics. Also, a number of global international fiber optic
suppliers are emerging as more important players in the market place. One such
customer is Siemens with which we announced a major order for 10 Gb light
modulators and drivers this quarter. Other customers with whom we received major
new orders include JDS Uniphase and Corning, both of whom have signed contracts
through 2001.
All told, we believe this increased diversity of customers with an
appetite for module level products is very good for SDL's business in the long
term. Certainly, our near term order levels also bear this out. We received
record orders in Q2, surpassing prior quarterly order levels by a healthy
margin. These record order levels have continued to spur expansion of our
manufacturing capacity at many of our sites.
Our overall manufacturing capacity goal is to increase our production
levels by up to five times over the next 12 to 18 months for most of our fiber
optic product lines. Our Victoria, British Columbia pump module manufacturing
line continued to expand into the new facility which came on line about nine
months ago. We expect to continue adding significantly more capacity going
forward by training new hires, adding more manufacturing equipment, occupying
unused space, leasing adjacent new facilities, and taking advantage of the labor
efficiency of our next generation module design. Nevertheless, our potential
order rate for pump modules is higher than our expected ability to expand
capacity. We also announced significant facility expansions for manufacturing of
our Raman amplifier modules and our modulator driver and receiver modules. Both
of these product lines are expected to expand rapidly in 2001 as new facilities
come on line. All told, we are expecting to add approximately 60% more floor
space to our sites by year end.
In another move to facilitate more rapid expansion, we bought out the
contingent portion of our acquisition agreement with Queensgate for 465,000
shares, this making the total purchase price for Queensgate approximately $200
million. This buyout will allow a higher level of investment in new
manufacturing capability and engineering to meet the heavy level of interest,
which has been demonstrated to date by potential customers for new network
monitoring
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modules. We expect these investments will allow us to expand our capacity as
well as achieve customized designs more rapidly, thereby servicing new customers
in a new growth market.
Finally, during the quarter, we closed on our most recent acquisition,
Photonics Integration Research, Incorporated, or PIRI. It, too, exceeded our
expectations during the final weeks of the quarter. PIRI is a very strategic
acquisition in that it offers the long-term potential of creating module level
products on a silicon wafer. In order to increase capacity at PIRI, we are
leasing and building 80% more manufacturing space and are in the processing of
adding additional manufacturing shifts over the next several quarters.
Greg Dougherty, our COO, is doing an extremely comprehensive job of
managing our integration plans for Queensgate, Veritech and PIRI. Our
integration plan includes day one integration with the SDL sales team to create
a single face to our customers. In addition, we are aligning our organization
around complementary product lines. One step in that alignment process is to
create a new transmission equipment division and bring on board John Wyatt, the
former Vice President of Sumitomo Electric as its head. John will be responsible
for lithium niobate modulator products manufactured at our Integrated Optics
subsidiary as well as driver and receiver modules at our Veritech subsidiary. We
certainly welcome John on board.
I would now like to switch topics and discuss our proposed merger with
JDS Uniphase. We look at this merger as an opportunity to serve our customers
better. I expect there are a number of ways this will occur. By merging two
complementary sets of technologies contributed by the two companies, I believe
we will be able to create even more advanced module level products for next
generation systems. This includes transmission modules containing JDSU lasers or
APDs combined with SDL's high-speed modulator and receiver electronics. It also
is expected to include amplifier modules containing JDSU's EDFAs combined with
SDL's Raman amplifiers or small EDFAs containing low cost SDL pumps as specific
examples. We expect to be able to bring these and other modules to the market
more rapidly and to be able to maximize their performance in our customers
network. We also believe that together we will be able to jointly manufacture
more products at a lower cost as we reduce present manufacturing bottlenecks for
pump modules, light modulators and amplifiers in our respective organizations.
In short, we believe the merger will create a better partner for our customers
going forward. This, of course, is always our goal as we supply a greater
quantity and diversity of bandwidth generating products to meet the expected
continued strong demand for these products.
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I'd now like to address the issue of HSR as I'm sure that will be a
question many of you will have. First, with regard to the SDL-JDSU merger, we
have studied the HSR issue thoroughly. We believe that we should be able to
complete the merger by the end of December. I believe SDL's products are
generally complementary to those of JDSU. A good example is that JDSU is one of
our largest customers for 980 nm pump modules which, I should emphasize, they do
not manufacture themselves. We believe others are competing vigorously in the
businesses that SDL and JDSU participate in and that new developments, new
entrants and new technologies continue to spur competition.
We will cooperate with the Justice Department to provide them with all
the necessary information for them to make an informed decision. As you can
appreciate, we are at the earliest stages of the regulatory review process and
we believe that in fairness to that process and to the regulators, that we
should participate in that review on a confidential basis just as is envisioned
for such matters. As a result, I believe it would be inappropriate to comment
further on the HSR issues at this time.
Thank you for listening and now Mike, Greg and I welcome your
questions.
VI. Q&A - OPERATOR
Ladies and gentlemen, we will now begin the question and answer
session. If you have a question, you will need to press the "1" followed by the
"4" on your push-button phone. You will hear a three-tone prompt acknowledging
your request, and your questions will be polled in the order they are received.
If your question has been answered and you would like to withdraw your polling
request, you may do so by pressing the "1" followed by the "3" on your
push-button phone. If you are using a speakerphone, please pick up the hand set
before pressing the numbers. One moment for the first question, please.
VII. SUMMARY
Thank you for your questions and for participating in SDL's second
quarter earnings release conference call. I hope you share with me my enthusiasm
for our prospects going forward. I believe that both our near and long term
prospects have never been brighter as our industry continues to gobble up
bandwidth at what seems like an accelerating rate. I expect that
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the strategic acquisition and merger moves we made this quarter will position us
for continued strong results going forward.
Thank you again, and as always, Mike and I available at any time to
discuss the company. |
