To: Marsha Landau who wrote (2310 ) 7/21/2000 8:10:15 PM From: pat mudge Respond to A few quotes from JP Morgan's SDLI Q2 report:We are increasing our EPS estimate for 2000 from $1.25 to $1.39 and for 2001 from $1.70 to $2.10. We reiterate our Buy rating on shares of SDLI. Our revised EPS projections are the result of more optimistic assumptions for the company’s gross and operating margins as it scales its internal communications volumes and benefits from higher-margin business at Veritech and PIRI. Several important points from on the call: – This quarter marked the first time that we have seen just how much SDL's aggressive acquisition strategy this spring (Queensgate, Veritech, and PIRI) has brought to the company's revenue growth, margins, and broadening product lines. We expect these businesses to continue to contribute significantly to the top-line as technology synergies, capacity expansions, and further design wins become realized. Margins benefited significantly in the quarter from these acquisitions as the company began integrating the higher-margin business of Veritech and PIRI. PIRI was only part of SDL for 4 weeks in 2Q/00 so we expect it to continue to drive margins higher in the second half of 2000. Integration of the acquisitions seems to be progressing well as the sales teams were integrated from the beginning and the divisions are rapidly becoming organized by complementary product areas. One good example is the recent hire of John Wyatt from Sumitomo Electric. He is to lead the Transmission Division at SDL, uniting the development efforts of SDL's transmitter and receiver products including modulators and the Veritech modulator drivers and receivers.· Continued Margin Improvement - The company reached the 50% gross margin and 30% operating margin standard last quarter, which they were able to expand into this quarter. While our model projects gross margins declining to the 51% range in late 2001 and into 2002, we actually believe that there maybe longer-term expansion opportunities as the demand environment for SDL’s products is likely to remain very strong for some time to come, creating an appealing pricing environment. As SDL strips out costs from it production processes, we may very well see gross margin expansion – clearly a potential leverage point for upside to our current estimates. We believe that as the company rapidly becomes better at making its 980 nm pump chip and modules (yields improve), greater volumes of production will offset the fixed manufacturing costs. SDL also has aggressive plans to ramp capacity by 5x over the next 12-18 months -- giving it more volume at what it is quickly becoming good at producing.· Next Generation Products – There was a lot of talk on the call about the company's next generation products including 10 Gbps modulators, Raman amplifiers, and array waveguides from PIRI. Although these continue to be only a small portion of revenues today, we believe capacity increases over the next several months and targeted design win efforts will give these next generation offerings more traction in 2001. Today there are 13 customers sampling Raman technology -- with coastal hopping or festooning bringing in production orders -- indicating the early, yet exciting, state of this technology. High-speed 10 Gbps. modulators remain a small business for the company with a handful of production orders including the publicized Siemens (SMAWY/$164.50/Buy) contract and an additional large systems customer working out its driver packaging issues and ramping purchases in 4Q/00. PIRI's higher-margin array waveguides commanded the most attention as these next generation filtering technologies are exceeding the company's expectations. Manufacturing space should be up by 80%, which is critical as capacity currently is serving as the limitation to bringing more customers, beyond Lucent (LU/$54.19/Buy), on-line for the technology. We believe the array waveguide platform will provide a good foundation for SDL's integration and greater functionality efforts over the next several quarters.We reiterate our BUY rating on shares of SDLI.
