COMMENTARY--JDS Uniphase is quickly becoming one of Wall Street's more interesting case studies. The company's latest earnings showcase what can happen when a company built on stock swaps and a seemingly invincible fiber-optic sector hits a bear market.
JDS Uniphase (Nasdaq: JDSU) is a maker of fiber-optic components, stuff that companies like Alcatel (NYSE: ALA) and Nortel (Nasdaq: NT) use to make their telecom equipment. It also is the lowest on the food chain in the fiber-optic market--and it shows.
After meeting twice-reduced estimates for the third quarter, JDS Uniphase projected fourth-quarter earnings of 5 cents a share on sales of $700 million. Those results exclude a host of charges. According to First Call, analysts were expecting earnings of 12 cents a share on sales of $930 million. The company, which also cut 20 percent of its work force, couldn't give an outlook for anything past the June quarter. To no one's surprise, JDS Uniphase fell 13 percent to $20.82 Tuesday as analysts questioned whether the company's restructuring was large enough.
Here's how JDS Uniphase fell into its current conundrum. Wall Street pulled funding for telecom startups, Internet infrastructure spending fell, Cisco (Nasdaq: CSCO), Nortel and others took a beating, and JDS Uniphase got whacked. It's a big circle that started with Wall Street and its wild swings. When times were good, JDS Uniphase couldn't grow fast enough. It grew through acquisitions, using its inflated stock to purchase companies like E-Tek and SDL to meet demand. And why not? JDS Uniphase shares topped $146 in March 2000.
What a difference a year makes. The real bear market bite to JDS Uniphase is its goodwill on the balance sheet.
JDS Uniphase had a terrible habit of overpaying for acquisitions with its inflated shares. When those shares collapsed, JDS Uniphase got zapped with major goodwill expenses. In accounting, goodwill is any advantage, such as a well-regarded brand name or symbol, that enables a business to earn better profits than its competitors. Goodwill also dings the real bottom line--net income--when a company pays a big premium.
The whole goodwill issue is academic in many ways because analysts pretend like it never existed. And new accounting guidelines will allow companies to take a big goodwill write-off and forget about it after a merger.
But a lot of companies are lugging goodwill around--especially JDS Uniphase. The company is carrying a staggering $56.2 billion in goodwill on its balance sheet as of March 31. Most of the goodwill comes from JDS Uniphase's purchase of SDL. The goodwill was based on JDS Uniphase's stock price when the deal was announced, but shares have since fallen dramatically. Now JDS Uniphase's goodwill is well above its market capitalization--a feat that rubs against accounting rules.
So JDS Uniphase said it is consulting with (begging?) the Securities and Exchange Commission to evaluate the amount of goodwill the company is carrying. Analysts are expecting a whopping $40 billion goodwill write-off in the next quarter, but most observers will just shrug it off--it's only accounting. And it's only about half the 1999 gross domestic product of Ireland, according to the CIA World Factbook.
We'd like to forget the goodwill too, but $40 billion is a lot to hide under the mattress.
More balance sheet woes
And the goodwill thing is just a starting point. JDS Uniphase's days sales outstanding (DSOs)--a measure of how long it takes a company to collect money from customers--climbed to 69 days, compared with 61 days in the December quarter, and inventory turns fell from 4 to 3.2 turns. JDS' inventory balances grew 36 percent sequentially to $673 billion despite the company's third-quarter inventory writedowns.
U.S. Bancorp Piper Jaffray analyst Conrad Leifur said in a research note that JDS Uniphase's balance sheet could continue to suffer.
Leifur, who rates JDS Uniphase a "neutral," said his best guess is that the June quarter will mark a trough for the company, but there are no guarantees. "The inventory draw-down at the systems vendors has just begun, and, more distressingly, the fundamental outlook of the backbone carriers which have driven the optical network build-out is poor," he said. "Emerging carriers are suffering a severe case of financial distress and established carriers are announcing further capital spending cuts."
You don't have to look far for examples. Qwest Communications (NYSE: Q), one of the healthiest telecoms around, said it will cut capital spending. Leifur predicts that JDS Uniphase may see some slight sales improvement in the September and December quarters, but for the most part sales will be "flattish," much like JDS Uniphase shares.
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