When I last wrote on JDSU (Nasdaq:JDSU) about a year ago, I pointed out that there were encouraging signs across the business, and that if this historically boom/bust company could show some consistency the stock could perform well. Flash forward one year: severe flooding did real harm to a contract manufacturer; weak carrier spending rippled through equipment providers; and just about everybody started to worry about the sustainability of tech hardware spending.

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A Good Quarter, But ...
JDSU actually had a surprisingly strong fiscal second quarter. Operations in Thailand recovered faster than anticipated and the company's sequential revenue decline of 2% was considerably better than Street analysts had predicted. Still, it was a tough quarter. Test revenue did rise almost 6% from the preceding quarter, but optical components and advanced technologies both saw declines (nearly 10 and 3%, respectively).

Profitability was challenging on an absolute basis. Gross margin continues to slide, down about three points from last year and about a point from the fiscal first quarter. Operating performance was also soft; reported operating income tipped into the red on an as-reported basis, and segment operating profit was down almost by half on significant margin erosion in test and optical.

The good news, such as it is, is that management had led investors to expect a lot worse in optical components, so all things considered this was a decent quarter.

... Guidance Is a Mixed Bag
Although JDSU shares traded stronger in the immediate aftermath of earnings, guidance on the call cooled things significantly. Sales look pretty good, actually, and the company did see a book-to-bill above one across all segments. Unfortunately, the annual price revisions in the industry look a little worse than expected and margin guidance came down due in large part to lower optical component ASPs. (For related reading, see A Look At Corporate Profit Margins.)

Does JDSU Make Sense as Is?
JDSU is a curious amalgamation of businesses that don't necessary support and reinforce each other.

The optical products business sounds like a good place to be when you think about the absolute increases in data traffic volume projected by companies like Cisco (Nasdaq:CSCO). Unfortunately, there has been a lot of supplier and customer consolidation and both volume and pricing have taken on boom/bust characteristics. JDSU has some growth opportunities for products in fields like liquid crystal on silicon and tunable XFP, but share losses to Finisar (Nasdaq:FNSR) in ROADM may be repeated in the tunable business.

JDSU's test business is relatively stronger, though it has the unenviable task of competing with Danaher (NYSE:DHR) and Agilent (NYSE:A). Margins are relatively good here now, though, and wireless networking equipment market growth should be a tailwind.

Last and not least is the small but undeniably cool advanced optical technologies (AOT) segment. This unit provides a lot of the equipment that makes the Microsoft (Nasdaq:MSFT) Kinnect work, as well as other products like pigments (used to deter currency counterfeits) and holograms. It's a small, highly-profitable business, but I wonder if it gets all of the attention from management that it could really use.

The Bottom Line
The issue in front of JDSU investors hasn't really changed much in the past year. It comes down to belief - belief in whether sales trends in optical networking can become less volatile, whether this amalgamation of businesses makes sense, and whether or not management can gain and hold truly appealing returns on capital and free cash flow conversion. (For related reading, see The Essentials Of Corporate Cash Flow.)

Unfortunately, even the assumption of fairly bold progress in free cash flow conversion isn't enough to make this stock look cheap on discounted cash flow absent some impressive top line growth. Given that I just don't see double-digit revenue growth as sustainable over the next five years, I won't be buying JDSU.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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