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Optical Coating in the Money with New $20s

Optical Coating Laboratory (OCLI) is in the money.

The new $20 bills to be exact. Optical Coating, maker of a film that plays with light, supplies the Treasury with pigments to use in the new $20 bills to stymie counterfeiters. But more lucratively, as a leading supplier of components that add to the capacity of fiber-optic networks, Optical Coating is now a player in a growing sector of the telecommunications business.

Being near money has rubbed off on the company: In the past four years Optical Coating has bumped up revenue, more than doubled its share price and broken into a new territory. In the July quarter Optical Coating posted net income of $3.4 million, or 27 cents per share, up from $1.9 million, or 17 cents a share, a year earlier. Revenue rose 12% to $67.3 million from $60 million.

Wall Street is valuing Optical Coating at $203 million, about 19 times profits and less than one time revenue. Shares of Optical Coating, which closed unchanged at 16 7/8 yesterday, are up 23% this year, easily beating the Nasdaq Composite Index's 2% decline and the Russell 2000's 23% loss.

No Optical Illusion
Optical Coating earnings and revenue
FISCAL YEAR NET INCOME REVENUE
1998* $7.8m $185.1m
1997 $7.1m $217.8m
1996 $5.2m $189.2m
1995 $6.9m $169.4m
1994 $4.6m $131.8m
*For nine months ended in June. All figures in millions.

Optical Coating has found myriad uses for its special film since World War II veteran Rolf Illsley founded it in 1948 in the Washington, D.C., area and moved it to Santa Rosa, Calif., shortly afterward. The federal government proved a valuable customer, applying Optical Coating's secret sauce to windows on space shuttles in the 1980s. Optical Coating's ultrathin film, made with a precision of five to 10 atoms, refracts only certain colors of the spectrum.

"It's such an interesting technology that we're just learning applications for it," says CFO Craig Collins.

Telecom is the story today. In early 1997 Optical Coating cemented an exclusive partnership with Canadian JDS Fitel to build components for new "wavelength division multiplexing" systems. Put simply, WDM allows multiple colors of light to wash through a fiber-optic network simultaneously. JDS Fitel installs Optical Coating's color-filtering materials in the components that it in turn sells to most builders of WDM systems, including Lucent (LU), Northern Telecom (NT), Alcatel (ALA).

One investor says Optical Coating furnishes a unique piece to the puzzle. "Without it, JDS Fitel would not have the competitive edge it does," says Al Brown from IG Investment Management in Manitoba.

"That's what's driving [Optical Coating] now," adds analyst Eugene Starr with investment bank Brean Murray, who discovered Optical Coating at a trade show three years ago and rates the stock a buy. His firm has not done banking for any recent Optical Coating deals.

WDM is one pocket of telecommunications that evidently hasn't slowed. Northern Telecom and Alcatel have seen their shares decline in part because carriers are swinging from old telephone systems into new Internet products. But both companies still report brisk sales of their "optical" products, including WDM technology. The reason, explains analyst Bill Rabin with J.P. Morgan, is that carriers need an optical layer in their networks for both voice and Internet traffic. Optical equipment is something they must keep buying, albeit in fits and starts.

It's a tough market to crack. Optical Coating engineers spent years building what the company calls the world's largest manufacturing facilities for optical thin film. The catch, and it's not a small one, is that a giant such as Lucent might decide to enter the same market and effectively steal Optical Coating's leading position.

Lucent didn't return calls for comment on its plans. Optical Coating's Collins admits it would be tough to compete head-on with Lucent.

Yet, investors see little threat. "They're the largest in the world in a niche that nobody wants to go after," says IG Investment's Brown. "I don't see anybody displacing them."

Optical Coating has other markets though. Auto makers are mixing Optical Coating's magical pigments into their paint. Nissan dealerships in Europe have promoted limited-edition cars that subtly shift between colors, like a hummingbird, as the observer changes angles. Nissan might make this flashy tint an affordable option for European car buyers as early as 2000.

But right now, the light-refracting trick already generates a steady income. The U.S. government selected ink concocted by Sicpa, a Swedish concern, which uses the special color-changing pigment from Optical Coating. The feds released the $20 bills last month; Collins says they typically spend several years replacing the bills in circulation with a new set.

For Optical Coating that's money in the bank.
For more info on institutional holders of these stocks, as well as financial statements and earnings estimates, please see the Thomson Company Reports .

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