Viavi Solutions Inc (VIAV) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the JDS Uniphase fiscal 2005 first-quarter earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Jacquie Ross, Director of Investor Relations. Please go ahead ma'am.

Thank you, Ralph, and welcome to the JDS Uniphase fiscal 2005 first-quarter earnings conference call. Joining me on the call today are Kevin Kennedy, Chief Executive Officer, and Ron Foster, Executive Vice President and Chief Financial Officer.

Before we get started, I would like to remind you that this call is likely to include forward-looking statements about the future financial performance of the Company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to look at the Company's most recent filings with the SEC, particularly the "Risk Factors" section of our Form 10-K filed for the year ended June 30, 2004. The forward-looking statements including guidance provided during this call are valid only as of today's date, and JDS Uniphase undertakes no obligation to publicly update these statements as we move through the quarter.

Our comments today will include non-GAAP measures. A detailed reconciliation of these non-GAAP results to our GAAP results, as well as a discussion of the usefulness and limitations of these non-GAAP measures, is included in the news release announcing our first-quarter results issued earlier today and available on our Web site at www.jdsu.com.

Finally, another reminder, this call is being recorded and will be available for reply from the Investor portion of our Web site, again at www.jdsu.com./investors. I would now like to introduce JDS Uniphase's Chief Executive Officer, Kevin Kennedy.

Good afternoon. Thanks for joining us today. My comments will address our first fiscal-quarter results, the market environment we participate in, the operational progress and status underpinning them. Following my remarks, Ron will discuss our financial results and outline our financial guidance for the second fiscal quarter.

Relative to revenue, this was an extremely strong quarter. Total revenue in the first quarter was up to 194.5 million, up 11 percent from the previous quarter and up 32 percent from the first quarter of fiscal 2004. Once again, we exercised firm cost control with non-GAAP operating expenses declining on a percentage basis.

Loss per share was also in line with expectations. While non-GAAP EBITDA improved for the seventh consecutive quarter, we continued to require significant work to leverage our revenue increases to drive profitability improvements. This said, controls on spending in general and inventory management specifically improved.

The first quarter represented our fourth consecutive quarter of revenue growth and the first of double-digit growth in just under four years. However, it is worth noting that the business climate continues with one to two months of visibility amid a telecom and communications market is still healing and a commercial and consumer market is growing tentatively. The mix of revenues in any quarter continues to be driven by variations in demand from a small number of customers with strong needs one quarter and the lower demand in yet another quarter.

We experienced out of the ordinary quarter-over-quarter growth in our communications business of 24 percent, resulting in unusual mix swings. We believe this performance will build upon previously noted JDS Uniphase market share gains in the communications market. When fully aggregated, we continue to believe that over time the markets we serve should generally allow us to grow on average with some fluctuation in the single digit range quarter-over-quarter.

Our customers continue to place value on our ability to offer vertically integrated products. Circuit pack revenue, for example, experienced double-digit growth in the quarter and amounted to double-digit millions of dollars during the first quarter -- one full quarter ahead of our expectations. (technical difficulty)-- and we are noting an interesting trend in other parts of our communications business. We're seeing signs that our historically distinct long-haul, metro, access and cable TV markets are beginning to converge on common platforms. As a result, products are beginning to have broader market relevance. Examples include cable TV and telecom transponders with common wavelength platforms and optical layer solutions that leverage new reconfigurable optical add-drop multiplexing technology at our agnostic over long-haul metro applications. The breadth and quality of JDS' product offerings suggest that we are poised to gain momentum if this trend continues.

We're also encourage by the FCC's recent decision that enables incumbent carriers to invest in fiber-optic deployment to within 500 feet of a customer's home without requiring them to share the benefit with competitors, thus accelerating fiber to the curb deployments by major regional operator companies.

Directionally we believe that fiber to the home deployment will evidence visible growth for optical component purchases in the second half of calendar '05 and in 2006. Our team executed very well during a quarter of considerable ongoing transition. I must thank our employees who have embraced the change necessary to set the stage for further improvements.

As you may remember from our July call, fiscal Q1, it was the first full quarter of a focused exercise to centralize key functions such as sales and manufacturing. As we have commented previously, this activity is fundamental to driving process improvements and enabling future leverage. Consistent with our focus on organizational improvement, we continue to strengthen our executive team. This week we consolidated three of our Communications Products to two. Later this quarter we intend to announce a new executive to lead the combined group.

Now I would like to update you on the status of our operational improvement program. As a reminder, at the end of fiscal 2004 we launched an 18 to 24 month program to reduce the Company's footprint, rationalizing the manufacturer of our products based on core competencies, cost efficiency and alternative manufacturers where appropriate.

During the first quarter, we successfully executed on many fronts. In line with the expectations we shared during the fourth-quarter call, we completed the development of our revised manufacturing strategy, substantially consolidating our contract manufacture base and identifying two primary partners. We reinvigorated product transfers to our lower cost manufacturing facility in Shenzhen, China. Shipments from Shenzhen accelerated during the quarter. With many more products now at the qualification stage, we continue to strive to ensure that the majority of our communications cost of goods sold is derived from Shenzhen and other lower-cost sites by the end of fiscal 2005.

We initiated transition plans for the reduction of manufacturing personnel at three North American assembly sites, one North American fab and one Asian facility. The North American manufacturing operations will now be reduced in headcount over time, albeit with a staffing nucleus to remain focused on new product introduction and prototyping. These initiatives should save tens of millions of dollars per year once completed.

We made substantial improvements in the management of our inventory on a global basis. For the first time, we implemented a centralized inventory management process overseen by a global master scheduler. As a result, inventory turns improved from 4.3 to 4.8 quarter-over-quarter. We expect further improvement on this front subject to quarterly fluctuations.

We continue to reduce our footprint, fully exiting the UNL Eindhoven facility and selling our polymer optics business. We will continue to divest noncore assets as appropriate.

Generally these operational improvements have been achieved without detriment to our customers. Major Tier 1 customers who rated us as a supplier during the quarter considered our performance to be stable or improved. For the second year, we received Sun Microsystems Meritorious Performance Supplier Award, recognizing the value Sun places on their relationship with JDS Uniphase. While it will take several quarters to see these initiatives start to impact our bottom-line, the team has made significant progress with the very deliberate changes we're making consistent with our plan.

I would now like to discuss challenges in areas requiring improvement. At a macrolevel, the JDS Uniphase contained team is continuing to improve relative to a focus on customer-driven execution. The centralized manufacturing organization has given greater control and operational focus. In this area we're strong in information systems support, yet still overburdened in brick and mortar.

While our numbers this quarter were strong on a revenue line, the fact is that the revenues and more importantly profitability measures were impacting in part by areas of execution requiring improvement. These transitional challenges include first, within our commercial and consumer business we found we were unable to achieve yields that permitted volume production of a specific LCOS light engine product. It is not unusual to experience delays in the transition to volume shipments, particularly when the technology is innovative and highly complex. A number of players have exited or revisited their schedule for LCOS rollouts. This said, we will continue to invest in the emerging LCOS platform while also serving the current DLP market.

Also within the commercial and consumer business, demand far outstripped our ability to manufacture digital mirror. For 25 years JDS Uniphase played a leading role in the manufacture of front surface mirrors used in televisions. These mirrors reflect the image generated by the light engine onto the television screen. A year ago only 10 percent of our mirrors were digital mirrors used for the new generation of rear projection televisions. The remaining 90 percent were standard mirrors used in CRT systems. Now more than 40 percent of the mirrors we shipped is digital with the percentage expected to increase. Due to the far greater number of pixels in a digital television, digital mirror can accommodate far fewer faults than standard mirror. As a result, significantly higher quality is required resulting in lower current yields.

Ron will discuss the specifics of how yield challenges impacted our overall gross margin. Suffice it to say that we will apply extreme focus on new product introductions.

We continued to evidence less gross margin leverage in our revenue growth than desired. As we have noted in the past, two ongoing downward pressures on gross margins exist. First, average selling price declines while slowing in general continue and can be potent for any particular product line or customer in any quarter. These ASP pressures challenge margins in advance of offsetting build material improvements.

Second, an adverse margin makes exist when we realize faster growth in our communications business versus our commercial and consumer products segment in advance of fully executing product transfers to lower-cost manufactures. During the first quarter, all of the upside was derived from our communications business, which as you know tens to have lower margins than our commercial and consumer business.

Another class of gross margin pressure is transient. As we transition products to lower-cost manufacturing locations, there is a period of redundant overhead impact. While the benefits of moving to Shenzhen and contract manufactures are clear, it is also a fact that these plants will adversely impact our margins for three or so quarters as we carry redundant manufacturing capability to ensure adequate qualification time and customer support. And as mentioned earlier, yield improvements are required to remediate transitional deviations within our optics and display business while we have opportunity for upside. Emerging from past restructuring, we're also experiencing a gradual weaning of beneficial factors such as E&O benefits, cancellation revenues and the resolution of warranty issues. At a minimum, these particular factors create margin variation in any quarter.

Moving forward, improvement initiatives will be driven by accelerating the consolidation of our manufacturing footprint and the introduction of a specialized supply chain management function. We will name a VP of Supply Chain Management during fiscal Q2. We expect leverage to be gained from our supply chain in general and specifically localized content for building material elements of products transferred to China.

Once, the majority of the product transfers are complete, we will see some fundamental improvements in our gross margins. Strategically we will continue to manage our product portfolio in concert with acquisition choices intended to improve our gross margin and profitability.

To sum up our progress on stabilizing and improving, our demand side trajectory has been strong. Looking back over the first year since the transition, we took a number of deliberate decisions, each to play its part in moving the company closer to execution improvement and profitability. During this period, we successfully executed against those decisions.

First, we have refocused our organization and activities along customer-focused imperatives. We established a single California-based corporate headquarters and infused new talent as the Company upgraded its formation for greater operational focus. We stabilized the organization and then began to grow revenues, which on average have increased roughly 5 to 6 percent for four consecutive quarters. We centralized the major functions of the company to ensure we could recruit functional excellence, establish our corporate culture and execute with greater control and efficiency consistent with our cost structure imperatives and Sarbanes-Oxley regulations.

We exerted and maintained control of our operating expenses and now almost at a desirable ratio to revenues. We redefined our product strategy and order to increase time to revenue, improve customer satisfaction and gain market share. We adopted compensation and other governance programs declined to align to the interests of our various stakeholders. We reset and reinitiated a significant program of product transfers and manufacturing consolidations designed to improve our business model and increased gross margins, although the runway to desired outcomes is still ahead of us. And most importantly, we controlled the degree and impact of change very carefully so that it did not negatively impact customer relationships, and in fact, we raised customer satisfaction.

As a result of these and other changes, JDSU has established a necessary balance foundation. We're now more focused and better equipped for the multi quarter journey to profitability improvement.

Just before I hand over the call to Ron, I would like to remind you of two important events. First, our shareholder meeting will take place at our corporate headquarters in San Jose, California on Tuesday, November 16. Second, we're hosting a Financial Analyst Day in San Jose, California on Wednesday, December 1. Please contact Jacquie in our Investor Relations Department for more information on either event.

With that, I will now hand the call over to our Chief Financial Officer, Ron Foster, for a more detailed discussion of the financials. Ron?

Thank you, Kevin. Before I begin, let me remind you that all P&L numbers are non-GAAP unless I state otherwise.

Just to recap total revenues were $194.5 million. GAAP net loss was $36 million or 2 cents per share, which compares to a net loss of 22 million or 2 cents per share in the previous quarter and to a loss of 28 million or 2 cents per share in the first quarter of fiscal 2004. Excluding certain items, non-GAAP net loss was 14 million or 1 cent per share, which compares to a net loss of 12 million or 1 cent per share in the prior quarter and to a loss of 14 million or 1 cent per share in the first quarter of fiscal 2004.

The geographic split of our revenue shifted slightly in favor of domestic revenues due to the strength in our communications business and in particular circuit packs. North American contributed $126 million or 65 percent, which compares 109 million or 62 percent last quarter. Consistent with our strategy to grow nondomestic revenues, Asia-Pacific strengthened, contributing $34 million or 17 percent of total revenues which compares to $28 million or 16 percent of total revenues last quarter.

Typical European summer seasonality softened results slightly, and this region contributed $35 million or 18 percent of total revenues as compared to $38 million or 22 percent in the prior quarter. Communications revenues increased 24 percent quarter-over-quarter and 43 percent year-over-year, representing now 55 percent or $106 million of total revenues. Highlights included double-digit growth in the circuit pack business.

As a reminder, our strategy is to move customers from first generation build to print circuit packs to higher margin second generation original design and manufacture or ODM circuit packs. ODM circuit packs contributed several million dollars in revenue during the first quarter, and we secured several new ODM design wins, which should translate into revenue in the latter stages of fiscal 2005.

Long-haul showed continued strength as deployments of previously announced wins on the part of equipment providers continued to roll out and are now starting to see live traffic. Reconfigurable optical ad drop multiplexers or ROEDMs, which enjoyed some early design wins in the fourth quarter, shipped in the first quarter supporting our strategy to speed time to revenue.

Commercial and consumer revenues were essentially flat quarter-over-quarter due to the yield issues with digital mirror and the difficulties with the introduction of the LCOS light engine. Revenues of 88 million increased 21 percent year-over-year and represented 45 percent of total revenues in the quarter. Highlights included, first, solid growth in our own DLP light engine. For the first time, the revenue contribution from our DLP light engines broke the $1 million mark. Demand for television optical components, including digital mirror, color wheels and light pipes, was strong in the quarter with revenue limited only by production constraints.

In our Flex group, our optically variable pigments performed well in the quarter. Our color shifting technology is now used to protect 19 leading brands for six of the largest pharmaceutical companies, and we're starting to see some design wins where our technology is being applied in new ways. For example, on gift cards and to project new consumer brands.

Overall new bookings exceeded total revenues in the quarter, but net bookings resulted in a book-to-build marginally below 1 as debookings notably in LCOS light engines occur.

The primary disappointment in the quarter was the decline in our gross margin. Kevin has talked about the steps we are taking to drive gross margins improvement, but let me give you some color around our first-quarter performance. Non-GAAP gross margin declined from 24 percent last quarter to 23 percent in the first quarter due to product mix, ramping costs associated with the introduction of newer technologies, and to a lesser extent pricing pressure.

On product mix, much of the revenue upside was communications related where margins are lower and where we were impacted by ongoing pricing pressure in the low single digit range. And within the communications business itself, the mix tilted toward some lower margin products, some of which will carry through Q2.

In our digital mirror and light engines businesses, we continue to be impacted by higher costs associated with ramping these newer products. The incremental costs associated with these ramps will be worked out in the next couple of quarter. The combined effect of these items negatively impacted gross profit by millions of dollars in the quarter.

While we remain committed to achieving 30 percent gross margins in the mid-term and then progressing to 40 percent in the longer-term, it is clear that the impact of product transitions will limit our ability to extract improvements in the near-term. By Q4 '05 we expect to see the benefits of these transfers exceeding the associated incremental transition costs.

Non-GAAP operating expenses were within our target range of $61 million or 31 percent of total revenues. At 13 percent of total revenues, the $25 million we spent on R&D was at the low-end. SG&A increased to 36 million due to higher seasonal costs related to our annual meeting and proxy costs and legal expenses, which remain hard to predict. SG&A remained roughly flat, however, on a percentage of revenue basis at 19 percent.

Non-GAAP EBITDA improved for the seventh consecutive quarter, but fell slightly short of our expectations at a loss of $5.9 million. Interest and other income was just under 3 million, dampened by foreign exchange losses and loss on disposal of assets. Included in the GAAP results, in line with previous quarters, amortization of other intangibles was just under 5 million. And the 5 million reduction of the other long-lived assets relates to adjustments made to the value of one of our North American facilities which is held for sale. Restructuring and other related charges of just over $5 million largely associated with a planned reduction of 225 employees during the first quarter and two North American facilities.

Moving now to the balance sheet. Our total cash and marketable securities was just under 1.5 billion. We consumed $60 million in cash for operations, of which 9 million was for restructuring. In addition, $16 million of working capital was consumed to support higher inventory levels and associated higher revenues. $12 million of cash was used for acquisitions and capital expenditures were $8 million. Our reduction in the value of marketable investments reduced the cash balance by 14 million.

DSOs increased slightly from 59 days last quarter to 60 days. At $126 million net inventory increased by 1 percent from last quarter with improved inventory management maintaining control even as our revenues increased significantly. Overall and consistent with our comments last quarter, inventory turns improved from 4.3 to 4.8.

There was a net benefit of inventory recovery compared to excess inventory write-offs of about $8 million as compared to 3 million last quarter. Goodwill and acquired intangibles increased by around $10 million, primarily related to the acquisition of Advanced Digital Optics in the first quarter. And finally, headcount was essentially flat, decreasing slightly from 6041 last quarter to 6027 at the end of the first quarter. There are now over 2000 people in our Asia operations.

We're seeing the gradual phasing out of financial effects on our P&L and cash flows related to the lengthy downturn in our industry such as cancellation revenues, which worked out in fiscal year '04. This fiscal year we expect to see a return to normalized levels for both warranty settlements and tax refunds. The effect of excess and obsolete inventory adjustments and restructuring charges will continue to impede our ability to forecast for the next several quarters, but will work out through fiscal '05 and into the next fiscal year.

Now to second quarter guidance. Based on our very strong and out of the ordinary revenue performance in the first quarter and consistent with the ongoing uncertainty we are seeing in our markets, we expect net revenues to be in the range of down 8 percent to flat over the first quarter of fiscal 2005. Depending on revenues and variations in cost and product mix, we expect our non-GAAP gross margins to be in the low 20s and non-GAAP EBITDA to be in the range of a loss of $10 to $16 million. Finally, we expect non-GAAP loss per share to be 1 cent.

Now we will open the call for questions. In order to allow us to respond to as many questions as possible, we will ask you to limit yourself as always to a single one part question and time permitting we will come back around for subsequent questions. Operator, I will turn it over to you for questions.

(OPERATOR INSTRUCTIONS). Rick Schafer. CIBC.

Just a question on the brilliant announcement that came out today. I saw the release. They mentioned the tight supply of light engines. I guess I was just looking I know you mentioned yield -- some yield issues on the light engine side. But I am just curious if you could give us some more color as to what the problem is or what you guys are doing to fix it and when do you expect it to not be a problem looking forward?

The reality is that we have been able to jointly create a product that has superior contrast when viewed next to almost anything else in the industry. So I think it is early for LCOS what we have created as a prototype or something for people to experience has been validated in the market, hence we're all continuing to build.

That being said, we have probably had it is fair to say as you try to move from prototype to a scalable level of production, there are probably someplace between three and five issues or technical challenges that thwart our yields. And so we are -- I would say probably half of those we feel are pretty well underway. Some of those are process-oriented, some of them require some level of redesign, and we are working on them as fast as we can right now.

So it is a fair thing to say that we're reinvesting our efforts upstream and back in the design process as the way to solve our yield problem. So that is probably the best color I can give you at this point.

As part of that question, what revenue run-rate for that business, for light engine business, will you guys be breakeven, and do you guys hit that revenue run-rate next year or --?

Ron?

Just an operating breakeven, yes. Sorry.

We are still trying to shake out design elements in the development process and get it ready for production. When you don't need no fundamental elements like yield, etc., it is difficult to characterize what a breakeven point would be. We do, as Kevin mentioned, believe that we have got a very competitive product once we bring it out.

Bear in mind also that we have consistently commented that we did not expect significant revenue to be occurring on this product until next calendar year and in front of the next holiday season.

Stephen Koffler. Wachovia Securities.

So there is a dichotomy in what we are hearing here. I mean the results are very strong. Maybe a couple of places it was not as strong as you wanted. But then we are giving them guidance. And you gave some sort of macro discussion there. But my question is I would like to explore that. Sometimes when this happens, companies are able to ship against backlog for some hot products faster than they thought and that takes away from visibility going forward.

Is that one element here, and maybe you could -- maybe it is circuit packs, but maybe comment on where that might be happening? And also how much did E2O contribute in the quarter?

With regard to shipping backlog, we actually did not draw our backlog down very much this quarter. We built up significant backlog about a quarter ago, and so we are still in a fairly healthy backlog situation. Part of the issues associated with our guidance relate to some level of uncertainty in the marketplace as we look out and our inability to call out a full quarter in terms of what the flow of bookings would look like and the turns business we will need to get from those bookings in order to arrive at our numbers.

Let me just add I think there are probably three things that are -- I keep in my mind in terms of the market outlook. I would say the market is healing. In this particular quarter, the three interesting or fun parts we had an absolutely blowout quarter in terms of circuit packs work and what I would call the agile network portion of our portfolio -- things like wave blockers, ROEDMs, etc., so the really intelligent pieces.

We also had a bit of an anomaly where things that -- people have not ordered from us in several years that we had to look back and figure out how to make again. So I view both of those as supportive of this concept that the market continues to be healing.

That being said, let's be clear, that when you grow in comps 24 percent quarter on quarter that is an anomalous function. We have never suggested that we could do that. So our guidance is really respectful of two things. One is that was a singularity in this event. We probably are in general growing more in the lower double digits in comps quarter-over-quarter.

And then secondly, there is a lot of uncertainty whether you look at any of the semiconductor folks. So as we hit this initial quarter and we look at where our bookings levels are, we are being a little bit cautious as we reflect on the patterns around us.

Yes. With regard to E2O, we're not able to cleanly break that out postacquisition. But it showed some level of growth in our contribution to our datacom business in the quarter, and we are pleased with how it is going.

Just remind me when the deal closed?

I believe it was -- we got half a quarter last quarter, so it was about the middle of last quarter in May, and so we got about a half a quarter's worth of activity last quarter and a full quarter this quarter.

Steve Savas. Goldman Sachs.

Good evening. I guess I had a question -- I will lump a couple together here. Lucent certainly had a strong optical quarter, so I am wondering if you had any 10 percent customers.

And then related to that, I was just wondering about going forward you mentioned SEC regulatory changes that should be helpful for fiber deeper in networks. I was just wondering your views based on what we just went through where Verizon seemed to up their activity on acquiring fiber in the September quarter for fiber to the home rollouts. Do you think that your component sales would lead, lag or be coincident with fiber sales?

This is Ron. I will take the first one on the customers and let Kevin handle the fiber to the home question. We did not have any 10 percent customers this quarter. However, notably if you look at our Tier 1 customers and our top 10 customers, we had notable growth across a number of them. So we had a more balanced rate of performance lift quarter to quarter across a number of customers, but no specific 10 percent customers this quarter.

And, Steve, on the second piece of that, which is on the fiber to the home or fiber to the node, I would say in general I believe that we will not see a real visible uptick at an administer level, not just suggesting JDS, probably until best case second half of '05, more likely 2006.

As you can imagine and I know that you know, the fiber to the node architectures have significantly less optical component content in it as the downstream ONT (ph) looks at copper. If you are looking upstream, there used to be changes, but that is probably going to be a bit more evolutionary and know spike, if you will.

On the fiber to the home, I think those require people putting in fiber, so I actually think we're going to have lots of conversations on what people are doing before the components guys actually see a lot of activity, especially on the subscribers side of that. So I think both of those observations tend to bias the components business to be a little bit later in '05 or '06. I hope that helps.

Okay, that is exactly what I was looking for. Thank you.

Natarajan Subramanyan. Sanders Morris Harris.

I'm trying to understand on the display side of the business it seems like the problems you had were related to LCOS, but your LCOS expectations on revenue were fairly low. So on the DLP side also was revenues somewhat lower than we expected, especially with TI having some record revenues on the DLP side. Could you talk about that a little bit?

This is Ron Foster. With regard to display, as I mentioned earlier, we have commented that we did not expect significant revenue until maybe the end of this fiscal year gearing up for the next holiday season, not this one, with regard to LCOS light engines. We do sell both in DLP and LCOS components into those systems.

And with regard to your specific question about DLP light engines, as I mentioned we did see some growth off a relatively small base, but significant growth this quarter in our DLP light engines, as well as our continuing DLP component sales.

So was TI a 10 percent customer for the DLP component this quarter?

TI was not a 10 percent customer for the company this quarter.

Understood. Sorry, go ahead.

Alright. Thanks.

Daryl Armstrong. Smith Barney.

You talked about the difference in the revenue contribution depending upon if the service provider implements the fiber to the premise or fiber to the node architecture. From a margin standpoint, is there a meaningful difference in terms of what type of buildout you see there?

I don't know that the industry knows enough to believe that there is a margin difference yet. As you know, once you get to the ONT (ph) or the subscriber unit you begin to bring in a set of products such as triplexers and others. So when if you are upstream from the node on and a large part there are splitters, Gigabit Ethernet transceivers, and so the components are fundamentally different. So I think right now what is a truthful thing to say the technology that wins at triplexer service will offer people the appropriate gross margin structure. Otherwise, they are not going to play in the gain. And there are competing technologies for what that triplexer/diplexer will look like. I hope that helps.

No, that is very helpful.

Paras Bhargava. BMO Nesbitt Burns.

Kevin, did I hear you say that you could get sequential single digit growth every quarter in '05 after the December quarter? You made some comment to that effect early on, and just a second question on TI. TI business, was it up sequentially? It could of been up sequentially instead of the non-telecom stuff. The telecom stuff went up.

I will take the first one and let Ron take your second question. Certainly historically looking if you go back over the last four quarters, we have demonstrated 5 percent or better. So the statement that I made was that I believe the markets that we serve will allow us to handle mid single digit or 5 to 6 percent quarter on quarter growth. If we don't, it could be our execution at this particular point in time. But certainly the last four quarters have allowed us to operate in a market that would serve us with that level of growth, and that was my comment.

Well, it could be that what happened over the last few quarters was a cyclical uptick as a lot of networks just were starved. And maybe now the second changes are going to be not nearly as big?

You know there are probably many theories. I would say that my point of view specifically is one that the industry is healing. I do believe that there could be changes in any particular quarter, but I do believe that the industry is healing. The conversations on the breadth of the portfolio that are occurring today are more significant, and frankly there is a new generation of smarter intelligence that is being required.

The second piece is that I think in many of the prior quarters I have been pretty overt about saying where I thought our execution challenges preclude us from fully realizing the revenue opportunities that existed. We sit here in another quarter where I think there was more money to be had had we executed even better. And so I would be more concerned if we were executing flawlessly and you know revenues were lower. So I think the market still will allow a reasonable amount of growth.

This is Ron. With regard to your question about TI, we don't call out specific numbers on customers. But one thing you can see from the history and our relationship here is there is variation quarter to quarter, and I would not discern too much out of trend movements. And we also as you observed enjoyed some significant growth on the total line which can drop the percents even at level performance. But we continue to have a very good relationship with TI on an ongoing basis on a number of fronts in this area.

Ehud Gelblum. J.P. Morgan.

My questions have to do with the COM side of the business. I will the commercial and exploring that to others. On the COM side of the business, obviously the performance was very impressive, up to 24 percent.

What I guess my question is, is understanding that growth in this quarter, how much of that was due to you mentioned the LD buildouts from your OEM customers. You gave last quarter for instance that LD was 24 percent or over 25 percent of COMs. Was this growth this quarter due to LD? What percent of the COMs was LD?

And then when you look forward, is that 106 sustainable, and is that the reason for the guidance of down 8 percent next quarter because that falls off. What I cannot have a correlation with is, Kevin, your statement that we are seeing sequential growth and there is a healing, so then why are we down 8 percent next quarter unless it has to do with this issue that there was a growth at LD this quarter in COMs that pulls off next quarter? If you can kind of talk around those issues, that would be very helpful.

This is Ron. With regard to your question about I think it's about long-haul growth. On the long-haul segment, yes, we did comment that we had that substantial sequential growth for a couple of quarters. We continue to see strength in long-haul. So that is a very strong area and continues to grow for us.

Can you give a comparable number to the 25 percent that you did last quarter?

I don't have it for you here, but it was up in absolute sense.

More than 24 percent?

I believe it was, yes. And in addition to that, we had the growing circuit pack business that we mentioned which deploys in both metro and long-haul arenas. So that was notably a significant area of growth in our overall COMs results.

With regard to the 106 holding, as I commented, we will be down 8 percent to flat, are not calling out particular variation in the two businesses, but obviously we had very healthy COMs performance this quarter. And as Kevin already mentioned, if you look at it on a trendline basis, we are continuing to see good performance over the last several quarters and think we're running on an average trendline in the mid single digit range.

So if we were to -- that could be an explanation for why -- I am just trying to correlate how if the world is healing, why we are down 8 percent and not up the next quarter. But it sounds as though maybe that is part of the reason.

Yes. On a trendline basis, we don't have any reason to believe that we are fundamentally off of what we have been doing the last four quarters.

You know the spike -- let me reiterate what I think I said already on the nature of the COMs business. I think we had a spike that from a customer perspective centered around four specific systems vendors, and we had good growth -- all of them having specific wins. So in other words, a customer that you can relate their activity, too.

Second, remember many of the systems vendors are outsourcing their design work to companies such as JDS in terms of the circuit pack model. So we had a -- that trend will continue over time. That certainly began to hit in force this particular quarter.

And third, we probably had one of the largest volumes of what I would call the high-end agile wavelength systems, wave blockers or ROEDMs, which is a new thing which that should continue, although it could be spiky. Both of these things are new generations of products.

So I think the latter two from a portfolio perspective will continue to have an upward trendline to them, and the piece that is harder to gauge is how much was this significant demand generating from four customers.

So I do think this was anomalous at 24 percent. I think if you go back to the quarters prior to this, our COMs business has been low double-digit in growth, sometimes a little bit below that, and I think this ratcheting down is representative of that more normalized trendline. I hope that helps.

That definitely does.

John Harmon. Needham & Co.

I was wondering if you could discuss your datacom transceiver business a little bit. We have been hearing about pricing pressure coming from Asia. In particular, the E2O acquisition, your philosophy behind the acquisition, did you buy them to gain market share; did you buy them for their long wavelength pixels?

I think there were a number of pieces that came together for it. Certainly the industry is verticalizing its pixel technologies, and they have both either in development or in prototype short and long wave technology. So for a cost structure for the future, we felt that that was of strategic import to us.

Now I would say secondly we were not as penetrated in the storage area networking arena, which, of course, E2O was relatively strong. So the components of those two pieces and sets of knowledge basically drove us. And lastly that particular piece of the business is consolidating, so we were really at a point where we were either going to double down or you have to question what you're doing. So we fortified and we are continuing to try to execute.

John, it also added several new customers that we did not have significant presence with that we hoped to be able to expand our base in those arenas.

And with regard to your datacom transceiver competition question, we commented previously on a couple of occasions that we certainly see a higher level of pricing pressure in the datacom arena. We believe we will still be able to very effectively compete here. But at least in this current timeframe, we're seeing a little bit higher ASP pressure in this area typically.

David Finberg. Morgan Stanley.

Just trying to clarify something I think you touched on earlier. I understand the idea of the trendline here over the last four quarters about the communications revenue increasing. What I'm trying to gather is you made some comments earlier on in the script about having to manufacture some products, which you have not done so in quite a period of time.

What I'm trying to understand is on those products where you -- would you feel they were actually being deployed from the OEM, or were OEMs building up inventories again that were once depleted? And I am just trying to get an idea or get some insight into end market demand and your insight as far as whether or not these products are actually getting deployed at this point or the OEMs replenishing some depleted inventories?

No, in general, these are the kinds of orders that come from telecom systems providers, and they represent usually some level of maintenance or upgrade that is required by their end customer. So in general those are built to order type things. And so I think in my mind it is reflective of aging infrastructure or parts where people have not paid attention to, and now that more fiber is being lit up and people are rebuilding, they (inaudible) have maintenance to do and I need to order these pieces.

Harmon: Okay and begin just to confirm the majority of this maintenance right now is on the long-haul portion of the network. You're seeing very minimal pull-through on anything for metro or fiber curb metro or fiber to the home applications?

Relative to the specific comment on items that we probably have not seen an order for in a long time that we're having to figure out how to make and supply again, that is true. That is probably mostly long-haul.

It is further true that from a design win perspective we are probably operating in any quarter, at least this quarter and last quarter, and I think we gave a statistic last quarter on the conference call, probably on a two for one basis. So that is where some of these things like ROEDMs and wave blockers that could serve both the long-haul and metro market are relevant. And so we are seeing good deployments beyond long-haul, and certainly the design win activity is bias toward metro right now.

This is Kevin. I will also mention we are seeing more and more technology overlap between metro and long-haul applications, David. So we don't have as clean a view as to where the deployment is occurring. We have to actually look at our customers, the location of our customer's product to figure that out.

Alex Sparrows (ph). Deutsche Bank.

I'm wondering whether you could talk a little bit about pricing, particularly within the various segments of datacom, telecom and net storage, as well as on the non-telecom side?

I don't think we -- every product line has a different pricing profile. I think Ron has been pretty specific that in general pricing declines have somewhat more gradually stabilized or certainly slowed, and that is pretty true. I think as Ron has also mentioned in anyone quarter things like datacom, but frankly sometimes telecom transceivers, we can have on a per customer or per region or per deal interesting discussions. But in general I would say we see less pressure today than a year ago. And in fact, it really is our challenge is to apply that kind of same pressure on our supply chain, which is the stage that we are just trying to get exercised on right now.

I guess you can help us with you articulated that pricing seemed to be moderating, it seems to be coming down, yet we seem to be getting a lot of data points as well. I think you have indicated as well that pricing and datacom and I think also in storage is still fairly fierce. How do you circle those two things together?

I think, as I just said, for any customer in any region we could end up with a very significant pricing pressure. And there can be wide variations sometimes for gross margins actually by customer, even across the same product line. So that is true. But I do not know how to aggregate that at the moment into a trend other than to tell you that in aggregate for the company, the pressure is slower today than it was -- the slope of the curve is less today than it was a year ago.

In fact, it has been declining almost sequentially quarter by quarter here in terms of the ASP pressure rate, but it does vary a lot from time to time in various areas.

Chris Dzurinko. American Technology Research.

I have some questions on the COM side of the business on the margin outlook. (inaudible) just on the margin profile. You mentioned that there was some mix shift to lower margin products in the quarter just within COM, but at the same time, (inaudible) mentioned his exciting intelligent products were strong this quarter, as well as the circuit pack business was up, and not only circuit packs, but the ODM stuff. Can you just help me reconcile -- those seem to be higher margin, as well as more long-haul versus datacom expense during the quarter. How do you reconcile all those things?

Let me take a stab at it, and Ron may -- I will try a qualitative approach to this, and maybe Ron will see a better way of providing help. I would say that the age-old observation of where there is an oversaturation of competition you will probably see the biggest pricing challenges. I think that is as true today in COMs as anyplace else. So I think that is one piece of guidance that I can reinforce. That is something you already know I think.

There is a second, which is there are a number of new generation products that we are just nascent in their adoption, and the agile networks, the things like ROEDMs, wave blockers and other things are exactly that. If you go back two quarters ago, there was basically no revenue. If you look at those today, things are -- we have numbers on the chart so to speak, and the margins for some of those products are actually quite good. And by the way, we probably shipped more than all of our competition combined. So from a competitive perspective, there is less, which means that we are probably seeing good things there.

I would say the third observation is where there are lots of Legacy products where you have either Legacy supply pressures or there is just a lot of competitors. Plus, they have had a lot of time to try to either enter or stay in the market. You know in many of those cases some of those can be challenging left to competition (inaudible).

And then the final comment is on the circuit pack piece, which was a big piece, over time we believe that that will have very very good gross margins because we will control more and more of the build materials, and we will be applying more software. But in our first generation of those, the margins are actually not at the sort of the terminus objective because they are closer to taking a person's design and putting our own basically assembly for it. So they are going to be in the midrange to low of our corporate medics.

So circuit packs represent very very large or disproportionate revenue growth, but they don't necessarily bring with it the same gross margins that the intelligent devices do.

At least in the early stages. (multiple speakers). I think you covered it pretty well. I guess the only thing I would add that there is certainly a degree of mix variation that occurs in any particular quarter, and we do have a significant degree of variation in margins on various products. So I would not read a whole lot more into some of the general trends than just the way the mix worked out this quarter, added onto Kevin's comments about the fact that some of our new value-added products are just beginning to ramp up and will make a bigger difference in the future.

Okay. One more if I could. On the non-COM lasers, did that grow faster or slower than non-COMs in general?

The non-COM lasers I think in general that is a pretty stable market and it was relatively flat.

Pang Zao (ph). Credit Science (ph).

My question is on the incremental margin of the Communications Products segment. If I look at this quarter versus a year ago, your incremental revenue was $32 million and incremental profit was $.5 million which makes the incremental operating margin about 1.5 percent. Now looking forward, what should we think about the incremental margin of this business?

That was on COM specifically?

On COM specifically.

Okay. I think the reason Kevin and I spent time talking about some of the vectors in COMs is it was important to understand that there are some elements in the marketplace that are pressuring margins right now that are somewhat longer-term. There is also tranching elements specifically related to actions we are taking to fundamentally get us to a lower cost structure, higher margin structural over time (technical difficulty)-- relocation of manufacturing to China and outsourcing as appropriate.

So looking at the current margin results (technical difficulty)-- it is hard to get a clean read combined with the product mix effects as to what incremental margin driver is. It is more a function of these other factors, some of which are transient that is affecting our near-term origin.

We believe that as we start coming out with our lower-cost production activities as we mentioned would be later in this fiscal year and starting into the next fiscal year, we will be saying higher contribution rates in our COMs business as we lever up in lower-cost manufacturing. And the incremental margins will be better at that time as we grow revenue. And we will have the capability to scale on those new limitations.

What kind of magnitude are we talking about? Is there any guidance on that part?

I don't have the specific characterization for you in terms of looking out that far, except that we believe that by the end of this fiscal year we will be seeing the benefits of that margin leverage outweighing the incremental costs that we have been incurring to get it there.

Ehud Gelblum. J.P. Morgan.

Not to beat at dead horse, but really just trying to understand how modeling could look going forward, especially on the gross margin line. First of all, I wanted to make sure I heard you correctly that this quarter there was 8 million I think in the zero cost inventory that was sold. If that is true, calculate that I think gross margin went to 18.6 percent, not including that zero cost inventory. Just some clarification if that calculation is correct.

I did comment that the net benefit of the zero -- recovery of zero value inventory netted against inventory write-offs or provisions was $8 million. That needs to be taken over against all the elements that Kevin and I mentioned in the quarter that had adverse effects on margin in the quarter including some of the transient elements and startup elements we mentioned. But you did get that number correctly. That is a net benefit number.

Something to keep in mind here is that also as I commented in general, these zero dollar inventory recoveries are expected to trend in a somewhat unpredictable fashion, but over a longer timeframe as we look out into the future because we do have still large amounts of previously written off inventory. Does that help?

Yes, so basically the 8 million is basically what we compared to last quarter's 3 million in terms of the deal cost inventory that was sold?

That is correct. That was also in that number.

Looking at that and where the margin, therefore, stands today, I think when you look at your longer-term business model, and my guess is you will get into this more on December 1, my guess is that it is that 18.6 percent that needs to get up into these 30s and 40s longer longer-term to sustain the company profitably.

If COMs is doing as well as it is doing, and it appears to have a lower gross margin, how do we get there? Is it the fact that COMs in total as volume get stronger, COMs margin gets better as you move offshore to these lower-cost inventory areas, or do they move away from a product mix shift from these couple of products that seem to have gotten us down this quarter that had lower margins? I'm just trying to see the levers and how the model moves up the gross margin over the next couple of quarters?

So I will take a shot at that. We mentioned several things already at this point that can affect the trends in the longer run. First of all, the introduction of new products with new value-added, our involvement in circuit packs and moving into the next generation of those things being an example. Some of the new technologies such as ROEDM technologies. Also the fact that we have got a market environment which is certainly not at a stable point to date in the COMs world is affecting it. And also we believe we can get to a substantially lower cost structure going forward as we move to a different manufacturing model, just to name a few.

Let me put an underscore on this one. This is a battle of attrition on the COM side, and in order to play in it, you have to have the financial wherewithal to restructure your company and essentially cost reduce the past. We have given you some insight as to the activities, and of course, when you transfer things to China, you do get the benefit of two things. One is lower net labor, but the second is probably almost equivalent in some cases savings on building materials localization. So the bottom piece of the variable cost goes down.

Yes, there is a second reality that you have to have to have enough of a portfolio of new stuff to have a favorable mix. And I have tried to give you some insight as to the items such as wave blockers, multi-wavelength switches, ROEDMs that have the opportunity to do that.

And third is you have to be able to invest in -- many of the optical technologies have been around for a decade ago. So to think that the same technology base that has served the last decade will be the same technology base that serves fiber to the home is a challenge. And so you have to have a platform, and a good example is our wave guide technology that gives you a new cost structure.

So the confluence of those three things create a barrier to the future that we will pursue on all three fronts and becomes the challenge for the rest of the industry. I want to turn it over to Jacquie at this point.

We are out of time, so that concludes our conference call for today. Note that both our shareholder meeting on the 16th of November and our Analyst Day on the 1st of December will be Web cast live and accessible at www.jdsu.com./investors. Those events aside, we will look forward to updating you on our progress in future quarters, and thank you again for joining us today.

Thank you, ladies and gentlemen. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.