Viavi Solutions Inc (VIAV) 2005 Q2 法說會逐字稿

Thank you for standing by and welcome to the JDS Uniphase conference call. I am Carlo and I will be the coordinator for today's presentation. At this time all participants are in a listen-only mode. We will have a Q&A session at the end. If at anytime during this call you require assistance, feel free to press, star zero and a coordinator will be happy to assist you. It is now my pleasure to turn this presentation over to your host for today's call, Ms. Jackie Ross, director of investor relations. Please proceed, ma'am.

Thank you, Carlo and welcome to the JDS Uniphase fiscal 2005 second quarter earnings conference call. Joining me on the call today are Kevin Kennedy, chief executive officer and Ron Foster, chief financial officer.

Before we get started I would like to remind you 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 say differ materially from management's current expectations. We encourage you to look at the companies most recent filings with the SEC particularly the risk factor section of our form 10-Q and filed for the quarter ended September 30, 2004. The forward-looking statements including guidance provided during this call are valid 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 second quarter results, issued earlier today and available on our website at www.jdsu.com

Finally, another reminder this call is being recorded and will be available for replay from the investor portion of our website. Again at www.jdsu.com/investors I would now like to introduce JDS Uniphase's chief executive officer Kevin Kennedy.

Good afternoon. And thank you for joining us today. Revenue for the second quarter was 180.5 million. Down 7% from the first quarter of fiscal 2005. Up 18% from the year ago quarter. An unexpected decrease in revenue from a major consumer optics and display customer accounted for overall revenue dipping to the low end of our guidance range. Ron will discuss this in detail later in the call.

Impacted by this event the overall commercial and consumer business delivered revenue of 74 million, down from 17% from the first quarter of 2005 and down slightly from the year ago quarter. Our communications business performed solidly with revenues at 107 million. When we originally guided for total revenues of flat to down 8% in the second quarter, we did so because we considered the communications businesses first quarter revenues to have been unusually strong. So we are pleased with this revenue performance representing 37% growth from the year ago quarter.

Relative to profitability measures Ron will discuss the details but I will note the three principle items contributed to our second quarter results. First, the unexpected revenue decreases in our optics and display business. Second, the related and related to the first, excess inventory at quarter end in the optics and display business and third, higher than expected SG&A due to increased legal expenses.

Our second quarter results confirm two realities underlying our business worth highlighting again. First, the majority of our revenues have historically derived from a relatively small number of customers, and second, we continue to operate in an environment constrained by the customer's visibility. As a result a single customer experiencing variations and requirements from quarter to quarter can significantly impact our own revenue performance. Both realities are in part products of historically concentrated vertically integrated industries undergoing a series of fundamental transitions.

The commercial and consumer segment is experience seasonality and the communications segment is healing amid specific customer surges and stalls, hence predictability is difficult. Since transitions involve changes in both magnitude and speed of market outcomes they are naturally hard to predict. On the one hand transitions present opportunities and are necessary for the health of a company.

On the other hand, these transitions create complexity in near term forecasting resulting in significant volatility and bottom line results. For JDSU, there are three sets of transitions impacting our business today. Transitions in our markets, in our products, and in our cost structure. A few of these transitions are related to legacies of our past. But the bulk of them are very deliberate improvements and adjustments carefully architected to strengthen JDS Uniphase for growth and profitability in the longer term. We therefore believe that these transitions bringing opportunity in the long term but require careful navigation in the near term.

Moving on to markets as mentioned on the last call. We are over time purging a series of transitory items impacting our quarterly results. Associated with legacy products and practices and down turn related restructuring activities. These items include legacy benefits from cancellation revenues which have now expired, warranty reversals and the use of previously written off inventory. With each quarter benefits from these specific legacy affects have diminished in their absolute values with variability due to the particular product mix for that quarter. These historically favorable effects reside predominantly in the communications business.

We continue to carefully monitor these items, but note that their variability is expected to impact overall predictability for the foreseeable future. Transitions have strongly impacted our segment mix. This mix is particularly important because of the sharp profitability differential between our two business segment. Our CCP margins are generally higher than our communications margins. Consequently a significant downward [INAUDIBLE] in CCP business as was experienced in the second quarter can have a greater impact on company profitability than would a similarly sized downturn in our communications business.

Moving forward, we expect to continue to improve our mix across our business through internal and external programs. In the short term, we expect to continue to be exposed to these market factors. Operating expense in general and what I will call course of business SG&A, in particular, have purposely trended downward. Through calendar 2004 we reduced SG&A expenses and will continue to manage [INAUDIBLE] in terms of head count and structure.

Nevertheless future major SG&A improvements are dependant upon the longer term implementation and success of our facility and infracture rationalization [INAUDIBLE]. [INAUDIBLE] ongoing litigation. [INAUDIBLE] company from a severe downturn the expenses associated with these items are notable. From a point of view of product transitions a series of transitions in our various markets are effecting each of our product groups requiring new products, systems, and processes to respond all of which cause decrease short term predictability, but afford a strategic opportunities going forward.

At one time our flex business which you will recall is part of our CCP business consisted almost entirely of currency related revenues. Building on its strong legacy and currency protection, flex is successfully establishing a role for its color shifting technologies and consumer goods, counter protection. Lengthy customer approval cycles resulted in flex products experiencing longer time to revenue, however, this is an exciting move from the currency to the consumer grants we purchased every day.

Today these products enjoy a growth trajectory that should continue.

We believe our laser business is another fundamentally stable group subject of course to industry cyclicality. Technologically, the products we [INAUDIBLE] transitioning from gas to solid state lasers. On certainty regarding the speed of this transition combined with normal market cyclicality, lasers that serve semi-conductor equipment manufacturers can lead to a lack of forecasting visibility in the near term, but should support deliver growth as solid state lasers bring greater reliability and improved form factors. Our optics and display business is greatly influenced by the large screen television industry being engaged in the transition from standard definition to higher definition.

Major multimillion dollar investments are being made by the major competing players in one or more new microdisplay projection technologies, in particular LCD, DLP, and Outcost. We believe our investments in these markets will bring benefits over time. The challenges we experience in the optics and display business prompted us to reexamine our role in increasingly competitive market. Notably in the market spaces that require the confluence of system level manufacturing at mass consumer volumes, and are dominated by a small number of vertically integrated systems providers. To be clear, we remain committed to developing our optics and display business as we believe the opportunities for JDSU are compelling.

With that in mind, allow me to update you on selective products and subsegments of this business. First, front surface mirrors. We believe that we will continue to play an important role in the supply of front surface mirror, particularly digital versions commensurate with the noted display transition. Digital, unsurface mirror required by microdisplay television has higher defect tolerances creating yield pressures. To achieve this, we have begun to make process improvements at our Santa Rosa site to drive higher yields and expect to improve gross margins. We observed in calendar 2004 that front surface mirror was a highly seasonal product. Second, coated devices for DLP microdisplay. Again, a highly seasonal product with limited visibility that often results in capacity constraints one quarter and over supply in the next.

And third, optics and display components for light engines. We believe that our components would serve as enabling ingredients to our light engine technology, rank among the best in the world. Specifically, we possess a recognized capability for the development of components and process designed to improve rear projection, image performance, such as contrast, color fidelity and brightness. For the near term, we intend to focus on component integration techniques and systems integration for early market innovators where extreme scale is not required of JDSU manufacturing. And we are exploring alternative ways to leverage our technical expertise while still retaining the intellectual property and core competencies in house. Relative to large vertically integrated systems providers, JDSU also remains committed to a long standing compliment strategy that capitalizes on our intellectual property and volume manufacturing capability for differentiated display components.

In our communications business, we have been responding to industry transitions and customer requests by transforming JDS Uniphase from a component supplier to a leading provider of intelligent modules in integrated subsystems. Including, for example, circuit packs, wave blockers and our reconfigureable optical ad drop multiplexors. Where as once we served largely long haul markets, we are now enabling next generation metro, core and access networks as well. These metro related products represent the single largest revenue stream in our communications business.

As in our CCP business, this transformation requires new products, processes and systems. We will continue to aggressively transfer products manufacturing to lower cost locations without detriment to our quality or customer's expectations; and we will relentlessly strive to innovate, deliver high quality, and create technically excellent communications products. We are making progress towards these objectives including the important goal of increasing our communications cost and goods sold from Shinzen and other lower cost sites.

We continue to remain focused on strengthing our business model despite the heightened pricing environment experience this quarter. The third set of transitions we are driving is designed to improve our cost structure.

As you know we are in the middle of a program of product transfers that will move manufacturing to lower cost locations. We have previously commented that there is necessarily some redundancy in the structure as we execute these transfers, and we anticipate the first significant cost benefits in fiscal 2006. However, as we successfully complete each transfer phase, we expect to be able to start consolidating our North American facilities and reducing overhead. Ultimately, we expect to achieve benefits in labor differentials. Bill of materials reductions due to localization of content and reduce facilities in overhead. Belated and as we discussed at our analysts day in December, we are strategically employing outsourcing for higher volume products. Our decisions to build in-house are now governed by technical and quality considerations allowing us to partner with a concentrated set of contract manufacturers to gain efficiencies and cost advantage. While we have made progress over the last 12 to 18 months, there are more benefits to be gained from further centralization of our consolidating yet still dispersed G&A functions.

As I begin to conclude in summary, while each of these transitions is essential to our future success, the combination of so many transitions in our industries, product groups, and cost structure and financial effects of transitory benefits, has resulted in increased volatility in the near term. We believe that this period of transitions allows us to liberate ourselves from the past and navigate to new markets of the future. Our team remains committed to a strategy that we believe will deliver improved profitability over time. At a corporate level we will continue to opportunistically pursue acquisition candidates that compliment our product portfolio and profitability ambitions.

JDS Uniphase has both the appetite and the ability to benefit from carefully selected acquisitions, although we do not underestimate the challenges involved in acquiring and integrating new businesses. From a team perspective, we were happy to add Mike Ricci to the executive team. Mike joined us in early November leading our newly consolidated components and modules product group. Mike is 25 years in industry experience most recently as general manager of Intel's optical products group. We are certainly very pleased to have an executive of this caliber to join our team and we look forward to updating you on the progress in coming quarters. I'd now like to invite Ron to share more details on our second quarter financials. Ron?

Thank you, Kevin. Before I begin let me remind you that all numbers are non-GAAP unless I state otherwise. Just to recap. Total revenues were $185 million. GAAP net loss was 44 million or $.03 per share, which compares to a net loss of 36 million or $.02 per share in the previous quarter, and to 59 million or $.04 per share in the second quarter of fiscal 2004. Excluding certain items non-GAAP net loss was $31 million or $.02 per share which compares to a net loss of 14 million or $.01 in the prior quarter. And to 19 million or $.01 per share in the second quarter of fiscal 2004.

On a six month year-to-date basis total revenue grew 25% from the same prior year period. Communications grew 40% while CCP grew 10% during the same period. We continue to see opportunity for the communications market to grow on a single digit quarter to quarter trend line. While the CCP growth trend is less clear given seasonality and product transitions. In terms of geographic split North America contributed 122 million or 68% which compares to 126 million or 65% last quarter. Asia Pacific contributed 26 million or 14% of total revenues which compares to 34 million or 17% of total revenues last quarter. Europe contributed 32 million or 18% of total revenues as compared to 35 million or the same 18% in the prior quarter. Communications revenue was up slightly at 107 million. And up 37% year-over-year. Coming off a very strong performance in the first quarter of fiscal 2005, our communications business performed well. As a trend, and consistent with our product strategy. Customers continue to seek ever higher levels of integration.

We secured a new design win for our fifth major circuit pack customer, and ODM or original design and manufactured circuit packs remain on track to ship in the beginning in the first quarter of fiscal 2006. Other communications highlights in the quarter included a 25% increase in design wins in the quarter. Toast Us and Roast Us moved into the qualification stage and we achieved our first design win with one major telecom OEM. We expect that the first products will be qualified in the current quarter.

The shipment of our 1,000th wave length management module used by optical communication system manufacturers in next generation designs that can be reconfigured remotely and/or automatically, and the shipment of our 20,000th communication circuit pack. In fact, shipments of circuit packs increased 5%. Although, some of the benefit was offset by a scheduled price reductions which occurred ahead of product transfers to our lower cost overseas locations. Overall average selling prices continued to decline within our previously discussed range in the low single digits sequentially. Our commercial and consumer business delivered revenues of 73.8 million down 17% from last quarter. And down $1 million from the year ago quarter.

As you know, while we met our second quarter revenue guidance we were at the low end due exclusively to one major customer. Specifically in the optics and display part of the commercial and consumer business. Before I share some detail on the performance of the optics and display business, specifically I'd like to mention two other highlights of our commercial and consumer products segments performance this quarter. They included an engagements initiated with two very well known electronics companies on new optics and display opportunities. And we continued to see growth for our Flex business. Specifically with pharmaceutical companies and new consumer brands. We believe now that we are transitioning our optics and display business for the next generation of products playing to our technical strengths as we do so, we are mindful of the fact that this is a new market and as such there is no bank of historical data from which to cross reference customer forecasts.

In a second quarter, seasonal trends were exacerbated by the speed, magnitude, and frequency of in quarter adjustments. Amid an aggressive and forecasted ramp of new technology. As you know, this negatively impacted our performance. In gross margin our overall gross margin declined significantly from 23% of revenue to 17% of revenue quarter to quarter. Two major impacts were optics and display revenue decline and the associated inventory write-offs and overhead absorption impacts amounting to high single digit millions in lost margin in the business. And secondly, the net benefit of inventory recoveries versus inventory write-offs declined from $8 million Q1 to less than $1million in Q2. We had anticipated a more gradual weaning over time of favorable inventory recoveries. In addition, inventory write-offs continued to run at unacceptably high levels although progress has been made, we are redoubling our efforts to improve inventory management and factory loading in light of the volatile market environment. The combined effect of these two items alone accounted for the quarterly sequential decline of six points in gross margin. The mix swing from the higher margin CCP segment to the communications segment also put downward pressure on margins. This mix effect was offset by stronger margin performance in some of our communications product lines.

We will continue to see some downward pressure on communications margins in the next two quarters as we incur incremental costs to transition manufacturing to lower cost locations. Our non-GAAP operating expenses were higher than anticipated at $66 million or 37% of total revenues. R&D remained roughly flat at $24 million while SG&A increased from 36 million in the first quarter to 42 million in the second quarter. We stated last quarter that legal expenses were hard to predict and this proved to be the case in the second quarter where unanticipated legal expenses were responsible for all of the incremental SG&A.

We consider these matters to be routine for any public company, but as our portfolio of legacy issues progresses, it is likely that our legal expenses will remain higher for a period. Non-GAAP EBITDA declined from a loss of $6 million in the first quarter to a loss of $26 million in the second quarter. We had expected second quarter non-GAAP EBITDA to be in the range of a loss of 10 to $16 million.

This guidance anticipated further negative mix effects and new product start-up costs similar to those we experienced in the first quarter , as well as our observations on the weaning of net beneficial affects such as cancellation fees, net inventory, and warranty recoveries. Unfortunately, as we preannounced we were additionally impacted by a series of unanticipated items. As noted the lower revenue and related costs associated with the decline in the optics and display business contributed to a sequential drop in the CCP segment contribution margin of $10 million. The additional legal costs adversely impacted EBITDA by approximately $6 million.

Turning now to some other P&L items. Interest and other income increased more than $2 million to 5.3 million, largely due to improved performance in foreign exchange. And included in our GAAP results in line with previous quarters, amortization of other intangibles was just under $5 million. Restructuring and other related charges of just under $4 million related mainly to facility exit expenses and employee severance for our Binton facility.

Moving now to the balance sheet. Our total cash and marketable securities were just under $1.4 billion. We consume 33 million in cash for operations. Of the $33 million, 26 million was restructuring related, including 23 million foreclosure of our obligations related to our U&L facility in the Netherlands. Approximately seven million was used for investments. Most for the investment we acquired from Brillian. And $8 million was invested in capital expenditures in the quarter. Day sales outstanding improved to 57 days from 60 in the prior quarter. And at $121million net inventory declined five million from last quarter. Turns improved slightly to five. And finally, head count decreased from just over 6,000 at the end of the first quarter to just over 5,500 at the end of our second quarter, largely due to the Fabrinet transaction which impacted approximately 400 employees.

Now to third quarter guidance. As we described, a range of legacy related transitional activity is impacting the predictability of our performance in the near term. As we continue to execute against these very deliberate and necessary transitions, we anticipate near term volatility. Notably our book to bill, this quarter came in around the .9. With these facts in mind, we expect third quarter revenues in the range of $155 million to 165 million. We expect communications to continue to show year-over-year growth while we expect CCP will show a year-to-year decline, driven largely by our optics and display business. And we expect third quarter non-GAAP loss per share will be about $.02.

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

Thank you, sir. Ladies and gentlemen, at this time if you wish to ask a question, please press, star one on your touch-tone telephone. If that question has been answered and you would like to withdraw yourself from the queue, you may press, star two. Again, star one at this time for any questions. One moment please.

Sir, our first question is from the line of John Harmon with Needham & Co.

Hi, good afternoon. So my one question would be -- could you talk about the Brillian asset acquisition. What your motivation was, what capabilities it gives you and how it helps your relationship with them.

John, let me take it, this is Kevin. Let me take it -- this was an important quarter for us in terms of our relationship with Brillian. It actually represented the first time that we have actually had a contractual engagement with Brillian and allowed us to better define out roles, and how we will work together in an envelope of collaboration towards the future.

So for us making sure that we codified that was an important thing and that was a milestone for us. Second accomplishment for the quarter was many of the technical challenges that we jointly had in the early, you know, several quarters ago, we've made -- we've made progress on. Many of those through the hard efforts of the Brillian team and, of course, with collaboration with our team as well. In terms of the color link asset acquisition. On one hand since there are multiple pieces of technology and sort of path that you can use to deliver capabilities we viewed this as a bit of a hedge. So good technology.

Secondly, it was a way for us to mobilize the relationship further given that the technology standards are still somewhat uncertain in the market. So I think we were -- we did it as a bit of a hedge in terms of how the market may evolve, and allowed us to completely codify our relationship going forward.

Okay. Thank you.

Yes.

Sir, next question from the line of Ehud Gelblum with J.P. Morgan

Hi, thank you very much. Let's see if I can formulate a single question here.

First of all, clarifications. I just want to understand that the entire difference in SG&A from last quarter to this quarter, which I calculated at about 11 million. It's not a question, just clarification. The entire legal expenses and just wanted to know if you can compare those prior quarters just to see -- was that kind of lumpy, or --

I believe it was -- Ehud, this is Ron. I believe it was 36 to 42 million. And that was entirely explainable by legal costs.

42, okay. We can take this offline, I guess. But I am looking at 43.5 at the SG&A this quarter? Or am I looking at the wrong thing?

I was approximating, let me look here. You're looking at GAAP numbers. It was 42 million on the non-GAAP basis that's what I am referring to.

And that's the difference [INAUDIBLE]

Yes.

Okay, and if you can actually -- if you can compare that to legal things in the past. But I guess my real question --legal fees in the past quarters -- my real question is as you look towards your guidance going forward, the 155 to 165, let's just take the mid-point of that, I guess 160.

There's a wide range of saying that COMs is going to be up year-over-year given that it was about 80 million in March of '04. So that means it could be anywhere from 80 to 106. Could you give us some kind of -- what are the leverage there, you obviously were surprised on the upside this quarter as to how COMs remained as strong as it was at 106.

Can you give -- you've in the past given some sort of indication as to what [INAUDIBLE] long haul is. If you can give that and give other parts of the drivers to that. To try and give us a sense as to where in that range of 80 million to I guess 160 at this quarter, you think you might come out at and what the drivers that really -- I mean it seemed like there's not much visibility coming on. How did you put together that guidance at 155 to 165 and what level confidence do you have in that?

Ehud, it's Kevin. Let me take a stab at it, and if Ron needs to help me, we'll see where we end up. I think you are right as we set guidance for last quarter.

We were probably starting the quarter out with a greater level of caution on communications and it was a positive thing, frankly, that we came out as strong as we did. And we were surprised in the consumer and commercial place with this one customer. I think the lesson of that is that it shows the lack of visibility that we are experiencing in both segments. I'd say we probably -- I think I've even quoted in the past of saying that we have six weeks of visibility. We're probably at around a four week level or thereabouts today.

So we think we're inherently strong. We do see some signs such as operator consolidation and some of our customer's delaying projects that causes us concern in some long haul areas. On the other hand, Metro as I stated has been one of the real strengths for us in recent quarters. So anything could happen there. And on the consumer side I think we're being cautious so the way that we develop the guidances, we look at the bottom's up, roll up. We look at what we think the up sides might be and what the down sides are and we try to make sure that we're predictable and we fall within that range, so Ron and I are using management judgement as we provide that that window for you.

As a customer that NCCP indicated that their issues have been resolved or have they not given you any comfort level that things will return to normal levels next quarter.

I'm sorry, what customer did you say? The customer that fell off in the CCP side.

Did they give you any indication of comfort level of what next quarter looks like would be for the last quarter?

We do have a forecast from them and so history's not a good guide. I think Ron had mentioned we had numerous in quarter forecast adjustments from that particular customer.

You are right that there is a -- we enter the quarter feeling, you know, some what optimistic, but again, using last quarter as a guide. We're cautious about the forecast we're getting from the customer.

And your guidance I guess is conservative, below what they actually have forecasted for you. There's a little bit of cushion?

We absolutely consider downsides and upsides in any window that we provide to the street. The other, just additional comment, Ehud. As we commented in the script, that we do have some observation of a seasonality on that side of the business as well which we commented in the prior quarter. We didn't have a real good view of being relatively new in the market place and with new plays in that market. But we clearly have some seasonality play on the downside here going into Q3. Okay. Could you give us a little history on the legal fees.

Don't specifically break those out. What I can tell you is they have been variable based upon both contingency [INAUDIBLE] that they're done as we estimate possible settlement liabilities and also legal litigation expenses. They move around quite substantially. And that's why I commented last quarter and at the analyst day that legal costs are hard to predict. Thanks, Ehud.

Sir, our next question is from from the line of Stephen Koffler with Wachovia.

Hi, Kevin. Hi, Ron. So back onto the large consumer customer. What can you tell us to give us confidence that this is very much ebb and flow related as opposed to market share or operational. You know there was a pretty big market share shift against you and the same customer goods five quarters ago. You know they took out a second source. Do you have real visibility that you're holding your own and it's all about them or are there any issues that you really feel you need to resolve?

Steve, I'lll take a stab at it. I think, you know -- I don't know if it was you or someone else at the analyst day asked the question, there are two things. We absolutely think that the significant number which is a double digit number of forecast changes in quarter is indicative of a seasonal phenomenon, so let me be clear about that.. There's a second point which --

Did you say a double-digit number of forecast changes.

Yes.

That's like basically every two weeks or every week.

My comments earlier Steve, was that it was on average greater than one per week.

Okay.

So let me put that as a stake in the ground as to the phenomena that we observed which I would say is not a normal phenomenon. And then the second reality is as I said we were perhaps a decade ago a sole source provider of the piece of this equation and today there are three competitors, so absolutely shares in the mix and in fact pricing compression is in the mix. You can serve up a lot of units but you may not get the same revenue. So I think there are three factors there. A part of our reality is we are going to serve that customer as best we can. And we're also looking for new customers with new components that will serve higher end markets. We are working through both of those transitions. Does that help.

Yes, it does, thanks.

Sir, next question from the line Pete Wu with CIBC World Market.

Actually, it's Eddie Wu. Hi gentlemen, I want to expand on Steve's question a little bit. Right now you have a handful of primary components that you sell into the consumer market and handful of big customers in that segment. What kind of diversification measures are you looking at in terms of getting more customers and on the same note expanding your product base?

Yeah, I think -- Eddie, this is Kevin. I think you know, there are the blessing here is that there are -- there's a small number of customers but there's also large ones, the particular coatings that sit on microdisplay is a single component that sits on a DLP chip that goes to one particular. So that's about as concentrated as you are going to get.

When you get beyond that we sell mirrors, components, color wheels, trim retarders, all sorts of things that -- and filters that sit in these light engines and in a DLP light engine we may provide six -- upwards of six or more components in an L cost we maybe eight, nine or more. So first is to have as large a footprint as you can in the display as well as the light engine, second is to diversify a cost multiple technologies, be it DLP, XLCD, L cost. So we are investing so that we can go across a larger range of sets, a larger range of technologies and therefore, a larger number of customers. And with that probably the canonical thing that we have is a world renowned expertise in coatings. That's really what allows us this capability. So you are right, we have a specific footprint today but there are multiple dimensions to expand on. Hope that helps.

Yeah, question about DLP light engine itself. It's been kind of discussed among the street that this business is not a profitable business for you at all. How close are you to gaining profitability with selling light engine itself and how -- how many customers do you have who source from you?

Yeah, so Eddie, the strategy that I tried to outline here and let me just reiterate, we have come to the conclusion that our best in class components and our knowledge of how to integrate those components is probably where we are best served. We are not people that are going to create a light engine at the scale of a that a Sony would from their inhouse manufacture and design so we are focusing or energies right now on investments for process and sort of specialty components that will be ingredients to most light engines and we will reach higher levels of integration where smaller scale manufacture, so very niche oriented high specialty places are -- would allow us not only to be effected with our manufacturing processes at a systems level, but also to afford us better profitability. And I think that new focus on what I will call the lower end or soft tooling of manufacture is something that you know, we are beginning to exercise now but it is still early. Ron? [INAUDIBLE] in this business it's been on the component side of things and [INAUDIBLE] integrated and have less need for that. We can play at different levels both with our component capabilities as well as our specific process expertise and deliver it to various customers.

And again ladies and gentlemen, we ask that you limit your query to one question per person, please. Sir, your next question is from the line of Pahras Bargada with EMO.

And good afternoon, gentlemen.

Hi, Paras. Question with regards to your guidance, gentlemen. Last quarter and on December 1st, at your analyst day, we had a long discussion about the sequential growth quarter over quarter for calendar year '05. Is the change in guidance for this quarter. Made only because of the display business or have other things changed in the COM business and other businesses also. Because we had a long discussion about this, Kevin, and you were very, very confident that both times this was going to happen.

I'm just trying to understand, maybe the telecom business was a little bit better in December than you expected, and as a result it's not going to show the single digit, the kind of growth you might have thought from a higher base or are there other businesses, the commercial laser business, maybe some other businesses aren't performing in the first part of this year. Paras, this is Ron. Let me take an initial shot at that. In terms of my -- the guidance that was given, one communication was that we still see that we are on a single digit trend line on the communications side of the business in terms of sequential growth. And don't see significant changes. We have said all along that there would be variability quarter to quarter but if you look at the longer term trend lines that's the better way to view it.

Does that include March, Ron? For the March quarter you're saying from December to March you expect single digit sequential growth in Telecom?

We're talking about trend lines in averages. If you recall, I pointed out six months year-to-date versus last year-to-date. We are at a 40% growth track which is probably well above the sustainable average for communications.

Yes.

Right. So we're going to move around quarter by quarter but we're still on as near as we can on a positive positive single digit kind of trend line on COMs. To your specific question, the new piece of information is we have less visibility especially given the emergence of new products and technologies and the seasonality cycle which we're not real familiar with on the CCP side of the business. And that is the new piece of information.

Well, Ron, last year in the March quarter and in '02 in the March quarter, you had a display customer that was more than 10% in both of those quarters. 11% and 13%. So there was actually the reverse seasonality. Are you sure it's seasonality and it's not something else? I notice Samsung dropping its prices for DLP TV, 35%. I notice TIs DLP revenues being down 10% sequentially. Is there something else afoot that maybe it is not seasonality. Maybe there's a secular change?

As Kevin also mentioned earlier in terms of particular customers, there are other players also in the market place. And for us to dissect and understand what the order patterns going to be relative to seasonality and what the ordering patterns from some of these customers from some of these customers are going to be relative to other supplier choices is difficult for us to call.

Sir, our next question is from the line of Ping Zao with Credit Sites.

HI, how are you? Two parts of a single question. The first one is that focus on the display customer, if I hear you correct, at lease part of the reason is the loss of share. I guess my question is that something that you guys are doing? Making that share or that share is forever lost?

You know, Ping, I don't know the answer to that. I think the trendline for many years has been in a very specific direction and I don't think that we're thinking that that's going to change dramatically. In order for us to cope with that trajectory, I think we are doing two things. One is we're investing in some new processes that will help us stay in the game and improve our chances or our longevity with that particular customer. We probably believe that the industry could hit a capacity issues where you know, there could be an improvement in share and then there is second, is we're going to have to find new markets for our optical coding technologies and other components and I say we are pursuing those trajectories pretty aggressively right now.

Second part of it, it's coming back to the SG&A. As you mentioned the litigation is ongoing. I still haven't figured out why we see a sudden jump? Or is this going to go back to a level of last quarter or this is the level we should expect? And the legal expense?

Pang, this is Ron. In terms of legal expenses, they are -- as I mentioned earlier, they are not real easy to predict because they are a function of both internally incurred legal cost to deal with litigation and they're also a function of contingency estimates related to potential settlements, and those things vary from time to time and quarter to quarter and are assessed every quarter. This is not the first time we've had significant moves in some of those expense structures. There has been variation over certainly the last couple of years, there was just a disproportionate amount of impact in this quarter in terms of our expenses and it hit more of a lump, but that's not a clear indicator of what will happen in the next quarter, for example.

And our next question comes from the line of Todd Kauffman with Raymond James.

Thank you. If I could just follow on the last couple of questions, but frame the question differently. It seems as though you're sort of managing and running a $200 million business plus or minus quarter to quarter. Sequential trends and blah, blah blah, and then maybe under somewhat better circumstances, the gross margins in this business could get into the 30 to 35% range. Even if that were the case which you are nowhere near now and haven't been for many years. But even if that were the case, it would look like your discretionary operating expenses of where they sit today wouldn't allow you to make any money. And in your opening remarks you actually commented that you're still managing and dealing with the disbursed G&A functions. So my question is, where does the discretionary operating expenses go in the next sort of one to three quarters from where they are today? Thank you.

Todd, this is Ron. You are correct that we have some progress to make both in terms of the gross margin side and in our operating expense structure. One thing that Kevin elaborated on in his comments is that we are narrowing our footprint and moving to lower cost locations and fewer of them and as we do that it will not only help our gross margin, but it helps our G&A cost structures as well. So clearly we have to get to a point where we are in the mid to long term moving to higher gross margins ranges and we would expect that our G&A, our SG&A cost as a percent of revenue will continue to decline. And the combination of those effects would give us some profit spread. Okay. Todd, let me give you a sense of the timing and the journey there.

Remember, that this company was an amalgamation of numerous acquisitions. It was only about May or June of last year where I announced that we were going to centralize the company. We basically made San Jose headquarters about a year ago. In May we announced the centralization. The process of that centralization really requires a central organization, not only to be hired and be put in place but you have to seize control from the disbursed sites often removing products or certain functions until you can get the people in all the supporting functions out. So we are six months into the seizing of control and I think as we report back over time where we can close down one site after another, you will see a pretty dramatic reduction in G&A. But, you know, we're probably an inning two or three of a nine inning game here on that. Hope that helps frame it.

And, sir, our next question is from the line of Jeremy Bunting with Thomas Weisel Partners.

Thanks, very much. You did mention I think in your prepared comments, Ron, that you had had a head count reduction Q2 over Q1. Doesn't seem to have impacted either the SG&A line or the R&D line. What am I missing? What is your near term outlook for R&D and SG&A and any expenses for the next couple of quarters?

Hi, Jeremy. The head count reduction was mainly 400 of the 500 so head count reduction related to the sale of our Binton Indonesia facility to Fabrinet. We had some other head count reduction. That was the major driver, quarter to quarter. You can certainly expect as was commented on the prior question, that as we continue to move our operations to lower cost jurisdictions as we continue to outsource other activities to contract manufacturers, and as we consolidate we'll have head count reductions both in the manufacturing operations as well as other SG&A functions.

Let me add, Jeremy, that I think, I probably would not recommend that you look or use as a metric, the head count reductions. I think it's quite conceivable that we will reduce head count in certain North America locations , however, we may actually gain head count in lower cost areas. The general trending of [INAUDIBLE] down, both in RD perspective and a SG&A perspective, is a likely phenomena from an expense perspective perspective. Whether the actual numbers of heads will be reduced is something that it depends on how we backfill in other locations, lower cost locations. Okay?

Sir, we have a question from the line of Darrell Armstrong with Smith Barney.

Great, thanks a lot. This is Mike Genevese for Darrell Armstrong. I think we've been talking around this a little bit but I'm wondering if you could remind me, you know, any long term targets in terms of either gross margins or components of Op Ex as a percentage of revenue. What do you see as a sort of normalized model for this company that you can approach over the next couple of years?

Mike, this is Ron. And we will make this our last call. There is some things we have commented on through the quarters here. One is that when we believe that we should be able to achieve 30s and and longer term -- in the mid term and longer term 40s, kind of gross margins, there are a number of effects that need to occur there including change in rate of ASP compressions going through the lower cost transitions that we have talked about. Getting to a smaller footprint structures. Consolidation and irrationalization of our market place and those sorts of things. On the operating expense side, we believe that our operating expenses should be sub 30% kind of range and we can get there both in terms of revenue growth expectations over time as well as cutting our cost structures as we commented on earlier.

I think that will wrap it up. Operator, I'll turn it back to you.

Thank you, sir. As we have no further questions at this time, I'd like to turn the call back over to Ms. Ross for any closing remarks. I will turn it back over to Ms. Ross for closing remarks.

Thank you, Carlos. That concludes JDS Uniphases second quarter conference call. Thank you for joining us today. We look forward to updating you on our progress in future quarters.