Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

JDS Uniphase Corporation (NASDAQ:JDSU)

F1Q07 Earnings Call

November 2, 2006 5:00 pm ET

Executives

Jacquie Ross - Director of Investor Relations

Kevin Kennedy - CEO

David Vellequette - CFO

Analysts

Michael Genovese - Citigroup

John Harmon - Needham & Company

John Anthony - Cowen & Company

Cobb Sadler - Deutsche Bank

Ehud Gelblum - JP Morgan

Jeff Evenson - Sanford Bernstein

Subu Subrahmanyan - Sanders Morris

Ajit Pai - Thomas Weisel Partners

J.J. Flores - Lehman Brothers

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2007 JDSU Earnings Call. My name is Melanie and I will be your coordinator for today. (Operator Instructions). I would now like to turn the call over to Ms. Jacquie Ross, Director of Investor Relations. Please proceed ma'am.

Jacquie Ross

Thank you Melanie, and welcome to JDSU's fiscal 2007 first quarter earnings conference call. Joining me on the call today are Kevin Kennedy, Chief Executive Officer, and David Vellequette, Chief Financial Officer. As always, 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 sections of our Form 10-K filed for our fiscal year ended June 30, 2006. The forward-looking statements, including guidance, provided during this call are valid only as of today's date, November 2, 2006, and JDSU 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 today's news release announcing our results and available on our website at www.JDSU.com. Finally, and as a reminder, this call is being recorded and will be available for replay from the investor portion of our website at www.JDSU.com/investors. I would now like to introduce JDSU's Chief Executive Officer, Kevin Kennedy.

Kevin Kennedy

Good afternoon. Today's results, which include the achievements of non-GAAP positive net income for the first time in more than five years, marked another necessary milestone in the journey to redefine JDSU. While the journey is not over, we continue to believe that there is still significant potential to unlock in our emerging business model. Dave and I will share with you some of the actions that are underway to further strengthen our gross margin and operating income performance later in the call. But first, our first quarter results. Non-GAAP first quarter revenue of $318.2 million was down slightly sequentially, yet solid performances in our optical communications and commercial and consumer markets could not offset lower revenue from our Communications Test and Measurement segment. While test and measurement revenue was lower, JDSU delivered sequential growth in our optical communications, advanced optical technologies and commercial laser businesses collectively for the first time in ten quarters. Additionally, our P&L evidences positive contribution from all four of our businesses on an operating margin basis.

During the first quarter we continued to make steady progress on our gross margin objectives, despite ongoing downward pressure associated with the transitional activities and unfavorable mix. Despite a lower revenue contribution from our higher margin communications test and measurement business, non-GAAP gross profit for the quarter improved to $110.3 million, or 34.7%, up from 33.9% last quarter and from 31.6% in the year ago quarter. Non-GAAP EBITDA was $9.6 million, up 75% from last quarter's $5.5 million and compared to non-GAAP EBITDA loss of $4.3 in the year ago quarter. The improvement in EBITDA, despite a lower operating contribution from our Communications Test And Measurement business, further highlights the progress of the profitability improvement programs throughout the rest of the Company. Moving to the bottom line, JDSU delivered non-GAAP net income of $6.8 million, or $0.03 on a per-share basis. Net interest and other income of $12.7 million was clearly instrumental in this result, and we remain committed to further progress. That said, this marks the first time in five years that JDSU has achieved positive net income results on a non-GAAP basis. Our split adjusted non-GAAP performance has improved from a net loss of $0.08 in the first quarter of fiscal 2006 to net income $0.03 in the first quarter of fiscal 2007. Finally, the book to bill was greater than one for the Company.

I will now update you on each of our three markets in turn. In an ongoing favorable environment, our optical communications segment delivered its fourth consecutive order of growth with revenue of $138 million, growing nearly 4% from last quarter and 37% from the same quarter a year ago. Metro and long haul both continued their growth trajectories, with particular strength in Metro during the first quarter. Ongoing investment, particularly Metro, is essential for carrier sequence of future (proof their)4:57 networks in order to support the rapid proliferation of triple play and rich media services. JDSU's Agile Optical Network portfolio continues to gain traction as carriers seek to build in the flexibility to ramp services as consumer demand grows. With the broadest portfolio of Agile products in the industry, JDSU is the leading supplier in this fast-growing market. Looking at some of the Agile products in more detail, we continue to enjoy a strong leadership position in the growing market for ROADMs. Only JDSU offers a broad portfolio of ROADMs solutions based on each of three underlying technologies. That is liquid crystal-based blockers, (plainer)5:35 Lightwave circuit, and micro electromechanical systems or MEMS-based wavelength switch systems. Resolution of our litigation with Metconnex demonstrates our commitment to the protection of our IP portfolio, which represents the most comprehensive in the industry today. With more than 9,000 ROADMs shipped and carrying live traffic in both long-haul and Metro networks, JDSU is the leader in this market and the only established vendor with the ability to deliver at these volumes. Moving to tunable transponders, we continue to ramp aggressively to support demand. Although we increased capacity in the first quarter, we continue to see strong demand for our 10 G portfolio, which includes 310 tunable transponders.

JDSU continues to lead the market with our broad portfolio of transponders, transceivers and lasers covering 2.5 G and 10 G, and are executing plans to further increase our capacity for fiscal 2007. You'll recall that our optical communications business generally derives the bulk of its revenues from a relatively small number of very large customers. While we continue to experience growth in a number of our largest accounts this quarter, it is interesting to note that smaller accounts also contributed to this quarter's growth. This development highlights both the strength of the underlying drivers behind the network upgrades, as well as our increased traction among a broader customer set. At the same time, we view this as evidence that some of our larger customers did, as we suspected they might, pause spending in response to ongoing consolidation activity among our network equipment manufacturer and carrier customers. Despite the impact of this pause during the quarter the segment as a whole continued to grow with continued strength in or our Agile product portfolio.

The acquisition of certain assets and IP of Optovia, a supplier of long-range amplification products, further demonstrates JDSU's commitment to expanding its portfolio roadmap to support peripheral optical transport subsystems for telecom carriers, cable providers and enterprise. On an operating contribution basis, optical communications improved approximately $4 million to a positive $2.2 million, highlighting the progress achieved by our fiscal 2006 cost reduction programs. We remain focused on driving further profitability improvements. For example, we completed the transfer of manufacturing out of Ottawa by the end of the first quarter, and expect to exit the facility by the end of the calendar year. Based on the success of our optical communications manufacturing transition to date, we are currently in the process of transferring manufacturing from our Santa Barbara, California site, acquired as part of the Agility transaction, to San Jose, Shenzhen and contract manufacturers. This move was in part motivated by our ongoing efforts to minimize costs, but additionally by the fact that the demand for tunable transponders had far outgrown our capacity at the Santa Barbara site. We started shipping subsystems from Shenzhen in the first quarter and continue to ramp aggressively. We expect to have increased capacity threefold or more by the end of fiscal 2007.

The communications test and measurement segment delivered revenue of $116.8 million in the first quarter, down 8% sequentially and down 4% year-over-year. As noted earlier, revenue of $116.8 million was below internal expectations due to a combination about internal and external factors. Let me address each in turn. First, as we noted in our August call, we believe that industry consolidation did result in fewer large deals from our North America telecom carrier customers. For example, the revenue contribution from our top 10 customers was more than 15% lower in the first quarter than it was in the previous quarter. Similar to our optical communications segment, we continue to believe that consolidation creates a pause rather than a long-term downsizing of the opportunity. And we believe that we're strongly positioned to benefit when this phase of consolidation is completed. For the first quarter, however, we believe that the smaller number of large deals impacted revenue by mid single digits millions of dollars.

Moving to the internal factors. We performed lower than our desired pace on two fronts. These are bookings ramp and the conversion of our September bookings to revenue. With regard to our bookings ramp, we believe that the realignment of our communications test and measurement sales forces to a new fiscal year start, new territory assignments and other segment reorganizations resulted in a slower bookings ramp in the first quarter. As a result, we experienced a quarter were all (three year)9:54 had lower than expected bookings, and the quarter was extremely back end loaded in this historically high turns business. As we move to the second half of the quarter, and on the back of the excellent track record that the team has in driving turns, our operations team embraced the additional challenges and risks of our Oracle conversion. This work ultimately necessary, impacted turns conversion. As a result, the combination of sales force realignment, speed, and conversion of bookings and our Oracle implementation resulted in the delay of revenue in the mid single digit millions of dollars. With these essential transitions largely behind us, including the first quarter end close on Oracle, there is clearly opportunity to improve our execution in the second quarter and beyond. Engagement with our customers remains robust. The test and measurement equipment is playing an ever more integral role in the deployment of IP networks and triple play services.

We believe that we're well-positioned with one of the industry's broadest and most innovative sets of broadband test instruments, systems and services. We continue to see strong worldwide demand for our T-BERD 8000 fiber fiber-to-the-test platform. We introduced a new 10 G Ethernet module for our ONT-506 and 512 product lines, designed to help labs who are manufacturing verify GigE networks for element reliability, interoperability and quality of service. We also shipped our first ONT units with 40 G capabilities during the quarter, highlighting JDSU's technology leadership in a growing market. JDSU's communication test and measurement team also continues to enjoy industry wide recognition for its innovation. September we won Frost & Sullivan's Growth Strategy Award for our IP video and IPTV solutions. Earlier in the quarter Frost & Sullivan also honored JDSU with its Services Strategy Leadership Award. And more recently JDSU's NetComplete VoIP Service Assurance Solution earned the IEC 2006 InfoVision Award for Access Network Technology and Services.

Overall, we still expect the December quarter to be strong for the communications test and measurement business based on historical spending patterns among carriers. The OE sales funnel is strong and the volume of large deals that we're pursuing is favorable. Additionally, book to bill was favorable for communication test and measurement as we exited fiscal Q1. Our advanced optical technology segment delivered revenue of $39.3 million, up 7% from last quarter, marking the segment's first quarter of growth since September 2004. Operating contribution continued to improve despite ongoing consolidation at our Santa Rosa site, which continues to exert some downward pressure on the segment's operating performance. The sale and lease back of or Santa Rosa campus and consolidation from 13 buildings to 6 is progressing, and should be complete by the end of our fiscal third quarter. Combined with the ramp of our next generation coating technology platform, growth in the flex business and a renewed focus on yield improvements, we expect this segment's profitability to continue to improve as we progress through the fiscal year.

Despite the ongoing industry wide decline of legacy gas lasers, our commercial lasers photonic power revenues grew 7% during the first quarter to $24.1 million. Leveraging our expertise in telecom packaging, diode lasers, and custom optics, we expect JDSU will continue to develop some of the most reliable and efficient lasers available, and provide customers with lower cost of ownership. JDSU lasers are used, for example, to shape hard drives and portable mass storage devices, semiconductor micromachine, and a biotechnology instrumentation used for DNA testing and (closatometry)13:28. JDSU is committed to playing a leading role in the industry's transition to solid-state and fiber lazers. Our solid-state lazers tend to enjoy higher margins than gas lasers, so this transition will also support our focus on operating performance improvement. Additionally, we continue to transition our lasers' manufacturing to improve our cost structure. We expect to complete the transition from our Santa Rosa facility to our contract manufacturing partner in calendar 2007. And our newest product designs are targeted to leverage our optical communications manufacturing capability.

Dave will discuss our target business model in more detail later in the call. I wanted to comment briefly on one important metric that we track closely inside the Company to measure our progress. That is non-GAAP EBITDA. Non-GAAP EBITDA in the first quarter of fiscal 2006 represented a negative 1.7% of revenue. By fiscal Q4 '06 this metric had improved to a positive 1.7%, and this quarter our non-GAAP EBITDA improved again to 3% of revenue. With four consecutive quarters of positive non-GAAP EBITDA, we believe that the early results of our focus on profitability improvement are visible and gaining momentum. As we complete the manufacturing transitions in are optical communications, advanced optical technologies and commercial lasers businesses, we will be increasing focused on execution-based improvements, including yield, building materials, lead times and so on. As we progress through fiscal 2007, you can expect to hear us talk more about these execution-based improvement programs that we believe offer the further potential to strengthen JDSU's profitability profile.

Moving to corporate development, when JDSU's Board of Directors met a few months ago to consider the execution of the reverse stock split approved by stockholders last year, we assessed, as we had done several times throughout the year, JDSU's progress against several criteria. Most important among these was JDSU's profitability momentum. The Board noted the achievement of three consecutive quarters of non-GAAP EBITDA positive results. They further noted that cost savings achieved during fiscal 2006 and improving trajectory of profitability metrics in general. With almost 1.7 billion shares outstanding, it was extremely difficult for investors to track our improving bottom line. But with non-GAAP profitability on the horizon, it was the right time to execute the reverse stock split. It is clear from today's results that the reverse stock split has improved visibility into our progress. With the reverse, for example, and despite our improving profitability, we will be talking to you today about our fourth and consecutive quarter of approximately breakeven on a non-GAAP per-share basis, while post split our net income of $6.8 million shows as $0.03 per-share.

Moving to corporate events, I would like to invite our stockholders to join us for our 2006 annual meeting of stockholders, which will be held in Milpitas, California on Tuesday, November 14, starting at 9 AM Pacific time. We welcome you to participate in person or via webcast, and further details are available on the Investor Relations pages of our website. Finally, it is with sadness that I share with you news that one of our Board members, Peter Guglielmi, passed away yesterday after a long illness. Several months ago after more than eight years as a Board member, Peter had made the decision to step down as of the upcoming annual meeting in order to spend more time with his family. Peter will be remembered by this Board for his many qualities, including forcefulness, fight and heart. Our thoughts are with his wife, Jeannie, and the rest of his family at this difficult time.

With that, I will hand the call over to our CFO, Dave Vellequette, to discuss the financials in greater detail.

Dave Vellequette

Thank you, Kevin. Before I start, please note that all numbers are non-GAAP unless I state otherwise. Also, per-share numbers will all be presented on a split adjusted basis. GAAP revenue for the first fiscal quarter of 2007 was $318.1 million. Non-GAAP revenue of $318.2 million, which includes revenue associated with acquisition accounting, was down slightly from last quarter. Despite lower revenue, first quarter non-GAAP gross profit of $110.3 million, or 34.7% of revenue, improved from $108.1 million or 33.9% of revenue last quarter. At the same time our non-GAAP gross margin was negatively impacted by mix. With 63% the total revenue derived from our lower margin optical communications and commercial and consumer businesses, while our higher margin communications test and measurement business dropped to 37% of total revenue for the quarter. Non-GAAP operating expenses declined to 36.9% of revenue from 37.3% of revenue last quarter, and within our targeted 35% to 38% range. The decrease was the result of slower hiring in R&D and sales, and lower selling costs associated with the lower communications test and measurement revenue. First quarter non-GAAP net income of $6.8 million, or $0.03 on a per-share basis, improved from a net loss of $2.1 million, or $0.01 per loss per share last quarter, and to a net loss of $15.4 million, or an $0.08 loss per share in the year ago quarter.

A detailed reconciliation of our non-GAAP results to our GAAP results is available in today's press release. Our non-GAAP results exclude amortization of acquired technology and intangibles of $16.3 million, a $6.6 million charge related to stock-based compensation, $5.2 million of charges for restructuring and non-recurring expenses, primarily associated with Ottawa manufacturing transition and our Santa Rosa site consolidation. And these charges were partially offset by $5.4 million of income, which came primarily from the collection of an outstanding note receivable. Including these items, GAAP net loss of $17.4 million compared to last quarter's net loss of $45.8 million. GAAP net loss of $0.08 per share compared to a net loss of $0.22 per share last quarter and to a net loss of $0.34 per share in the same quarter a year ago.

Moving to the quarterly results for the business segments. Optical communications revenue grew nearly 4% sequentially and 37% year-over-year to $138 million. Operating income of $2.2 million improved $4 million from last quarter due to higher revenues and also the fact that last quarter's results included transient charges in the cost of goods sold area.

Moving to our communications test and measurement segment, revenue of $116.8 million was down $9.5 million from last quarter, or almost 8% sequentially. Reported revenue of $95.4 million in the year ago quarter reflected the first partial quarter post acquisition. Allowing for a full quarter of revenue in Q1 '06, the segment declined 4% year-over-year due in part to external market factors associated with customer consolidation and to some internal execution challenges as discussed earlier.

Operating income of $6.8 million or 5.8% of segment revenue was down from last quarter's 7.4% of revenue, reflecting the impact of lower revenues, which was partially offset by lower operating expenses. The third market addressed by JDSU is the commercial and consumer market, which comprises our advanced optical technologies segment and our commercial lasers business. Advanced optical technologies, which includes our flex and custom optics businesses delivered revenue of $39.3 million. This was up 7% over the last quarter, highlighting this business as a emergence from a period of significant portfolio realignment. Operating income improved more than $2 million to $11 million, or 28% of segment revenue.

Our commercial lasers business also grew 7% this quarter to $24.1 million reflecting ongoing operational improvement in addition to the going mix of higher margin solid-state products, operating income improved to $1.7 million this quarter or from 3.1% segment revenue last quarter to 7.1% segment revenue in the first quarter.

On a geographic basis, the Americas contributed 57% of revenue. The EMEA contributed 26% of revenue, and Asia-Pacific was 17% of revenue. The EMEA and Asia-Pacific regions delivered their highest quarterly revenues since the acquisition of Acterna.

Moving to the balance sheet. Total cash, cash equivalents, short-term investments and restricted cash was $1,216,000,000 at the end of the first quarter. Total cash was down approximately $22 million primarily associated with the increase in total inventory and fixed asset purchases.Net accounts receivable of $231 million was basically flat from last quarter. Due to the higher returns activity in the communications test and measurement business, and our customers request for late in the quarter shipments, our DSO has trended up in the last several quarters. For the first quarter of fiscal 2007, however, DSO declined one day to 66. Net inventory increased in both optical communications and communications test and measurement. The increase in Optical Communications was due to strategic buys were we are transitioning products. The increase in Communications Test and Measurement was is due to the higher turns nature of the business and the preliminary buildup of inventory to support anticipated demand in the December quarter.

Inventory turns declined slightly this quarter, and we expect to see turns improve by the end of the second quarter. Note that starting with the first quarter of fiscal 2007, we are reporting headcount excluding temporary staff. With that in mind, headcount as of September 30, 2006 was 6,817, up from 6,736 last quarter.

Next, I would like to update you on our ongoing cost reduction initiatives. Despite the elimination of about $90 million of annualized expenses from our business model during fiscal 2006, it is clear that JDSU remains a work in progress. We believe that there are opportunities for further improvement. With the achievement of $2 million in cost savings targeted for Q1 '07, we are today increasing our cost savings targets for the remainder of fiscal 2007. Incremental activities include the exit of our Santa Barbara fab facility by the end of our fiscal Q3, reducing the cost structure of some of our San Jose productlines, and further reductions in our North America assembly cost structure. We had previously shared with you targets of $3 million for Q2 '07 and $5 million for Q3 '07 associated with actions at our Santa Rosa, Ottawa, and Rochester sites. Combined with the additional initiatives announced today, we're increasing the targets to $4 million in Q2 '07, $7 million in Q3 '07, and $8 million in Q4 '07. Operational savings will mostly be visible in our gross margin, while a smaller portion of the previously announced initiatives will impact operating expenses.

Given the cost savings initiatives and the seasonality of our communications test and measurement business, I would like to share some insights into how we think about our business model. When we look at our segments, we note that they support three different markets, optical communications, communications test and measurement, and commercial and consumer. In the near-term, we anticipate the revenue mix for these three different markets will be divided approximately 40% optical communications, 40% communications test and measurement, and 20% commercial and consumer. With this revenue mix, we are targeting our near-term non-GAAP gross margins to be slightly above or below 40%, and our operating expenses to be near the lower end of a 35% to 38% range. This suggests that our near-term operating margins as a percentage of revenue will be 2% to 5%, and our non-GAAP EBITDA will be in the 6% to 9% range. You should note that on a quarterly basis, we expect to continue to experience revenue and expense seasonality in the communications test and measurement segment, especially in our fiscal second quarter. Therefore, you should look at the 40, 40, 20 split as a rough guide for an overall annual mix. As we have seen over the last year, mix can have an impact on our overall gross margin performance in any given quarter. Finally, notwithstanding our 35% to 38% target range for operating expenses, we expect operating expenses to fluctuate around $125 million for each of the next several quarters.

Now to our financial guidance. Risks to our revenue guidance for the second quarter include; first, ongoing pauses among both our network equipment manufacturer and carrier customers associated with industry consolidation, albeit in a generally favorable environment for optical and broadband equipment. Second, the high level of in quarter book and ship business in the communications test and measurement segment. And finally, supplier delivery constraints in our optical communications business.

With these factors in mind and the fact that fiscal Q2 has historically been the strongest in the communication test measurement business to be in the range of $332 to $352 million or up 4% to 11% in the first quarter and with that I would like to invite the operator to begin the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). And gentlemen, your first question comes from the line Michael Genovese with Citigroup. Please proceed.

Michael Genovese - Citigroup

Hi, thanks a lot. Good quarter guys. So, when you talk about pause, both on the optical side and in the test and measurement side, help me understand how long -- especially, if we look at the guidance for testing and measurement, clearly there's a sequential increase -- a pretty nice sequential increase in test and measurement. Now is this -- are we still looking for the big customers to pause in the fourth quarter or -- I'm sorry -- the calendar fourth quarter, the fiscal second quarter? Or is that an ongoing problem in the second quarter, is that easing? Please help me understand that and then similarly on the optical communications side, the pause that you referenced, what is the timeframe of that pause that you are seeing going forward?

Kevin Kennedy

First, any guidance that we provide you, it tends to comprehend the impact of any one particular carrier or set of customers that might slow down. And we think we have baked it into our guidance for this quarter. I believe that for the next two or three quarters, we will see a lumpiness. Some large network equipment manufacturers will continue their buying. While if they acquired somebody, they might spend some time rationalizing the supply chain. On the carrier side, we're still awaiting certain approvals for some of the assets, and so we are seeing slowdowns in conversations. What actually happens is very dependent upon wherein the architecture you are. Test and measurement is a very turns business. If you have the right product when people need it and they have to budget, they buy it. There are other more architectural strategic products that may see less of a pause. So, I think the industry at large will be mindful of these pauses for the next three quarters. On the other hand, I am sending you a message that the overall climate is favorable. In this particular quarter, the Tier 2 customers and such were very strong. And so that is not where we are seeing any of the consolidation and the flow through of business was fine. I'm hoping that was helpful.

Michael Genovese - Citigroup

Well, let me just switch topics here and ask one more question. When you talk about the near-term, 2% to 5% operating margin guidance, is that explicit for the second quarter? I assume that is included in near term, and how many quarters are we going to be in that range before we can start to think about going higher than 5%?

David Vellequette

The near term basically covers us through the end of the fiscal year where I have talked about the cost savings initiatives that we have going on. The seasonality will obviously impact the gross margin range. And then, I think I talked about where I think the operating expenses will be. So, I will let you model how that works out as far as the operating income and Non-GAAP EBITDA.

Michael Genovese - Citigroup

Okay, thanks.

Operator

And gentleman, your next question comes from the line of John Harmon with Needham & Company, please proceed.

John Harmon - Needham & Company

Hi, good afternoon and congratulations. I would like to ask you just about a couple things. One, you said you were adding capacity, which is probably also a first in five years. Is it just tunable lasers or -- you mentioned transponders, or in other areas as well?

David Vellequette

John, we have been adding capacity in a number of our facilities for certainly in the last year. Shenzhen is one. We have a fab on the East Coast. And certainly the tunable laser is one where the assets that we bought had fairly limited capacity in Santa Barbara, and it is good that we had capacity to share here in San Jose, so the fab is basically moving up here into San Jose. So, business has been good. It turns out because of the assets that we have, the kinds of capacity decisions that are made and the people and test equipment as opposed to facilities. And, so we have been able to do it pretty quickly. Hopefully that helps.

John Harmon - Needham & Company

Thank you, and the other part of that, you mentioned some component constraints. Are those things you produce internally or purchase externally?

Kevin Kennedy

I think this is probably true for most providers of optics. It is certainly true for us. There's a fairly thin supply chain once you get beneath the component manufacturers. And anyplace that we do not have direct control over that part of the supply chain, we tend to have longer lead times or tighter supply constraints. So, it is usually in those pieces that we don't have vertically integrated that -- where there is only one or two sources, okay.

John Harmon - Needham & Company

Okay, thank you.

Operator

And gentlemen, your next comes from the line of John Anthony with Cowen and Company. Please proceed.

John Anthony - Cowen & Company

Good evening guys. I guess I just want to verify that I heard correctly. So, you are effectively guiding for the next fiscal -- the next three fiscal quarters operating -- pro forma operating margins of 2% to 5%?

David Vellequette

What we are saying is the near-term model achievement of those ranges will result in that. And that, near-term model basically covers us through the end of the year, and within any quarter it could vary. But that the near-term model what we're shooting for.

Kevin Kennedy

Let me say it in another way. At the end of the day, we are on a road and we think that the next place to achieve or to get off that road is that operating model. We think we will achieve that sometime in the next three quarters. And clearly, the more favorable to mix of test and measurement, the quicker we're going to get there. So, hopefully that helps.

John Anthony - Cowen & Company

Okay, so it is not a comment on the sustainability of it, you are just saying at some point over the next three quarters you will hit that range?

David Vellequette

It is the mix. It is probably the way we look at it. And our point was that the mix in any quarter may not hit the 40, 40, 20. Overall, we see that the business running at a 40, 40, 20 mix, and with that mix and near-term objectives that we spelled out here, we should be able to hit those ranges.

Kevin Kennedy

I will be even more specific, this is not about -- we would not be happy with that being the destination of sustainability. That is the next milestone that we have to get to. We think we will get there sometime in the next three quarters, but we certainly want to go far beyond that.

John Anthony - Cowen & Company

Okay. Also, if I just kind of look at the trend of the T&M business since you bought it, the operating margins have come down in each quarter. So, you're giving this update, which is a fairly bullish forecast of achieving this next milestone, with this backdrop of your main profit center here having deteriorating returns. So, what gives you the confidence that this is going to turn around, especially since you just said that a lot of the T&M business is book and ship?

Kevin Kennedy

It really comes down to some of the basics of the asset. Number one, we have been thrilled with the asset because the revenues have -- the way that we measure success in this one is we watch the year-over-year growth. We have had year-over-year growth numbers like going back to Q1 '06, 12%, 6%, 11%, and 21% in fiscal Q4. So, in terms of picking up share and bringing a strong asset, it has been very favorable. The part of the operating margin that has come down, number one, it has come down as revenues have come down. Number two, we actually backward integrated a number of things, one was our Ottawa components which had a lower gross margin. We shutdown that factory, so you had transition cost in it. We acquired Test-Um, so you have transition costs in that. So, we've had a number of factors that as we rationalize that asset pulls a gravity on the operating margin. So, it is really for those reasons.

John Anthony - Cowen & Company

And lastly, I apologize if you address this. But did you specify what was underneath the interest and other income that caused it to spike up, and if that is sustainable?

David Vellequette

We did the convert, as you will recall and raised slightly over $400 million. And, so we had the full quarter impact of basically the interest income from that convert.

John Anthony - Cowen & Company

Okay, thank you very much guys.

Operator

And gentleman, your next question comes from the line of Cobb Sadler with Deutsche Bank. Please proceed.

Cobb Sadler - Deutsche Bank

I had a quick question on your agile optics business. Are you breaking that out as a percentage of the overall optical segment? And then also what are you seeing -- so legacy SONET and passive components, at least legacy SONET probably has been relatively weak over the last couple of quarters. Are those components going into legacy SONET applications stabilizing, continuing to decline? How do you characterize that? And, also just a question on agile optics, roughly what percentage is that of the overall optics category?

David Vellequette

Cobb, we don't break it out specifically. I think on a prior Q&A, I had given a range that it was about 20% or 25%, and I think that is still true. But we haven't broken it out at any other level of granularity, nor do we normally do it, so. To your second question on SONET, I do not know the specific answer off the top of my head. I would say that, as I define the market as favorable, in general we haven't seen anything that has precipitously fallen. So most of our portfolio is flat with some jitter or there is some -- many of the new things, the agile products are really just taking off very well. So, I wouldn't be able to corroborate a view that there is any precipitous decline.

Cobb Sadler - Deutsche Bank

Okay great, just a follow-up on the gross margin guidance, I believe you said 40 plus or minus, is that -- it is probably tough to quantify, but I'm assuming some of that is product mix back to test and measurement being seasonally strong in Q4. And, then also you get some gains from restructuring. It sounds like those may end at the fiscal Q4. Could you confirm that that is kind of when they will -- we will stop seeing some of those? But the real question is on gross margins, ASPs, what do you see in there, overall stability or any increases and any cases? Thanks a lot.

David Vellequette

So, this is Dave. First of all, let me take it with the ASP. The ASP erosion was at the same level as we had in the prior quarter, so stability as far as ASP erosion goes. As far as margins go, again, the important part to note with those numbers was about the weighting of a 40, 40, 20 overall model, as opposed to addressing what the margin would be in a specific quarter.

Kevin Kennedy

And the last piece, Cobb as you picked up, we tried to call out in the script, under each business area what are the next two or three events or things that are going to improve our gross margins. The real messages through most of fiscal year '06, there are events that will probably, with at least a one quarter lag, hit the P&L. And so, we have -- I wouldn't call it heavy lifting, but there's a lot of work going on that will hit towards the end of fiscal Q4 of '07.

Cobb Sadler - Deutsche Bank

Okay got it. And then anything that could happen in the next two or three quarters that could push more benefits out maybe, into the '08 timeframe, or we kind of hit a sustainable level at that point, at the end of '07?

Kevin Kennedy

In either Dave's or my part of the script, we referred to what I would call execution-based initiatives, where you're managing yields for profitability -- improving yields. And that’s a long-term process which we will speak about as we have more clarity. And that’s the kind of thing which you'll see us focus on in fiscal year '08.

Cobb Sadler - Deutsche Bank

Okay thanks a lot.

Operator

And gentlemen your next question comes from the line of Ehud Gelblum with JP Morgan, please proceed.

Ehud Gelblum - JP Morgan

Thank you so much. Couple of questions if I could. Kevin, when you were talking about your 40, 40, 20 split. Today, you were at 43, 37 and 20, with the 43 being optical component. As you move to 40, 40 your Test and Measurement moves up and your optical components moves down, so that naturally they provide the natural lift to the margin. How much of the move into that 2% to 5% range of operating margin and move into the gross margin, comes from just the revenue shift of doing that, moving from 43, 37 to 40, 40 versus improvements within each of those sector -- segments for themselves?

Kevin Kennedy

Ehud, one way to attempt to answer that is maybe for me to ask Dave, if we have had a 40, 40, 20, split this quarter. Do you know what the gross margins would have been?

Ehud Gelblum - JP Morgan

That’s actually was my next question. That’s awesome.

David Vellequette

So if we -- yeah if we had a 40, 40, if you look at that, that would be about a $9 million swing. And if you think about -- but we have talked about the Comtest margins being in the mid-50s and the optical communications margins being below 30% right now. You would argue that that spread would be approximately 30 points? And so 9 million, that would be about 1 point of margin more, or $3 million.

Kevin Kennedy

It is all rounded Ehud, but I hope that gives you a sense.

Ehud Gelblum - JP Morgan

Okay I think I got that. I appreciate that. On the ROADMs and your Agile Networks, all your things that kind of play into ROADMs, for next year and going forward. We are hearing on the OEM side, that ROADMs are actually doing very well. That there will be a lot of strength in the ROADM market for next year. Can you give some commentary and some color on what you think growth for all of your tunable lasers and your Agile pieces of equipment and things that go into to ROADMs, would do next year? And I saw recently that you acquired, not the entire company of Metconnex, but it sounds like the intellectual property. There, I believe, it was a tunable lasers, or it was some component that they manufactured went into the Tellabs 7100, which is going to be deployed in a big way, Verizon next year. Does that business accrue to you because of your acquisition of what you got from Metconnex, and does that help this growth rate? How do we look at that?

Kevin Kennedy

Yeah so -- you know first thing is we have been blessed as being early Pioneers in ramping manufacture for ROADMs. We do have about 9,000 out there, which is more than anyone else on the planet. And I think we would continue to believe what other people say that tunables plus ROADMs will be rolling in the 25%, 30%, 40% year-over-year for the next several years. And so I -- we have grown probably faster than that, to get to where we are. We think the market will serve that kind of thing. But we may not believe the market is as big as some people say it is today. But at least from the growth rate perspective, we think it's up there. On the Metconnex piece, the way that you should look at that Ehud is we were focused on simply protecting our intellectual property. There was litigation out there and it ends up being terminated by a commercial arrangement, which is sometimes the fastest way to get to the results. So, there is no reason to believe that the way that we have concluded the litigation will translate to more business for JDSU. We will have to earn that.

Ehud Gelblum - JP Morgan

Okay I know only too well about intellectual property these days. But as you look towards your tunables and the ROADM business going forward, is that an appreciably higher margin business than the rest of your -- I guess, the average margin in the rest of your business? And the line that we should be really following up?

Kevin Kennedy

It would be nice to be able to say that in an umbrella fashion as you did. What I would say is that, most of the ROADM technology is a healthy, better than our norm gross margin. It is somewhat customer specific or technology specific, simply because some of the specs allow for better yields than others. On the tunable, while we are still in a ramp phase, I would say that we're not at the kinds of gross margins that we want to be. But on the other hand, we believe that the platform will get us to the higher end of a range. So, I would say as a product category, we believe both categories will get us to the higher end of our optical comes. I don't want to mislead you, tunables are not there right now, largely because we're doing a lot of work ramping. ROADMs, some are phenomenally favorable, and some we struggle with because of yield, so that is a mixed bag.

Ehud Gelblum - JP Morgan

Okay and finally, would it be too much to say that they are 10% to 15% of your optical components revenue?

Kevin Kennedy

I don't know that -- we have the category for [A&M] products, which as I said before, is probably in the 20% to 25%. Those two categories would be less than that, but I don't know the specific breakout.

Ehud Gelblum - JP Morgan

That's very helpful. Thanks so much Kevin.

Operator

(Operator Instructions). Jeff Evenson with Sanford Bernstein, please proceed.

Jeff Evenson - Sanford Bernstein

Hi one question, at the time of the Acterna acquisition, you put $55 million in escrow that expired on August 31. I was wondering what happened with the escrow account?

David Vellequette

So, right now one of the reasons we had that escrow was there was a tax situation which is disclosed in our 10-K with -- in Germany. And so right now that money is still in escrow as that tax situation gets resolved.

Jeff Evenson - Sanford Bernstein

And how do you expect it to be resolved?

David Vellequette

We will deal with the tax authorities in Germany. We are always looking for a favorable outcome.

Jeff Evenson - Sanford Bernstein

Thanks.

Operator

Your next question comes from the line of Subu Subrahmanyan of Sanders Morris, please proceed.

Subu Subrahmanyan - Sanders Morris

Thank you my question is on year-over-year growth rates in Comtest. Kevin, if you look at the $146 million or so you did in the December '05 quarter, even if December '06 was flat sequentially, flat year-over-year, I would assume all your sequential growth from quarter to quarter from September to December would all come from Comtest. So, I am wondering what you're thinking in terms of year-over-year, trends in Comtest? And also ties to optical com, or do you think optical com will be part of the sequential growth into December, or is it primarily test and measurement?

Kevin Kennedy

Yeah so as I mentioned, our book-to-bill was greater than one for the Company. As you can tell from the results for the non-Comtest portions of the Company, there was strength in -- laser 7%, optical com was 4%. That portion -- all those portions of the business are growing at a reasonable rate. I would say, it is not clear to me that we will grow off of a -- over a favorable year-over-year, number from last December. Our guidance comprehends what we exited this quarter at, which was say 116 or 117 for Comtest. And given the -- we have given you insight before that if you take the [curve] of the four quarters and compare that to the peak, we would operate in this 1.1 to 1.2 range. I think that will true again for relative to how we exited this quarter. Yeah, 1.1 to 1.3. But and I think that will -- that calculus will stay the same for this, but it may not -- it may or may not make us flat with a year-over-year growth number from last year.

Subu Subrahmanyan - Sanders Morris

Understood And just in terms of your sequential growth assumption, does it assume broad based growth across business segments or is it weighted towards Comtest for the December quarter?

Kevin Kennedy

Yeah in general, we think things are growing. So we're not trying to suggest that all the growth is in one business.

Subu Subrahmanyan - Sanders Morris

Okay thank you very much.

Operator

Ajit Pai with Thomas Weisel Partners, please proceed.

Ajit Pai - Thomas Weisel Partners

Yeah good afternoon.

Kevin Kennedy

Ajit.

Ajit Pai - Thomas Weisel Partners

Two quick questions;. The first one is just looking at your test and measurement segment and the ERP installation that was happening there. I think you flipped the switch at the beginning of the last quarter. Hence most of the expense associated with that is already out in the September quarter, were there any hiccups over there? And also like the linearity you talked about within the September quarter and the strength going into October, do you see that continuing even now? And could you give us some colors there?

Kevin Kennedy

Yeah let me take the first one. I will let Dave handle the second one. We flipped the switch on Oracle beginning in August. As you might guess there's a lot of expense that you'll incur well before that time. Even after you close the books and you basically have a successful implementation, there are changes, bugs to fix. And, of course, once we get that team closed, we will be moving on to other Comtest assets such as the UK, Germany and so forth. There should be no inference that because we have successfully put on Oracle or our North American Comcast team, that there will be a precipitous decline in our cost structure. That was your question. Dave, you want --?.

David Vellequette

Yeah one thing I want to clarify is that actually -- I will say flip the switch at the beginning of the September month. So as we close September that was the first month that we closed the North America books for Comtest on Oracle. But everything else, Kevin said is correct. You asked about linearity Ajit. Our linearity is such we're working diligently to improve linearity for the Company, but the Comtest, the customers tend to order and expect delivery in a very short lead-time. So the -- it does tend to be a back end -- quarter end loaded business. And we typically enter a quarter with about less than 50% of the quarter's revenue covered.

Ajit Pai - Thomas Weisel Partners

Right when you look at the 5.8% operating margin in the Comtest business, and you look at December quarter of last year, 18%, when you look at that sort of 1,200 basis point delta there, how much of that is just volumes and how much of that is some of these onetime expenses, and those related to the ERP, etc.? And of those onetime expenses, are most of those in the all other category, or are most of those impacting the, within these segment operating income -- operating expenses?

David Vellequette

The Comtest segment hasn't had actually a lot of onetime expenses. What they do have is a highly variable selling cost structure. So for example, as they sale to rep firms in the way we leverage their sales force, when they have a low revenue period, their operating expenses tend to be lower. And when they have a high revenue quarter their operating expenses tend to go up. And that increase could be between 6% and 10% of the increase in the revenue. Just to give you a sense of how leveraged that is. So, we didn't see the one timers and so obviously that well, with their margins being more favorable than the other groups, a high revenue quarter for them, has a good trickle-down effect.

Kevin Kennedy

I would say internally we view the business, when we annualize it over the course of a year to be a double-digit operating contribution business.

Ajit Pai - Thomas Weisel Partners

Right and the last question regarding the sort of same Comtest business and maybe there might be a spillover into the communications product business as well. But broadly when you have been looking at the market recently in terms of your peer results, you're looking at the international business growing much more rapidly, relative to the domestic business because of the [career] consolidation. Could you give a some color as to what the relative growth rates over there might be domestic versus international?

Kevin Kennedy

I don't know that I could corroborate that. I would say that broadband build outs have been extraordinarily aggressive as AT&T, SPC, and others are driving. So we have seen a very healthy environment in general in North America. I would say we see quarters where Europe might give us a pop or Asia might give us a pop, but I probably would not characterize the general market as one of non-North America growth, North America slow. That would not be my characterization.

Ajit Pai - Thomas Weisel Partners

Okay thank you so much.

Operator

The final question of the day comes from Arnab Chanda with Lehman Brothers, please proceed.

J.J. Flores - Lehman Brothers

Hi good afternoon guys this is J.J. Flores calling for Arnab Chanda. I have a question about your test and measurement business. With respect to that, do you guys continue to see that as a strategic business unit, or are there any considerations that you'll ever monetize that financially?

Kevin Kennedy

No as I mentioned earlier, we're thrilled with it. As I look at the four trailing quarters, it has registered year-over-year growth numbers, that were superb, and we are integrating it very well right now. So, no intent to monetize it, other than to make it, as a productive asset as possible.

J.J. Flores - Lehman Brothers

Okay and just last question. With respect to your optical business, can you just talk about your utilization rates in the factories?

Kevin Kennedy

Probably a year or two ago, I would have made the statement that the industry at-large and JDS probably on the high end of it, was operating in utilization rates between 10% and 30%. I would say the industry at-large is probably up in the 25% to 50%. We're probably a bit higher than that. And the difference is where we have assembly plants we're probably at the highest utilizations and offloading that with some CMs, so we can be selective about what we put in our plants. And the lower end, which is close to that 40% or 50% is probably in our fabs. So, significantly better situation for optics in general and JDSU more specifically.

J.J. Flores - Lehman Brothers

Okay thanks a lot, guys, and congratulations.

Operator

Ladies and gentlemen, that does conclude the time that we have for questions and answers today. Thank you for your participation in today's conference. This does conclude today's call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: JDS Uniphase F1Q07 (Qtr End 9/30/06) Earnings Call Transcript
This Transcript
All Transcripts