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Darkness before dawn for JDS, Agere

The latest news from JDS Uniphase and Agere Systems offers further proof that the current business climate is lousy--and could get worse before it gets better.

The latest news from network component giants JDS Uniphase and Agere Systems offers further proof that the current business climate is lousy--and could get worse before it gets better.

Component makers JDS and Agere greeted investors Tuesday morning with news of lower-than-expected earnings, plans to lay off a significant number of employees, and even limited information on when their businesses might pick up.

Yet some analysts think that the worst will be over in the second quarter of this year, and the industry will soon see healthier demand.

"There's no uptick in demand yet, and we think the worst of times will be in the June quarter," said Jim Jungjohann, an analyst at CIBC World Markets.

JDS announced earnings that were largely in line with analysts' expectations but cautioned investors that the company will miss current earnings and sales forecasts for its fiscal fourth quarter ending in June.

JDS reported earnings of 14 cents a share on revenue of $925 million, excluding charges, for the fiscal second quarter. But the components giant expects earnings of 5 cents a share on sales of $700 million for the fiscal fourth quarter, also excluding charges. According to First Call, analysts were expecting earnings of 12 cents a share on sales of $925 million.

Despite the brutal period ahead, analyst Jim Liang at WR Hambrecht recently raised his rating on JDS to a "strong buy" this month. "We think we're near the bottom," Liang said.

While acknowledging that the June quarter will shellac components makers, Liang notes that equipment maker Nortel Networks indicated during its earnings call last week that it made significant progress toward shaving down its component inventory in the first quarter and expects further decline in the second quarter. Nortel is one of JDS' largest customers and one of the biggest consumers of components in the networking business.

Nortel cut $200 million off its inventory during the quarter, which now stands at $4.17 billion. Reduction in the second quarter will be much more, said Nortel Chief Financial Officer Frank Dunn. "You will see going forward across the board improvement...it's not going to be another $200 million," he said. A year ago, Nortel inventory stood at $3.63 billion.

Telecommunications equipment maker Cisco Systems told investors last week that it will write off about $2.5 billion worth of inventory.

Executives at JDS Uniphase also expressed confidence that excess inventory at its customers could be worked through as soon as June.

Agere slow out of the gate
Agere Systems also reported lackluster earnings for its second fiscal quarter ending March 31. Revenue increased to $1.2 billion from the $1.1 billion reported in the same quarter last year, but down from the previous quarter's $1.4 billion. Pro forma earnings came in at zero cents per share, down from 5 cents a year ago, and 6 cents in the previous quarter.

Agere expects revenue for the third fiscal quarter in a range between $950 million and $1.03 billion and a pro forma net loss between 6 cents and 8 cents a share.

Jungjohann also agrees that components makers could see a rebound, and he thinks that Agere might be the first in the group because most of its products are "active" components as opposed to the "passive" components that JDS mostly makes.

A simple distinction between the two is active components, such as lasers, are products that must be plugged in to function, while passive components, like light filters, do not need a power supply to work.

Jungjohann and CIBC analyst Rick Schafer point out that active components generally help telecommunications service carriers 'light up' unused fiber already laid in the ground, which is a way for carriers to cheaply add capacity to their networks.

But there is a downside to a pick-up in demand. Jungjohann and Arnad Chanda at Lehman Brothers think that component makers could be forced to cut prices in the future as equipment makers start buying again.

Chanda says components makers already face reduced margins because of demand and inventory issues, and price pressure will continue to snip at margins.

"What's going on in the space right now is a demand as well as inventory correction, and the next level will be margin reductions driven by pricing pressure," he said.