Viavi Solutions Inc (VIAV) 2004 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the first quarter fiscal year 2004 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct the question and answer session.

I would now like to turn the call over to Mr. Ronald C. Foster, Executive Vice President and Chief Financial Officer. Mr. Foster, you may begin.

Thank you. Welcome to the call. I am Ron Foster, CFO of JDS Uniphase, and I’m here with Kevin Kennedy, who joins us for the first time as our CEO. On this call, we will report our first quarter results and provide guidance for the second quarter of our fiscal year 2004. Kevin will provide an update on the leadership transition, as well as an overview of our business and the general market. I will provide further details on our operations, along with a review of our financials and guidance.

But first we would like to advise you that our report and the discussions we will have today include forward-looking statements. Forward-looking statements include all statements we make, other than those dealing specifically with historical matters. Our forward-looking statements include any information or projections we provide on future economic conditions, industry trends, business operations, and financial guidance.

All forward-looking statements mentioned are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Some, but not all, of these risks and uncertainties are discussed from time to time in the press releases and securities filings of the company with the SEC, particularly the risk factor section of our form 10-K filed for the year ended June 30, 2003. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

I would like to also indicate that this call is being recorded and will be available for replay from the investor portion of our website, www.jdsu.com. Our discussion today will include non-GAAP measures. A detailed reconciliation of these non-GAAP measures to our GAAP results, as well as a discussion of the usefulness and limitations of these non-GAAP measures is included in the news release announcing our first quarter results issued earlier today. This news release is available on the website www.jdsu.com.

With that, I would like to introduce Kevin Kennedy.

Thank you, Ron. I’m pleased to be here today for my first conference call as CEO. As most of you know, I’ve served on the board for two years, and I’m very focused on a successful transition with JDS Uniphase in this new role. For this first call, I’d like to spend my time discussing the transition, the status of our business and an overview of the market, and some initial thoughts on strategy and company priorities going forward.

Before getting into the specifics, I would like to emphasize that this transition is reflective of a series of deliberate choices intended to ensure the success of JDS Uniphase as a leader in the industry with a customer-driven focus on operations excellence and profitability.

Now, about the transition. The leadership transition is proceeding strongly. As you will recall, the transition began with Jozef’s desire to retire from the CEO role, and the belief by the Board that it was imperative to be well-positioned for a stabilizing market and an eye toward the long term. As such, the transition brought immediate deliberate choices around organizational clarity and a focus on fundamentals; specifically, establishing one independent chairman of the board, Marty Kaplan; one leader as CEO, and one headquarters location; San Jose, California. Based upon our rapid progress on the transition, Syrus Madavi decided to leave the company on October 17th after tremendous contribution over the past 15 months. Jozef continues as a close advisor to me.

During my first few weeks in the CEO role, I have focused my attention on performing a preliminary evaluation of the company and the business. As such, I’ve been fortunate in being able to visit over 13 sites, a half a dozen customers, and have had frequent meetings with members of our senior management team. While more assessment will be done in the upcoming weeks with additional facilities, customers and other stakeholders, the preliminary synopsis is clear. Our customers see us maturing and desire our continued success. We must continue to improve our execution and focus on profitability. Our team is comprised of an extraordinary set of resilient and bright contributors, and we must continue to align the team around common goals and the merging customer-driven strategies.

As a result of the discussions that occurred, we have already identified and made a number of additional deliberate choices consistent with future strategic priorities of the company. First, to further align ourselves with our customers, we will compensate employees for improved customer satisfaction and product quality. This program will be fully developed over the next quarter.

Second, to further align ourselves with our investors, we have plans to restructure our compensation program with pay-for-performance objectives in customer satisfaction measures. Third, to focus on profitability, cash preservation and cash accumulation, assets no longer consistent with the current size and direction of our company will be jettisoned. In this regard, we have already disposed of the corporate plane and specific unused real estate properties. I expect significant developments on these programs during the current quarter and will provide an update on our next call.

Now from a market perspective, we believe we are fortunate to participate in the convergence of two major trends. The telecom market was built around a century of cost-effectively distributing constrained bandwidth or narrow band. Now, however, we are seeing a deliberate march to unconstrained bandwidth or broadband in communications spanning business, entertainment, government and education. We believe this trend will strongly drive the demand for telecom at datacom rates.

Second, while the last century was dominated by voice communications, we believe this century will be a century dominated by visual communications and experiences. Broadband will provide this, enriching the user experience by adding visual elements. The concept of enriching the user experience to visual elements also accurately applies to our non-communication business, particularly in the areas of display and decorative applications. This results in more effective communications, more productive business processes, and more compelling entertainment.

On the communications front, cell phones with picture messaging capability and the broadband music and video downloads, online gaming, virtual reality and other applications all drive the need for more bandwidth, bringing large data payloads to the user. Both of these trends relate to larger payloads, increased bandwidth, new infrastructure from core to the edge to the home to the user, and are served by the compons, devices, codings and technologies of JDS Uniphase.

Hence, we believe that JDS Uniphase is well-positioned with tremendously talented people, a strong product and technology portfolio, an acumen in applying the science of light to communications and visual experience, a substantial cash position, and a customer base that will help to drive us toward the future. [Technical difficulty] overall remains in a state of transition with customer concentration and stabilization bringing focus and pricing compression. We believe our non-communications business continues to be strong, albeit amid product portfolio transitions. While transitions will bring top line variability, we believe the resultant diversity of this business is essential to the success of JDS Uniphase.

Our communications businesses continue to execute in an environment where unit volumes are increasing. On one hand, these volume trends are excellent news and an indication of the stabilization of the industry. On the other hand, average selling price compression continues, resulting in continuing revenue and gross margin tensions. Moreover, as we continue our restructuring efforts, which involve product line transfers and associated customer qualifications, timing risks, a focus on lead time improvement and overall execution should provide opportunities to capture more revenue.

In general, our customer satisfaction continues to improve. We have instituted and are now accelerating an organized customer satisfaction survey process whereby we measure ongoing customer satisfaction in the areas of technology, response, delivery, price and relationship. Our first survey was recently completed, and we were generally satisfied with the results. This provides us with a baseline going forward, allows us to set targets, establish champions to drive improvement in each focus area, and finally, establish regular progress reports, which we will offer some insight into next quarter. These metrics, although specific to our communications business, will also be extended across our entire business.

Also, on a customer satisfaction note, we recently received recognition from Sun for leading performance and value, one of 16 vendors recognized. On the [Design One] front, a leading indicator of long-term market share, our quarterly metrics showed growth this quarter, roughly a 50% increase quarter over quarter. From a strategy perspective, first and foremost, we believe we will execute our way to profitability. Specifically, we anticipate near term improvements and top line will be driven predominantly by our operational execution as opposed to changes in market condition.

We have had success to date in two principal strategic areas; first, driving a verticalization of our communications business from compons to modules to customer-driven delivery of circuit packs and network-ready products. And, second, driving more design wins in horizontal products, such as datacom, for example, GIG-E and fiber channel. An example illustrating the strategy is our recent circuit pack wins. We have had 14 circuit pack wins among our top 10 customers. Most recently, we received multiple awards for different designs by Ciena. We believe these wins demonstrate our ability to develop applied integration skills and technologies to serve customer-driven, optically-rich subsystem projects.

Finally, we believe fiber to the home is an opportunity for the industry. We have compons to play in several levels, and will continue to stalk this opportunity, recognizing it is a potential fiscal year ’05 and ’06 impact.

Before I turn it over to Ron, I would like to say a few words on our global realignment program. Our restructuring efforts to date have fallen under the company’s global realignment program, which focused on impressive rationalization, integration, and resizing the company to market reality.

As has been discussed on past calls, the activities under the global realignment program are expected to be completed by the end of this calendar year. Going forward, while we will no doubt incur additional expenses as we continue to improve our cost structure, these expenses will be associated with overt decisions in furtherance of customer-driven productivity improvements. I will report details during the next call.

From a financial focus, Ron will now provide thoughts on results and guidance. A key point here is that our team will remain committed to delivering the expectations of the annual operating plan. As you would expect, the team’s efforts will be intense to remove any risks to the plan, as well as seeking mechanisms for improvement. I personally have more work to do to understand these envelopes. We will also maintain an intensity around cash preservation and accumulation, as indicated by choices such as the sale of the company aircraft.

In summary, let me conclude that we are making deliberate choices around improving our customer-driven execution and maturing our operational and investor alignment. We will focus on people and execution in the near term, as we stabilize and improve our participation in the market.

Ron?

Thanks, Kevin. Before I get to the numbers for the quarter, let me begin with an overview of both the positive areas and areas for improvement this quarter. Under positives, from my perspective and the view of most others at the company, the transition from Jozef and Syrus to Kevin has been very smooth.

Second, we were within our guidance in both revenue and EPS during the quarter, and our communications book-to-bill ratio during the quarter was above 1 for the second quarter in succession. The mix of our international revenues has increased. Operating expenses continued to decline, our non-GAAP EBITDA loss saw an improvement from $25m loss to a $19m loss in Q1 on lower revenues.

Our cost structure declined associated with head count reductions of approximately 300 employees during the quarter. For the communications segment, including the circuit pack award that Kevin referred to, we experienced design win growth in each business unit, and we made significant progress in simplifying our organization, shedding excess, and liquidating assets.

Areas for improvement are we experienced continued near term fragility in our markets, both in communications and non-communications. There’s a need to improve our [DAYS AR] outstanding, and we need to improve cash burn and asset management, and the focus on improving our gross margins in an environment of continuing price pressures.

I will now review the key financial numbers for the quarter, beginning with the income statement. I will then discuss the balance sheet, and finally, guidance for the coming quarter. I will be commenting primarily on our non-GAAP presentation of financial results.

Revenues of 147m in the quarter were within our guidance of 145 to 155. Our communications products segment represented 74m in revenues, or 50% of the total. Revenue in this segment was down one million sequentially. Bear in mind the 4th quarter’s revenue number included 6m in cancellation revenue. This quarter had no cancellation revenue.

To offer further insight into our revenue, our communications products segment is currently broken down into three business units. Components includes high-powered lasers, wave guides, transmission components and passive components. Transmission includes telecom and datacom modules, cable TV and specialty products; and subsystems includes instrumentation, network-ready products, amplifiers, and card level products.

In our components group, we experienced some higher activity this quarter associated with long haul. There was an increase resulting from customer inventory draw-downs. However, it’s too early to call this a trend. In a couple of these component areas where we have undergone product transfers, we’ve had some challenges in meeting demand. For our transmission group within datacom, revenue has been relatively stable, with volume levels actually increasing, but tempered by ASP declines. And for our transmission group’s telecom product lines, we continue to win many of the available deals and design wins and see long-term growth opportunities for this segment.

Within our subsystem product group, as Kevin mentioned, we are pleased with circuit pack activity, particularly with the recent design wins we have seen. Note it will be several quarters before these wins translate to revenues. We have seen a quick return on our [Ditech] acquisition, as evidenced by good demand for the amp network-ready products and circuit pack design wins leveraged by the acquisition. We are seeing stronger demand for both optical amplifiers and advanced modules.

Product innovation in the three communication groups included; our components group has been working to reduce component size, a key design feature for our customers. The new micro receiver that is now shipping is about the size of a thumbnail, about 60% smaller than the previous model. And our next generation design now in the alpha stage is, again, 50% smaller. Our instrumentation unit, which falls under the subsystem products group, announced new products within its multiple application platform and Swept Wavelength system product lines. The added capabilities help customers meet the more complicated multifunction tests and measurement requirements resulting from the trend toward higher levels of integration and complexity.

Within Datacom, we announced a 10-gigabit XFP, and also extended our fiber channel and gigabit Ethernet datacom transceiver lines. The products break new ground in important areas for high-speed LAN and SAN applications. We’re also leveraging our small form factor XFP into telecom applications, including sonic, and are sampling with customers now.

Our Thin Film products segment, or our non-communications businesses, accounted for 73m in revenues, or 50% of the total. Revenues in this segment showed a 14% decrease from last quarter, as was expected, and is due to declines in our display and document authentication businesses. This segment is currently broken down into three business units; coded optics, that’s products which include optical components and front surface mirrors for display; optical filters for medical instruments and infrared filters, beam splitters, and optical sensors for aerospace, and light-interference pigments for color-shifting characteristics used in security products and decorative surface treatments.

Our currency authentication, for example, resides in this group. And the third is commercial lasers, which includes solid state gas, fiber and diode lasers used in biotechnology, biohazard detection, graphics, semi-conductor, and materials processing.

Priorities for this segment are to reduce costs and focus resources on the greatest opportunities, while reducing resources working on legacy low-margin, slow-growth businesses. We are seeing both encouraging signs, as well as areas of softness in these businesses. Within coded optics, our display business saw the launch of both DLP-based and LCOST-based light engines. These products demonstrated leading-edge performance for rear projection micro-display television applications. Component revenues in the rear projection micro-display television segments remains promising in light of increased volume forecasts from OEM television manufacturers.

Within light-interference pigments, we have yet to see any real tangible macro economic growth drivers appear. In document authentication, the release of the new $20 U.S. bill and the government’s $54m ad campaign highlights our optical variable pigment authentication technology as one of the key features in the redesign. High market penetration and the consolidation of national currency such as the Euro have resulted in fewer redesign and reprints. Future growth in this segment is expected to come from the application of this technology to the protection of other valued documents, such as passports and I.D. cards.

In product authentication, in light of the success our technologies had in currency applications, many of the major pharmaceutical companies continued to adopt and show interest in JDS Uniphase’s Secure Shift product line. Secure Shift is now protecting seven drug brands from six of the top 20 pharmaceutical companies worldwide, and we believe this represents great potential, considering the increasing needs and interest in this application.

We believe we are making good inroads in the adoption of JDS Uniphase’s products to protect against pharmaceutical counterfeiting. Protection of pharmaceuticals is also become a significant concern for the U.S. government, as highlighted in the FDA’s interim report on drug counterfeiting issued in October 2003, recommending the use of overt authentication technologies, and the House Medicare Bill HR2427 requiring the use of these technologies on the packaging on imported pharmaceuticals.

We are seeing continued cyclical weakness in our decorative pigment markets, which is dependent on a strong general economic recovery. However, encouraging opportunities are starting to be identified for applications in the 6- to 12-month time frame. As an example, at the SEMA show in Las Vegas, three new vehicles from Ford, Chrysler and Dodge will be shown, introducing SpectraFlare as a decorative paint option. A second example includes project approval from a major retailer with regard to the launch of a line of consumer electronics featuring ChromaFlare finishes projected for an Easter 2004 launch.

For our commercial laser products, we continue to leverage technical capability, market position and low cost manufacturing capabilities to drive business. Revenues appear to have stabilized, with modest growth projected in Q2. All industry indicators are up in the semi-conductor front-end market, which we serve with laser inspection devices and fiber laser marking systems. Interesting developments in new low cost, high-speed DNA sequencing instruments, 3-D laser scanning applications, and fiber laser soldering, welding and marking applications represent promising new opportunities for the company’s solid state laser technologies at chip, module and system levels.

Now by geographic region, revenues for the quarter were 66% from North America, 18% from Europe, and 16% from Asia. This represents a 4% increase in our international revenue. Expansion of our international markets represents a significant growth opportunity for the company. Our book-to-bill ratio was one in total, and was above one for our communications group for the second consecutive quarter.

Now the gross margin. Non-GAAP gross margin was 22% in the first quarter, better than our guidance of 19 to 21%. Although it declined from 25% in the fourth quarter, as you may recall, the higher gross margin in the fourth quarter reflected in part the benefit of cancellation revenue and net inventory recoveries. Net inventory recovery in the first quarter, which is the difference between inventory write-offs and recovery of previously written-off inventory, was a net benefit of $7m. Adjusted for these same items, gross margin in Q4 and Q1 was 20% and 18% respectively.

Total gross margin for the company was adversely affected by two percentage points as a result of the mix shift between the communications and non-communications segments. Lower volumes and continuing ASP declines, in addition to the business mix shift, were partially offset by our cost reductions in the quarter.

The communications business segment has continued to experience sequential, increasingly positive gross margins. As Kevin mentioned, price declines are standard fare for our industry, yet we have experienced improvements in gross margin through our aggressive cost-reduction activities. Our gross margin is impacted by five main factors; average selling prices, industry consolidation, volumes and [indecipherable], supply management activities, and cost reductions. We have more leverage and a more direct impact on some of these areas than others. We need to witness more industry exits and consolidations and see that translate into a further slowing in the rate of average selling price declines.

In the meantime, we are pursuing and are accelerating our path to improvements and various supply chain management initiatives and cost reduction activities. And while volumes in many areas are beginning to increase, plant utilization levels overall still show much room for progress. These are the five basic fundamentals we are chasing in improving gross margin. While there is an organized focus around these concepts and much progress has been made, there remains significant opportunities to achieve the ideal outcomes for each.

Now to global realignment. With regard to the restructuring activities implemented under the global realignment program, we continue to run on plan, both for the expected cost of the program, which remains at approximately $1.2b, as well as the annual savings the company expects to realize going forward, which remains at approximately 1.3b.

In the first quarter, the impact of our recorded restructuring and other charges under the program on our income statement was effectively zero. Total program costs to date under the program remain at about 1.2b. We anticipate that the bulk of the remaining costs of this program, about 20m, will be incurred through the remainder of fiscal 2004.

On a cash basis, we spent $19m in our first quarter under the global realignment program, bringing the total outlay so far to approximately $300m. We anticipate additional cash outlays of about $120m in future quarters, the majority of which will be paid in settlement of various obligations associated with abandoned and phased out facilities. Included in the cost of the global realignment program are primarily charges for employee severance, lease costs, accelerated depreciation, write-down of restructured assets, and moving and employee costs related to the phasing out of certain facilities and equipment.

We expect the restructuring activities associated with a global realignment program to be largely completed by December 2003, as Kevin mentioned. As we transition from a set program of restructuring toward ongoing customer-driven productivity improvements, we will undoubtedly continue to see significant opportunities to further reduce costs as we align our resources toward building a stronger customer intimacy model. While we will likely continue to incur further expenses related to these actions, they will be viewed as a normal course of business in pursuing our strategic priorities of profitability, operational excellence, and customer satisfaction. As Kevin mentioned, we will have more detailed information for you on this next quarter.

Now to operating expenses. Our total non-GAAP operating expenses were $62m, or 42% of revenues for the quarter, an improvement of 13m, or 5 points sequentially. Non-GAAP R&D expenses were 24m, or 16% of revenues for the quarter, a $7m improvement from the fourth quarter, as we had projected last quarter. Non-GAAP SG&A expenses for the first quarter dropped 6m to 38m. On the income loss side, non-GAAP operating loss for the quarter improved 29m in the first quarter from a $34m loss in the fourth quarter despite a $13m revenue decline. The non-GAAP segment loss for the communications business narrowed from 15m to 13m, while non-GAAP segment income for Thin Film products group dropped from 11m to 9m on lower revenue.

Interest and other net income was approximately $3m for the quarter, down sequentially due primarily to reduced interest income and increases in other expenses. The GAAP net loss for the quarter was 28m, or 2 cents per share, and the non-GAAP loss was 14m or 1 cent per share, coming in a little better than our guidance 2 to 3 cents due to a favorable tax credit on unrealized gains of marketable equity securities. As described last quarter, when we incurred a similar gain, we are likely to see tax credits or expenses as the value of our marketable equities securities rises or falls or are liquidated.

Now the balance sheet. Our balance of cash and marketable securities at the end of the quarter was $1b, 160m, of which $1b, 52m was cash, money market and other highly liquid income securities. Our cash and marketable securities declined 74m during the quarter. The company used $77m in cash for operations in the first quarter, including 19m cash used by the global realignment program. The other notable impact on operating cash was accounts payable and other liability balances, which declined during the quarter, resulting in the use of working capital of approximately $46m. These reductions are due in part to reduced inventory levels and the timing of other payments and settlements.

DSO increased to 65 days for the quarter compared to 55 in the prior quarter, contributing to a decline in working capital of approximately $8m. This increase in DSO was primarily due to fluctuations in the linearity of shipments between quarters and reductions in AR reserve requirements. Notably, during the quarter we experienced a reduction in past due receivables. Net inventory decreased $10m in the quarter to $74m, reflecting continued improvement in our inventory balances.

Capital spending was 49m in the quarter, 45m of which was related to the buyout of a synthetic lease for two of our U.S.-based properties. Additionally, we realized $18m from the sale of our facility in Taiwan. During the quarter we recorded a $5m reduction in the value of long live assets in accordance with FAS-144. We currently have $15m in assets held for sale that are included in other current assets on the balance sheet. In addition, the company completed a review to determine if impairment indicators existed relating to its other long live assets for the quarter. The company determined that there were no impairment indicators, therefore, no impairment review was required under FAS-144. Lastly, employment dropped by 300 in the quarter, to about 5,200 people.

Now to guidance for the second quarter of fiscal 2004. Net revenues are projected to be in the $140- to $150m range. Going forward, as the business stabilizes, we expect the effect of cancellation revenue and deferred revenue in our reported revenue to decline. In line with this, we expect revenue, net of cancellation and deferrals to increase in Q2.

Non-GAAP gross margin is expected to be in the 19 to 21% range of total net revenues. We expect operating expenses to decline sequentially. We expect non-GAAP net loss will be in the range of 2 to 3 cents per share. As a reminder, our non-GAAP projections exclude global realignment program charges, as well as other acquisition and impairment-related expenses such as amortization of purchased intangibles, reductions to goodwill, and long live assets, stock-based compensation expense, and gains and losses on investments.

The company continues on a path to deliver a cost structure that would enable non-GAAP EBITDA break even at a revenue threshold of $200m in Q2 fiscal year ’04, and 170m in Q4 fiscal year ’04. Note at the Q1 fiscal year ’04 level of 147m, our non-GAAP EBITDA loss has been reduced to $19m. As a reminder, these break-even forecasts represent a projection of our anticipated cost structure and are not a prediction of future revenue levels. We are expressly not providing any revenue guidance beyond the second quarter.

Cash flow is a priority focus, and our objective is to reach operating cash flow break-even as soon as possible. We now anticipate having capital expenditures for fiscal year ’04 in the $80m range, including the synthetic lease buyout in this first quarter. Cash used for global realignment should be about 55 to 75m. In addition, we plan to dispose of our remaining assets held for sale during fiscal year 2004. As Kevin mentioned, our corporate plane has been sold in the current quarter, that is the second quarter, for $11m.

To summarize our position, looking forward, our top priorities are; customer intimacy, lead time improvements and product quality. A break-even and return to profitability as soon as possible, third, revenue stabilization, cash preservation and accumulation, gross margin improvement, and R&D productivity.

Now we will open the call for questions. In order to allow us to respond to as many questions as possible, we will ask that you limit yourself to a single, one-part question. Time permitting, we will come back around for subsequent questions. Operator, we will take questions now.

Thank you. We will now begin the question and answer session. If you have a question, you will need to press * 1 on your touchtone phone. You will hear an announcement that you have been placed in queue. If your question has been answered and you wish to be removed from the queue, please press the # sign. Your questions will be taken in the order that they are received. If you are using a speaker phone, please pick up the handset before pressing the numbers. Once again, if there are any questions, please press * 1 on your touchtone phone. One moment, please.

We have Jim Jungjohann, from CIBC World Markets, online with a question. Please go ahead.

Thanks, guys. Question for Ron. [Inaudible] a little bit ahead of that. This quarter, if you backed out that cancellation from last quarter, it looks like it was up. But I guess the big questions is on non-telecom. You look at those three subgroups, one of them you’re guiding up the industrial lasers. What is going on, then, in the display and in the pigment side? Are these just cyclically down? TI actually reported growth in their DLP business this quarter, so kind of how are we supposed to look at these businesses in the end market? Is pigments just slowly declining, or is there any growth in these other two subsegments?

Jim, to answer your question, first of all the commercial lasers business is the smaller piece of the three. If you look at our decorative business, our optical coatings, we’ve seen some continuing weakness related to general market movement, and we see, as I mentioned, that that will generally move with market recovery. We aren’t seeing significant declines there, but we’re not seeing growth there, either. And on the display business, we see significant opportunities going forward, not only with our component side, but also with our new light offerings, which are being looked at by a number of potential customers. So we see potential there, but net/net when you put that altogether, the business has been running after the decline from Q4 to Q1. We see a fairly level movement from Q1 to Q2.

Jim, let me build on that. I think the best way to frame it is you have three businesses that had a set of well-defined revenue streams. All of them are in a state of incubation of new applications, meaning there are deterministic trials underway for new pigment applications and to different industries. We have a transition in our laser program from argon lasers to new applications. We have a light engine product that is being incubated into a new set of launches.

And so the challenge we have is how quickly will the equipment providers that are in those new applications actually launch their products? When will the trial end and when will we get to real volume production? The good news is that the trials are deterministic. The good news is the internal forecasts have a positive trajectory over time, but no way in the near term to begin to count on revenue next quarter from that transition.

I know you want to keep this short, but any way to quantify the ramp in the circuit pack business? It sounds like it’s obviously a growth area, but one that got hit. Any way to quantify it?

My take, Jim, is that we don’t anticipate a significant amount of revenue contribution in either fiscal Q2 or fiscal Q3, but we will probably see some significance after that.

Significant, meaning maybe incremental 10% of the business or?

Measured in millions of dollars.

Okay. All right. Thanks, guys.

Our next question comes from Stephen Koffler, from Wachovia Securities.

Please go ahead.

Kevin, I’d like to try to get a little more color or point of view on the end markets in communications. As you probably noticed, the data coming out of the public reports in the space is actually quite good on trends in the summer and Q3 if you look at the big OEMs and also Corning’s fiber business.

So if, in light of that, and I know the desire to be conservative, if you could talk about three – or slice communications into three businesses; long haul, metro and enterprise uses of optical, and give us reasons why you think either each business could continue to show growth for the industry and hopefully for JDS as well, or why you might be conservative even in light of recent trends.

Sure. Let me take the macro view that in general cross communications volumetrically, we are seeing positive signs. So things are feeling pretty good in terms of the unit volumes almost in all three areas that you enumerated. In the case of enterprise, for example, we probably have seen double-digit growth in terms of unit volumes. The challenge that Ron enumerated was that particular area has had one of the most dramatic tensions in terms of pricing compression.

So the fundamental aspect that you’re probing, is why be conservative, is that there is uncertainty with how to balance the [technical difficulty] uptake with the ASP compression that’s happening more generally. Let me give you another example in terms of some of our passive components. We’ve seen as much as – it’s high, double-digit, quarter-on-quarter growth on a fairly large basis, so that’s great, but there’s also pricing compression and other pieces.

So I’d say this particular quarter, we saw activity in long haul that we didn’t necessarily anticipate or we feel good about. We are diversifying our participation in metro and we continue to see metro as a growth area, both as a market in general, and for JDS more specifically, and enterprise we are enjoying from a utilization standpoint, high uptake volumetrically, but we are being cautious relative to pricing compression. Okay?

Yeah, that’s great. Ron, could you just quickly contrast linearity of shipments in communications versus film areas.

We have fairly good linearity in both businesses, and there’s not a lot of disparity. We have a longer production cycle in some of our Thin Film areas, and so we have a longer bookings profile. But in terms of shipment linearity, it’s fairly consistent and fairly level.

Good. Thanks.

Our next question comes from [Arindum Bastu], from Morgan Stanley.

Please go ahead.

Hi, gentlemen, how are you?

Doing well.

I have a quick question on the enterprise and fiber scan Ethernet products. Is that still bigger than cable TV applications, or is there any change to that based on discussions or information you’ve had from your MSO partners?

So Arindum, you’re asking for a comparison of enterprise and fiber channel convertible cable TV volumes?

Yeah, for you guys.

Well, we don’t report and break down precisely at that level. We’re seeing reasonably good business levels in all three. I would say that our enterprise and fiber channel business are bigger somewhat than our cable business, just to give you rough order of magnitude on that.

Are any changes sequentially or that you can see into the next quarter?

We haven’t specifically called out any notable changes from the macro-assessment I gave you.

Okay. Thanks very much.

Our next question comes from Ping Xao, from Credit Suisse. Please go ahead.

Hi. How are you?

Hi, Ping. We’re doing well.

A few questions. The first one is the pricing trend. You did mention the datacom, the pricing is compressed. What about the long haul and the cable TV?

As Kevin mentioned, and I did as well, we’re seeing pricing pressure in all areas. In certainly all those categories you mentioned, we see some pricing compression. Datacom is probably a little bit more extreme than the others.

Okay. Second question, I just want to make sure that I understand correctly. There is a $7m benefit from selling off the previously [indecipherable] amounts of inventory in the quarter. Is that correct?

Yes. That is a net benefit of the – the net of excess inventory that we’ve written off in the quarter netted against recovered, previously written off inventory. We had a net benefit of $7m. We’ve been reporting that net number for several quarters now, and it’s been a net benefit for several quarters.

Okay. The final question is that there’s no cancellation fees this quarter, but you did mention a deferred revenue.

My comment there at the end in terms of guidance was if you look at the general flow of business orders and shipments and revenue, a net of deferrals that flow in and out, we are seeing – we’re expecting to see growth from Q1 to Q2, net of cancellations and the movements in and out of deferred revenue.

How big is the deferred revenue in general?

Well, it’s not as large as a software company, but it’s over 10m.

Okay. Thank you.

Our next question comes from David Way, from RBC Capital Markets.

Please go ahead.

Thank you. I just have a quick question on gross margins for the two businesses and where you see them going long term. And, also, just on the next step in terms of bringing break-even down to 170m, is that primarily an OpEx cut, or is there some, obviously, improvement in the gross margin?

Give me your second question again.

Just in terms of bringing the break-even down to 170m, is the focus of the restructuring going to be mainly on the OpEx line, or is it improvement of the gross margin line?

Okay. With regard to your first question on gross margin between the two businesses, as you can see from our segment reporting, we don’t call out specifically gross margin, but the contribution between the two businesses is different, markedly different. And the Thin Film business has a higher contribution. In fact, it’s positive for what we report in the business unit contribution, and we have a declining negative number in the context of communications.

In terms of what we see going forward, we see continued improvement in the communications profit contribution as the market recovers, and we see stabilization and continued health in the Thin Film arena. So they’re significantly different now, but I would expect to see the greatest improvement in communications.

With regard to our $170m break-even and how we are going to achieve that at that revenue level in the fourth fiscal quarter, we are going to continue to find benefits in both OpEx areas and cost of sales. We have, as I mentioned, significant opportunities in gross margin management through better procurement supply chain management, better utilization of factories. We invest significantly in redesign for cost reduction, and that goes on on a regular basis, so we’ll see all those things happening in the cost of sales arena. And, likewise, in operating expenses, we’ll be continuing to work down the efficiency of our overall operating cost structure.

David, let me calibrate before both of those questions with one more sort of graphic thought. On the gross margin front, Ron enumerated five sort of basic elements that we’re chasing for gross margin improvement. I think it would be fair to say that if we were to think of this as a baseball game, we are in the early innings of our mobilization and getting the outcomes that we want out of that. And I would frame that as sort of innings 1 and 2. So I think there is a lot of upside on gross margin improvement.

From the point of view of your question on OpEx improvement, I think the calibration point there should be that the team has already undertaken the decisions and the mobilization to achieve the majority of the cost structure that Ron has created a road map for in his comments. So my point is, there’s not a lot of invention required to do it; there’s just a lot of execution ahead of us.

All right. Thank you.

Our next question comes from Darrell Armstrong, from Smith Barney.

Please go ahead.

This is Nigel Franks, calling in for Darrell Armstrong. Regarding the fiber to the home opportunity, I was wondering if you could give us insight into the economics of that on a percentage, or if you could estimate hard numbers, whichever you like. Regarding aerial deployment, if you were to estimate about $800 per home pass, how much of that flows through to JDS?

Gee, I tell you, I’m actually not prepared to answer you on either of those today. I’m struggling just making sure that I’m engaged in the fiber to the home thought leadership. What I’ve convinced myself of in my first 30 days is that at a components play, we are playing horizontally in fiber to the home, and whether it’s components, biplexors, triplexors, we have engagements and road maps to make that play. I’m going to be challenged by your questions and see if I could be more helpful on the next conference call, but this is just a time where I’ve got to tell you what I don’t know, and it’s as honest as I can be.

Okay. Thank you.

Yep.

Our next question comes from [Peraz Vergava], from BMO.

Please go ahead.

At the break-even level of 170m, what kind of head count are you looking at in Q4 ’04?

Peraz, we haven’t specifically called that out. It will be lower than we are currently, and we will be getting gains in our cost structure, both from some head count areas, but also other areas such as supply chain management and significant ways, et cetera. So it will be a mixture, but we can expect that our head count will be somewhat lower at that kind of level.

The important thing, Peraz, though, is to get a framework for the relative contributions of the levers, and I do not think that head count is the significant lever to get us to that level of break even. It will be actually further utilization and improvements in the other elements of our cost structure.

Okay. Thank you.

Our next question comes from Max Sheutz, from Credit Suisse First Boston.

Please go ahead.

Jeff Law, for Max. Kind of a macro level question; but wanted to get a sense of when you look at the telecom side of the business, the optical components market, what’s your best estimate as to the addressable market opportunity this year?

Jeff, I don’t have specific numbers for you in terms of available market. We have that data, but I didn’t bring it along. We have estimates of it, I should say. You know, Jeff, I’d say in most cases, we believe that we are someplace between probably 25 to 30% market share on most of our products to upwards of 60 to 70%, in some cases significantly better than that. So that’s sort of how we measure. We actually have a pretty detailed measurement scheme sort of by customer.

Right now, I think as the market is trying to figure out what’s the relationship between volumes and ASPs, a question like that is very hard. You get a different answer volumetrically versus pricing structure. So right now, companies like ourselves are probably less focused on what the available market is and more focused on what we need to do each quarter to get more revenues. And then we’ll begin to think about how much our customers spend and what level of customer share did we get.

So you do have us caught in the sense that we are probably less focused on macro market shares. We are extremely focused on these design win and customer market shares, and that’s something we think we’re doing pretty well.

In general, Jeff, as Kevin mentioned, it’s pretty hard to estimate market share, and there are different numbers out there. What we do focus on is winning all the deals that we can for products that we have to offer.

Okay. And then maybe something closer to today, then. What’s the gross margin level you’re looking for at the $200m break-even level and at the $170m level?

We haven’t specifically called that out in terms of our projection. Obviously it would need to be better than what we have, and as Kevin mentioned, given that we expect that some of our significant levers can be in our supply chain management areas, as well as focusing on the right products and pricing, and I mentioned earlier our cost reduction efforts in our design activities that reduce the cost structures of our products going forward, and that’s where a lot of our focus goes. You can suffice it to say it will be significantly improved over time, and we have a track to get there.

It is a fair statement, however, that I will be driving the company to get its gross margins in excess of something that begins with a “2.”

I understand that. But is there any help at all you can provide on things like where OpEx levels off or what mix of product you see at that break-even level?

We haven’t specifically provided that modeling.

Okay. Thanks a lot.

Our next question comes from Chris Umiastowski, from Orion Securities.

Please go ahead.

Good evening, gentlemen. This is Robert Winslow, for Chris.

Hello, Robert.

First, I just wanted to confirm something I heard you say earlier, I believe, that the Thin Film business had positive gross margins this quarter; is that correct?

It has positive contribution margins as shown on the segment reporting schedule attached to the press release. There are other significant costs that are carried at the corporate level, if you will, and are not fully reflected in the segment reports.

Okay. I thought I’d heard you say that just the gross margin was positive in the Thin Film, but that’s not the case.

The gross margin is positive. The contribution margin is positive.

Okay. And then I guess in the telecom business, we’re not allowed to say whether the gross margin is positive in that yet?

Yes, it is positive, gross margin.

It is positive?

Yes.

Thank you very much.

Yep.

Our last question comes from [Shif Perry], from Brookside Capital.

Please go ahead.

You mentioned the long haul market is sort of seeing some pickup. Can you give us a little more color into what specifically the carriers are doing to add capacity? One of the things and what the carrier just said is even until now is that they have excess capacity on most networks, and even where their data revenues are growing, you know, it doesn’t appear that there are capacity constraints.

So I’m just curious as to what exactly they’re doing over there. And then second, maybe you can talk about, given the consolidation we’ve seen in the marketplace in the optical component space, when do you think prices could potentially stabilize? Thank you.

Ron and I will do this as a tag team, perhaps, and [inaudible]. One is on the long haul side, naturally your general characterization that there is more excess capacity inventory than demand right now is a characterization that has been true for a number of years. However, as you know, I’m sure, and you discover as you have conversations with each operator individually, it is definitely changing operator by operator and equipment vendor by equipment vendor.

So I would say that we did see it pick up on a select case-by-case basis in a few spots where we didn’t anticipate, and that’s a good thing. So Ron may have more specifics, but I at least wanted to frame it that the answer to your question is on a case-by-case or a customer-specific basis; not on a generality for the industry.

On your second question, which is ASP stabilization, I think it’s normal to see volumes go up. It is normal to see a hyper competition while you have so many players that haven’t fallen out yet, so I think industry consolidation will begin to play here. I think in some cases or some subsegments, we have begun to see a slowdown in the rate of ASP decline, so that’s a good thing, but we think we’re going to be playing in this environment for a period longer, and that’s why we’re going to have an intensity on our own cost reduction initiatives so we can play well in that environment.

Just to add a little bit. In terms of ASP, it’s hard to call a trend when you have relatively few data points and they’re moving on you. But as Kevin mentioned, we do see some indicators in the last couple of quarters that some rate of reduction and the rate of decline, at least, is happening in the ASPs. And with regard to the long haul situation, as I commented in my earlier comments, we do believe that, as Kevin mentioned for select customers, there has been some drawdown of their inventories, and so we’re getting some ordering of new long haul products. But it’s very discontinuous, customer to customer at this point. And we, I don’t believe, are seeing the full demand flowing through to us yet because the inventory is still out there.

Thank you.

Operator, I think our time is up in terms of questions.

Yes, gentlemen, we have no further questions.

Okay. So I’d like to thank you all for joining the call. Once again, you can hear the replay of this call on our website, www.jdsu.com. Thank you all for calling.

Thank you. Ladies and gentlemen, this concludes our teleconference. Thank you for participating. You may now disconnect.