Viavi Solutions Inc (VIAV) 2004 Q2 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the second quarter fiscal 2004 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I would now like to turn the call over to Mr. Ron Foster, CFO. Mr. Foster, you may begin.

Thank you Operator. Welcome to the call. I am Ron Foster, CFO of JDS Uniphase. Here with me is Kevin Kennedy, our CEO. On this call we will report our second quarter results, and provide guidance for the third quarter of our fiscal year 2004. Kevin will provide an overview of our business and operations. I will provide further details on our operations, along with a review of our financials and guidance.

First, we would like to advise you that today’s report and discussions include some 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 Factors section of our Form 10Q, filed on the quarter ended September 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 also to indicate that this call is being recorded, and will be available for replay from the Investor portion of our Web site, 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 second quarter results, issued earlier today. This news release is available also on the Web site.

With that, I will turn it over to Kevin.

Thank you Ron. Today I will discuss an overview of our execution focus, a market update, and an update on our strategy and priorities. First, let me note that overall we accomplished our financial and operational objectives for fiscal Q2, and in fact exceeded them in several respects. In general, we believe our markets are stabilizing. Certain areas are showing signs of growth, as evidenced in particular by externally driven lead time pressures.

During Q2, the team was intensely focused on customer driven execution, operational improvements, and a continuing drive towards profitability. With the aggressive efforts of our team, and with the support of our customers, we have seen improvements on these fronts. We also continue to make deliberate choices around organization clarity, and a focus on fundamentals.

Relative to execution focus, last quarter we began to develop and implement a series of deliberate decisions, designed to establish a customer-focused culture, and conservative disciplined practices. Let me tell you where the items I mentioned last quarter stand. We developed compensation programs to drive alignment among customers, stockholders, and employees, citing customer satisfaction and profitability goals.

To this end, we have restricted our fiscal year ’04 cash compensation programs to only three up sides – customer satisfaction improvements, profitability attainment, and exception-based competitive compensation adjustments. As planned, we have introduced a special incentive program for our employees, as we achieve clear, objective customer satisfaction goals, such as customer responsiveness and product quality.

In concert with a customer satisfaction focus, we established an incentive program for the achievement of objective profitability targets, such as EBITDA and GAAP measures. Since our last call, our stockholders approved a new broad-based equity plan at our November Annual Stockholders meeting. The new plan introduces several conservative approaches to equity compensation. Chief among these are the elimination of our non-stockholder approved Evergreen Option Plan.

Therefore, we will now seek stockholder approval to modify our equity plan, or to increase the number of share available for issuance, and the introduction of a 5% limitation on the aggregate equity issuable in any year to the top five most compensated executive officers. This will broaden the distribution of equity among our key knowledge-based employees. We are enhancing and streamlining our organization, by identifying key positions for staffing or reductions. In this regard, with the leadership transition now complete, we have eliminated the Chief Operating Officer position.

Bringing important new skills to our team in Q2, we hired a Vice-President of Corporate Development, [David Gubinton], a former Vice-President at Cisco Systems, with acquisition experience. And, consistent with commitments made at our shareholder meeting, we are closing on a Director of Investor Relations. This quarter we have identified additional customer focused conservative actions, which we are currently implementing.

We have put in place a formal customer-focused critical accounts process, managed by a dedicated leader. This centralized function is intended to focus intense attention to customer issues that may not be addressed by normal response procedures.

Last quarter we established a Customer Satisfaction Survey. The Q1 survey was administered to over 100 communications customers. In Q2 we expanded the survey to include our TFPG customers. This survey, combined with customer generated report cards, will form the baseline for our fiscal year ’04 customer satisfaction improvement bonus discussed earlier.

My discussions with our key customer leaders continue. To date, indications are that our technical expertise is recognized. Customers evidence a desire to do more business with JSD Uniphase. And most communicated a desired emphasis on operational improvement, such as lead times. Customer feedback on our emerging strategy has been positive. Customers have responded positively to both our customer satisfaction incentive plan, and the initiation of a critical accounts process.

Beyond that, I wanted to share with you several things from customer feedback, all of which we are embracing. First, JDS Uniphase needs to succeed in both our communications and non-communications businesses. The company needs to continue to focus on execution as job number one. A unified company culture, to achieve cross-company excellence is important. JDS Uniphase should continue to drive thought leadership in addressing customer challenges and product opportunities.

We need to continue to vertically integrate where customers pull us, expand horizontally via leveraging into adjacent markets, and develop differentiation through device integration and the addition of embedded module intelligence. A focus on low cost is crucial. And finally, expansion of markets beyond North America should be a priority.

On the financial and operational front, Ron will provide more depth. But here are the highlights in the areas of focus this quarter. Overall, we exceeded our revenue guidance. Revenue grew. And our book to bill was greater than one. On a non-GAAP basis, operating expenses continue to decline. This is the first quarter since Q4 fiscal year ’01 where op-ex as a percent of net sales declined to a threshold of 40%. Non-GAAP EPS and gross margins showed improvement. Our non-GAAP EBITDA loss decreased by 21%, with continued operational focus.

Areas of focus and improvement – we must continue to improve our execution, most importantly in the areas of factory and product transitions, and supply chain management. For our communications business, customers are asking for improved lead time clarity and, in many instances, shorter lead times. Process improvements will be required. While strong progress is underway on this front, these improvements will be a continuing priority for the foreseeable future.

Several product areas, amidst factory and product transitions, experienced protracted lead times, and customer dissatisfaction in Q2. In all cases, we are exiting the quarter with higher production volumes than we entered the quarter. However, this matter will require continued vigilance. We expect to see improvements in fiscal Q3.

Speaking broadly, in Q2 we saw volume demand increasing above initial customer forecasts for the communications side of our business. Again, this is a positive business indicator, but has the near-term result of some supply chain constraints, and associated incremental expense of JDS Uniphase. While we believe that this is not a long-term supply issue, we are quickly working to increase supplier raw stock inventory for those higher volume products.

While we are seeing some improvements in select product areas, average selling price tensions continue. The rate of gross margin improvement remains an area of focus, as price declines continue to strain revenues associated with volume increases. This strain is expected to moderate, as trending for lead-time improvements should be associated with stabilizing pricing trends.

While roughly half of our business operates near the corporate average gross margin, 20% of the remainder operates well below this. And 80% of the remainder operates well above this threshold. We continue to focus on numerous other elements of gross margin improvement, which Ron will discuss. Relative to our markets, consistent with our results and forecasts, we believe that the market is stabilizing overall. In fact, communications is trending up, demonstrated largely by lead time requests, and a general trend among our customers to purchase to forecast, as opposed to upon order receipt.

Today, JDS Uniphase business profile remains roughly equally balanced between communications and non-communications. Of the communications business, our long-haul business currently accounts for less than 20% of our communications revenue, due in large part to the advancement of our portfolio to serve metro, datacom, and other edge markets.

A few highlights on the product side, new communications products introduced in fiscal Q2 include new access metro, and core network transponders we call the PM1 and PH1 Series, which extend our family or products to provide all reaches and rates required for 10-gigabit per second telecom applications.

We also announced the xEMT 2100 Series a next generation 1550 nm externally modulated transmitters for original equipment manufacturers, and system integrators for CATV and fiber to the premise markets. We developed additional Circuit Pack opportunities with our key customers. More than 20 customer-specific transceiver and transponder configurations were launched. During the quarter we achieved business tractions, or share awards, with four new targeted customers for our datacom product portfolio. We anticipate that these wins will lead to new revenue streams during calendar year 2004.

On the design win front for Q2, we saw significant growth, again, across the board, driven largely by increasing JDS Uniphase customer engagement. Circuit Pack design win activity is particularly good again this quarter. And we are beginning to see revenue growth from these products. For our TFPG portfolios, we saw stability amid product transitions. Demand for light management technologies across industry is strong.

In Q2, the company delivered prototype Digital Light Processing engines to several customers, and received initial production orders for deliveries in Q3. As per our recent press release, we had a design win with ViewSonic for our DLP engine. Our liquid-crystal-on-silicon-based microdisplay light engines were also being evaluated by various customers in Q2. And we believe we are gaining momentum with this product.

Our engine was chosen by Intel to demonstrate their L-Class panel at the Consumer Electronics Show earlier in January in Las Vegas. Brillian has announced that they have chosen this light engine for their HDTV RPTV product. Our L-Class engine won the Photonics Circle of Excellence Award, as one of the 25 leading technology products of the year.

Relative to our strategy and priorities, to reiterate, our key product and market strategy elements, JDS Uniphase will continue to focus on both communications and non-communications markets. We will continue customer driven vertical integration, expand horizontally via adjacencies, and develop differentiation through device integration and embedded intelligence. Low cost is a critical objective. And finally, expansion of markets beyond North America is a priority.

Our operational strategy is to continue with a set of delivered choices, focused on completing the broader transformation of the company, including, but not limited to, governance, compensation, leadership, organizational direction, clarity and alignment. Stabilizing and accelerating the financial performance and cost structure of the company through revenue growth, operating expense improvements, gross margin improvements, and cash preservation and accumulation are crucial. Customer satisfaction and confidence are a priority, and, finally, operational execution excellence.

As you know, JDS Uniphase operates in a product space that has been crushed by a contraction of the market. During the past two years, the company expanded its portfolio from core to metro and datacom. With steady progress thus far, we will continue to drive improvements in our fundamentals, focusing on our competitive position financially, technically, and operationally. With that, I will turn the call over to Ron.

Thanks Kevin. I will be commenting primarily on our non-GAAP presentation of the financial results. Revenues of $153m in the quarter exceeded our guidance of $140m to $150m, and grew 4% sequentially. We have largely passed the era of favorable cancellation revenues, and unusual revenue reserve adjustments, indicating that our revenue levels this quarter and going forward are more representative of the normal flow of our business. Our communications products segment represented $78m in revenues, or 51% of the total. Revenues in this segment were up 5% sequentially.

In terms of mix, as Kevin mentioned, we estimate long haul represented less than 20% of our communications segment revenue this quarter, as metro, telecom and datacom products have grown to become a significant element of our business. We expect long haul to pick up later this fiscal year, as [Gig-B] [ph] and Siemens AT&T deployments begin to roll out.

Modules continue to represent about two-thirds of our communications revenue, as components, modules and sub-systems have all shown some growth. In fact, components revenue grew at double-digit rates sequentially.

Our Thin-Film product segment for our non-communications business accounted for $75m in revenue, or 49% of the total. Revenues in this segment showed a 2% increase from last quarter. Both commercial lasers and display engines were up quarter over quarter. North American revenue of $103m grew to 68% of worldwide revenue, while Europe revenue was flat at $27m, and Asia was $23m.

As Kevin mentioned, our overall book to bill ratio was above one in total, and has been above one for our communications group for three consecutive quarters. Although we had no 10% customers during the quarter, based on an invoice or bill to basis, if you combine the direct shipments and shipments to contract manufacturers covered under their master agreement, Cisco exceeded 10% of revenue.

We added a fourteenth week to our typical thirteen week quarter during Q2, in order to bring our calendar in line with the required fiscal year-end. Adding it to the second quarter provided the least impact to the business, since most of the additional time was concurrent with company and customer holidays and year-end shutdowns. We estimate that incremental revenue was approximately $1m, and incremental costs and expenses were about $2m as a result of the added week.

Gross margin was 23% in the second quarter, better than our guidance of 19-21%, and a slight improvement from last quarter’s gross margin of 22%. Total gross profit of the company was $36m. The gross margin is impacted by a number of key factors – average selling prices, product mix, manufacturing yields and utilization, material procurement costs, new product introductions, product transition costs, and labor and overhead input costs.

We see much opportunity to improve gross margins, recognizing some improvement targets can take time to reach, as they are dependent on execution and, in many cases, gated by customer qualifications. The communications business continued to experience average selling price declines, albeit at a much slower rate, while unit volumes grew at double digit rates. Pricing in the TFPG business was generally stable quarter to quarter.

The communications business segment has continued to experience sequential increasingly positive gross margins, with improved manufacturing utilization yields and procurement costs offsetting pricing declines, and approximately $2m in increased expenses to respond to customer lead-time needs.

Notably, our components business, which is experiencing double-digit revenue growth, as I mentioned earlier, is also leading the communications segment in profitability. TFPG margins were stable quarter over quarter. The net benefit to gross margin of inventory recovery, compared to excess inventory write-offs, was about $7m, roughly comparable to Q1.

We expect favorable inventory recovery to continue for some time, as customers initiate orders for products that have not been produced for years. Going forward for the next few quarters, we expect that gross margin trends will improve overall, one to several points per quarter. While ASP declines continue to put some downward pressure on margins, we believe improvements we are achieving in overhead costs, factory utilization, yields, material costs, and introduction of low cost designs, will drive sequential improvement. Some quarter to quarter variations will typically result from normal volatility in product mix.

Now to operating expenses. Our total non-GAAP operating expenses were $61m, or 40% of revenues for the quarter, a two percentage point improvement over Q1. Non-GAAP R&D expenses were $24m, flat from Q1. However, the mix of spending was shifted during the quarter toward higher priority datacom and metro telecom projects.

Non-GAAP SG&A expenses for the second quarter dropped $1m to $37m. Greater reductions in G&A were partially offset by strategic investments in sales and marketing in the quarter. Non-GAAP operating loss for the quarter improved to $25m in the second quarter, from a $29m loss in the first quarter. Non-GAAP EBITDA improved to a loss of $15m from a loss of $19m in Q1.

The non-GAAP segment loss for communications business decreased from approximately $11m loss to $9m loss. And non-GAAP segment income for the Thin-Film products group increased from $9m profit to $11m. Please note that our Q1 segment operating income loss report above has been adjusted to be consistent with our Q2 presentation.

Interest and other net income was approximately $9m for the quarter, up $6m sequentially, mainly due to a higher cash balance from the convertible proceeds, and foreign exchange gains. Included in GAAP results for the quarter was approximately $20m in gains associated with the sale of marketable public securities.

Income tax expense for the quarter was approximately $3m, and resulted primarily from the realized gain on the sale of public equities. The GAAP net loss for the quarter was $59m, or $0.04 per share. And the non-GAAP loss was $19m, or $0.01 per share, coming in better than our guidance of $0.02 to $0.03 loss.

Now to Global Realignment – this will likely be the last time we speak to this program in detail. The actions previously outlined in the program, which focused on aggressive rationalization, are essentially done. However, the beneficial effects, and also some cash payments, are expected to continue for a number of years.

While the end of the Global Realignment Program does not translate to the end of all restructuring activities within the company, we believe fundamental resizing is largely complete. We will continue to realign as it relates to operational improvements and customer-focused requirements. This will involve investment and divestment in specific focused areas.

We expect to incur further restructuring and other realignment expenses related to these actions. Restructuring charges will continue to be excluded from our non-GAAP results, while other realignment expenses will be included in our non-GAAP results going forward.

To highlight the program, we continue to run on plan, both for the expected and the 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 second quarter, the impact of restructuring and other charges under the program on our income statement was $10m. The remaining costs of this program should be minimal. When comparing this quarter’s non-GAAP profit performance to last year’s second quarter of fiscal year ’03, operating losses have been reduced by $73m, on $4m lower revenue, primarily as a result of the Global Realignment Program.

On a cash basis, we spent $14m in our second quarter under the Global Realignment Program, bringing the total cash outlay so far to approximately $300m. We anticipate additional cash outlays of about $100m in future quarters, the majority of which will be paid in settlement of various obligations associated with abandoned and phased out facilities.

Now to the balance sheet and cash flow. Our balance of cash and marketable securities at the end of the quarter was $1.648b, of which $1.499b was cash, money market, and other highly liquid fixed income securities. Our cash and marketable securities increased by $487m.

Consistent with our priority of cash preservation and accumulation, in October we completed a zero coupon, zero yield convertible debt offering, which provided $463m in net cash proceeds. The historically unprecedented financing terms will allow the company to record upwards of $65m in net interest income, if not used for higher priority purposes during the term of the convertible offering.

The proceeds of this offering provide a conservative cash floor, while enabling the financial flexibility for committed, but not yet spent, restructuring expenses, future restructuring, acquisitions and investments, and other possible capital restructuring. The addition of this cash has not diminished our focus on cash preservation, however, as we continue to seize every opportunity to eliminate and hopefully monetize unnecessary assets.

In the second quarter, we sold one more unused facility, liquidated equity investments for a $20m book gain, collected proceeds from the sale of the company plane, and received a prior year’s tax refund of $14m. This continues to be a high priority for us. We saw positive high cash from operations of $7m in the quarter due to improvements in working capital and improved operational performance. This was the first positive cash flow from operations since our June, 2002 quarter.

Our asset management in general was better. Day sales accounts receivable declined to 54 days from 65 days in the prior quarter. The quality of our receivables continued to improve, as the percentage of past due receivables declined to its lowest level in two years. The A/R balance benefited from incremental cash collections during the additional fourteenth week of the quarter.

Net inventory increased to $86m, as customers requested improved lead times on certain products. Capital spending was $7m in the quarter, while depreciation expense was $11m. During the quarter we recorded a $38m reduction in the value of long-lived assets, in accordance with FAS 144. This reduction is due primarily to the decline in value of assets held for sale, including certain buildings owned, but no longer needed by the company.

Additionally, we completed a review to determine if impairment indicators existed relating to our other long-lived assets for the quarter. We determined that there were no impairment indicators. Therefore, no impairment review was required under FAS 144. Lastly, employment increased slightly to approximately 5,300. An increase in overall manufacturing head count offset the decreases we realized in other areas.

Now to guidance for the third quarter of fiscal year 2004. Net revenues are projected to be in the range of up 1-6% sequentially. Non-GAAP gross margin is expected to be in the 23% to 25% range of total net revenues. As with prior quarters, we expect operating expenses to decline sequentially. Non-GAAP net loss should be about $0.01 per share. Our non-GAAP projections exclude restructuring charges, as well as other acquisition and impairment related expenses, such as amortization of purchased intangibles, reductions of good will, and long-lived assets, stock-based compensation expense, and gains and losses on investments.

As mentioned in our press release, the company remains on track for a cost structure that will be EBITDA break-even at $170m revenue level in Q4. We continue to take actions that will bias us towards further improvement of this cost structure going forward. We currently anticipate having capital expenditures during fiscal ’04 of $80m, and expect to consume $70-80m in cash during the year for the global realignment program.

Before I conclude, I wanted to make mention that a particular priority for us for the next two quarters will be addressing the final phases of Sarbanes-Oxley, Section 404 implementation. Having had a dedicated s404 team working on this initiative for the past several months, as we approach the June, 2004 compliance deadline, employee training programs are underway, and testing and improvement implementations are ongoing.

Given that operating excellence is one of our key company priorities, we are engaging in the s404 implementation not just as a compliance requirement, but with a view that this will benefit our company as an additional enabler to improving our business processes and organizational performance. Our efforts to implement s4 will continue to require significant internal resources, and will involve some incremental costs to our company in the second half of fiscal year ’04.

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

Thank you. (Operator instructions) Our first question comes from Stephen Koffler with Wachovia Capital. Please go ahead.

Good afternoon. Quick clarification, Ron, and then a question. When you were talking about the component business, you went through some comparison of component growth to modules, and it sounded like you said components grew faster than modules, but it just got by me, if you cold repeat that. And then for Ron and Kevin, the question is on your $170m breakeven revenue target, based on guidance you could be getting pretty close to that in the March quarter, so it occurred to me that you are still looking for significant growth margin contribution from the inventory rate ups that you’ve been experiencing and just experienced. So my question is, what are the embedded assumptions about how long that lasts, you know, once you hopefully break even say in the next six to nine months? Thank you.

Hello, Steve. First of all, on the first item, the comment was that components growth rate was up double-digits, quarter to quarter, and overall in the communications business we are 5 percent, so it was higher than the – with regard to your question about the breakeven, $170m breakeven and the impact on inventory write ups, and how long that will carry through in terms of our financials, we believe that there will be some ongoing beneficial result, not necessarily even across quarters, but over some quarters to come, as a result of the large amount of inventory that we have that was written off a couple – three years ago, and now is in some cases being recovered as customers are reordering those products where we’ve had no visibility to any need for them for some time. So I would say it is certainly going to go four to eight quarters out would be an estimate on my part.

And I guess that assumes that you get demand in the products, it continues, is that correct?

Yes, demand continuing and of course we’ve got products that still haven’t been ordered for some period of time that we still have inventory that we haven’t scrapped, so it could be other products as well that haven’t been ordered to date.

I see. Thank you.

All right.

Thank you. Your next question comes from James Jungjohann from CIBC World Markets. Please go ahead.

Hi, guys. Just a little more detail on the guidance, 1 percent to 6 percent, where do you see coms versus non-coms in that guidance, and I am quite certain that coms will pull up better, and is that the circuit pack business really taken off? You talked about that like a quarter ago, that maybe it’s a first half phenomenon, and you are talking about some revenues. Is that, you know, a lot of this growth that we are going to see going forward?

Jim, let me take a stab at that. I think in general we, the way that we believe the quarter will evolve and the intelligence that’s embedded into whatever guidance that we’ve produced is that things will roll out trend-wise not so far different than this particular quarter. Meaning, components will continue to probably have the highest growth rate, there will be pieces of the non-coms that will continue to power through a transition. We are a little bit less diffident about some of the downside risks in the non-com piece, so that helps the numbers there. So I think proportionality wise we don’t expect any major changes to what we saw this quarter.

And relative to the circuit packs, I think it’s fair to say that this is the first quarter that we are seeing tangible revenues, albeit very small, and therefore the growth rate might end up looking high. Of course, the denominator is very small in the subsequent quarter.

And we’re still seeing good traction in the design wins in the circuit pack area as well, that’s continuing.

Okay. And then I’m assuming that’s all incremental business on the circuit pack side, and that the margins are you know, relative to corporate, pretty good?

I think it’s not all incremental because obviously some of the components would have been hopefully JDSU selected before, and I think you should assume that the margins are more of a start-up business as opposed to super strong margins at this particular point in time.

Okay. Part two to my one-part question is the IBM division. You know, a lot of guys are seeing good growth in fiber channel and gigB. How is that division doing?

I think the same state as we’ve seen for a couple of quarters where volumes are continuing to grow dramatically, we are continuing to see nice design wins, but average selling price pressures are neutralizing much of the upswing that you might have hoped from the volumes that we are seeing.

Is that business profitable?

We don’t specifically break those components out, Jim, but I would say that the rate of decline in pricing in that market, like some of the other communications markets, the rate of decline is slowing.

All right. I apologize. Just one more, its on the same thing, guys. So on that business though, it’s still kind of small relative to your telecom business, and you know, Kevin you are sitting on $1.6b in cash, and then [Finian] is also talking about putting that business on the block. Is this anything that you need to stay in, or do you need to make it bigger and more profitable?

I’d say our strategy will be to continue to look for the customer diversification that that business brings us, so you shouldn’t think that we would be having any thoughts other than to continuing to fortify and help that business along.

Okay, good answer. Thanks, Kevin.

Thank you. Our next question comes from Jeremy Bunting from Thomas Weisel Partners. Please go ahead, sir.

Hi, Ron and Kevin. This is Ruben for Jeremy. I wanted a little more clarification on the data coms if I could, following up on that last question. Would you say that the data coms was bigger than the long haul segment, this quarter?

Yes, data com was bigger than the long haul segment this quarter.

Okay.

So your point being that it would be erroneous to think it as a small piece of the business, that’s true.

Okay, thanks. And then when you talk about transitioning focus over from the core to metro and data com, can you talk at all about how you look at your opportunity and these new segments compared to the long haul equipment that went out in the past?

Let me take a stab at that. I think, and a similar question emerged last quarter in terms of what is the financial opportunity in fiber to the home, and such like that. Number one, the first dominant logic is that our opportunity tends to be driven by how we play in different architectures. It turns out that in almost every architecture that you think about moving from the core to the home, we have some level of relevance, whether it be a source laser, whether it be a triplex or a diplexer, a gig B transceiver and so on. There are elements that we are playing in across the board.

So I think the right thing to say is, if you see a network element, the probability that we are going to be either there or on one another adjacent to it is pretty high probability. The way that we play will be differentiated by each particular, whether it’s a cable TV architecture or a sonnet architecture, and we are going to stay – there is a lot of tumult in the network for the time being, we’re going to focus on the things that we know in terms of being an ingredient player for the time being, although we may begin to verticalize more at a later point in time.

Thank you.

Thanks.

Thank you. Our next question comes from Arindum Bastu from Morgan Stanley.

Can you hear me?

Yes.

Okay, great. I wanted to ask you to comment about display opportunities in general, and if we could specifically get into a little bit on the TI projection TV opportunity, and what kind of visibility and what contribution you had this year, because you mentioned in a couple of different areas the LCD micro display opportunity for you folks.

Ron may have more subject-specific knowledge than I do. I don’t know that I know a lot about TI, but what I can say, and certainly the way that I think about it when I go home at night, is we have two areas that are going through a dramatic transition that are at a very positive, relatively positive margins, subject to our corporate average, and that’s both commercial lasers and displays. And in the display case, we are at a point where we are at a new level of verticalization, and we are I would say more in the paid prototyping stage of that market embrace. Now the good news is that market tends to move at a cadence of nine months, of course you tend to like to be in markets by either Christmas or some, you know, calendar event, so I think the accurate thing to say is that we are at the stage where we have won technical designs, people are paying us for prototypes, that’s not immaterial, so we are beginning to feel good about it, but are we at a stage where we know when they are actually going to hit the market? It’s hard to predict in a particular quarter, hence our caution as we try to set expectations around volume ramps or revenue ramps.

The only thing I’d add to that is our TI involvement, historically in the past we’ve made components for the DLP engine, which is a licensed technology of TI. We’re now expanding not only into a complete DLP engine, but also the L-Cost based engine, so we are expanding our base going forward.

Thank you.

Thank you.

Thank you. Our next question comes from Dennis Gallagher from Schwab Soundview. Please go ahead.

Thank you. Just wanted to follow up a little bit on the non-tel communications. Last year during the March quarter you saw a nice pick up. Have you any visibility into seasonality for that business going forward?

Hi Dennis. Just a general comment that the non-telecom businesses in some cases have some larger customers that order in a discontinuous fashion, so we tend to see some lumpiness in the flow of orders and therefore business, as they are restocking. For example, in our flex business. So that is typically what you are seeing, it is not so much seasonality but just cyclicality in their ordering patterns.

So we can’t anticipate similar trends that we saw over the last 12 months going forward?

Well our revenue was flat quarter to quarter, and we do get some variability over quarters as I was just describing. There is some small amount of seasonality in that total business that happens around the holiday time, the Christmas season, but otherwise that is one of the challenges we have in predicting our product mix volatility and how that actual flow will come in. But in general, we’ve been roughly level in recent quarters and we are sequentially up over the last year, year-and-a-half timeframe in total for that business.

Thank you.

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

Hi, how are you?

Great, Ping.

I have two questions. First is looking at gross margin, aside from the inventory recovery, what would you expect the pace of the improvement on that line? And a second question, you did mention about the factory transition and supply chain management, there are some issues, how long do you expect to actually fully resolve those?

We’re going to break that into the two questions that you asked, and I want to answer the last one first, and I’ll let Ron take the gross margin one, because he’s the expert. I think the majority of the factory transition challenges are both process-wise and impact-wise behind us. As I said in the script, we have exited the fiscal Q2 with probably significantly higher volumes of shipments than we were able to produce in the first month of that quarter, so most of that is behind us, although the demand is continuing to ramp up, so hence the comment that we will require continue vigilance.

The second piece of that question is, what do we think the implications are on supply chain management, and there I’d say we are, you know, discovering what we don’t know, occasionally, in the sense that there are some things, as Ron said, that people haven’t ordered in a long time, so as you go back and you begin to try to get forecasts, their ability to respond to your new needs, you sometimes discover it is not what customers want. So I’d say that the factory transitions will remediate and by and large the physics behind the remediation is either behind us or is closing this month, and on the supply chain management, we’ve got the forces marshaled, but from case to case we could find a surprise here and there.

On the gross margin side, Ping, a couple of points. One is that we see that in general we are going to be improving our gross margin in the range sequentially, quarter to quarter of one to several points each quarter. With the caveat that I mentioned in my comments that – and just a minute ago – that product mix can sometimes swing quarter to quarter results, but that’s the fundamental underlying trend line which I think you were generally asking about.

It’s important to also bear in mind that not only are we getting improvements in factory cost structures, supply chain management as Kevin mentioned, but we’re also focusing a lot of our design efforts on design for low cost, because that’s what the customers are looking for us to provide; lower cost, higher reliability, and better performance. So that also is playing in over time as we introduce new products in the mix.

Okay, thank you.

Thank you. Our next question comes from Alex Barrows from Deutsche Bank. Please go ahead.

Hello?

Alex, go ahead.

My question is basically on geographies, I was wondering if you could talk a little bit about some of the regional trends, both in this quarter and what you are expecting going forward, particularly in the context of your plans to expand beyond North America and when you look into telecom space, when you are talking about things like FTTP, GigB and ATT deployment, but you all seem to be more focused around North America. Thanks.

Alex, I’ll start with a comment and then Kevin can fill in any blanks. In general, with the geographic numbers, when you saw that our North American percentage actually went up sequentially quarter to quarter, but as Kevin also mentioned, we’ve got to focus on strategically expanding that business base and we are deploying resources with the sales and marketing effort in that direction, and also notably we’ve got a significant amount of our backlog right now in design wins, they are coming from the international marketplace. So we are in good position going forward initially, in terms of just the basic trend of current business. I don’t know if you want to add anything.

No, I think you are right. Bottom line is, we haven’t been looking backwards, it was not a huge focus over the last year there has been a number of design wins which makes us cautiously optimistic for work that we’ve already done that will bring revenue in the future. I went to China, and I would say that especially on the data com side of the house and the modules, there is business that people want to do with us that is quite positive, and I would say as I look to Europe, that landscape has changed a lot when you think about supply agreements with Alcatel and others that – so we are beginning to learn how to penetrate those accounts, given the dynamics that have occurred over the last two years. I hope that helps.

Great. Thanks.

Your next question comes from Martin Sichasto from UBS. Please go ahead.

Hi, thank you. Can you hear me?

Yes, Martin. Go ahead.

Great. I just would like to get some more information on your non-telecom business. I think you said you are less cautious, and what I want to understand a little bit better is you said you were being conservative on the DLP side, so are there other segments in the non-telecom that you are less cautious on?

You are catching me in a non-lucid moment, but clearly what’s happening in non-telecom is that the transitions seem to be going better, or our pulse of the transitions today is better than where we were a quarter ago.

Yes, we are seeing some stabilization of our businesses there as well, I think that was the nature of the comment, we are getting a little more confidence at least in our Q3 view of revenue opportunities. That was the nature of the comment.

So can you write it down into your – you did some [inaudible] business, you did some display business, can you break it down there? Is it – are you saying?

I think what we said was that this quarter we had some good successes with the commercial laser and display, and we anticipate that progress to continue as we’ve given you guidance.

Okay, thank you.

Thanks.

Thank you. Our next question comes from Mack Schoots from Credit Suisse First Boston. Please go ahead.

It’s Jeff Roth for Mack. Just as you look last year in the March quarter, you guys grew sequentially and then declined in June and September. Again you are giving guidance for an up tick in March. How do you characterize your differences between last year and the environment this year, and then what would you highlight as kind of the key revenue growth drivers as you look across 2004 in both of your businesses?

Jeff, I have the advantage of not having been here a year ago, but having been around the industry, let me tell you the most significant thing that I think has changed, and that is in every customer that I have been to at an executive level, they have all communicated to me that they are beginning to change their procurement practices from moving from only buying materials when somebody gives them an order, so much as to say they expect JDS to begin to build to forecast rather than wait until they give us an order.

That is a very significant change than anything that has occurred over the last year or two.

The thing I might add is that I think that our customers are in a position now with this stabilization of their markets, as they are looking at them, that they can look forward in more strategic perspective than maybe they could a year ago, and as a result we are having more discussions about forward-looking design win opportunities, et cetera, that are coming into the mix. That’s part of the reason that’s happening.

I think the whole industry is beginning to look forward versus a year ago when we were basically the industry was focused on just survival to the next quarter, largely.

And then what about kind of the key revenue drivers for 2004 in each of your businesses?

I think you are going to continue to see our communications businesses continue to grow, and I think the success on the non-telecom side will be largely via the display successes over the future.

Okay.

Thank you. Our next question comes from Michael Kohn from Pacific America Securities. Please go ahead.

Congratulations on the quarter, guys. I am just trying to get a feel for where the upside to the revenue came from. I was wondering, was it pretty linear throughout the quarter, or did most of the ordering kind of come in towards the tail end to give the upside spread?

Michael, this is Ron. I would say that there wasn’t anything unusual about the flow of orders or revenue this quarter. As a matter of fact, if you think about our second fiscal quarter, there is a lot of holidays that happened at the end of the quarter, so business is often transacted in front of that. And then we are shipping out, usually up to and a little bit in the holiday season, so there was nothing unusual about the flow of orders during the quarter or the revenue profile.

Probably accurate to say that the greatest level of tension in the quarter was just simply, what would we be able to ship and you know, manufacture.

Okay. And it sounds to me like your greatest strength was probably in the communications components, and I was wondering, was it a handful of customers, or a single customer, that provided most of the strengths, or was it pretty much across the board, seeing increased demand from everybody.

I think it would be fair to say it was strong demand across the board, and any upside that occurred in our estimate came by an increasing confidence of what we would be able to ship.

And I would just add that we not only got business strength from our top tier customers, but we saw significant activity with our second tier customers as well.

Okay. Nice to see you increasing [inaudible] and stuff again. Thanks a lot.

Thank you.

Thank you. Our next question comes from Darrell Armstrong from Smith Barney.

Thank you very much. First, I was wondering if you could clarify the foreign exchange translation impact, both on your revenues and your costs this quarter?

You are talking about the foreign exchange impact on our – I don’t have a specific number to call out for you, but we have some expense presence in Canada, so we had some expense impact as a result of that exchange rate in Canada, adverse. But it wasn’t a real significant number in terms of our total business going forward.

Okay, and then second of all, because of the longer lead times, did some business go away from you during the quarter, because you couldn’t manufacture and ship in time, or do you expect pretty much all of your orders that came to you to that weren’t filled in the December quarter to be filled in the March quarter?

Clearly one of the reasons that we are so focused on execution is that if you can ship, you can take the order, so I would say that there were probably orders that could have gone to someone else – by the way, very much an industry thing. We ended up having orders where people moved away from us, then came back to us because somebody else couldn’t ship, so I think we are dealing with something that is seen on a number of fronts, and on any particular transaction I think we could have lost a piece of business here and there. On the other hand, in the net we ended up doing better than we could have anticipated.

Thank you.

Thank you. Our next question comes from Peraz Vergava from BMO. Please go ahead.

Thanks. A couple of clarifying questions. It sounds like your book to build was greater than one, things were getting better as you went along and you shipped as much as you could, but your DSOs were down markedly. Can you maybe reconcile that?

You said DSOs down markedly?

Yes. I mean, if your book to build is above one and you are shipping a lot near the end of the quarter, typically your receivables tend to go up, but your receivables went down. I am just sort of –

Maybe I wasn’t clear, Peraz. What I said is that the shipments were fairly linear.

Oh, the shipments were linear. Sorry.

As was the order rate.

Okay.

Some improvement was largely as a result of the fact of a significant reduction, increase in the quality of our receivables and a reduction in the past due receivables.

Okay. I hadn’t done my math. Thanks. The second question is, just on your breakeven guidance, $170m EBITDA breakeven, are you expecting margins to improve as you get more components and less modules, is that the main impact that you are going to get breakeven at $170m, or do you think you are going to bring your opex down?

Clearly we are focused on across the board, bringing our opex down and also in improving our gross margins across the board. In addition, we see general improvement in the communications business, both in terms of the margin in that business as well as it continuing to grow, so I think the main drivers are expense management and better factory performance.

But you’ve got to get a low 30’s kind of gross margins, right? You are not going to be able to bring your opex down significantly, your population is increasing, you are increasing marketing as you are reducing admin. I am just looking at the modeling here.

I think we need to do both. We need to get the opex down and we are focused on doing that, as well as you indicate moving the margins up, and I already gave a view that sequentially for some quarters here we expect to be moving our margins up.

Did you just mention something, Ron, about capacity utilization on the call? I missed it if you – I thought I heard you say something about that.

I said we’ve improved our capacity utilization and obviously we hope that will continue as business picks up.

Did you give a number?

No.

Finally on the TI business, TI used to be a 10 percent customer when their DLT revenues were much below what they are now. TI is no longer a 10 percent customer. Is that mainly because of pricing in that business sort of coming down, or is there another effect?

Well first of all, TI has been a 10 percent customer twice in our history. I believe only twice, and their order rates, again I mentioned earlier about lumpiness that happens in the order flow in the non-communications business, that has some effect. The timing and the pooling of those orders. That’s the bigger driver in that scenario, and now we are seeing movement in the communications customer base such that I made the comment about Cisco being in the mix this quarter.

Thanks a lot.

Yes.

Thank you. Our next question comes from Anab Banda from Lehman Brothers. Please go ahead.

Filling in for me. Anyway, a quick question for you. First of all, if you could talk a little bit about, you know, what sort of lead times you are talking about, is it a – are you seeing a 10 percent, 15 percent increase and are you expecting that to occur over the next few quarters? And I have a follow up.

I am not sure what question you’ve asked, I think customers are asking for a compression of lead times, and that could be anywhere from 20 to 35 percent. I mean, they are significant. And you know, we are trying to alter our response to that kind of pressure.

Thank you. Just one follow up if I could. In terms of pricing, you are saying that pricing is moderating. Should we expect eventually pricing actually to be going up? I know in 2000 we saw that, I don’t know if that was a normalized scenario, just curious if you could comment about the sort of magnitude that it’s been down in the bad times, and what you expect is normalized.

I guess I will make one general comment, Anab, that in high tech environments when you are talking about technology innovation, as you well know, as things become more commodity-like in nature, clearly it becomes a price issue and high tech industries move on to other components and move up the technology value-added chain, so I think that we will continue to move in our business where we will try to be as cost effective as possible on products our customers want that are relatively high volume and maybe lower down the technology food chain, and we will be introducing new high tech products in the leading edge, which will be focused more on delivery and capability and performance.

So to put an edge on it, I don’t think we’re anticipating that we will see pricing changes that are associated with the feast and famine cycles of some industries that people are associated with, but as Ron said, we will see price increases with higher levels of integration and consequently as more things are commoditized, we will see pricing decreases at that end, so it will be a [bifurcated] pricing structure.

Thanks for the clarification.

Thank you. Our next question comes from Chris Hymatoski from Orion Securities. Please go ahead.

Hi, this is Matthew Light for Chris. We’re just wondering if you can give some information on the gross margins across the telecom versus non-telecom?

Hi Matthew, and this will have to be our last call, we need to wrap up. In terms of gross margins, telecom versus non-telecom, as I mentioned the gross margin trends in the non-telecom business were generally stable quarter to quarter, and our communications gross margins improved, as they have for awhile now. So in general, that’s not a prediction of the future performance, we hope and expect that in both businesses going forward, as I commented, we will see gross margin improvements in the one to several points range.

Okay? And Operator, that’s all –

Is there any chance that you can give us some sort of a breakdown as far as if telecom margins are positive or not?

If telecom margins? You mean communications business?

Right, telecom. Or communications, sure.

Yes, the communications gross margin business are positive, yes. Operator, we need to wrap up now. I want to thank you all for joining us today and being on the call.

Thank you. Ladies and gentlemen, this concludes the second quarter fiscal 2004 earnings conference call. You may now disconnect. Thank you for participating.