Viavi Solutions Inc (VIAV) 2004 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. And welcome to the Third 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, Chief Financial Officer. Mr. Foster, you may begin.

Thank you. Welcome to the JDS Uniphase Fiscal Q3 Earnings conference call. My name is Ron Foster, Chief Financial Officer. With me is Kevin Kennedy, President and CEO. I’d also like to welcome Brook Deterline, our new Director of Investor Relations.

We will discuss our third quarter results and offer guidance for our fiscal 2004 fourth quarter. Kevin will begin with third quarter highlights, provide an update on the market and operations, as well as review strategy. I will review the financials and provide guidance going forward.

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 press releases and securities filings of the company with the SEC, particularly the risk factor section of our Form 10-Q filed for the quarter ended December 31st, 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 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 third quarter results, issued earlier today. This news release is available on the web site, again, www.jdsu.com.

With that, I’ll turn it over to Kevin.

Thank you, Ron. And thank you, everyone, for attending the Fiscal Q3 Earnings call.

Today I’ll provide an overview of our [present health] [ph], an assessment of the current market, and an update on our operational progress and strategic intent. Before I do, let me briefly summarize some of the key highlights from our fiscal third quarter. I’ll touch on these in more detail in a moment.

In fiscal Q3 we again achieved our financial and operational objectives, our balance sheet remains strong, and we continue to focus on execution and operational improvements. As our financial results attest we improved profitability and made progress on most fronts, though challenges remain.

We continued to focus on organizational development during the quarter by strengthening our team with key hires, and developed our organization around a unified culture focused on fundamentals. Consistent with our observations of last quarter our markets indicate stabilization, albeit with changes in short-term predictability due to product area and customer variations.

Our growth strategy is to pursue opportunities across the communications, commercial, and consumer markets we serve. Our execution an organizational imperatives place a priority on operational initiatives and improved financial performance.

Now to our quarterly results, highlights, and disappointments. Let me start by thanking the JDS Uniphase Team for executing and delivering another quarter marked by improvements on all major financial operating metrics. In general, most financial metrics improved to the best levels in three to five quarters.

For the second consecutive quarter JDSU showed strong revenue growth, achieving roughly six percent quarter over quarter. With a third consecutive quarter company wide book-to-bill was greater than one. Both segments of our business grew, each accounting for roughly one-half of total revenue. Our Commercial and Consumer Products Group showed stronger results this quarter, achieving nine percent sequential growth. To better identify with the markets served by the segment we have renamed this group, formerly known as the ‘[Thin Sell and Products Group] [ph]’ to the ‘Commercial and Consumer Product Segment.’

Moving to profitability metrics, fiscal Q3 showed improvement on most fronts. Quarter over quarter gross margin showed a slight improvement while our non-GAAP EBITDA was narrowed by 34 percent, and non-GAAP operating loss decreased by 25 percent.

disappointments were primarily contained to three: inventory growth in response to deliver choices made for customer lead-time improvement, a specific Communications product revenue decline, and lower North American sales associated with a single customer.

Areas for improvement that we remain focused on are execution improvements, first. The specific concerns noted on our last call have largely been remedied. However, ongoing progress or process and organizational improvement opportunities that provide enhanced scale with less complexity remain areas of focus going forward.

Improved execution will continue to present up side to our top line, while directly improving our opex and gross margin trajectory. We continue to work to improve lead-times, inventory management, and product quality to bring our execution in line with expectations. Continued improvement should result from actions taken during the last three months.

On the expense side, we relentlessly pursued cost reductions at both the gross margin and opex levels. Ron will discuss both of these items later in the call.

Relative to margins, moderating ASP declines continue while volumes generally increased, continuing to underscore our need to reduce costs and drive gross margin improvement.

A few highlights on the product side include first, we announced a number of products and design wins during the quarter, many of which reflect our strategy and recent success in moving up the value chain to higher levels of integration. These included the first widely available 4 gigabyte per second fiber channel and Ethernet transceiver for storage area network applications, the first full band tunable integrated laser modulator, and new reconfigureable optical add drop multiplexor technology.

Shipment of our transmitters for cable TV networks doubled sequentially, and more than quadrupled versus our first quarter. We had volume shipments and initial deployments of wavelength blockers, part of our family of wavelength routing products, where we believe we are strongly positioned in the market. Additionally, for alternative applications we believe we lead the industry with our plainer wave [dive circuit rodem] [ph].

Customer driven circuit pack demand and revenue grew, validating our vertical expansion strategy and customer intimacy. Product shipments of circuit packs to tier one customers grew to a total of three.

For commercial and consumer products we gained traction in our DLP light engine business. Shipments began against orders. And liquid crystal on silicon engines, Intel placed an order with us for prototype systems using our innovative two-panel architecture to be demonstrated publicly in May.

And our security and authentication business also showed strong growth during the quarter.

From a general company update, since September we undertook the task of better aligning our operational abilities with our strategic programs. As such, we made a number of deliberate choices designed to make JDS Uniphase more customer focused, improve our fundamentals, and create a more unified culture.

Some of those decisions included enhancing our organization and execution, emphasizing stabilization, and improving customer response, while acknowledging that this focus could impact short-term cost structure improvement expectations.

We established a five-stage plan. We see ourselves in the midst of this program. Let me review the steps taken and the path ahead. In the first phase, focused on stabilization which began in the transition from fiscal Q1 to fiscal Q2, we reconsidered extent and timing of products and factory transfers where such place customers at risk. We slowed specific downsizing initiatives to achieve customer driven goals, purged excesses, and strengthened our balance sheet through cash preservation and accumulation actions, and we assessed the organization and identified areas to strengthen and streamline. And finally, in this particular phase we evolved an operational and growth strategy across our served markets.

And the second phase focused on alignment which began in the transition from fiscal Q2 to fiscal Q3. We implemented a customer satisfaction set of measures, and created compensation programs around these. We remedied specific product transition issues, sought customer feedback on our imperatives, and we implemented a critical customer response function.

In the third phase, focused on team dimension which began in the transition from fiscal Q3 to fiscal Q4, we made key hires of expertise in newly prioritized functions. [David Goodmanson] [ph] for Corporate Development, Debbie Shoquist in Operations, and [Manu Zahore] [ph] in Supply Chain Management, [Hos Christiansen] [ph] Display and Commercial Laser Development, and Brook Deterline, Investor Relations. We reduced the number of executive levels by three, streamlined our management team, and improved span of control. We restructured manufacturing as a corporate wide function, and realigned equity based compensation and adopted an annual option pool roughly 15 percent smaller than last year.

In the fourth phase focused on consolidated execution excellence, which begins today and focuses toward the beginning of fiscal year ’05, our key priorities are to continue to consolidate corporate functions company wide, including sales, finance, operations, and legal, each of which are now consolidated under company wide leaders reporting directly to me. Continuous financial improvement, we will reduce operational complexity as in the complexity of sites, organization, and product P&Ls. We’ll continue to focus on incremental divestitures and modest GAAP filling acquisitions. We’ll continue to process improvements including Sarbanes-Oxley 404 initiatives, and we will make systematic improvements to our operations.

Through these steps we expect to emerge from the legacy of numerous acquisitions, creating a foundation for new additions, establishing a strong streamlined organization with one consistent customer focus culture. Over the last eight months we have already seen positive results from our initiatives, including increased volumes and revenues quarter on quarter, a book-to-bill ratio greater than one for three consecutive quarters, and improved customer satisfaction.

Now to market conditions and our strategy update. Our company possesses a broad spectrum of products and technologies leveraging our optical expertise in communications, commercial, and consumer markets. The results are influenced by macro economic factors in each of these segments, and the benefits of this diversity are realized by an ability to offset the challenges of post [global] [ph] customer concentration, severe industry cyclicality, and time to revenue constraints.

Technologically, two macro trends exist in the market today serving our strengths. The Commercial and Consumer segment continues to be driven by demand for improved visual experiences in everything from security, to entertainment, to displays. The Communications segment is moving from the deployment of constrained bandwidth in the public telecommunications network, formerly referred to as ‘time division multiplexing’, to a converging world of unconstrained bandwidth where optical technology provides unparalleled speed and capacity. In short, we are moving from clock speed to light speed.

In terms of growth, there’s potential for a significant annual growth in new display technologies. On the communications side we observed a number of trends, including first increase unit volumes over the past three quarters, albeit with concurrent declines in ASPs. Ongoing industry consolidation and increased customer management of supply chains for customization tends to delay volume procurement of new technology and new product qualifications.

Telecommunications customers continued their outsourcing trend with a preference for more highly integrated products, and our customers’ desire to use fewer suppliers. Service provider spending continues to show signs of recovery with a bias toward increasing data centric network infrastructure, and higher non-domestic growth, and increasing signs of demand in long haul in concert with ongoing metro buildouts.

Overall, these trends indicate stabilization in communications. Nevertheless, we believe the short-term is likely to be lumpy with strengths in certain areas offset by weaknesses in others. Our past observations show that the optical markets are inherently uneven with growth ranges from zero to nine percent quarter over quarter. And we emphasize that visibility remains short-term and limited.

Supporting the lumpy nature of the recovery and limited predictability at least three customers in fiscal Q3 and Q4 have expressed interest in moving orders out. Thus, we continue to remain cautious as we look ahead, set guidance, and invest in the future.

Longer term we believe there will be further growth prospects in our communications businesses. We believe higher levels of integration will contribute to higher revenues and margins. As networks evolve new features and functions will be required of optical solutions. In order for carriers and service providers to lower costs and provide higher value services they need to invest in new flexible networks with advanced wavelength routing capabilities. These investments will provide significant future opportunities, accelerated commitments to broadband or fiber to the premise deployments backed by government support, but also provide additional up side.

Phase five of our plan will reflect our company’s strategy going forward, from fiscal 2005 onward. In both segments our strategy will be driven to address three financial realities of the post [problem] [ph] market. First, our business model must adapt as our customer bases become more concentrated amid lower overall spending. Second, gross margin structures and a concentrated customer base require greater emphasis on cost reductions. Third, the portfolio investment strategy must address product choices that improve time to revenue, such as customer driven developments.

The following steps are imperative to the growth strategy of JDS Uniphase. One, drive success from both market segments. Two, expand horizontally by entering new and existing markets with high growth potential, such as Datacom where storage area networks and other core-to-edge communications markets, as well as light engine and display in commercial markets. Third, we will increase vertical customer penetration and move-up the value chain by expanding in each market segment, that is from components to modules, to circuit packs. In the communications market develop differentiation through device integration and intelligence. Fifth, increase revenue via international expansion especially in Asia-Pacific. And sixth, focus on operational excellence to operating expense improvements, simplified structures, divestitures of non-core assets, and customer driven execution. Finally, we’ll make strategic investments as we position ourselves with the team, operational excellence and financial capabilities to take advantage of the market opportunities to expand.

At this point, I’d like to turn the call over to Ron Foster to discuss our financial performance during the quarter.

Thanks, Kevin. I’ll be commenting primarily on our non-GAAP presentation of financial results.

Total revenues grew approximately six percent in the quarter to 161m which was at the upper end of our third quarter guidance. The breakdown of revenues was as follows: Communications Products revenue of 79m represented 49 percent of our total and an increase of two percent sequentially. In the Communications segment, long haul crossed the 20 percent boundary of the Communications’ revenue this quarter showing healthy sequential growth. As we begin to see revenue related to long haul deployment such as gig B, DISA, and Siemens AT&T, the exact timing of volume shipments is still uncertain.

Our revenues from the subsystems business which includes many of our higher value add products, such as modules and circuit packs, grew at double digit rates sequentially, evidencing the continuing success of our vertical integration strategy, and accelerating collaborative design efforts with our customers.

Our design wins from the past quarters continue to pay dividends while we had significant activity in new design wins across the board. New wins at tier one customers included our WaveReady protection switching solutions and another circuit pack based integration. Design win penetration increased internationally, specifically in Asia-Pacific.

Commercial and Consumer Products Group revenue of $82m represented 51 percent of our total and an increase of nine percent sequentially. The company benefited from a strong increase in demand for DLP optical packaging. Shipments of DLP optical packages grew dramatically from Q2 to Q3, with demand expected to be strong through the remainder of Q4. The majority of the growth was driven by the projection television market.

We now have four rear projection TV manufacturers that have selected our DLP light engines for production shipments: [Mawell] [ph], BuSonic, a yet to be announced North American electronics brand, and a leading Chinese consumer electronics manufacturer. Three of these customers booked orders in Q3, and we have launched our production capacity to meet current and future demand in this area.

As planned, our L costs or liquid crystal and silicon light engine activity trails our DLP activity by approximately two quarters. The L costs supply chain and assembly work will leverage the infrastructure put in place for DLP. In L costs engines we have received our first volume orders from Brillion and are beginning this build. One major retail chain has already selected Brillion as their rear projection TV provider.

Geographically, North American revenue of 100m decreased to 62 percent of total revenue. European revenue increased to 34m or 21 percent of total. And Asia-Pacific revenue grew to 27m or 17 percent of total.

Our overall book-to-bill ratio was above one for the third consecutive quarter, as Kevin mentioned, and has been above one for our communications products for four consecutive quarters.

We had two 10 percent customers during the quarter, Texas Instruments and SICPA, both Commercial and Consumer Products Group customers.

It is clear that our uniquely broad portfolio is providing a stability in this uneven market recovery. It is also enabling us to accelerate our strategy of higher value add verticalized offerings in collaboration with our customers. Notable examples this quarter are circuit packs and light engines.

Gross margin was 25.4 percent in the third quarter, a two point improvement from last quarter’s gross margin of 23.3 percent. During the third quarter we began classifying certain engineering costs previously classified as cost of goods sold into research and development. This contributed approximately one point to gross margin improvement. Additionally, we experienced more favorable product mix offset in part by continued declining average selling prices and increased material related costs.

The communications business continued to experience single digit sequential average selling price declines, while unit volumes grew at double digit rates. Pricing in the commercial and consumer products group was generally stable quarter to quarter.

The net benefit to gross margin of inventory recovery compared to excess inventory write-offs was about $1m, down significantly from favorable inventory recovery during the second quarter of $7m.

Excess inventory write-offs increased several million dollars in the quarter, in part due to mix changes in the forecast and improvements in our yields. Although it will vary from quarter to quarter we generally expect to see favorable inventory recoveries in future quarters as customers initiate orders for products that have not been produced for some time.

In the Commercial and Consumer Product Group our commercial lasers, and security, and authentication business gross margins increased in the quarter as costs and reductions from operational initiatives were realized.

Now to operating expenses. Our total non-GAAP operating expenses were $60m or 37 percent of revenues for the quarter, a three point improvement over Q2. Non-GAAP R&D expenses were 25.4m versus 23.8m in Q2. Adjusting for the reclassification I mentioned R&D expenses were flat sequentially. This reclassification had a commensurate affect on total operating expenses, as well. Non-GAAP SG&A expenses for the third quarter were 35m compared with 37m in Q2. An $11m reduction in other long lived assets primarily reflects a write-off of capital equipment and other assets that are no longer used.

During the third quarter restructuring and realignment costs were approximately $3.4m, down significantly from the second quarter. We expect these costs to be in roughly the same range in Q4.

Non-GAAP operating loss for the quarter improved to 19.1m from 25.3m loss in the second quarter. Non-GAAP EBITDA improved to a loss of 9.7m from a loss of 14.7m in Q2. The non-GAAP segment loss for the Communications business decreased from approximately 13.1m to 11.5m, and non-GAAP segment income for Commercial and Consumer Products Group increased from 11.5m to $15.1m. Consistent with prior quarters this segment information excludes approximately $23m in unallocated costs.

Interest and other income was $5m for the quarter, down 3.4m sequentially, mainly due to reduced foreign exchange gains and reduced interest income resulting from lower average investment returns.

Included in GAAP results for the quarter was $19m in gains associated with the sale of marketable public equities. During the third quarter we recorded an income tax benefit of $7m which resulted primarily from the increase in the market value of our public equities.

The GAAP net loss for the quarter was 7.3m or one cent per share, and the non-GAAP loss was 6.7m or rounding to zero cents per share.

For the balance sheet, as of March 31st our total cash and marketable securities were 1.66b, 1.56b of which was cash, money market, and other highly liquid fixed income securities. Our cash and marketable securities increased by approximately $9m. We believe that our strong cash position will continue to provide us with financial flexibility, and enable potential acquisitions and investments in other possible capital activities.

As we continue our focus on cash accumulation through elimination and monetization of non-core assets during the third quarter we sold one more non-core business, continued to sell equity investments, and received a prior year tax refund of $26m. This continues to remain a high priority for us.

Days sales accounts receivable increased to 63 days from 54 days in the second quarter, primarily resulting from a higher percentage of shipments occurring in the third month of the quarter. Although days sales outstanding increased the quality of our receivables continued to improve as the percentage of past due receivables declined to its lowest level in years.

Our net inventory turns decreased from 5.6 to 4.6. Net inventory increased by approximately $18m to $104m as we respond to customer requested shorter lead-times on certain products and continued product transfers. We expect our inventory turns to increase as we focus on execution and operational improvements going forward.

We consumed approximately $32m in cash, primarily due to increases in working capital. We spent approximately $13m on restructuring and realignment costs during the quarter, $46m year-to-date. We expect to spend another $90m over the next several quarters in settlement of obligations associated with previous restructuring activities.

Capital spending was approximately $5m in the quarter, which we expect will trend up during the fourth quarter, reaching about $75m for the year.

And lastly, employment was relatively unchanged at about 5,300 people.

Now to guidance. Our guidance for the next quarter is as follows. For our fourth fiscal quarter we expect net revenues to increase zero to five percent sequentially. We believe our non-GAAP gross margin will be in the 25 to 27 percent range, up one to two points. Operating expenses should decline sequentially. We expect non-GAAP EBITDA to be in the range of minus $7m to breakeven, depending on revenue outcome, transient variations in our cost structure, and a product mix in the quarter.

In recent months we have deliberately chosen to make transitional investments that improve customer responsiveness and improve business processes. These transitory investments have increased our near-term cost structure several million dollars per quarter.

Before I conclude I want to mention that the SEC announced in February the deferral of the adoption of Section 404 of the Sarbanes-Oxley Act of 2002. This has had the impact of deferring until June 30th, 2005 the requirement for JDS Uniphase to certify and its independent auditors to attest to the company’s internal control environment.

JDS Uniphase continues to have a dedicated 404 Team working on this initiative as we continue to view the 404 implementation as not just a compliance requirement but as an additional catalyst to improve our business processes and organizational performance.

Now we will open the call for questions. In order to allow us to respond to as many questions as possible we will ask you to limit yourself as always to a single one-part question, and time permitting we’ll come back around for subsequent questions.

Operator, I’ll turn it over to you for questions.

[Caller instructions.]

Our first question comes from [Steve Savas] [ph] from Goldman Sachs. Please go ahead.

Thanks, good evening. I guess for one question on the digital light engine stuff, now that you have a handful of customers for the product I was wondering if you could give us a sense of the pricing revenue model that it’s looking like? I know, you know, a couple of quarters ago that was uncertain because you hadn’t negotiated with customers yet, but what’s that looking like now?

Hey, Steve. This is Ron. We’re still developing the relationships with a number of different customers and prototyping with a number of customers on light engines, and those pricing for production volume relationships are still under discussion. And so at this point, I don’t have any further clarification on that, other than I can say that we’ve got what seems to be industry leading performance in our light engines and I think it will yield positive results in terms of the margin line.

Do you have any, I guess, target gross margin then for the product?

Haven’t specifically called out a target on that.

Okay, [I’ll put] [ph] myself to that.

Okay.

Thank you. Our next question comes from [Darrel Armstrong] [ph] from Smith Barney. Please go ahead.

Thank you very much. The comment about the increase in the long haul part of your business, how much of that do you think is really true improvement in terms of market demand, or is this just inventory restocking at the systems suppliers’ level?

Yeah, let me take a crack there. I think as we have mentioned earlier, you know, consumption and what’s being utilized varies very dramatically network by network. And in general, I don’t think anybody is trying to increase their inventory levels right now. And so I think what we’re seeing is continued utilization in consumption. Some networks are becoming leaner and more ready for revitalization than others, and I think that’s what we’re seeing.

If I can just add to that, Darrel. In some long haul areas, as I think you know, there has been inventory built-up from the bubble. And that’s being drawn down in a sort of discontinuous manner from one customer to another. And so I think over time we’re going to be seeing additional long haul volume coming in for just replacement and maintenance demand as they chew down that inventory. Some of that is still in front of us.

Right, so the actual percentage of long haul overall still continues to move-up over the next couple of quarters?

I think that will happen both from a standpoint of people drawing down their legacy inventories, if you will, and the fact there are some new design wins we’ve got, such as gig B, DISA and the ATT Siemens deal. Yes.

Thank you very much.

All right, Darrel.

Thank you, our next question comes from [Arinso Vestu] [ph] from Morgan Stanley. Please go ahead.

Hi, folks.

Hi, Arinso.

Ask for some clarification on the DLP versus [indiscernible] cross demand. So if you could talk a little about visibility to display opportunities for DLP in the June quarter. And then, if you are -- you talked about the two quarter trailing or two quarter spread between DLP and [indiscernible]. Should we be expecting [indiscernible] wins in the June quarter or are we still talking about [indiscernible] in the discussion stage at that point?

Let me take a stab at where we are, I think, on both of these programs. In general, we think there is a momentum that has built up around the larger screens and projection market in general.

Secondly is we are early with both of these sets of design wins in participating. As Ron said, one offset from the other by about two quarters.

Third, is we’re at the stage where there’s a good news and a bad news story. The good news is we’re more supply constrained and we’re betting our supply chain out and making sure that we don’t have choke points. So the good news is there’s a fair amount of demand in front of us. Whether we can muster all the energy to resolve all the supply chain issues, make sure that we make the date so that our customers can be in play for the holiday seasons. These are sort of the issues that consume our time right now.

I’d just add to that. The [L cost] [ph] is a little bit newer technology. It’s probably emerging and that’s part of the reason why it’s lagging a little bit. And, if you look at the overall cost structure of L costs rear-projection T.V.’s at the market level compared to DLP, they’re per higher in coming down the cost curve as you’d normally expect with an emerging technology. So that’s also the reason why we haven’t seen a cross-over point in L costs versus DLP cost structure. So that can affect the timing of demand for L costs production volume versus DLP.

Okay, thanks. That helps a lot.

Thank you. Our next question comes from Eddie [Woo] [ph] from CIBC World Markets. Please go ahead.

Hi, Kevin. Hi, Ron.

Hi, Eddie.

I’d like to get some comments on pricing pressure and ASP declines as it relates to geography and product lines.

I guess probably -- in general, there’s probably not a lot of trends other than there is a the goods news, but almost across all the products, there’s a continued consumption where volume pick up. There continues to be ASP compression due to what I would consider more supply chain management aggressive that’s in the market with the concentrated customer base.

I think in Asia, especially as we enter the China market, we can have -- we see some pretty severe pricing pressure. I think, the rest of the world, I don’t know that I would discriminate any other pricing trend other than Asia can be quite competitive or aggressive.

On the datacomm. front, I continue to see aggressive pricing on that particular front. And, I’d say -- so those are probably maybe the major pieces. Asia is probably more competitive right now than the rest of the world. Datacomm is a bit more aggressive than other product areas. And, as Ron sort of gave you the macro trimline for us, which was a single-digit compression.

And as it relates to the Chinese and Southeast Asian vendors, how much impact are they making right now? I mean, product wise, they still don’t have your diversity. But, customer wise, are they growing it across the board or it’s just niche-type growth?

You’re either asking one or two questions, so let me break them up.

Okay.

I’d say from a competitive perspective in the non-Asian markets, I don’t think we’ve seen a huge amount of pressure from newly defined competitors in Asia. I’d say the good news is that with growth in Asia, there is a need for components or holes that, you’re right, a broader company like ours has. Hence, our conversations and design wins with companies like ZTE and [indiscernible] are better today than they were two quarters ago, and you can see that shift, as Ron mentioned, in the mix of our business.

So we view that there’s plenty of opportunity to grow outside the U.S. You’ve already seen that in this particular quarter. Yes, you’re right, there is competition. I’d say the macro trend is we tend to be involved with providing components or elements as opposed to necessarily all the intricative pieces that we’re doing for vendors here in North America.

And, I’d just add on the component level in Asia, we’re doing quite well, but it tends to be at the component level.

Thank you.

Thank you. Our next question comes from Joseph Wolfe from Bank of America Securities. Please go ahead.

Thanks, guys. I had a question. You talked about three design ones, I think, for your -- for the cert packs. And, I’m wondering if you could give us a timeframe for deployment of any volume. And also, I know there are start-up costs associated with that right now that kind of skew the margin. But, if you could somehow make an estimate of how you’re exiting that out and getting two-fold production. Are those [indiscernible] design wins moving at a pace that you think you’re going to achieve your margin targets for those kind of integrated solutions?

Sure, Joseph. Let me try to break that down into three pieces. First, we probably have a double-digit number of design wins that involve us integrating at a circuit pack level for a diversity of customers, at least, we perhaps, a more -- a comment today in the script was that we began shipping production units and read that as some level of volume to at least three tier one customers. And so, you are correct that this quarter was an inflection point that we are now getting production levels to three tier one customers.

And then, your third question relates to sort of the margin structure. And, I think the way to think of it is that we’ve emerged into what is sort of an ODM or an original design and manufacture model where we become an integrator at the both the development and manufacture level. And so, the margin structure is a sack structure where you have circuit packs that are the delivery vehicle and you’re picking up the margins of all the sub-assemblies, plus the incremental margin on the circuit packs.

So, another way of saying that is the margin is -- all the margins that you would have gotten at compound levels, the good news is you’re controlling the design and then you get an extra ten to plus more margin points on top of that because you are putting your entirety in the billing materials. Does that help?

That helps. Can I just dig a little bit deeper on that. You talked about the tier one customers. I assume you’re working with some of the newer customers as well. Could you go through some of the differences in terms of what the demand or what the profile of what the customers are looking for with these integrated solutions is right now?

Yeah. I may end up not answering the question that you asked, but it may be a useful context.

When you think of why somebody engages in this discussion and what our strategic intent in terms of a business model is, we do not have the intention of trying to become a contract manufacturer for, you know, frankly anyone. What we tend to see is a confluence of several factors. One is an opportunity where the vendor is trying to outsource some of their development. Two, it tends to be in an area where there’s a very high optical component content in the bill of materials. So, for example, in the long haul segment. Third, is there some level of software or soft expertise that’s required in the integration of those pieces. And fourth, that the nature of that business that that vendor sees tends to be lumpy. So they’re concerned about the utilization of their own internal engineering resources.

When that confluence of factors occurrs, they tend to ask JDS to say, hey, could you do the design and manufacture for us. That’s good business for us. That’s really not competitive with the contract manufacturer. And, in fact, we may go to a contract manufacturer for the final piece of our development.

Does that help?

Yeah, that’s very helpful. Thank you.

Thank you. Our next question comes from Arnab Chanda from Lehman Brothers. Please go ahead.

Thank you. Just a couple questions. First of all, if you could describe a little bit more in detail that you were talking about a couple of push ups from your customers. You know, what is going on there? Is it an inventory situation? Are they seeing -- you know, is there supply chain constraint?

And then, secondly, if you could just talk a little bit about, what do you think happened in North America? You said that the business was a little weaker. Is it supply a chain shift or is there something else going on? Thank you.

I think the comments that we made was intended to draw a contrast to the nature of conversations that we are having this quarter versus the nature of conversations that we reported last quarter. As I reflect upon our comments last quarter, we were across the board consumed with our customers being concerned about lead time, and you almost couldn’t have an aggressive enough lead time.

At this particular juncture, we have a mix. We have a lot of business as usual, but we do have three customers that have engaged us in a conversation of not being worried about lead times any more. In fact, they may push out.

So the point here is the conversation rhythm has changed a little bit this quarter. And, I think that’s important. Certainly, we consider that in the way that we set our guideance. What is affecting those? I think it’s different in each case. In some cases, it may have been a sense of over ordering. In other cases, it may be a sense of caution that people are embracing. And, in other cases, they may have subsequent customers that have moved at a slower pace than they had anticipated in their plan.

So I think we may find that there are differences in each specific instance.

Ron, do you have more color to that?

Yeah, I just add briefly to that that our customers were engaged in some conversations, as we commented last quarter, also from a sinking from a forecast perspective rather than just giving us P.O.’s. And as we went to forecast discussions, they gave us forward-looking views in some cases. And now, we naturally engaged in a conversation about whether those forecasts were correct as originally prescribed. And what Kevin’s characterizing, in some cases, now that we’re having forecast discussions, those have pushed out somewhat in terms of our thinking in a relative near term. So I think that’s the general context of things.

In terms of our North America volume, we had decline of about $3m, I think, in total. Stronger shift in volume increases in Asia and Europe. Some of that’s just natural movement, flow of business, and timing of orders. And, we had some drop off with one particular customer in North America that also affected that.

Thanks for the clarification.

Thank you. Our next question comes from Martin [Chakettle] [ph] from UBS. Please go ahead.

Hi. Thank you. Good evening. Just one quick question. With respect to your gross margin guidance for next quarter, can you answer whether or not there’s any of your own cost inventory functions in there? Do you expect any for that quarter?

Martin, this is Ron. We have a lot of [indiscernible] in our cost structure in particular quarter. So I would like you to think that we’re precise in knowing each and every element in advance. We do the best we can, but there are some interaction and uncertainty associated with each element.

That being said, as I commented, we do expect for some number of quarters here in the future that we will be getting net inventory benefits into our gross margin structure. It’s a little unsure about the length of that, as well as the lumpiness we might see from one quarter to the next in terms of those favorable effects. I expect that a major percentage of it will also be related to long haul business since that’s where a lot of our excess inventories occurred during the bubble period.

Perhaps, Ron, a clarification though is that we don’t -- we have not provided in the context of an increase of our guidance for next quarter the thought that there would be an increase in those favorable adjustments.

Not necessarily, right.

Great. Thank you.

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

Thank you. Just with regards to your comments about the cable television modules. With the improvement they’re sustainable, is it tied to upgrade business that’s likely to tail off or is it perhaps being bolstered by more notes splitting and underlying demand [indiscernible] with demands in the cable industry?

Our belief right now is that the underlying demand in basically broadband and the cable delivery of broadband is continuing on the rise.

Thank you.

Thank you. Our next question comes from Paras Bhargava from BMO Nesbitt Burns. Please go ahead.

Good afternoon. First a clarification, Ron. It looks like you’re going to have a -- you’re going to lose less money on a non-GAAP EBITDA basis. But, it looks like your EPS is worsening a little bit or is that just rounding?

Paras, if you look at the non-GAAP EPS -- if you actually look at the schedules on the press release, you’ve got to inspect them a little bit. But, there’s a favorable tax effect in the third quarter of about $7m. And this has to do with gains on our equity portfolio where we take deferred tax assets back as a credit into our tax line per accounting regulations. We’re not assuming in the fourth quarter that we will have necessarily appreciation in our equity portfolio. We don’t forecast that, and so therefore, we don’t have that assumed credit.

Thanks for the clarification. I haven’t looked through these in as much detail as I’d like.

Yeah, that was a good question.

So the other thing I’m trying to gauge is it looked TI came back after a few quarters of being soft. Now, you mentioned to me last time that it was a lumpiness issue. Should we continue to see this trend from TI or is that lumpiness going to continue because there is a [indiscernible] growth of DLP that’s continuing?

Yeah, I’d say I think the characterization that we’ve provided to you in the past that it’s lumpy, and therefore, it is very execution oriented as well as TI business oriented is still true. We are not forecasting a precipitous decline next quarter and that’s why we’re anticipating both of our segments are going to continue to grow. But, we’re always very cautious and continue to do it as potential lumpy business.

If we look at all the DLP related businesses, could you be as high as 20 percent in the quarter?

I’m sorry, 20 percent what, Paras?

Of all your revenues, not of the non -- not on the [indiscernible] segment, but all your revenues? Could it be as high as 20 percent, all the DLP related revenues?

You mean, if we put displays moving forward versus where they are today?

Yes.

Well, I’d say that we do look upon display as an area that could have very significant growth for us. It is going -- before we begin being confident about that, we want to make sure we get through this incubation period.

Sure. And, the margins are going to come down as you get into the engines, right? The gross margins have got to be lower.

That could be too. Now, let me clear though that in the non-communication side of the business, you have two classes of sort of products or margin structures. One that I would say is roughly average with our corporate gross margin structure and those that are very good. Ones that are very, very good tend to have a significant amount of IP protection at multiple layers of an architectural delivery vehicle. Those that are sort of the norm may have sort of one level of IP protection.

So I think a lot of it depends on how we play it in terms of building or IP portfolio. So it could be better than the midpoint. But, you’re right, on average, it might not be. And, I would say that if we come through the next year strongly in this incubation period, this could be a very significant market for us [indiscernible].

Keep in mind, Paras, that we’re also wrapping up a startup curve, and there are inherently higher costs in the startup curve. So we get cost reductions that move along with that market entry. The fundamental things that drive to Kevin’s point about IP is we believe -- and our engine business is an example and then that display business in general -- we have got significant value add in what we’re contributing both at our component level that we’ve been doing for some time and now in the new light engine.

Sure. On the communication side, is there still the gap between gross margins or is that narrowed between components and modules? I mean, you must be at a very, very low volume level in components now, in which case, gross margins might be very low too.

No, I would say that our components team, as Ron has shared before, have led us both in growth, as well as gross margin improvement because we -- that is probably one of the areas where we were the most aggressive in transitioning to different factories and lower cost manufacture base. So I’d say the components is on the mid to positive side. And, I’d say on the modules and systems level, we have a higher variance with some things being well above the corporate average and some things being struggling as we’re going through manufacturing execution [indiscernible].

One final question if you --

Paras, we need to move on --

All right. Thanks a lot.

Thank you. Our next question comes from Alex [Borrows] [ph] from Deutsche Bank. Please go ahead.

Good afternoon, gentlemen. I’d like to get some additional color if I could on the commercial or consumer business. Obviously, displays are doing extremely well for you guys. I’m wondering if you could give us an indication on a qualitative basis how the relative contribution of display, security, and commercial lasers.

Alex, we don’t -- I mean, we break out some granularity in terms of the size of the businesses, as I think I commented on a prior call. Our display business is our largest business in that segment. Our flex business is the second largest. And our commercial lasers is third in size. We don’t break out granularity of size between that.

We also have shown in our segment reports that the margin for that business is higher than the communications business today in general. There is some variation in that structure among elements of the various businesses, but it is a higher margin in aggregate than the communications business, and that’s the extent to which we break down that granularity.

Fair enough. And, it seems pretty clear that display and security are both up this quarter. Is it also fair to assume the commercial laser business was up?

Yeah, commercial lasers was up sequentially, yes.

Okay. And last question, is it conceivable to think that displays could grow over the next several quarters to a point where you may actually break it out to a separate reporting segment with operating detail?

We haven’t had that discussion, and certainly, we have no stated intent at this point in time.

Okay. Thank you very much.

Thank you. Our next question comes from Stephen Koffler from Wachovia Securities. Please go ahead.

Hey, Ron. Most of my questions have been answered. Just with European so strong for you, was there a currency effect? Did you benefit from currency?

Hi, Steve. No, we didn’t see any significant currency effects. And just so you know, in general, on our revenue line, we don’t have significant currency effects. A lot of our business is transacted in dollars.

Okay. That’s it. Thanks.

Thank you. Our next question comes from [Ping Zu] [ph] from Credit Suisse. Please go ahead.

Hi, how are you?

Good, thanks.

I have two quick questions. First one is to Kevin. I think in the December quarter, within the metro product, you had some problems of delivery [indiscernible] and basically on the [indiscernible] shortage, as well as a security transfer. Are those issues resolved now?

Yes. Ping, as I mentioned in the script, just about all of the problems that we stated on the January call have been remediated. In all cases, we’ve moved -- improved lead times by someplace between three or four or, at least, within weeks, so hence, within target. And those issues by and large are behind us.

Okay. Second question. On the revenue guidance, where do you expect the strength versus the weakness among your product lines?

Ping, this is Ron. We haven’t specifically called out performance of one versus the other. As you heard, we have a range of zero to five overall. We have the potential in both segments to be near the zero or up five percent kind of range. So aren’t specifically calling that out, but both have the potential to be [indiscernible] a significant differentiation there.

Okay. Thank you.

Thank you. Our next question comes from John Harmon from Needham & Company. Please go ahead.

Hi. Good afternoon.

Hi, John.

My question is about your datacomm [indiscernible] business. I know you normally lump it into other businesses, but I was wondering if you could talk about whether it grew in the quarter, whether you might be gaining or losing market share and make some comment on the performance of [indiscernible] versus datacomm and ultimately, make the roadmaps between that kind of lower cost point to your telecomm [indiscernible].

John, let me maybe -- probably provide you with several thoughts, although, we may not end up fully satisfying your thirst for analogy.

We don’t break out the revenue of individual product lines, so probably won’t go there. However, it is fair to say that we continue to believe that the customer diversification and the packaging disciplines that are required that are crucial for our strategic evolution of the company. So we will continue to invest in them. We’ll continue to look to diversify our customer base as we roll out our transceiver base. And, we do think that that will ultimately have -- leverage will benefit into our telecomm modules over time, and that’s one of the reasons that we keep that collection of products under one leader in that -- such a mission, if you will. So we’re going to continue to invest there and that’s probably -- I can’t break it out any deeper than that.

Okay. Thank you very much.

Thank you. Our next question comes from Michael [Collin] [ph] from Pacific American Securities. Please go ahead.

Yeah, Ron, in the script, you mentioned that some costs were reclassified from costs of goods sold to R&D and that resulted in the one point change in gross margin. I was wondering if you could give us a little more color on what that was and the justification for that decision.

Yeah, Michael, we have done evaluating for a while in the context of looking at our overall product development process and improving that process going forward whether or not we have most appropriately characterized R&D or engineering expenses in the total flow of our product development process. And our conclusion after apparently lengthy assessment was that in a couple of areas, we were including manufacturing engineering and cost of sales where it was more appropriately part of the product development process. And so we re-classed that manufacturing engineering cost into R&D to more properly characterize the structure.

And, Michael, you should know -- understand that that’s a fairly likely transition to occur anytime that you’re moving a company that is the amalgamation of vertical acquisitions into a more horizontal structure. So as you’ve seen, that’s one of the [indiscernible] helping drive us with right now.

Okay. Thank you very much.

Thank you. Our next question comes from Arinso Vestu from Morgan Stanley.

Hi. I just had a quick follow up on contribution. I think you gave some color on this already, but [technical difficulties].

Arinso, you were asking for the demand for cable T.V. business or the strength of that business?

Well, the strength in this reported quarter.

We didn’t -- we haven’t specifically called out cable T.V. revenue levels. Kevin commented on the fact that we had some good design development and good product traction there. So that continues to be a very important business for us. We didn’t specifically call out revenue growth in that area uniquely. It’s part of our overall communications business. We simply said that we had significant sequential growth for two quarters in a row.

Okay. Gotcha. Thank you.

Thank you. Our next question comes from David [Fineburg] [ph] from Morgan Stanley. Please go ahead.

Hi. Can you hear me?

Yes, David, go ahead.

I guess [indiscernible] there. Quick question for you. Under the disappointing area, you listed three disappointments. The inventory, the lack of revenue from one customer, and the follow up of one product line. You did a good job of explaining why the inventory [indiscernible] occurred in the quarter. I was hoping you could give a little more color around two other issues: the one customer in North America and the one product line that fell off.

Yeah, basically, it was a quality challenge where we had to go rework some product. So they were -- by and large, a heavy intersection between those two.

Oh, so, like the one product and the one customer were pretty much one in the same issue?

Yes.

Okay. Thank you very much.

Thank you. Our next question comes from Eddie Woo for CIBC World Market. Please go ahead.

Hi. Can you tell us what your current average lead time is and in relation to the inventory going up, to bring no lead time for certain customers. Do you expect inventory -- do you expect that process to continue where inventory increases will drive a decrease in lead time going forward?

Hi, Eddie. This is Ron. In general, our -- we are seeing lead time improvement and part is we’re getting our processes smoothed out broadly in the communications business and catching up with some of the shortfalls Kevin talked about in deliveries that we specifically referred to last quarter.

In terms of using inventory to shore that up, we’ve done that in some cases as a short-term fix. And as I mentioned, we’d expect our inventory terms to improve as we stabilize the normal flow of business. In other cases, we made conscious decisions to shorten lead times and put stocking strategies in place in a few isolated instances. We do expect our inventory turns to improve.

So this is a short-term, one-time sort of --

Yeah, I would expect it to improve over time.

I’d say there’s one other aspect to it. In some cases this quarter, we have been asked to make things that we probably haven’t made in the recent past. That tends to force you to go back to your supply chain and you begin to get inventory from some and you have to wait for others. So in some sense, that’s a good news story.

Okay. Well noted. Thank you.

We’ll take one last question.

Thank you. Our last question comes from Martin Chakettle from UBS. Please go ahead.

Hi. Thank you. Just wanted to ask on the display business. You mentioned four customers per DLP that you were shipping to. I just wanted to clarify, those are DLP engines that you’re shipping? And then, can you give the approximate percentage or range of percentage of engine shipments versus component unit shipments?

Martin, this is Ron. Yes, before I mentioned our DLP engine customers, and we are just moving out of prototype stage in some cases to production. In other cases, we’re still in prototype and marketing phases. So we’re just gearing up. And so the volume in that business in general is significantly higher to components today than to engines.

Okay. That’s what I thought. Thank you.

Okay. Thank you all and that sums our conference call for today. Thank you all for joining us. And we’ll see you next quarter.

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