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Executives

Michelle Levine Schwartz – Director, IR

Tom Waechter – President and CEO

Dave Vellequette – CFO

Analysts

Mark Sue – RBC Capital Markets

Ehud Gelblum – JP Morgan

Ajit Pai – Thomas Weisel Partners

Paul Bonenfant – Morgan Keegan

Natarajan Subrahmanyan – SMH Group

JDS Uniphase Corporation (JDSU) F2Q09 (Qtr End 12/27/08) Earnings Call Transcript February 5, 2009 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the JDSU fiscal 2009 second quarter earnings conference call. My name is Khama [ph], and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, ladies and gentlemen, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Michelle Levine, Director of Investor Relations. Please proceed.

Michelle Levine Schwartz

Thank you, operator. And welcome to JDSU's fiscal 2009 second quarter financial results conference call. Joining me on the call today are Tom Waechter, Chief Executive Officer, and Dave Vellequette, Chief Financial Officer.

I would like to remind you that this call is likely to include forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations.

We encourage you to look at the company's most recent filings with the SEC, particularly the Risk Factors section of our report on Form 10-Q filed today, February 5, 2009, and in our most recent annual report. The forward-looking statements, including guidance, provided during this call are valid only as of today's date, and JDSU undertakes no obligation to update these statements as we move through the quarter.

Please note that all numbers are non-GAAP unless otherwise stated. A detailed reconciliation of these non-GAAP results to our GAAP results as well as the discussion of their usefulness and limitation is included in today's news release announcing our results available on our website at www.jdsu.com. Finally, and as a reminder, this call is being recorded and will be available for replay from the Investor portion of our website at www.jdsu.com/investor.

I would now like to turn the call over to Tom.

Tom Waechter

Thank you, Michelle, and good afternoon. I’m pleased to be here today leading JDSU and discussing our fiscal Q2 results and future outlook. In the coming weeks and months, I look forward to meeting many of you on the call today. As you may know, I joined JDSU 15 months ago to lead our Communications Test and Measurement business. I joined JDSU because of our strong employee talent pool, the breadth and depth of our products and technologies, and the significant opportunity to increase the value of the company.

During the first 15 months, my conviction has grown even stronger. I see the great potential of this company through our people, the ability to innovate, and the power of our global reach. Our strong balance sheet, aggressive cost saving programs and strategic focus will allow us to weather the current global economic headwind as we build the foundation for long-term success.

Before I talk more about our business, I’d like to take a few minutes to describe the format of the call. Many of you have provided us with suggestions pertaining to the content we share with you on earnings call and we have taken note. Moving forward, we intend to provide more insight into each of our businesses and the respective trends. I will spend most of my time on this and future calls addressing these trends and how they are shaping our strategy and our priority.

My formal remarks today will be more extensive than I plan on future calls as I’d like to spend time at the outset to help you understand my perspective of the business. Following my discussion, Dave will provide a detailed review of the current quarter’s financial results and our outlook. Let me start by providing a high level overview of JDSU’s second quarter results followed by what I see as the priorities for the company. I will then provide results and outlook for our business segments.

Revenues for the second quarter were $357.2 million. The decline was driven primarily by the Communication and Commercial Optical Products segment as demand weakened with the economic downturn. In addition, our revenue and gross profit were negatively affected by $10 million due to Nortel’s announced bankruptcy. Dave will provide more detail regarding Nortel later on the call.

Second quarter gross profit of $155.4 million or 43.5% of revenue was up primarily due to favorable segment mix and successful execution against our lean initiative. Operating expense for the second fiscal quarter of $137 million or 38.4% of revenue was down, reflecting our effort across the company to lower expenses due to the economic downturn.

Operating income for the quarter was $18.4 million or 5.2% of revenue, relatively flat as the percentage of the prior quarter but on a much lower revenue base. This is a result of our improved gross margins and lower operating expenses as we focused on lean initiatives and cost cutting across the company. Overall, I’m pleased with the progress we have made improving the cost structure and operating model of the company if there is more work ahead of us.

We continue to see advancements in high-speed broadband services and network build-outs. We believe broadband capacity will continue to expand as higher data rates are being delivered to the access/edge accompanied by video applications and high-definition network requirement. Although we believe that broadband demand and network traffic will continue to increase, the environment is such that we are experiencing slowdown in spending from these customers.

I see this challenging economic time as a time of both challenge and opportunity. I strongly believe that by focusing on core priorities we will remain healthy during this difficult period, further differentiate ourselves, and increase our leadership position in the markets we serve when economic conditions improve.

First priority is to continue to simplify and scale the business model. A little over 12 months ago we began productivity improvement program in the form of lean initiatives across the company. They are designed to reduce the overall complexity of JDSU to move the company from a fixed to variable cost manufacturing model. As a result of these actions, more than 20% of presently occupied real estate will be vacated. JDSU started these measures in advance of a downturn, which I believe puts us at an advantage compared to our peers.

I will now cover a few of the major milestones recently achieved as part of these initiatives. An agreement with Sanmina, which transfers our Shenzhen manufacturing facility to Sanmina to the manufacture of JDSU’s optical communications transport and transmission product line. The Communications Test and Measurement has signed an agreement with contract manufacturer Benchmark. This will enable the largest JDSU business to move primarily to a variable manufacturing cost model and improve overall scalability. And finally, agreements are already in place with Fabrinet for a production of select laser products.

Second is continued focus on innovation. Advanced product offerings across a diverse technology portfolio is the hallmark of JDSU. During these uncertain economic times, we see a unique opportunity for JDSU to further strengthen its leadership position through innovation. We will invest in high growth, profitable areas where we can add value to our customers. We believe we are uniquely positioned to sustain our investment levels during the economic downturn. JDSU is also looking for improved design efficiency by consolidating the design site and outsourcing non-core development activity.

The third priority is expanding our global presence. We will place more emphasis on expanding outside of our traditionally strong North American and Western European markets. High opportunity markets across Asia-Pacific, Eastern Europe, Latin America, the Middle East and Africa offer incremental growth for our business. We have built strong leadership teams in these areas and we will emphasize both direct sales and channel development. A higher level of diversification will provide with better balance as we see fluctuations in various economies around the globe. Over the last year, both Asia-Pacific and Latin America sales have grown by 12% and 86% respectively.

And finally, maximizing utilization of our assets. We will focus on utilization of our assets in order to maximize shareholder value. Our priorities for our cash for maintaining a solid cash balance, completing and advancing our lean initiative, and making profitable acquisition. With regard to M&A, our focus will be to strengthen our core businesses and to expand into adjacent high-growth markets that are accretive.

Now let’s move on to our individual business segments for fiscal Q2. The Communications Test and Measurement segment performed well against our business model. I’m pleased with the execution of the segment’s lean initiative and cost-cutting activities, which resulted in improved gross margin and operating margin. Revenue grew sequentially, but not at a typical seasonal level. This reflects reduced spending by network operators and equipment manufacturers hampered by the global economic downturn. We expect the quarters ahead to be challenging from a top line perspective, but we remain positive about the fundamental trends driving the test and measurement industry in our long-term position.

Let me go into more detail. First, we believe that our telecom and cable customers’ financial fundamentals are relatively sound. And while cautious, our customers are not signaling CapEx reductions as with the previous industry downturn. Telecom and cable operators are engaged in intense competition with a focus on increasing ARPU and quality of consumer experience while reducing churn. They are also focused on reducing network expenses and increasing productivity. These trends have positive implications for test and measurement solutions.

Second, consumer demand continues to grow for broadband Internet access and applications. More than ever, consumers depend on broadband for entertainment, daily work and personal activity. For example, Americans increased online video viewing by 34% in November 2008 versus the prior year, and in Asia, more than half of our Internet users visited online gaming sites in August of 2008.

JDSU is well established as the leader in wireline communications test and measurement equipment for both network operators and equipment manufacturers. And JDSU holds the number one market share position in broadband field test and in remote fiber test system. We earned this position through innovation driven by customer collaboration. Our ability to collaborate on multiple levels with field technicians, network managers, and executives gives a competitive advantage.

A number of deals in the second quarter reflect the trust our customers continue to place in our test solutions. For example, one of Europe’s largest service providers booked a 3 million order for the HST-3000, one of the most widely adopted all-in-one handheld for installation and maintenance of IT-based broadband networks and services. A tier one operator booked a major deal for the T-BERD 8000 to support reliable fiber network expansion in Latin America.

One of India’s largest service providers picked our fiber test probes for remote testing to reduce truck dispatches. Two tier one North American network operators chose JDSU’s NetComplete software solutions for efficient broadband service delivery and consumer quality of experience. Deutsche Telekom selected the T-BERD 6000 10-GigE field test solution, the smallest in the industry for metro network capacity expansion to support IPTV deployment. And LG Dacom selected our NetComplete test system for IPTV service deployment in Korea.

Through collaborative innovation, we earned the trust and business of our customers. And we are proud to say that the industry continues to take notice. We were pleased to receive two 2008 Product of the Year awards from INTERNET TELEPHONY magazine for the test system solutions addressing Home Network Performance Management and Wireless Backhaul.

Moving on to our Communications and Commercial Optical Products segment. As a reminder, last quarter our Optical Communication and Laser segments were combined into one segment called Communications and Commercial Optical Products or CCOP. First, our Optical Communications business. In fiscal Q2, revenue declined primarily due to a slowdown in market demand and deferred Nortel revenue. We are making progress in improving our gross margin in optical communications by pruning less possible products and realizing the benefits of our lean initiative and work force reduction. We expect the demand in optical communications to be soft in the quarters ahead that will slow down the CapEx spending by service providers and only the data network cascades through network equipment manufacturers.

As we look ahead, we believe that our focus strategy of technology leadership, cost leadership and functional integration, which enables JDSU to differentiate ourselves in a very competitive market is aligned with our customers’ requirements. There are three customer trends that JDSU is addressing with the technology leadership and innovation. First, agile optical network. The industry continues to ask for solutions that are highly reconfigurable giving network equipment manufacturers and service providers the ability to reduce inventory and help reduce OpEx and CapEx. Examples of our leadership and reconfigurable solutions are ROADM, tunable transponders and photonically integrated amplifiers.

Next, higher transmission speed. Our customers are focused on 40G followed by 10G in the near future. For transmission we have our partnership with Mintera and internal component level development underway. For transport, we are already there, as our products are designed to work in 40-gig and future 100-gig network. Finally, functional integration. Over the past year we introduced a number of platforms that present high functional integration. Customers have demonstrated enthusiasm for these new product platforms.

For example, we’ve had significant Super Transport Blade design wins with four programs for three customers. We have started revenue shipments with our first customer in Q2 FY ’09. The single-slot blade solution dramatically reduces size, cost, and power requirements for our customers, enabling deployment of optics closer to the network edge. Going forward, the highly modular framework of the Super Transport Blade enables JDSU to more easily add functionality to simplify optical network infrastructure.

JDSU is one of the only vendors taking this approach to product development. During the quarter we received 12 design wins at a total of nine customers for our tunable XFP transceivers. With these designs, we bring the world smaller, widely tunable transmitter optical sub-assembly or close for DWDM applications. And we added two new design wins for Mini WSS platforms, including two new design wins in Q2. We expect to record revenue on this new platform before the end of the fiscal year. The Mini WSS is designed to provide a compact and low-cost solution for traffic management in the metro and access areas at DWDM network. Finally, we have received positive feedback and interest from customers for our photonic integrated amplifier or PIA platform.

In relation to cost leadership, last year JDSU began implementing lean manufacturing initiatives. We continue to make progress on lean programs and continue to interlock safely with customers. One example is facilitating reduced lead-time to help our customers meet their goal of holding less inventory. And as mentioned earlier, we announced our contract manufacture agreement with Sanmina as we moved to a more variable cost manufacturing model. Our lean manufacturing strategy is to go to the outside market for the products and services that we can while retaining manufacturing processes unique to JDSU and the industry.

Our Commercial Lasers business experienced a decline in revenue due to lower demand from our semiconductor equipment manufacturing customers as well as the biomedical field. Therefore this quarter signaled a deeper market slowdown as our customers push purchases out to future quarters and deplete inventory. While this is an industry-wide occurrence, we believe we are not losing market share and are tracking with the slowdown of our customers are experiencing.

Our pipeline for new products over the fiscal year is robust. Our product development will continue to be focused on advanced solid-state and fiber laser platforms. These new products when introduced will increase their served available market by more than threefold.

And finally, onto our Advanced Optical Technologies segment. This segment provides optical security solutions, including brand protection, anti-counterfeiting for currency, transaction card authentication, custom optics for aerospace and defense, and innovative decorative solutions for helping manufacturers differentiate the product. Q2 revenue was relatively flat quarter-over-quarter. And for the fifth quarter in a row gross margins were above 50%. The diversity of this group of products contributed to some resiliency that has shown during periods of economic contraction, while we do expect a slowdown in the consumer faith in the market.

We believe the breadth of our product portfolio places JDSU in a unique position to go to market with integrated solutions for our customers. This quarter we expanded a scope of our business relationship from authentication labels only by adding optical effects to labels. This helps our customers differentiate the brand and drive increased sales. We expect to continue our emphasis moving forward towards solutions in the form of integrated products, market strategies and product road maps.

As I conclude my formal remarks, I'd like to reiterate I am pleased to be here leading JDSU and I’m excited about the opportunities that exist for the company. There is no doubt we are taking challenges amid a current economic backdrop, but I believe we can weather this economic downturn and come out stronger as we continue to focus on simplifying and scaling our business model for our lean initiative, continued innovation, expanding our global reach, and maximizing our assets.

I would like to thank JDSU employees whose focused commitment and tremendous efforts continue to advance JDSU towards long-term success. I would also like to thank our customers, partners, vendors and long-term shareholders for their continued support of JDSU.

And with that, I’ll hand the call over to Dave.

Dave Vellequette

Thank you, Tom. Before I start, please note that all numbers are non-GAAP unless I say otherwise. Second quarter revenue of $357.2 million was down 6.2% from the prior quarter and down 10.5% when compared to the second quarter of fiscal 2008. The second quarter revenue decline was mainly in the CCOP segment, as demand softened with the economic downturn and we deferred $10 million of Nortel revenue. Given the Nortel bankruptcy filing last month, we not only deferred $10 million of revenue, we also deferred $10 million of gross profit and operating profit, lowering their margins by approximately 150 and 260 basis points respectively. Earnings per share were reduced by $0.04.

For fiscal Q2, Test and Measurement represented 49% of total revenue as compared to 43% in the prior quarter. The CCOP segment represented 36% of total revenue as compared to 43% in the prior quarter. And AOT represented 15% of total revenue, which is relatively unchanged from the prior quarter. Second quarter gross margin of 43.5% of revenue was up from the previous quarter’s gross margin of 43.3% of revenue and down from the second quarter of fiscal 2008 gross margin of 46.3% of revenue. The second quarter gross margin reflects a favorable segment mix as the Test and Measurement segment increased as a percentage of total revenue and the execution against our lean initiatives.

Operating expense for the second fiscal quarter of $137 million or 38.3% of revenue was down from the prior quarter’s $144.6 million and down from the prior year’s $139.4 million. The lower operating expenses reflect reductions in discretionary spending, office consolidation, workweek shutdowns, reductions in headcount and the favorable impact from foreign exchange rates.

Operating income for the quarter was $18.4 million or 5.2% of revenue, down slightly from the prior quarter’s $20.4 million or 5.4% of revenue. The improved gross margins along with the lower operating expenses resulted in our operating margin continuing to be over 5% despite the decline in revenue.

Second quarter net income was $24.8 million or $0.11 per share. This compares to first quarter fiscal 2009 net income of $23.4 million or $0.11 per share. A detailed reconciliation of our non-GAAP results to our GAAP results is available in today’s press release.

Our second quarter non-GAAP results exclude, among other items, the impairment of goodwill and long-lived assets of $699.6 million, amortization of acquired technology and intangibles of $18.8 million, a $13 million impairment of long-term investment, a $12.5 million charge related to stock-base compensation, $6.6 million for restructuring and other non-recurring charges, and a $22.3 million gain from the repurchase of our 1% convertible debt.

As we announced last month, the impairment of our goodwill and long-lived assets is the result of the adverse impact of the current macroeconomic business environment on the company’s financial outlook in the overall decline in equity values resulting in a decline in our own market capitalization. The impairment charges and estimate, the final analysis will be completed in the third fiscal quarter.

Including these items, the second quarter fiscal 2009 GAAP net loss was $705.3 million or a loss of $3.28 per share, which compares to the prior year’s second quarter GAAP net income of $21.2 million or $0.09 per share.

Now looking at revenue by region. Americas revenue of $165.7 million, 47% of total revenue, was down approximately $4 million from the prior quarter, primarily driven by the impact of the deferred revenue adjustment. We also noted that the typical end of year carrier procurement activity was significantly lower than historical levels.

EMEA revenue was $108.2 million, 30% of total revenue, down approximately $10 million from fiscal Q1. The decline was split evenly between the Test and Measurement segment primarily due to the impact of foreign exchange and the CCOP segment, which was also impacted by the deferred revenue adjustment. Asia revenue was $83.1 million, 23% of total revenue, down approximately $9 million from the prior quarter. The decline was due to lower revenue from commercial lasers and AOT products.

Moving to segments. In the Test and Measurement segment, second quarter revenue of $176.2 million was up 6.6% from the previous quarter’s $165.3 million and down 10.8% from the previous year’s $197.5 million. The increase was due to demand in the Americas, which included higher demand for cable products in Latin America.

Looking at the product portfolio, we saw growth in our field services products and declines in our lab and production and service assurance products. Book-to-bill for the quarter was less than 1, as we experienced a number of large deal delays from our customers. Fiscal Q2 gross margins for Test and Measurement of 59.6% was up slightly compared to the prior quarter and above the midpoint of our targeted range of 57% to 61%, reflecting the benefits from our lean initiatives as well as favorable product mix.

The Test and Measurement operating profit of $36.7 million or 20.8% of revenue increased when compared to the operating profit of $26.0 million or 15.7% of revenue in the prior quarter. This increase was due to higher gross margins and lower operating expenses. The Test and Measurement segment’s operating profit was negatively impacted by approximately $3 million from currency fluctuations.

Now moving on to the Test and Measurement business model in the initiatives within the segment to achieve this model, we began implementing lean initiative programs during the prior fiscal year with a focus on reducing structural complexity and therefore improving productivity.

We expect to complete the current set of initiatives over the next nine months as follows. First, consolidating R&D sites from 19 down to 12. To date, we have closed five R&D sites and expect the remaining two to be completed by the end of the fiscal year. Second, we are transitioning more product lines to contract manufacturers, which will reduce our manufacturing overhead. This quarter we signed an agreement with Benchmark Electronics for the manufacturing of select T&M products. We expect temporary gross margin pressure in Q3 due to cost associated with the transition to Benchmark.

Last, we continue to focus on operating expense reductions through discretionary spend reductions, cost benefits from fewer development sites, workweek shutdowns, and headcount reductions. These initiatives have yielded financial benefits in the first and second quarters of this fiscal year as operating margins increased in each of the last two quarters from 11.3% for Q4 fiscal 2008 to 20.8% for Q2 fiscal 2009. We believe that these initiatives provide the structure to support sustainable operating margin between 20% and 23% at quarterly revenue levels of $175 million or greater.

Now moving on to our CCOP segment. Breakout of the key metrics for Optical Communications and Lasers is as follows. For optical communications, revenue in fiscal Q2 was $109.5 million, down 22.2% compared to the prior quarter’s revenue of $140.6 million and down 15.6% when compared to the prior year’s $129.7 million. The $31 million quarter-to-quarter revenue decline includes $10 million of deferred revenue, $5 million due to product portfolio printing, and $16 million due to a slowdown in market demand.

Book-to-bill was less 1 for the quarter as our customers are seeing a slowing of demand from their customers and are also reducing their inventory positions. ASP decline was approximately 2% at the lower end of our expected range of 2% to 4% quarterly. Q3 ASP decline is expected to be above our historical range, as we have just completed a set of competitive pricing negotiations.

Looking at the product lines. Our ROADM product revenues grew 30% and now represent approximately 30% of our optical revenue. To date we have shipped over 30,000 units and we believe we are maintaining our number one market share for ROADM. At the same time, we saw softening of bookings across the product portfolio, including ROADM, as our customers are being impacted by the current economic climate.

Moving to the business model. We continued our progress of improving the gross margin structure in the optical communication. Excluding the impact from the revenue deferral, fiscal Q2 gross margin was 24.6%, up compared to the prior quarter, which had significantly higher revenue. Reported gross margin was 17.4%. Our gross margin improvement initiatives include moving to a more variable cost model, pruning products that don’t need our profitability targets, and executing against our lean initiatives. Our near-term gross margin goal is for sustainable margins in the 25% to 30% range and longer-term gross margins in excess of 30%.

As we discussed last quarter, it is our intention to reduce the fixed cost structure of this business by transitioning more manufacturing to contract manufacturers. Additionally, today we announced an agreement with Sanmina, which in effect transfers our Shenzhen manufacturing facility to Sanmina. JDSU benefits from a lower fixed cost model, and Sanmina increases its capacity in the Shenzhen area and immediately adds to its expertise of optical assembly and test.

The agreement will include the transition of approximately 2,000 JDSU employees as well as the sale of JDSU’s Shenzhen manufacturing assets and inventory. Sanmina will fulfill orders immediately following the close of the agreement, which is expected to be at or near the beginning of our fiscal Q4.

In addition, we are in a process of doing last time product builds at our submarine assembly facility in San Jose, California. Our future submarine products and services will be assembled in Shenzhen. We expect to complete this manufacturing transition before the end of the calendar year.

In our Commercial Lasers business, second quarter revenue of $18.4 million declined 13.7% from the prior quarter. The decline in revenue was due to declining demand for our semiconductor equipment manufacturing and biomedical customers. Operating loss for CCOP was $3.5 million. The improvements realized the manufacturing operational cost reduction initiatives were offset by the impact of the deferred revenue.

Now moving on to the CCOP business model. Moving forward, we believe that the CCOP cost-saving initiatives provide a structure to support operating margins of 10% to 15% at revenue level of $150 million or greater. For the Advanced Optical Technologies or AOT segment, fiscal Q2 revenue was $53.1 million, down less than 1% compared to fiscal Q1 revenue. Revenue in the currency market remained healthy. As we have noted before, we expect the trending of this business to have some level of surges and ebbs, which tend to correlate with a country’s GDP.

Fiscal Q2 gross margins for our AOT business were 51.2%, down from the previous quarter due to lower batter utilization. This is the fifth consecutive quarter in which our gross margin has exceeded 50%. AOT operating profit for the quarter was $19.5 million or 36.7% of revenue, down from $21.7 million or 40.6% of revenue in the prior quarter. Our targeted sustainable operating profit range for this segment is 34% to 37%.

Moving to the balance sheet. For fiscal Q2, the company’s operating cash flow was positive, but the free cash flow was negative $4.6 million. Total cash balance was $689 million. The company had been free cash flow positive for the past seven quarters. This quarter we are slightly negative, as we invested $14 million in inventory from products transitioning to contract manufacturers. And $3.7 million was consumed for restructuring activity.

Net cash increased this quarter as we reduced our outstanding debt balance by approximately $125 million. We retired substantially all remaining zero coupon senior convertible notes and we’ve repurchased $50 million of the 1% senior convertible notes resulting in a gain of $22.3 million. In January we repurchased an additional 50 million of the 1% senior convertible notes, which will result in a gain of $20 million in our fiscal Q3 result.

Headcount as of December 27, 2008 were 6,645, down slightly from the prior quarter. With the transition of the Shenzhen factory and the other headcount reductions previously communicated, we expect a total company headcount to decline by more than 2,200 by the end of the fiscal year.

Moving on to our operating model. We continue to focus on executing against our initiatives to achieve our sustainable segment business model and reduce our corporate cost. In the last quarter, each of the segments successfully executed against their initiatives, and we lowered our corporate costs. We now have a sustainable cost structure from which we can realize 10% operating margins on revenues of $400 million and gross margins of 46%.

That being said, over the last several quarters, we have taken steps to reduce our fixed cost structure in manufacturing and to lower our operating expenses. We have now lowered our operating income and free cash flow breakeven point absent one-time transition cost to $300 million to $310 million of revenue per quarter. Given the current macroeconomic conditions, we are taking additional steps to further lower these breakeven points.

By the end of the fiscal year we expect that our operating income breakeven point would be $15 million to $20 per quarter lower. Taking as a whole, the initiatives we have identified since the beginning of the fiscal year are designed to increase our ability to scale our manufacturing while lower the cost structure associated with manufacturing by more than $28 million per quarter – per year and lower our operating expenses by approximately $110 million per year. These savings are compared against our fiscal 2008 fourth quarter results.

Finally, given the strength of our balance sheet, the breadth of our product portfolio, and the geographic diversity of our customer base, we believe that the current market conditions provide us with unique opportunity to increase our leadership position in the markets we serve.

Now to our Q3 guidance. First, some points to consider as you think about our financial performance over the coming quarters. As noted, there is a significant level of economic uncertainty in the markets that we serve. Book-to-bill was less than 1 in all segments except for AOT. Our CCOP customers have signaled that they are seeing softness in demand from their customers and will be lowering their inventory. Visibility in Test and Measurement is seasonally lower in the March quarter, operator CapEx budgets are expected to be released late in the fiscal quarter.

We expect Q3 gross margins will be adversely impacted primarily by the lower customer demand and by the transition cost associated with the transfer to contract manufacturers. We expect a further decline in operating expenses in Q3. Finally, we expect our quarterly tax provision to range between $2 million and $4 million.

Taking into consideration factors above and based on our current visibility, we expect third quarter revenue to be in the range of $275 million to $300 million, and non-GAAP operating margins to be breakeven to negative 4%. We expect the CCOP and Test and Measurement segments’ sequential revenues to decline by the same percentage.

Thank you. And operator, we will now take questions.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of (inaudible) from RBC Capital. Please proceed.

Mark Sue – RBC Capital Markets

Hi, it’s actually Mark Sue from RBC Capital Markets. Can you help us understand the moving parts in your revenue guidance? If I take the low end, it implies an almost 23% sequential decline. Recognizing it’s tough out there, it can’t all be the macro and you should be able to recover some of the deals which kind of delayed. Maybe if you could quantify some of the inventories that your customers and maybe the impact of portfolio pruning? Any further granular details you could provide would be helpful.

Dave Vellequette

Mark, this is Dave Vellequette. So – as far as the deferred revenue, we do have – we are going through the normal legal processes there to try to recover some of that $10 million. From what we have identified, we think there is $4.4 million roughly to $5.0 million that gets a – it’s called a pre-petition claim and – but as far as when we will actually be able to realize that, it could be in Q3 or Q4. As far as the reduction in the revenues, as I stated right at the end there, we are basically seeing that the percentage decline to be even between the Test and Measurement and the CCOP group. In the CCOP reduction, we think there is about another $5 million impact from product pruning included in the number.

Tom Waechter

Mark, I’d just add to what Dave is talking about also on the Comm Test side, I think you know that the March quarter is when budgets are typically released for the network operators. And due to the economic conditions today and when those possibly would be released that they are released later into the quarter, further into March than (inaudible) revenue range –

Mark Sue – RBC Capital Markets

Okay, that’s helpful. And then with that being said, does – do you – will you start seeing at least a sequential balance in the June quarter? At least you had some confidence there from your initial discussions with your customers. And then lastly, Dave, as you consider data response, maybe just your overall gross margins as we exit fiscal 2009, that might be helpful.

Dave Vellequette

Yes, Mark, we are just right now with our visibility, and as has been our habit, we talk about one quarter at a time. And so right now it’s best that we just focus on our Q3. And the gross margins are – I’ll try to give some insight of what could impact the gross margins, and basically we only give guidance on the revenue and the operating margins.

Mark Sue – RBC Capital Markets

Okay. And then – but the impact –

Michelle Levine Schwartz

Operator, next question please.

Operator

And the next question comes from the line of Ehud Gelblum from JP Morgan. Please proceed.

Ehud Gelblum – JP Morgan

Hi, guys, how are you?

Tom Waechter

Hi, how are you doing?

Ehud Gelblum – JP Morgan

Good. Couple questions. One of the margins you said you are now with a sustainable business model for 10% operating margin, but you need a $400 million run rate. With the downturn in the markets, what makes you confident that you cannot get anywhere near $400 million going forward? And that you are down to the $300 million range, how do you know that kind of we are not – as inventory levels come down, we are not going to permanently down in the low 300. At what point would you make that decision and cut costs? And the flipside of that – or the other side of that coin, it sounded like you are expanding more and going more international. Is this really the wisest time for you to be spending on international and spending on R&D rather than kind of cutting back in costs and try to save some of the margin?

Tom Waechter

Let me take the second part of that question regarding the R&D and the international scope. Most of our infrastructure is already there from an international standpoint. We had over the last 6 to 12 months rebuilt quite a bit of our leadership team, especially in the Asian market. But we don’t believe there is any significant additional incremental investments we need to make really expand our presence in the global market. I think it’s really more of a focus from the top down through the organization, more of an emphasis of focusing on those areas and gaining market share there. As far as R&D, as I mentioned, that’s one of our 4Q priorities that we continue to invest in innovation. And we believe that during these uncertain times, while maybe some of our competitors out there in the market are having difficulty investing into innovation and R&D. That’s a good sign for us to look at the ratings and technological gaps. So think we found enough areas through our lean initiative and other cost reductions and we don’t really need to cut into our R&D or see the need to do that.

Dave Vellequette

On the first part of your question, Ehud, one, we’ve got ourselves structured as we have talked on a number of calls for 10% and 400. Second part, if – as you see the – where we’ve guided for the revenues, we are taking steps to continue to lower our breakeven point for the company to the $300 million to $310 million range, which is where we are at right now, and we want to bring it down even further as we exit the fiscal year. So we’re continuing to work on lowering our costs. If – as our business – as we go through the quarters and our visibility improves, we’ll take the appropriate steps to – with regard to our expenses.

Ehud Gelblum – JP Morgan

Okay. I got one last question on the top line if I could. The Test and Measurement business was obviously very strong this quarter and yet it’s going to fall off pretty precipitously along with optical components next quarter. Was there ever a sense in this particular quarter that these were either last time buys or something going on that was keeping it while your optical components was falling off, the Text and Measurement business was continuing to do well right before a cliff? Was there any sense that maybe there was some extra buying last quarter just before calendar 2008 reasons that may not return?

Tom Waechter

No, there wasn’t any indication of that. As a matter of fact, last fiscal – December or last calendar December quarter, we did see quite a bit year-end buying, consuming our budget. We did not see that to any great extent this year. We do see some pretty strong business out there from communications – Comm Test business didn’t get an indication that (inaudible).

Ehud Gelblum – JP Morgan

Okay, thank you.

Michelle Levine Schwartz

Next question, please.

Operator

And our next question comes from the line of Ajit Pai from Thomas Weisel Partners. Please proceed.

Ajit Pai – Thomas Weisel Partners

Yes, good afternoon.

Tom Waechter

Good afternoon.

Dave Vellequette

Hi, Ajit.

Ajit Pai – Thomas Weisel Partners

A couple of quick questions. The first one, just looking at the sort of market segments for your Test and Measurement and Optical Communications group, was there a pattern that you observed at the slowdown and push-outs? Were they more on the MSO side? Were they more than sort of large US carriers? Were they going to be centered in any one particular geography?

Tom Waechter

We saw some strength in the Latin American market around the cable product, cable test product. So that was definitely a strength for us last quarter. So that was probably the first quarter and three or four quarters where we actually saw a pickup in the cable test product. So that was a definite improvement. We did see softness in our service assurance business and lab and production, which we would expect to see in the kind of a soft (inaudible).

Ajit Pai – Thomas Weisel Partners

Right. And then just looking at the M&A environment right now, there has been a lot of consolidation on the optical communications industry, the component industry. Could you give some color as to uses of your cash right now? You’ve been quite aggressive I think in buying back your own debt. So does that mean that you’re not looking at further business development activity? And also, how do you think that some of the recent announcements over the past three to six months positions JDSU in terms of market share?

Tom Waechter

I’d take the first part of that and I’ll turn it over to Dave. From an M&A standpoint, we continued to look at the market. We have been a strong player in that area in the past. As I mentioned, we will make sure that it fits into our strategy as we go forward and that it’s accretive to the business if we do decide to make any moves from an M&A standpoint.

Dave Vellequette

And as far as – what we’ve always said is, our first goal is to grow the net cash, which we have done. The next is obviously we took advantage we believe of an opportunity to buy back some of the 1% notes. And we will be using our cash also for our restructuring purposes as needed. And then as Tom said, if the right opportunity is out there, we will be looking at those actions as appropriate.

Ajit Pai – Thomas Weisel Partners

Right. And then the breakeven level that you just indicated of having reached the $310 million sort of level already, could you give us some color as to that’s after Shenzhen is out or for this quarter is your breakeven level, for the March quarter is your breakeven level $310 million? And then also I think you mentioned you have another $15 million to $20 million that you are planning to drop to breakeven. So that would be $290 million $295 million exiting the year. Does that mean for the full quarter, the June quarter, that you will have a breakeven level that’s at $290 million to $295 million?

Dave Vellequette

Yes. So as you can tell from the guidance where we gave the guidance $275 million to $300 million, and I gave operating margin guidance of zero to minus 4%, that should be obviously – we think that we’re at that breakeven point at the $300 million, $310 million mix always going to have an impact on it. And then as we exit the June quarter with the changes we are making not only to Shenzhen but other activities we have going on, we think we will exit it with the opportunity of having that breakeven lower by $15 million to $20 million.

Ajit Pai – Thomas Weisel Partners

Got it. Thank you.

Tom Waechter

You’re welcome.

Michelle Levine Schwartz

Next question please.

Operator

The next question comes from the line of Paul Bonenfant from Morgan Keegan. Please proceed.

Paul Bonenfant – Morgan Keegan

Hi, thank you. You talked about OpEx reduction sequentially. I was wondering if you could talk about the context of percent of sales. Would it be similar to what we saw this quarter?

Dave Vellequette

I don’t think I talked about it other than it will be coming down. Paul, we are taking out the equivalent of $110 million a year run rate as we are going to exit the fiscal year. So we didn’t talk specifically about what the OpEx would be. It will be coming down quarter-to-quarter. To get the $128 million, I have to go to a run rate about $124 million, $125 million for the fourth quarter. So – I just finished $137 million. So I’ll be heading towards the 120 – $124 million, $125 million range from here to the fourth quarter. So it will be somewhere in between those two.

Paul Bonenfant – Morgan Keegan

Okay. And just a quick question of clarification on your $110 million a year in savings exiting the year, that’s relative to which quarter?

Dave Vellequette

To the fourth quarter last year where we did $151 million of OpEx.

Paul Bonenfant – Morgan Keegan

Okay. And last question is, if the downturn is prolonged, have you considered next steps for cost reduction or aligning costs with a lower revenue base, maybe additional product pruning or considering shutting business units?

Dave Vellequette

As I stated on a previous question, with our visibility as we go through we will constantly be looking at opportunities, as I noted in the script, that we had a set of actions. We added to those actions in the quarter. And that’s what we are constantly doing. As our visibility comes through, we will continually evaluate the business because we’re looking at where the profitable businesses are and we will make adjustments appropriately.

Tom Waechter

I think I’ll add to what Dave was saying. I think on a lot of our lean initiatives, we are just starting to see some of those benefits. A lot of the manufacturing outsourcing will really start seeing larger benefits over the next quarter.

Paul Bonenfant – Morgan Keegan

Thank you for taking my questions.

Tom Waechter

You’re welcome.

Operator

(Operator instructions) The next question comes from the line of Natarajan Subrahmanyan from SMH Group. Please proceed.

Natarajan Subrahmanyan – SMH Group

Thank you. I have two questions. First, if you can talk about your OpEx again, you are reducing headcount by almost a third, going from 6,600 to 2,200 people going off of the payroll. Can you talk about how this will offset gross margin versus operating expense? Imagine a significant decline to OpEx because you are outsourcing these components versus making them internally, will it hit gross margin OpEx? Or are most of these employees already cost to goods sold since they are in the manufacturing side?

Dave Vellequette

Yes. The – of the 2,200, the majority of them being from the Shenzhen facility, right, where we had – and I stated that more than 2,000 employees will transfer. So the remaining 200 – the majority of the remaining 200 will be in the OpEx area.

Natarajan Subrahmanyan – SMH Group

Got it. So we won’t see the impact of that on the OpEx, the other 2,000 on the OpEx side because they were on cost of goods sold. And can you talk about what kind of deals you’ve struck with Sanmina for the Shenzhen facility, what kind of pricing you guys look at in kind of broad strokes?

Dave Vellequette

Basically we haven’t actually revealed specific terms of it. It’s contemplated in the – number one, I said that as we complete these initiatives we should be able to reduce our manufacturing cost structure by $28 million on an annual basis.

Natarajan Subrahmanyan – SMH Group

Understood. And then, Dave, can you repeat what you said in terms of the negative gross margin impact of the Nortel deferred revenue, what kind of impact it had on the December quarter and what kind of recovery you think could happen over the next couple of quarters?

Dave Vellequette

When we deferred the revenue, obviously since they have the inventory, we deferred 100% of the revenue obviously hitting gross profit. And that hit obviously went all the way down to operating margin. So that’s why I said it’s a $10 million impact on gross profit and operating margin. As I said previously, we have some – we are going to the normal legal process here and there is a $4 million to $5 million that’s identified. It’s what’s called pre-petition claims, and we hope that we will be able to get those paid for because of all the bankruptcy laws work. And then the rest of that will be handled how the bankruptcy proceedings typically go. As far as when we get any of that money, we don’t know at this time.

Natarajan Subrahmanyan – SMH Group

And a final question if I could get one in, you are taking a breakeven point down. It seems like kind of a $280 million to $290 million kind of range, which is where the midpoint of the guidance for the March quarter is. Should we read into that that you are expecting things to flatten out versus March levels? Should we expect to see some sort of bottoming in March in recovery from there on to June? If you could talk in general about the outlook, I know you are not giving specific guidance, but anything would be helpful.

Dave Vellequette

I think that – what we are trying to communicate is how we normally go about our process of our visibility and the guidance associated with that visibility. And then we are letting folks know that given that, that we’re going to continue to adjust our cost structure, so – and take our breakeven point down further.

Natarajan Subrahmanyan – SMH Group

Got it. Thank you.

Operator

And we have no more further questions at this time. I would like to turn the call back over to Ms. Michelle Levine Schwartz. Please proceed.

Michelle Levine Schwartz

Thank you, operator. We would like to thank you again for joining us today and we appreciate your interest in JDSU. Thank you.

Operator

This concludes the presentation for today, ladies and gentlemen. You may now disconnect. Have a wonderful day.

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Source: JDS Uniphase Corporation F2Q09 (Qtr End 12/27/08) Earnings Call Transcript
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